UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended: September 30, 2017

For the Transition Period from              to             

Commission file number 001-34702

SPS COMMERCE, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

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)

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.

 

 

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 23, 2017 was 17,224,320 shares.

 

 

---

 

SPS COMMERCE, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX

 

 

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.

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains forward-looking statements regarding us, our business prospects and our results of operations that 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 for the year ended December 31, 2016 as filed with the Securities and Exchange Commission.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  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 Commission that advise interested parties of the risks and factors that may affect our business.

 

2

---

 

PART I. – FINANCIAL INFORMATION

SPS COMMERCE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; in thousands, except share amounts)

 

 

See accompanying notes to these condensed consolidated financial statements.

3

---

 

SPS COMMERCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; in thousands, except per share amounts)

 

 

See accompanying notes to these condensed consolidated financial statements.

 

4

---

 

SPS COMMERCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)

 

 

See accompanying notes to these condensed consolidated financial statements.

5

---

 

SPS COMMERCE, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

NOTE A – General

Business Description

We are a leading provider of cloud-based supply chain management solutions, providing network-proven fulfillment, sourcing, and item assortment management solutions, along with comprehensive retail performance analytics to thousands of customers worldwide. We provide our solutions through the SPS Commerce platform, a cloud-based product suite that improves the way suppliers, retailers, distributors and logistics firms orchestrate the sourcing, set up of new vendors and items, and fulfillment of the products that customers buy from retailers and suppliers. We derive the majority of our revenues from thousands of monthly recurring subscriptions from businesses that utilize our solutions.

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 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.  The December 31, 2016 condensed consolidated balance sheet data was derived from our audited financial statements at that date.  For further information, refer to the consolidated financial statements and accompanying notes for the year ended December 31, 2016 included in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 27, 2017.

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 and 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.

Significant Accounting Policies

During the nine months ended September 30, 2017, there were no material changes in our significant accounting policies.  See Note A to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on February 27, 2017, for additional information regarding our significant accounting policies.

Recently Adopted Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled and provides an accounting policy election to account for forfeitures as they occur. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows within operating activities. The standard also allows entities to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting and clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on the statements of cash flows. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted.

We adopted ASU 2016-09 during the nine months ended September 30, 2017. The impact to our consolidated balance sheet as of January 1, 2017 was a $16.3 million increase in deferred income tax assets, non-current and a corresponding $16.3 million decrease in accumulated deficit. This impact results from the cumulative-effect adjustment for previously unrecognized excess tax benefits using the modified retrospective method required by the new standard. We elected to adopt the changes in cash flow statement presentation prospectively to be consistent with the prospective transition for the treatment of excess tax benefits in the income statement. Accordingly, we no longer classify excess tax benefits as a financing activity subsequent to January 1, 2017.

6

---

 

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  This guidance will replace most existing revenue recognition guidance in GAAP when it becomes effective. These new requirements are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. We do not believe the new revenue recognition standard will materially impact our recognition of the primary fees received from customers for our cloud-based supply chain solutions. We believe the adoption of the new standard will impact our accounting for certain upfront set-up fees and the periods over which the related revenues are recognized, as well as the timing of cost recognition for some sales commissions. These impacts will not be material to our financial statements. We are currently finalizing our evaluation of implementation methods and the extent of the impact that implementation of this standard will have on our financial statement disclosures upon adoption.

In February 2016, the FASB issued ASU 2016-02, Leases which will supersede the existing lease guidance and will require all leases with a term greater than 12 months to be recognized in the statements of financial position and eliminate current real estate-specific lease guidance, while maintaining substantially similar classification criteria for distinguishing between finance leases and operating leases. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. We believe the adoption of the new lease accounting standard will materially impact our consolidated financial statements by increasing our non-current assets and non-current liabilities on our consolidated balance sheets in order to record the right of use assets and related lease liabilities for our existing operating leases. We are in the process of determining the financial statement impact and are currently unable to estimate the impact on our consolidated financial statements.

NOTE B – Financial Instruments

We invest primarily in money market funds, highly liquid debt instruments of the U.S. government, and U.S. corporate debt securities.  All highly liquid investments with original maturities of 90 days or less are classified as cash equivalents.  All investments with original maturities greater than 90 days and remaining maturities less than one year from the balance sheet date are classified as short-term marketable securities.  Investments with remaining maturities of more than one year from the balance sheet date are classified as marketable securities, non-current.  Short-term marketable securities and marketable securities, non-current, are also 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.  Consequently, we may or may not keep securities with stated holding periods to maturity.

Our fixed-income investments are carried at fair value; and unrealized gains and losses on these investments are included in other comprehensive income in the condensed consolidated statements of comprehensive income.  Realized gains or losses are included in other income (expense) 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.

Cash equivalents and marketable securities, consisted of the following:

 

 

7

---

 

 

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, 2017.  We expect to receive the full principal and interest on all of these cash equivalents and marketable securities.

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 Measurements

Our cash equivalents held in money market funds are measured at fair value using level 1 inputs.

Level 2 Measurements

Our available-for-sale U.S. treasury securities, U.S. agency obligations, commercial paper and corporate debt securities are measured at fair value using level 2 inputs. We obtain the fair values of our level 2 available-for-sale securities from a professional pricing service.

8

---

 

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:

 

 

 

We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value.

NOTE C – Goodwill and Intangible Assets, net

Changes in the carrying amount of goodwill for the nine months ended September 30, 2017 are as follows:

 

 

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 9 years). Information regarding intangible assets included on our consolidated balance sheets is as follows:

 

 

9

---

 

 

Total amortization expense for intangible assets during the three months ended September 30, 2017 and 2016 was $1.1 million and $1.2 million, respectively. Total amortization expense for intangible assets during the nine months ended September 30, 2017 and 2016 was $3.5 million and $3.6 million, respectively. The estimated annual amortization expense related to intangible assets subject to amortization for the next five years is as follows:

 

 

NOTE D – Commitments and Contingencies

Operating Leases

At September 30, 2017, our future minimum payments under operating leases were as follows:

 

 

NOTE E – Stock-Based Compensation

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, to employees, non-employee directors and other consultants who provide services to us.  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 2017, 1,024,868 additional shares were reserved for future issuance under our 2010 Equity Incentive Plan.  At September 30, 2017, there were approximately 4.5 million shares available for grant under approved equity compensation plans.

10

---

 

We recorded stock-based compensation expense of $2.3 million and $6.8 million for the three and nine months ended September 30, 2017 and $2.0 million and $6.0 million for the three and nine months ended September 30, 2016, respectively.  This expense was allocated in the consolidated statements of comprehensive income as follows (in thousands):

 

 

As of September 30, 2017, there was approximately $17.9 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:

 

 

Of the total outstanding options at September 30, 2017, 708,209 were exercisable with a weighted average exercise price of $43.91 per share. The total outstanding options had a weighted average remaining contractual life of 4.3 years.

The weighted average grant date fair value of options granted during the first nine months of 2017 was $18.90 and this was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

 

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). During the three months ended March 31, 2017, we recognized expense of $169,000 for PSU awards; and during the three months ended June 30, 2017 we recognized a reversing benefit of $169,000 as the probability of attainment was decreased. We recognized no expense for PSU awards during the three months ended September 30, 2017.

Restricted stock units 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.

11

---

 

Activity for our performance share units and restricted stock units was as follows:

 

 

The number of restricted stock units outstanding at September 30, 2017 included 30,907 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:

 

 

Employee Stock Purchase Plan

Our employee stock purchase plan 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 1.0 million shares of common stock are reserved for issuance under the plan.

For the offering period that began on January 1, 2017 and ended on June 30, 2017, we withheld approximately $1,021,000 from employees participating in the plan.  On June 30, 2017, approximately $1,011,000 of these funds were used to purchase 18,655 shares on behalf of the employees participating in the plan.  The remaining funds were refunded to employees pursuant to the requirements of the plan. For the offering period that began on July 1, 2017 and will end on December 31, 2017, we have withheld approximately $599,000 as of September 30, 2017 from employees participating in the plan.

For the three and nine months ended September 30, 2017, we recorded approximately $152,000 and $444,000, respectively, of stock-based compensation expense associated with the employee stock purchase plan.  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:

 

 

NOTE F – 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 credit. Additionally, excess tax benefits generated upon settlement or exercise of stock awards are now 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

12

---

 

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, 2017 we do not have any unrecognized tax benefits nor any accrued interest or tax penalties.  

NOTE G – 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 and restricted stock units.  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):

 

 

13

---

 

Overview

We are a leading provider of cloud-based supply chain management solutions, providing network-proven fulfillment, sourcing, and item assortment management solutions, along with comprehensive retail performance analytics to thousands of customers worldwide. We provide our solutions through the SPS Commerce platform, a cloud-based product suite that improves the way suppliers, retailers, distributors and logistics firms orchestrate the sourcing, set up of new vendors and items, and fulfillment of the products that customers buy from retailers and suppliers. 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 the three months ended September 30, 2017, our revenues were $56.2 million, an increase of 14% from the comparable period in 2016, and represented our 67^th consecutive quarter of increased revenues.  Total operating expenses increased 14% for the same period in 2017 from 2016.  For the nine months ended September 30, 2017, our revenues were $162.4 million and total operating expenses were $99.3 million, representing increases of 14% and 10%, respectively, compared to the same period in 2016.

Key Financial Terms and Metrics

We have several key financial terms and metrics, including annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share.  During the nine months ended September 30, 2017, there were no changes in the definitions of our key financial terms and metrics, which are discussed in more detail under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on February 27, 2017.

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 U.S. generally accepted accounting principles (“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.  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, income taxes, stock-based compensation and the valuation of goodwill and purchased intangible assets are the most critical to fully understand and evaluate our financial condition and results of operations.

During the nine months ended September 30, 2017, there were no changes in our significant 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

14

---

 

Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on February 27, 2017, for additional information regarding our accounting policies.

Results of Operations

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

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

 

 

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

Revenues.  Revenues for the three months ended September 30, 2017 increased $6.9 million, or 14%, to $56.2 million from $49.3 million for the same period in 2016.  The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the increase in annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share.

Recurring revenues from recurring revenue customers accounted for 92% of our total revenues for each of the three months ended September 30, 2017 and 2016. 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 the three months ended September 30, 2017 increased $2.5 million, or 15%, to $18.6 million from $16.2 million for the same period in 2016.  The increase in cost of revenues for the three-month period in 2017 was primarily due to an increase in personnel-related costs of approximately $2.1 million, driven by increased headcount and an increase of $878,000 in consulting costs. Compared to the same period in 2016, stock-based compensation expense increased by $176,000. Additionally, as we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $184,000 and direct network costs increased by $38,000 compared to the same period in 2016. As a percentage of revenues, cost of revenues was 33% for each of the three months ended September 30, 2017 and 2016. Going forward, we anticipate that cost of revenues will increase in absolute dollars as we continue to expand our business.

15

---

 

Sales and Marketing Expenses.  Sales and marketing expenses for the three months ended September 30, 2017 increased $1.7 million, or 10%, to $18.2 million from $16.5 million for the same period in 2016.  The increase in sales and marketing expenses for the three-month period in 2017 was due to increased headcount, which resulted in an increase of $737,000 in personnel-related costs, as well as an increase of $1.3 million in variable compensation earned by sales personnel and referral partners from new business, compared to the same period in 2016. We also incurred higher promotional costs of approximately $152,000.  These increased costs were partially offset by various immaterial decreases in other expense categories.  As a percentage of revenues, sales and marketing expenses were 33% for each of the three months ended September 30, 2017 and 2016. 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 the three months ended September 30, 2017 increased $975,000, or 17%, to $6.5 million from $5.6 million for the same period in 2016. During the three months ended September 30, 2017, personnel costs increased by $612,000, costs of software and cloud-based subscriptions increased by $294,000 and stock-based compensation increased by $98,000 compared to the same period in 2016. As a percentage of revenues, research and development expenses were 12% and 11% for the three months ended September 30, 2017 and 2016, respectively. As we enhance and expand our solutions and applications, we expect that research and development expenses will continue to increase in absolute dollars.

General and Administrative Expenses.  General and administrative expenses for the three months ended September 30, 2017 increased $1.6 million, or 22%, to $8.7 million from $7.1 million for the same period in 2016.  The increase in general and administrative expenses for the three-month period in 2017 was primarily due to headcount growth, which resulted in an increase of $914,000 in personnel-related costs and an increase of $116,000 in stock-based compensation compared to the same period in 2016. Additionally, legal, audit and tax fees increased by $205,000, bad debt expense increased by $108,000 and costs of software subscriptions increased by $213,000, while hardware maintenance costs decreased by $90,000 compared to the same period in 2016. As a percentage of revenues, general and administrative expenses were 16% and 15% for the three months ended September 30, 2017 and 2016, respectively. Going forward, we expect that general and administrative expenses will continue to increase in absolute dollars as we expand our business.

Other Income (Expense), net.  Other income (expense), net for the three months ended September 30, 2016 included a $1.0 million adjustment to the fair value of the Toolbox Solutions share-based earn-out liability due to a change in our estimate of probability of attainment. There was no similar activity during the three months ended September 30, 2017 as the contingent consideration arrangement had been resolved.

Income Tax Expense.  We recorded income tax expense of $1.1 million for the three months ended September 30, 2017 compared to income tax expense of $1.2 million for three months ended September 30, 2016. The decrease in income tax expense for the three-month period in 2017 was primarily due to decreased pretax book income.  Under ASU 2016-09, excess tax benefits generated upon the settlement or exercise of stock awards are no longer recognized as additional paid-in capital but are instead recognized as a reduction to income tax expense.  As a result of recording these excess tax benefits in income tax expense, we expect that our annual effective income tax rate will be more volatile than it has been historically.

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 Toolbox Solutions share-based earn-out liability. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands):

 

 

16

---

 

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 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 Toolbox Solutions share-based earn-out liability. The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts):

 

 

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016 

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

 

 

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

Revenues.  Revenues for the nine months ended September 30, 2017 increased $20.1 million, or 14%, to $162.4 million from $142.2 million for the same period in 2016.  The increase in revenues resulted from two primary factors: the increase in recurring revenue customers and the increase in annualized average recurring revenues per recurring revenue customer, which we also refer to as wallet share.

17

---

 

Recurring revenues from recurring revenue customers accounted for 91% and 92% of our total revenues for the nine months ended September 30, 2017 and 2016, respectively.  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 the nine months ended September 30, 2017 increased $7.1 million, or 15%, to $54.2 million from $47.0 million for the same period in 2016. The increase in cost of revenues for the nine-month period in 2017 was primarily due to an increase in personnel-related costs of approximately $5.4 million, driven by increased headcount and an increase of $2.4 million in consulting costs. Compared to the same period in 2016, stock-based compensation expense increased by $498,000 and occupancy costs increased by $68,000. Additionally, as we continued to invest in the infrastructure supporting our platform, costs for software and cloud-based subscriptions increased by $934,000 and depreciation expense increased by $469,000, while direct network costs decreased by $175,000 compared to the same period in 2016. As a percentage of revenues, cost of revenues was 33% for each of the nine months ended September 30, 2017 and 2016. Going forward, we anticipate that cost of revenues will increase in absolute dollars as we continue to expand our business.

Sales and Marketing Expenses.  Sales and marketing expenses for the nine months ended September 30, 2017 increased $5.0 million, or 10%, to $54.1 million from $49.1 million for the same period in 2016.  The increase in sales and marketing expenses for the nine-month period in 2017 was primarily due to increased headcount, which resulted in an increase of $1.9 million in personnel-related costs, as well as an increase of $3.3 million in variable compensation earned by sales personnel and referral partners from new business compared to the same period in 2016. We also incurred higher promotional costs of approximately $303,000, partially offset by a decrease in depreciation expense of $250,000 and a decrease in stock-based compensation of $257,000. As a percentage of revenues, sales and marketing expenses were 33% and 35% for the nine months ended September 30, 2017 and 2016, respectively. 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 the nine months ended September 30, 2017 increased $838,000, or 5%, to $17.0 million from $16.2 million for the same period in 2016. During the nine months ended September 30, 2017, personnel costs increased by $56,000 and stock-based compensation increased by $277,000 compared to the same period in 2016. Additionally, occupancy costs increased by $127,000 and costs of software and cloud-based subscriptions increased by $498,000 during the nine months ended September 30, 2017 compared to the same period in 2016. As a percentage of revenues, research and development expenses was 11% for each of the nine months ended September 30, 2017 and 2016.  As we enhance and expand our solutions and applications, we expect that research and development expenses will continue to increase in absolute dollars.

General and Administrative Expenses.  General and administrative expenses for the nine months ended September 30, 2017 increased $3.2 million, or 15%, to $24.7 million from $21.5 million for the same period in 2016.  The increase in general and administrative expenses for the nine-month period in 2017 was primarily due to headcount growth, which resulted in an increase of $1.9 million in personnel-related costs and an increase of $311,000 in stock-based compensation compared to the same period in 2016. Additionally, costs of software and cloud-based subscriptions increased by $696,000, bad debt expense increased by $389,000 and credit card fees increased by $174,000, while legal, audit and tax fees decreased by $77,000 and hardware costs decreased by $228,000 compared to the same period in 2016. As a percentage of revenues, general and administrative expenses was 15% for each of the nine months ended September 30, 2017 and 2016.  Going forward, we expect that general and administrative expenses will continue to increase in absolute dollars as we expand our business.

Other Income (Expense), net.  Other income (expense), net for the nine months ended September 30, 2016 included a $1.0 million adjustment to the fair value of the Toolbox Solutions share-based earn-out liability due to a change in our estimate of probability of attainment. There was no similar charge during the nine months ended September 30, 2017 as the contingent consideration arrangement had been resolved.

Income Tax Expense.  We recorded income tax expense of $2.6 million for the nine months ended September 30, 2017 compared to income tax expense of $2.2 million for nine months ended September 30, 2016. The increase in income tax expense for the nine-month period in 2017 was primarily due to increased pretax book income, offset by discrete tax benefits from the adoption of ASU 2016-09 relating to stock-based compensation.  Under ASU 2016-09, excess tax benefits generated upon the settlement or exercise of stock awards are no longer recognized as additional paid-in capital but are instead recognized as a reduction to income tax

18

---

 

expense.  As a result of recording these excess tax benefits in income tax expense, we expect that our annual effective income tax rate will be more volatile than it has been historically.

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 Toolbox Solutions share-based earn-out liability. The following table provides a reconciliation of net income to Adjusted EBITDA (in thousands):

 

 

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 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 Toolbox Solutions share-based earn-out liability. The following table provides a reconciliation of net income to non-GAAP income per share (in thousands, except per share amounts):

 

 

Liquidity and Capital Resources

At September 30, 2017, our principal sources of liquidity were cash, cash equivalents and marketable securities of $166.3 million and accounts receivable, net of allowance for doubtful accounts, of $24.2 million.  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.

Net Cash Flows from Operating Activities

Net cash provided by operating activities was $22.0 million and $10.4 million for the nine months ended September 30, 2017 and 2016, respectively.  The increase in operating cash flows as compared to the same period in 2016 was primarily due to increased net income and deferred income taxes, along with increased cash flows from other assets, partially offset by a decrease in accrued compensation.

19

---

 

Net Cash Flows from Investing Activities

Net cash used in investing activities was $12.5 million and $29.7 million for the nine months ended September 30, 2017 and 2016, respectively. The decrease in net cash used in investing activities as compared to the same period in 2016 was primarily due to the prior year acquisition of Toolbox Solutions for $18.1 million.  For the nine months ended September 30, 2017 and 2016, we purchased marketable securities, net of maturities, of $6.8 million and $5.6 million, respectively; and had capital expenditures of $5.2 million and $6.0 million, respectively.  Our capital expenditures are for supporting our business growth and existing customer base, as well as for our internal use such as equipment for our employees.

Net Cash Flows from Financing Activities

Net cash provided by financing activities was $2.3 million and $7.0 million for the nine months ended September 30, 2017 and 2016, respectively, from the exercise of stock options, proceeds from employee stock purchase plan and excess tax benefit from the exercise of stock options.  

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 11% of our total cash and cash equivalents outside of the United States 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:

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 expand our business.

We believe our cash, cash equivalents, 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.

Inflation and changing prices did not have a material effect on our business during the nine months ended September 30, 2017 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, 2017 are summarized below:

 

 

20

---

 

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, 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, 2017. 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, 2017, we maintained approximately 11% of our total cash and cash equivalents outside of the United States 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 Securities and Exchange Commission’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, 2017.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

21

---

 

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 for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on February 27, 2017.

Not Applicable.

Not Applicable.

Not Applicable.

Not Applicable.

 

 

 

22

---

 

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.

 

 

 

23