SPS COMMERCE INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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. 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,” “assume,” “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. Similarly, statements that describe our future plans, objectives or goals are also forward-looking. Forward-looking statements may also be made from time to time in oral presentations, including telephone conferences and/or webcasts open to the public. Shareholders, potential investors and others are cautioned that all forward-looking statements involve risks and uncertainties that could cause results in future periods to differ materially from those anticipated by some of the statements made in this report, including the risks and uncertainties described under the heading “Risk Factors” appearing in our Annual Report on Form 10-K for the year ended December 31, 2021, as may be updated in our subsequent Quarterly Reports on Form 10-Q from time to time. 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. Overview SPS Commerce is a leading provider of cloud-based supply chain management services across our global retail network. Our products 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 omnichannel retail channels. SPS Commerce delivers our products using a full-service model whereby our internal experts monitor, update, and boost network performance on our customers’ behalf. The services 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 services we provide enable 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, to help ensure that suppliers, grocers, distributors, and logistics firms can satisfy exacting retailer requirements. 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 products and applications. We also intend to selectively pursue acquisitions that will add customers, allow us to expand into new regions, or allow us to offer new functionalities. Key Financial Terms, Metrics and Non-GAAP Measures We have several key financial terms and metrics, as discussed in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC, under the heading “ Management’s Discussion and Analysis of Financial Condition and Results of Operations. ” To supplement our financial statements, we provide investors with Adjusted EBITDA, Adjusted EBITDA Margin, and non-GAAP income per share, all of which are non-GAAP financial measures. We believe that these non-GAAP measures provide useful information to our management, board of directors, 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 our 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 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. ” SPS COMMERCE, INC. 18 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents Results of Operations Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021 The following table presents our results of operations for the periods indicated: Three Months Ended June 30, 2022 2021 Change (dollars in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 109,178 100.0 % $ 94,539 100.0 % $ 14,639 15.5 % Cost of revenues 37,530 34.4 31,730 33.6 5,800 18.3 Gross profit 71,648 65.6 62,809 66.4 8,839 14.1 Operating expenses Sales and marketing 24,582 22.5 21,952 23.2 2,630 12.0 Research and development 11,432 10.5 8,899 9.4 2,533 28.5 General and administrative 17,198 15.8 15,758 16.7 1,440 9.1 Amortization of intangible assets 2,468 2.3 2,671 2.8 (203) (7.6) Total operating expenses 55,680 51.0 49,280 52.1 6,400 13.0 Income from operations 15,968 14.6 13,529 14.3 2,439 18.0 Other expense, net (1,338) (1.2) (383) (0.4) (955) 249.4 Income before income taxes 14,630 13.4 13,146 13.9 1,484 11.3 Income tax expense 3,877 3.6 2,963 3.1 914 30.8 Net income $ 10,753 9.8 % $ 10,183 10.8 % $ 570 5.6 % (1) Amounts in column may not foot due to rounding Revenues - Revenues increased for the 86th consecutive quarter. The increase in revenue resulted from two primary factors: the increase in recurring revenue customers, which is driven primarily by continued business growth and by business acquisitions, and the increase in average recurring revenues per recurring revenue customer, which we also refer to as wallet share. • The number of recurring revenue customers increased 12% to 38,650 at June 30, 2022 from 34,550 at June 30, 2021 primarily due to sales and marketing efforts to acquire new customers and due to recent acquisitions. • Wallet share increased 4% to $10,550 for the three months ended June 30, 2022 from $10,150 for the same period in 2021. This was primarily attributable to increased usage of our products by our recurring revenue customers. Recurring revenues increased 16% to $101.2 million for the three months ended June 30, 2022 compared to the three months ended June 30, 2021. Recurring revenues from recurring revenue customers accounted for 93% and 92% of our total revenues for the three months ended June 30, 2022 and 2021, respectively. We anticipate that the number of recurring revenue customers and wallet share will continue to increase as we execute our growth strategy focused on further penetrations of our market. Cost of Revenues - The increase in cost of revenues was primarily due to increased headcount, which resulted in an increase of $4.7 million in personnel-related costs and an increase of $0.5 million in software subscriptions. Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in an increase of $2.0 million in personnel-related costs. Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount, which resulted in an increase of $2.1 million in personnel-related costs. SPS COMMERCE, INC. 19 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents General and Administrative Expenses - The increase in general and administrative expense was primarily related to supporting continued business growth, including an increase in headcount which resulted in an increase in personnel-related costs of $0.8 million. Additionally, there was an increase in professional fees of $0.8 million, which was offset by a decrease of $0.8 million in charitable contributions. Amortization of Intangible Assets - The decrease in amortization of intangible assets was driven by the full amortization of previously acquired intangible assets as partially offset by acquired intangible assets related to recent business combinations. Other Expense, Net - The increase in net other expenses was primarily due to unfavorable foreign currency exchange rate changes. Income Tax Expense - The increase in income tax expense was primarily driven by a decrease in the excess tax deductions due to the current quarter equity award settlements. 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 fluctuate. Adjusted EBITDA - Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income adjusted for income tax expense, depreciation and amortization expense, stock-based compensation expense, realized gain or loss from foreign currency on cash and investments held, investment income or loss, and other adjustments as necessary for a fair presentation. For the three months ended June 30, 2021, other adjustments included disposals of cloud hosting arrangement implementation costs. The following table provides a reconciliation of net income to Adjusted EBITDA: Three Months Ended June 30, (in thousands) 2022 2021 Net income $ 10,753 $ 10,183 Income tax expense 3,877 2,963 Depreciation and amortization of property and equipment 3,950 3,529 Amortization of intangible assets 2,468 2,671 Stock-based compensation expense 8,661 7,499 Realized loss from foreign currency on cash and investments held 1,327 349 Investment income (172) (79) Other — 213 Adjusted EBITDA $ 30,864 $ 27,328 SPS COMMERCE, INC. 20 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents Adjusted EBITDA Margin - Adjusted EBITDA Margin, which is a non-GAAP measure of financial performance, consists of Adjusted EBITDA divided by revenue. Margin, the comparable GAAP measure of financial performance, consists of net income divided by revenue. The following table provides a comparison of Margin to Adjusted EBITDA Margin: Three Months Ended June 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2022 2021 Revenue $ 109,178 $ 94,539 Net income 10,753 10,183 Margin 10 % 11 % Adjusted EBITDA 30,864 27,328 Adjusted EBITDA Margin 28 % 29 % Non-GAAP Income per Share - Non-GAAP income per share, which is a non-GAAP measure of financial performance, consists of net income plus stock-based compensation expense, amortization expense related to intangible assets, realized gain or loss from foreign currency on cash and investments held, other adjustments as necessary for a fair presentation, and the corresponding tax impacts of the adjustments to net income, divided by the weighted average number of shares of common and diluted stock outstanding during each period. For the three months ended June 30, 2021, other adjustments included disposals of cloud hosting arrangement implementation costs. To quantify the tax effects, we recalculated income tax expense excluding the direct book and tax effects of the specific items constituting the non-GAAP adjustments. The difference between this recalculated income tax expense and GAAP income tax expense is presented as the income tax effect of the non-GAAP adjustments. The following table provides a reconciliation of net income to non-GAAP income per share: Three Months Ended June 30, (in thousands, except per share amounts) 2022 2021 Net income $ 10,753 $ 10,183 Stock-based compensation expense 8,661 7,499 Amortization of intangible assets 2,468 2,671 Realized loss from foreign currency on cash and investments held 1,327 349 Other — 213 Income tax effects of adjustments (3,491) (3,999) Non-GAAP income $ 19,718 $ 16,916 Shares used to compute non-GAAP income per share Basic 36,085 35,903 Diluted 36,862 36,753 Non-GAAP income per share Basic $ 0.55 $ 0.47 Diluted $ 0.53 $ 0.46 SPS COMMERCE, INC. 21 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021 The following table presents our results of operations for the periods indicated: Six Months Ended June 30, 2022 2021 Change (dollars in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 214,371 100.0 % $ 184,633 100.0 % $ 29,738 16.1 % Cost of revenues 72,919 34.0 61,700 33.4 11,219 18.2 Gross profit 141,452 66.0 122,933 66.6 18,519 15.1 Operating expenses Sales and marketing 49,237 23.0 43,307 23.5 5,930 13.7 Research and development 22,133 10.3 17,605 9.5 4,528 25.7 General and administrative 32,666 15.2 30,495 16.5 2,171 7.1 Amortization of intangible assets 4,938 2.3 5,335 2.9 (397) (7.4) Total operating expenses 108,974 50.8 96,742 52.4 12,232 12.6 Income from operations 32,478 15.2 26,191 14.2 6,287 24.0 Other expense, net (915) (0.4) (708) (0.4) (207) 29.2 Income before income taxes 31,563 14.7 25,483 13.8 6,080 23.9 Income tax expense 8,207 3.8 5,100 2.8 3,107 60.9 Net income $ 23,356 10.9 % $ 20,383 11.0 % $ 2,973 14.6 % (1) Amounts in column may not foot due to rounding Revenues - The increase in revenue resulted from two primary factors: the increase in recurring revenue customers, which is driven primarily by continued business growth and by business acquisitions, and the increase in average recurring revenues per recurring revenue customer, which we also refer to as wallet share. • The number of recurring revenue customers increased 12% to 38,650 at June 30, 2022 from 34,550 at June 30, 2021 . • Wallet share increased 4% to $10,450 for the six months ended June 30, 2022 from $10,100 for the same period in 2021. The increase was primarily attributable to increased usage of our solutions by our recurring revenue customers. Recurring revenues increased 17% to $198.7 million for the six months ended June 30, 2022 compared to the six months ended June 30, 2021. Recurring revenues from recurring revenue customers accounted for 93% and 92% of our total revenues for the six months ended June 30, 2022 and 2021, respectively. We anticipate that the number of recurring revenue customers and wallet share will continue to increase as we execute our growth strategy focused on further penetrations of our market. Cost of Revenues - The increase in cost of revenues was primarily due to increased headcount, which resulted in an increase of $8.4 million in personnel-related costs, an increase of $1.1 million in stock-based compensation, and an increase of $1.0 million of software subscriptions. Additionally, as we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $0.8 million. Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in an increase of $3.7 million in personnel-related costs, an increase of $0.8 million in stock-based compensation, and an increase of $0.7 million in variable compensation earned by sales personnel. Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount, which resulted in an increase of $3.2 million in personnel-related costs, an increase of $0.8 million in stock-based compensation, and an increase of $0.6 million in software subscriptions. SPS COMMERCE, INC. 22 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents General and Administrative Expenses - The increase in general and administrative expense was primarily related to supporting continued business growth, including an increase in headcount, which resulted in an increase in personnel-related costs of $1.6 million and an increase in stock-based compensation of $0.6 million. This was partially offset by a decrease of $1.3 million in charitable contributions. Amortization of Intangible Assets - The decrease in amortization of intangible assets was driven by the full amortization of previously acquired intangible assets as partially offset by acquired intangible assets related to recent business combinations. Other Expense, Net - The increase in net other expenses was primarily due to unfavorable foreign currency exchange rate changes. Income Tax Expense - The increase in income tax expense was primarily driven by a decrease in the excess tax deductions due to the current period equity award settlements, partially offset by a decrease in nondeductible executive compensation. 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 fluctuate. Adjusted EBITDA - Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income adjusted for income tax expense, depreciation and amortization expense, stock-based compensation expense, realized gain or loss from foreign currency on cash and investments held, investment income or loss, and other adjustments as necessary for a fair presentation. For the six m onths ended June 30, 2021 , o ther adjustments included disposals of cloud hosting arrangement implementation costs and accelerated tenant improvement benefit, which was incurred as part of executing a lease agreement. This tenant improvement adjustment was partially offset by accelerated depreciation, which is included within Depreciation and amortization of property and equipment and was also incurred as part of executing a lease agreement. The following table provides a reconciliation of net income to Adjusted EBITDA: Six Months Ended June 30, (in thousands) 2022 2021 Net income $ 23,356 $ 20,383 Income tax expense 8,207 5,100 Depreciation and amortization of property and equipment 7,814 7,294 Amortization of intangible assets 4,938 5,335 Stock-based compensation expense 17,676 14,424 Realized loss from foreign currency on cash and investments held 859 638 Investment income (220) (176) Other — (213) Adjusted EBITDA $ 62,630 $ 52,785 Adjusted EBITDA Margin - Adjusted EBITDA Margin, which is a non-GAAP measure of financial performance, consists of Adjusted EBITDA divided by revenue. Margin, the comparable GAAP measure of financial performance, consists of net income divided by revenue. The following table provides a comparison of Margin to Adjusted EBITDA Margin: SPS COMMERCE, INC. 23 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents Six Months Ended June 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2022 2021 Revenue $ 214,371 $ 184,633 Net income 23,356 20,383 Margin 11 % 11 % Adjusted EBITDA 62,630 52,785 Adjusted EBITDA Margin 29 % 29 % Non-GAAP Income per Share - Non-GAAP income per share, which is a non-GAAP measure of financial performance, consists of net income plus stock-based compensation expense, amortization expense related to intangible assets, realized gain or loss from foreign currency on cash and investments held, other adjustments as necessary for a fair presentation, and the corresponding tax impacts of the adjustments to net income, divided by the weighted average number of shares of common and diluted stock outstanding during each period. For the six m onths ended June 30, 2021 , o ther adjustments included disposals of cloud hosting arrangement implementation costs and accelerated tenant improvement benefit, which was incurred as part of executing a lease agreement. This tenant improvement adjustment was partially offset by accelerated depreciation, which is included within Depreciation and amortization of property and equipment and was also incurred as part of executing a lease agreement. To quantify the tax effects, we recalculated income tax expense excluding the direct book and tax effects of the specific items constituting the non-GAAP adjustments. The difference between this recalculated income tax expense and GAAP income tax expense is presented as the income tax effect of the non-GAAP adjustments. The following table provides a reconciliation of net income to non-GAAP income per share: Six Months Ended June 30, (in thousands, except per share amounts) 2022 2021 Net income $ 23,356 $ 20,383 Stock-based compensation expense 17,676 14,424 Amortization of intangible assets 4,938 5,335 Realized loss from foreign currency on cash and investments held 859 638 Other — (213) Income tax effects of adjustments (6,710) (7,974) Non-GAAP income $ 40,119 $ 32,593 Shares used to compute non-GAAP income per share Basic 36,110 35,828 Diluted 36,897 36,741 Non-GAAP income per share Basic $ 1.11 $ 0.91 Diluted $ 1.09 $ 0.89 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, and expenses and related disclosures. On an ongoing basis, SPS COMMERCE, INC. 24 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents 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 or estimate 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, internal-use software, and business combinations are the most critical to fully understand and evaluate our financial condition and results of operations. During the six months ended June 30, 2022, there were no changes in our critical accounting policies or estimates. For additional information regarding our critical accounting policies and estimates, see the discussion under "Critical Accounting Policies and Estimates" in "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, 2021, as filed with the SEC. Liquidity and Capital Resources As of June 30, 2022 , our principal sources of liquidity were cash and cash equivalents and short-term investments totaling $259.2 million and net accounts receivable of $40.1 million. Our investments are selected in accordance with our investment policy, with a goal of maintaining liquidity and capital preservation. Our cash equivalents and short-term investments are held in highly liquid money market funds, certificates of deposits, and commercial paper. The summary of activity within the condensed consolidated statements of cash flows was as follows: Six Months Ended June 30, (in thousands) 2022 2021 Net cash provided by operating activities $ 36,785 $ 54,658 Net cash used in investing activities (5,294) (17,772) Net cash used in financing activities (26,183) (2,276) Net Cash Flows from Operating Activities The decrease in cash provided by operating activities was primarily driven by changes in the amount and timing of settlement of operating assets and liabilities, primarily the change in accrued compensation. Net Cash Flows from Investing Activities The decrease in cash used in investing activities was primarily due to increased maturities of investments, partially offset by increased purchases of investments. Net Cash Flows from Financing Activities The increase in cash used in financing activities was primarily due to the increase in cash used for share repurchases. SPS COMMERCE, INC. 25 Form 10-Q for the Quarterly Period ended June 30, 2022 Table of Contents Contractual and Commercial Commitment Summary Our contractual obligations and commercial commitments as o f June 30, 2022 are summarized below: Payments Due by Period (in thousands) Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Total Operating lease obligations, including imputed interest $ 5,012 $ 8,459 $ 6,887 $ — $ 20,358 Purchase commitments 5,516 515 — — 6,031 Total $ 10,528 $ 8,974 $ 6,887 $ — $ 26,389 Future Capital Requirements Our future capital requirements may vary significantly from those now planned and will depend on many factors, including: • costs to develop and implement new products and applications, if any; • sales and marketing resources needed to further penetrate our market and gain acceptance of new products and applications that we may develop; • expansion of our operations in the U.S. and internationally; • response of competitors to our products 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 personnel, and we anticipate that our expenditures will continue to increase as we expand our business. We believe our cash, cash equivalents, investments 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. 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. Foreign Currency Exchange and Inflation Rate Changes For information regarding the effect of foreign currency exchange rate changes, refer to the section entitled “Foreign Currency Exchange Risk,” included in Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk” of this Quarterly Report on Form 10-Q. Inflation and changing prices did not have a material effect on our business during the six months ended June 30, 2022 and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.