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 Securities and Exchange Commission (“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. We believe these non-GAAP financial measures are useful to an investor as they are widely used in evaluating operating performance. Adjusted EBITDA and Adjusted EBITDA Margin are used to measure operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of capital structure and the method by which assets were acquired. SPS COMMERCE, INC. 19 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents 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. ” Results of Operations Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021 The following table presents our results of operations for the periods indicated: Three Months Ended September 30, 2022 2021 Change ($ in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 114,486 100.0 % $ 97,887 100.0 % $ 16,599 17.0 % Cost of revenues 38,605 33.7 34,343 35.1 4,262 12.4 Gross profit 75,881 66.3 63,544 64.9 12,337 19.4 Operating expenses Sales and marketing 25,334 22.1 22,079 22.5 3,255 14.7 Research and development 11,135 9.7 10,854 11.1 281 2.6 General and administrative 16,724 14.6 14,691 15.0 2,033 13.8 Amortization of intangible assets 2,998 2.6 2,399 2.5 599 25.0 Total operating expenses 56,191 49.1 50,023 51.1 6,168 12.3 Income from operations 19,690 17.2 13,521 13.8 6,169 45.6 Other expense, net (695) (0.6) (716) (0.7) 21 (2.9) Income before income taxes 18,995 16.6 12,805 13.1 6,190 48.3 Income tax expense 3,132 2.7 1,356 1.4 1,776 131.0 Net income $ 15,863 13.9 % $ 11,449 11.7 % $ 4,414 38.6 % (1) Amounts in column may not foot due to rounding Revenues - Revenues increased for the 87th 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 39,550 at September 30, 2022 from 35,400 at September 30, 2021 primarily due to sales and marketing efforts to acquire new customers and due to recent acquisitions. • Wallet share increased 5% to $10,900 for the three months ended September 30, 2022 from $10,350 for the same period in 2021. This was primarily attributable to increased usage of our products by our recurring revenue customers. Recurring revenues increased 18% to $106.6 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Recurring revenues from recurring revenue customers accounted for 93% and 92% of our total revenues for the three months ended September 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 $2.8 million in personnel-related costs, and an increase of $0.6 million in software subscriptions. SPS COMMERCE, INC. 20 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in an increase of $2.6 million in personnel-related costs. Research and Development Expenses - No significant changes. General and Administrative Expenses - The increase in general and administrative expense was primarily due to an increase in professional fees of $0.7 million and an increase of $1.0 million in charitable contributions. This was partially offset by a decrease of $1.0 million in bad debt expense given favorable accounts receivable collection rates. Amortization of Intangible Assets - The increase in amortization of intangible assets was driven by acquired intangible assets related to recent business combinations. Other Expense, Net - The decrease in net other expenses consisted of increased investment income partially offset by unfavorable currency exchange rates. Income Tax Expense - The increase in income tax expense was primarily driven by an increase in pre-tax income and a decrease in the excess tax deductions due to the current period equity award settlements. This was 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 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. The following table provides a reconciliation of net income to Adjusted EBITDA: Three Months Ended September 30, (in thousands) 2022 2021 Net income $ 15,863 $ 11,449 Income tax expense 3,132 1,356 Depreciation and amortization of property and equipment 4,169 3,695 Amortization of intangible assets 2,998 2,399 Stock-based compensation expense 7,960 6,849 Realized loss from foreign currency on cash and investments held 1,151 854 Investment income (586) (66) Adjusted EBITDA $ 34,687 $ 26,536 SPS COMMERCE, INC. 21 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents Adjusted EBITDA Margin - Adjusted EBITDA Margin 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 September 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2022 2021 Revenue $ 114,486 $ 97,887 Net income 15,863 11,449 Margin 14 % 12 % Adjusted EBITDA 34,687 26,536 Adjusted EBITDA Margin 30 % 27 % Non-GAAP Income per Share - Non-GAAP income per share consists of net income adjusted for 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. 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 September 30, (in thousands, except per share amounts) 2022 2021 Net income $ 15,863 $ 11,449 Stock-based compensation expense 7,960 6,849 Amortization of intangible assets 2,998 2,399 Realized loss from foreign currency on cash and investments held 1,151 854 Income tax effects of adjustments (4,866) (4,178) Non-GAAP income $ 23,106 $ 17,373 Shares used to compute non-GAAP income per share Basic 36,093 35,961 Diluted 36,915 37,015 Non-GAAP income per share Basic $ 0.64 $ 0.48 Diluted $ 0.63 $ 0.47 SPS COMMERCE, INC. 22 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021 The following table presents our results of operations for the periods indicated: Nine Months Ended September 30, 2022 2021 Change ($ in thousands) $ % of revenue (1) $ % of revenue (1) $ % Revenues $ 328,857 100.0 % $ 282,520 100.0 % $ 46,337 16.4 % Cost of revenues 111,524 33.9 96,043 34.0 15,481 16.1 Gross profit 217,333 66.1 186,477 66.0 30,856 16.5 Operating expenses Sales and marketing 74,571 22.7 65,386 23.1 9,185 14.0 Research and development 33,268 10.1 28,459 10.1 4,809 16.9 General and administrative 49,390 15.0 45,186 16.0 4,204 9.3 Amortization of intangible assets 7,936 2.4 7,734 2.7 202 2.6 Total operating expenses 165,165 50.2 146,765 51.9 18,400 12.5 Income from operations 52,168 15.9 39,712 14.1 12,456 31.4 Other expense, net (1,610) (0.5) (1,424) (0.5) (186) 13.1 Income before income taxes 50,558 15.4 38,288 13.6 12,270 32.0 Income tax expense 11,339 3.4 6,456 2.3 4,883 75.6 Net income $ 39,219 11.9 % $ 31,832 11.3 % $ 7,387 23.2 % (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 39,550 at September 30, 2022 from 35,400 at September 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 nine months ended September 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 $305.3 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Recurring revenues from recurring revenue customers accounted for 93% and 92% of our total revenues for the nine months ended September 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 $11.2 million in personnel-related costs, an increase of $1.6 million of software subscriptions, and an increase of $1.5 million in stock-based compensation. Additionally, as we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $1.1 million. Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount, which resulted in an increase of $6.3 million in personnel-related costs, an increase of $1.0 million in stock-based compensation, and an increase of $0.9 million in variable compensation earned by sales personnel and referral partners. SPS COMMERCE, INC. 23 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount, which resulted in an increase of $3.0 million in personnel-related costs, an increase of $1.0 million in stock-based compensation, and an increase of $0.9 million in software subscriptions. General and Administrative Expenses - The increase in general and administrative expense was primarily related to supporting continued business growth, including an increase in headcount. The increase in headcount resulted in an increase in personnel-related costs of $2.0 million, an increase of $0.8 million of software subscriptions, and an increase of $0.8 million in stock-based compensation. Additionally, there was an increase in professional fees of $1.3 million partially offset by a decrease of $1.1 million in bad debt expense. Amortization of Intangible Assets - The increase in amortization of intangible assets was driven 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 an increase in pre-tax income and a decrease in the excess tax deductions due to the current period equity award settlements. This was 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 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 nine m onths ended September 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: Nine Months Ended September 30, (in thousands) 2022 2021 Net income $ 39,219 $ 31,832 Income tax expense 11,339 6,456 Depreciation and amortization of property and equipment 11,983 10,989 Amortization of intangible assets 7,936 7,734 Stock-based compensation expense 25,636 21,273 Realized loss from foreign currency on cash and investments held 2,010 1,492 Investment income (806) (242) Other — (213) Adjusted EBITDA $ 97,317 $ 79,321 Adjusted EBITDA Margin - Adjusted EBITDA Margin consists of Adjusted EBITDA divided by revenue. Margin, the comparable GAAP measure of financial performance, consists of net income divided by revenue. SPS COMMERCE, INC. 24 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents The following table provides a comparison of Margin to Adjusted EBITDA Margin: Nine Months Ended September 30, (in thousands, except Margin and Adjusted EBITDA Margin) 2022 2021 Revenue $ 328,857 $ 282,520 Net income 39,219 31,832 Margin 12 % 11 % Adjusted EBITDA 97,317 79,321 Adjusted EBITDA Margin 30 % 28 % Non-GAAP Income per Share - Non-GAAP income per share consists of net income adjusted for 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 nine m onths ended September 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: Nine Months Ended September 30, (in thousands, except per share amounts) 2022 2021 Net income $ 39,219 $ 31,832 Stock-based compensation expense 25,636 21,273 Amortization of intangible assets 7,936 7,734 Realized loss from foreign currency on cash and investments held 2,010 1,492 Other — (213) Income tax effects of adjustments (11,576) (12,152) Non-GAAP income $ 63,225 $ 49,966 Shares used to compute non-GAAP income per share Basic 36,104 35,873 Diluted 36,942 36,898 Non-GAAP income per share Basic $ 1.75 $ 1.39 Diluted $ 1.71 $ 1.35 SPS COMMERCE, INC. 25 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents 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, we evaluate our estimates, judgments 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 nine months ended September 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 September 30, 2022 , our principal sources of liquidity were cash and cash equivalents and short-term investments totaling $237.2 million and net accounts receivable of $36.8 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: Nine Months Ended September 30, (in thousands) 2022 2021 Net cash provided by operating activities $ 76,483 $ 81,568 Net cash used in investing activities (60,593) (32,087) Net cash used in financing activities (36,655) (3,360) 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 increase in cash used in investing activities was primarily due to an acquisition of a business along with the net investment activity. 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. 26 Form 10-Q for the Quarterly Period ended September 30, 2022 Table of Contents Contractual and Commercial Commitment Summary Our contractual obligations and commercial commitments as o f September 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 $ 4,990 $ 8,701 $ 6,283 $ — $ 19,974 Purchase commitments 5,528 1,918 — — 7,446 Total $ 10,518 $ 10,619 $ 6,283 $ — $ 27,420 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, including the $49 million InterTrade acquisition in October 2022. 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 cash flows from our 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 nine months ended September 30, 2022 and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.