SPS COMMERCE INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (form 10-K) – marketscreener.com

 The following discussion and analysis of our financial condition and results of operations should be read together with our audited financial statements and related notes which are included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in Part I, Item 1A, "  Risk Factors  " of this Annual Report on Form 10-K.  

Overview

  SPS Commerce is a leading provider of cloud-based supply chain management services across our global retail network. Our products that make it easier for retailers, suppliers, grocers, distributors, and logistics firms to orchestrate the management of item data, order fulfillment, inventory control and sales analytics across 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 SPS Commerce provides 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, ensuring 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.  For the years ended December 31, 2021, 2020, and 2019, we generated revenues of $385.3 million, $312.6 million and $279.1 million, respectively. Our quarter ended December 31, 2021 represented our 84th consecutive quarter of revenue growth. Recurring revenues from recurring revenue customers accounted for 92%, 94%, and 94% of our total revenues for the years ended December 31, 2021, 2020, and 2019, respectively. Our revenues are not concentrated with any customer, as our largest customer represented less than 1% of total revenues for the years ended December 31, 2021, 2020, and 2019.  

Key Financial Terms and Metrics

Sources of Revenues

Fulfillment – Our Fulfillment product provides fulfillment automation and replaces or augments an organization’s existing staff and trading partner electronic communication infrastructure by enabling easy compliance with retailers’ rulebooks, automatic, digital exchange of information among numerous trading partners through various protocols, and greater visibility into the journey of an order.

  Analytics - Our Analytics product consists of data analytics applications that enable our customers to improve their visibility across their supply chains through greater analytics capabilities. When focused on point-of-sale data, for example, retailers and suppliers can ensure inventory is located where demand is highest. Additionally, retailers improve their visibility into supplier performance and their understanding of product sell-through.  Other Products - We provide several complimentary products such as our assortment product (which enables accurate order management and rapid fulfillment) and our community solution (which accelerates vendor onboarding and ensures trading partner adoption of new supply chain requirements). In addition to our product offerings, we also provide one-time services such as professional services and testing and certification.  

Cost of Revenues and Operating Expenses

Cost of Revenues – Cost of revenues consist primarily of personnel costs for our customer success and implementation teams, customer support personnel, and application support personnel as well as network services costs.

Sales and Marketing Expenses – Sales and marketing expenses consist primarily of personnel costs for our sales, marketing and product management teams, commissions earned by our sales personnel and marketing costs.

  Research and Development Expenses - Research and development expenses consist primarily of personnel costs for development of new and maintenance of existing products, net of amounts capitalized as developed software.                                                         Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        24                                    2021   

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   General and Administrative Expenses - General and administrative expenses consist primarily of personnel costs for finance, human resources, and internal information technology support, as well as legal, accounting, and other fees, such as bad debt expense and credit card processing fees.  

Overhead Allocation – We allocate overhead expenses such as rent, certain employee benefit costs, office supplies and depreciation of general office assets to cost of revenues and operating expenses categories based on headcount.

Metrics and Non-GAAP Measures

  Recurring Revenue Customers - As of December 31, 2021, we had approximately 37,500 customers with contracts to pay us recurring fees, which we refer to as recurring revenue customers. A small portion of our recurring revenue customers consist of separate units within a larger organization. We treat each of these units, which may include divisions, departments, affiliates and franchises, as distinct customers.  Wallet Share - We calculate average recurring revenues per recurring revenue customer, which we also refer to as wallet share, by dividing the recurring revenues from recurring revenue customers for the period by the average of the beginning and ending number of recurring revenue customers for the period.  Non-GAAP Financial Measures - To supplement our financial statements, we also provide investors with Adjusted EBITDA, Adjusted EBITDA Margin, and non-GAAP income per share, which are non-GAAP financial measures. We believe that these non-GAAP measures provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Our management uses these non-GAAP measures to compare the Company's performance to that of prior periods for trend analyses and planning purposes. Adjusted EBITDA is also used for purposes of determining executive and senior management incentive compensation. These measures are also presented to our board of directors.  These non-GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with 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

  The discussion of our financial condition and results of operations is based upon our consolidated financial statements, which are prepared in accordance with GAAP. The preparation of these consolidated 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 and assumptions. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable. Our actual results may differ from these estimates under different assumptions or conditions.  We believe that our critical accounting policies and estimates, which are described in the notes to our consolidated financial statements, involve a greater degree of judgment and complexity and are material to our financial statement presentation. 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 for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.  Revenue Recognition  Revenues are the amount that reflects the consideration we are contractually and legally entitled to, as well as expect to collect, in exchange for those services. Set-up fees are specific for each connection a customer has with a trading partner and many of our customers have connections with numerous trading partners. These nonrefundable fees are necessary for our customers to utilize our services and do not provide any standalone value.  Set-up fees constitute a material renewal option right that provide customers a significant future incentive that would not be otherwise available to that customer unless they entered into the contract, as the set-up fees will not be incurred again upon contract renewal. As such, set-up fees and related costs are deferred and recognized ratably over two years, which is the estimated period for which a material right is present for our customers.                                                         Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        25                                    2021   

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Internal-Use Software

  Internal-use software consists of capitalized costs incurred during the application development stage, which include costs related to the design of the chosen path, coding, installation of the hardware necessary to run the software, and any testing done before the operational stage. Costs incurred during the preliminary project stage and post-implementation stage are expensed as incurred. Internal-use software is amortized over the estimated useful life, three years, commencing on the date when the asset is ready for its intended use. Amortization is computed using the straight-line method. Maintenance and enhancements of internal-use software are expensed as incurred.  

Business Combinations

  We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values as of the acquisition date. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require us to make significant estimates and assumptions, especially with respect to intangible assets.  Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customers and acquired technology from a market participant perspective, useful lives, and discount rates. Significant estimates in valuing liabilities for contingent consideration include, but are not limited to, discount rates, projected financial results of the acquired businesses based on our most recent internal forecasts, and factors indicating the probability of achieving the forecasted results.  Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.  

Results of Operations

Year Ended December 31, 2021 Compared to Year Ended December 31, 2020

  The following table presents our results of operations for the periods indicated:                                                       Year Ended December 31,                                                2021                            2020                        Change (dollars in thousands)                            % of revenue                    % of revenue                      % Revenues                            $ 385,276             100.0 %   $ 312,630             100.0 %   $ 72,646         23.2 % Cost of revenues                      131,678              34.2        99,836              31.9       31,842         31.9 Gross profit                          253,598              65.8       212,794              68.1       40,804         19.2 Operating expenses Sales and marketing                    88,044              22.9        75,955              24.3       12,089         15.9 Research and development               39,038              10.1        31,024               9.9        8,014         25.8 General and administrative             61,305              15.9        50,119              16.0       11,186         22.3 Amortization of intangible assets      10,126               2.6         5,538               1.8        4,588         82.8 Total operating expenses              198,513              51.5       162,636              52.0       35,877         22.1 Income from operations                 55,085              14.3        50,158              16.0        4,927          9.8 Other income (expense), net            (1,544 )            (0.4 )       2,522               0.8       (4,066 )     (161.2 ) Income before income taxes             53,541              13.9        52,680              16.9          861          1.6 Income tax expense                      8,944               2.3         7,094               2.3        1,850         26.1 Net income                          $  44,597              11.6 %   $  45,586              14.6 %   $   (989 )       (2.2 )%  

Revenues – The increase in revenues resulted from two primary factors: the increase in recurring revenue customers, which is driven 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 13% to 37,500 at

December 31, 2021 from 33,150 at December 31, 2020 due to sales and

marketing efforts to acquire new customers and due to new acquisitions.

• Wallet share increased 9% to $10,050 at December 31, 2021 from $9,250 at

December 31, 2020. This was primarily attributable to increased usage of

our products by our recurring revenue customers.

                                                          Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        26                                    2021   

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   Recurring revenues from recurring revenue customers increased 20% in 2021, as compared to 2020, and accounted for 92% and 94% of our total revenues in 2021 and 2020, 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 and on new sources of revenues.  

Cost of Revenues – The increase in cost of revenues was primarily due to increased headcount which resulted in an increase of $26.3 million in personnel-related costs and an increase of $2.8 million in stock-based compensation. Additionally, as we continued to invest in the infrastructure supporting our platform, depreciation expense increased by $1.7 million.

  Sales and Marketing Expenses - The increase in sales and marketing expense was primarily due to increased headcount which resulted in an increase of $5.9 million in personnel-related costs, an increase of $1.6 million in sales commissions, and an increase of $2.1 million in stock-based compensation. Also, with continued business growth, our referral partners costs increased $2.4 million.  Research and Development Expenses - The increase in research and development expense was primarily due to increased headcount which resulted in increases of personnel costs of $5.9 million and stock-based compensation of $0.8 million. In addition, there was an increase in software subscription expense of $1.4 million.  General and Administrative Expenses - The increase in general and administrative expense was primarily due to increased headcount which resulted in an increase in personnel-related costs of $5.8 million and a stock-based compensation increase of $2.9 million. The remaining increase primarily related to supporting continued business growth which resulted in increased general and administrative costs, such as credit card fees, professional fees, and software subscriptions.  Amortization of Intangible Assets - The increase in amortization of intangible assets was driven by the amortization of the acquired intangible assets related to recent business combinations.  

Other Income (Expense) – The change was primarily due to unfavorable foreign currency exchange rate changes and decreased investment income.

  Income Tax Expense - The increase in income tax expense was due to an increase in nondeductible executive compensation and an increase in pre-tax income. 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. See Note M to our consolidated financial statements, included in this Annual Report on Form 10-K, for additional information regarding our income taxes.  Adjusted EBITDA - Adjusted EBITDA, which is a non-GAAP measure of financial performance, consists of net income 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 year ended December 31, 2021, other adjustments include 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. For the year ended December 31, 2020, other adjustments included the expense impact from the disposals of certain capitalized internally developed software and cloud hosting arrangement implementation costs in addition to an earn-out liability fair value adjustment. The following table provides a reconciliation of net income to Adjusted EBITDA:                                                             Year Ended December 31, (in thousands)                                              2021                2020 Net income                                              $      44,597       $     45,586 Income tax expense                                              8,944              7,094 Depreciation and amortization of property and equipment                                                      14,788       

13,127

 Amortization of intangible assets                              10,126       

5,538

 Stock-based compensation expense                               27,574       

18,936

 Realized (gain) loss from foreign currency on cash and investments held                                            1,456             (1,753 ) Investment income                                                (278 )           (1,208 ) Other                                                            (192 )             (326 ) Adjusted EBITDA                                         $     107,015       $     86,994                                                            Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        27                                    2021   

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    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:                                                                Year Ended December 31, (in thousands, except Margin and Adjusted EBITDA Margin)       2021                2020 Revenue                                                    $     385,276       $    312,630  Net income                                                        44,597             45,586 Margin                                                                12 %               15 %  Adjusted EBITDA                                            $     107,015       $     86,994 Adjusted EBITDA Margin                                                28 %               28 %     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, and 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 stock outstanding during each period. For the year ended December 31, 2021, other adjustments include 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. For the year ended December 31, 2020, other adjustments included the expense impact from the disposals of certain capitalized internally developed software and cloud hosting arrangement implementation costs in addition to an earn-out liability fair value adjustment.  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:

                                                             Year Ended December 31, (in thousands, except per share amounts)                    2021            

2020

 Net income                                              $      44,597       $     45,586 Stock-based compensation expense                               27,574       

18,936

 Amortization of intangible assets                              10,126       

5,538

Realized (gain) loss from foreign currency on cash and investments held

                                            1,456             (1,753 ) Other                                                            (192 )             (326 ) Income tax effects of adjustments                             (16,454 )          (12,285 ) Non-GAAP income                                         $      67,107       $     55,696 Shares used to compute non-GAAP income per share Basic                                                          35,928             35,226 Diluted                                                        36,962             36,285 Non-GAAP income per share Basic                                                   $        1.87       $       1.58 Diluted                                                 $        1.82       $       1.53    

Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

  The discussion of our results from operations for the year ended December 31, 2020 compared to the year ended December 31, 2019 can be found in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the year ended December 31, 2020.   

Liquidity and Capital Resources

  At December 31, 2021, our principal sources of liquidity were cash and cash equivalents, and short-term investments totaling $257.3 million, and net accounts receivable of $34.6 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, commercial paper, U.S. treasury securities and U.S. corporate bonds.  The summary of activity within the consolidated statements of cash flows was as follows:                                                         Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        28                                    2021   

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                                                           Twelve Months Ended                                                             December 31, (in thousands)                                          2021           2020 Net cash provided by operating activities             $ 112,893     $   

88,562

 Net cash used in investing activities                   (46,703 )     

(120,469 ) Net cash provided by (used in) financing activities $ (8,361 ) $ 2,328

Net Cash Flows from Operating Activities

  The increase in cash provided by operating activities was primarily driven by an increase in non-cash expenses and changes in operating assets and liabilities. Significant changes in non-cash items included increased stock-based compensation and amortization of intangible assets resulting from business expansion. Significant changes in operating assets and liabilities included increases in deferred revenue and accrued compensation balances. This was partially offset by decreases in other assets and deferred costs.  

Net Cash Flows from Investing Activities

The decrease in net cash used in investing activities was primarily due to decreased cash used for acquisitions of business and intangible assets, driven by the larger acquisition in 2020 as compared to 2021.

Net Cash Flows from Financing Activities

The change in net cash flows from financing activities was primarily due to the decrease in net proceeds from stock option exercises.

  The discussion of our liquidity and capital resources for the year ended December 31, 2020 compared to the year ended December 31, 2019 can be found in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the year ended December 31, 2020.  

Contractual and Commercial Commitment Summary

  Our contractual obligations and commercial commitments as of December 31, 2021 are summarized below:                                                                Payments Due by Period                                        Less Than                                       More Than (in thousands)                          1 Year         1-3 Years       3-5 Years        5 Years        Total Operating lease obligations, including imputed interest            $     4,865     $     8,944     $     7,631     $     1,269     $ 22,709 Purchase commitments                        6,462           3,460               -               -        9,922 Total                                 $    11,327     $    12,404     $     7,631     $     1,269     $ 32,631  

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 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

                                                        Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        29                                    2021   

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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 II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" of this Annual Report on Form 10-K.  

During the last three years, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

Recent Accounting Pronouncements

  For information regarding recent accounting pronouncements, refer to Note A, General, in our Notes to Consolidated Financial Statements in the sections entitled "Recently Adopted Accounting Pronouncements" and "Accounting Pronouncements Not Yet Adopted" as applicable, included in Part II, Item 8, "Financial Instruments and Supplementary Data" of this Annual Report on Form 10-K.                                                           Form 10-K for the Annual [[Image Removed]]  SPS                                 Period ended December 31, COMMERCE, INC.                        30                                    2021   

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