UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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Commission File Number 000-52170

________________________________________ 

 

(Exact Name of Registrant as Specified in its Charter)

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600 West Chicago Avenue, Suite 850

Chicago, Illinois 60654

Phone: (312) 642-3700

(Address, zip code and telephone number, including area code, of principal executive offices)

 

INNERWORKINGS, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

InnerWorkings, Inc. and subsidiaries

Condensed Consolidated Statement of Comprehensive Income (Loss)

(In thousands, except per share data)

(Unaudited)

InnerWorkings, Inc. and subsidiaries

InnerWorkings, Inc. and subsidiaries

Condensed Consolidated Statement of Cash Flows

(In thousands)

(Unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation of Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements of InnerWorkings, Inc. and subsidiaries (the “Company”) included herein have been prepared to conform to the rules and regulations of the Securities and Exchange Commission (“SEC”) and accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation of the accompanying unaudited financial statements have been included, and all adjustments are of a normal and recurring nature. The operating results for the three and ninesix months ended SeptemberJune 30, 20162017 are not necessarily indicative of the results to be expected for the full year ending December 31, 2016.2017. These condensed interim consolidated financial statements and notes should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto as of and for the year ended December 31, 20152016 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 10, 2016.9, 2017.

 

Description of the Business

 

InnerWorkings, Inc.The Company was incorporated in the state of Delaware on January 3, 2006. The Company is a leading global marketing execution firm for some of the world's most marketing intensive companies, including those in the Fortune 1000, across a wide range of industries. As a comprehensive outsourced enterprise solution, the Company leverages proprietary technology, an extensive supplier network and deep domain expertise to streamline the creation, production and distribution of marketing and promotional materials, signage and displays, retail experiences, events and promotions and packaging across every major market worldwide. The items the Company sources are generally procured through the marketing supply chain and are referred to collectively as marketing materials. The Company’s technology and database of information is designed to capitalize on excess manufacturing capacity and other inefficiencies in the traditional marketing and print supply chain to obtain favorable pricing and to deliver high-quality products and services.

The Company is organized and managed as two business segments, North America and International, and is viewed as two operating segments by the chief operating decision maker for purposes of resource allocation and assessing performance. See Note 14 for further information about the Company’s reportable segments.

 

Preparation of Financial Statements and Use of Estimates

 

The preparation of the consolidated financial statements is in conformity with accounting principles generally accepted in the United States ("GAAP"). GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. On an ongoing basis, the Company evaluates its estimates, including those related to product returns, allowance for doubtful accounts, inventories and inventory valuation, valuation and impairments of goodwill and long-lived assets, income taxes, accrued bonus, contingencies, stock-based compensation and litigation.litigation costs. The Company bases its estimates on historical experience and on other assumptions that its management believes are reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities when those values are not readily apparent from other sources. Actual results canmay differ from those estimates.

Foreign Currency Translation

The Company determines the functional currency for its parent company and each of its subsidiaries by reviewing the currencies in which their respective operating activities occur. Assets and liabilities of these operations are translated into U.S. currency at the rates of exchange at the balance sheet date. Income and expense items are translated at average monthly rates of exchange. The resulting translation adjustments are included in accumulated other comprehensive loss, a separate component of stockholders’ equity. Transaction gains and losses arising from activities in other than the applicable functional currency are calculated using average exchange rates for the applicable period and reported in net income as a non-operating item in each period. Non-monetary balance sheet items denominated in a currency other than the applicable functional currency are translated using the historical rate.

The Company recognizes revenue upon meeting all of the following revenue recognition criteria, which areis typically met upon shipment or delivery of itsour products to customers: (i) persuasive evidence of an arrangement exists through customer contracts and orders, (ii) the customer takes title and assumes the risks and rewards of ownership, (iii) the sales price charged is fixed or determinable as evidenced by customer contracts and orders and (iv) collectability is reasonably assured. Unbilled revenue relates torepresents shipments that have been made to customers for which the related account receivable has not yet been billed.

The Company recognizes revenue for creative, design, installation, warehousing and other services provided to its customers which may be delivered in conjunction with the procurement of marketing materials at the time when delivery and customer acceptance occur and all other revenue recognition criteria are met. TheWhen provided on a stand-alone basis, the Company recognizes revenue for creative and otherthese services provided on a stand-alone basis upon completion of the service. Service revenue has not been material to the Company’s overall revenue to date.

Stock-Based Compensation

Stock-based compensation cost recognized during the period is based on the portionfull grant date fair value of the share-based payment awards that are ultimately expected to vest. Accordingly, stock-based compensation cost recognized has been reducedadjusted for estimated forfeitures. Forfeitures are estimated atany forfeitures during the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.period.

 

The Company recorded $1.7$1.5 million and $1.2$1.1 million in stock-based compensation expense for the three months ended SeptemberJune 30, 20162017 and 2015,2016, respectively, and $4.1$2.9 million and $4.9$2.4 million in stock-based compensation expense for the ninesix months ended SeptemberJune 30, 2017 and 2016, and 2015, respectively. During 2015, $0.4 million of stock-based compensation expense was recognized related to the modification of a former executive’s award agreements in connection with his transition agreement.

2. Contingent Consideration

In connection with certain of the Company’s acquisitions, contingent consideration is payable in cash or common stock of the Company upon the achievement of certain performance measures over future periods. The Company recorded the acquisition date fair value of the contingent consideration liability as additional purchase price. As discussed in Note 10, the process for determining the fair value of the contingent consideration liability consists of reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to each acquisition as well as the Company’s historical experience with similar arrangements. Subsequent to the acquisition date, the Company estimates the fair value of the contingent consideration liability each reporting period and any adjustments made to the fair value are recorded in the Company’s results of operations. If an acquisition reaches the required performance measures within the reporting period, the fair value of the contingent consideration liability is increased to 100%, the maximum potential payment, and reclassified to Duedue to seller.

The Company has recorded $19.3 million in contingent considerationOn June 30, 2017, the EYELEVEL acquisition reached the required performance measures at September 30, 2016 related to these arrangements. Any adjustments made tothe end of its earnout period and the balance of the fair value of the contingent consideration liability subsequentwas reclassified to due to seller. At June 30, 2017, the acquisition date will beCompany reduced the contingent liability to $0.0 million and recorded $17.8 million in the Company’s results of operations.Due to Seller related to these arrangements. During the three months ended SeptemberJune 30, 2017 and 2016, the Company recorded expense of $1.9 million and 2015,$7.3 million, respectively. During the six months ended June 30, 2017 and 2016 the Company recorded expense of $0.8 million and $0.7$9.2 million, respectively, to increase its contingent liability related to these arrangements. During

 

3. Goodwill 

The fair value estimates used in the goodwill impairment analysis require significant judgment. The Company's fair value estimates for purposes of performing the analysis are considered Level 3 fair value measurements. The fair value estimates were based on assumptions that management believes to be reasonable, but that are inherently uncertain, including estimates of future revenues and operating margins and assumptions about the overall economic climate and the competitive environment for the business.

The Company reviewsassesses for potentialgoodwill impairment indicators each reporting period and does not believe that goodwill is impaired as of SeptemberJune 30, 2016.2017.

The following is a summary of the Company’s other intangible assets as of SeptemberJune 30, 20162017 and December 31, 20152016 (in thousands):

In accordance with ASC 350, the Company amortizes its intangible assets with finite lives over their respective estimated useful lives and reviews for impairment whenever impairment indicators exist. Impairment indicators could include significant under-performance relative to the historical or projected future operating results, significant changes in the manner of use of assets, significant negative industry or economic trends or significant changes in the Company’s market capitalization relative to net book value. Any changes in key assumptions used by the Company, including those set forth above, could result in an impairment charge and such a charge could have a material adverse effect on the Company’s consolidated results of operations. The Company’s intangible assets consist of customer lists, noncompete agreements, trade names and patents. The Company’s customer lists, which have an estimated weighted-average useful life of approximately fourteen years, are being amortized using the economic life method. The Company’s noncompete agreements, trade names and patents are being amortized on a straight-line basis over their estimated weighted-average useful lives of approximately four years, thirteen years and nine years, respectively.

  

5. Restructuring Activities and Other Charges 

     

As of SeptemberFor the three and six months ended June 30, 2016,2017, the Company has recognized $5.5 million inno additional restructuring charges related to this plan, of which $0.3 million, $4.2 million and $1.0 million related toas the North America, International and Other segments, respectively. This plan is expected to bewas completed by the end of 2016.

As of June 30, 2016, the accruedCompany recognized $5.0 million in restructuring activities forcharges related to this plan, forof which $0.3 million, $3.9 million and $0.8 million related to the nine months ended September 30, 2016 (in thousands):

6. Income Taxes

 

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items. The Company’s reported effective income tax rate was 42.7%43.0% and 47.0%702.0% for the three months ended SeptemberJune 30, 20162017 and 2015,2016, respectively, and 109.2%36.5% and 43.7%(2,038.9)% for the ninesix months ended SeptemberJune 30, 2017 and 2016 and 2015, respectively.. The Company’s effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

 

The effective tax rates were affected by the fair value changes to contingent consideration in each period. Portions of the total amount recognized from fair value changes to contingent consideration relate to non-taxable acquisitions for which deferred taxes are not recognized, consistent with the treatment of goodwill and intangible assets for those acquisitions under U.S. GAAP. In the three months ended SeptemberJune 30, 2017 and 2016, and 2015, $0.8$1.9 million and $0.7$7.3 million, respectively, was recognized as expense from fair value changes to contingent consideration, and inconsideration. In the ninesix months ended SeptemberJune 30, 2017 and 2016, and 2015, $10.0$0.8 million and $1.7$9.2 million, respectively, was recognized as expense from fair value changes to contingent consideration, which did not result in recognition of a deferred tax asset, therefore, increasing theconsideration.

The effective tax rate for these periods.the three and six months ended June 30, 2017 was unfavorably impacted by $0.2 million and $0.2 million, respectively, of stock-based compensation activity due to the adoption ASU 2016-09 on January 1, 2017.

Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will expire unutilized. At the end of each reporting period, the Company reviews the realizability of its deferred tax assets. During the second quarter of 2017, the valuation allowance balance was decreased for a Peruvian valuation allowance adjustment. The Company believes sufficient positive evidence exists to release the valuation allowance, therefore, the Company adjusted the valuation allowance by $0.8 million resulting in a $0.2 million benefit to income tax expense for the three and six months ended June 30, 2017. Additionally, the global realignment plan resulted in restructuring and other chargesCompany continues to incur losses in jurisdictions which have valuation allowances against tax loss carryforwards, so a tax benefit has not been recognized in the financial statements.statements for these losses.

7. Earnings Per Share

Basic earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding.outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average shares outstanding plus share equivalentsassuming dilution. Dilutive common shares outstanding is computed using the Treasury Stock Method and reflects the additional shares that would arise from the exercise ofbe outstanding if dilutive stock options vesting ofwere exercised and restricted stock and restricted stock units were settled for common shares and contingentlyduring the period. In addition, dilutive shares would include any shares issuable shares in connection withrelated to PSUs for which the Company’s acquisitions.performance conditions have been met as of the end of the period. During the three months ended SeptemberJune 30, 20162017 and 2015,2016, an aggregate of 2.5 million and 4.04.2 million options and restricted common shares, respectively, and during the ninesix months ended SeptemberJune 30, 20162017 and 2015,2016, an aggregate of 4.02.6 million and 4.14.2 million options and restricted common shares, respectively, were excluded from the calculation as these options and restricted common shares were anti-dilutive. The computations of basic and diluted earnings (loss) per common share for three and ninesix months ended SeptemberJune 30, 20162017 and 20152016 are as follows (in thousands, except per share amounts): 

8. Accumulated Other Comprehensive Loss

 

The table below presents changes in the components of accumulated other comprehensive loss for the three and ninesix months ended SeptemberJune 30, 20162017 and 20152016 (in thousands):

9. Related Party Transactions

The Company provides print procurement services to Arthur J. Gallagher & Co. J. Patrick Gallagher, Jr., a member of the Company’s Board of Directors, is the Chairman, President and Chief Executive Officer of Arthur J. Gallagher & Co. and has a direct ownership interest in Arthur J. Gallagher & Co. The total amount billed for such print procurement services during the three months ended SeptemberJune 30, 2017 and 2016 and 2015 was $0.4$0.5 million and $0.5 million, respectively, and $1.3$0.9 million and $1.4$1.0 million during the ninesix months ended SeptemberJune 30, 20162017 and 2015,2016, respectively. Additionally, Arthur J. Gallagher & Co. provideshas provided insurance brokerage and risk management services to the Company. As consideration of these services, Arthur J. Gallagher & Co. billed the Company $0.0 million and $0.3$0.1 million for the three months ended SeptemberJune 30, 2017 and 2016, respectively, and 2015,$0.0 million and $0.2 million for the six months ended June 30, 2017, respectively. The net amount receivable from Arthur J. Gallagher & Co. was $0.2 million and $0.4 million as of June 30th, 2017 and December 31, 2016, respectively.

10. Fair Value Measurement

ASC 820 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on observable or unobservable inputs to valuation techniques that are used to measure fair value. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions.

TheAs of June 30, 2017 the Company no longer has any Level 3 assets or liabilities remaining on its condensed consolidated financial statements as a result of the finalization of the contingent consideration liabilities discussed in Note 2. As of December 31, 2016, the only Level 3 liabilities on the Company's financial statements related to its potential contingent consideration payments relating tofrom acquisitions occurring subsequent to January 1, 2009 are its only Level 3 liabilities as of September 30, 2016 and December 31, 2015.2009. The fair value of the liabilities determined by this analysis iswas primarily driven by the probability of reaching the performance measures required by the applicable purchase agreements and the associated discount rates. Probabilities arewere estimated by reviewing financial forecasts and assessing the likelihood of reaching the required performance measures based on factors specific to each acquisition as well as the Company’s historical experience with similar arrangements. If an acquisition reachesreached the required performance measure, the estimated probability would be increased to 100% and reclassified to Duedue to seller, and if the measure iswas not reached, the probability would behave been reduced to reflect the amount earned, if any, depending on the terms of the agreement. Discount rates are estimatedwere determined by using the local government bond yields plus the Company’s credit spread. A one percentage point increase in the discount rate across all contingent consideration liabilities would result inapplying a decreaserisk premium to the fair value of approximately $0.1 million.a risk-free interest rate.

The following table sets forth the Company’s financial assets and financial liabilities measured at fair value on a recurring basis and the basis of measurement at SeptemberJune 30, 20162017 and December 31, 20152016 (in thousands):

  

The following table provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant unobservable inputs (Level 3) (in thousands): 

11. Commitments and Contingencies

 

In January 2014, a former finance employee of Productions Graphics initiated wrongful termination and overtime claims in the Labor Court of Boulogne-Billancourt, and he currently seeks damages of approximately €0.6 million (approximately $0.8 million). The Company disputes these allegations and intends to vigorously defend these matters. In addition, the Company’s criminal complaint in France, described above, seeks to redress harm caused by this former employee in light of his participation in the fraudulent transactions described above. The labor claim has been stayed in deference to the Company’s related criminal complaint.

12. Revolving Credit Facilities

The Company entered into a Credit Agreement, dated as of August 2, 2010, subsequently amended most recently as of September 25, 2014,February 3, 2017, among the Company, the lenders party thereto and Bank of America, N.A., as Administrative Agent (the “Credit Agreement”). The Credit Agreement includes a revolving commitment amount of $175 million in the aggregate with a maturity date of September 25, 2019, and provides the Company the right to increase the aggregate commitment amount by an additional $50 million. Outstanding borrowings under the revolving credit facility are guaranteed by the Company’s material domestic subsidiaries, as defined in the Credit Agreement. The Company’s obligations under the Credit Agreement and such domestic subsidiaries’ guaranty obligations are secured by substantially all of their respective assets. The ranges of applicable rates charged for interest on outstanding loans and letters of credit are 125-250 basis point spread for letter of credit fees and loans based on the Eurodollar rate and 25-150 basis point spread for loans based on the base rate.

 

The terms of the Credit Agreement include various covenants, including covenants that require the Company to maintain a maximum leverage ratio and a minimum interest coverage ratio. The Credit Agreement requires the Company to maintain a leverage ratio of no more than 3.003.0 to 1.0 for the trailing twelve months ended SeptemberJune 30, 20162017 and 3.003.0 to 1.0 for each period thereafter. The Company is also required to maintain an interest coverage ratio of no less than 5.005.0 to 1.0. The Company is in compliance with all debt covenants as of SeptemberJune 30, 2016.2017.

 

 

The book value of the debt under this Credit Agreement is considered to approximate its fair value as of SeptemberJune 30, 20162017 as the debt is considered short-term in nature and the interest rates are considered in line with current market rates.

 

13. Share Repurchase Program

On February 12, 2015, the Company announced that its Board of Directors approved a share repurchase program authorizing the repurchase of up to an aggregate of $20 million of its common stock through open market and privately negotiated transactions over a two-year period. On November 2, 2016, the Board of Directors approved a two-year extension to the share repurchase program. The Company now expects the program to run through February 12,28, 2019. On May 4, 2017, the Board of Directors authorized the repurchase of up to an additional $30.0 million of its common stock through open market and privately negotiated transactions over a two-year period ending May 31, 2019. The timing and amount of any share repurchases will be determined based on market conditions, share price and other factors, and the program may be discontinued or suspended at any time. Repurchases will be made in compliance with SEC rules and other legal requirements.

 

During the six months ended June 30, 2017, the Company repurchased 1,028,654 shares of its common stock for $10.0 million in the aggregate at an average cost of $9.76 per share. During the three months ended June 30, 2017, the Company repurchased 459,030 shares of its common stock for $4.6 million in the aggregate at an average cost of $9.91 per share. During the three and ninesix months ended SeptemberJune 30, 2016 the Companycompany did not repurchase any shares of its common stock. During the three months ended September 30, 2015, the Company did not repurchase any shares of its common stock. During the nine months ended September 30, 2015, the Company repurchased 763,787 shares of its common stock for $4.9 million in the aggregate at an average cost of $6.41 per share. Shares repurchased under this program are recorded at acquisition cost, including related expenses.

14. Business Segments

Segment information is prepared on the same basis that our Chief Executive Officer, who is our chief operating decision maker (“CODM”), manages the segments, evaluates financial results, and makes key operating decisions. In fiscal year 2015, segments wereThe Company is organized and managed by the CODM as three business segments: North America, including the United States and Canada; EMEA, including operations in the United Kingdom, continental Europe, the Middle East, Africa and Asia; and LATAM, including operations in Mexico, South America and Central America. Effective in the first fiscal quarter of 2016, the Company implemented changes to the organizational structure of the Latin America and EMEA segments which included combining the two segments under single management and managing those businesses as one segment. In conjunction with this change, the CODM now manages the results of the Company as two business segments: North America and International. The North America segment includes operations in the United States and Canada; the International segment includes all other operations across Europe, Asia, Mexico, Central America and South America; Other consists of intersegment eliminations, shared service activities and unallocated corporate expenses. All transactions between segments are presented at their gross amounts and eliminated through Other. Prior period amounts have been restated to reflect this change.

Management evaluates the performance of its operating segments based on revenues and Adjusted EBITDA, which is a non-GAAP financial measure. The accounting policies of each of the operating segments are the same as those described in the summary of significant accounting policies in Note 1. Adjusted EBITDA represents income from operations excluding depreciation and amortization, stock-based compensation expense, income/expense related to changes in the fair value of contingent consideration liabilities and restructuring and other charges. Management does not evaluate the performance of its operating segments using asset measures.

The table below presents financial information for the Company’s reportable segments and Other for the three and ninesix month periods noted (in thousands):

The table below reconciles the total of the reportable segments' Adjusted EBITDA and the Adjusted EBITDA included in Other to income before income taxes (in thousands):

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a leading global marketing execution firm for some of the world's most marketing intensive companies, including those in the Fortune 1000 brands, across a wide range of industries.1000. As a comprehensive outsourced global solution, we leverage proprietary technology, an extensive supplier network substantial procurement data, buying power and deep domain expertise to design, procurestreamline the creation, production and execute brandeddistribution of marketing and promotional materials, signage and displays, retail experiences, events and promotions creative services and product packaging across every major market worldwide. The items we source generally are generally procured through the marketing supply chain and we refer to these items collectively as marketing materials. Our solution is designedThrough our network of more than 8,000 global suppliers, we offer a full range of fulfillment and logistics services that allow us to deliver substantial savings, shorter lead times, greater brand consistency,procure marketing materials of virtually any kind. The breadth of our product offerings and more controlservices and transparency acrossthe depth of our supplier network enable us to fulfill the marketing supply chain while delivering high-quality products and services formaterials procurement needs of our clients.

 

Our proprietary software applications and databases create a fully-integrated solution that stores, analyzes and tracks the production capabilities of our supplier network, as well as detailed pricing data. As a result, we believe we have one of the largest independent repositories of supplier capabilities and pricing data for suppliers of marketing materials around the world. We leverage our supplier capabilities and pricing data to match our orders with suppliers that are optimally suited to meet the client’s needs at a highly competitive price.

We use our supplier network enable uscapability and pricing data to fulfillmatch orders with suppliers that are optimally suited to meet the marketing materials procurementclient's needs of our clients.at a highly competitive price. By leveraging our technology and data, our clients are able to reduce overhead costs, redeploy internal resources and obtain favorable pricing and service terms. In addition, our ability to track individual transactions and provide customized reports detailing procurement activity on an enterprise-wide basis provides our clients with greater visibility and control of their marketing materials expenditures.

We generate revenue by procuring and purchasing marketing materials from our suppliers and selling those products to our clients. We procure products for clients across a wide range of industries, such as retail, financial services, hospitality, consumer packaged goods, non-profits, healthcare, pharmaceuticals, food and beverage, broadcasting and cable and transportation. Our clients fall into two categories, enterprise and transactional. We enter into contracts with our enterprise clients to provide some or substantially all, of their marketing materials typicallyfor certain categories, geographies and/or campaigns, on a recurring basis. We provide marketing materials to our transactional clients on an order-by-order basis.  During

As of June 30, 2017, we had approximately 1,900 employees and independent contractors in more than 26 countries. We organize our operations into two operating segments based on geographic regions: North America and International. The North America segment includes operations in the threeUnited States and nine months ended September 30,Canada; the International segment includes operations in Mexico, South America, Central America, Europe, the Middle East, Africa and Asia. In 2016, we generated global revenue from third parties of $734.2 million in the North America segment and $356.5 million in the International Segment. We believe the opportunity exists to expand our business into new geographic markets. Our objective is to continue to increase our sales in the United States and internationally by adding new clients and increasing our sales to existing clients through additional marketing execution services or geographic markets. We intend to hire or acquire more account executives within close proximity to these large markets.

We generate revenue through the procurement of marketing materials for our clients. Our revenue is generated from two different types of clients: enterprise and transactional. Enterprise clients usually order marketing materials in higher dollar amounts and volume than our transactional clients. We categorize a client as an enterprise client if we have a contract with the client for the provision of marketing materials on a recurring basis; if the client has signed an open-ended purchase order or a series of related purchase orders; or if the client has enrolled in our e-stores program, which enables the client to make online purchases of marketing materials on a recurring basis. We categorize all other clients as transactional. We enter into contracts with our enterprise clients accounted for 84% and 85%to provide some or a specific portion of their marketing products on a recurring basis. Our contracts with enterprise clients are generally three to five years, often subject to termination by either party upon prior notice ranging from 90 days to twelve months. 

Several of our revenue, respectively, whileenterprise clients have outsourced substantially all of their recurring marketing materials needs to us. We provide marketing materials to our transactional clients accounted for 16% and 15% of our revenue, respectively.on an order-by-order basis. 

Our revenue consists of the prices paid to us by our clients for marketing materials. These prices, in turn, reflect the amounts charged to us by our suppliers plus our gross profit. Our gross profit margin, in the case of some of our enterprise clients, is fixed by contract or, in the case of transactional clients, is dependent on prices negotiated on a job-by-job basis. Once either type of client accepts our pricing terms, the selling price is established and we procure the product for our own account in order to re-sell it to the client. We take full title and risk of loss for the product upon shipment. The finished product is typically shipped directly from our supplier to a destination specified by our client. Upon shipment, our supplier invoices us for the products and we invoice our client.

Our revenue from enterprise clients tends to generate lower gross profit as a percentage of revenue, which we refer to as gross profit margins than our revenue from transactional clients because the gross profit margins established in our contracts

Cost of Goods Sold and Gross Profit

Our cost of goods sold consists primarily of the price at which we purchase products from our suppliers. Our selling price, including our gross profit, in the case of some of our enterprise clients, is based on a fixed gross margin established by contract or, in the case of transactional clients, is determined at the discretion of the account executive or production manager given predetermined parameters. Our gross profit margins on our enterprise clients are typically lower than our gross profit margins on our transactional clients. As a result, our cost of goods sold as a percentage of revenue for our enterprise clients is typically higher than those for our transactional clients. Our gross profit for the three months ended SeptemberJune 30, 2017 and 2016 and 2015 was $67.8$70.2 million and $63.6$65.1 million, or 24.2%25.1% and 24.0%24.2% of revenue, respectively.

Operating Expenses

Our selling, general and administrative expenses consist of commissions paid to our account executives, compensation costs for our management team and production managers, as well as compensation costs for our finance and support employees, public company expenses, corporate systems, legal and accounting, facilities and travel and entertainment expenses. Selling, general and administrative expenses as a percentage of revenue were 18.8% and 18.4%gross profit decreased to 78.4% for the three months ended SeptemberJune 30, 2016 and 2015, respectively.2017 compared to 79.0% for the three months ended June 30, 2016.

We accrue for commissions when we recognize the related revenue. Some of our account executives receive a monthly draw to provide them with a more consistent income stream. The cash paid to our account executives in advance of commissions earned is reflected as a prepaid expense on our balance sheet. As our account executives earn commissions, a portion of their commission payment is withheld and offset against their prepaid commission balance, if any. Our prepaid commission balance, net of accrued earned commissions not yet paid, increaseddecreased to $1.1$0.2 million as of SeptemberJune 30, 20162017 from $0.9$0.5 million as of December 31, 2015.2016.

We agree to provide our clients with marketing materials that conform to the industry standard of a “commercially reasonable quality,” and our suppliers in turn generally agree to provide us with products of the same quality. In addition, the quotes we execute with our clients typically include customary industry terms and conditions that limit the amount of our liability for product defects. Product defects have not had a material adverse effect on our results of operations.

 

North America

North America revenue increased by $5.2$9.8 million, or 2.9%5.5%, from $180.0$177.0 million during the three months ended SeptemberJune 30, 20152016 to $185.2$186.8 million during the three months ended SeptemberJune 30, 2016.2017. This increase in revenue is driven primarily by organic growth from new enterprise accounts added during the last 12 to 18 months.

International

International revenue increased by $10.1$0.5 million, or 11.9%0.6%, from $84.7$92.2 million during the three months ended SeptemberJune 30, 20152016 to $94.8$92.7 million during the three months ended SeptemberJune 30, 2016.2017. This increase in revenue is driven primarily driven by organic growth from new and existing customers, partially offset by the strengthening of the U.S. Dollar.enterprise customers. 

Cost of goods sold

Our cost of goods sold increased by $11.1$5.2 million, or 5.5%2.5%, from $201.1$204.1 million during the three months ended SeptemberJune 30, 20152016 to $212.2$209.3 million during the three months ended SeptemberJune 30, 2016. The increase is a result of increased revenue during the three months ended September 30, 2016 as described above.2017. Our cost of goods sold as a percentage of revenue was 75.8%74.9% and 76.0%75.8% during the three months ended SeptemberJune 30, 20162017 and 2015,2016, respectively.

 

Gross profit margin

Our gross profit margin was 24.2%25.1% and 24.0%24.2% during the three months ended SeptemberJune 30, 20162017 and 2015,2016, respectively. This increase is due to a shift in revenuewas primarily driven by benefits from supply chain initiatives and favorable product category and geographical mix to higher margin categories during the three months ended SeptemberJune 30, 2016.2017.

Selling, general and administrative expenses

 

Selling, general and administrative expenses increased by $3.8$3.7 million, or 7.8%7.1%, from $48.8$51.4 million during the three months ended SeptemberJune 30, 20152016 to $52.6$55.1 million during the three months ended SeptemberJune 30, 2016.2017. This increase is primarily driven by increased investments in operational improvements and product category and geographical mix during the increase in revenue described above.current quarter. As a percentage of revenue,gross profit, selling, general and administrative expenses remained relatively consistent at 18.8%decreased to 78.4% for the three months ended SeptemberJune 30, 2016 and 18.4%2017 compared to 79.0% for the three months ended SeptemberJune 30, 2015.2016.

Depreciation and amortization

Depreciation and amortization expense increaseddecreased by $0.6$1.5 million, or 12.9%32.6%, from $4.5$4.7 million during the three months ended SeptemberJune 30, 20152016 to $5.1$3.2 million during the three months ended SeptemberJune 30, 2016.2017. This increasedecrease is driven by additional depreciation expense from the timingimpact of capital expenditures, including internal-use software.the change in useful life of certain proprietary software made during the fourth quarter of 2016 as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.

Change in fair value of contingent consideration

Expense from the change in fair value of contingent consideration increaseddecreased by $0.1$5.4 million from $0.7$7.3 million during the three months ended SeptemberJune 30, 20152016 to $0.8$1.9 million during the three months ended SeptemberJune 30, 2016.2017. The change in the fair value

Restructuring and other charges

 

During the three months ended September 30, 2016, we recorded restructuring and other charges of $0.5 million. During the fourth quarter of 2015, wemanagement approved a global realignment plan that is expected to allow usallowed the Company to more efficiently meet client needs across ourits international platform. Through improved integration of global resources, the plan will createcreated back office and other efficiencies and allowallowed for the elimination of approximately 100 positions. As required by law, we are consultingpositions deemed unnecessary. The realignment plan was completed during the fourth quarter of 2016. In connection with each of the affected countries’ local Works Councils throughout implementation of this plan.

No restructuring activitiescharges occurred during the three months ended SeptemberJune 30, 2015.2017.

Income from operations

Income from operations decreasedincreased by $0.7$9.0 million or 8.1%, from $9.6$1.1 million during the three months ended SeptemberJune 30, 20152016 to $8.9$10.1 million during the three months ended SeptemberJune 30, 2016.2017. As a percentage of revenue, income from operations was 3.2%3.6% and 3.6%0.4% during the three months ended SeptemberJune 30, 2017 and 2016, respectively. As a percentage of gross profit, income from operations was 14.3% and 2015,1.6% during the three months ended June 30, 2017 and 2016, respectively. This decreaseincrease is primarily attributable to the restructuring chargesoperating leverage and changes in depreciation and amortization, fair valuesvalue of contingent consideration asand restructuring charges discussed above, partially offset by higher gross profit margin.above.

Other expense

Other expense decreasedincreased by $0.9$1.5 million from $2.2$0.7 million duringfor the three months ended SeptemberJune 30, 20152016 to $1.3$2.2 million during the three months ended SeptemberJune 30, 2016.2017. This decrease isincrease included a $0.4 million foreign exchange loss due to the Czech National Bank's decision to discontinue the Czech koruna's peg to the Euro during the second quarter of 2017. The remaining expense was primarily driven by unrealized foreign exchange losses on balances denominated in foreign currency transactionscurrencies, including intercompany loans, caused by exchange rate changes in the International segment in the prior year due to exchange rate fluctuations across multipleEuro, Brazilian Real, and some other currencies.

Income tax expense

Income tax expense decreasedincreased by $0.3$0.7 million from $3.5$2.7 million during the three months ended SeptemberJune 30, 20152016 to $3.2$3.4 million during the three months ended SeptemberJune 30, 2016.2017. Our effective tax rate was 42.7%43.0% and 47.0%702.0% for the three months ended SeptemberJune 30, 2017 and 2016, respectively. Our effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

Net income (loss) increased by $6.8 million, or 293.4%, from a net loss of $2.3 million during the three months ended June 30, 2016 to net income of $4.5 million during the three months ended June 30, 2017. Net income (loss) as a percentage of revenue was 1.6% and (0.9)% during the three months ended June 30, 2017 and 2016, respectively. Net income (loss) as a percentage of gross profit was 6.4% and (3.6)% during the three months ended June 30, 2017 and 2016, respectively. This increase is primarily attributable to changes in depreciation and amortization, change in fair value of contingent consideration and restructuring charges discussed above.

During the fourth quarter of 2015, management approved a global realignment plan that allowed the Company to more efficiently meet client needs across its international platform. Through improved integration of global resources, the plan created back office and other efficiencies and allowed for the elimination of approximately 100 positions deemed unnecessary. The realignment plan was completed during the fourth quarter of 2016. In connection with these actions, the Company incurred total pre-tax cash restructuring charges of $6.7 million, the majority of which were recognized during 2016.

Income tax expense increased by $0.9 million from $4.8 million during the six months ended June 30, 2016 to $5.7 million during the six months ended June 30, 2017. Our effective tax rate was 36.5% and (2,038.9)% for the six months ended June 30, 2017 and 2016, respectively. Our effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.

 

The effective tax rates were affected by the fair value changes to contingent consideration in each period. Portions of the total amount recognized from fair value changes to contingent consideration relate to non-taxable acquisitions for which deferred taxes are not recognized, consistent with the treatment of goodwill and intangible assets for those acquisitions under U.S. GAAP. In the three months ended September 30, 2016 and 2015, $0.8 million and $0.7 million was recognized as expense from fair value changes to contingent consideration, respectively, which did not result in recognition of a deferred tax asset, therefore, increasing the effective tax rate for these periods. Additionally, the global realignment plan resulted in restructuring and other charges in jurisdictions which have valuation allowances against tax loss carryforwards, so a tax benefit has not been recognized in the financial statements. Excluding the impact of these transactions in each period, the effective tax rate was 34.6% and 42.9% in the three months ended September 30, 2016 and 2015, respectively. The decrease in the effective tax rate in 2016 is primarily due to forecasted changes in pre-tax income mix by jurisdiction and the effect of valuation allowances on the tax losses of certain entities.