UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| x | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| For the quarterly period ended March 31, 2012 |
| ¨ | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| For the transition period from to |
Commission File Number 000-52170
INNERWORKINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
| Delaware | 20-5997364 | |
| (State or Other Jurisdiction of | (I.R.S. Employer | |
| Incorporation or Organization) | Identification No.) |
600 West Chicago Avenue, Suite 850
Chicago, Illinois 60654
Phone: (312) 642-3700
(Address (including zip code) and telephone number (including area code) of registrant’s principal executive offices)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: x No: ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes: x No: ¨
Indicate by check mark whether the Registrant is an a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check one:
| Large accelerated filer: ¨ | Accelerated filer: x |
| Non-accelerated filer: ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes: ¨ No: x
As of April 26, 2012, the Registrant had 48,255,804 shares of Common Stock, par value $0.0001 per share, outstanding.
INNERWORKINGS, INC.
TABLE OF CONTENTS
| Page | ||
| PART I. FINANCIAL INFORMATION | ||
| Item 1. | Consolidated Financial Statements | 1 |
| Consolidated Statement of Comprehensive Income for the three months ended March 31, 2011 and 2012 (Unaudited) | 1 | |
| Consolidated Balance Sheet as of December 31, 2011 and March 31, 2012 (Unaudited) | 2 | |
| Consolidated Statement of Cash Flows for the three months ended March 31, 2011 and 2012 (Unaudited) | 3 | |
| Notes to Consolidated Financial Statements (Unaudited) | 4 | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 13 |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 18 |
| Item 4. | Controls and Procedures | 18 |
| PART II. OTHER INFORMATION | ||
| Item 1. | Legal Proceedings | 19 |
| Item 1A. | Risk Factors | 19 |
| Item 6. | Exhibits | 19 |
| SIGNATURES | 20 | |
| EXHIBIT INDEX | 21 | |
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
InnerWorkings, Inc.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)
| Three months ended March 31, | ||||||||
| 2011 | 2012 | |||||||
| Revenue | $ | 145,180,692 | $ | 188,546,402 | ||||
| Cost of goods sold | 111,852,782 | 147,153,019 | ||||||
| Gross profit | 33,327,910 | 41,393,383 | ||||||
| Operating expenses: | ||||||||
| Selling, general, and administrative expenses | 26,990,237 | 33,083,264 | ||||||
| Depreciation and amortization | 2,422,045 | 2,444,096 | ||||||
| Income from operations | 3,915,628 | 5,866,023 | ||||||
| Other income (expense): | ||||||||
| Gain on sale of investment | 979,501 | 247,697 | ||||||
| Interest income | 81,326 | 51,741 | ||||||
| Interest expense | (595,985 | ) | (698,094 | ) | ||||
| Other, net | (78,214 | ) | 138,268 | |||||
| Total other income (expense) | 386,628 | (260,388 | ) | |||||
| Income before taxes | 4,302,256 | 5,605,635 | ||||||
| Income tax expense | 1,511,904 | 1,917,947 | ||||||
| Net income | $ | 2,790,352 | $ | 3,687,688 | ||||
| Basic earnings per share | $ | 0.06 | $ | 0.08 | ||||
| Diluted earnings per share | $ | 0.06 | $ | 0.07 | ||||
| Comprehensive income | $ | 2,548,259 | $ | 4,089,394 | ||||
See accompanying notes.
| 1 |
InnerWorkings, Inc.
CONSOLIDATED BALANCE SHEET
| December 31, | March 31, | |||||||
| 2011 | 2012 | |||||||
| Assets | (unaudited) | |||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 13,219,385 | $ | 15,665,972 | ||||
| Short-term investments | 1,129,757 | 888,897 | ||||||
| Accounts receivable, net of allowance for doubtful accounts of $3,293,241 and $3,179,465, respectively | 124,678,502 | 146,807,088 | ||||||
| Unbilled revenue | 28,318,751 | 30,883,113 | ||||||
| Inventories | 14,201,606 | 12,198,821 | ||||||
| Prepaid expenses | 11,066,451 | 10,696,763 | ||||||
| Related party receivables | 268,119 | 292,835 | ||||||
| Deferred income taxes | 1,729,349 | 1,463,492 | ||||||
| Other current assets | 13,875,918 | 24,697,846 | ||||||
| Total current assets | 208,487,838 | 243,594,827 | ||||||
| Property and equipment, net | 12,086,627 | 12,168,279 | ||||||
| Intangibles and other assets: | ||||||||
| Goodwill | 205,282,587 | 208,313,495 | ||||||
| Intangible assets, net of accumulated amortization of $13,503,735 and $14,437,434, respectively | 26,565,315 | 25,743,759 | ||||||
| Deferred income taxes | 4,246,592 | 3,715,207 | ||||||
| Other assets | 984,227 | 791,106 | ||||||
| 237,078,721 | 238,563,567 | |||||||
| Total assets | $ | 457,653,186 | $ | 494,326,673 | ||||
| Liabilities and stockholders' equity | ||||||||
| Current liabilities: | ||||||||
| Accounts payable-trade | $ | 102,245,865 | $ | 119,531,508 | ||||
| Related party payable | 44,578 | 460,316 | ||||||
| Current portion of contingent consideration | 14,232,980 | 16,199,571 | ||||||
| Due to seller | 7,554,000 | 2,620,392 | ||||||
| Other liabilities | 6,979,516 | 9,004,553 | ||||||
| Accrued expenses | 17,324,598 | 15,406,150 | ||||||
| Total current liabilities | 148,381,537 | 163,222,490 | ||||||
| Revolving credit facility | 60,000,000 | 71,400,000 | ||||||
| Contingent consideration, net of current portion | 67,769,862 | 67,684,309 | ||||||
| Total liabilities | 276,151,399 | 302,306,799 | ||||||
| Stockholders' equity: | ||||||||
| Common stock, par value $0.0001 per share, 57,903,418 and 58,961,117 shares issued, 46,998,011 and 48,123,303 shares outstanding, respectively | 4,700 | 4,812 | ||||||
| Additional paid-in capital | 179,688,593 | 185,459,929 | ||||||
| Treasury stock at cost, 10,905,407 and 10,837,814 shares, respectively | (71,241,947 | ) | (70,479,927 | ) | ||||
| Accumulated other comprehensive income | 268,331 | 670,037 | ||||||
| Retained earnings | 72,782,110 | 76,365,023 | ||||||
| Total stockholders' equity | 181,501,787 | 192,019,874 | ||||||
| Total liabilities and stockholders' equity | $ | 457,653,186 | $ | 494,326,673 | ||||
See accompanying notes.
| 2 |
InnerWorkings, Inc.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
| Three Months Ended March 31, | ||||||||
| 2011 | 2012 | |||||||
| Cash flows from operating activities | ||||||||
| Net income | $ | 2,790,352 | $ | 3,687,688 | ||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||
| Deferred income taxes | (145,962 | ) | 902,380 | |||||
| Stock-based compensation expense | 941,362 | 1,047,645 | ||||||
| Depreciation and amortization | 2,422,045 | 2,444,096 | ||||||
| Deferred financing cost amortization | 93,909 | 41,821 | ||||||
| Gain on sale of investment | (979,501 | ) | (247,697 | ) | ||||
| Gain on sale of fixed assets | — | (11,567 | ) | |||||
| Excess tax benefit from exercise of stock awards | — | (4,163,793 | ) | |||||
| Change in fair value of contingent consideration liability | — | 200,141 | ||||||
| Bad debt provision | 574,533 | 145,447 | ||||||
| Change in assets, net of acquisitions: | ||||||||
| Accounts receivable and unbilled revenue | (17,989,914 | ) | (22,809,398 | ) | ||||
| Inventories | 303,336 | 2,119,878 | ||||||
| Prepaid expenses and other | (7,801,815 | ) | (10,271,793 | ) | ||||
| Change in liabilities, net of acquisitions: | ||||||||
| Accounts payable | 22,557,152 | 16,003,529 | ||||||
| Advances to (from) related parties | 839,067 | 391,022 | ||||||
| Accrued expenses and other | 3,446,223 | 3,047,963 | ||||||
| Net cash provided by (used in) operating activities | 7,050,787 | (7,472,638 | ) | |||||
| Cash flows from investing activities | ||||||||
| Purchases of property and equipment | (1,761,053 | ) | (1,862,648 | ) | ||||
| Proceeds from sale of marketable securities | 984,845 | 249,540 | ||||||
| Proceeds from sale of fixed assets | — | 11,567 | ||||||
| Payments for acquisitions, net of cash acquired | (5,294,117 | ) | (1,587,576 | ) | ||||
| Net cash used in investing activities | (6,070,325 | ) | (3,189,117 | ) | ||||
| Cash flows from financing activities | ||||||||
| Principal payments on capital lease obligations | (7,081 | ) | (4,349 | ) | ||||
| Net borrowings of revolving credit facility | 500,000 | 11,400,000 | ||||||
| Payments of contingent consideration | — | (3,228,375 | ) | |||||
| Excess tax benefit from exercise of stock awards | — | 4,163,793 | ||||||
| Proceeds from issuance of shares | 26,749 | 555,355 | ||||||
| Net cash provided by financing activities | 519,668 | 12,886,424 | ||||||
| Effect of exchange rate changes on cash and cash equivalents | 127,224 | 221,918 | ||||||
| Increase in cash and cash equivalents | 1,627,354 | 2,446,587 | ||||||
| Cash and cash equivalents, beginning of period | 5,259,272 | 13,219,385 | ||||||
| Cash and cash equivalents, end of period | $ | 6,886,626 | $ | 15,665,972 | ||||
See accompanying notes
| 3 |
InnerWorkings, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended March 31, 2012
| 1. | Summary of Significant Accounting Policies |
Basis of Presentation of Interim Financial Statements
The accompanying unaudited 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 months ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year of 2012. 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 December 31, 2012 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 7, 2012.
Foreign Currency Translation
The functional currency for the Company’s foreign operations is the local currency. Assets and liabilities of these operations are translated into U.S. currency at the rates of exchange at the balance sheet date. The resulting translation adjustments are included in accumulated other comprehensive income, a separate component of stockholders’ equity. Income and expense items are translated at average monthly rates of exchange. Realized gains and losses from foreign currency transactions were not material.
Goodwill and Other Intangibles
Goodwill represents the excess of purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. In accordance with Accounting Standards Codification (“ASC”) 350, Intangibles – Goodwill and Other, goodwill is not amortized, but instead is tested for impairment annually, or more frequently if circumstances indicate a possible impairment may exist. The Company evaluates the recoverability of goodwill using a two-step impairment test. For goodwill impairment test purposes, the Company has two reporting units, United States and International. In the first step, the fair value for the Company is compared to its book value including goodwill. In the case that the fair value is less than the book value, a second step is performed which compares the implied fair value of goodwill to the book value of goodwill. The fair value for the goodwill is determined based on the difference between the fair value of the Company and the net fair values of the identifiable assets and liabilities. If the implied fair value of the goodwill is less than the book value, the difference is recognized as an impairment. Absent any interim indicators of impairment, the Company has elected to test for goodwill impairment during the fourth quarter of each year, and as a result of the 2011 analysis performed, no impairment charges were required.
The following is a summary of the goodwill balance for each operating segment as of March 31, 2012:
| United States | International | Total | ||||||||||
| Balance as of December 31, 2011 | $ | 114,608,290 | $ | 90,674,297 | $ | 205,282,587 | ||||||
| Adjustment of purchase accounting for prior year acquisitions | — | 810,185 | 810,185 | |||||||||
| Foreign exchange impact | — | 2,220,723 | 2,220,723 | |||||||||
| Balance as of March 31, 2012 | $ | 114,608,290 | $ | 93,705,204 | $ | 208,313,495 | ||||||
| 4 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
In accordance with ASC 350, Intangibles – Goodwill and Other, the Company amortizes its intangible assets with finite lives over their respective estimated useful lives and reviews for impairment whenever impairment indicators exist. 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 fourteen years, are being amortized using the economic life method. The Company’s noncompete agreements, trade names and patents are being amortized on the straight-line basis over their estimated weighted-average useful lives of approximately four years, twelve years and ten years, respectively.
The following is a summary of the intangible assets:
| December 31, 2011 | March 31, 2012 | Weighted- Average Life | ||||||||||
| Customer lists | $ | 35,485,590 | $ | 35,597,733 | 14.1 years | |||||||
| Noncompete agreements | 1,077,349 | 1,077,349 | 3.9 years | |||||||||
| Trade names | 3,467,655 | 3,467,655 | 12.4 years | |||||||||
| Patents | 38,456 | 38,456 | 10.0 years | |||||||||
| 40,069,050 | 40,181,193 | |||||||||||
| Less accumulated amortization | (13,503,735 | ) | (14,437,434 | ) | ||||||||
| Intangible assets, net | $ | 26,565,315 | $ | 25,743,759 | ||||||||
Amortization expense related to these intangible assets was $872,072 and $889,248 for the three months ended March 31, 2011 and 2012, respectively.
The estimated amortization expense for the next five years is as follows:
| 2012 | $ | 2,670,167 | ||
| 2013 | 3,080,690 | |||
| 2014 | 2,714,940 | |||
| 2015 | 2,515,253 | |||
| 2016 | 2,367,221 | |||
| Thereafter | 12,395,488 | |||
| $ | 25,743,759 |
| 5 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
Fair Value of Financial Instruments
The Company accounts for its financial assets and liabilities that are measured at fair value within the financial statements in accordance with ASC 820, Fair Value Measurements and Disclosure (ASC 820). ASC 820 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements. In accordance with this interpretation, the Company has only applied ASC 820 with respect to its financial assets and liabilities that are measured at fair value within the financial statements. The Company’s investments in cash equivalents and available-for-sale securities are carried at fair value. See Notes 6 and 7 for additional information on fair value measurements.
Stock-Based Compensation
The Company accounts for stock-based compensation awards in accordance with ASC 718,Compensation-Stock Compensation. Compensation expense is measured by determining the fair value using the Black-Scholes option valuation model and is then recognized over the requisite service period of the awards, which is generally the vesting period, on a straight-line basis for the entire award.
Stock-based compensation cost recognized during the period is based on the portion of the share-based payment awards that are ultimately expected to vest. Accordingly, stock-based compensation cost recognized has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
During the three month periods ended March 31, 2011 and 2012, the Company issued 45,004 and 131,660 options, respectively, to various employees of the Company. In addition, during the three month periods ended March 31, 2011 and 2012, the Company granted 79,976 and 66,593 restricted common shares, respectively, to employees. During the three month periods ended March 31, 2011 and 2012, 107,203 and 1,057,199 options were exercised and restricted common shares vested, respectively. The Company recorded $941,362 and $1,047,645 in compensation expense for the three month periods ended March 31, 2011 and 2012, respectively.
| 2. | Acquisitions |
Prior Year Acquisitions
During the three months ended March 31, 2012, goodwill related to acquisitions made in prior years increased by $3,030,908. The increase is the result of $810,185 of changes to purchase price allocations and $2,220,723 related to foreign currency translation. At March 31, 2012, the purchase accounting for the Company’s acquisition of Productions Graphics from the fourth quarter of 2011 is preliminary and remains subject to change. Specifically, the Company is in the process of determining the fair values of the intangible assets acquired and the contingent consideration liability. Changes to these fair values will also impact the amount of goodwill recorded in connection with this acquisition. The valuations of these items will be completed within one year of the period in which the acquisition occurred.
Contingent Consideration
In connection with certain of the Company’s acquisitions, contingent consideration is payable in cash upon the achievement of certain performance measures over future periods. For acquisitions prior to January 1, 2009, contingent consideration payments will be recorded as additional purchase price. The Company paid $1,500,000 related to these agreements in the three months ended March 31, 2012. Total remaining potential contingent payments under these agreements amount to $1,500,000 as of March 31, 2012. For the acquisitions occurring subsequent to January 1, 2009, the Company has estimated and recorded potential contingent consideration as an increase in purchase price as of the acquisition date. The Company has recorded $83,883,880 in contingent consideration at March 31, 2012 related to these arrangements. Any future adjustments related to the acquisitions occurring after January 1, 2009 to the valuation of contingent consideration will be recorded in the Company’s results from operations.
| 6 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 2. | Acquisitions (Continued) |
As of March 31, 2012, the potential maximum contingent payments are payable as follows:
| 2012 | $ | 17,112,184 | ||
| 2013 | 16,905,533 | |||
| 2014 | 25,091,533 | |||
| 2015 | 48,016,100 | |||
| $ | 107,125,350 |
| 3. | Earnings Per Share |
Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is calculated by dividing net income by the weighted average shares outstanding plus share equivalents that would arise from the exercise of stock options and vesting of restricted common shares. During the three months ended March 31, 2011 and 2012, respectively, 1,144,955 and 769,691 options and restricted common shares were excluded from the calculation as these options and restricted common shares were anti-dilutive. The computations of basic and diluted earnings per common share for the three months ended March 31, 2011 and 2012 are as follows:
| Three Months Ended March 31, | ||||||||
| 2011 | 2012 | |||||||
| Numerator: | ||||||||
| Net income | $ | 2,790,352 | $ | 3,687,688 | ||||
| Denominator: | ||||||||
| Denominator for basic earnings per share—weighted-average shares | 46,128,025 | 47,193,327 | ||||||
| Effect of dilutive securities: | ||||||||
| Employee stock options and restricted common shares | 2,210,999 | 2,820,242 | ||||||
| Denominator for dilutive earnings per share | 48,339,024 | 50,013,569 | ||||||
| Basic earnings per share | $ | 0.06 | $ | 0.08 | ||||
| Diluted earnings per share | $ | 0.06 | $ | 0.07 | ||||
| 4. | Comprehensive Income |
| Three Months Ended March 31, | ||||||||
| 2011 | 2012 | |||||||
| Net income | $ | 2,790,352 | $ | 3,687,688 | ||||
| Other comprehensive income: | ||||||||
| Change in unrealized gain on available-for-sale securities, net of tax | (440,393 | ) | 547,032 | |||||
| Foreign currency translation adjustment | 198,300 | (145,326 | ) | |||||
| Comprehensive income | $ | 2,548,259 | $ | 4,089,394 | ||||
| 7 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 5. | Related Party Transactions |
Investment in Echo Global Logistics, Inc.
In February 2005, the Company acquired 2,000,000 shares of common stock of Echo Global Logistics, Inc. (“Echo”), a technology enabled transportation and logistics business process outsourcing firm, for $125,000. Echo is a related party to the Company as a majority of the members of the Company’s Board of Directors have a direct and/or indirect ownership interest in Echo.
On September 25, 2009, Echo completed a one-for-two reverse stock split of all outstanding shares of its capital stock and immediately following, recapitalized all outstanding shares into newly issued shares of common stock on approximately a one-for-one basis. Echo recapitalized its outstanding capital stock in connection with its initial public offering.
Following Echo’s initial public offering in October 2009, the Company has periodically sold shares of Echo common stock. The Company sold 85,500 and 14,743 of its shares of Echo’s common stock for $984,845 and $249,540 and recorded a gain on sale of investment of $979,501 and $247,697 during the three months ended March 31, 2011 ad 2012, respectively. The Company has classified this investment as “available for sale” and has recorded it at fair value, which is determined based on quoted market prices (refer to Note 6 for additional information on these securities). The gain on sale of investment is included in other income. At March 31, 2012, the Company owned 55,211 shares of Echo’s common stock.
Agreements and Services with Related Parties
The Company provides print procurement services to Echo. The total amount billed for such print procurement services during the three months ended March 31, 2011 and 2012 were approximately $20,000 and $27,000, respectively. In addition, Echo has provided transportation services to the Company. As consideration for these services, Echo billed the Company approximately $1.9 million and $2.2 million for the three months ended March 31, 2011 and 2012, respectively. The net amount payable to Echo at March 31, 2012 was $401,945.
During the second quarter of 2010, the Company entered into an agreement with Groupon, Inc. (“Groupon”) related to corporate procurement cards. The agreement allows Groupon to obtain corporate procurement cards under the Company’s existing credit arrangement. Under the agreement, the Company billed Groupon $24,000 and $32,000 during the three months ended March 31, 2011 and 2012, respectively. The net amount receivable from Groupon was $72,000 at March 31, 2012.
The Company also provides promotional product procurement services to Groupon. The total amount billed for such services during the three months ended March 31, 2011 and 2012 was approximately $241,000 and $184,000, respectively. The net amount receivable from Groupon for these services was $150,086 at March 31, 2012.
The Company provides print procurement services to Arthur J. Gallagher & Co. J. Patrick Gallagher, Jr., who was appointed to the Company’s Board of Directors in August 2011, 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 March 31, 2012 was approximately $139,000. Additionally, Arthur J. Gallagher & Co. provides insurance brokerage and risk management services to the Company. As consideration of these services, Arthur J. Gallagher & Co. billed the Company approximately $52,000 for the three months ended March 31, 2012. The net amount receivable from Arthur J. Gallagher & Co. at March 31, 2012 was $84,377.
| 8 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 6. | Valuation of Equity Investments |
As discussed in Note 1, the Company applies ASC 820,Fair Value Measurement and Disclosure (ASC 820), to its financial assets and liabilities. At March 31, 2012, the Company’s financial assets relate to their available-for-sale securities and are included in short-term investments.
The Company has classified its investment in Echo as “available for sale” in accordance with ASC 320,Investments – Debt and Equity Securities. The investment is stated at fair value based on market prices, with any unrealized gains and losses included as a separate component of stockholders’ equity. Any realized gains and losses and dividends will be included in other income. At March 31, 2012, the Company’s investment in Echo, which has a cost basis of $6,901, was carried at fair value of $888,897. The unrealized gain of $881,996 is included in accumulated other comprehensive income, net of tax of $345,725.
| 7. | 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.
The fair value hierarchy consists of the following three levels:
| • | Level 1: Inputs are quoted prices in active markets for identical assets or liabilities. | |
| • | Level 2: Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable and market-corroborated inputs, which are derived principally from or corroborated by observable market data. | |
| • | Level 3: Inputs that are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. |
The Company's potential contingent consideration payments relating to acquisitions occurring subsequent to January 1, 2009 are its only Level 3 liabilities as of March 31, 2012. The fair values of these liabilities are estimated using a present value analysis as of March 31, 2012. This analysis considers, among other items, the financial forecasts of future operating results of the seller, the probability of reaching the forecast and the associated discount rate.
| 9 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 7. | Fair Value Measurement (Continued) |
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 March 31, 2012 and December 31, 2011, respectively:
| At March 31, 2012 | Total Fair Value Measurement | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets: | ||||||||||||||||
| Money market funds (1) | $ | 1,665,822 | $ | 1,665,822 | $ | — | $ | — | ||||||||
| Available for sale securities (2) | 888,897 | 888,897 | — | — | ||||||||||||
| Total assets | $ | 2,554,719 | $ | 2,554,719 | $ | — | $ | — | ||||||||
| Liabilities: | ||||||||||||||||
| Contingent consideration | $ | (83,883,880 | ) | $ | — | $ | — | $ | (83,883,880 | ) | ||||||
| At December 31, 2011 | Total Fair Value Measurement | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets: | ||||||||||||||||
| Money market funds (1) | $ | 1,664,916 | $ | 1,664,916 | $ | — | $ | — | ||||||||
| Available for sale securities (2) | 1,129,757 | 1,129,757 | — | — | ||||||||||||
| Total assets | $ | 2,794,673 | $ | 2,794,673 | $ | — | $ | — | ||||||||
| Liabilities: | ||||||||||||||||
| Contingent consideration | $ | (82,002,842 | ) | $ | — | $ | — | $ | (82,002,842 | ) | ||||||
| (1) | Included in cash and cash equivalents on the balance sheet. |
| (2) | Included in short-term investments on the balance sheet. |
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):
| Fair Value Measurements at Reporting Date Using Significant Unobservable Inputs (Level 3) | ||||
| Contingent Consideration | ||||
| Balance at December 31, 2011 | $ | (82,002,842 | ) | |
| Contingent payments on acquisitions made after January 1, 2009 | 393,513 | |||
| Contingent consideration - change in fair value (1) | (200,141 | ) | ||
| Foreign exchange impact | (2,074,410 | ) | ||
| Balance as of March 31, 2012 | $ | (83,883,880 | ) | |
| (1) | Adjustments to original contingent consideration obligations recorded were the result of using revised financial forecasts and updated fair value measurements. |
| 10 |
InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 8. | Commitments and Contingencies |
In 2011, in connection with the Circuit City Stores, Inc. (“Circuit City”) bankruptcy proceedings, the Trustee of the Circuit City Liquidating Trust, filed a lawsuit against the Company in United States Bankruptcy Court in the Eastern District of Virginia for the avoidance of payments as allegedly preferential transfers of $3.2 million were paid to the Company during the 90 days preceding the filing of the bankruptcy petition of Circuit City on November 10, 2008. In the second quarter of 2011, the Company accrued a loss reserve of $950,000 related to this claim. Management believes that the Company has an adequate reserve for this liability and the ultimate resolution of this matter will not have a material adverse effect on its financial statements.
In May of 2011, Her Majesty’s Revenue and Customs (“HMRC”) contacted the Company’s U.K. subsidiary, Etrinsic, to request information relating to its position that certain printed matter and direct mail services are zero-rated under the U.K.’s VAT law. Although Etrinsic has voluntarily exchanged information with the HMRC as to its position that the products and services at issue are zero-rated for VAT pursuant to UK law and HMRC’s guidance, HMRC has stated that it disagrees with Etrinsic’s position and in March of 2012, HMRC issued Etrinsic with a VAT assessment of £2,316,008 for VAT periods covering the 2008, 2009, 2010 and 2011 calendar years. Etrinsic has sought independent review of the assessment with HMRC. If the outcome of the independent review is unfavorable, Etrinsic intends to file a legal appeal against HMRC’s assessment at the UK Tax Tribunal. The potential range of loss for this tax liability is £0 to £2,316,008 and in the event of an unfavorable final outcome, Etrinsic may seek indemnification of the taxes from its end customer(s). The Company believes that an unfavorable final outcome is reasonably possible but not probable, and therefore, no reserve has been recorded for this potential loss.
| 9. | Recently Issued Accounting Pronouncements |
In June 2011, the Financial Accounting Standards Board (FASB) amended its standard on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting standard requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of this new standard are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. While the new standard changes the presentation of comprehensive income, there are no changes to components that are recognized in net income or other comprehensive income under current accounting guidance. For interim periods, the standard requires companies to present a total for comprehensive income in either a single continuous statement or two consecutive statements. The Company adopted this standard in the first quarter of 2012.
In September 2011, the FASB amended its standards related to goodwill impairment testing with the objective being to simplify the annual goodwill impairment process by allowing entities to use qualitative factors first before performing the traditional two-step goodwill impairment test. The two-step impairment test is now only required if an entity determines through this qualitative analysis that it is more likely than not that the fair value of the reporting unit is less than its carrying value. Adoption of the new standard was permitted for the Company’s fourth quarter 2011 impairment test, but the Company elected to perform the traditional two-step test until a further assessment could be made. The Company has not yet determined if this standard will be adopted in 2012. Because the measurement of a potential impairment has not changed, the standard will not have an impact on the Company’s consolidated results of operations, financial position or cash flows.
| 10. | Business Segments |
The Company is organized and managed as two business segments, United States and International, and is viewed as two operating segments by the chief operating decision maker for purposes of resource allocation and assessing performance. “Other” consists of shared service activities and unallocated corporate expenses.
Management evaluates the performance of its operating segments based on net revenues and Adjusted EBITDA. 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 with the addition of depreciation and amortization and stock-based compensation expense, less any change in the fair value of contingent consideration liabilities. Management does not evaluate the performance of its operating segments using asset measures.
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InnerWorkings, Inc.
Notes to Consolidated Financial Statements (Unaudited)—(Continued)
| 10. | Business Segments (Continued) |
The table below presents financial information for the Company’s reportable operating segments and Other for the three months periods noted (in thousands):
| United States | International | Other | Total | |||||||||||||
| Three Months Ended March 31, 2012 | ||||||||||||||||
| Total net revenues | $ | 157,616 | $ | 30,930 | $ | — | $ | 188,546 | ||||||||
| Adjusted EBITDA (1) | 14,751 | 292 | (5,485 | ) | 9,558 | |||||||||||
| Three Months Ended March 31, 2011 | ||||||||||||||||
| Total net revenues | $ | 126,368 | $ | 18,813 | $ | — | $ | 145,181 | ||||||||
| Adjusted EBITDA (1) | 9,260 | 1,388 | (3,369 | ) | 7,279 | |||||||||||
| (1) | Adjusted EBITDA, which represents income from operations with the addition of depreciation and amortization, stock-based compensation expense and any change in the fair value of contingent consideration liabilities, is considered a non-GAAP financial measure under SEC regulations. Income from operations is the most directly comparable financial measure calculated in accordance with GAAP. The Company presents this measure as supplemental information to help investors better understand trends in its business results over time. The Company’s management team uses adjusted EBITDA to evaluate the performance of the business. Adjusted EBITDA is not equivalent to any measure of performance required to be reported under GAAP, nor should this data be considered an indicator of our overall financial performance and liquidity. Moreover, the adjusted EBITDA definition the Company uses may not be comparable to similarly titled measures reported by other companies. |
The table below reconciles the total of the reportable segments' Adjusted EBITDA and the Adjusted EBITDA included in Other to consolidated earnings before income taxes (in thousands):
| Three Months Ended March 31, | ||||||||
| 2011 | 2012 | |||||||
| Adjusted EBITDA | $ | 7,279 | $ | 9,558 | ||||
| Stock-based compensation | (941 | ) | (1,048 | ) | ||||
| Depreciation and amortization | (2,422 | ) | (2,444 | ) | ||||
| Change in fair value of contingent consideration | — | (200 | ) | |||||
| Total other income (expense) | 386 | (260 | ) | |||||
| Income before income taxes | $ | 4,302 | $ | 5,606 | ||||
| 11. | Subsequent Events |
On April 20, 2012, the Company entered into a first amendment (the “First Amendment”) to its Credit Agreement, dated as of August 2, 2010, among the Company, the lenders party thereto and Bank of America, N.A., as Administrative Agent (the “Credit Agreement”). The First Amendment to the Credit Agreement: (i) increases the revolving commitment amount by $50 million, to $150 million in the aggregate, and provides the Company the right to increase the aggregate commitment amount by an additional $25 million, to $175 million; (ii) extends the maturity date of the revolving credit facility from August 2, 2014 to August 2, 2015; (iii) decreases the ranges of applicable rates charged for interest on outstanding loans and letters of credit by 0.35%, from 2.50%-1.50% to 2.15%-1.15% for letter of credit fees and loans based on the Eurodollar rate and from 1.50%-0.50% to 1.15%-0.15% for loans based on the base rate; and (iv) permits the Company to incur certain securitization transactions of up to $50 million in the aggregate, so long as certain tests are met, including a maximum Consolidated Leverage Ratio test (as defined in the First Amendment) and a minimum Consolidated EBITDA test (as defined in the First Amendment). In the event the Company elects to incur securitization transactions in the future pursuant to (iv) above, (a) a new mandatory prepayment test will be implemented that will trigger prepayments based on the sum of the total outstanding borrowings under the revolving credit facility and any such securitization transaction measured against certain of the Company’s account receivables and (b) the quarterly maximum Consolidated Leverage Ratio test will be adjusted from 3.00:1.00 to 2.75:1.00.
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Overview
We are a leading global marketing supply chain company. With proprietary technology, an extensive supplier network and deep domain expertise, the Company procures, manages and delivers printed materials and promotional products as part of a comprehensive outsourced enterprise solution. Our technology is designed to capitalize on excess manufacturing capacity and other inefficiencies in the traditional print supply chain to obtain favorable pricing and to deliver high-quality products and services for our clients.
Our proprietary software applications and database, PPM4™, create a fully-integrated solution that stores, analyzes and tracks the production capabilities of our supplier network, as well as quote and price data for each bid we receive and print job we execute. As a result, we believe PPM4™ contains one of the largest independent repositories of equipment profiles and price data for print suppliers in the United States. We leverage our technology to match each print job with the supplier that is optimally suited to meet the client’s needs at a highly competitive price. Our procurement managers use PPM4™ to manage the print procurement process from end-to-end.
Through our supplier network of approximately 9,000 suppliers, we offer a full range of print, fulfillment and logistics services that allows us to procure printed products on virtually any substrate. The breadth of our product offerings and services and the depth of our supplier network enable us to fulfill all of the print procurement needs of our clients. By leveraging our technology platform, 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 print procurement activity on an enterprise-wide basis provides our clients with greater visibility and control of their print expenditures.
Since 2002, we have expanded from a regional focus to a national and then international focus with the acquisitions of CPRO, a leading provider of print solutions in Latin America, and Productions Graphics, a leading print management firm with a particular strength in continental Europe, in 2011. We operate in 44 different countries. Our operations are organized into two segments based on geographic regions: United States and International. The United States segment includes operations in the United States, and the International segment includes operations in the United Kingdom, continental Europe and Latin America. In the three months ended March 31, 2012, we generated revenues of $157.6 million in the United States segment and $30.9 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 major print markets in the United States and internationally. We intend to hire or acquire more account executives within close proximity to these large markets.
Revenue
We generate revenue through the sale of printed products to our clients. Our revenue was $145.2 million and $188.5 million during the three months ended March 31, 2011 and 2012, respectively. Total revenue increased 30% from the prior year of which 21% was from organic growth. Our revenue is generated from two different types of clients: enterprise and middle market/transactional. Enterprise jobs usually involve higher dollar amounts and volume than our middle market/transactional jobs. We categorize a client as an enterprise client if we have a contract with the client for the provision of printing services 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 printing services on a recurring basis. We categorize all other clients as middle market/transactional clients. We enter into contracts with our enterprise clients to provide some or a specific portion of their printed products on a recurring basis. Our contracts with enterprise clients generally have an open-ended term subject to termination by either party upon prior notice ranging from 90 days to twelve months.
Several of our enterprise clients have outsourced substantially all of their recurring print needs to us. We provide printed products to our middle market/transactional clients on an order-by-order basis. During the three months ended March 31, 2012, enterprise clients accounted for 79% of our revenue, while middle market/transactional clients accounted for 21% of our revenue.
Our revenue consists of the prices paid by our clients for printed products. 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 middle market/transactional clients, is 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 its production costs and we invoice our client.
Our revenue from enterprise clients tends to generate lower gross profit margins than our revenue from middle market/transactional clients because the gross profit margins established in our contracts with large enterprise clients are generally lower than the gross profit margins we typically realize in our middle market/transactional business. Although our enterprise revenue generates lower gross profit margins, our enterprise business tends to be as profitable as our middle market/transactional business on an operating profit basis because the commission expense associated with enterprise jobs is generally lower.
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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 jobs, is based on a fixed gross margin established by contract or, in the case of middle market/transactional jobs, is determined at the discretion of the account executive or procurement manager within predetermined parameters. Our gross margins on our enterprise jobs are typically lower than our gross margins on our middle market/transactional jobs. As a result, our cost of goods sold as a percentage of revenue for our enterprise jobs is typically higher than it is for our middle market/transactional jobs. Our gross profit for the three months ended March 31, 2011 and 2012 was $33.3 million and $41.4 million, or 23.0% and 22.0% of revenue, respectively.
Operating Expenses and Income from Operations
Our selling, general and administrative expenses consist of commissions paid to our account executives, compensation costs for our management team and procurement 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 18.6% and 17.5% for the three months ended March 31, 2011 and 2012, respectively.
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, increased to $4.5 million as of March 31, 2012 from $3.6 million as of December 31, 2011.
We agree to provide our clients with printed products that conform to the industry standard of a “commercially reasonable quality,” and our suppliers in turn agree to provide us with products of the same quality. In addition, the quotes we provide our clients 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.
Our income from operations for the three months ended March 31, 2011 and 2012 was $3.9 million and $5.9 million, respectively.
Comparison of three months ended March 31, 2012 and 2011
Revenue
Our revenue by segment for each of the years presented was as follows:
| Three months ended March 31, | ||||||||||||||||
| 2011 | % of Total | 2012 | % of Total | |||||||||||||
| (dollars in thousands) | ||||||||||||||||
| United States | $ | 126,368 | 87.0 | % | $ | 157,616 | 83.6 | % | ||||||||
| International | 18,813 | 13.0 | 30,930 | 16.4 | ||||||||||||
| Revenue | $ | 145,181 | 100.0 | % | $ | 188,546 | 100.0 | % | ||||||||
United States
United States revenue increased by $31.2 million, or 24.7%, from $126.4 million during the three months ended March 31, 2011 to $157.6 million during the three months ended March 31, 2012. This increase in revenue is driven primarily by organic new enterprise and middle market/transactional account growth.
International
International revenue increased by $12.1 million, or 64.4%, from $18.8 million during the three months ended March 31, 2011 to $30.9 million during the three months ended March 31, 2012. This increase is due to our expansion into Latin America and continental Europe through the acquisitions of CPRO and Productions Graphics, respectively, during 2011.
Cost of goods sold
Our cost of goods sold increased by $35.3 million, or 31.6%, from $111.9 million during the three months ended March 31, 2011 to $147.2 million during the three months ended March 31, 2012. The increase is a result of the revenue growth during the three months ended March 31, 2012. Our cost of goods sold as a percentage of revenue increased slightly from 77.0% during the three months ended March 31, 2011 to 78% during the three months ended March 31, 2012.
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Gross Profit
Our gross profit as a percentage of revenue, which we refer to as gross margin, decreased from 23.0% during the three months ended March 31, 2011 to 22.0% during the three months ended March 31, 2012. The decrease is primarily the result of a higher concentration of our business coming from enterprise clients, which generate lower gross margins, and the addition of the South American operations during the first quarter of 2011, which have lower gross margins than the United States operations. Additionally, due to the planned timing of various projects and services Productions Graphics, which was acquired in the fourth quarter of 2011, regularly experiences relatively low margins in the first half of each fiscal year with increasing margins in the second half.
Selling, general and administrative expenses
Selling, general and administrative expenses increased by $6.1 million, or 22.6%, from $27.0 million during the three months ended March 31, 2010 to $33.1 million during the three months ended March 31, 2012. As a percentage of revenue, selling, general and administrative expenses decreased from 18.6% for the three months ended March 31, 2011 to 17.5% for the three months ended March 31, 2012. The increase in selling, general and administrative expenses is primarily due to incremental sales commission and cost of procurement staff to secure new enterprise accounts. The decrease in selling, general and administrative expenses as a percentage of revenue is primarily the result of increased leverage from higher revenue.
Depreciation and amortization
Depreciation and amortization expense remained consistent at $2.4 million during the three months ended March 31, 2011 and 2012.
Income from operations
Income from operations increased by $2.0 million, or 49.8%, from $3.9 million during the three months ended March 31, 2011 to $5.9 million during the three months ended March 31, 2012. As a percentage of revenue, income from operations increased from 2.7% during the three months ended March 31, 2011 to 3.1% during the three months ended March 31, 2012. The increase in income from operations as a percentage of revenue is a result of our decrease in selling, general and administrative expenses as a percentage of revenue.
Other income and expense
Other income decreased by $0.7 million from income of $0.4 million for the three months ended March 31, 2011 to a loss of $0.3 million during the three months ended March 31, 2012. The decrease is due to a decrease in the gain on sale of Echo shares.
Income tax expense
Income tax expense increased by $0.4 million, or 26.9%, from $1.5 million during the three months ended March 31, 2011 to $1.9 million during the three months ended March 31, 2012. Our effective tax rate was 35.1% and 34.2% for the three month periods ended March 31, 2011 and 2012, respectively. The decrease in the effective tax rate is due to our international expansion in to countries with lower statutory tax rates, offset by the United States research and development tax credit which expired at the end of 2011 and has not been renewed for 2012.
Net income
Net income increased by $0.9 million, or 32.2%, from $2.8 million during the three months ended March 31, 2011 to $3.7 million during the three months ended March 31, 2012. Net income as a percentage of revenue was 1.9% and 2.0% during the three months ended March 31, 2011 and 2012, respectively.
Liquidity and Capital Resources
At March 31, 2012, we had $15.7 million of cash and cash equivalents and $0.9 million in available-for-sale securities.
Operating Activities. Cash used in operating activities primarily consists of net income adjusted for certain non-cash items, including depreciation and amortization, and the effect of changes in working capital and other activities. Cash used in operating activities for the three months ended March 31, 2012 was $7.5 million and consisted of net income of $3.7 million, $0.4 million of non-cash items and $11.6 million used by working capital and other activities. The most significant impact on working capital and other activities consisted of an increase in accounts receivable and unbilled revenue of $22.8 million and an increase in prepaid expenses and other of $10.3 million offset by an increase in accounts payable of $16.0 million.
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Cash provided by operating activities for the three months ended March 31, 2011 was $7.1 million and consisted of net income of $2.8 million, $2.9 million of non-cash items and $1.4 million provided by working capital and other activities. The most significant impact on working capital and other activities consisted of an increase in accounts receivable and unbilled revenue of $18.0 million and an increase in accounts payable of $22.6 million, offset by an increase in prepaid expenses and other of $7.8 million.
Investing Activities. Cash used in investing activities in the three months ended March 31, 2012 of $3.2 million was attributable to payments made in connection with acquisitions of $1.6 million and capital expenditures of $1.9 million, offset by proceeds from the sale of Echo shares and other investments of $0.3 million.
Cash used in investing activities in the three months ended March 31, 2011 of $6.1 million was attributable to capital expenditures of $1.8 million and $5.3 million in payments made in connection with acquisitions, offset by the proceeds on sale of Echo shares of $1.0 million.
Financing Activities. Cash provided by financing activities in the three months ended March 31, 2012 of $12.9 million was primarily attributable to the $11.4 million of borrowings under the revolving credit facility and $4.2 million of excess tax benefits over compensation cost on exercised stock awards offset by $3.2 million of payments of contingent consideration.
Cash provided by financing activities in the three months ended March 31, 2011 of $0.5 million was primarily attributable to the $0.5 million of borrowings under the revolving credit facility.
In May of 2011, Her Majesty’s Revenue and Customs (“HMRC”) contacted our U.K. subsidiary, Etrinsic, to request information relating to its position that certain printed matter and direct mail services are zero-rated under the U.K.’s VAT law. Although Etrinsic has voluntarily exchanged information with the HMRC as to its position that the products and services at issue are zero-rated for VAT pursuant to UK law and HMRC’s guidance, HMRC has stated that it disagrees with Etrinsic’s position and in March of 2012, HMRC issued Etrinsic with a VAT assessment of £2,316,008 for VAT periods covering the 2008, 2009, 2010 and 2011 calendar years. Etrinsic has sought independent review of the assessment with HMRC. If the outcome of the independent review is unfavorable, Etrinsic intends on filing a legal appeal against HMRC’s assessment at the UK Tax Tribunal. The potential range of loss for this tax liability is £0 to £2,316,008 and in the event of an unfavorable final outcome, Etrinsic may seek indemnification of the taxes from its end customer(s). We believe that an unfavorable final outcome is reasonably possible but not probable, and therefore, no reserve has been recorded for this potential loss.
Although we can provide no assurances, we believe that our available cash and cash equivalents, short-term investments and amounts available under our revolving credit facility will be sufficient to meet our working capital and operating expenditure requirements for the foreseeable future. Thereafter, we may find it necessary to obtain additional equity or debt financing. In the event additional financing is required, we may not be able to raise it on acceptable terms or at all.
Off-Balance Sheet Obligations
We do not have any off-balance sheet arrangements.
Contractual Obligations
With the exception of the contingent consideration in connection with our business acquisitions discussed in Note 2 in the Notes to the Consolidated Financial Statements, there have been no material changes outside the normal course of business in the contractual obligations disclosed in Item 7 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, under the caption “Contractual Obligations.”
Critical Accounting Policies and Estimates
As of March 31, 2012, there were no material changes to our critical accounting policies and estimates disclosed in our Form 10-K for the year ended December 31, 2011.
Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) amended its standard on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting standard requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of this new standard are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. While the new standard changes the presentation of comprehensive income, there are no changes to components that are recognized in net income or other comprehensive income under current accounting guidance. For interim periods, the standard requires companies to present a total for comprehensive income in either a single continuous statement or two consecutive statements. We adopted this standard in the first quarter of 2012.
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In September 2011, the FASB amended its standards related to goodwill impairment testing with the objective being to simplify the annual goodwill impairment process by allowing entities to use qualitative factors first before performing the traditional two-step goodwill impairment test. The two-step impairment test is now only required if an entity determines through this qualitative analysis that it is more likely than not that the fair value of the reporting unit is less than its carrying value. Adoption of the new standard was permitted for our fourth quarter 2011 impairment test, but we elected to perform the traditional two-step test until a further assessment could be made. We have not yet determined if this standard will be adopted in 2012. Because the measurement of a potential impairment has not changed, the standard will not have an impact on our consolidated results of operations, financial position or cash flows.
Forward-Looking Statements
This Quarterly Report on Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains words such as “may,” “will,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “project,” “estimate” and “objective” or the negative thereof or similar terminology concerning the Company’s future financial performance, business strategy, plans, goals and objectives. These expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include information concerning our possible or assumed future performance or results of operations and are not guarantees. While these statements are based on assumptions and judgments that management has made in light of industry experience as well as perceptions of historical trends, current conditions, expected future developments and other factors believed to be appropriate under the circumstances, they are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different. Some of the factors that would cause future results to differ from the recent results or those projected in forward-looking statements include, but are not limited to, the risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2011.
Additional Information
We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, other reports and information filed with the SEC and amendments to those reports available, free of charge, through our Internet website(http://www.inwk.com) as soon as reasonably practical after we electronically file or furnish such materials to the SEC. All of our filings may be read or copied at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the Public Filing Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet website(http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Commodity Risk
We are dependent upon the availability of paper, and paper prices represent a substantial portion of the cost of our products. The supply and price of paper depend on a variety of factors over which we have no control, including environmental and conservation regulations, natural disasters and weather. We believe a 10% increase in the price of paper would not have a significant effect on our consolidated statements of income or cash flows, as these costs are generally passed through to our clients.
Interest Rate Risk
We have exposure to changes in interest rates on our revolving credit facility. Interest is payable at the adjusted LIBOR rate or the alternate base. Assuming our $100.0 million revolving credit facility was fully drawn, a 1.0% increase in the interest rate would increase our annual interest expense by $1.0 million.
Our interest income is sensitive to changes in the general level of United States interest rates, in particular because all of our investments are in cash equivalents and marketable securities. The average duration of our investments as of December 31, 2011 was less than one year. Due to the short-term nature of our investments, we believe that there is no material risk exposure.
Foreign Currency Risk
A portion of our sales and earnings are attributable to operations conducted outside of the United States. The United States dollar value of sales and earnings of these operations varies with currency exchange rate fluctuations. We believe a 10% fluctuation in the currency exchange rate would not have a significant effect on our consolidated statements of income or cash flows.
Item 4. Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2012. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2012, our chief executive officer and chief financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the first quarter ended March 31, 2012 that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not a party to any legal proceedings that we believe would have a material adverse effect on our business, financial condition or operating results. See Note 8 “Commitments and Contingencies” to the financial statements.
Item 1A. Risk Factors
There have been no material changes in the risk factors described in Item 1A (“Risk Factors”) of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
Item 6. Exhibits
| Exhibit No | Description of Exhibit | |
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 10.1 | First Amendment to Credit Agreement, dated as of April 20, 2012, among InnerWorkings, Inc., the lenders party thereto and Bank of America, N.A., as Administrative Agent (incorporated by reference to the Company’s Form 8-K filed on April 26, 2012). | |
| 19 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| INNERWORKINGS, INC. | ||
| Date: May 7, 2012 | By: | /s/ Eric D. Belcher |
Eric D. Belcher Chief Executive Officer | ||
| Date: May 7, 2012 | By: | /s/ Joseph M. Busky |
Joseph M. Busky Chief Financial Officer | ||
| 20 |
EXHIBIT INDEX
| Number | Description | |
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 10.1 | First Amendment to Credit Agreement, dated as of April 20, 2012, among InnerWorkings, Inc., the lenders party thereto and Bank of America, N.A., as Administrative Agent (incorporated by reference to the Company’s Form 8-K filed on April 26, 2012). | |
| 21 |