S-1/A 1 g22513a6sv1za.htm FORM S-1/A sv1za
Table of Contents

As filed with the Securities and Exchange Commission on September 22, 2010
Registration No. 333-165720
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Amendment No. 6
to
Form S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
SCIQUEST, INC.
(Exact name of registrant as specified in its charter)
 
         
Delaware   7372   56-2127592
(State or other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)
 
6501 Weston Parkway, Suite 200
Cary, North Carolina 27513
(919) 659-2100
(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)
 
 
Stephen J. Wiehe
President and Chief Executive Officer
SciQuest, Inc.
6501 Weston Parkway, Suite 200
Cary, North Carolina 27513
(919) 659-2100
(919) 659-2199 (Facsimile)
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
 
 
Copies to:
     
Grant W. Collingsworth, Esq.
Seth K. Weiner, Esq.
Morris, Manning & Martin, LLP
3343 Peachtree Road, N.E.
Atlanta, GA 30326
Phone: (404) 233-7000
Facsimile: (404) 365-9532
  William B. Asher, Jr., Esq.
Lee S. Feldman, Esq.
Choate, Hall & Stewart LLP
Two International Place
Boston, MA 02110
Phone: (617) 248-5000
Facsimile: (617) 248-4000
 
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effectiveness of this registration statement.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer þ Smaller reporting company o
(Do not check if a smaller reporting company)
 
CALCULATION OF REGISTRATION FEE
 
                         
            Proposed Maximum
    Proposed Maximum
     
Title of Securities
    Amount to be
    Aggregate Offering
    Aggregate Offering
    Amount of
to be Registered     Registered(1)     Price Per Share     Price(1)(2)     Registration Fee
Shares of Common Stock, $0.001 par value per share
    6,900,000     $11.50     $79,350,000     $5,658(3)
                         
 
 
(1) Includes 900,000 shares of common stock that the underwriters have the option to purchase solely to cover over-allotments, if any.
 
 
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
 
 
(3) Previously paid.
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant files a further amendment which specifically states that this Registration Statement will thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement becomes effective on such dates as the Commission, acting pursuant to said Section 8(a), may determine.
 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.
 
 
SUBJECT TO COMPLETION, DATED SEPTEMBER 22, 2010
 
PRELIMINARY PROSPECTUS
 
(SCIQUEST LOGO)
 
6,000,000 Shares
Common Stock
$      per share
 
 
SciQuest, Inc. is selling 6,000,000 shares of our common stock. The selling stockholders have granted the underwriters a 30-day option to purchase up to an additional 900,000 shares of common stock to cover over-allotments, if any. We will not receive any of the proceeds from the sale of the shares of the selling stockholders.
 
 
This is an initial public offering of our common stock. We currently expect the initial public offering price to be between $9.50 and $11.50 per share. We have applied for approval for quotation of our common stock on the NASDAQ Global Market under the symbol “SQI.”
 
Investing in our common stock involves risks. See “Risk Factors” beginning on page 11.
 
 
                         
    Per Share   Total    
 
Initial public offering price
  $                $                     
Underwriting discount
  $       $            
Proceeds, before expenses, to us
  $       $          
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
 
Stifel Nicolaus Weisel  
  William Blair & Company  
              JMP Securities  
  Pacific Crest Securities
The date of this prospectus is          , 2010.


Table of Contents

 

(SCIQUEST)


 

 
TABLE OF CONTENTS
 
     
    Page
 
  1
  11
  27
  28
  29
  30
  31
  33
  38
  63
  78
  84
  99
  101
  103
  107
  109
  113
  118
  118
  118
  118
  F-1
 EX-23.1
 
 
You should rely only on the information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. We have not, and the underwriters have not, authorized anyone to provide you with additional information or information different from that contained in this prospectus. This prospectus is not an offer to sell, nor is it seeking offers to buy, shares of our common stock in jurisdictions where offers and sales are not permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock. Our business, prospects, financial condition and results of operations may have changed since that date.
 
Through and including          , 2010 (the 25th day after the date of this prospectus), all dealers that effect transactions in shares of our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.
 
This prospectus contains registered and unregistered trademarks, service marks, trade names and references to intellectual property owned by other companies. All trademarks, service marks and trade names appearing herein are the property of their respective holders. We obtained industry and market data used throughout this prospectus through our research, surveys and studies conducted by third parties and industry and general publications. We have not independently verified market and industry data from third-party sources.


Table of Contents

 
PROSPECTUS SUMMARY
 
The following summary highlights information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus, including the section entitled “Risk Factors,” before making a decision to invest in shares of our common stock. In this prospectus, references to “our company,” “we,” “us,” and “our” mean SciQuest, Inc., a Delaware corporation. Unless otherwise indicated, the information contained in this prospectus assumes (1) the shares of common stock to be sold in this offering are sold at $10.50 per share, which is the mid-point of our filing range, and (2) no exercise by the underwriters of their overallotment option to purchase up to an additional 900,000 shares of common stock from the selling stockholders. Except as otherwise indicated, all share and per share information referenced in this prospectus has been adjusted to reflect the one-for-two reverse split of our common stock that occurred on September 20, 2010.
 
Our Business
 
Overview
 
SciQuest provides a leading on-demand strategic procurement and supplier enablement solution that integrates customers with their suppliers to improve procurement of indirect goods and services. Our on-demand software enables organizations to realize the benefits of strategic procurement by identifying and establishing contracts with preferred suppliers, driving spend to those contracts and promoting process efficiencies through electronic transactions. Using our managed SciQuest Supplier Network, our customers do business with more than 30,000 unique suppliers and spend billions of dollars annually.
 
Our current target markets are higher education, life sciences, healthcare and state and local governments. We tailor our solution for each of the vertical markets we serve by offering industry-specific functionality, content and supplier connections. We serve more than 165 customers operating in 16 countries and offer our solution in five languages and 22 currencies. Our value proposition has led to an average annual customer renewal rate of over 94% over the last three fiscal years. On a dollar basis, our annual renewal rate has been 106% over this same time period solely as a result of pricing increases at the time of renewal. We believe our renewal rates are among the highest for on-demand model companies.
 
Customers pay us subscription fees and implementation service fees for the use of our solution under multi-year contracts that are generally three to five years in length. We typically receive subscription payments annually in advance and implementation service fees as the services are performed, typically within the first three to eight months of contract execution. Our revenues have grown to $36.2 million in 2009 from $20.1 million in 2007, and our Adjusted Free Cash Flow increased to $6.8 million from $3.6 million during this period. Adjusted Free Cash Flow is not determined in accordance with U.S. generally accepted accounting principles, or GAAP, and is not a substitute for or superior to financial measures determined in accordance with GAAP. For further discussion regarding Adjusted Free Cash Flow and a reconciliation of Adjusted Free Cash Flow to cash flows from operations, see footnote 4 to the table in “Summary Financial Data” included elsewhere in this prospectus summary.
 
Industry Background
 
Indirect goods and services procurement is the purchase of the day-to-day necessities of the workplace such as office supplies, laboratory supplies, furniture, computers, MRO (maintenance, repair and operations) supplies, and food and beverages. Indirect goods and services tend to be low cost but are usually bought in high volumes by a wide variety of employees throughout an organization.
 
Our target market for strategic procurement of indirect goods and services is a subset of the broader supply procurement and sourcing application chain management market, which AMR Research estimates in a July 2009 report entitled “The Global Enterprise Application Market Sizing Report, 2008-2013” as a $2.9 billion global opportunity in 2010, growing at an 8% compounded annual growth rate from 2010 through 2013. Based on our


1


Table of Contents

own internal analysis, we believe that our current addressable market is approximately $1.0 billion within our current target markets as follows: higher education ($305 million), life sciences ($300 million), healthcare ($175 million) and state and local government ($250 million).
 
The procurement process for indirect goods and services is often not well-managed or controlled. Characteristics of traditional procurement processes include:
 
  •  Lack of clearly defined procurement guidelines and awareness of preferred suppliers.  In many cases, because processes are cumbersome, ill-defined and time consuming, many employees have difficulty following the procurement approval processes and fail to purchase from preferred suppliers.
 
  •  Limited ability to analyze spend.  Given the lack of automation and centralized reporting, organizations have difficulty analyzing what they are buying from suppliers.
 
  •  Dissatisfied employees.  Manual, non-integrated processes often lead to excess costs, delays and errors, resulting in a frustrating experience for the employee.
 
Efforts to automate the procurement function for indirect goods and services initially consisted of add-on modules to enterprise resource planning, or ERP, systems and first generation procurement systems developed 10 to 15 years ago. The introduction of Software-as-a-Service, or SaaS, strategic procurement solutions within the past few years has enabled buyers and suppliers to transact with each other online more efficiently. However, these offerings still suffer from the fact that they are primarily horizontal solutions that neither provide functionality and content specific to vertical markets nor have a robust supplier network that drives economies of scale.
 
Our Solution
 
We offer an on-demand strategic procurement and supplier enablement solution that enables organizations to more efficiently source indirect goods and services, manage their spend and obtain the benefits of compliance with purchasing policies and negotiating power with suppliers. Our on-demand strategic procurement software suite coupled with our managed supplier network forms our integrated solution, which is designed to achieve rapid and sustainable savings. Our solution provides customers with a set of products and services that enable them to optimize existing procurement processes by automating the entire source-to-settle process. The SciQuest Supplier Network acts as a communications hub that connects our customers to their suppliers.
 
Our solution provides the following key benefits:
 
  •  Significant return on investment (“ROI”).  Our customers are able to achieve significant returns on investment through savings from negotiated discounts, automated requisition/order processing, contract lifecycle management, settlement automation and sourcing.
 
  •  Content and functionality specific to our vertical markets.  Our software has specific configurable content and functionality that meets the unique needs of our targeted vertical markets.
 
  •  Easier access to customers’ supplier network.  Customers can easily access their preferred suppliers using a single solution and avoid the costs and inefficiencies associated with traditional one-to-one supplier management.
 
  •  Greater adoption by employees.  Our intuitive shopping interface provides employees with easy and automated visibility and access to goods and services.
 
  •  Greater adoption by suppliers.  Suppliers typically are motivated to join our network due to ease of enablement and lack of supplier fees.
 
  •  Visibility into spending patterns and activity.  Our solution provides granular detail into user spending behavior and provides detailed analytics that allow organizations to continually improve their purchasing practices.
 
  •  Ease of deployment via integration with existing systems.  Our highly-configurable solution integrates with many leading ERP systems to speed deployment and facilitate the interchange of transaction, accounting, settlement and user data.


2


Table of Contents

 
Our Business Strengths
 
In addition to our differentiated customer solution, we believe our market approach and business model offer specific benefits that are instrumental to our successful growth. These include:
 
  •  Focus on customer value.  We focus extensively on ensuring that customers achieve maximum benefit from our solution, and we proactively engage with our customers to continually improve our software and services.
 
  •  Expertise in our targeted vertical markets.  Our domain expertise allows us to provide our customers with a highly tailored and differentiated solution that is difficult for our competitors to replicate.
 
  •  Extensive content and supplier network.  Suppliers are not charged any fees or transaction costs for purchases consummated through the SciQuest Supplier Network, which facilitates the growth of our network of over 30,000 unique suppliers servicing the higher education, life sciences, healthcare and state and local government markets.
 
  •  Ability to manage costs.  Our culture of lean management principles that extends from our senior management throughout our company has kept our capital expenditures low and helped lower our operating expenses as a percentage of revenues from 95% in 2007 to 72% in 2009.
 
  •  High visibility business model.  The recurring nature of our revenues provides high visibility into future performance, and the upfront payments result in cash flow generation in advance of revenue recognition. For each of the last three fiscal years, greater than 80% of our revenues were recognized from contracts that were in place at the beginning of the year.
 
Our Growth Strategy
 
We seek to become the leading provider of strategic procurement solutions for indirect goods and services. Our key strategic initiatives include:
 
  •  Further penetrating our existing vertical markets.  We will continue to focus our efforts on acquiring new customers in our newer healthcare and state and local government markets while increasing our emphasis on mid-sized customer acquisition opportunities in our core higher education and life sciences markets.
 
  •  Capitalizing on cross-selling opportunities into our installed customer base.  We plan to develop and/or acquire additional modules and products to sell to our existing customers by leveraging our position as a trusted strategic procurement solution vendor in our targeted verticals.
 
  •  Selectively pursuing acquisitions.  We may pursue acquisitions to accelerate our growth, enhance the capabilities of our existing solution, broaden our solution offerings or expand into new verticals or geographies.
 
  •  Selectively expanding into new vertical markets.  We may pursue new vertical expansion through internal product development, sales and marketing initiatives or strategic acquisitions.
 
  •  Investing in international expansion to acquire new customers.  We intend to continue our international expansion by increasing our international direct sales force and establishing additional third-party sales relationships.
 
Risks That We Face
 
Our business is subject to a number of risks that you should understand before making an investment decision. These risks are discussed more fully in the “Risk Factors” section of this prospectus and include but are not limited to the following:
 
  •  our failure to sustain our historical renewal rates, pricing and terms of our customer contracts would adversely affect our operating results;


3


Table of Contents

 
  •  if we are unable to attract new customers, or if our existing customers do not purchase additional products or services, the growth of our business and cash flows will be adversely affected;
 
  •  continued economic weakness and uncertainty, which may result in a significant reduction in spending in our target markets, could adversely affect our business, lengthen our sales cycles and make it difficult for us to forecast operating results accurately;
 
  •  we may experience service failures or interruptions due to defects in the hardware, software, infrastructure, third-party components or processes that comprise our solution, any of which could adversely affect our business;
 
  •  if we do not successfully maintain the SciQuest brand in our existing vertical markets or successfully market the SciQuest brand in new vertical markets, our revenues and earnings could be materially adversely affected;
 
  •  if we are unable to adapt our products and services to rapid technological change, our revenues and profits could be materially and adversely affected;
 
  •  the market for on-demand strategic procurement and supplier enablement solutions is at a relatively early stage of development; if the market for our solution develops more slowly than we expect, our revenues may decline or fail to grow and we may incur operating losses;
 
  •  our customers are concentrated in our targeted vertical markets, and adverse trends or events affecting these markets could adversely affect our revenue growth and profits; and
 
  •  we have been, and may continue to be, subject to claims that we or our technologies infringe upon the intellectual property or other proprietary rights of a third party. Any such claims may require us to incur significant costs, to enter into royalty or licensing agreements or to develop or license substitute technology, which may harm our business.
 
Our Corporate Information
 
We were originally incorporated in November 1995. Our principal executive offices are located at 6501 Weston Parkway, Suite 200, Cary, North Carolina 27513, and our telephone number is (919) 659-2100. Our website address is www.sciquest.com. Information contained on our website is not a part of this prospectus, and the inclusion of our website address in this prospectus is an inactive textual reference only.


4


Table of Contents

THE OFFERING
 
Common stock offered by us 6,000,000 shares
 
Common stock to be outstanding after this offering 20,307,489 shares
 
Over-allotment option offered by selling stockholders 900,000 shares
 
Use of proceeds We estimate that the net proceeds from our sale of shares of common stock in this offering will be approximately $56.1 million. This estimate is based upon an assumed initial public offering price of $10.50 per share, the mid-point of our filing range, less estimated underwriting discounts and commissions and offering expenses payable by us. To the extent the underwriters exercise their over-allotment option, we will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.
 
We intend to use approximately $36.2 million of these net proceeds to redeem all outstanding shares of our preferred stock. We intend to use the remaining net proceeds for working capital and general corporate purposes. We may also use a portion of the proceeds to acquire complementary businesses, products or technologies. We have no agreements or commitments with respect to any acquisitions at this time. By establishing a public market for our common stock, this offering is also intended to facilitate our future access to public markets.
 
Pending the uses described above, we intend to invest the net proceeds of this offering in short- to medium-term, investment-grade, interest-bearing securities, certificates of deposit or direct or guaranteed obligations of the U.S. government.
 
Proposed symbol on the NASDAQ Global Market ‘‘SQI”
 
The number of shares of our common stock outstanding after this offering is based on 14,307,489 shares outstanding as of August 31, 2010 and excludes:
 
  •  an aggregate of 707,173 shares issuable upon the exercise of then outstanding options at a weighted average exercise price of $2.30 per share;
  •  an aggregate of 221,680 shares issuable upon the exercise of then outstanding warrants at a weighted average exercise price of $0.08 per share; and
  •  an aggregate of 1,325,058 shares reserved for issuance under our 2004 Stock Incentive Plan, which includes an increase of 1,000,000 shares approved by our board of directors in August 2010.
 
Except as otherwise indicated, information in this prospectus assumes no exercise of the underwriters’ overallotment option to purchase up to 900,000 additional shares of our common stock from the selling stockholders.


5


Table of Contents

SUMMARY FINANCIAL DATA
 
The following tables summarize the financial data for our business. You should read this summary financial data in conjunction with “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes, all included elsewhere in this prospectus.
 
The summary financial data under the heading “Statements of Operations Data” for each of the three years ended December 31, 2007, 2008 and 2009, under the heading “Non-GAAP Operating Data” relating to Adjusted EBITDA and Adjusted Free Cash Flow for each of the three years ended December 31, 2007, 2008 and 2009 have been derived from our audited annual financial statements, which are included elsewhere in this prospectus.
 
The summary financial data under the heading “Statements of Operations Data” for each of the six months ended June 30, 2009 and 2010, under the heading “Non-GAAP Operating Data” relating to Adjusted EBITDA and Adjusted Free Cash Flow for each of the six months ended June 30, 2009 and 2010 and under the heading “Balance Sheet Data” as of June 30, 2010 have been derived from our unaudited financial statements. In the opinion of management, our unaudited financial statements include all adjustments, consisting only of normal recurring items, except as noted in the notes to the financial statements, necessary for a fair statement of interim periods. The financial information presented for the interim periods has been prepared in a manner consistent with our accounting policies described elsewhere in this prospectus and should be read in conjunction therewith.
 
The pro forma balance sheet data as of June 30, 2010 is unaudited and gives effect to (1) our receipt of estimated net proceeds of $56.1 million from this offering, based on an assumed initial public offering price of $10.50 per share, which is the mid-point of our filing range, after deducting estimated underwriting discounts and offering expenses payable by us, and (2) the redemption of all of our outstanding preferred stock immediately after the consummation of this offering. The pro forma summary financial data is not necessarily indicative of what our financial position or results of operations would have been if this offering had been completed as of the date indicated, nor is this data necessarily indicative of our financial position or results of operations for any future date or period.


6


Table of Contents

                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
    (In thousands, except per share data)  
 
Statements of Operations Data:
                                       
Revenues
  $ 20,107     $ 29,784     $ 36,179     $ 17,406     $ 20,688  
Cost of revenues(1)(2)
    6,101       6,723       7,494       3,748       4,446  
                                         
Gross profit
    14,006       23,061       28,685       13,658       16,242  
                                         
Operating expenses:(1)
                                       
Research and development
    6,908       8,307       8,059       4,360       3,919  
Sales and marketing
    7,213       9,280       10,750       5,346       5,969  
General and administrative
    2,717       3,942       3,703       1,945       2,635  
Litigation settlement and associated legal expenses
                3,189       100        
Amortization of intangible assets
    2,286       537       403       201       151  
                                         
Total operating expenses
    19,124       22,066       26,104       11,952       12,674  
                                         
Income (loss) from operations
    (5,118 )     995       2,581       1,706       3,568  
Interest and other income, net
    118       113       27       31       1,688  
                                         
Income (loss) before income taxes
    (5,000 )     1,108       2,608       1,737       5,256  
Income tax benefit (expense)
          9       16,821             (2,052 )
                                         
Net income (loss)
    (5,000 )     1,117       19,429       1,737       3,204  
Dividends on redeemable preferred stock
    2,207       2,395       2,595       1,261       1,364  
                                         
Net income (loss) attributable to common stockholders
  $ (7,207 )   $ (1,278 )   $ 16,834     $ 476     $ 1,840  
                                         
Net income (loss) attributable to common stockholders per share:
                                       
Basic
  $ (0.53 )   $ (0.09 )   $ 1.20     $ 0.03     $ 0.13  
Diluted
  $ (0.53 )   $ (0.09 )   $ 1.16     $ 0.03     $ 0.13  
Weighted average shares outstanding used in computing per share amounts:
                                       
Basic
    13,492       13,800       14,061       14,008       14,079  
Diluted
    13,492       13,800       14,450       14,397       14,680  
 
                                         
    Year Ended December 31,   Six Months Ended June 30,
    2007   2008   2009   2009   2010
    (In thousands)
 
Non-GAAP Operating Data:
                                       
Adjusted EBITDA(3)
  $ (2,099 )   $ 2,666     $ 7,349     $ 2,603     $ 4,842  
Adjusted Free Cash Flow(4)
  $ 3,636     $ 6,003     $ 6,785     $ (640 )   $ 2,765  
 
                 
    As of June 30, 2010
    Actual   Pro Forma
    (In thousands)
 
Balance Sheet Data:(5)
               
Cash and cash equivalents
  $ 20,195     $ 41,327  
Working capital excluding deferred revenues
    25,089       46,571  
Total assets
    59,807       79,396  
Deferred revenues
    35,508       35,508  
Redeemable preferred stock
    35,436        
Total stockholders’ equity (deficit)
    (14,771 )     40,604  


7


Table of Contents

 
(1) Amounts include stock-based compensation expense, as follows:
 
                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
    (In thousands)  
 
Cost of revenues
  $ 3     $ 25     $ 33     $ 18     $ 31  
Research and development
    56       53       86       42       175  
Sales and marketing
    42       150       83       37       118  
General and administrative
    9       158       163       88       432  
                                         
    $ 110     $ 386     $ 365     $ 185     $ 756  
                                         
 
(2) Cost of revenues includes amortization of capitalized software development costs of:
 
                                         
    Year Ended December 31,     Six Months Ended June 30  
    2007     2008     2009     2009     2010  
    (In thousands)  
 
Amortization of capitalized software development costs
  $ 114     $ 154     $ 167     $ 86     $ 97  
                                         
 
(3) EBITDA consists of net income (loss) plus depreciation and amortization, less interest and other income, net and less income tax benefit (expense). Adjusted EBITDA consists of EBITDA plus our non-cash, stock-based compensation expense and settlement and legal costs related to a patent infringement lawsuit settled in 2009. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure, the one-time costs associated with a non-recurring event and such items as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired.
 
Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash expenditure requirements for such replacements;
  •   Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
  •   Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;
  •   Adjusted EBITDA does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
  •   other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted EBITDA along with these other measures in order to fully evaluate our financial performance.


8


Table of Contents

 
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:
 
                                         
                      Six Months
 
                      Ended
 
    Year Ended December 31,     June 30,  
    2007     2008     2009     2009     2010  
    (In thousands)  
 
Net income (loss)
  $ (5,000 )   $ 1,117     $ 19,429     $ 1,737     $ 3,204  
Depreciation and amortization
    2,909       1,285       1,214       612       518  
Interest and other (income), net
    (118 )     (113 )     (27 )     (31 )     (1,688 )
Income tax expense (benefit)
          (9 )     (16,821 )           2,052  
                                         
EBITDA
    (2,209 )     2,280       3,795       2,318       4,086  
Non-cash, stock-based compensation expense
    110       386       365       185       756  
Litigation settlement and associated legal expenses
                3,189       100        
                                         
Adjusted EBITDA
  $ (2,099 )   $ 2,666     $ 7,349     $ 2,603     $ 4,842  
                                         
 
(4) Free Cash Flow consists of net cash provided by operating activities, less purchases of property and equipment and less capitalization of software development costs. Adjusted Free Cash Flow consists of Free Cash Flow plus one-time settlement and legal costs related to a patent infringement lawsuit in 2009 as well as public stock offering costs incurred in 2010. We use Adjusted Free Cash Flow as a measure of liquidity because it assists us in assessing the company’s ability to fund its growth through its generation of cash. We believe Adjusted Free Cash Flow is useful to an investor in evaluating our liquidity because Adjusted Free Cash Flow and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s liquidity without regard to revenue and expense recognition, which can vary depending upon accounting methods.
 
Our use of Adjusted Free Cash Flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   Adjusted Free Cash Flow does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted Free Cash Flow does not reflect one-time litigation expense payments, which reduced the cash available to us;
  •   Adjusted Free Cash Flow does not include public stock offering costs;
  •   Adjusted Free Cash Flow removes the impact of accrual basis accounting on asset accounts and non-debt liability accounts; and
  •   other companies, including companies in our industry, may calculate Adjusted Free Cash Flow differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted Free Cash Flow alongside other liquidity measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted Free Cash Flow along with these other measures in order to fully evaluate our liquidity.


9


Table of Contents

 
The following table provides a reconciliation of net cash provided by operating activities to Adjusted Free Cash Flow:
 
                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
    (In thousands)  
 
Net cash provided by operating activities
  $ 4,693     $ 6,582     $ 4,501     $ (278 )   $ 2,373  
Purchase of property and equipment
    (695 )     (480 )     (685 )     (462 )     (379 )
Capitalization of software development costs
    (362 )     (99 )     (220 )           (422 )
                                         
Free Cash Flow
    3,636       6,003       3,596       (740 )     1,572  
Litigation settlement and associated legal expenses
                3,189       100        
Public stock offering costs
                            1,193  
                                         
Adjusted Free Cash Flow
  $ 3,636     $ 6,003     $ 6,785     $ (640 )   $ 2,765  
                                         
 
(5) A $1.00 increase (decrease) in the assumed initial public offering price of $10.50 per share would increase (decrease) cash and cash equivalents, working capital excluding deferred revenues, total assets and total stockholders’ equity (deficit) after this offering by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and estimated offering expenses payable by us.


10


Table of Contents

 
RISK FACTORS
 
An investment in shares of our common stock involves significant risks. In addition to other information in this prospectus, you should carefully consider the following risks before investing in shares of our common stock offered by this prospectus. The occurrence of any of the following risks could materially and adversely affect our business, prospects, financial condition and results of operations, which could cause you to lose all or a significant portion of your investment in shares of our common stock. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. See the section of this prospectus entitled “Special Note Regarding Forward-Looking Statements and Industry Data” for a discussion of forward-looking statements.
 
Risks Related to Our Business and Industry
 
Our failure to sustain our historical renewal rates, pricing and terms of our customer contracts would adversely affect our operating results.
 
We derive, and expect to continue to derive, substantially all of our revenues from our on-demand strategic procurement and supplier enablement solution in the higher education, life sciences, healthcare and state and local government markets. Should our current customers lose confidence in the value or effectiveness of our solution, the demand for our products and services will likely decline, which could materially and adversely affect our renewal rates, pricing and contract terms. Our subscription agreements with customers are typically for a term of three to five years. Over the past three fiscal years, customers have renewed at an average annual rate of over 94%. On a dollar basis, our annual renewal rate has been 106% over this same time period solely as a result of pricing increases at the time of renewal. If our customers choose not to renew their subscription agreements with us at similar rates and on similar or more favorable terms, our business, operating results and financial condition may be materially and adversely affected.
 
If we are unable to attract new customers, or if our existing customers do not purchase additional products or services, the growth of our business and cash flows will be adversely affected.
 
To increase our revenues and cash flows, we must regularly add new customers and, to a somewhat lesser extent, sell additional products and services to our existing customers. If we are unable to hire or retain quality sales personnel, unable to sell our products and services to companies that have been referred to us, unable to generate sufficient sales leads through our marketing programs, or if our existing or new customers do not perceive our solution to be of sufficiently high value and quality, we may not be able to increase sales and our operating results would be adversely affected. In addition, if we fail to sell new products and services to existing or new customers, our operating results will suffer, and our revenue growth, cash flows and profitability may be materially and adversely affected.
 
Continued economic weakness and uncertainty, which may result in a significant reduction in spending in our target markets, could adversely affect our business, lengthen our sales cycles and make it difficult for us to forecast operating results accurately.
 
Our revenues depend significantly on economic conditions in our target markets as well as the economy as a whole. We have experienced, and may experience in the future, reduced spending by our customers and potential customers due to the current financial turmoil and economic weakness affecting the U.S. and global economy, and other macroeconomic factors affecting spending behavior. Many of our customers and potential customers, particularly in the higher education market, have been facing significant budgetary constraints that have limited spending on technology solutions. Continued spending constraints in our target markets may result in slower growth, or reductions, in revenues and profits in the future. In addition, economic conditions or uncertainty may cause customers and potential customers to reduce or delay technology purchases, including purchases of our solution. Our sales cycle may lengthen if purchasing decisions are delayed as a result of uncertain budget availability or if contract negotiations become more protracted or difficult as customers institute additional internal approvals for information technology purchases. These economic conditions could result in reductions in sales of our products and services, longer sales cycles, difficulties in collecting accounts receivable


11


Table of Contents

or delayed payments, slower adoption of new technologies and increased price competition. Any of these events or any significant reduction in spending in the higher education, life sciences, healthcare and state and local government markets would likely harm our business, financial condition, operating results and cash flows.
 
We may experience service failures or interruptions due to defects in the hardware, software, infrastructure, third-party components or processes that comprise our solution, any of which could adversely affect our business.
 
A technology solution as complex as ours may contain undetected defects in the hardware, software, infrastructure, third-party components or processes that are part of the solution we provide. If these defects lead to service failures, we could experience delays or lost revenues during the period required to correct the cause of the defects. Furthermore, from time to time, we have experienced immaterial service disruptions in the ordinary course of business. We cannot be certain that defects will not be found in new products or upgraded modules or that service disruptions will not occur in the future, resulting in loss of, or delay in, market acceptance, which could have an adverse effect on our business, results of operations and financial condition.
 
Because customers use our on-demand strategic procurement and supplier enablement solution for critical business processes, any defect in our solution, any disruption to our solution or any error in execution could cause customers to not renew their contracts with us, prevent potential customers from purchasing our solution and harm our reputation. Although most of our contracts with our customers limit our liability to our customers for these defects, disruptions or errors, we nonetheless could be subject to litigation for actual or alleged losses to our customers’ businesses, which may require us to spend significant time and money in litigation or arbitration or to pay significant settlements or damages. We do not currently maintain any warranty reserves. Defending a lawsuit, regardless of its merit, could be costly and divert management’s attention and could cause our business to suffer.
 
The insurers under our existing liability insurance policy could deny coverage of a future claim for actual or alleged losses to our customers’ businesses that results from an error or defect in our technology or a resulting disruption in our solution, or our existing liability insurance might not be adequate to cover all of the damages and other costs of such a claim. Moreover, we cannot be assured that our current liability insurance coverage will continue to be available to us on acceptable terms or at all. The successful assertion against us of one or more large claims that exceeds our insurance coverage, or the occurrence of changes in our liability insurance policy, including an increase in premiums or imposition of large deductible or co-insurance requirements, could have an adverse effect on our business, financial condition and operating results. Even if we succeed in litigation with respect to a claim, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.
 
If we do not successfully maintain the SciQuest brand in our existing vertical markets or successfully market the SciQuest brand in new vertical markets, our revenues and earnings could be materially adversely affected.
 
We believe that developing, maintaining and enhancing the SciQuest brand in a cost-effective manner is critical in expanding our customer base. Some of our competitors have well-established brands. Although we believe that the SciQuest brand is well established in the higher education and life sciences markets where we have a significant operating history, our brand is less well known in the healthcare and state and local government markets. Promotion of our brand will depend largely on continuing our sales and marketing efforts and providing high-quality products and services to our customers. We cannot be assured that these efforts will be successful in marketing the SciQuest brand, particularly beyond the higher education and life sciences markets. If we are unable to successfully promote our brand, or if we incur substantial expenses in attempting to do so, our revenues and earnings could be materially and adversely affected.
 
If we are unable to adapt our products and services to rapid technological change, our revenues and profits could be materially and adversely affected.
 
Rapid changes in technology, products and services, customer requirements and operating standards occur frequently. These changes could render our proprietary technology and systems obsolete. Any technological


12


Table of Contents

changes that reduce or eliminate the need for a solution that connects purchasing organizations with their suppliers could harm our business. We must continually improve the performance, features and reliability of our products and services, particularly in response to our competition.
 
Our success will depend, in part, on our ability to:
 
•   enhance our existing products and services;
•   develop new products, services and technologies that address the increasingly sophisticated and varied needs of our target markets; and
•   respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
 
We cannot be certain of our success in accomplishing the foregoing. If we are unable, for technical, legal, financial or other reasons, to adapt to changing market conditions or buyer requirements, our market share, business and operating results could be materially and adversely affected.
 
The market for on-demand strategic procurement and supplier enablement solutions is at a relatively early stage of development. If the market for our solution develops more slowly than we expect, our revenues may decline or fail to grow and we may incur operating losses.
 
We derive, and expect in the near-term to continue to derive, substantially all of our revenues from our on-demand strategic procurement and supplier enablement solution in the higher education, life sciences, healthcare and state and local government markets. Our current expectations with respect to growth may not prove to be correct. The market for our solution is at a relatively early stage of development, making our business and future prospects difficult to evaluate. In particular, we have only recently entered the healthcare and state and local government markets, and our penetration of these vertical markets is at a substantially lower level than our penetration of the higher education and life sciences vertical markets.
 
Should our prospective customers fail to recognize, or our current customers lose confidence in, the value or effectiveness of our solution, the demand for our products and services will likely decline. Any significant price compression in our vertical markets as a result of newly introduced solutions or consolidation among our competitors could have a material adverse effect on our business. A number of factors could affect our customers’ assessment of the value or effectiveness of our solution, including the following:
 
•   their comfort with current purchasing and asset management procedures;
•   the costs and resources required to adopt new business procedures;
•   reductions in capital expenditures or technology spending budgets;
•   the price, performance and availability of competing solutions;
•   security and privacy concerns; or
•   general reticence about technology or the Internet.
 
Our customers are concentrated in our targeted vertical markets, which could make us vulnerable to adverse trends or events affecting those markets. The occurrence of any such adverse trends or events in our vertical markets could adversely affect our business.
 
We are also subject to certain risks because of our concentration of customers in the higher education and life sciences markets. For example, approximately 65% of our customers and approximately 56% of our 2009 revenues came from the higher education market. Many of our customers and potential customers in the higher education market have been facing significant budgetary constraints that have limited spending on technology solutions. Continued spending constraints in the higher education market may result in slower growth, or reductions, in our revenues and profits in the future. In addition, the number of potential customers in the higher education market is relatively finite, which could limit our growth prospects. Moreover, our brand is less well known among mid-sized higher education institutions, and unless we are successful in promoting and marketing our brand in this market segment, our sales within the higher education market may not increase. Furthermore, many of our sales opportunities are generated by referrals from existing customers in the higher education market. We believe that institutions in this market are collaborative in nature, and therefore, our failure to provide


13


Table of Contents

a beneficial solution to our existing customers could adversely impact our reputation in the higher education market and our ability to generate new referral customers. With respect to the life sciences market, approximately 23% of our customers and approximately 31% of our 2009 revenues came from the life sciences market. The life sciences industry has been experiencing a period of consolidation, during which many of the large domestic and international pharmaceutical companies have been acquiring mid-sized pharmaceutical companies. The potential consolidation of our life sciences customers may diminish our negotiating leverage and exert downward pressure on our prices or cause us to lose the business of valuable customers who are consolidated with other pharmaceutical companies that are not our customers. If the circumstances described above result in decreased revenues or profitability from our existing customers in the higher education and life sciences markets or reduce our ability to generate new customers in these markets, this would have a material and adverse effect on our overall revenues and profits.
 
In addition, we face certain risks related to the state and local government and healthcare markets which we have recently entered. Approximately 1% of our customers and approximately 4% of our 2009 revenues came from the state and local government market and approximately 11% of our customers and approximately 9% of our 2009 revenues came from the healthcare market. We plan to continue to invest in sales and marketing efforts in these markets, which we believe are important to our future revenue growth. However, we cannot provide assurances that these efforts will be successful. If we are not successful in selling our solution in these markets, or if we incur substantial expenses in attempting to do so, our ability to increase our revenues and earnings could be materially and adversely affected. Furthermore, with respect to the healthcare market, healthcare costs have risen significantly over the past decade and numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry, including hospitals. This has resulted in greater pricing and other competitive pressures and the exclusion of certain suppliers from important market segments. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the national and worldwide healthcare industry, resulting in further business consolidations and alliances among customers and competitors. Healthcare reform legislation may exacerbate these potential challenges and impact our relationship with our healthcare customers in unanticipated ways. To the extent that our sales are concentrated in these markets, consolidation may reduce competition, exert downward pressure on the prices of our products and adversely impact our business, financial condition or results of operations.
 
We have been, and may continue to be, subject to claims that we or our technologies infringe upon the intellectual property or other proprietary rights of a third party. Any such claims may require us to incur significant costs, to enter into royalty or licensing agreements or to develop or license substitute technology, which may harm our business.
 
The on-demand strategic procurement and supplier enablement market is characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by litigation based on allegations of infringement or other violations of intellectual property rights. As we seek to extend our solution, we could be constrained by the intellectual property rights of others. We have been, and may in the future be, subject to claims that our technologies infringe upon the intellectual property or other proprietary rights of a third party. While we believe that our products do not infringe upon the proprietary rights of third parties, we cannot guarantee that third parties will not assert infringement claims against us in the future, particularly with respect to technology that we acquire through acquisitions of other companies.
 
In February 2010, we received a letter from a company offering us a license to certain of its patent rights. We have reviewed the offer and do not believe that a license is required or that our products infringe that company’s patent rights. We cannot guarantee that this company will not assert a patent infringement claim against us in the future or that we would prevail should a patent infringement claim be asserted.
 
We might not prevail in any intellectual property infringement litigation, given the complex technical issues and inherent uncertainties in such litigation. Defending such claims, regardless of their merit, could be time-consuming and distracting to management, result in costly litigation or settlement, cause development delays, or require us to enter into royalty or licensing agreements. We generally provide in our customer agreements that


14


Table of Contents

we will indemnify our customers against third-party infringement claims relating to our technology provided to the customer, which could obligate us to fund significant additional amounts. If our products are found to have violated any third-party proprietary rights, we could be required to withdraw those products from the market, re-develop those products or seek to obtain licenses from third parties, which might not be available on reasonable terms or at all. Any efforts to re-develop our products, obtain licenses from third parties on favorable terms or license a substitute technology might not be successful and, in any case, might substantially increase our costs and harm our business, financial condition and operating results. Withdrawal of any of our products from the market could have a material adverse effect on our business, financial condition and operating results.
 
We are subject to a lengthy sales cycle and delays or failures to complete sales may harm our business and result in slower growth.
 
Our sales cycle may take several months to over a year. Furthermore, we expect to experience relatively longer sales cycles as we expand into the healthcare and state and local government markets. During this sales cycle, we may expend substantial resources with no assurance that a sale will ultimately result. The length of a customer’s sales cycle depends on a number of factors, many of which we may not be able to control, including the following:
 
•   potential customers’ internal approval processes;
•   budgetary constraints for technology spending;
•   customers’ concerns about implementing new procurement methods and strategies; and
•   seasonal and other timing effects.
 
Any lengthening of the sales cycle could delay our revenue recognition and cash generation and could cause us to expend more resources than anticipated. If we are unsuccessful in closing sales or if we experience delays, it could have a material adverse effect on our operating results.
 
Our cash flows, quarterly revenues and operating results have fluctuated in the past and may fluctuate in the future due to a number of factors. As a result, we may fail to meet or exceed the expectations of securities analysts or investors, which could cause our stock price to decline.
 
Our cash flows, quarterly revenues and operating results have varied in the past and may fluctuate in the future. As a result, you should not rely on the results of any one quarter as an indication of future performance and period-to-period comparisons of our revenues and operating results may not be meaningful.
 
Fluctuations in our quarterly results of operations may be due to a number of factors including, but not limited to, those listed below and others identified throughout this “Risk Factors” section:
 
•   concentrated sales to large customers;
•   our ability to retain and increase sales to existing customers and to attract new customers;
•   the timing and success of new product and module introductions or upgrades by us or our competitors;
•   changes in our pricing policies or those of our competitors;
•   renewal rates of existing customers;
•   potential consolidation among our customers within the life sciences market;
•   potential foreign currency exchange gains and losses associated with expenses and sales denominated in currencies other than the U.S. dollar;
•   the amount and timing of expenditures related to development, adaptation or acquisition of technologies, products or businesses;
•   competition, including entry into the industry by new competitors and new offerings by existing competitors; and
•   general economic, industry and market conditions that impact expenditures for technology solutions in our target markets.
 
Such fluctuations might lead analysts to change their models for valuing our common stock. As a result, our stock price could decline rapidly and we could face costly securities class action suits or other unanticipated issues.


15


Table of Contents

Our future profitability and cash flows are dependent upon our ability to control expenses.
 
Our operating plan to maintain profitability is based upon estimates of our future expenses. For instance, we expect our operating expenses to increase in 2010 as compared to 2009 in order to support anticipated revenue growth. Furthermore, as a public company, we will incur significant legal, accounting and other expenses that we have not incurred as a private company. If our future expenses are greater than anticipated, our ability to maintain profitability may be negatively impacted. Greater than anticipated expenses may negatively impact our cash flows, which could cause us to expend our capital faster than anticipated. Also, a large percentage of our expenses are relatively fixed, which may make it difficult to reduce expenses significantly in the future.
 
Our future revenue growth could be impaired if our investment in direct and indirect sales channels for our products is unsuccessful.
 
We have invested significant time and resources in developing our direct sales force and our indirect sales channels. Sales through our direct sales force represent the primary source of our revenues. We supplement our direct sales force with indirect sales channels for our products through relationships with suppliers, enterprise resource planning, or ERP, providers, technology providers and purchasing consultants and consortia. We cannot be assured that our direct or indirect sales channels will be successful or that we will be able to develop additional indirect sales channels to support our direct sales channel. If our direct sales efforts, and to a lesser extent our indirect sales efforts, are not effective, our ability to achieve revenue growth may be impaired. As we develop additional indirect sales channels, we may experience conflicts with our direct sales force to the extent that these sales channels target the same customer bases. Successful management of these potential conflicts will be necessary in order to maximize our revenue growth.
 
If we are unable to facilitate the use of our implementation services by our customers in an optimal manner, the effectiveness of our customers’ use of our solution would be negatively impacted, resulting in harm to our reputation, business and financial performance.
 
The use of our solution typically includes implementation services to facilitate the optimal use of our solution. For example, in delivering our services, we typically work closely with customer personnel to improve the customer’s procurement process, enable the customer’s suppliers on the SciQuest Supplier Network, assist suppliers in loading product catalogs and support organizational activities to assist our customer’s transition to our strategic procurement and supplier enablement solution. These activities require substantial involvement and cooperation from both our customers and their suppliers. If we do not receive sufficient support from either the customer or its suppliers, then the optimal use of our services by the customer may be adversely impacted, resulting in lower customer satisfaction and negatively affecting our business, reputation and financial performance.
 
If we are not able to successfully create internal efficiencies for our customers and their suppliers, our operating costs and relationships with our customers and their suppliers will be adversely affected.
 
A key component of our products and services is the efficiencies created for our customers and their suppliers. In order to create these efficiencies, it is typically necessary for our solution to work together with our customer’s internal systems such as inventory, customer service, technical service, ERP systems and financial systems. If these systems do not create the anticipated efficiencies, relationships with our customers will be adversely affected, which could have a material adverse affect on our financial condition and results of operations.
 
We expect to develop and acquire new product and service offerings with no guarantee of success.
 
Expanding our product and service offerings is an important component of our business strategy. Any new offerings that are not favorably received by prospective customers could damage our reputation or brand name. Expansion of our services will require us to devote a significant amount of time and money and may strain our management, financial and operating resources. We cannot be assured that our development or acquisition efforts will result in commercially viable products or services. In addition, we may bear development and


16


Table of Contents

acquisition costs in current periods that do not generate revenues until future periods, if at all. To the extent that we incur expenses that do not result in increased current or future revenues, our earnings may be materially and adversely affected.
 
Our failure to raise additional capital or generate cash flows necessary to expand our operations and invest in new technologies could reduce our ability to compete successfully and adversely affect our results of operations.
 
We have funded our business through our cash flows from operations since the going private transaction in 2004. We may need to raise additional funds to achieve our future strategic objectives, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our security holders may experience significant dilution of their ownership interests and the value of shares of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness, force us to maintain specified liquidity or other ratios or restrict our ability to pay dividends or make acquisitions. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:
 
•   develop and enhance our solution;
•   continue to expand our technology development, sales and/or marketing organizations;
•   hire, train and retain employees; or
•   respond to competitive pressures or unanticipated working capital requirements.
 
Our inability to do any of the foregoing could reduce our ability to compete successfully and adversely affect our results of operations.
 
Product development delays could damage our reputation and sales efforts.
 
Developing new products and updated versions of our existing products for release at regular intervals is important to our business efforts. At times, we may experience delays in our development process that result in new releases being delayed or lacking expected features or functionality. New product or version releases that are delayed or do not meet expectations may result in customer dissatisfaction, which in turn could damage significantly our reputation and sales efforts. Such damage to our reputation and sales efforts could negatively impact our operating results.
 
The market for on-demand strategic procurement and supplier enablement solutions is highly competitive, which makes achieving market share and profitability more difficult.
 
The market for on-demand strategic procurement and supplier enablement solutions is rapidly evolving and intensely competitive. We experience competition from multiple sources, which makes it difficult for us to develop a comprehensive business strategy that addresses all of these competitive factors. We face competition from other on-demand strategic procurement and supplier enablement solution providers, large enterprise application providers, smaller market-specific vendors and internally developed and maintained solutions. Competition is likely to intensify as this market matures.
 
As competitive conditions intensify, competitors may:
 
•   devote greater resources to marketing and promotional campaigns;
•   devote substantially more resources to product development;
•   secure exclusive arrangements with indirect sales channels that impede our sales;
•   develop more extensive client bases and broader client relationships than we have; and
•   enter into strategic or commercial relationships with larger, more established and well-financed companies.
 
In addition, some of our competitors may have longer operating histories and greater name recognition than we have. New technologies and the expansion of existing technologies may increase competitive pressures. As a result of increased competition, we may experience reduced operating margins, as well as loss of market share and brand recognition. We may not be able to compete successfully against current and future competitors.


17


Table of Contents

These competitive pressures could have a material adverse effect on our revenue growth and results of operations.
 
Mergers or other strategic transactions involving our competitors could weaken our competitive position, limit our growth prospects or reduce our revenues.
 
We believe that our industry is highly fragmented and that there is likely to be consolidation, which could lead to increased price competition and other forms of competition. Increased competition may cause pricing pressure and loss of market share, either of which could have a material adverse effect on our business, limit our growth prospects or reduce our revenues. Our competitors may establish or strengthen cooperative relationships with strategic partners or other parties. Established companies may not only develop their own products but may also merge with or acquire our current competitors. It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Any of these circumstances could materially and adversely affect our business and operating results.
 
Interruptions or delays from third-party data centers could impair the delivery of our solution, which could cause our business to suffer.
 
We use two third-party data centers, our primary operating center located in Raleigh, North Carolina and a fully redundant disaster recovery platform located in Scottsdale, Arizona, to conduct our operations. Our solution resides on hardware that we own and operate in these locations. Our operations depend on the protection of the equipment and information we store in these third-party data centers against damage or service interruptions that may be caused by fire, flood, severe storm, power loss, telecommunications failures, unauthorized intrusion, computer viruses and disabling devices, natural disasters, war, criminal acts, military action, terrorist attacks and other similar events beyond our control. A prolonged service disruption affecting our solution for any of the foregoing reasons could damage our reputation with current and potential customers, expose us to liability and cause us to lose recurring revenue customers or otherwise adversely affect our business. We may also incur significant costs for using alternative equipment or taking other actions in preparation for, or in reaction to, events that damage the data centers we use.
 
Our on-demand strategic procurement and supplier enablement solution is accessed by a large number of customers at the same time. As we continue to expand the number of our customers and products and services available to our customers, we may not be able to scale our technology to accommodate the increased capacity requirements, which may result in interruptions or delays in service. In addition, the failure of our third-party data centers to meet our capacity requirements could result in interruptions or delays in our solution or impede our ability to scale our operations. In the event that our data center arrangements are terminated, or there is a lapse of service or damage to such facilities, we could experience interruptions in our solution as well as delays and additional expenses in arranging new facilities and services.
 
If we are unable to protect our intellectual property rights, our business could be materially and adversely affected.
 
Any misappropriation of our technology or the development of competing technology could seriously harm our business. We regard a substantial portion of our software products as proprietary and rely on a combination of patent, copyright, trademark, trade secrets, customer license agreements and employee and third-party confidentiality agreements to protect our intellectual property rights. These protections may not be adequate, and we cannot be assured that they will prevent misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect proprietary rights as fully as do the laws of the U.S. Other companies could independently develop similar or competing technology without violating our proprietary rights. The process of enforcing our intellectual property rights through legal proceedings would likely be burdensome and expensive, and our ultimate success cannot be assured. Our failure to protect adequately our intellectual property and proprietary rights could adversely affect our business, financial condition and results of operations.


18


Table of Contents

We utilize proprietary technology licensed from third parties, the loss of which could be costly.
 
We license a portion of the proprietary technology for our products and services from third parties. These third-party licenses may not be available to us on favorable terms, or at all, in the future. In addition, we must be able to integrate successfully this proprietary technology in a timely and cost-effective manner to create an effective finished product. If we fail to obtain the necessary third-party licenses on favorable terms or are unable to integrate successfully this proprietary technology on favorable terms, it could have a material adverse effect on our business operations.
 
Our SciQuest Supplier Network incorporates content from suppliers that is critical to the effectiveness of our products.
 
A critical component of our solution is the SciQuest Supplier Network, which is the single integration point between our customers and all of their suppliers that provides customers with on-demand access to comprehensive and up-to-date multi-commodity supplier catalogs. These catalogs and other content are provided to us by each supplier for integration into our platform, which requires a high degree of involvement and cooperation from the suppliers. We must be able to integrate successfully this content in a timely manner in order for our customers to realize the full benefit of our solution. Also, any errors or omissions in the content provided by the suppliers may reflect poorly on our solution. If we are unable to successfully incorporate supplier content into our platform or if such content contains errors or omissions, then our products may not meet customer needs or expectations, and our business and reputation may be materially and adversely affected.
 
A failure to protect the integrity and security of our customers’ information could expose us to litigation, materially damage our reputation and harm our business, and the costs of preventing such a failure could adversely affect our results of operations.
 
Our business involves the collection and use of confidential information of our customers and their trading partners. We cannot be assured that our efforts to protect this confidential information will be successful. If any compromise of this information security were to occur, we could be subject to legal claims and government action, experience an adverse effect on our reputation and need to incur significant additional costs to protect against similar information security breaches in the future, each of which could adversely affect our financial condition, results of operations and growth prospects. In addition, because of the critical nature of data security, any perceived breach of our security measures could cause existing or potential customers not to use our solution and could harm our reputation.
 
Our use of “open source” software could negatively affect our ability to sell our solution and subject us to possible litigation.
 
A portion of the technologies licensed by us incorporate so-called “open source” software, and we may incorporate open source software in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses. If we fail to comply with these licenses, we may be subject to certain conditions, including requirements that we offer the portion of our solution that incorporates the open source software for no cost, that we make available source code for modifications or derivative works we create based upon, incorporating or using the open source software and/or that we license such modifications or derivative works under the terms of the particular open source license. If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could incur significant legal expenses defending against such allegations and could be subject to significant damages, enjoined from the sale of our solution that contained the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of our solution.
 
Further, the terms of many open source licenses to which we are subject have not been interpreted by U.S. or foreign courts, and although we believe we comply with the terms of those licenses, there is a risk that those licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our solution. In that event, we could be required to (i) seek licenses from third parties,


19


Table of Contents

(ii) re-develop our solution, (iii) discontinue sales of our solution, or (iv) release our proprietary software code under the terms of an open source license, any of which could adversely affect our business.
 
If we fail to attract and retain key personnel, our business may suffer.
 
Given the complex nature of the technology on which our business is based and the speed with which such technology advances, our future success is dependent, in large part, upon our ability to attract and retain highly qualified managerial, technical and sales personnel. In particular, Stephen Wiehe, our President and Chief Executive Officer, Rudy Howard, our Chief Financial Officer, James Duke, our Chief Operating Officer, Jeffrey Martini, our Senior Vice President of Worldwide Sales, Jennifer Kaelin, our Vice President of Finance and Gamble Heffernan, our Vice President of Marketing and Strategy, are critical to the management of our business and operations. A key factor of our success will be the continued services and performance of our executive officers and other key personnel. If we lose the services of any of our executive officers, our financial condition and results of operations could be materially and adversely affected. Our success also depends upon our ability to identify, hire and retain other highly skilled technical, managerial, editorial, sales, marketing and customer service professionals. Competition for such personnel is intense. We cannot be certain of our ability to identify, hire and retain adequately qualified personnel. Failure to identify, hire and retain necessary key personnel could have a material adverse effect on our business and results of operations.
 
Our growth could strain our personnel resources and infrastructure, and if we are unable to implement appropriate controls and procedures to manage our growth, we will not be able to implement our business plan successfully.
 
We have experienced a period of growth in our operations and personnel, which places a significant strain on our management, administrative, operational and financial infrastructure. Our success will depend in part upon the ability of our senior management to manage this growth effectively. To do so, we must continue to hire, train and manage new employees as needed. If our new hires perform poorly, or if we are unsuccessful in hiring, training, managing and integrating these new employees, or if we are not successful in retaining our existing employees, our business would be harmed. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. The additional headcount we may add will increase our cost base, which will make it more difficult for us to offset any future revenue shortfalls by reducing expenses in the short term. If we fail to successfully manage our growth, we will be unable to execute our business plan.
 
The failure to integrate successfully businesses that we may acquire could adversely affect our business.
 
An element of our strategy is to broaden the scope and content of our products and services through the acquisition of existing products, technologies, services and businesses. Acquisitions entail numerous risks, including:
 
•   the integration of new operations, products, services and personnel;
•   the diversion of resources from our existing businesses, sites and technologies;
•   the inability to generate revenues from new products and services sufficient to offset associated acquisition costs;
•   the maintenance of uniform standards, controls, procedures and policies;
•   accounting effects that may adversely affect our financial results;
•   the impairment of employee and customer relations as a result of any integration of new management personnel;
•   dilution to existing stockholders from the issuance of equity securities; and
•   liabilities or other problems associated with an acquired business.
 
We may have difficulty in effectively assimilating and integrating these businesses, or any future joint ventures, acquisitions or alliances, into our operations, and such integration may require a significant amount of time and effort by our management team. To the extent we do not successfully avoid or overcome the risks or problems related to any acquisitions, our business, results of operations and financial condition could be adversely


20


Table of Contents

affected. Future acquisitions also could impact our financial position and capital needs and could cause substantial fluctuations in our quarterly and yearly results of operations. Acquisitions could include significant goodwill and intangible assets, which may result in future impairment charges that would reduce our stated earnings.
 
Our international sales efforts will require financial resources and management attention and could have a negative effect on our earnings.
 
We are investing resources and capital to expand our sales internationally. This will require financial resources and management attention and may subject us to new or increased levels of regulatory, economic, tax and political risks, all of which could have a negative effect on our earnings. We cannot be assured that we will be successful in creating international demand for our products and services. In addition, our international business may be subject to a variety of risks, including, among other things, increased costs associated with maintaining international marketing efforts, applicable government regulation, conflicting and changing tax laws, economic and political conditions and potential instability in various parts of the world, fluctuations in foreign currency, increased financial accounting and reporting burdens and complexities, difficulties in collecting international accounts receivable and the enforcement of intellectual property rights. If we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could adversely affect our operating results as a result of increased operating costs.
 
Our actual operating results may differ significantly from our guidance.
 
From time to time, we may release guidance in our quarterly earnings releases, quarterly earnings conference call, or otherwise, regarding our future performance that represents our management’s estimates as of the date of release. This guidance, which includes forward-looking statements, will be based on projections prepared by our management.
 
Neither our independent registered public accounting firm nor any other independent expert or outside party compiles or examines the projections. Accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.
 
Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. These projections are also based upon specific assumptions with respect to future business decisions, some of which will change. We may state possible outcomes as high and low ranges, which are intended to provide a sensitivity analysis as variables are changed but are not intended to represent that actual results could not fall outside of the suggested ranges. The principal reason that we release guidance is to provide a basis for our management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by analysts.
 
Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the guidance furnished by us will not materialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of the date of release. Actual results will vary from our guidance, and the variations may be material. In light of the foregoing, investors are urged not to rely upon, or otherwise consider, our guidance in making an investment decision regarding our common stock.
 
Any failure to implement our operating strategy successfully or the occurrence of any of the events or circumstances set forth in this “Risk Factors” section of the prospectus could result in our actual operating results being different from our guidance, and those differences may be adverse and material.


21


Table of Contents

If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investor views of us.
 
Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. In 2010, our independent registered public accounting firm identified a material weakness in our internal controls related to the failure to properly consider all subsequent event information available related to the recognition of deferred tax assets. The material weakness was subsequently remedied by the design and implementation of procedures to review and analyze subsequent event information. We cannot assure you that we will not experience future material weaknesses in internal controls. We are in the process of documenting, reviewing and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors addressing this assessment. To the extent that we are not currently in compliance with Section 404, we may be required to implement new internal control procedures and re-evaluate our financial reporting. We may experience higher than anticipated operating expenses as well as increased independent auditor fees during the implementation of these changes and thereafter. Further, we may need to hire additional qualified personnel in order for us to comply with Section 404. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, harm our ability to operate our business and reduce the trading price of our stock.
 
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.
 
A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way in which we conduct our business.
 
Our costs and demands upon management may continue to increase as a result of complying with the laws and regulations affecting public companies, which could harm our operating results.
 
We expect to incur significant legal, accounting, investor relations and other expenses as a public company that we have not incurred as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with current corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the NASDAQ Listing Rules. The expenses incurred by public companies for reporting and corporate governance purposes have increased dramatically over the past several years. These rules and regulations have increased our legal and financial compliance costs substantially and have made some activities more time-consuming and costly. We are unable currently to estimate these future costs with any degree of certainty.
 
Our business and financial performance could be negatively impacted by changes in tax laws or regulations.
 
New sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. Those enactments could adversely affect our domestic and international business operations, and our business and financial performance. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. These events could require us or our customers to pay additional tax amounts on a prospective or retroactive basis, as well as require us or our customers to pay fines and/or penalties and interest for past amounts deemed to be due. If we raise our product and maintenance prices to


22


Table of Contents

offset the costs of these changes, existing customers may elect not to renew their agreements and potential customers may elect not to purchase our services. Additionally, new, modified or newly interpreted or applied tax laws could increase our customers’ and our compliance, operating and other costs, as well as the costs of our services. Further, these events could decrease the capital we have available to operate our business. Any or all of these events could adversely impact our business and financial performance.
 
Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or our failure to comply with regulations could harm our operating results.
 
As Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. For example, we believe increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation, collection, processing or use of personal or consumer information could affect our customers’ ability to use and share data, potentially reducing demand for our products. In addition, taxation of products and services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services and product offerings, which could harm our business and operating results.
 
Our ability to use U.S. net operating loss carryforwards might be limited.
 
As of June 30, 2010, we had net operating loss carryforwards of approximately $192 million for U.S. federal tax purposes, the use of which may be substantially limited. These loss carryforwards will begin to expire in 2014. To the extent these net operating loss carryforwards are available, we intend to use them to reduce the corporate income tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that might be used to offset taxable income when a corporation has undergone significant changes in stock ownership. As a result, prior or future changes in ownership could put limitations on the availability of our net operating loss carryforwards. In addition, our ability to utilize the current net operating loss carryforwards might be further limited by the issuance of common stock in this offering. To the extent our use of net operating loss carryforwards is significantly limited, our income could be subject to corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.
 
Risks Related to this Offering and Ownership of Our Common Stock
 
Our common stock could trade at prices below the initial public offering price.
 
There has not been a public trading market for shares of our common stock since August 2004. An active trading market may not develop or be sustained after this offering. If an active trading market does not develop, investors may have difficulty selling any of our common stock that they buy. The initial public offering price for the shares of common stock sold in this offering was determined by negotiations between representatives of the underwriters and us. This price may not be indicative of the price at which our common stock will trade after this offering, and our common stock could easily trade below the initial public offering price.
 
Our stock price may be volatile, and investors may be unable to sell their shares at or above the initial public offering price.
 
The market price of our common stock has been and could be subject to wide fluctuations in response to, among other things, the factors described in this “Risk Factors” section or elsewhere in this prospectus, and other factors beyond our control, including the following:
 
•   variations in our quarterly operating results;
•   decreases in market valuations of similar companies;
•   the failure of securities analysts to cover our common stock after this offering or changes in financial estimates by analysts who cover us, our competitors or our industry;


23


Table of Contents

•   failure by us or our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market; and
•   fluctuations in stock market prices and volumes.
 
Furthermore, the stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market fluctuations, as well as general economic, political and market conditions, such as recessions, interest rate changes and international currency fluctuations, may negatively affect the market price of our common stock.
 
In the past, many companies that have experienced volatility in the market price of their stock have become subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business. All of these factors could cause the market price of our stock to decline, and you may lose some or all of your investment.
 
The continued concentration of our capital stock ownership with insiders upon completion of this offering will limit your ability to influence corporate matters.
 
We anticipate that our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately 67.1% of our common stock after this offering. These stockholders may have interests that differ from yours, and they may vote in a way with which you disagree and that may be adverse to your interests. This concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. Also, these stockholders, acting together, will be able to control the outcome of matters submitted to our stockholders for approval, including the election of directors and the approval of significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:
 
•   delaying, deferring or preventing a change in corporate control;
•   impeding a merger, consolidation, takeover or other business combination involving us; or
•   discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.
 
Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.
 
Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales could also make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
 
Upon completion of this offering, we will have 20,307,489 outstanding shares of common stock, assuming no exercise of outstanding options after August 31, 2010. The shares sold in this offering will be immediately tradable without restriction. Of the remaining shares:
 
•   24,902 shares will be eligible for sale immediately upon the completion of this offering, subject in some cases to volume and other restrictions of Rule 144 and Rule 701 under the Securities Act of 1933, as amended, or the Securities Act; and
•   14,282,587 shares will be eligible for sale upon the expiration of lock-up agreements (13,382,587 shares if the underwriters’ over-allotment option is exercised in full), subject in some cases to volume and other restrictions of Rule 144 and Rule 701 under the Securities Act.
 
The lock-up agreements expire 180 days after the date of this prospectus, except that the 180-day period may be extended under certain circumstances where we announce or pre-announce earnings or a material event occurs within approximately 17 days prior to, or approximately 15 days after, the termination of the 180-day


24


Table of Contents

period. The representatives of the underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements.
 
Following this offering, holders of substantially all of the shares of our common stock not sold in this offering will be entitled to rights with respect to the registration of these shares under the Securities Act. See “Description of Capital Stock — Registration Rights.” If we register their shares of common stock following the expiration of the lock-up agreements, these stockholders could sell those shares in the public market without being subject to the volume and other restrictions of Rule 144 and Rule 701.
 
After the closing of this offering, we intend to register 4,307,736 shares of common stock that have been issued or reserved for future issuance under our stock incentive plan. Of these shares, 2,984,178 shares are outstanding or subject to the exercise of outstanding options as of August 31, 2010 and will be eligible for sale, in some cases subject to vesting requirements, after the expiration of the lock-up agreements.
 
Investors in this offering will experience immediate and substantial dilution in the net tangible book value of the common stock they purchase in this offering.
 
Investors in this offering will experience immediate dilution of $8.89 per share, because the price that they pay will be substantially greater than the net tangible book value per share of common stock that they acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the price of the shares being sold in this offering when they purchased their shares of our capital stock. If outstanding options to purchase our common stock are exercised, investors in this offering will experience additional dilution.
 
We have broad discretion in the use of the proceeds of this offering.
 
Approximately $36.2 million of the net proceeds to us from this offering will be used to redeem all outstanding shares of our preferred stock. The remainder of the net proceeds will be used, as determined by management in its sole discretion, for working capital and general corporate purposes. We may also use a portion of the proceeds to acquire complementary businesses, products or technologies. We have not, however, determined the allocation of those remaining net proceeds among such uses. Our management will have broad discretion over the use and investment of these net proceeds, and, accordingly, you will need to rely upon the judgment of our management with respect to our use of these net proceeds, with only limited information concerning management’s specific intentions. You will not have the opportunity, as part of your investment decision, to assess whether our proceeds are being used appropriately. We may place the net proceeds in investments that do not produce income or that lose value, which may cause our stock price to decline.
 
Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock.
 
Our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that could delay or discourage a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:
 
•   a classified board of directors with three-year staggered terms;
•   not providing for cumulative voting in the election of directors;
•   authorizing the board of directors to issue, without stockholder approval, preferred stock with rights senior to those of our common stock;
•   prohibiting stockholder action by written consent; and
•   requiring advance notification of stockholder nominations and proposals.
 
These and other provisions in our amended and restated certificate of incorporation and our amended and restated bylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay in the future for shares of our common stock and result in the market price of our common stock being lower than it would be without these provisions. See “Description of Capital Stock — Preferred Stock,” “Description of Capital Stock — Anti-Takeover Effects of Our Amended and Restated Certificate


25


Table of Contents

of Incorporation and Amended and Restated Bylaws,” and “Description of Capital Stock — Delaware Anti-Takeover Statute.”
 
Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.
 
Our amended and restated certificate of incorporation provides that we will indemnify and advance expenses to our directors, officers, employees and other agents to the fullest extent permitted by the Delaware General Corporation Law. Therefore, we will be obligated to indemnify such persons if they acted in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the company and, with respect to any criminal action or proceeding, had no reasonable cause to believe their conduct was unlawful, except that, in the case of an action by or in right of the company, no indemnification may generally be made in respect of any claim as to which such person is adjudged to be liable to the company. Furthermore, our amended and restated certificate of incorporation provides that our directors are not personally liable for breaches of fiduciary duties to the fullest extent permitted by the Delaware General Corporation Law. Therefore, our directors shall not be personally liable to the company or its stockholders for monetary damages for breach of fiduciary duties as a director, except for liability for any:
 
•   breach of a director’s duty of loyalty to the corporation or its stockholders;
•   act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;
•   unlawful payment of dividends or redemption of shares; or
•   transaction from which the director derives an improper personal benefit.
 
As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist absent the current provisions in our amended and restated certificate of incorporation or that might exist with other companies.
 
If securities analysts do not continue to publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.
 
We believe that the trading price for our common stock will be affected by research or reports that industry or financial analysts publish about us or our business. If one or more of the analysts who may elect to cover us downgrade their evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease coverage of our company, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.
 
We do not intend to pay dividends on our common stock in the foreseeable future.
 
We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently anticipate that we will retain all of our available cash, if any, for working capital and other general corporate purposes. Any payment of future dividends will be at the discretion of our board of directors and will depend upon, among other things, our earnings, financial condition, capital requirements, debt levels, statutory and contractual restrictions applying to the payment of dividends and other considerations that our board of directors deems relevant. Investors seeking cash dividends should not purchase our common stock.


26


Table of Contents

 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA
 
This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Our Business” and “Executive Compensation” sections of this prospectus. Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, potential market opportunities and the effects of competition. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions and the negatives of those terms.
 
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks in greater detail in the “Risk Factors” section and elsewhere in this prospectus. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.
 
Except as required by law, we assume no obligation to update these forward-looking statements publicly or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
 
In this prospectus, we also rely on and refer to information and statistics regarding the industries and the markets in which we compete. We obtained this information and these statistics from various third-party sources. We believe that these sources and the estimates contained therein are reliable, but we have not independently verified them. Such information involves risks and uncertainties and is subject to change based on various factors, including those discussed in the “Risk Factors” section of this prospectus.


27


Table of Contents

 
USE OF PROCEEDS
 
We estimate that the net proceeds from our sale of shares of common stock in this offering will be approximately $56.1 million. This estimate is based upon an assumed initial public offering price of $10.50 per share, the mid-point of our filing range, less estimated underwriting discounts and commissions and offering expenses payable by us. To the extent that the underwriters exercise their over-allotment option, we will not receive any proceeds from the sale of shares of our common stock by the selling stockholders. A $1.00 increase (decrease) in the assumed initial public offering price of $10.50 per share would increase (decrease) the net proceeds to us from this offering by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and estimated offering expenses payable by us.
 
We intend to use approximately $36.2 million of these net proceeds to redeem all outstanding shares of our preferred stock. We intend to use the remaining net proceeds for working capital and general corporate purposes. We may also use a portion of the proceeds to acquire complementary businesses, products or technologies. We have no agreements or commitments with respect to any acquisitions at this time. By establishing a public market for our common stock, this offering is also intended to facilitate our future access to public markets.
 
Pending the uses described above, we intend to invest the net proceeds of this offering in short- to medium-term, investment-grade, interest-bearing securities, certificates of deposit, or direct or guaranteed obligations of the U.S. government.
 
The amount and timing of what we actually spend may vary significantly and will depend on a number of factors, including future cash generated from operations as well as other factors described in the section titled “Risk Factors.”


28


Table of Contents

 
DIVIDEND POLICY
 
We have not historically declared or paid dividends on our common stock, and we do not expect to declare or pay dividends on our common stock for the foreseeable future. Instead, we anticipate that all of our earnings will be used for the operation and growth of our business. Any future determination to pay dividends on our common stock would be subject to the discretion of our board of directors and would depend upon various factors, including our earnings, financial condition, capital requirements, debt levels, statutory and contractual restrictions applying to the payment of dividends and other considerations that our board of directors deems relevant.


29


Table of Contents

 
CAPITALIZATION
 
The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2010:
 
•   on an actual basis, giving effect to the one-for-two reverse split of our common stock that occurred on September 20, 2010; and
•   on a pro forma basis to reflect (i) our sale of shares in this offering at an assumed initial public offering price of $10.50 per share, which is the mid-point of our filing range, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, and (ii) the redemption of all outstanding preferred stock immediately after the consummation of this offering, as if each had occurred as of June 30, 2010.
 
The information below is illustrative only and our capitalization following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes appearing elsewhere in this prospectus.
 
                 
    As of June 30, 2010  
    Actual     Pro Forma(1)  
    (Unaudited; in thousands, except share and
 
    per share data)  
 
Cash and cash equivalents
  $ 20,195     $ 41,327  
                 
Current liabilities excluding current portion of deferred revenues
  $ 2,821     $ 2,471  
Deferred revenues
    35,508       35,508  
Deferred tax liability
    813       813  
Redeemable preferred stock:
               
Redeemable preferred stock: $0.001 par value; 222,073 shares authorized; 222,073 shares issued and outstanding, actual, and 0 shares issued and outstanding, pro forma
    35,436        
Stockholders’ equity (deficit):
               
Common stock: $0.001 par value; 50,000,000 shares authorized; 14,305,989 shares issued and outstanding, actual, and 20,305,989 issued and outstanding, pro forma
    14       20  
Additional paid-in capital
          55,369  
Notes receivable from stockholders
    (15 )     (15 )
Accumulated deficit
    (14,770 )     (14,770 )
                 
Total stockholders’ equity (deficit)
    (14,771 )     40,604  
                 
Total capitalization
  $ 59,807     $ 79,396  
                 
 
 
(1) A $1.00 increase (decrease) in the assumed initial public offering price of $10.50 per share would increase (decrease) cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriter discount and estimated offering expenses payable by us.
 
The table and calculations above are based on the number of shares of common stock outstanding as of June 30, 2010 and exclude:
 
•   an aggregate of 711,673 shares issuable upon the exercise of then outstanding options at a weighted average exercise price of $2.33 per share;
•   an aggregate of 221,680 shares issuable upon the exercise of then outstanding warrants at a weighted average exercise price of $0.08 per share; and
•   an aggregate of 322,058 shares reserved for issuance under our 2004 Stock Incentive Plan.


30


Table of Contents

 
DILUTION
 
If you invest in our common stock, your ownership interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the adjusted net tangible book value per share of our common stock immediately after completion of this offering. Net tangible book value per share represents total tangible assets less total liabilities and redeemable preferred stock, divided by the number of shares of common stock outstanding. As of June 30, 2010, the net tangible book value of our common stock was approximately $(22.7) million, or approximately $(1.59) per share.
 
After giving effect to our sale of shares at an assumed initial public offering price of $10.50 per share, which is the mid-point of our filing range, deducting estimated underwriting discounts and commissions and offering expenses payable by us, and applying the net proceeds from this sale (including the redemption of all of our outstanding shares of preferred stock), the pro forma net tangible book value of our common stock, as of June 30, 2010, would have been approximately $32.7 million, or $1.61 per share. This amount represents an immediate increase in net tangible book value to our existing stockholders of $3.20 per share and an immediate dilution to new investors of $8.89 per share. The following table illustrates this per share dilution:
 
                 
Assumed initial public offering price per share
              $ 10.50  
Net tangible book value per share as of June 30, 2010
  $ (1.59 )        
Pro forma increase per share attributable to new investors
  $ 3.20          
                 
Pro forma net tangible book value per share after this offering
          $ 1.61  
Dilution per share to new investors
          $ 8.89  
                 
 
A $1.00 increase or decrease in the assumed initial public offering price per share would increase or decrease, respectively, the pro forma net tangible book value per share of common stock after this offering by $0.27 per share and increase or decrease, respectively, the pro forma dilution per share of common stock to new investors in this offering by $0.73 per share, in each case calculated as described above and assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.
 
The following table summarizes, as of June 30, 2010, on a pro forma basis, the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by our existing stockholders and by new investors, based upon an assumed initial public offering price of $10.50 per share and before deducting estimated underwriting discounts and commissions and offering expenses payable by us.
 
                                         
    Shares Purchased     Total Consideration     Average Price per
 
    Number     Percent     Amount     Percent     Share  
 
Existing stockholders
    14,305,989       70.5 %   $ 2,187,147       3.1 %   $ 0.15  
New investors
    6,000,000       29.5 %   $ 63,000,000       96.9 %   $ 10.50  
                                         
Total
    20,305,989       100 %   $ 65,187,147       100 %   $ 3.21  
 
The discussion and tables above are based on 14,305,989 shares of common stock outstanding as of June 30, 2010 and exclude:
 
•   an aggregate of 711,673 shares issuable upon the exercise of then outstanding options at a weighted average exercise price of $2.33 per share;
•   an aggregate of 221,680 shares issuable upon the exercise of then outstanding warrants at a weighted average exercise price of $0.08 per share; and
•   an aggregate of 322,058 shares reserved for issuance under our 2004 Stock Incentive Plan.


31


Table of Contents

 
If the underwriters’ overallotment option is exercised in full, the number of shares held by the existing stockholders after this offering would be reduced to 13,405,989, or 66.0% of the total number of shares of our common stock outstanding after this offering, and the number of shares held by new investors would increase to 6,900,000, or 34.0% of the total number of shares of our common stock outstanding after this offering.
 
If all our outstanding options and warrants had been exercised, our pro forma net tangible book value (deficit) as of June 30, 2010 would have been $(21.1) million, or $(1.38) per share, and the pro forma as adjusted net tangible book value after this offering would have been $34.3 million, or $1.62 per share, causing dilution to new investors of $8.88 per share.


32


Table of Contents

 
SELECTED FINANCIAL DATA
 
You should read the following selected financial data together with our financial statements and the related notes appearing at the end of this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which follows immediately after this section. Our historical results are not necessarily indicative of our results to be expected in any future period.
 
The selected financial data under the heading “Statements of Operations Data” for each of the three years ended December 31, 2007, 2008 and 2009, under the heading “Non-GAAP Operating Data” relating to Adjusted EBITDA and Adjusted Free Cash Flow for each of the three years ended December 31, 2007, 2008 and 2009 and under the heading “Balance Sheet Data” as of December 31, 2008 and 2009 have been derived from our audited financial statements, which are included elsewhere in this prospectus. The selected financial data under the heading “Statements of Operations Data” for each of the two years ended December 31, 2005 and 2006, under the heading “Non-GAAP Operating Data” relating to Adjusted EBITDA and Adjusted Free Cash Flow for each of the two years ended December 31, 2005 and 2006 and under the heading “Balance Sheet Data” as of December 31, 2005, 2006 and 2007 have been derived from our audited financial statements not included in this prospectus.
 
The selected financial data under the heading “Statements of Operations Data” for each of the six months ended June 30, 2009 and 2010, under the heading “Non-GAAP Operating Data” relating to Adjusted EBITDA and Adjusted Free Cash Flow for each of the six months ended June 30, 2009 and 2010 and under the heading “Balance Sheet Data” as of June 30, 2010 have been derived from our unaudited financial statements. In the opinion of management, our unaudited financial statements include all adjustments, consisting only of normal recurring items, except as noted in the notes to the financial statements, necessary for a fair statement of interim periods. The financial information presented for the interim periods has been prepared in a manner consistent with our accounting policies described elsewhere in this prospectus and should be read in conjunction therewith.
 
The pro forma balance sheet data as of June 30, 2010 is unaudited and gives effect to (1) our receipt of estimated net proceeds of $56.1 million from this offering, based on an assumed initial public offering price of $10.50 per share, which is the mid-point of our filing range, after deducting estimated underwriting discounts and offering expenses payable by us and (2) the redemption of all of the outstanding preferred stock immediately after the consummation of this offering. The pro forma summary financial data is not necessarily indicative of what our financial position or results of operations would have been if this offering had been completed as of the date indicated, nor is this data necessarily indicative of our financial position or results of operations for any future date or period.
 


33


Table of Contents

                                                         
          Six Months
 
    Year Ended December 31,     Ended June 30,  
    2005     2006     2007     2008     2009     2009     2010  
    (In thousands, except per share data)  
 
Statements of Operations Data:
                                                       
Revenues
  $ 8,805     $ 15,183     $ 20,107     $ 29,784     $ 36,179     $ 17,406     $ 20,688  
Cost of revenues(1)(2)
    3,701       4,766       6,101       6,723       7,494       3,748       4,446  
                                                         
Gross profit
    5,104       10,417       14,006       23,061       28,685       13,658       16,242  
                                                         
Operating expenses:(1)
                                                       
Research and development
    5,316       6,124       6,908       8,307       8,059       4,360       3,919  
Sales and marketing
    4,543       5,954       7,213       9,280       10,750       5,346       5,969  
General and administrative
    2,546       2,531       2,717       3,942       3,703       1,945       2,635  
Litigation settlement and associated legal expenses
                            3,189       100        
Amortization of intangible assets
    3,877       3,631       2,286       537       403       201       151  
                                                         
Total operating expenses
    16,282       18,240       19,124       22,066       26,104       11,952       12,674  
                                                         
Income (loss) from operations
    (11,178 )     (7,823 )     (5,118 )     995       2,581       1,706       3,568  
Interest and other income (expense), net
    (304 )     (78 )     118       113       27       31       1,688  
                                                         
Income (loss) before income taxes
    (11,482 )     (7,901 )     (5,000 )     1,108       2,608       1,737       5,256  
Income tax benefit (expense)
                      9       16,821             (2,052 )
                                                         
Net income (loss)
    (11,482 )     (7,901 )     (5,000 )     1,117       19,429       1,737       3,204  
Dividends on redeemable preferred stock
    1,877       2,038       2,207       2,395       2,595       1,261       1,364  
                                                         
Net income (loss) attributable to common stockholders
  $ (13,359 )   $ (9,939 )   $ (7,207 )   $ (1,278 )   $ 16,834     $ 476     $ 1,840  
                                                         
Net income (loss) attributable to common stockholders per share:
                                                       
Basic
  $ (1.06 )   $ (0.76 )   $ (0.53 )   $ (0.09 )   $ 1.20     $ 0.03     $ 0.13  
Diluted
  $ (1.06 )   $ (0.76 )   $ (0.53 )   $ (0.09 )   $ 1.16     $ 0.03     $ 0.13  
Weighted average shares outstanding used in computing per share amounts:
                                                       
Basic
    12,624       13,058       13,492       13,800       14,061       14,008       14,079  
Diluted
    12,624       13,058       13,492       13,800       14,450       14,397       14,680  
 
                                                         
        Six Months
    Year Ended December 31,   Ended June 30,
    2005   2006   2007   2008   2009   2009   2010
    (In thousands)
 
Non-GAAP Operating Data:
                                                       
Adjusted EBITDA(3)
  $ (6,626 )   $ (3,557 )   $ (2,099 )   $ 2,666     $ 7,349     $ 2,603     $ 4,842  
Adjusted Free Cash Flow(4)
  $ (2,403 )   $ 1,636     $ 3,636     $ 6,003     $ 6,785     $ (640 )   $ 2,765  
 

34


Table of Contents

                                                         
                        As of June 30, 2010
    2005   2006   2007   2008   2009   Actual   Pro Forma
    (In thousands)
 
Balance Sheet Data:(5)
                                                       
Cash and cash equivalents
  $ 4,041     $ 5,218     $ 7,791     $ 13,502     $ 17,132     $ 20,195     $ 41,327  
Working capital excluding deferred revenues
    1,779       4,899       7,631       14,273       19,963       25,089       46,571  
Total assets
    24,309       24,883       26,332       32,922       55,211       59,807       79,396  
Deferred revenues
    9,853       19,164       26,124       31,590       34,275       35,508       35,508  
Redeemable preferred stock
    24,646       26,778       28,985       31,477       34,072       35,436        
Total stockholders’ equity (deficit)
    (16,487 )     (26,403 )     (33,461 )     (34,391 )     (17,158 )     (14,771 )     40,604  
 
 
(1) Amounts include stock-based compensation expense, as follows:
 
                                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2005     2006     2007     2008     2009     2009     2010  
    (In thousands)  
 
Cost of revenues
  $     $     $ 3     $ 25     $ 33     $ 18     $ 31  
Research and development
                56       53       86       42       175  
Sales and marketing
                42       150       83       37       118  
General and administrative
                9       158       163       88       432  
                                                         
    $     $     $ 110     $ 386     $ 365     $ 185     $ 756  
                                                         
 
(2) Cost of revenues includes amortization of capitalized software development costs of:
 
                                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2005     2006     2007     2008     2009     2009     2010  
    (In thousands)  
 
Amortization of capitalized software development costs
  $ 227     $ 235     $ 114     $ 154     $ 167     $ 86     $ 97  
                                                         
 
(3) EBITDA consists of net income (loss) plus depreciation and amortization, less interest and other income, net and less income tax benefit (expense). Adjusted EBITDA consists of EBITDA plus our non-cash, stock-based compensation expense and settlement and legal costs related to a patent infringement lawsuit settled in 2009. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure, the one-time costs associated with a non-recurring event and such items as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired.

35


Table of Contents

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash expenditure requirements for such replacements;
  •   Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
  •   Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;
  •   Adjusted EBITDA does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
  •   other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted EBITDA along with these other measures in order to fully evaluate our financial performance.
 
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:
 
                                                         
          Six Months
 
    Year Ended December 31,     Ended June 30,  
    2005     2006     2007     2008     2009     2009     2010  
    (In thousands)  
 
Net income (loss)
  $ (11,482 )   $ (7,901 )   $ (5,000 )   $ 1,117     $ 19,429     $ 1,737     $ 3,204  
Depreciation and amortization
    4,552       4,266       2,909       1,285       1,214       612       518  
Interest and other expense (income), net
    304       78       (118 )     (113 )     (27 )     (31 )     (1,688 )
Income tax expense (benefit)
                      (9 )     (16,821 )           2,052  
                                                         
EBITDA
    (6,626 )     (3,557 )     (2,209 )     2,280       3,795       2,318       4,086  
Non-cash, stock-based compensation expense
                110       386       365       185       756  
Litigation settlement and associated legal expenses
                            3,189       100        
                                                         
Adjusted EBITDA
  $ (6,626 )   $ (3,557 )   $ (2,099 )   $ 2,666     $ 7,349     $ 2,603     $ 4,842  
                                                         
 
(4) Free Cash Flow consists of net cash provided by (used in) operating activities, less purchases of property and equipment and less capitalization of software development costs. Adjusted Free Cash Flow consists of Free Cash Flow plus one-time settlement and legal costs related to a patent infringement lawsuit in 2009 as well as public stock offering costs incurred in 2010. We use Adjusted Free Cash Flow as a measure of liquidity because it assists us in assessing the company’s ability to fund its growth through its generation of cash. We believe Adjusted Free Cash Flow is useful to an investor in evaluating our liquidity because Adjusted Free Cash Flow and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s liquidity without regard to revenue and expense recognition, which can vary depending upon accounting methods.


36


Table of Contents

Our use of Adjusted Free Cash Flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   Adjusted Free Cash Flow does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted Free Cash Flow does not reflect one-time litigation settlement expense payments, which reduced the cash available to us; 
  •   Adjusted Free Cash Flow does not include public stock offering costs;
  •   Adjusted Free Cash Flow removes the impact of accrual basis accounting on asset accounts and non-debt liability accounts; and
  •   other companies, including companies in our industry, may calculate Adjusted Free Cash Flow differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted Free Cash Flow alongside other liquidity measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted Free Cash Flow along with these other measures in order to fully evaluate our liquidity.
 
The following table provides a reconciliation of net cash provided by (used in) operating activities to Adjusted Free Cash Flow:
 
                                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2005     2006     2007     2008     2009     2009     2010  
    (In thousands)  
 
Net cash provided by (used in) operating activities
  $ (1,748 )   $ 2,227     $ 4,693     $ 6,582     $ 4,501     $ (278 )   $ 2,373  
Purchase of property and equipment
    (594 )     (531 )     (695 )     (480 )     (685 )     (462 )     (379 )
Capitalization of software development costs
    (61 )     (60 )     (362 )     (99 )     (220 )           (422 )
                                                         
Free Cash Flow
    (2,403 )     1,636       3,636       6,003       3,596       (740 )     1,572  
Litigation settlement and associated legal expenses
                            3,189       100        
Public stock offering costs
                                        1,193  
                                                         
Adjusted Free Cash Flow
  $ (2,403 )   $ 1,636     $ 3,636     $ 6,003     $ 6,785     $ (640 )   $ 2,765  
                                                         
 
(5) A $1.00 increase (decrease) in the assumed initial public offering price of $10.50 per share would increase (decrease) cash and cash equivalents, working capital excluding deferred revenues, total assets and total stockholders’ equity (deficit) after this offering by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and estimated offering expenses payable by us.


37


Table of Contents

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes that appear elsewhere in this prospectus. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.”
 
Overview
 
We provide a leading on-demand strategic procurement and supplier enablement solution that integrates our customers with their suppliers to improve procurement of indirect goods and services. Our on-demand software enables organizations to realize the benefits of strategic procurement by identifying and establishing contracts with preferred suppliers, driving spend to those contracts and promoting process efficiencies through electronic transactions. Strategic procurement is the optimization of tasks throughout the cycle of finding, procuring, receiving and paying for indirect goods and services, which can result in increased efficiency, reduced costs and increased insight into an organization’s buying patterns. Using our managed SciQuest Supplier Network, our customers do business with more than 30,000 unique suppliers and spend billions of dollars annually.
 
We derive our revenues primarily from subscription fees and associated implementation services from the sale of our solution to entities in the higher education, life sciences, healthcare and state and local government markets. Our contracts are typically three to five years in length, with total subscription fees typically ranging from $450,000 to $1.5 million ($150,000 to $300,000 per year) and the associated one-time implementation service fees typically ranging from $150,000 to $300,000. We sell primarily through our direct sales channel and, to a very limited extent, through indirect sales channels. We have over 165 customers operating in 16 countries and offer our solution in five languages and 22 currencies. Our revenue growth is driven primarily through the sale of our solution to new customers. For the six months ended June 30, 2010, revenues increased 19% to $20.7 million from $17.4 million for the six months ended June 30, 2009. For the fiscal year ended December 31, 2009, revenues increased 21% to $36.2 million from $29.8 million for the year ended December 31, 2008. For the fiscal year ended December 31, 2008, revenues increased 48% from $20.1 million for the year ended December 31, 2007.
 
Revenues, expenses and cash flow are the key measures we use to analyze our business and results of operations for both the short and long-term. Key elements of our revenue analysis include revenues from new customers and renewal revenues from existing customers. Our expense analysis focuses heavily on headcount by function, as compensation expense is our primary expense item. We also monitor the impact of expenses on Adjusted EBITDA. To analyze cash flow, we primarily use Adjusted Free Cash Flow.
 
For the years ended December 31, 2007, 2008 and 2009, the higher education market accounted for approximately 57%, 54% and 56%, respectively, of our revenues, the life sciences market accounted for approximately 36%, 35% and 31%, respectively, of our revenues, the healthcare market accounted for approximately 7%, 9% and 9%, respectively, of our revenues and the state and local government markets accounted for approximately 0%, 2% and 4%, respectively, of our revenues. To date, the higher education and life sciences markets have been our primary markets, generally as a result of our historical focus and past success in these markets, and we have achieved greater market penetration in these markets as compared to our newer healthcare and state and local government markets. Historically, we enter new markets largely based on their similarities to our then existing markets in terms of customer profiles, procurement characteristics and market opportunity. For example, we expanded into the healthcare and state and local government markets because they are both adjacent to and have similar procurement characteristics as the higher education and life sciences markets, thus allowing us to leverage our market expertise. Since we sell a single set of products and services to vertical markets with similar characteristics, we view our business on an integrated basis and manage our business as a single unit rather than as separate lines of business. Accordingly, we generally do not analyze our


38


Table of Contents

business performance by vertical market, nor do we manage our revenues, earnings or cash flows by vertical market. Further, we do not establish separate revenue targets for each vertical market.
 
Maintaining and managing revenue growth is a primary operating focus for us, and therefore, we will continue to focus our efforts on acquiring new customers and expanding our relationships with existing customers. Expanding our customer base in the higher education and life sciences markets to include more mid-sized organizations as well as expanding our product offerings to our existing customers in all our markets will be important to maintain revenue growth. We plan to continue to invest in sales and marketing efforts, particularly in our newer healthcare and state and local government markets, to take advantage of what we believe are significant growth opportunities in these newer markets. We tailor our sales and marketing efforts to each of our vertical markets through industry-specific marketing events, and we have hired, and will continue to hire, personnel with experience and relationships in these markets. We cannot provide assurances, however, that these efforts will be successful in achieving revenue growth. If we are unable to market our solution successfully, or if we incur substantial expenses in attempting to do so, our revenues and earnings could be materially and adversely affected.
 
We believe Adjusted EBITDA and Adjusted Free Cash Flow are the primary non-GAAP financial metrics upon which to measure our business. EBITDA consists of net income (loss) plus depreciation and amortization, less (plus) interest and other income (expense), net and plus (less) income tax expense (benefit). Adjusted EBITDA consists of EBITDA plus our non-cash, stock-based compensation expense and settlement and legal costs related to a patent infringement lawsuit settled in 2009. Because Adjusted EBITDA excludes certain non-cash expenses such as depreciation, amortization and stock-based compensation, as well as the one-time impact of the settlement of a patent litigation suit in 2009, we believe that this measure provides us with additional useful information to measure and understand our performance on a consistent basis, particularly with respect to changes in performance from period to period. Free Cash Flow consists of net cash provided by (used in) operating activities, less purchases of property and equipment and less capitalization of software development costs. Adjusted Free Cash Flow consists of Free Cash Flow plus one-time settlement and legal costs related to a patent infringement lawsuit in 2009 as well as public stock offering costs incurred in 2010. Because Adjusted Free Cash Flow measures the ability of the company to generate cash from operations, after investment in software development and property and equipment, we believe this is a meaningful measurement in which to gauge our ability to fund future growth. Our Adjusted Free Cash Flow normally fluctuates quarterly due to the combination of the timing of new business and the payment of annual bonuses. We use Adjusted EBITDA and Adjusted Free Cash Flow in the preparation of our budgets and to measure and monitor our financial performance. Adjusted EBITDA and Adjusted Free Cash Flow are not determined in accordance with GAAP and are not substitutes for or superior to financial measures determined in accordance with GAAP. For further discussion regarding Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see “— Key Financial Terms and Metrics,” below. For further discussion regarding Adjusted Free Cash Flow and a reconciliation of Adjusted Free Cash Flow to cash flows from operations, see footnote 4 to the table in “Selected Financial Data” included elsewhere in this prospectus.
 
We were founded in 1995 as an e-commerce business-to-business exchange for scientific products and conducted an initial public offering in 1999. In 2001, we brought in a new management team, exited the business-to-business exchange model and began selling our on-demand strategic procurement and supplier enablement solution. Our company was subsequently taken private in 2004. Since 2001, we have focused on developing our current on-demand business model, building out our technology, acquiring a critical mass of customers in our higher education and life sciences vertical markets, and selectively expanding our solution to serve the healthcare and state and local government markets. We have funded our operations since the going private transaction through our cash flow from operations. We generated Adjusted EBITDA of $(2.1) million, $2.7 million, $7.3 million and $4.8 million in 2007, 2008, 2009 and the six months ended June 30, 2010, respectively. We generated Adjusted Free Cash Flow of $3.6 million, $6.0 million, $6.8 million and $2.8 million in 2007, 2008, 2009 and the six months ended June 30, 2010, respectively. We generated a net loss of $(5.0) million for 2007 and net income of $1.1 million, $19.4 million and $3.2 million in 2008, 2009 and the six months ended June 30, 2010, respectively. No customer accounted for more than 10% of our total revenues in 2007, 2008, 2009


39


Table of Contents

and the six months ended June 30, 2010. Our ten largest customers accounted for no more than 25% of our total revenues in 2009 and the six months ended June 30, 2010.
 
We plan to continue the growth of our customer base by expanding our direct and indirect distribution channels and increasing our international market penetration. As a result, we plan to hire additional personnel, particularly in sales and implementation services, and expand our domestic and international sales and marketing activities. We also intend to identify and acquire companies that would either expand our solution’s functionality, provide access to new customers or markets, or both.
 
Key Financial Terms and Metrics
 
Sources of Revenues
 
We primarily derive our revenues from sales of our on-demand strategic procurement and supplier enablement software solution and associated implementation services. Revenues are generated from subscription agreements that permit customers to access and utilize our procurement solution and related services.
 
Our subscription agreements generally contain multiple service elements and deliverables. These elements include access to our on-demand software, implementation services and, on limited occasions, perpetual licenses for certain software modules and related maintenance and support. The typical term of our subscription agreements is three to five years, and we generally invoice our customers in advance of their annual subscription, with payment terms that require our customers to pay us within thirty days of invoice. We recognize revenues, both from subscription and perpetual licenses and related maintenance and support, ratably on a daily basis over the term of the agreement. Our agreements are generally non-cancelable, though customers have the right to terminate their agreements for cause if we materially breach our obligations under the agreement.
 
Implementation services revenues consist primarily of configuration, integration, training and change management services sold in conjunction with the initial subscription agreement as part of a multiple-element arrangement. Typically, our implementation services engagements are billed on a fixed fee, performance milestone basis with payment terms requiring our customers to pay us within thirty days of invoice. Revenues from implementation services sold as part of the initial agreement are recognized ratably over the remaining subscription term once the performance milestones have been met. Revenues from services sold separately from subscription agreements are recognized as the services are performed and have not been material to our business.
 
Historically, we have increased the price of our subscriptions upon the renewal of our customers’ subscription agreements to reflect the increased feature functionality inherent in the solution since the initial subscription agreement. Our annual customer renewal rate has been over 94% over the last three fiscal years. On a dollar basis, our annual renewal rate has been 106% over this same time period solely as a result of pricing increases at the time of renewal. We believe these customer and dollar renewal rates reflect our customers’ satisfaction with our solution and improve the visibility of our revenues.
 
Cost of Revenues and Operating Expenses
 
We allocate certain overhead expenses, such as rent, utilities, and depreciation of general office assets to cost of revenues and operating expense categories based on headcount. As a result, an overhead expense allocation is reflected in cost of revenues and each operating expense category.
 
Cost of Revenues.  Cost of revenues consists primarily of compensation and related expenses for implementation services, supplier enablement services, customer support staff and client partners, costs related to hosting the subscription software, amortization of capitalized software development costs and allocated overhead. Costs of implementation services are expensed as incurred. We expect cost of revenues to increase in absolute dollars as we continue to increase the number of customers over time but remain relatively consistent as a percentage of revenues.


40


Table of Contents

Research and Development.  Research and development expenses consist primarily of wages and benefits for software application development personnel and allocated overhead. We have focused our research and development efforts on both improving ease of use and functionality of our existing products as well as developing new offerings. We primarily expense research and development costs. The small percentage of direct development costs related to on-demand software enhancements that add functionality are capitalized and depreciated as a component of cost of revenues. We expect that research and development expenses will increase in absolute dollars as we continue to enhance and expand our product offerings but decrease as a percentage of revenues over time.
 
Sales and Marketing.  Sales and marketing expenses consist primarily of wages and benefits for our sales and marketing personnel, sales commissions, marketing programs, including lead generation, events and other brand building expenses and allocated overhead. We capitalize our sales commissions at the time a subscription agreement is executed by the customer, and we expense the commissions as a component of sales and marketing ratably over the subscription period, matching the recognition period of the subscription revenues for which the commissions were incurred. In order to continue to grow our business and brand awareness, we expect that we will continue to invest in our sales and marketing efforts. We expect that sales and marketing expenses will increase in absolute dollars but decrease as a percentage of revenues over time.
 
General and Administrative.  General and administrative expenses consist of compensation and related expenses for administrative, human resources, finance and accounting personnel, professional fees, other taxes and other corporate expenses. We expect that general and administrative expenses will increase as we continue to add personnel in connection with the growth of our business. In addition, we anticipate that we will also incur additional personnel expense, professional fees, including auditing and legal, and insurance costs related to operating as a public company. Therefore, we expect that our general and administrative expenses will increase in absolute dollars. Over the next two years, we expect that our general and administrative expenses also will increase as a percentage of revenues.
 
Amortization of Intangible Assets.  Amortized intangible assets consist of acquired technology and customer relationships from the going private transaction in 2004. The acquired technology was amortized on a straight-line basis over the estimated life of three years, and the customer relationships are amortized over a ten-year estimated life in a pattern consistent with which the economic benefit is expected to be realized.
 
Adjusted EBITDA.  EBITDA, a non-GAAP operating measure, consists of net income (loss) plus depreciation and amortization, less interest and other income, net and less income tax benefit. Adjusted EBITDA, a non-GAAP operating measure, consists of EBITDA plus our non-cash, stock-based compensation expense and settlement and legal costs related to a patent infringement lawsuit in 2009. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure, the one-time costs associated with a non-recurring event and such items as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it is widely used by investors, securities analysts and other interested parties in our industry to measure a company’s operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired. Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
•   although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash expenditure requirements for such replacements;
•   Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•   Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;
•   Adjusted EBITDA does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;


41


Table of Contents

•   Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
•   other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted EBITDA along with these other measures in order to fully evaluate our financial performance.
 
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:
 
                                         
    Year Ended December 31,     Six Months Ended June 30,  
    2007     2008     2009     2009     2010  
    (Unaudited; in thousands)  
 
Net income (loss)
  $ (5,000 )   $ 1,117     $ 19,429     $ 1,737     $ 3,204  
Depreciation and amortization
    2,909       1,285       1,214       612       518  
Interest and other (income) expense, net
    (118 )     (113 )     (27 )     (31 )     (1,688 )
Income tax expense (benefit)
          (9 )     (16,821 )           2,052  
                                         
EBITDA
    (2,209 )     2,280       3,795       2,318       4,086  
Non-cash, stock-based compensation expense
    110       386       365       185       756  
Litigation settlement and associated legal expenses
                3,189       100        
                                         
Adjusted EBITDA
  $ (2,099 )   $ 2,666     $ 7,349     $ 2,603     $ 4,842  
                                         
 
Critical Accounting Policies
 
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.
 
We believe that of our significant accounting policies, which are described in Note 2 to the financial statements, the following accounting policies involve a greater degree of judgment and complexity. A critical accounting policy is one that is both material to the preparation of our financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
 
Revenue Recognition
 
We primarily derive our revenues from subscription fees for our on-demand strategic procurement and supplier enablement software solution and associated implementation services. Revenue is generated from subscription agreements and related services permitting customers to access and utilize our hosted software. Customers may on occasion also purchase a perpetual license for certain software modules. Revenue is recognized when there is persuasive evidence of an agreement, the service has been provided or delivered to the customer, the collection of the fee is probable and the amount of the fee to be paid by the customer is fixed or determinable.
 
Our contractual agreements generally contain multiple service elements and deliverables. These elements include access to the hosted software, implementation services and, on a limited basis, perpetual licenses for certain software modules and related maintenance and support. Subscription agreements do not provide customers the right to take possession of the hosted software at any time, with the exception of a triggering event in source code escrow arrangements. In applying the multiple element revenue recognition guidance, we determined that we do not have objective and reliable evidence of the fair value of the subscription agreement and related services. We therefore account for fees received under multiple-element agreements as a single unit


42


Table of Contents

of accounting and recognize the agreement consideration ratably over the term of the subscription agreement, which is generally three to five years. The term of the subscription agreement commences on the start date specified in the subscription agreement, which is the date access to the software is provided to the customer provided all other revenue recognition criteria have been met. Fees for professional services that are contingent upon future performance are recognized ratably over the remaining subscription term once the performance milestones have been met. We recognize revenue from any professional services that are sold separately as the services are performed.
 
Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from our software and services described above. For multiple year subscription agreements, we generally invoice our customers in annual installments. Accordingly, the deferred revenue balance does not represent the total contract value of these multi-year subscription agreements. Our services, such as implementation, are generally sold in conjunction with subscription agreements. These services are recognized ratably over the remaining term of the subscription agreement once any contingent performance milestones have been satisfied. The portion of deferred revenue that we anticipate will be recognized after the succeeding 12-month period is recorded as non-current deferred revenue and the remaining portion is recorded as current deferred revenue.
 
Stock-Based Compensation.  As of January 1, 2006, we adopted new stock-based compensation accounting guidance using the prospective application method, which requires that all stock-based payments to employees, including grants of employee stock options, are recognized in the statements of operations based on their fair values. Stock-based compensation costs are measured at the grant date based on the fair value of the award and are recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.
 
Stock-based compensation costs are calculated using the Black-Scholes option-pricing model. Determining the appropriate fair value model and related assumptions requires judgment, including estimating stock price volatility, forfeiture rates and expected term. The assumptions used in determining the fair value of stock-based awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation could be materially different in the future.
 
Because there has not been a public market for our common stock since 2004, we have lacked company-specific historical and implied volatility information. Therefore, we estimate our expected stock volatility based on that of publicly-traded peer companies, and we expect to continue to use this methodology until such time as we have adequate historical data regarding the volatility of our publicly-traded stock price. We do not have information available that is indicative of future exercise and post-vesting behavior to estimate the expected term. Therefore, the expected term used in our estimated fair value calculation represents the average time that options that vest are expected to be outstanding based on the mid-point between the vesting date and the end of the contractual term of the award. We have not paid dividends and do not anticipate paying dividends in the foreseeable future and, accordingly, use an expected dividend yield of zero. The risk-free interest rate is based on the rate of U.S. Treasury securities with maturities consistent with the estimated expected term of the awards. Pre-vesting forfeiture rates are estimated based on our historical forfeiture data.
 
The assumptions used in calculating the fair value of common stock options granted in 2008, 2009 and 2010 are set forth below:
 
             
    2008   2009   2010
 
Estimated dividend yield
  0%   0%   0%
Expected stock price volatility
  100.0%   100.0%   100.0%
Weighted-average risk-free interest rate
  2.6% – 3.6%   1.9% – 2.8%   2.6% – 3.0%
Expected life of award (in years)
  6.25   6.25   6.25


43


Table of Contents

We typically grant options on a semi-annual basis. The following table summarizes by grant date the number of stock options granted from January 1, 2008 through June 30, 2010, the per share exercise price of options and the fair value per option on each grant date:
 
                         
    Number of Shares Subject
  Per Share Exercise
  Fair Value
Grant Date
  to Options Granted   Price of Option(1)   per Option(2)
 
January 23, 2008(3)
    73,561     $ 2.60     $ 2.10  
July 23, 2008(3)
    31,500     $ 3.16     $ 2.56  
January 22, 2009
    174,547     $ 2.04     $ 1.63  
July 22, 2009
    17,500     $ 1.90     $ 1.53  
January 21, 2010
    223,599     $ 2.26     $ 1.82  
April 20, 2010
    79,500     $ 8.18     $ 6.61  
 
 
(1) The per share exercise price of option represents the determination by our board of directors of the fair value of our common stock on the date of grant, as determined by taking into account our most recent valuation of common stock.
 
(2) As described above, the fair value per share of each option was estimated for the date of grant using the Black-Scholes option-pricing model. This model estimates the fair value by applying a series of factors including the exercise price of the option, a risk free interest rate, the expected term of the option, expected share price volatility of the underlying common stock and expected dividends on the underlying common stock. Additional information regarding the valuation of our common stock and option awards is set forth in Note 8 to our financial statements included elsewhere in this prospectus.
 
(3) Represents stock options that were amended to reduce the exercise price for substantially all of the shares subject to stock options granted on January 23, 2008 and July 23, 2008. The amendments reduced the exercise price of the previously granted options to $2.04 per share, which was the fair value of our common stock on the date of the amendments. The amendments did not affect the vesting provisions or the number of shares subject to any of the option awards. For financial statement reporting, we treat the previously granted options as being forfeited and the amendments as new option grants.
 
As part of our stock incentive plan, and as set forth in Note 8 to our financial statements, we have also allowed certain employees to purchase shares of our restricted stock. We hold subscription notes receivable for the aggregate purchase price of the shares. Upon employee termination, we have the option to repurchase the shares. The repurchase price is the original purchase price plus interest for unvested restricted stock and the current fair value (as determined by our board of directors) for vested restricted stock. The shares generally vest ratably over two to four years. As of June 30, 2010, there were 2,200,558 shares of vested and unvested restricted stock outstanding. The following table summarizes by grant date the number of shares of restricted stock granted from January 1, 2008 through June 30, 2010, the per share purchase price of restricted stock and the fair value per share of restricted stock on each grant date.
 
                         
        Per Share
   
    Number of Shares of
  Purchase Price(s) of
  Fair Value(s)
Grant Date
  Restricted Stock Granted   Restricted Stock(1)   per Share(2)
 
January 23, 2008
    292,137     $ 2.60     $ 1.38 – $1.81  
January 22, 2009
    159,024     $ 2.04     $ 1.41 – $2.04  
January 21, 2010
    95,861     $ 2.26     $ 1.58  
 
 
(1) The per share purchase price of restricted stock represents the determination by our board of directors of the fair value of our common stock on the date of grant, as determined by taking into account our most recent valuation of common stock.
 
(2) As described above, the fair value per share of restricted stock was estimated for the date of grant using the Black-Scholes option-pricing model since the notes receivable are deemed non-recourse for accounting purposes. This model estimates the fair value by applying a series of factors including the exercise price of


44


Table of Contents

the option, a risk free interest rate, the expected term of the option, expected share price volatility of the underlying common stock and expected dividends on the underlying common stock.
 
Significant Factors Used in Determining the Fair Value of Our Common Stock
 
We have historically granted stock-based awards at exercise or purchase prices equivalent to the fair value of our common stock as of the date of grant, as determined by our board of directors taking into account our most recently available valuation of common stock.
 
Prior to June 2008, the annual common stock valuations were prepared using the income and market approaches. Under the income approach, the fair value of our common stock was estimated based upon the present value of a future stream of income that can reasonably be expected to be generated by the company. Under the market approach, the guideline market multiple methodology was applied, which involved the multiplication of free cash flows by risk-adjusted multiples. Multiples were determined through an analysis of certain publicly traded companies, which were selected on the basis of operational and economic similarity with our principal business operations.
 
Commencing in June 2008, we moved to semi-annual common stock valuations prepared using the “probability-weighted expected return” method. Under this methodology, the fair value of our common stock is estimated based upon an analysis of future values assuming various outcomes. The fair value is based on the probability-weighted present value of expected future investment returns considering each of the possible outcomes available to us as well as the rights of each share class. The possible outcomes considered were continued operation as a private company, an initial public offering and a sale of the company.
 
The private company scenario analysis utilized averages of the market and income approaches. Under the market approach, we estimated our enterprise value using the guideline public company method, which compares our company to publicly traded companies in our industry group after applying a discount for lack of marketability. The companies used for comparison under the guideline public company method were selected based on a number of factors, including but not limited to, the similarity of their industry, business model and financial risks. The multiples selected were adjusted for differences in expected growth, profitability and risk between the company and the comparable public companies. Under the income approach, we estimated our enterprise value using the discounted future cash flow method, which involves applying appropriate discount rates to estimated cash flows that are based on forecasts of revenues, costs and capital requirements. Our assumptions underlying the estimates were consistent with the plans and estimates that we use to manage our business. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rates.
 
The initial public offering scenario analysis utilized the guideline public company method. We estimated our enterprise value by comparing our company to publicly traded companies in our industry group. The companies used for comparison under the guideline public company method were selected based on a number of factors, including, but not limited to, the similarity of their industry, business model and financial risks to those of ours.
 
The sale scenario analysis utilized the guideline transaction enterprise value method. We estimated our enterprise value based on a range of values from guideline transactions. The companies used for comparison under the guideline transaction method were selected based on a number of factors, including, but not limited to, the similarity of their industry, business model and financial risks to those of ours.
 
Finally, the present values calculated under each scenario were weighted based on our management’s estimates of the probability of each scenario occurring. The resulting values represented the estimated fair value of our common stock at each valuation date.


45


Table of Contents

Specific information related to option grants is as follows:
 
January 2008 Grants
 
In January 2008, we granted 73,561 stock options with an exercise price of $2.60. Additionally, we issued 292,137 shares of restricted stock with a purchase price of $2.60. In the absence of a public trading market for our common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $2.60 per share.
 
We performed a contemporaneous valuation of the fair value of our common stock as of December 31, 2007 using the income and market approaches. The income approach used a discounted cash flow analysis by applying a risk-adjusted discount rate of 17.1% to estimated debt-free cash flows, based on forecasted revenues. The projections used in connection with the income approach were based on our expected operating performance over the forecast period. There is inherent uncertainty in these estimates; if different discount rates or assumptions had been used, the valuation would have been different. Under the market approach, we reviewed an analysis of comparable publicly traded companies to apply the guideline market multiple methodology. In this analysis, we applied an average multiple of free cash flow to our free cash flow. We then applied a 25% discount for lack of marketability. We also considered the rights, preferences and privileges of the preferred stock relative to the common stock. Based on this analysis, the aggregate fair value of our common stock was determined to be $36.9 million, with a per share value of $2.60.
 
July 2008 Grants
 
In July 2008, we granted 31,500 stock options with an exercise price of $3.16. In the absence of a public trading market for our common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $3.16 per share.
 
We performed a contemporaneous valuation of the fair value of our common stock as of July 1, 2008 using the probability-weighted expected return methodology discussed above.
 
Under the private company scenario, we applied the income and market approaches. Under the income approach, we used a discounted cash flow analysis. Under the market approach, we used a weighted-average of the public guideline company method and the guideline transaction method. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a 25% discount rate for lack of marketability. This resulted in a common equity valuation of $42.8 million.
 
Under the initial public offering scenario, we applied a multiple to our forecasted trailing 12 months revenue as of the estimated future date of an initial public offering. The multiple was based on a review of guideline public companies. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 20%. This resulted in an aggregate common equity value of $57.3 million.
 
Under the sale scenario, we reviewed an analysis of selected guideline transactions and applied a median revenue multiple to determine our enterprise value. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 20%. This resulted in an aggregate common equity value of $28.8 million.
 
We then estimated the probability of each scenario occurring. We assigned a 5% probability to the sale scenario, a 50% probability to the initial public offering scenario and a 45% probability to the private company scenario. Based on these approaches, the fair value of our common equity was determined to be $3.16 per share.
 
January 2009 Grants
 
In January 2009, we granted 174,547 stock options with an exercise price of $2.04. Additionally, we issued 159,024 shares of restricted stock with a purchase price of $2.04. In the absence of a public trading market for our common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $2.04 per share.


46


Table of Contents

We performed a contemporaneous valuation of the fair value of our common stock as of December 31, 2008 using the probability-weighted expected return methodology discussed above.
 
Under the private company scenario, we applied the income and market approaches. Under the income approach, we used a discounted cash flow analysis. Under the market approach, we used a weighted-average of the public guideline company method and the guideline transaction method. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a 25% discount rate for lack of marketability. This resulted in a common equity valuation of $29.0 million.
 
Under the initial public offering scenario, we applied a multiple to our forecasted trailing 12 months revenue as of the estimated future date of an initial public offering. The multiple was based on a review of guideline public companies. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $37.2 million.
 
Under the sale scenario, we reviewed an analysis of selected guideline transactions and applied a median revenue multiple to determine our enterprise value. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $38.7 million.
 
We then estimated the probability of each scenario occurring. We assigned a 10% probability to the sale scenario, a 20% probability to the initial public offering scenario and a 70% probability to the private company scenario. Based on these approaches, the fair value of our common equity was determined to be $2.04 per share.
 
July 2009 Grants
 
In July 2009, we granted 17,500 stock options with an exercise price of $1.90. In the absence of a public trading market for our common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $1.90 per share.
 
We performed a contemporaneous valuation of the fair value of our common stock as of July 1, 2009 using the probability-weighted expected return methodology discussed above.
 
Under the private company scenario, we applied the income and market approaches. Under the income approach, we used a discounted cash flow analysis. Under the market approach, we used a weighted-average of the public guideline company method and the guideline transaction method. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a 25% discount rate for lack of marketability. This resulted in a common equity valuation of $25.1 million.
 
Under the initial public offering scenario, we applied a multiple to our forecasted trailing 12 months revenue as of the estimated future date of an initial public offering. The multiple was based on a review of guideline public companies. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $36.9 million.
 
Under the sale scenario, we reviewed an analysis of selected guideline transactions and applied a median revenue multiple to determine our enterprise value. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $36.4 million.
 
We then estimated the probability of each scenario occurring. We assigned a 10% probability to the sale scenario, a 25% probability to the initial public offering scenario and a 65% probability to the private company scenario. Based on these approaches, the fair value of our common equity was determined to be $1.90 per share.
 
January 2010 Grants
 
In January 2010, we granted 223,599 stock options with an exercise price of $2.26. Additionally, we issued 95,861 shares of restricted stock with a purchase price of $2.26. In the absence of a public trading market for our


47


Table of Contents

common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $2.26 per share.
 
We performed a contemporaneous valuation of the fair value of our common stock as of December 31, 2009 using the probability-weighted expected return methodology discussed above.
 
Under the private company scenario, we applied the income and market approaches. Under the income approach, we used a discounted cash flow analysis. Under the market approach, we used a weighted-average of the public guideline company method and the guideline transaction method. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a 25% discount rate for lack of marketability. This resulted in a common equity valuation of $31.1 million.
 
Under the initial public offering scenario, we applied a multiple to our forecasted trailing 12 months revenue as of the estimated future date of an initial public offering. The multiple was based on a review of guideline public companies. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $43.9 million.
 
Under the sale scenario, we reviewed an analysis of selected guideline transactions and applied a median revenue multiple to determine our enterprise value. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 35%. This resulted in an aggregate common equity value of $44.2 million.
 
We then estimated the probability of each scenario occurring. We assigned a 5% probability to the sale scenario, a 25% probability to the initial public offering scenario and a 70% probability to the private company scenario. Based on these approaches, the fair value of our common equity was determined to be $2.26 per share.
 
April 2010 Grants
 
In April 2010, we granted 79,500 stock options with an exercise price of $8.18. In the absence of a public trading market for our common stock, our board of directors, with input from management, considered the factors described below and determined the fair value of our common stock in good faith to be $8.18 per share. The increase from the fair value that was used for the January 2010 grants is primarily a result of the increased probabilities of an initial public offering or a sale of the company, as well as an increased multiple under the initial public offering scenario based on a review of guideline public companies, each as described below. To a lesser extent, the increase was also attributable to the use of forecasted fiscal year 2011 revenue in the initial public offering scenario as opposed to using the trailing 12 months revenue as of December 31, 2010, as discussed below. Changes in revenue assumptions due to developments in our business and a decrease in the discount rate from 35% to 28% for the initial public offering scenario and the sale scenario also contributed slightly to the increase. The difference between the mid-point of our filing range and the fair value that was used for the April 2010 grants results from increasing the probability of the initial public offering scenario.
 
We performed a contemporaneous valuation of the fair value of our common stock as of March 31, 2010 using the probability-weighted expected return methodology discussed above.
 
Under the private company scenario, we applied the income and market approaches. Under the income approach, we used a discounted cash flow analysis. Under the market approach, we used a weighted-average of the public guideline company method and the guideline transaction method. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a 25% discount rate for lack of marketability. This resulted in a common equity valuation of $37.3 million.
 
Under the sale scenario, we reviewed an analysis of selected guideline transactions and applied a median revenue multiple to determine our enterprise value. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 28%. This resulted in an aggregate common equity value of $83.8 million.


48


Table of Contents

 
Under the initial public offering scenario, we applied a multiple to our forecasted fiscal year 2011 revenue. We then subtracted debt and the aggregate preferred stock liquidation preference. We then applied a discount rate of 28%. This resulted in an aggregate common equity value of $189.6 million.
 
The increase in the common equity value under the initial public offering scenario in this valuation as compared to the initial public offering scenario with respect to our January 2010 grants is due both to changes in our valuation methodology and an increase in the multiple applied in this scenario. The revenue multiple increased between December 31, 2009 and March 31, 2010 from 1.8 to 4.3. The valuation methodologies and assumptions that were used to establish the fair value of our common stock for both the January 2010 and April 2010 grants are not inconsistent with any of our financial statement assertions.
 
Although our methodologies for the private company scenario and sale scenario are consistent with our prior valuations, we made two changes in our methodology under the initial public offering scenario in this valuation. Since a registration statement for an initial public offering had been filed at the time of this valuation, we determined that these changes were appropriate to reflect the then current environment for initial public offerings. The first change in our methodology was to use forecasted fiscal year 2011 revenue in our analysis, as opposed to using revenue for the most recently completed fiscal year as had been used for prior valuations. At the time of this valuation, it appeared likely that our initial public offering would occur in the second half of 2010. We believe the use of forecasted revenue provides greater consistency with the expected valuation methodology for an initial public offering occurring after the mid-point of the current year. As a result, the revenue multiple was applied to our forecasted fiscal year 2011 revenue as opposed to our fiscal year 2009 revenue used in the initial public offering scenario with respect to our January 2010 grants.
 
The second change in methodology was to use the upper quartile revenue multiple from the guideline public companies rather than the mean revenue multiple from the guideline public companies used in the initial public offering scenario with respect to our January 2010 grants. We determined the use of the upper quartile revenue multiple from the guideline public companies to be more representative of our company based on our increased earnings and cash flows for forecasted fiscal year 2011 as opposed to valuations based on prior fiscal periods where we determined the use of the mean revenue multiple from the guideline public companies to be more appropriate in light of our lower earnings and cash flows for those periods. In addition, the upper quartile companies included those who underwent the more recent initial public offerings and were the most similar to us in size, growth and profitability.
 
The guideline public companies used in the valuation for the April 2010 grants consisted of SaaS companies that underwent initial public offerings between March 31, 2007 and March 31, 2010 and that are similar to us in size, growth and profitability. The revenue multiples were determined by dividing the enterprise value as of the applicable valuation date by the preceding 12 months of revenue as of the applicable valuation date, We believe that the use of revenue multiples is a common and appropriate valuation method for smaller, earlier stage public companies such as us.
 
In addition to the changes in methodology used in the valuation for our April 2010 grants, the multiple increase resulted from updating the revenue multiples for each of the guideline public companies as of the new valuation date. We believe that enterprise values of the guideline public companies increased over this period at a greater rate than their increases in revenue, resulting in a significant increase in the applicable revenue multiples. We believe the increase in enterprise values reflected a broader increase in valuations of public companies as the increases in their stock prices were consistent with increases in many stock market indices during this period. Accordingly, increases in fair value do not necessarily correlate with revenue growth. We believe our company’s valuation as a public company would have increased commensurate with those of the upper quartile of the guideline public companies due to the similarities between us and those companies, particularly our comparable earnings and revenue growth rates. Further, because these guideline public companies all underwent initial public offerings within the past three years, we believe these companies to be in a similar stage in the development and growth of their business as our company. Specifically, our net income growth rates for 2009 and the first quarter of 2010 generally exceeded the growth rates for the guideline public companies, while our revenue growth rates for these periods were comparable to those of the guideline public companies. We


49


Table of Contents

further believe that our forecasted net income and revenue growth rates compare favorably to those of the guideline public companies.
 
We then estimated the probability of each scenario occurring. We assigned a 30% probability to the sale scenario, a 50% probability to the initial public offering scenario and a 20% probability to the private company scenario. Based on these approaches, the fair value of common equity was determined to be $8.18 per share.
 
Deferred Project Costs.  We capitalize sales commission costs that are directly related to the execution of our subscription agreements. The commissions are deferred and amortized over the contractual term of the related subscription agreement. The deferred commission amounts are recoverable from the future revenue streams under the subscription agreements. We believe this is the appropriate method of accounting, as the commission costs are so closely related to the revenues from the subscription agreements that they should be recorded as an asset and charged to expense over the same period that the subscription revenues are recognized. Amortization of deferred commissions is included in sales and marketing expense in the statements of operations. The deferred commissions are reflected within deferred project costs in the balance sheets.
 
Goodwill.  Goodwill represents the excess of the cost of an acquired entity over the net fair value of the identifiable assets acquired and liabilities assumed. We review the carrying value of goodwill at least annually to assess impairment since it is not amortized. Additionally, we review the carrying value of goodwill whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. We have concluded that we have one reporting unit for purposes of our annual goodwill impairment testing. To assess goodwill impairment, the first step is to identify if a potential impairment exists by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to have a potential impairment and the second step of the impairment test is not necessary.
 
However, if the carrying amount of the reporting unit exceeds its fair value, the second step is performed to determine if goodwill is impaired and to measure the amount of impairment loss to recognize, if any. The second step compares the implied fair value of goodwill with the carrying amount of goodwill. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. However, if the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The fair value of the reporting unit is allocated to all the assets and liabilities, including any previously unrecognized intangible assets, as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. We performed our annual assessment on December 31, 2009. The estimated fair value of our reporting unit exceeded its carrying amount, including goodwill, and as such, no goodwill impairment was recorded.
 
Income Taxes.  Deferred income taxes are provided using tax rates enacted for periods of expected reversal on all temporary differences. Temporary differences relate to differences between the book and tax basis of assets and liabilities, principally intangible assets, property and equipment, deferred subscription revenue, pension assets, accruals and stock-based compensation. Valuation allowances are established to reduce deferred tax assets to the amount that will more likely than not be realized. To the extent that a determination is made to establish or adjust a valuation allowance, the expense or benefit is recorded in the period in which the determination is made.
 
Our company recognizes a tax benefit when it is more-likely-than-not, based on the technical merits, that the position would be sustained upon examination by a taxing authority. The amount to be recognized is measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Our company records interest or penalties accrued in relation to unrecognized tax benefits as income tax expense.


50


Table of Contents

Results of Operations
 
The following table sets forth, for the periods indicated, our results of operations:
 
                                         
          Six Months
 
    Year Ended December 31,     Ended June 30,  
    2007     2008     2009     2009     2010  
                      (Unaudited)  
    (In thousands)  
 
Revenues
  $ 20,107     $ 29,784     $ 36,179     $ 17,406     $ 20,688  
Cost of revenues
    6,101       6,723       7,494       3,748       4,446  
                                         
Gross profit
    14,006       23,061       28,685       13,658       16,242  
                                         
Operating expenses:
                                       
Research and development
    6,908       8,307       8,059       4,360       3,919  
Sales and marketing
    7,213       9,280       10,750       5,346       5,969  
General and administrative
    2,717       3,942       3,703       1,945       2,635  
Litigation settlement and associated legal expenses
                3,189       100        
Amortization of intangible assets
    2,286       537       403       201       151  
                                         
Total operating expenses
    19,124       22,066       26,104       11,952       12,674  
                                         
Income (loss) from operations
    (5,118 )     995       2,581       1,706       3,568  
Interest and other income net
    118       113       27       31       1,688  
                                         
Income (loss) before income taxes
    (5,000 )     1,108       2,608       1,737       5,256  
Income tax benefit (expense)
          9       16,821             (2,052 )
                                         
Net income (loss)
  $ (5,000 )   $ 1,117     $ 19,429     $ 1,737     $ 3,204  
                                         
 
The following table sets forth, for the periods indicated, our results of operations expressed as a percentage of revenues:
 
                                         
    Year Ended December 31,   Six Months Ended June 30,
    2007   2008   2009   2009   2010
                (Unaudited)
 
Revenues
    100 %     100 %     100 %     100 %     100 %
Cost of revenues
    30       23       21       21       21  
                                         
Gross profit
    70       77       79       79       79  
                                         
Operating expenses:
                                       
Research and development
    34       28       22       25       19  
Sales and marketing
    36       31       30       31       29  
General and administrative
    14       13       10       11       13  
Litigation settlement and associated legal expenses
                9       1        
Amortization of intangible assets
    11       2       1       1       1  
                                         
Total operating expenses
    95       74       72       69       62  
                                         
Income (loss) from operations
    (25 )     3       7       10       17  
Interest and other income, net
          1                   8  
                                         
Income (loss) before income taxes
    (25 )     4       7       10       25  
Income tax benefit (expense)
                47             (10 )
                                         
Net income (loss)
    (25 )%     4 %     54 %     10 %     15 %
                                         


51


Table of Contents

 
Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009
 
Revenues.  Revenues for the six months ended June 30, 2010 were $20.7 million, an increase of $3.3 million, or 19%, over revenues of $17.4 million for the six months ended June 30, 2009. The increase in revenues resulted primarily from an increase in the number of customers from 133 as of June 30, 2009 to 168 as of June 30, 2010, as well as recognition of revenue for a full six-month period for the new customers added in the three months ended June 30, 2009. We have increased our customer count through our continued efforts to enhance brand awareness and our sales and marketing efforts.
 
Cost of Revenues.  Cost of revenues for the six months ended June 30, 2010 was $4.4 million, an increase of $0.7 million, or 19%, over cost of revenues of $3.7 million for the six months ended June 30, 2009. As a percentage of revenues, cost of revenues was 21% for both the six months ended June 30, 2010 and 2009. The increase in dollar amount primarily resulted from a $0.6 million increase in employee-related costs attributable to our existing personnel and additional implementation service personnel. We had 70 full-time equivalents in our implementation services, supplier enablement services, customer support and client partner organizations at June 30, 2010, compared to 55 full-time equivalents at June 30, 2009.
 
Research and Development Expenses.  Research and development expenses for the six months ended June 30, 2010 were $3.9 million, a decrease of $0.5 million, or 11%, from research and development expenses of $4.4 million for the six months ended June 30, 2009. As a percentage of revenues, research and development expenses decreased to 19% for the six months ended June 30, 2010 from 25% for the six months ended June 30, 2009. The decrease in dollar amount was primarily due to a decrease of $0.1 million in employee-related costs attributable to our existing personnel and an increase in capitalization of research and development costs of $0.4 million in 2010 and was partially offset by an increase in stock compensation expense of $0.1 million. We had 54 full-time equivalents in our research and development organization at June 30, 2010, compared to 52 full-time equivalents at June 30, 2009.
 
Sales and Marketing Expenses.  Sales and marketing expenses for the six months ended June 30, 2010 were $6.0 million, an increase of $0.7 million, or 13%, over sales and marketing expenses of $5.3 million for the six months ended June 30, 2009. As a percentage of revenues, sales and marketing expenses decreased to 29% for the six months ended June 30, 2010 from 30% for the six months ended June 30, 2009. The increase in dollar amount is primarily due to an increase of $0.3 million in marketing costs, an increase of $0.1 million in stock compensation expense and an increase of $0.2 million in amortized commission expense. We had 46 full-time equivalents in our sales and marketing organization at June 30, 2010, compared to 47 full-time equivalents at June 30, 2009.
 
General and Administrative Expenses.  General and administrative expenses for the six months ended June 30, 2010 were $2.6 million, an increase of $0.7 million, or 37%, over general and administrative expenses of $1.9 million for the six months ended June 30, 2009. As a percentage of revenues, general and administrative expenses increased to 13% for the six months ended June 30, 2010, from 11% for the six months ended June 30, 2009. The increase in dollar amount is primarily due to an increase of $0.3 million in stock compensation expense and an increase of $0.2 million in employee-related costs attributable to existing personnel and additional general and administrative headcount. We had 13 full-time equivalents in our general and administrative organization at June 30, 2010, compared to 11 full-time equivalents at June 30, 2009.
 
Litigation and Settlement and Associated Legal Expenses.  Litigation settlement and associated legal expenses for the six months ended June 30, 2010 were none, compared to $0.1 million, or 1% of revenues for the six months ended June 30, 2009. In 2009, a company filed a patent infringement action against us and other, unrelated companies. We entered into a settlement agreement in 2009, and there were $0.1 million of the total settlement and related legal costs of $3.2 million recognized as operating expenses in the six months ended June 30, 2009.
 
Amortization of Intangible Assets.  Amortization of intangible assets for the six months ended June 30, 2010 and June 30, 2009 was $0.2 million. As a percentage of revenues, amortization of intangible assets was 1% for both the six months ended June 30, 2010 and 2009.


52


Table of Contents

Income from Operations.  Income from operations for the six months ended June 30, 2010 was $3.6 million, an increase of $1.9 million, or 112%, over income from operations of $1.7 million for the six months ended June 30, 2009. As a percentage of revenues, income from operations increased to 17% for the six months ended June 30, 2010 from 10% for the six months ended June 30, 2009. The increase in dollar amount was a result of our increase in revenues partially offset by our increased expenses required to support the additional revenues.
 
Interest and Other Income.  Interest and other income for the six months ended June 30, 2010 was $1.7 million compared to no interest and other income for the six months ended June 30, 2009. This increase was due to a gain on the sale of warrants we had in an unaffiliated private company during the six months ended June 30, 2010.
 
Income Tax Expense.  Income tax expense for the six months ended June 30, 2010 was $2.1 million compared to no income tax expense for the six months ended June 30, 2009. The increase in income tax expense was due to the reversal of our valuation reserve against our deferred tax assets in December 2009 and the subsequent recognition of tax expense for the six months ended June 30, 2010 at our effective tax rate of 39% of our income before income taxes.
 
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
 
Revenues.  Revenues for 2009 were $36.2 million, an increase of $6.4 million, or 21%, over revenues of $29.8 million for 2008. The increase in revenues resulted primarily from an increase in the number of customers from 127 as of December 31, 2008 to 156 as of December 31, 2009, as well as recognition of a full year’s revenues for the new customers added in 2008. Revenues in 2008 included $0.8 million for a one-time termination fee received for the cancellation of a reseller agreement recognized in that year. We have increased our customer count through our continued efforts to enhance brand awareness and our sales and marketing efforts.
 
Cost of Revenues.  Cost of revenues in 2009 was $7.5 million, an increase of $0.8 million, or 12%, over cost of revenues of $6.7 million in 2008. As a percentage of revenues, cost of revenues decreased to 21% in 2009 from 22% in 2008. The increase in dollar amount primarily resulted from a $0.5 million increase in employee-related costs attributable to our existing personnel and additional implementation service personnel, as well as a $0.1 million increase in allocated overhead due to increases in leased square footage of office space. We had 56 full-time employee equivalents in our implementation services, supplier enablement services, customer support and client partner organizations at December 31, 2009, compared to 55 full-time employee equivalents at December 31, 2008.
 
Research and Development Expenses.  Research and development expenses for 2009 were $8.1 million, a decrease of $0.2 million, or 2%, from research and development expenses of $8.3 million for 2008. As a percentage of revenues, research and development expenses decreased to 22% in 2009 from 28% in 2008. The decrease in dollar amount was due to an increase in capitalization of research and development costs of $0.1 million in 2009 and a reduction of $0.1 million in employee-related costs attributable to our existing personnel. We had 50 full-time employee equivalents in our research and development organization at December 31, 2009, compared to 53 full-time employee equivalents at December 31, 2008.
 
Sales and Marketing Expenses.  Sales and marketing expenses for 2009 were $10.8 million, an increase of $1.5 million, or 16%, over sales and marketing expenses of $9.3 million for 2008. As a percentage of revenues, sales and marketing expenses decreased slightly to 30% in 2009 from 31% in 2008. The increase in dollar amount is primarily due to an increase of $1.0 million in employee-related costs from our existing personnel and additional sales and marketing headcount, an increase of $0.4 million in amortized commission expense and an increase of $0.1 million of allocated overhead. We had 45 full-time employee equivalents in our sales and marketing organization at December 31, 2009, compared to 43 employee equivalents at December 31, 2008.
 
General and Administrative Expenses.  General and administrative expenses for 2009 were $3.7 million, a decrease of $0.2 million, or 5%, from general and administrative expenses of $3.9 million for 2008. As a percentage of revenues, general and administrative expenses decreased to 10% in 2009 from 13% in 2008. The decrease in dollar amount is due to a reduction in legal expenses of $0.4 million primarily due to efforts in 2008 to


53


Table of Contents

file 13 patent applications, a reduction of $0.1 million in auditing fees due to the performance of a three-year audit in 2008 and a reduction of $0.2 million in recruiting costs due to bringing our recruiting efforts inside the business instead of relying on outside recruiting firms in 2009, offset by an increase of $0.4 million in employee-related costs attributable to existing general and administrative personnel. We had 11 full-time employee equivalents in our general and administrative organization at December 31, 2009 and December 31, 2008.
 
Litigation Settlement and Associated Legal Expenses.  Litigation settlement and associated legal expenses for 2009 were $3.2 million, or 9% of revenues, compared to no litigation settlement and associated legal expenses for 2008. In 2009, a company filed a patent infringement action against us and other, unrelated companies. We entered into a settlement agreement in 2009, and the settlement and related legal costs of $3.2 million were paid and recognized as operating expenses in the year ended December 31, 2009.
 
Amortization of Intangible Assets.  Amortization of intangible assets for 2009 was $0.4 million, a decrease of $0.1 million, or 20%, over amortization of intangible assets of $0.5 million for 2008. As a percentage of revenues, amortization of intangible assets decreased to 1% in 2009 from 2% in 2008. The decrease in dollar amount was the result of the declining amortization recognized on the customer relationships asset over the 10-year estimated life. The customer relationships asset was recorded as a result of the going private transaction in 2004.
 
Income from Operations.  Income from operations for 2009 was $2.6 million, an increase of $1.6 million, or 160%, over income from operations of $1.0 million for 2008. As a percentage of revenues, income from operations increased to 7% in 2009 from 3% in 2008. The increase in dollar amount was the result of our increase in revenues offset by our increased expenses required to support the additional revenues, as well as the one-time impact of the litigation settlement and associated legal expenses.
 
Income tax benefit (expense).  Income tax benefit (expense) for the year ended December 31, 2009 was $16.8 million compared to $0.0 million for the year ended December 31, 2008. The increase in income tax benefit was due to the reversal of our valuation reserve against our deferred tax asset of $16.8 million in December 2009. This reversal was due to our attaining sufficient positive evidence to support the likelihood of realizing the deferred tax asset.
 
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
Revenues.  Revenues for 2008 were $29.8 million, an increase of $9.7 million, or 48%, over revenues of $20.1 million for 2007. The increase in revenues resulted primarily from an increase in the number of customers from 105 as of December 31, 2007 to 127 as of December 31, 2008, as well as recognition of a full year’s revenues for the new customers added in 2007. Revenues in 2008 included $0.8 million due to a one-time termination fee received for the cancellation of a reseller agreement recognized in that year. We have increased our customer count through our continued efforts to enhance brand awareness and our sales and marketing efforts.
 
Cost of Revenues.  Cost of revenues in 2008 was $6.7 million, an increase of $0.6 million, or 10%, over cost of revenues of $6.1 million in 2007. As a percentage of revenues, cost of revenues decreased to 22% in 2008 from 30% in 2007. The increase in dollar amount primarily resulted from a $0.6 million increase in employee-related costs attributable to our existing personnel and additional implementation service personnel. We had 55 full-time employee equivalents in our implementation services, supplier enablement services, customer support and client partner organizations at December 31, 2008, compared to 51 full-time employee equivalents at December 31, 2007.
 
Research and Development Expenses.  Research and development expenses for 2008 were $8.3 million, an increase of $1.4 million, or 20%, over research and development expenses of $6.9 million for 2007. As a percentage of revenues, research and development expenses decreased to 28% in 2008 from 34% in 2007. The increase in dollar amount was primarily due to an increase of $1.2 million in employee-related costs attributable to our existing personnel and additional research and development personnel as well as a decrease in capitalization of research and development costs of $0.3 million in 2008. We had 53 full-time employee


54


Table of Contents

equivalents in our research and development organization at December 31, 2008, compared to 48 full-time employee equivalents at December 31, 2007.
 
Sales and Marketing Expenses.  Sales and marketing expenses for 2008 were $9.3 million, an increase of $2.1 million, or 29%, over sales and marketing expenses of $7.2 million for 2007. As a percentage of revenues, sales and marketing expenses decreased to 31% in 2008 from 36% in 2007. The increase in dollar amount is primarily due to an increase of $0.9 million in employee-related costs from our existing personnel and additional sales and marketing headcount, an increase of $0.6 million in amortized commission expense, an increase of $0.3 million in travel costs and $0.1 million in allocated overhead due to our additional personnel and an increase of $0.1 million in additional marketing costs for tradeshows. We had 43 full-time employee equivalents in our sales and marketing organization at December 31, 2008, compared to 30 employee equivalents at December 31, 2007.
 
General and Administrative Expenses.  General and administrative expenses for 2008 were $3.9 million, an increase of $1.2 million, or 44%, from general and administrative expenses of $2.7 million for 2007. As a percentage of revenues, general and administrative expenses was 13% in both 2008 and 2007. The increase in dollar amount is due to an increase in legal expenses of $0.5 million primarily due to efforts in 2008 to file 13 patent applications, an increase of $0.2 million in auditing fees due to the performance of a three-year audit in 2008, an increase of $0.3 million in employee-related costs attributable to our existing personnel and additional general and administrative personnel and an increase of $0.2 million in stock-based compensation. We had 11 full-time employee equivalents in our general and administrative organization at December 31, 2008, compared to eight at December 31, 2007.
 
Amortization of Intangible Assets.  Amortization of intangible assets for 2008 was $0.5 million, a decrease of $1.8 million, or 78%, over amortization of intangible assets of $2.3 million for 2007. As a percentage of revenues, amortization of intangible assets decreased to 2% in 2008 from 11% in 2007. The decrease in dollar amount was the result of final amortization of the acquired technology and the declining amortization recognized on the customer relationships asset over the 10-year estimated life. Both the acquired technology and the customer relationships asset were recorded as a result of the going private transaction in 2004.
 
Income from Operations.  Income from operations for 2008 was $1.0 million, an increase of $6.1 million over the loss from operations of $(5.1) million for 2007. As a percentage of revenues, income from operations increased to 3% in 2008 from (25%) in 2007. The increase in dollar amount was the result of our increase in revenues offset by our increased expenses required to support the additional revenues.
 
Quarterly Results of Operations
 
The following table sets forth our unaudited operating results, Adjusted EBITDA and Adjusted Free Cash Flow for each of the ten quarters preceding and including the period ended June 30, 2010 and the percentages of revenues for each line item shown. The information is derived from our unaudited financial statements. In the opinion of management, our unaudited financial statements include all adjustments, consisting only of normal recurring items, except as noted in the notes to the financial statements, necessary for a fair statement of interim periods. The financial information presented for the interim periods has been prepared in a manner consistent with our accounting policies described elsewhere in this prospectus and should be read in conjunction therewith. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full-year period.
 


55


Table of Contents

                                                                                 
    Three Months Ended  
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
 
    2008     2008     2008     2008     2009     2009     2009     2009     2010     2010  
    (Unaudited; in thousands)  
 
Statements of Operations Data:
                                                                               
Revenues
  $ 7,134     $ 6,750     $ 7,674     $ 8,227     $ 8,595     $ 8,811     $ 9,049     $ 9,724     $ 10,126     $ 10,562  
Cost of revenues
    1,694       1,603       1,666       1,760       1,847       1,901       1,879       1,867       2,109       2,337  
                                                                                 
Gross profit
    5,440       5,147       6,008       6,467       6,748       6,910       7,170       7,857       8,017       8,225  
                                                                                 
Operating expenses:
                                                                               
Research and development
    2,101       2,083       2,014       2,109       2,230       2,130       1,968       1,731       2,037       1,882  
Sales and marketing
    2,315       2,279       2,217       2,469       2,694       2,652       2,528       2,876       3,138       2,831  
General and administrative
    989       776       1,148       1,029       1,000       945       805       953       1,380       1,255  
Litigation settlement and associated legal expenses
                                  100       3,089                    
Amortization of intangible assets
    134       134       134       135       101       100       101       101       76       75  
                                                                                 
Total operating expenses
    5,539       5,272       5,513       5,742       6,025       5,927       8,491       5,661       6,631       6,043  
                                                                                 
Income (loss) from operations
    (99 )     (125 )     495       725       723       983       (1,321 )     2,196       1,386       2,182  
Interest and other income (expense), net
    58       27       14       14       15       16             (4 )     1,687       1  
                                                                                 
Income (loss) before income taxes
    (41 )     (98 )     509       739       738       999       (1,321 )     2,192       3,073       2,183  
Income tax benefit (expense)
                      9                         16,821       (1,143 )     (909 )
                                                                                 
Net income (loss)
  $ (41 )   $ (98 )   $ 509     $ 748     $ 738     $ 999     $ (1,321 )   $ 19,013     $ 1,930     $ 1,274  
                                                                                 
 
                                                                                 
    Three Months Ended
    March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
    2008   2008   2008   2008   2009   2009   2009   2009   2010   2010
    (Unaudited; in thousands)
 
Non-GAAP Operating Data:
                                                                               
Adjusted EBITDA(1)
  $ 285     $ 263     $ 992     $ 1,127     $ 1,113     $ 1,490     $ 2,171     $ 2,575     $ 2,256     $ 2,586  
Adjusted Free Cash Flow(2)
  $ (1,260 )   $ 538     $ 3,678     $ 3,047     $ (2,326 )   $ 1,686     $ 2,829     $ 4,596     $ 158     $ 2,607  
 
 
(1) EBITDA consists of net income (loss) plus depreciation and amortization, less interest and other income, net and less income tax benefit (expense). Adjusted EBITDA consists of EBITDA plus our non-cash, stock-based compensation expense and settlement and legal costs related to a patent infringement lawsuit settled in 2009. We use Adjusted EBITDA as a measure of operating performance because it assists us in comparing performance on a consistent basis, as it removes from our operating results the impact of our capital structure, the one-time costs associated with a non-recurring event and such items as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets. We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance because it and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired.

56


Table of Contents

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash expenditure requirements for such replacements;
  •   Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
  •   Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation;
  •   Adjusted EBITDA does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and
  •   other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted EBITDA along with these other measures in order to fully evaluate our financial performance.
 
The following table provides a reconciliation of net income (loss) to Adjusted EBITDA:
 
                                                                                 
    Three Months Ended  
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
 
    2008     2008     2008     2008     2009     2009     2009     2009     2010     2010  
    (Unaudited; in thousands)  
 
Net income (loss)
  $ (41 )   $ (98 )   $ 509     $ 748     $ 738     $ 999     $ (1,321 )   $ 19,013     $ 1,930     $ 1,274  
Depreciation and amortization
    315       316       322       332       300       312       311       291       262       256  
Interest and other expense (income), net
    (58 )     (27 )     (14 )     (14 )     (15 )     (16 )           4       (1,687 )     (1 )
Income tax expense (benefit)
                      (9 )                       (16,821 )     1,143       909  
                                                                                 
EBITDA
    216       191       817       1,057       1,023       1,295       (1,010 )     2,487       1,648       2,438  
Non-cash, share-based compensation expense
    69       72       175       70       90       95       92       88       608       148  
Litigation settlement and associated legal expenses
                                  100       3,089                    
                                                                                 
Adjusted EBITDA
  $ 285     $ 263     $ 992     $ 1,127     $ 1,113     $ 1,490     $ 2,171     $ 2,575     $ 2,256     $ 2,586  
                                                                                 
 
(2) Free Cash Flow consists of net cash provided by operating activities, less purchases of property and equipment and less capitalization of software development costs. Adjusted Free Cash Flow consists of Free Cash Flow plus one-time settlement and legal costs related to a patent infringement lawsuit in 2009 as well as public stock offering costs incurred in 2010. We use Adjusted Free Cash Flow as a measure of liquidity because it assists us in assessing the company’s ability to fund its growth through its generation of cash. We believe Adjusted Free Cash Flow is useful to an investor in evaluating our liquidity because Adjusted Free Cash Flow and similar measures are widely used by investors, securities analysts and other interested parties in our industry to measure a company’s liquidity without regard to revenue and expense recognition, which can vary depending upon accounting methods.
 
Our use of Adjusted Free Cash Flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
  •   Adjusted Free Cash Flow does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
  •   Adjusted Free Cash Flow does not reflect one-time litigation expense payments, which reduced the cash available to us;
  •   Adjusted Free Cash Flow does not include public stock offering costs;


57


Table of Contents

  •   Adjusted Free Cash Flow removes the impact of accrual basis accounting on asset accounts and non-debt liability accounts; and
  •   other companies, including companies in our industry, may calculate Adjusted Free Cash Flow differently, which reduces its usefulness as a comparative measure.
 
Because of these limitations, you should consider Adjusted Free Cash Flow alongside other liquidity measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Adjusted Free Cash Flow along with these other measures in order to fully evaluate our liquidity.
 
The following table provides a reconciliation of net cash provided by operating activities to Adjusted Free Cash Flow:
 
                                                                                 
    Three Months Ended  
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
 
    2008     2008     2008     2008     2009     2009     2009     2009     2010     2010  
    (Unaudited; in thousands)  
 
Net cash provided by (used in) operating activities
  $ (1,146 )   $ 677     $ 3,888     $ 3,163     $ (2,055 )   $ 1,777     $ (34 )   $ 4,813     $ 368     $ 2,005  
Purchase of property and equipment
    (114 )     (139 )     (131 )     (96 )     (271 )     (191 )     (65 )     (158 )     (102 )     (277 )
Capitalization of software development costs
                (79 )     (20 )                 (95 )     (125 )     (202 )     (220 )
                                                                                 
Free Cash Flow
    (1,260 )     538       3,678       3,047       (2,326 )     1,586       (194 )     4,530       64       1,508  
Litigation settlement and associated legal expenses
                                  100       3,023       66              
Public stock offering costs
                                                    94       1,099  
                                                                                 
Adjusted Free Cash Flow
  $ (1,260 )   $ 538     $ 3,678     $ 3,047     $ (2,326 )   $ 1,686     $ 2,829     $ 4,596     $ 158     $ 2,607  
                                                                                 
 
As a percentage of revenues:
 
                                                                                 
    Three Months Ended  
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
    September 30,
    December 31,
    March 31,
    June 30,
 
    2008     2008     2008     2008     2009     2009     2009     2009     2010     2010  
    (Unaudited)  
 
Statements of Operations Data:
                                                                               
Revenues
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %
Cost of revenues
    24       24       22       21       21       22       21       19       21       22  
                                                                                 
Gross profit
    76       76       78       79       79       78       79       81       79       78  
                                                                                 
Operating expenses:
                                                                               
Research and development
    30       31       26       26       26       24       22       18       20       18  
Sales and marketing
    32       34       29       30       31       30       28       29       31       27  
General and administrative
    14       11       15       13       12       11       9       10       14       12  
Litigation settlement and associated legal expenses
                                  1       34                    
Amortization of intangible assets
    2       2       2       1       1       1       1       1       1        
                                                                                 
Total operating expenses
    78       78       72       70       70       67       94       58       66       57  
                                                                                 
Income (loss) from operations
    (2 )     (2 )     6       9       9       11       (15 )     23       13       21  
Interest and other income (expense), net
    1       1       1                                     17        
                                                                                 
Income (loss) before income taxes
    (1 )     (1 )     7       9       9       11       (15 )     23       30       21  
Income tax benefit (expense)
                                              173       (11 )     (9 )
                                                                                 
Net income (loss)
    (1 )%     (1 )%     7 %     9 %     9 %     11 %     (15 )%     196 %     19 %     12 %
                                                                                 


58


Table of Contents

Revenues increased sequentially in each of the quarters presented primarily due to the increase in the number of total customers, with the exception of the three months ended June 30, 2008. Revenues in the three months ended June 30, 2008 declined sequentially by $0.8 million due to a one-time termination fee received for the cancellation of a reseller arrangement recognized in the three months ended March 31, 2008.
 
Gross profit, in absolute dollars, also increased sequentially for the quarters presented primarily due to revenue growth, with the exception of the three months ended June 30, 2008. The decrease in gross profit, in absolute dollars, in the three months ended June 30, 2008 was due to the $0.8 million one-time termination fee received for the cancellation of a reseller arrangement recognized in the three months ended March 31, 2008.
 
Total operating expenses, in absolute dollars, have generally increased over the nine quarters presented, while the quarterly fluctuations have been as a result of timing of capitalization of research and development costs, timing of marketing expenditures and timing of legal and audit fees.
 
In June 2010, we terminated our Exit Event Bonus Plan and determined to pay cash bonuses to our executives in connection with our initial public offering in the aggregate amount of up to $5,888,045 in lieu of issuing shares of common stock under the plan. The payment of these bonuses is subject to consummation of our initial public offering. We will incur compensation expense in the amount of such bonuses in the same quarter in which our initial public offering occurs. As a result, total operating expenses for such quarter are expected to increase significantly and gross profit for such quarter is expected to decrease significantly, each as compared to prior quarters. We do not expect the payment of these bonuses to impact the sufficiency of our cash and cash equivalents to meet our working capital and capital expenditure requirements for at least the next 12 months.
 
Liquidity
 
Since the going private transaction in July 2004, we have funded our operations through cash flow generated by the operating activities of our business.
 
Net Cash Flows from Operating Activities
 
Net cash provided by operating activities was $2.4 million during the six months ended June 30, 2010, $4.5 million during 2009, $6.6 million during 2008 and $4.7 million during 2007. The amount of our net cash provided by operating activities is primarily a result of the timing of cash payments from our customers, offset by the timing of our primary cash expenditures, which are employee salaries. The cash payments from our customers will fluctuate quarterly as our new business sales normally fluctuate quarterly, primarily due to the timing of client budget cycles, with the second and fourth quarters of each year generally having the most sales and the first and third quarters generally having fewer sales. The cash payments from customers are typically due annually on the anniversary date of the initial contract. The cash payments from customers were approximately $20 million during the six months ended June 30, 2010, $38 million during 2009, $36 million during 2008 and $28 million during 2007. The cash payments to employees are typically ratable throughout the fiscal year, with the exception of annual incentive payments, which occur in the first quarter. The cash expenditures for employee salaries, including incentive payments, were approximately $11 million during the six months ended June 30, 2010, $20 million during 2009, $18 million during 2008 and $14 million during 2007.
 
For the six months ended June 30, 2010, net cash provided by operating activities of $2.4 million was primarily the result of $3.2 million of net income plus a $1.8 million decrease in deferred taxes and a $1.2 million increase in deferred revenues, less a $1.7 million gain on the sale of warrants and a $1.9 million increase in accounts receivable. Our accounts receivable and deferred revenues typically decrease in our first quarter and then increase in our second quarter. As of June 30, 2010, both accounts receivable and deferred revenues have increased compared to our fourth quarter due to our historical occurrence of lower new sales in our first quarter followed by our historical occurrence of high new sales in our second quarter.
 
For 2009, net cash provided by operating activities of $4.5 million was primarily the result of $19.4 million of net income, non-cash depreciation and amortization expense of $1.2 million and a $2.7 million increase in deferred revenues offset by a $16.8 million increase in deferred taxes, a $1.3 million increase in accounts


59


Table of Contents

receivable and a $0.6 million decrease in accrued liabilities. Increases in deferred revenues are due to continued growth in new business, offset by the subscription revenues recognized ratably over time. Increases in accounts receivable are primarily due to growth in the number of customer subscription agreements.
 
For 2008, net cash provided by operating activities of $6.6 million was primarily a result of $1.1 million of net income, non-cash depreciation and amortization expense of $1.3 million and a $5.5 million increase in deferred revenues due to growth in new business offset by a $0.8 million increase in deferred project costs due to increased capitalized commissions from new business in 2008.
 
For 2007, net cash provided by operating activities of $4.7 million was primarily a result of a $(5.0) million net loss, offset by $2.9 million in non-cash depreciation and amortization expense and a $7.0 million increase in deferred revenues due to growth in new business.
 
Our deferred revenues were $35.5 million at June 30, 2010, $34.3 million at December 31, 2009, $31.6 million at December 31, 2008 and $26.1 million at December 31, 2007. The increases in deferred revenues at the end of each of these fiscal periods reflects growth in the total number of customers. Customers are invoiced annually in advance for their annual subscription fee and the invoices are recorded in accounts receivable and deferred revenues, which deferred revenues are then recognized ratably over the term of the subscription agreement. With respect to implementation services fees, customers are invoiced as the services are performed, typically within the first three to eight months of contract execution, and the invoices are recorded in accounts receivable and deferred revenues, which are then recognized ratably over the remaining term of the subscription agreement once the performance milestones have been met. If our sales increase, we would expect our deferred revenues balance to increase.
 
As of June 30, 2010, we had net operating loss carryforwards of approximately $192 million available to reduce future federal taxable income. In the future, we may fully utilize our available net operating loss carryforwards and would begin making income tax payments at that time. In addition, the limitations on utilizing net operating loss carryforwards and other minimum state taxes may also increase our overall tax obligations. We expect that if we generate taxable income and/or we are not allowed to use net operating loss carryforwards for federal/state income tax purposes, our cash generated from operations will be adequate to meet our income tax obligations.
 
Net Cash Flows from Investing Activities
 
For the six months ended June 30, 2010, net cash provided by investing activities was $1.2 million, consisting of a gain on the sale of warrants of $1.7 million, various capital expenditures of $0.4 million and capitalization of $0.4 million of software development costs, offset by a decrease in restricted cash of $0.4 million. In general, our capital expenditures are for our network infrastructure to support our increasing customer base and growth in new business and for internal use, such as equipment for our increasing employee headcount. The restricted cash collateralized our line of credit, which was obtained in 2008 and repaid and extinguished in 2010. For 2009, net cash used in investing activities was $0.9 million, consisting of various capital expenditures of $0.7 million and capitalization of $0.2 million of software development costs. Net cash used in investing activities for 2008 was $0.9 million, consisting of capital expenditures of $0.5 million, capitalization of software development costs of $0.1 million and an increase in restricted cash of $0.4 million. Net cash used in investing activities for 2007 was $1.1 million, consisting of $0.7 million for capital expenditures and $0.4 million for capitalization of software development costs.
 
Net Cash Flows from Financing Activities
 
For the six months ended June 30, 2010, net cash used by financing activities was $0.6 million, consisting primarily of a $0.4 million repayment of our line of credit and a $0.3 million payment for the repurchase of restricted stock. For 2009, net cash provided by financing activities was $0.03 million and was primarily for the issuance of common stock under the 2004 Stock Incentive Plan. For 2008, net cash provided by financing activities was $0.06 million and was primarily for the issuance of common stock under the 2004 Stock Incentive Plan. For 2007, net cash used in financing activities was $1.1 million and was primarily for the repayment of the remainder of our note payable from the going private transaction.


60


Table of Contents

Line of Credit
 
As of June 30, 2010, we had terminated our $2.5 million line of credit and repaid the $0.4 million which had been drawn down. This line of credit was collateralized by a $0.4 million restricted cash deposit which was maintained at the granting financial institution and was released upon repayment of the amount drawn down. This line of credit had renewed annually in October. The interest rate on the unpaid principal balance was the LIBOR Market Index Rate plus 1.5%. As of December 31, 2009, the interest rate was 1.7%.
 
Off-Balance Sheet Arrangements
 
As of December 31, 2007, 2008 and 2009 and June 30, 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases for office space, we do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
 
Capital Resources
 
Our future capital requirements may vary materially from those now planned and will depend on many factors, including the costs to develop and implement new products and services, the sales and marketing resources needed to further penetrate our targeted vertical markets and gain acceptance of new modules we develop, the expansion of our operations in the United States and internationally and the response of competitors to our products and services. Historically, we have experienced increases in our expenditures consistent with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase as we grow our business. We expect our research and development, sales and marketing and capital expenditures to decline as a percentage of revenues, but increase in absolute dollars in the future. In the future, we may also acquire complementary businesses, products or technologies. We have no agreements or commitments with respect to any acquisitions at this time.
 
We believe our cash and cash equivalents, the proceeds from this offering and cash flows from our operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months.
 
During the last three years, inflation and changing prices have not had a material effect on our business, and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.
 
Contractual and Commercial Commitment Summary
 
The following table summarizes our contractual obligations as of June 30, 2010. These contractual obligations require us to make future cash payments.
 
                                         
        Payments Due by Period
        Less Than
          More Than
Contractual Obligations
  Total   1 Year   1 – 3 Years   3 – 5 Years   5 Years
            (In thousands)    
 
Operating lease commitments
  $ 3,089     $ 756     $ 1,568     $ 666     $ 99  
 
Quantitative and Qualitative Disclosures About Market Risk
 
Foreign Currency Exchange Risk.  We bill our customers predominately in U.S. dollars and receive payment predominately in U.S. dollars. Accordingly, our results of operations and cash flows are not materially subject to fluctuations due to changes in foreign currency exchange rates. If we grow sales of our solution outside of the United States, our contracts with foreign customers may be denominated in foreign currency and may become subject to changes in currency exchange rates.


61


Table of Contents

Interest Rate Sensitivity.  Interest income and expense are sensitive to changes in the general level of U.S. interest rates. However, based on the nature and current level of our investments, which are primarily cash and cash equivalents, and our debt obligations, we believe there is no material risk of exposure.
 
Seasonality
 
Our new business sales normally fluctuate as a result of seasonal variations in our business, principally due to the timing of client budget cycles. Historically, we have had lower new sales in our first and third quarters than in the remainder of our year. Our expenses, however, do not vary significantly as a result of these factors, but do fluctuate on a quarterly basis due to varying timing of expenditures. Our Adjusted Free Cash Flow normally fluctuates quarterly due to the combination of the timing of new business and the payment of annual bonuses. Historically, due to lower new sales in our first quarter, combined with the payment of annual bonuses from the prior year in our first quarter, our Adjusted Free Cash Flow is lowest in our first quarter, and due to the timing of client budget cycles, our Adjusted Free Cash Flow is lower in our second quarter as compared to our third and fourth quarters. In addition, deferred revenues can vary on a seasonal basis for the same reasons. This pattern may change, however, as a result of acquisitions, new market opportunities or new product introductions.
 
New Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board, or FASB, issued The FASB Accounting Standards Codification, or Codification, which is the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification is non-authoritative. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Codification did not change or alter existing GAAP and, therefore, did not have an impact on our balance sheets, statements of operations and cash flows.
 
In October 2009, the FASB’s Emerging Issues Task Force revised its guidance on revenue recognition for multiple-deliverable revenue arrangements. The amendments in this update will, in certain circumstances, enable companies to separately account for multiple revenue-generating activities (deliverables) that they perform for their customers. Existing GAAP requires a company to use vendor-specific objective evidence, or VSOE, or third-party evidence of selling price to separate deliverables in a multiple-deliverable arrangement. The update will allow the use of an estimated selling price if neither VSOE nor third-party evidence is available. The update will require additional disclosures of information about an entity’s multiple-deliverable arrangements. The requirements of the update may be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, although early adoption is permitted. We are currently evaluating the impact of the update on our financial position and results of operations and do not plan to early or retroactively adopt the new guidance.


62


Table of Contents

 
OUR BUSINESS
 
Overview
 
We provide a leading on-demand strategic procurement and supplier enablement solution that integrates our customers with their suppliers to improve procurement of indirect goods and services. Our on-demand software enables organizations to realize the benefits of strategic procurement by identifying and establishing contracts with preferred suppliers, driving spend to those contracts and promoting process efficiencies through electronic transactions. Strategic procurement is the optimization of tasks throughout the cycle of finding, procuring, receiving and paying for indirect goods and services, which can result in increased efficiency, reduced costs and increased insight into an organization’s buying patterns. Using our managed SciQuest Supplier Network, our customers do business with more than 30,000 unique suppliers and spend billions of dollars annually.
 
Our current target markets are higher education, life sciences, healthcare and state and local governments, and our customers are the purchasing organizations and individual employees that purchase indirect goods and services using our solution. We tailor our solution for each of the vertical markets we serve by offering industry-specific functionality, content and supplier connections. Once connected to our network, customers and suppliers can easily exchange real-time electronic procurement information and conduct transactions. We serve more than 165 customers operating in 16 countries and offer our solution in five languages and 22 currencies. Our value proposition has led to an average annual customer renewal rate of over 94% over the last three fiscal years. On a dollar basis, our annual renewal rate has been 106% over this same time period solely as a result of pricing increases at the time of renewal. We believe our renewal rates are among the highest of on-demand model companies.
 
We deliver our solution over the Internet using a Software-as-a-Service, or SaaS, model, which enables us to offer greater functionality, integration and reliability with less cost and risk to the organization than traditional on-premise solutions. Customers pay us subscription fees and implementation service fees for the use of our solution under multi-year contracts that are generally three to five years in length. We typically receive subscription payments annually in advance and implementation service fees as the services are performed, typically within the first three to eight months of contract execution. Unlike many other providers of procurement solutions, we do not charge suppliers any fees for the use of our network, because suppliers ultimately may pass on such costs to the customer.
 
We were founded in 1995 as an e-commerce business-to-business exchange for scientific products and conducted an initial public offering in 1999. In 2001, we brought in a new management team, exited the business-to-business exchange model and began selling our on-demand strategic procurement and supplier enablement solution. Our company was subsequently taken private in 2004. Since 2001, we have focused on developing our current on-demand business model, building out our technology, acquiring a critical mass of customers in our higher education and life sciences vertical markets, and selectively expanding our solution to serve the healthcare and state and local government markets. Our revenues have grown to $36.2 million in 2009 from $20.1 million in 2007, and our Adjusted Free Cash Flow increased to $6.8 million in 2009 from $3.6 million in 2007 (Adjusted Free Cash Flow is not determined in accordance with GAAP and is not a substitute for or superior to financial measures determined in accordance with GAAP; for further discussion regarding Adjusted Free Cash Flow and a reconciliation of Adjusted Free Cash Flow to cash flows from operations, see footnote 4 to the table in “Selected Financial Data” included elsewhere in this prospectus). No customer accounted for more than 10% of our revenues during this period. Our high customer retention, combined with our long-term contracts, increases the visibility and predictability of our revenues compared with traditional perpetual license-based software businesses. We manage our business with three key principles: focus on customer value, vertical market expertise and financial stewardship.
 
Industry Background
 
The Indirect Goods and Services Procurement Market
 
Procurement is an essential activity for virtually every organization, encompassing a significant portion of an organization’s spending beyond payroll. The procurement function is typically split into two categories, direct


63


Table of Contents

and indirect. Direct goods and services procurement is the purchase of goods and services that are directly incorporated into an organization’s products or services, while indirect goods and services procurement is the purchase of the day-to-day necessities of the workplace such as office supplies, laboratory supplies, furniture, computers, MRO (maintenance, repair and operations) supplies, and food and beverages. Indirect goods and services tend to be low cost but are usually bought in high volumes by a wide variety of employees throughout an organization.
 
The procurement process for indirect goods and services is often not well-managed or controlled. Buyers generally follow a sequential set of processes, referred to as the “source-to-settle” cycle, which is comprised of the following steps:
 
•   identify which suppliers have the required goods and services;
•   negotiate purchasing or contractual relationships;
•   establish a mechanism to transact business;
•   find, compare, approve and order the necessary goods and services;
•   receive, inspect and pay for the goods and services; and
•   analyze spending for potential savings and contract compliance.
 
Organizations with a procurement department establish purchasing policies, monitor purchasing activity, designate preferred suppliers, negotiate volume discounts and other contractual terms and otherwise manage supplier relationships. Although the procurement department is responsible for the purchasing function, most purchasing activity is conducted outside the procurement department by employees throughout the organization. These employees are challenged to comply with procurement policies to acquire their needed goods and services while performing their day-to-day duties. Employees often do not know who the preferred suppliers are and must work within antiquated systems that are cumbersome and time consuming. As a result, many purchases are not made from the available preferred suppliers and/or the purchases are conducted “off-contract,” a behavior sometimes referred to as “maverick spending.” This results in the organization not taking advantage of negotiated discounts. In many cases, the procurement department has limited ability to monitor, control or even influence this purchasing activity. Procurement departments are seeking ways to have greater visibility and control over the organization’s purchasing activity, reduce maverick spending and better serve the employees who make purchases for the organization.
 
Our target market for strategic procurement of indirect goods and services is a subset of the broader supply procurement and sourcing application chain management market, which AMR Research estimates in a July 2009 report entitled “The Global Enterprise Application Market Sizing Report, 2008-2013” as a $2.9 billion global opportunity in 2010, growing at an 8% compounded annual growth rate from 2010 through 2013. Based on our own internal analysis, we believe that our current addressable market is approximately $1.0 billion within our current target markets as follows: higher education ($305 million), life sciences ($300 million), healthcare ($175 million) and state and local government ($250 million).
 
Manual Procurement Processes Are Inefficient
 
Historically, efforts and investments to streamline the procurement process have tended to focus on direct goods and services. The procurement of indirect goods and services, which are typically lower cost but higher volume and thus still represent a large percentage of overall expenses, remains subject to significant inefficiencies. Traditionally, procurement organizations and employees have relied on manual, catalog-based processes to procure indirect goods and services, resulting in inaccuracies, inefficiencies, poor control and reduced user productivity. For example, in many instances, users may have to pay out-of-pocket for supplies and then seek reimbursement through expense reports. In addition, there are often long lead times to fulfill orders and an inability to analyze spending and minimize waste. Characteristics of these traditional processes include:
 
•   Lack of clearly defined procurement guidelines and awareness of preferred suppliers.  In many cases, because processes are cumbersome, ill-defined and time consuming, many employees have difficulty following the procurement approval processes and fail to purchase from preferred suppliers. As a result, buying the right goods and services from the right suppliers at the right prices rarely occurs. Employees


64


Table of Contents

frequently purchase indirect materials from a local retail outlet or from a generic online retailer, such as Amazon.com. This maverick spending can result in the organization purchasing products at unfavorable prices.
•   Limited ability to analyze spend.  Given the lack of automation and centralized reporting, organizations have difficulty analyzing what they are buying from suppliers. This limits the ability to negotiate better contracts or understand the organization’s compliance with spending limits. Additionally, without the proper systems, it is difficult to enforce supplier compliance with all negotiated contract terms.
•   Dissatisfied employees.  Employees prefer an efficient and user-friendly procurement process. Manual, non-integrated processes often lead to excess costs, delays and errors, resulting in a frustrating experience. In addition, employees are unable to track the goods and supplies already on-hand, thus leading to excess purchases.
 
Traditional Automated Procurement Solutions Have Had Limited Effectiveness
 
Efforts to automate the procurement function for indirect goods and services initially consisted of add-on modules to enterprise resource planning, or ERP, systems and first generation procurement systems. These systems, initially developed 10 to 15 years ago, provide efficiencies by allowing organizations to automate parts of the procurement process, such as requisitioning, authorizing, ordering, receiving and payment. However, providers of these systems often have pricing models that charge fees to suppliers, which are costs that suppliers ultimately may pass on to the customer. These supplier fees discourage suppliers from entering the offering platform and result in off-platform purchases. Furthermore, most have limited effectiveness, because they often:
 
•   are implemented on-premise, and thus are expensive to deploy and maintain;
•   are generalized horizontal market solutions with limited industry-specific supplier participation, content and functionality;
•   require each organization to have its own customized one-to-one connections to each supplier; and
•   lack managed service capabilities to enable suppliers.
 
The introduction of SaaS-based strategic procurement solutions within the past few years has enabled buyers and suppliers to transact with each other online more efficiently. These systems provide better access to suppliers through a basic hub-and-spoke architecture and offer lower implementation and ongoing costs due to their on-demand nature. Yet despite their benefits, many other SaaS procurement offerings still suffer from the fact that they are primarily horizontal solutions that do not provide functionality and content specific to vertical markets, nor do they have a robust supplier network that can benefit from economies of scale. In addition, existing systems often have complicated interfaces that are difficult for employees to navigate. We believe there is a substantial market for focused, easy-to-use solutions that establish and maintain strong and efficient commercial relationships between organizations and suppliers.
 
Our Solution
 
We offer an on-demand strategic procurement and supplier enablement solution that enables organizations to more efficiently source indirect goods and services, manage their spend and obtain the benefits of compliance with purchasing policies and negotiating power with suppliers. Our on-demand strategic procurement software suite coupled with our managed supplier network forms our integrated solution, which is designed to achieve rapid and sustainable savings. Our solution provides customers with a set of products and services that enable them to optimize existing procurement processes by automating the entire source-to-settle process. The SciQuest Supplier Network acts as a communications hub that connects over 165 customers to over 30,000 unique suppliers.
 
Our solution provides the following key benefits:
 
•   Significant return on investment (“ROI”).  Our solution enables organizations to realize the benefits of strategic procurement by identifying and establishing contracts with preferred suppliers, driving spend to those contracts and promoting process efficiencies through electronic transactions. As a result, customers are able to achieve significant returns on investment through savings associated with contract compliance and


65


Table of Contents

strategic procurement. These savings result from negotiated discounts, automated requisition/order processing, contract lifecycle management, settlement automation and sourcing (such as the ability to conduct on-line bidding processes).
•   Content and functionality specific to our vertical markets.  While we offer a single solution, our software has specific configurable functionality that meets the unique needs of our targeted vertical markets. We have a critical mass of suppliers to achieve economies of scale, and new suppliers can be readily added as the needs of our customers dictate.
•   Easier access to customers’ supplier network.  Customers can easily access their preferred suppliers using a single solution and avoid the costs and inefficiencies associated with traditional one-to-one supplier management.
•   Greater adoption by employees.  Our intuitive shopping interface provides employees with easy and automated visibility and access to goods and services. Streamlining the procurement process spurs user adoption and increases the level of spend under management, meaning spend that occurs pursuant to a pre-established contract with the supplier.
•   Greater adoption by suppliers.  Suppliers typically are motivated to join our network due to ease of enablement and lack of supplier fees. This allows our solution to support a robust supplier network in which our customers benefit from economies of scale.
•   Visibility into spending patterns and activity.  Our solution provides granular detail into user spending behavior and provides detailed analytics that allow organizations to continually improve their purchasing practices.
•   Ease of deployment via integration with existing systems. Our highly-configurable solution integrates with many leading ERP systems to speed deployment and facilitate the interchange of transaction, accounting, settlement and user data.
 
Our Business Strengths
 
In addition to our differentiated customer solution, we believe our market approach and business model offer specific benefits that are instrumental to our successful growth. These include:
 
•   Focus on customer value.  Delivering value to our customers is at the core of our business philosophy. We focus extensively on ensuring that customers achieve maximum benefit from our solution, and we proactively engage with our customers to continually improve our software and services. To this end, each of our customers is partnered with a member of our client partner organization that proactively assists that customer to maximize the ROI and related benefits from their implementation of our solution. This has led to a 36% compound annual growth rate in the average transaction volume by customers through our system over the last three years. In addition, each customer has access to our separate client support staff. Our customer-centric focus, significant domain expertise and integrated solution have led to the establishment of consistent long-term customer relationships, exemplified by an average annual customer renewal rate of over 94% over the last three fiscal years. On a dollar basis, our annual renewal rate has been 106% over this same time period solely as a result of pricing increases at the time of renewal.
•   Expertise in our targeted vertical markets.  Because we have developed a solution that solves specific procurement problems for customers in our target vertical markets, we are able to differentiate ourselves from other solution providers that are horizontally focused. As a result, we are able to drive greater value to customers through increased cost savings and improved contract compliance. Additionally, our focus on a core set of vertical markets allows us to be more efficient in our sales and marketing efforts through an understanding of the specific needs and requirements of our customers. Our domain expertise allows us to provide our customers with a highly tailored and differentiated solution that is difficult for our competitors to replicate.
•   Extensive content and supplier network.  Essential to our solution is building a critical mass of suppliers within a vertical market. Suppliers are not charged any fees or transaction costs for purchases consummated through the SciQuest Supplier Network, which facilitates the growth of our network of over 30,000 unique suppliers servicing the higher education, life sciences, healthcare and state and local government markets. Upon signing of a new customer, we seek to add that customer’s suppliers to our supplier network. We


66


Table of Contents

charge our customers for each of their suppliers with whom they interact on our supplier network. Therefore, to the extent that a customer’s suppliers are already on our supplier network, our costs to enable these suppliers are reduced, allowing us to benefit from improved operating margins and other economies of scale.
•   Ability to manage costs.  While we manage our business to maximize customer benefit, we also seek to optimize returns to our stockholders and employees by managing our cost structure. Our culture of lean management principles extends from our senior management throughout our company, including our development processes and our professional services engagements. This lean management of our cost structure has kept our capital expenditures low and helped lower our operating expenses as a percentage of revenues from 95% in 2007 to 72% in 2009.
•   High visibility business model.  Our customers pay us subscription fees and implementation service fees for the use of our solution under multi-year contracts that are generally three to five years in length, and we typically receive cash payments annually in advance. The recurring nature of our revenues provides high visibility into future performance, and the upfront payments result in cash flow generation in advance of revenue recognition. For each of the last three fiscal years, greater than 80% of our revenues were recognized from contracts that were in place at the beginning of the year.
 
Our Growth Strategy
 
We seek to become the leading provider of strategic procurement solutions for indirect goods and services. Our key strategic initiatives include:
 
•   Further penetrating our existing vertical markets.  Over 80% of our customers currently come from the higher education and life sciences vertical markets, where we have a significant operating history, with the remainder of our customers coming from our newer healthcare and state and local government markets. We will continue to focus our efforts on acquiring new customers in our vertical markets, including investing in sales and marketing to increase our profile in the healthcare and state and local government markets while increasing our emphasis on mid-sized customer acquisition opportunities in the higher education and life sciences markets.
•   Capitalizing on cross-selling opportunities into our installed customer base.  As of August 31, 2010, our solution was being used by over 165 customers in our vertical markets. Our existing customer base provides us with a significant opportunity to sell additional modules and new products that we may develop or acquire. For each of the past three fiscal years, approximately 20% of new sales have consisted of sales of additional modules and services to existing customers. We plan to develop and/or acquire additional modules and products to sell to our existing customers by leveraging our position as a trusted strategic procurement solution vendor in our targeted vertical markets.
•   Selectively pursuing acquisitions.  We may pursue acquisitions of businesses, technologies and solutions that complement our existing offerings in an effort to accelerate our growth, enhance the capabilities of our existing solution and broaden our solution offerings. We also may pursue acquisitions that allow us to expand into new verticals or geographies where we do not have a significant presence.
•   Selectively expanding into new vertical markets.  In the future, we intend to selectively expand into new vertical markets that are adjacent to, or have similarities to, our existing verticals and where we can leverage our market expertise. For instance, we expanded into the healthcare and state and local government markets because they are both adjacent to and have similar procurement characteristics as the higher education and life sciences markets. Vertical markets where procurement is still predominately handled through paper processing, with multiple suppliers of high volume, low-cost goods, offer potential expansion opportunities. We may pursue such expansion through internal product development, sales and marketing initiatives or strategic acquisitions.
•   Investing in international expansion to acquire new customers.  We believe that the market outside the United States offers us significant growth potential. Currently, we have customers operating in 16 countries and offer our solution in five languages and 22 currencies, although many of our international sales have consisted of sales to multinational organizations based in the United States. To date, sales to customers that are not based in the United States have represented an insignificant portion of our annual sales. We intend to continue our international expansion by increasing our international direct sales force and establishing


67


Table of Contents

additional third-party sales relationships in an effort to leverage our leadership position and reputation as a leading provider of strategic procurement solutions to organizations with global operations.
 
Our Products and Services
 
Our strategic procurement and supplier enablement solution automates the source-to-settle process. We provide our solution on-demand over the Internet using a SaaS model, which enables us to offer greater functionality, integration and reliability with less cost and risk than traditional on-premise solutions. We continue to evolve our solution based on our interaction with our customers around the world.
 
The following diagram provides an overview of our solution:
 
(DIAGRAM)
 
Our on-demand strategic procurement software suite provides customers with a set of products and services that enables them to automate the entire source-to-settle process. These integrated modules maximize the benefits customers derive from using the SciQuest Supplier Network and allow our customers to more efficiently communicate and transact with their suppliers.
 
Our solution also includes business intelligence features that enable organizations to analyze spend at the supplier, commodity and requisition levels. These reporting tools help users identify and establish contracts with preferred suppliers, drive spend to those contracts, and promote process efficiencies through electronic transactions.
 
SciQuest Strategic Procurement Software Suite
 
Our modular strategic procurement software suite optimizes processes to reduce costs, improve productivity and increase visibility for enterprise spend management. The individual modules of our solution can be deployed together or separately and integrate with many leading ERP systems.


68


Table of Contents

The following table provides an overview of the modules of our solution:
 
           
  Module     Key Features
Sourcing Manager
      Manages and expedites the bid creation process
        Provides ability to create auctions, invite supplier participants and monitor and control the reverse auction process in real-time
        Provides self-service access for registered suppliers to view events, enter responses, review award decisions and manage their own profiles
        Graphs and highlights key event information
           
Spend Director
      Enables a critical mass of suppliers
        Promotes preferred suppliers
        Provides an intuitive procurement user environment
        Provides visibility into spending
           
Requisition Manager
      Creates and submits error-free requisitions electronically
        Previews approval workflow and tracks requisitions online
        Routes requisitions electronically based on any requisition attribute
        Provides buyers and managers flexible approval options and 24/7 remote access
        Consolidates requisitions to minimize shipping fees and maximize discounts
        Analyzes requisition data to identify savings opportunities and audit contract compliance
           
Order Manager
      Exchanges purchase documents electronically and securely with suppliers
        Manages purchase documents automatically, eliminating paper processes
        Communicates order status to requisitioners electronically
        Tracks order status automatically with participating suppliers
        Integrates directly with SciQuest Requisition Manager or existing ERP and financial systems
        Analyzes order data to identify saving opportunities
           
Settlement Manager
      Integrates order/receipt/invoice data
        Automates receipt creation
        Supports automated matching of invoices with purchase orders and/or receipts
        Streamlines invoice management
        Avoids error-prone manual data entry
           
Contract Management
      Creates and manages a detailed, accessible and searchable contract repository
        Assigns contract numbers to purchases
        Ensures the order price is the best price
        Generates proactive alerts for key dates and contract milestones
        Enhances visibility into contract spending and compliance, including comparison of contract budget versus contract spending
           


69


Table of Contents

           
  Module     Key Features
Inventory Materials Management
      Provides comprehensive, stockroom-level inventory management, reducing backorders and stockouts
        Integrates available onsite inventory with product searches to avoid redundant purchases
        Maintains trusted inventory count
        Manages multiple inventory locations
        Controls user access to inventory
           
 
Our solution is priced based primarily on the modules purchased and the size of the organization. An organization’s size is determined based on its operating budget and/or number of employees. Our typical total subscription fees over the three to five year term of the subscription agreement range from $450,000 to $1.5 million ($150,000 to $300,000 per year), and our typical one-time implementation service fees range from $150,000 to $300,000. Customers are not charged based on the number of users or transaction volume, which encourages organizations to maximize the number of employees using our solution, resulting in enhanced efficiencies and customer satisfaction.
 
SciQuest Supplier Network
 
The SciQuest Supplier Network is a SaaS communications hub that enables efficient and automated transaction interactions between our customers and their existing suppliers. It is the single integration point between our customers and their suppliers that also provides customers with on-demand access to comprehensive and up-to-date multi-commodity supplier catalogs. By utilizing the SciQuest Supplier Network, our customers and their suppliers can connect in a hub-and-spoke configuration versus a one-to-one configuration, dramatically reducing the cost of integration. The SciQuest Supplier Network also provides customers with the infrastructure to add additional suppliers as needed. The dollar volume of transactions conducted through the SciQuest Supplier Network has increased from less than $2 billion in 2007 to over $6 billion in 2009. The SciQuest Supplier Network includes suppliers of broad commodity categories such as:
 
•   IT equipment;
•   office supplies;
•   laboratory and medical supplies;
•   MRO supplies;
•   services, such as temporary labor;
•   retail (books, CDs, appliances, etc.);
•   furniture; and
•   food and beverages.
 
While our solution addresses many different commodities and markets, our experience in the higher education and life sciences verticals has resulted in the ability to create unique additional products for these markets such as:
 
•   the Science Catalog, which is a list price catalog of approximately 400 niche and midsize suppliers that support diverse and specialized scientific research;
•   catalog consortium contracts which offer preferred pricing arrangements with industry-specific buying cooperatives; and
•   inventory management solutions for specialty materials.
 
Our Service Offerings
 
We offer our customers a number of services, some of which are included as part of their annual subscription fee and others, such as implementation services, are billed separately.

70


Table of Contents

Client Partners.  Our client partner organization proactively assists customers to maximize the benefit from their SciQuest solution. Each of our customers is partnered with a member of our client partner organization, who monitors the customer’s utilization of our solution and tracks performance metrics. Our client partners can identify underuse of the solution within the organization and proactively assist customers to better integrate our solution into their procurement processes.
 
Supplier Enablement Services.  Our supplier enablement organization manages the SciQuest Supplier Network and all supplier connections to our customers. This organization’s role is to ease the integration of suppliers into our network and to increase the efficiency of communication between our customers and their suppliers. These efforts include enabling each new customer’s suppliers on the SciQuest Supplier Network, assisting suppliers in loading and updating product catalogs and adding new suppliers of existing customers.
 
Implementation Services.  Our client delivery organization is responsible for implementing and deploying our solution with customers. These services are designed primarily to enhance the usability of the software for our customers and to assist them with configuration, integration, training and change management. Our implementation services include analyzing a customer’s current procurement processes, identifying specific high-value procurement needs, configuring our software products to the customer’s specific business and providing guidance on implementing and reinforcing best practices for procurement. In order to provide reliable, repeatable and cost-effective implementation and use of our products, we have developed a standard methodology to deliver implementation services that is milestone-based and emphasizes early knowledge transfer and solution usage. We develop project requirements based on the customer’s specific needs and set objective project goals, such as usage levels, in order to measure success.
 
Customer Support.  Our customer support organization provides technical product support to our customers by phone, email and through our online Solutions Portal. Our Solutions Portal provides instant 24-hour Internet access to a searchable solutions database that includes release notes, answers to frequently asked questions, links to release preview webinars and product documentation. The portal allows customers to notify us of product software defects and incidents and to track our resolutions of such incidents in a centralized location.
 
Customers
 
We serve more than 165 customers operating in 16 countries and offer our solution in five languages and 22 currencies. As of June 30, 2010, we had over 115,000 active users of our solution within our customer organizations. In 2007, 2008 and 2009, substantially all of our revenues were derived from customers in the United States or United States-based multinational companies. No customer accounted for more than 10% of our total revenues in 2007, 2008, 2009 and the six months ended June 30, 2010. Our ten largest customers accounted for no more than 25% of our total revenues in 2009 and the six months ende