UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

For the fiscal year ended December 31, 2014

OR

For the transition period from                     to                     .

Commission file number: 001-34875

 

SCIQUEST, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(919) 659-2100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes  ¨    No  x 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold on the NASDAQ Global Market as of the last business day of its most recently completed second fiscal quarter was $486,359,307.

As of January 31, 2015, 27,577,698 shares of the registrant’s common stock, par value $0.001 per share, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III — Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s 2014 fiscal year. Except as expressly incorporated by reference, the registrant’s Proxy Statement shall not be deemed to be a part of this report on Form 10-K.

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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FORWARD-LOOKING STATEMENTS

This report 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 “Part I, Item 1, Business,” “Part I, Item 1A, Risk Factors” and “Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K (this “Report”). 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 consist of all statements that are not historical facts and can be identified by terms such as “accelerates,” “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 “Part I, Item 1A, Risk Factors” and elsewhere in this Report. 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 Report. You should read this Report and the documents that we have filed as exhibits to this Report 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.

Except as otherwise indicated, all share and per share information referenced in this Report has been adjusted to reflect the one-for-two reverse split of our common stock that occurred on September 20, 2010.

As used herein, except as otherwise indicated by context, references to “we,” “us,” “our,” or the “Company” refer to SciQuest, Inc.

PART I

 

ITEM 1. BUSINESS

Overview

We provide leading cloud-based business automation solutions for spend management that include:

Our solutions are designed to meet customer needs to reduce costs, simplify and improve visibility into key business processes, further strategic initiatives, enhance control over spending decisions and improve compliance and risk management. By simplifying and streamlining cumbersome, tedious, and often manual, processes and creating a comprehensive view of spending and compliance across the organization, organizations can identify and capitalize on opportunities to reduce costs by gaining control over suppliers, contracts, purchases and payments.

Our spend management solutions provide a significant return on investment for our customers by facilitating the reduction of spending on goods and services, enhancing visibility and control over spending decisions and practices as well as optimizing the efficiency of key business processes.  As a result of these benefits, our customers have the tools to focus on strategic initiatives that result in even greater value to their organizations.

Our procurement, supplier management and accounts payable solutions utilize our managed SciQuest Supplier Network, which facilitates our customers doing business with many thousands of unique suppliers and spending billions of dollars annually. Unlike many other providers, we do not charge suppliers any fees for the use of our network in part because we believe many suppliers ultimately will pass on such costs to the customer. Our approach encourages suppliers to participate in the network and facilitates customers consolidating more of their spending through our solutions.

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We deliver our cloud-based solutions using a Software-as-a-Service, or SaaS, model, which enables us to offer greater functionality, faster innovation, easier integration and improved 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 solutions under either multi-year contracts that are generally three to five years in length or one-year contracts with annual renewal provisions. Subscription payments are typically payable annually in advance. A portion of the implementation service fees are typically payable in advance with the remainder payable as the services are performed, usually within the first three to eight months of contract execution.

As of December 31, 2014, we served 529 customers, excluding customers that spend less than $10,000 per year with us. For the fiscal year ended December 31, 2014, revenues increased 13% to $101.9 million from $90.2 million for the fiscal year ended December 31, 2013. For the fiscal year ended December 31, 2013, revenues increased 36% to $90.2 million from $66.5 million for the fiscal year ended December 31, 2012. No customer accounted for more than 10% of our revenues during 2012, 2013 or 2014. 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.

Company Background

In 2001, we began developing and marketing our procurement solutions. We initially acquired a critical mass of customers in the higher education and life sciences vertical markets and selectively expanded to serve the healthcare and state and local government markets. In 2010, we completed an initial public offering of our common stock. In 2011, we acquired all of the capital stock of AECsoft USA, Inc., or “AECsoft”, a leading provider of supplier management and sourcing solutions. In 2012, we acquired substantially all of the assets of Upside Software, Inc., or “Upside”, a leading provider of contract lifecycle management solutions, and substantially all of the assets of Spend Radar LLC, or “Spend Radar”, a leading provider of spend analysis solutions. In 2013, we acquired all of the capital stock of CombineNet, Inc., or “CombineNet”, a leading provider of advanced sourcing software to organizations with large and potentially complex strategic sourcing needs.

Due to our historical focus on vertical markets, we have had a relatively high concentration of higher education, life sciences, healthcare and state and local government customers. But a majority of our customers now span the general commercial market as a result of our acquisitions as well as our own marketing efforts. We currently market our solutions across the entire addressable market for spend management solutions.

Industry Background

Spend Management

Spend management is the method by which organizations control and optimize their spending and spending-related processes to improve their financial results and value to the organization. A comprehensive approach to spend management requires a provider to address multiple unique business processes and needs in order to identify and realize cost savings, including procurement, spend analysis, supplier management, contract lifecycle management and accounts payable.

We believe that the market for spend management solutions is fragmented among relatively small specialty vendors offering point solutions that address certain aspects of spend management, large enterprise resource planning, or ERP, vendors and internally developed and maintained solutions.

Procurement. The procurement process for goods and services, especially with regard to indirect spend, is often not well-managed or controlled. As a result, many purchases are not made from preferred suppliers and/or purchases are conducted “off-contract,” a behavior sometimes referred to as “maverick spending.” Buyers generally follow a sequential set of processes, referred to as the “source-to-settle” cycle, which is comprised of the following steps:

Traditionally, procurement organizations and employees have relied on manual, paper-based processes to procure goods and services, resulting in inaccuracies, inefficiencies, poor control and reduced user productivity. Automated processes can provide procurement departments with greater visibility and control over purchasing, maverick spending and the ability to realize cost-savings by negotiating price discounts and driving spend to lower priced goods. According to Gartner, the global procurement software

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market, which is a subset of the spend management market, is forecast to grow at an average annual growth rate of 10.3% to $4.6 billion in 2018.  

Spend Analysis. In the course of their procurement activities, organizations typically generate large amounts of spend data, the analysis of which is essential in order to identify spending patterns and savings opportunities. This spend data, however, is typically derived from a variety of sources in different formats, which is then extremely complex and time-consuming to collect, cleanse and classify based on specific business requirements. Many organizations are dependent upon manual processes to extract this spend data from multiple sources and to compile it within spreadsheets that provide minimal analytic capabilities and are error-prone. The resulting information is often incomplete, inaccurate and insufficient to conduct meaningful spend analysis. With complete spend data that is accurately classified, organizations are capable of identifying targets for improved contracted pricing, identifying non-compliant purchasing behavior, verifying supplier compliance with contract terms and measuring effectiveness of ongoing strategic sourcing initiatives.

Supplier Management. Organizations often have difficulties understanding, monitoring and managing not only their large and often diverse supplier base but also having clear insights into their more strategic suppliers. Typically, many departments in an organization work with the same supplier but have separate interactions independent from each other and have limited resources to manage these suppliers. This often results in duplication of efforts, inaccurate and fragmented supplier records spread across multiple, disconnected systems, inconsistent or non-existent processes to on-board new suppliers and lack of visibility into supplier performance, risk exposures and financial metrics. By managing supplier information and interaction centrally, the organization can reduce costs through more focused buying power, increased competition among its suppliers, greater collaboration with suppliers, greater visibility and control over supply chain risk and better management of supply chain performance. According to AMR Research, managing supplier information manually can cost up to $1,000 per supplier on an annual basis but can be reduced to less than $150 per supplier by implementing technology solutions.

Contract Lifecycle Management. The process of creating and managing contracts, known as contract lifecycle management, is largely a manual and disjointed function in many organizations that involves disparate departments in the organization, such as procurement, legal, sales and finance. This can result in significant inefficiencies and limitations, such as cumbersome contract creation, negotiation and approval processes; greater risk of contract errors; the inability to effectively enforce contracting policies; the inability to easily track contract requirements, milestones, expirations or renewals; the inability to measure contract performance; and difficulty in enforcing internal contracting policies. By streamlining contract processes, reducing contract inaccuracies and improving contract compliance, organizations can reduce costs and liability risks and increase cycle times.

Accounts Payable. Historically, accounts payable processes have been highly manual and inefficient. According to recent research published by the Aberdeen Group, leading companies have an average cost of $4.34 to process an invoice from receipt through settlement, with a processing time of 7.3 days, with annualized savings of 11.7% when capturing early payment discount opportunities. Inefficient accounts payable processes can lead to late payment penalties due to lengthy invoice processing cycle times, duplicate or incorrect payments due to manual data entry errors, the inability to capitalize on prompt payment discounts, lack of visibility into outstanding liabilities and increased supply chain risks due to frustrated suppliers. Technology solutions to automate accounts payable processes enable organizations to reduce invoice processing errors, late payment penalties, duplicate payments and overpayments as well as realize prompt payment discounts. Through automation, organizations can also reduce the number of employees dedicated to the accounts payable function and redirect them to more strategic roles.

Business Automation Efforts

Efforts to automate these functions initially consisted of add-on modules to ERP systems and first generation systems. While these systems provide some business automation benefits, most have limited effectiveness, because they are implemented on-premise and lack managed service capabilities to enable suppliers. Many of these systems are also point solutions that only address a single aspect of spend management and do not offer a comprehensive approach.

The introduction of SaaS-based spend management solutions within the past several years has enabled commercial transactions and other business processes to be conducted online more efficiently. These systems provide better access both within an organization and suppliers and other third parties and offer lower implementation and ongoing maintenance and upgrade costs. 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 their suppliers and other third parties.

Our Solutions

We provide leading cloud-based business automation solutions for spend management that include:

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Our solutions are designed to meet customer needs to reduce costs, simplify and improve visibility into key business processes, further strategic initiatives, enhance control over spending decisions and improve compliance and risk management. By simplifying and streamlining cumbersome, and often manual, processes and creating a comprehensive view of spending and compliance across the organization, organizations can identify and capitalize on opportunities to reduce costs by gaining control over suppliers, contracts, purchases and payments. Our procurement, supplier management and accounts payable solutions utilize our managed SciQuest Supplier Network, which facilitates our customers doing business with many thousands of unique suppliers and spending billions of dollars annually. We deliver our cloud-based solutions using a Software-as-a-Service, or SaaS, model, which enables us to offer greater functionality, easier integration and improved reliability with less cost and risk to the organization than traditional on-premise solutions.

Our solutions provide a significant return on investment for our customers through the following key benefits:

Business Strengths and Success Factors

We believe that there are a number of characteristics that have facilitated, and are expected to continue to facilitate, our growth, including:

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Our Growth Strategy

We seek to become the leading provider of business automation solutions for spend management. Our key strategic initiatives include:

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Our Products and Services

Our solutions automate business processes that are essential to spend management. We provide our solutions 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 solutions based on our interaction with our customers around the world.

Our solutions are priced based primarily on the products purchased and the size of the organization. Sales vary between multi-product sales and single-product sales. Our total subscription fees over a three to five year term of the subscription agreement for sales of single products typically range from $60,000 to $500,000 ($20,000 to $100,000 per year) while a multi-product sale range can typically range from $450,000 to $1.5 million ($150,000 to $300,000 per year). Our typical one-time implementation service fees are generally equivalent to one year of license fees. Generally, customers are not charged based on the number of users or transaction volume, which encourages organizations to maximize the number of employees using our solutions, resulting in enhanced efficiencies and customer satisfaction.

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The following diagram provides an overview of our solutions:

 

 

Our cloud-based spend management solutions provides customers with a set of products and services that enable them to automate key business processes. These integrated products allow our customers to more efficiently communicate and transact with their suppliers and better manage their spending.

Our software suite optimizes processes to reduce costs, improve productivity and increase visibility for enterprise spend management. The individual products within our solutions can be deployed together or separately and integrate with many leading ERP systems.

The following is an overview of the products comprising our solutions:

Procurement Products

Spend Director Enterprise:

Sourcing Director:

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Advanced Sourcing Optimizer:

Requisition Manager:

Order Manager:

Enterprise Reagent Manager:

Spend Analysis Products

Spend Radar Data Manager:

Spend Radar Refresh Manager:

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Spend Radar Reporting and Analysis:

Supplier Information Management Product

Total Supplier Manager:

Contract Lifecycle Management Product

Contract Director:

Accounts Payable Product

AP Director:

SciQuest Supplier Network

The SciQuest Supplier Network is a SaaS communications hub that enables efficient and automated transaction interactions between our customers and their suppliers through our procurement, accounts payable and supplier management solutions. It is the single integration point between our customers and their suppliers that provides customers with comprehensive and up-to-date supplier information, including 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. By creating a tight connection between customer and their key suppliers, the SciQuest Supplier Network is an important contributing factor to our high customer retention. In addition, we believe that the SciQuest Supplier Network and the large number of suppliers who currently participate in it is a significant competitive advantage over potential competitors who do not have a robust supplier network.

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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.

Client Partners. Our client partner organization proactively assists customers to maximize the benefit from their SciQuest solutions. Our customers are paired with a member of our client partner organization, who monitors the customer’s utilization of our solutions and tracks performance metrics. Our client partners can identify underuse of the solutions within the organization and proactively assist customers to better integrate our solutions into their processes. Client partners also promote best practices for maximizing the value of our solutions throughout our customer base.

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 solutions 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 processes, identifying specific high-value needs, configuring our software products to the customer’s specific business and providing guidance on implementing and reinforcing best practices. 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. Successful implementation projects can be critical to maintaining our high customer satisfaction rates and can also lower support costs.

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.

Spend Classification Services. While customers can use our spend analysis products to collect, cleanse and classify their spend data themselves, we also offer solution consultants who collect, cleanse and classify spend data on behalf of the customer. Following the initial classification, our spend analysis organization can perform periodic refreshes of the spend data or the customer can utilize our Spend Radar Refresh Manager product for ongoing management and maintenance of the spend data. Most customers will rely upon our services organization to perform the initial data classification and then utilize them for ongoing management and maintenance to varying degrees.

Customers

As of December 31, 2014, we served 529 customers, excluding customers that spend less than $10,000 per year with us. In 2012, 2013 and 2014, 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 2012, 2013 and 2014. Our ten largest customers accounted for no more than 15% of our total revenues in each of 2012, 2013 or 2014. Our value proposition and high customer satisfaction rates have led to strong recurring revenue retention rates of approximately 106%, 100% and 96% for 2012, 2013 and 2014, respectively. We calculate recurring revenue retention rates for a particular period by comparing the subscription revenue for all customers at the end of the prior period to the subscription revenue for those same customers at the end of the current period.

Due to our historical focus on vertical markets, we have had a relatively high concentration of higher education, life sciences, healthcare and state and local government customers. But a majority of our customers now span the general commercial market as a result of our acquisitions as well as our own marketing efforts. We currently market our solutions across the entire addressable market for spend management solutions.

Sales and Marketing

We market and sell our solutions through a direct sales force, which represents the largest source of our total revenues. Our sales force is generally organized by market, including general commercial, higher education, healthcare and state and local government, as well as by region.

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We supplement our direct sales efforts with strategic partner relationships principally in order to increase market awareness and generate sales leads. Our strategic partners generally consist of suppliers, consulting firms, technology providers, ERP providers and purchasing consultants and consortia. The relationships include referral and re-seller relationships. We have a business development group within our sales organization to manage these relationships.

Our marketing efforts focus on increasing awareness of our brand and products, establishing SciQuest as a thought leader for spend management and generating qualified sales leads. Our principal marketing initiatives target key executives and decision makers within our existing and prospective customer base and include sponsorship of, and participation in, industry events including user conferences, trade shows and webinars. Many sales opportunities are generated by referrals from existing customers. We also participate in cooperative marketing efforts with our strategic partners and other providers of complementary services or technology.

As of December 31, 2014, our sales and marketing organization consisted of 101 employees.

We also conduct NextLevel, an annual event that brings the spend management community, including industry experts, thought leaders and suppliers, together to discuss the latest thinking, newest strategies and most innovative solutions. The annual NextLevel conference typically occurs in late February or early March and is attended by customers, prospects, suppliers, partners and other attendees.

Historically, we had lower new sales in our first and third quarters than in the remainder of our year as a result of seasonal variations in our business, principally due to the timing of client budget cycles in the higher education and state and local government vertical markets. Due in large part to the expansion of our product portfolio and market focus, we do not believe that we currently experience material seasonality.

Competition

The market for spend management solutions is competitive, highly fragmented, rapidly evolving and subject to changes in technology. We compete primarily with relatively small specialty software vendors, large ERP vendors and internally developed and maintained solutions. Our current principal competitors include:

We believe the principal competitive factors and market demands in our industry include the following:

We believe we compete favorably with our competitors on the basis of these factors. However, some of our existing and potential competitors have greater financial resources, longer operating histories and more name recognition. We may face future competition in our markets from other large, established companies, as well as emerging companies.

 

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Technology

Our product suite is primarily cloud-based, requiring only a standard Web browser and access to the Internet, with no behind-the-firewall components. We also have one specialty inventory management product that can be deployed behind the customer’s firewall, and our contract lifecycle management product is available to be deployed behind the firewall as well.

Our procurement, supplier management, accounts payable and Sourcing Director products operate in a multi-tenant, on-demand applications environment using Java-based application code, IBM’s DB2 database management system, and an open source operating environment. Our contract lifecycle management products operate in a multi-tenant, on-demand applications environment utilizing Microsoft.Net architecture and SQL Server database management system. Our spend analysis products operate in a multi-tenant, on-demand applications environment utilizing Microsoft architecture and Oracle database management system.  Our Advanced Sourcing Optimizer product operates in a multi-tenant, on-demand applications environment using Java-based application code and Perl-based application code, Oracle’s MySQL database management system, and an open source operating environment.

The single code-base for each product supports thousands of users and delivers robust, scalable, secure solutions for customers. Our solutions have multiple layers of security, with all production operating systems protected against unauthorized access, sensitive data encrypted, all network/firewall devices actively monitored and updated, and user authentication required for system access.

We use commercially available operating, application and database management systems. We support key industry standards and have an overall technology architecture that is highly redundant and designed to be highly available, while supporting rapid development and deployment of new releases. We have implemented standard practices in the areas of development, deployment, production control, administration and monitoring.

Our integration layer is based on technology provided by a technology partner, providing flexible, scalable, and deep integrations to customers’ existing IT systems infrastructure (e.g., into customers’ authentication, financial or ERP systems). This technical architecture facilitates true Internet-native standards support, scalability, reliability, recoverability, security and ease of maintenance.

We generally own and administer all of our hosted production servers and web site hardware, which physically reside in tier-1 data center hosting facilities. Our primary data center facilities offers physical security, redundant power systems, and multiple OC3 internet network connections and are located in Durham, North Carolina, Houston, Texas and Pittsburgh, Pennsylvania. We also have a fully redundant, disaster recovery platform in a data center in Scottsdale, Arizona which is automatically synchronized with the primary systems.

Product Development

Our product development organization is responsible for the design, development and testing of our software. Our current product development efforts are focused on maintenance and enhancements of existing products as well as development of new products.

Our development teams follow an agile Scrum methodology, which allows for a tight feedback loop. Our customer community provides extensive input that we incorporate into our products through regular reviews and demonstration-based focus groups. Typically, our product development organization will conduct four to six focus groups and 30 to 40 customer interviews during a release cycle and works closely with our implementation and customer support organization.

As of December 31, 2014, our product development organization consisted of 222 employees.

Our research and development expenses were $17.2 million, $28.3 million and $28.3 million in 2012, 2013 and 2014, respectively.

Intellectual Property

Our success and ability to compete is dependent in part on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing upon the proprietary rights of others. We rely primarily on a combination of patent, copyright, trade secret, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary information.

We have registered trademarks and service marks in the United States and abroad, and have applied for the registration of additional trademarks and service marks. Our principal trademark is “SciQuest.”

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We have 33 issued U.S. patents (with expiration dates ranging from 2018 to 2031) with additional U.S. patent applications pending. We have no foreign patents or patent applications. We do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims.

We also use contractual provisions to protect our intellectual property rights. We license our software products directly to customers. These license agreements, which address our technology, documentation and other proprietary information, include restrictions intended to protect and defend our intellectual property. We also require all of our employees, contractors and many of those with whom we have business relationships to sign non-disclosure and confidentiality agreements.

The legal protections described above afford only limited protection for our technology. Due to rapid technological change, we believe that factors such as the technological and creative skills of our personnel, new product and service developments and enhancements to existing products and services are more important than the various legal protections of our technology to establishing and maintaining a technology leadership position.

Our products also include third-party software that we obtain the rights to use through license agreements. These third-party software applications are commercially available on reasonable terms. We believe that we could obtain substitute software, or in certain cases develop substitute software, to replace these third-party software applications if they were no longer available on reasonable terms.

Employees

As of December 31, 2014, we had 562 full-time employees. None of our employees are represented by labor unions or covered by collective bargaining agreements. We consider our relationship with our employees to be good.

 

ITEM 1A. RISK FACTORS

We operate in a business environment that involves numerous known and unknown risks and uncertainties that could have a materially adverse impact on our operations. The risks described below highlight some of the factors that have affected, and in the future could affect, our operations. You should carefully consider these risks. These risks are not the only ones we may face. Additional risks and uncertainties of which we are unaware or that we currently deem immaterial also may become important factors that affect us. If any of the events or circumstances described in the followings risks occurs, our business, financial condition, results of operations, cash flows, or any combination of the foregoing, could be materially and adversely affected.

Our risks are described in detail below; however, the more significant risks we face include the following:

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Risks Related to Our Business and Industry

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 sell additional products and services to our existing customers. If we are unable to hire or retain quality sales personnel, unable to generate sufficient sales leads through our marketing programs, unable to sell our products and services to potential or current customers or if our existing or new customers do not perceive our solutions 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, our revenue growth is partially dependent on the continued sale of our products across the entire addressable market for spend management solutions without regard to our historical vertical markets. If we are unsuccessful in our efforts to sell our products services outside of our historical vertical markets, our revenue growth, cash flows and profitability may be materially and adversely affected. 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.

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 license revenues from recurring subscription fees for our spend management solutions. Should our current customers lose confidence in the value or effectiveness of our solutions, 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 either a term of ranging from three to five years in length or a one-year term with automatic renewal provisions. Our value proposition and high customer satisfaction rates have led to strong recurring revenue retention rates of approximately 106%, 100% and 96% for 2012, 2013 and 2014, respectively. We calculate recurring revenue retention rates for a particular period by comparing the subscription revenue for all customers at the end of the prior period to the subscription revenue for those same customers at the end of the current period. 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.

We expect to continue to develop and acquire new product and service offerings with no guarantee that we will be able to market those acquired products and services successfully or to develop or integrate any new products effectively or efficiently.

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. As part of this strategy, we added our advanced sourcing product in 2013, while in 2012 we added our spend analysis, contract lifecycle management and accounts payable solutions. Expansion of our offerings 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 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.

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. We may also experience unexpected delays that may lengthen the sales cycle for particular customers or potential customers. Such delays also make it more difficult to predict sales cycles and the timing of future revenues. 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:

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Any lengthening of the sales cycle or unexpected delays with respect to particular customers or potential customers 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.

To the extent that future sales opportunities trend towards individual product sales rather than multi-product sales, the average sales price per customer of our solutions would likely decrease, which could have an adverse effect on our ability to increase future revenue and profitability.

Our solutions consist of individual products that can be deployed together as an integrated software suite or separately as individual solutions. We price our solutions in part based on the number of products purchased. Accordingly, multi-product sales of an integrated software suite will likely result in significantly higher subscription and service fees than sales of individual products even though the sales cycle will often be similar in terms of length and effort. Most of our customers do not currently utilize all, or even a majority, of our solutions, and we anticipate that many of the cross-selling opportunities into our installed customer base will be individual product sales as opposed to multi-product sales. To the extent that future sales opportunities trend towards individual product sales rather than multi-product sales, then the average sales price per customer of our solutions will likely decrease. Decreases in our average sales price per customer will require us to convert a greater number of sales opportunities, at potentially greater expense, in order to meet our revenue objectives. Thus, an increase in the number of individual product sales as compared to multi-product sales could have an adverse effect on our ability to increase future revenue and profitability.

The failure to successfully integrate businesses that we have acquired or 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:

We may also have difficulty in effectively assimilating and integrating future acquired 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 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.

Economic factors can cause reductions in spending by our customers and potential customers, which in turn 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 addressable market as well as the economy as a whole. We have experienced, and may experience in the future, spending constraints by our customers and potential customers due to economic factors affecting particular customers, industries or the U.S. or global economy as a whole. Many of our customers and potential customers face significant budgetary constraints that have limited spending on technology solutions. Continued spending constraints may result in slower growth, or reductions, in revenues and profits in the future. In addition, economic factors or uncertainty may cause customers and potential customers to reduce or delay technology purchases, including purchases of our solutions. 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. Economic factors could also cause customers to attempt to cancel or not renew existing contracts. These economic factors could result in reductions in sales of our products and services, longer sales cycles, difficulties in collecting accounts receivable or delayed payments,

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slower adoption of new technologies and increased price competition. Any of these events or any significant reduction in spending by our customers and potential customers would likely harm our business, financial condition, operating results and cash flows.

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. In addition, we have undertaken, and may in the future undertake, significant development efforts with respect to acquired products in order for these products to better integrate with our full product suite, which may cause interruptions or delays in our ability to sell these acquired products. 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.

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 changes that reduce or eliminate the need for spend management solutions 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:

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.

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 spend management 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 solutions, 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.

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 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.

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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 solutions and could harm our reputation.

If we do not successfully maintain the SciQuest brand, 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, particularly in the general commercial market. Some of our competitors have well-established brands. Although we believe that the SciQuest brand is well established in certain markets where we have a significant operating history, our brand may not be as well established throughout our entire addressable market. 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. 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.

We may experience service failures or interruptions due to defects in the hardware, software, infrastructure, third-party components or processes that comprise our solutions, any of which could adversely affect our business.

Technology solutions as complex as ours may contain undetected defects in the hardware, software, infrastructure, third-party components or processes that are part of the solutions 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 or upgraded products 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 spend management solutions for critical business processes, any defect in our solutions, any disruption to our solutions or any error in execution could cause customers to not renew their contracts with us, prevent potential customers from purchasing our solutions 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 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 solutions, or our 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.

The market for cloud-based spend management solutions is at a relatively early stage of development. If the market for our solutions develop 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 spend management solutions. Our current expectations with respect to growth may not prove to be correct. The market for our solutions is at a relatively early stage of development, making our business and future prospects difficult to evaluate. Should our prospective customers fail to recognize, or our current customers lose confidence in, the value or effectiveness of our solutions, the demand for our products and services will likely decline. Any significant price compression 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 solutions, including the following:

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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 significant growth in our operations and personnel, which places a significant strain on our management, administrative, operational and financial infrastructure. Our business strategy includes preparing for significant future growth and expanding our management, administrative, operational and financial infrastructure to facilitate this growth. Our success will depend in part upon the ability of our senior management to prepare for and manage this growth effectively. To do so, we must continue to hire, train and manage new employees, including managers, 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 materially 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. There is no assurance that we will do so effectively. The additional headcount and operating systems that 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.

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 2015 as compared to 2014 in order to support anticipated revenue growth. 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, technology providers, consultants, ERP providers and purchasing 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 solutions would be negatively impacted, resulting in harm to our reputation, business and financial performance.

The use of our solutions typically includes implementation services to facilitate the optimal use of our solutions. Successful implementation projects can be critical to maintaining our high customer satisfaction rates and can also lower support costs. These activities require substantial involvement and cooperation from both our customers and their suppliers. For example, we typically work closely with customer personnel to improve the customer’s business processes, enable the customer’s suppliers on the SciQuest Supplier Network and support organizational activities to assist our customer’s transition to our spend management solutions. In addition, our implementation services often include extensive end-user training in order to facilitate product adoption and maximize the benefits for the organization. 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 renewal rates, business, reputation and financial performance.

 

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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 solutions 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.

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.

To date, we have funded our business through our cash flows from operations, and the proceeds of our initial public offering in September 2010 and our follow-on public offerings in April 2011 and March 2014. We also established a $30 million credit facility in November 2012. In February 2014, we filed a shelf registration statement on Form S-3 covering 8,000,000 shares of common stock, which may be offered and sold in one or more public offerings in the future. We sold 3,450,000 shares of common stock in our March 2014 follow-on public offering pursuant to such shelf registration statement. There can be no assurance as to whether all or any portion of the remaining shares covered by this registration statement will be offered or sold in the future. However, we may need to raise additional funds to achieve our future strategic objectives, including the execution of our strategy to pursue acquisitions. We may not be able to obtain additional debt or equity financing on favorable terms, if at all. Decreases in our stock price could adversely affect our ability to raise capital or complete acquisitions. 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:

Our inability to do any of the foregoing could reduce our ability to compete successfully and adversely affect our results of operations.

The market for spend management solutions is highly competitive, which makes achieving market share and profitability more difficult.

The market for spend management 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 primarily from relatively small specialty software vendors, large ERP vendors and internally developed and maintained solutions. Competition is likely to intensify as this market matures.

As competitive conditions intensify, competitors may:

In addition, some of our competitors may have longer operating histories and greater name recognition than us. 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

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successfully against current and future competitors. These competitive pressures could have a material adverse effect on our revenue growth and results of operations.

We continue to have revenue concentration in the higher education market, which could make us vulnerable to adverse trends or events affecting those markets.

Due to our historical focus on vertical markets, we continue to have a significant portion of our revenue concentrated in 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 this market may result in slower growth, or reductions, in our revenues and profits in the future. In addition, the number of potential customers in this market is relatively finite, which could limit our future growth prospects. Furthermore, many of our sales opportunities are generated by referrals from existing customers due to the collaborative nature of these markets, and therefore, our failure to provide a beneficial solution to our existing customers could adversely impact our reputation in these markets and our ability to generate new referral customers. If any of these circumstances result in decreased revenues or profitability from our existing customers in the higher education market or reduce our ability to generate new customers in this market, our overall revenues and profits could be materially and adversely affected.

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.

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 solutions, which could cause our business to suffer.

We use third-party data centers to conduct our operations, including our primary operating centers located in Durham, North Carolina, Houston, Texas and Pittsburgh, Pennsylvania and a redundant disaster recovery platform located in Scottsdale, Arizona. Generally, our solutions reside on hardware that we own and operate in these and other 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 the availability of our solutions 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 cloud-based spend solutions are 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 solutions or impede our ability

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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 solutions 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.

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 solutions 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 supplier information, including 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 solutions. Also, any errors or omissions in the content provided by the suppliers may reflect poorly on our solutions. 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.

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. 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 or other key personnel, 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.

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. We cannot assure you that we will not experience material weaknesses in internal controls. We have reviewed and documented 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. To the extent that we are not or do not remain 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

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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 incur significant legal, accounting, investor relations and other expenses as a result of being a public company. 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. If these costs increase significantly in the future, our operating results could be materially and adversely affected.

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, we may become subject to new sales, use or other tax laws, statutes, rules, regulations or ordinances as we expand our geographic reach and product offerings. In addition, 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 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.

Our use of “open source” software could negatively affect our ability to sell our solutions and subject us to possible litigation.

A portion of the technologies licensed by us incorporate so-called “open source” software, and we may incorporate other 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 solutions 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 solutions that contained the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of our solutions.

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 solutions. In that event, we could be required to seek licenses from third parties, re-develop our solutions, discontinue sales of our solutions, or release our proprietary software code under the terms of an open source license, any of which could adversely affect our business.

 

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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. 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 or requiring modifications to 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.

We may be subject to legal proceedings and claims in the conduct of our business, which may require us to spend significant time and money in litigation or arbitration or to pay significant settlements or damages.

From time to time, we may be subject to legal proceedings and claims in the ordinary course of business. For instance, we may have claims against customers for nonpayment of subscription fees or customers may pursue claims against us for our errors or omissions. In addition, disputes may arise from strategic business relationships, acquisitions or other business transactions. As our business grows, the likelihood of disputes arising may increase. Litigation or arbitration, whether as a plaintiff or a defendant, could be costly and divert management’s attention and could cause our business to suffer, regardless of the outcome. Failing to prevail in any legal proceeding could result in us paying significant damages or being unable to recover for damages incurred, either of which could harm our financial position.

Our ability to use U.S. net operating loss carryforwards might be limited.

As of December 31, 2014, we had net operating loss carryforwards of approximately $212.6 million for U.S. federal tax purposes, the use of which may be substantially limited. These loss carryforwards will begin to expire in 2018. 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. 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 the Ownership of Our Common Stock

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:

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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.

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 calls or otherwise, regarding our future performance that represents our management’s estimates as of the date of release. This guidance contains forward-looking statements and 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 “Part I, Item 1A, Risk Factors” section of this Report could result in our actual operating results being different from our guidance, and those differences may be adverse and material.

Our stock price may be volatile, and investors may be unable to sell their shares at or above their purchase 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 “Part I, Item 1A, Risk Factors” section or elsewhere in this Report, and other factors beyond our control, including the following:

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.

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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 will limit your ability to influence corporate matters.

As of December 31, 2014, our directors and executive officers, together with their affiliates, beneficially owned, in the aggregate, approximately 6% of our common stock. In addition, as of December 31, 2014, approximately 40% of our outstanding common stock was held by holders of more than 5% of our common stock. 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 significant concentration of ownership. Also, these stockholders, acting together, may 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, could 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:

Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.

If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decrease significantly. The perception in the public market that our stockholders might sell shares of our common stock could also depress the market price of our common stock. As of December 31, 2014, we had approximately 6,700,000 shares of our common stock issuable under approved equity compensation plans that are covered by effective registration statements.

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:

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.

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

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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:

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.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Our corporate headquarters are located in Morrisville, North Carolina, where we currently lease approximately 78,500 square feet of office space. This lease expires in July 2024. In 2014, we assigned our rights and obligations under the office lease for our former headquarters to a third party, and we do not expect to have any further material obligations with respect to this lease.

We also maintain the following office leases:

 

We believe that our current facilities are suitable and adequate to meet our current needs and that suitable additional or substitute space will be available as needed to accommodate future growth.

 

ITEM 3. LEGAL PROCEEDINGS

We are not party to any material legal proceedings at this time. From time to time, we may be subject to legal proceedings and claims in the ordinary course of business.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock has been listed on the NASDAQ Global Market under the symbol “SQI” since September 24, 2010. The following table presents, for the periods indicated, the range of high and low per share sales prices of our common stock, as reported on the NASDAQ Global Market. Our fiscal year ends on December 31.  

 

As of December 31, 2014, we had approximately 59 stockholders of record of our common stock, including Cede & Co., which holds shares of our common stock on behalf of an indeterminate number of beneficial owners.

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 the board of directors deems relevant.

The following table provides information regarding our current equity compensation plans as of December 31, 2014:  

 

See Note 10 to the financial statements provided under “Part II, Item 8, Financial Statements and Supplementary Data” of this Report for a description of the material features of our equity compensation plans.

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Stock Performance Graph

The following graph compares, for the period from September 24, 2010 through December 31, 2014, the cumulative total stockholder return on our common stock with that of the NASDAQ Composite Index and the NASDAQ Computer Index. The graph assumes that $100 was invested on September 24, 2010 and assumes reinvestment of any dividends. Our fiscal year ends on December 31. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing we make under the Securities Act of 1933, as amended, or the Exchange Act.  

COMPARISON OF CUMULATIVE TOTAL RETURN AMONG SCIQUEST, INC.,

NASDAQ COMPOSITE INDEX AND NASDAQ COMPUTER INDEX

 

 

 

 

 

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ITEM 6. SELECTED FINANCIAL DATA

You should read the following selected financial data together with our financial statements and the related notes provided under “Part II, Item 8, Financial Statements and Supplementary Data” of this Report as well as “Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report. 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, 2012, 2013 and 2014, under the heading “Non-GAAP Operating Data” relating to Non-GAAP Net Income and Adjusted Free Cash Flow for each of the three years ended December 31, 2012, 2013 and 2014 and under the heading “Balance Sheet Data” as of December 31, 2013 and 2014 have been derived from our audited financial statements, which are provided under “Part II, Item 8, Financial Statements and Supplementary Data” of this Report. The selected financial data under the heading “Statements of Operations Data” for each of the two years ended December 31, 2010 and 2011, under the heading “Non-GAAP Operating Data” relating to Non-GAAP Net Income and Adjusted Free Cash Flow for each of the two years ended December 31, 2010 and 2011 and under the heading “Balance Sheet Data” as of December 31, 2010, 2011 and 2012 have been derived from our audited financial statements not included in this Report.  

 

 

 

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Our use of Non-GAAP Net Income 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:

Because of these limitations, you should consider Non-GAAP Net Income alongside other financial performance measures, including various cash flow metrics, net income (loss) and our other GAAP results. Our management reviews Non-GAAP Net Income along with these other measures in order to fully evaluate our financial performance.

The following table provides a reconciliation of net income (loss) to Non-GAAP Net Income:

 

 

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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:

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:

 

 

 

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the accompanying financial statements and notes “Part II, Item 8, Financial Statements and Supplementary Data” of this Report.

Overview

We provide leading cloud-based business automation solutions for spend management that include:

Our solutions are designed to meet customer needs to reduce costs, simplify and improve visibility into key business processes, further strategic initiatives, enhance control over spending decisions and improve compliance and risk management. By simplifying and streamlining cumbersome, and often manual, processes and creating a comprehensive view of spending and compliance across the organization, organizations can identify and capitalize on opportunities to reduce costs by gaining control over suppliers, contracts, purchases and payments.

We deliver our cloud-based solutions using a Software-as-a-Service, or SaaS, model, which enables us to offer greater functionality, faster innovation, easier integration and improved 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 solutions under either multi-year contracts that are generally three to five years in length or one-year contracts with annual renewal provisions. Our total subscription fees over a three to five year term of the subscription agreement for sales of single products typically range from $60,000 to $500,000 ($20,000 to $100,000 per year) while a multi-product sale range can typically range from $450,000 to $1.5 million ($150,000 to $300,000 per year). Our typical one-time implementation service fees are generally equivalent to one year of license fees. As of December 31, 2014, we had 529 customers, excluding customers that spend less than $10,000 per year with us. Our revenue growth is driven primarily through the sale of our products and services to new customers and the sale of new products and related services to existing customers. For the fiscal year ended December 31, 2014, revenues increased 13% to $101.9 million from $90.2 million for the fiscal year ended December 31, 2013. For the fiscal year ended December 31, 2013, revenues increased 36% to $90.2 million from $66.5 million for the fiscal year ended December 31, 2012.

No customer accounted for more than 10% of our total revenues in 2012, 2013 and 2014. Our ten largest customers accounted for no more than 15% of our total revenues in each of 2012, 2013 and 2014.

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 Non-GAAP Net Income. To analyze cash flow, we primarily use Adjusted Free Cash Flow.

In 2001, we began developing and marketing our procurement solutions. We initially acquired a critical mass of customers in the higher education and life sciences vertical markets and selectively expanded to serve the healthcare and state and local government markets. In 2010, we completed an initial public offering of our common stock. In 2011, we acquired all of the capital stock of AECsoft USA, Inc., or “AECsoft”, a leading provider of supplier management and sourcing solutions. In 2012, we acquired substantially all of the assets of Upside Software, Inc., or “Upside”, a leading provider of contract lifecycle management solutions, and substantially all of the assets of Spend Radar LLC, or “Spend Radar”, a leading provider of spend analysis solutions. In 2013, we acquired all of the capital stock of CombineNet, Inc., or “CombineNet”, a leading provider of advanced sourcing software to organizations with large and potentially complex strategic sourcing needs.

Due to our historical focus on vertical markets, we have had a relatively high concentration of higher education, life sciences, healthcare and state and local government customers. For the years ended December 31, 2012, 2013 and 2014, the higher education market accounted for approximately 59%, 50% and 47%, respectively, of our revenues. But a majority of our customers now span the general commercial market as a result of our acquisitions as well as our own marketing efforts. We currently market our solutions across the entire addressable market for spend management solutions.

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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 across the entire addressable market for spend management solutions as well as expanding our product offerings to our existing customers will be important to maintain revenue growth. We plan to continue to invest in sales and marketing efforts to take advantage of what we believe are significant growth opportunities in the entire addressable market for spend management solutions. We cannot provide assurances, however, that these efforts will be successful in achieving revenue growth. If we are unsuccessful in our efforts to sell our products and services outside of our historical vertical markets, or if we incur substantial expenses in attempting to do so, our revenues and earnings could be materially and adversely affected.

We believe Non-GAAP Net Income and Adjusted Free Cash Flow are the primary non-GAAP financial metrics upon which to measure our business. Non-GAAP Net Income consists of net income plus our non-cash, stock-based compensation expense, amortization of intangible assets, headquarter relocation costs in 2014, purchase accounting deferred revenue adjustments in 2012, 2013, and 2014, acquisition related costs incurred in 2010, 2011, 2012, and 2013, compensation expense relating to management bonuses paid in connection with our initial public offering in 2010, and a stock contribution to fund a charitable trust established by us in 2010, less the acquisition related escrow distribution received in 2011, and the gain realized upon the sale of a warrant in 2010. Non-GAAP Net Income is determined on a tax-effected basis. For 2011, 2012, 2013, and 2014, due to the impact that non-taxable expenses, e.g. stock-based compensation, had on our effective tax rate, we determined the tax effect of Non-GAAP Net Income by arriving at Non-GAAP Income before taxes, multiplying this by our statutory rate of 38.9% and the difference between our statutory tax expense and our book tax expense is the tax effect of adjustments to arrive at Non-GAAP Net Income. For 2010, we used our quarterly effective tax rate to determine the tax effect for Non-GAAP Net Income. Because Non-GAAP Net Income excludes certain non-cash expenses such as amortization, stock-based compensation and a stock contribution in 2010, as well as acquisition related costs incurred in 2010, 2011, 2012, and 2013, the sale of a warrant and one-time bonus payments associated with the initial public offering in 2010, the acquisition related escrow distribution received in 2011, and headquarter relocation costs in 2014, 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 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 acquisition related costs incurred and one-time bonus payments associated with the initial public offering incurred in 2010, less the acquisition related escrow distribution received in 2011 and headquarter relocation costs in 2014. 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 historical timing of new business and the payment of annual bonuses. We use Non-GAAP Net Income and Adjusted Free Cash Flow in the preparation of our budgets and to measure and monitor our financial performance. Non-GAAP Net Income 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 Non-GAAP Net Income and a reconciliation of Non-GAAP Net Income 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 “Part II, Item 6, Selected Financial Data” included in this Report.

Financial Terms and Metrics

Sources of Revenues

We primarily derive our revenues from subscription fees and related services, permitting customers to access and utilize our cloud-based business automation solutions for spend management. Customers may also purchase a perpetual license for certain software products.

Our contractual agreements generally contain multiple service elements and deliverables. These elements include access to the hosted software, implementation or data classification services and, on a limited basis, perpetual licenses for certain software products and related maintenance and support. The typical term of our subscription agreements is either a multi-year contract of three to five years or a one-year contract with annual renewal provisions, 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. 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.

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 value proposition and high customer satisfaction rates have led to strong recurring revenue retention rates of 106%, 100% and 96% for 2012, 2013 and 2014, respectively. We calculate recurring revenue rates for a particular period by comparing the subscription revenue for all customers at the end of the prior period to the subscription revenue for those same customers at the end of the current period.

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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.  

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 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 remain relatively consistent 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 but decrease as a percentage of revenues over time.

Amortization of Intangible Assets. Amortized intangible assets consist of covenants not to compete and customer relationships from the CombineNet, Spend Radar, Upside, AECsoft acquisitions in August 2013, October 2012, August 2012 and January 2011, respectively, as well as customer relationships from the going private transaction in 2004. The covenant not to compete from the CombineNet acquisition is amortized on a straight-line basis over an estimated life of two years and the covenants not to compete from the Spend Radar, Upside and AECsoft acquisitions are amortized on a straight-line basis over an estimated life of five years. The customer relationships from the Spend Radar acquisition are amortized over a five-year estimated life, the customer relationships from the Upside and AECsoft acquisitions and going private transaction are amortized over a ten-year estimated life and the customer relationships from the CombineNet acquisition are amortized over a fifteen-year estimated life, in a pattern consistent with which the economic benefit is expected to be realized.

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Non-GAAP Net Income. Non-GAAP Net Income, a non-GAAP operating measure, consists of net income (loss) plus our non-cash, stock-based compensation expense, amortization of intangible assets, amortization of acquired software, headquarter relocation costs in 2014, purchase accounting deferred revenue adjustments and acquisition related costs incurred in 2012 and 2013. Non-GAAP Net Income is determined on a tax-effected basis. Due to the impact that non-taxable expenses, e.g. stock-based compensation, had on our effective tax rate, we determined the tax effect of Non-GAAP Net Income by arriving at Non-GAAP Income before taxes, multiplying this by our statutory rate of 38.9% and the difference between our statutory tax expense and our book tax expense is the tax effect of adjustments to arrive at Non-GAAP Net Income. We use Non-GAAP Net Income 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, acquisition related costs, the one-time costs associated with non-recurring events and such non-cash items such as stock-based compensation expense and amortization of intangible assets, which can vary depending upon accounting methods. We believe Non-GAAP Net Income 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 non-cash items such as stock-based compensation expense and amortization of intangible assets, which can vary depending upon accounting methods, 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 Non-GAAP Net Income 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:

Because of these limitations, you should consider Non-GAAP Net Income alongside other financial performance measures, including various cash flow metrics, net income and our other GAAP results. Our management reviews Non-GAAP Net Income along with these other measures in order to fully evaluate our financial performance.

The following table provides a reconciliation of net income (loss) to Non-GAAP Net Income:

 

Adjusted Free Cash Flow.  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 acquisition related costs less headquarter relocation costs in 2014. We use Adjusted Free Cash Flow as a measure of liquidity because it assists us in assessing our ability to fund our growth through our 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.

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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:

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:

 

 

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.

Of our significant accounting policies, which are described in Note 2 to the financial statements provided under “Part II, Item 8, Financial Statements and Supplementary Data” of this Report, we believe that 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 and related services, permitting customers to access and utilize our cloud-based business automation solutions for spend management. Customers may also purchase a perpetual license for certain software products.

Our contractual agreements generally contain multiple service elements and deliverables. These elements include access to the hosted software, implementation or data classification services and, on a limited basis, perpetual licenses for certain software products and related maintenance and support. We evaluate each element in a multiple element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered item has standalone value and delivery of the undelivered element is probable and within the Company’s control.

For arrangements in which elements do have standalone value, we allocate revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on vendor-specific objective evidence of selling price (“VSOE”), if available, third-party evidence of selling price (“TPE”), if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available. Because we have neither VSOE nor TPE for our deliverables, the allocation of revenue is based on ESP.

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Our process for determining ESP for deliverables considers multiple factors that may vary depending upon the facts and circumstances related to each deliverable. Key factors considered in developing ESP related to deliverables include established pricing and approval policies, type and size of customer, number of products purchased, and historical transactions. We regularly review ESP and maintain internal controls over the establishment and updates of these estimates.

We evaluate our SaaS subscription agreements and consider whether the associated services have standalone value to our customers. For arrangements when implementation services do not have stand-alone value to the customer, licenses and related implementation services are considered a single unit of accounting. Accordingly, the consideration allocated to licenses and services is recognized ratably over the term of the subscription agreement, beginning with the later of the start date specified in the subscription agreement, or 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. Alternatively, when services have standalone value to the customer, licenses and related services are considered separate units of accounting. For separate units of accounting, services are recognized as the services are performed and delivered to the customer and licenses are recognized over the term of the subscription arrangement, beginning with the later of the start date specified in the subscription agreement, or the date access to the software is provided to the customer, provided all other revenue recognition criteria have been met.

Revenue from sales of certain of our perpetual software products and related implementation services and maintenance is recognized as a single unit of accounting since VSOE of fair value does not exist for the contractual elements. Accordingly, revenue for all elements in these arrangements is recognized over the contractual maintenance term, which is typically one year.

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 multi-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. 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.

We estimate our expected stock volatility based on the historical volatility of our publicly-traded stock price. Prior to the second half of 2013, because there was not a public market for our common stock from July 2004 until September 2010, we lacked company-specific historical and implied volatility information. Therefore, we estimated our expected stock volatility based on that of publicly-traded peer companies. 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 2012, 2013 and 2014 are set forth below:

 

 

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The assumptions used in calculating the fair value of stock purchase rights granted under the Employee Stock Purchase Plan in 2012, 2013, and 2014 are set forth below:  

 

 

The following table summarizes by grant date the number of stock options granted from January 1, 2012 through December 31, 2014, the per share exercise price of options and the fair value per option on each grant date:

 

 

As part of our stock incentive plan, we issued restricted stock units to certain employees and our non-employee directors during 2012, 2013 and 2014. Restricted stock units differ from restricted stock awards in that restricted stock units represent the right to receive shares of common stock once such shares are vested and issuable in accordance with the terms of the restricted stock units. Once issued, such shares are not subject to further restrictions. The following table summarizes by grant date the number of shares of restricted stock granted from January 1, 2012 through December 31, 2014, and the fair value per restricted stock unit on each grant date:

 

 

(1)The fair value per unit represents the closing sale price of our common stock on the date of grant.

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Determination of the Fair Value of Our Common Stock.  Following our initial public offering on September 24, 2010, all stock option grants were granted with an exercise price equal to the closing price of our common stock on the NASDAQ Global Market on the date of grant. The fair value of restricted stock unit grants is equal to the closing price of our common stock on the NASDAQ Global Market on the date of grant.

Deferred Commissions. 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.

Software Development Costs. We incur certain costs associated with the development of our cloud-based solutions, which are accounted for as internal-use software. Certain qualifying costs incurred during the application development phase are capitalized and amortized to expense over the estimated useful life of the related applications, which is generally three years.

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, 2014. 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, 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.

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Results of Operations

The following table sets forth, for the periods indicated, our results of operations:

 

 

The following table sets forth, for the periods indicated, our results of operations expressed as a percentage of revenues:

 

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Revenues. Revenues for 2014 were $101.9 million, an increase of $11.7 million, or 13%, over revenues of $90.2 million for 2013. The increase in revenues resulted primarily from an increase in new customers from December 31, 2013 to December 31, 2014,- recognition of a full year’s revenues for the new customers added in 2013, and revenue relating to customers acquired as a result of our acquisition of CombineNet in August 2013, partially offset by completing the remaining recognition of perpetual license revenue from some acquired customers during the period and revenue loss from customer attrition.

Cost of Revenues. Cost of revenues in 2014 was $31.5 million, an increase of $4.1 million, or 15%, over cost of revenues of $27.4 million in 2013. As a percentage of revenues, cost of revenues increased to 31% in 2014 from 30% in 2013. The increase in dollar amount primarily resulted from a $1.8 million increase in employee-related costs attributable primarily to the full year impact of the personnel gained through our CombineNet acquisition in 2013, as well as our additional and existing implementation services, supplier enablement services, customer support and client partner personnel, a $1.1 million increase in amortization of capitalized software development costs, a $0.5 million increase in amortization of acquired software due to the full year impact of the acquisition

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of CombineNet in 2013, a $0.2 million increase in stock-based compensation expense, a $0.3 million increase in allocated overhead due to increases in leased square footage of office space and increased depreciation associated with purchased property and equipment, and a $0.2 million increase in other spend. We had 211 full-time employee equivalents in our implementation services, supplier enablement services, customer support and client partner organizations at December 31, 2014 compared to 202 full-time employee equivalents at December 31, 2013.

Research and Development Expenses. Research and development expenses were $28.3 million for 2014 and 2013. As a percentage of revenues, research and development expenses decreased to 28% in 2014 from 31% in 2013. In 2014, employee-related costs attributable primarily to the full year impact of the personnel gained through our CombineNet acquisition, as well as our additional and existing research and development personnel increased by $3.1 million, maintenance and hardware costs attributable to the full year impact of the CombineNet acquisition increased by $1.4 million, allocated overhead due to increases in leased square footage of office space and increased depreciation associated with purchased property and equipment increased by $0.5 million, and other research and development spend increased by $0.3 million. These increases were offset by decreases in compensation expense and stock-based compensation expense of $2.4 million and 1.0 million, respectively, attributable to earn-out payments that were completed in 2013, as well as a $1.9 million increase in capitalized software development costs. We had 222 full-time employee equivalents in our research and development organization at December 31, 2014 compared to 211 full-time employee equivalents at December 31, 2013.

Sales and Marketing Expenses. Sales and marketing expenses for 2014 were $25.6 million, an increase of $1.3 million, or 5%, over sales and marketing expenses of $24.3 million for 2013. As a percentage of revenues, sales and marketing expenses decreased to 25% in 2014 from 27% in 2013. The increase in dollar amount is primarily due to an increase of $2.6 million in employee-related costs attributable primarily to the full year impact of the personnel gained through our CombineNet acquisition in 2013, as well as our additional and existing sales and marketing personnel, an increase of $0.3 million in amortized commission expense, an increase of $0.3 million related to trade shows, a $0.3 million increase in allocated overhead due to increases in leased square footage of office space and increased depreciation associated with purchased property and equipment, a $0.2 million increase in marketing expenses, and a $0.5 million increase in other sales expenses attributable primarily to the full year impact of our CombineNet acquisition. These increases were partially offset by decreases in compensation expense and stock-based compensation expense of $2.4 million and 1.0 million, respectively, attributable to earn-out payments that were completed in 2013.. We had 101 full-time employee equivalents in our sales and marketing organization at December 31, 2014 compared to 99 full-time employee equivalents at December 31, 2013.

General and Administrative Expenses. General and administrative expenses for 2014 were $14.0 million, an increase of $1.0 million, or 8%, from general and administrative expenses of $13.0 million for 2013. As a percentage of revenues, general and administrative expenses was 14% in 2014 and 2013. The increase in dollar amount was primarily due to a $0.5 million increase in stock-based compensation, a $0.2 million increase in allocated overhead due to increases in leased square footage of office space and increased depreciation associated with purchased property and equipment, and a $0.3 million increase in other general and administrative spend required to support our growing business. We had 28 full-time employee equivalents in our general and administrative organization at December 31, 2014 compared to 26 full-time employee equivalents at December 31, 2013.

Amortization of Intangible Assets. Amortization of intangible assets for 2014 was $3.2 million, an increase of $0.8 million, or 33%, over amortization of intangible assets of $2.4 million for 2013. As a percentage of revenues, amortization of intangible assets was 3% in 2014 and 2013. The increase in dollar amount was due to a full year of amortization attributable to intangible assets acquired in connection with our acquisition of CombineNet in August 2013.

Loss from Operations. Loss from operations for 2014 was $0.7 million, an improvement of $4.4 million, or 85%, from loss from operations of $5.1 million for 2013. As a percentage of revenues, loss from operations decreased to (1)% in 2014 from (5)% in 2013. The decrease in dollar amount was primarily the result of the increase in revenues, partially offset by our increased costs in costs of revenue and sales and marketing costs required to grow and support our additional revenues, as well as our increased general and administrative expenses.

Income Tax Benefit (Expense). Income tax benefit for the year ended December 31, 2014 was $0.5 million compared to income tax benefit of $0.4 million for the year ended December 31, 2013. The change in income tax benefit was primarily due to differences in our pre-tax net loss and effective tax rates in each period. In addition, a state deferred tax rate change in 2013, which was treated as a discrete item, resulted in a reduced tax benefit for the year ended December 31, 2013.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Revenues. Revenues for 2013 were $90.2 million, an increase of $23.7 million, or 36%, over revenues of $66.5 million for 2012. The increase in revenues resulted primarily from an increase in the number of customers from 428 as of December 31, 2012 to 534 as of December 31, 2013 (excluding customers that spend less than $10,000 per year with us) recognition of a full year’s revenues for the new customers added in 2012, as well as revenue relating to customers acquired as a result of our acquisition of CombineNet in

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August 2013. We have increased our customer count through our continued efforts to enhance brand awareness, our sales and marketing efforts and our acquisitions.

Cost of Revenues. Cost of revenues in 2013 was $27.4 million, an increase of $7.1 million, or 35%, over cost of revenues of $20.3 million in 2012. As a percentage of revenues, cost of revenues decreased to 30% in 2013 from 31% in 2012. The increase in dollar amount primarily resulted from a $3.6 million increase in employee-related costs attributable primarily to personnel gained through our acquisitions, as well as our additional and existing implementation services, supplier enablement services, customer support and client partner personnel, a $0.9 million increase in amortization of capitalized software development costs, a $1.0 million increase in amortization of acquired software due to our acquisitions of CombineNet, Spend Radar and Upside, a $0.2 million increase in stock-based compensation expense, a $0.5 million increase in allocated overhead due to increases in leased square footage of office space and increased depreciation associated with acquired and purchased property and equipment, an increase of $0.6 million in hosting costs required to support our growing business, and a $0.3 million increase in other spend. We had 202 full-time employee equivalents in our implementation services, supplier enablement services, customer support and client partner organizations at December 31, 2013, of which 20 were added as part of our CombineNet acquisition, compared to 195 full-time employee equivalents at December 31, 2012.

Research and Development Expenses. Research and development expenses for 2013 were $28.3 million, an increase of $11.1 million, or 65%, from research and development expenses of $17.2 million in 2012. As a percentage of revenues, research and development expenses increased to 31% in 2013 from 26% in 2012. The increase in dollar amount was primarily due to a $9.1 million net increase in employee-related costs attributable primarily to personnel gained through our acquisitions, as well as our additional and existing research and development personnel, which employee-related costs were offset by increases in capitalized software development costs, a $0.5 million increase in stock-based compensation expense, a $0.6 million increase in maintenance and hardware costs required to support our growing business, a $0.7 million increase in allocated overhead due to increases in leased square footage of office space and increased depreciation associated with acquired and purchased property and equipment, and a $0.2 million increase in other research and development spend. We had 211 full-time employee equivalents in our research and development organization at December 31, 2013, of which 30 were added as part of our CombineNet acquisition, compared to 191 full-time employee equivalents at December 31, 2012.

Sales and Marketing Expenses. Sales and marketing expenses for 2013 were $24.3 million, an increase of $6.4 million, or 36%, over sales and marketing expenses of $17.9 million for 2012. As a percentage of revenues, sales and marketing expenses were 27% in 2013 and 2012. The increase in dollar amount is primarily due to an increase of $4.7 million in employee-related costs attributable primarily to personnel gained through our acquisitions, as well as our additional and existing sales and marketing personnel, a $0.5 million increase in stock-based compensation expense, an increase of $0.5 million in amortized commission expense, and a $0.6 million increase in other sales and marketing spend. We had 99 full-time employee equivalents in our sales and marketing organization at December 31, 2013, of which 24 were added as part of our CombineNet acquisition, compared to 70 full-time employee equivalents at December 31, 2012.

General and Administrative Expenses. General and administrative expenses for 2013 were $13.0 million, an increase of $2.1 million, or 19%, from general and administrative expenses of $10.9 million for 2012. As a percentage of revenues, general and administrative expenses decreased to 14% in 2013 from 16% in 2012. The increase in dollar amount was primarily due to a $0.9 million increase in employee-related costs attributable primarily to our additional and existing general and administrative personnel, as well as personnel gained through our acquisitions, a $0.6 million increase in stock-based compensation expense, a $0.3 million increase in acquisition related costs attributable to our acquisition of CombineNet in August 2013, and a $0.3 million increase in other spend required to support our growing business. We had 26 full-time employee equivalents in our general and administrative organization at December 31, 2013, of which 5 were added as part of our CombineNet acquisition, compared to 23 full-time employee equivalents at December 31, 2012.

Amortization of Intangible Assets. Amortization of intangible assets for 2013 was $2.4 million, an increase of $1.1 million, or 85% over amortization of intangible assets of $1.3 million for 2012. As a percentage of revenues, amortization of intangible assets increased to 3% in 2013 from 2% in 2012. The increase in dollar amount was due to amortization attributable to intangible assets acquired in connection with our acquisitions of Spend Radar and Upside in October 2012 and August 2012, respectively.

Loss from Operations. Loss from operations for 2013 was $5.1 million, an increase of $4.0 million, or 364%, from loss from operations of $1.1 million for 2012. As a percentage of revenues, loss from operations increased to (5)% in 2013 from (2)% in 2012. The increase in dollar amount was primarily the result of the increase in revenues, partially offset by our planned increases in sales and development expenses required to grow and support our additional revenues, as well as the expected dilutive impact of the current year operations of our Spend Radar and Upside acquisitions.

Income Tax Benefit (Expense). Income tax benefit for the year ended December 31, 2013 was $0.4 million compared to income tax expenses of $(0.1) million for the year ended December 31, 2012. Our effective tax rate of 7% for the year ended December 31,

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2013 was primarily the result of a state deferred tax rate change, which was treated as a discrete item, and additional state valuation allowances due to losses that are projected to expire before we are able to utilize them.

Liquidity

Net Cash Flows from Operating Activities

Net cash provided by operating activities was $17.4 million during 2014, $18.0 million during 2013 and $20.4 million during 2012. 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 primarily employee related expenses. Since annual subscription fees are typically due on each anniversary of contract signing, the amount of cash received for annual subscription fees typically fluctuates on a quarterly basis based on the historical levels of new business sales in that quarter. Due to lower historical sales levels in our first quarter, combined with the payment of annual bonuses from the prior year in our first quarter, our cash flow from operations has historically been lowest in our first quarter. The historical timing of our client budget cycles has impacted our cash flow from operations to be lower in our second quarter as compared to our third and fourth quarters. The cash payments from customers are typically due annually on the anniversary date of the initial contract. The cash payments from customers were approximately $104 million during 2014, $98 million during 2013 and $79 million during 2012. 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 $58 million during 2014, $52 million during 2013 and $38 million during 2012.

For 2014, net cash provided by operating activities of $17.4 million was primarily the result of $0.1 million of net loss plus $6.2 million of stock-based compensation and $10.9 million of depreciation and amortization, a $0.5 million increase in deferred revenues, a $0.9 million decrease in accounts receivable, a $0.7 million decrease in deferred commissions and a $0.4 million increase in loss on disposal from fixed assets, less a $1.7 million net increase in accrued liabilities and deferred rent and a $0.4 million increase in accounts payable.

For 2013, net cash provided by operating activities of $18.0 million was primarily the result of $4.7 million of net loss plus $6.9 million of stock-based compensation and $8.0 million of depreciation and amortization, a $4.1 million increase in deferred revenues, a $4.2 million increase in accrued liabilities, and a $2.5 million decrease in accounts receivable, less a $1.5 million increase in prepaid expenses, a $0.4 million increase in deferred taxes and a $1.2 million decrease in accounts payable.

For 2012, net cash provided by operating activities of $20.4 million was primarily the result of $1.2 million of net loss plus $5.2 million of stock-based compensation and $4.3 million of depreciation and amortization, a $7.9 million increase in deferred revenues, a $2.0 million increase in accrued liabilities, a $1.8 million increase in accounts payable and a $0.6 million decrease in accounts receivable, less a $0.1 million increase in prepaid expenses.

Our deferred revenues were $71.1 million at December 31, 2014 and $70.8 million at December 31, 2013. The increase in deferred revenues is primarily related to the increase in sales during the period, partially offset by a decrease in the average contract length of agreements sold to customers, which has impacted long-term deferred revenues. Customers are typically 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 short-term deferred revenues balance to increase while our long-term deferred revenues balance may be impacted by the average length of contract sold.

As of December 31, 2014, we had net operating loss carryforwards of approximately $212.6 million available to reduce future federal taxable income. Use of these carryforwards is subject to significant limitations. In the future, we may fully utilize our available net operating loss carryforwards that are not subject to limitations 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.

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Net Cash Flows from Investing Activities

For the year ended December 31, 2014, net cash used in investing activities was $66.1 million, consisting of net purchases of $56.4 million short-term investments, various capital expenditures of $4.2 million and capitalization of $5.6 million of software development costs. For the year ended December 31, 2013, net cash used in investing activities was $17.5 million, consisting of the acquisitions of CombineNet, net of cash acquired, of $25.6 million, various capital expenditures of $2.9 million and capitalization of $3.7 million of software development costs, partially offset by the net maturities of $14.6 million of short-term investments. For the year ended December 31, 2012, net cash used in investing activities was $20.2 million, consisting of the acquisitions of Spend Radar and Upside, net of cash acquired, of $30.2 million, various capital expenditures of $1.8 million and capitalization of $3.1 million of software development costs, partially offset by the net maturities of $14.9 million of short-term investments. In general, our capital expenditures are for our network infrastructure to support our increasing customer base and expected growth in new business and for internal use, such as equipment for our increasing employee headcount.

Net Cash Flows from Financing Activities

For the year ended December 31, 2014, net cash provided by financing activities was $89.1 million, consisting of $87.4 million in proceeds from our public offering, net of underwriting discounts and offering costs, proceeds from the exercise of common stock options of $0.7 million and proceeds from employee stock purchase plan activity of $0.9 million. For the year ended December 31, 2013, net cash provided by financing activities was $3.0 million, consisting of proceeds from the exercise of common stock options of $2.1 million and proceeds from employee stock purchase plan activity of $0.9 million. For the year ended December 31, 2012, net cash provided by financing activities was $0.5 million, representing proceeds from the exercise of common stock options.

Line of Credit

On November 2, 2012, we established a $30 million revolving credit facility to cost effectively increase our liquidity, though we have no current plans to utilize it. The facility consists of a $20 million securities secured revolving credit facility and a $10 million receivables secured revolving credit facility and will be available for use until November 2, 2015. The securities secured facility and the receivables secured facility bear interest equal to the BBA LIBOR Daily Floating Rate plus 0.75% and the BBA LIBOR Daily Floating Rate plus 1.50%, respectively. We pay a quarterly fee equal to 0.10% on any unused funds under the facility. As of and for the periods ending December 31, 2013 and 2014, we had $0 outstanding.

Off-Balance Sheet Arrangements

As of December 31, 2013 and 2014, 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 as well as the broader commercial market and gain acceptance of new products we develop or acquire, 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 cost of revenues, research and development, sales and marketing, general and administrative and capital expenditures to increase in absolute dollars in the future. As a percentage of revenues, we expect cost of revenues and sales and marketing to remain relatively consistent and research and development, general and administrative and capital expenditures to decline in the future. In the future, we may also acquire complementary businesses, products or technologies. We have no formal agreements or commitments with respect to any acquisitions at this time.

We believe our cash and cash equivalents and our 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.

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Contractual and Commercial Commitment Summary

The following table summarizes our contractual obligations as of December 31, 2014. These contractual obligations require us to make future cash payments:

 

Seasonality

Historically, our new business sales have fluctuated as a result of seasonal variations in our business, principally due to the timing of client budget cycles, with lower new sales in our first and third quarters than in the remainder of our year. Due in large part to the expansion of our product portfolio and market focus, however, we do not believe that we currently experience material seasonality with respect to new business sales. Our expenses have not and do not vary significantly as a result of these historical factors, but they do fluctuate on a quarterly basis due to varying timing of expenditures. Our cash flow from operations normally fluctuates quarterly due to the combination of the historical timing of new business sales and the payment of annual bonuses. Since annual subscription fees are typically due on each anniversary of contract signing, the amount of cash payments for annual subscription fees typically fluctuates on a quarterly basis based on the historical levels of new business sales in that quarter.  Due to annual customer payments being less in the first quarter, combined with the payment of annual bonuses from the prior year in our first quarter, our cash flow from operations has historically been lowest in our first quarter. Due to the timing of client budget cycles, our cash flow from operations 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. These seasonal patterns for cash flow and deferred revenues may lessen or otherwise change in the future as the impact of our historical seasonality of new business sales lessens over time.

Recent Accounting Pronouncements

In August 2014, the FASB issued new accounting guidance which addresses management’s responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and to provide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. This guidance is effective for the fiscal year ending after December 15, 2016, and for fiscal years and interim periods thereafter. Early adoption is permitted. The Company does not expect to early adopt this guidance and does not believe that the adoption of this guidance will have a material impact on its financial statements.

In May 2014, the FASB issued new accounting guidance on revenue recognition, which provides for a single five-step model to be applied to all revenue contracts with customers. The new standard also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. The Company will adopt this standard in the first quarter of 2017. The Company is currently evaluating the impact that the implementation of this standard will have on its financial statements.

In July 2013, the FASB issued a revised accounting standard, which clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In situations where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This standard is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. Retrospective application is permitted. The Company adopted this guidance on January 1, 2014. The adoption for this guidance did not have a material impact on the Company’s financial position, results of operations, or cash flows.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk

We bill and receive payments from our customers predominately in U.S. dollars as well as make payments predominately in U.S. dollars. Our primary exposure to foreign currencies results from payments made in Canadian dollars for payroll and other

- 46 -

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expenses relating to our office in Edmonton, Alberta, which represented approximately 10% of our total expenses in 2014.  Although our results of operations could be adversely affected by a decline in the value of the U.S. dollar relative to the Canadian dollar, such a decline would have to be significant in order to have a material impact on our results of operations given our limited exposure to foreign currencies. The majority of our sales contracts are currently denominated in U.S. dollars. Therefore, we have minimal foreign currency exchange risk with respect to our revenue. If we further grow sales of our solution outside the United States or establish other material operations outside the United States, we may become subject to greater risks with respect to changes in currency exchange rates.  

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, we believe there is no material risk of exposure.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our accompanying financial statements, financial statement schedule and the report of our independent registered public accounting firm appear in Part IV of this Report.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.

As required by Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended, an evaluation as of December 31, 2014 was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of December 31, 2014, were effective for the purposes stated above.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the year ended December 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). 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 for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

- 47 -

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Our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014, based on the framework in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2014.

Our independent registered public accounting firm has issued an auditors’ report on the effectiveness of our internal controls over financial reporting, which it included herein.

 

 

 

- 48 -

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
SciQuest, Inc.:

We have audited the internal control over financial reporting of SciQuest, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2014, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s 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 for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2014, and our report dated February 23, 2015 expressed an unqualified opinion on those financial statements.

 

/s/ GRANT THORNTON LLP

 

Raleigh, North Carolina

February 23, 2015

 

 

 

 

- 49 -

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ITEM 9B. OTHER INFORMATION

None.

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

We will include the information required by this item in our definitive proxy statement for our 2015 annual meeting of stockholders, which we will file within 120 days after the end of the fiscal year covered by this Report. This information is incorporated in this Report by reference.

 

ITEM 11. EXECUTIVE COMPENSATION

We will include the information required by this item in our definitive proxy statement for our 2015 annual meeting of stockholders, which we will file within 120 days after the end of the fiscal year covered by this Report. This information is incorporated in this Report by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

We will include the information required by this item in our definitive proxy statement for our 2015 annual meeting of stockholders, which we will file within 120 days after the end of the fiscal year covered by this Report. This information is incorporated in this Report by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

We will include the information required by this item in our definitive proxy statement for our 2015 annual meeting of stockholders, which we will file within 120 days after the end of the fiscal year covered by this Report. This information is incorporated in this Report by reference.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

We will include the information required by this item in our definitive proxy statement for our 2015 annual meeting of stockholders, which we will file within 120 days after the end of the fiscal year covered by this Report. This information is incorporated in this Report by reference.

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The following financial statements of the Company are filed herewith:

 

 

- 50 -

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None.

 

- 51 -

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- 52 -

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- 53 -

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:

 

 

 

 

 

- 54 -

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders
SciQuest, Inc.:

We have audited the accompanying consolidated balance sheets of SciQuest, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the years ended December 31, 2014 and 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SciQuest, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years ended December 31, 2014 and 2013 in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 23, 2015 expressed an unqualified opinion.

 

/s/ GRANT THORNTON LLP

 

Raleigh, North Carolina

February 23, 2015

F-2

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders of SciQuest, Inc. and Subsidiaries

We have audited the consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows of SciQuest, Inc. and Subsidiaries for the year ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of SciQuest, Inc. and Subsidiaries for the year ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.

/s/ Ernst & Young LLP

Raleigh, North Carolina

March 8, 2013

 

 

 

 

F-3

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SciQuest, Inc.

Consolidated Balance Sheets

(in thousands, except per share amounts)

 

 

The accompanying notes are an integral part of consolidated the financial statements.

 

 

 

F-4

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SciQuest, Inc.

Consolidated Statements of Operations and Comprehensive Loss  

(in thousands, except per share amounts)

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

F-5

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SciQuest, Inc.

Consolidated Statements of Stockholders’ Equity  

(in thousands)

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

F-6

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SciQuest, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

F-7

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

 

1. Description of Business

SciQuest, Inc. (the Company) provides leading cloud-based business automation solutions for spend management. The Company’s solutions include procurement solutions that automate the source-to-settle process, spend analysis solutions that cleanse and classify spend data to drive and measure cost savings, supplier management solutions that facilitate our customers’ interactions with their suppliers, contract lifecycle management solutions that automate the complete contract lifecycle from contract creation through maintenance and accounts payable solutions that automate the invoice processing and vendor payment processes. The Company’s solutions are designed to meet customer needs to reduce costs, simplify and improve visibility into key business processes, further strategic initiatives, enhance control over spending decisions and improve compliance and risk management. By simplifying and streamlining cumbersome, and often manual, processes and creating a comprehensive view of spending and compliance across the organization, organizations can identify and capitalize on opportunities to reduce costs by gaining control over suppliers, contracts, purchases and payments. The Company is headquartered in Morrisville, North Carolina.

 

Public Offering

On April 1, 2014, the Company completed a public offering of 3,000 shares of common stock at an offering price of $26.75 per share. An additional 450 shares of common stock were sold at an offering price of $26.75 per share pursuant to the underwriters’ over-allotment option. The Company received aggregate net proceeds of approximately $87,433, after payment of underwriting discounts and commissions and legal, accounting, and other fees incurred in connection with the offering and the over-allotment option.

 

2. Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Revenue Recognition

The Company primarily derives its revenues from subscription fees and related services, permitting customers to access and utilize the Company’s cloud-based business automation solutions for spend management. Customers may also purchase a perpetual license for certain software products. Revenue is recognized when there is persuasive evidence of an arrangement, 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. The Company’s arrangements do not contain general rights of return.

Because customers do not have the right to take possession of the Software-as-a-Service (“SaaS”) based software, these arrangements are considered service contracts and are not within the scope of Industry Topic 985, Software. The Company’s contractual agreements generally contain multiple service elements and deliverables, for which we follow the guidance provided in Accounting Standards Codification (“ASC”) 605-25, Revenue Recognition for Multiple-Element Arrangements. These elements include access to the hosted software, implementation or data classification services and, on a limited basis, perpetual licenses for certain software products and related maintenance and support. The Company evaluates each element in a multiple-element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered item has standalone value and delivery of the undelivered element is probable and within the Company’s control.

F-8

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

For arrangements in which elements do have stand-alone value, the Company allocates revenue to each element in the arrangement based on a selling price hierarchy. The selling price for a deliverable is based on vendor-specific objective evidence of selling price (“VSOE”), if available, third-party evidence of selling price (“TPE”), if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available. Because the Company has neither VSOE nor TPE for its deliverables, the allocation of revenue is based on ESP.

The Company’s process for determining ESP for its deliverables considers multiple factors that may vary depending upon the facts and circumstances related to each deliverable. Key factors considered in developing ESP related to deliverables include established pricing and approval policies, type and size of customer, number of products purchased, and historical transactions. The Company regularly reviews ESP and maintains internal controls over the establishment and updates of these estimates.

The Company evaluates its SaaS subscription agreements and considers whether the associated services have standalone value to its customers. For arrangements when implementation services do not have standalone value to the customer, licenses and related implementation services are considered a single unit of accounting. Accordingly, the consideration allocated to licenses and services is recognized ratably over the term of the subscription agreement, beginning with the later of the start date specified in the subscription agreement, or 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. Alternatively, when services have standalone value to the customer, licenses and related services are considered separate units of accounting. For separate units of accounting, services are recognized as the services are performed and delivered to the customer and licenses are recognized over the term of the subscription arrangement, beginning with the later of the start date specified in the subscription agreement, or the date access to the software is provided to the customer, provided all other revenue recognition criteria have been met.

Revenue from sales of certain of the Company’s perpetual software products and related implementation services and maintenance is recognized as a single unit of accounting since VSOE of fair value does not exist for the contractual elements. Accordingly, revenue for all elements in these arrangements is recognized over the contractual maintenance term, which is typically one year.

The Company recognizes 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 the Company’s software and services described above. For multi-year subscription agreements, the Company generally invoices its customers in annual installments. Accordingly, the deferred revenue balance does not represent the total contract value of these multi-year subscription agreements. The Company’s 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 the Company anticipates 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.

Cost of Revenues

Cost of revenues primarily consists of costs related to hosting the Company’s subscription software services, compensation and related expenses for implementation services, supplier enablement services, customer support staff and client partners, amortization of capitalized software development costs and allocated fixed asset depreciation and facilities costs. Cost of revenues is expensed as incurred.

Deferred Commissions

The Company capitalizes sales commission costs that are directly related to the execution of its subscription agreements. The commissions are deferred and amortized over the contractual term of the related non-cancelable subscription agreement. The Company believes 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 accompanying consolidated statements of operations and comprehensive loss.

F-9

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

Concentrations

As of December 31, 2014 and 2013, no individual customer comprised more than 10% of the accounts receivable balance. During each of the years ended December 31, 2014, 2013 and 2012, no individual customer comprised more than 10% of the Company’s revenues. During the year’s ended December 31, 2014, 2013 and 2012, approximately 87%, 89% and 93%, respectively, of the Company’s revenue was from sales transactions originating in the United States. As of December 31, 2014 and 2013, all of the Company’s long-lived assets were located in North America.

Cash and Cash Equivalents

The Company considers all highly liquid debt investments with an original maturity of three months or less at the date of purchase to be cash equivalents. The Company maintains cash balances at financial institutions that may at times exceed federally insured limits. The Company maintains this cash at reputable financial institutions and, as a result, believes credit risk related to its cash is minimal.

Short-Term Investments

Management determines the appropriate classification of investments at the time of purchase and evaluates such determination as of each balance sheet date. The Company’s investments were classified as available-for-sale securities and are stated at fair value at December 31, 2014 and 2013. Realized gains and losses are included in other income based on the specific identification method. There were no realized gains or losses for the years ended December 31, 2014, 2013 or 2012. Net unrealized gains and losses on available-for-sale securities are reported as a component of other comprehensive loss, net of tax. As of December 31, 2014 and 2013, there were no unrealized gains or losses on available-for-sale securities. The Company regularly monitors and evaluates the fair value of its investments to identify other-than-temporary declines in value. Management believes no such declines in value existed at December 31, 2014 or 2013.

Accounts Receivable

The Company assesses the need for an allowance for doubtful accounts based on estimates of probable credit losses. This assessment is based on several factors including aging of customer accounts, known customer specific risks, historical experience and existing economic conditions. The Company generally does not require collateral for receivable balances. Accounts would be charged against the allowance after all means of collection were exhausted and recovery was considered remote. Based on management’s analysis of its outstanding accounts receivable, the Company recorded an allowance of $1,100 and $556 at December 31, 2014 and 2013, respectively.  

Property and Equipment

Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which are usually seven years for furniture and three to five years for computer software and equipment. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the remainder of the lease term. Costs for repairs and maintenance are expensed as incurred. Upon retirement or sale, the cost of the disposed assets and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is credited or charged to operations.

Software Development Costs

The Company incurs certain costs associated with the development of its cloud-based solution, which are accounted for as internal-use software. Certain qualifying costs incurred during the application development phase are capitalized and amortized to expense over the estimated useful life of the related applications, which is generally three years.

Although the Company’s development efforts are primarily focused on its hosted, cloud-based solution, the Company also incurs costs in connection with the development of certain of its software products licensed to customers on a perpetual basis, which are accounted for as costs of software to be sold, leased or otherwise marketed. Under this guidance, capitalization of software development costs begins upon the establishment of technological feasibility (based on a working model approach), subject to net realizable value considerations. To date, the dates between achieving technological feasibility and the general availability of such software have substantially coincided; therefore, software development costs for these products that would qualify for capitalization have been immaterial. Accordingly, the Company has not capitalized any software development costs related to these software products and has charged all such costs to research and development expense.

F-10

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

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. Goodwill is not amortized, but rather is assessed for impairment at least annually. Additionally, the Company would also review the carrying value of goodwill whenever events or changes in circumstances indicated that its carrying amount may not be recoverable. The Company has concluded that it has one reporting unit for purposes of its 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. The Company performed its annual assessments on December 31, 2014 and 2013. The estimated fair value of the Company’s reporting unit exceeded its carrying amount, including goodwill, and as such, no goodwill impairment was recorded.

Long-Lived Assets

The Company evaluates the recoverability of its property and equipment and other long-lived assets, including acquired technology and customer relationships, when events change or circumstances indicate the carrying amount may not be recoverable. If such events or changes in circumstances are present, the undiscounted cash flow method is used to determine whether the asset is impaired. An impairment loss is recognized when, and to the extent, the net book value of such assets exceeds the fair value of the assets or the business to which the assets relate. Cash flows would include the estimated terminal value of the asset and exclude any interest charges. The discount rate utilized would be based on the Company’s best estimate of the related risks and return at the time the impairment assessment is made. There were no impairments of the Company’s long-lived assets during the years ended December 31, 2014, 2013, and 2012.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of costs, including salaries and sales commissions, of all personnel involved in the sales process. Sales and marketing expenses also include costs of advertising, trade shows, certain indirect costs and allocated fixed asset depreciation and facilities costs. Advertising costs are expensed as incurred. Advertising expenses totaled approximately $883, $678 and $522 for the years ended December 31, 2014, 2013 and 2012, respectively.

Stock-Based Compensation

Stock-based payments to employees, including grants of employee stock options, are recognized in the consolidated statement of operations and comprehensive loss 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 based on the fair value of the underlying option calculated using the Black-Scholes option-pricing model on the date of grant for stock options. Determining the appropriate fair value model and related assumptions requires judgment, including estimating stock price volatility, forfeiture rates and expected term. The Company uses the historical volatility of its stock price to calculate the expected volatility. Prior to the second half of 2013, the expected volatility rates were estimated based on the actual volatility of comparable public companies over the expected term. The expected term for the years ended December 31, 2014, 2013 and 2012, 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. The Company has not paid dividends and does not anticipate paying a cash dividend in the foreseeable future and, accordingly, uses 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.

F-11

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

Foreign Currency and Operations

The reporting currency for all periods presented is the U.S. dollar. The functional currency for the Company’s foreign subsidiaries is generally their local currency. The translation of each subsidiary’s financial statements into U.S. dollars is performed for assets and liabilities using exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate during the period. The resulting translation adjustments are recognized in accumulated other comprehensive loss, a separate component of stockholders’ equity. Also included in accumulated other comprehensive loss is the foreign translation adjustment of $4,228 related to the intercompany balance with the Company’s Canadian subsidiary not expected to be settled in the foreseeable future. Realized foreign currency transaction gains and losses are included in the other income section of the consolidated statements of operations and comprehensive loss.

Loss Per Share

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding for the period. Outstanding unvested restricted stock purchased by employees is subject to repurchase by the Company and therefore is not included in the calculation of the weighted-average shares outstanding until vested. Diluted net loss per share is computed giving effect to all potentially dilutive common stock, including options and restricted stock. The dilutive effect of outstanding awards is reflected in diluted earnings per share by application of the treasury stock method.

The following summarizes the calculation of basic and diluted net loss per share:

 

 

For the years ended December 2014, 2013, and 2012, the Company incurred net losses and, therefore, the effect of the Company’s outstanding stock options, nonvested restricted stock and common stock issuable pursuant to the employee stock purchase plan was not included in the calculation of diluted net loss per share as the effect would be anti-dilutive. For the years ended December 31, 2014, 2013, and 2012, diluted net loss per share excluded the impact of 361, 430, and 384 outstanding stock options, 13, 28, and 43 nonvested shares of restricted stock, and approximately 12, 18, and 0 shares of common stock issuable pursuant to the employee stock purchase plan, respectively.

Segment Data

The Company manages its operations on a consolidated basis for purposes of assessing performance and making operating decisions. Accordingly, the Company has determined that it has a single reporting segment.

F-12

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

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 revenues, 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.

Judgment is required in determining the provision for income taxes. Additionally, the income tax provision is based on calculations and assumptions that are subject to examination by many different tax authorities and to changes in tax law and rates in many jurisdictions. The Company would adjust its income tax provision in the period in which it becomes probable that actual results differ from management estimates.

The Company accounts for uncertain tax positions by recognizing and measuring tax benefits taken or expected to be taken on a tax return. A tax benefit from an uncertain position may be recognized only if it is more likely than not that the position is sustainable, based solely on its technical merits and consideration of the relevant taxing authority’s widely understood administrative practices and precedents. If the recognition threshold is met, only the portion of the tax benefit that is greater than fifty percent likely to be realized upon settlement with a taxing authority is recorded. The tax benefit that is not recorded is considered an unrecognized tax benefit. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense.

Recent Accounting Pronouncements

In August 2014, the FASB issued new accounting guidance which addresses management’s responsibility to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and to provide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. This guidance is effective for the fiscal year ending after December 15, 2016, and for fiscal years and interim periods thereafter. Early adoption is permitted. The Company does not expect to early adopt this guidance and does not believe that the adoption of this guidance will have a material impact on its financial statements.

In May 2014, the FASB issued new accounting guidance on revenue recognition, which provides for a single five-step model to be applied to all revenue contracts with customers. The new standard also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2016. Early adoption is not permitted. The Company will adopt this standard in the first quarter of 2017. The Company is currently evaluating the impact that the implementation of this standard will have on its financial statements.

In July 2013, the FASB issued a revised accounting standard, which clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In situations where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This standard is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. Retrospective application is permitted. The Company adopted this guidance on January 1, 2014. The adoption for this guidance did not have a material impact on the Company’s financial position, results of operations, or cash flows.

 

3. Business Combinations

CombineNet

On August 30, 2013, the Company acquired all of the outstanding capital stock of CombineNet, Inc. (“CombineNet”), a leading provider of advanced sourcing software. The acquisition of CombineNet expands the Company’s strategic sourcing footprint with an advanced, cloud-based tool that improves procurement decisions for spend categories that are typically beyond the capabilities of traditional eSourcing software.

F-13

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The purchase price consisted of approximately $26,575 in cash and 820 shares of the Company’s common stock at a fair value of $17,055. The purchase price was subject to an adjustment based on the closing amount of working capital of CombineNet and accordingly as a result of this adjustment, the Company paid an additional $59 in cash and issued approximately 1 shares of common stock at a fair value of $38. The purchase price included $2,465 in cash and 76 shares of common stock that were deposited in escrow to satisfy potential indemnification claims. The Company incurred acquisition costs of approximately $431 during the year ended December 31, 2013, which are included in general and administrative expense in the consolidated statements of operations and comprehensive loss. The acquisition was accounted for under the purchase method of accounting. The operating results of CombineNet are included in the accompanying consolidated financial statements from the date of acquisition.

The purchase consideration consisted of the following:

 

 

The purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. Acquired technology, trademarks and the covenant not to compete are amortized on a straight-line basis over their respective estimated useful lives. Acquired customer relationships are amortized over a fifteen-year estimated life in a pattern consistent with which the economic benefit is expected to be realized. The excess of the purchase price over the net tangible and identifiable intangible assets acquired was recorded as goodwill, which is not deductible for tax purposes. This asset is attributed to a trained workforce and buyer-specific value resulting from synergies that are not included in the fair values of assets.

The allocation of the purchase price as of the acquisition date was as follows:

 

 

The measurement period for the acquisition purchase accounting was closed December 31, 2013.

F-14

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The following unaudited pro forma consolidated results of operations for the years ended December 31, 2013 and 2012 assume that the CombineNet acquisition occurred at the beginning of 2012. The unaudited pro forma information combines the historical results for the Company with the historical results for CombineNet for the same period. The unaudited pro forma financial information includes amortization of acquired intangible assets of $2,228 and $2,355 for the years ended December 31, 2013 and 2012, respectively, and includes the fair value adjustment for deferred revenue of $2,366 and $1,202 for the years ended December 31, 2013 and 2012, respectively.

The following unaudited pro forma information is not intended to be indicative of future operating results.

 

 

Spend Radar

On October 1, 2012, the Company completed the acquisition of substantially all of the assets of Spend Radar LLC (“Spend Radar”), a leading provider of spend analysis solutions. The acquisition of Spend Radar added cloud-based software for cleansing and classifying spend data to drive and measure cost savings to the Company’s existing business automation solutions for spend management.

The purchase price consisted of $8,000 in cash and 113 shares of the Company’s common stock at a fair value of $2,087. The purchase agreement also contained an earnout provision for up to $6,000 in cash and 85 shares of the Company’s common stock based on the successful achievement of certain performance targets and continued employment with the Company from the closing date to December 31, 2013. The performance conditions for Q4 2012 and Q1 2013 were met and the Company paid $2,400 and issued 34 shares of common stock on April 29, 2013. Additionally, the performance conditions for Q2, Q3 and Q4 2013 were met and the Company paid $3,600 on January 31, 2014 and issued 51 shares of common stock on February 3, 2014. The cash earn-out was recognized as compensation expense in the consolidated statement of operations and comprehensive loss in the period in which it was earned. The fair value of the shares under the stock earn-out was recognized as stock-based compensation expense in the consolidated statement of operations and comprehensive loss over the requisite service period of the award. During the years ended December 31, 2013 and 2012, the Company recognized compensation expense of $4,800 and $1,200, respectively, and stock-based compensation expense of $1,252 and $300, respectively, related to this earn-out arrangement.

AECsoft

On December 21, 2010, the Company entered into a Stock Purchase Agreement to acquire all of the issued and outstanding shares of capital stock of AECsoft USA, Inc., a Texas corporation, and AEC Global (Shanghai) Co., Ltd., a Chinese corporation (collectively, “AECsoft”), which together are a leading provider of supplier management and sourcing technology.

The Company completed the acquisition of AECsoft, USA, Inc. on January 1, 2011 and the acquisition of AEC Global (Shanghai) Co., Ltd. on March 31, 2011. The acquisition of AECsoft added comprehensive supplier management, sourcing and compliance reporting to the Company’s existing business automation solutions for spend management.

The total purchase price of $13,795 consisted of $9,256 in cash and 351 shares of the Company’s common stock at a fair value of $4,539. The issuance of 25 of these shares, with an estimated fair value of $300, was subject to successful completion of certain performance targets under an earn-out arrangement with a former shareholder of AECsoft. Additionally, 300 shares of the Company’s common stock were issuable under an earn-out arrangement with the other former shareholders of AECsoft, upon the successful achievement of performance conditions over three fiscal years, including continued employment with the Company. The performance conditions for 2012 and 2011 were met in full, and the Company issued 122 shares of common stock on March 20, 2013 and April 14, 2012, respectively. The performance conditions for 2013 were met in full, and the Company issued 81 shares of common stock on February 5, 2014. The fair value of these shares was recognized as stock-based compensation expense in the consolidated statement of operations and comprehensive loss over the requisite service period of the award. During the years ended December 31, 2013 and

F-15

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

2012, the Company recognized stock-based compensation expense of $976 and $1,466, respectively, related to this earn-out arrangement.

  

4. Cash Equivalents and Short-Term Investments

The components of cash equivalents and short-term investments at December 31, 2014 and 2013 are as follows:

 

 

There were no unrealized gains or losses as of December 31, 2014 or 2013.

 

5. Fair Value Measurements

Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., “the exit price”) in an orderly transaction between market participants at the measurement date. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

The financial assets for which the Company performs recurring fair value remeasurements are cash equivalents and short-term investments.

As of December 31, 2014 and 2013, the Company had cash equivalents of $48,469 and $5,349, respectively, which consist of money market accounts and commercial paper. As of December 31, 2014 and 2013, the Company had short-term investments of $71,493 and $15,105, respectively, which consist of commercial paper and variable rate demand notes that are invested in corporate and municipal bonds. These commercial paper investments have maturities between one and six months whereas the variable rate demand notes have final maturities between 2017 and 2042, but are puttable by the Company at any time with seven days notice. These cash equivalents and short-term investments are classified within Level 1 of the fair value hierarchy since they are valued using quoted market prices. As of December 31, 2014 and 2013, the Company did not have any financial assets or liabilities with observable inputs not quoted on active markets (Level 2), or without observable market values that would require a high level of judgment to determine fair value (Level 3).

F-16

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The fair value measurements of the Company’s financial assets at December 31, 2014 are as follows:

 

 

The fair value measurements of the Company’s financial assets at December 31, 2013 are as follows:

 

 

 

6. Property and Equipment

Property and equipment consist of the following as of December 31, 2014 and 2013:

 

 

Depreciation expense related to property and equipment (excluding capitalized internal-use software) for the years ended December 31, 2014, 2013 and 2012 was $2,685, $2,159 and $1,532, respectively.

 

During the year ended December 31, 2014, the Company entered into a lease assignment, pursuant to which the Company assigned all of its right, title and interest in the Company’s office lease at its former headquarters. In accordance with the assignment, certain fixed assets were transferred with the office space. Accordingly, the Company wrote off furniture and fixtures and leasehold improvements with an original cost of $1,366 and accumulated depreciation of $936. The Company recognized a loss of $430 in the accompanying consolidated statements of operations and comprehensive loss for the year ended December 31, 2014 related to these disposals.

 

The Company disposed of fully-depreciated computer software and equipment with a cost of $996 during the year ended December 31, 2013. During 2012, the Company disposed of computer software and equipment with an original cost of $1,036 and accumulated depreciation of $998 . The Company recognized a loss in the accompanying consolidated statements of operations and comprehensive loss of $38 during the year ended December 31, 2012 related to these disposals.  

Computer software and equipment includes capitalized software development costs incurred during development of the Company’s cloud-based solution. The Company capitalized software development costs of $5,431 and $3,623 during the years ended December 31, 2014 and 2013, respectively. Net capitalized software development costs totaled $7,867 and $5,349 as of December 31, 2014 and 2013, respectively. Amortization expense for the years ended December 31, 2014, 2013 and 2012 related to capitalized software development costs was $2,934, $1,842 and $928, respectively, which is classified within cost of revenues in the accompanying consolidated statements of operations and comprehensive loss.

 

7. Goodwill and Other Intangible Assets

The Company acquired goodwill and certain identifiable intangible assets as part of the acquisitions in August 2013, October 2012, August 2012 and January 2011 and the going private transaction in July 2004.

F-17

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The changes in the carrying amount of goodwill for the years ended December 31, 2014 and 2013 were as follows:

 

 

As the functional currency of the Company’s Canadian subsidiary, where certain of the Company’s goodwill is recorded, is its local currency, there are related foreign currency translation adjustments. The foreign currency is translated into U.S. dollars using the exchange rate in effect at period end, with any adjustment included in other comprehensive loss.

A summary of intangible assets as of December 31, 2014 and 2013 follows:

 

 

 

As the functional currency of the Company’s Canadian subsidiary, where certain intangible assets are recorded, is its local currency, there are related foreign currency translation adjustments. The foreign currency is translated into U.S. dollars using the exchange rate in effect at period end, with any adjustment included in other comprehensive loss.

Amortization expense of intangible assets was $5,232, $3,962 and $1,821 for the years ended December 31, 2014, 2013 and 2012, respectively, of which $2,078, $1,580 and $553 is recorded in cost of revenues in the accompanying consolidated statements of operations and comprehensive loss for the years ended December 31, 2014, 2013 and 2012, respectively.

F-18

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The Company estimates the following amortization expense related to its intangible assets for the years ended December 31:

 

 

 

8. Accrued Liabilities

Current accrued liabilities are comprised of the following as of December 31, 2014 and 2013:

 

 

 

9. Debt

On November 2, 2012, the Company established a $30,000 revolving credit facility which will be available for use until November 2, 2015. The revolving credit facility will be used for general corporate purposes. The facility consists of a $20,000 securities secured revolving credit facility and a $10,000 receivables secured revolving credit facility. The securities secured revolving credit facility and the receivables secured revolving credit facility bear interest equal to the BBA LIBOR Daily Floating Rate plus 0.75% and the BBA LIBOR Daily Floating Rate plus 1.50%, respectively. In addition, the Company pays a quarterly fee equal to 0.10% on any unused funds under the facility. As collateral for extension of credit under the facility, the Company and a domestic subsidiary granted security interests in substantially all of their assets, and the Company pledged the stock of a domestic subsidiary and 66% of the shares of one of its foreign subsidiaries. As of and for the periods ending December 31, 2014 and 2013, the Company had $0 outstanding under the revolving credit facility.

 

10. Stockholders’ Equity

Preferred Stock

The Company is authorized to issue up to 5,000 shares of $0.001 par value preferred stock, of which 222 shares are designated as Series A redeemable preferred stock. The Company’s Board of Directors has the authority to issue up to 4,778 shares of preferred stock in one or more series and to fix the designations, rights, preferences and privileges and any qualifications, limitations or restrictions of the shares of each such series of preferred stock, including dividend rights and rates, conversion rights, voting rights, terms of redemption including price and sinking fund provisions, liquidation preferences and number of shares constituting any series or the designation of that series. As of December 31, 2014 and 2013, no shares of preferred stock were issued or outstanding.

Stock Incentive Plan

The Company’s 2013 Stock Incentive Plan (the “Plan”) allows the Company to grant common stock options, stock appreciation rights, restricted stock units and restricted stock awards to employees, board members and others who contribute materially to the success of the Company. The Company reserved 3,500 shares of its common stock for issuance under the Plan. Additionally, per the terms of the Plan, shares of common stock previously reserved for issuance under the 2004 Stock Incentive Plan (the “Prior Plan”) as well as shares reserved for outstanding awards under the Prior Plan for which the awards are canceled, forfeited, repurchased or otherwise result in common stock not being issued will be added to the number of shares available for issuance under the Plan. Restricted stock units and restricted stock awards that are granted shall count towards the total number of shares reserved for issuance under the Plan as 1.65 shares. As of December 31, 2014, 3,507 shares of common stock were available for issuance under the Plan.

F-19

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The following table summarizes the number of shares outstanding and the number of shares available for future grant under the stock incentive plan at December 31, 2014:

 

 

The Company’s Board of Directors approves the terms of stock options granted. Individual option grants generally become exercisable ratably over a period of four years from the grant date. The contractual term of the options is approximately ten years from the date of grant.

The Company recognizes compensation expense associated with restricted stock and common stock options based on the grant-date fair value of the award on a straight-line basis over the requisite service period of the individual grantees, which generally equals the vesting period.

Restricted Stock

The Company issues restricted stock units to certain employees and non-employee directors. Restricted stock units differ from restricted stock awards in that restricted stock units represent the right to receive shares of common stock once such shares are vested and issuable in accordance with the terms of the restricted stock units. Once issued, such shares are not subject to further restrictions. Stock-based compensation expense related to these restricted stock units is recognized in the consolidated statements of operations and comprehensive loss based on the fair value of these awards, which is the grant date market value of the Company’s common stock. Stock-based compensation expense of $701, $500, and $256 was recorded during the years ended December 31, 2014, 2013, and 2012, respectively, in connection with these restricted stock units. The total unrecognized compensation cost related to these awards is approximately $1,210 at December 31, 2014. This amount is expected to be recognized over a weighted-average period of 2.6 years.

The following summarizes the activity of restricted stock units for the years ended December 31, 2014, 2013 and 2012:  

 

 

Additionally, the Company previously issued restricted shares of its common stock to certain employees under the Prior Plan.

F-20

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

These awards are recognized in the consolidated statements of operations and comprehensive loss based on their fair values. Stock-based compensation expense of $41 and $110 was recorded during the years ended December 31, 2013 and 2012, respectively, in connection with these restricted stock awards. As of December 31, 2013, these awards were fully vested.  

The following summarizes the activity of nonvested shares of restricted stock for the years ended December 31, 2013 and 2012:

 

 

Stock Options

The Company also issues common stock options. The following summarizes stock option activity for the year ended December 31, 2014:

 

 

The aggregate intrinsic value in the table above represents the difference between the exercise price of the underlying awards and the estimated fair value of the Company’s common stock at December 31, 2014 multiplied by the number of shares that would have been received by the option holders had all option holders exercised their options on December 31, 2014. The aggregate intrinsic value of options exercised during the years ended December 31, 2014, 2013 and 2012 was $1,465, $3,295 and $1,774, respectively.

The total unrecognized compensation cost related to outstanding stock options is $9,920 at December 31, 2014. This amount is expected to be recognized over a weighted-average period of 2.6 years.

F-21

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The following table summarizes information about stock options outstanding and exercisable at December 31, 2014:

 

 

The fair value of common stock options for employees is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used:

 

 

Stock-based compensation expense of $5,195, $3,890 and $2,925 was recorded during the years ended December 31, 2014, 2013 and 2012, respectively, related to the Company’s outstanding stock options. The weighted average grant date fair value per share for stock options granted in 2014, 2013 and 2012 was $11.57, $10.34 and $9.22, respectively. The aggregate fair value of stock options that vested during the years ended December 31, 2014, 2013 and 2012 was $5,422, $3,481 and $3,408, respectively.

As discussed in Note 3, the Company recognized stock-based compensation expense of $1,252 and $300 in the accompanying consolidated statement of operations and comprehensive loss for the years ended December 31, 2013 and 2012, respectively, related to the earn-out arrangement associated with the Spend Radar acquisition. In addition, the Company recognized stock-based compensation expense of $976 and $1,466 in the accompanying consolidated statements of operations and comprehensive loss for the years ended December 31, 2013 and 2012, respectively, related to the earn-out arrangement with certain former shareholders of AECsoft.

Employee Stock Purchase Plan

The Company adopted an Employee Stock Purchase Plan (the “Purchase Plan”) effective June 1, 2012. Eligible employees can contribute up to 10% of their gross earnings for each pay period, up to a maximum of $25 for any calendar year. The initial offering period that commenced on June 1, 2012 was a period of 12 months, and thereafter six month offering periods begin on December 1 and June 1 of each year. During the offering period eligible employees may elect to purchase shares of the Company’s common stock according to the terms of the offering. The per share purchase price is equal to the lessor of 85% of the fair market value of the Company’s common stock on the offering date or 85% of the fair market value of the Company’s common stock on the purchase date. As of December 31, 2014, 880 shares of common stock were available for issuance to participating employees under the Purchase Plan. During the years ended December 31, 2014, 2013 and 2012, the Company recognized stock-based compensation expense of $293, $273 and $140, respectively, related to the Purchase Plan.

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

The fair value of stock purchase rights granted under the Purchase Plan is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used:

 

 

 

 

11. Income Taxes

 

The following are the components of loss before income taxes:

 

 

The provision for (benefit from) income taxes in the accompanying consolidated statements of operations and comprehensive loss for the years ended December 31, 2014, 2013 and 2012 consisted of the following:

 

 

A reconciliation of the statutory income tax rate to the effective income tax rate is as follows:

 

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

 

 

The Company reevaluated its federal and state loss carryforwards during 2012 and determined that various losses would never be utilized based on the section 382 limit. Therefore, the Company reduced its deferred tax asset related to these losses. These deferred tax assets previously had a full valuation provided against them. The Company had no tax expense (benefit) related to the removal of the net operating losses. In 2013 and 2014, certain state net operating loss carryforwards were reevaluated based on current activity and it was determined that an additional valuation allowance was required, resulting in tax expense of $624 and $621, respectively.

During 2013, the Company acquired the stock of CombineNet in a tax-free reorganization under IRC Sec. 368(a)(2)(d). The acquisition resulted in a net deferred tax liability of $2,027 being recorded as part of purchase accounting, with a corresponding adjustment to goodwill. There was no impact to income tax expense.

The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset at December 31, 2014 and 2013 are as follows:

 

 

As of December 31, 2014, the Company has federal and state net operating loss carryforwards of approximately $212,568 and $124,578, respectively, which will begin to expire in 2018 for federal tax purposes and began to expire in 2009 for state tax purposes. Furthermore, the Company has approximately $491 of alternative minimum tax credit carryforwards and $3,873 of research and development credit carryforwards. The research and development credits began to expire in 2013. The Tax Reform Act of 1986 contains provisions that limit the ability of companies to utilize net operating loss carryforwards and tax credit carryovers in the case of certain events including significant changes in ownership. These limitations may significantly impact the amount of net operating loss and tax credit carryovers available to offset future taxable income. As of December 31, 2014, the Company believes that federal and state net operating loss carryforwards in the amounts of $14,164 and $37,890, respectively, will be available for future utilization to the extent of future income. The Company has provided a valuation allowance for the remaining federal and state losses of $198,404 and $86,688, respectively, due to uncertainty regarding the Company’s ability to fully realize these assets.

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

At December 31, 2014 and 2013, unrecognized tax benefits of $1,014 and $1,024, respectively, net of federal tax benefits, would have increased the Company’s deferred tax assets. This amount, if recognized, would impact the effective tax rate. The Company does not believe there will be any material changes in its unrecognized tax positions over the next twelve months.

The following is a tabular reconciliation of the Company’s change in uncertain tax positions:

 

 

As of December 31, 2014 and 2013, the Company did not have any accrued interest or penalties associated with any unrecognized tax positions, and there were no such interest or penalties recognized during the years ended December 31, 2014, 2013 or 2012. The Company’s open tax years that are subject to federal examination are 2011 through 2013. All prior years with applicable net operating losses will remain open to the extent of the amount of the net operating loss. The Company provides for U.S. income taxes on earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of December 31, 2014, U.S. income taxes were not provided for any undistributed earnings for non-U.S. subsidiaries, as the Company currently intends to reinvest any earnings from foreign operations indefinitely.   

 

 

12. Commitments and Contingencies

Operating Leases

The Company leases office space under non-cancelable operating leases. The Company did not have any capital lease obligations as of December 31, 2014 or 2013. The Company is committed to a lease agreement for office space for its headquarters through July 2024. On July 29, 2014, the Company entered into a lease assignment, pursuant to which the Company assigned all of its right, title and interest in the Company’s office lease at its former headquarters. The assignment required the Company to pay an amount equal to $20 as an estimate of additional rental adjustments that are expected to be payable under the lease, and a lump sum payment to the landlord in the amount of $685 as a partial prepayment of rental payments owed under the lease for the remaining lease term. These costs, adjusted for the existing deferred rent balance of $468, are included in general and administrative expense in the accompanying consolidated statements of operations and comprehensive loss for the year ended December 31, 2014. In addition, in connection with the negotiation of the lease assignment, the Company incurred broker’s fees of $141, which are included in general and administrative expense for the year ended December 31, 2014. As discussed in Note 6, certain fixed assets were transferred in accordance with the lease assignment. The Company recognized a loss of $430 in the accompanying consolidated statements of operations and comprehensive loss for the year ended December 31, 2014 related to the disposal of these assets. The Company is also committed to leases through February 2016, May 2016, June 2016, July 2018 and March 2019. Future minimum lease payments required under leases in effect as of December 31, 2014 are as follows:

 

 

Rent expense is calculated on a straight-line basis over the term of the lease. Rent expense recognized under operating leases totaled approximately $3,190, $2,378 and $1,777 for the years ended December 31, 2014, 2013 and 2012, respectively.

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SciQuest, Inc.

Notes to Consolidated Financial Statements

(in thousands, except per share amounts)

 

Legal Contingencies

From time to time, the Company is subject to legal proceedings and claims that arise in the ordinary course of business. The Company records an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company is not currently subject to any material legal proceedings.

On January 31, 2012, a lawsuit alleging patent infringement was filed against the Company and certain customers and suppliers that participate in the SciQuest Supplier Network. On March 31, 2012, SciQuest, Inc. entered into a settlement agreement with the plaintiff. The settlement amount, which did not have a material adverse effect on the Company’s financial position, results of operations, or cash flows, is recorded in operating expenses in the accompanying consolidated statement of operations and comprehensive loss for the year ended December 31, 2012.

Warranties and Indemnification

The Company’s hosting service is typically warranted to perform in a manner consistent with general industry standards that are reasonably applicable under normal use and circumstances. The Company’s arrangements also include certain provisions for indemnifying customers against liabilities if its products or services infringe a third party’s intellectual property rights. The Company to date has not incurred costs to settle claims or pay awards under these indemnification obligations. The Company accounts for these indemnity obligations as contingencies and records a liability for these obligations when a loss is probable and reasonably estimable. To date, the Company has not incurred any material costs as a result of these indemnifications and has not accrued any liabilities related to the obligations in the accompanying consolidated financial statements.

The Company enters into service level agreements with its cloud-based solution customers warranting certain levels of uptime reliability. To date, the Company has not incurred any material costs and has not accrued any liabilities related to such obligations.

 

13. Employee Benefit Plan

The Company offers various defined contribution plans covering eligible employees in the United States and foreign locations. The total expense associated with the contribution plans during the years ended December 31, 2014, 2013 and 2012, was $978, $892 and $628, respectively.

 

14. Quarterly Results of Operations (unaudited)

The following is a summary of the Company’s quarterly results of operations for the years ended December 31, 2014 and 2013:

 

 

 

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