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N > SEC Filings for N > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for NETSUITE INC

Form 10-Q for NETSUITE INC


31-Oct-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the discussion contained in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC on February 28, 2012. Certain statements in this Quarterly Report constitute forward-looking statements and as such, involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectation of earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements related to adding employees; statements related to future capital expenditures; statements related to future economic conditions or performance; statements related to the integration of acquired companies; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," or "will," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to those discussed in the section titled "Risk Factors" included in Item 1A of Part II of this Quarterly Report on Form 10-Q, and the risks discussed in our other SEC filings.

We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. These statements are based on the beliefs and assumptions of our management based on information currently available to management. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

Overview

We are the industry's leading provider of cloud-based financials/ERP software suites. In addition to financials/ERP software suites, we offer a broad suite of applications, including accounting, CRM, PSA and Ecommerce that enable companies to manage most of their core business operations in our single integrated suite. Our "real-time dashboard" technology provides an easy-to-use view into up-to-date, role-specific business information. We also offer customer support and professional services related to supporting and implementing our suite of applications. We deliver our suite over the Internet as a subscription service using the software-as-a-service ("SaaS") model.

In 1999, we released our first application, NetLedger, focused on accounting applications. We then released Ecommerce functionality in 2000 and CRM and sales force automation functionality in 2001. In 2002, we released our next generation suite under the name NetSuite, and we have regularly added features and functionality. In 2008, we acquired OpenAir and in 2009 we acquired QuickArrow, both of which offer professional services automation and project portfolio management products.

Our headquarters are located in San Mateo, California. We were incorporated in California in September 1998 and reincorporated in Delaware in November 2007. We conduct our business worldwide, with international locations in Canada, Europe, Asia, South America and Australia.

During the second quarter of 2012, we completed the purchase all of the outstanding equity of two small South American companies ("SAC") that specialize in Ecommerce technology and services. We also purchased certain assets from two entities related to the SAC. The SAC workforce will augment our existing professional services and product development teams. On the closing dates, we paid $4.0 million in cash. Additional consideration of $2.2 million in cash is being withheld for various periods up to the next 10 years following the close of the transaction as protection against certain losses we may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. During the second quarter of 2012, we recorded $736,000 in operating expenses related to transaction costs associated with this business combination.


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Key Components of Our Results of Operations

Revenue

Our revenue has grown from $17.7 million during the year ended December 31, 2004 to $236.3 million during the year ended December 31, 2011.

We generate sales directly through our sales team and, to a lesser extent, indirectly through channel partners. We sell our service to customers across a broad spectrum of industries, and we have tailored our service for wholesalers/distributors, manufacturers, e-tailers, services companies and software companies. The primary target customers for our service are medium-sized businesses and divisions of large companies. An increasing percentage of our customers and our revenue have been derived from larger businesses within this market. For the nine months ended September 30, 2012, we did not have any single customer that accounted for more than 3% of our revenue.

We are pursuing a number of strategies that we believe will enable us to continue to grow. The goals of those strategic objectives are to continue to move up-market; to increase use of NetSuite as a platform; and to extend the verticalization of our product line. Although we have made progress towards our goals in recent periods, there are still many areas where we believe that we can continue to grow. To achieve these goals, we are focused on the following initiatives:

Growth of sales of OneWorld, our platform for ERP, CRM and Ecommerce capabilities in multi-currency environments across multiple subsidiaries and legal entities, which supports the needs of large, standalone companies, and divisions of very large enterprises;

Strengthening our offerings for targeted industries such as wholesale/distribution, manufacturing, e-tail, retail, technology and professional services by adding deeper verticalized functionality; and

Developing our SuiteCloud ecosystem to enable third parties to extend our offerings with their vertical expertise or horizontal solution.

We experience competitive pricing pressure when our products are compared with solutions that address a narrower range of customer needs or are not fully integrated (for example, when compared with Ecommerce or CRM stand-alone solutions). In addition, since we sell primarily to medium-sized businesses, we also face pricing pressure in terms of the more limited financial resources or budgetary constraints of many of our target customers. We do not currently experience significant pricing pressure from competitors that offer a similar on-demand, integrated business management suite.

We sell our application suite pursuant to subscription agreements. The duration of these agreements is generally one year. We rely in part on a large percentage of our customers to renew their agreements to drive our revenue growth. Our customers have no obligation to renew their subscriptions after the expiration of their subscription period.

Our subscription agreements provide service level commitments of 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require us to credit qualifying customers up to the value of an entire month of their subscription and support fees. In light of our historical experience with meeting our service level commitments, we have not accrued any liabilities on our balance sheet for these commitments.

We generally invoice our customers in advance in annual or quarterly installments, and typical payment terms provide that our clients pay us within 30 to 60 days of invoice. Amounts that have been invoiced where the customer has a legal obligation to pay are recorded in accounts receivable and deferred revenue. As of September 30, 2012, we had deferred revenue of $135.5 million.

During the second quarter of 2012, we updated the terms of our standard renewal agreement form so that the legal obligation to pay by our customers occurs upon execution of the renewal agreement rather than on their renewal date. Based on our existing policy of recording amounts that have been invoiced in accounts receivable and deferred revenue where the customer has a legal obligation to pay, invoices from these renewal agreements are now recorded in accounts receivable and deferred revenue upon execution of the renewal agreement rather than at the start of the renewal period. Had we not revised the terms of these renewal agreements, we would have recorded approximately $4.3 million less in accounts receivable and deferred revenue as of September 30, 2012.


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As part of our overall growth, we expect the percentage of our revenue generated outside of the United States to increase as we invest in and enter new markets. Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented:

Nine Months Ended September 30, Three Months Ended September 30,
2012 2011 2012 2011
(dollars in thousands)

United States $ 164,609 $ 126,031 $ 58,668 $ 45,210 International 59,210 46,202 21,123 15,749 Total revenue $ 223,819 $ 172,233 $ 79,791 $ 60,959

Percentage of revenue generated
outside of the United States 26 % 27 % 26 % 26 %

Employees

The number of full-time employees as of September 30, 2012 was 1,630 as compared to 1,265 at December 31, 2011 and 1,243 at September 30, 2011. As of September 30, 2012, our headcount included 484 employees in sales and marketing; 639 employees in operations, professional services, training and customer support; 345 employees in product development; and 162 employees in a general and administrative capacity.

Cost of Revenue

Subscription and support cost of revenue primarily consists of costs related to hosting our application suite, providing customer support, data communications expenses, personnel and related costs of operations, stock-based compensation, software license fees, outsourced subscription services, costs associated with website development activities, allocated overhead, amortization expense associated with capitalized internal use software and acquired developed technology, and related plant and equipment depreciation and amortization expenses.

Professional services and other cost of revenue primarily consists of personnel and related costs for our professional services employees and executives, external consultants, stock-based compensation and allocated overhead.

We allocate overhead such as rent, information technology costs, employee benefit costs and recruiting costs to all departments based on headcount. As such, general overhead expenses are reflected in cost of revenue and each operating expense category.
We expect cost of revenue to remain flat as a percentage of revenue over the near term; however, it could fluctuate period to period depending on the growth of our professional services business and any associated increased costs relating to the delivery of professional services and the timing of significant expenditures.

Operating Expenses - Product Development

Product development expenses primarily consist of personnel and related costs for our product development employees and executives, including salaries, stock-based compensation, employee benefits and allocated overhead. Our product development efforts have been devoted primarily to increasing the functionality and enhancing the ease of use of our on-demand application suite, as well as localizing our product for international use. A key component of our strategy is to expand our business internationally. This will require us to conform our application suite to comply with local regulations and languages, causing us to incur additional expenses related to translation and localization of our application for use in other countries.

At our product development facility in the Czech Republic, we participate in a government program that subsidizes us for employing local residents. Under the program, the Czech government will reimburse us for certain operating expenses we incur. During the first nine months of 2012, we reduced our product development expense for eligible operational expenses we expect the Czech government to reimburse. On a quarterly basis, we will accrue our expected subsidies for the duration of the program.


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We expect product development expenses to increase in absolute dollars and increase slightly as a percentage of revenue as we continue to extend our service offerings internationally and as we expand and enhance our application suite technologies. Such expenses may vary due to the timing of these offerings and technologies.

Operating Expenses - Sales and Marketing

Sales and marketing expenses primarily consist of personnel and related costs for our sales and marketing employees and executives, including wages, benefits, bonuses, commissions and training, stock-based compensation, commissions paid to our channel partners, the cost of marketing programs such as on-line lead generation, promotional events, webinars and other meeting costs, amortization of intangible assets related to trade name and customer relationships and allocated overhead. We market and sell our application suite worldwide through our direct sales organization and indirect distribution channels such as strategic resellers. We capitalize and amortize our direct and channel sales commissions over the period the related revenue is recognized.
We believe we have sufficient sales and marketing staff to meet our revenue goals for the remainder of 2012. We expect to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers. As such, we expect our sales and marketing expenses to increase in terms of absolute dollars and increase slightly as a percentage of total revenue for the remainder of 2012.

Operating Expenses - General and Administrative

General and administrative expenses primarily consist of personnel and related costs for executive, finance, human resources and administrative personnel, stock-based compensation, legal and other professional fees, other corporate expenses and allocated overhead.
We expect our general and administrative expenses to increase in terms of absolute dollars and remain constant as a percentage of total revenue for the remainder of 2012.

Income Taxes

Since inception, we have incurred annual operating losses and, accordingly, have not recorded a provision for income taxes for any of the periods presented other than provisions for state and foreign income taxes.

Critical Accounting Policies and Judgments

Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application, while in other cases, significant judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We consider these policies requiring significant management judgment to be critical accounting policies. These critical accounting policies are:
Revenue recognition;

Internal use software and website development costs;

Deferred commissions;

Accounting for stock-based compensation; and

Goodwill and other intangible assets

There have been no significant changes in our critical accounting policies and estimates during the nine months ended September 30, 2012 as compared to the critical accounting policies and estimates disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Judgments" included in our


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Annual Report on Form 10-K for the year ended December 31, 2011 filed on February 28, 2012. In addition, please see Note 2 of Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and Note 2 of the Notes to Consolidated Financial Statements included in our 2011 Annual Report on Form 10-K filed on February 28, 2012 for a description of our accounting policies.

Results of Operations

Revenue, Cost of Revenue, Gross Profit and Gross Margin

Information about revenue, cost of revenue, gross profit and gross margin was as
follows for the periods presented:
                                        Nine Months Ended September 30,          Three Months Ended September 30,
                                           2012                 2011                 2012                 2011
                                                                 (dollars in thousands)
Revenue:
Subscription and support            $       184,368       $       145,388     $        65,329       $        51,334
Professional services and other              39,451                26,845              14,462                 9,625
Total revenue                               223,819               172,233              79,791                60,959
Cost of revenue (1):
Subscription and support                     30,722                24,342              10,880                 8,627
Professional services and other              38,218                27,450              14,211                 9,658
Total cost of revenue                        68,940                51,792              25,091                18,285
Gross profit                        $       154,879       $       120,441     $        54,700       $        42,674
Gross margin                                     69 %                  70 %                69 %                  70 %

(1) Includes stock-based compensation expense and amortization of intangible assets of:
Cost of revenue:

Subscription and support            $         3,557       $         2,698     $         1,169       $           807
Professional services and other               4,365                 3,055               1,688                 1,067
                                    $         7,922       $         5,753     $         2,857       $         1,874

Nine Months Ended September 30, 2012 as Compared to the Nine Months Ended September 30, 2011

Revenue for the nine months ended September 30, 2012 increased $51.6 million, or 30%, compared to the same period in 2011.

Subscription and support revenue: Subscription and support revenue for the nine months ended September 30, 2012 increased $39.0 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $32.2 million increase in revenue resulting from the acquisition of new customers, the continued adoption of OneWorld and a $6.8 million increase in revenue from existing customers.

Professional services and other revenue: Professional services and other revenue for the nine months ended September 30, 2012 increased $12.6 million, or 47%, compared to the same period in 2011. The increase was primarily the result of a $25.6 million increase in revenue resulting from the acquisition of new customers and an increase in productivity. As we move up market to larger customers, the scope of our professional services engagements have increased resulting in an increase in demand for our professional services. The increase in professional services and other revenue was partially offset by a $13.0 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2011 that did not recur for those customers in 2012.


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Revenue generated outside of the United States was $59.2 million, or 26%, of our total revenue for the nine months ended September 30, 2012 as compared to $46.2 million, or 27%, for the same period in 2011. Revenue generated outside of the United States increased primarily due to an increase in our sales efforts internationally, particularly in Australia.

Cost of revenue for the nine months ended September 30, 2012 increased $17.1 million, or 33%, compared to the same period in 2011.

Subscription and support cost of revenue: Subscription and support cost of revenue for the nine months ended September 30, 2012 increased $6.4 million, or 26%, compared to the same period in 2011. The increase was primarily due to a $3.3 million increase in personnel costs resulting from an increase in headcount and annual salary increases. Additionally, data center and other costs increased by $2.7 million due to an increase in vendor prices, support costs, depreciation and other operational costs associated with an increase in our data center capacity and activity. In the second quarter of 2012, we also recorded a $401,000 impairment charge related to the acquired QA developed technology intangible asset because the legacy customers migrated to another NetSuite product or terminated their service completely.

Professional services and other cost of revenue: Professional services and other cost of revenue for the nine months ended September 30, 2012 increased $10.8 million, or 39%, compared to the same period in 2011. The increase was primarily the result of a $6.6 million increase in personnel costs, a $2.2 million increase in overhead expense allocations and a $1.9 million increase in fees related to outsourced consulting services. Personnel costs increased due to an increase in headcount, annual merit increases and incentive bonuses. Overhead expense allocations increased due to an increase in overhead costs, which are primarily facility costs, and an increase in headcount which is the basis for the allocation. Outsourced consulting fees increased due to an increase in demand for our professional services and an increase in training expenses for professional services consultants.

Our gross margin decreased slightly to 69% during the nine months ended September 30, 2012 from 70% during the same period in 2011. Our professional services, which has a lower gross margin than subscription and support services, represented a larger portion of total revenue during the first nine months of 2012 when compared to the same period in 2011, so our increase in total revenue did not increase the gross margin percentage. Additionally, during the second quarter of 2012, our gross margin was negatively affected by higher subscription revenue costs, particularly a $401,000 impairment charge related to the acquired QA developed technology intangible asset because the legacy customers migrated to another NetSuite product or terminated their service completely.

Three Months Ended September 30, 2012 as Compared to the Three Months Ended September 30, 2011

Revenue for the three months ended September 30, 2012 increased $18.8 million, or 31%, compared to the same period in 2011.

Subscription and support revenue: Subscription and support revenue for the three months ended September 30, 2012 increased $14.0 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $11.7 million increase in revenue resulting from the acquisition of new customers, the continued adoption of OneWorld and a $2.3 million increase in revenue from existing customers.

Professional services and other revenue: Professional services and other revenue for the three months ended September 30, 2012 increased $4.8 million, or 50%, compared to the same period in 2011. The increase was primarily the result of a $9.5 million increase in revenue resulting from the acquisition of new customers and an increase in productivity. As we move up market to larger customers, the scope of our professional services engagements have increased resulting in an increase in demand for our professional services. The increase in professional services and other revenue was partially offset by a $4.7 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2011 that did not recur for those customers in 2012.

Revenue generated outside of the United States was $21.1 million, or 26%, of our total revenue for the three months ended September 30, 2012 as compared to $15.7 million, or 26%, for the same period in 2011. Revenue generated outside of the United States increased primarily due to an increase in our sales efforts internationally, particularly in Australia.

Cost of revenue for the three months ended September 30, 2012 increased $6.8 million, or 37%, compared to the same period in 2011.


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Subscription and support cost of revenue: Subscription and support cost of revenue for the three months ended September 30, 2012 increased $2.3 million, or 26%, compared to the same period in 2011. The increase was primarily due to a $1.2 million increase in personnel costs resulting from an increase in headcount and annual salary increases. Additionally, data center and other costs increased by $1.1 million due to an increase in vendor prices, support costs, depreciation and other operational costs associated with an increase in our data center . . .

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