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MKTG > SEC Filings for MKTG > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for RESPONSYS INC


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes in this report. This discussion contains forward-looking statements that involve risks and uncertainties. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as "anticipates," "expects," "intends," "plans," "predicts," "believes," "seeks," "estimates," "may," "will," "should," "would," "could," "potential," "continue," "ongoing," similar expressions and variations or negatives of these words and include, but are not limited to, statements regarding projected results of operations and management's future strategic plans. Our actual results could differ significantly from those projected in the forward-looking statements as a result of factors, including those discussed under Item 1A, "Risk Factors," and elsewhere in this report. We assume no obligation to update the forward-looking statements or such risk factors.

Overview

We are a leading provider of on-demand software that enables companies to engage in relationship marketing across the interactive channels that consumers are embracing today-email, mobile, social, the web and display. The Responsys Interact Suite, the core element of our solution, provides marketers with a set of integrated applications to create, execute, optimize and automate marketing campaigns. Our solution is comprised of our on-demand software and our professional services, all focused on enabling the marketing success of our customers.


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The following is a timeline of significant milestones in our corporate history:

• We were founded in 1998 to provide on-demand software designed to enable marketers to design, execute and manage email campaigns. Our core product, Interact Campaign, was commercially released in 1999.

• In 2004, under a new management team, we broadened our strategy from solely an email campaign management platform to a set of integrated applications for creating, executing, optimizing and automating email marketing campaigns.

• In 2006, we acquired Inbox Marketing, Inc., a professional services firm, to increase the size and breadth of our professional services organization.

• In 2007, we launched Interact Team to help marketers manage the campaign creation and deployment process by automating the design and tracking of campaign materials, communications, handoffs and approvals.

• In 2008, we launched Interact Connect, which enables marketers to automate the transfer of data to and from our on-demand software platform and their customer data management systems and those of third parties.

• In 2009, we achieved a key technology milestone by releasing our next-generation on-demand software platform, which integrated all of our core applications into one platform, the Responsys Interact Suite. Substantially all of our new customers added since this time are on this platform and we are migrating our other existing customers to this platform over time. This suite included a new application, Interact Program, for visually designing, managing and automating complex marketing programs with multiple stages across multiple channels. In 2009, we also acquired Smith-Harmon, Inc. to increase the size and breadth of our professional services organization.

• In April 2010, we added mobile and social functionality to Interact Campaign to coordinate the creation, scheduling, automation and tracking of short message service, or text message, marketing campaigns and promotions to consumers who engage with our customers' brands as Facebook fans or Twitter followers.

• In July 2010, we acquired a non-controlling, fifty-percent equity interest in Eservices Group Pty Ltd, or Eservices, a privately-held company headquartered in Melbourne, Australia, and in January 2011 we acquired the remaining equity interests in Eservices. Following the acquisition, the company was renamed Responsys Pty Ltd. As of and for the year ended December 31, 2010, the investment is reflected in our consolidated financial statements using the equity method. We have consolidated our results with those of Eservices beginning in January 2011. We acquired Eservices to expand the scope of our business internationally, increase our customer base and grow our professional services and sales teams.

• In October 2011, we introduced Responsys Interact for Display, which allows marketers to add display advertising to their cross-channel marketing programs. This offering enables marketers to leverage CRM and behavioral data to target the serving of relevant display ads to consumers at opportune times in the customer lifecycle.

• In March 2012, we acquired a 19.9% equity interest in PM Comunica็ใo LTDA, or Pmweb, a customer relationship management and digital marketing company in Brazil. We currently hold a call option to purchase the remaining 80.1% of Pmweb's outstanding equity exercisable at our discretion at any time prior to March 31, 2014. We acquired this interest to expand the scope of our business internationally, increase our customer base and grow our professional services and sales teams.

• In July 2010, we acquired a non-controlling, fifty percent equity interest in Responsys Denmark A/S, or Responsys Denmark, a company headquartered in Copenhagen, Denmark and in July 2012 increased our percent ownership to 95%. We have consolidated our results with those of Responsys Denmark beginning in July, 2012. We acquired Responsys Denmark to expand the scope of our business internationally, increase our customer base and grow our professional services and sales teams.


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We derive revenue from subscriptions to our on-demand software and related professional services. As part of a subscription, a customer generally commits to a minimum monthly or quarterly fee that permits the customer to send up to a specified number of email messages. If a customer sends additional messages above the contracted level, the customer is required to pay additional per-message fees. No refunds or credits are given if a customer sends fewer messages than the contracted level. Customer agreements are non-cancellable for a minimum period, generally one year but ranging up to three years. Revenue from messages sent above contracted levels during the last three years has historically ranged from approximately 20% to 25% of our subscription revenue in any given 12-month period but varies from quarter to quarter due to seasonal, macroeconomic and other factors. We have generally had higher subscription revenue in our fourth quarter than other quarters in a given 12-month period, primarily due to revenue from messages sent above contracted levels. Subscription revenue accounted for 69.6%, 70.0% and 73.7% of our total revenue during the years ended December 31, 2012, 2011 and 2010, respectively. Subscription revenue is driven primarily by the number of customers, demand from existing customers, contracted value of the subscription agreements and number of messages sent above contracted levels. To date, our customers have primarily used email messages for their marketing campaigns, and email will continue to be the primary driver of our subscription revenue in the foreseeable future. However, if customers increase their use of other interactive channels in the future, we anticipate that revenue associated with email campaigns will decrease as a percentage of subscription revenue. Although revenue associated with our mobile, social, the web and display channels has not been material to date, we believe that our cross-channel capabilities have been important factors in our new customers' purchasing decisions.

Deferred revenue primarily consists of the unearned portion of billed professional services fees or fees for our on-demand software. As we bill nearly all our customers on a monthly or quarterly basis, our deferred revenue balance does not serve as a primary source of our future subscription revenue.

We sell subscriptions to our on-demand software and professional services primarily through a direct sales force. We target enterprise and mid-market companies that seek to implement more advanced marketing programs across interactive channels. Our customers are of varied size across a wide variety of industries, including retail and consumer, travel, financial services and technology. Our revenue from outside the United States as a percentage of total revenue was 23%, 21% and 11% for the years ended December 31, 2012, 2011 and 2010, respectively.

Our revenue growth over these periods has been driven by an increased number of customers with higher subscription fees. Over the past three years, we have added larger enterprise customers with higher subscription commitments, higher messaging volumes and greater professional services demands. Our subscription revenue fluctuates as a result of seasonal variations in our business, principally due to timing of our customers' sales and marketing cycles. We have generally had higher subscription revenue in our fourth quarter than in other quarters during a given 12-month period, primarily due to revenue from messages sent above contracted levels by our retail and consumer customers. Our cost of revenue and operating expenses have increased in absolute dollars over this period due to our need to increase bandwidth and capacity to support larger messaging volumes and the overall increased size of our business. We expect that our cost of revenue and operating expenses will continue to increase in absolute dollars as we continue to invest in our growth and incur additional costs as a public company.

Key Metrics

We regularly review a number of metrics to evaluate growth trends, measure our performance, establish budgets and make strategic decisions. We discuss revenue, gross margin, and the components of operating income and margin below under Basis of Presentation, and we discuss other key metrics below.

Subscription Dollar Retention Rate

Our Subscription Dollar Retention Rate is the way we measure how well we retain customers and increase their use of our software. We also believe it reflects the stability of our revenue base and the long-term value of


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our customer relationships. We calculate our Subscription Dollar Retention Rate by dividing (a) Retained Subscription Revenue by (b) Retention Base Revenue. We define Retention Base Revenue as subscription revenue from all customers in the prior period, and we define Retained Subscription Revenue as subscription revenue from that same group of customers in the current period. Our Subscription Dollar Retention Rate has been greater than 100% for every quarter of the last three years.

Number of Customers

We believe that our ability to expand our customer base is an indicator of our market penetration and the growth of our business as we continue to invest in our direct sales force and marketing initiatives. We define our number of customers at the end of a particular quarter as the number of direct-billed subscription customers with $3,000 or more in committed subscription revenue for that quarter. We had 413, 346 and 277 customers as of December 31, 2012, 2011 and 2010, respectively. For more information about our customers, see Item 1, Business-Customers above.

Basis of Presentation

Revenue

Subscription Revenue

We derive our subscription revenue from subscriptions to our on-demand software. Subscription revenue primarily consists of revenue from contractually committed messaging and other fees and revenue from messages sent above contracted levels. Customer agreements are non-cancellable for a minimum period, generally one year but ranging up to three years. Our contracts provide our customers with access to our on-demand software and the ability to send up to a specified number of messages during each month or quarter in the contract term. If customers exceed the specified messaging volume, per-message fees are billed for the excess volume, generally at rates equal to or greater than the contracted minimum per-message fee. If customers send less than the specified number of messages, no rollover credit or refunds are given.

We recognize the aggregate minimum subscription fee payable ratably on a straight-line basis over the subscription term, provided that an enforceable contract has been signed by both parties, access to our software has been granted to the customer, the fee for the subscription is fixed or determinable and collection is reasonably assured. We do not recognize revenue in excess of the amount we have the right to invoice. Revenue for messages sent above contracted levels is recognized in the period in which we are contractually able to bill for those messages. We also derive revenue from setup fees when the services are first activated. The setup fees are initially recorded as deferred revenue and are then recognized as revenue ratably over the estimated life of the customer relationship.

For a discussion of how we expect seasonal factors to affect our subscription revenue, see Results of Operations below.

Professional Services Revenue

Professional services revenue consists primarily of fees associated with campaign services, creative and strategic marketing services, technical services and education services. For more information about our professional services, see Item 1, Business-Our Services above. Our professional services are not required for customers to begin using our on-demand software. Our professional services engagements are typically billed on a fixed fee, time and materials or unit basis.

Cost of Revenue

Cost of Subscription Revenue

Cost of subscription revenue primarily consists of hosting costs, data communications expenses, personnel and related costs, including salaries and employee benefits, allocated overhead, software license fees, costs


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associated with website development activities, amortization expenses associated with capitalized software, and depreciation and amortization expenses associated with computer equipment. To date, the expenses associated with capitalized software have not been material to our cost of subscription revenue. Expenses related to hosting and data communications are affected by the number of customers using our on-demand software, the complexity and frequency of their use, the volume of messages sent and the amount of data processed and stored. We plan to continue to significantly expand our capacity to support our growth, which will result in higher cost of subscription revenue in absolute dollars.

Cost of Professional Services Revenue

Cost of professional services revenue primarily consists of personnel and related costs for our professional services employees and allocated overhead. Our cost associated with providing professional services is significantly higher as a percentage of revenue than our cost of subscription revenue due to the labor costs associated with providing professional services. As it takes several months to ramp up a productive professional consultant, we generally increase our professional services capacity ahead of associated professional services revenue, which can result in lower margins in the given investment period. We expect the number of professional services personnel to increase in the future, which will result in higher cost of professional services revenue in absolute dollars.

Operating Expenses

Research and Development

Research and development expenses primarily consist of personnel and related costs for our product development and product management employees and allocated overhead. Our research and development efforts have been devoted primarily to increasing the functionality and enhancing the ease of use of our on-demand software and to improving scalability and performance. We expect research and development expenses will increase in the future as we extend our on-demand software offerings and develop new technologies and capabilities.

Sales and Marketing

Sales and marketing expenses primarily consist of personnel and related costs for our sales and marketing employees, including bonuses and commissions, as well as the cost of marketing programs, promotional events and webinars, amortization of our acquired customer lists and allocated overhead. We generally expense sales commissions when the customer contract is signed because our obligation to pay a sales commission arises at that time. We plan to continue to invest in sales and marketing by increasing the number of direct sales personnel in order to add new customers and increase penetration within our existing customer base, expanding our domestic and international sales and marketing activities, building brand awareness and sponsoring additional marketing events. We expect sales and marketing expenses will increase in the future and continue to be our largest functional cost.

General and Administrative

General and administrative expenses consist primarily of personnel and related costs, and allocated overhead. In addition, general and administrative expenses include professional fees, bad debt expenses, sales and use tax expense and other corporate expenses. We anticipate that we will incur additional costs for personnel, systems and external professional services as we grow and operate as a public company, including higher legal, insurance and financial reporting expenses, and the costs to maintain compliance with Section 404 of the Sarbanes-Oxley Act and costs in connection with litigation. Accordingly, we expect general and administrative expenses will increase in the future.


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Gain on Acquisition

Gain on acquisition represents the fair value adjustments of our initial investment in Responsys Denmark and Eservices upon the acquisition of the remaining equity interests in 2012 and 2011, respectively.

Other Income (Expense.)

Other income (expense) primarily consists of interest income, interest expense and foreign exchange gains (losses). Other income (expense) for the year ended December 31, 2012 includes the foreign currency adjustment for our contingent consideration in Responsys Denmark and for the year ended December 31, 2011 includes fair value adjustments of our put and call options to purchase the remaining equity interests in Eservices. Interest income represents interest received on our cash, cash equivalents and short-term investments. Interest expense is associated with our outstanding capital leases. Foreign exchange gains (losses) relate to transactions denominated in currencies other than the functional currency.

Equity in Net Loss of Unconsolidated Affiliates

Equity in net income (loss) of unconsolidated affiliates represents our proportionate share of operating results from our non-controlling equity investment in Responsys Denmark for the year ended December 31, 2011 and in Eservices and Responsys Denmark for the year ended December 31, 2010 prior to their acquisitions.

Results of Operations

The following tables set forth selected consolidated statements of income data for each of the periods indicated.

                                                              Year Ended December 31,
                                                       2012             2011             2010
                                                                   (in thousands)
Revenue:
Subscription                                         $ 113,363        $  94,501        $ 69,284
Professional services                                   49,461           40,438          24,787

Total revenue                                          162,824          134,939          94,071

Cost of revenue: (1)
Subscription                                            32,672           27,918          20,221
Professional services                                   42,727           36,747          20,697
Total cost of revenue                                   75,399           64,665          40,918

Gross profit                                            87,425           70,274          53,153

Operating expenses:
Research and development (1)                            15,224           13,544          10,597
Sales and marketing (1)                                 45,544           33,300          20,849
General and administrative (1)                          17,679           11,463           8,225
Gain on acquisition                                     (2,233 )         (2,220 )            -

Total operating expenses                                76,214           56,087          39,671

Operating income                                        11,211           14,187          13,482
Other income (expense), net                               (285 )           (268 )         1,171

Income before income taxes                              10,926           13,919          14,653
Provision for income taxes                              (3,380 )         (5,824 )        (5,821 )
Equity in net income (loss) of unconsolidated
affiliates                                                  36             (124 )          (234 )

Net income                                           $   7,582        $   7,971        $  8,598


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(1) Total cost of revenue and operating expenses include the following amounts related to stock-based compensation:

                                                           Year Ended December 31,
                                               2012                  2011                 2010
                                                                (in thousands)
Cost of revenue                               $ 1,644          $          1,004          $   523
Research and development                          914                       610              331
Sales and marketing                             1,785                       861              694
General and administrative                      2,085                     1,238              958

Total costs and expenses                      $ 6,428          $          3,713          $ 2,506


                                                           Year Ended December 31,
                                               2012                  2011                 2010
Revenue:
Subscription                                     69.6 %                    70.0 %           73.7 %
Professional services                            30.4                      30.0             26.3

Total revenue                                   100.0                     100.0            100.0

Cost of revenue:
Subscription                                     20.1                      20.7             21.5
Professional services                            26.2                      27.2             22.0

Total cost of revenue                            46.3                      47.9             43.5

Gross profit                                     53.7                      52.1             56.5

Operating expenses:
Research and development                          9.3                      10.0             11.3
Sales and marketing                              28.0                      24.7             22.2
General and administrative                       10.9                       8.5              8.7
Gain on acquisition                              (1.4 )                    (1.6 )             -

Total operating expenses                         46.8                      41.6             42.2

Operating income                                  6.9                      10.5             14.3
Other income (expense), net                      (0.2 )                    (0.2 )            1.2

Income before income taxes                        6.7                      10.3             15.5
Provision for income taxes                       (2.1 )                    (4.3 )           (6.2 )
Equity in net loss of unconsolidated
affiliates                                         -                       (0.1 )           (0.2 )

Net income                                        4.6 %                     5.9 %            9.1 %


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Comparison of Years Ended December 31, 2012, 2011 and 2010

Revenue



                                         Year Ended December 31,                                  Year Ended December 31,
                                                               Change in                                                Change in
                             2012            2011            $            %            2011           2010            $            %
                                         (dollars in thousands)                                    (dollars in thousands)
Subscription revenue       $ 113,363       $ 94,501       $ 18,862        20.0 %     $ 94,501       $ 69,284       $ 25,217        36.4 %
Percentage of total
revenue                         69.6 %         70.0 %                                    70.0 %         73.7 %
Professional services
revenue                    $  49,461       $ 40,438       $  9,023        22.3 %     $ 40,438       $ 24,787       $ 15,651        63.1 %
Percentage of total
revenue                         30.4 %         30.0 %                                    30.0 %         26.3 %

Subscription revenue

Subscription revenue for the year ended December 31, 2012 increased by $18.9 million over the year ended December 31, 2011. The increase was primarily due to an increase in contractually committed messaging of $6.1 million from new customers, and a net increase of $6.4 million from existing customers. In addition, revenue from messages sent above contracted levels increased in absolute dollars to $25.7 million from $19.3 million, and increased to 22.6% of subscription revenue from 20.4% of subscription revenue, for the years ended December 31, 2012 and 2011, respectively.

Subscription revenue for the year ended December 31, 2011 increased by $25.2 million over the year ended December 31, 2010. The increase was primarily due to an increase in contractually committed messaging of $11.5 million from new customers, including $5.1 million of revenue from customers acquired through our acquisition of Eservices, and a net increase of $10.3 million from existing customers. In addition, revenue from messages sent above contracted levels increased in absolute dollars to $19.3 million from $15.9 million, but decreased to 20.4% of subscription revenue from 22.9% of subscription revenue, for the years ended December 31, 2011 and 2010, respectively.

Professional services revenue

Professional services revenue for the year ended December 31, 2012 increased by $9.0 million over the year ended December 31, 2011. The increase was primarily due to a $8.0 million increase from new customers.

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