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N > SEC Filings for N > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for NETSUITE INC


1-May-2013

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, 2012 as filed with the SEC on February 28, 2013. 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

NetSuite Inc. ("NetSuite" or the "Company" is the industry's leading provider of cloud-based financials / Enterprise Resource Planning ("ERP") software suites. In addition to financials/ERP software suites, we offer a broad suite of applications, including accounting, Customer Relationship Management ("CRM"), Professional Services Automation ("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 implementing and supporting 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, which 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 to which we have regularly added features and functionality. In December 2007, we went public. In 2008, we acquired OpenAir, and in 2009 we acquired QuickArrow Inc. ("QA"), both of which offer professional services automation and project portfolio management products. In 2012, we acquired Retail Anywhere, a point-of-sale ("POS") solution that is used by retail businesses.
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.
On February 28, 2013, we entered into a third amendment (the "Amendment") to the ordering document (the "Ordering Document") entered into with Oracle America, Inc. ("Oracle) on October 31, 2007. The Ordering Document provides for a 48 month extension of a license from Oracle to us which permits us to download an unlimited number of certain perpetual licenses and a specified number of other perpetual licenses for Oracle database and application server software. The Amendment provides that we will pay a one-time fee of $13.1 million to extend the term of this license from May 31, 2014 to May 31, 2018. The Ordering Document also provides for technical support services. We will pay $2.4 million for the support services from February 28, 2013 to February 27, 2014. We may renew Oracle support services for four subsequent annual periods for a fee of $4.3 million per year. The support services to be provided us by Oracle automatically renew unless we provide written notice of cancellation at least 60 days prior to the support renewal date. We financed the fees due under the Amendment pursuant to a note issued to Oracle Credit Corporation. The note bears interest at a rate of 2% per annum with payments scheduled over the term of the Amendment.


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In March 2013, we completed the purchase of all the outstanding equity of a website hosting provider company ("WH") that specializes in Ecommerce technology and services. The WH workforce augments our existing product development teams which allows us to expand our business capabilities in Ecommerce technology and services. The assets and operating results of the WH are reflected in our condensed consolidated financial statements from the date of acquisition. On the closing date, we paid $10.2 million in cash. Additional consideration of $1.8 million in cash is being withheld for various periods up to the next 24 months 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 first quarter of 2013, we recorded $560,000 in operating expenses related to transaction costs associated with this business combination.

Key Components of Our Results of Operations

Revenue

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 three months ended March 31, 2013, 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. For the most part, the duration of subscription and support agreements is 12 to 36 months. 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.

We generally invoice our customers in advance in monthly, 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 March 31, 2013, we had deferred revenue of $172.3 million.

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.


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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:

Three Months Ended March 31,
2013 2012
(dollars in thousands)

United States $ 67,890 $ 50,930 International 23,739 18,389 Total revenue $ 91,629 $ 69,319

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

Employees

The number of full-time employees as of March 31, 2013 was 1,953 as compared to 1,778 at December 31, 2012 and 1,336 at March 31, 2012. As of March 31, 2013, our headcount included 583 employees in sales and marketing; 750 employees in operations, professional services, training and customer support; 424 employees in product development; and 196 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 and employee benefit costs to all departments based on headcount. Recruiting costs are systematically allocated the respective departments that utilize recruiting services during the period. As such, general overhead expenses are reflected in cost of revenue and each operating expense category.
We expect cost of revenue to increase over the near term; however, it could fluctuate period to period depending on the growth of our professional services business.

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. Since the first quarter of 2012, we have 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.
We expect product development expenses to increase in absolute dollars 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.


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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 2013. 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 for the remainder of 2013.

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 for the remainder of 2013.

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 three months ended March 31, 2013 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 Annual Report on Form 10-K for the year ended December 31, 2012 filed on February 28, 2013. 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 2012 Annual Report on Form 10-K filed on February 28, 2013 for a description of our accounting policies.

Results of Operations


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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:
                                            Three Months Ended March 31,
                                              2013                 2012
                                              (dollars in thousands)
Revenue:
Subscription and support                $      73,960         $      57,990
Professional services and other                17,669                11,329
Total revenue                                  91,629                69,319
Cost of revenue (1):
Subscription and support                       12,315                 9,211
Professional services and other                17,330                11,584
Total cost of revenue                          29,645                20,795
Gross profit                            $      61,984         $      48,524
Gross margin                                       68 %                  70 %

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

Cost of revenue:
Subscription and support                $       1,127         $         904
Professional services and other                 1,846                 1,173
                                        $       2,973         $       2,077

Three Months Ended March 31, 2013 as Compared to the Three Months Ended March 31, 2012

Revenue for the three months ended March 31, 2013 increased $22.3 million, or 32%, compared to the same period in 2012.

Subscription and support revenue: Subscription and support revenue for the three months ended March 31, 2013 increased $16.0 million, or 28%, compared to the same period in 2012. The increase was primarily the result of a $12.5 million increase in revenue resulting from the acquisition of new customers, the continued adoption of OneWorld and a $3.5 million increase in revenue from existing customers.

Professional services and other revenue: Professional services and other revenue for the three months ended March 31, 2013 increased $6.3 million, or 56%, compared to the same period in 2012. The increase was primarily the result of a $10.4 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. Additionally, existing customers have purchased additional product modules which has also resulted in an increase in demand for our professional services. The increase in professional services and other revenue was partially offset by a $4.1 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2012 that did not recur for those customers in 2013.

Revenue generated outside of the United States was $23.7 million, or 26%, of our total revenue for the three months ended March 31, 2013 as compared to $18.4 million, or 27%, for the same period in 2012. Revenue generated outside of the United States increased primarily due to an increase in revenue generated in Australia and the United Kingdom.

Cost of revenue for the three months ended March 31, 2013 increased $8.9 million, or 43%, compared to the same period in 2012.

Subscription and support cost of revenue: Subscription and support cost of revenue for the three months ended March 31, 2013 increased $3.1 million, or 34%, compared to the same period in 2012. The increase was primarily due to a $1.7 million increase in personnel costs resulting from an increase in headcount and annual salary increases. Additionally, data


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center and other costs increased by $1.4 million due to an increase in support costs, depreciation and other operational costs associated with an increase in our data center capacity and activity.

Professional services and other cost of revenue: Professional services and other cost of revenue for the three months ended March 31, 2013 increased $5.7 million, or 50%, compared to the same period in 2012. The increase was primarily the result of a $4.6 million increase in personnel costs, a $585,000 increase in fees related to outsourced consulting services and a $467,000 increase in allocated overhead expenses and other operational expenses. Personnel costs increased due to an increase in headcount, annual merit increases, incentive bonuses and training costs. Headcount increased as result of an increase in the demand for our professional services and the small company acquisitions in 2012. Outsourced consulting fees increased due to an increase in demand for our professional services and an increase in training expenses for external consultants. Allocated overhead expense and other operational expenses increased due to higher overhead and other costs.

Our gross margin decreased slightly to 68% during the three months ended March 31, 2013 from 70% during the same period in 2012. Our professional services, which has a lower gross margin than subscription and support services, represented a larger portion of total revenue during the three months ended March 31, 2013 when compared to the same period in 2012, so our increase in total revenue did not increase the gross margin percentage. Additionally, our subscription and support services gross margin has been negatively affected by additional costs to increase capacity and enhance performance at our data centers.

Operating Expenses

Operating expenses were as follows for the periods presented:


                                           Three Months Ended March 31,
                                         2013                            2012
                                Amount         % of revenue     Amount     % of revenue
                                              (dollars in thousands)
Operating expenses (1):
Product development        $    16,650               18 %      $ 11,090          16 %
Sales and marketing             46,752               51 %        35,579          51 %
General and administrative      11,745               13 %         8,979          13 %
Total operating expenses   $    75,147               82 %      $ 55,648          80 %

(1) Includes stock-based compensation expense, amortization of acquisition-related intangible assets and transaction costs for business combinations as follows:

                                   Three Months Ended March 31,
                                          2013                  2012
                                     (dollars in thousands)
Product development          $         4,848                  $ 3,207
Sales and marketing                    5,175                    3,958
General and administrative             3,946                    2,554
Total                        $        13,969                  $ 9,719

Three Months Ended March 31, 2013 as Compared to the Three Months Ended March 31, 2012

Product development expenses for the three months ended March 31, 2013 increased $5.6 million, or 50%, as compared to the same period in 2012. The increase was primarily the result of a $5.1 million increase in personnel costs resulting from an increase in headcount, annual salary increases, payroll tax increases and an increase in stock-based compensation. The increase in personnel costs includes a $1.6 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards to a larger employee base. Additionally, allocated overhead expenses and other operational expenses increased by $444,000 primarily due to an increase in overhead costs such as facility costs, information


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technology costs and recruiting costs, and an increase in costs allocated to product development expense due to an increase in headcount.

Sales and marketing expenses for the three months ended March 31, 2013 increased $11.2 million, or 31%, as compared to the same period in 2012. The increase was primarily the result of a $7.6 million increase in personnel costs, a $1.9 million increase in marketing expenses and an $1.7 million increase in allocated . . .

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