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RALY > SEC Filings for RALY > Form 10-Q on 11-Sep-2013All Recent SEC Filings

Show all filings for RALLY SOFTWARE DEVELOPMENT CORP

Form 10-Q for RALLY SOFTWARE DEVELOPMENT CORP


11-Sep-2013

Quarterly Report


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

The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with (1) the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the fiscal year ended January 31, 2013 included in our prospectus dated July 24, 2013, filed with the SEC on July 25, 2013 pursuant to Rule 424(b)(4) under the Securities Act (File No. 333-189928). This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "will," "would" or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors", set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

Rally Software is a leading global provider of cloud-based solutions for managing Agile software development. Agile is a software development methodology characterized by short, iterative and highly-adaptable development cycles. Our platform transforms the way organizations manage the software development lifecycle by enabling close alignment of software development and strategic business objectives, facilitating collaboration, increasing transparency, and automating manual processes. Organizations use our solutions to accelerate the pace of innovation, improve productivity and more effectively adapt to rapidly-changing customer needs and competitive dynamics. Our enterprise-class platform is extensible, cost-effective and designed to be easy to use.

Our operating results in a given period can fluctuate based on the mix of subscription and support, perpetual license and professional services revenue. In the three and six months ended July 31, 2013, subscription and support revenue accounted for 72% and 77% of total revenue, respectively. Our subscription contracts are typically sold on a per-seat basis with a one-year term, paid upfront and provide us with revenue visibility over a number of quarters. We typically negotiate the total number of seats a customer is entitled to provision as part of their subscription, but these seats may not be fully utilized over the term of the agreement. However, we have recently, and may in the future, enter into multi-year contracts in which the fees are paid upfront and the customer is entitled to an unlimited number of seats. These contracts may lead to significant fluctuations in cash flow from operations and will positively impact cash flow from operations in the period in which the cash is received. To a lesser extent, we sell perpetual licenses, which are also paid upfront and include support agreements, which are one year in duration and entitle the customer to support and upgrades. In the three and six months ended July 31, 2013, perpetual license revenue accounted for 14% and 9% of total revenue, respectively. We also offer professional services, which include training on Agile software development methodologies and the use of our solutions. In both the three and six months ended July 31, 2013, professional services accounted for 14% of total revenue.

We have achieved significant growth since inception. From the three months ended July 31, 2012 to the three months ended July 31, 2013, our subscription and support revenue grew from $10.5 million to $14.2 million, representing a 36% period-over-period growth rate. From the six months ended July 31, 2012 to the six months ended July 31, 2013, our subscription and support revenue grew from $20.0 million to $27.6 million, representing a 38% period-over-period growth rate.

From the three months ended July 31, 2012 to the three months ended July 31, 2013, our total revenue grew from $13.6 million to $19.8 million, representing a 45% period-over-period growth rate. From the six months ended July 31, 2012 to the six months ended July 31, 2013, our total revenue grew from $26.6 million to $35.9 million, representing a 35% period-over-period growth rate. We expect to continue to make significant expenditures to support and grow our business, including investing in our data center infrastructure, expanding our sales force and increasing our international presence. In addition, as a public company we will incur significant legal, accounting and other expenses that we did not incur as a private company. We expect to incur losses for the foreseeable future and we may not be able to achieve or sustain profitability. We increased our overall employee headcount to 396 as of July 31, 2013 from 314 as of July 31, 2012.

On April 17, 2013, we issued and sold 6,900,000 shares of common stock in our IPO. The net offering proceeds to us, after deducting underwriting discounts and commissions totaling approximately $6.8 million and offering expenses totaling approximately $2.9 million, were approximately $87.0 million.


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On July 30, 2013, we closed our follow-on public offering in which we and certain of our stockholders sold an aggregate of 5,589,455 shares of common stock, including 729,058 shares sold pursuant to the underwriters' option to purchase additional shares. The public offering price of the shares sold in the offering was $24.75 per share. Of the 5,589,455 shares of common stock sold in the offering, 250,000 shares were sold by us and 5,339,455 shares were sold by selling stockholders. We received proceeds from the offering of $5.9 million, net of underwriting discounts and commissions, but before offering expenses of $0.6 million. Approximately $0.6 million of deferred offering costs related to the offering are in accounts payable as of July 31, 2013.

Key Metrics

We regularly review the following key metrics to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions.

Total paid seats. We believe total paid seats are a key indicator of our market penetration, growth and future revenue. We define a paid seat as a seat with a subscription or support contract as of the measurement date. Our total paid seats were 192,119 and 144,425 as of July 31, 2013 and, 2012, respectively. In the case of a contract that allows a customer to provision an unlimited number of seats, total paid seats includes an estimate of the total number of seats to be provisioned during the term of the contract. Total paid seats as of July 31, 2013 includes 14,666 in aggregate seat upgrades pursuant to such contracts with five different enterprise customers. Total paid seats as of July 31, 2012 includes a 6,000 seat upgrade pursuant to such a contract with an enterprise customer.

Renewal rate. We believe our renewal rate is an important metric to measure the long-term value of customer agreements and our ability to upsell or expand in our existing customer base. We calculate our renewal rate by comparing the number of paid seats of all of our existing customers at the beginning of a twelve-month period to the number of paid seats for those same customers at the end of such period, taking into account nonrenewals, upgrades and downgrades. We exclude seats sold to new customers. For the twelve months ended July 31, 2013 and 2012, the renewal rate was 122% and 126%, respectively.

Components of Operating Results

Revenue

Subscription and support revenue. We derive our subscription revenue from fees paid to us by our customers for access to our cloud-based solutions. We recognize the revenue associated with subscription agreements ratably on a straight-line basis over the term of the agreement, provided all criteria required for revenue recognition have been met.

Our support revenue consists of maintenance associated with our perpetual licenses and hosting fees paid to us by our customers. Typically, when purchasing a perpetual license, a customer also purchases maintenance for which we charge a fee, priced as a percentage of the perpetual license fee. Maintenance agreements include the right to support and unspecified product upgrades. We recognize the revenue associated with maintenance ratably, on a straight-line basis, over the term of the contract. In limited instances, at the customer's option, we may host the software purchased by a customer under a perpetual license on systems at our third-party data centers. For hosting, we charge a fee, priced as a percentage of the perpetual license fee, and we recognize the revenue associated with hosting ratably on a straight-line basis over the associated hosting period.

Perpetual license revenue. Perpetual license revenue reflects the revenue recognized from sales of perpetual licenses to new customers and additional licenses to existing customers. We generally recognize the license fee portion of the arrangement upfront, provided all revenue recognition criteria are satisfied.

Professional services revenue. Professional services revenue consists primarily of fees related to the instruction of customers in Agile software development methodologies and training on our solutions, as well as reimbursable expenses. We generally recognize the revenue associated with these professional services on a time-and-materials basis as we deliver the services or provide the training to our customers.

Cost of Revenue

Cost of product revenue. Cost of product revenue consists primarily of personnel and related costs of our support and operations teams, including salaries, benefits, bonuses, payroll taxes, stock-based compensation and allocated overhead, as well as software license fees, hosting costs, Internet connectivity and depreciation expenses directly related to delivering our solutions. As we add data center capacity and support personnel in advance of anticipated growth, our cost of product revenue will increase and if such anticipated revenue growth does not occur, our product gross profit will be adversely affected. In February 2013, we purchased Flowdock Oy, a company based in Helsinki, Finland, for approximately $4.4 million. Our purchase accounting allocation is not yet


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complete; however, we expect a meaningful portion of the purchase consideration will be allocated to intangible assets that will be capitalized and amortized over time to cost of product revenue, thereby increasing our cost of product revenue. Our cost of product revenue is generally expensed as the costs are incurred.

Cost of professional services revenue. Cost of professional services revenue consists primarily of personnel and related costs, including salaries, benefits, bonuses, payroll taxes, stock-based compensation, the costs of contracted third-party vendors, reimbursable expenses and allocated overhead. As most of our personnel are employed on a full-time basis, our cost of professional services is largely fixed in the short-term, while our professional services revenue may fluctuate, leading to fluctuations in professional services gross profit. Our cost of professional services revenue is generally expensed as costs are incurred.

Operating Expenses

Our operating expenses are classified into three categories: sales and marketing, research and development and general and administrative. For each category, the largest expense component is personnel and related costs, which includes salaries, employee benefit costs, bonuses, commissions, stock-based compensation and payroll taxes. Operating expenses also include allocated overhead costs for facilities and depreciation of equipment, which are allocated to each department based on relative department headcount. Operating expenses are generally recognized as incurred.

Sales and marketing. Sales and marketing expenses primarily consist of personnel and related costs for our sales and marketing staff, including salaries, benefits, commissions, bonuses, payroll taxes, stock-based compensation and costs of promotional events, corporate communications, online marketing, product marketing and other brand-building activities, in addition to allocated overhead. We expense sales commissions when the initial customer contract is signed and upon any renewal as our obligation to pay a sales commission arises at these times. We expect that sales and marketing expenses will continue to increase in absolute dollars, partially as a result of our international expansion, and will continue to be the largest expense component of our operating expenses. However, we expect sales and marketing expenses to be relatively constant as a percentage of revenue in the near term.

Research and development. Research and development expenses primarily consist of personnel and related costs of our research and development staff, including salaries, benefits, bonuses, payroll taxes, stock-based compensation and costs of certain third-party contractors, as well as allocated overhead. Research and development costs related to the development of our software products are generally expensed as incurred as development costs that have qualified for capitalization are not significant. We have devoted our product development efforts primarily to enhancing the functionality and expanding the capabilities of our solutions. We expect that our research and development expenses will continue to increase in absolute dollars as we increase our research and development headcount to further strengthen and enhance our solutions. For example, in February 2013 we increased our research and development headcount by eight employees with the purchase of Flowdock Oy, a company based in Helsinki, Finland.

General and administrative. General and administrative expenses primarily consist of personnel and related costs for our executive, administrative, finance, information technology, legal, accounting and human resource staffs, including salaries, benefits, bonuses, payroll taxes and stock-based compensation, professional fees, other corporate expenses and allocated overhead. We have recently incurred, and expect to continue to incur, additional expenses as we grow our operations and transition to operating as a public company, including higher legal, corporate insurance, accounting and auditing expenses, and the additional costs of enhancing and maintaining our internal control environment through the adoption of new corporate policies. We also expect that general and administrative expenses will continue to increase in absolute dollars as we expand our operations, including internationally.

Other Income (Expense)

Other income (expense) consists primarily of interest income on our cash balances, changes in the estimated fair value of our preferred stock warrants, which are recorded as interest expense because the warrants were issued in conjunction with debt facilities, and foreign exchange gains (losses) that relate to expenses and transactions denominated in currencies other than our functional currency. Our functional currency is the U.S. dollar. On April 17, 2013, our preferred stock warrants converted to common stock warrants upon the closing of our IPO and, as such, we will no longer be required to present the warrants at fair value.

Provision for Income Taxes

Because we have generated net losses in all periods to date and recorded a full valuation allowance against our deferred tax assets, we have historically not recorded a provision for federal or state income taxes. Foreign income taxes prior to the six months ended July 31, 2013 have not been material. The tax provision for the six months ended July 31, 2013 is exclusively related to foreign income taxes and is a result of the cost-plus transfer pricing agreements we have in place with our foreign subsidiaries. Realization of any of our deferred tax assets depends upon future earnings, the timing and amount of which are uncertain. Utilization of our net operating losses may be subject to annual limitations due to the ownership change rules under the Internal Revenue Code of 1986, as


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amended, and similar state provisions. We completed an analysis covering the period through April 30, 2013 to determine whether an ownership change had occurred since our inception. The analysis indicated that although an ownership change had occurred in 2003, the net operating losses and research and development credits remained available to offset future taxable income, if any. However, in the event we have subsequent changes in ownership, the availability of net operating losses and research and development credit carryovers could be limited.

Results of Operations

To enhance comparability, the following tables set forth our results of operations for the periods presented as dollars (in thousands) and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.


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                                        Three Months Ended July 31,         Six Months Ended July 31,
                                           2013              2012             2013             2012
Consolidated Statements of
Operations Data:
Revenue:
Subscription and support              $       14,220    $       10,457    $      27,593    $      19,987
Perpetual license                              2,735             1,407            3,364            3,018
Total product revenue                         16,955            11,864           30,957           23,005
Professional services                          2,840             1,763            4,888            3,600
Total revenue                                 19,795            13,627           35,845           26,605
Cost of revenue:
Product                                        1,800             1,226            3,485            2,379
Professional services                          2,336             1,830            4,209            3,416
Total cost of revenue                          4,136             3,056            7,694            5,795
Gross profit                                  15,659            10,571           28,151           20,810
Operating expenses:
Sales and marketing                            9,085             6,537           17,919           13,543
Research and development                       5,051             3,505           10,131            6,545
General and administrative                     3,782             2,567            7,636            4,853
Sublease termination income                        -                 -                -             (839 )
Total operating expenses                      17,918            12,609           35,686           24,102
Loss from operations                          (2,259 )          (2,038 )         (7,535 )         (3,292 )
Other (expense) income:
Interest and other income                         36                30               49               31
Interest expense                                  (2 )            (237 )           (464 )           (676 )
Loss on foreign currency
transactions and other gain (loss)                (4 )             (15 )            (24 )            (44 )
Loss before provision for income
taxes                                         (2,229 )          (2,260 )         (7,974 )         (3,981 )
Provision for income taxes                        49                 -               94                -
Net loss                              $       (2,278 )  $       (2,260 )  $      (8,068 )  $      (3,981 )




                                       Three Months Ended July 31,       Six Months Ended July 31,
                                         2013               2012           2013             2012
Consolidated Statements of
Operations Data:
Revenue:
Subscription and support                       72 %               77 %          77 %             75 %
Perpetual license                              14                 10             9               11
Total product revenue                          86                 87            86               86
Professional services                          14                 13            14               14
Total revenue                                 100                100           100              100
Cost of revenue:
Product                                         9                  9            10                9
Professional services                          12                 13            12               13
Total cost of revenue                          21                 22            21               22
Gross profit                                   79                 78            79               78
Operating expenses:
Sales and marketing                            46                 48            50               51
Research and development                       25                 26            28               24
General and administrative                     19                 19            21               18
Sublease termination income                     -                  -             -               (3 )
Total operating expenses                       90                 93           100               90
Loss from operations                          (11 )              (15 )         (21 )            (12 )
Other (expense) income:
Interest and other income                       -                  -             -                -
Interest expense                                -                 (2 )          (1 )             (3 )
Loss on foreign currency
transactions and other gain (loss)              -                  -             -                -
Loss before provision for income
taxes                                         (11 )              (17 )         (22 )            (15 )
Provision for income taxes                      -                  -             -                -
Net loss                                      (11 )%             (17 )%        (22 )%           (15 )%


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Comparison of the Three Months Ended July 31, 2013 and 2012



Revenue



                             Three Months Ended July 31,
                                2013              2012        % Change
                                (dollars in thousands)
Revenue:
Subscription and support   $       14,220    $       10,457         36 %
Perpetual license                   2,735             1,407         94 %
Total product revenue              16,955            11,864         43 %
Professional services               2,840             1,763         61 %
Total revenue              $       19,795    $       13,627         45 %
Percentage of revenue:
Subscription and support               72 %              77 %
Perpetual license                      14                10
Total product revenue                  86                87
Professional services                  14                13
Total                                 100 %             100 %

Subscription and support revenue increased $3.8 million from the three months ended July 31, 2012 to the three months ended July 31, 2013. Of the total increase in subscription and support revenue, approximately $1.4 million, or 37%, represented revenue from new customers acquired after July 31, 2012, and approximately $2.4 million, or 63%, represented revenue from existing customers at or prior to July 31, 2012. The increase in revenue from existing customers was due primarily to sales of additional seats, which we believe is attributable to increased adoption of Agile practices by our customers.

Perpetual license revenue increased $1.3 million from the three months ended July 31, 2012 to the three months ended July 31, 2013. We believe that the overall increase in perpetual license revenue was primarily due to further adoption of Agile practices by our customers, which resulted in purchases of additional seats, as well as an increase in purchases of perpetual licenses by certain large enterprise customers.

Professional services revenue increased $1.1 million from the three months ended July 31, 2012 to the three months ended July 31, 2013. The increase was driven by higher demand for our services to help companies implement Agile software development methodologies.

Cost of Revenue and Gross Profit Percentage



                                   Three Months Ended July 31,
                                    2013                2012         % Change
                                     (dollars in thousands)
Cost of revenue:
Product                        $         1,800     $         1,226         47 %
Professional services                    2,336               1,830         28 %
Total cost of revenue          $         4,136     $         3,056
Percentage of total revenue:
Product                                      9 %                 9 %
Professional services                       12 %                13 %
Total gross profit                          79 %                78 %

Cost of product revenue increased $0.6 million from the three months ended July 31, 2012 to the three months ended July 31, 2013. The increase was primarily comprised of a $0.2 million increase in personnel and related expenses, a $0.1 million increase in depreciation expense as a result of computer equipment purchases and amortization of intangible assets acquired in business combinations and a $0.2 million increase in additional software licenses.

Cost of professional services revenue increased $0.5 million from the three months ended July 31, 2012 to the three months ended July 31, 2013. The increase was primarily due to an increase of $0.1 million in personnel and related expenses, an increase of $0.1 million in reimbursements for out of pocket expenses and an increase of $0.1 million in third-party consulting services.


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Operating Expenses



Sales and Marketing



                                  Three Months Ended July 31,
                                   2013                2012         % Change
                                    (dollars in thousands)
Sales and marketing           $         9,085     $         6,337         39 %
Percentage of total revenue                46 %                48 %

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