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MKTO > SEC Filings for MKTO > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for MARKETO, INC.

Form 10-Q for MARKETO, INC.


8-Nov-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 and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Prospectus filed on September 13, 2013, pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the "Securities Act") with the SEC. As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion and analysis contains forward-looking statements that 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. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included under Part II, Item 1A below.

Overview

We are the provider of a leading cloud-based marketing software platform that enables organizations to engage in modern relationship marketing. Our software platform is designed to enable the effective execution, management and analytical measurement of marketing activities, helping organizations to acquire new customers more efficiently, build stronger relationships with existing customers, improve sales effectiveness and drive faster revenue growth. On our platform, we deliver an easy-to-use, integrated suite of advanced applications, which today include Marketing Automation, Social Marketing, Sales Insight, Revenue Analytics and Marketing Management. To enable our customers to obtain maximum value from our platform, we have created an ecosystem of third-party applications, as well as a network of resources to foster marketing thought leadership, sharing and collaboration among our users. Furthermore, we provide our customers with expert professional services, delivered by marketers, for marketers, to enable rapid time to value through effective implementation and usage of our solutions.

We designed our platform to be valuable across large enterprises and Small and Medium Businesses (SMBs) that sell to both businesses and consumers in virtually any industry. We market and sell our products directly and through a growing network of distribution partners. Our client base is diverse, with 2,760 customers across a wide range of industries including business services, consumer, financial services, healthcare, manufacturing, media, technology and telecommunications. Representative customers include one or more divisions of the following companies: Capgemini, CenturyLink, Citrix, Gannett, General Electric, Medtronic, Moody's, Panasonic, Symantec and Sony. No single customer represented more than 1% of subscription and support revenue during the three and nine months ended September 30, 2013 and 2012. During the three and nine months ended September 30, 2013 and 2012, our 20 largest customers accounted for less than 10% of our total revenue.

We deliver our solutions entirely through a multi-tenant cloud-based, or Software as a Service (SaaS), architecture which customers can configure to their specific needs. We initially focused our selling efforts on the SMB market, but beginning in late 2010, we began to invest in an enterprise sales organization to address growing enterprise demand. We define the SMB market as companies with fewer than 1,500 employees and the enterprise market as companies with 1,500 or more employees. The percentage of our subscription and support revenue from enterprise customers was 27% and 25% during the three and nine months ended September 30, 2013.

Our direct sales force has separate sales teams for the enterprise market and for the SMB market. Within our direct sales force, we also have a team that is responsible for selling to existing customers, who may renew their subscriptions, increase their usage of our platform and applications, acquire additional applications from our product family, or broaden the deployment of our solutions across their organizations. In addition, we have indirect sales teams that sell to distributors, agencies, resellers and OEMs, who in turn resell or use our platform to provide managed marketing services to their end customers. To date, substantially all of our revenue has been derived from direct sales, but we intend to invest in our indirect sales teams to increase indirect revenue as a percentage of our total revenue over time.

We provide our solutions on a subscription basis, and we generated revenue of $25.5 million and $15.4 million for the three months ended September 30, 2013 and 2012, respectively, and $67.7 million and $41.6 million for the nine months ended September 30, 2013 and 2012, respectively. We derive most of our revenue from subscriptions to our cloud-based software and related customer support services. Subscription and support revenue accounted for 88% and 91% of our total revenue during the three months ended September 30, 2013 and 2012, respectively, and 88% and 90% of our total revenue during the nine months ended September 30, 2013 and 2012, respectively. We price our products based on customer usage measures, which can include the number of records in each customer's database and the number of user seats authorized to access our service. Our subscription contracts are typically one year in length, but can range from one quarter to three years in length.

Professional services revenue accounted for 12% and 9% of our total revenue for the three months ended September 30, 2013 and 2012, respectively, and 12% and 10% of our total revenue for the nine months ended September 30, 2013 and 2012, respectively. Our software is designed to be ready to use immediately upon provisioning of a new customer subscription. However, we believe that our customers' success is enhanced by the effective use of modern relationship marketing strategies performed with our software,


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which we foster primarily through the sale and delivery of expert services that educate our customers on the best use of our solutions as well as assist in the implementation of our solutions. In addition, some of our customers require services to support integrating their existing systems with our solutions. Enterprise customers exhibit a higher demand for all of these services. Over the near term, due to market demand for expertise in modern relationship marketing, we expect our professional services revenue to grow at a faster rate than our subscription and support revenue, and therefore, to increase as a percentage of our total revenue. In addition, we also partner with third party consulting organizations that provide similar services to our customers in connection with their use of our solutions.

Our customer base has grown from over 200 at the end of 2009 to 2,760 at the end of September 30, 2013, which has resulted in rapid revenue growth. We generate the majority of our revenue in the United States; however, we are focused on growing our international business. Revenue generated from our international customers was 14.7% and 13.0% during the three months ended September 30, 2013 and 2012, respectively, and 14.4% and 12.3% during the nine months ended September 30, 2013 and 2012, respectively.

We have focused on rapidly growing our business and plan to continue to invest in growth. We expect our cost of revenue and operating expenses to continue to increase in absolute dollars in future periods. Marketing and sales expenses are expected to increase in absolute dollars as we continue to expand our sales teams, increase our marketing activities and grow our international operations. Research and development expenses are expected to increase in absolute dollars to support the enhancement of our existing products and the development of new products. We also intend to invest in maintaining a high level of customer service and support which we consider critical for our continued success. We plan to continue investing in our data center infrastructure and services capabilities in order to support continued future customer growth. We also expect to incur additional general and administrative expenses as a result of both our growth and the infrastructure required to be a public company. We also may acquire or invest in businesses, products or technologies that we believe could complement or expand our platform and enhance our technical capabilities. Considering our plans for investment, we do not expect to be profitable in the near term and, in order to achieve profitability, we will need to grow revenue at a rate faster than our investments in cost of revenue and operating expenses. For the fourth quarter of 2013, we expect the demand for our solutions and services, along with revenue growth rates, to remain strong.

We had net losses of $10.0 million and $9.8 million for the three months ended September 30, 2013 and 2012, respectively, and $31.9 million and $26.3 million for the nine months ended September 30, 2013 and 2012, respectively, primarily due to increased investments in our growth.

Since our inception, we financed our operations through cash collected from customers as well as preferred equity financings, our initial public offering and concurrent private placement completed in May 2013, and our follow-on public offering completed in September 2013. We also maintain a credit facility. As of September 30, 2013, we had outstanding borrowings of $7.8 million under this facility.

Seasonality, Cyclicality and Quarterly Trends

We have historically experienced seasonality in terms of when we enter into new customer agreements for our solutions and services. We sign a significantly higher percentage of agreements with new customers as well as renewal agreements with existing customers in the fourth quarter of each year as compared to any of the prior quarters. The first quarter and third quarter are typically the slowest in this regard. Furthermore, we usually sign a significant portion of these agreements during the last month, and often the last two weeks, of each quarter. This seasonality is reflected to a much lesser extent, and sometimes is not immediately apparent, in our revenue, because we recognize subscription revenue over the term of the customer agreement, which is typically one year, but ranges from one quarter to three years. As a result, a slowdown in our ability to enter into customer agreements may not be apparent in our revenue for the quarter, as the revenue recognized in any quarter is primarily from customer agreements entered into in prior quarters. In addition, the percentage of customers that pay quarterly rather than annually varies from quarter to quarter and impacts our deferred revenue balance. We have historically seen billing frequencies that were predominately quarterly. However, our enterprise and larger SMB customers are increasingly opting for annual versus quarterly billing terms. While we expect this dynamic to continue, customer mix shifts from quarter to quarter. The percentage of customers who are billed quarterly and pay us quarterly has a material impact on our change in deferred revenue and, therefore, on our net cash used in operating activities. Historical patterns should not be considered a reliable indicator of our future sales activity or performance.

Our revenue has increased over the periods presented due to increased sales to new customers, as well as increased usage of existing and new products by existing customers. Our operating expenses generally have increased sequentially in every quarter primarily due to increases in headcount and other related expenses to support our growth. We anticipate our operating expenses will continue to increase in absolute dollars in future periods as we invest in the long-term growth of our business.

In addition, each year we typically participate in several key industry trade shows, such as our upcoming participation in Dreamforce in the fourth quarter of 2013, as well as host our own annual user conference. The timing of these events can vary from


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year to year, and the costs associated with these events typically have a significant effect on our sales and marketing expenses for the applicable quarter and cause our quarterly results to fluctuate.

Results of Operations for the Three and Nine Months Ended September 30, 2013 and 2012

The following tables set forth our results of operations for the periods presented 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.

                                          Three Months                Nine Months
                                      Ended September 30,         Ended September 30,
                                      2013           2012         2013           2012
Revenue:
Subscription and support                 88.2 %         91.2 %       88.5 %        90.1 %
Professional services and other          11.8            8.8         11.5           9.9
Total revenue                           100.0          100.0        100.0         100.0
Cost of revenue:
Subscription and support                 24.5           28.5         27.1          26.8
Professional services and other          14.0           14.0         13.7          14.6
Total cost of revenue                    38.5           42.5         40.9          41.4
Gross margin:
Subscription and support                 63.7           62.6         61.3          63.3
Professional services and other          (2.2 )         (5.2 )       (2.2 )        (4.7 )
Total gross margin                       61.5           57.5         59.1          58.6
Operating expenses:
Research and development                 23.3           30.2         25.0          33.3
Sales and marketing                      59.8           70.3         63.5          68.4
General and administrative               17.1           20.0         17.2          20.1
Total operating expenses                100.1          120.5        105.7         121.8
Loss from operations                    (38.6 )        (63.1 )      (46.6 )       (63.3 )
Other income (expense), net              (0.4 )         (0.2 )       (0.4 )        (0.1 )
Loss before provision for income
taxes                                   (39.0 )        (63.3 )      (47.0 )       (63.4 )
Provision for income taxes                0.0            0.0          0.1           0.0
Net loss                                (39.0 )%       (63.3 )%     (47.0 )%      (63.4 )%

Percentages are based on actual values. Totals may not sum due to rounding.

Revenue



                                          Three Months                                      Nine Months
                                       Ended September 30,                              Ended September 30,
(in thousands, except percentages)      2013          2012     $ Change    % Change      2013          2012     $ Change    % Change
Revenues:
Subscription and support             $    22,504    $ 14,064   $   8,440       60.0 % $    59,942    $ 37,464   $  22,478       60.0 %
Professional services and other            3,003       1,363       1,640      120.3 %       7,805       4,102       3,703       90.3 %
Total revenue                        $    25,507    $ 15,427   $  10,080       65.3 % $    67,747    $ 41,566   $  26,181       63.0 %

Percentage of revenues:
Subscription and support                    88.2 %      91.2 %                               88.5 %      90.1 %
Professional services and other             11.8 %       8.8 %                               11.5 %       9.9 %
Total                                      100.0 %     100.0 %                              100.0 %     100.0 %

Total revenue increased $10.1 million, or 65%, during the third quarter of 2013 compared to the comparable period in 2012, due to the increase in subscription and support revenue of $8.4 million and an increase in professional services revenue of $1.7 million. During the nine month period ended September 30, 2013, total revenue increased $26.2 million, or 63%, compared to the comparable period in 2012, due to the increase in subscription and support revenue of $22.5 million and an increase in professional services revenue of $3.7 million.


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The increase in subscription and support revenue was primarily attributable to
(1) growth in our total customer count primarily from the SMB market, (2) upsell of additional products either during the term of their subscription or at the point of renewal of their subscription, (3) the customers we added in the first nine months of 2013 who generally had larger record databases, on average, managed by our solution than the customers that we added in the first nine months of 2012 and (4) volume and price increases resulting from the lapsing of introductory discounts on subscriptions.

Of the total increase in subscription and support revenue for the third quarter of 2013, 88% was attributable to revenue from new customers acquired from October 1, 2012 through September 30, 2013, and 12% was attributable to revenue from customers existing on or before September 30, 2012. New customers are defined as those acquired from October 1, 2012 through September 30, 2013. Existing customers are defined as those existing on or before September 30, 2012. The percentage mix of revenue generated from new versus existing customers can vary from quarter to quarter due to seasonality based on when we enter into the new customer agreement for our service. We sign a significantly higher percentage of agreements with new customers as well as renewal agreements with existing customers in the fourth quarter of each year as compared to any of the prior quarters. The first and third quarters are typically our seasonally slowest in this regard. Furthermore, we usually sign a significant portion of these agreements during the last month, and often the last two weeks, of each quarter. This seasonality is reflected to a much lesser extent, and sometimes is not immediately apparent, in our subscription and support revenue because we recognize subscription revenue over the term of the license agreement, which is typically one year, but ranges from one quarter to three years. As a result of this seasonality and linearity of sales, the percentage mix of revenue generated from new customers will generally be higher in the first and third quarter when compared to the second and fourth quarters.

The increase in professional services revenue resulted from increased delivery of services across our customer base. A majority of this increase was attributable to SMB customers as they continue to comprise a larger proportion of our business. However, during the fourth quarter of 2012 and the first half of 2013, we added a higher proportion of enterprise customers who typically exhibit a higher demand for professional services than our SMB customers. We expect professional services revenue from enterprise customers to comprise a larger proportion of the total balance in future quarters.

Cost of Revenue and Gross Margin



                                          Three Months                                        Nine Months
                                       Ended September 30,                                Ended September 30,
(in thousands, except percentages)      2013          2012       $ Change    % Change      2013          2012      $ Change    % Change
Cost of revenue:
Subscription and support             $    6,245     $  4,402    $    1,843       41.9 % $    18,386    $ 11,144    $   7,242       65.0 %
Professional services and other           3,568        2,162         1,406       65.0 %       9,307       6,068        3,239       53.4 %
Total cost of revenue                $    9,813     $  6,564    $    3,249       49.5 % $    27,693    $ 17,212    $  10,481       60.9 %

Gross margin:
Subscription and support                   72.2 %       68.7 %                                 69.3 %      70.3 %
Professional services and other           (18.8 )%     (58.6 )%                               (19.2 )%    (47.9 )%
Total gross margin                         61.5 %       57.5 %                                 59.1 %      58.6 %

Cost of subscription and support increased due to the following (in thousands):

                                     Change
                                 Three     Nine
                                Months    Months
Personnel-related costs         $   999   $ 2,767
Depreciation and amortization       749     1,594
Hosting costs                      (312 )   1,445
Facilities and IT allocations       213       627
Various other items                 194       809

                                $ 1,843   $ 7,242

The increase in cost of subscription and support for the three and nine months ended September 30, 2013 as compared to the same periods in 2012 was primarily due to increases in personnel-related costs resulting from an increase in headcount to support our customer growth, and to a lesser extent, increases in headcount to support our transition to co-location data center facilities. During 2012, to improve the responsiveness and long-term cost efficiency of our data center operations, we began an effort to transition from our managed hosting service provider to co-location data center facilities for which we have purchased and are managing our own computer equipment and systems. As a result, we hired additional personnel associated with the project, resulting in increased personnel costs and depreciation expense related to expenses associated with this project. The increase in hosting costs for the nine months ended September 30, 2013 reflects the overall increase in computing and network capacity to support our customer growth,


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while the decrease in costs for the three months ended September 30, 2013 reflects the decreased use of our managed hosting service provider, as we began to utilize some of our co-location data center facilities during the period.

Our subscription and support gross margin was 72.2% and 68.7% for the three months ended September 30, 2013 and 2012, respectively, and 69.3% and 70.3% for the nine months ended September 30, 2013 and 2012, respectively. The increase in subscription and support gross margin for the three months ended September 30, 2013 primarily reflects the decreased use of our managed hosting service provider as we began to use some of our co-location data center facilities. The decrease in subscription and support gross margin for the nine months ended September 30, 2013 primarily reflects increased personnel-related costs from increases in headcount and additional expenses incurred associated with the migration of our data centers from our managed hosting service provider to new co-location facilities.

Cost of professional services and other increased due to the following (in thousands):

                               Change
                           Three     Nine
                          Months    Months
Personnel-related costs   $   793   $ 2,037
Consulting                    475       676
Various other items           138       526

                          $ 1,406   $ 3,239

The increase in cost of professional services and other during the three and nine months ended September 30, 2013 was primarily due to an increase in personnel-related costs, as we continue to grow our headcount in our professional services organization to support demand for expert services. Additionally, consulting costs increased as a result of increased usage of outside contractors to supplement our existing staff.

Our professional services and other gross margin was (18.8)% and (58.6)% for the three months ended September 30, 2013 and 2012, respectively, and (19.2)% and
(47.9)% for the nine months ended September 30, 2013 and 2012, respectively. The improvement in gross margin was due to improved staff utilization resulting primarily from higher demand for professional services from our customers and from improvements in our economies of scale as a result of fixed expenses being spread across a larger base of billable resources.

We expect that cost of revenue may increase in the future depending on the growth rate of new customer acquisition. We also expect that cost of revenues as a percentage of total revenues could fluctuate from period to period depending on growth of our professional services business and any associated costs relating to the delivery of professional services, the timing of sales of products that have royalties associated with them and the timing of significant expenditures.

Research and Development



                                          Three Months                                       Nine Months
                                       Ended September 30,                               Ended September 30,
(in thousands, except percentages)      2013          2012      $ Change    % Change      2013          2012      $ Change    % Change
Research and development             $     5,938    $  4,661   $    1,277       27.4 % $    16,919    $ 13,835   $    3,084       22.3 %
Percentage of total revenue                 23.3 %      30.2 %                                25.0 %      33.3 %

Research and development expenses increased due to the following (in thousands):

                                        Change
                                    Three     Nine
                                   Months    Months
Personnel-related costs            $ 1,021   $ 2,338
Consulting                             164       714
Capitalized software development      (130 )    (358 )
Various other items                    222       390

                                   $ 1,277   $ 3,084


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The increase in research and development expenses during the three and nine months ended September 30, 2013 was primarily due to an increase in personnel-related costs as a result of the increase in headcount to help continue the enhancement of our existing product suite and an increase in stock-based compensation expense. Consulting fees, mostly related to sub-contracted development, increased as the result of the use of more outside contractors. These increases were partially offset by an increase in capitalized software development costs, which consists primarily of personnel-related expenses.

We believe that continued investment in our technology is important for our future growth, and, as a result, we expect research and development expenses to increase in absolute dollars, but decline modestly, as a percentage of total revenues.

Sales and Marketing



                                          Three Months                                       Nine Months
                                       Ended September 30,                               Ended September 30,
(in thousands, except percentages)      2013          2012      $ Change    % Change      2013          2012     $ Change    % Change
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