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MKTO > SEC Filings for MKTO > Form 10-Q on 15-May-2014All Recent SEC Filings

Show all filings for MARKETO, INC.

Form 10-Q for MARKETO, INC.


15-May-2014

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 Annual Report on Form 10-K filed on March 3, 2014. As discussed in the section above 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, Marketing Management, and Real-time Personalization. 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 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 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 define the SMB market as companies with fewer than 1,500 employees and the enterprise market as companies with 1,500 or more employees.

We market and sell our products directly and through a growing network of distribution partners. Our client base is diverse, with 3,215 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, General Electric, Hyundai, Medtronic, Moody's, Panasonic, Symantec and Sony. No single customer represented more than 1% of subscription and support revenue during the three months ended March 31, 2014 and 2013. During the three months ended March 31, 2014 and 2013, our 20 largest customers accounted for approximately 10% of our total revenue. The percentage of our subscription and support revenue from enterprise customers was 28% and 25% during the three months ended March 31, 2014 and 2013, respectively.

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 $32.3 million and $19.7 million for the three months ended March 31, 2014 and 2013, 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 89% of our total revenue during each of the three months ended March 31, 2014 and 2013. 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 11% of our total revenue during each of the three months ended March 31, 2014 and 2013. Our solution 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, 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 typically 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.


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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 approximately 15% and 14% during the three months ended March 31, 2014 and 2013, 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 remaining nine months of 2014, we expect the demand for our solutions and services, along with revenue growth rates, to remain strong.

We had net losses of $12.5 million and $9.5 million for the three months ended March 31, 2014 and 2013, respectively, primarily due to increased investments in our current and projected future 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 March 31, 2014, we had outstanding borrowings of $7.3 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 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 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 license agreement, which is typically one year, but generally ranges from one 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. 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, including our own annual user conference, which typically occurs in the second quarter of the fiscal year. The timing of these events can vary from 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.


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Results of Operations for the Three Ended March 31, 2014 and 2013

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
                                                                 Ended March 31,
                                                                 2014       2013
Revenue:
Subscription and support                                           88.6 %     88.9 %
Professional services and other                                    11.4       11.1
Total revenue                                                     100.0      100.0
Cost of revenue:
Subscription and support                                           19.3       29.5
Professional services and other                                    15.0       13.3
Total cost of revenue                                              34.3       42.8
Gross margin:
Subscription and support                                           69.3       59.5
Professional services and other                                    -3.6       -2.2
Total gross margin                                                 65.7       57.2
Operating expenses:
Research and development                                           22.1       25.3
Sales and marketing                                                63.1       62.4
General and administrative                                         19.2       17.4
Total operating expenses                                          104.3      105.1
Loss from operations                                              -38.6      -47.8
Other income (expense), net                                        -0.2       -0.3
Loss before provision for income taxes                            -38.8      -48.2
Provision for income taxes                                          0.0        0.1
Net loss                                                          -38.8      -48.3
Net loss attributable to redeemable non-controlling interests       0.0        0.0
Net loss attributable to Marketo                                  -38.7 %    -48.3 %

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

Revenue



                                        Three Months
                                       Ended March 31,
(in thousands, except percentages)     2014       2013     $ Change    % Change
Revenues:
Subscription and support             $ 28,611   $ 17,555   $  11,056       63.0 %
Professional services and other         3,681      2,181       1,500       68.8 %
Total revenue                        $ 32,292   $ 19,736   $  12,556       63.6 %

Percentage of revenues:
Subscription and support                 88.6 %     88.9 %
Professional services and other          11.4 %     11.1 %
Total                                   100.0 %    100.0 %

Total revenue increased $12.6 million, or 64%, during the first quarter of 2014 compared to the comparable period in 2013, due to the increase in subscription and support revenue of $11.1 million and an increase in professional services revenue of $1.5 million.

The increase in subscription and support revenue was primarily attributable to
(1) growth in our total customer count primarily from the SMB market and customers added in the first three months of 2014 who generally had larger record databases, on average, managed by our solution than the customers that we added in the first three months of 2013 and (2) our subscription dollar retention rates have increased as a result of higher customer retention rates, volume and price increases resulting from the lapsing of introductory discounts on subscriptions and growth in both usage rights (driven by higher use, consumptions and/or database size of our products used by existing customers) and cross sell of additional products either during the term of their subscription or at the point of renewal of their subscription.


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Of the total increase in subscription and support revenue for the first quarter of 2014, 69% was attributable to revenue from new customers acquired from April 1, 2013 through March 31, 2014, and 31% was attributable to revenue from customers existing on or before March 31, 2013.

The increase in professional services revenue resulted from increased delivery of services across our customer base. During the fourth quarter of 2013, we added a higher proportion of enterprise customers and the majority of these projects for our enterprise customer base were delivered during the first quarter of 2014. We expect professional services revenue from enterprise customers to continue to comprise a larger proportion of the total balance in future quarters.

Cost of Revenue and Gross Margin



                                        Three Months
                                       Ended March 31,
(in thousands, except percentages)     2014       2013      $ Change    % Change
Cost of revenue:
Subscription and support             $   6,235   $ 5,820   $      415        7.1 %
Professional services and other          4,841     2,618        2,223       84.9 %
Total cost of revenue                $  11,076   $ 8,438   $    2,638       31.3 %

Gross margin:
Subscription and support                  78.2 %    66.8 %
Professional services and other          -31.5 %   -20.0 %
Total gross margin                        65.7 %    57.2 %

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

                                    Change
                                 Three Months
Personnel-related costs         $          833
Depreciation and amortization              819
Hosting costs                           (1,500 )
Various other items                        263

                                $          415

The increase in cost of subscription and support for the three months ended March 31, 2014 reflects an increase in personnel-related costs (salary, benefits and stock-based compensation) and depreciation and amortization expense. The increase in salary and benefit costs primarily reflects an increase in headcount directly associated with our cloud infrastructure, customer support and customer success organizations to support our customer growth, while the increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees. The increase in depreciation and amortization expense reflects the completion of our transition to co-location data center facilities at the end of fiscal 2013, where we now manage our own computer equipment and systems. These increases were partially offset by a decrease in hosting costs for the three months ended March 31, 2014 as compared to the corresponding period in 2013 as a result of our decreased use of a managed hosting service provider due to the completion of the transition to our own co-location data center facilities.

Our subscription and support gross margin were 78.2% and 66.8% for the three months ended March 31, 2014 and 2013, respectively. The increase in subscription and support gross margin for the three months ended March 31, 2014 primarily reflects the transition to our own co-location data center facilities from a managed hosting service provider which we completed at the end of fiscal 2013.


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

                             Change
                          Three Months
Personnel-related costs   $       1,353
Consulting                          566
Various other items                 304

                          $       2,223

The increase in cost of professional services and other during the three months ended March 31, 2014 was due primarily to an increase in personnel-related costs (salary, benefits and stock-based compensation). The increase in salary and benefit costs primarily reflects an increase in headcount as we continue to grow our professional services organization to support demand for expert marketing services, while the increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees. 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 were (31.5)% and (20.0)% for the three months ended March 31, 2014 and 2013, respectively. The decrease in gross margin was due in part to lower staff utilization. As we have added headcount in our professional services group, these new employees undergo a training period before becoming fully billable, and as a result, their associated costs have a near-term negative impact on gross margins.

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 revenue as a percentage of total revenue 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
                                       Ended March 31,
(in thousands, except percentages)     2014       2013      $ Change    % Change
Research and development             $   7,131   $ 4,996   $    2,135       42.7 %
Percentage of total revenue               22.1 %    25.3 %

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

                                      Change
                                   Three Months
Personnel-related costs            $       1,785
Depreciation and amortization                273
Capitalized software development            (190 )
Various other items                          267

                                   $       2,135

The increase in research and development expenses during the three months ended March 31, 2014 was primarily due to an increase in personnel-related costs (salary, benefits and stock-based compensation). The increase in salary and benefit costs primarily reflects the increase in headcount to help continue the enhancement of our existing product suite and to a lesser extent, an increase in headcount from our acquisition of Insightera in December 2013, while the increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees. The increase in depreciation and amortization expense is primarily driven by growth in depreciable assets. 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 revenue for the remainder of 2014.


Table of Contents

Sales and Marketing



                                        Three Months
                                       Ended March 31,
(in thousands, except percentages)     2014       2013      $ Change    % Change
Sales and marketing                  $ 20,368   $ 12,318   $    8,050       65.4 %
Percentage of total revenue              63.1 %     62.4 %

Sales and marketing expenses increased due to the following (in thousands):

                                  Change
                               Three Months
Personnel-related expenses     $       5,484
Marketing expenses                     1,467
Facilities and IT allocation             560
Various other items                      539

                               $       8,050

The increase in sales and marketing expenses during the three months ended March 31, 2014 was due primarily to an increase in personnel-related costs (salary, benefits and stock-based compensation). The increase in salary and benefit costs was primarily driven by an increase in headcount for our sales, marketing and business development employees and executives, while the increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees. The increase in marketing program costs reflects increased activity to support growth in our business. The increase in the allocation of facility and IT expenses was due principally to headcount growth in the sales and marketing department as compared to other departments and overall higher IT and facilities expenses.

We expect sales and marketing expenses to increase in absolute dollars and remain our largest expense in absolute dollars and as a percentage of total revenue, although they may fluctuate as a percentage of total revenue for the remainder of 2014.

General and Administrative



                                        Three Months
                                       Ended March 31,
(in thousands, except percentages)     2014       2013      $ Change    % Change
General and administrative           $   6,192   $ 3,427   $    2,765       80.7 %
Percentage of total revenue               19.2 %    17.4 %

General and administrative expenses increased due to the following (in thousands):

                             Change
                          Three Months
Personnel-related costs   $       1,753
Professional Services               644
Recruiting                          305
Consulting                         (233 )
Various other items                 296

                          $       2,765


Table of Contents

The increase in general and administrative expenses during the three months ended March 31, 2014 was primarily due to increased personnel-related costs (salary, benefits and stock-based compensation). The increase in salary and benefit costs was primarily driven by an increase in headcount for our administrative, legal, human resources, finance and accounting departments, while the increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees. The increase in professional services represents increases in both legal and accounting fees, primarily from supporting our international expansion and our Sarbanes-Oxley compliance efforts. The increase in recruiting expense reflects a general increase in the use of outside recruiters as we added more headcount throughout the Company. The decrease in consulting fees reflects our decreased use of external consultants during the first three months of March 31, 2014, as we utilized outside consultants to assist us with preparatory work associated with our IPO in the comparable quarter of 2013.

We expect that our general and administrative expenses will increase in absolute dollars as we continue to expand our business and infrastructure to support being a public company although they may fluctuate as a percentage of total revenue for the remainder of 2014.

Liquidity and Capital Resources

To date, we have financed our operations through cash collected from customers as well as preferred equity financings, our IPO 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 March 31, 2014 and December 31, 2013, we had cash and cash equivalents of $119.6 million and $128.3 million, respectively, most of which was held in money market accounts.

In May 2012, we entered into a loan and security agreement with a bank related to a credit facility providing us with an equipment line of up to $4.0 million. . . .

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