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MKTO > SEC Filings for MKTO > Form 10-Q on 11-Aug-2014All Recent SEC Filings

Show all filings for MARKETO, INC.

Form 10-Q for MARKETO, INC.


11-Aug-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 3,359 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 and six months ended June 30, 2014 and 2013. During the three and six months ended June 30, 2014, our 20 largest customers accounted for slightly over 11% and 10% of our total revenue, respectively, and our 20 largest customers accounted for less than 10% of our total revenue for the three and six months ended June 30, 2013. The percentage of our subscription and support revenue from enterprise customers was 27% and 28% during the three and six months ended June 30, 2014, 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 total revenue of $36.0 million and $22.5 million for the three months ended June 30, 2014 and 2013, respectively, and $68.3 million and $42.2 million for the six months ended June 30, 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 87% and 88% of our total revenue during each of the three months ended June 30, 2014 and 2013, respectively, and 88% and 89% of our total revenue during the six months ended June 30, 2014 and 2013, 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 year to three years in length.

Professional services revenue accounted for 13% and 12% of our total revenue during the three months ended June 30, 2014 and 2013, respectively, and 12% and 11% of our total revenue during the six months ended June 30, 2014 and 2013, respectively. 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 16% and 14% during the three months ended June 30, 2014 and 2013, respectively, and 15% and 14% during the six months ended June 30, 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 six months of 2014, we expect the demand for our solutions and services, along with revenue growth rates, to remain strong.

We had net losses attributable to Marketo of $13.1 million and $12.4 million for the three months ended June 30, 2014 and 2013, respectively, and $25.6 million and $21.9 million for the six months ended June 30, 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 June 30, 2014, we had outstanding borrowings of $6.7 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 and Six Months Ended June 30, 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             Six Months
                                           Ended June 30,          Ended June 30,
                                          2014        2013        2014        2013
Revenue:
Subscription and support                    86.7 %      88.4 %      87.6 %      88.6 %
Professional services and other             13.3        11.6        12.4        11.4
Total revenue                              100.0       100.0       100.0       100.0
Cost of revenue:
Subscription and support                    19.1        28.1        19.2        28.7
Professional services and other             15.4        13.9        15.2        13.6
Total cost of revenue                       34.5        42.0        34.4        42.3
Gross margin:
Subscription and support                    67.6        60.3        68.4        59.9
Professional services and other             -2.1        -2.2        -2.8        -2.2
Total gross margin                          65.5        58.0        65.6        57.7
Operating expenses:
Research and development                    20.0        26.6        21.0        26.0
Sales and marketing                         66.0        68.8        64.6        65.8
General and administrative                  15.9        17.2        17.5        17.3
Total operating expenses                   101.9       112.6       103.1       109.1
Loss from operations                       -36.4       -54.6       -37.4       -51.4
Other income (expense), net                 -0.5        -0.4        -0.4        -0.3
Loss before provision for income
taxes                                      -36.9       -55.0       -37.8       -51.8
Provision (benefit) for income taxes         0.0         0.1         0.0         0.1
Net loss                                   -36.8       -55.1       -37.7       -51.9
Net loss attributable to redeemable
non-controlling interests                    0.4         0.0         0.2         0.0
Net loss attributable to Marketo           -36.4 %     -55.1 %     -37.5 %     -51.9 %
Percentages are based on actual
values. Totals may not sum due to
rounding.

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

Revenue



                                        Three Months                                  Six Months
                                       Ended June 30,                               Ended June 30,
(in thousands, except percentages)     2014       2013     $ Change    % Change     2014       2013     $ Change    % Change
Revenues:
Subscription and support             $ 31,236   $ 19,883   $  11,353       57.1 % $ 59,847   $ 37,438   $  22,409       59.9 %
Professional services and other         4,794      2,621       2,173       82.9      8,475      4,802       3,673       76.5
Total revenue                        $ 36,030   $ 22,504   $  13,526       60.1 % $ 68,322   $ 42,240   $  26,082       61.7 %

Percentage of revenues:
Subscription and support                 86.7 %     88.4 %                            87.6 %     88.6 %
Professional services and other          13.3 %     11.6 %                            12.4 %     11.4 %
Total                                   100.0 %    100.0 %                           100.0 %    100.0 %

Total revenue increased $13.5 million, or 60%, during the second quarter of 2014 compared to the comparable period in 2013, due to the increase in subscription and support revenue of $11.4 million and an increase in professional services revenue of $2.2 million. During the six month period ended June 30, 2014, total revenue increased $26.1 million, or 62%, compared to the comparable period in 2013, due to the increase in subscription and support revenue of $22.4 million and an increase in professional services revenue of $3.7 million.

The increase in subscription and support revenue was primarily attributable to
(1) growth in our total customer count primarily from the SMB market, (2) growth in both usage rights (driven by higher use, consumption 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 and (3) higher customer retention rates.


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Of the total increase in subscription and support revenue for the second quarter of 2014, 62% was attributable to revenue from new customers acquired from July 1, 2013 through June 30, 2014, and 38% was attributable to revenue from customers existing on or before June 30, 2013.

The increase in professional services revenue resulted from increased demand of services across our customer base. We expect professional services revenue to continue to grow as we continue to grow our customer base, and as we sell follow-on services, training, education and optimization of our products to our installed base.

Cost of Revenue and Gross Margin



                                        Three Months                                  Six Months
                                       Ended June 30,                               Ended June 30,
(in thousands, except percentages)     2014      2013      $ Change    % Change     2014       2013      $ Change    % Change
Cost of revenue:
Subscription and support             $  6,876   $ 6,321   $      555        8.8 % $ 13,111   $ 12,141   $      970        8.0 %
Professional services and other         5,540     3,121        2,419       77.5     10,381      5,739        4,642       80.9
Total cost of revenue                $ 12,416   $ 9,442   $    2,974       31.5 % $ 23,492   $ 17,880   $    5,612       31.4 %

Gross margin:
Subscription and support                 78.0 %    68.2 %                             78.1 %     67.6 %
Professional services and other         -15.6 %   -19.1 %                            -22.5 %    -19.5 %
Total gross margin                       65.5 %    58.0 %                             65.6 %     57.7 %

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

                                      Change
                                 Three       Six
                                 Months    Months
Depreciation and amortization   $    745   $ 1,569
Personnel-related costs              676     1,384
Software subscription                230       436
Hosting costs                     (1,640 )  (3,140 )
Various other items                  544       721

                                $    555   $   970

The increase in cost of subscription and support for the three and six month ended June 30, 2014 primarily reflects an increase in depreciation and amortization expense and personnel-related costs (salary, benefits and stock-based compensation). The increase in depreciation and amortization expense and software subscription expense reflects the completion of our transition to our U.S. based co-location data center facilities at the end of fiscal 2013, where we now manage our own computer equipment and systems. 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. These increases were offset by a decrease in hosting costs for the three and six months ended June 30, 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 U.S. based co-location data center facilities.

Our subscription and support gross margin were 78.0% and 68.2% for the three months ended June 30, 2014 and 2013, respectively, and 78.1% and 67.6% for the six months ended June 30, 2014 and 2013, respectively. The increase in subscription and support gross margin for the three and six months ended June 30, 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      Six
                          Months    Months
Personnel-related costs   $ 1,639   $ 2,992
Consulting                    566     1,132
Various other items           214       518

                          $ 2,419   $ 4,642

The increase in cost of professional services and other during the three and six months ended June 30, 2014 was due primarily to an increase in personnel-related costs (salary, commissions, benefits and stock-based compensation) and consulting costs. 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 (15.6)% and (19.1)% for the three months ended June 30, 2014 and 2013, respectively, and (22.5)% and
(19.5)% for the six months ended June 30, 2014 and 2013, respectively. The improvement in gross margin for the three months ended June 30, 2014 was due to higher billable utilization of professional services consultants. While our overall utilization of professional services consultants was higher for the six months ended June 30, 2014, the increase in personnel-related costs, primarily associated with stock-based compensation, had a 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                                  Six Months
                                       Ended June 30,                               Ended June 30,
(in thousands, except percentages)     2014      2013      $ Change    % Change     2014       2013      $ Change    % Change
Research and development             $  7,198   $ 5,985   $    1,213       20.3 % $ 14,329   $ 10,981   $    3,348       30.5 %
Percentage of total revenue              20.0 %    26.6 %                             21.0 %     26.0 %

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

                                     Change
                                 Three      Six
                                Months    Months
Personnel-related costs         $   668   $ 2,442
Depreciation and amortization       281       554
Various other items                 264       352
                                $ 1,213   $ 3,348

The increase in research and development expenses during the three and six months ended June 30, 2014 was primarily due to an increase in personnel-related costs (salary, bonuses, 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 driven by growth in depreciable assets.

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, and increase modestly as a percentage of total revenue for the remainder of 2014.


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Sales and Marketing



                                        Three Months                                   Six Months
                                       Ended June 30,                                Ended June 30,
(in thousands, except percentages)     2014       2013      $ Change    % Change     2014       2013     $ Change    % Change
Sales and marketing                  $ 23,786   $ 15,488   $    8,298       53.6 % $ 44,154   $ 27,806   $  16,348       58.8 %
Percentage of total revenue              66.0 %     68.8 %                             64.6 %     65.8 %

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

                                     Change
                                Three      Six
                               Months     Months
Personnel-related expenses     $ 5,136   $ 10,620
Marketing programs               1,816      3,283
Facilities and IT allocation       430        949
Travel and entertainment           564        639
Various other items                352        857

                               $ 8,298   $ 16,348

The increase in sales and marketing expenses during the three and six months ended June 30, 2014 was due primarily to an increase in personnel-related costs (salary, benefits, stock-based compensation and commission expense). 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. The increase in stock-based compensation reflects grants of additional equity awards to existing employees and of equity awards to new employees and the increase in commission expense primarily reflects an increase in new customer acquisitions. 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. The increase in travel costs reflects increased international sales and marketing efforts.

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                                  Six Months
                                       Ended June 30,                               Ended June 30,
(in thousands, except percentages)     2014      2013      $ Change    % Change     2014      2013      $ Change    % Change
. . .
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