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NetSuite Inc. (NYSE:N)

February 13, 2013 7:00 pm ET

Executives

Zachary Nelson - Chief Executive Officer, President and Director

Ronald Gill - Chief Financial Officer and Principal Accounting Officer

Unknown Analyst

Good afternoon. Thanks so much. Zach Nelson, thank you, CEO of NetSuit, for joining us this afternoon.

Question-and-Answer Session

Unknown Analyst

I think -- I mean, Software-as-a-Service ERP has gotten a lot of awareness in the last couple of years. But I think as just a level-setting mechanism maybe kind of describe what you guys do for your customers, how the company kind of evolved over the course since founding what -- 13 years ago? 14?

Zachary Nelson

14 years ago. Yes, I think -- in reality, we were probably -- I would assume we were the first cloud software company ever founded. The company was founded in a 5-minute conversation between Evan Goldberg, who is still our CTO, and Larry Ellison of Oracle. And when I was at Oracle, Evan was there. Young, really good developer. He had left Oracle. Went to start a company. Ultimately competed with the Flash technology. And so when Macromedia bought Flash, his company went out of business. He and Larry were sitting around talking, because Larry wanted to invest in Evan again, Evan was just a spectacular developer. And Evan started to complain about how hard it was to run a business. He had an accounting system here, a sales system there, a website here, a support system there. He had to try to tie everything together. Took you 3 months to figure out what happened yesterday in your business. All of the complexities that large enterprises solve with huge amounts of money, mid-size businesses couldn't deal with. And Larry basically said, "Well, I have an idea, why don't you build the system that solves that problem? Number one. And number two, deliver it over the Internet."

And so those 2 big ideas really are still the core foundation of the company. If you look at -- I've been there, I joined in 2002 as CEO after they've done 3 years of development to build this complex application. But the big idea that still no one has done is to build an application designed to run a business. Most people build applications to run departments. The accounting app, sales app, and you see that all over the place. That decision to build an application to run a business, it had all sorts of positive benefits for our business over time. If you look at some of the things we're doing now in e-commerce, that's a direct result of us having built a business data model, not an accounting data model, per se. But to build that application, to build an application to run a business, you had to build the back office first. ERP is the most complex application. For any of you who have ever run a business, the only data you trust in that business is what your financial system says. You don't really trust the sales guys, what they said they sold. You look into the invoices and you look into the accounts receivable and say, that's what we actually sold. So you build that system first but around that, we built essentially 10 applications in 1 against a common data model.

The other thing that you've seen as NetSuite has evolved over the years, when you build a complex application like that, at first, you can only meet the needs of very small companies. So when I joined, our average sales price was $127 and that was a 3-year deal. So our actual average sales price was $90 a year. Today, our average deal size across all of our products is about $50,000 a year, and our largest deals are $100,000 on average, the OneWorld product, and we certainly have customers that pay us in excess of $1 million recurring now. But that's really a function of 2 factors. One is, it takes time to build functionality, to meet the needs of larger and larger companies. We've certainly been at it now for several years. And then secondly, you have to scale the organization to support those larger companies.

So -- and that's really been the story of the last few years where you've seen enormous growth in the company is average sales price in 2011 grew something like 45%. Last year, they grew something like 20%. And you don't really see average sales prices growing like this in any other company, forget any other market. So you can see the incredible value now that NetSuite's unlocking for our customers.

Unknown Analyst

So when you think about that, and you're right, I mean, you don't typically see an acceleration litho growth as you get bigger, right? The law of large numbers is going against you. How much of the improvement is just SaaS ERP getting -- going mainstream versus just your ability to increase ASPs by moving up market a little bit?

Zachary Nelson

Well, again, NetSuite a bit -- most SaaS companies have a pricing model that's per-user, per-month. And we have per-user, per-month pricing. It's $99 per-user, per-month. But when you build a rich ERP application, you can actually charge for the functionality of the customers using. So we actually get more revenue from the functionality we sell. Advanced inventory, revenue recognition, those are all module-based pricing modules. We get more revenue from the functionality than we do from the user accounts. So that's very unusual in a cloud application. Again, it shows you why this -- why what we're doing is very different from other companies. So there are 2 things that have really been driving the ASP growth. One is we have been selling to larger companies, and so obviously, to sell to larger companies, they pay more money. So it's a obvious sort of scenario there. But secondly, the more interesting thing is in the mid-market, what's happened is that midsize companies are actually beginning to value the technology we're delivering and the way we're delivering it more than they did 3 years ago. 3 years ago, it'd be NetSuite versus Great Plains. Great Plains cost $300,000. NetSuite, I don't care that you're going to save me all this IT cost. You have to beat $300,000 over 5 years. Now what they've realized is NetSuite really isn't Great Plains. NetSuite does so much more than Great Plains ever could. It enables all these new capabilities in your business and they're actually willing to pay more because they're going to get more. And in fact, where most people see staff as a cost reduction play, in our midsize customers, they're actually paying more for NetSuite than they would be paying for their existing products. In fact, they've already paid for Great Plains. Great Plains cost them nothing, but they realized their business isn't going to grow, they're not be able to map to current business challenges on a product design before the cloud existed. So they're actually paying more to move to NetSuite.

Unknown Analyst

I mean it brings -- that happened with Salesforce.com as well. I mean they were the low-priced offering against SiVO. And then over time, they're actually the premium-priced offering today.

Zachary Nelson

Yes, the amazing thing is this stuff actually works. I mean, you spend $1 million on it and you can actually generate an invoice out of it. Imagine that. We look at these people that spent -- as we moved up market, you see these huge SAP deployments and that's like -- they spent $40 million on it and they're still running the company in Excel. It is the most shocking thing I have ever seen. So, yes, I mean they're getting -- our software actually works.

Unknown Analyst

How do -- I mean, other thing about ERP that makes it a little bit more challenging is you have to have the functionality.

Zachary Nelson

Yes.

Unknown Analyst

You can't come to market with something that's not fully functional. And typically the buyer is very vertical-driven. They want to have a reference account in software and wholesale distribution. How do you think about when you're investing in R&D going upmarket in some of these areas? And where are you placing your bets today?

Zachary Nelson

Well, you're right. The ERP is definitely a functionally-driven sale. If you're selling to a distributor and they need demand-based inventory replenishment and you don't have it, it doesn't matter if the bits come from Mars or from the Palace Hotel or on a disc, they're not going to buy it because it doesn't solve their problem. So that's one of the challenges -- why nobody really -- we're the last -- we're the first system ever built designed to run a business. We're probably the last ERP system built in 20 years is because it's very hard to build these applications. The second piece that comes into play is their product needs become very vertical, very quickly, and the sales process becomes very vertical, very quickly. If I go to sell to Goldman Sachs, you say, "Show me some other investment banks using NetSuite." I don't care that John Deere dealerships are using NetSuite. So the sale becomes very vertical and the functionality becomes very verticalized. So that's another challenge in moving upmarket is how do you verticalize software for all these different industries? So we've spent the last 5 years verticalizing the product, verticalizing our go-to-market strategy, verticalizing our services strategy around a number of industry groups, number one. And number two, we were lucky enough to find in 2008 a horizontal problem to solve in ERP, which is almost impossible to find. And that was with our OneWorld product, where we were able to do multi-company consolidation. Every multinational has the challenges, how do I run my international subsidiaries as separate instances, U.K. and that in pounds. Japan in Yen and Tagata and on and on and on, but then consolidate results across those. And when we built OneWorld, suddenly we tapped into a horizontal ERP problem and that was a big accelerator to our growth. The latest horizontal that we've tapped into, which you don't really think of as ERP but e-commerce, is the latest horizontal we found introduced a new version of our commerce platform that we think is going to be very important, a driver very similar to what OneWorld has been.

Unknown Analyst

Yes. And another thing that you've done a good job of is, I guess, when you say 2-tier ERP, what does that mean and what's the strategy?

Zachary Nelson

So 2-tier for us is all about -- and if you look at large enterprises, what they've -- they spent $100 million on Oracle or SAP. That was really to provide a standard platform at their top tier, their biggest subsidiaries, the corporate level. But these multinationals have hundreds of subs below that, that either aren't worth the cost of Oracle or SAP, you don't have the 3 years to go implement in Mexico, in the Philippines, in Thailand and you don't want to put the humans to support the systems, right? It's not just like you put SAP in India, you put 40 people in India with the system, right? So what we began to do with OneWorld is drive what we call 2-tier ERP, and that has begin to consolidate these companies' second tiers not from a value standpoint but from a subsidiary standpoint, remove that Tower of Babel where you have a Sage-based system in the U.K. and a Yayoi-based system in Japan, a TOVAS Systems in Brazil. Suddenly, you can have a common platform called NetSuite where you can have your Brazilian sub, U.K. sub, French sub, Swedish sub running on a common platform in their currency locally, but then consolidating across those subsidiaries. So you get a standardization across both tiers of your enterprise, if you will. Your enterprise tier where you spent the $100 million on Oracle or SAP, and now your subsidiary tier where you had a Tower of Babel before, you have a common cloud-based platform called NetSuite OneWorld that you run that portion of your company on.

Unknown Analyst

And how broadly penetrated is that? Where are we in terms of 2-tier deployment?

Zachary Nelson

We're just -- we're doing quite well, we're just at the beginning of it. But the interesting thing is we are being deployed litho essentially Oracle's and SAP's largest customers in that way today. And so that's a pretty good sign that this approach, I think, is going to work across-the-board. The other things we've had to do operationally in addition to the product, OneWorld is an incredible product to solve the problem technically is to build an enterprise sales force to actually deal with the enterprise sales cycle. NetSuite has largely built its sales model around midsize companies, which frankly I think is the harder problem to solve. How do you sell SAP-like software to a company that can't afford SAP-like software, right? And how do you have a 35-year-old selling to a CEO? This is a very complex sales challenge to solve in the mid-market. Actually moving the enterprise is much simpler. Companies have budgets, they have IT people, they have resources. So we've spent the -- last year was a huge investment for NetSuite in terms of a true enterprise sales force.

Unknown Analyst

Yes, can you maybe talk about that investment. That enterprise group of -- I guess the first year really was last year. How big do you want that? Where is it today? How big do you want it to be over time?

Zachary Nelson

Well, the group from a percentage standpoint was the largest investment in terms of sales heads. It was also the fastest ramping group we've ever seen. The pipeline growth was spectacular. We're not talking about going from $1 million to $5 million of pipeline. I mean, it's a substantial pipeline growth. So this year, again, I think the percentage growth of that group will be the highest again, but it's coming off a smaller base. The other thing we're doing there and I think you're going to see us double down is how we go to market with systems integrators, Accenture, Deloitte. These folks have great relationships with all of those companies they're in. In many cases, they deployed SAP and they deployed Oracle in those organizations. So we had great success really partnering with them in going to market and we're going to see incremental investments certainly from us in terms of how we partner with the big SIs.

Unknown Analyst

Interesting. I mean that brings up a good point. A lot of the sales of ERP, even at the higher end of the mid-market, and definitely at the large-scale was sold via SIs or held [ph]. Now, SaaS, one of the things is it doesn't have the same services drag to it, right? Can you talk about kind of the fits and starts of the SI ecosystem? And are we at a point where these SIs are really betting big on SaaS ERP?

Zachary Nelson

Well, frankly, I think it should have as large a services pull through as traditional software for a couple of reasons. One is the implementation processes is still -- implementing SAP, implementing NetSuite, kind of the same. I mean, our servers are spun up, you don't have to go buy a bunch of hardware. But you have to migrate data, you have to do business process definition and customization and you have to train the users. So very similar sort of implementation process. Secondly, I think there is an enormous opportunity for value-based pricing here. If you look at what we did for Groupon, for example. You love Groupon, you hate Groupon, I happen to love Groupon. They're a great customer, one of the fastest-growing companies in the world. We deployed 26 countries, full financials, 3 months; 44 countries, full financials, 1 year. Could you even have done it in SAP or Oracle? So if that would have normally been a $40 million SAP implementation, and it may not have actually worked, shouldn't they have paid $40 million for something that worked in 6 months? They should have actually paid more. So I think there is this enormous time-to-value that NetSuite provides customers that we don't necessarily do as good of a job of extracting that value because we're not a services company, we're a software subscription company. We see services as an investment in the recurring. Accenture is a services company. They would now how to value price. Well, you want to get live in 3 years or 6 months? 6 months. Okay, that will cost you 6 times as much, no problem, right? So I think there's some interesting opportunities around value-based pricing on the services side.

Unknown Analyst

And when do you think, I guess, because you -- McGladrey, Baker Tilly, Accenture, I mean, you've kind of lined up a bunch of these, done at the higher end and some at the mid-market level, where are we in that kind of impact to your business? I know it's less than 40% of your new business today. But where do you think that can go over time?

Zachary Nelson

Well, I think it's gone very well. If you think about how disruptive Software-as-a-Service model is to other software companies, right? We've disrupted the SAP model. We've disrupted the traditional client server software model. Everything is different about it, right? We built -- we get our value over time, they get their value upfront. We run the software for our customers, they hand the customer a disc and dare them to install it. Everything is entire -- is complete upsetting of their old business model, which is why they have such a hard time doing what we do. The services world has in many ways the same problem. If you look at the classic VAR channel that supported the mid-market, they make most of their money -- or they made most of their money, frankly, shocking the server back into life, running the server for the -- guess what, we shocked the server back into life, and in fact, we never have to shock it back into life. It never goes down. We built -- made the software so it's maintainable, right? So all of that revenue vanished. And so what had to happen in the mid-market VAR channel was a whole new class of VARs had to emerge. Number one, they've tooled their business around being experts in their customers' business, not in terms of maintaining NetSuite software. So you've seen that happen. And we've also encouraged that by giving them a piece of our recurring revenue. If they -- if we didn't give them a piece of the renewal, they would never survive because so much of the maintenance revenue they traditionally got was gone. So that was one headwinds for VARs being successful. In the -- so that's low-end VAR, then you have sort of midsized VAR, the McGladreys of the world, those folks, and then the big SIs. All of them have similar headwinds. So when you have -- and that's why most SaaS companies built direct sales forces because the channel was never going to sell the stuff for you. In fact, they were against the stuff. So NetSuite, Salesforce.com, go through the list, all direct salesforces. So when you have a direct salesforce and you try to add a channel to it, the fantasy always is, "Oh, some day I want to be 50-50. I want everything split." You never get there. Amazingly, last year, 33% of our revenue came through channel partners. That is pretty amazing. And so I think we could someday get to the mythical 50-50. Part of it has to do with our program, we give them 30% of the recurring. That's enormous. It's an incredible business model. We give them a chance to enjoy what NetSuite enjoys and what our investors enjoy in terms of the gift that keeps giving, this renewal. The second thing that you've seen change is the demand curve. So the other thing that motivated, frankly, the channel was not NetSuite's great program, it was customers saying, "We're not going to buy anymore of this Great Plains stuff. We want stuff that looks like Salesforce.com.", so they said "okay". Or NetSuite beat them in 5 deals, right? So like we have to start offering this because the customer is demanding it. So clearly,

the customer demand curve has changed and the VARs have come along with that. So and then you look at something like McGladrey. McGladrey was Microsoft's biggest reseller. They love NetSuite. They -- all guns are pointed towards cloud, cloud ERP, NetSuite. So you've seen a big sea change. So I think you could get to the mythical 50-50 someday.

Unknown Analyst

You mentioned, I guess, there's more awareness now. One thing that you mentioned in the earnings call that your investment posture is going to get a little bit more aggressive next year. Could you talk about kind of the thought process as why get more aggressive? Where are you placing those bets? And you've been a consistent performer of actually accelerating growth and free cash flow margin expansion at the same time, and you've taken a more aggressive approach. Why?

Zachary Nelson

Well, you look at the last 2 years of NetSuite's performance and as you say, the top line's accelerating, it's nice to see in a company of our scale. And we've always felt over the last 2 years that we've been capacity-constrained. And the reason we felt that way is we looked -- we added enormous capacity last year, 50% quota capacity. And that's only 50% reps, but 50% incremental quota. And when you add that much quota capacity, you expect your productivity to go down. Our productivity remained flat last year. So to us, we feel pretty confident that we could do that again, at least do that again because we're not nearly meeting what the demand that's presenting itself to us must exist for us to have that much capacity. So this year, and frankly, last year if you remember when we put out our guidance at the beginning of the year, I think we were talking about doing something maybe a little north of 6% operating margin. We actually -- it's 7.2%. But that's, we didn't -- sorry, we didn't want to do 7.2%. We just couldn't spend the money fast enough. We couldn't hire fast enough. So while it looks like we're going from 7.2% to something closer to 6% this year, our intention was never really to do 7.2% last year. So the investment looks more aggressive but part of that is because we didn't hire to our plan last year. We hope to hire to our plan and spend it all, as we promise you, in terms of -- to getting to the opportunity.

Unknown Analyst

And where -- sales and the...

Zachary Nelson

So the major focus of investment, if you look at what we're focused on at the company, it's really 4 things. One, how do we grow at 30% or more for a long time? So that has a lot to do with sales, it also has to do a lot with product. It's really focusing investment in 3 core product areas where we see big competitive advantage and traction. One area is OneWorld, which is obviously growing very quickly. Second area is SuiteCommerce, really the commerce enablement. Of turning your ERP system into your customer-facing system. Incredible opportunity there. And the third area is in some deeper functionality in the recurring billing area. So big incremental investments in those areas. The third thing we're investing in is brand advertising. We actually do have pretty good awareness in the world. But and where we're known, we're incredibly favorably known. So if we can move our unaided awareness from 6% to 10%. We think that has a big impact as people refresh their ERP systems. And the fourth area is really incremental investment in customer success, particularly our very large customers.

Unknown Analyst

Advertisements, okay. What have you seen -- and it sounds like SaaS ERP is something that, it feels like it's been coming on for years, right? And Great Plains has been around, Microsoft has announced different cloud initiatives...

Zachary Nelson

It never happens, yes.

Unknown Analyst

Yes. What are the tactics you're seeing from the competitors today? And are they any -- how are they different than they were 3 years ago?

Zachary Nelson

It's pretty crazy. In the mid-market, these -- the mid-market companies, the Microsoft, Great Plains, the Sage, the Epicor, well, let's take those 2 because they're still standalone companies. They just don't have -- Microsoft, I don't think they can even spell ERP anymore, right? It's not strategic to their business. If you talk -- listen to the call, business unit that has -- they don't even mention ERP. So they're not going to go spend $1 billion, even though it might be interesting to rebuild all of their systems to be cloud-native systems. This is what you have to do. You can't put a browser on these things and host them. Sage, different set of problems. They just don't have the money. They have hundreds of code bases, and they can't invest in any of them, right? So they don't have a way to get to the cloud efficiently. You look at the other mid-market players who have really vanished in the last year, Epicor, Lawson, Infor, these guys have become private equity companies, right? And private equity isn't know for its technology innovation, right? It's a financial play now. So they will never get the money to invest in building a NetSuite-like product. It's time to milk the cash cow. So you look at the mid-market, it's NetSuite as far as the eye can see. In the enterprise space, which I think the challenge is -- if the Oracle could build this -- yes, SAP has tried to build it. They failed a couple of times, Business ByDesign. They're changing their strategy there. They are more about job reviews than about ERP today in the cloud. So -- but I think the bigger issue for them is, in addition to having -- it's really hard to build what we built is the business model. It's the do I take my sales guy who is used to getting $3 million on Day 1, how do I turn that into an average $50,000-a-year sale? So the business model doesn't really allow them to make the transition that we've made. And the good news for us is we started -- and that's why technology always moves from the bottom-up, right? Every time I sell to an SAP customer, my margins expand. Every time they sell to a NetSuite customer, their margins contract. Nobody likes contracting margins. That's why technology never comes down, it always moves up. So we feel pretty confident about our technology position. And obviously, we bet on the business model at 14 years ago, before anybody else bet on it.

Unknown Analyst

How far up do you want to go?

Zachary Nelson

As far as the customer wants to take us. We had a conversation with one of these big enterprise customers that started to deploy us around the edge. They were -- the thing that you run into in these large enterprises is incredible institutional disarming because we're an SAP shop. We don't -- but in these cases, we got in there, they say, "Holy cow, this stuff actually does work." And our last meeting with one of those CIOs and one of those traditional on-premise ERP biggest is was how quickly can you replace all of this at our company? And I'm like, "Well, you tell me. I mean, you know more about how you're operating your operation than I am." But that's a pretty powerful statement when you start to see that sea change. Now that said, I think the biggest impediment in those large institutions is institutional resistance to change, particularly around the system. But they have so much on their plate, we're going to penetrate around the edges, we're going to be successful and they're going to want more and more and more of this stuff because, as I said, it works.

Unknown Analyst

Couple more questions. I do want to open up to the group, but you did a list price increase a couple of years ago. Where are you on pricing? Do you feel like you're adding value every year with some of the innovations. Is there an opportunity to capture some more of that value?

Ronald Gill

Yes, I mean I still think in the enterprise were underpriced. I mean you just look at our average sales price growth is pretty -- you don't see companies growing 45% average sales price, even last year at 20%. I mean you just don't see it. And then you look at things like SuiteCommerce, which are enormous incremental value that they simply can't accomplish today. So we haven't done a significant across-the-board price increase for a couple of years, but ASPs continue to grow, and we're certainly looking at what we're charging in the enterprise because we're bringing enormous value at a fraction of the cost of things like SAP.

Unknown Analyst

One of the things, I guess, get to 1 financial question before I open it up. The billings growth was very strong in Q4, 41%. But then you had some adjustments. Can you maybe explain what those adjustments are just so we get an understanding of why there's some normalization going on?

Zachary Nelson

Yes. So there's always things that we adjust for in billings. The term, obviously, impact that we tend to try to do 1-year deals, but our dealing has expanded a little bit to 2-year deals. But so 1 part of the billings metric that you have to look at is how much do we bill upfront, right? Bill more upfront, that has a positive impact to the deferred revenue as an example. So we always normalize for those things, currency fluctuations. What happened last year that has the biggest sort of normalization impact was in our old contracts, we had a clause upon renewal said when you sign this renewal clause, you're going to renew. But another clause, you have until the actual date of your renewal to back out of the renewal you just committed to doing. And so, since there was a right for them to back out which they never did of the renewal, even though we might bill at that point for the renewal, we couldn't put it on the balance sheet we had to back it, we had to de-gross it off the balance sheet because they had a right to back out of the deal. So what we did in Q2 is we took that clause out, which effect -- which in effect, now when they sign that renewal invoice or that renewal invoice, it goes into deferred revenue, the amount you bill. So every quarter, in a sense, you're pulling forward billings that would have been recognized the prior quarter into the coming forward quarter. Now this effect obviously cascades throughout the year. And so in Q2, it had a positive effect to billings because more came in and none went into Q1, right? Q3, the amount that went into Q2 was about equal to the amount that came into Q3. So it really had no effect. Q4, it was a big effect because you have a lot of Q4 renewals, which with the old model would have been effectively allowed to be billed. In Q1, you now saw in Q4, the amount was like $5.7 million on a net basis. So now you've got $5.7 million that came out of Q1 into Q4. The amount that's going to come in from Q2 pull-forward is not going to offset the $5.7 million. So in effect, when we normalize 41 came down to 43 because of this pull-forward. In Q1, we'll probably normalize up because the negative effect will be separate. So...

Unknown Analyst

Yes, and then Q2 will be down, yes.

Zachary Nelson

It was really just an accounting change. It made our life the heck of a lot easier because what we have to do at the end of quarter was we'd have to de-gross all of our renewals to see what our actual billings were and all these things. And nobody ever used the out clause anyway. So that's what it is. But we always trying to get people like to like. And we always warn people on the calculated billings, you really look at the 4-quarter number, anyway. There's so many things that go into a given quarter, but a 40 in a given quarter isn't as good as looking across 4 quarters for the actual billings.

Unknown Analyst

Okay. I do want to open it up to questions?

Zachary Nelson

So I'm sure that was more confusing than it was, explanatory. I'm confused.

Unknown Analyst

Will go here, right here, and then we'll go there next.

Unknown Analyst

[indiscernible] what percentage of your business that is greenfields versus cramping out someone else?

Zachary Nelson

Yes. So there is no greenfield for ERP. If you look at -- if you're running a business, there's 1 system that kind of works, it's called your ERP system. So we're always replacing something.

Unknown Analyst

I guess I just thought being a mid-market focus that you would be selling a little bit into new companies or spinouts or that kind of...

Zachary Nelson

A little bit. Most new companies, frankly, they go by QuickBooks, right? And so and they worked that for as long as they -- now, in some cases, you look -- now it's pretty rare. I mean you see some high-tech companies doing it. But by and large, you're replacing something.

Unknown Analyst

Okay. And the second question is on a workday. Obviously coming from a more of an HCM focus but they are trying to wrap their financials. I wonder if it's possible to compare and contrast a little bit between your strategies.

Zachary Nelson

Well, I think ultimately, you're right. They don't really have financials to speak of today. We don't have much HR to speak of today. So other than that, we compete all the time. That's kind of a joke. Obviously, we don't compete much. I think what they're going to do is what PeopleSoft did. PeopleSoft was really strong in non-transactional business, government, universities, higher ed. We -- NetSuite is really strong in transactional businesses, wholesale distribution, manufacturing. So even when they have financials, I don't believe we are going to be in very similar industry groups. And they have a long way to go to having anything close to what we have in financials. So it could be a long time before they can do things like OneWorld, multi-company consolidation. It will be a long time before we can compete. And I think even when they have some form of financials, it's going to be -- there's not going to be a ton of overlap between the industries that we're focused on. Ultimately, I think we're going to very well in HR-oriented processes. We're going to own the operational process world, right? Where SAP is, that's what NetSuite looks and smells much more like.

Unknown Analyst

In the past, you've spoken about how the software proliferates because you get into in enterprise you kind of start maybe international subs and you grow. Can you give us a sense, for one, your growth between new customers and penetration of existing customers and how that's accelerating? And then secondarily, as we think about an S-curve in terms of that adoption within enterprise, how long did it take for you to get to some type of holistic solution across the entire enterprise?

Zachary Nelson

A lot of it depends on how quickly the company wants to move. In general, we are very early in all of these cycles. We're very early -- if you look at our market share, if you look at Gartner, what is it, 3%, 4%? We're #8, we're in the top 10, but we have a long way to go across the model. I'd say the way we look at the business, the way we modeled the business is, across-the-board, we view our renewal base effectively as renewing it 100% a year. So in effect, churn and down-sell is replaced by upsell at 100%. So what we sold in Q4 of last year, we sell again 100% Q4 this year. So all of our growth generally the way we model it comes from the new business. And so that's whether it's across midsize or large -- now, in most cases, upsell more than replaces churn and down-sell, but that's not how we model it. So in terms of upsell into larger accounts versus smaller accounts, we're looking at that a little bit now. Larger accounts tend to buy more on Day 1 than smaller accounts. So strangely enough, anecdotally, we've seen more upsell in smaller accounts than larger accounts because of that phenomenon. But we're really looking at it, trying to understand it better and seeing if there are different ways we can structure our price book so that we do see more ongoing product sales. We see a ton of ongoing services sales into these larger accounts. You certainly see our services revenue grow as we've grown upmarket, but we're definitely evaluating how we structure things to see more product sales as product gets more broadly deployed in larger companies.

Unknown Analyst

There's a question right there.

Unknown Analyst

I'm just curious about the position in emerging markets. It seems like there's been a lot of software underinvestment in these countries with high growth, Brazil, India and over in Asia. Then you have SAP really tackling that multinational corporations. But local players like TOVAS in Brazil seem to be doing well with the -- in the SMB market. Can you just talk about your position in those markets? And how the company is positioned?

Zachary Nelson

Yes, I mean Asia is growing rapidly for us, both Australia but also sort of greater Asia, Thailand, Singapore areas, China multinationals in China. So we continue to invest incrementally there. We have the products totally localized. OneWorld is all about multi-company consolidation. 190 currencies, 50 direct tax regimes, great support in the product from a localization standpoint. Brazil is very interesting. Brazil probably has the toughest tax code to model of anything that we've seen. So we're looking -- we're going to have to add some serious tax engine capabilities in the next year in Brazil. That said, TOVAS, the reason I'm talking to them says that cloud won't work in Brazil. They want it all on-premise, which is always music to the ears of NetSuite. So TOVAS is doing very well, but they -- I guess the cloud doesn't work in Brazil, according to them.

Unknown Analyst

Okay. One more.

Unknown Analyst

Recognizing that margins are not a focus for you right now, can you perhaps talk about the unit economics on a typical contract? And potentially, what structural margins for a SaaS business like yours would look like over time?

Zachary Nelson

Well, you could see it pretty much on the income statement, what it looks like. I mean we anecdotally, say, "Hey, first year, we'll break even on a deal, right?" A dollar -- it costs us $1 to get $1. Now as you get to larger companies, the economics get a little better, it gets a little more profitable faster, but obviously, all of the economics are in the renewal. And so if you look at the cost of our gross margin on the services line of the income statement, it's-- what is it 86%, 87% gross margin? I mean, this is very high margin business in years 2, 3, 4, 5, with very little cost on an ongoing basis. So we think certainly this model looks as profitable as the maintenance streams of an Oracle or SAP, because it has almost identical characteristics with the exception of this is healthier than those maintenance streams. The customer is actually getting benefit from our upgrade year after year after year, where the maintenance they paid for, I guess SAP just raised their maintenance because it was so good. They raised their maintenance prices. A customer actually sees as a pain, they have to install it, they have to upgrade it. So this is actually a healthier revenue stream, I think, even though it is has almost all of the same characteristics from a profitability standpoint of a license-based maintenance stream.

Unknown Analyst

Any other questions? We've got time for maybe one more. One other question I had a perception that ERP is macro sensitive, right? And there's been not a lot of software companies, at least in our universe, that have -- had very strong quarters. A lot of it is due to macro-ish holdup kind of dynamic. What's your view on that? Are you seeing a lot of deals pushed due to macro? Or is there -- is the secular trend that way in that?

Zachary Nelson

No. I mean our opportunity is interesting since we sold the Fortune 5 Million, right? So you have -- some industries are doing well, some industries are doing poor in that world. So you've got this enormous opportunity. So I don't think -- everybody is countercyclical but I think a little bit of it is true for NetSuite. I think the other thing that's very important, the other big driver of our business now is what's happened, I think, over the last couple of years is that every CEO has realized their business is a cloud business. P&G is certainly a consumer packaged goods business, but they're a cloud company. If you're producing cattle and beef, you're a cloud company. You have to figure out how to use this ubiquitous network to reach customers in new ways. And what they do is they look internally and they say, "Look at our core business systems." Not only are they not network-aware, they're actually built to prevent the access on the network. There's no way we're going to be able to transform our business on systems that are inaccessible on this ubiquitous thing called the cloud. And so that to me is, I think, what the fundamental change that's happening, the retooling, the acceleration of ERP replacement is really driven by that phenomenon. These systems were designed for a world that no longer exists.

Unknown Analyst

Right, we'll close it there, Zach, thank you so much. Fantastic...

Zachary Nelson

Thank you. Great.

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Source: NetSuite Inc. Presents at Goldman Sachs Technology & Internet Conference 2013, Feb-13-2013 04:00 PM
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