Welcome to NetSuite's fourth quarter and full year 2008 financial results conference call. (Operator Instructions) At this time, I'd like to turn the conference over to Jim McGeever, Chief Financial Officer of NetSuite.
Good afternoon everyone and welcome to NetSuite's fourth quarter and fiscal year 2008 financial results conference call. By now you should have received a copy of our press release issued today after the market closed and furnished on Form 8-K to the SEC.
Joining me on the call today is Zach Nelson, our Chief Executive Officer. Zach and I will begin with prepared remarks and then we'll open up the lines for questions.
As a reminder, today's call is being recorded and a replay will be available following the conclusion of the call. To access the press release and the financial details please access our investor relations web site at www.netsuite.com/investors.
During the call we will be referring to both GAAP and non-GAAP financial measures. The GAAP reconciliation to non-GAAP information is provided in the press release and on our web site. All of the non revenue financial measures we will discuss today are non GAAP unless we state that the measure is a GAAP number. These non-GAAP measures exclude stock based compensation expense and the amortization of intangible assets.
Any non-GAAP outlook we provide has not been reconciled to the comparable GAAP outlook, because we cannot readily estimate the impact of our future stock price on our future stock based compensation expenses.
Some of the information discussed during this call including any financial outlook we provide may constitute forward-looking statements within the meaning of the Federal Securities laws. These statements are subject to risks and uncertainties and assumptions and are based upon information available as of today. We disclaim any obligation to update any forward-looking statements.
The risks and uncertainties that could cause our results to differ materially from those expressed or implied by any such forward-looking statements are summarized in the press release we issued earlier today. They are also described in detailed reports that we file from time to time with the SEC including our most recent 10-Q filing which I encourage you to read. All of these filings are available at the investor relations section of our web site.
With that, I will now turn the call over Zach.
Thank you all for joining us this afternoon. Following the shock that hit the world wide economy at the end of Q3, we were cautious as we moved into the fourth quarter. Now with Q4 behind us, I'm happy to report that NetSuite turned in a very strong quarter to close the fiscal year with record results on both top and bottom line.
Q4 also answered the question that some of our investors have asked over the past year. When will NetSuite become profitable? Well, Q4 gave you the answer. For the first time in our history, we made a non-GAAP net profit and were profitable on a non-GAAP operating basis as well. Non-GAAP net profit of $0.01 or $534,000 represents a $2.2 million improvement over the prior quarter.
For the full year, non-GAAP net loss was $0.04 per share or $2.5 million, an improvement over the $0.10 per share or $5.7 million non-GAAP net loss in 2007. And, in the face of what most agree is the most challenging economic environment in our lifetime, NetSuite continued as one of the fastest growing software and software service companies in the world.
Q4 marked another record quarter with revenue growing 30% plus over Q4 2007 to $41.4 million. In a quarter where our revenue was negatively impacted by foreign exchange and saw U.S. equipment and software spending fall some 28%, we were very pleased with the top line performance.
For the year, total revenue reached $152.5 million, growth of more than 40% when compared to 2007. We also saw solid customer acquisition and continued average selling price increases in Q4. We added roughly 350 new customers in the quarter, and importantly, our average selling price hit a new record in Q4 reaching $340,000 per customer.
This increase in average selling price indicates continued success in our efforts to move up market to larger, more profitable customers. For the quarter, our average selling price increased 20% versus Q4 of 2007.
This sizeable growth in average selling price is attributable to several factors. In the quarter, we saw the average number of users per deal increase. Also, new products like NetSuite OneWorld continued to gain traction. NetSuite OneWorld is the first and only on-demand system to deliver real time subsidiary management and business consolidation capabilities to mid market companies for accounting, ERP, CRM and e-commerce operations.
All of this capability comes at a fraction of the cost of traditional on premise ERP solutions. Since its launch in April, NetSuite OneWorld has gained popularity not only in North America but also in Europe and Asia Pacific. There really is no other product like it in the world and it's helping companies run their global business with an ease and at a cost they've never imagined possible.
Less than a year after its introduction, OneWorld has been adopted by more than 200 customers across the globe. OneWorld's impact on NetSuite as a company is also meaningful. In Q4, OneWorld accounted for more than 35% of our new business bookings, were our total average selling price grew to $34,000 per new business contract. That number changes to more than $100,000 per contract when you look only at NetSuite OneWorld new business. And importantly, our pipeline continues to build.
One final point on the Q4 results. While we don't typically talk about bookings, I did want to give you an idea about the tone of the business during the quarter. On a bookings basis, we were up approximately 20% over Q3. As seen in the results of other SAPS companies, and as expected given the economic uncertainty, more of our customers requested quarterly or even monthly payment terms versus the usual one year upfront contract we strive for.
This change in billing term decreased the amount of our new business bookings that ultimately showed up in deferred revenue. Jim will speak in more detail about the change in term and the impact of that change, but we were really happy to see the new business aspect of the model rebound in Q4. For the year, bookings grew approximately 30% over 2007.
So to summarize the quarter and the year, with 20% quarter over quarter bookings growth, record quarterly and annual revenue, our first profitable quarter on a non-GAAP basis and record average selling price, NetSuite turned in one of our best performances ever.
What led to the success in Q4 and fiscal '08 and what will drive the company in 2009 is our unique business strategy and focus tactical execution. Our strategy of providing an integrative suite of applications, delivered on demand to small and medium sized businesses and increasingly to divisions of very large enterprises, is even more applicable in these times where cost reduction and productivity improvements are required for survival.
The cost reduction that our products enable companies to achieve is partially due to the fact that we deliver our applications from the Cloud. Unlike applications like Microsoft Great Plains years before the internet became ubiquitous, with NetSuite, customers no longer have to pay for the resources required to manage, update and upgrade our applications.
Firms like McKenzie have indicated that our software service delivery model such as the one NetSuite pioneered in 1998 can reduce the cost of ownership by as much as 40%. But NetSuite takes that cost savings a step further by integrating the functionality of multiple applications into a single application eliminating the cost of cowboying together multiple incompatible applications with our Suite approach, compounds the value of our offering.
Synchronizing data between applications, even Cloud based applications, is always difficult and expensive and even the world's largest companies have a hard time of doing it right. Combine this integration challenge and related expense with the multiple training and subscription requirements required for users, the different technical resources required to manage the vagaries of each application and the lack of a single vendor who takes responsibility for the coupled together application environment, and one can easily see why Gardner concluded that most companies spend 75% of their IT budgets just to maintain the Legacy systems that they have.
As evidenced by the 350 companies that licensed NetSuite during the quarter, we believe companies will continue to migrate to NetSuite because it is far more affordable, provides massive improvements in productivity and moves their businesses to a modern internet based platform that takes them into the future.
In fact, an early driver of our growth occurred after the dot com bubble burst when companies moved to NetSuite to reduce the cost of their IT infrastructure and prepare their company for the turn around by building on a modern web based suite.
I would also like to add that the concept of the suite is not at odds with another important element of our strategy, and that is our platform strategy. NetSuite, with its NS-BOS environment is arguably the most flexible and extensible business application in the world.
With NS-BOS, corporate application developers and third party ISV's can extend NetSuite's core ERP CRM and e-commerce functionality to meet the unique business requirements of most businesses. And Net Suite's usage of the platform continued to grow during the quarter and the year.
We saw a unique log in to a NetSuite platform increase 36% from 33 million unique log ins in 2007 to 4.5 million unique log ins in 2008. A great example of how the suite and the platform come together to benefit customers is our recent deployment of NetSuite that we announced this morning at Iron Mountain Digital.
Iron Mountain Digital is a roughly $200 million subsidiary of Iron Mountain, the multi-billion dollar publicly traded company. While Iron Mountain runs a traditional ERP solution at the corporate level, they're using NetSuite OneWorld to manage Iron Mountain Digital including subsidiaries in the U.S. and Canada, with subsidiaries in the U.K., France, Germany and Japan to be rolled out in the coming quarter.
They went from concept to full implementation in three months, initially replacing three separate applications and myriad of spreadsheets in the process. The deployment also required the additional functionality within NetSuite to handle complex usage based billing requirements. This requirement was met by building an application using the NetSuite NS-BOS platform and now accommodates incredibly complex billing rules that Iron Mountain has for their multiple product lines.
In addition, they have used NetSuite's web services to bring into NetSuite customer utilization data from their internal delivery systems. And finally, our web services key financial data for NetSuite into the Oracle corporate ARP instance to roll up financial data at the corporate level.
The Iron Mountain Digital deployment is a great example of the power of NetSuite turning a patchwork of systems into a single unified global system of record in only seven months. NetSuite provides the unified system for the core ARP CRM business processes, the NS-BOS platform enables the application to be extended to meet the exact requirements of a complex $200 million company.
The deployment of delivering a unified system not just in one country but in multiple countries supporting multiple currencies and local taxation around the globe, and the implementation is integrated with other important systems to provide a complete 360 degree view of the customer, and to support mandates handed down by corporate.
The implementation also shows continued progress in targeting divisions of large corporations where an implementation of something like SAP could actually be harmful to the business from a financial and flexibility standpoint.
So we closed the books on 2008 with great momentum. During the year, we have delivered a great product in OneWorld that will carry the company far into the future. We have begun the investments in the NetSuite NS-BOS platform to enable customers and partners to leverage the incredible functionality of our suite.
We have executed well against our sales strategy of moving up market as evidenced by the continued rise in our average selling price. Our substantial investments in professional services and support have helped us increase customer success and satisfaction. And, we continue to press our competitive advantage not just in North America, but around the world.
While 2009 will be challenging for all companies, I truly believe NetSuite is one of the best positioned software companies in the world, and I think we will continue to gain share in the coming year.
I'll go into some of the specifics of the 2009 plant following our CFO, Jim McGeever's remarks detailing our numbers for the quarter and for the year. So with that, I'll turn it over to Jim.
I would like to remind you today that this discussion will be primarily based on non-GAAP financial measures which excludes stock based compensation expense and the amortization of intangibles.
As Zach mentioned, 2008 marked continued enhancement to our best financial performance on both the top and bottom line with the fourth quarter marking the company's first quarter of non-GAAP operating income as well as our first quarter of non-GAAP profitability.
Let me turn to our financial statements for the fourth quarter and year ended 2008. Total revenue for the year was a record $152.5 million, a year over year increase of over 40%. Total revenue for the fourth quarter was $41.4 million, an increase of over 30% over the fourth quarter of 2007.
The increase in revenue was driven by the continued strong growth in our customer base as well as an increase in our average revenue per customer. As Zach mentioned, over the year we have seen solid progress with our strategy to move up market towards larger customers with larger associated first year contract values, or ASP's.
As a result of this up market success, our overall ASP's continue to grow. During the fourth quarter our ASP for new customers reached a record $74,000 per customer, a healthy improvement of Q3's ASP. This was driven in part by our OneWorld product which as Zach mentioned, represented 35% of our new business bookings in Q4 and which carries a higher associated first year ASP of more than $100,000 per customer.
Customers who pay $10,000 a year or more now represent over 90% of our revenue in 2008. Up sell continued to see healthy up take within our install based. Our up sell in the quarter continued to replace lost revenue from customers who either did not renew or renewed for a lower amount than their prior year subscription.
Moving on to revenue by geography, customers located in the U.S. and Canada, delivered $123.4 million in revenue in 2008 while $29.1 million of revenue came from our international regions. Continued strong growth across all our areas of our business fueled this increase.
International revenue represented 90% of our global business in 2008 as compared to 18% in 2007 and 14% in 2006. However, in terms of absolute dollars, international revenue grew over 51% over 2007. We believe international markets provide us with an exciting opportunity to continue to expand our business and we plan to continue to invest in this growth area.
During Q4, we recognized $1.5 million of revenue related to distribution rights of our localized Japanese product. We also expect to recognize $1.5 million of revenue related to distribution rights for our localized Japanese product in the first quarter of 2009. But as a reminder, this level of revenue will not occur in the second quarter of 2009 and beyond. I'll discuss this in more detail later as I address our outlook.
Gross margin for the fourth quarter was 71% which was an improvement over third quarter's gross margin of 68.8%. This was primarily the result of our ability to leverage first half 2008 investment in our services and support organizations. Looking ahead, we anticipate our gross margins to remain approximately 70% to 71% level.
Turning to our operating expenses, product development expense was $17.9 million in 2008 an increase of 34.2% year over year largely due to hiring and translation expenses incurred related to the development of international additions to our service.
Product development expense was $5.5 million in the fourth quarter, an increase of 11.5% over the third quarter primarily as a result of a full quarter impact of new hires that took place at the end of Q3.
For 2009 we expect product development expense to be roughly 13% to 14% of our revenues driven by the continued investment in more internationalized versions of the NetSuite and OneWorld product. Product development continues to be a key strategic investment into NetSuite.
Sales and marketing expense was $73.6 million in 2008, an increase of 32.8% year over year. Sales and marketing expense was $18.3 million in the fourth quarter which represented a decrease of 3.7% over the third quarter. The year over year increase in sales expenses was primarily due to hiring as well as higher commission and travel expenses related to increased sales activity.
As planned, we didn't make any significant hires in the fourth quarter within our sales organization. We ended the year with approximately 170 quote to carrying sales reps which gives us significant sales to continue to grow our business into 2009.
G&A expense was $24 million in 2008, an increase of 55.7% versus the prior year. G&A for the fourth quarter was $4.5 million, a 2.5% increase over the third quarter. This increase reflects the additional expense related to operating as a public company.
Looking into Q1 of 2009, we anticipate G&A to be higher due to our annual audit and legal fees which are certain to be higher in the first quarter. Looking into 2009, we expect G&A expense to be roughly 12% to 13% of our revenue.
In 2008 we recorded a net income tax expense of $1.1 million. In Q4 2008 our income tax provision was $246,000. This provision was principally related to our international entities. For tax purposes, we expect our net operating losses to offset any domestic earnings for the foreseeable future.
Now to discuss our profitability. As we outlined at the beginning of 2008 our goal for the year was to show 2% non-GAAP net margin improvement as we planned to balance top line growth with reinvesting in the business. We are pleased to exceed this and post a 3% net margin improvement over 2007, almost double our stated goal.
On a non-GAAP basis, we improved net loss for 2008 by 66% to $2.5 million compared to a loss of $5.7 million in 2007. On a non-GAAP basis, we improved $0.06 a share but lost $0.04 per share in 2008 versus a loss of $0.10 per share in 2007.
Non-GAAP net income for the fourth quarter was $534,000 versus non-GAAP net loss of $1.7 million in the prior quarter, an improvement of 131% or 5% of revenue. As a result, on a non-GAAP basis, we're reporting earnings per share of $0.01 for the quarter as compared to a loss of $0.03 in Q3 of 2008.
Moving to the balance sheet, we closed the quarter with $124 million in cash and cash equivalents. We believe our strong financial position enhances our competitive position in the market place, particularly with respect to smaller competitors.
Accounts receivable for the year ended at $26.7 million versus $22.6 million at the end of the third quarter 2008. As we have noted to you in the past, given our revenue recognition model and the flow of deferred revenue, we do not use the traditional DSO calculations as an internal metric to manage days sold outstanding.
During Q4 days billing outstanding was up over the prior quarter, however, it was in line with Q4 of 2007. During Q4 the average billing term for new customers was approximately five months, down from nine months in Q34 2007 and seven months in Q3 2008.
As Zach noted, while bookings were strong in Q4, the reduced billing term equates to a smaller portion of these booking reflected in our short term deferred revenue bars. Had our billing terms remained constant with either Q4 '07 or Q3 '08, then our deferred revenue bars would have grown more in line with our bookings growth.
Short term deferred revenue totaled $66.7 million at the end of the year. Excluding deferred revenue associated with our Japanese partnership, total deferred revenue was $64.5 million, an increase from $64.2 million in the prior quarter. As a reminder, we've included a reconciliation of our deferred revenue on our website.
Long term deferred revenue totaled $7.2 million at the end of the year a decrease from $11.1 million over the last year. As continue to shift away from multi-year to one year contracts with our customer contracts, we expect the long term deferred revenue balance to continue to decline.
Cash flow used in operations for Q4 was $5.3 million as compared to $3.4 million for Q3 of 2008. Cash flow used in operations was impacted by the reduction in billing terms, the increase in days billed outstanding and a decrease in our day's payable outstanding. Our goal is to be break even in cash flow from operations for 2009.
Cash flow used in investing in Q4 2008 was $4 million as compared to $1.8 million for Q3 of '08 and $1.4 million for Q4 of '07. Fourth quarter '08 investing cash flows related almost entirely to the purchase of capital equipment as well as lease hold improvements as I outlined on our last call. These related to expansion in our San Mateo headquarters and other international offices.
We added 12 net employees in the fourth quarter 2008 to end the year at 971 employees, an increase of 44% from 675 at December 31, 2007. As we discussed on our last call, looking forward we intend to take a cautious approach on hiring and will only invest in certain functional areas as we see opportunities present themselves.
As such, we expect head count to grow at a more measured pace in the near term. Given the substantial hiring during 2008 in services, support and sales, we believe we have significant capacity at present to continue to grow the company.
Now I'd like to move on to our forward-looking financial outlook which is covered by the cautionary language outlined at the start of the call and based on assumptions which are subject to change over time.
For Q1 2009, we anticipate revenue in the range of $41.5 million to $42.5 million, a non-GAAP net loss of $250,000 to a non-GAAP net income of $250,000. This equates to non-GAAP EPS of approximately break even.
This Q1 revenue outlook takes into account the impact of foreign exchange rates as well as expected delayed revenue recognition on some of the larger, more complex deals that we signed in Q4.
Note that this outlook also incorporates seasonal incremental expenses related to our annual audit and legal fees which are incurred in the first calendar quarter each year. In addition, we will incur incremental expense in Q1 over Q4 levels which relates to the resetting the time and benefit matching and payroll taxes.
In Q4 we demonstrated a bottom line leverage of our model. Looking into 2009 we expect the bottom line possibility with industry leading recurring revenue growth. For 2009 our outlook is for non-GAAP EPS to be $0.04 to $0.06 for the year. This represents over 200% improvement in our expected net income for the year.
Moving on to 2009 top line, the current global macro economic uncertainty has resulted in our visibility not being as strong as it has been in prior years and as such, we aren't giving explicit annual 2009 revenue guidance. However, I still wanted to give you some indication of the relative growth rates of the components of our revenue.
The major components of our revenue are recurring from subscription and support. Non recurring revenue from professional services which is primarily associated with new customers and which does not recur after the initial contract and elements of partner revenue which is non-recurring since it is the Japan distribution right.
If for example, we were to grow our top line revenue at 15% in 2009 over 2008, then the components of our revenue would change as follows; recurring subscription and support revenue would grow year over year by 24%, non-recurring professional services revenue would decline year over year by 4% and partner revenue would decline by $4.5 million as we end the recognition of the Japanese distribution rights at the end of the Q1 2009.
Importantly, in this scenario, recurring revenue which is what we value most is expected to grow significantly faster than our overall revenue growth despite the macro economic environment. Given our significant success in growing our revenue outside of North America, our international recurring revenue is significantly higher than most of the software services companies. Without the impact of foreign exchange rates, our 2009 recurring revenue would grow in excess of 30% year over year.
We're especially happy with our performance for Q4 and 2008 and look forward to continued improvements in our recurring growth and non-GAAP profit line bottom line profitability in 2009.
This concludes my prepared remarks. With that I will turn the call back to Zach.
Managing in times like these calls for cautious investments and fortunately for NetSuite, many of the investments we needed happened in 2008, so we look to harvest the benefit of those investments in 2009 and beyond.
On the product front in 2008, we expanded our product strategy significantly with the release of NetSuite OneWorld, continued investments in the NS-BOS platform and with the acquisition of Open Air.
While of course we will continue to invest in our technology aggressively particularly in the areas of moving up market and the verticalization of solutions, those three 2008 initiative gave us a significant lead over our competition. It would be hard for them to catch our technology head start in good times, and in times like these, our lead looks substantial indeed.
On the sales front, we grew our sales force by more than 25% in 2008. As we enter 2009 we have enough capacity to grow the business faster than the market without additional hiring. One thing you will see us do in the coming months is strengthen our sales management.
This week, you saw the addition of Jeff Honeycomb for example to the Open Air team, and you should expect us to add other seasoned leaders. We will also continue to focus our resources and expand our organization outside North America both in existing geographies and in new markets which we see as important to pressing our advantage and serving our customers around the globe.
We had a great year in 2008 in professional services and support where we saw our investments over the past two years in people and process pay off in higher customer satisfaction. In 2009, we will continue to grow these teams as required to ensure our customers are successful in implementing and using NetSuite.
And finally, in 2008 we delivered rapid revenue growth and delivered bottom line profitability earlier than expected. In 2009, we plan to grow faster in the business applications industry while targeting a more than 200% improvement on the bottom line.
In closing, I do believe we are one of the best positioned software companies in the industry. Our balance sheet and financial performance are sound and they certainly let our customers know we will be around for the long term. And, we have a ten year lead in building the technology and organization to deliver rich business applications that enable the under served mid market to run their businesses more efficiently and for far less money than they are spending today. That sort of value proposition never goes out of style and it's compelling in both up and in down markets.
So with that, we'll now open the line for your questions.
(Operator Instructions) Your first question comes from Tom Roderick – Thomas Weisel Partners.
Tom Roderick – Thomas Weisel Partners
You mentioned that you expect to be cash flow even in '09 and I was hoping you could perhaps walk us through some of the assumptions you're making just to get to that point. Are you assuming the stabilization in the billing terms because you did see a pretty significantly at the end of this quarter?
There's several levers that we have on our cash flow for break even 2009. Obviously expenses is one of them, and we're certainly looking at expense control and not looking to add additional people until we see if opportunities present themselves.
One of the levers is billing term and a lot of that is really driven by the sales comp plan and traditionally our sales comp plan has been more levered to driving revenue growth and you can add components of it in cash flow, so we're carefully monitoring that and will adjust the levels within our sales compensation plan to get back to billing terms if we feel it's necessary in order to get to cash flow break even.
Just to add a couple of comments to that. As you know, as a company, as a management team we are primarily focused on managing the business to the top and the bottom line and we've never before given guidance on cash flow. That's a bit of an indication that we obviously know it's important, but we haven't' necessarily managed it aggressively.
That combined with the economic situation certainly in Q4 where we did see customers requesting more monthly and quarterly terms, and we were certainly open to helping them with those terms and in fact financing their purchases of NetSuite with our balance sheet. So that obviously had an impact on the cash flow, both of those elements.
As Jim said, in '09 we're going to pull some of the levers that we have certainly to more aggressively manage cash flow and as a management team we're also going to put a bogey on our own head to manage the cash flow more aggressively than we have in the past.
Tom Roderick – Thomas Weisel Partners
Can you walk us through the foreign exchange impact on the quarter both on revenue and [inaudible]? Do you have those numbers?
On a revenue basis, the foreign exchange impact was about $300,000. Typically with NetSuite versus some of the other service companies, we actually have a smaller proportion of our revenue in deferred, the number of months of revenue, we have an actual deferred revenue balance.
So what you see is a typically, because those bills go out more frequently and at the time you would bill a new lower exchange rate impacts your revenue. So we do see some of that creeping into our revenue results a little quicker than I think some of the other SAS guys.
It's certainly helps on the bottom line as well but the revenue impact is about $300,000.
Your next question comes from Laura Lederman – William Blair.
Laura Lederman – William Blair
Given the change in duration, we really can't calculate bookings. You gave us a sequential growth, can you give us rough sales year over year growth because you know the calculated billing you get 15% growth but that doesn't take into account the change in duration, so can you give us a rough feel?
If you look at the short term, just look at the change in the short term revenue, excluding the Japan transactions we often back out, then the Q4 '08 over Q4 '07, the rate of bookings that you can calculate is actually 19%. So that's very healthy growth.
Laura Lederman – William Blair
You adjusted for the change in duration? Can you give us a feel for what that would look like?
It would be in the high two's.
Laura Lederman – William Blair
Can you talk a little bit about how the enterprise business did to small business? Obviously last quarter we saw the enterprise business and the mid size business do well, and then the really small ones where people up grade off of corporate not doing as well. Can you talk a little bit about that break out? And also, given how well you did in Q4 on a bookings basis, how come no guidance on a top line even within a very large banded range for '09 and that 15% growth you gave theoretical, is that sort of a realistic number?
Obviously what's going on in the economy, things seem to be changing very rapidly so it doesn't feel like giving '09 guidance is appropriate at this time. Certainly we're looking at how the numbers are turning on a quarterly basis before we decide what investment we're going to make.
So just in terms of how we're looking at the business, and our cautiousness in managing the business, we didn't feel appropriate to give '09 guidance. The 15% was an example just to give you some idea of the elements of the revenue and how they're changing, and certainly this pause on revenue especially if you look at the Japan distribution rights where had it not be for that impact of one time transaction, our revenue would have grown by 3% more in 2009.
Obviously we want to grow as fast as humanly possible. We think we have a huge opportunity. We certainly have enough resources to grow at a very high rate and so we don't intent to let the macro economic considerations slow down what our philosophy is on growth on that front.
In terms of the split between smaller business and enterprise business, it's a little bit hard to sort of quantify. I guess I'll make a couple of statements. One is as you know, we've been focusing on moving up market for most of this year and I think Jim mentioned it in his remarks that something like more than 90% of our revenue is now coming from accounts that pay us more than $10,000 a year. So we've started to make that shift just in terms of order complexity.
The second point I'd make is while we do see a good amount of business coming from Quick Books, you'd be surprised at the size of companies that get along on Quick Books. One of our large OneWorld deals this quarter had 20 users of Quick Books running around the world and they moved to OneWorld.
I think in general, the tone of the business and you see it with OneWorld, and that's really the larger and more complex companies. What they're using in those companies really varies by industry and by company type and it's really hard to assess exactly what they're moving from in that regard.
Laura Lederman – William Blair
What I'm trying to get at is design versus default. In other words were all parts of the business equally strong. I realize you're going up market but was that the strongest piece of the business in terms of everything that came in versus what you expected?
I think the good news about Q4 is that what we expected to happen did happen, and when a customer told us they were going to close, they did close, so that was a very positive thing I think for the tone of the business in general.
I think even if you look at the business excluding OneWorld, what you would assume to be the larger companies, the average selling price in that segment of the business also grew. So we're seeing positive impact of the strategy really across both ends, the low end of the market place, the mid end of the market place and the high end of the market place in terms of where we're focusing our sales resources and services resources and how we're having them go to market.
Certainly new customers who pay less than $10,000 a year, that trend is essentially flat to down, so we are seeing in terms of the slightly larger and then the very large. That's actually where there's more strength in the business versus the very small.
The very small, that's probably the part of the business that we've been moving away from intentionally for quite awhile, and I think just the macro economic environment has just accelerated that trend.
Your next question comes from Brendon Barnicle – Pacific Crest Securities.
Brendon Barnicle – Pacific Crest Securities
You mentioned the log in you had on NS-BOS; can you give us any sense on the number of developers you're developing on it now?
We're going to actually make a fairly significant announcement later in the quarter where we announce a number of third party ISV's developing on it. The strategy with NS-BOS is really twofold; one is targeting corporate developers and effectively extend the functionality of NetSuite and very much the way Iron Mountain extended our core accounting and billing functionality to deal with complex billing requirements. It's a great example of internal ISV usage, or internal corporate developer usage.
Then there's the external ISV developer and we're really looking at those in sort of multiple camps. One camp are those companies that integrate their existing applications with NetSuite to enhance their value proposition and our value proposition. There are lots of those types of companies.
And then there are going to be strategic partners that we work with that are really around the notion of verticalizing NetSuites for specific verticals. So a great example is, tomorrow, we're going to announce a new version of NetSuite targeting multi-channel retail and that is going to be a solution that we offer jointly with one of our partners that has a great POS solution.
So you'll start to see more efforts and more announcements like that that are really strategic for us and take us into a defined vertical or maybe more broadly. In this case, a defined industry where we work with a partner with domain expertise that can help NetSuite expand the application to meet the needs of that particular industry.
How we go to market with each of those partners may vary on the partner and the solution, but that's really sort of the landscape of partners building on and with the NS-BOS environment.
Brendon Barnicle – Pacific Crest Securities
Do you see ISV's who've been on premise only who want to go to a SAS solution who will build sort of an NS-BOS native?
We're starting to see interest in that. Now that's a big commitment and we've had a number of discussions with a variety of large providers in that space. They have a non SAS application and they want to move to SAS. That non SAS application for example needs functionality like accounting, like billing, like CRM so they have a choice. They can go build it all from scratch or they can effectively embed NetSuite in their application and use NS-BOS to extend their application to get to market quickly, to use our experience in managing data centers, all of those things.
So yes, those discussions are certainly underway with regards to existing companies, and again, there are other companies that are doing simple web services type of integrations that allow them to pass data back and forth with NetSuite as well. So that's one type.
There are also other types that have a SAS offering, but again, they need a rich back office functionality and they want to embed that in NetSuite so they're also building on NetSuite using their SAS offering to link to NetSuite in particular for back office accounting functionality.
So you'll see both on premise and SAS based applications building solutions on NetSuite. The key differentiation I think for NS-BOS from other platforms out there is that companies are using NS-BOS to extend our application, so they're effectively embedding our accounting, our CRM, our e-commerce in their application.
In other platforms that you see out there, that's not what's happening. They're saying just come here and build your random application on our infrastructure – very different approach and very different strategy and ours obviously appropriate for where we think NetSuite is pointed, and that is in helping companies run their business.
Brendon Barnicle – Pacific Crest Securities
Gross margins ticked up this quarter. Is that seasonality or it's a little closer to the beginning of the year. Is that the type of thing we should be modeling as we look out to next year?
Next year we expect to stay in the range of 70% to 71%. It may go a little above or below that. There's not really a seasonality so much in our gross margin. It's just relating to the timing of when we make investments in our service and support organization, and we did a lot of investment in 2008 which we really saw some of the benefit of coming through in Q4 of '08.
So we didn't hire that many people in services and support in Q4 which is part of one of the reasons why we saw an uptick in the gross margin line.
Brendon Barnicle – Pacific Crest Securities
The percentage of customers that have come to talk to you about going to a quarterly or monthly bill, do you have a sense of where you are on that cycle as people reevaluate the terms?
The bigger issue for us is really around new business and the terms associated with new business. You do see a little bit of pressure in renewals. By and large you have existing contracts with this customer. They're used to paying based on that contract. So in the case of renewal, it typically tends to renew on the same contractual terms as it was previously signed.
So the focus for us is really, we are focusing on the renewal side and term; it's really on the new business side as well.
Your next question comes from [Michael Nemeroff – Wedbush Morgan]
[Michael Nemeroff – Wedbush Morgan]
Looking at the gross customer ads that you've put up for the last couple of quarters, and then comparing that to the net number that you've given for the end of the year about 6,600 versus last year that was about 5,800 there's a delta there of about 750 customers. How should we be thinking about that maybe the attrition rate among customers during the first year of service, or how should we be thinking about that?
In 2008 the number of customers that did not renew was less than it was in 2007, so we saw an improvement in absolute count basis on a customer count churn. But the one thing, the customers that leave us, historically have been the very small companies, and as we're moving up market and signing larger and larger companies, those companies have a much lower churn rate than the smallest companies.
So as we're essentially working through that small customer base, what you're seeing is the churn is naturally improving. So whilst these customers that pay us $10,000 a year have a higher churn rate on an account basis, it's been fairly insignificant on an actual revenue basis because they make up less than 10% of our overall revenue.
So just to really clearly summarize, our churn on both the customer count side and on the revenue side, decreased in 2008 over 2007 so we are doing a better job of retaining our existing customers both from account standpoint and a revenue standpoint. Part of that is related to how we're targeting our resources so as we move up market, those tend as Jim said to be the stickier customers and more capable in some sense of implementing a suite like NetSuites.
And it's also a part of what we have done over the last couple of years, and that is moving away from the very low end of the market place where the churn is naturally higher.
[Michael Nemeroff – Wedbush Morgan]
Could you tell us what the size is of the customers that are asking for the quarterly or monthly billing option and I guess that leads into the question of what was the size distribution of the customer growth during the quarter?
As you can imagine in Q4 it was everyone. I shouldn't be so bold as to say that, but basically in that environment in Q4, a lot of folks were asking for different terms than our traditional one year up front. As I'm sure most of your businesses and our business was, we went to our vendors saying how can you do this for me?
Q4 has been a real bit of an aberration both in terms of the macro environment, and quite frankly in terms of our internal focus on maintaining terms. So I think it was a bit aberrant for both those reasons, and I can't really give you a feel for was it the big guys, the small guys, I think it was probably everybody.
The two components of billing terms is, one where if you have a monthly or quarterly payments, and we saw many customers ask for that. Also what tends to happen in the larger deals, the larger deals tend to have structured payment terms. So it's often they'll only pay a smaller amount up front when they sign the contract, but then they'll pay the bigger amount when the users go live.
So they pay for services, they pay for modules in the suite, but then when the users are adding in three or four months, that's when they'll pay for those. So it's not always the components of monthly and quarterly terms, it's also a component of some of these larger deals having structured payment terms.
Typically in these larger deals with structured payment terms, once you're through the first year, those are typically on annual payment cycles.
[Michael Nemeroff – Wedbush Morgan]
In the past you've highlighted some customer successes over salesforce.com and SAP, are there any of note that you'd like to highlight from Q4?
I haven't really dug through Q4 yet. The Iron Mountain example was the classic example where certainly I'm focusing my resources. Larger companies, divisions of very large companies that are probably either SAP or some other large ERP shop where they spend tens, hundreds of millions of dollars at the corporate level and now they see the incredible cost it takes to get that pushed down into divisions that require a more flexible, a more malleable system.
So we think there's huge opportunity in those divisions in large companies. And in many cases, in some cases it may be replacing an SAP deployment at a divisional level. Often times it's supporting an SAP implementation at the corporate level. So there is a co-existence that goes on in those large corporate's and we're comfortable with that.
We'll be making some announcements that enable that integration of NetSuite with a corporate instance of SAP and make that simpler for our companies to do because we think there's enormous opportunity in that segment of the market.
Your next question comes from Mark Murphy – Piper Jaffray.
Mark Murphy – Piper Jaffray
I wanted to go back to the question on the customer count. By my records you had 6,600 customers today and about 5,600 a year ago, and I think the gross customer ads were about right around 1,500 during the year. Is that a fair way to look at it that the gross ads are about 1,500 and then the net ads were about 1,000?
If you look at the way we define that count. We define it as active customers. We only count customers that are actively using the product. There may be some others that are actually under contract but not actively using the product.
An example is that they were added in Q4 so those are not live. So that's something else to take into consideration.
If you look at that and you do those calculations percentage you're going to get to an approximately the number which is if you go back and look at our historical numbers on customer count, you'll see that's definitely a pretty significant improvement in 2008 over prior years.
Mark Murphy – Piper Jaffray
Is there a time approaching possibly in 2009 where you might be able to disclose a revenue break out of the subscription line versus the services line or do you think you're going to kind of stick with the current methodology indefinitely?
In our financial statements which we filed with the SEC, we're actually not allowed to break out the lines just because we don't have fair value between the elements. So I can talk to it and explain exactly what the components are and just give you an idea, and it is falling as a percentage of our revenue, the services line. In 2007 it was in the high teens and in 2008 it was more in the mid teen number.
Mark Murphy – Piper Jaffray
When the contract duration or the billing terms are changing to your disadvantage, I'm just curious what does that customer negotiation look like, and I guess being that, I guess most customers are very committed and they're very entrenched on NetSuite, why not in these negotiations just stand your ground rather than giving in to seeing your own cash flow suffer this way? How do you avoid having a slippery slope where the customers are exerting leverage over you rather than vice versa?
I'll speak briefly to negotiation. First of all, the contract length is still the same. It's always a minimum year contract. So while they're payment terms may be changing on that contract, it is still a one year contract so that's solid and really doesn't change at all.
In terms of negotiation, at some point why we've been a little more flexible on terms is we want to keep the recurring revenue high and in these negotiations you may hold firm on one year up front, you may have to give more in discount to get that with a particular customer. So our first mantra has been, if you look at all of our deals is, how do we keep the recurring high? That's the focus.
So for example, we'll give on term in order to not have to discount the contract as much because we know as you say, it's sticky. We'll get that back the second year.
Similarly, if you look at how we do negotiate contracts, for example, we'll discount services before we discount the license, because again, the license is a recurring component and the service is only one time.
So our real focus is building the recurring and we would rather do things like, or have historically rather do things like give on billing terms than give on decreasing the recurring.
And a lot of how this works is driven by the sales compensation plan and what the levers are and what their incentives are. So we have some levers in terms of how we design our compensation plan to change the waiting between that revenue growth and cash. And so we're actively monitoring that. We'll look to make changes as we deem appropriate to hit our goal in 2009.
Mark Murphy – Piper Jaffray
So just to be clear, you think by your logic it would be to your advantage to keep bringing the billing terms down even if they go to a month or a week or something like that. Is that going to be the long term direction here?
I don't know if we'd be that extreme. I don't think we'd like to see the term fall any more than it has and it certainly as I said, as we look to manage the business now more to cash flow in the coming year, obviously we're going to manage that much more aggressively. I don't think you need to worry about it coming down any lower.
In fact as Zach mentioned earlier on, NetSuite will have a component of that bonus on cash flow in 2009 which wasn't there in 2008. So you'll see as a company, we're certainly moving towards managing more to cash flow more aggressively than we have in the past.
Mark Murphy – Piper Jaffray
So you'll give in to a certain point to build up the long term recurring revenue but there's some point at which you want to hold steady and you think you've reached that point?
I think Q4 was aberrant. It was a very unusual quarter. On the flip side, if you look at the bookings growth both quarter over quarter and year over year, we were very pleased with that so again, that's always been our focus, is the new business aspect, the top line, the bottom line and now adding a component of cash flow not just to our comp but pushing it down through the organization all the way quite frankly to the front line sales people is going to have an impact.
Your next question comes from Adam Holt – Morgan Stanley.
Adam Holt – Morgan Stanley
A question on your commentary about focusing on larger customers, I think you mentioned that the OneWorld bookings were almost a third of total bookings if not a little bit more. Where do you think that number can go over time and how do you envision refocusing as the environment gets more difficult, your organization on selling larger deals from a sales perspective?
The bookings number around OneWorld has grown each quarter since we introduced it, so that's been very positive, and I think maybe a quarter or two ago we talked about how OneWorld was 15% of the pipeline. So you can see actually a really positive conversion ratio when it's 35% of booking a quarter or two later.
So there's an enormous amount of interest in the product. Macro economic issues aside, we think there's huge opportunity in divisions of large companies, and also just in broad based stand alone companies in general.
Generally speaking I also think as Jim said, that we have over the last year been marching all our resources, not just OneWorld resources but all our resources to focus on larger and larger customers that we changed our pricing model to make that happen. So I think you'll continue to see us move that way with our resources.
Now that said, we continue to do business at what you would consider the lower end of the market place. And my belief is that while that market may be suffering perhaps a bit more than the high end of the market, at the end of the day I call it the fortune five million. There are five million companies in that market segment.
There's an enormous opportunity. It's massively underserved. At the end of the day, some segment of that market is going to be buying enterprise software. We are going to take that share because of the cost reduction and the productivity gains you gain with a solution like NetSuite, and we're already seeing ourselves in deals that we wouldn't normally be in based on some of those attributes.
We're just beginning to touch the tip of the iceberg on this opportunity both on the low end and on the high end and so we think the opportunity is pretty big in both places.
Adam Holt – Morgan Stanley
If I could ask on some of the planning assumptions for 2009, obviously the December quarter was a difficult selling period. There may or may not have been any budget flush, but as we look into the first part of next year and the year as a whole, are you assuming that the environment continues to deteriorate from the December quarter? Are you assuming the environment doesn't get any better? What are some of your macro assumptions and maybe tie that back into how you're thinking about pipeline coverage, close rates, etc.
Our view on Q4 was it was a positive. Almost all the vectors were positive in Q4 for NetSuite which we think bodes quite well for the coming year quite frankly. Churn decreased year over year both on a customer count and on a revenue count. Billings as you guys typically measure it; the change in deferred plus revenue grew 19% Q4 over Q4. That's pretty darn strong.
New business booking grew the way we count it, grew 20% Q4 '08 over Q3 '08. The tone was predictable. When companies said they were going to buy, they did buy. And our customer base quite frankly is somewhat different perhaps than some of the other companies you cover in that there's not a huge budget flush at the end of the quarter. These people are running their business on the product.
In some cases, they're larger companies, but by and large they're not going to flush the dollars down the budget if they don't have to so with all those vectors pointing positively in Q4, we're actually pretty excited about what we see going forward in '09 for our business.
The other comment that I'd make on that is one of the things that we're seeing, if we look at on premise market, software companies, they seem to be struggling, having a lot more struggles than we are. So one of the things that we've always said, and we think this is absolutely coming true that even in a down economy, the business application pie may shrink, but we think us as well as small size companies are going to just take a much bigger piece of that pie.
We think we're already seeing even into 2009 we're going to see an acceleration of our market share grow against other mid market on premise companies. So even if the pie shrinks itself, we think we may be able to offset that with share improvement.
Your next question comes from Michael Huang – Thinkequity.
Michael Huang – Thinkequity
How would you characterize your relationship with larger global especially given your focus on increasing your moving up market. Is there anything that you're seeing that gives you some confidence that you're getting some increased leverage from these types of organizations?
We're having conversations with some of those folks. Our definition of mid market is typically not the big five's definition of mid market. For them a mid market account is a billion dollar company, and they have not been able to get their head around how they move from doing multi-hundred million dollar SAP implementations down to our type of implementation.
Again, I think there's a giant opportunity in the mid market for some service providers who crack the code on it. Barring that, that's why we invested in a pretty significant services organization, because we've had to crack the code on how to deliver services into that market place.
I believe it will happen. We continue to have discussions. You'll see experiments that will do what some of those companies over the coming year, but really it's really up to them to tweak their business model to come to this market not for us to tweak our business model to work with them. We would love to work with them. I just don't see that they know how to make money delivering services into this market place.
Somebody will figure it out however, and I think they will figure it out on NetSuite based on the tools we have at NS-BOS that enable them to reuse their customizations and verticalize the suite and turn those services into software in effect, on top of the NetSuite platform. So it will happen. We continue to have those discussions and we'll see who will be successful in doing that.
Michael Huang – Thinkequity
I'm not sure if you mentioned this on the call, but can you talk about the [inaudible] and was that any different from any typical Q4 and maybe if you could give us some thoughts on what you see early in Q1. Is it trending as you would have expected it to?
Q4 was interesting in that it was fairly evenly distributed across the quarter. You always see a bit more in December. You usually see a very large hockey stick quite frankly in December. Maybe it wasn't as high this quarter as it has been in past quarters. Going forward into Q1, we always sort of plan of somewhat of a step down in Q1.
Even though it's software and service, you still get some of the traditional seasonal software buying patterns that have been pounded into the heads of most customers, so we plan on that a bit, and we'll see how it goes the rest of the quarter goes on.
Michael Huang – Thinkequity
Getting a little clarification on a hypothetical 15% growth for '09. What was does this imply with respect to close rate and reorder rates and direct to ASP's etc., kind of relative to what you saw in Q4. Q4 you talked about metrics being pretty strong.
We were just saying that close rates stay approximately where they are in Q4, and they have come down from where they historically have been obviously in this environment, but we'd say roughly flat to Q4.
And we would assume that we would see some growth in ASP. If you look over the history of the company, the last five or six years, the increase in the ASP has been a very consistent trend and with the new products that we're coming out with and enhancements to what OneWorld and more international additions for OneWorld, I think we'll continue to see the ASP continue to rise in 2009.
I'd just make another couple of comments. On the lead side, the last time I looked the leads have continued to grow at about a pretty brisk pace year over year, so that's very heartening. While the close rates have fallen a little bit, there's still a great deal of interest I think. I think that's good news for the future.
To Jim's point, on insurance side, we've seen that decrease year over year and we look to that rate as we look into 2009. The other thing I would say you should take into consideration in our pricing model that we're pretty excited about is as you know, it's only a per user per month on that suite, so while you're going to see some SAS guys talk about number of users falling off the system and impacting their forward bookings and deferred, we certainly per user pricing, but as you know more of our revenue comes from non user pricing, more functionality based pricing, the suites and the modules.
So we're somewhat insulated I think from that phenomena where users fall off because more of our revenue comes from non user fees than from user fees on the recurring side.
That concludes the question and answer session.
Thank you all for joining us today. We really appreciate your time, and look forward to talking to you following Q1.
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