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NetSuite Inc. (NYSE:N)

Morgan Stanley Conference

February 26, 2013; 06:15 p.m. ET

Executives

Ron Gill - Chief Financial Officer

Analysts

Adam Holt - Morgan Stanley

[No presentation session for this event]

Question-and Answer Session

Adam Holt

So you can sit there and I can sit here.

Ron Gill

Very well.

Adam Holt

So they can look this way. All right why don’t everyone – get everyone to come in. Shut the doors if possible and we’ll go ahead and get started.

Thanks everyone for coming. It’s always great to see a full room in the late afternoon. Very happy to have our next presenter for a conversation, Ron Gill, the Chief Financial Officer at NetSuite, and I, for those of you who don’t know, my name is Adam Holt, and I run the software group in Equity Research at Morgan Stanley.

So I’ll start the Q&A and then we want to make sure we get some of your questions answered as well. So just raise your hand and we’ll call on you for the webcast. So with that, thanks so much for coming.

So you guys just came off of a very good fourth quarter, a very good end of the year, where you had a number of different metrics converged to drive out performance. Can you walk us through what you saw and how you set the table for calendar ‘13?

Ron Gill

Yes, it was a good year for us and we’ve had a couple of good years in a row now with the business accelerating very well. Obviously I think still some macro economic challenges in 2012. Certainly there seems to be a lot of uncertainty in the overall business environment.

We had a pretty good year; revenue growth accelerated its about 31% revenue growth. We grew operating cash flow at about 50% year-over-year; we grew net income and operating income growth at about 75% year-over-year. So a pretty good year for us in terms of the overall performance of the business, and the business has been accelerating pretty well, really in the last couple of years. We drew something like 22% the year before, so a nice acceleration in the business.

And its really been driven by the core ERP business and increasingly by sort of move up market into the larger end of the mid market space and now into the sort of two tier business into the enterprise space as well.

Adam Holt

I want to drill into a couple of those things, for some of you in the back, there is some room up here on the left side and then on the right side if you want to come in and sit down.

So why don’t we start with the spending environment. It doesn’t look to us like there was a whole lot of help form a macro perspective, particularity in the SMB business in calendar ’12. How are you thinking about the spending environment in the macro and what is embedded in your numbers for calendar ’13?

Ron Gill

Yes, the overall macro environment certainly has been uncertain for several years now. I’ve been CFO at NetSuite for 2.5 years and it sort of feels like every other quarter there’s some sort of a shock that either the USS being downgraded or what is a bad job’s report or whether its a bad day in the stock market or whether its a fiscal cliff or it’s a cluster or something that makes everybody think that the word’s about to come to an end. That’s been the environment that we’ve been in for the past couple of years and as I said, I think the business has grown pretty well and accelerated pretty nicely through that period.

So obviously there are some other trends, other than the overall macro economic trend I think that has been nice tailwinds for us. Certainly just a general acceptance for SaaS, both in the mid market and increasingly in the enterprise, and then our own product readiness has probably helped with that as well. So we’ve been able to grow pretty well, even in a fairly uncertain environment.

So that’s probably a long way of saying, we don’t have a great deal of concern about macro economic environment having an impact on us in 2013 as well. So we are not really planning with any sort of uncertainty in mind. We are very well aware that had we paused and been overly conservative in the past couple of years with each one of those scares, we probably wouldn’t have been set up as well for growth as we are now.

So we are kind of investing full stream ahead with the expectation that those trends overwhelm any weakness that we see in the macro environment in 2013 again.

Adam Holt

That’s terrific. I want to touch on a few of the key growth initiatives. One is, you talked a lot about sort of expanding your sales capacity and where you are in terms of the amount of sales folks that are ramped to how much capacity you are putting in the next year. Could you set the context for us, so we can get a flavor for how you’re thinking about what you’ve done and what you have going forward.

Ron Gill

Yes, it’s a good question, because we’ve certainly felt capacity constrained in terms of sales capacity. We’ve been very adding very aggressively, probably some of you heard us talk about in 2012, having a what was admittedly a bit of stretch goal of adding 60% year-over-year increase in sales capacity.

That’s a combination; sales capacity here, just a quick definition is quotas and people. So some of that year-over-year increase will come from increasing quotas, some of it would come from adding people. But obviously we are adding very aggressively to the team.

By the end of the year we actually achieved about 50% year-over-year increase in capacity. So adding very aggressively, it certainly still feels like we are capacity constrained in sales and so we’ve got another plan again this year to add very aggressively to the sales organization. We are putting some additional structure in place in the organization to make sure we are hiring as quickly as possible and then ramping those reps as quickly as possible.

I think we did a good job on both last year, but we’ve got a growth factor that really demands that we keep it up and keep at it pretty aggressively. So that’s certainly in the plan for this year as well.

Adam Holt

And remind me, is there a similar goal to that 60% goal heading the account…

Ron Gill

We haven’t set it probably this year. I think fundamentally it will look – we’ll be hiring as aggressively headcount wise as last year. If there’s any difference, 2011 was a year where we had really, really over achieved on the sales attainment for the year.

We were coming out of the year and I’ve talked about this with a number of people here. We are coming out of the year where with the enterprise business, the very large deals really started to come in and in 2011 we’re starting to see a lot of enterprise deals when we fundamentally had a sales organization set up to do mid market deals. So we had very high sales attainment in 2011.

One of the goals in 2012 was to really increase quotas, increase the capacity with both headcount and quota. We had attainments backed down to a normal level I would say and ultimately affects our commissions’ expense. Get that back down to a normal.

So to achieve that in 2012, what that means is that in 2013 the mix will be slightly different. We’ll add people aggressively. Quota increase will not be a big a factor in increasing the overall sales productivity this year. That’s another long random to not answer your question directly, because we haven’t published the target.

Adam Holt

I can say, you just drew a very big circle right around it.

Ron Gill

Right, there you go.

Adam Holt

If you were to look at the 50% increase over the last year, how should I think about the correlation there between that and billings or revenue growth.

Ron Gill

Right, so I touched on it a little bit. One of the things that we really intentionally set out to do and it sounds a bit counter intuitive, in 2012 was to get attainment down. The problem, and it’s a very happy problem to have, but the problem in 2011 was that attainments were too high and we’ve talked about this before, that we had a couple of sales reps in the first quarter of 2011 hit annual quarter.

Again, that’s because we had some very big deals coming in, enterprise level deals coming in, we really had a sales organization that was set up more for the mid-market. That’s 2011, very high sales attainment against quota, which is great and happy and you love to see the new cars in the parking lot, at the same time its not what your designed for.

The result of that in 2012, our commissions expense in the P&L was higher than it traditionally was. We’ll get some savings out of that in 2013, getting that back down to a more normal rate.

So we really designed to get sales attainments back down to a normal level that we target for. What that means is even as capacity goes up by 50% in 2012, it doesn’t mean that you are expecting booking to increase by 50% in 2012 as you get the attainment back down to a more normal level.

Adam Holt

Got it. Another thing that’s been a real break out in my mind, we’ve had a tremendous amount of success, that’s on the enterprise side. It was up market and really expanding your footprints. That is another initiative. Can you talk about what you’ve done now on the product, the sort of go-to-market side to make that happen?

Ron Gill

Yes, so there’s really two vectors here. One is, what’s really been the tradition of the company. We do two major releases a year, the product gets more robust with each release and then with each release you are able to address a slightly larger customer, a slightly more sophisticated customer, a more scenario and that causes a natural progression of market, and traditionally that for us isn’t a 10% to15% ASP increase each year.

The other aspect of this and the one that your probably talking about is really the more kind of enterprise breakout that we started to see in 2011 with these large enterprise. Really for the first time, really enterprise CIO’s starting to think about a fast strategy in the enterprise and especially a two tiered strategy, where they’ve got apathy or oracle at headquarters, but they really start thinking about an intentional strategy to deploy of that solution in the second tier.

I would love to say that that was our design. From the very beginning we always envisioned that and we were very clever. What really happened is that’s kind of a business that found us originally. We were making a product when we originally came out with the OneWorld, which is the multi currency, multi subsidiary consolidation part of NetSuite.

We really came out of it, because a lot of mid market companies had multi currency needs that they needed roll out. But what happened is, some larger enterprise started to find that as a solution and deploy it into a second tier, where even thought they may run oracle SAP at headquarters, they have never gotten that headquarters with them deployed into that second tier. Those companies sort of are starting to find out initially and we really sort of discovered that late 2010, early 2011.

Only started to get deliberate about that business on our part really in 2011. We put an enterprise sales team in place, so that we try to actually have people aggressively going after, singing up those two tier customers, avoid that phenomenon of having those large deals come in when you have a sales team only targeted on small deals, so we started to go about the enterprise sales team. That’s been very successful for us.

You heard us on the Q4 call probably talk about the number of deals greater than $200,000, up 50% year-over-year. So we not only have seen ASP’s increase very healthily, 45% in 2011, 21% in 2012, but up and just the volume of up market deals that’s gone up very nicely.

At the same time I don’t want – I think this is dangerous sometimes when we talk about this, because we’re very enthusiastic about it and it’s a great vector of growth, it’s a great vector for acceleration for us. But I also don’t want to let you distinct it. This is completely where the company is going.

We still have a large core of our business in selling to the mid-market. It’s a super economics for us when we’re selling into the mid-market. We have cracked and really made a healthy business out of selling to the mid-market in a way that a lot of companies are really finding those challenged to do, especially when they are coming down from the top. So I want to kind of keep doing that business. It’s a great business for us, at the same time there’s obviously this huge opportunity opening up up-market.

I think that maybe the last thing I’ll say on this, we’ve been very fortunate and it could be to a down rock, it could be that we are driving the market to some degree, but we are very fortunate to be in the market I feel, with a market that is ready for the enterprise at exactly the same time as the enterprise is becoming ready for SaaS ERP.

I think if we’ve been in the market with a SaaS ERP product five years ago, there would not have been a buyer for that product, no matter how good the product was, because enterprise CIO’s were not ready to buy SaaS ERP five years ago.

There’s been a progression in the thinking and the psychology of SaaS, the acceptance of SaaS in the enterprise. That’s certainly been helped by sales forces success, by the success of products like Success Factor, other products in other areas in the enterprise has made everybody get more comfortable with SaaS and so I think we’re in a very nice place to be ready with the product at the same time as just sort of a marshes kind of opening up to the idea.

Adam Holt

I do want to come back to the sort of market business, but just while we’re on pneumatics of the enterprise, can you touch on what you think the impact has been on the product side around OneWorld and also on limited?

Ron Gill

Yes, so OneWorld has been introduced in 2008 and it’s remarkable, because we introduced the product in 2008 and still here in the Q4 call of 2012 we are still talking about OneWorld penetration as the driver of deal size and the driver of sort of up market trajectory. OneWorld does have a significantly larger ASP. They are usually well north of $100,000, whereas our traditional mid-market product ASP’s are generally in the $40,000 to $50,000 range.

So OneWorld is still a big driver of the business, even sort of four years after we introduced the product and as I said before, its really opened up this vector, because large enterprises, especially when they are going to deploy at the cross multiple subsidiary, which is what we usually see, they are utilizing that functionality in multiple currency, being able to roll out multiple subsidiary.

The interesting thing is I think that SuiteCommerce, even now as we just begin on this vector of bringing this enterprise level of SuiteCommerce solution to market, actually expect it to kind of play out in the same way, with initially kind of the start slow, but I think that a couple of years from now we’ll be at that time talking about SuiteCommerce attach rates, SuiteCommerce penetration rates, SuiteCommerce deal size as drivers of that market strategy for us. So it’s interesting to have another vector sort of coming online at this time.

Adam Holt

Well, just since you brought up SuiteCommerce, before I get back to the traditional market business, how material is SuiteCommerce now? You obviously called it out and spent some time talking about it on lots of conference calls. How material is it and as you think about calendar ’13, how incremental can it be to the growth rates for ’13?

Ron Gill

Yes, so it’s a good question. I think there’s probably an important distinction to make here. So we got a traditional eCommerce business, which is a pretty healthy established vertical for us, and most of the companies in that space were running, they are actually running their website on NetSuite.

NetSuite hosts the website, NetSuite processes all the transaction through that website and that’s a business that we’ve been doing for some years and is a very healthy business and we’ve got, at this point I think we talked – there’s about 4,000 websites I believe running on that solution now. But they are traditionally smaller companies with a smaller website.

What the SuiteCommerce solution is meant to do is really meant to bring that part of the suite up to par with the rest of the suite, so that it can really go up market and take a much larger customer that’s got a much larger throughput in their own eCommerce website. So that’s the product that we are talking about as the sort of new vector here. That is still in its very early stages.

So the product’s been in controlled release now. Actually we talked about it on the call of having in controlled release, something in the neighborhood of 30 customers now going onto that product in controlled release. We probably go general availability on that product in the second quarter of this year, so I expect it to have some impact on bookings this year. I don’t expect it to be material in terms of incremental revenue on the product this year and I think it probably starts to be a more significant driver next year.

Adam Holt

If you look at your more traditional mid-market business, can you talk about how your vertical distribution has been and how that might change over the next two to three years?

Ron Gill

Right. Yes, the verticals there, we are strongest today and it makes you think of a deal size that differ by vertical. So wholesale distribution is one of our strongest verticals that makes up a significant portion of business. The functionality is pretty well built out there, but there are a lot of very small companies in this space and deal size there tends to be a little bit smaller.

At the other end of the vertical section we have what’s the software vertical, where again the product functionality is pretty robust there. We are in a software company operating in the middle of Silicon Valley, so you can imagine that that’s an important addressable market for us and there we do some of the most up-market deals that we do.

So you got wholesale distribution at one end as a pretty robust vertical, software as a very robust vertical. Its in the software vertical that we need more or less, more likely to see like an oracle head to head, because we refer to sub market there and then we talked about eCommerce already, and then professional services are literally companies that do professional services as their business is also a significant vertical for us.

Those are really the ones that are probably the most flushed out right now and really the vertical lines manufacturing we introduced about two years ago. It had a great year in 2012 and so its not the biggest vertical we have by far and we are still a little bit more down market there, but that vertical is growing very well. Now SuiteCommerce is really the next biggest vertical initiative that we introduced.

I think they’ll continue to see us add additional verticals, but probably at about the kind of pace that we’ve been at in the average, which is something like one a year. We are not – it’s not vertical of the week and it takes a while to build out this functionality.

Adam Holt

And so if you are to just sort of think forward, may be two to three years. I mean any rough sense for what you’d like to see in terms of the vertical mix?

Ron Gill

I think definitely this year I think SuiteCommerce and maybe slightly more broadly than SuiteCommerce, lets say multi-channel commerce is probably the key area of focus, probably the key area of investment on the product side.

The reason I expanded slightly from SuiteCommerce is we’ve got SuiteCommerce, it’s all leased now. We’ve just done the retail anywhere acquisition, which will add the retail side to that. So we can actually go with what will be not just another offering in the space, but really a unique offering where you can have a single platform that runs core ERP, the website and retail, all on a single platform and nobody is doing this today.

Even where you have an Oracle that has an ATG, you don’t have a single platform running website and ERP. So I think that’s really where the focus of investment is for the year and then we’ll see what’s the vertical after that. I think the focus was on making that more successful for the time being.

Adam Holt

I’m going to ask a couple of model questions and then I’ll turn it over to the audience. So first in the fourth quarter you had 400 customer ads. One of the best numbers, maybe the best numbers you ever had. How should we think about the new customer ads going forward and the mix between customer ads and up sells?

Ron Gill

Yes, it’s a good question. So up sells for us, I guess that its interesting to understand that for us at any given quarter up sell may account for 40% of bookings as it moves around from quarter-to-quarter, but its that significant. So selling into the installed base is a very sufficient portion of the overall business that we do.

And its very interesting, because that’s been about that number with our traditional ERP business in the mid-market, and a lot of the mid markets accounts that we sell to have this huge room for us. So we may sell the account and we sold the whole account by running this for everything, and the up sell opportunities come because they are grown and they need additional users, so they are adding subsidiaries.

The new business that we do in the enterprise actually has a little bit of even better vector for up sell, because we can sell a couple of subsidiaries at a very large company and the sales cycle tends to be very long to get that initial sale, but once you sold it the potential for subsidiary, subsidiary, subsidiary expansion is much larger than its been in the past. So up sell is a really important vector for us.

Adam Holt

And my last question on sort of the model is you talked about some expenses that are rolling through the model in the first half, so margins are going to be under a little bit of pressure. Can you sort of detail how you are thinking about (a) where those investments are going and (b) long term operating leverage.

Ron Gill

Yes. It’s interesting in the SaaS model and it’s actually an interesting exercise to build a quite and very excel model of the SaaS company. Whenever you get to a place where you want to expand the business more rapidly, you have to increase spend, and you have to increase that spend in advance of what you are going to see, where you are going to see that revenue.

Its probably true in any business, it’s a little bit more dramatic in the SaaS business, because you start paying the sales rep the pay check a year and a half before you’ll see a material impact in the P&L from the sales that they might do, and so that’s fundamentally that’s the phenomenon.

We are adding dramatically to the sales and marketing organization, to sales capacity like we talked about. We’ve also talked about some specific marketing campaigns really around branding the company. And then the R&D organization is also expanding with very good leverage, because its more of a season finish, but expanding very rapidly because of the investments we are making around SuiteCommerce and the investments we are making around the vertical.

We always are trying to front end load those investments at the beginning of the year. We often have this lower margin at the beginning of the year, margin expansion later in the year, just because of the way the cycle runs. So that’s certainly what the plan is for this year and its all – I guess with one caution I’ll tell you, its all worked on a very aggressive hiring plan, and so we got to execute on building out that origination in a pretty aggressive manner for the spending to play out the way we’ve got it.

Adam Holt

All right, we’ve got time for a couple of questions.

Unidentified Participant

When you are going into divisions of larger companies, who are you generally replacing there or what were they using that you are going at?

Ron Gill

Yes, it’s a good question. So I guess the misconception is a lot of times companies will say that they are standardized on SAP or they are standardized on Oracle. What they usual mean is that they got out 50 companies, out of 50 subsidiaries in their entire group, they’ve got the top five or six or eight running on SAP or running on Oracle and they’ve got a whole couple of a dozen of them that are running on whatever they’ve always run on.

And so it’s interesting, because what we are replacing can be anything. Its actually shocking who old some and we go into companies that have subsidiaries running on some old AS-400 green screen system. And probably what happened was back in 2007, the guys at that subsidiary said, guys -- or actually probably 2003 he said, guys I’m running this ancient system, you got to replace it, and he said, hang on we are standardizing on SAP, we’ll be right there and then they rolled out SAP for the next decade and never got to the guy.

So a lot of times we are replacing some old on premise system. They could be something that old. It might just be whatever they were running on when that subsidiary was acquired or when it was originally established. So it might be an ethicore, a loss in the JD Edward kind of on premise system. And then I wouldn’t say that’s the compete, but that’s the replace.

The compete is usually do they continue trying the roll out SAP or Oracle into those subsidiaries or do they pick a different strategy. We often refer to going from a one-system strategy, and a 30-system reality to a two-system strategy, with a two-system reality, and so it’s usually the acquisition that’s driving.

Adam Holt

One over here on the left. It could mean you’re further away. Why don’t you go ahead and I’ll just repeat the question.

Unidentified Participant

Just as to follow on that, just when you think about the competitive dynamic and you think about the oracle’s and SEC’s at the world and have they gone from sort of resisting class or at least their language has become much more cloud constructive I would say. How does that competitive dynamics evolve directly for you over the past couple years? Are they in fact any more competitive or is it more dialog than execution at this point.

Ron Gill

Yes, I guess we think that’s a fair characterization at this point, more dialog than execution. We are not seeing a whole lot of head to head compete from cloud solutions, from either of them and we certainly are not seeing a strong push from either of them, selling into their installed base.

I assume that its got to inherently internally sort of conflictive to try to make a decision between selling on premise old model into that installed base versus selling a SaaS model, because the economics are going to be very different all the way up. The economics are different for company, I’m sure the economics are different all the way down to the sales rep. So we are not seeing a lot of SaaS, we are not seeing almost any SaaS solutions from either of those competitors’ head to head.

Adam Holt

We got time for one more. Okay.

Unidentified Participant

Could you say a little about your European business and what the difference is to the U.S. business.

Ron Gill

Yes, I don’t think it’s in the – the main thing I would say is the difference for us in the U.S. business in the last couple of years is the rate of growth. Our European business is the one business and the business is growing and it grew in 2012, but our European business has not taken off.

We are just coming out of the recession. Ever since everything sort of turned down in 2008, 2009, the rest of the world has reaccelerated for us. Asia has accelerated very well. All of North America has accelerated very well and Europe just has not accelerated as quickly for us. It’s growing, but its not growing as well for us.

The competitive environment is a little bit different, mainly because there’s so much stage installed base there and we see stage a lot, both as a replacement and it’s the smaller end of our market as a head to head compete and I guess the business is growing, but definitely the macro economic environment has been a little bit tougher.

It feels to me like SaaS is not quite as for a long in Europe as it is in the United States in terms of the acceptance. So it’s some combination of those and perhaps our own execution as well. I mean, we’ve not been growing the business there as quickly as in the rest of the world. So it’s an area that we got to work on.

Adam Holt

All right, thanks so much. Great.

Ron Gill

All right.

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