NetSuite Inc (N) Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.25.13 | About: NetSuite Inc. (N)

NetSuite Inc (NYSE:N)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

Ronald Gill - Chief Financial Officer and Principal Accounting Officer

Zachary Nelson - Chief Executive Officer, President and Director

Analysts

Jason Maynard - Wells Fargo Securities, LLC, Research Division

Philip Winslow - Crédit Suisse AG, Research Division

David M. Hilal - FBR Capital Markets & Co., Research Division

Brad R. Reback - Stifel, Nicolaus & Co., Inc., Research Division

Patrick D. Walravens - JMP Securities LLC, Research Division

Gregory Dunham - Goldman Sachs Group Inc., Research Division

Justin Furby

Jennifer Swanson Lowe - Morgan Stanley, Research Division

Scott R. Berg - Northland Capital Markets, Research Division

Operator

Thank you so much for holding everyone, and welcome to the NetSuite Second Quarter 2013 Financial Results Conference Call. Just a quick reminder that today's call is being recorded. [Operator Instructions] Now, at this time, I would like to turn things over to our host, Mr. Ron Gill, Chief Financial Officer. Please go ahead, sir.

Ronald Gill

[Audio Gap]

2013 financial results conference call. A more complete disclosure of our results can be found in our press release issued about an hour ago, as well as in our related Form 8-K furnished to the SEC earlier today. To access the press release and the financial details, please see the Investor Relations section of our website. As a reminder, today's call is being recorded, and a replay will be available following the conclusion of the call.

On the call with me today is Zach Nelson, our Chief Executive Officer. Zach and I will begin with prepared remarks, and then we'll open up the line for questions.

During the call today, we'll be referring to both GAAP and non-GAAP financial measures. The reconciliation of our GAAP to non-GAAP financial information is provided in our press release, which is available on our website. All of the non-revenue financial measures we will discuss today are non-GAAP, unless we state that the measure is a GAAP measure.

The primary purpose of today's call is to discuss our second quarter 2013 results. However, some of the information discussed during this call, including any financial outlook we provide, may constitute forward-looking statements within the meaning of the U.S. federal securities laws. These statements are subject to risks, uncertainties and assumptions and are based on financial information available as of today. We disclaim any obligation to update any forward-looking statements or outlook, risks and uncertainties that would cause our results to differ materially from those expressed or implied by such forward-looking statements include those summarized in today's press release.

These risks and additional risks are also described in detail in our reports that we file from time to time with the SEC, including our most recent 10-K and 10-Q filings, which I encourage you to read.

With that, I'd like to turn the call over to Zach.

Zachary Nelson

Thank you, Ron. While many traditional enterprise software companies missed in their most recent quarter, in Q2, NetSuite continued the momentum we experienced in Q1 and throughout all of last fiscal year, as companies of all sizes continued to move their mission-critical business systems to the cloud and NetSuite.

And while many enterprise software companies also saw their license revenues slow, growth was the word of the quarter for NetSuite. Year-over-year, revenue grew 35%, average selling price grew by more than 20%, our deferred revenue balance was up 39% and sales through our channel partners grew more than 70%.

All in all, NetSuite had a great quarter and, once again, met or exceeded our outlook on revenue, operating cash flow and non-GAAP EPS. And the continued execution against our core strategies allows us to increase our full-year outlook for revenue, once again.

Now to some of the highlights of the quarter. On the top line, we posted our first quarter greater than $100 million, delivering record revenue of $101 million at the high end of our stated outlook. On the bottom line, we delivered non-GAAP EPS of $0.05 per share, exceeding our stated outlook of $0.02 per share. In addition to hitting the high end of our outlook for revenue and overachieving our outlook for EPS, cash flow from operations grew to $15.6 million, exceeding our previously stated outlook for the quarter of $12 million to $12.5 million.

In addition, our overperformance in the quarter and the first half is a demonstration of our continued execution against the strategy we have laid out over the past several years. Our strategy of providing a suite of applications designed to run a business, combined with our move up market to bring the benefits of this suite to larger companies and the verticalization of the suite to bring the benefit of the suite to many different industries continues to pay dividends for NetSuite, our stockholders and our customers.

There was no better place to see the success of our strategy and its impact on customers than in our SuiteWorld Conference held in Q2. Once again, SuiteWorld was a phenomenal success, drawing roughly 5,000 attendees. There were customers of all sizes at the show, but a few of our recent deployments highlighted at the event bear repeating.

As you recall, at our 2012 SuiteWorld event last year we announced the new version of NetSuite, SuiteCommerce, our commerce platform that provides the central system to manage all transactions and associated customer interactions with consumers and other businesses regardless of touch point. At that time, I said we would eventually have multibillion dollar retailers using NetSuite as a cornerstone of their global commerce strategy. It was nice to see that prediction come true only a year later. Williams Sonoma's deployment of NetSuite to support their multi-channel commerce strategy in Australia was a significant milestone.

This year's SuiteWorld showcased the continued success of our investments in new products, as we demonstrated a host of new technology offerings that expand the market NetSuite can target with our suite of cloud-based business applications, as well as extend our capabilities to meet more of our existing customers' business management requirements.

In particular, we announced a new version of NetSuite designed for discrete manufacturers, a market in dire need of application upgrade. And we further extended our offering with many new manufacturing ecosystem partners, crowned by a joint announcement to integrate Autodesk's PLM 360 offering with NetSuite for manufacturers. The Autodesk relationship was just the one announcement highlighting the strength of the NetSuite application to provide a rich platform for third-party products that extend our solutions to meet a broad swath of our customers needs.

In total, more than 33 parties made announcement at SuiteWorld and we unveiled our new Built for NetSuite verification program. Of particular note, a host of companies, including TribeHR, Asentus, Insperity and SilkRoad announced their intent to provide broad HR solutions to meet the needs of small and mid-sized businesses. And, of course, late in Q2, we also announced an important strategic relationship with Oracle and Deloitte to bring together NetSuite's ERP system with Oracle's industry-leading HCM products, with the joint goal of bringing customers around the world a best-of-breed solution for their business processes and their HR processes.

Beyond third-party application partners, our partners selling channel also had a great quarter. In Q2, our worldwide channel business grew by more than 70% year-over-year. This blows away previous growth rates we have seen in our channel business and is driven by great partners like Blytheco and McGladrey, who last year began to move their practices from dying Sage and Microsoft products, and this year are seeing amazing growth with NetSuite. Our growth of channel partners was not just in the mid-market, it continued with large systems integrators as well. At SuiteWorld, we announced another large SI partnering with NetSuite, as Capgemini joined our impressive list of SI partners. The Capgemini partnership is indicative of NetSuite's continued move upmarket, as well as our plans to aggressively expand internationally.

Capgemini has a large global footprint, with offices and operations in 44 countries. We intend to drive aggressive growth overseas, in areas such as continental Europe and Capgemini will be an important part of that effort.

And speaking of Europe, while the United States continued to be strong for us and represented 75% of revenue, importantly in Q2, we saw continued strengthening in EMEA. As I mentioned in our last call, Q1 was notable for strength in Europe, but it was the first time we've seen that in a while, and so we didn't want to call it a trend based on a single data point. But given our strong performance in EMEA in Q2, I'm more confident in saying that EMEA, and in particular, the U.K. is starting to accelerate their move to the cloud.

Our progress there is almost entirely coming at the expense of Sage, who's myriad, antiquated, on-premise, non-cloud products are more than showing their age. Customers and the Sage partner channel have finally given up on Sage delivering a compelling strategy or a product set to run a modern business.

In Q2, Sage did made a last gasp attempt to prove to its customers and partners that it gets to the cloud, but it was just more lipstick on the pig, as they announced Sage 200, a hosted version of the on premise application of the same name, but offered with even less functionality. So much for getting the cloud.

So I'm very bullish on our European operation, driven by these market and competitive trends, as well as the great team we have put in place in EMEA, culminating during the quarter with the announcement of Pete Daffern, to head our operations there. You can certainly expect to see incremental investment in NetSuite Europe to take advantage of what we see as a wide-open market for our industry-leading cloud suite.

In summary, global momentum in both the direct and indirect channels enabled us to finish the quarter with great new customer momentum. During the quarter, we added 330 new customers. Average selling price leaps more than 20% year-over-year and the absolute dollar amount broke all previous records. And while many people focus on our enterprise business, this quarter was incredibly strong in our mid-market customer base, which remains the heart of our company.

So anyway you look at the quarter, on our continued execution against our strategy, major customer deployments, new product initiatives, significant new partnerships, emerging international engines of growth, or by continued successful delivery against our financial plan, Q2 was another very strong quarter and now a multi-year track record of accelerating growth.

Now I'll pass it over to Ron, to provide some more insight on that momentum.

Ronald Gill

Thank you, Zach. So you've heard some of the highlights of what was another great quarter for NetSuite. Let me take you through some of the Q2 numbers in more detail.

As a reminder, all the non-revenue financial figures I will discuss here are non-GAAP, unless I state the measure as a GAAP number. Revenues are, of course, GAAP numbers and as always, you can find a reconciliation of GAAP to non-GAAP results in today's press release.

Revenues for the second quarter totaled $101 million, up 10% sequentially and up 35% year-over-year. Recurring revenues from subscription and support grew 8% sequentially and 31% over the year ago quarter to $80.2 million, for yet another quarter of accelerating growth and recurring revenue. Strong new business bookings and larger implementations continued to drive high demand for implementation services and our nonrecurring revenue, which comes primarily from Professional Services, was $20.8 million for the quarter and grew 52% over Q2 of 2012.

Once again, year-over-year, the United States was the fastest growing geographic area on a revenue basis, and approximately 25% of our revenue for Q2 was generated outside the U.S. Average deal size continued to increase in Q2, with the overall ASP on new business deals up more than 20% over that for the second quarter of last year. At the larger end of the spectrum, sales of NetSuite OneWorld, which was typically purchased by larger customers with more complex operations, were again very strong in Q2 and accounted for more than 40% of new business. The total number of OneWorld deal sold in the quarter was another new record, exceeding that for both the prior quarter and Q4 of last year.

Moving down the P&L to gross margins. We saw a slight decrease year-over-year in the blended gross margins from 73% to 71%, driven primarily by the larger portion of Professional Services revenue in the mix. The gross margin on recurring revenue was 85.1%, while the gross margin on nonrecurring revenue was 16%. Overall we expect the blended gross margin to continue at about this level for the full year in 2013.

Turning to our non-GAAP operating expenses. Product development expense was $12.5 million for the quarter, up 35% over Q2 of 2012 and representing about 12% of Q2 2013 revenue. We continued to make aggressive investments in our product team, with a number of people in that group up 60% over the year ago quarter.

Sales and marketing expenses were $46.6 million or 46% of revenue in Q2, an increase over approximately 45% of revenue in Q2 of last year. As Zach discussed, we hosted the largest SuiteWorld ever in Q2, and even as the event grew beyond our anticipated demand, the team did a good job of managing that spend and strong attendance and partnership participation helped offset the cost.

At the same time, growing our distribution capability remains a priority and in the face of ongoing strong demand, and we continue to invest aggressively in sales capacity, adding headcount fastest in the direct sales, sales engineering and account management teams.

G&A expenses were $7.8 million or 7.7% of revenue in the second quarter. That's down from 8.7% of revenue in Q2 2012, so continuing the efficiency gains we've been seeing there. Non-GAAP operating income in the second quarter was $4.8 million. This equates to a non-GAAP operating margin of 4.7% compared with the 75% margin in the second quarter of last year. And this is inline with our stated objective to step up the pace of investment in the sales, marketing and product teams this year.

During the quarter, we reported a net income tax expense of approximately $450,000, principally related to our international entities. We continue to expect our accumulated net operating losses to offset any domestic earnings for tax purposes for the foreseeable future.

Non-GAAP net income for the second quarter was $4 million. Non-GAAP earnings per share for Q2 was $0.05. Moving on to the balance sheet. Our cash balance now stands at $455 million. You may remember that during the quarter we priced a convertible debt offering and the net cash proceeds of debt operating after the related share repurchase and fees were about $272 million. We also had another record quarter for cash collections, and cash flow from operations in Q2 was $15.6 million, which was ahead of our expectations and up from $15.2 million in the same quarter last year.

Moving down the balance sheet from cash to deferred revenue. Our total deferred revenue balance increased to $181 million, an increase of 39% over the balance at the end of Q2 last year. As you may calculate from the financials published in the press release, calculated billings, defined as revenue plus the change in deferred revenue, were approximately $110 million for the quarter, representing an increase of 30% over the second quarter of 2012. As I usually point out on these calls, there's a wide array of factors that influence calculated billings and quarter-to-quarter fluctuations in the calculated billings metric should not be taken as an indicator of changes in future revenues.

You may recall that on the Q2 2012 call, I mentioned that changes in our renewal arrangements had caused the recording of some renewals to pull out of Q3 2012 and into Q2 of that year. As a result, on that call a year ago, I normalized the calculated billings growth rate down from the 35% you saw on the face of the financials to 30%. If you compare this quarter's calculated billings to that normalized number for last year, you'll get a growth rate of about 34%. This marks the anniversary of that change in their renewal agreements, so I don't plan to normalize for this particular effect again in future quarters.

Headcount on June 30, 2013, was 2,138, up 185 heads from Q1 2013 and an increase of 651 heads or 44% from Q2 of 2012. Hiring momentum picked up at the beginning of the year and continued in Q2 and we added headcount across the entire organization.

Now I'd like to move to the forward-looking financial outlook, which is covered by the cautionary language I outlined at the start of the call and based on assumptions, which are subject to change over time. We've had a terrific first half of the year. We have solid momentum in the business and we're investing aggressively in both product and distribution for the future. With that in mind, we're going to be raising our full-year outlook for revenue. Our previous outlook was for revenue in the range of $404 million to $408 million, and we're now raising that to a range of $406 million to $410 million. We're going to keep putting the overachievement back into the business that will maintain our earlier outlook for operating cash flow of $55 million to $60 million, and for the year, we continue to expect non-GAAP EPS of $0.26 to $0.27.

For the third quarter of 2013, we expect revenues in the $105 million to $106 million range. We anticipate non-GAAP EPS of $0.07 to $0.08 and operating cash flow of $12 million to $13 million.

That concludes my prepared remarks. We are very pleased with our momentum as we head into the second half of the year. And with that, I'll turn the call back over to Zach.

Zachary Nelson

Thank you, Ron. As cloud computing becomes a dominant business application architecture for companies of all sizes, I don't believe there is any company better positioned than NetSuite to benefit from the shift to this new architecture. And I think that if you look at our success over the last several years, you will see many proof point that my belief is justified.

While certainly we have the cloud wind at our back, the strategic investments we have made over the last several years and our execution against our strategy is paying off. We bet on verticals and R&D and that is paying off. The addition of SuiteCommerce and new verticalized products, like NetSuite for manufacturers, expands our total available market.

This year, we are increasing our development efforts and are targeting to increase our R&D investment by year end to around 13% of revenue from the 12.1% it represented in 2012. You'll see the contribution of the R&D effort in our ability to address the needs of customers large and small across a variety of industries and verticals, all on a single cloud-based code base.

We bet on sales capacity and you see our direct and now indirect channels really kicking in. We bet on a global opportunity and we are seeing strength in every market around the globe, including EMEA. And I have to say, while strategy is one thing, execution is almost everything. Our 2,000-plus employees have executed exceedingly well across a complex set of product, distribution and customer initiatives. This incredible execution on our product, on the business model and the global expansion gives NetSuite a significant advantage over those who consider themselves our competition, and it also gives our customers a huge advantage over their competition.

While we continue to execute on our plan over the remainder of the year, Q3 is also the quarter that we look at our multi-strategic plan and prioritize our next investments. Based on that strategic planning process, I look forward to giving you an early glimpse into our operational plan for 2014, including our first announced financial outlook for 2014 during our next quarterly conference call.

And with that, I'd like to open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take the first question today from Jason Maynard, Wells Fargo.

Jason Maynard - Wells Fargo Securities, LLC, Research Division

I got a couple of questions. First up, on the indirect channel, that's a big increase in terms of the contribution, and I wanted to just to drill down there a little bit. Is that coming primarily from some of your mid-market partners? And what do you expect to happen say in the next 12 months or so as some of the larger SIs begin to kick in? And then the second question is following up on the raising the additional capital, how are you thinking about your M&A strategy? Do you announce some partnerships in the HR space? Is there anything that should change now that you have more capital from some of the moves that you've made in the last year, so I think you've bought a half dozen companies in terms of how you're thinking about making additional incremental moves on the product line?

Zachary Nelson

Thanks, Jason. In the quarter I think the largest increase -- we had a couple of factors. One was sort of the larger partners that we brought on last year in the mid-market as an example, McGladrey, Blytheco, McGladrey being Microsoft's biggest reseller effect, Blytheco being in North America. Blytheco being Sage's biggest reseller in North America, and then others like Baker Tilly. Those were announced about a year ago at SuiteWorld and what you're really seeing happen now is the ramp time end and the bookings begin to kick in. So they just had incredible quarters. And so we're very excited to see that ramp happen. Additionally, some of our longer-term mid-market partners also had good quarters. And I think generally, when you look at both of those factors, clearly one of the factors was just the expertise of the Blytheco, of the McGladrey, of the Baker Tilly in solving larger, midsized company's problems is part of the equation. A second part of the equation that it indicates to me is just massive customer demand. As you know, I've always said customer demand is a key component in driving the channel transition from things old non-cloud based products like Microsoft, Great Plains here in the U.S. and Sage in the U.K., and so I think that's probably the second exciting thing about that mid-market channel kicking in, in such an enormous way is that it clearly is an indication of demand. The other place where it also played a role was not just in North America, but outside North America, Asia, the channel grew enormously. And as you know, Asia is a large geography so we moved outside of Australia and New Zealand to a largely channel-only model in many other parts of Asia, Japan is still direct as well. But we have channel partners in both Asia and Japan as well. So it was nice to see those kick in, in Asia. And then as I said, we also had a good channel quarter in EMEA, and I think EMEA is a very exciting place to look right now in terms of what's going on with the competitive landscape with Sage as well as the strength of the OneWorld product in addressing the needs of European companies. So -- now that said, the large SI channel, great momentum there as well. We added Capgemini to the list. We had some very interesting things going on that we'll announce later on some additional strategic partnerships in that space. So stay tuned on the larger SI front. In terms of the money raised for the convert -- our acquisition strategy to date has largely been around buying companies to augment our expertise in verticals, and they tend to be very small and certainly that's one approach we'll take a look at. And we're also looking at other opportunities as they present themselves. But it's really about bringing new domain expertise to the NetSuite platform, and that's really is what drives our acquisition philosophy.

Operator

Up next, we'll hear from Phil Winslow, Credit Suisse.

Philip Winslow - Crédit Suisse AG, Research Division

When I look at you guys normalized billings, it was in the sort of mid-30s in the second half of '12 and then it's the sort of mid- to high-30s now in the first half of '13. And not a lot of guys that are seeing out there in applications land and you accelerating growth in the first half of this year. Zach, when you look at your business, what's sort of driving this relative to the others? There's one segment outperforming, is it OneWorld? Are we starting to see SuiteCommerce show up? The SAPs just sort of how does that mix across is driving the sort of acceleration?

Zachary Nelson

I think it certainly expanded distribution. It's helping us get more of the opportunity we should get. I mean, I think you saw that in the channel, of course, this quarter the fact that we're getting larger distribution partners with great expertise in solving complex business problems. It's a very important part of the accelerating growth, and that's really exciting to see that multi-year investment kick in. I think the other thing you really are starting to see is two-tier ERP is becoming a very hot discussion in large enterprises. And as I look at the sort of competitive landscape of who we're competing with, we're competing -- we're really keeping it more and more with SAP, and this is not competing with SAP Business ByDesign, which is actually decreasing, it's getting into SAP's core market and competing with their enterprise products. So that's very exciting. I had a discussion this quarter with a very large SAP shop that's essentially going to standardize on NetSuite as their 2-tier platform of choice in the mid-sized and smaller subs, while they maintain their huge investment in the on-premise product of SAP. So I think that's really starting to kick in. And we're just scratching the surface of the two-tier opportunity. But the interesting thing there is the selling by NetSuite of two-tier ERP has turned into customers actually beginning to architect a two-tier ERP strategy and deploy it.

Philip Winslow - Crédit Suisse AG, Research Division

And then just one quick follow-up on SuiteCommerce. The 2 of us talked about this at our conference back in June, but how is the point of sales ability that you guys have, differentiating SuiteCommerce versus some of the competition out there?

Zachary Nelson

Yes. I should have added SuiteCommerce on the upmarket side. It's also a great driver. I've always said SuiteCommerce has a lot of parallels with what happened with OneWorld when we introduced it, and we certainly saw that during the quarter where the average selling price of the SuiteCommerce offering and our sales into eTail -- the eTail/Retail vertical were greater than $100,000. So you're definitely seeing another parallel with OneWorld, it quickly ramped to that sort of level. But, of course, the POS for me, the whole thing that SuiteCommerce is about is a single system to address omnichannel selling. And of course, still the biggest channel to sell through, if you're selling to consumers, is retail, it's something like 94% of the channel, and NetSuite is the only system on the planet that has a common platform for point-of-sale, for e-commerce, for mobile. So it's an enormous advantage. The retail-only acquisition was a great acquisition, and we're the only cloud-based commerce vendor that has an integrated solution for point-of-sale, online and off-line sales. So it's very powerful.

Operator

We'll now hear from David Hilal, FBR.

David M. Hilal - FBR Capital Markets & Co., Research Division

I guess, I wanted to understand any feedback from the field since the Oracle partnership was announced. And maybe specifically within the SAP base, as you go after those 2-tier deployments and maybe thoughts as it relates to SAP's acquisition on Hybris and what feedback you're getting from the field within that base.

Zachary Nelson

Well, I know on the Hybris front, I made at least 2 gentleman very happy. I was at a conference this week, and I think 2 of the core executive of Hybris came running out to me and shake my hand and said, "Thank you for making SAP buy us." So -- no, I said, "That's fine, but unfortunately, they're probably setting up to kill your product now. So as they swallow these product, they don't tend to do much with them." So we'll see what they actually end up doing with Hybris. We don't really see them much as competition in the market. We see more Demandware and Magento than we do Hybris. So I think they have a long way to go to make that an established part of all of the cloud offering they've acquired. The Oracle HCM announcement, I think it was very important, certainly from a strategic standpoint as we move into 2-tier deployments, many of them have Oracle HCM in their operations. So the fact that we can offer integration with those makes a lot of sense in 2-tier deployments. And likewise, one of the things -- we rarely get asked for HR. We typically -- people look at NetSuite to run business processes and they look for something else to run HR processes. And especially in the lower end of the market, HR is usually just called payroll. And they have a payroll system installed, and they're not interested in decoupling it. But as you move in to larger organizations, as an example, just an anecdotal piece of data. We were talking to an SAP customer and they were looking at replacing SAP in their warehouses with NetSuite and then they said, "Well, we have this SAP HR stuff and we'd like to replace it as well." And that was really what got us thinking a little more about how we might partner with some of these larger HR vendors. And so now it's great to have -- to be able to refer Oracle as an offering in those particular scenarios.

Operator

Up next, we'll hear from Brad Reback, Stifel Financial.

Brad R. Reback - Stifel, Nicolaus & Co., Inc., Research Division

Last quarter, you had indicated that you were running a bit behind on hiring enterprise salespeople. I was just wondering if you caught up there and how you see sort of the pipe for hiring for the back half of the year?

Zachary Nelson

Yes, we did a fantastic job of hiring during the quarter, not just in sales but across the front, development is also getting enormous amount of investment with services organization. I think we're going to add on a gross basis, something like 1,000 employees this year. So we're pretty much on track there. It's probably the most salespeople -- quota-bearing salespeople we've added in a long time to the field organizations. So that's going great. The other thing that we also did that our investors allowed us to do is we tried to front load as much of this hiring as we could. And so I think we've done a very good job at that. We don't have nearly as much hiring to do in the second half of the year as we did in the first half of the year. So, of course, most of that incremental productivity and incremental capacity, we really see the effect of in the 2014 year, but we're really happy to get it done early this year. The other place that we did also invest and given some of the results we've seen this quarter was in the channel sales organization and with the sort of results we saw at the channel this quarter, that's certainly a place we'll look to invest more as well.

Operator

Pat Walravens of JMP Group is up next.

Patrick D. Walravens - JMP Securities LLC, Research Division

So Zach, let me ask you a big picture question, which is, I mean, can we say at this point that Software-as-a-Service has gone mainstream? When you're talking to these larger enterprises, are there still a lot of objections around security and we need to have an on-premise? Or where are we in that journey?

Zachary Nelson

Well, as I've always said about the latter question, we see a pretty skewed piece of the market. In a sense that if you're coming to NetSuite, you're already going to be comfortable with the fact that you're hosting your data in a public cloud sort of setting. But that said, obviously, we're growing very quickly and I was pretty -- I think the other thing to look at, not just how fast NetSuite is growing, but boy, if you just look at the SAP's of the world, the Microsofts of the world and even take out the surface write off at Microsoft, you see their software license revenue going negative. So I think you weigh all of the factors, and it's pretty clear that people are not only comfortable, it's not even a factor of comfort with the cloud anymore in my view. It's a matter of business survival. If you're not building your infrastructure on a cloud-based system like NetSuite, you're not going to be competitive in the modern world. I mean, you have systems that were designed before the Internet existed, you're not going to be a very competitive company with somebody running NetSuite that has a system with the Internet at its heart. And I really think that's the main driver of what you're seeing in the shift from things like Microsoft and Sage and SAP to NetSuite.

Operator

Greg Dunham, from Goldman Sachs, is up next.

Gregory Dunham - Goldman Sachs Group Inc., Research Division

Just one question for me. The average deal size, again, up 20%. It's pretty impressive to look over that trend over the last couple of years. A question I often get, and a little pushback, is what's the longevity of that trend? Is that sustainable and can you address that question and maybe just talk to how you think about average deal size today and where you could be a year from now and 3 years from now?

Zachary Nelson

Yes, I don't want to predict that it's sustainable, but boy, it sure looks -- the way our business model works, we're pretty bullish on it. In a sense of we're just -- we continue to grow the size of the companies we sell to. I think this quarter was a record in terms of number of users that we're selling on the systems. So as we get to larger and larger companies, you get more and more users. And we have a lot of -- a long way to expand in that dimension, as you look at NetSuite. Second factor is if you look at -- what also adds to average selling price is the depths of functionality you provide. And so when you look at things we did, I'll ask you about [ph] adding SuiteCommerce. That expands the average selling price and the total available market at the same time. At SuiteWorld we announced NetSuite for manufacturers. So suddenly, new marketplace, deeper functionality, higher ASP, and we're certainly not stopping on these things. You look at what we're doing in the services world. You look at what we're doing in other verticals. You have that dimension working. And finally, even though we did raise prices, particularly in the enterprise space, this last -- over the -- in the first quarter, we didn't see discounts go up that much. So I think if you look at all 3 dimensions here, we're feeling pretty bullish about the customer actually being willing to pay more for these types of easy to install but highly functional solutions designed for their industry. The other factor, you can't -- in many ways I think we're massively underpriced. When you look at the fact that many of our customers, you look at Williams Sonoma, they deployed, in Australia, 4 brands at point-of-sale, e-commerce and call center in 5 months. Any other platform, it would've been years to do that. So what's the value of going from years to get to your business vision to months? It's enormous. And so we're also -- I think you're also starting to see that play into the equation.

Operator

Next up is Justin Furby, William Blair & Company.

Justin Furby

Ron, I guess, for you, it looked like the recurring revenue line accelerated quite a bit, much more so than we've seen over the last several quarters. I guess, if you look at your guidance into Q3 and for the full year, do you think that, that trend continues, maybe not at the same pace, but do you continue to expect acceleration there? And then do we hit a point, maybe Q4 or early next year where you think the recurring revenue growth actually trumps the services growth rate?

Ronald Gill

Great question. I probably -- I'm not going to start trying to parse a revenue guidance between the 2, but I can give you a little color on it. We have seen this trend especially as we moved more into the enterprise and we're doing larger implementations, it's really a combination of factors. Larger implementations at larger companies, we were able to run a more efficient implementation. But also, you know we've been making a kind of multi-year effort to improve margins in our Professional Services business. And both of those have served to push up the portion of Professional Services in the overall revenue mix. So it's good news we've gotten the margins up and Professional Services up to a healthy level, now I expect that we'll probably keep the margins about where they are now, probably something similar to last year, 14%, 15%, margins in Professional Services. But as long as we keep doing these larger enterprise deals and as long as the new business portion of our business is strong, we'll be booking more and more Professional Services. The great -- of course, the great news is all of that Professional Services is the beginning of what will be a long and growing recurring revenue relationship. But in the meantime, it means that the Professional Services bookings are high, and we get the kind of ratio that we've had recently where we've grown up from a couple of years ago, where we would have had 18% or so of revenue in Professional Services to something like -- I mean, the current quarter, where I think it was 21% or so. So it probably -- I don't expect this view to change a whole lot more, but I also wouldn't expect that trend to reverse dramatically. So I'm expecting that we sort of stay on this current course. As long as the demand stays as strong as it is right now, we'll be booking a lot of new deals that come with big implementations and you'll probably see this same kind of shape in the P&L.

Zachary Nelson

I might just say the one thing about the channel business is that's -- what we see there is largely recurring. So a bit of an offset to what Ron said is the channel business continues to screen like it is, that's a very positive aspect to the recurring revenue growth.

Ronald Gill

Absolutely, yes.

Justin Furby

Okay. And a year or 2 ago, you used to break out kind of the recurring piece on the ASP side. If you look at that this quarter, is it higher than the overall ASP growth or can you give us any sense for where that is this quarter and in the last few quarters?

Ronald Gill

Yes, I don't have it in front of me. The recurring -- but the recurring ASP growth has been very strong throughout this whole recent trend, so it's certainly not being driven by just Professional Services bookings or something like that. In terms of the deal size, we tend to see both. The larger implementation's obviously are larger recurring and Professional Services. I don't have the recurring ASP number in front of me, but it was up as well.

Justin Furby

And Zach, I guess, I'd love to hear your comments in terms of the pipeline, as you look to the second half of this year.

Zachary Nelson

Yes, no -- I think pipeline growth is great across all sort of the small, medium, the upper mid-market and the enterprise organizations. My field checks, going out visiting customers, which you have to take with a grain of salt, because they are somewhat random data points look incredibly strong at the higher end of the market, the e-commerce aspects of the market. That said, we have a lot of work to do from a technology standpoint to continue to address the needs of those larger companies, but we're certainly focused on it, we're investing heavily on it, and it's just great to see sort of the household names of the world begin to look at NetSuite as a core part of their 20-year vision of where they're going.

Justin Furby

Okay. And then just one more, actually, Ron, if I may. On the ASP side, is there anyway to parse out sort of what of that 20% year-over-year is driven by just mix shift versus the pricing increases that you guys recently put through?

Ronald Gill

Yes, it's interesting because your first thought might go to pricing, but when we look at actually what got sold in those deals and compare what got sold this year versus last year, we actually see about a 20% increase in the number of users sold with the average new deal. So it's nice, but it's not actually being driven just by pricing. But we're actually seeing the footprint of a new deal that's being sold this year being materially larger than that from a year ago. So I think that's a pretty healthy trend.

Operator

Next up is Jennifer Lowe, Morgan Stanley.

Jennifer Swanson Lowe - Morgan Stanley, Research Division

Just one for me. Looking at the trajectory around long-term deferreds, there was a period of time where that have been declining, I think, it was related to the Japanese joint venture for a few years and then it stabilized. And just in the last few quarters, that's really started to reaccelerate for you again. So, I guess, the question there is, as you start to move into larger customer accounts and go deeper and more strategic with some of these bigger customers, are you seeing a difference in the types of billing terms your customers want? Are they asking for more multi-year prepaid deals? Is that something that maybe continues to be a trend in your deferred revenue? Or is it just -- it's lumpy quarter-to-quarter, as this quarter was particularly strong, but maybe not something that you expect to continue?

Ronald Gill

Yes. This is Ron. We do see, at the higher end, we do see the larger customers often have an appetite and they want to lock-in a larger -- a longer contract, I should say. So they're really wanting to lock-in 3 years. Sometimes, that's driven by their own accounting. Sometimes they've got a solid proof-of-concept and they just really wanted to lock-in the contract. So we do, at the higher end, see a larger -- a longer contract. That said, though, even in the current quarter as an example, although you can see there's an increase in long term deferred, when I look at overall billing term, it didn't really increase across the population. In fact, I did that, in the prepared remarks, I did the quick normalization, just comparing this year's calculated billings versus that normalized number that I gave on the year ago call, and it normalized to about a 34%. If I actually do the more complex normalization and factor in FX and all the impacts of billing term between the 2 periods, as it happens, I get back to the same 34% number. So although you see more going into long-term in the current quarter, overall, billing term really hasn't grown significantly and it wasn't a big impact in the quarter.

Operator

And we have time for one final question. It comes from Scott Berg, Northland Capital Markets.

Scott R. Berg - Northland Capital Markets, Research Division

I just have one question. Zach, can you -- can you talk a little bit about the partnership with Oracle in terms of -- is this the only partnership we'll see with them in the HR software arena? Or is this kind of the beginnings of something that might broaden to other non-ERP/financial products that they currently have?

Zachary Nelson

With Oracle -- right now, with Oracle, it's related to the HR products and you never say never about what you might do with any partner. But Oracle has been a part of what NetSuite's done from the beginning of its history in the sense that the infrastructure stack were built on. So we're built on much of the same infrastructure that, of course, the Oracle app SaaS is built on, built on the Oracle database, the Oracle application server, we're evaluating Exadata and Exalogic as parts of our puzzle. So we're obviously a good customer and partner on that front. And we'll see where things take us on the HR front. We're just in the beginnings now with building -- of working with them to build that integration and the go-to-market strategy. So I think it's an exciting early start to partnering with Oracle on that front.

Operator

And ladies and gentlemen, that does conclude the question-and-answer session. I'd like to turn things back to Zach Nelson, CEO, for any additional or closing remarks.

Zachary Nelson

Well, thank you all again, for joining us for our quarterly call. We look forward to speaking with you in Q3, where we will report our results from the quarter, as well as give you our first outlook for 2014. Thank you very much.

Operator

Ladies and gentlemen, that does conclude today's conference. We would like to thank you all for your participation. Have a great day.

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NetSuite (N): Q2 EPS of $0.05 beats by $0.03. Revenue of $101M beats by $0.38M. Shares -4.2% AH. (PR)