NetSuite CEO Discusses Q4 2012 Results - Earnings Call Transcript

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NetSuite (NYSE:N) Q4 2012 Results Earnings Call January 31, 2013 5:00 PM ET


Ronald Gill - CFO

Zachary Nelson - CEO


Gregory Dunham - Goldman Sachs

Raimo Lenschow - Barclays

Jason Maynard - Wells Fargo

Philip Winslow - Crédit Suisse

Mark Murphy - Piper Jaffray

Laura Lederman - William Blair

[unintelligible] - Deutsche Bank

Adam Holt - Morgan Stanley

Michael Huang - Needham

Karl Keirstead - BMO Capital Markets

Scott Berg - Northland Capital Markets


Welcome everyone, and welcome to the NetSuite fourth quarter and fiscal 2012 financial results conference call. [Operator instructions.] At this time, I will turn things over to your host, Mr. Ron Gill, chief financial officer. Please go ahead sir.

Ronald Gill

Thank you, operator. Good afternoon everyone, and welcome to NetSuite’s fourth quarter and fiscal 2012 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 will open up the line for questions. During the call, 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 the measure is a GAAP measure.

The primary purpose of today's call is to discuss our third quarter 2012 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 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 any such forward-looking statements include those summarized in the press release that we issued today. These risks and additional risks are also described in detail in 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'll turn over the call to Zach.

Zachary Nelson

Thank you, Ron, and thank you all for joining us. It is a pleasure to speak with you today and provide our final report on the 2012 fiscal year. While some legacy client server application vendors continued to struggle and missed their top line and bottom line forecasts, NetSuite went from strength to strength to deliver our best year as a public company, with record results on the top line, non-GAAP bottom line, and cash flow.

And what’s most exciting about these record results is that we are just at the beginning of the disruption of the traditional ERP market. Given our momentum, at the end of this call, we will also raise the top line outlook for 2013 that we gave on our last quarterly call, as well as provide outlook on the rest of our traditional metrics.

While we had a strong Q4, our pipeline is by no means drained, and we have already had a great start to the new year. While Ron will detail our quarterly and fiscal year numbers, I would like to cover some of the highlights of our results.

For the quarter, on the top line, our revenue grew by 33% year over year to a record $85 million for the quarter, exceeding our previously stated outlook of $82.5 million to $83 million. For the year, we closed with record revenue of $300.8 million, growth of 30.7%.

In Q4, on the bottom line, we delivered $0.06 of non-GAAP EPS, exceeding our previously stated outlook of $0.03 to $0.04. As we discussed during our Q3 call, Q4 began a new level of incremental investment that we plan to accelerate in 2013 to take advantage of our market position and the growing market demand we see.

For the year, we delivered record non-GAAP EPS of $0.26 per share, exceeding the top of the outlook we gave at the beginning of the year by $0.05. In Q4 on the cash flow front, we exceeded the outlook we gave by delivering $13.4 million of operating cash flow, versus our outlook of $12 million to $12.5 million of cash flow. We ended 2012 with more than $185 million in cash, a record total for NetSuite.

And finally, deferred revenue also exhibited healthy growth. Year over year, total deferred revenue grew an impressive 45%. In addition, short term deferred revenue accelerated from approximately 40% year over year growth in the year ago quarter to 46% year over year growth in the current quarter. Calculated billings, defined as quarterly revenue plus the change in deferred revenue, grew at 41% year over year.

All in all, NetSuite’s quarterly and fiscal year financial results were spectacular, and were driven by the tremendous effort and commitment of our now more than 1,700 employees around the globe. In particular, our sales organization really delivered in 2012, and 2012 was the latest in a string of great years delivered by our sales team.

As always happens as you close the books on the last year and the dial is reset to zero, you make alterations to your sales force. One change we will be making this year will be in the leadership of our sales organization. James Ramsey, who has been with NetSuite for almost 10 years, has decided to take a leave of absence from the company.

Unlike enterprise software companies that close most of their business on December 31, NetSuite runs our organization as a monthly sales operation. In his tenure here, James has had the joy of closing more than 100 months. Given the intensity of the last decade, and James’ incredible dedication and success during that period, we can understand his desire to step back for a while.

James, like all good managers, has built a great organization, and we are very excited to announce the appointment of Jeff Honeycomb as the president of the Americas, reporting to Jim McGeever. I have worked with Jeff for many years, and he is undoubtedly one of the best leaders in the business. Most recently, he headed up NetSuite’s software and services industry sales organization. Before NetSuite, he was the president of cloud pioneer RightNow, and at Network Associates, he was president of the Magic Solutions division.

While James’ departure would normally leave a hard-to-fill gap, the fact that we have an experienced and high-integrity leader like Jeff Honeycomb stepping in should keep our sales machine running like clockwork. James will stay through the end of the first quarter to ensure a good transition with Jeff and with Jim McGeever.

So 2012 was a great year as measured by NetSuite’s numbers, and it also provided a yardstick to measure the success of our strategy of broadening the functionality of our suite and making it available, not just to small and mid-sized businesses, but also to the world’s largest companies.

While the move to the cloud by customers of all sizes is accelerating, and certainly helps a pure-play SaaS company like NetSuite, it is really the strategy beyond how the bits are delivered that will define the long term winners, and we think our strategy and execution against that strategy will make us one of those few long term winners.

We continue to take market share in the mid-market, where our competitors still struggle to deliver web-native applications. For example, in 2012 Microsoft once again missed their target date for cloud-native ERP solutions.

Likewise, our move up market continued unabated, as large enterprises continued to move to NetSuite and move away from legacy providers, most notably SAP, whose recent quarterly miss on the top and bottom lines shows their struggle with the disruptive shift to the cloud, even after investing billions of dollars in new products and narrow point product acquisitions.

And the ultimate measure of the success of our strategy and our execution is how our customers are transforming their operations with NetSuite. This quarter, we added more than 400 new customers, a threshold we have not seen in more than three years. More impressively, our average selling price for new customers grew a whopping 38% year over year, and more than doubled the average sales price we saw in Q2 2008, when we last sold 400 new customers.

In total, we closed this year with more than 16,000 companies, subsidiaries, and organizations transforming their operations with NetSuite. Our ASP growth over the last few years has been remarkable, and this growth is driven by several customer benefits when compared to pre-cloud applications like Microsoft Dynamics Great Plains, any number of Sage software products, and of course SAP.

The ASP growth begins with the customers’ willingness to pay more for NetSuite’s unified suite of applications as our multi-application solution can dramatically lower costs as businesses move from disjointed, disparate, multi-vendor systems to a single system for accounting, sales, service, and ecommerce.

For example, the implementation we announced today at NASDAQ-listed CallidusCloud replaced 14 disparate applications with one instance of NetSuite running globally in 14 countries around the world. Furthermore, when customers transform their operations with NetSuite, they also typically experience a substantial increase in productivity.

And the final factor playing into ASP is that larger companies, in fact some of the world’s largest, are moving to NetSuite. Notably in 2012, we saw some of our competitors’ largest customers move their fast-growing subsidiaries onto the NetSuite platform.

Our NetSuite OneWorld offering, which is clearly the industry-leading multi-company, multi-currency, multi-language ERP solution in the world, is an important driver of our success with larger, more complex midsized businesses and with the world’s largest enterprises.

And for both the quarter and the year, OneWorld again showed incredible gains. In Q4, we signed more OneWorld deals than in any prior quarter, and for the year we saw a 38% increase in the number of OneWorld customers. OneWorld has been, and will continue to be, an important driver in our enterprise business, and we are just at the beginning of that product cycle.

What’s amazing about our competitive position is that competitors like Microsoft and Sage in the mid-market and SAP in the enterprise market, are still trying to catch up with our product line as it existed circa 2007, before we introduced OneWorld, and in 2012 we moved even further ahead of them, with the introduction of our SuiteCommerce offering, which has generated great excitement in the marketplace.

NetSuite as an ecommerce platform has been remarkably successful over the last decade. Our customers, who use NetSuite as their commerce system, are running more than 3,000 B2B and B2C websites worldwide.

We spent the last two years rearchitecting this offering to meet the needs of modern retailers and etailers of all sizes by adding several new capabilities. First, we added capabilities to handle enormous product catalogs and transaction volumes. Second, we opened our SuiteCloud platform from bring primarily focused on how data moves across an enterprise to enabling rich customization of the customer experience when a customer lands on your website.

And finally, we made SuiteCommerce touchpoint-agnostic, so businesses could deliver a compelling brand experience to their customers, regardless of touchpoint, be it an ecommerce website, smartphone, or in a retail setting. Omnichannel commerce is what SuiteCommerce is all about.

Furthering our omnichannel commerce strategy, we made a small but important acquisition this quarter, with our purchase of Retail Anywhere. While some may think retail is dead, what is dead is the current approach to retail, where a dedicated, point of sale system provides no insight into customer interactions happening in other commerce systems within an enterprise.

All one has to do is look at Apple’s unified approach to retail and etail to see the power of NetSuite’s approach. The combination of Retail Anywhere and SuiteCommerce allows us to enable any company to deliver that Apple-like experience.

So as we close the chapter on 2012, it’s hard to imagine that we could be any better positioned. Our record results once again confirm that NetSuite is where business is going. Our current offerings are altering the business software landscape. Our next-generation offerings, like NetSuite OneWorld and SuiteCommerce, are delivering capabilities available nowhere else in the market, and fundamentally transforming the operations of small, medium, and large enterprises so that they can achieve their business visions.

2013 is a year of enormous opportunity for NetSuite, and following Ron’s comments, I’ll speak briefly on some of the investments we will be making to take advantage of that opportunity. Now here’s Ron Gill, our CFO.

Ronald Gill

Thank you, Zach. As you may have been able to glean from Zach’s remarks, Q4 was another strong quarter in what turned out to be another very strong year for NetSuite. There are a number of areas I’d like to highlight for you as we go through the 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. Revenue numbers are, of course, GAAP numbers, and as always you can find a reconciliation of GAAP to non-GAAP results in today’s press release.

Our revenue for the fourth quarter totaled $85 million, up 7% sequentially and up 33% over Q4 of 2011. Recurring revenues from subscription and support in Q4 grew 5% sequentially and 26% over the year ago quarter to $68.5 million and accounted for 81% of our total revenue.

Our nonrecurring revenue, which comes predominantly from professional services, was $16.5 million for the quarter and grew 66% over that for the same period last year, driven both by a significant increase in the number of hours worked and by a continuing rise in our average realized hourly rate as our professional services teams handled larger implementations.

For the full year, revenue totaled $308.8 million, an increase of $72.5 million, or 31%, over that for 2011. You may remember that our total revenue growth rate in 2010 was 16%. We accelerated that to 22% in 2011, and the business continued to build momentum nicely in 2012.

Recurring revenues totaled $252.9 million, an increase of $53.3 million, or 27%, year over year also a nice acceleration over the 22% rise we saw in 2011. Approximately 26% of our revenue for very was generated outside of the United States.

So as you can see, the growth rates for both recurring revenue and professional services revenue accelerated sharply again in 2012. While improving retention continued to be a factor in growth in the year, the real driver of acceleration has been the continuing move upmarket to the larger end of the SMB space and increasingly into two-tier deals at larger enterprises.

Rising ASPs were a recurring theme again this year. Our average new business deal size was up 38% year over year in Q4, and up 21% for the full year, while the number of new deals greater than $100,000 hit an all-time high in Q4 and for the full year was 50% higher than in 2011.

As Zach discussed, we launched some pretty exciting strategic initiatives in 2012 that we think are going to become drivers of larger deals in the commerce space, so I expect the up-market momentum to continue going forward.

Moving down the P&L to gross margins, in Q4 the gross margin on recurring revenue was 85.4%, while the gross margin on nonrecurring revenue was 15.8%. For the full year, recurring gross margins improved slightly from 85.2% to 85.3%, and nonrecurring gross margin improved from 8.5% to 14.7%. The overall blended gross margin went from 73.3% in 2011 to 72.5% in 2012, due to the slightly higher ratio of services revenue in the mix in 2012 versus the prior year.

Turning to our non-GAAP operating expenses, product development expense was $10.4 million for the quarter, up 21% over Q4 of 2011 and represented 12% of Q4 2012 revenue.

We continue to make significant and efficient investments in our product development team. While spending in that area was up 21% year over year, total headcount in the group ended Q4 up more than 150 heads, or about 64% over the year ago quarter. I would expect that, even with our plans for continued aggressive investment, spending on the product team will be in the 12-13% of revenue range for 2013.

Sales and marketing expenses were $38.3 million, or 45% of revenues in Q4, slightly up from 44% of revenue in the year ago quarter. Total headcount in the sales and marketing organization was up about 35% year over year in 2012. Looking ahead to 2013, as we’ve discussed, given the strong demand environment, you’re going to again see us invest aggressively in this area.

G&A expenses were $7 million, or 8.2% of revenue in the fourth quarter. That’s down from 9.1% of revenue in Q4 of 2011. For the full year, G&A expenses were 8.6% of revenue, down from 9.4% in 2011, so we continue to scale well in this area. For 2013, I expect G&A expenses to be roughly 8-8.5% of revenue.

Non-GAAP operating income in the fourth quarter was $5.4 million, an increase of 33% over that for Q4 in 2011. This equates to a non-GAAP operating margin of 6.4% for the quarter. For the year, operating income was $22.1 million, an increase of 75% over that for 2011, and resulting in an operating margin of 7.2% for the year.

During the quarter, we reported a net income tax expense of $646,000, principally related to our international operations. For income tax purposes in the U.S., we continue to expect our net operating losses to offset any domestic earnings for the foreseeable future.

Foreign exchange movement did not have a significant impact on results for the quarter. A generally weaker U.S. dollar versus the year ago quarter increased U.S. dollar revenues slightly, and increased costs by about $560,000, for a net negative impact on non-GAAP net income of approximately $480,000 in the quarter.

Non-GAAP net income for the fourth quarter was $4.6 million, an increase of 33% over the year ago quarter. For the full year, non-GAAP net income increased 77% to $19.1 million for a net margin of 6.2% compared with 4.6% for 2011.

Non-GAAP earnings per share was $0.06, up 20% versus the year ago quarter. For the year, we posted $0.26 of non-GAAP earnings per share, up 73% from the $0.15 in 2011.

On to the balance sheet, we closed the quarter with $185.9 million in cash and cash equivalents, and minimal debt. That represents an increase in our cash balance of $44.4 million, or 31% of the balance we had just a year ago at the end of 2011.

Cash flow from operations in Q4 was $13.4 million, up 15% year over year. For the full year, cash flow from operations was $54.3 million, up 50% over the $36.3 million number in 2011.

Moving down the balance sheet, from cash to deferred revenue, our total deferred revenue balance increased to $161.4 million, an increase of 19% over the prior quarter, and up 45% of the prior 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 $110.9 million for the quarter, representing an increase of 41% over the same quarter in 2011.

As I’ve consistently pointed 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.

In Q4, this metric was favorably impacted by changes in foreign exchange rates and billing terms versus the year ago quarter, and to a larger degree by the change in our renewal agreements that we introduced back in the second quarter of 2012.

The year over year growth rate in calculated billings for Q4 with these impacts normalized out is about 33%. Significantly, the portion of that normalization driven by the renewal effect in particular represents a net impact of about $5.7 million of billing that is a direct shift into Q4 of renewals that in past years would have shown up in Q1. There’s a pretty good chance I may remind you of that fact again on the Q1 call, so please keep in mind that these normalizations can go both ways.

Total headcount on December 31, 2012 was 1,778, up 148 from Q3 of 2012 and an increase of 41% from Q4 of 2011. For the full year, we added more than 500 employees, with the majority of the additions coming in product development, sales and marketing, and professional services.

Now I’d like to move on 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.

First, I’d like to talk about what we’re expecting for 2013 as a whole, and then we’ll come back to some specifics about the March quarter. For 2013, we’re raising our prior revenue outlook and currently expect revenues to be in the range of $397 million to $402 million. I’ve mentioned areas of investment several times this afternoon already, and that will certainly be a theme for 2013.

We’ll again be aggressively growing our product team and expanding our sales organization around the world. In the area of facilities alone, expanding headcount globally is going to mean a need for additional office space at multiple locations here in the U.S. as well as locations in South America, Australia, Europe, and Asia.

We said on the last call that we were very bullish on the future, and we’ll have a bias toward investing rather than driving to increase margins. Given the expansion we’re planning for the year, we now expect EPS in the range of $0.26 to $0.27 for 2013, which would result in operating cash flows in the range of $55 million to $60 million.

Again this year, I expect you’ll see what has become the usual pattern for us, with the most significant investments focused early in the year and margins expanding in the second half. For the March quarter, we foresee revenue in the $90.5 million to $91 million range, and non-GAAP EPS of $0.02 to $0.03. We expect operating cash flow to be between $11.5 million and $12 million.

So as we promised you last year on Groundhog Day, we did get up every day in 2012 and do the same thing over and over again. Based on the results we’ve just reported, it seems to be working, so I’ll say again what I said on this call last year: We’re very much looking forward to waking up tomorrow and repeating the effort.

That concludes my prepared remarks. With that, I’ll turn the call back over to Zach.

Zachary Nelson

Thank you, Ron. NetSuite gained incredible momentum in 2012. I think in 2013 the trends that drove NetSuite’s growth will only strengthen as the year progresses. In 2013, we will make investments to ensure that we, our customers, and our shareholders continue to gain from the market leadership position we have achieved, driven by our laser focused cloud computing strategy and our excellent historical execution against that strategy.

To take advantage of our leadership position and market opportunity, we’re going to continue to invest aggressively in 2013. We plan to add more sales people than we have during any year in our history. We will invest incrementally in brand marketing, and we will continue to expand the size of our development organization markedly as we expand our product capabilities to meet the needs of small, medium, and large companies across many industries.

As we have for the last two years, we plan to front-load as much of this investment as possible in Q1 and Q2. This early investment allows our operating results to benefit more rapidly than if we were to equally proportion the spending across each of the four quarters. Given the nature of our recurring revenue business model, these investments should have the majority of their impact in the acceleration of our business beyond 2013.

So with that outlook, we will now open the lines for your questions. Operator?

Question-and-Answer Session


[Operator instructions.] Your first question will come from Greg Dunham with Goldman Sachs.

Gregory Dunham - Goldman Sachs

Obviously a very strong billings number. One thing you didn’t mention, Zach, on the call, was the partner contribution this quarter, and how that’s progressing. Can you just comment on that briefly? And then I’ll let others ask.

Ronald Gill

I didn’t not mention it for any reason other than the script was a little long. The channel for the year had a great year any way you look at it. This year we had 15 of the top 100 VAR, the VAR 100 group sign up for NetSuite in total. So the size of the VARs certainly getting larger. The deals that the VARs are doing are larger.

If you remember back from our past calls, VARs have tended to do smaller deals, but that’s changing now too. You’re starting to see many, many six-figure license deals come out of the VAR channel.

And beyond that, the larger channel, some of the large channel partners that we talk to, are also showing a lot of traction. McGladrey, which I think is probably Microsoft Great Plains’ biggest reseller, had an incredible year. And I know McGladrey is very excited about what’s going on in their transition from things like Great Plains to NetSuite.

Grant Thornton we signed up sort of mid-year, and I think they’re going to have a great year in 2013. A lot of resources being applied by Grant Thornton. And in the large SI category, Accenture had a good year, but I really think 2013 is going to be an even bigger year for NetSuite and Accenture.

And Deloitte, who we signed up midyear - you know, we’re very excited about what’s going on with Deloitte, and in particular Deloitte digital, around the SuiteCommerce platform. Their digital strategy is very tightly aligned with what we’ve built in SuiteCommerce. So we see a lot of promise there.

In terms of percentage of booking, I think it grew to about 30% of new business out of the channel, so that’s very strong. And you know, our view of the channel has always been this is as disruptive a model to their business as it has been to the traditional software companies’ business.

And I talked a little bit about companies like Microsoft and SAP and the difficulty they’ve had making the transition. Frankly, the channel had a similar difficult transition to make, but if you look at them doing 30% of our new business, that transition has started.

If you look at the quality of the partners, it’s clear they’re transitioning their business. So we’re very excited about the channel. And incrementally next year we’re going to be investing more in indirect sales than we will be in direct sales proportionally, so we see the channel kicking in very strongly.


And next we’ll go to Raimo Lenschow from Barclays.

Raimo Lenschow - Barclays

Can you talk a little bit about the verticals, what you’re seeing there? Obviously you had a good year, but anything standing out? Anything you want to do better in ’13?

Ronald Gill

Yeah, I’ll talk about the verticals sort of one by one. It was a great year across all the verticals. Revenue from all the verticals grew double digits. If you look at the software, our software vertical, and that’s probably really our true vertical market approach. Everything else is really an industry approach by and large I think is the way to think of it.

But we basically own the software industry today. We have the world’s best solution to run a software company of any size. We doubled the number of new business deals. The average selling price grew nicely there.

So we’re just killing it in the software business. And if any of the other companies you follow don’t use NetSuite, they’re doing something wrong, and it’s a big question of their management. If you’re not using NetSuite to run your software business, you’re spending way too much and getting way too little. So I would encourage all of you to ask those questions of the other public companies and private companies that you follow.

Manufacturing had an incredible year. We added a lot of new features to the manufacturing product over the last year, and that really paid off in the manufacturing group, as well as in the wholesale distribution industry group that we sell. And we’ve always been strong with distributors. They tend to be smaller, but even in wholesale distribution this year our average sale price grew by something like 50%, which shows you as we add this new functionality we get to larger companies in those particular areas.

Ecommerce, we’ll talk probably a lot more on this call about ecommerce, SuiteCommerce, but the average sale price there in Q4 also grew by 50%. So a lot of the things we’re doing to move the ecommerce capabilities upmarket are having an effect. We certainly see it in the average selling price and you also see it in the competitive environment, where we’re butting heads and winning against narrow, low-functionality point products like Demandware.

Regionally, we also saw some interesting new trends in the year. Japan had a great year. Average sales price in Japan grew by something like almost 4x, and so that’s really positive to see. I think Japan has Salesforce’s largest region outside the U.S., so we’re starting to see traction there. We’re very excited about that. And in general, APAC had a great year.

And in Q4, the U.K. had a fantastic quarter. So I think we’re turning the corner in Europe, even as Europe continues to suffer from maybe some of their economic malaise. So vertically and regionally, it was a great year across the board.


Moving on, we’ll go to Jason Maynard with Wells Fargo.

Jason Maynard - Wells Fargo

A question I had for you around the ramping of the opex. You mentioned a little bit more on indirect. I’m curious just to maybe drill a little bit deeper into that. Where do you think you add domestically? How do you spread it out versus the international markets, and then obviously the indirect mix? Just any color on how that assortment will look when we exit 2013. Thanks.

Ronald Gill

We have so many different levers in the sales model. We have selling into the installed base, selling new business, selling vertically, selling regionally. There are lots of different ways you can cut and look at the investment.

Generally speaking, I would say we grew the enterprise group the largest on a percentage basis this year, and we’re going to continue to invest heavily in that enterprise sales organization. The pipeline there is growing very rapidly. Great opportunity there, and great wins in the last year.

So again, I think proportionally that enterprise group will get more. From a vertical and industry standpoint, obviously we’re investing very heavily in ecommerce, and ecommerce has two sort of dimensions to it. One is horizontally. Wholesalers and distributors need to do a B2B site that’s as sexy as a B2C site, so we have now resources applied horizontally across all of our groups that are commerce experts.

And, with the acquisition of Retail Anywhere, we’re going to create a vertical we call etail/retail, which is specifically focusing on the retail opportunity and the opportunity of pure etailers. So there’s going to be significant investment there as well.

And Asia’s growing, I think, faster than certainly some of the other regions, and you’ll see incremental investment in that particular category as well. Ron, I don’t know if you have any other color on the sales?

And then of course, beyond sales, we’re investing enormously. In particular, development is getting an enormous amount of investment, and if you look at the percentage of revenue, I think that’s probably the one that’s growing the most or the potential to grow the most is R&D. So it’s not just sales that’s growing, it’s all the other pieces of NetSuite.

Jason Maynard - Wells Fargo

You had mentioned about industry groups and the verticalization being one of your key strategic goals. As you ramp this headcount, and you think about going into that and etail and some of these, what percentage of revenue or bookings would you attribute maybe coming from industry or vertical groups? Perhaps not this year, but next year, as you start to progress on that journey.

Ronald Gill

Well, we’ve never really given out bookings by industry group. I think the way that we’ve historically said it is that about half of our expenses are in industry organizations, and about half are what we call general business. I think that’s a rough rule of thumb. So you could assume sort of comparable revenue generation from the large groups.

General business, by the way, are those groups that we have not put into an industry category. So for example our services industry category is focused really around time-based and project-based processes. So financial services would fall into our general business groups, because it’s not really related to time-based processes.

So general business still a very large portion of the revenue stream, but what happens in general business is you identify the next industries and vertical groups when you see traction, for example, like in media publishing, like in financial services, you begin to resource those differently, and ultimately they turn into an industry focus group. So general business is really the way we identify the next emerging organizations.

And retail, obviously, was one of those organizations that was in general business last year that we’ve now identified, taken out, and put into a specific industry group that has dedicated sales, dedicated services, and really dedicated engineering at this point.


Moving on, we’ll go to Philip Winslow with Crédit Suisse.

Philip Winslow - Crédit Suisse

Just wanted to focus on two items. First, Zach, what are you seeing with OneWorld and selling into the two-tier opportunity? Obviously some of your competitors have talked about this space, having seen a lot of traction there. So just curious for an update.

And also, obviously you launched SuiteCommerce back in May. Now that it’s been out there for multiple months, just what’s the feedback from customers? In particular, I’d just be curious, just integration back into the back office and the ERP systems, if that’s really becoming a differentiator versus the pure just commerce plays.

Ronald Gill

We pioneered this whole two-tier concept, and certainly everyone is talking about it, but it’s a heck of a lot easier to talk about delivering a tier-two solution than it is to actually deliver a two-tier solution. What OneWorld does is incredibly complex. The ability to run multiple subsidiaries in a single instance of the application, and do real-time consolidation across those is not a trivial exercise.

And so companies can talk about it, but doing it is very, very challenging. And you can look at a company like SAP. They’ve had sort of three runs at business by design, and it still doesn’t really work. So you have to build an incredible product that actually works, and our development team has done that.

The second thing that I think is a little bit misunderstood about OneWorld is it’s not just about financial consolidation. Because what NetSuite built was a system designed to run a business. Companies aren’t just running their financials in these different subsidiaries in OneWorld, they’re running the business in those subsidiaries. They’re running the orders, they’re running the inventory. They’re running the CRM, they’re running the marketing campaigns. This is a business consolidation system.

And so that’s the second secret sauce of NetSuite OneWorld and two-tier deployments, is it’s way beyond financial consolidation, it’s business consolidation. And I talked a little bit about how the suite approach, our multiapplication approach, drives up ASP.

That happens on steroids with OneWorld, because you’re now displacing - take the example of Callidus. You’re not displacing two ERP systems, you’re displacing 14 systems, across marketing and order management, and a whole host of systems.

So that’s the second piece of two-tier. The guys who are talking about it don’t really understand. When they talk about it, they’re talking about financial consolidation. That’s just a small piece of what NetSuite does.

Now, SuiteCommerce is actually an interesting jumping off point for two-tier, because in many ways NetSuite and SuiteCommerce is being deployed in a two-tier fashion. How do you now begin to run your commerce operation in multiple subsidiaries?

It’s another great example of the power of OneWorld. Not only can you do financial consolidation in OneWorld, not only can you run your CRM system across countries in OneWorld, you can also run multiple websites in multiple currencies, with multiple stock levels, multiple inventory, multiple shipping, in a single instance of the product. And that’s the backbone of OneWorld.

So when you think about it, something like Demandware trying to compete with us in that environment, they can’t, because you have to build a multicompany consolidation system to deliver a multinational ready commerce experience, and that’s what these large etailers are trying to do, is to have a common back end across all of their websites, across their French website, their Australian website, their German website. And you cannot do that unless you have a common, multicurrency, multilanguage, multicompany back end like OneWorld.

So it’s incredibly important for where the world is going. And if you look at Demandware, I’m always surprised… First of all, I think they’re incredibly vulnerable. They only have 130-some customers. When they lose a customer, it’s a big deal, number one. But number two, they need so many systems to make that thing function it’s a giant hairball.

And I think you saw some of the downside of that in something like their customer Finish Line, who had incredible problems going live in December because they had to tie together a separate order management system, from a separate inventory system, from a separate tax system. And when you start to tie together these very complex transactional systems, to essentially a display system, which is all Demandware really is, displaying the bits to a page, it’s very hard to make it work.

So Demandware calls themselves an ecommerce company, but the amazing thing is they can’t even take the order. They don’t have order management. How do you do commerce without the ultimate piece of a commerce system? And so yeah, I think what NetSuite has is the heart of commerce. It’s called order management, it’s called multicompany order management, and that’s why we’re going to win big, in addition to all the things we’ve done on the front end that bring us parity with what Demandware does on the front end.

So yeah, I think all of the things that we’ve built… And it turns out, effectively, ecommerce is an ERP problem. Right? It’s about taking the order, shipping the order. That’s why people love Not because of Amazon’s UI. In fact, people probably don’t like Amazon’s UI. It’s all the things that happen when you order. And that’s effectively what we’ve built.


And from Piper Jaffray, we’ll hear from Mark Murphy.

Mark Murphy - Piper Jaffray

It looks like your subscription revenue has been growing 27% each quarter this year, so it’s been very consistent. And then the professional services revenue growth has accelerated from 26% to 66% in the last four or five quarters, in terms of the growth. And I’m just wondering, how does that translate into the deferred revenue line? And to what extent is the billings acceleration, or deceleration, a function of subscriptions versus services in general.

Zachary Nelson

The recurring revenue growth accelerated pretty nicely this year. I think we went from about 22% recurring last year to 27% recurring revenue growth this year. So recurring revenue is growing nicely, and that growth rate is accelerating nicely. As you point out, the PS revenue growth rate accelerated even faster.

So your question is about how does that impact deferred revenue. One of the things I’ve talked about in the past is we’re often designing the way we’re doing business to solve the right problems for the business, to grow the business, without much of a thought to what that’s going to do to deferred revenue, or what that’s going to do to calculated billings, because neither of those is a real metric that we’re going to drive by.

So one of the things we’ve been trying to do over the past couple of years in professional services is increase the gross margin. We talked about that. Two years ago, in 2010, we had a negative 6% gross margin in professional services. Now we’ve just finished a year where it’s about 15%.

So that has worked, but one of the things that we’ve done to do that is more time and materials. And the impact of time and materials has been that as we book an increasing amount of time and materials deals, those deals don’t put anything into deferred revenue. So actually, in most quarters, for the year that’s been a net drag on calculated billings.

It’s not an effect that I’m normally normalizing for, but we’re taking a portion of deals that if you build them the old way, and did a fixed price project, maybe you’d build the whole thing up front and put it in deferred revenue. We’re changing that now to time and materials, which doesn’t get billed up front, and so it doesn’t create any deferred revenue.

It’s actually better for the way we manage projects. It’s actually better for the communication and relationship with the customer, and ultimately we’ve gotten a better gross margin out of that, but it is a drag on the way calculated billings work.

Ronald Gill

And the other thing I would add, just on PS again, just to remind you, the way we look at PS is really an investment in driving the recurring. And I think that you’ve seen the payoff in that investment in the remarkable reduction in revenue churn that we’ve seen. It actually improved year over year again. Last year we thought it couldn’t get any better. This year it got better, so I don’t know that it can get any better, but it’s all because of that PS investment that that is happening.

And the other thing I think you see when you compare us to others in the SaaS world is it’s nowhere near, for example, what Workday’s professional services line is. So what we’ve done, and I think it points to a flaw, perhaps, in the Workday product line, is we’ve made this thing incredibly customizable. End users can actually alter the schema. End users can actually do customizations.

It’s pretty amazing how large Workday’s professional services line is. So I think that’s pointing to a problem they have in not having a platform-based approach to what they’ve developed. And so they have to have engineering, as far as I can tell, do those customizations.

And finally, you look at our channel growth, that’s another thing that keeps our recurring revenue down vis-à-vis something like the 30 some-odd percent that Workday has. It’s the channel is kicking in, doing a ton of services that we don’t actually see, and so we’re really happy with exactly what we’re doing in the services side to ensure the recurring, how the channel is engaged in that with us. And also, all the effort we’ve put in our platform accrues as a benefit to us as we do faster, cheaper, and better services than the competition.


From William Blair, we’ll go to Laura Lederman.

Laura Lederman - William Blair

Can you, following up on the last question, talk a little bit about the growth rate of professional services versus subscription for next year? Just kind of give us a sense of how that splits out, even roughly?

Zachary Nelson

We’re not going to probably get into the business of trying to guidance the two elements separately, so I think I won’t get into trying to parse how much each will be in 2013. The trend that we’ve seen is, as the earlier question pointed out, the blend was sort of 84%, 16%, in 2011. 84% recurring, 16% professional services. In 2012, that went to 82-18.

I think, just given what we’ve seen in bookings, and especially with one, the strength of the new business bookings, two the size of deals we’ve been doing, it won’t surprise me if that trend continues a little bit more with PS growing a little bit faster than recurring. But as I said, the recurring revenue growth rate has been accelerating pretty nicely as well. But it won’t surprise me if PS continues to grow a little bit faster in ’13.

Laura Lederman - William Blair

Can you talk a little bit about the ecommerce pipeline and what are the ASPs looking like? Is it bimodal, where there’s a few really big ones, and a lot of them are small? Just kind of a feel for what that pipeline looks like.

Ronald Gill

Good question. We approach the ecommerce market with two product versions. One is designed for mid-sized/small etailers, or people that want to build commerce sites. And the most recent iteration, the SuiteCommerce enterprise product, as we call it, is really the rearchitected product design for much-larger companies and to move up market.

So the existing SuiteCommerce product, doing well. Very large companies running on that, guys like GoPro, are doing hundreds of millions of dollars through our existing products. Awesome set of solutions. But targeted typically at smaller etailers.

The SuiteCommerce enterprise product that we introduced midyear, as you’ll recall, we released that in a controlled version. I think we were expecting to keep it to 20 last year, and in the second half of the year we actually signed up 30. Which doesn’t sound like that many, but we intended to control it so that we had great implementations.

But to give you a point of reference, I think Demandware also just signed up 30 customers on their existing product. So when you look at that product, vis-à-vis Demandware, we’re selling as many deals as they are in a controlled fashion. If we’d taken off the harness on that thing, we would have sold many, many, many more deals than 30 deals.

So we’ve got incredible demand in that pipeline. The other thing we did that was very important in that product that we added last quarter is retail. So everybody’s talking about omnichannel commerce. Demandware’s talking about omnichannel commerce, but for them omnichannel commerce is basically a single channel called your website. They have no way to support retail point of sale.

In fact, nobody does. We’re the first cloud-based system that supports both retail and online transactions in a single system. And so that is also changing the landscape and is changing the deal scope dramatically for us as we move forward.

So we’re releasing the next iteration. We have our next major release as a company, 13.1. It’s beginning to roll out now. And once that is completely rolled out, we’re going to open up the entire SuiteCommerce platform for general availability. So we’re really excited, both about the existing mid-market product and the SuiteCommerce product.

You’re seeing multi-hundred million dollar etailers sign up for us. And just anecdotally, you know, we beat Demandware in one deal in Q4. Multi-hundred million dollar public company, replacing ATG. And the reason they went with NetSuite was number one, the pricing model. And as I’ve said, Demandware’s pricing model, pricing as a percentage of revenue, is history. There is no way large companies will ever allow that to happen. And we don’t price that way. So the main competition in the market is going to completely change the pricing model on them.

System agility. You know, this product is built as a platform. It’s really designed to be customized, both front and back end, and multi-company, multi-currency. We talked about all the national things that you have to solve. Huge advantage there.

And then finally, functionality. I think the big piece of the functionality, order management. We have the world’s best order management, bar none. And now you add retail on top of that. And Demandware’s functionality, let’s face it, is basically a display functionality. They have to get all of their inventory, all of their orders, everything else, from a separate system. And that hairball approach to commerce is exactly what people are moving away from.

So I think we are in a very, very strong position vis-à-vis the only other cloud guy, and certainly against the on-premise people that are trying to cobble together solutions that are not cloud-native.

Laura Lederman - William Blair

To be fair to them, they did introduce an order management, so it’s new [unintelligible] probably.

Ronald Gill

Well, it’s new, and nobody’s using it. So you can send a news release out, but order management’s very hard. When they get somebody using it, I’d like to see that news release.


Next from Deutsche Bank, we’ll go to Tom Ernst.

[unintelligible] - Deutsche Bank

This is [unintelligible] on behalf of Tom. Thanks for taking my question. I’m not sure if you guys talked about this, but what are your sales expansion plans for 2013? By how much do you plan to increase the headcount.

Ronald Gill

In 2012, we talked about increasing headcount someplace in the ballpark of 60% of capacity. We didn’t quite hit that mark. We did pretty well. And the other great thing about that, even while we expanded that capacity, our productivity basically remained flat over the years. So in our world, usually when you have that much capacity, your productivity craters. It didn’t crater. It remained flat. That’s a very good sign.

So we’re going to hire as much capacity as humanly possible. Really not going to put a number out there this year. My philosophy on this is goals only limit you. And we don’t want to be limited to the number of sales people we can hire this year.

[unintelligible] - Deutsche Bank

And in terms of adding sales force, are you looking to add on new accounts? Is it equally between new accounts and existing accounts?

Ronald Gill

Not necessarily equally, but we will add in both areas. The way we manage our installed base accounts is we have a ratio of how many accounts to reps, and so we try to keep that ratio established, and so that’s pretty formulaic about how many internal reps you have to add. And then as I said, there’s the external. We want to hire as many reps as humanly possible. We added 50% capacity next year. We’re going to see what we can do this year.


From Morgan Stanley, we’ll hear from Adam Holt.

Adam Holt - Morgan Stanley

I had two questions. The first is on the improvement in average selling price. You talked earlier about the suites driving ASPs up, but in this quarter in particular, with that 38% increase, was it more oriented toward scope, so bigger seat deals? Or was it more oriented toward products? Or was it more oriented toward mix? How do you think about the ASP increase?

Ronald Gill

It’s a good question. Generally I think the ASP is driven, as I said in my points, by really three factors. One is it’s a suite. It’s broader usage of the multi-application environment we’ve created, a la what we announced with Callidus. Fourteen applications replaced with one instance of NetSuite. That’s a big driver of ASP, certainly in midsized companies as the suite begins to subsume more and more functionality.

The second piece certainly is larger deals. And that’s a major piece. The third piece is new functionality. I think if you look at ecommerce, ecommerce average selling price in the quarter grew 50%.

And the interesting thing about what we’re doing with ecommerce, and as I said it’s the only cloud-native, multi-channel solution available in the world today, is it brings you to the revenue side of the equation with the customers, rather than the cost reduction side of the equation.

And it is the future of customer-facing systems, how do you interact with them without humans involved, right? The machine becoming the CRM system. So I think that piece of functionality will also be a driver going forward. And all three of those levers continue to work next year, right?

This year we really didn’t expect the average sale price to grow that much. If you remember, at the end of 2011 it grew 45%, and we really didn’t think it would grow again this year, but it did. The way we’re modeling it again this year is we really don’t think it’s going to grow that much, because of this great growth we’ve seen this year. But that may be an additional growth lever as the year goes on.

Adam Holt - Morgan Stanley

And then my second question is I believe you mentioned that durations benefited billings in the quarter. What was the impact of durations on the quarter? And as you look forward, what’s the assumption for durations heading into the first part of the year?

Zachary Nelson

Let me just make the distinction between the contract term, which would be the overall length of the contract that was signed, and the billing term, which is the portion of the annual contract that’s billed up front. And so in the normalization that I do on calculated billings, that I did this quarter on calculated billings, I’ve got the billing term impact in that normalization.

So when I normalize down from the 41 to the 33, that impact is normalized out. Really billing term moved very little year over year. It was a very small part of that normalization. It wasn’t a big difference. We haven’t seen a dramatic move in billing term in several quarters.


Next question will come from Michael Huang with Needham.

Michael Huang - Needham

First of all, in terms of your SuiteCommerce win with the large etailer, how long was that sale cycle, and when would this one be launched?

Ronald Gill

I think it was a pretty long sales cycle. It was about a six to nine month sales cycle, and it will be launched second half of the year. So when you do these big replatformings, and obviously when you move them from ATG, that’s a big replatforming, those things take a lot of time and a lot of thought. So particularly as we move SuiteCommerce up market, where you see it go, I think the deal cycles get a little longer. The implementation timeframes are a bit more generous, but the average sales price is also more generous. So I think it all sort of works itself out.

Michael Huang - Needham

And this one would be a full suite deal, so it’s SuiteCommerce plus the breadth of NetSuite’s capabilities?

Ronald Gill

Yeah, the great thing about what NetSuite enables is it’s not just about displaying a website. It’s about capturing the order, then do marketing back against that order, true customer relationship management. It’s about providing support. It’s about managing the inventory. And then it’s also about spinning out the financials of what’s going on in the business. So yeah, it’s a complete suite.

And that’s why, when you look at ecommerce, it is designed for a complete suite. If you have one system doing your website display called Demandware, and you have another system doing your marketing automation called X, and you have another system for orders, there’s no way you can get visibility across this very complex business. And you have to have visibility control, because it’s a real-time business. You have to be able to respond to things in real time. The more systems you have, the less real time it will be.

So yeah, it is a complete suite. In most cases it’s a complete suite. Now, in some cases, it isn’t a complete suite, but it is order management. So for example, I think one of Demandware’s biggest customers uses NetSuite for the order management system. They’re using a separate system to do the financials, but NetSuite is doing the order management. So we have an in. When Demandware is the display system, it’s very possible that NetSuite could be the order management system.

Michael Huang - Needham

Just in terms of the ASPs, when you think about 2013, given the strength of ASP growth in 2012, what are the higher-level assumptions around what ASP growth could look like in 2013, especially with SuiteCommerce launching in full production?

Ronald Gill

We’re taking the same approach that we took last year as we saw a large ASP growth, that hey, that’s something that you really shouldn’t plan for. It’s nice to see, but you shouldn’t plan for it. Last year we weren’t looking at any ASP growth. This year we’re looking for very, very modest ASP growth from a modeling standpoint.


Next we’ll go to Karl Keirstead with BMO Capital Markets.

Karl Keirstead - BMO Capital Markets

I’m just wondering if you could add a little bit more color about the trajectory of the investments you’re going to make in 2013. Extremely Q1 heavy to get to your $0.02 to $0.03 non-GAAP EPS guide. And then obviously earnings have to accelerate sharply in the second half. I’m wondering if you could just talk a little bit about what’s driving the need to front-end load the investments, and what are some of the temporary or one-time expenses that you won’t have in the second half.

Zachary Nelson

Just to level-set, the target was $0.04 in Q4. We actually did $0.06. Frankly, we didn’t really want to do $0.06. We wanted to start the investment in Q4. So I think maybe if you compare the $0.02 to the $0.04 that it was expected to be, it’s a little less of a step down.

And so we were planning, of course, in Q4, against that sort of scenario. That said, if you look at really the past two years, we have front-loaded as much expense as we could into Q1 and Q2. Because it does really benefit the model to have the sales guys on earlier, have the engineers on earlier. It takes engineers a while now to ramp too. So if you can get them on six months earlier, they actually affect the 14.1 release, not the 14.2 release. Those kinds of things. So you get more functionality as a result.

And we’re also for the first time investing in brand advertising, which is a large incremental, you can call it one-time expense, but we hope to continue it, that’s all in Q1 and Q2. So that’s all new spending.

The other important area of spending is we are expanding our footprint massively around the world. We’re investing a lot in real estate. That has to happen very soon. We’re busting at the seams in every country, and every office that we’re in. And so all of that’s going to happen very early in the year as well. So you’re seeing the effects of all of those elements happening within the $0.02 model.


And we have time for one more question. Your last question will come from Scott Berg with Northland Capital Markets.

Scott Berg - Northland Capital Markets

A two-part question on deal flow in the quarter. First of all, can you talk about linearity in the quarter relative to the fourth quarter of ’11, and if there’s any differences there? And then secondly is how much of the initial sale is coming from more multicomponents of the deals, maybe relative to the fourth quarter of ’11? Just trying to understand that.

Zachary Nelson

You know, it’s hard to contrast linearity in any given quarter, because we do do 400 deals, right? It’s very different than a company doing 10 deals or 20 deals a quarter. So linearity does move around a little bit. That said, in this particular Q4, not related to any Q4, we started out very strong, and we ended very strong. It was just a strong quarter across the quarter. So it wasn’t like we were waiting for December really to make everything happen. We had a very strong start to the quarter.

The other thing in our model, obviously, is Q1 does step down from Q4. We are like other enterprise software companies in that way, so we always expect Q1… Our general linearity is Q4 big, Q1 steps down, Q2 up from Q1, Q3 flat, Q4 steps up. And so that’s the general stepping that we’ve historically seen, and that’s what we plan to.

Ronald Gill

Yeah, I think we’ve seen it skew just slightly more toward the fourth quarter in the last couple of years, as we’ve had more enterprise sales, and it’s become slightly more enterprise hockey stick shaped.

Zachary Nelson

Thank you all for joining us. We really appreciate it. It’s a great way to kick off 2013, and we’ll speak to you in a quarter.

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