SeekingAlpha reports: NetSuite Inc. (NYSE:N) Q2 2014 Earnings Conference Call
July 24, 2014, 05:00 PM ET
Executives
Jennifer Gianola - Director, Investor Relations
Zachary Nelson - President and Chief Executive Officer
Ronald Gill - Chief Financial Officer
Analysts
Jason Maynard - Wells Fargo
Frank Robinson - Goldman Sachs
Samad Samana - FBR Capital Markets
Brad Reback - Stifel
Harris Heyer - Barclays
Justin Furby - William Blair & Company
Philip Winslow - Credit Suisse
Alex Zukin - Stephens
Operator
Good afternoon. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the NetSuite Q2 earnings conference call. (Operator Instructions) I now turn the call over to Jennifer Gianola, Director of Investor Relations. You may begin your conference.
Jennifer Gianola - Director, Investor Relations
Good afternoon, everyone, and welcome to NetSuite's second quarter 2014 financial results conference call. A more complete disclosure can be found in the 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 visit 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; and Ron Gill, our Chief Financial Officer. Zach and Ron will begin with prepared remarks, and we will turn the call over to question-and-answer session.
During the call, we will 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 the second quarter 2014 financial results. However, some of the information discussed during this call, including 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 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 now turn the call over to Zach.
Zach Nelson
Thank you, Jennifer. And welcome everyone to NetSuite's conference call to discuss our fiscal 2014 second quarter results. After a quarter like Q2, it's hard not to look back and appreciate all that we have accomplished with a history of firsts, from our founding in 1998 as arguably the first cloud business application provider to our position today as the most widely deployed ERP-based cloud suite in the world.
But what is even more exciting is that we have an enormous opportunity in front of us. We are really just at the beginning of the journey to create the next-generation business system for companies of the future.
Q2 also provided a few new-first in our history. On the business front, we hit two milestones worth noting. First, we had our first $100 million recurring revenue quarter. In addition, based on our Q2 results, NetSuite has become the first ERP driven cloud software company to achieve an annual total revenue run rate of over $0.5 billion.
On the industry front, we also received notable recognition during the quarter. Last month, NetSuite was recognized by Forbes Magazine as one of the most innovative growth companies in the world. In June, the Software & Information Industry Association announced that NetSuite had won three CODiE awards for product excellence.
First, we won for OneWorld, named as the best financial management solution. We also won for NetSuite PSA, named as the best project management solution. And finally, we won for NetSuite SuiteCommerce, named the best commerce solution.
As you read in today's press release, our second quarter's performance highlights our continued progress. We once had record revenue, hitting the high-end of our revenue outlook for the quarter and we exceeded our outlook on both operating cash flow and non-GAAP EPS.
For the quarter, year-over-year our topline grew by 30% to a record $131.8 million. Revenue grew 32% year-over-year at slightly faster pace than what we saw in Q2 of 2013.
Our non-GAAP earnings came in $0.06 per share, well above our previously stated outlook of $0.02 to $0.03 per share for the quarter. In addition, operating cash flow came in at a healthy $18.6 million versus our stated outlook of $14 million to $15 million. In Q2, calculated billings defined as the change in deferred revenue plus revenue grew by 34% over Q2 of 2013.
These quarterly results are a tribute to our customers, who are using NetSuite to transform their operations and enable their business decision. And we had our strongest Q2 since 2009 in terms of new customer additions, adding more than 360 new customers to our installed base. Our average selling price was up slightly over the prior year and for the first half of the year, it is up more than 40%.
Probably, the biggest highlight of the quarter was SuiteWorld, our annual global gathering for customers and partners. We exceeded our goals for this conference with over 6,500 members of the NetSuite committee joining to share the unique experience of SuiteWorld. That's 30% more than the roughly 50% who attended it just one-year ago.
And one of the most notable things about SuiteWorld was the sheer amount of product we introduced. A reflection of the increased investment we have made across the suite to support the vertical and horizontal business applications needs of our growing customer base. As announced at SuiteWorld, we launched new capabilities that allow us to address the needs of large services and project-based businesses.
The new NetSuite SRP provides a comprehensive end-to-end services resource planning solution that supports an entire services business. We are seeing significant upsell and new customer wins from customers who have either bought the entire SRP suite in the past or bought modules, such as the advanced projects, resource allocation, job costing and budgeting.
We are in the process of rolling SRP out globally and we anticipate similar success in EMEA and APAC from both software and services verticals. And during the quarter, our services verticals saw good new business growth. So we are pleased with the early success of the new offering.
With out SuiteGL announcement, feedback from customers, as this capability is game changing in meeting local statutory and business process requirements. We have just scratched the surface on use cases for SuiteGL. And we are working closely with our partners and customers, as they begin to adopt the new technology, starting with the 2014 two release, which is rolling out later this quarter.
Also, later this year, we are planning to rollout our next-generation user interface. NetSuite over the years has pioneered many of the features considered standard today in a modern web-based application, and the new UI build on that heritage. This release will include a fantastic mix of features that are simple, intuitive and bold. We believe the new user interface will make NetSuite the easiest and most enjoyable business application to use anywhere.
And finally, we delivered new capabilities in our SuiteCommerce offering that enabled global customers to deliver a true omnichannel experience to their customers. While most people consider omnichannel commerce a concern only for B2C companies, we believe omnichannel will be an important capability in any business model.
For example, the State of Texas Comptroller's Office was featured at SuiteWorld, highlighting their use of our SuiteCommerce capabilities to support their government-to-government internal purchasing portal. And I'm happy to announce that they have gone completely live across all their department and agencies, since the time that their CIO joined us on stage. The new SuiteCommerce B2B portal that we also announced at SuiteWorld is now rolling out to customers to support their omnichannel business model requirements as well.
The other important capability unique to SuiteCommerce, in addition to its ability to support multiple business models, B2B, B2C, B-2-anything, is its ability to support those customer requirements around the globe in multiple languages, in multiple currencies.
And in that regard, last week we announced the important acquisition of Venda, Europe's pioneering provider of cloud-based ecommerce to some of the biggest and best known brands in the world. And while they certainly do have great customer logos using their offerings, this acquisition is really about extending our strategy to take advantage of our market opportunity around the globe.
Today, about 24% of our revenue comes from outside the U.S. and Europe remains one of our biggest growth opportunities. While we have done well in Europe, we could do better with more resources, focus and investment. And as I have said in the past, we would be doubling down in Europe someday. Well, someday officially arrived last Thursday.
While there is a lot of work ahead, we think the financial results we delivered in Q2 provide the proof that the investments we are making in our strategy of brining the power of unified cloud-based business applications to companies of all sizes are paying off for our customers, our employees and our shareholders.
And so with that, let me turn it over to Ron Gill, our CFO.
Ronald Gill - Chief Financial Officer
Thank you, Zach. I'm pleased to report another excellent quarter at NetSuite. We had a very successful first half of 2014, and are on track for a really solid year. In Q2, we had a fantastic SuiteWorld, brought onboard a record number of new employees and reported record revenue and deferred revenue.
But just to step back a moment, and put the quarter in some historical context, our revenue in the second quarter of 2014 alone was more than the revenue we recorded during our entire fiscal 2007, the year that we went public. Our revenue of $255 million for the first half of 2014 was more revenue than we posted for our entire fiscal 2011.
In other words, the steady effort to build a world-class company by growing a high-quality team, building an increasingly sophisticated product and providing a great experience for our customers continues to pay off.
Let me take you through some of the numbers in more detail. As a reminder, all of the non-revenue financial figures I will discuss here are non-GAAP, unless I state the measure is 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.
During Q2, total revenue grew to $131.8 million, up 7% sequentially and up 30% over Q2 of 2013. This is our eighth consecutive quarter, with a year-over-year growth rate in total revenue of 30% or more.
Recurring revenues from subscription and support grew 6% sequentially and 32% over the year-ago quarter to $105.9 million, representing, as Zach mentioned, our first ever $100 million recurring revenue quarter. Non-recurring revenue, which comes primarily from professional services was $25.9 million for the quarter and grew 25% over that for the same period last year.
Moving down the P&L to gross margins. We saw an increase in our total gross margin year-over-year from 71% to 72%. Gross margins on recurring revenue improved from 85% in the year-ago quarter to 86%, and the gross margin on non-recurring revenue was down from 16% in the year-ago quarter to 14% in the second quarter of this year.
Overall, we expect the blended gross margin to be approximately 71% to 72% of revenue for the full year in 2014. In Q2, 24% of our revenue was generated outside the United States.
Turning to our non-GAAP operating expenses. We continue to make significant investments in our product team as well as in expanding sales capacity. The product organization, where the number of employees in the team was up more than 40% over the year-ago quarter, continues to be the fastest growing area of the company.
Product development expense was $18.5 million for the quarter and represented 14% of Q2 2014 revenue. I expect that spending on the product team will be approximately 13% to 14% of revenue for 2014.
Sales and marketing expenses were $60.6 million or 46% of revenue in Q2 on par with the same percentage of revenue in Q2 of last year. As Zach discussed, we hosted the largest SuiteWorld ever in Q2, but the team did a good job of managing that spend and strong attendance and partnership participation helped offset the cost as well.
G&A expenses were $9.4 million or 7.1% of revenue in the second quarter, that's down from 7.7% of revenue in Q2 of 2013. So we continue to have good scaling efficiency in that area. Non-GAAP operating income in the second quarter was $5.8 million, up 22% over the prior year, and equating to a non-GAAP operating margin of 4.4%.
During the quarter we reported a net income tax expense of approximately $448,000. We continue to expect our net operating losses to offset any domestic earnings for tax purposes for the foreseeable future. Non-GAAP net income for the second quarter was $4.8 million, up 20% over the prior year. Non-GAAP earnings per share for Q2 were $0.06. This was up from $0.05 in the year-ago quarter.
Moving on to the balance sheet. We had another great quarter for cash collections and closed the quarter with a record $479 million in cash and cash equivalents. Cash flow from operations in Q2 was $18.6 million, up 19% year-over-year.
Moving down the balance sheet, from cash to deferred revenue. Our total deferred revenue balance increased 39% year-over-year to a record $252 million. As you may calculate from the financials published in the press release, calculated billings defined as the quarterly revenue plus the change in deferred revenue, were $146.5 million for the quarter, representing an increase of 34% over the second quarter of 2013.
As I have consistently pointed out on these calls, there is a wide array of factors that influence calculated billings and quarter-to-quarter fluctuations in the calculated billing's metric should not be taken as an indicator of changes in future revenues.
Headcount on June 30, 2014, was 2,762, up 29% from Q2 of 2013. We added a record 212 employees to our headcount across the organization in Q2 with the fastest growing teams being those in product development and sales.
Before I move on to outlook, I'd like to briefly address the recent acquisition. As we announced last week on July 17, we acquired Venda, a privately held ecommerce company based in London. This is not a material transaction for us and we did not publish the purchase price in the press release, but since the announcement there has been some speculation, both about the purchase price itself and about the run rate of revenue that company was doing before the acquisition.
I've seen estimates as high as a few hundred million dollars for the purchase price and of revenue in the $40 million range. To bring things down to earth of it, I want to clarify that the total purchase price pay was $50.5 million in a combination of cash and stock. As you can imagine at that price, the revenue estimates are also well off the mark. We did acquire a great team of people with significant domain expertise, a great product and some wonderful customers, but nowhere near that amount of revenue.
Given the current state of business and the accounting required by the acquisition, we're currently forecasting incremental revenue to NetSuite for the remainder of 2014 of about $5 million. And we expect the bottomline impact to be dilutive.
With that understanding 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 overtime.
We've had a great first half and have solid momentum going into the second half of the year. Taking into account the Venda acquisition, we're raising our revenue outlook for the year to a new range from $545 million to $550 million.
Given our EPS and cash flow over performance in the first half, I believe we can observe the dilutive impact from Venda I mentioned and still be within our current outlook, so we're maintaining our outlook for operating cash flow of $65 million to $70 million and non-GAAP EPS of $0.24 to $0.26 for 2014.
For the third quarter of 2014, we expect revenues to be in the range of $140 million to $142 million. We anticipate non-GAAP EPS of approximately $0.03 to $0.04 and operating cash flow of $14 million to $15 million for the quarter.
In summary, the first half was a great start to the year. We're positioned well for a strong second half and an another year of record revenues and industry-leading growth. That concludes my prepared remarks.
With that, I will turn the call back over to Zach.
Zachary Nelson - President and Chief Executive Officer
Thank you, Ron. Ron's comments detail that the significant momentum we gained in 2013, carried over into the first half of 2014. And I think the trends driving NetSuite's growth will continue as the year progresses.
To summarize, the highlights in today's prepared comments, we posted record revenue, record deferred revenue, record levels of revenue retention, our 20th consecutive quarter of revenue growth, our eighth consecutive quarter of 30% or greater revenue growth, and today we have more employees at NetSuite than we have had in our history.
By achieving a $0.50 billion total revenue run rate this quarter, we are well on our way of achieving our goal to be the leading provider of next-generation business systems and to achieve $1 billion and beyond in annual revenue. Our consistent vision of designing a system to run a business and deliver it via the cloud continues to be the driving force behind what we do at NetSuite.
And with that, we will turn it over to the operator for your questions. Operator?
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Jason Maynard from Wells Fargo.
Jason Maynard - Wells Fargo
I have two questions for you. So first, Zach, can you maybe talk a little bit more about your international and European opportunity? And you made the comment about doubling down, and I'd just be curious in terms of beyond the acquisition of Venda, what other investments do you think are necessary to really make that a bigger part of the overall revenue stream?
And then just quickly, Ron, you gave the $5 million contribution to revenue, maybe I missed it. But what would you assume just sort of compared to last quarter's guidance, the EPS dilution from the deal would be for the second half of the year?
Zachary Nelson - President and Chief Executive Officer
Thank you, Jason. So I'll take the first half about just the strategy around international investments and maybe the other things we'll have to do. I think one of the great things about Venda, as I've said, in discussing this acquisition, is the fact that I think now we really do have critical mass, certainly in the U.K. with the addition of the Venda team. The Venda location right in the Central London, all of those things I think will have a big impact on our ability to execute from a distribution standpoint in Europe.
The other aspect of executing in Europe, we have great capabilities in One World today for companies operating really in any country, we have multi-currency, we have multi-language, our tax engine is unmatched in the world in terms of being able to comply with local statutory requirements.
But as you begin to get into some of these countries more specifically, the actual business practices and the customs differ materially. And so now our ability to have visibility in sort of the second and third derivatives issues around doing business and not ecommerce business, but any type of business in places like Germany and France.
I think we'll have much better visibility into that. We'd able to finely tune our product to look and smell and feel that much more French or German, as the case maybe, as we go to those markets.
So I think that insight is going to be important. I think in terms of additional investments, obviously I think the big additional investment certainly in Europe, perhaps a little bit less so in parts of Asia. It is just the language requirement of our people, and the ability to actually conduct business in German and in French specifically. And so I think that will be another big piece of investment you'll see here.
And over time, that will be the next big piece of investment, is how do you go to Germany. Well, you go hire German sales people, German SEs, German consulting, German support, and that's yet another large investment that I don't think we have in front of us, but I think the Venda acquisition gives us the foundation to begin to make those investments coherently.
And then finally, that the final piece, of course, is the data center in Europe. And as you know, we've been talking about the data center in Europe here, the Venda acquisition actually gives us now obviously a data center in Europe, given that they're delivering to most of their customers out of that data center. And so we're also gaining great expertise in terms of making the decision on how to rollout the data center in Europe. They have a great data center operations team. So we also have to foot up on that front as well.
Ronald Gill - Chief Financial Officer
Maybe I'll take the second part of that question, Jason. So yes, $5 million on the revenue, it's probably a few cents dilutive on EPS. We over-performed plan on EPS in Q1 and have just done the same again in Q2. So we were probably on target to overachieve EPS for the year. So as I said in the prepared remarks, I think we can absorb this diluted impact and still be back within the original guidance range to $0.24 to $0.26.
Operator
Your next question comes from the line of Greg Dunham.
Frank Robinson - Goldman Sachs
You actually have Frank Robinson here for Greg Dunham. I guess want to say, starting at early March, we saw like significant sell-off in growth stocks and some investors seem to be favoring stocks, because they're more profitable. On previous calls, you stated, you prefer to invest as you can get the growth. Have your thoughts around that changed at all?
Zachary Nelson - President and Chief Executive Officer
No. Not at all. Frank, and I think every study that you see and certainly history tells us that if you to can invest, every software coming to invest in growth, the winners investing growth, when the growth opportunity present itself. And so that's certainly our tendency and it's been what we stated for all the time since we've been public.
And so while we did overachieve on the bottomline, and we're happy about that from a fiscal management standpoint, frankly, we would have rather spent that money investing to get growth not so much for this year, as you know it takes a while for this to impact, but get the growth for next year.
And so we're happy about the extra EPS, but in some ways we feel frankly that we should have spent that money in our growth strategy. Now that said, the fact that we did deliver extra EPS, the thing that we won't do is just spend the money to spend the money. And if we can't spend the money efficiently to invest in that growth, we're not going to go, just try to wipeout over attainment just to show that we're spending the money.
So I think we invested wisely and we're going to continue to invest it wisely, and we have invested it wisely over the past several years. I think you've seen that result in more and more growth and that's really what our whole strategy is here.
Frank Robinson - Goldman Sachs
And I want to go back to the Venda acquisition. You listed a bunch of things you got from the acquisition in terms of more capacitating Europe data center and a different things like that. But was there any unique functionality you got with the acquisition. And I guess, was there any plans to integrate the product with SuiteCommerce?
Zachary Nelson - President and Chief Executive Officer
Well, they have a very deep product certainly, and so there are many capabilities in the product that are exciting. I think from a strategy standpoint, the thing that I am most excited about in terms of what we're getting from Venda from a product standpoint, but really more of a domain expertise standpoint is depth of knowledge around shipping and payments, which are substantially different in Europe, so many of our customers are beginning to go global.
We can see on the horizon that we're going to have to address many of these unique shipping and payment requirements of Europe. And so I think this is really going to give us a good wake in terms of addressing those.
In terms of integrating Venda with the NetSuite platform, we already have some customers that are using Venda in conjunction with NetSuite today. And so there are some integrations that exist, so we'll certainly continue to support those and we'll support a variety of deployment options depending on what the customer sees fit.
I think more likely than not, you'll see customers deploying Venda with legacy systems like SAP, where they don't necessarily want to replace the ERP system. But every customer has unique strategy and we'll certainly look to support that and the products that we own.
Operator
Your next question comes from the line of Samad Samana from FBR Capital Markets.
Samad Samana - FBR Capital Markets
I wanted to ask a question on Venda and then SuiteCommerce. Could you give us a little bit of idea of how fast Venda was growing by itself and the typical customer size? And then I have a follow-up on SuiteCommerce.
Zachary Nelson - President and Chief Executive Officer
Venda was very similar to OpenAir for those of you that remember that acquisition, which is our first acquisition, while probably back in 2008 or something like that. And a lot of similarities between the two, and the biggest similarity between the two, at least from an operation standpoint was they had great product teams, they had great service teams, they had great support teams, they had almost non-existent sales team. And so it's safe to say Venda was not growing. When we acquired it, it turns out we need sales people to grow revenue.
So it's great news that on the logos, we're getting incredibly happy customers. We're getting incredible development team. We're getting a great services and support team. The nature of what NetSuite does in acquisitions is trying to acquire great teams more so than fast growing revenue streams or large customer bases frankly. So it's really sort of a perfect match for the way we look at acquisitions in that regard.
And then the second half of the question.
Samad Samana - FBR Capital Markets
So on SuiteCommerce, could you give us an update on where your deals are coming from? Are you seeing greater uptick within the install-based or do you certainly see a healthier flow of new customers that are new to NetSuite coming because of SuiteCommerce?
Zachary Nelson - President and Chief Executive Officer
SuiteCommerce's continues to do really well. It's like every new product introduction at NetSuite, the installed base tends to be the early adopters, because people are waiting for that functionality. So you've certainly seen that. I don't know the exact number, but I'm sure it's pretty close to equal proportions new and existing.
The other thing that's very different about SuiteCommerce and Venda or Demandware or any other ecommerce product in the market is SuiteCommerce applies really to not just B2C environments, it applies almost across all of our industry groups. So you're seeing the new B2B portal being used in our manufacturing vertical as manufacturers begin to want to do B2B transaction through an incredibly functional and beautiful website.
State of Texas is another one, right, where you're seeing the government agencies wanting to do effectively commerce applications, but in that case to their internal audiences. So the big difference between SuiteCommerce and really every other solution on there it's not just omnichannel, which we've nailed with the integration of our retail point-of-sales system and the SuiteCommerce capabilities, but also omni-business model, B2B, B2C.
And so we certainly look at SuiteCommerce on a standalone basis, but you also need to put into your mind and into your model, that SuiteCommerce also gets sold almost across all of our verticals. The primary exception to that from a vertical standpoint would the services companies, if they're pure project-based services businesses, they may not have the need for an omnichannel commerce machine.
But every other industry group software -- we have software companies deploying it for maintenance and renewals management. Manufacturing and distribution, obviously B2B and many of those guys are expanding with B2C models as well. You've now seen government roll it out, and then certainly retail. So it's a really broad applicatio