Item 1B.
Unresolved Staff Comments
None.
Our corporate headquarters is located in San Mateo, California and comprises approximately 117,000 square feet of leased space. We also have leased facilities in Denver, Austin, Chicago, Atlanta, New York, Boston, Oklahoma City, Canada, the United Kingdom, Spain, the Czech Republic, Japan, Hong Kong, the Philippines, Thailand, Singapore, Australia and Uruguay.
We believe that our existing properties are in good condition and are suitable for the conduct of our business. As our existing leases expire and as we continue to expand our operations, we believe that suitable space will be available to us on commercially reasonable terms.
Item 3.
Item 3.
Legal Proceedings
From time to time, we are involved in various legal proceedings arising from the normal course of business activities. We are not presently a party to any litigation the outcome of which, we believe, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results or financial condition.
Item 4.
Item 4.
Mine Safety Disclosures
Not Applicable.
PART II
Item 5.
Item 5.
Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock has been quoted on the New York Stock Exchange under the symbol "N". The following table sets forth for the indicated periods the high and low sales prices of our common stock as reported by the New York Stock Exchange.
We have never paid any cash dividends on our common stock. Our Board of Directors currently intends to retain any future earnings to support operations and to finance the growth and development of our business and does not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our board.
As of December 31, 2014, there were 87 registered stockholders of record of our common stock. The actual number of stockholders is greater than this number of holders of record, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities.
The graph set forth below compares the cumulative total stockholder return on our common stock between December 31, 2010 and December 31, 2014, with the cumulative total return of (i) the Nasdaq Composite Index and (ii) the Nasdaq Computer Index, over the same period. This graph assumes the investment of $100 on December 31, 2009 in our common stock, the Nasdaq Composite Index and the Nasdaq Computer Index, and assumes the reinvestment of dividends, if any. The graph assumes the initial value of our common stock on December 31, 2009 was the close price of $15.98 per share.
The comparisons shown in the graph are based upon historical data. We caution that the stock price performance shown in the graph above is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.
Item 6.
Item 6.
Selected Financial Data
The following selected condensed consolidated financial data should be read in conjunction with our audited consolidated financial statements and related notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report. The consolidated statement of operations data for the years ended December 31, 2014, 2013 and 2012 and the selected condensed consolidated balance sheet data as of December 31, 2014 and 2013 are derived from, and are qualified by reference to, the audited consolidated financial statements included in this Annual Report. The condensed consolidated statement of operations data for the fiscal years ended December 31, 2011 and 2010 and the consolidated balance sheet data as of December 31, 2012, 2011 and 2010 are derived from audited consolidated financial statements which are not included in this Annual Report.
ITEM 7.
ITEM 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report on Form 10-K contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectation of earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements related to future capital expenditures; statements related to future economic conditions or performance; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," or "will," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to those discussed in the section titled "Risk Factors" included in Item 1A of Part I of this Annual Report on Form 10-K, and the risks discussed in our other SEC filings.
We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Annual Report on Form 10-K. These statements are based on the beliefs and assumptions of our management based on information currently available to management. The forward-looking statements included in this Annual Report are made only as of the date of this Annual Report on Form 10-K. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.
Overview
We are the industry's leading provider of cloud-based financials/ERP and omnichannel commerce software suites. In addition to financials/ERP and omnichannel commerce software suites, we offer a broad suite of applications, including accounting, CRM, Ecommerce and retail management, PSA and HCM, which enable companies to manage most of their core business operations in our single integrated suite. Our software allows businesses to automate operations, streamline processes and access real-time business information anytime, anywhere.
We also offer customer support and professional services related to implementing and supporting our suite of applications. We deliver our suite over the Internet as a SaaS model.
In 1999, we released our first application, NetLedger, which focused on accounting applications. We then released Ecommerce functionality in 2000 and CRM and sales force automation functionality in 2001. In 2002, we released our next generation suite under the name NetSuite to which we have regularly added features and functionality. In December 2007, we went public. In 2008, we acquired OpenAir, and in 2009 we acquired QuickArrow Inc., both of which offer professional services automation and project portfolio management products.
Our headquarters are located in San Mateo, California. We were incorporated in California in September 1998 and reincorporated in Delaware in November 2007. We conduct our business worldwide, with international locations in Canada, Europe, Asia, Australia and Uruguay.
On September 26, 2014, we purchased certain assets from an on-line warehouse management solution provider ("WMS"). We purchased certain WMS assets to expand our manufacturing vertical. The WMS assets, liabilities and operating results are reflected in our consolidated financial statements from the date of acquisition. On the closing date, we paid $15.6 million in cash of which, $2.4 million is being held in escrow for up to 18 months following the close of the transaction as indemnification against certain losses we may incur in the event of certain breaches of representations and warranties covered in the asset purchase agreement. Additionally, $350,000 in consideration is being held in escrow until certain WMS tax matters are resolved.
On July 17, 2014, we completed the purchase of all the outstanding equity of Venda Limited (“Venda"), a private company that provides Ecommerce solutions to its customers. Venda expands our European customer base and adds certain functionality to our product suite. The Venda assets, liabilities and operating results are reflected in our consolidated financial statements from the date of acquisition. On the closing date, we paid $25.7 million in cash and issued 304,364 unregistered shares of our common stock with a fair value of $22.8 million, inclusive of a discount from the quoted market price due to certain trading restrictions associated with the shares. Of the consideration paid, $10.1 million is being held in escrow for up to two years following the close of the transaction as protection against tax contingencies and losses we may incur in the event of certain breaches of representations and warranties covered in the purchase agreement.
Key Components of Our Results of Operations
Revenue
Our revenue has grown from $17.7 million during the year ended December 31, 2004 to $556.3 million during the year ended December 31, 2014.
We generate sales directly through our sales team and, to a lesser extent, indirectly through channel partners. We sell our service to customers across a broad spectrum of industries, and we have tailored our service for wholesalers/distributors, manufacturers, e-tailers, services companies and software companies. The primary target customers for our service are medium-sized businesses and divisions of large companies. An increasing percentage of our customers and our revenue have been derived from larger businesses within this market. For the year ended December 31, 2014, we did not have any single customer that accounted for more than 3% of our revenue.
We are pursuing a number of strategies that we believe will enable us to continue to grow. The goals of those strategic objectives are to continue to move up-market, to increase the use of NetSuite as a platform, and to extend the verticalization of our product line. Although we have made progress toward our goals in recent periods, there are still many areas where we believe that we can continue to grow. To achieve these goals, we are focused on the following initiatives:
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Growth of sales of OneWorld, our platform for ERP, CRM, PSA and Ecommerce capabilities in multi-currency environments across multiple subsidiaries and legal entities, which supports the needs of large, standalone companies, and divisions of large enterprises;
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Strengthening our offerings for targeted industries such as wholesale/distribution, manufacturing, e-tail, retail, technology and professional services by adding deeper verticalized functionality; and
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Developing our SuiteCloud ecosystem to enable third parties to extend our offerings with their vertical expertise or horizontal solution.
We experience competitive pricing pressure when our products are compared with solutions that address a narrower range of customer needs or are not fully integrated (for example, when compared with Ecommerce or CRM stand-alone solutions). In addition, since we sell primarily to medium-sized businesses, we also face pricing pressure in terms of the more limited financial resources or budgetary constraints of many of our target customers. We do not currently experience significant pricing pressure from competitors that offer a similar cloud-based integrated business management suite.
We sell our application suite pursuant to subscription agreements. The duration of these agreements is generally one to three years. We rely in part on a large percentage of our customers to renew their agreements to drive our revenue growth. Our customers have no obligation to renew their subscriptions after the expiration of their subscription period.
We generally invoice our customers in advance in monthly, annual or quarterly installments, and typical payment terms provide that our clients pay us within 30 to 60 days of invoice. Amounts that have been invoiced where the customer has a legal obligation to pay are recorded in accounts receivable and deferred revenue. As of December 31, 2014, we had deferred revenue of $314.5 million.
Backlog was approximately $325.2 million and $187.1 million as of December 31, 2014 and 2013, respectively. Of the $325.2 million in backlog as of December 31, 2014, $182.8 million was short-term backlog and $142.4 million was long-term backlog. The $187.1 million in backlog as of December 31, 2013 included $116.2 million in short-term backlog and $70.9 million in long-term backlog. Backlog represents future billings under our subscription agreements that have not been invoiced or have not been recorded as deferred revenue. We expect that the amount of backlog may change from year-to-year for several reasons, including specific timing and duration of large customer subscription agreements, varying billing cycles of non-cancelable subscription agreements, the specific timing of customer renewals, foreign currency fluctuations, the timing of when unbilled deferred revenue is to be recognized as revenue and changes in customer financial circumstances. For multi-year subscription agreements billed annually, the associated backlog is typically high at the beginning of the contract period, zero immediately prior to expiration and increases if the agreement is renewed. Low backlog attributable to a particular subscription agreement is typically associated with an impending renewal and is not an indicator of the likelihood of renewal or future revenue of that customer. Accordingly, we expect that the amount of backlog may change from year to year depending in part upon the number of subscription agreements in particular stages in their renewal cycle. Such fluctuations are not reliable indicators of future revenues.
For the most part, our subscription agreements provide service level commitments of 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require us to credit qualifying customers up to the value of an entire month of their subscription and support fees. In light of our historical experience with meeting our service-level commitments, we do not currently have any liabilities on our balance sheet for these commitments.
Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented:
Employees
As of December 31, 2014, our headcount was 3,357 employees including 985 employees in sales and marketing, 1,217 employees in operations, professional services, training and customer support, 835 employees in product development, and 320 employees in a general and administrative capacity.
Cost of Revenue
Subscription and support cost of revenue primarily consists of costs related to hosting our application suite, providing customer support, data communications expenses, personnel and related costs of operations, stock-based compensation, software license fees, outsourced subscription services, costs associated with website development activities, allocated overhead which includes IT, facility and recruiting costs, amortization expense associated with capitalized internal use software and acquired developed technology, and related plant and equipment depreciation and amortization expenses. These costs are partially offset by a government subsidy credit received from the Czech government. See Product Development expenses below.
Professional services and other cost of revenue primarily consists of personnel and related costs for our professional services employees and executives, external consultants, stock-based compensation and allocated overhead.
We allocate overhead such as facility costs, information technology costs and employee benefit costs to all departments based on headcount. As such, general overhead expenses are reflected in cost of revenue and each operating expense category.
We expect cost of revenue to remain relatively constant as a percentage of revenue over time; however, it could fluctuate period to period depending on the growth of our professional services business and any associated increased costs relating to the delivery of professional services and the timing of significant expenditures.
Operating Expenses
Product Development
Product development expenses primarily consist of personnel and related costs for our product development employees and executives, including salaries, stock-based compensation, employee benefits and allocated overhead which includes IT, facility and recruiting costs. Our product development efforts have been devoted primarily to increasing the functionality and enhancing the ease of use of our on-demand application suite as well as localizing our product for international use. A key component of our strategy is to expand our business internationally. This will require us to conform our application to comply with local regulations and languages, causing us to incur additional expenses related to translation and localization of our application for use in other countries.
At our product development facility in the Czech Republic, we participate in a government program that subsidizes us for employing local residents. Under the program, the Czech government will reimburse us for certain operating expenses we incur. During the years ended December 31, 2014, 2013 and 2012, we reduced our cost of subscription revenue and product development expenses for eligible operational expenses we expect the Czech government to reimburse. In the first quarter of 2014, we reached the initial program's reimbursement limit. We then began participating in a second subsidy program, similar in nature to the initial program, in the second quarter of 2014.
In 2015, we expect product development expenses to increase in absolute dollars as we continue to extend our service offerings in other countries, and as we expand and enhance our application suite technologies. Such expenses may vary due to the timing of these offerings and technologies.
Sales and Marketing
Sales and marketing expenses primarily consist of personnel and related costs for our sales and marketing employees and executives, including wages, benefits, bonuses, commissions and training, stock-based compensation, commissions paid to our channel partners, the cost of marketing programs such as on-line lead generation, promotional events, webinars and other meeting costs, amortization of intangible assets related to trade name and customer relationships, and allocated overhead which includes IT, facility and recruiting costs. We market and sell our application suite worldwide through our direct sales organization and indirect distribution channels such as strategic resellers. We capitalize and amortize our direct and channel sales commissions over the period the related revenue is recognized.
We expect to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers. As such, we expect our sales and marketing expenses to increase in absolute dollars in 2015.
General and Administrative
General and administrative expenses primarily consist of personnel and related costs for executive, finance, human resources and administrative personnel, stock-based compensation, legal and other professional fees, other corporate expenses and allocated overhead.
In 2015, we expect our general and administrative expenses to increase in absolute dollars as we continue to expand our business.
Income Taxes
Since inception, we have incurred annual operating losses and, accordingly, have not recorded a provision for income taxes for any of the periods presented other than provisions for minimum and foreign income taxes.
Critical Accounting Policies and Judgments
Our consolidated financial statements are prepared in accordance with GAAP in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial position, results of operations and cash flows will be affected.
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application, while in other cases, significant judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We consider these policies requiring significant management judgment to be critical accounting policies. These critical accounting policies are:
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Revenue recognition;
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Internal use software and website development costs;
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Deferred commissions;
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Accounting for stock-based compensation; and
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Goodwill and other intangible assets.
A description of our critical accounting policies and judgments for those areas are presented below. In addition, please refer to the Notes to Consolidated Financial Statements for further discussion of our accounting policies.
Revenue Recognition
We generate revenue from two sources: (1) subscription and support services; and (2) professional services and other. Subscription and support revenue includes subscription fees from customers accessing our cloud-based application suite and support fees from customers purchasing support. Our arrangements with customers do not provide the customer with the right to take possession of the software supporting the cloud-based application service at any time. Professional services and other revenue include fees from consultation services to support the business process mapping, configuration, data migration, integration and training. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
For the most part, subscription and support agreements are entered into for 12 to 36 months. In aggregate, more than 90% of the professional services component of the arrangements with customers is performed within 300 days of entering into a contract with the customer.
For the most part, the subscription agreements provide service-level commitments of 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require us to credit qualifying customers up to the value of an entire month of their subscription and support fees. In light of our historical experience with meeting our service-level commitments, we do not currently have any liabilities on our balance sheet for these commitments.
We commence revenue recognition when all of the following conditions are met:
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there is persuasive evidence of an arrangement;
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the service is being provided to the customer;
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the collection of the fees is reasonably assured; and
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the amount of fees to be paid by the customer is fixed or determinable.
In most instances, revenue from a new customer acquisition is generated under sales agreements with multiple elements, comprised of subscription and support fees from customers accessing our cloud-based application suite and professional services associated with consultation services. We evaluate each element in a multiple-element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered item has standalone value and delivery of the undelivered element is probable and within our control. Subscription and support have standalone value because we routinely sell it separately. For the most part, professional services have standalone value because we have sold professional services separately, and there are several third party vendors that routinely provide similar professional services to our customers on a standalone basis.
We allocate revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on its vendor-specific objective evidence (“VSOE”), if available, third-party evidence (“TPE”), if VSOE is not available, or estimated selling price (“ESP”), if neither VSOE nor TPE is available. As we have been unable to establish VSOE or TPE for the elements of our sales arrangements, we establish the ESP for each element primarily by considering the weighted average of actual sales prices of professional services sold on a standalone basis and subscription and support including various add-on modules when sold together without professional services, and other factors such as gross margin objectives, pricing practices and growth strategy. The consideration allocated to subscription and support is recognized as revenue over the contract period commencing when the subscription service is made available to the customer. The consideration allocated to professional services is recognized as revenue using the proportional performance method.
The total arrangement fee for a multiple element arrangement is allocated based on the relative ESP of each element. However, since the professional services are generally completed prior to completion of delivery of subscription and support services, the revenue recognized for professional services in a given reporting period does not include fees subject to delivery of subscription and support services. This results in the recognition of revenue for professional services that is generally no greater than the contractual fees for those professional services.
For single element sales agreements, subscription and support revenue is recognized ratably over the contract term beginning on the provisioning date of the contract. We recognize professional services revenue using the proportional performance method for single element arrangements.
Internal Use Software and Website Development Costs
The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Capitalized costs are recorded as part of property and equipment. Maintenance and training costs are expensed as incurred. Internal use software is amortized on a straight line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal use software during the years ended December 31, 2014, 2013 or 2012. We capitalized $4.0 million, $3.2 million and $4.1 million in internal use software during the years ended December 31, 2014, 2013 and 2012, respectively.
Deferred Commissions
We capitalize commission costs that are incremental and directly related to the acquisition of customer contracts. Commission costs are accrued and capitalized upon execution of the sales contract by the customer. Payments to sales personnel are made shortly after the receipt of the related customer payment. Deferred commissions are amortized over the term of the related non-cancelable customer contract and are recoverable through the related future revenue streams. We believe this is the preferable method of accounting as the commission costs are so closely related to the revenue from the customer contracts that they should be expensed over the same period that the related revenue is recognized. We capitalized commission costs of $95.5 million, $70.4 million and $50.5 million during the years ended December 31, 2014, 2013 and 2012, respectively.
Accounting for Stock-Based Compensation
We recognize the fair value of stock-based compensation in the financial statements over the requisite service period of the individual grants, which generally equals a four year vesting period. We recognize compensation expense for stock option awards, restricted stock awards and restricted stock unit awards on a straight-line basis over the requisite service period. We recognize compensation expense related to performance share awards based on the accelerated method which recognizes a larger portion of the expense during the beginning of the vesting period than in the end of the vesting period. Estimates are used in determining the fair value of stock option awards using a Black-Scholes model. The fair value of restricted stock, restricted stock units performance share and performance share units is generally determined based on the intrinsic value of the award on the grant date. Our 2011 performance share unit grants included a market condition performance criteria so we used a Monte Carlo simulation model to determine their fair value. Changes in the estimates used to determine the fair value of share-based equity compensation instruments could result in changes to our compensation charges.
Effective the first quarter of 2014, we changed our methodology for estimating the expected term assumption used to determine employee stock option grant fair value. We changed from the simplified method to a historical data method because we believe we have sufficient data to estimate the stock option exercise period based on historical stock option activity and historical employee termination data. Please see Note 13 of Notes to the Consolidated Financial Statements.
In recent years, we have awarded more restricted stock, restricted stock units and performance share units than granted stock options. Consequently, our restricted stock, restricted stock units and performance share units stock-based compensation expense represents a larger portion of total stock-based compensation expense recorded in our financial statements than stock options.
As a result of our stock-based compensation activity, we recorded $96.5 million, $73.7 million and $48.4 million of stock-based compensation during the years ended December 31, 2014, 2013 and 2012, respectively, excluding the effect previously capitalized stock-based compensation amortized during the year. Please see Note 13 of Notes to the Consolidated Financial Statements.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of net assets acquired. We allocated a portion of the purchase price of the acquisition of our acquired businesses to intangible assets, including customer relationships, developed technology and trade names that are being amortized over their estimated useful lives of one to seven years. We also allocated a portion of the purchase price to tangible assets and assessed the liabilities to be recorded as part of the purchase price. The estimates we made in allocating the purchase price to tangible and intangible assets, and in assessing liabilities recorded as part of the purchase, involved the application of judgment and the use of estimates and these could significantly affect our operating results and financial position.
We review the carrying value of goodwill for impairment annually and whenever events or changes in circumstances indicate that the carrying value of goodwill may exceed its fair value. We evaluate impairment by comparing the estimated fair value of the reporting unit to its carrying value. Actual results may differ materially from these estimates. The estimates we make in determining the fair value of the reporting unit involve the application of judgment potentially affecting the timing and size of any future impairment charges. Impairment of our goodwill could significantly affect our operating results and financial position. Based on our most recent assessment, there was no goodwill impairment.
We continually evaluate whether events or circumstances have occurred that indicate that the estimated remaining useful life of our long-lived assets, including intangible assets, may warrant revision or that the carrying value of these assets
may be impaired. Any write-downs are treated as permanent reductions in the carrying amount of the assets. We must use judgment in evaluating whether events or circumstances indicate that useful lives should change or that the carrying value of assets has been impaired. Any resulting revision in the useful life or the amount of impairment also requires judgment. Any of these judgments could affect the timing or size of any future impairment charges. Revision of useful lives or impairment charges could significantly affect our operating results and financial position.
There were no impairment of goodwill during the years ended December 31, 2014, 2013 or 2012.
Results of Operations
Revenue, Cost of Revenue, Gross Profit and Gross Margin
Our revenue, cost of revenue, gross profit and gross margin was as follows for the periods presented:
Twelve Months Ended December 31, 2014 as Compared to the Twelve Months Ended December 31, 2013
Revenue for the year ended December 31, 2014 increased $141.8 million, or 34%, compared to the same period in 2013.
Subscription and support revenue: Subscription and support revenue for the year ended December 31, 2014 increased $114.2 million, or 34%, compared to the same period in 2013. The increase was primarily the result of a $69.9 million increase in revenue resulting from the acquisition of new customers and a $44.3 million increase in revenue from existing customers. Additionally, subscriptions and support revenue increased during the year due to an increase in number of customers, continued adoption of OneWorld and an increase in the average selling price on deals for new customers.
Professional services and other revenue: Professional services and other revenue for the year ended December 31, 2014 increased $27.6 million, or 34%, compared to the same period in 2013. The increase was primarily the result of a $54.2 million increase in revenue resulting from the acquisition of new customers. The increase in professional services and other revenue was partially offset by a $26.6 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2013 that did not recur for those customers in 2014. Additionally, demand for our professional services increased during 2014, while our average consulting rates for professional services remained constant.
Revenue generated outside of the United States was $142.1 million, or 26%, of our revenue during the year ended December 31, 2014, as compared to $106.0 million, or 26% of our revenue, during the same period in 2013.
Cost of revenue for the year ended December 31, 2014 increased $41.6 million, or 31%, compared to the same period in 2013.
Subscription and support cost of revenue: Subscription and support cost of revenue for the year ended December 31, 2014 increased $16.7 million, or 30%, compared to the same period in 2013. The increase was primarily the result of a $9.9 million increase in data center production costs, a $5.0 million increase in personnel costs and a $1.8 million increase in IT, facility and other operating expenses. Data center and other production costs increased due to an increase in support costs, depreciation of new equipment, amortization of intangibles related to our 2014 and 2013 business acquisitions, maintenance costs and other operational costs associated with an increase in our data center capacity and activity. Personnel costs increased due to an overall increase in headcount and an increase in incentive bonuses. IT, facility and other operating expenses related to our data center increased due to an increase in recruiting and other costs incurred to grow our business.
Professional services and other cost of revenue: Professional services and other cost of revenue for the year ended December 31, 2014 increased $24.9 million, or 31%, compared to the same period in 2013. The increase was primarily the result of a $17.9 million increase in personnel costs, a $4.9 million increase in IT, facility and other operating expenses and a $2.1 million increase in fees related to outsourced consulting services. Personnel costs increased due to an overall increase in headcount and annual merit increases. Headcount increased as a result of an increase in the demand for our professional services. IT, facility, recruiting and other operating expenses related to our professional services increased primarily due to our global expansion. The net increase in outsourced consulting fees resulted from professional service fees incurred to develop our professional services organization, partially offset by a decrease in other outside consulting costs.
Our gross margin was 68% during the year ended December 31, 2014 and 67% for the same period in 2013. Our gross margin increased primarily due to an increase in the average selling price on customer deals and because our gross margin for subscription services is higher than our gross margin for professional services.
Twelve Months Ended December 31, 2013 as Compared to the Twelve Months Ended December 31, 2012
Revenue for the year ended December 31, 2013 increased $105.7 million, or 34%, compared to the same period in 2012.
Subscription and support revenue: Subscription and support revenue for the year ended December 31, 2013 increased $80.7 million, or 32%, compared to the same period in 2012. The increase was primarily the result of a $56.2 million increase in revenue resulting from the acquisition of new customers including the continued adoption of OneWorld, and a $24.5 million increase in revenue from existing customers. Additionally, subscriptions and support revenue increased during the year due to an increase in customer usage and an increase in the average selling price on deals for new customers.
Professional services and other revenue: Professional services and other revenue for the year ended December 31, 2013 increased $25.0 million, or 45%, compared to the same period in 2012. The increase was primarily the result of a $42.8 million increase in revenue resulting from the acquisition of new customers. The increase in professional services and other revenue was partially offset by a $17.8 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2012 that did not recur for those customers in 2013. Additionally, demand for our professional services, particularly from our enterprise customers, has increased during 2013, however, our average consulting rates for professional services decreased slightly in 2013.
Revenue generated outside of the United States was $106.0 million, or 26%, of our revenue during the year ended December 31, 2013, as compared to $80.9 million, or 26%, during the same period in 2012. Revenue generated outside the United States increased primarily due to our increased international sales efforts, particularly in Australia.
Cost of revenue for the year ended December 31, 2013 increased $39.6 million, or 41%, compared to the same period in 2012.
Subscription and support cost of revenue: Subscription and support cost of revenue for the year ended December 31, 2013 increased $13.4 million, or 32%, compared to the same period in 2012. The increase was primarily due to a $6.4 million increase in personnel costs resulting from an increase in headcount and annual salary increases. The increase in personnel costs includes an $854,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. Additionally, data center and other costs increased by $6.9 million due to an increase in support costs, depreciation, amortization of intangibles related to our 2013 and 2012 business acquisitions, amortization of capitalized internal use software costs, and other operational costs associated with an increase in our data center capacity and activity.
Professional services and other cost of revenue: Professional services and other cost of revenue for the year ended December 31, 2013 increased $26.2 million, or 49%, compared to the same period in 2012. The increase was primarily the result of a $18.4 million increase in personnel costs, a $6.0 million increase in fees related to outsourced consulting services and a $1.8 million increase in IT, facility and other operating expenses. Personnel costs increased due to an increase in headcount, annual merit increases, incentive bonuses and training costs. The increase in personnel costs includes a $2.8 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. Outsourced consulting fees increased due to an increase in demand for our professional services and an increase in training expenses for external consultants. IT, facility, recruiting and other operating expenses increased primarily due to travel costs to engagements and costs to expand our global operations.
Our gross margin was 67% during the year ended December 31, 2013 and 69% for the same period in 2012. The decrease in our gross margin resulted primarily from an increase in demand for our professional services which represented a larger percentage of total revenue in 2013 compared to 2012 and has lower gross margins than subscription and support revenue.
Operating Expenses
Operating expenses were as follows for the periods presented:
(1)
Includes stock-based compensation expense, amortization of acquisition-related intangible assets and transaction costs for business combinations as follows:
Twelve Months Ended December 31, 2014 as Compared to the Twelve Months Ended December 31, 2013
Product development expenses: Product development expenses for the year ended December 31, 2014 increased $28.4 million, or 36%, as compared to the same period in 2013. The increase was primarily the result of a $22.1 million increase in personnel costs resulting from an overall increase in headcount, annual salary increases, payroll tax increases and an increase in stock-based compensation. The increase in personnel costs includes a $5.0 million increase in stock-based compensation resulting primarily from the issuance of annual employee equity awards and equity grants to new hires. Additionally, IT, facility and other operating expenses related to our product development increased by $6.3 million due to an increase in outsourced product development services costs associated with our global expansion, data center costs incurred in connection with our product development and a decrease in government subsidies from the Czech Republic.
Sales and marketing expenses: Sales and marketing expenses for the year ended December 31, 2014 increased $80.9 million, or 39%, as compared to the same period in 2013. The increase was primarily the result of a $61.9 million increase in personnel costs, a $9.8 million increase in marketing and other operating expenses, a $4.8 million increase in sales related expenses and a $4.4 million increase in IT, facility and recruiting costs. The increase in personnel costs related primarily to increases in commission and payroll expenses resulting from higher sales and an increase in headcount. Additionally, personnel costs include a $9.5 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards and grants to new employees. Marketing and other operating expenses increased due to our annual user conference, trade shows, product branding and other media campaigns. Sales related costs increased due to outsourced consulting service fees incurred to increase customer demand and an increase in amortization expenses resulting from customer relationship and trade name intangible assets acquired through our business acquisitions in 2014 and 2013. IT, facility and recruiting costs increased due to an increase in costs associated with our global expansion.
General and administrative expenses: General and administrative expenses for the year ended December 31, 2014 increased $13.4 million, or 26%, when compared to the same period in 2013. The increase was primarily the result of an $8.2 million increase in personnel costs and a $5.2 million increase in other operational costs. The increase in personnel costs resulted from an increase in headcount, an increase in incentive pay and other personnel costs. Additionally, personnel costs include a $5.3 million increase in stock-based compensation costs resulting primarily from the issuance of annual equity awards and equity awards to new employees. Other operating expenses increased primarily due to legal, outside accounting and other business combination transaction costs incurred in connection with the acquisitions of Venda and WMS in the third quarter of 2014.
Twelve Months Ended December 31, 2013 as Compared to the Twelve Months Ended December 31, 2012
Product development expenses: Product development expenses for the year ended December 31, 2013 increased $25.6 million, or 48%, as compared to the same period in 2012. The increase was primarily the result of a $21.9 million increase in personnel costs resulting from an increase in headcount, annual salary increases, payroll tax increases and an increase in stock-based compensation. The increase in personnel costs includes an $8.3 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards to employees. Additionally, IT, facility, recruiting and other operational costs related to our product development increased by $3.7 million because we expanded our global operations.
Sales and marketing expenses: Sales and marketing expenses for the year ended December 31, 2013 increased $55.8 million, or 36%, as compared to the same period in 2012. The increase was primarily the result of a $42.3 million increase in personnel costs, an $8.7 million increase in IT, facility and other operating expenses and a $4.8 million increase in marketing expenses. The increase in personnel costs related primarily to increases in commission and payroll expenses resulting from higher sales and an increase in headcount. Additionally, personnel costs include a $8.4 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards and grants to new employees. IT, facility and recruiting costs increased by $5.9 million because we expanded our global operations. Other operating costs increased by $2.9 million primarily due to an increase in amortization expense resulting from customer relationship and trade name intangible assets acquired through our business acquisitions in 2012 and 2013. Marketing expenses increased primarily due to a $4.8 million increase in on-line and corporate marketing expenses to develop "NetSuite" name recognition and product branding.
General and administrative expenses: General and administrative expenses for the year ended December 31, 2013 increased $13.2 million, or 34%, when compared to the same period in 2012. The increase was primarily the result of a $9.0 million increase in personnel costs and a $4.1 million increase in other operational costs. The increase in personnel costs resulted from an increase in headcount, an increase in merit pay, an increase in other payroll costs such as recruiting and a $5.5 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. Other operational costs increased primarily due to an increase in costs such as outside legal services. Additionally, we incurred $3.0 million in transaction costs in connection with our acquisition of T-HR, OM and WH during 2013. In connection with expanding our global operations, we also experienced a $10.3 million increase in IT, facility, recruiting and other operating expenses that were mostly allocated to other departments.
Non-operating items, including interest income and expense, other income / (expense) and income taxes were as follows for the periods presented:
Twelve Months Ended December 31, 2014 as Compared to the Twelve Months Ended December 31, 2013
Our interest expense increased by $5.9 million during the year ended December 31, 2014 as compared to 2013 primarily due to our issuance of $310.0 million in aggregate principal amount of 0.25% convertible senior notes in June 2013. In connection with these notes, we record interest costs consisting of amortization of debt discount, coupon interest and amortization of debt issuance costs. In 2014, we recorded interest cost for an entire year as compared to half a year in 2013.
Our provision for income taxes increased by $1.3 million during the year ended December 31, 2014 as compared to 2013 primarily due to tax benefits associated with our 2013 business combinations. See Note 15 to our consolidated financial statements for more information regarding our income taxes.
Twelve Months Ended December 31, 2013 as Compared to the Twelve Months Ended December 31, 2012
Our interest expense increased by $8.2 million during the year ended December 31, 2013 as compared to 2012 primarily due to our issuance of $310.0 million in aggregate principal amount of 0.25% convertible senior notes in June 2013. In connection with these notes, we recorded $7.8 million in interest costs consisting of amortization of debt discount, coupon interest and amortization of debt issuance costs during the year ended December 31, 2013. Additionally, related party interest increased by $349,000 because we amended our Oracle perpetual software license agreement in February 2013.
Our provision for income taxes decreased by $1.6 million during the year ended December 31, 2013 as compared to 2012 primarily due to tax benefits associated with our 2013 business combinations. See Note 15 to our consolidated financial statements for more information regarding our income taxes.
Quarterly Results of Operations
The following tables set forth our unaudited quarterly condensed consolidated statements of operations data for each of the eight quarters ended December 31, 2014. The data has been prepared on the same basis as the audited consolidated financial statements and related notes included in this Annual Report on Form 10-K and you should read the following tables in conjunction with such financial statements. The table includes all necessary adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of this data. The results of historical periods are not necessarily indicative of future results.
Liquidity and Capital Resources
As of December 31, 2014, our primary sources of liquidity were our cash and cash equivalents totaling $367.8 million, marketable securities totaling $91.8 million and $139.2 million in accounts receivable, net of allowance.
In the year ended December 31, 2014, cash flows from operations generated $74.9 million of cash.
Restricted cash totaled $211,000 and $753,000 at December 31, 2014 and 2013, respectively. These restricted cash accounts secure letters of credit applied against certain of our facility lease agreements. Of the $211,000 restricted cash balance as of December 31, 2014, $35,000 is classified as current other assets and $176,000 is classified as long-term other assets. The $753,000 restricted cash balance as of December 31, 2013 includes $38,000 classified as current other assets and $715,000 classified as long-term other assets.
As of December 31, 2014, we had an accumulated deficit of $549.2 million. We have funded this deficit primarily through the net proceeds raised from the sale of our capital stock and convertible notes and cash flows from operations.
Our cash flow activities were as follows for the periods presented:
Twelve Months Ended December 31, 2014 as Compared to the Twelve Months Ended December 31, 2013
Cash provided by operating activities was driven by sales of our application suite and costs incurred to deliver that service. The timing of our billings and collections relating to our sales and the timing of the payment of our liabilities have a significant impact on our cash flows. Cash flows from operations increased during the year ended December 31, 2014 as compared to 2013 primarily as a result of an increase in collections from customers and the timing of payments to vendors, partially offset by an increase in commissions paid.
Cash used in investing activities during the year ended December 31, 2014 was related to the purchase and sale of marketable securities, acquiring companies and capital expenditures for property and equipment, consisting of the purchase of software licenses, computer equipment, leasehold improvements and furniture and fixtures as we develop and enhance our infrastructure. Cash used in investing increased due to our $91.8 million net investment into marketable securities in 2014, a $3.4 million increase in capital expenditures associated with our 2014 global expansion, partially offset by a $19.4 million decrease in business combination related cash payments , net of cash received. In 2014, we paid $39.7 million, net of cash received, to acquire Venda and WMS compared to 2013 when we paid $57.4 million, net of cash received, to acquire T-HR
("TribeHR"), OM ("OrderMotion") and WH ("Website Hosting Provider") and $747,000 in other business combination related payments.
The net cash used in financing activities during the year ended December 31, 2014 increased from 2013 due to $301.7 million in net proceeds received from the issuance of $310.0 million at par value of 0.25% convertible senior notes partially offset by the repurchase of $30.0 million of our common stock in June 2013, a $7.9 million decrease in proceeds received from employee stock option exercises and $5.9 million in payments to the former owners of businesses acquired in late 2012 and 2013.
Twelve Months Ended December 31, 2013 as Compared to the Twelve Months Ended December 31, 2012
Cash provided by operating activities was driven by sales of our application suite and costs incurred to deliver that service. The timing of our billings and collections relating to our sales and the timing of the payment of our liabilities have a significant impact on our cash flows. Cash flows from operations increased during the year ended December 31, 2013 as compared to 2012 primarily as a result of an increase in deferred revenue resulting from an increase in billings associated with the increase in bookings. This increase was offset by the increase in deferred commission resulting from the increase in sales activity.
Cash used in investing activities during the year ended December 31, 2013 was related to acquiring companies and capital expenditures for property and equipment, consisting of the purchase of software licenses, computer equipment, leasehold improvements and furniture and fixtures as we develop and enhance our infrastructure. Cash used in investing increased due to a $24.8 million cash payment, net of cash acquired, for the acquisition of T-HR in the fourth quarter of 2013, a $22.7 million cash payment, net of cash acquired, for the acquisition of OM in the second quarter of 2013, a $9.9 million cash payment, net of cash acquired, for the acquisition of WH in the first quarter of 2013, $747,000 in payments related to other acquisitions, an $8.5 million increase in capital expenditures for property and equipment to expand our global operations and a $500,000 equity investment in a small Ecommerce company in the first quarter of 2013.
The net cash provided by financing activities during the year ended December 31, 2013 increased from 2012 due to the $301.7 million in net proceeds received from the issuance of $310.0 million at par value of 0.25% convertible senior notes in June 2013 and a $1.0 million increase in proceeds received from employee stock option exercises. These increases were partially offset by the second quarter 2013 repurchase of 348,837 shares of our common stock for $30.0 million or $86.00 per share and a $1.1 million increase in related party capital lease payments related primarily to the Oracle unlimited license agreement amended during the first quarter of 2013.
We intend to use our cash for general corporate purposes, including potential future acquisitions or other transactions. Further, we expect to incur additional expenses in connection with our international expansion. We believe that our cash and cash equivalents are adequate to fund those potential or anticipated activities.
While we believe that our uncommitted current working capital and anticipated cash flows from operations will be adequate to meet our cash needs for daily operations and capital expenditures for at least the next 12 months, we may elect to raise additional capital through the sale of additional equity or debt securities, obtain a credit facility or sell certain assets. If additional funds are raised through the issuance of additional debt securities, these securities could have rights, preferences and privileges senior to holders of common stock or holders of the convertible notes, and terms of any debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders and additional financing may not be available in amounts or on terms acceptable to us. If additional financing becomes necessary and we are unable to obtain the additional funds, we may be required to reduce the scope of our planned product development and marketing efforts, potentially harming our business, financial condition and operating results.
Contractual Obligations
We generally do not enter into long-term minimum purchase commitments. Our principal commitments consist of our convertible senior notes, obligations under capital leases for equipment, notes payable used for purchase of equipment, operating leases primarily for office space, and other purchase obligations consisting of maintenance support contracts on leased or owned equipment and other general purchase obligations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2014, for the next five years and thereafter.
Off-Balance Sheet Arrangements
During the years ended December 31, 2014, 2013 and 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or variable interest entities, which would have been established for the purpose of facilitating off balance sheet arrangements or other contractually narrow or limited purposes.
Recent Accounting Pronouncements
See Note 2. in Notes to our Consolidated Financial Statements "Significant Accounting Policies".
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
We had cash and cash equivalents of $367.8 million and marketable securities of $91.8 million at December 31, 2014. These amounts were held primarily in money market funds, commercial paper and U.S government securities.
Cash and cash equivalents are held for working capital purposes, marketable securities are held as short-term investments and restricted cash amounts are held as security against various lease obligations. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates.
Market Risk
In June 2013, we issued at par value $310.0 million of 0.25% convertible senior notes due June 1, 2018 ("the Notes"). The Notes have a fixed annual interest rate of 0.25% and we, therefore, do not have economic interest rate exposure on the Notes. However, the fair value of the Notes is exposed to interest rate risk. Generally, the fair value of the Notes will increase as interest rates fall and decrease as interest rates rise. These Notes are also affected by volatility in our common stock price. As of December 31, 2014, the fair value of the Notes was $347.6 million.
Foreign Currency Risk
Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound Sterling, Canadian Dollar, Australian Dollar, Philippine Peso, Uruguayan Peso and the Czech Koruna. Our revenue is generally denominated in the local currency of the contracting party. The majority of our invoicing relates to sales occurring in the United States and therefore is denominated in U.S. dollars. We have an increasing percentage of sales denominated in foreign currencies including, but not limited to, the local currencies of Australia, the United Kingdom and Canada. Our expenses are incurred primarily in the United States, Canada, the Philippines, Australia and the United Kingdom, with a small portion of expenses incurred in other countries where our international sales and operations offices are located. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. During the year ended December 31, 2014, the U.S. dollar increased against the foreign currencies that our invoicing and operational expenses are denominated in by approximately 6.9% when compared to the same period in the prior year. For the year ended December 31, 2014, the fluctuation in foreign currency rates positively affected our income by approximately $5.1 million.
During the year ended December 31, 2014, we continued a hedging program initiated in 2008 to limit the exposure of foreign currency risk resulting from the revaluation of foreign denominated assets and liabilities through the use of forward exchange contracts. See “Balance Sheet Hedging - Hedging of Foreign Currency Assets and Liabilities” in Note 6 under the heading “Notes to the Consolidated Financial Statements” of Part 1, Item 1, “Financial Statements” herein for further disclosures.
Fair Value of Financial Instruments
We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments with various maturity dates over the next 18 months. We do not use derivative financial instruments for speculative or trading purposes. However, this does not preclude our adoption of specific hedging strategies in the future.
Item 8.
Item 8.
Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
The following financial statements are filed as part of this Annual Report:
Page
number
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Loss
Consolidated Statements of Total Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
NetSuite, Inc.:
We have audited the accompanying consolidated balance sheets of NetSuite Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive loss, total equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we have also audited financial statement Schedule II, as set forth in Item 15(b). We also have audited NetSuite Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). NetSuite Inc.'s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule and an opinion on NetSuite Inc.'s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NetSuite Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, NetSuite Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
Santa Clara, California
March 2, 2015
NetSuite Inc.
Consolidated Balance Sheets
(dollars in thousands)
See accompanying Notes to Consolidated Financial Statements.
NetSuite Inc.
Consolidated Statements of Operations and Comprehensive Loss
(dollars and shares in thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
NetSuite Inc.
Consolidated Statements of Cash Flows
(dollars in thousands)
See accompanying Notes to Consolidated Financial Statements
NetSuite Inc.
Notes to Consolidated Financial Statements
Note 1. Organization
NetSuite Inc. (the “Company”) provides cloud-based financials/Enterprise Resource Planning (“ERP”) and omnichannel commerce software suites. In addition, the Company offers a broad suite of applications, including financial management, Customer Relationship Management (“CRM”), Ecommerce and retail management, Professional Services Automation (“PSA”) and Human Capital Management ("HCM") that enables companies to manage most of their core business operations in its single integrated suite. The Company’s "real-time dashboard" technology provides an easy-to-use view into up-to-date, role-specific business information. The Company also offers customer support and professional services related to implementing and supporting its suite of applications. The Company delivers its suite over the Internet as a subscription service using the software-as-a-service ("SaaS") model. The Company’s headquarters are located in San Mateo, California. The Company conducts its business worldwide, with international locations in Canada, Europe, Asia, Australia and Uruguay.
Note 2. Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.
Recent Accounting Standards
In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will replace most existing U.S. GAAP guidance on this topic. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for the Company beginning January 1, 2017 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the impact of adopting this new accounting standard on its financial statements and has not selected a transition method.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Segments
The Company's chief operating decision maker is its Chief Executive Officer ("CEO"), who reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region. Accordingly, the Company has determined that it has a single reportable segment, specifically, the provision of cloud-based business management application suites.
Revenue Recognition
The Company generates revenue from two sources: (1) subscription and support; and (2) professional services and other. Subscription and support revenue includes subscription fees from customers accessing its cloud-based application suite and support fees from customers purchasing support. Arrangements with customers do not provide the customer with the right to take possession of the software supporting the cloud-based application service at any time. Professional services and other revenue include fees from consultation services to support the business process mapping, configuration, data migration, integration and training. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
For the most part, subscription and support agreements are entered into for 12 to 36 months. In aggregate, more than 90% of the professional services component of the arrangements with customers is performed within 300 days of entering into a contract with the customer.
For the most part, the subscription agreements provide service level commitments of 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require the Company to credit qualifying customers up to the value of an entire month of their subscription and support fees. In light of the Company’s historical experience with meeting its service level commitments, the Company does not currently have any liabilities on its balance sheet for these commitments.
The Company commences revenue recognition when all of the following conditions are met:
NetSuite Inc.
Notes to Consolidated Financial Statements
•
There is persuasive evidence of an arrangement;
•
The service is being provided to the customer;
•
The collection of the fees is reasonably assured; and
•
The amount of fees to be paid by the customer is fixed or determinable.
In most instances, revenue from new customer acquisition is generated under sales agreements with multiple elements, comprised of subscription and support fees from customers accessing its cloud-based application suite and professional services associated with consultation services. The Company evaluates each element in a multiple-element arrangement to determine whether it represents a separate unit of accounting. An element constitutes a separate unit of accounting when the delivered item has standalone value and delivery of the undelivered element is probable and within the Company’s control. Subscription and support have standalone value because they are routinely sold separately by the Company. For the most part, professional services have standalone value because the Company has sold professional services separately and there are several third party vendors that routinely provide similar professional services to its customers on a standalone basis.
The Company allocates revenue to each element in an arrangement based on a selling price hierarchy. The selling price for a deliverable is based on its vendor-specific objective evidence (“VSOE”), if available, third-party evidence (“TPE”), if VSOE is not available, or estimated selling price (“ESP”), if neither VSOE nor TPE is available. As the Company has been unable to establish VSOE or TPE for the elements of its arrangements, the Company establishes the ESP for each element primarily by considering the weighted average of actual sales prices of professional services sold on a standalone basis and subscription and support including various add-on modules when sold together without professional services, and other factors such as gross margin objectives, pricing practices and growth strategy. The consideration allocated to subscription and support is recognized as revenue over the contract period commencing when the subscription service is made available to the customer. The consideration allocated to professional services is recognized as revenue using the proportional performance method.
The total arrangement fee for a multiple element arrangement is allocated based on the relative ESP of each element. However, since the professional services are generally completed prior to completion of delivery of subscription and support services, the revenue recognized for professional services in a given reporting period does not include fees subject to delivery of subscription and support services. This results in the recognition of revenue for professional services that is generally no greater than the contractual fees for those professional services.
For single element sales agreements, subscription and support revenue is recognized ratably over the contract term beginning on the provisioning date of the contract. The Company recognizes professional services revenue using the proportional performance method for single element arrangements.
Sales and other taxes collected from customers to be remitted to government authorities are excluded from revenues.
Deferred Revenue
Deferred revenue consists of billings or payments received in advance of revenue recognition and is recognized as the revenue recognition criteria are met. The Company generally invoices its customers annually or in monthly or quarterly installments. Accordingly, the deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue that will be recognized during the succeeding 12 month period is recorded as current deferred revenue, and the remaining portion is recorded as non-current deferred revenue.
Cost of Revenue
Cost of revenue primarily consists of costs related to hosting the Company's cloud-based application suite, providing customer support, data communications expenses, salaries and benefits of operations and support personnel, software license fees, costs associated with website development activities, allocated overhead, amortization expense associated with capitalized internal use software and acquired developed technology assets and property and equipment depreciation. Costs related to professional services are expensed as incurred.
Deferred Commissions
The Company capitalizes commission costs that are incremental and directly related to the acquisition of customer contracts. Commission costs are accrued and capitalized upon execution of the sales contract by the customer. Payments to partners and sales personnel are made shortly after the receipt of the related customer payment. Deferred commissions are amortized over the term of the related non-cancelable customer contract and are recoverable through the related future revenue streams. The Company capitalized commission costs of $95.5 million, $70.4 million and $50.5 million during the years ended December 31, 2014, 2013 and 2012, respectively. Commission amortization expense was $75.2 million, $55.5 million and $45.3 million during the years ended December 31, 2014, 2013 and 2012, respectively.
Internal Use Software and Website Development Costs
NetSuite Inc.
Notes to Consolidated Financial Statements
The Company capitalizes certain development costs incurred in connection with its internal use software and website. These capitalized costs are primarily related to the integrated business management application suite that is hosted by the Company and accessed by its customers on a subscription basis. Costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Capitalized costs are recorded as part of property and equipment. Maintenance and training costs are expensed as incurred. Internal use software is amortized on a straight line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal use software during the years ended December 31, 2014, 2013 and 2012. The Company capitalized $4.0 million, $3.2 million and $4.1 million in internal use software during the years ended December 31, 2014, 2013 and 2012, respectively. Included in the December 31, 2014, 2013 and 2012 capitalized development costs are $1.4 million, $1.1 million and $990,000, respectively, in stock-based compensation costs. Amortization expense totaled $2.7 million, $1.6 million and $629,000 during the years ended December 31, 2014, 2013 and 2012, respectively. The net book value of capitalized internal use software at December 31, 2014 and 2013 was $7.8 million and $6.5 million, respectively. In December 2012, the Company purchased $1.5 million in developed technology which was capitalized as internal use software. A total of $1.3 million was paid to the two former owners on the purchase date and the remaining $225,000 was paid within 15 months after the purchase date. The $1.5 million total purchase price is included in the $4.1 million in development costs capitalized in 2012. During 2013, the Company integrated this developed technology into its data center production environment.
Income Taxes
The Company accounts for income taxes under the asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and amounts recognized for income tax reporting purposes, net operating loss carryforwards and other tax credits measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
Compliance with income tax regulations requires the Company to make decisions relating to the transfer pricing of revenue and expenses between each of its legal entities that are located in several countries. The Company's determinations include many decisions based on management's knowledge of the underlying assets of the business, the legal ownership of these assets, and the ultimate transactions conducted with customers and other third parties. The calculation of the Company's tax liabilities involves dealing with uncertainties in the application of complex tax regulations in multiple tax jurisdictions. The Company may be periodically reviewed by domestic and foreign tax authorities regarding the amount of taxes due. These reviews may include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various filing positions, the Company records estimated reserves when it is more likely than not that an uncertain tax position will not be sustained upon examination by a taxing authority. Such estimates are subject to change. See Note 15 for information regarding the impact of the Company's accounting for uncertainty in income taxes.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. Cash equivalents are comprised of investments in money market mutual funds and commercial paper. Cash and cash equivalents are recorded at cost, which approximates fair value.
Goodwill and Other Intangible Assets
The Company records goodwill when consideration paid in a purchase acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. Goodwill is not amortized, but rather is tested for impairment annually or more frequently if facts and circumstances warrant a review. The Company has determined that there is a single reporting unit for the purpose of goodwill impairment tests. For purposes of assessing the impairment of goodwill, the Company annually, on October 1st, estimates the fair value of the reporting unit and compares this amount to the carrying value of the reporting unit. If the Company determines that the carrying value of the reporting unit exceeds its fair value, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds its fair value. In 2014, the Company changed its annual goodwill impairment date from December 31, to October 1. On October 1, 2014, the Company completed its annual impairment test of goodwill. Based upon that evaluation, the Company determined that its goodwill was not impaired.
Other intangible assets, consisting of developed technology, trade name and customer relationships, are stated at cost less accumulated amortization. All other intangible assets have been determined to have definite lives and are amortized on a straight-line basis over their estimated remaining economic lives, ranging from one to seven years. Amortization expense related to developed technology is included in cost of subscription and support revenue while amortization expense related to tradenames and customer relationships is included in sales and marketing expense.
Long-lived Assets
The Company continually monitors events and changes in circumstances that could indicate that carrying amounts of its long-lived assets, including property and equipment and intangible assets may not be recoverable. When such events or changes in circumstances occur, the Company assesses the recoverability of long-lived assets by determining whether the
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Notes to Consolidated Financial Statements
carrying value of such assets will be recovered through their undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets.
In 2009, the Company acquired QuickArrow (“QA”) for approximately $19.4 million and assigned $3.3 million to the developed technology intangible asset. The QA developed technology was being amortized over a four years period to cost of revenue. In the second quarter of 2012, certain QA customers transitioned from the QA service offering to a NetSuite service offering or terminated their service completely. As a result, the QA expected undiscounted cash flows decreased below the carrying value of the QA developed technology assets and the Company recorded a $401,000 impairment charge. $401,000 represented the excess of the carrying amount of the QA developed technology over the fair value of such asset as of June 30, 2012. The QA developed technology fair value at June 30, 2012 was derived from the expected QA future cash flows which were based on revenue generated by customers using the QA service, a Level 3 unobservable input as described in Note 5. The Company amortized the remaining $481,000 net carrying value of the asset over the second half of 2012.
The Company did not recognize any impairment charges on its long-lived assets during the years ended 2014 and 2013.
Leases
The Company leases worldwide facilities and certain other equipment under non-cancelable lease agreements. The terms of certain lease agreements provide for rental payments on a graduated basis. The Company recognizes rent expense on a straight-line basis over the lease period and accrues for rent expense incurred but not paid.
Under certain leases, the Company also receives reimbursements for leasehold improvements. These reimbursements are lease incentives which are recognized as a liability and are amortized on a straight-line basis over the term of the lease as a reduction of minimum rental expense. The leasehold improvements are included in property, plant and equipment and are amortized over the shorter of the estimated useful life of the improvements or the lease term.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated asset lives. The estimated useful lives by asset classification are generally as follows:
Amortization of leasehold improvements is computed on a straight-line basis over the shorter of the lease term or the estimated useful lives of the assets.
Upon retirement or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in other income.
Warranties and Indemnification
The Company's cloud-based application service is typically warranted to perform in a manner consistent with general industry standards that are reasonably applicable and materially in accordance with the Company's on-line help documentation under normal use and circumstances.
The Company includes service level commitments to its customers warranting certain levels of uptime reliability and performance and permitting those customers to receive credits in the event that the Company fails to meet those levels. To date, the Company has not incurred any material costs as a result of such commitments. And the accrued liability related to such obligations in the accompanying consolidated financial statements is negligible.
The Company has also agreed to indemnify its directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person's service as a director or officer, including any action by the Company, arising out of that person's services as the Company's director or officer or that person's services provided to any other company or enterprise at the Company's request. The Company maintains director and officer insurance coverage that may enable the Company to recover a portion of any future amounts paid.
The Company's arrangements include provisions indemnifying customers against liabilities if our products infringe a third-party's intellectual property rights. The Company has not incurred any costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the accompanying consolidated financial statements.
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Notes to Consolidated Financial Statements
Concentration of Credit Risk and Significant Customers and Suppliers
Financial instruments potentially exposing the Company to concentration of credit risk consist primarily of cash and cash equivalents, marketable securities, restricted cash and trade accounts receivable. The Company maintains an allowance for doubtful accounts receivables balance. The allowance is based upon historical loss patterns, the number of days that billings are past due and an evaluation of the potential risk of loss associated with problem accounts. The Company generally charges off uncollectible accounts receivable balances when accounts are 120 days past-due based on the account's contractual terms. Credit risk arising from accounts receivable is mitigated due to the large number of customers comprising the Company's customer base and their dispersion across various industries. At December 31, 2014 and 2013, there were no customers that represented more than 10% of the net accounts receivable balance. There were no customers that individually exceeded 10% of the Company's revenue in any of the periods presented. At December 31, 2014 and 2013, long-lived assets located outside the United States were not significant.
Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented:
No single country outside the United States represented more than 10% of revenue during the years ended December 31, 2014, 2013 or 2012.
Certain Significant Risks and Uncertainties
The Company participates in the dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on the Company's future financial position, results of operations or cash flows; advances and trends in new technologies and industry standards; pressures resulting from new applications offered by competitors; changes in certain strategic or customer relationships; litigation or claims against the Company based on intellectual property, patent, product, regulatory or other factors; risk associated with changes in domestic and international economic or political conditions or regulations; availability of necessary product components; and the Company's ability to attract and retain employees necessary to support its growth.
Foreign Currency Translation
The U.S. dollar is the reporting currency for all periods presented. The financial information for entities outside the United States is measured in their functional currency which, depending on circumstances, may either be the local currency or the U.S. dollar. The Company translates its financial statements of consolidated entities whose functional currency is not the U.S. dollar into U.S. dollars. The Company translates its assets and liabilities at the exchange rate in effect as of the financial statement date and translates statement of operations accounts using the average exchange rate for the period. Exchange rate differences resulting from translation adjustments are accounted for as a component of accumulated other comprehensive income / (loss). Gains or losses, whether realized or unrealized, due to transactions in foreign currencies are reflected in the consolidated statements of operations under the line item other income / (expense). The Company recognized net foreign currency losses of $437,000, $343,000 and $487,000 during the years ended December 31, 2014, 2013 and 2012, respectively.
Advertising Expense
Advertising costs are expensed as incurred. For the years ended December 31, 2014, 2013 and 2012, advertising expense was $12.8 million, $8.2 million and $4.1 million, respectively.
Stock-Based Compensation
The Company uses the fair value method for recording stock-based compensation for new awards granted, modified, repurchased or cancelled. The Company recognizes compensation costs for stock option grants, restricted awards and restricted stock unit awards on a straight-line basis over the requisite service period for the entire awards. The Company recognizes compensation expense related to performance share awards based on the accelerated method which recognizes a larger portion of the expense during the beginning of the vesting period than in the end of the vesting period.
Under the 2007 Equity Incentive Plan (the "2007 Plan"), the Company has granted selected executives and other key employees performance shares ("PS") and performance share units ("PSUs"), which are restricted stock units (“RSUs”). PS vesting is contingent upon meeting certain company-wide performance goals while PSUs vesting is contingent upon meeting certain company-wide performance goals and market-based performance goals. Unforfeited PS and PSUs generally will vest in three equal annual tranches over the service period. The PS and PSUs grant date fair value, which is also the total stock-based compensation expense associated with the performance based awards, is determined based on the value of the underlying
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shares on the grant date and is recognized over the vesting term. On a quarterly basis, management estimates the number of PS and PSUs that will be granted at the end of the performance period. The PS fair value is based on market value of shares on the grant date (the intrinsic value). The fair value of the market-based PSUs on the grant date (measurement date) is calculated using a Monte Carlo simulation model that estimates the distribution of the potential outcomes of the PSU grants based on simulated future stock prices of the peer group.
The Company accounts for compensation expense related to stock options granted to consultants and other non-employees based on the fair values estimated using the Black-Scholes model on the date of grant and re-measured at each reporting date over the performance period. The compensation expense is amortized using the straight-line method over the related service term.
The Company issues new shares of its common stock upon the exercise of stock options and the vesting of restricted stock, RSUs, PSs and PSUs.
Qualified Operational Expense Reimbursements
At the Company's product development facility in the Czech Republic, the Company participates in a government subsidy program for employing local residents. Under the program, the Czech Republic government will reimburse the Company for certain operational expenses it incurs. While the Company became eligible to participate in this program in 2010, it did not record a subsidy credit in the financial statements until it was assured of collection in 2012. Effective January 2012, when the Company incurs reimbursable operating expenses, it records a reduction in operational expenses and a receivable from the Czech government. In the first quarter of 2014, the Company reached the initial program's reimbursement limit. The Company then began participating in a second subsidy program, similar in nature to the initial program, in the second quarter of 2014. During the years ended December 31, 2014, 2013, and 2012, the Company's operational expenses were reduced by approximately $1.5 million, $2.5 million and $2.0 million, respectively, for reimbursements of eligible operating expenses incurred during the years ended December 31, 2014, 2013 and the period from November 2010 to December 31, 2012, respectively. The Company received approximately $2.2 million, $2.0 million and $1.2 million in payments from the Czech Republic government during the years ended December 31, 2014, 2013 and 2012 , respectively. As of December 31, 2014, $645,000 in reimbursements, adjusted for foreign currency valuations, are due the Company and included in other current assets.
Net Loss Per Common Share
Basic net loss per common share is computed by dividing net loss attributable to NetSuite Inc. common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is computed by giving effect to all potentially dilutive common shares including options, restricted stock, restricted stock units, performance share units, performance shares and convertible debt shares. Basic and diluted net loss per common share was the same for all periods presented as the impact of all potentially dilutive securities outstanding was anti-dilutive.
Accumulated Other Comprehensive Income / (Loss)
Accumulated other comprehensive income / (loss) is comprised of foreign currency translation gains and losses, net of tax, unrealized losses on marketable securities and an accumulated pension liability for employees located in the Philippines. The foreign currency translation gains /(losses), net of taxes as of December 31, 2014 and 2013 were $(5.7) million, and $22,000, respectively. Unrealized loss on marketable securities was $5,000 as of December 31, 2014. During the years ended December 31, 2014, 2013 and 2012, there were no realized gains/(losses) on marketable securities. The unamortized defined benefit pension costs as of December 31, 2014 and 2013 was $(178,000) and $(268,000), respectively.
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Notes to Consolidated Financial Statements
Note 3. Business Combinations
During 2014, the Company purchased certain warehouse management solution provider ("WMS") assets to expand its manufacturing vertical and Venda Limited (“Venda") to further develop its Ecommerce vertical. In connection with these acquisitions, the Company incurred transaction costs totaling $4.6 million.
Under the acquisition method of accounting, the Company allocated the purchase price to the identifiable assets and liabilities based on their estimated fair value at the date of acquisition. To determine the value of the intangible assets, the Company made various estimates and assumptions. Methodologies used in valuing the intangible assets include, but are not limited to, the with-and-without excess earnings for customer relationships, relief of royalty for trademarks and multiple period excess earnings method for developed technology. The excess of the purchase price over the total net identifiable assets has been recorded as goodwill which includes synergies expected from the expanded service capabilities and the value of the assembled work force in accordance with generally accepted accounting principles. The Company did not record any in-process research and development intangible assets in connection with the acquisition.
WMS
On September 26, 2014, the Company purchased certain WMS assets to expand its manufacturing vertical. The WMS assets, liabilities and operating results are reflected in the Company’s consolidated financial statements from the date of acquisition. On the closing date, the Company paid $15.6 million in cash of which, $2.4 million is being held in escrow for up to 18 months following the close of the transaction as indemnification against certain losses the Company may incur in the event of certain breaches of representations and warranties covered in the asset purchase agreement. Additionally, $350,000 of consideration is being held in escrow until certain WMS tax matters are resolved.
The Company will amortize the intangible assets on a straight-line basis over the following periods:
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developed technology, five years; and
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customer relationships, four years;
Venda
On July 17, 2014, the Company completed the purchase of all the outstanding equity of Venda, a private company that provides Ecommerce solutions to its customers. Venda expands the Company’s European customer base and adds certain functionality to the Company's product suite. The Venda assets, liabilities and operating results are reflected in the Company’s consolidated financial statements from the date of acquisition. On the closing date, the Company paid $25.7 million in cash and issued 304,364 unregistered shares of the Company's common stock with a fair value of $22.8 million inclusive of a discount from the quoted market price due to certain trading restrictions associated with the shares. Of the cash consideration paid,
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$10.1 million is being held in escrow for up to two years following the close of the transaction as protection against tax contingencies and losses the Company may incur in the event of certain breaches of representations and warranties covered in the purchase agreement.
The Company will amortize the intangible assets on a straight-line basis over the following periods:
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developed technology, five years;
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customer relationships, seven years; and
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trademarks, three years.
The initial accounting for Venda accounts receivable, intangible assets, other customer related liabilities, facilities related liabilities and employee related liabilities is incomplete because the Company is in the process of determining the fair value of these assets and liabilities. The Company is also undertaking an analysis of certain tax matters associated with the Venda acquisition which could result in an adjustment to the acquisition price allocation.
Comparative pro forma financial information for WMS and Venda acquisitions has not been presented because the WMS and Venda historical financial statements are not material to the Company's consolidated results of operations.
During 2013, the Company acquired TribeHR, an on-line human capital management software provider and, OrderMotion, an online Ecommerce company and a website hosting provider company. In connections with these acquisitions, the Company incurred transaction costs totaling $3.0 million.
Under the acquisition method of accounting, the Company allocates the purchase price to the identifiable assets and liabilities based on their estimated fair value at the date of acquisition. To determine the value of the intangible assets, the Company makes various estimates and assumptions. Methodologies used in valuing the intangible assets include, but are not limited to, the expected costs to recreate the assets, present value of future payments, relief of royalty and multiple period excess earnings. The excess of the purchase price over the total identifiable assets has been recorded as goodwill which includes synergies expected from the expanded service capabilities and the value of the assembled work force in accordance with generally accepted accounting principles.
TribeHR
On November 1, 2013, the Company completed the purchase all of the outstanding equity of TribeHR ("T-HR"), an on-line human capital management software provider. The T-HR product expands the Company's product suite and the T-HR workforce augments the Company's existing product development teams, which allows the Company to expand its business capabilities in human resource management. The assets, liabilities and operating results of T-HR are reflected in the Company’s consolidated financial statements from the date of acquisition. On the closing date, the Company paid $24.8 million in cash of which, $2.5 million was being held in escrow for up to 12 months following the close of the transaction as indemnification against certain losses the Company may incur in the event of certain breaches of representations and warranties covered in the purchase agreement.
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In 2014, the escrow agent disbursed the withheld funds except for $140,000 which is being held for certain escrow claims. During the fourth quarter of 2013, the Company recorded $1.3 million in operating expenses related to transaction costs associated with this business combination.
The Company will amortize the intangible assets on a straight-line basis over the following periods:
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developed technology, five years;
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customer relationships, four years; and
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trademarks, two years.
OrderMotion
On May 3, 2013, the Company completed the purchase all of the outstanding equity of OrderMotion ("OM"). OM provides online Ecommerce Order Management Services that performs the back-end process for Ecommerce web stores. The OM product augments the Company's existing product offering, which allows the Company to expand its business capabilities in Ecommerce technology and services. The assets, liabilites and operating results of OM are reflected in the Company’s consolidated financial statements from the date of acquisition. On the closing date, the Company paid the former owners $23.5 million in cash. Additional consideration of $3.5 million in cash is being withheld up to 15 months following the close of the transaction as indemnification against certain losses the Company may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. The Company also withheld $1.1 million as indemnification against losses the Company may incur from certain tax related matters of OM. This consideration is restricted until the Company determines that the matters have been properly settled. During the second quarter of 2013, the Company recorded $311,000 in employee termination costs and $1.1 million in operating expenses related to transaction costs associated with this business combination.
The Company will amortize the intangible assets on a straight-line basis over the following periods:
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developed technology, four years;
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customer relationships, four years; and
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trademarks, two years.
As of December 31, 2013, the Company's OM purchase consideration obligations totaled $3.9 million. During the year ended December 31, 2014, the Company paid the former OM owners $3.3 million in cash. As of December 31, 2014, the Company's remaining OM purchase consideration obligation is $655,000.
Website Hosting Provider
On March 6, 2013, the Company completed the purchase of all the outstanding equity of a website hosting provider company ("WH") that specializes in Ecommerce technology and services. The WH workforce augments the Company's existing product development teams, which allows the Company to expand its business capabilities in Ecommerce technology and services. The assets, liabilities and operating results of WH are reflected in the Company’s consolidated financial statements from the date of acquisition. On the closing date, the Company paid $10.2 million in cash. Additional consideration of $1.8 million in cash is being withheld for various periods up to 24 months following the close of the transaction as indemnification against certain losses the Company may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. During the first quarter of 2013, the Company recorded $560,000 in operating expenses related to transaction costs associated with this business combination.
The Company will amortize the intangible assets on a straight-line basis over the following periods:
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developed technology, three years;
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customer relationships, four years; and
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trademarks, two years.
During the year ended December 31, 2014, the Company paid the former owners $1.0 million of the withheld consideration and reduced the remaining obligation by approximately $200,000 for various adjustments. As of December 31, 2014, $600,000 in consideration is still being withheld by the Company.
Retail Anywhere
In November 2012, the Company purchased certain assets from Retail Anywhere ("RA"), an on-line retail solution service provider. The Company purchased certain RA assets and assumed certain liabilities to expand its retail software solutions in the Ecommerce vertical. On the closing date, the Company paid $5.0 million in cash.
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Notes to Consolidated Financial Statements
Additional consideration of $1.3 million in cash was being withheld for up to the 15 months following the close of the transaction as protection against certain losses the Company may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. As of December 31, 2013, the Company's remaining obligation was $1.1 million which was paid during the year ended December 31, 2014.
Note 4. Cash and Cash Equivalents
Cash equivalents are comprised of investments in money market mutual funds and commercial paper. Cash and cash equivalents are recorded at cost, which approximates fair value.
Restricted Cash
Restricted cash totaled $211,000 and $753,000 as of December 31, 2014 and December 31, 2013, respectively. These restricted cash accounts secure letters of credit applied against certain of the Company’s facility lease agreements. Of the $211,000 restricted cash balance as of December 31, 2014, $35,000 is classified as current other assets and $176,000 is classified as long-term other assets. The $753,000 restricted cash balance as of December 31, 2013 includes $38,000 classified as current other assets and $715,000 classified as long-term other assets.
The Company maintains cash balances at several banks. Accounts located in the United States are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $250,000. Certain operating cash accounts may exceed the FDIC limits.
Note 5. Financial Instruments
The Company invests primarily in money market funds, commercial paper, highly liquid debt instruments of the U.S. government and its agencies, U.S. municipal obligations, and U.S. and foreign corporate debt securities. All highly liquid investments with maturities of 90 days or less from date of purchase are classified as cash equivalents and all highly liquid investments with maturities of greater than 90 days but less than a year from date of purchase are classified as short-term marketable securities. Highly liquid investments with maturities of greater than a year from the balance sheet date are classified as marketable securities, non-current. Short-term marketable securities and marketable securities, non-current are also classified as available-for-sale. The Company intends to hold marketable securities until maturity; however, it may sell these securities at any time for use in current operations or for other purposes, such as consideration for acquisition. Consequently, the Company may or may not hold securities with stated maturities greater than twelve months until maturity.
The Company carries its fixed income investments at fair value and unrealized gains and losses on these investments, net of taxes, are included in accumulated other comprehensive loss, a component of total equity. Realized gains or losses are included in other income / (expense), net section of the consolidated statement of operations and comprehensive loss. When a determination has been made that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is realized and is included in the other income / (expense), net section of the consolidated statement of operations and comprehensive loss.
Marketable securities consist of the following investments:
The Company does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of December 31, 2014. The Company expects to receive the full principal and interest on all of these marketable securities.
Fair Value Measurements
The Company measures certain financial assets at fair value on a recurring basis based on a fair value hierarchy that requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value are:
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Level 1 - Quoted prices in active markets for identical assets or liabilities.
•
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
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Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
Level 1 Measurements
The Company's cash equivalents held in money market funds and available-for-sale United States Treasury securities are measured at fair value using level 1 inputs.
Level 2 Measurements
The Company's available-for-sale corporate debt securities and commercial paper are measured at fair value using level 2 inputs. The Company obtains the fair values of its level 2 available-for-sale securities from a professional pricing service.
The Company’s foreign currency forward contracts are measured at fair value using foreign currency rates quoted by banks or foreign currency dealers and other public data sources. Such instruments are classified as Level 2 and are included in other current assets and liabilities.
The fair value of these financial assets and liabilities was determined using the following inputs as of December 31, 2014 and 2013:
Note 6. Hedging Activity
Balance Sheet Hedging - Hedging of Foreign Currency Assets and Liabilities
During the year ended December 31, 2014, the Company hedged certain of its nonfunctional currency denominated assets and liabilities to reduce the risk that earnings would be adversely affected by changes in exchange rates. The notional amount of derivative instruments acquired during the period was $278.1 million. The Company accounts for derivative instruments as other current assets and liabilities on the balance sheet and measures them at fair value with changes in the fair value recorded as other income / (expense). These derivative instruments do not subject the Company to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being economically hedged.
As of year end, the Company had the following outstanding foreign exchange forward contracts:
The fair value of the derivative instruments reported on the Company’s Consolidated Balance Sheet were as follows:
The effect of derivative instruments on the Statement of Comprehensive Loss was as follows for the periods presented:
The Company has entered into all of its foreign exchange contracts with a single counterparty. During the periods such contracts are open, the Company is subject to a potential maximum amount of loss due to credit risk equal to the gross fair value of the derivative instruments if the counterparty to the instruments failed completely to perform according to the terms of the contracts. Generally, we have the right of offset for gains earned and losses incurred under these agreements. Our agreements with the counterparty do not require either party to provide collateral to mitigate the credit risk of the agreements.
Note 7. Property and Equipment
As of year end, property and equipment consisted of:
Depreciation and amortization expense was $20.1 million, $15.7 million and $11.0 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Note 8. Goodwill and Other Intangible Assets
The change in the carrying amount of goodwill for the years ended December 31, 2014 and 2013 was as follows:
The Company does not have a history of goodwill impairments.
The carrying amount of other intangible assets was as follows:
The total amortization expense for other intangible assets was $10.0 million, $6.7 million and $4.6 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Future amortization of intangible assets recorded as of December 31, 2014 is expected to be as follows:
Note 9. Accrued Compensation
Accrued compensation as of December 31, 2014 and 2013 consists of:
Note 10. Long-term Debt
0.25% Convertible Senior Notes
In June 2013, the Company issued at par value $310.0 million of 0.25% convertible senior notes due June 1, 2018 (the “Notes”). Interest is payable semi-annually in arrears on December 1 and June 1 of each year, commencing December 1, 2013.
The Notes are governed by an indenture dated as of June 4, 2013, between the Company, as issuer, and Wells Fargo Bank, National Association, as trustee. The Notes do not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by the Company. The Notes are unsecured and rank senior in right of payment to the Company's future indebtedness that is expressly subordinated in right of payment to the Notes, rank equal in right of payment to the Company's existing and future unsecured indebtedness that is not so subordinated. The Notes are effectively subordinated in right of payment to any of the Company's secured indebtedness to the extent of the value of the assets securing such indebtedness and are structurally subordinated to all existing and future indebtedness, liabilities incurred by our subsidiaries including trade payables, and preferred stock of the Company.
Upon conversion, the Company may choose to pay or deliver, as the case may be, either cash, shares of the Company's common stock or a combination of cash and shares of the Company's common stock. If converted, holders will receive, at the Company's election, cash and/or shares of the Company's common stock for the principal amount of the Notes and any amounts in excess of the principal amounts. The Company intends to settle the principal amount of the Notes with cash if converted.
The initial conversion rate is 8.6133 shares of the Company's common stock per $1,000 principal amount of Notes, subject to anti-dilution adjustments. The initial conversion price is approximately $116.10 per share of the Company's common stock and represents a conversion premium of approximately 35% based on the last reported sale price of the Company's common stock of $86.00 on May 29, 2013, the date the Notes offering was priced. The conversion rate is subject to adjustment from time to time upon the occurrence of certain events, including, but not limited to, the issuance of stock dividends and payment of cash dividends. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note unless the conversion date occurs after a regular record date related to the Notes and prior to the related interest payment date. At any time prior to the close of business on the business day immediately preceding March 1, 2018, holders may convert their Notes at their option only under the following circumstances:
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during any calendar quarter commencing after the calendar quarter ending on September 30, 2013 (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
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during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the conversion rate on each such trading day; or
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upon the occurrence of certain corporate transactions described in the indenture governing the Notes.
On and after March 1, 2018 until the close of business on the business day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances. If a make-whole fundamental change (as defined in the Indenture governing the Notes) occurs when the Company's stock price is between $86.00 and $275.00 per share and a holder elects to convert its Notes in connection with such make-whole fundamental change, such holder may be entitled to an increase in the conversion rate as provided for in the Indenture governing the Notes.
As of December 31, 2014, circumstances that would give rise to a conversion option for the holders of Notes do not exist.
Holders of the Notes have the right to require the Company to purchase with cash all or a portion of the Notes upon the occurrence of any event that constitutes a fundamental change (as defined in the Indenture governing the Notes) at a purchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes as a whole.
The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense using the effective interest method over the term of the Note. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the $8.4 million in transaction costs related to the Note issuance, the Company allocated the total amount incurred to the liability and equity components based on their relative values. The $6.7 million in transaction costs attributable to the liability component included in other assets are being amortized to interest expense over the term of the Notes, and the $1.7 million in transaction costs attributable to the equity component were netted with the equity component in additional paid-in capital. Debt issuance costs, net of amortization, were $4.7 million as of December 31, 2014. The Notes consisted of the following as of December 31, 2014:
(1) Included in the consolidated balance sheets within additional paid-in capital, net of the $1.7 million in equity issuance costs.
The Notes are carried at face value less any unamortized debt discount and also require disclosure of an estimate of fair value. The Company considers the fair value of the Notes at each balance sheet date to be a level 2 measurement because it is determined based on a recent quoted market price or dealer quote for the Notes. The Notes quoted market price or dealer quote is based on the trading price of the Company's common stock and market activity that is less than an active exchange.
As of December 31, 2014, the remaining life of the Notes is approximately 3.50 years.
The following table sets forth total interest expense recognized related to the Notes during the twelve months ended December 31, 2014 and 2013:
In connection with issuing at par value $310.0 million of 0.25% convertible senior notes due June 1, 2018, our Board of Directors approved the use of $30.0 million of the net proceeds to repurchase 348,837 shares of our common stock for $30.0 million, or $86.00 per share. The Company has since retired these shares.
Related Party Debt
On October 31, 2007, the Company entered into a perpetual software license agreement with Oracle USA, Inc. (“Oracle USA”), a related party, to license Oracle database and application server software, along with technical support. This license agreement had a forty-two month term that allowed the Company to download an unlimited number of perpetual licenses and was financed pursuant to notes issued to Oracle USA, Inc. at a rate of 6.20% per annum.
In May 2010, the Company entered into an amendment to the perpetual software license agreement with Oracle USA. The amendment provides for a 37-month extension of unlimited licenses to the October 2007 license agreement from Oracle and was financed pursuant to notes issued to Oracle USA, Inc. at a rate of 2.12% per annum. On February 28, 2013, the Company entered into the third amendment to the perpetual software license agreement with Oracle USA ("Amendment"). The Amendment provides for a 48-month extension to the May 2010 second amendment to the Oracle unlimited license agreement. The Amendment provides that the Company will pay a one-time fee of $13.1 million to extend the term for unlimited licenses from May 31, 2014 to May 31, 2018. The Amendment also provides for technical support services. The Company paid $2.4 million for the support services from February 28, 2013 to February 27, 2014. The Company renewed the support service agreement for $4.3 million in both February 2014 and 2015 and may renew support services for the two subsequent annual periods at the same rate. The support services to be provided to the Company by Oracle automatically renew unless the Company provides written notice of cancellation at least 60 days prior to the support renewal date. The Company financed the license fees due under the Amendment pursuant to a note issued to Oracle Credit Corporation. The note bears interest at a rate of 2.0% per annum with payments scheduled over the term of the amendment. The Company discounted the note at a rate of 4.5% because it approximates the interest rate the Company would obtain on the open market. The $12.4 million discounted note value was recorded as an asset addition to property and equipment that will be depreciated over seven years.
Future debt payments under notes payable as of December 31, 2014 are as follows:
The current and long-term portions of the notes payable, recorded in other current liabilities and other long-term liabilities, respectively, are as follows for the periods indicated:
The maximum amount outstanding under the notes was $11.8 million and $14.4 million during the years ended December 31, 2014 and 2013, respectively.
The following table details payments to Oracle USA and Oracle Credit Corporation for support services and license fees related to the following years:
Note 11. Lease Commitments
The Company leases computer equipment and purchased software from various parties under capital lease agreements that expire through December 2017. The total outstanding balance financed under capital leases was $238,000 and $247,000 at December 31, 2014 and 2013, respectively. Accumulated amortization on the leased assets was $2.4 million and $2.1 million at December 31, 2014 and 2013, respectively. Amortization of assets recorded under the capital leases is included in depreciation expense. The current and long-term portions of the capital leases have been recorded in other current liabilities and other long-term liabilities, respectively, on the consolidated balance sheets. The current and long-term portions of capital lease were as follows:
The Company also has several non-cancelable operating leases, primarily for its facilities, that expire through 2021. Certain of these leases contain renewal options for periods ranging from two to five years and require the Company to pay executory costs such as maintenance, taxes, and insurance. The Company leases office space in the U.S. and throughout the world with various expiration dates through 2021. Minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease including any periods of free rent and rent concessions.
Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) and the future minimum capital lease payments as of December 31, 2014 are as follows:
Rental expenses for operating leases were $15.4 million, $11.1 million and $8.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. Sublease income, which is recorded as reduction on of rental expense, was $321,000 for the year ended December 31, 2014 and negligible for 2013 and 2012.
Note 12. Commitments and Contingencies
Legal Proceedings
The Company is involved in various legal proceedings and receives claims from time to time, arising from the normal course of business activities. In the Company’s opinion, resolution of these matters is not expected to have a material adverse impact on its consolidated results of operations, cash flows or our financial position.
Note 13. Stock-based Compensation
Stock-based Plans
The Company maintains the 2007 Plan for the purpose of granting incentive stock options, nonstatutory stock options, RSUs, PSs, stock appreciation rights and PSUs to its employees and directors. Additionally, the Company has an additional plan, the 1999 Stock Plan ("the 1999 Plan"), with options outstanding from which it will not grant any additional awards.
The 2007 Plan, adopted by the Company's Board of Directors in June 2007 and effective in December 2007, reserved 2,375,000 shares of common stock for issuance under the plan. As of December 31, 2014, 4,808,788 shares remained available for future grants under the 2007 Plan. Options cancelled under the 1999 Plan are added to the shares available for issuance under the 2007 Plan when those cancellations occur. The 2007 Plan also provides for annual increases in the number of shares available for issuance on the first day of each fiscal year equal to the lower of a) 9,000,000 shares of the Company's common
stock; b) 3.5% of the Company's aggregate common stock outstanding plus common stock issuable pursuant to outstanding awards under the Company's equity plans; or c) such other amount as the Board of Directors may determine.
The exercise price for options granted under the 1999 Plan and the 2007 Plan is the fair market value of an underlying share of common stock on the date of grant. If an optionee, at the time the option is granted, owns stock totaling more than 10% of the total combined voting rights of all classes of stock of the Company (a "10% Owner"), the exercise price for such options will not be less than 110% of the fair value of an underlying share of common stock on the date of grant. Options generally vest over a four year period and have a term of 10 years from the date of grant. Options granted under the 2007 Plan to 10% Owners have a maximum term of 5 years.
Amounts recognized in the financial statements related to the 2007 Plan are as follows:
The Company issues new shares of common stock upon the exercise of stock options, the granting of restricted stock and the vesting of RSUs, PSs and PSUs.
During the third quarter of 2014, the Company granted 559,456 performance shares ("PS") to selected executives. This PS grant is subject to the Company's performance in 2015, 2016 and 2017. The PS vesting is contingent upon the Company meeting certain company-wide revenue and non-GAAP operating margin performance goals (performance-based) in 2015, 2016 and 2017. The Company's Board of Directors ("BOD") set the performance metrics in the third quarter of 2014 for the entire performance period. The related stock-based compensation expense is determined based on the value of the underlying shares on the date of grant and is recognized over the vesting term. During the interim financial periods, management estimates the probable number of PS that will be vested until the achievement of the performance goals is known.
During the first quarter of 2012, the Company granted 341,750 PS, with a fair value of $50.38 per share, to selected executives and other key employees. These PS grants were equally divided into two tranches: shares that are subject to the Company's performance in 2012 and 2014 ("PS 2014"). The PS vesting for each tranche is contingent upon the Company meeting certain company-wide revenue and non-GAAP operating margin performance goals (performance-based) in 2012 and 2014, respectively, which were set by the BOD at the time of grant . Additionally, in the first quarter of 2012, the Company also awarded these employees 170,875 PS for 2013 ("PS 2013") and an additional 170,875 PS award for 2014 ("PS 2014ii"). The BOD set the performance metrics for the PS 2014ii award and the PS 2013 award in first quarters of 2014 and 2013, respectively.
The PS are subject to term vesting conditions. The PS fair value and the related stock-based compensation expense are determined based on the value of the underlying shares on the date of grant and is recognized over the vesting term. During the interim financial periods, management estimates the probable number of PS that will be awarded until the achievement of the performance goals is known which is typically in the first quarter of the following year.
For the PS 2014 award, the Company achieved 200% of its company-wide performance goals resulting in the Company awarding an additional 154,750 shares to select executives and key employees. The PS 2014 grants vest 1/3 per year with the initial vesting event in February 2015.
For the PS 2014ii, the Company achieved 126% of its company-wide performance goals resulting in the Company awarding an additional 31,183 shares to select executives and key employees. The PS 2014ii grants vest 1/3 per year with the initial vesting event in February 2015.
For the PS tranche granted for 2013, the Company achieved 137% of its company-wide performance goals resulting in the Company awarding an additional 72,542 shares to select executives and key employees. The 2013 PS grants vest 1/3 per year with the initial vesting event in February 2014.
For the PS tranche granted for 2012, the Company achieved 110% of its company-wide performance goals resulting in the Company awarding an additional 16,532 shares to select executives and key employees. The 2012 PS grants vest 1/3 per year with the initial vesting event in February 2013.
As of December 31, 2014 and 2013, all outstanding stock-based payment awards qualified for classification as equity.
Stock Options
A summary of the Company's stock option activity during the year ended December 31, 2014 was as follows:
The total intrinsic value of the options exercised was $25.4 million, $75.9 million and $95.44 million during the years ended December 31, 2014, 2013 and 2012, respectively.
As of December 31, 2014, there was $25.7 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock option grants that are expected to be recognized over a weighted-average period of 2.7 years.
The Company uses the Black-Scholes pricing model to determine the fair value of stock options. The fair value of each option grant is estimated on the date of the grant. The weighted-average grant date fair value of options granted and the range of assumptions using the model are as follows for the periods presented:
The assumptions are based on the following for each of the years presented.
Expected Term. Prior to first quarter of 2014, the Company estimated the expected term consistent with the simplified method identified by the SEC. The Company elected to use the simplified method due to a lack of term length data since the Company completed its initial public offering in December 2007 and its stock options meet the criteria of the “plain-vanilla” options as defined by the SEC. The simplified method calculates the expected term as the average of the vesting and contractual terms of the award.
Effective the first quarter of 2014, the Company changed its methodology for estimating the expected term assumption used to determine employee stock option grant fair value. The Company changed from the simplified method to a historical data method because the Company believes it has sufficient data to estimate the stock option exercise period based on historical stock option activity and historical employee termination data.
Volatility. The expected volatility being used is based on a blend of the Company's implied volatility and its historical volatility.
Risk Free Interest Rate. The risk free interest rate is based on the U.S. Treasury's zero coupon issues with remaining terms similar to the expected term on the options.
Dividend Yield. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
Forfeitures. The Company estimates forfeitures at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting forfeitures and
records stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. If the Company's actual forfeiture rate is materially different from its estimate, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.
Restricted Stock Units, Restricted Stock, Performance Share and Performance Share Units
A summary of the Company's RSU, RS, PS and PSU activity during the year ended December 31, 2014 is as follows:
For the restricted stock units, restricted stock, performance shares and performance share units that vested during the years ended December 31, 2014, 2013 and 2012, the total intrinsic value was $122.2 million, $145.3 million and $94.6 million , respectively.
In accordance with the T-HR acquisition agreement, at the close of the transaction, the Company granted certain former T-HR stockholders and now employees of the Company, 37,852 restricted stock units valued at $4.0 million and will grant another $3.0 million in restricted stock units on the one year anniversary of the close date. The restricted stock units will vest over four years in accordance with the terms of the Company's equity compensation plan. The costs of the equity grants will be recognized in the Company's statement of operations over the four-year vesting period.
Compensation expense for RSUs, restricted stock, PS and PSUs is determined based on the value of the underlying shares on the date of grant. The typical RSUs, restricted stock, PS and PSU fair value is based on market value of shares on the grant date (the intrinsic value). The fair value of the market-based PSUs on the grant date (measurement date) is calculated using a Monte Carlo simulation model that estimates the distribution of the potential outcomes of the PSU grants based on simulated future stock prices of the peer group. As of December 31, 2014, there were $157.6 million of total unrecognized compensation costs, net of estimated forfeitures, related to RSUs, restricted stock, PSs and PSUs that is expected to be recognized over a weighted-average period of 2.4 years.
Reserved for Future Issuance
The Company has reserved the following shares of authorized but unissued common stock for future issuance:
Note 14. Other Employee Benefits Plans
The Company has a defined contribution retirement plan ("the Plan") that covers substantially all domestic employees of the Company. The Plan allows employees to contribute gross salary through payroll deductions up to the legally mandated limit based on their jurisdiction. During the years ended December 31, 2014 and 2013, the maximum annual employer contribution match was $4,000. The Company also contributes to various retirement plans for its employees outside the United States. The Company contributed $5.3 million, $3.9 million and $2.7 million to its various retirement plans for the years ended December 31, 2014, 2013 and 2012, respectively.
The Company recorded a total of $97,000 in 2014, $188,000 in 2013 and $152,000 in 2012 in service and interest costs and actuarial losses relating to its statutory pension benefit obligation for its employees in Manila, Philippines. Included in long-term liabilities is the total unfunded projected benefit obligation for this plan which is approximately $574,000 and $482,000 as of December 31, 2014 and 2013, respectively. During fiscal years 2014, 2013 and 2012, the Company recorded
$186,000, $126,000 and $74,000 respectively, in periodic benefit costs for this plan with a corresponding decrease in accumulated other comprehensive income.
Note 15. Income Taxes
The components of income before income taxes attributable to domestic and foreign operations are as follows:
The federal, state and foreign income tax provisions for the years ended December 31, 2014, 2013 and 2012 are summarized as follows:
During the three months ended March 31, 2013, the Company recorded approximately $1.1 million of additional net deferred tax liabilities related to the WH acquisition. These additional deferred tax liabilities create a new source of taxable income, thereby requiring us to release a portion of our deferred tax asset valuation allowance with a related reduction in income tax expense of approximately $1.1 million for 2013.
A reconciliation of the statutory U.S. federal income tax rate to the Company's effective income tax rate is as follows:
Significant components of the Company's deferred tax assets are as follows:
ASC 740, Income Taxes, provides for the recognition of deferred tax assets if realization of such assets is more likely than not. In assessing the need for a valuation allowance in 2014, the Company considered all available evidence both positive and negative, including historical levels of income, legislative developments, expectations and risks associated with estimates of future taxable income, and prudent and feasible tax planning strategies.
As a result of this analysis for the year ended December 31, 2014, the Company has determined that it is more likely than not that it will not realize the benefits of its deferred tax assets in the U.S. and Japan due to continuing losses and therefore has recorded a valuation allowance to reduce the carrying value of these deferred tax assets to zero. The additional deferred tax assets relate to operations in foreign jurisdictions where the Company has determined that it is more likely than not that the deferred tax assets will be realized.
As of December 31, 2014, the Company had approximately $744.6 million of consolidated federal net operating loss carryforwards and $340.3 million of California net operating loss carryforwards available to offset future taxable income, respectively. The increase in net operating loss carryforwards resulted primarily from employee stock-based compensation deductions in the U.S. The federal net operating loss carryforwards expire in varying amounts between 2018 and 2034. The California net operating loss carryforwards expire in varying amounts between 2015 and 2034. The Company also had
approximately $153.3 million of gross other state net operating loss carryforwards available to offset future taxable income which will expire in varying amounts between 2015 and 2034. In addition, there were $19.3 million of gross non-U.S. net operating loss carryforwards as of December 31, 2014, $5.9 million of which expire between 2017 and 2022 with the remaining carryforwards having an indefinite life.
The net operating losses include approximately $122.1 million relating to the tax benefit of stock option exercises that, when realized, will be recorded as a credit to additional paid-in capital. During 2014, the Company recorded approximately $313,000 of tax benefits related to stock-based compensation that were credited to stockholder's equity during the year.
The Company also had approximately $5.2 million of federal and $2.6 million of California research and development tax credit carryforwards at the end of 2014. The federal credits expire in varying amounts between 2019 and 2028. The California research credits do not expire. The Company records a full valuation allowance against these credits. The foreign research and development tax credit carryforwards are not material at the end of 2014.
The Company's ability to utilize the net operating loss and tax credit carryforwards in the future may be subject to substantial restrictions in the event of past or future ownership changes as defined in Section 382 of the Internal Revenue Code and similar state tax laws. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before utilization.
The Company has not provided for U.S. federal and foreign withholding taxes on its undistributed earnings from its non-U.S. operations as of December 31, 2014 because the Company intends to indefinitely reinvest such earnings offshore. Additionally, the undistributed earnings are not significant. The residual tax liability if such earnings were remitted may be reduced by foreign tax credits or other tax adjustments. Therefore, it is currently not practicable to compute.
ASC 740 requires the Company to recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination.
The following table summarizes the activity related to unrecognized tax benefits for the periods presented:
The state unrecognized tax benefits included in these amounts are reported gross instead of net of federal benefit.
The Company had gross unrecognized tax benefits of $15.5 million, $3.7 million and $3.4 million at December 31, 2014, 2013 and 2012 respectively. At December 31, 2014, 2013 and 2012, there were an estimated $190,000, $337,000 and $313,000, respectively of unrecognized tax benefit that if recognized would affect the annual effective tax rate. The change in unrecognized tax benefits in 2014 is primarily related to net operating losses that have not yet been utilized to offset taxable income combined with a nominal change due to the expiration of certain statute of limitations and the net accrual for uncertain tax positions based upon the annual analysis. The change in 2013 was primarily due to the expiration of certain statute of limitations and the net accrual for uncertain tax positions based upon the annual analysis.
The Company does not anticipate material changes in the total amount of its unrecognized tax benefits within 12 months of the reporting date. The Company accrues interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 31, 2014, the Company had $43,000 of accrued interest and penalties related to unrecognized tax benefits, and $71,000 and $56,000 as of December 31, 2013 and December 31, 2012, respectively.
The Company files federal, state and foreign income tax returns in jurisdictions with varying statutes of limitations. Due to its net operating loss carryforwards, the Company's income tax returns generally remain subject to examination by federal and most state tax authorities. In most of our significant foreign jurisdictions, the 2008 through 2014 tax years remain subject to examination by their respective tax authorities. In addition, the 2006 and 2007 tax years remain open to examination in Canada.
Note 16. Net Loss Per Common Share
Basic net loss per common share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share of common stock is computed by giving effect to all potential dilutive shares of common stock, including options, restricted stock units ("RSUs"), performance share units ("PSUs"), performance shares ("PS") and convertible debt shares. Basic and diluted net loss per share of common stock were the same for all periods presented as the impact of all potentially dilutive securities outstanding was anti-dilutive.
The following table presents the calculation of the numerator and denominator used in the basic and diluted net loss per common share:
The Company’s unvested RSUs, PSUs and PS do not contain non-forfeitable rights to dividends and dividend equivalents. As such, unvested RSUs, PSUs and PS are not participating securities and the Company is not required to use the two-class method to calculate diluted earnings per share in periods when the Company has net income.
The following table presents the weighted average potential shares that are excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect:
The effect of the Notes is reflected in diluted earnings per share by application of the treasury stock method as the Company intends to settle the principal amount of the Notes in cash upon conversion. During the year ended December 31, 2014, the Company's weighted average common stock price was below the Notes conversion price for the periods during which the Notes were outstanding.
Note 17. Related Party Transactions
The Company has entered into various software license agreements with Oracle USA, Inc., an affiliate of Oracle Corporation. Lawrence J. Ellison, who beneficially owns a significant portion of the Company’s common stock, is the Chief Technology Officer, a director and a principal stockholder of Oracle Corporation. In October 2007, the Company entered into a perpetual license for the use of Oracle database and application server software on a certain number of individual computers, along with technical support. This software license and support agreement has been amended with the latest amendment occuring in February 2013. See Note 10. to the financial statements for the terms of this agreement.
Commencing in 2004, the Company entered into a verbal agreement with Oracle Racing, Inc. ("Oracle Racing"), a sailboat racing syndicate. Lawrence J. Ellison, is the primary source of funding for Oracle Racing. Under the terms of the agreement, the Company agreed to supply certain of its cloud-based application services to Oracle Racing in exchange for logo placement on the sailboats. In November 2011, the Company renewed its subscription and professional services agreement with Oracle Racing for an additional 40 months. According to the terms of the agreement, the Company will provide services to Oracle Racing through the end of the American Cup racing season in exchange for logo placement and other advertising
services. The estimated value of the Company's services over the term of the agreement is $342,000. Oracle Racing values its service to be approximately $400,000 over the term of the agreement. Based on the pricing for similar licenses to unaffiliated third parties, the Company calculated the fair market value of the services provided to Oracle Racing to be approximately $67,000 and $62,000 for 2013 and 2012, respectively. The Company did not obtain an independent valuation of the logo placement rights received from Oracle Racing. Based on an estimate received from Oracle Racing, the Company determined the value of the logo placement on the sailboat to be approximately $33,000 during 2013 and 2012. The incremental cost to the Company of providing cloud-based services and the incremental cost to Oracle Racing of providing logo placement rights on the sailboat was nominal. For accounting purposes, total revenue and total costs related to the Oracle Racing agreement will be equal and will be recognized as revenue and expense, respectively, at historical cost. In connection with the license agreements discussed above, the Company recognized $15,000 and $112,000, respectively, in revenue for the years ended December 31, 2013 and 2012, respectively. During 2014, the Company received $19,000 in payments from Oracle Racing and recognized $24,000 in revenue.
The Company has entered into various software license agreements with Oracle Corporation. Lawrence J. Ellison, who beneficially owns a significant portion of the Company’s common stock, is the Chief Technology Officer, a director and a principal stockholder of Oracle Corporation. The Company paid Oracle Corporation $90,000 and $239,000 during the years ended December 31, 2014 and 2013, respectively, for services it received. During the years ended December 31, 2014 and 2013, the Company received payments totaling $124,000 and $123,000 from Oracle Corporation for services it performed. The Company recognized $127,000, $93,000 and $128,000 in revenue for the years ended December 31, 2014, 2013 and 2012, respectively. As of December 31, 2014, the Company had $131,000 in accounts receivable from Oracle Corporation.
In January 2011, the Company’s Chief Technology Officer and Chairman of the Board, purchased property from an entity affiliated with Lawrence J. Ellison, a principal stockholder, (“seller”) for $8.0 million. The seller financed the transaction with a nine year loan. The Company analyzed the transaction and determined that the fair value of the property approximated the fair value of the loan. Consequently, the Company determined there is no compensation expense or a related capital contribution associated with this transaction.
In addition to the companies affiliated with Lawrence J. Ellison, the Company enters into sales and purchases agreements with various companies that have a relationship with the Company's executive officers or members of the Company's board of directors. The relationships are typically an equity investment by the executive officer or board member in the customer / vendor company or the Company's executive officer or board member is a member of the customer / vendor company's board of directors. The Company has renewed the license agreements and sold additional services to these customers or purchased services from these vendors at various points in time. As of December 31, 2014, the Company had $1.1 million in accounts receivable from other related parties not affiliated with Mr. Ellison. Below is a summary of transactions between the Company and related parties other than Mr. Ellison during the years ended December 31, :
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Management's Report on Internal Control over Financial Reporting and Attestation Report of the Registered Accounting Firm
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Management assessed the effectiveness of our internal control over financial reporting, as of December 31, 2014, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Management's assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.
Based on this assessment, management has concluded that our internal control over financial reporting was effective as of the end of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. We reviewed the results of management's assessment with the Audit Committee of our Board of Directors.
The attestation report concerning the effectiveness of our internal control over financial reporting as of December 31, 2014, issued by KPMG LLP, Independent Registered Public Accounting Firm, appears in Part II, Item 8 of this Annual Report on Form 10-K.
Evaluation of Disclosure Controls and Procedures
An evaluation was performed by management, with the participation of our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO"), of the effectiveness of our disclosure controls and procedures as of December 31, 2014 (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of December 31, 2014 to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Committee rules and forms, and is accumulated and communicated to management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations of Internal Controls
Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information required by this item is incorporated by reference to NetSuite's Proxy Statement for its 2015 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2014.
The information required by this item concerning our executive officers is set forth under the heading "Executive Officers of the Registrant" in Part I, Item 1 of this Annual Report on Form 10-K.
The information required by this item is incorporated by reference to NetSuite's Proxy Statement for its 2015 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2014.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item is incorporated by reference to NetSuite's Proxy Statement for its 2015 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2014.
Item 13.
Item 13.
Certain Relationships, and Related Transactions, and Director Independence.
The information required by this item is incorporated by reference to NetSuite's Proxy Statement for its 2015 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2014.
Item 14.
Item 14.
Principal Accounting Fees and Services.
The information required by this item is incorporated by reference to NetSuite's Proxy Statement for its 2015 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2014.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a) Financial Statements
The financial statements filed as part of this report are listed on the Index to Consolidated Financial Statements in Item 8.
(b) Financial Statement Schedules
The following financial statement schedule is filed as a part of this Annual Report:
Schedule II-Valuation and Qualifying Accounts
Schedule II
Valuation and Qualifying Accounts
All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto.
(c) Exhibits
We have filed, or incorporated into the Report by reference, the exhibits listed on the accompanying Index to Exhibits immediately following the signature page of this Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on March 2, 2015.
NETSUITE INC.
By:
/S/ Zachary Nelson
Zachary Nelson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Exhibit Index
The following exhibits are incorporated by reference or filed herewith.
101.PRE**
XBRL Taxonomy Extension Presentation Linkbase Document
**
The information in these XBRL documents is unaudited.
The certification attached as Exhibit 32.1 that accompanies this Annual Report on Form 10-K is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of NetSuite Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any general incorporation language contained in such filing.
+
Indicates management contract or compensatory plan or arrangement.