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EXACTTARGET, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2011 included in the Company's registration statements on Form S-1. This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," 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 identified herein, those discussed in the section titled "Risk Factors", set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q, those discussed in the section titled "Risk Factors" included in our Prospectus filed pursuant to Rule 424(b) under the Securities Act with the U.S. Securities and Exchange Commission ("SEC") on March 22, 2012, and those discussed in the section titled "Risk Factors" included in our Prospectus filed pursuant to Rule 424(b) under the Securities Act with the U.S. Securities and Exchange Commission ("SEC") on September 12, 2012. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview We are a leading global provider of cross-channel, interactive marketing software-as-a-service ("SaaS") solutions that empower organizations of all sizes to communicate with their customers through the interactive channels they use most - email, mobile, social media and websites. Our solutions provide marketers with a broad and powerful suite of integrated applications to plan, automate, deliver and optimize data driven interactive marketing campaigns and real-time communications to drive customer engagement, increase sales and improve their return on marketing investment. Our direct client base consists of organizations ranging from large businesses, or "enterprises", to small businesses in numerous industries, including retail and e-commerce, media and entertainment, travel and hospitality, financial services and insurance, technology, daily-deal and flash-sale and marketing service providers. Our diverse direct client base includes marketing service providers that extend our global sales distribution by reselling our solutions to several thousand additional organizations. We provide our solutions primarily through annual and multi-year subscriptions based on the volume of contracted utilization, level of functionality, number of interactive marketing channels, number of users and level of customer support. Clients are charged additional usage-based fees for utilization above the contracted level. Our subscription-based model and track record of long-term client relationships have allowed us to achieve annual dollar-based subscription revenue renewal rates of over 100% for the nine month periods ended September 30, 2012 and 2011. We believe that the demand for cross-channel, interactive marketing SaaS solutions is significant and growing, driven by organizations' desire to develop a unified, cross-channel view of their customers to drive real-time, relevant engagement through email, mobile, social media and websites. We anticipate that organizations will continue to increase their use of cross-channel marketing SaaS solutions to plan, automate, deliver and optimize data-driven interactive marketing campaigns and real-time communications to better connect with their customers across interactive channels. We believe the market for our suite of cross-channel, interactive marketing SaaS solutions will become larger as organizations continue to adopt cross-channel, interactive marketing. We also believe significant opportunity exists in new markets worldwide that are unserved or underserved by existing providers. We intend to increase our direct global presence in international markets to serve our multinational clients and win new clients in these markets. In addition, in October 2012, we announced the acquisitions of Pardot LLC ("Pardot") and iGoDigital, Inc. and iGoDigital Holdings, LLC (collectively, "iGoDigital"). These acquisitions expand the functionality of our solutions and provide us with access to new clients and markets. We believe opportunities to acquire companies or technologies such as these will continue to emerge in the future. We face a number of risks in the execution of our strategy, including our potential failure to manage our domestic and international growth effectively, inability to attract new clients and retain existing clients, inability to achieve and sustain profitability, inability to integrate recent acquisitions and the overall impact of uncertain economic conditions. Due to the size and expected growth of the market opportunity, we recognize that we may face increased competition from established vendors and potential new entrants in our markets. We believe the expansion of our suite of cross-channel, interactive 12 -------------------------------------------------------------------------------- marketing SaaS solutions has been important in winning new clients and expanding relationships with our existing client base. While email continues to be the primary interactive marketing channel for our clients and represents a substantial majority of our total revenue, revenue from our mobile, social media and websites solutions is growing rapidly. We were founded in December 2000, and initially focused on providing email marketing solutions to small and medium-sized clients. Since that time, we have expanded our solutions to serve the enterprise market. We broadened our product strategy to expand beyond email into emerging cross-channel, interactive marketing technologies such as mobile, landing pages and microsites. We further expanded our suite of products with the acquisition of the enterprise social media management platform, CoTweet, now known as SocialEngage. Additionally, we continued to develop and improve our proprietary, cloud-based platform, expanding our integration framework to enable third-party marketing technology providers to embed our technology into their solutions and build applications on our platform. In 2011, we made our Interactive Marketing Hub generally available to clients, providing a broad and powerful suite of cross-channel, interactive marketing SaaS solutions to plan, automate, deliver and optimize data-driven interactive marketing campaigns and real-time communications. In 2012, we introduced our MobilePush product, which enables marketers to power push notifications from applications on smartphones and tablets and integrate the message with campaigns across email, mobile, social and the Web. Also in 2012, we opened our Fuel platform to developers and technology providers to build upon and integrate with our suite of cross-channel marketing and automation applications. As mentioned above, we announced the acquisitions of Pardot and iGoDigital in October 2012. The addition of Pardot's technology to our platform of solutions provides our clients with a lead scoring and lead nurturing solution that integrates with their broader marketing efforts and helps marketers around the globe achieve even greater results. By bringing the Pardot solution into the the ExactTarget product suite, we will redefine marketing automation and deliver the most scalable, comprehensive automation solution that helps both Business-to-Business and Business-to-Consumer marketers leverage the power of data to connect with customers across email, mobile, social media and the Web. The addition of iGoDigital's advanced Web capabilities and predictive analytics to our product suite will provide our clients with a powerful solution to transform data into highly personalized, seamless experiences across email, mobile, social media and the Web. We have established a direct presence in international markets through acquisitions and by opening new sales offices. We intend to continue to expand our direct and indirect sales channels, expand our global reach, extend our suite of cross-channel, interactive marketing SaaS solutions and increase revenue from new and existing clients. • In August 2009, we acquired a reseller in the United Kingdom, allowing us to directly support clients in Europe, including many of our U.S.-headquartered clients doing business in the region. • In August 2010, we acquired an Australian reseller to extend our ability to support multinational clients in the Asia-Pacific region. • In August 2011, we acquired a reseller in Brazil to support clients in Latin America and to expand our sales in the region. • In March 2012, we established a direct presence in Germany by opening a sales and professional services office in Munich. • In October 2012, we announced the opening of a new office in France and our plans to locate an office in Sweden during the fourth quarter of 2012. Key Metrics We use the following key metrics to evaluate and manage our business. Recurring Subscription Revenue. As a SaaS provider, we monitor recurring subscription revenue to measure our success in executing our strategy to increase the adoption of our SaaS solutions and expand our recurring revenue streams attributable to these solutions. We expect our recurring subscription revenue to remain the most significant portion of our total revenue although its percentage of total revenue may vary from period to period due to a number of factors, including the amount of revenue recognized from utilization above the contracted level and the timing of recognition of professional services revenue. We define recurring subscription revenue as the total amount of contractually-committed subscription revenue under each of our client agreements, which excludes revenue related to utilization above the contracted level. Recurring subscription revenue was as follows for the periods presented: 13 -------------------------------------------------------------------------------- Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 (in thousands, except percentages) Recurring subscription revenue $ 57,923 $ 42,467 $ 162,052 $ 114,918 Percentage of subscription revenue 98 % 94 % 98 % 93 % Subscription Revenue Renewal Rate. Our ability to retain our clients and expand their use of our suite of cross-channel, interactive marketing SaaS solutions over time is an indicator of the stability of our revenue base and the long-term value of our client relationships. We assess our performance in this area using a metric we refer to as subscription revenue renewal rate. This metric is calculated by dividing (a) total subscription revenue (including revenue related to messaging utilization above clients' contracted levels) in the current period from those clients who were clients during the prior year period, including additional sales to those clients, by (b) total subscription revenue (including revenue related to messaging utilization above our clients' contracted levels) from all clients in the prior year period. This metric is calculated on a quarterly basis and, for periods longer than one quarter, we use an average of the quarterly metrics. For each of the nine month periods ended September 30, 2012 and 2011 our subscription revenue renewal rate was greater than 100%. Adjusted EBITDA. We monitor Adjusted EBITDA because we believe this measure provides important supplemental information regarding our operating performance and is often used by investors and analysts in their evaluation of companies such as ours. In addition, we use Adjusted EBITDA as a measurement of our operating performance because it assists us in comparing our operating performance on a consistent basis by removing the impact of certain non-cash and non-operating items. We calculate Adjusted EBITDA as net income (loss) before (i) other (income) expense, which includes interest income, interest expense and other income and expense, (ii) income tax expense (benefit), (iii) depreciation and amortization of property and equipment, (iv) amortization of intangible assets and (v) stock-based compensation. This non-GAAP financial measure is used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. Adjusted EBITDA reflects an additional way of viewing aspects of our operations that we believe, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, provides a more complete understanding of factors and trends affecting our business. Adjusted EBITDA was as follows for the periods presented: Nine Months Ended September Three Months Ended September 30, 30, 2012 2011 2012 2011 (in thousands) (in thousands) Adjusted EBITDA $ 7,666 $ (924 ) $ 16,185 $ (892 ) For reconciliation of Net Loss to Adjusted EBITDA, see "Results of Operations." Components of Results of Operations Revenue We generate revenue through the sale of subscriptions to our suite of cross-channel, interactive marketing SaaS solutions and the delivery of professional services. More than 80% of our revenue for the three and nine month periods ended September 30, 2012 and 2011 was derived from our enterprise, medium-sized and small business clients, with the balance attributable to marketing service providers that resell our solutions to thousands of their customers. We serve a wide range of clients across many industries and sizes, and our revenue is not concentrated within any single client or small group of clients. For the three and nine month periods ended September 30, 2012 and 2011, no single client represented more than 5% of our revenue, and our largest ten clients accounted for less than 20% of our revenue in the aggregate. Clients are typically invoiced in advance on an annual, quarterly or monthly basis, with payment due upon receipt of the invoice within agreed upon terms. Invoiced amounts are reflected on the balance sheet as accounts receivable or as cash when collected and as deferred revenue until earned and recognized as revenue ratably over the performance period. Accordingly, deferred revenue represents the amount billed to clients that has not yet been earned or recognized as revenue, pursuant to agreements entered into in current and prior periods, and does not reflect that portion of a contract to be invoiced to clients on a periodic basis for which payment is not yet due. In recent periods, more of our clients have requested monthly instead of 14 -------------------------------------------------------------------------------- quarterly or annual billing terms. As a result, we believe that the proportion of aggregate contract value reflected on the balance sheet as deferred revenue may decrease if this trend continues. Subscription Revenue. Our subscriptions are based on volume of contracted utilization, level of functionality, number of interactive marketing channels, number of users and the level of customer support. Utilization levels are based on the volume of email messages, short message service ("SMS") messages, website impressions and other activities. If clients exceed the specified volume of utilization, additional fees are billed for the excess volume, generally at rates equal to or greater than the contracted minimum per-utilization fee, and are included in subscription revenue. If clients use less than the minimum contracted utilization, no rollover credit or refunds are given. Subscription agreements with our clients typically are not cancellable for a minimum period, generally at least one year but ranging up to three years. Our subscription revenue as a percentage of our total revenue was as follows for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Subscription revenue 79% 82% 80% 83% We recognize the aggregate minimum subscription fee ratably on a straight-line basis over the subscription term, provided that: (i) an enforceable contract has been signed by both parties, (ii) access to our SaaS solutions has been granted to the client, (iii) the fee for the subscription is fixed or determinable and (iv) collection is reasonably assured. Revenue from utilization above the contracted level is recognized in the period in which the utilization occurs. As a result of new client additions and expansion of our overall client base, we believe revenue attributable to utilization above the contracted level may grow in absolute dollars. Professional Services Revenue. Professional services revenue consists primarily of fees associated with training, implementation, integration, deliverability, campaign services and strategic consulting. Our professional services are not required for clients to utilize our suite of cross-channel, interactive marketing SaaS solutions. Depending upon the nature of the engagement, we may provide professional services over the term of the SaaS subscription or in connection with discrete projects. Revenue for our professional services engagements is recognized proportionally over the period of performance and is typically contracted on a fixed-fee basis. Our professional services revenue as a percentage of our total revenue was as follows for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Professional services revenue 21% 18% 20% 17% Cost of Revenue We allocate certain overhead expenses, such as rent, utilities, office supplies and depreciation of general office assets to cost of revenue categories based on related headcount. As a result, an overhead expense allocation is reflected in each cost of revenue category. Cost of Subscription Revenue. Cost of subscription revenue consists primarily of wages and benefits for software operations personnel, as well as depreciation, licensing, maintenance and support for hardware and software used in production, and co-location facilities, bandwidth and infrastructure expenses. The expenses related to co-location, bandwidth and infrastructure are affected by the number of clients using our suite of cross-channel, interactive marketing SaaS solutions, the complexity and frequency of their use, the level of utilization and the amount of stored data. In addition, these expenses are affected by our requirement to maintain high application availability. Our system hardware is co-located in two third-party operated hosting facilities in Indianapolis, Indiana and one in Las Vegas, Nevada. We expect to make further significant capital investments in the expansion and operation of our data centers and to continue to expand our business, which will increase our cost of subscription revenue in absolute dollars. Cost of Professional Services Revenue. Cost of professional services revenue primarily consists of wages and benefits for services personnel, third party contractors and related costs. Our cost of professional services revenue is significantly higher as a percentage of associated revenue than our cost of subscription revenue due to the labor costs associated with providing professional services. As it takes several months to ramp up a professional services consultant to full productivity, we generally increase our professional services capacity ahead of the recognition of associated professional services revenue, 15 -------------------------------------------------------------------------------- which can result in lower margins in a period of significant hiring. We expect the number of professional services personnel and third party contractors to increase in the future as we continue to serve more enterprise clients, resulting in higher cost of professional services revenue in absolute dollars. Operating Expenses We allocate certain overhead expenses, such as rent, utilities, office supplies and depreciation of general office assets to operating expense categories based on related headcount. As a result, an overhead expense allocation is reflected in each operating expense category. Sales and Marketing. Sales and marketing expenses consist primarily of wages and benefits for sales and marketing personnel, sales commissions, travel and meeting expenses and lead-generation marketing programs. All sales and marketing costs are expensed as incurred. In particular, sales bonuses are expensed in the period of contract signing and commissions are expensed upon contract billing. Our sales and marketing expenditures have historically been highest in the last two quarters of each year, which are periods of increased sales and marketing activity. In order to continue to grow our business and increase our brand awareness, we expect to continue investing substantial resources in our sales and marketing efforts. As a result, we expect sales and marketing expenses to increase as we invest to acquire new clients and retain and grow revenue from existing clients. Research and Development. Research and development expenses consist primarily of wages and benefits for product strategy, product architecture, product design, development and quality assurance personnel, and the costs of third-party development contractors. We focus our research and development efforts on usability, application performance, new features and functionality and development of emerging cross-channel marketing technologies. We expense research and development costs as incurred due to our relatively short development cycle. We expect research and development expenses to increase as we continue to enhance our product offerings. General and Administrative. General and administrative expenses consist primarily of wages and benefits for executive, finance and accounting, legal, human resources, internal information technology support and administrative personnel. In addition, general and administrative expenses include professional services fees, bad debt expenses and other corporate expenses. We expect that general and administrative expenses will increase as we continue to add personnel to support our growth. We also anticipate that we will incur additional costs for personnel and for professional services including accounting and legal services, insurance and other corporate governance-related costs related to operating as a public company. Critical Accounting Policies Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. The following accounting policies involve the most judgment and complexity: revenue recognition, income taxes, goodwill and acquired intangible assets, and stock-based compensation. Accordingly, we believe these policies are critical to fully understanding and evaluating our financial condition and results of operations. If actual results or events differ materially from the estimates, judgments and assumptions used by us in applying these policies, our reported financial condition and results of operations could be materially affected. There have been no material changes in our critical accounting policies since December 31, 2011. For further information please see the discussion of critical accounting policies included in our consolidated financial statements included in the Company's registration statement on Form S-1 for the year ended December 31, 2011, as filed with the SEC. Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financing activities other than operating leases for office space and computer equipment. We do not have any interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance entities. 16 -------------------------------------------------------------------------------- Results of Operations The following tables set forth selected consolidated statements of operations data for each of the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Revenue: (in thousands) (in thousands) Subscription (1) $ 59,188 $ 45,187 $ 165,438 $ 122,988 Professional services 15,467 9,936 42,592 24,997 Total revenue 74,655 55,123 208,030 147,985 Cost of revenue: Subscription (2,3) 13,492 10,487 38,922 28,489 Professional services (2) 11,235 7,824 33,454 21,106 Total cost of revenues 24,727 18,311 72,376 49,595 Gross profit 49,928 36,812 135,654 98,390 Operating expenses: Sales and marketing (2,3) 26,647 25,637 79,227 68,224 Research and development (2) 13,813 11,760 36,646 30,151 General and administrative (2,3) 10,189 6,901 27,435 18,082 Total operating expenses 50,649 44,298 143,308 116,457 Operating loss (721 ) (7,486 ) (7,654 ) (18,067 ) Other expense, net - (94 ) (352 ) (683 ) Loss before taxes (721 ) (7,580 ) (8,006 ) (18,750 ) Income tax expense - 14,742 - 10,540 Net loss $ (721 ) $ (22,322 ) $ (8,006 ) $ (29,290 ) Other comprehensive loss: Foreign currency translation adjustment 358 (1,173 ) (4 ) (911 ) Comprehensive loss $ (363 ) $ (23,495 ) $ (8,010 ) $ (30,201 ) Adjusted EBITDA (4) $ 7,666 $ (924 ) $ 16,185 $ (892 ) (1) Subscription revenue includes fees for utilization above the contracted level as follows: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 (in thousands, except percentages) Revenue from utilization above contracted level $ 1,265 $ 2,720 $ 3,386 $ 8,070 Percentage of subscription revenue 2 % 6 % 2 % 7 % Percentage of total revenue 2 % 5 % 2 % 5 % 17--------------------------------------------------------------------------------(2) Total cost of revenue and operating expenses include the following amounts related to stock-based compensation: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 (in thousands) (in thousands) Cost of revenue - subscription $ 59 $ 104 $ 264 $ 271 Cost of revenue - professional services 260 201 727 527 Sales and marketing 754 644 2,302 1,644 Research and development 486 337 1,266 1,010 General and administrative 1,212 644 3,165 1,490 Total stock-based compensation $ 2,771 $ 1,930 $ 7,724 $ 4,942 (3) Total cost of revenue and operating expenses include the following amounts related to amortization of intangible assets: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 (in thousands) (in thousands) Cost of revenue - subscription $ 75 $ 75 $ 225 $ 225 Sales and marketing 118 95 382 239 General and administrative 76 102 288 368 Total amortization of intangible assets $ 269 $ 272 $ 895 $ 832 (4) The following table sets forth the reconciliation of net loss to Adjusted EBITDA for each of the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 (in thousands) (in thousands) Net loss $ (721 ) $ (22,322 ) $ (8,006 ) $ (29,290 ) Stock-based compensation 2,771 1,930 7,724 4,942 Amortization of intangible assets 269 272 895 832 Adjusted net (loss) / income 2,319 (20,120 ) 613 (23,516 ) Income tax expense - 14,742 - 10,540 Depreciation and amortization of property and equipment 5,347 4,360 15,220 11,401 Other expense, net - 94 352 683 Adjusted EBITDA $ 7,666 $ (924 ) $ 16,185 $ (892 ) 18--------------------------------------------------------------------------------The following tables set forth selected consolidated statements of operations data for each of the periods indicated as a percentage of total revenue: Three Months Ended September Nine Months Ended September 30, 30, 2012 2011 2012 2011 Revenue: Subscription 79% 82% 80% 83% Professional services 21% 18% 20% 17% Total revenue (1) 100% 100% 100% 100% Cost of revenue: Subscription 18% 19% 19% 19% Professional services 15% 14% 16% 14% Total cost of revenues (1) 33% 33% 35% 34% Gross profit 67% 67% 65% 66% Operating expenses: Sales and marketing 36% 47% 38% 46% Research and development 19% 21% 18% 20% General and administrative 14% 13% 13% 12% Total operating expenses (1) 68% 80% 69% 79% Operating loss (1) (1)% (14)% (4)% (12)% Other expense, net -% -% -% -% Loss before taxes (1) (1)% (14)% (4)% (13)% Income tax expense -% 27% -% 7% Net loss (1) (1)% (40)% (4)% (20)% Other comprehensive loss: Foreign currency translation adjustment -% (2)% -% (1)% Comprehensive loss (1) -% (43)% (4)% (20)% (1) Due to rounding, totals may not equal the sum of the line items in the table. 19 --------------------------------------------------------------------------------Three Months Ended September 30, 2012 and 2011 Revenue Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Subscription revenue $ 59,188 $ 45,187 31% Professional services revenue 15,467 9,936 56% Total revenue $ 74,655 $ 55,123 35% The $14.0 million of growth in subscription revenue was attributable to an increase in revenue from new direct clients and the full period impact of recognition of revenue from new clients added during the prior period. A larger base of renewal clients was partly driven by growth in our international operations, which benefited from increased sales and marketing investments in the United Kingdom, Australia and Brazil. Subscription revenue recognized from international clients increased by $4.9 million, or 78%, to $11.2 million in 2012 from $6.3 million in 2011. Revenue from utilization above the contracted level decreased to $1.3 million in 2012 from $2.7 million in 2011 due to more renewal clients renewing at higher contracted utilization volumes. The $5.5 million of growth in professional services revenue was attributable to an increased number of enterprise and medium-sized clients with complex interactive marketing programs utilizing our professional services, and the acceleration of new direct client additions utilizing implementation, integration and other services. Growth in our international operations increased professional services revenue by $1.4 million or 89%. Cost of Revenue Three Months Ended September 30, % of % of 2012 Cost of 2011 Cost of % Amount Revenue Amount Revenue Change (in thousands, except percentages) Cost of subscription revenue $ 13,492 55% $ 10,487 57% 29% Cost of professional services revenue 11,235 45% 7,824 43% 44% Total cost of revenue $ 24,727 100% $ 18,311 100% 35% The $3.0 million increase in cost of subscription revenue was due in part to a $0.8 million increase in employee-related costs to support our international growth and expansion of our customer support and software operations team to support our larger base of clients. Cost of subscription revenue also increased due to a $0.6 million increase in depreciation and amortization costs related to equipment and software in our data centers and a $1.4 million increase in operating costs related to enhancing and expanding our infrastructure. The $3.4 million increase in cost of professional services revenue was primarily due to a $1.9 million increase in employee-related costs to support higher professional services revenue. Cost of professional services revenue also increased due to a $0.5 million increase in payments to third-party professional services consultants and a $0.6 million increase related to travel and meeting expenses due to the increase in professional services personnel to support our larger base of clients and international expansion. 20-------------------------------------------------------------------------------- Gross Profit Three Months Ended September 30, % of % of 2012 Associated 2011 Associated % Amount Revenue Amount Revenue Change (in thousands, except percentages) Subscription revenue gross profit $ 45,696 77% $ 34,700 77% 32% Professional services revenue gross profit 4,232 27% 2,112 21% 100% Total gross profit $ 49,928 67% $ 36,812 67% 36% Our subscription revenue gross profit increased $11.0 million and remained consistent as a percentage of associated revenue. The increase in the dollar amount of gross profit is attributable to the growth in the number of clients and our ability to grow revenues while controlling costs as a percentage of revenues. The $2.1 million increase in professional services revenue gross profit was due in part to the growth in the number of clients using our professional services in the U.S. and other countries as well as the prior year adoption of a new accounting standard for revenue recognition of multiple deliverable arrangements on a prospective basis as disclosed previously in our Prospectus. This prospective accounting change, along with increased revenue in the U.S. and other countries and leveraging the prior year investment in our professional services headcount, resulted in a 100% increase in professional services gross profit. Sales and Marketing Expenses Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Sales and marketing $ 26,647 $ 25,637 4% Percentage of total revenue 36 % 47 % The $1.0 million increase in sales and marketing expenses was primarily due to a $1.1 million increase in employee-related costs and marketing program expenses of $0.8 million. Sales and marketing increased as we continued to invest in expanding our domestic and international presence. These increases are offset by approximately $1.5 million of expenses incurred in September 2011 related to the Connections 2011 user conference. The Connections 2012 user conference occurred in October 2012. As a percentage of total revenue, sales and marketing expenses decreased 11 percentage points due to revenue growing at a faster rate than expenses during the period. Research and Development Expenses Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages)Research and development $ 13,813 $ 11,760 17% Percentage of total revenue 19 % 21 % The $2.1 million increase in research and development expenses was primarily due to a $1.6 million increase in employee-related costs and an increase of $0.5 million in software support costs. Our research and development spending increased as we accelerated the development of our suite of cross-channel, interactive marketing SaaS solutions. As a percentage of total revenue, research and development expenses decreased 2 percentage points due to revenue growing at a faster rate than expenses during the period. 21 --------------------------------------------------------------------------------General and Administrative Expenses Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) General and administrative $ 10,189 $ 6,901 48% Percentage of total revenue 14 % 13 % The $3.3 million increase in general and administrative expenses was primarily due to a $1.4 million increase in employee-related costs, including incentive compensation, in finance and accounting, legal, human resources, talent acquisition and internal information technology support to support our growth. Expenses incurred for third party accounting, information technology, insurance and consulting related fees also increased $0.6 million as the scope of such work grew in connection with our growth and the costs of becoming a publicly traded company. We also incurred $0.8 million in costs associated with the secondary offering completed in September 2012 and the two acquisitions previously mentioned above. As a percentage of total revenue, general and administrative expenses increased 1 percentage point due to increased expenses primarily as a result of becoming a publicly traded company. Other Expense, Net Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Other expense, net $ - $ (94 ) (100)% Other expense consists primarily of interest income and expense and foreign exchange gains and losses. The decrease of $0.1 million is due to less interest expense incurred as a result of terminating our term loan and revolving line of credit in April 2012. Income Tax Expense Three Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Income tax expense $ - $ 14,742 (100)% Income tax expense of no amount in 2012 compared to $14.7 million in 2011 is due to our determination in September of 2011 that it was no longer more likely than not that our deferred tax assets would be realized due to continued planned business investment. In making such determination, we considered all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial results. Accordingly, we established a full valuation allowance against the net deferred tax assets in the third quarter of 2011. 22 --------------------------------------------------------------------------------Nine Months Ended September 30, 2012 and 2011 Revenue Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Subscription revenue $ 165,438 $ 122,988 35% Professional services revenue 42,592 24,997 70% Total revenue $ 208,030 $ 147,985 41% The $42.5 million of growth in subscription revenue was attributable to an increase in revenue from new direct clients and the full period impact of recognition of revenue from new clients added during the prior period. A larger base of renewal clients was partly driven by growth in our international operations, which benefited from increased sales and marketing investments in the United Kingdom, Australia and Brazil. Subscription revenue recognized from international clients increased by $14.7 million, or 99%, to $29.5 million in 2012 from $14.8 million in 2011. Revenue from utilization above the contracted level decreased to $3.4 million in 2012 from $8.1 million in 2011 due to more renewal clients renewing at higher contracted utilization volumes. The $17.6 million of growth in professional services revenue was attributable to an increased number of enterprise and medium-sized clients with complex interactive marketing programs utilizing our professional services, and the acceleration of new direct client additions utilizing implementation, integration and other services. Growth in our international operations increased professional services revenue by $4.5 million or 130%. Cost of Revenue Nine Months Ended September 30, % of % of 2012 Cost of 2011 Cost of % Amount Revenue Amount Revenue Change (in thousands, except percentages) Cost of subscription revenue $ 38,922 54% $ 28,489 57% 37% Cost of professional services revenue 33,454 46% 21,106 43% 59% Total cost of revenue $ 72,376 100% $ 49,595 100% 46% The $10.4 million increase in cost of subscription revenue was due in part to a $2.9 million increase in employee-related costs, primarily in our customer support and software operations team to support our larger base of clients and our international expansion. Cost of subscription revenue also increased due to a $2.5 million increase in depreciation and amortization costs related to equipment and software in our data centers, a $3.9 million increase in operating costs related to enhancing and expanding our infrastructure and a $1.0 million increase in purchases of third-party partner applications and products for resale to our clients. The $12.3 million increase in cost of professional services revenue was primarily due to a $6.6 million increase in employee-related costs to support higher professional services revenue. Cost of professional services revenue also increased due to a $2.9 million increase in payments to third-party professional services consultants and a $1.6 million increase related to travel and meeting expenses due to the increase in professional services personnel to support our larger base of clients and international expansion. 23-------------------------------------------------------------------------------- Gross Profit Nine Months Ended September 30, % of % of 2012 Associated 2011 Associated % Amount Revenue Amount Revenue Change (in thousands, except percentages) Subscription revenue gross profit $ 126,516 76% $ 94,499 77% 34% Professional services revenue gross profit 9,138 21% 3,891 16% 135% Total gross profit $ 135,654 65% $ 98,390 66% 38% Our subscription revenue gross profit increased $32.0 million in absolute dollars and decreased 1 percentage point as a percentage of associated revenue. The increase in the dollar amount of gross profit is attributable to the growth in the number of clients and our ability to grow revenues while controlling costs as a percentage of revenue. The $5.2 million increase in professional services revenue gross profit was due in part to the growth in the number of clients using our professional services in the U.S. and other countries as well as the prior year adoption of a new accounting standard for revenue recognition of multiple deliverable arrangements on a prospective basis as disclosed previously in our Prospectus. This prospective accounting change, along with increased revenue in the U.S. and other countries and leveraging the prior year investment in our professional services headcount, resulted in a 135% increase in professional services gross profit. Sales and Marketing Expenses Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Sales and marketing $ 79,227 $ 68,224 16% Percentage of total revenue 38 % 46 % The $11.0 million increase in sales and marketing expenses was primarily due to a $7.8 million increase in employee-related costs and marketing program expense of $1.1 million. Our sales and marketing increased as we continued to invest in expanding our domestic and international presence. It also reflects an increase in travel and meeting expenses of $1.6 million. These increases are partially offset by approximately $1.5 million of expenses incurred in September 2011 related to the Connections 2011 user conference. The Connections 2012 user conference occurred in October 2012. As a percentage of total revenue, sales and marketing expenses decreased 8 percentage points due to revenue growing at a faster rate than expenses during the period. Research and Development Expenses Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Research and development $ 36,646 $ 30,151 22% Percentage of total revenue 18 % 20 % The $6.5 million increase in research and development expenses was primarily due to a $3.4 million increase in employee-related costs, a $1.5 million increase in third-party development contractor resources and an increase of $1.3 million in software support costs. Our research and development spending increased as we accelerated the development of our suite of cross-channel, interactive marketing SaaS solutions. As a percentage of total revenue, research and development expenses decreased 2 percentage points due to revenue growing at a faster rate than expenses during the period. 24 --------------------------------------------------------------------------------General and Administrative Expenses Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) General and administrative $ 27,435 $ 18,082 52% Percentage of total revenue 13 % 12 % The $9.4 million increase in general and administrative expenses was primarily due to a $4.9 million increase in employee-related costs, including incentive compensation, in finance and accounting, legal, human resources, talent acquisition and internal information technology support to support our growth. Expenses incurred for third-party accounting, information technology, insurance and consulting related fees also increased $2.7 million as the scope of such work grew in connection with our growth and costs of becoming a publicly traded company. We also incurred $0.8 million in costs associated with the secondary offering completed in September 2012 and the two acquisitions previously mentioned above. As a percentage of total revenue, general and administrative expenses increased 1 percentage point due to increased expenses primarily as a result of becoming a publicly traded company increasing at a faster rate than revenue. Other Expense, Net Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Other expense, net $ (352 ) $ (683 ) (48)% Other expense consists primarily of interest income and expense and foreign exchange gains and losses. The decrease of $0.3 million is due to less interest expense incurred as a result of terminating our term loan and revolving line of credit in April 2012. Income Tax Expense Nine Months Ended September 30, % 2012 2011 Change (in thousands, except percentages) Income tax expense $ - $ 10,540 (100)% Income tax expense of no amount in 2012 compared to $10.5 million in 2011 is due to our determination in September of 2011 that it was no longer more likely than not that our deferred tax assets would be realized due to continued planned business investment. In making such determination, we considered all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial results. Accordingly, we established a full valuation allowance against the net deferred tax assets in the third quarter of 2011. 25 -------------------------------------------------------------------------------- Liquidity and Capital Resources Since our inception, we have financed our operations primarily through the proceeds from the issuance of our common and preferred stock, borrowings under credit facilities and cash flows from operations. In March and April 2012, we repaid all outstanding amounts under, and terminated, the Loan and Security Agreement. As of September 30, 2012, our principal sources of liquidity were cash and cash equivalents totaling $212.0 million and accounts receivable of $51.6 million. Nine Months Ended September 30, 2012 2011 (in thousands) Net cash provided by operating activities $ 14,750 $ 1,840 Net cash used in investing activities (20,350 ) (30,743 ) Net cash provided by financing activities 156,800 35,650 Effect of exchange rate changes on cash and cash equivalents 114 (1 ) Net increase in cash and cash equivalents $ 151,314 $ 6,746 Operating Activities For the nine-month period ended September 30, 2012, net cash provided by operating activities was $14.8 million despite the net loss from operations of $8.0 million. This is primarily due to the add back of non-cash charges for depreciation, and stock-based compensation expense which were partially offset by changes in working capital. The comparable 2011 period's net cash provided by operating activities of $1.8 million resulted primarily from changes in working capital accounts. Investing Activities Net cash used in investing activities was $20.4 million and $30.7 million during the nine-month periods ended September 30, 2012 and 2011, respectively. Net cash used in investing activities consisted primarily of cash paid for purchases of fixed assets to expand our data center infrastructure, computer equipment and office furniture for our employees and leasehold improvements related to additional office space. Net cash used in investing activities also included a payment of $0.8 million in 2012, related to our acquisition of Frontier Technologia, Ltda. in 2011. Financing Activities Net cash provided by financing activities was $156.8 million and $35.7 million during the nine month periods ended September 30, 2012 and 2011, respectively. Activity during the nine-month period ended September 30, 2012 included proceeds from the issuance of $169.7 million of common stock, net of issuance costs, offset by $16.7 million of payments on our term loan and revolving line of credit. During the nine month period ended September 30, 2011, we raised $30.0 million of proceeds through the issuance of preferred stock. The activity during both these periods included repayments of borrowings pursuant to our capital leases. Capital Resources Based on our current cash and accounts receivable balances, we believe that we will have sufficient liquidity to fund our business, meet our contractual obligations for the next twelve months and pay $100.2 million in cash consideration for the acquisitions of Pardot and iGoDigital in October 2012. However, we may need to raise additional funds in the future in the event that we pursue acquisitions or investments in complementary businesses or technologies. If we raise additional funds through the issuance of equity or convertible securities, our stockholders may experience ownership dilution. During the last three years, inflation and changing prices have not had a material effect on our business, and we do not expect that inflation or changing prices will materially affect our business in the next twelve months. 26-------------------------------------------------------------------------------- |