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TMCNet:  NETSUITE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

[February 28, 2013]

NETSUITE INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) 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 software suites. In addition to financials/ERP software suites, we offer a broad suite of applications, including accounting, CRM, PSA and Ecommerce, which enable companies to manage most of their core business operations in our single integrated suite. Our "real-time dashboard" technology provides an easy-to-use view into up-to-date, role-specific business information. 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. ("QA"), 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.

During 2012, we acquired the following two companies to further develop our Ecommerce vertical. In connection with these acquisitions, we incurred transaction costs totaling $1.2 million.

In November 2012, we purchased certain assets from Retail Anywhere ("RA"), an on-line retail solution service provider. We purchased RA to expand our retail software solutions in our Ecommerce vertical. RA software allows us to expand our Ecommerce services to brick and mortar store point of sale terminals. The RA assets and operating results are reflected in our consolidated financial statements from the date of acquisition. On the closing date, we paid $5.0 million in cash. Additional consideration of $1.3 million in cash is being withheld for up to the next 15 months following the close of the transaction as protection against certain losses that we may incur in the event of certain breaches of representations and warranties covered in the purchase agreement.

21-------------------------------------------------------------------------------- Table of Contents During the second quarter of 2012, we completed the purchase of all of the outstanding equity of two small South American companies ("SAC") that specialize in Ecommerce technology and services. We also purchased certain assets from two entities related to the SAC. The SAC workforce will augment our existing professional services and product development teams. On the closing dates, we paid $4.0 million in cash. Additional consideration of $2.2 million in cash is being withheld for various periods up to the next 10 years following the close of the transaction as protection against certain losses we may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. During the second quarter of 2012, we recorded $736,000 in operating expenses related to transaction costs associated with this business combination.

Key Components of Our Results of Operations Revenue Our revenue has grown from $17.7 million during the year ended December 31, 2004 to $308.8 million during the year ended December 31, 2012.

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, 2012, 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: • 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; • Strengthening our offerings for targeted industries such as wholesale/distribution, manufacturing, e-tail, retail,technology and professional services by adding deeper verticalized functionality; and • 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, 2012, we had deferred revenue of $161.4 million.

Backlog was approximately $110.4 million and $95.3 million as of December 31, 2012 and 2011, respectively. Of the $110.4 million in backlog as of December 31, 2012, $73.4 million was short-term backlog and $37.0 million was long-term backlog. The $95.3 million in backlog as of December 31, 2011 included $67.6 million in short-term backlog and $27.7 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 22-------------------------------------------------------------------------------- Table of Contents upon the number of subscription agreements in particular stages in their renewal cycle. Such fluctuations are not reliable indicators of future revenues.

During the second quarter of 2012, we updated the terms of our standard renewal agreement form so that the legal obligation to pay by our customers occurs upon execution of the renewal agreement rather than on their renewal date. Based on our existing policy of recording amounts that have been invoiced in accounts receivable and deferred revenue where the customer has a legal obligation to pay, invoices from these renewal agreements are now recorded in accounts receivable and deferred revenue upon execution of the renewal agreement rather than at the start of the renewal period. Had we not revised the terms of these renewal agreements, we would have recorded approximately $10.0 million less in accounts receivable and deferred revenue as of December 31, 2012.

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: Year ended December 31, 2012 2011 2010 (dollars in thousands) United States $ 227,975 $ 172,527 $ 143,607 International 80,850 63,799 49,542 Total revenue $ 308,825 $ 236,326 $ 193,149 Percentage of revenue generated outside of the United States 26 % 27 % 26 % Employees As of December 31, 2012, our headcount was 1,778 employees including 518 employees in sales and marketing, 687 employees in operations, professional services, training and customer support, 393 employees in product development, and 180 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, amortization expense associated with capitalized internal use software and acquired developed technology, and related plant and equipment depreciation and amortization expenses.

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 rent, 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 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. 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 year ended December 31, 2012, we reduced our product development expense for eligible operational expenses we expect the Czech government to reimburse. On a quarterly basis, we will accrue our expected subsidies for the duration of the program.

23-------------------------------------------------------------------------------- Table of Contents In 2013, 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. 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 terms of absolute dollars in 2013.

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 2013, we expect our general and administrative expenses to increase in terms of 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: • Revenue recognition; • Internal use software and website development costs; • Deferred commissions; • Accounting for stock-based compensation; and • 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 24-------------------------------------------------------------------------------- Table of Contents 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.

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: • 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 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. 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.

In October 2009, the FASB amended the accounting standards for multiple-element revenue arrangements ("ASU 2009-13") to: • provide updated guidance on whether multiple deliverables exist, how the elements in an arrangement should be separated, and how the consideration should be allocated; • require an entity to allocate revenue in an arrangement using estimated selling prices ("ESP") of each element if a vendor does not have vendor-specific objective evidence of selling price ("VSOE") or third-party evidence of selling price ("TPE"); and • eliminate the use of the residual method and require a vendor to allocate revenue using the relative selling price method.

We early adopted this accounting guidance on April 1, 2010, for applicable arrangements entered into or materially modified after January 1, 2010 (the beginning of our fiscal year).

Prior to our adoption of ASU 2009-13, we were not able to establish VSOE or TPE for all of the undelivered elements. As a result, we typically recognized subscription and support, and professional services revenue ratably over the contract period, and allocated subscription and support revenue and professional services revenue based on the contract price.

As a result of the adoption of ASU 2009-13, 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 VSOE, if available, TPE, if VSOE is not available, or ESP, if neither VSOE nor TPE is available. We have been unable to establish VSOE or TPE for the elements of our sales arrangements. Therefore, we establish the ESP for each element primarily by considering the weighted average of actual sales prices of professional services when 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 ratably over the contract period. We have established processes to determine ESP, allocate revenue in multiple arrangements using ESP, and make reasonably dependable estimates of the percentage-of-completion method for professional services.

The consideration allocated to professional services and other is recognized as revenue on a percentage-of-completion method. The total arrangement fee for a multiple element arrangement is allocated based on the relative ESP of each element unless the fee allocated to the subscription and support under this method is less than the fee subject to refund if the performance conditions are not met. In most multiple element arrangements, the relative ESP of the subscription and support is less than the contractual amounts subject to the performance conditions. In these instances, pursuant to ASU 2009-13, since the professional services are generally completed prior to completion of the subscription and support, the allocation of the fee for subscription and support is at least equal to the contractual amounts subject to the performance conditions.

Prior to adoption of ASU 2009-13, in multiple element arrangements where we determined that a subset of professional services was essential to the customers use of the subscription services ("Essential Professional Services Arrangements"), we deferred the commencement of revenue recognition for the entire arrangement until we have delivered the essential professional services component or made a determination that the remaining professional services were no longer essential to the customer. With the adoption of ASU 2009-13, we recognize revenue for subscription and support services in 25-------------------------------------------------------------------------------- Table of Contents such arrangement over the contract period commencing when the subscription service is made available to the customer and for professional services on a percentage-of-completion method.

For single element sales agreements, subscription and support revenue is recognized ratably over the contract term beginning on the provisioning date of the contract. Prior to April 1, 2010, professional services revenue generated under single element sales agreements, was immaterial and therefore was recognized when fully delivered. As of April 1, 2010, the date of adoption of ASU 2009-13, we recognized professional services revenue based on a percentage-of-completion method for both single and multiple element arrangements since we now separate the professional services revenue from subscription and support revenue. Cost related to professional services is recognized as incurred.

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 and incremental, 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. 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, 2012, 2011 or 2010. We capitalized $4.1 million, $1.3 million and $96,000 in internal use software during the years ended December 31, 2012, 2011 and 2010, 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 $50.5 million, $44.4 million and $27.6 million during the years ended December 31, 2012, 2011 and 2010, respectively.

Accounting for Stock-Based Compensation We recognize the fair value of stock-based compensation in 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. Additionally, our 2011 performance share unit grants vest 1/12 per quarter with the initial vesting event on February 15, 2012. In 2012, performance metrics for certain performance shares awarded for 2013 and 2014 had not been set by our Board of Directors. As such, there is no accounting for these awards until the performances metrics are set.

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 $48.4 million, $38.3 million and $31.3 million of stock-based compensation during the years ended December 31, 2012, 2011 and 2010, respectively.

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. We estimate fair value based on our market capitalization and the market 26-------------------------------------------------------------------------------- Table of Contents multiples of revenue and gross profit for publicly traded peer companies. 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.

In 2009, we 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 year period to cost of revenue. QA computing solutions for professional services businesses has advanced our cloud computing application suite for services-based companies.

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 resulting in the carrying value of the QA developed technology assets exceeding the revised undiscounted expected future cash flows for the service.

As a result, we recorded a $401,000 impairment charge based on the excess of the carrying amount of the QA developed technology over the fair value of such asset as of June 30, 2012. We amortized the remaining $481,000 net carrying value of the asset over the second half of 2012 which was the period the intangible asset generated revenue.

There were no impairment of goodwill during the years ended December 31, 2012, 2011 or 2010.

Results of Operations Revenue and Cost of Revenue Our revenue, cost of revenue, gross profit and gross margin was as follows for the periods presented: Year ended December 31, 2012 2011 2010 (dollars in thousands) Revenue: Subscription and support $ 252,903 $ 199,579 $ 163,964 Professional services and other 55,922 36,747 29,185 Total revenue 308,825 236,326 193,149 Cost of revenue (1): Subscription and support 41,857 33,083 26,908 Professional services and other 53,706 37,777 34,741 Total cost of revenue 95,563 70,860 61,649 Gross profit $ 213,262 $ 165,466 $ 131,500 Gross margin 69% 70% 68% (1) Includes stock-based compensation expense and amortization of intangible assets of: Cost of revenue: Subscription and support $ 4,691 $ 3,568 $ 3,598 Professional services and other 5,978 4,138 3,802 $ 10,669 $ 7,706 $ 7,400 2012 compared to 2011 Revenue for the year ended December 31, 2012 increased $72.5 million, or 31%, compared to the same period in 2011.

Subscription and support revenue: Subscription and support revenue for the year ended December 31, 2012 increased $53.3 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $47.6 million increase in revenue resulting from the acquisition of new customers including the continued adoption of OneWorld, and a $5.7 million 27-------------------------------------------------------------------------------- Table of Contents 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, 2012 increased $19.2 million, or 52%, compared to the same period in 2011. The increase was primarily the result of a $36.6 million increase in revenue resulting from the acquisition of new customers. The increase in professional services and other revenue was partially offset by a $17.4 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2011 that did not recur for those customers in 2012. Additionally, demand for our professional services, particularly from our enterprise customers, has increased during 2012. Our consulting rates for professional services also increased in 2012.

Revenue generated outside of the United States was $80.9 million, or 26%, of our revenue during the year ended December 31, 2012, as compared to $63.8 million, or 27%, during the same period in 2011. 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, 2012 increased $24.7 million, or 35%, compared to the same period in 2011.

Subscription and support cost of revenue: Subscription and support cost of revenue for the year ended December 31, 2012 increased $8.8 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $4.3 million increase in personnel costs which resulted from an increase in headcount and wages, a $1.7 million increase in data center expenses resulting from enhancements to our product delivery infrastructure, a $1.2 million increase in depreciation expense associated with new equipment and a $1.6 million increase in overhead and other operational expenses due to an increase in amortization expense associated with intangible assets. The increase in personnel costs includes a $630,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

Professional services and other cost of revenue: Professional services and other cost of revenue for the year ended December 31, 2012 increased $15.9 million, or 42%, compared to the same period in 2011. The increase was primarily the result of a $10.3 million increase in personnel costs which resulted from an increase in headcount, salary increases and other personnel costs, a $2.6 million increase in external consultants costs which resulted from an increase in customer demand for our professional services and $2.7 million increase in allocated overhead and other operational expenses due to an increase in allocations associated with an increase in headcount. The increase in personnel costs includes a $1.8 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

Our gross margin was 69% during the year ended December 31, 2012 and 70% for the same period in 2011. 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 2012 compared to 2011.

2011 compared to 2010 Revenue for the year ended December 31, 2011 increased $43.2 million, or 22%, compared to the same period in 2010.

Subscription and support revenue: Subscription and support revenue for the year ended December 31, 2011 increased $35.6 million, or 22%, compared to the same period in 2010. The increase was primarily the result of a $32.4 million increase in revenue resulting from the acquisition of new customers including the continued adoption of OneWorld, and a $3.2 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, 2011 increased $7.6 million, or 26%, compared to the same period in 2010. The increase was primarily the result of a $25.2 million increase in revenue resulting from the acquisition of new customers. The increase in professional services and other revenue was partially offset by a $17.6 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2010 that did not recur for those customers in 2011. Additionally, our customer demand and consulting rates for professional services also increased in 2011.

Revenue generated outside of the United States was $63.8 million, or 27%, of our revenue during the year ended December 31, 2011, as compared to $49.5 million, or 26%, during the same period in 2010. 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, 2011 increased $9.2 million, or 15%, compared to the same period in 2010.

Subscription and support cost of revenue: Subscription and support cost of revenue for the year ended December 31, 2011 increased $6.2 million, or 23%, compared to the same period in 2010. The increase was primarily the result of a $3.0 million increase in personnel costs which resulted from an increase in headcount and wages, a $1.8 million increase in data center expenses resulting from enhancements to our product delivery infrastructure, a $1.2 million increase in depreciation expense associated with new equipment and a $664,000 increase in overhead expenses partially offset by a $567,000 decrease in amortization of intangibles. The increase in personnel costs includes a $510,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

28-------------------------------------------------------------------------------- Table of Contents Professional services and other cost of revenue: Professional services and other cost of revenue for the year ended December 31, 2011 increased $3.0 million, or 9%, compared to the same period in 2010. The increase was primarily the result of a $1.9 million increase in personnel costs which resulted from an increase in wages and other personnel costs and a $1.4 million increase in external consultants' costs which resulted from an increase in customer demand for our professional services. These cost increases were partially offset by a $300,000 net decrease in other expenses. The increase in personnel costs includes a $336,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. For the years ended December 31, 2011 and 2010, our professional services and other costs of revenue was greater than the professional services and other revenue. We view professional services as an investment in customer success to ensure that we continue to secure recurring subscription and support revenue.

Our gross margin was 70% during the year ended December 31, 2011 and 68% for the same period in 2010. The increase in our gross margin resulted primarily from an increase in demand for our professional services which were more profitable in 2011 compared to 2010 as a result of higher consulting rates.

Operating Expenses Operating expenses were as follows for the periods presented: Year ended December 31, 2012 2011 2010 Amount % of revenue Amount % of revenue Amount % of revenue (dollars in thousands) Operating expenses (1): Product development $ 52,739 17 % $ 43,531 18 % $ 35,019 18 % Sales and marketing 154,294 50 % 120,172 51 % 92,814 48 % General and administrative 38,469 12 % 31,951 14 % 29,232 15 % Total operating expenses $ 245,502 79 % $ 195,654 83 % $ 157,065 81 % (1) Includes stock-based compensation expense, amortization of acquisition-related intangible assets, transaction costs for business combinations and costs associated with the settlement of a patent dispute as follows: Year ended December 31, 2012 2011 2010 (dollars in thousands)Product development $ 15,301 $ 12,015 $ 9,723 Sales and marketing 16,588 13,437 10,249 General and administrative 11,803 9,662 8,565 Total $ 43,692 $ 35,114 $ 28,537 2012 compared to 2011 Product development expenses: Product development expenses for the year ended December 31, 2012 increased $9.2 million, or 21%, as compared to the same period in 2011. The increase was primarily the result of a $10.0 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 a $3.2 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards to employees. Additionally, allocated overhead expense and other costs increased by $1.9 million due to higher overhead costs which are primarily facility costs and other operational costs associated with product development headcount. These cost increases were partially offset by expense reductions related to a $2.0 million employment development subsidy from the Czech Republic government for the period from November 2010 to December 31, 2012 and a $1.3 million increase in capitalized product development costs associated with new product functionality.

Sales and marketing expenses: Sales and marketing expenses for the year ended December 31, 2012 increased $34.1 million, or 28%, as compared to the same period in 2011. The increase was primarily the result of a $24.4 million increase in personnel costs, a $7.0 million increase in marketing and other costs and a $2.7 million increase in allocated overhead expense. The increase in personnel costs related primarily to an increase in headcount, commission expenses related to an increase in sales and a $2.8 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and 29-------------------------------------------------------------------------------- Table of Contents new employees. Marketing and other expenses increased primarily due to higher on-line marketing costs, an increase in costs associated with our annual user conference, higher trade show fees and other promotional events.

General and administrative expenses: General and administrative expenses for the year ended December 31, 2012 increased $6.5 million, or 20%, when compared to the same period in 2011. The increase was primarily the result of a $3.6 million increase in personnel costs and a $2.9 million increase in other operational costs. The increase in personnel costs resulted from an increase in headcount, an increase in merit pay and an increase in other payroll costs such as recruiting. Other operational costs increased primarily due to an increase in costs related to general administrative services and $797,000 in additional sales taxes, partially offset by a decrease in patent costs due to a $720,000 patent settlement expense recorded in 2011, but not incurred in 2012.

Additionally, we incurred $1.2 million in transaction costs in connection with our acquisition of SAC and RA during the year ended December 31, 2012. We also experienced a $6.7 million increase in overhead expenses that are allocated to other departments due to an increase in costs such as facility costs, information technology costs and recruiting costs.

2011 compared to 2010 Product development expenses: Product development expenses for the year ended December 31, 2011 increased $8.5 million, or 24%, as compared to the same period in 2010. The increase was primarily the result of a $9.0 million increase in personnel costs and a $1.1 million increase in overhead allocations and other costs, partially offset by a $1.5 million decrease in outside professional services and an increase in the capitalization of internal software development costs during the year. The increase in personnel costs includes a $2.3 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. Personnel costs also increased during 2011 due to an increase in headcount and wages.

Sales and marketing expenses: Sales and marketing expenses for the year ended December 31, 2011 increased $27.4 million, or 29%, as compared to the same period in 2010. The increase was primarily the result of a $24.5 million increase in personnel costs, a $2.2 million increase in overhead costs allocations and a $704,000 increase in marketing and other costs. The increase in personnel costs related primarily to an increase in headcount, commission expenses related to an increase in sales and a $3.5 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

General and administrative expenses: General and administrative expenses for the year ended December 31, 2011 increased $2.7 million, or 9% ,when compared to the same period in 2010. The increase resulted primarily from a $2.4 million increase in personnel costs resulting from an increase in wages and other payroll related costs and $720,000 in costs associated with the settlement of a patent dispute. (See Note 7. in Notes to our Consolidated Financial Statements) The increase in personnel costs includes a $400,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

Non-operating items, including interest income and expense, other income / (expense), income taxes and the effect of net loss attributable to noncontrolling interest were as follows for the periods presented: Year ended December 31, 2012 2011 2010 Amount % of revenue Amount % of revenue Amount % of revenue (dollars in thousands) Interest income 158 - % 167 - % 209 - % Interest expense (192 ) - % (181 ) - % (129 ) - % Other expense, net (412 ) - % (34 ) - % (615 ) - % Provision for income taxes 2,543 1 % 1,771 1 % 1,380 1 % Noncontrolling interest - - % - - % 14 - % 2012 compared to 2011 Other expense, net for the year ended December 31, 2012 increased $378,000 as compared to the same period in 2011. The increase in other expense, net is primarily related to foreign currency losses during 2012.

Our provision for income taxes increased $772,000 during the year ended December 31, 2012 as compared to the same period in 2011 primarily due to foreign taxes.

2011 compared to 2010 30-------------------------------------------------------------------------------- Table of Contents Net other expense for the year ended December 31, 2011 decreased $581,000 as compared to the same period in 2010. The decrease in net other expense is primarily related to a write-off of a loan for a principal amount of $250,000 to a partner in 2010 and foreign currency gains during 2011.

Our provision for income taxes increased $391,000 during the year ended December 31, 2011 as compared to the same period in 2010 primarily due to foreign income tax.

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, 2012. 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.

Three months ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2012 2012 2012 2012 2011 2011 2011 2011 (dollars and shares in thousands, except per share amounts) (unaudited) Revenue: Subscription and support $ 68,534 $ 65,329 $ 61,049 $ 57,990 $ 54,191 $ 51,334 $ 48,240 $ 45,814 Professional services and other 16,472 14,462 13,660 11,329 9,902 9,625 9,593 7,627 Total revenue 85,006 79,791 74,709 69,319 64,093 60,959 57,833 53,441 Cost of revenue: Subscription and support (1) 11,135 10,880 10,631 9,211 8,741 8,627 8,084 7,631 Professional services and other (1) 15,488 14,211 12,423 11,584 10,327 9,658 9,390 8,402 Total cost of revenue 26,623 25,091 23,054 20,795 19,068 18,285 17,474 16,033 Gross profit 58,383 54,700 51,655 48,524 45,025 42,674 40,359 37,408 Operating expenses: Product development (1) 14,429 13,943 13,277 11,090 11,916 11,257 10,911 9,447 Sales and marketing (1) 42,563 38,591 37,561 35,579 31,963 30,279 30,469 27,461 General and administrative (1) 10,134 9,458 9,897 8,979 8,112 7,622 8,340 7,877 Total operating expenses 67,126 61,992 60,735 55,648 51,991 49,158 49,720 44,785 Operating loss (8,743 ) (7,292 ) (9,080 ) (7,124 ) (6,966 ) (6,484 ) (9,361 ) (7,377 ) Other income / (expenses), net,including the effect of noncontrolling interest and income taxes (878 ) (692 ) (833 ) (586 ) (649 ) (445 ) (430 ) (295 ) Net loss attributable to NetSuite Inc.

common stockholders $ (9,621 ) $ (7,984 ) $ (9,913 ) $ (7,710 ) $ (7,615 ) $ (6,929 ) $ (9,791 ) $ (7,672 ) Net loss per NetSuite Inc.

common share $ (0.13 ) $ (0.11 ) $ (0.14 ) $ (0.11 ) $ (0.11 ) $ (0.10 ) $ (0.15 ) $ (0.12 ) Weighted average number of shares used in computing net loss per common share 71,977 71,161 70,370 69,324 68,285 67,477 66,489 65,384 31-------------------------------------------------------------------------------- Table of Contents (1) Includes stock-based compensation expense, amortization of acquisition-related intangible assets, transaction costs for business combinations and costs associated with the settlement of a patent dispute as follows: Three months ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2012 2012 2012 2012 2011 2011 2011 2011 (in thousands) Cost of revenue: Subscription and support $ 1,135 $ 1,169 $ 1,484 $ 904 $ 870 $ 807 $ 919 $ 972 Professional services and other 1,612 1,688 1,504 1,173 1,083 1,067 1,024 964 Operating expenses: Product development 3,999 4,035 4,060 3,207 3,316 3,422 3,097 2,180 Sales and marketing 4,283 4,142 4,204 3,958 3,528 3,402 3,422 3,085 General and administrative 3,148 2,686 3,415 2,554 2,253 2,089 2,956 2,363 Total $ 14,177 $ 13,720 $ 14,667 $ 11,796 $ 11,050 $ 10,787 $ 11,418 $ 9,564 Liquidity and Capital Resources As of December 31, 2012, our primary sources of liquidity were our cash and cash equivalents totaling $185.9 million and $64.9 million in accounts receivable, net of allowance.

In the year ended December 31, 2012, cash flows from operations generated $54.3 million of cash. Despite the possibility of such fluctuations in operating cash outflows, management believes its current cash and cash equivalents are sufficient for the next 12 months and into the foreseeable future thereafter to meet our operating cash flow needs.

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 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, 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. As we believe that our cash and cash equivalents are adequate to fund our operating and investing cash flow needs for at least the next 12 months, we have not found it necessary to reassess our capacity to generate cash from financing cash flows in the current economic climate. 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. In the meantime, we intend to continue to manage our cash in a manner designed to ensure that we have adequate cash and cash equivalents to fund our operations as well as future acquisitions, if any.

Restricted cash totaled $541,000 and $494,000 at December 31, 2012 and 2011, respectively. These restricted cash accounts secure letters of credit applied against certain of our facility lease agreements. Of the $541,000 restricted cash balance as of December 31, 2012, $266,000 is classified as current other assets and $275,000 is classified as long-term other assets. The $494,000 restricted cash balance as of December 31, 2011 was classified as long-term other assets.

As of December 31, 2012, we had an accumulated deficit of $378.8 million. We have funded this deficit primarily through the net proceeds raised from the sale of our capital stock.

32-------------------------------------------------------------------------------- Table of Contents Our cash flow activities were as follows for the periods presented: Year ended December 31, 2012 2011 2010 (in thousands)Net cash provided by operating activities $ 54,298 $ 36,273 $ 18,232 Net cash used in investing activities (24,105 ) (11,252 ) (6,463 ) Net cash provided by / (used in) financing activities 13,732 12,175 (3,888 ) Effect of exchange rate changes on cash and cash equivalents 486 (46 ) 62 Net change in cash and cash equivalents $ 44,411 $ 37,150 $ 7,943 2012 compared to 2011 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, 2012 as compared to the same period in 2011 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 and an increase in accounts receivable resulting from the increase in sales activity.

Cash used in investing activities during the year ended December 31, 2012 was related to 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 activities during the year ended December 31, 2012 increased primarily due to the acquisition of two small professional service companies and an on-demand retail services company for a total of $9.2 million. Our property and equipment capital expenditures and our capitalized internal use software costs also increased in 2012 compared to 2011. Included in the 2012 capitalized internal use software costs is a $1.3 million payment associated with the purchase of developed technology to enhance our data center production environment.

The net cash provided by financing activities during the year ended December 31, 2012 increased primarily due to an increase in proceeds from the issuance of common stock as a result of the exercise of stock options.

2011 compared to 2010 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, 2011 to the same period in 2010 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 an increase in sales activity.

Cash used in investing activities during the year ended December 31, 2011was related to 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 activities during the year ended December 31, 2011 increased primarily due to the acquisition of a small on-demand software company and developed product technology related to an on-line property, plant and equipment solution. We also increased our capital expenditures for property and equipment and capitalized costs for internal use software.

The net cash provided by financing activities during the year ended December 31, 2011 increased primarily due an increase in proceeds from the issuance of common stock as a result of the exercise of stock options. During the year ended December 31, 2010, financing activities included a payment for the purchase of the remaining ownership equity in NetSuite Kabushiki Kaisha ("NetSuite KK"), payments to acquire shares upon vesting of RSUs to settle employee withholding liability and payments on capital leases.

Contractual Obligations We generally do not enter into long-term minimum purchase commitments. Our principal commitments consist of 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, 2012, for the next five years and thereafter.

33-------------------------------------------------------------------------------- Table of Contents Less than 1 More than 5 Total year 1 to 3 years 3 to 5 years Years (dollars in thousands) Capital lease obligations $ 1,010 $ 761 $ 249 $ - $ - Debt obligations 2,016 1,613 403 - - Total accrued contractual obligations 3,026 2,374 652 - - Operating lease obligations 34,212 8,020 11,540 8,014 6,638 Purchase obligations 15,075 10,003 5,072 - - Total off-balance sheet contractual obligations 49,287 18,023 16,612 $ 8,014 $ 6,638 Total contractual obligations $ 52,313 $ 20,397 $ 17,264 $ 8,014 $ 6,638 Off-Balance Sheet Arrangements During the years ended December 31, 2012, 2011 and 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose 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".

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