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EX-32.1 - CERTIFICATION OF THE CEO AND THE CFO PURSUANT TO SECTION 906 - NETSUITE INCdex321.htm
EX-31.2 - CERTIFICATION OF THE CFO PURSUANT TO SECTION 302 - NETSUITE INCdex312.htm
EX-31.1 - CERTIFICATION OF THE CEO PURSUANT TO SECTION 302 - NETSUITE INCdex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number 001-33870

 

 

NetSuite Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-3310471

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

2955 Campus Drive, Suite 100

San Mateo, California

  94403-2511
(Address of principal executive offices)   (Zip Code)

(650) 627-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). (Check one):    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer, large accelerated filer and a smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On October 31, 2009, 62,367,869 shares of the registrant’s Common Stock, $0.01 par value, were issued and outstanding.

 

 

 


Table of Contents

NetSuite Inc.

Index

 

Part I – Financial Information   

Item 1.

   Financial Statements:   
  

Condensed Consolidated Balance Sheets as of December 31, 2008 and September 30, 2009 (unaudited)

   1
  

Condensed Consolidated Statements of Operations for the Three and Nine Month Periods Ended September 30, 2008 and 2009 (unaudited)

   2
  

Condensed Consolidated Statements of Cash Flows for the Nine Month Periods Ended September 30, 2008 and 2009 (unaudited)

   3
   Notes to Condensed Consolidated Financial Statements (unaudited)    4

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    12

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk    23

Item 4.

   Controls and Procedures    24
Part II – Other Information   

Item 1.

   Legal Proceedings    24

Item 1A.

   Risk Factors    25

Item 6.

   Exhibits    36

Signatures

   37

 

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PART I – Financial Information

ITEM 1. Financial Statements

NetSuite Inc.

Condensed Consolidated Balance Sheets

(dollars in thousands)

(unaudited)

 

     December 31,
2008
    September 30,
2009
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 123,638      $ 97,768   

Accounts receivable, net of allowances of $589 and $652 as of December 31, 2008 and September 30, 2009, respectively

     26,675        24,975   

Deferred commissions

     11,363        10,205   

Other current assets

     2,385        3,672   
                

Total current assets

     164,061        136,620   

Property and equipment, net

     15,413        15,302   

Deferred commissions, non-current

     1,688        1,044   

Goodwill

     17,824        26,739   

Other intangible assets, net

     8,712        18,638   

Other assets

     2,636        2,469   
                

Total assets

   $ 210,334      $ 200,812   
                

Liabilities and equity

    

Current liabilities:

    

Accounts payable

   $ 2,893      $ 2,149   

Deferred revenue

     66,667        63,461   

Accrued compensation

     10,863        9,963   

Accrued expenses

     5,758        4,799   

Other current liabilities

     4,363        4,825   
                

Total current liabilities

     90,544        85,197   

Long-term liabilities:

    

Deferred revenue, non-current

     7,204        6,006   

Other long-term liabilities

     3,199        2,382   
                

Total long-term liabilities

     10,403        8,388   
                

Total liabilities

     100,947        93,585   
                

Commitments and contingencies (Note 6) Equity:

    

NetSuite Inc. stockholders’ equity:

    

Common stock

     609        623   

Additional paid-in capital

     368,801        383,870   

Accumulated other comprehensive income

     337        525   

Accumulated deficit

     (260,755     (277,519
                

Total NetSuite Inc. stockholders’ equity

     108,992        107,499   

Noncontrolling interest in subsidiary

     395        (272
                

Total equity

     109,387        107,227   
                

Total liabilities and equity

   $ 210,334      $ 200,812   
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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NetSuite Inc.

Condensed Consolidated Statements of Operations

(Dollars and shares in thousands, except per share amounts)

(unaudited)

 

     Nine months ended
September 30,
    Three months ended
September 30,
 
     2008     2009     2008     2009  

Revenue

   $ 111,075      $ 123,576      $ 40,404      $ 41,705   

Cost of revenue

     35,513        41,084        13,733        14,493   
                                

Gross profit

     75,562        82,492        26,671        27,212   
                                

Operating expenses:

        

Product development

     14,590        20,927        6,056        7,369   

Sales and marketing

     57,427        56,539        20,221        19,478   

General and administrative

     17,038        21,950        6,426        8,323   
                                

Total operating expenses

     89,055        99,416        32,703        35,170   
                                

Operating loss

     (13,493     (16,924     (6,032     (7,958
                                

Other income / (expense), net:

        

Interest income

     3,446        511        750        81   

Interest expense

     (139     —          (2     —     

Interest expense paid to related party

     (224     (147     (63     (36

Other income / (expense), net

     (1,029     (191     (875     (134
                                

Total other income / (expense), net

     2,054        173        (190     (89
                                

Loss before income taxes

     (11,439     (16,751     (6,222     (8,047

Provision for income taxes

     811        643        221        229   
                                

Net loss

     (12,250     (17,394     (6,443     (8,276

Less: net loss attributable to noncontrolling interest

     851        630        201        247   
                                

Net loss attributable to NetSuite Inc.

   $ (11,399   $ (16,764   $ (6,242   $ (8,029
                                

Net loss per common share, basic and diluted attributable to NetSuite Inc. common stockholders

   $ (0.19   $ (0.27   $ (0.10   $ (0.13
                                

Weighted average number of shares used in computing net loss per share

     60,230        61,737        60,436        62,100   
                                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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NetSuite Inc.

Condensed Consolidated Statements of Cash Flows

(dollars in thousands)

(unaudited)

 

     Nine months ended
September 30,
 
     2008     2009  

Cash flows from operating activities:

    

Net loss attributable to NetSuite Inc.

   $ (11,399   $ (16,764

Adjustments to reconcile net loss to net cash provided by / (used in) operating activities:

    

Depreciation and amortization

     3,823        5,171   

Amortization of other intangible assets

     967        2,413   

Provision for accounts receivable allowances

     507        1,309   

Stock-based compensation

     7,411        14,335   

Amortization of deferred commissions

     17,112        14,719   

Loss on disposal of property and equipment

     43        33   

Noncontrolling interests

     (851     (629

Changes in operating assets and liabilities, net of acquired assets and liabilities:

    

Accounts receivable

     (4,410     1,766   

Deferred commissions

     (15,242     (12,913

Other current assets

     (366     (1,211

Other assets

     (342     198   

Accounts payable

     (285     (574

Accrued compensation

     926        (1,179

Deferred revenue

     (800     (4,992

Other current liabilities

     (972     (218

Other long-term liabilities

     186        (241
                

Net cash provided by / (used in) operating activities

     (3,692     1,223   
                

Cash flows from investing activities:

    

Proceeds from disposal of property and equipment

     18        —     

Purchases of property and equipment

     (4,496     (4,113

Capitalized internal use software

     (184     (188

Advances on line of credit

     —          (70

Business combinations, net of cash received

     (28,221     (21,930

Acquisition of other intangible assets

     —          (275
                

Net cash used in investing activities

     (32,883     (26,576
                

Cash flows from financing activities:

    

Payment of stock offering costs

     (950     —     

Payments under capital leases and long-term debt

     (1,182     (1,191

Proceeds from issuance of common stock

     1,897        715   
                

Net cash used in financing activities

     (235     (476
                

Effect of exchange rate changes on cash and cash equivalents

     438        (41
                

Net change in cash and cash equivalents

     (36,372     (25,870

Cash and cash equivalents at beginning of period

     169,408        123,638   
                

Cash and cash equivalents at end of period

   $ 133,036      $ 97,768   
                

Supplemental cash flow disclosure:

    

Cash paid during the period for:

    

Interest paid to related party

   $ 248      $ 164   

Income taxes, net of tax refunds

   $ 1,871      $ 456   

Noncash financing and investing activities:

    

Lapse of restrictions on common stock related to early exercise of stock options

   $ 87      $ 34   

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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NetSuite Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 1. Organization

NetSuite Inc. (“the Company”) provides a cloud computing business management application suite that offers Accounting / Enterprise Resource Planning, Customer Relationship Management (“CRM”) and Ecommerce functionality to medium-sized businesses and divisions of large companies. The Company’s headquarters are located in San Mateo, California. The Company conducts its business worldwide, with international locations in Canada, Europe, Asia, and Australia.

Note 2. Basis of Presentation

The Condensed Consolidated Financial Statements as of and for the three and nine month periods ended September 30, 2008 and 2009 included in this Quarterly Report on Form 10-Q have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The condensed consolidated balance sheet data as of December 31, 2008 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures contained in this Quarterly Report comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, for a Quarterly Report on Form 10-Q and are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements are meant to be, and should be, read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

The unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q reflect all adjustments (which include only normal, recurring adjustments and those items discussed in these Notes) that are, in the opinion of management, necessary to state fairly the financial position and results for the dates and periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its majority- and wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.

In January 2009, the Company adopted Statement of Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 810-10-45-16. As a result of the adoption of this standard, the Company classifies noncontrolling interests as a component of equity and the results of operations attributable to noncontrolling interests is reported as a part of net loss. Prior periods have been restated to conform to the current presentation.

As of September 30, 2009, the Company owned a 72% interest in NetSuite Kabushiki Kaisha (“NetSuite KK”), a Japanese corporation. Given the Company’s majority ownership interest, the accounts of NetSuite KK have been consolidated with the accounts of the Company, and a noncontrolling interest has been recorded for the investors’ interests in the net assets and operations of NetSuite KK to the extent of the noncontrolling investors’ individual investments. There were no changes in either the Company’s or the noncontrolling interest’s ownership in NetSuite KK during the nine months ended September 30, 2008 or 2009.

 

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Segments

The Company’s chief operating decision maker is its Chief Executive Officer (“CEO”), who reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region. Accordingly, the Company has determined that it has a single reporting segment, specifically, the provision of its cloud computing management application suites.

Comprehensive Loss

Comprehensive loss consists of net loss and other comprehensive income / (loss). Other comprehensive income / (loss) is comprised of foreign currency translation adjustments, net of tax. This item has been excluded from net loss and is reflected instead in stockholders’ equity. The Company’s comprehensive loss was as follows for the periods presented:

 

     Nine months ended
September 30,
    Three months ended
September 30,
 
     2008     2009     2008     2009  
     (dollars in thousands)  

Net loss

   $ (12,250   $ (17,394   $ (6,443   $ (8,276

Other comprehensive income / (loss):

        

Foreign currency translation adjustments, net of taxes

     131        151        (69     (88
                                

Comprehensive loss

     (12,119     (17,243     (6,512     (8,364

Less: comprehensive loss attributable to noncontrolling interest

     777        667        201        278   
                                

Comprehensive loss attributable to NetSuite Inc.

   $ (11,342   $ (16,576   $ (6,311   $ (8,086
                                

Concentration of Credit Risk and Significant Customers and Suppliers

Financial instruments potentially exposing the Company to concentration of credit risk consist primarily of cash and cash equivalents, restricted cash, and trade accounts receivable. The Company maintains an allowance for doubtful accounts receivable balances. The allowance is based upon historical loss patterns, the number of days that billings are past due and an evaluation of the potential risk of loss associated with problem accounts. Credit risk arising from accounts receivable is mitigated due to the large number of customers comprising the Company’s customer base and their dispersion across various industries. At December 31, 2008 and September 30, 2009, there were no customers that represented more than 10% of the net accounts receivable balance. There were no customers that individually exceeded 10% of the Company’s revenue in any of the periods presented. At December 31, 2008 and September 30, 2009, long-lived assets located outside the United States were not significant.

 

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Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented:

 

     Nine months ended
September 30,
   Three months ended
September 30,
     2008    2009    2008    2009
     (dollars in thousands)

Americas

   $ 90,219    $ 101,177    $ 33,228    $ 34,687

International

     20,856      22,399      7,176      7,018
                           

Total revenue

   $ 111,075    $ 123,576    $ 40,404    $ 41,705
                           

No single country outside the United States represented more than 10% of revenue during the three or nine months ended September 30, 2008 or 2009.

The Company maintains cash balances at several banks. Accounts located in the United States are insured by the Federal Deposit Insurance Corporation (“FDIC”), up to $250,000. Certain operating cash accounts may exceed the FDIC limits.

Intellectual Property Rights Indemnifications

The Company’s arrangements include provisions indemnifying customers against liabilities if our products infringe a third-party’s intellectual property rights. The Company has not incurred any costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the accompanying condensed consolidated financial statements.

Note 3. Business Combinations

Acquisition of QuickArrow

On July 24, 2009, the Company acquired all of the outstanding share capital of QuickArrow Inc. (“QuickArrow”), for initial aggregate consideration of approximately $19.4 million (the “Consideration”) gross of acquired cash. Transaction costs of $1.7 million were expensed as part of the acquisition.

QuickArrow develops and markets cloud computing solutions for professional services businesses. QuickArrow will be integrated into NetSuite’s OpenAir business. This acquisition is expected to further advance NetSuite’s creation of a next-generation cloud computing application suite for services-based companies.

As a result of the transaction, QuickArrow became a wholly-owned subsidiary of the Company. The results of QuickArrow’s operations have been included in the consolidated financial statements since July 24, 2009, the date of the closing of the acquisition.

The Company has recorded goodwill in its consolidated financial statements in connection with the acquisition of QuickArrow. Goodwill represents the excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets. This amount represents buyer-specific value resulting from synergies that are not included in the fair values of assets that would not be available to another likely marketplace buyer. The factors that contributed to the recognition of goodwill in the acquisition of QuickArrow included increased revenues and profits resulting from the expected enhancement of OpenAir’s application suite through the inclusion of QuickArrow’s functionality designed specifically for services companies, the potential to cross-sell NetSuite’s fully integrated application suite to QuickArrow’s clients, as well as the acquisition of a talented workforce.

 

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The allocation of the Consideration to the net assets acquired was as follows:

 

     (dollars in thousands)  

Tangible assets:

  

Cash and cash equivalents

   $ 710   

Accounts receivable

     895   

Other current assets

     143   

Property and equipment

     502   
        

Total tangible assets

     2,250   
        

Intangible assets:

  

Goodwill

     6,690   

Developed technology

     2,927   

Tradename

     259   

Customer relationships

     8,319   
        

Total intangible assets

     18,195   
        

Liabilities assumed:

  

Accounts payable and accrued liabilities

     (997
        

Total liabilities assumed

     (997
        

Net assets acquired

   $ 19,448   
        

The estimated economic lives of intangible assets are three years for developed technology, eight years for customer relationships and one year for tradename. The Company is also undertaking an analysis of the tax attributes of the assets acquired and the liabilities assumed. The allocation of the Consideration may be adjusted upon the completion of that analysis.

Pro forma financial statements for the Company reflecting the acquisition of QuickArrow have not been included as the amounts are not material to the consolidated financial results of the Company.

Acquisition of Australian Distributor

During the quarter ended June 30, 2009, we acquired the assets of our Australian distributor for cash consideration totaling $3.2 million and forgiveness of accounts receivable of $933,000. This acquisition has been accounted for as a business combination. The Company completed the purchase price allocation for this acquisition during the third quarter of 2009. We have recorded $701,000 of customer relationship intangible assets with a estimated economic life of eight years, $158,000 in trade name intangible assets estimated economic life of one year and $2.4 million in goodwill related to this acquisition. The Company is also undertaking an analysis of the tax attributes of the assets acquired and the liabilities assumed. The allocation of the Consideration may be adjusted upon the completion of that analysis.

Note 4. Financial Instruments

Fair Value Measurements

The Company measures certain financial assets at fair value on a recurring basis based on a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value:

 

   

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

   

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

 

   

Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.

For certain financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable and other current liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these balances.

 

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As of September 30, 2009, financial assets stated at fair value on a recurring basis were comprised money mutual funds included in cash and equivalents. The fair value of these financial assets was determined using the following inputs at September 30, 2009:

 

          Fair value measurements at reporting date using
     Total    Quoted prices in
active markets for
identical assets
(level 1)
   Significant other
observable inputs
(level 2)
   Significant
unobservable inputs
(level 3)
          (dollars in thousands)     

Money market funds

   $ 76,874    $ 76,874    $ —      $ —  

Restricted Cash

Restricted cash totaled $518,000 at December 31, 2008 and $520,000 at September 30, 2009 and is included in long-term other assets. These restricted cash accounts secure letters of credit applied against certain of the Company’s facility lease agreements.

Balance Sheet Hedging - Hedging of Foreign Currency Assets and Liabilities

During the nine months ended September 30, 2009, the Company hedged certain of its foreign denominated assets and liabilities to reduce the risk that earnings would be adversely affected by changes in exchange rates. The notional amount of derivative instruments acquired during the period was $26.0 million. The Company accounts for derivative instruments as either assets or liabilities on the balance sheet and measures them at fair value. Gains and losses from foreign exchange forward contracts which hedge nonfunctional currency denominated assets and liabilities are recorded each period as a component of other income / (expense) in the consolidated statements of operations. The derivatives are carried at fair value with changes in the fair value recorded as other income / (expense). These derivative instruments do not subject the Company to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being economically hedged. All contracts that the Company entered into during the period expired prior to quarter end and the Company did not have any derivative contracts outstanding as of December 31, 2008 or September 30, 2009 and there were no unrecognized gains or losses on derivative instruments on either of those dates. The effect of derivative instruments on the Statement of Operations was as follows for the periods presented:

 

     

Location

of net gain/(loss)

recognized in

income on

derivatives

   Amount of
net gain/(loss) recognized in income on derivatives during the:
 
        Nine months ended
September 30,
    Three months ended
September 30,
 

Derivatives and forward contracts

      2008    2009     2008    2009  
          (dollars in thousands)  

Foreign exchange contracts

  

Other income/(expense), net

   $ 9    $ (853   $ 9    $ (292
                                 

Total

      $ 9    $ (853   $ 9    $ (292
                                 

 

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The Company has entered into all of its foreign exchange contracts with a single counterparty. During the periods such contracts are open, the Company is subject to a potential maximum amount of loss due to credit risk equal to the gross fair value of the derivative instruments if the counterparty to the instruments failed completely to perform according to the terms of the contracts. Generally, we have the right of offset for gains earned and losses incurred under these agreements. Our agreements with the counterparty do not require either party to provide collateral to mitigate the credit risk of the agreements.

Note 5. Exchange Program

On June 20, 2009, the Company completed a stock option exchange program (the “exchange program”) that permitted the Company’s eligible employees to exchange certain outstanding stock options (the options eligible for the exchange program are referred to here as “eligible options”) with an exercise price greater than or equal to $13.11 which was 120% of the closing price of the Company’s common stock approximately one week before the May 20, 2009 launch date of the exchange program. The Company used this threshold to ensure that only outstanding stock options that were substantially “underwater” (meaning the exercise prices of the options are greater than the Company’s current stock price) were eligible for exchange under the exchange program.

Employees who participated in the exchange program, except the executive officers, received 0.5 restricted stock units for each share underlying an exchanged option. Executive officers who participated in the exchange program instead received a new option at a ratio equal to 0.64 to 0.88 new options for each share underlying an exchanged option. This ratio was based on (a) the number of shares underlying the option exchanged multiplied by (b) an exchange ratio set at a value to equal value ratio. The contractual term of the new equity awards was identical to the remaining term of the exchanged options.

Information about the options exchanged under the exchange program was as follows:

 

Employee group

   Options
exchanged
   Weighted
average
exercise
price of
exchanged
options
  

New equity award type

   New options or
restricted stock
units
   Strike price
of new stock
options

Executive officers

   470,011    $ 17.33    Stock options    387,360    $ 10.62

All other eligible employees

   1,263,803    $ 17.47    Restricted stock units    632,100   
                

Total

   1,733,814    $ 17.43         
                

In determining the stock based-compensation to be recognized for the new equity awards, the Company was required to determine the fair value of the exchanged options immediately prior to the exchange. The Company used the Binomial-Lattice pricing model to determine the fair value of the exchanged options and the incremental compensation costs of the fair value of the new equity awards issued over those exchanged will be recognized over the vesting term of the new awards.

Note 6. Commitments and Contingencies

As of September 30, 2009, the Company was not subject to any material legal proceedings. From time to time, however, the Company is named as a defendant in legal actions arising from normal business activities with customers, vendors and partners. Although the Company cannot accurately predict the amount of its liability, if any, that could arise with respect to currently pending legal actions, it is not expected that any such liability will have a material adverse effect on the Company’s financial position, operating results or cash flows.

Note 7. Income Taxes

The Company has incurred annual operating losses since inception. As a result of those continuing losses, management has determined insufficient evidence exists to support that it is more likely than not that the Company will realize the benefits of its U.S. net deferred tax assets and therefore has recorded a valuation allowance to reduce the net carrying value of these deferred tax assets to zero. Accordingly, the Company has not recorded a provision for income taxes for any of the periods presented other than provisions for state and foreign income taxes.

 

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As of September 30, 2009, the Company had net deferred tax assets in certain foreign jurisdictions of approximately $167,000 which is included in other assets. Based on all available evidence, both positive and negative, management believes that it is more likely than not that the benefits of those foreign deferred tax assets will be realized in full. The Company also had deferred tax assets of $3.6 million for Japan where it had a full valuation allowance as of September 30, 2009 reducing its carrying value to zero.

The Company’s only material uncertain tax position relates to its research and development credits. There were no material changes to the Company’s unrecognized tax benefits during the nine months ended September 30, 2009. The Company does not anticipate either material changes in the total amount or composition of its unrecognized tax benefits within 12 months of the reporting date. The Company has not accrued any interest or penalties related to unrecognized tax benefits as of December 31, 2008 or September 30, 2009.

The Company files federal, state and foreign income tax returns in jurisdictions with varying statutes of limitations. Due to its net operating loss carryforwards, the Company’s income tax returns generally remain subject to examination by federal and most state tax authorities until such carryforwards are utilized. In most significant foreign jurisdictions, the 2006 through 2008 tax years remain subject to examination by their respective tax authorities. In addition, the 2004 and 2005 tax years remain open to examination in a single foreign jurisdiction.

Note 8. Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period less the weighted-average number of unvested common shares subject to the Company’s right of repurchase. Diluted net loss per common share is computed by giving effect to all potential dilutive common shares, including options, common stock subject to repurchase and warrants. Basic and diluted net loss per common share were the same for all periods presented as the impact of all potentially dilutive securities outstanding was anti-dilutive.

The following table presents the calculation of the numerator and denominator used in the basic and diluted net loss per common share:

 

     Nine months ended
September 30,
    Three months ended
September 30,
 
     2008     2009     2008     2009  
     (dollars and shares in thousands, except per share amounts)  

Numerator:

        

Net loss attributable to NetSuite Inc.

   $ (11,399   $ (16,764   $ (6,242   $ (8,029
                                

Denominator:

        

Weighted-average number of common shares outstanding

     60,320        61,759        60,514        62,113   

Less: Weighted-average number of common shares subject to repurchase

     (90     (22     (78     (13
                                

Weighted-average number of common shares outstanding used in computing basic and diluted net loss per common share

     60,230        61,737        60,436        62,100   
                                

Net loss per common share, basic and diluted, attributable to NetSuite Inc. common stockholders

   $ (0.19   $ (0.27   $ (0.10   $ (0.13
                                

Outstanding common stock owned by employees and subject to repurchase by the Company is not included in the calculation of the weighted-average shares outstanding for basic and diluted earnings per share.

 

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The following table presents the weighted average potential shares that are excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect:

 

     Nine months ended September 30,    Three months ended September 30,
     2008    2009    2008    2009
     (shares in thousands)

Options to purchase shares of common stock and restricted stock units

   8,617    8,980    9,202    9,197

Warrants to purchase shares of common stock

   10    10    10    10

Common stock subject to repurchase

   90    22    78    13
                   

Total

   8,717    9,012    9,290    9,220
                   

The Company’s unvested restricted stock and restricted stock units do not contain nonforfeitable rights to dividends or dividend equivalents. As such unvested shares of restricted stock and restricted stock units are not required to be included in our computation of earnings per share, in accordance with FASB ASC 260-10-45-61A.

Note 9. Related Party Transactions

In August 2006, the Company entered into a license agreement with SolarWinds.net, Inc. (“SolarWinds”). A member of the Company’s Board of Directors, Kevin Thompson, is SolarWinds’ Chief Operating Officer, Chief Financial Officer and Treasurer. The licensing agreement has been renewed and additional services have been sold to SolarWinds at various points in time. In March 2009, SolarWinds entered into a two year renewal of the license agreement and purchased additional professional services for which they will pay the Company $957,000. Under the terms of the agreements, SolarWinds paid the Company $582,000 during the nine months ended September 30, 2009.

In August 2006, the Company entered into a license agreement with a division of MetLife, Inc. (“MetLife”). A member of the Company’s Board of Directors, Catherine R. Kinney, became a member of MetLife’s Board in April 2009. Under the terms of the license agreement, MetLife paid the Company $179,000 during the nine months ended September 30, 2009 for the use of its services.

In 2008, the Company engaged Horn Productions to produce videos on behalf of the Company. Horn Productions is owned by the wife of the Company’s President and Chief Executive Officer, Zachary Nelson. For the nine months ended September 30, 2009, the Company made payments to Horn Productions totaling $20,000. The Company also provides Horn Productions the right to use the Company’s services at no consideration.

In April 2009, the Company entered into an amendment of its existing sponsorship agreement with the Oakland Athletics (“the Athletics”). William L. Beane III, the General Manager of the Athletics, is a member of the Company’s Board of Directors. Under the terms of the amendment, the Company agreed to purchase additional in-stadium signage for $50,000 per year through 2011. During the nine months ended September 30, 2009, the Company made payments totaling $236,000 under its amended sponsorship agreements with the Athletics.

There were no additional related party transactions entered into during the nine months ended September 30, 2009. Additional related party transactions entered into prior to December 31, 2008 are described in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

Note 10. Subsequent Events

The Company has evaluated subsequent events through November 6, 2009, the date which the financial statements were issued. No such reportable events exist as of that date.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the discussion contained in our Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the SEC on March 13, 2009. Certain statements in this Quarterly Report constitute forward-looking statements and as such, 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 related to the integration of acquired companies 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 II of this Quarterly Report on Form 10-Q, 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 Quarterly Report on Form 10-Q. 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 Quarterly Report are made only as of the date of this Quarterly Report. 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 provide a cloud computing business management application suite that provides Accounting / ERP, CRM and Ecommerce functionality to medium-sized businesses and divisions of large companies. We also offer customer support and professional services related to our suite. We deliver our suite over the Internet as a subscription service using the software-as-a-service (“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 2008, we acquired OpenAir which offers both professional services automation and project portfolio management products. In July 2009, we acquired QuickArrow to further expand our suite for services-based companies.

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 and Australia.

 

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Key Components of Our Results of Operations

Revenue

Our revenue has grown from $17.7 million during the year ended December 31, 2004 to $152.5 million during the year ended December 31, 2008.

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, services companies and software companies. The primary target customers for our service are medium-sized businesses. An increasing percentage of our customers and our revenue has been derived from larger businesses within this market. For the nine months ended September 30, 2009, we did not have any single customer that accounted for more than 3% of our revenue.

We are pursuing a number of strategies which we believe will provide us with significant prospects for future growth. The goals of those strategic initiatives are to continue to move up-market, to increase use of NetSuite as a platform and to extend the verticalization of our product line. Although we have made progress towards our goals in recent periods, there are still many areas in which we believe that we can continue to grow. To implement these goals, we are focused on the following initiatives:

 

   

Growth of sales of OneWorld which supports the needs of large, standalone companies, and divisions of very large enterprises.

 

   

Strengthening our professional services automation verticalization with the July acquisition of QuickArrow.

 

   

Developing our SuiteCloud ecosystem strategy to enable third parties to extend our offerings with their vertical expertise.

We experience competitive pricing pressure where 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 computing business management suite.

We sell our application suite pursuant to subscription agreements. The duration of these agreements is generally one year. 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 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 September 30, 2009, we had deferred revenue of $69.5 million.

In most instances, revenue is generated under sales agreements with multiple elements comprised of subscription fees for access to our application suite and customer support, and fees for professional services. We have determined that we do not have objective and reliable evidence of fair value for each element of our sales agreements that contain a subscription to our application suite and customer support, and fees for professional services. As a result, the elements within our multiple-element sales agreements do not qualify for treatment as separate units of accounting. Accordingly, we account for fees received under multiple-element arrangements as a single unit of accounting and recognize the entire arrangement ratably over the term of the related agreement, commencing upon the later of the agreement start date or when all revenue recognition criteria have been met.

 

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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 reserves on our balance sheet for these commitments.

As part of our overall growth, we expect the percentage of our revenue generated outside of North America to increase as we invest in and enter new markets. Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented:

 

     Nine months ended September 30,     Three months ended September 30,  
     2008     2009     2008     2009  
     (dollars in thousands)  

Americas

   $ 90,219      $ 101,177      $ 33,228      $ 34,687   

International

     20,856        22,399        7,176        7,018   
                                

Total revenue

   $ 111,075      $ 123,576      $ 40,404      $ 41,705   
                                

Percentage of revenue generated outside of the Americas

     19     18     18     17

During June 2009, we acquired the assets of our Australian distributor. This acquisition has been accounted for as a business combination. During July 2009 we acquired QuickArrow an Austin, Texas based software maker of cloud computing software for professional services businesses. These acquisitions are not expected to have a material impact on our 2009 revenue or operating expenses, except for the estimated $1.7 million in transaction costs for QuickArrow which were expensed in the third quarter of 2009.

Employees

The number of full-time employees at September 30, 2009 was 975 as compared to 971 at December 31, 2008 and 959 at September 30, 2008. As of September 30, 2009, our headcount included 283 employees in sales and marketing, 445 employees in operations, professional services, training and customer support, 138 employees in product development, and 109 employees in a general and administrative capacity.

Cost of Revenue

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, support, professional services and training personnel, stock-based compensation, software license fees, costs associated with website development activities, allocated overhead, intangible asset amortization expense associated with capitalized internal use software and acquired developed technology and related plant and equipment depreciation and amortization expenses. The cost associated with providing professional services is significantly higher as a percentage of revenue than the cost associated with delivering our software services due to the labor costs associated with providing professional services.

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 decrease slightly 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. Additionally, we expect to further increase data center capacity in 2010, which will further increase our cost of revenue. We may also incur additional expenses associated with the acquisition of additional database software licenses.

 

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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 cloud computing 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, which will cause us to incur additional expenses related to translation and localization of our application for use in other countries.

We expect product development expenses to increase in absolute dollars as we 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.

Operating Expenses - 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 tradename 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. The commission expense for customer renewals is at lower rates than for sales to new customers. As such, we expect our commission expense to decline as a percentage of revenue going forward as a larger percentage of our recognized revenue is expected to result from customer renewals.

We intend to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers. Our sales and marketing expenses have decreased both in terms of absolute dollars and as a percentage of total revenue over the past quarter. Despite this decrease, we expect our sales and marketing expenses to increase in absolute dollars for the foreseeable future.

 

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Operating Expenses - 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 and other corporate expenses and allocated overhead.

We expect our general and administrative expenses to increase in absolute dollars as we 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. 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 condition, 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 appears in our 2008 Annual Report on Form 10-K under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Judgments.” In addition, please see Note 2 to Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and Note 2 of the Notes to Consolidated Financial Statements included in our 2008 Annual Report on Form 10-K for a description of our accounting policies.

 

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Results of Operations

Revenue and Cost of Revenue

Information about revenue, cost of revenue and gross profit was as follows for the periods presented:

 

     Nine months ended
September 30,
    Three months ended
September 30,
 
     2008     2009     2008     2009  
     (dollars in thousands)  

Revenue

   $ 111,075      $ 123,576      $ 40,404      $ 41,705   

Cost of revenue (1)

     35,513        41,084        13,733        14,493   
                                

Gross profit

   $ 75,562      $ 82,492      $ 26,671      $ 27,212   
                                

Gross margin

     68     67     66     65
                                

 

        

(1)    Includes stock-based compensation expense and amortization of intangible assets of:

   $ 1,932      $ 3,655      $ 1,113      $ 1,373   
                                

Nine Months Ended September 30, 2008 as Compared to the Nine Months Ended September 30, 2009

Revenue for the nine months ended September 30, 2009 increased $12.5 million, or 11%, compared to the same period in 2008. The overall increase in revenue was primarily the result of $18.5 million in new revenue as a result of acquiring new customers (customers acquired after September 30, 2008), the introduction of new products, an increase in average selling price per new customer and the incremental customer revenue resulting from the acquisition of OpenAir and QuickArrow. New revenue during the same period in 2008 was $25.2 million. The increase in new revenue was offset by a $7.3 million decrease in revenues from existing customers and other sources including our Japanese distribution rights. The decrease in revenue from existing customers resulted primarily from a $9.2 million decrease in professional services revenue from those customers as a result of the nonrenewal of those services. The nonrenewal of professional services by existing customers is a natural occurrence as such services are most frequently purchased in connection with the initial implementation of our product by new customers. Existing customers’ purchases of additional user subscriptions and modules (or “upsell”) largely offset the impact of customer churn and decreases in subscription and support revenues (or “downsell”) for existing customers. We believe that the increase in both churn rate and downsell that we have recently experienced are a result of global economic conditions. The overall change in revenue was also impacted by a $2.5 million reduction of revenue recognized from our Japanese distribution rights agreement, as described above.

Revenue generated outside of North America was $22.4 million, or 18%, of our revenue during the nine months ended September 30, 2009, as compared to $20.9 million, or 19%, during the same period in 2008.

Cost of revenue for the nine months ended September 30, 2009 increased $5.6 million, or 16%, compared to the same period in 2008. The increase was primarily the result of a $3.6 million increase in personnel costs and a $671,000 increase in amortization of intangibles. The increase in personnel costs includes a $995,000 increase in stock-based compensation and is primarily associated with an increase in the number of employees required to support our growing client base.

Our gross margin decreased to 67% during the nine months ended September 30, 2009 compared to 68% for the same period in 2008. This decrease was primarily due to additional expenses related to hiring additional employees in our services organization.

 

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Three Months Ended September 30, 2008 as Compared to the Three Months Ended September 30, 2009

Revenue for the three months ended September 30, 2009 increased $1.3 million, or 3%, compared to the same period in 2008. The overall increase in revenue was primarily the result of $9.2 million in new revenue as a result of acquiring new customers (customers acquired after September 30, 2008), the introduction of new products, an increase in average selling price per new customer and the incremental customer revenue resulting from the acquisition of OpenAir and QuickArrow. New revenue during the same period in 2008 was $13.1 million. The increase in new revenue was offset by a $5.5 million decrease in revenues from existing customers and other sources including our Japanese distribution rights. The decrease in revenue from existing customers resulted primarily from a $4.2 million decrease in professional services revenue from those customers as a result of the nonrenewal of those services. The nonrenewal of professional services by existing customers is a natural occurrence as such services are most frequently purchased in connection with the initial implementation of our product by new customers. Existing customers’ purchases of additional user subscriptions and modules (or “upsell”) largely offset the impact of customer churn and decreases in subscription and support revenues (or “downsell”) for existing customers. We believe that the increase in both churn rate and downsell that we have recently experienced are a result of global economic conditions. The change in revenue was also impacted by a $1.4 million reduction of revenue recognized from our Japanese distribution rights agreement, as described above.

Revenue generated outside of North America was $7.0 million, or 17%, of our revenue during the three months ended September 30, 2009, as compared to $7.2 million, or 18%, during the same period in 2008.

Cost of revenue for the three months ended September 30, 2009 increased $760,000, or 6%, compared to the same period in 2008. The increase was primarily the result of a $490,000 increase in personnel costs. The increase in personnel costs includes a $201,000 increase in stock-based compensation and is primarily associated with an increase in the number of employees required to support our growing client base.

Our gross margin decreased to 65% during the three months ended September 30, 2009 compared to 66% for the same period in 2008. This decrease was primarily due to additional expenses related to hiring additional employees in our services organization.

 

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Operating Expenses

Operating expenses were as follows for the periods presented:

 

     Nine months ended September 30,  
     2008     2009  
     Amount    % of
revenue
    Amount    % of
revenue
 
     (dollars in thousands)  

Operating expenses (1):

          

Product development

   $ 14,590    13   $ 20,927    17

Sales and marketing

     57,427    52     56,539    46

General and administrative

     17,038    15     21,950    17
                  

Total operating expenses

   $ 89,055    80   $ 99,416    80
                  
     Three months ended September 30,  
     2008     2009  
     Amount    % of
revenue
    Amount    % of
revenue
 
     (dollars in thousands)  

Operating expenses (1):

          

Product development

   $ 6,056    15   $ 7,369    18

Sales and marketing

     20,221    50     19,478    47

General and administrative

     6,426    16     8,323    19
                  

Total operating expenses

   $ 32,703    81   $ 35,170    84
                  

 

(1) Includes stock-based compensation expense, amortization of acquisition-related intangibles and transaction costs for business combinations as follows:

 

     Nine months ended
September 30,
   Three months ended
September 30,
     2008    2009    2008    2009
     (dollars in thousands)

Product development

   $ 2,178    $ 4,502    $ 1,147    $ 1,709

Sales and marketing

     2,136      4,908      1,234      2,242

General and administrative

     2,133      5,743      1,048      3,054
                           

Total

   $ 6,447    $ 15,153    $ 3,429    $ 7,005
                           

Nine Months Ended September 30, 2008 as Compared to the Nine Months Ended September 30, 2009

Product development expenses for the nine months ended September 30, 2009 increased $6.3 million, or 43%, as compared to the same period in 2008. The increase was primarily the result of a $6.0 million increase in personnel costs. The increase in personnel costs is associated with an increase in the number of employees. The increase in personnel costs also includes a $2.3 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees. Product development has increased as a percentage of revenue as this area is a key strategic investment for NetSuite, driven by the continued investments in OneWorld and internationalized versions of our product.

Sales and marketing expenses for the nine months ended September 30, 2009 decreased $888,000, or 2%, as compared to the same period in 2008. The decrease was primarily the result of a $2.2 million decrease in personnel costs. The decrease in personnel costs primarily related to decreases in commissions expenses, recruiting costs and travel expenses. The decrease in personnel costs is net of a $2.0 million increase in stock-based compensation expense resulting from the issuance of equity awards to both existing and new employees. The decrease in personnel costs was partially offset by facilities costs and marketing expenses.

 

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General and administrative expenses for the nine months ended September 30, 2009 increased $4.9 million, or 29%, as compared to the same period in 2008. The increase was primarily the result of a $2.4 million increase in personnel costs and $2.0 million in business combination costs. The increase in personnel costs was the result of an increase in the number of employees. The increase in personnel costs also includes a $1.6 million increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

Three Months Ended September 30, 2008 as Compared to the Three Months Ended September 30, 2009

Product development expenses for the three months ended September 30, 2009 increased $1.3 million, or 22%, as compared to the same period in 2008. The increase was primarily the result of a $1.3 million increase in personnel costs. The increase in personnel costs is associated with an increase in the number of employees. The increase in personnel costs also includes an $546,000 increase in stock-based compensation resulting from the issuance of equity awards to both existing and new employees.

Sales and marketing expenses for the three months ended September 30, 2009 decreased $743,000 or 4%, as compared to the same period in 2008. The decrease was primarily the result of a $1.2 million decrease in personnel costs. The decrease in personnel costs related primarily to decreases in commission expenses, recruiting and training costs. The decrease in personnel costs is net of a $638,000 increase in stock-based compensation expense resulting from the issuance of equity awards to both existing and new employees.

General and administrative expenses for the three months ended September 30, 2009 increased $1.9 million, or 30%, as compared to the same period in 2008. The increase was primarily the result of $1.7 million in business combination costs for the QuickArrow acquisition.

 

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Non-operating Items

Non-operating items, including interest income and expense, other income / (expense), income taxes and the effect of noncontrolling interest was as follows for the periods presented:

 

     Nine months ended September 30,  
     2008     2009  
     Amount     % of
revenue
    Amount     % of
revenue
 
     (dollars in thousands)  

Interest income

   $ 3,446      3   $ 511      0

Interest expense, including amounts paid to related party

     (363   0     (147   0

Other income / (expense)

     (1,029   -1     (191   0

Income taxes

     (811   -1     (643   -1

Noncontrolling interest

     851      1     630      1
     Three months ended September 30,  
     2008     2009  
     Amount     % of
revenue
    Amount     % of
revenue
 
     (dollars in thousands)  

Interest income

   $ 750      2   $ 81      0

Interest expense, including amounts paid to related party

     (65   0     (36   0

Other income / (expense)

     (875   -2     (134   0

Income taxes

     (221   -1     (229   -1

Noncontrolling interest

     201      0     247      1

Interest income for the nine months ended September 30, 2009 decreased $2.9 million as compared to the same period in 2008. The decrease is primarily related to lower cash balances and a decrease on interest rates paid on cash equivalents invested in money market mutual funds.

The decrease in other income / (expense) during the three and nine months ended September 30, 2009 as compared to the same periods during 2008 was primarily the result of the hedging program implemented in September 2008 and net foreign exchange rate gains and losses recognized during those periods.

Liquidity and Capital Resources

As of September 30, 2009, our primary sources of liquidity were our cash and cash equivalents totaling $97.8 million and $25.0 million in accounts receivable, net of allowance. Our cash and cash equivalents are comprised of the remaining unused portion of the $161.9 million in proceeds from our December 2007 IPO.

In the nine months ended September 30, 2009, cash flows from operations resulted in a $1.2 million source of cash. Although we have positive operating cash flows for two consecutive quarters, the possibility remains that we could return to a position of having operating cash outflows in a future period. 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. Management does expect cash received from customers to be sufficient to cover operating expenses in future periods as our losses decrease.

We intend to use the cash provided from the initial public offering for general corporate purposes, including potential future acquisitions or other transactions. Further, during 2009, we expect to incur additional expenses in connection with our international expansion and the localization of our service in new locations. We believe that our cash and cash equivalents proceeds are adequate to fund those anticipated activities.

 

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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 twelve months, we have not found it necessary to reassess our capacity to generate cash from financing cash flows in the current economic climate. We would expect to find it more difficult to raise cash in the near term than in prior periods as a result of the economic downturn that has occurred since our IPO. If additional financing were to become necessary and we are unable to obtain the additional financing, 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 consisting of letters of credit for our facility lease agreements, is included in long-term other assets which totaled $518,000 at December 31, 2008 and $520,000 at September 30, 2009.

As of September 30, 2009, we had an accumulated deficit of $277.5 million. We have funded this deficit primarily through the net proceeds raised from the sale of our capital stock.

A summary of our cash flow activities were as follows for the periods presented:

 

     Nine months ended
September 30,
 
     2008     2009  
     (dollars in thousands)  

Net cash provided by (used in) operating activities

   $ (3,692   $ 1,223   

Net cash used in investing activities

     (32,883     (26,576

Net cash used in financing activities

     (235     (476

Effect of exchange rate changes on cash and cash equivalents

     438        (41
                

Net change in cash and cash equivalents

   $ (36,372   $ (25,870
                

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 nine months ended September 30, 2009 as compared to the same period in 2008 primarily as a result of an increase in cash collections on accounts receivable.

Cash used in investing activities during the nine months ended September 30, 2009 was related to the acquisition of QuickArrow and our Australian distributor for $21.9 million in cash and capital expenditures for property and equipment, consisting of the purchase of software licenses, computer equipment, leasehold improvements and furniture and fixtures as we expanded our infrastructure.

The net cash used in financing activities for the nine months ended September 30, 2009 was primarily related to payments on capital leases offset by the proceeds from the issuance of common stock from the exercise of stock options. During the nine months ended September 30, 2008, we also paid $950,000 in costs related to our 2007 IPO.

 

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Off-Balance Sheet Arrangements and Contractual Obligations

During the nine months ended September 30, 2008 and 2009, 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.

We did not enter into any significant new contractual obligations during the nine months ended September 30, 2009.

Recent Accounting Pronouncements

In September 2009, the FASB issued new authoritative guidance that provides guidance on determining multiple elements in an arrangement and how total consideration should be allocated amongst the elements. It also expands disclosure requirements for multiple-element arrangements. Concurrently, the FASB also issued new authoritative guidance for arrangements that include both software and tangible products that excludes tangible products and certain related elements from the scope of the revenue recognition authoritative guidance specific to software transactions. The standards must both be adopted in the same period and can be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted, or they can be adopted on a retrospective basis. We have not yet adopted the standards and are currently assessing their impact on our consolidated financial statements.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Sensitivity

We had cash and cash equivalents of $97.8 million at September 30, 2009. These amounts were held primarily in money market funds.

Cash and cash equivalents are held for working capital purposes, and restricted cash amounts are held as security against various lease obligations. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, will reduce future interest income. We believe that we do not have any material exposure to changes in the fair value as a result of changes in interest rates.

Foreign Currency Risk

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound Sterling, Canadian Dollar, Australian Dollar, Euro, Japanese Yen, Singapore Dollar and Philippine Peso. Our revenue is generally denominated in the local currency of the contracting party. The majority of our billings are denominated in U.S. Dollars. Our expenses are generally denominated in the currencies of the countries in which our operations are located. Our expenses are incurred primarily in the United States, Canada and the UK, with a small portion of expenses incurred where our other international sales and operations offices are located. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. During the nine months ended September 30, 2009, we continued a hedging program initiated in 2008 to limit the exposure of foreign currency risk resulting from the revaluation of foreign denominated assets and liabilities through the use of forward exchange contracts. All contracts that we entered into during the period expired before quarter end. We expect to continue to enter into similar hedging transactions in future periods.

Fluctuations in currency exchange rates could harm our business in the future. The effect of an immediate 10% adverse change in exchange rates on un-hedged foreign denominated receivables as of September 30, 2009 would result in a loss of approximately $608,000.

Fair Value of Financial Instruments

We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments purchased with a remaining maturity of three months or less. We do not use derivative financial instruments for speculative or trading purposes. However, this does not preclude our adoption of specific hedging strategies in the future.

 

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was performed by management, with the participation of our CEO and our Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures as of September 30, 2009 (as defined in Rules 13a-15(e) and 15d - 15(e) under the Securities Exchange Act of 1934, as amended). Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Based on that evaluation, our CEO and CFO have concluded that as of September 30, 2009, our disclosure controls and procedures are effective, to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms and that such information is accumulated and communicated to management including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations of Internal Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II – OTHER INFORMATION

ITEM 1. Legal Proceedings

From time to time, we are involved in various legal proceedings arising from the normal course of business activities. We are not presently a party to any litigation the outcome of which, we believe, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results or financial condition.

 

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ITEM 1A. Risk Factors

A description of the risks and uncertainties associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risks and uncertainties associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. You should carefully consider such risks and uncertainties, together with the other information contained in this report, our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and in our other public filings. If any of such risks and uncertainties actually occurs, our business, financial condition or operating results could differ materially from the plans, projections and other forward-looking statements included in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report and in our other public filings. In addition, if any of the following risks and uncertainties, or if any other risks and uncertainties, actually occurs, our business, financial condition or operating results could be harmed substantially, which could cause the market price of our stock to decline, perhaps significantly.

Risks Related to Our Business

Continued adverse economic conditions or reduced investments in cloud computing applications and information technology spending may harm our business.

Our business depends on the overall demand for cloud computing applications and information technology spending and on the economic health and general willingness of our current and prospective customers to make capital commitments. If the conditions in the U.S. and global economic environment remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results, and financial condition may be materially adversely affected. Continued weak or volatile economic conditions, or a reduction in spending for cloud computing applications and information technology even if economic conditions improve, would likely harm our business and operating results in a number of ways, including longer sales cycles, extended payment terms, lower prices for our products and services, reduced sales, and lower customer retention rates.

We have a history of losses and we may not achieve profitability in the future.

We have not been profitable on a generally accepted accounting principles (“GAAP”) basis during any quarterly or annual period since our formation. We experienced a net loss of $16.8 million for the nine months ended September 30, 2009. As of that date, our accumulated deficit was $277.5 million. We expect to make significant future expenditures related to the development and expansion of our business. As a result of these increased expenditures, we will have to generate and sustain increased revenue to achieve and maintain future profitability. While historically our revenue has grown, this growth may not be sustainable and we may not achieve sufficient revenue to achieve or maintain profitability. We may incur significant losses in the future for a number of reasons including the other risks described in this Quarterly Report, unforeseen expenses, difficulties, complications and delays and other unknown factors. Accordingly, we may not be able to achieve or maintain profitability and we may continue to incur significant losses for the foreseeable future.

Our customers are medium-sized businesses and divisions of large companies, which may result in increased costs as we attempt to reach, acquire and retain customers.

We market and sell our application suite to medium-sized businesses and divisions of large companies. To grow our revenue quickly, we must add new customers, sell additional services to existing customers and encourage existing customers to renew their subscriptions. However, selling to and retaining medium-sized businesses can be more difficult than selling to and retaining large enterprises because medium-sized business customers:

 

   

are more price sensitive;

 

   

are more difficult to reach with broad marketing campaigns;

 

   

have high churn rates in part because of the nature of their businesses;

 

   

often lack the staffing to benefit fully from our application suite’s rich feature set; and

 

   

often require higher sales, marketing and support expenditures by vendors that sell to them per revenue dollar generated for those vendors.

 

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If we are unable to cost-effectively market and sell our service to our target customers, our ability to grow our revenue quickly and become profitable will be harmed.

Our business depends substantially on customers renewing, upgrading and expanding their subscriptions for our services. Any decline in our customer renewals, upgrades and expansions would harm our future operating results.

We sell our application suite pursuant to service agreements that are generally one year in length. Our customers have no obligation to renew their subscriptions after their subscription period expires, and these subscriptions may not be renewed at the same or higher levels. Moreover, under specific circumstances, our customers have the right to cancel their service agreements before they expire. In addition, in the first year of a subscription, customers often purchase a higher level of professional services than they do in renewal years. As a result, our ability to grow is dependent in part on customers purchasing additional subscriptions and modules after the first year of their subscriptions. We have limited historical data with respect to rates of customer subscription renewals, upgrades and expansions so we may not accurately predict future trends in customer renewals. Our customers’ renewal rates may decline or fluctuate because of several factors, including their satisfaction or dissatisfaction with our services, the prices of our services, the prices of services offered by our competitors or reductions in our customers’ spending levels due to the macroeconomic environment or other factors. If our customers do not renew their subscriptions for our services, renew on less favorable terms, or do not purchase additional functionality or subscriptions, our revenue may grow more slowly than expected or decline and our profitability and gross margin may be harmed.

Our services are delivered primarily out of a single data center. Any disruption of service at this facility could interrupt or delay our ability to deliver our service to our customers.

We host our services and serve our customers primarily from a third-party data center facility with SAVVIS located in California. We do not control the operation of this facility. This facility is vulnerable to damage or interruption from earthquakes, hurricanes, floods, fires, terrorist attacks, power losses, telecommunications failures and similar events. Our data facility is located in an area known for seismic activity, increasing our susceptibility to the risk that an earthquake could significantly harm the operations of this facility. It also could be subject to break-ins, computer viruses, sabotage, intentional acts of vandalism and other misconduct.

The occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice or other unanticipated problems could result in lengthy interruptions in our services. We currently operate and maintain an offsite facility for customers who specifically pay for accelerated disaster recovery services. For customers who do not pay for such services, although we maintain tape backups of their data, we do not operate or maintain a separate disaster recovery facility, which may increase delays in the restoration of our service for those customers.

Our data center facility provider has no obligation to renew its agreement with us on commercially reasonable terms, or at all. If we are unable to renew our agreement with the facility provider on commercially reasonable terms or if in the future we add additional data center facility providers, we may experience costs or downtime in connection with the transfer to, or the addition of, a new data center facility.

Any errors, defects, disruptions or other performance problems with our services could harm our reputation and may damage our customers’ businesses. Interruptions in our services might reduce our revenue, cause us to issue credits to customers, subject us to potential liability, cause customers to terminate their subscriptions and harm our renewal rates.

 

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We may become liable to our customers and lose customers if we have defects or disruptions in our service or if we provide poor service.

Because we deliver our application suite as a service, errors or defects in the software applications underlying our service, or a failure of our hosting infrastructure, may make our service unavailable to our customers. Since our customers use our suite to manage critical aspects of their business, any errors, defects, disruptions in service or other performance problems with our suite, whether in connection with the day-to-day operation of our suite, upgrades or otherwise, could damage our customers’ businesses. If we have any errors, defects, disruptions in service or other performance problems with our suite, customers could elect not to renew, or delay or withhold payment to us, we could lose future sales or customers may make warranty claims against us, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable or costly litigation.

The market for cloud computing applications may develop more slowly than we expect.

Our success will depend, to a large extent, on the willingness of medium-sized businesses to accept cloud computing services for applications that they view as critical to the success of their business. Many companies have invested substantial effort and financial resources to integrate traditional enterprise software into their businesses and may be reluctant or unwilling to switch to a different application or to migrate these applications to cloud computing services. Other factors that may affect market acceptance of our application include:

 

   

the security capabilities, reliability and availability of cloud computing services;

 

   

customer concerns with entrusting a third party to store and manage their data, especially confidential or sensitive data;

 

   

our ability to minimize the time and resources required to implement our suite;

 

   

our ability to maintain high levels of customer satisfaction;

 

   

our ability to implement upgrades and other changes to our software without disrupting our service;

 

   

the level of customization or configuration we offer;

 

   

our ability to provide rapid response time during periods of intense activity on customer websites; and

 

   

the price, performance and availability of competing products and services.

The market for these services may not develop further, or may develop more slowly than we expect, either of which would harm our business.

If our security measures are breached and unauthorized access is obtained to a customer’s data, we may incur significant liabilities, our service may be perceived as not being secure and customers may curtail or stop using our suite.

The services we offer involve the storage of large amounts of our customers’ sensitive and proprietary information. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and someone obtains unauthorized access to our customers’ data, we could incur significant liability to our customers and to individuals or businesses whose information was being stored by our customers, our business may suffer and our reputation will be damaged. Because techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and customers. Such an actual or perceived breach could also cause a significant and rapid decline in our stock price.

We provide service level commitments to our customers, which could cause us to issue credits for future services if the stated service levels are not met for a given period and could significantly harm our revenue.

Our customer agreements provide service level commitments. If we are unable to meet the stated service level commitments or suffer extended periods of unavailability for our service, we may be contractually obligated to

 

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provide these customers with credits for future services. Our revenue could be significantly impacted if we suffer unscheduled downtime that exceeds the allowed downtimes under our agreements with our customers. In light of our historical experience with meeting our service level commitments, we do not currently have any reserves on our balance sheet for these commitments. Our service level commitment to all customers is 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require us to credit qualifying customers for the value of an entire month of their subscription fees, not just the value of the subscription fee for the period of the downtime. As a result, a failure to deliver services for a relatively short duration could cause us to issue these credits to all qualifying customers. Any extended service outages could harm our reputation, revenue and operating results.

We have experienced rapid growth in recent periods. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service or address competitive challenges adequately.

We have increased our annual revenue from $17.7 million during the year ended December 31, 2004 to $152.5 million during the year ended December 31, 2008. We have increased our number of full-time employees from 296 at December 31, 2004 to 975 at September 30, 2009.

Our expansion has placed, and our anticipated growth may continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. We intend to further expand our overall business, customer base, headcount and operations. We also intend to continue expanding our operations internationally. Creating a global organization and managing a geographically dispersed workforce will require substantial management effort and significant additional investment in our infrastructure. We will be required to continue to improve our operational, financial and management controls and our reporting procedures and we may not be able to do so effectively. As such, we may be unable to manage our expenses effectively in the future, which may negatively impact our gross margin or operating expenses in any particular quarter.

Our quarterly operating results may fluctuate in the future. As a result, we may fail to meet or exceed the expectations of research analysts or investors, which could cause our stock price to decline.

Our quarterly and annual operating results may fluctuate as a result of a variety of factors, many of which are outside of our control. A decline in general macroeconomic conditions could adversely affect our customers’ ability or willingness to purchase our application suite, which could adversely affect our operating results or financial outlook. Fluctuations in our quarterly operating annual results or financial outlook may also be due to a number of additional factors, including the risks and uncertainties discussed elsewhere in this Annual Report.

Fluctuations in our operating results could cause our stock price to decline rapidly, may lead analysts to change their long-term model for valuing our common stock, may impact our ability to retain or attract key personnel, or cause other unanticipated issues. If our operating results or financial outlook fall below the expectations of research analysts or investors, the price of our common stock could decline substantially.

We believe that our revenue and operating results may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance.

Our limited operating history makes it difficult to evaluate our current business and future prospects, and may increase the risk of your investment.

Our company has been in existence since 1998, and much of our growth has occurred since 2004, with our revenue increasing from $17.7 million during the year ended December 31, 2004 to $152.5 million during the year ended December 31, 2008. Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries. If we do not address these risks successfully, our business may be harmed.

 

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The market in which we participate is intensely competitive, and if we do not compete effectively, our operating results may be harmed.

The markets for ERP, CRM and Ecommerce applications are intensely competitive and rapidly changing with relatively low barriers to entry. With the introduction of new technologies and market entrants, we expect competition to intensify in the future. In addition, pricing pressures and increased competition generally could result in reduced sales, reduced margin or the failure of our service to achieve or maintain more widespread market acceptance. Often we compete to sell our application suite against existing systems that our potential customers have already made significant expenditures to install. Competition in our market is based principally upon service breadth and functionality; service performance, security and reliability; ability to tailor and customize services for a specific company, vertical or industry; ease of use of the service; speed and ease of deployment, integration and configuration; total cost of ownership, including price and implementation and support costs; professional services implementation; and financial resources of the vendor.

We face competition from both traditional software vendors and SaaS providers. Our principal competitors include Epicor Software Corporation, Intuit Inc., Microsoft Corporation, SAP, The Sage Group plc and salesforce.com, inc. Many of our actual and potential competitors enjoy substantial competitive advantages over us, such as greater name recognition, longer operating histories, more varied products and services and larger marketing budgets, as well as substantially greater financial, technical and other resources. In addition, many of our competitors have established marketing relationships and access to larger customer bases, and have major distribution agreements with consultants, system integrators and resellers. If we are not able to compete effectively, our operating results will be harmed.

Our brand name and our business may be harmed by aggressive marketing strategies of our competitors.

Because of the early stage of development of our markets, we believe that building and maintaining brand recognition and customer goodwill is critical to our success. Our efforts in this area have, on occasion, been complicated by the marketing efforts of our competitors, which may include incomplete, inaccurate and false statements about our company and our services that could harm our business. Our ability to respond to our competitors’ misleading marketing efforts may be limited under certain circumstances by legal prohibitions on permissible public communications by us as a public company.

Many of our customers are price sensitive, and if the prices we charge for our services are unacceptable to our customers, our operating results will be harmed.

Many of our customers are price sensitive, and we have limited experience with respect to determining the appropriate prices for our services. As the market for our services matures, or as new competitors introduce new products or services that compete with ours, we may be unable to renew our agreements with existing customers or attract new customers at the same price or based on the same pricing model as previously used. As a result, it is possible that competitive dynamics in our market may require us to change our pricing model or reduce our prices, which could harm our revenue, gross margin and operating results.

If we are unable to develop new services or sell our services into new markets, our revenue growth will be harmed and we may not be able to achieve profitability.

Our ability to attract new customers and increase revenue from existing customers will depend in large part on our ability to enhance and improve our existing application suite and to introduce new services and sell into new markets. The success of any enhancement or new service depends on several factors, including the timely completion, introduction and market acceptance of the enhancement or service. Any new service we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. Any new markets into which we attempt to sell our application, including new vertical markets and new countries or regions, may not be receptive. If we are unable to successfully develop or acquire new services, enhance our existing services to meet customer requirements or sell our services into new markets, our revenue will not grow as expected and we may not be able to achieve profitability.

 

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Because we are a global organization and our long-term success depends, in part, on our ability to expand the sales of our services to customers located outside of the United States, our business is susceptible to risks associated with international sales and operations.

We currently maintain offices outside of the United States and have sales personnel or independent consultants in several countries. Approximately one quarter of our employees are located in an office in the Philippines. We have limited experience operating in foreign jurisdictions and are rapidly building our international operations. Managing a global organization is difficult, time consuming and expensive. Our inexperience in operating our business outside of the United States increases the risk that any international expansion efforts that we may undertake will not be successful. In addition, conducting international operations subjects us to new risks that we have not generally faced in the United States. These risks include:

 

   

localization of our services, including translation into foreign languages and adaptation for local practices and regulatory requirements;

 

   

lack of familiarity with and unexpected changes in foreign regulatory requirements;

 

   

longer accounts receivable payment cycles and difficulties in collecting accounts receivable;

 

   

difficulties in managing and staffing international operations;

 

   

fluctuations in currency exchange rates;

 

   

potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings;

 

   

dependence on certain third parties, including channel partners with whom we do not have extensive experience;

 

   

the burdens of complying with a wide variety of foreign laws and legal standards;

 

   

increased financial accounting and reporting burdens and complexities;

 

   

political, social and economic instability abroad, terrorist attacks and security concerns in general; and

 

   

reduced or varied protection for intellectual property rights in some countries.

Operating in international markets also requires significant management attention and financial resources. The investment and additional resources required to establish operations and manage growth in other countries may not produce desired levels of revenue or profitability.

We rely on third-party software, including Oracle database software, that may be difficult to replace or which could cause errors or failures of our service that could lead to lost customers or harm to our reputation.

We rely on software licensed from third parties to offer our service, including database software from Oracle. This software may not continue to be available to us on commercially reasonable terms, or at all. Any loss of the right to use any of this software could result in delays in the provisioning of our service until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. Any errors or defects in third-party software could result in errors or a failure of our service which could harm our business.

Assertions by a third party that we infringe its intellectual property, whether successful or not, could subject us to costly and time-consuming litigation or expensive licenses.

The software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us may grow. Our technologies may not be able to withstand any third-party claims or rights against their use. Additionally, although we have licensed from other parties proprietary technology covered by patents, we cannot be certain that any such patents will not be challenged, invalidated or circumvented. Furthermore, many of our service agreements require us to indemnify our customers for certain third-party intellectual property infringement claims, which could increase our costs as a result of defending such claims and may require that we pay damages if there were an adverse ruling related to any such claims. These types of claims could harm our relationships with our customers, may deter future customers from subscribing to our services or could expose us to

 

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litigation for these claims. Even if we are not a party to any litigation between a customer and a third party, an adverse outcome in any such litigation could make it more difficult for us to defend our intellectual property in any subsequent litigation in which we are a named party.

Any intellectual property rights claim against us or our customers, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management attention and financial resources. An adverse determination also could prevent us from offering our suite to our customers and may require that we procure or develop substitute services that do not infringe.

For any intellectual property rights claim against us or our customers, we may have to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to seek a license for the technology, which may not be available on reasonable terms, if at all, may significantly increase our operating expenses or may require us to restrict our business activities in one or more respects. As a result, we may also be required to develop alternative non-infringing technology, which could require significant effort and expense.

Our success depends in large part on our ability to protect and enforce our intellectual property rights.

We rely on a combination of patent, copyright, service mark, trademark and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights, all of which provide only limited protection. We cannot assure you that any patents will issue from our currently pending patent applications in a manner that gives us the protection that we seek, if at all, or that any future patents issued to us will not be challenged, invalidated or circumvented. We do not have any issued patents and currently have eight patent applications pending. Any patents that may issue in the future from pending or future patent applications may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringers. Also, we cannot assure you that any future service mark or trademark registrations will be issued for pending or future applications or that any registered service marks or trademarks will be enforceable or provide adequate protection of our proprietary rights.

We endeavor to enter into agreements with our employees and contractors and agreements with parties with whom we do business to limit access to and disclosure of our proprietary information. The steps we have taken, however, may not prevent unauthorized use or the reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive to ours or infringe our intellectual property. Enforcement of our intellectual property rights also depends on our successful legal actions against these infringers, but these actions may not be successful, even when our rights have been infringed.

Furthermore, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are available. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving.

If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired and investors’ views of us could be harmed.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. Although we have completed the process of documenting, reviewing and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors on our internal control over financial reporting for the year ended December 31, 2008, there can be no assurances that control deficiencies will not be identified in the future.

 

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Implementing any additional required changes to our internal controls may distract our officers and employees, entail substantial costs to modify our existing processes and add personnel and take significant time to complete. These changes may not, however, be effective in maintaining the adequacy of our internal controls. Any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and harm our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements on a timely basis may harm our stock price and make it more difficult for us to effectively market and sell our service to new and existing customers.

Because we recognize subscription revenue over the term of the applicable agreement, the lack of subscription renewals or new service agreements may not be reflected immediately in our operating results.

The majority of our quarterly revenue is attributable to service agreements entered into during previous quarters. A decline in new or renewed service agreements in any one quarter will not be fully reflected in our revenue in that quarter but will harm our revenue in future quarters. As a result, the effect of significant downturns in sales and market acceptance of our services in a particular quarter may not be fully reflected in our operating results until future periods. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, because revenue from new customers must be recognized over the applicable subscription term.

Material defects or errors in the software we use to deliver our services could harm our reputation, result in significant costs to us and impair our ability to sell our services.

The software applications underlying our services are inherently complex and may contain material defects or errors, particularly when first introduced or when new versions or enhancements are released. We have from time to time found defects in our service, and new errors in our existing service may be detected in the future. Any defects that cause interruptions to the availability of our services could result in:

 

   

a reduction in sales or delay in market acceptance of our services;

 

   

sales credits or refunds to our customers;

 

   

loss of existing customers and difficulty in attracting new customers;

 

   

diversion of development resources;

 

   

harm to our reputation; and

 

   

increased warranty and insurance costs.

After the release of our services, defects or errors may also be identified from time to time by our internal team and by our customers. The costs incurred in correcting any material defects or errors in our services may be substantial and could harm our operating results.

Government regulation of the Internet and Ecommerce is evolving, and unfavorable changes or our failure to comply with regulations could harm our operating results.

As Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. For example, we believe increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation, collection, processing or use of personal or consumer information could affect our customers’ ability to use and share data, potentially reducing demand for ERP, CRM and Ecommerce solutions and restricting our ability to store, process and share our customers’ data. In addition, taxation of services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services, which could harm our business and operating results.

 

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Privacy concerns and laws or other domestic or foreign regulations may reduce the effectiveness of our application suite and harm our business.

Our customers can use our service to store personal or identifying information regarding their customers and contacts. Federal, state and foreign government bodies and agencies, however, have adopted or are considering adopting laws and regulations regarding the collection, use and disclosure of personal information obtained from consumers and other individuals. The costs of compliance with, and other burdens imposed by, such laws and regulations that are applicable to the businesses of our customers may limit the use and adoption of our service and reduce overall demand for it.

In addition to government activity, privacy advocacy groups and the technology and other industries are considering various new, additional or different self-regulatory standards that may place additional burdens on us. If the gathering of personal information were to be curtailed, ERP, CRM and Ecommerce solutions would be less effective, which may reduce demand for our service and harm our business.

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and harm our operating results.

A change in accounting standards or practices could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business.

Unanticipated changes in our effective tax rate could harm our future operating results.

We are subject to income taxes in the United States and various foreign jurisdictions, and our domestic and international tax liabilities are subject to the allocation of expenses in differing jurisdictions. Our tax rate is affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses arising from the requirement to expense stock options and the valuation of deferred tax assets and liabilities, including our ability to utilize our net operating losses. Increases in our effective tax rate could harm our operating results.

We may be unable to integrate acquired businesses and technologies successfully or to achieve the expected benefits of such acquisitions. We may acquire or invest in additional companies, which may divert our management’s attention, result in additional dilution to our stockholders and consume resources that are necessary to sustain our business.

We have undertaken an acquisition in the past and may continue to evaluate and consider potential strategic transactions, including acquisitions and dispositions of businesses, technologies, services, products and other assets in the future. An acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the businesses, technologies, products, personnel or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, the company’s software is not easily adapted to work with ours or we have difficulty retaining the customers of any acquired business due to changes in management or otherwise. Acquisitions may also disrupt our business, divert our resources and require significant management attention that would otherwise be available for development of our business. Moreover, the anticipated benefits of any acquisition, investment or business relationship may not be realized or we may be exposed to unknown liabilities.

We may in the future seek to acquire or invest in additional businesses, products, technologies or other assets. We also may enter into relationships with other businesses to expand our service offerings or our ability to provide service in foreign jurisdictions, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing or investments in other companies. Negotiating these transactions can be time-consuming, difficult and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close. For one or more of those transactions, we may:

 

   

issue additional equity securities that would dilute our stockholders;

 

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use cash that we may need in the future to operate our business;

 

   

incur debt on terms unfavorable to us or that we are unable to repay;

 

   

incur large charges or substantial liabilities;

 

   

encounter difficulties retaining key employees of the acquired company or integrating diverse software codes or business cultures; and

 

   

become subject to adverse tax consequences, substantial depreciation or deferred compensation charges.

Any of these risks could harm our business and operating results.

We rely on our management team and need additional personnel to grow our business, and the loss of one or more key employees or our inability to attract and retain qualified personnel could harm our business.

Our success and future growth depends to a significant degree on the skills and continued services of our management team, especially Zachary Nelson, our President and CEO, and Evan M. Goldberg, our Chief Technology Officer and Chairman of the Board. We do not maintain key man insurance on any members of our management team, including Messrs. Nelson and Goldberg. Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, sales, marketing and service and support personnel, including members of our management team. Competition for sales, marketing and technology development personnel is particularly intense in the software and technology industries. As a result, we may be unable to successfully attract or retain qualified personnel. Our inability to attract and retain the necessary personnel could harm our business.

Risks Related to Ownership of our Common Stock

Lawrence J. Ellison or members of his family, and related entities, beneficially own a majority of our outstanding shares of common stock, which may limit your ability to influence or control certain of our corporate actions. This concentration of ownership may also reduce the market price of our common stock and impair a takeover attempt of us.

Entities beneficially owned by Lawrence J. Ellison hold an aggregate of approximately 52.1% of our common stock as of September 30, 2009. Further, Mr. Ellison, his family members, trusts for their benefit, and related entities together beneficially own an aggregate of approximately 63.1% of our common stock as of that date. Mr. Ellison is able to exercise control over approval of significant corporate transactions, including a change of control or liquidation. In addition, if the voting restrictions that apply to NetSuite Restricted Holdings LLC, the investment entity to which Mr. Ellison has transferred his shares, lapse or are amended, Mr. Ellison will be able to exercise control over additional corporate matters, including elections of our directors. So long as Mr. Ellison continues to be either an officer or director of Oracle, these voting restrictions cannot be changed without the approval of an independent committee of Oracle’s board of directors. Mr. Ellison’s interests and investment objectives may differ from our other stockholders. Mr. Ellison is also the CEO, a principal stockholder and a director of Oracle Corporation. Oracle supplies us with database software on which we rely to provide our service and is also a potential competitor of ours.

Our Board of Directors adopted resolutions which renounce and provide for a waiver of the corporate opportunity doctrine as it relates to Mr. Ellison. As a result, Mr. Ellison will have no fiduciary duty to present corporate opportunities to us. In addition, Mr. Ellison’s indirect majority interest in us could discourage potential acquirers or result in a delay or prevention of a change in control of our company or other significant corporate transactions, even if a transaction of that sort would be beneficial to our other stockholders or in our best interest.

 

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Our failure to raise additional capital or generate the cash flows necessary to expand our operations and invest in our application services could reduce our ability to compete successfully.

We may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness and force us to maintain specified liquidity or other ratios. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

 

   

develop or enhance our application and services;

 

   

continue to expand our product development, sales and marketing organizations;

 

   

acquire complementary technologies, products or businesses;

 

   

expand operations, in the United States or internationally;

 

   

hire, train and retain employees; or

 

   

respond to competitive pressures or unanticipated working capital requirements.

Future sales of shares by existing stockholders could cause our stock price to decline.

If our existing stockholders sell or otherwise dispose of, or indicate an intention to sell or dispose of, substantial amounts of our common stock in the public market, the trading price of our common stock could decline. As of September 30, 2009, we have a total of 62.3 million shares of our common stock outstanding. Although shares that are held by NetSuite Restricted Holdings LLC are subject to certain restrictions on disposition and a portion of the remaining shares are subject to our Insider Trading Compliance Policy during certain periods of each quarter, substantially all of the shares held by parties other than NetSuite Restricted Holdings LLC, representing 47.9% of our outstanding shares, are freely tradable, subject to our quarterly black-out periods that apply to shares held by our directors, officers, employees and consultants. If a significant number of these shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

Anti-takeover provisions contained in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions of Delaware law, could impair a takeover attempt.

Our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our Board of Directors. Our corporate governance documents include provisions:

 

   

authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;

 

   

limiting the liability of, and providing indemnification to, our directors and officers;

 

   

limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting;

 

   

requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our Board of Directors;

 

   

controlling the procedures for the conduct and scheduling of board and stockholder meetings;

 

   

providing the Board of Directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings;

 

   

limiting the determination of the number of directors on our board and the filling of vacancies or newly created seats on the board to our board of directors then in office; and

 

   

providing that directors may be removed by stockholders only for cause.

These provisions, alone or together, could delay hostile takeovers and changes in control or changes in our management.

 

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As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock. Under Section 203, our majority stockholder, which is beneficially owned by Lawrence J. Ellison, and our current stockholders associated with members of Mr. Ellison’s family are not subject to the prohibition from engaging in such business combinations.

Any provision of our amended and restated certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

ITEM 6. Exhibits

The exhibits listed below are filed or incorporated by reference as part of this Report.

 

Exhibit No.

  

Description of Exhibits

31.1

   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2

   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1

   Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

Date: November 6, 2009     NETSUITE INC.
    By:  

/s/    JAMES MCGEEVER        

      James McGeever
      Chief Financial Officer

 

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