Infoblox's CEO Discusses F2Q 2014 Results - Earnings Call Transcript

Feb.27.14 | About: Infoblox Inc. (BLOX)

Infoblox Inc. (NYSE:BLOX)

F2Q 2014 Results Earnings Conference Call

February 27, 2014; 04:30 p.m. ET

Executives

Robert Thomas - President & Chief Executive Officer

Remo Canessa - Chief Financial Officer

Jane Underwood - Senior Director & Investor Relations

Analysts

Kent Schofield - Goldman Sachs

Amitabh Passi - UBS Securities

Jason Ader - William Blair

Vjay Bhagavath - Deutsche Bank

Brent Bracelin - Pacific Crest Securities

Sanjit Singh - Wedbush

Jeremy David - Citigroup

Alex Henderson - Needham & Company

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Infoblox, second quarter financial results conference call.

At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session; instructions will be given at that time. (Operator Instructions) And as a reminder, your conference is being recorded.

I would now like to turn the conference over to your host, Ms. Jane Underwood. Please go ahead.

Jane Underwood

Good afternoon and thank you for joining us to discuss Infoblox's financial results for the second quarter of fiscal 2014. With me on today's call are Robert Thomas, our President and Chief Executive Officer; and Remo Canessa, our Chief Financial Officer.

By now, everyone should have access to our earnings announcement, which we released this afternoon. This announcement may also be found on our website at www.infoblox.com in the Investor Relations section.

Before I turn the call over to Robert, let me remind you that the presentation we'll be making today includes forward-looking statements. These statements and other comments are not guarantees of future performance, but rather are subject to risks and uncertainties.

Our actual results may differ significantly from those projected or suggested in any forward-looking statements. For a more complete discussion of the risks and uncertainties that could impact our future operating results and financial condition, please see our filings with the Securities and Exchange Commission, including but not limited to our Quarterly Report on Form 10-K filed on December 6, 2013.

For the sake of clarity, unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis. Please refer to the tables in our press release and the Investor Relations portion of our website for a reconciliation of GAAP to the non-GAAP numbers we will be discussing.

Now I’d like to turn the call over to Robert.

Robert Thomas

Thank you, Jane and good afternoon. Infoblox reported financial results, which were consistent with the preliminary results that we reported on February 10. Second quarter net revenue came in below our expectations at $60.9 million, which was up 12% year-over-year but down 4% sequentially.

The revenue shortfall in the quarter was primarily attributable to three factors, all of which would not typically happen in a single quarter. Our sales for the first two months of the quarter met our internal expectations, January results ended weaker than we had anticipated, particularly in the north eastern region of the United States and in the central and western regions of EMEA.

We also closed fewer $1 million plus transactions than we typically do. In the second quarter we closed three, seven figure deals versus the usual five or six per quarter. While our large deal pipeline remains healthy, the timing to close these large transactions can sometimes be difficult to predict.

Our federal business also came in below our expectations with the second quarter being our weakest federal quarter in two years. In the quarter a couple of large deals did not close as expected, but those deals remain in our pipeline and we expect to close them. Overall, it was the unusual combination of events that caused us to miss the quarter and we are now taking actions indented to insulate us from these types of events in future quarters.

In light of this, when we reviewed our demand generation activities and sales productivity metrics, it was apparent that we need to focus on new customer acquisition. Over the last two years, our new customer growth rate has remained fairly constant at approximately 200 new customers per quarter. New customer growth is obviously important, because it results in more repeat business. We are refocusing demand generation activities, primarily upon new customer acquisition related to DDI.

Also security has not yet become a meaningful contributor to revenue growth. Over the last several quarters we have placed a significant emphasis on security with a large part of our demand creation activities directed in that area.

While we remain convinced that security will drive future growth, we have not yet seen a revenue return commensurate with the investments that we have made to-date. Importantly, that competitive win rate remains strong in the second quarter and we do not believe competition was a significant factor.

We also continue to view DDI and network automation as emerging markets with strong prospects for growth. In the recent IDC survey of networking decision markers at mid to large enterprises, 57% of the respondents did not have a commercial grade DDI solution intent to buy one within the next three years. On a positive note, our gross margin in the quarter remained strong and was 80%, and from the bottom line perspective, operating margin came in at 11% and EPS was $0.11.

As I do on every quarter, I’d like now to discuss the new customer win for the quarter. This new customer is one of the largest global life insurance companies. This transaction actually started back in early 2012 when the company was looking to acquire an international division of one the world’s largest insurance companies.

At the time, the customer realized the Windows architecture in the Americans and the British Telecom deployment in the overseas company would not scale for worldwide network services. Infoblox completed seven proof-of-concept global deployment designs for both Trinzic and NetMRI appliances, before the customer approved and subsequently budgeted for our solutions. This sales process was particularly time consuming because of the customers legal and procurement process to handover global network deployment.

Investments for Phase I, was made at the end of the calendar 2013 and we expect further Infoblox deployments to be made in Americas, EMEA and APAC. This customer is also interested our DNS Firewall and Advanced DNS Protection Solutions, to secure their network infrastructure from DNS related attacks.

In the second quarter we saw particular strength from the service provider vertical. According to one of our largest service provider customers, mobility is experiencing our full X year-over-year increase in demand for DNS caching performance, which has been driven by the adoption of 4G LTE and the explosive demand for Smartphones, Tablets, and applications that stress network services. And at the same time the transition to IPv6 is becoming increasingly important to largest mobile service providers as approximately 30% of their DNS traffic is now IPv6.

As a result the service providers have two options. They can build multiple service arms to host DNS services or they can experience the operational efficiencies of several centrally managed appliances at each of their data centers, which also protect their customers and their network from security threats.

Our Trinzic 4030 appliances are now installed at some of the largest Tier 1 service providers in the world. We believe our Trinzic 4030 is one of the highest performing DNS caching appliances on the market today.

In the second quarter we also introduced our Network Insight solution, which brings infrastructure data and management together in a single interface, making networks easier to manage and secure. Until now, network data has existed in multiple silos, managed by various IT teams. One silo manages network devices such as routers, switches and firewalls, another silo has information on connected endpoints such as PC, Smartphones and Tables and yet another silo tracks configuration of network services such as DNS, DACP and IP address management.

Network Insight brings these silos together in a single IP address management console, empowering network engineers with the ability to automatically gather a broad range of data, analyze it and take action in real time.

While developing Network Insight we spoke with many networking professionals. One network manger told us that it’s sometimes easier to buy a new switch than determine what ports are available on current switches.

Another manager descried the network outage that impacted several branch offices of his company. After multiple teams worked several days to resolve the outage, they later learnt that the issue was caused by an employee who had installed a home router without permission.

We view Network Insight as a key competitive differentiator, because it helps IT teams overcome the lack of visibility that prevents them from fully controlling and securing their networks. DNS is now being recognized as an Achilles heel in the network and as a result, we are seeing more customers looking for a more robust and secure DNS infrastructure.

In the second quarter we introduced our Advanced DNS Protection Solution. This solution is our first appliance with integrated defenses against a number of security threats, including Distributed Denial of Service or DDoS attacks, Cache Poisoning, Malformed Queries and Tunneling.

In the quarter we had several customers evaluating this solution in their network labs. These customers represent a fairly wide range of verticals, including financial services, service providers and government. We believe the market opportunity for our Advance DNS Protection Solution is quite strong, because it’s the first self-protecting DNS appliance in the world.

In closing, while we are disappointed with our second quarter results, we believe the secular trends driving our markets remain strong. The trends towards mobile devices, cloud computing, virtualization and next generation data centers are placing incredible demands on networks worldwide, and with DNS based attacks up significantly, we have a great opportunity in the security market. We remain confidence in our long-term strategy and we will take the necessary actions to improve our current growth trajectory.

Now I’d like to hand the call over to Remo to further discuss our financial results.

Remo Canessa

Thank you, Robert. I would like to remind everyone that the results I will be discussing are non-GAAP financial results and excludes stock-based compensation expenses, amortization of intangibles and acquisition-related expenses. All share counts that I'll be providing will be on a fully diluted weighted average share basis.

As Robert mentioned we reported financial results, which were consistent with the preliminary results that we reported on February 10. Total net revenue was $60.9 million, which represents the year-over-year increase of 12% and a sequential decries of 4%. Product revenue in the quarter was $31.6 million or 52% of total revenue, which increased 2% year-over-year and was down 12% sequentially.

Service and support revenue was $29.3 million or 48% of total revenue, which represents a year-over-year increase of 24% and a sequential increase of 6%. The increase in our service support revenue is primarily due to our growing installed base of customers with prepaid support contracts that are amortized over the service period. From a geographic perspective, Americas represented approximately 66% of total revenue and was up 17% year-over-year, a decrease of 7% sequentially.

As Robert mentioned earlier, we experienced weaker performance in our federal business near the northeaster region of the United States. EMEA revenue represented approximately 23% of total revenue and decreased 7% year-over-year and was down 1% sequentially.

In the quarter the central and western region of EMEA came in below our internal expectation. APAC revenue represented approximately 11% of total revenue and increased 29% year-over-year and was up 8% sequentially. In the January quarters, product gross margin was 79% compared with 78% in the same quarter last year and 79% in the prior quarter.

Service and support gross margin was 80% for the quarter compared with 82% in the same quarter last year and 81% in the prior quarter. As a result total gross margin in the quarter was 80% compared with 80% in the same quarter last year and 80% in the prior quarter.

In the January quarter, total operating expenses were $41.8 million, which increased $2.1 million year-over-year. As a percent of total net revenue operating expenses decreased to 69% from 73% in the same quarter last year.

On a year-over-year basis, R&D increased 6% and was 16% of total net revenue compared with 17% last year. Sales and marketing increased 4% and was 44% of total net revenue compared with 47% last year and G&A increased 11% and was 8% of total net revenue compared with 9% last year.

In the quarter total operating expenses decreased 3% compared with the prior quarter. On a quarter-over-quarter basis, R&D was unchanged from the prior quarter. Sales and marketing decreased 3% and G&A decreased 6%.

As percent of total net revenue, operating expenses increased from 68% in the prior quarter to 69% in the January quarter. At the end of the January quarter our worldwide headcount was 675 employees. In the quarter we executed to our earnings plan and added 42 employees with the majority in our sales and marketing organizations.

Operating margin for the January quarter was 10.9% compared with 7% in the same quarter last year and 12.1% in the prior quarter. Net income in the quarter was $6.6 million or $0.11 per share. This compares to net income of $3 million or $0.06 per share in the same quarter last year. In the prior quarter net income was $7.1 million or $0.12 per share.

As of January 31, 2014 we had $251 million in cash, cash equivalents and short-term investment. We have net cash provided by operating activities of a record $17.6 million in the January quarter. Total net differed revenue increased by $24.4 million when compared to the same quarter of last year and a $7.3 million increase since the end of the prior quarter. Deferred revenue primarily represents support contracts that amortize over the contract period and to a smaller extent channel inventory and now DNS Firewall subscriptions.

Now I'd like to provide guidance for our April quarter and our fiscal year 2014. As a reminder, these numbers are all non-GAAP, which excludes stock-based compensation expenses, amortization of intangibles and acquisition-related expenses.

As Robert mentioned, we are disappointed with our second quarter results. In terms of our guidance, while we are using the same methodology as we have used in previous quarters, we’ve taken a more cautious stand because of the January quarter miss. We continue to see a tremendous growth opportunity before us and will continue to invest in the company.

For the April quarter we expect revenue to be in the range of $61 million to $62 million or a year-over-year growth of 5% to 7%. We expect gross margin to be between 78% and 79%. We anticipate operating margin to be between 2.5% and 3.5%, and we expect the EPS to be between $0.02 and $0.03 using 57.7 million shares.

For our fiscal year 2014, we expect revenue to be in the range of $250 million to $254 million or a year-over-year growth of 11% to 13%. We anticipate operating margin to be between 7.5% to 8.5%, and we expect the EPS to be in the range of $0.30 to $0.34, using 57.5 million shares.

With that, Robert and I would be happy to take your questions.

Jane Underwood

Thank you, Remo. That concludes today’s prepared remarks. Operator, we would now like to open up the call for analyst questions.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Our first question is from Kent Schofield from Goldman Sachs. Please go ahead.

Kent Schofield - Goldman Sachs

Robert, Remo thank you. You mentioned taking some actions to improve – you have a new customer acquisition engine going forward. Can you give us a little bit of granularity, a little bit of color as to what sort of actions you’re taking and when should we start to see some improvement there.

Robert Thomas

Kent, yes, I think for a while now, as I mentioned in the body of the call, that in demand creation, we have focused quite a bit of energy and time and money on the security offerings we have and aiming a lot of that at our existing base customers. They are the easiest people to go and sell security products to, because they having existing Infoblox infrastructure. And with that, we’ve also introduced over the last 18 months or so other products that are more customer oriented, like reporting severe and so on

So there has been, I think a drift and a pin to spend more dollars on selling to our base, than in trying to attract new customers. And as we think they are through for the future, I think one of the things we need to do is try and increase the number of new names we add every quarter. As I said its been around 200, it was slightly up actually in Q2 over Q1, new name addition. But, I think we need to push that up a big higher.

So in the coming quarters, starting now, actually starting towards the end of last quarter and from here onwards, for a while we will be spending a much higher proportion of their demand creation dollars, their field activities in attracting brand new customers to Infoblox and we’ll still continue of course to sell new products to existing customers, but more money will be spent on increasing our customer base by numbers greater than 200.

When will we start to see that take effect? I think we do have fairly long sales cycle as we talked about before, but I think it will be at least two to three quarters. We’ll see pipelines start to build with new customers a little sooner, because we can add them to the pipeline. But before we actually start to close incremental business beyond the existing customer run rate, I think we can probably expect to see that maybe two, three or four quarters out.

Kent Schofield - Goldman Sachs

And as you go after those new customers, has there been a change in terms of that kind of push-pull dynamic that you talked about? Are you seeing less greenfield opportunity than you did prior as you go after some of these new customers?

Robert Thomas

No I don’t think so. I think we still believe it’s a largely untapped market and the market opportunity is very big. I think we just need to spend more time in front of potential new customers, than perhaps we’ve been spending in the past.

I think one think that we are looking at the moment is in the larger deal numbers we mentioned in Q2, we closed only three seven figure deals, where normally we close five to six. We are looking to see whether it’s a bit of trend in elongation of sales cycle time in the larger deals.

Today as we sell larger opportunities, we are including more products in those opportunities. We sell security, we sell NetMRI as well, and so we sold to more than one buying center. Usually our customer as we expand we reach into them and there’s a bit of a feeling that that might be pushing out sales cycles a bit, because we have more than one buying center involved and more people will have to buy into the decision.

So while there is no hardcore or large body of evidence to suggest that, its kind of a feeling that we have. So we’ll be looking at that too over the coming quarters, to see whether in fact sales cycles are being pushed up by in-sales, where they are selling to different buying centers at the same time.

Kent Schofield - Goldman Sachs

And maybe the last follow-up, Remo is that, when you talk about some conservatism, and its a little bit more conservative I mean your guidance outlook, is that some of what you’re taking into account. Is that elongation of sales cycles?

Remo Canessa

Its really a combination of that missing Q2. The large deal size, going from that last quarter, six down to three, the miss in federal, I mean those are all the reasons that we are being more cautious related to our guidance going forward.

Kent Schofield - Goldman Sachs

Thank you.

Operator

Thank you and our next question from Amitabh Passi with UBS Securities. Please go ahead.

Amitabh Passi - UBS Securities

Hi, thank you. I guess Robert, Remo, just trying to understand the implied reacceleration in fiscal 4Q, what gives you the confidence. And if I've done my math right, it seems like revenue growth sequentially would have to reaccelerate to about 7% just to get to the full-year number. So, maybe you can give us an appreciation of what reaccelerates revenues, particularly as you move into 4Q after a couple of really tough quarters?

Robert Thomas

We mentioned that in Q2 we only closed three seven-figure deals rather the five to six we normal do. We didn’t loose any of the other deals; we defiantly had deals in the pipeline and more of them in that category, in the high-end category.

We do have kind of a nagging feeling that the sales cycle has been pushed out on some of those larger deals. So coming in to this quarter, we feel pretty confident about that pipeline coming in. There are a larger number of big deals that we are looking at as well.

As Remo said, we are somewhat cautious in our guidance going forwarded given the Q2 miss, given the fact that we don’t expect federal to rebound in the next couple of quarters at least. So we don’t expect federal to return to its normal run rate of even growing run rate as well. But all those deals that we have in the pipeline that didn’t close in Q2 and that may be pushed into Q3 or Q4 will come to fruition at some time.

So I think when you look at our guidance for this quarter and our guidance for the second half of the year, Q4 and after that as well, we feel pretty good about being able to achieve that because of what we know about our business today and adding some factor in for perhaps larger deals being pushed a little more.

Remo Canessa

I’ll add onto Robert. We take a look at our six-month pipeline, we look at the three month and six month, that’s what gives us the bases also for what we feel comfortable with for in the fourth quarter.

Amitabh Passi - UBS Securities

And given your effort, you sort of refocus on customer acquisition, maybe should we expect, maybe a couple of quarters of elevated levels of spending on OpEx in general. Maybe you can give us some help in terms of how we should be thinking about OpEx over the next two to three quarters.

Remo Canessa

We’re going to stay with our plan on operating expenses that we had at the beginning of the year. We feel this is a very big market opportunity and so we’ll continue to invest and the primary investment that we are going to make as we made in the past will be in sales and marketing. So that’s the reason that the operating profitability this quarter, the 2% to 3% guidance and for the full year its 7.5%, 8.5% basically reflects our continued investment.

Robert Thomas

Just for me to add to that too, when we said we will be focusing more on new account acquisition, its more a redirection of dollars. We have a reasonable marketing and demand creation budget now I think, but when we examined where we had been spending it over the last two or three or four quarters, it was a bit of a tendency to spend it more on our existing base customers, with trying to sell new products to them and a little less on new names.

So its not an increase in spending necessarily, but a redirection of spending more towards the new name side of the business than to existing base customers. And in fact when we looked at field marketing events, we run a lot of field marketing events every quarter and a large number of the people coming to those events were existing customers. I think we should have the majority of people coming to those events as new prospects.

Amitabh Passi - UBS Securities

And then just one final one for me, I appreciate the color there. Robert, what do you think the challenges have been on the security side? You said the returns have not been commensurate to the level that we invest in. I mean is it the way you’re positioning the products or is it a pricing issue? Why is it taking longer than I guess your original expectations?

Robert Thomas

I think a couple of things. I think when we look at DNS Firewall in particular, there are several different deployment scenarios that a customer can adopt. They can use DNS Firewall at one or two locations in their organization and that will provide significant coverage for what we do. But if they have a very security intense philosophy, then they can deploy it much more widely in their organization, of course generate more revenue for us.

We’re finding that in the early stages of DNS Firewall deployment, the deployments are relatively small. We’re getting a number of customers interested and we think its still a very strong competitive differentiator.

A number of customers are interested, but they are deploying in smaller quantities than we would expect and then when you add to that, the fact that 50% of the booking we would take for that product or even a little bit more in some cases is deferred revenue, in the subscription and therefore recognized over a 12 month period rather than immediately. It contributes to a smaller return than we would have hoped. Its about where we budgeted it to be at the moment in terms of revenue that we thought the uptake may have been a little higher.

And then the other thing is we did spend quite a bit of effort on demand creation activities for DNS Firewall and of course it takes time to sell the product and you had to take away some sales cycle selling other things. So when demand creation dollars are put into it and sales cycle is put into it. We’re not quite sure that today we’re getting the return that we would want for it.

I think its still a big opportunity there, and Advanced DNS Protection, the other product we introduced this quarter, which will have a much higher ASP, because its appliance based. It’s a whole range of appliances rather than a license key. It could present even bigger opportunities for us.

So I think it’s a bang for buck when we’re talking about money we spent on demand creation and sales cycle spend. We haven’t got quite the return we would expect although we are on that budget. We thought we would be ahead of budget.

Operator

Thank you and our next question comes from Jason Ader with William Blair. Please go ahead.

Jason Ader - William Blair

(Inaudible) (Technical Difficulty). You don't think it's demand, you don't think it's competition. So, if I had to think about execution, (inaudible).

Robert Thomas

Jason Ader is a little bit blurry and I got most of it I think, so let me answer the question as I thought I heard them. Correct me if I’m missing something. We went into Q2 with a pipeline that supported our projections and our forecast and we feel good about that pipeline. There’s a number of things that happened in Q2 as we’ve mentioned and I think in the normal world you might not expect all those things to happen in one quarter and so it resulted in a miss.

The pipeline we had going into this quarter I think is very strong, it supports the quarter. I mentioned earlier that we would like to spend more money on new account demand generation than we have been doing in the past, because not only does that add on new names, but it also gives us ongoing business in the future, because we have a very strong return rate from customers and given the sort of circumstances that happened in Q2, I think we would feel much more comfortable with an even more robust pipeline than we have today.

So change in the demand creation activity to go after newer names and focus on forecasting bigger deals in a way that are relevant, I think will give us more confidence in the future. Its not often that the whole group of things conspire in one quarter to create a problem. But when it does, we’d like to have much more coverage, so that we are somewhat insulated from that kind of event again.

So improving that pipeline in the new name area I think is one of the ways of doing that and focusing on some of the higher value sales. The security, as I said is returning decent returns, but maybe not the high value we would like it to do. Focusing on those deals that have higher value, a little bit more than we have in the past is one of the ways that we’re doing that.

So did I answer the question or did I miss?

Jason Ader - William Blair

No, you answered I would say 50%. I guess what I’m trying to get at is, there are fewer million dollar part deals. January slowed down and you made that clear and you gave some analysis of the situation in terms of new customer acquisitions and some of the security stuff.

What I’m getting at is really why you think January slowed down? Why didn’t you think more bigger deals didn’t close? Is there something else that happened? Is there something else that you looked at, because you obviously had the pipeline to support the forecast and the pipeline didn’t play out the way you had hoped for, so I’m just trying to understand if there’s anything else? Is there some regional things that happened that you know is just – was it macro related, was there something else that you felt happening that hurt the business in the second quarter?

Robert Thomas

I don’t think there is anything on the macro front that we saw. I think it was a surprise to us that the federal was significantly below where we expected it to be. I mentioned earlier that it’s the worst quarter we had in federal for two years and so we didn’t expect that and in the next quarter or two, we don’t expect that to improve much.

We do have a nagging feeling that sales cycle time on the bigger deals is being somewhat extended. We don’t have enough empirical data yet I think to be definitive about that, but in looking at the deals we expected to close in Q2 and then those that did and what happened to the ones that didn’t, none of which were lost.

We have a bit of a nagging feeling that as we add more product to what we saw in our larger deal, the security alongside DDI and got off the NetMRI as well and network automation side of it, but as we engage other buying senders beyond just the network guys we normally sell to and we have to get other peoples buy in and other agreement that it can push the sales cycle up, so we feel that that maybe happening.

That maybe a permanent trend if we’re right and the sales cycle has been pushed out. But as we deal with more pipeline in bigger deals and as we build that into the overall forecasting process and general pipeline development, then it kind of takes care of itself by the time as we get more things into the pipe.

So nothing macro, I don’t think and we mentioned we believe we’re as competitive as we ever were. Our gross margins as you can see were very good. We were discounting enormously to get deals that was just standard business practices, so we didn’t leave any more to competition than we though and it was just a number of things in Q2 that happen to come together. Perhaps this elongated sales cycles which caused less million dollar plus deals, federal disappointing beyond what we would definitely expect and then the north east as we said, which was somewhat affected by the larger deals to not getting to where we wanted them to be.

So a combination of things and nothing that threatens our normal business overall. Well, I see demand is definitely not down. We get just as much interest in the product. In fact enquiries, lead generation enquiries are at an all time high in terms of number of enquiries we are generating over the last two or three months, because those haven’t turned into deals yet, because they are enquiries. But nothing that would cause us to indicate the market is saturated or there’s no interest or customers are diverting dollars to other things.

Jason Ader - William Blair

Thank you.

Operator

Your next question is from Vjay Bhagavath from Deutsche Bank. Please go ahead.

Vjay Bhagavath - Deutsche Bank

Yes thanks. Yes, hi Robert, hi Remo; two questions if I may. One is, I was at the IRSA conference this week. I mean I hear a real demand for IP address automation, your DDI product for looking at DNS Security. I think my question to you is, are you reorienting you sales force to look at IPAM DDI opportunities, aside from the bigger deals you know into the mid market, into other slivers of the enterprise and in service providers that you, historically your sales teams would have focused less on, because there was low hanging fruit in the higher end of the market. That’s the first question.

Robert Thomas

I think as we focus on a more new name acquisition, more customer acquisition and we spend more sales cycle and demand creation dollars and time in getting new names, I think we will naturally expand the companies we talk to. Of course we have a lot of large companies that are customers now, but we also have a lot of large – lot of mid organizations too in the 10,000, 15,000, 20,000 and 5,000 kind of employee range, who all are experiencing these kind of problems too in terms of how they manage IP address spaces and DNS becoming extremely vulnerable from the security point of view. So I think it will be a natural extension, our focusing more time on new names than we do focus on a broader range of people as well.

Remo Canessa

Yes, sorry just the other thing I would add to that is that as you probably know and we’ve said in the past, amongst our 900 channel partners worldwide, two-thirds of them, about two-thirds anyway have a security practice as well. So we are doing something on the channel front to help our partners who have a security practice and a networking practice focus on mid market opportunities and small accompanying opportunities than we do generally anyway. So there is a campaign and a push within the channel to focus on that segment too.

Vjay Bhagavath - Deutsche Bank

And the next question is on the DNS Firewall business. I mean you have an outbound use case and an inbound use case. I think my question is when would we start seeing the DNS Security business overall on some steady state trajectory and what I mean by that is your sales people would start – routinely your booking orders for it. You no longer have to push it harder, push it hard from an education point of you. I understand its early stage, so would it be more of earlier fiscal ’15 when you start seeing kind of booking that’s starting to get into a steady state from a sales or the bookings point of view.

Robert Thomas

I think it will be fiscal ’15. I don’t know whether I’d say early or late yet, but I think it would be fiscal ’15. I think just on the channel comment too, I think we’re doing quite a bit of work on training channel partners on DNS Firewall and how they can slot that opportunity into their overall security practice and as they sell customers broader security solutions and co-paying DNS Firewall as one of those layers in that defense and debt strategy.

So I think some of that will depend upon how quickly the channel can adopt the product and so as a normal part of your security offerings to their customers as well. And I think we’re seeing quite a lot of interest in the channel and a quick understanding of how that product works. So the channel will play a part in the adoption cycle too.

Vjay Bhagavath - Deutsche Bank

And you know one final question if I may, which is, would you be worried about some of the specialists and security incorporating one or more of your DNS Firewall capabilities as a feature in their platforms. So how do you feel versus competing with some of the pure plays in the security market? Thank you.

Robert Thomas

I think other people will start to incorporate some level of DNS protection into the security offerings they have. I think Palo Alto networks has already done something along these lines where they incorporate a level of DNS protection.

But unfortunately DNS vulnerabilities are not just limited to one or two things. They are not just outside inner text and not just inside outer text and not just DDoS; they are cache poisoning; they are amplification attacks. There’s 10 or 12 different vectors that are being used today to subvert the whole DNS subsystem to make it an entry point for people who want to insert malware or extricate information.

So I think unless you’re a DNS expert or a DNS provider, its very difficult to provide a complete DNS protection system if your adding bits and pieces in as features to other security products. And we just happened to sit in the right position to do that I think. If people are using are using our DNS infrastructure, then embedded in that infrastructure we can provide our level of security that would be far superior to bits and pieces and features that other people can bolt on to existing security.

Jane Underwood

Operator we’d like to go onto the next question please.

Operator

Thank you. Its from Brent Bracelin from Pacific Crest Securities. Please go ahead.

Brent Bracelin - Pacific Crest Securities

Thank you. I wanted to really follow up around kind of what happened in the quarter. I know you talked about a confluence of factors. But I look at Cisco and NetApp, they actually also saw a bit of a slowdown in January within their Americas business. Your Americas business obviously have slowed, but still good at 20%. It looks like international was much weaker down 3% combined across EMEA and APAC.

As you think about the international magnitude or slow down, I know it’s a smaller region for you, but what’s happening there? Are there other changes that you need to make internationally and how should we kind of think about the slow down that you saw internationally versus lets say Cisco, NetApp with also January quarters that actually saw a bit of a reacceleration in Europe versus what you just reported.

Robert Thomas

Yes, as you said we did see a slowdown in parts of Europe, not all of Europe, but in a couple of parts of Europe we did see it play down. I don’t think there’s anything structurally wrong with that business in Europe. There were also two or three deals, fairly large deals in Europe that we expected we would close during the quarter and we didn’t and they got pushed out for procurement cycle reasons and a couple of other things. So I would say Europe is not generally down. Apart from the two regions that were down for any kind of endemic reason, but more for some specific deal driven regions.

Brent Bracelin - Pacific Crest Securities

Okay. So it sounds like large deal driven internationally and then if I look at your guidance, obviously over the next six months your guidance would imply a product revenue decline year-over-year and as you think about the breakout of our Americas internal, what’s factored in. Are you factoring in Americas that still grew 20% this quarter, going into a year-over-year decline the next two quarters and international kind of going into a deeper decline.

How should we kind of think about what’s factored into your guidance, given the fact that deferred revenue and the maintenance contracts continues to be very healthy and your guidance would imply a pretty meaningful decline in product revenue year-over-year. Is that based on the existing pipeline and visibility and coverage that you have now or is that just a higher level of conservatism going forward around large deals?

Robert Thomas

I mean its based on – again we’ve missed in Q2 and we gave the reasons for that. Going forward we feel we have a strong pipeline; however the large deals did flow going from six down to three. So from a percentage basis, the Americas versus international, we’ve been pretty consistent, about two-third the Americas and a third international. I wouldn’t expect any change with that in Q3 or Q4.

Brent Bracelin - Pacific Crest Securities

Fair enough. And then my last question is around security. I know six months ago was really early, but there was some optimism that security would actually accelerate and shorten the sales cycle and open up actually budget allocated dollars for you guys. Now you’re talking about a potential lengthening in the sales cycle, maybe on a large deal front. But have you seen any sort of over emphasis or sales folks out there trying to lead with security and given it’s soo small that there’s some distractions.

I’m just trying to understand kind of what we thought six months ago of potential security helping and security partners helping accelerate deals and now we’re sitting here looking at the kind of the opportunities being a little tougher and more challenging. How do you explain…?

Robert Thomas

Yes, I think if I could answer on two fronts. One on the large deal size front and when we’re in a large deal, we do try and expand that deal by offering more just DDI and including security and NetMRI and so on. And so as I mentioned earlier, so as we do that we do involve a lot of blanks into this and there’s at least a preliminary feeling that as we introduce things like security into larger deals and so on we might delay the sales cycle a little, because we are including other buyers and they still need to buy into it, so that’s the large end side of things.

I think on the more base oriented or smaller security deals, we have quite a bit of emphasis on the security offerings as you said. We do believe that there is a big opportunity in security for us and we continue to believe that, but we have probably spent a disproportionate number of some non-creation dollars and activities in educating people about security and bringing it to the notice of their customers, their existing customers who have probably the best early prospects for that and in doing that I think we have redirected some activity from what I would call a normal traditional large transaction size business.

And we had I think good results with security. We have a lot of customers who bought DNS Firewall, but they are probably the best practices. Deployment would be different for now as its in the early stages. So organizations would buy one or two or three maybe DNS files and install them at critical points of their network, but perhaps not deploy them as widely as we would think would be a good idea to provide a broader network coverage.

I think part of that is education and part of that is people understanding the value of it, but we have had a lot of smaller sized deals in DNS Firewall and not a large number of large deals and in a lot of cases whether your selling a small deal or a large deal, it can take almost as much time, because you need to go through proof of concept, you need to get budget thought and so on. So I think there has been some part of the time and cycle spent on smaller sized deals.

I think again over time as we educate people and as we get more entrenched in the security business, we will do better with that and with advanced DNS protection, we probably announced last quarter, which is a different product all together and expands our footprint in security, we’ll see even more security opportunities, but its evolving at a slower rate I think.

Brent Bracelin - Pacific Crest Securities

That’s very helpful color. Thank you.

Operator

Your next question is from Sanjit Singh from Wedbush. Please go ahead.

Sanjit Singh – Wedbush

Thank you Rob and Remo for taking my questions. I wanted to go back to the installed base. I know you discussed some more focus on new account generation going forward, but looking back to maybe fiscal year ’13 when we saw some really strong performance, I think 32% growth, how much of the core product DDI clients upgrade cycle, how much of that was a factor driving that growth and then as you look at the recent performance, was there a saturation effect going on with the current installed base. How would you view the role of the core appliance upgrade that’s been going on for the past several quarters?

Robert Thomas

I think when we sell to our existing base it falls into two or three different categories. One is new product, of course DNS Firewall or reporting appliances or other add on products we have. Another is expansion of our footprint in the customers network and I would say the majority of the sales to base customers are generally around expansion of their footprint into their network, whether they include this in another data center or they include it in another geography or they just push us to the edge. So a lot of the business we do with those customers is expansion in that footprint.

And of course there is the third element as you say where appliances are getting old or depreciated and the customer will upgrade them to a new appliance because it’s a replacement cycle for them, so that factors into it as well. But there are really those three categories in how we sold to our existing base and I think the bigger of the three categories or the biggest of the three categories is more about expansion into their networks.

Sanjit Singh – Wedbush

I guess to follow-up on that, is there any sense about how penetrated you are in terms of core DDI and NetMRI. That part of the product portfolio within the customer base is like 20%.

Robert Thomas

Our guess is its not 100% accurate, but when we look at buying patterns of customers and how they come back and buy more over the years and if they continue to be an Infoblox customer and where they are in that cycle, my guess is that with their existing base we are probably 20% to 25% penetrated. Probably less that 25% and probably more than 20% in terms of opportunity within that existing customer for DDI products; that doesn’t include security, it doesn’t include network automation but on a pure DDI front probably in the 20% plus penetrated range.

Sanjit Singh – Wedbush

Great. One other thing that I found interesting is that the deferred revenue growth is actually still very healthy, I think around 28%, and when I look at kind of deceleration in terms of growth of the overall business, how do we square those two factors. Its just a function of, this is just a service revenue part of the business or have you guys booked some longer term contracts over one year that that’s causing that differed revenue to remain in high 20s.

Robert Thomas

It’s just the service part of the business and the other ratios really haven’t changed between one year and three year maintenance. So our renewal rate remains high once we get into customer accounts. The customers tend to renew their maintenance.

Sanjit Singh – Wedbush

And then my last question is, Robert you are talking about the smaller deal sizes in security. But on a steady state, once the security business has ramped up a bit, is the order size profile for DNS Firewall or the security portfolio significantly smaller than the order size profile of the quarter DDI type of order. Is there like a discrepancy there?

Robert Thomas

Yes, I think there is. For example, in our initial order for our DDI customer, it might be in the – for someone who buys 10 or 12 of our appliance, first time customer it might be $60,000, $70,000, $50,000, $80,000 depending upon the customer.

With DNS Firewall and we focused early with DNS Firewall on our existing base, because you get the most benefit from DNS Firewall if you already have an Infoblox infrastructure. It’s a smaller sale, because you are buying a license and a subscription and depending upon the size of the appliance you are putting it on, the license might be from $5 to $30,000 and the subscription might be from similar kind of numbers, $5 to $30,000 or $40,000 and the customer might buy one of those and deploy them in the network and see how that goes and then decide whether they want to push that elsewhere. So it’s a single license in a lot of cases and single fee that customers are buying initially.

Sanjit Singh – Wedbush

All right. Thank you very much.

Operator

Thank you. Our next question is from Jeremy David from Citigroup. Please go ahead.

Jeremy David - Citigroup

Hi, good afternoon. Thank you for taking my question; one for Robert and one for Remo. For Robert, service provider vertical was very strong this quarter from your commentary. What was the revenue growth rate year-over-year for the service provider business? Was it north of 20% of sales?

And then if you could tell us a little bit more about specifically, the contribution of the 4030 appliance. Is that the majority of your service provider sales and any that’s ramping at this point? And then going forward, should we expect the service provider vertical to grow faster than any other verticals?

Robert Thomas

I’ll get Remo to tell you the growth of sales provided year-over-year, because I don’t have that off the top of my head, so I’ll ask him to answer that when you ask him your question.

I think the 4030 does have a lot of opportunity for us and we mentioned that we are in some of the biggest tier 1 service providers in the world now with 4030. Of course they all have a long adoption cycle, and they have a long tier cycle and they go into their labs for a long time. The 4030 has been out now for I think three quarters roughly and we’re just starting to see service providers beyond the couple that we had already start to adopt. So I think we have a lot of confidence in the fact that 4030 can fulfill the unique position in the service providers network.

We mentioned earlier that the kind of stress that 4G phone, LTE puts on the service provider network with DNS, number of DNS queries that they generate, the number of DNS quarries every application that runs on generate is just huge and I mentioned that I think the service provider is seeing a 4X annual increase in DNS caching requirements, and 4G networks aren’t deployed everywhere in the world yet. They are deployed in the U.S. to a reasonable extent, but as you look at Europe its very, very low penetration today and Asia Pacific even less.

So I think we do have a lot of confidence and opportunity with that device in that particular market and we will see some healthy growth from there. Remo do you know the European number on that?

Remo Canessa

:

Yes, so on a bookings basis, the service providers as a percentage of total bookings in the January quarter was in the higher teens, and typically service provider is in the lower teens to mid-teens.

Jeremy David - Citigroup

Great. So Remo, I have another question for you and I’m pretty sure this one's not for Robert, but Robert pitch in if you want. How are you thinking about investing in the business in the near to mid term in terms of operating expenses? Are you still planning to reach your 20% to 22% operating margin target by fiscal Q4, 2015, and if not by when should we expect to see you getting to your target? Thanks.

Remo Canessa

We planned to continue to invest in the business across the board and our investments that we are making no changes from what we originally thought or planned for at the beginning of the year. Our major investments will be in the sales and marketing areas.

From a operating profitability perspective, given that we will lower the guidance to the $250 million to $254 million, our original guidance was that we hit the 20% to 22% operating profitability in Q4, 2015. We still feel that the long term operating model of Infoblox is 20% to 22%, but now we’d expect to hit the 20% to 22% sometimes in fiscal ’15.

Jeremy David - Citigroup

Okay. Thank you.

Jane Underwood

Operator we have time for one more question.

Operator

Thank you and our next question will come from Alex Henderson from Needham. Please go ahead.

Alex Henderson - Needham & Company

Sneaking it in under the wire. First, I'd like to ask you a question about how you think about changing guidance for the April and July period off of the month of January. You guys were talking about business being reasonably solid through December. The month of January is probably the least visible month in terms of giving you good indications on what's going on in the environment of any month of the year, except for maybe December if you’re not in retail. How do you come to a conclusion based off of that one month that alters your April and your July guidance so dramatically?

Robert Thomas

Well as we said in the second quarter, we thought at the end of December we were tracking to where we want to be, as we mentioned all the metrics that we used to judge where we are, linearity in the quarter and all of the deals in the pipeline and all the rest was indicated at the end of December that we would have a decent Q2.

As you said and as we know, January did drop off and when you look at the reasons for it, firstly weak federal, significantly weaker federal business than we expected and we can’t see that federal is gong to recover it he next quarter or two. We don’t believe in looking at federal opportunities, but then you’ve gone away and talking to the federal guys and then talking to their potential customers and existing customers who are buying more stuff.

We don’t see them significantly increasing the business beyond where we were in Q2 over the next quarter or two. Now that’s probably a temporary things in federal, but as least our visibility into federal today, would give us cause to believe that we are not going to see a federal company. So that is one factor that helps us come to a conclusion that we should lower our guidance in the second half of the year.

A second factor as I mentioned earlier is that we only closed three, seven figures deals instead of five or six which we normally do and I think one of the reasons for that is, although not a lot of data yet, but a feeling is that sales cycle have extended out a little bit for those bigger deals.

So we still have a healthy number of seven figure deals in the pipeline at the moment, but we are a little bit more cautious in forecasting when they will close in case there is a patter of extending sales cycles because of maybe selling to more than one buying center and so on all the things I’ve talked about earlier. So that’s a second reason we will be, we would forecast larger deals a little differently, trying to examine whether sales cycles have extend or not.

I think the third thing is that give a group of events that caused us to miss the quarter, we would like to have an even stronger pipeline going into a quarter, so that we can insulate ourselves from a combination of a few events, which would cause us to miss the number, and so focusing our demand creation activities on new account generation and stepping that up, we believe will give us an every more robust pipeline in the future, but that will take a quarter or two or three to start the yield results.

We’ll start to see things in the pipeline sooner, but before they come to a close it will be later. So we would like to get ourselves a more robust pipeline and maybe a bit more breathing room.

And then there's of course the cautiousness, because we did miss Q2. We are a bit more cautious now in the way we forecast, although we look at all the same metrics and we look at it in the same way we did. We are a little bit more cautious in forecasting where we will be just based upon the history of Q2.

Alex Henderson - Needham & Company

The second question along the same lines. So if you missed by that amount, you sort of sound like you're saying, well, I'm going to spend the same amount of money and I'm going to use the same number of salespeople. I’m going to basically do things the way I was doing them and I'm just going to refocus the orientation.

Is there any change in management that needs to happen here in terms of the way the sales force was operating and organized and run, that allowed you to get into the bind that you're in or is it you’re comfortable with your existing team. You're not worried about the quality of people running the various pieces, say European business or whatever that came off.

It seems awfully stable for somebody who’s just saw a 50% hit in their stock price and took that much heat on a quarter and changed the guidance by such a dramatic amount that you seem comfortable with the existing staffing.

Robert Thomas

Well, you know I won't comment on the reduction in the stock price, its just the vagaries of Wall Street. But I think the healthier the business is the more important thing and if we felt that we had misjudged the market, if we have misjudged the opportunity, if suddenly we were dramatically less competitive than we were, if customers were less interested in what we had to offer and demand was lower or we were convinced that we had an extremely sloppy sales execution and a lot of people had just performed badly, then I think we would be looking at those things and do look at those things to see whether we need to make changes.

But I think we have a pretty stable sales force and we have a lot of confidence in our ability to hire the right people. It does take quit a while as we’ve mentioned many times before to reach kind of critical masses of sales guys in our organizing and we do have a lot of people in sales organization that have been there for less than 18 months. So they are still working out to maturity levels.

There is no, and I believe we have the right sales management in place to run the sales force as well. After all we’ve had many, many quarters of solid and we’ve accumulated a great customer base I think, which is a great asset for us as well.

So although we had a misstep in Q2, I don’t think its time to start shooting people and firing people, unless they are not doing the right thing and I don’t think its around core performance in sales execution. There maybe some focus areas we need to focus on more and I think as I said we like to see more new named customers and we are doing things to address that. So I think we feel confident about the team we’ve got.

Alex Henderson - Needham & Company

Yes, last question and then I'll cede the floor back. The way I’m trying to understand the approach to the sales spending, the OpEx spending is that you’ve lowered your revenue guidance, therefore you can't justify increasing spending on OpEx. But if your revenue were to come back, would you then choose to then step up more aggressively to build out a bigger sales organization, to be able to reach more new customers while simultaneously pushing up the performance of your penetration in the existing customers that as you say is only 20%, therefore you have plenty of opportunity on both fronts?

Is the back half stability to the guide on spend because of the lower revenue, and that is therefore an increase in percentage of spend, but if you had more revenue you’d be accelerating it?

Robert Thomas

I think we’ve always said that we believe there is a huge opportunity and the more we invest in it, the more we will make from it. And when we had original guidance of 20% to 22% operating profitability in the July 15 quarter, if growth was continuing beyond expectations, we wouldn’t have brought that guidance in. In other words we wouldn’t have reached that level of profitability sooner because of increased revenue. We would have reinvested the increased revenue back in the business to grow at a faster rate.

So I think when we get to the right levels of growth again, this is a growth business and as we get to those new levels of growth we will meet the targets we promised to meet. But anything beyond that we generate we will invest back in the business, because we do believe the opportunity is big.

Alex Henderson - Needham & Company

Thank you.

Operator

Thank you. And there are no further questions in queue. Please continue.

Jane Underwood

Thank you. I would like to thank you for joining us on today’s call. A replay will be made available at (800)-475-6701 beginning on February 26, 2014 at 4:00 p.m. Pacific. An audio archive will also be available on our website.

Have a good day and we look forward to speaking to you again soon. Thank you.

Operator

Thank you. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Infoblox Inc. (BLOX): FQ2 EPS of $0.11 beats by $0.01. Revenue of $60.90M (+11.9% Y/Y) beats by $0.32M.