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Executives

Deb Murphy – VP & Corporate Controller

Jim Baum – President & CEO

Pat Scannell – SVP, CFO & Treasurer

Analysts

Alex Kurtz – Merriman & Company

Katy Huberty – Morgan Stanley

Nabil Eisheshai – Pacific Crest Securities

Paul Mansky – Canaccord Adams

Jayson Noland – Robert W. Baird

Nathan Schneiderman – ROTH Capital

Rajesh Ghai – ThinkEquity

Glenn Hanus – Needham & Company

Brad Reback – Oppenheimer

Netezza Corporation (NZ) F2Q2011 Earnings Call Transcript August 26, 2010 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the second quarter fiscal 2011 Netezza Corporation earnings conference call. My name is Tony and I will be your coordinator today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I will now like to hand the call over to your host for today, Ms. Deb Murphy, Netezza's Vice President and Corporate Controller. Please proceed.

Deb Murphy

Thank you, Tony. Good afternoon, everyone and thank you for joining us on our earnings release conference call for our second quarter of fiscal 2011, which ended July 31st, 2010. Speaking today will be Jim Baum, President and Chief Executive Officer; and Pat Scannell, Senior Vice President and Chief Financial Officer.

Before we begin, I would like to remind you that some of the statements made on this call may be forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to differ materially. These risk factors are described in our most recent Quarterly Report on Form 10-Q, which is on file with the SEC.

In addition, any forward-looking statements represent our views only as of today, and should not be relied upon as representing our views as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our views change.

On this conference call, we will be referencing both GAAP and non-GAAP financial measures. We provided GAAP and non-GAAP reconciliation information in the press release we issued earlier today announcing our Q2 results. The press release is available on the homepage of the Investor Relations section of our website at www.netezza.com. The webcast of this call will be archived in the same section.

I would now like to turn the call over to Jim.

Jim Baum

Thank you, Deb and welcome to you all and thank you for joining us on our fiscal Q2 2011 earnings call. During the call, I will provide an overview of our business and the environment we operated in during the quarter and I will then turn the call over to Pat Scannell for his commentary on the detailed operations of the business and a discussion of guidance.

As you can see from our earnings release, we had a very strong second quarter. We are extremely pleased with the results and we believe they are direct results of our continued strong positioning in an increasingly strategic market segment. The momentum we described the last time we spoke with you is translating into customer transactions as we continue to be able to convert our growing pipeline into closed business.

During the quarter, we closed 28 new customers and experienced significant wins in digital media, financial services, telecommunications, and retail. And geographically, we saw good traction across all geographies.

Our pipeline continues to grow as a direct result of our sales and marketing programs with notable growth in EMEA and North America. We are encouraged by our coverage metrics as they continue to trend upward over the course of the year. We continue to invest in our organization, growing from 447 to 469 employees during the quarter. We hired across the board, but primarily focused our efforts on expanding sales, partnering, and development.

We opened a satellite development office in Cambridge, Massachusetts that is now staffed like our other development offices with extraordinarily talented engineers. We also initiated our operations in China, having now hired the country manager and we signed our first partner agreement in China with Longtop, a leader in IT solutions for the Chinese financial services industry.

We recently imitated our professional services business and have hired the leader and some initial personnel at this point. As we stated in the past, our objective in offering professional services is to provide only high-value architectural level consulting services to our clients to help them architect and design the applications they wish to deploy on our appliances. We don't expect the services business to become a significant revenue contributor during this fiscal year, although we view the ability to provide these services to a select few accounts as highly strategic.

Our investment in developing strategic partnerships to support both our horizontal selling efforts, as well as our vertical strategy continues. During the quarter, we announced a partnership with Cloudera, an emerging leader in providing Hadoop platforms. This partnership will accelerate our ability to leverage the emerging Hadoop distributed storage and processing environment, effectively allowing our customers to create solutions that leverage the strengths of both Hadoop and our analytical database appliances.

In addition, our partnership with NEC continues to progress. We are constantly working with them to enable their sales force, providing training sessions each month to their industry sales teams. The response has been positive and we are seeing increasing pipeline demand as a result. We still see that it will take ongoing effort on our part to help ramp their distribution and we are still early in this process.

Competitively, we continue to see mainly Oracle, Teradata, and IBM in our opportunities. Our win rates in Q2 were typical of what we have historically seen – of what we have seen historically, very high against our primary competitors and nearly 100% against the other entrants. We believe that this is due to our value proposition resonating well, the highest price/performance available, appliance simplicity, reducing total cost of ownership, and very fast time to value. This coupled with our proven sales teams and business methodology positions us very strongly against our competition.

We saw Exadata in approximately the same percentage of deals in Q2 as last quarter and our win rate continues to be at our historically high rates against it. In general, we see Oracle positioning Exadata in OLTP opportunities where there is a need to consolidate multiple servers and not focusing their efforts on the data warehouse. We also find that when we perform POCs against Exadata, the performance and simplicity characteristics of our appliance far exceed theirs. These characteristics enabled significant wins against them in financial services and retail during the quarter.

Teradata continues to aggressively compete and usually fields the 2580 and is now positioning the 2650 products against Netezza in their initial client engagement. Our win rate in Q2 against Teradata was at its historically high level as we continue to demonstrate higher performance, lower total cost of ownership, lower administrative overhead, faster time to value, and overall simplicity of our products and business practices.

Also, as you all know, EMC acquired Greenplum recently, and at this point we have seen no competitive differences in the market. We do expect EMC to aggressively position the Greenplum solution and we believe we are very well positioned technologically to continue to compete effectively against them. Our historical win rates against Greenplum have been near 100%, although we encountered them infrequently. We do not currently believe that the combination with EMC will have a significant impact on their technological competitiveness, although we do expect to encounter them more frequently given EMC's enterprise market coverage.

The industry's pursuit of business improvement to the deployment of business analytics solutions continues at a great pace. Our customers look to Netezza to provide the infrastructure to cost-effectively optimize the environment in which these solutions are deployed. As is my usual practice, I would like to convey the means by which our customers derive value from our appliances through a few real world examples.

In one case, Netezza's ability to easily accommodate complex, in-database analytics has helped one of the largest health insurers in the U.S. offer what is recognized as the best network of health care providers by scoring the quality of care delivered by these providers in less than one hour. This is a process that used to take them six weeks.

In this case, Netezza facilitates in-database analytics with simplicity and high performance, creating a competitive advantage resulting from unprecedented insight into this provider network. This practice was previously impossible with this frequency. So the ability to optimize and improve the provider network based on customer and market drivers is dramatic.

In another case, Netezza's ability to run massive-scale complex analytics over detailed historical data has empowered a large North American grocer to launch a revolutionary marketing campaign, offering individualized promotions to loyal customers for products that they are likely to buy.

In this case, Netezza facilitates large-scale production of individualized campaigns that are predicted to yield high return on investment. The business value was generated through the capability of high performance complex analytics on granular household level data, enabling predictions of the right price on the right product at the right time to the right buyer. This is significant because it was previously impossible, but now with the ability to conduct predictive analytics on household level data across the continent in a short time frame, this customer has generated ROI and time to value far ahead of their expectations.

Although the campaign is not yet finished, the simplicity, performance, and total cost of ownership of Netezza has caused this customer to shut down many of the incumbent vendor nodes within months of going into production on TwinFin as they work to migrate their entire infrastructure.

These customer experiences are typical and solutions that these companies deploy are obviously highly strategic for their business operations.

Moving on to the products, overall, we feel very good about our products, our progress on our roadmap, and the productivity of our engineering team. Release 6.0, a TwinFin software upgrade, which was announced at the Enzee Universe Conference, is slated for general availability in the third quarter. This release doubles the capacity and more than doubles the performance of Netezza appliances through software enhancements only. The release also provides fully appliantized, meaning easy to administer enterprise workload management capabilities.

We currently have several customers and partners doing beta testing on this release and the results are supporting the performance and scale objectives we expect. We will also be including the i-Class extension with Release 6.0. We announced these capabilities as core to our embedded analytics strategy and we now have several beta customers and partners using i-Class to create or embed advanced algorithmic analytics inside the TwinFin appliance, providing significant performance and cost advantages over traditional methods.

The CRUISER high capacity appliance is targeted for availability later this year. The appliance will serve as both a queryable archive to meet the growing retention needs of customers and a system for consolidating disaster recovery from multiple Netezza appliances. CRUISER appliances can hold as much as half a petabyte of user data per rack and scale up to 10 petabytes of user data capacity in a single appliance.

Overall, we believe we remain very well positioned to exploit the growth in this industry as business analytics continue to emerge as mission-critical solutions for businesses of all sizes. Based on our outstanding Q2 results, we feel even more confident in our outlook for the rest of the year.

Now, I would like to turn the call over to Pat Scannell.

Pat Scannell

Thanks, Jim and good afternoon, everyone. We are very pleased with the results of Q2. We added 28 new customers this quarter from across all six vertical markets and all geographies. We saw increasing strength in the continued deployment of TwinFin in all markets. We saw some major upgrades in our installed base from Mustang to TwinFin and 81% of our business was from the installed base.

For Q2, we delivered revenues of $63.8 million, representing an increase of 45% year-over-year. We saw product revenues increase 58% and service revenues increase 18%. International customers represented 23% of our business in the quarter, which is slightly higher than a year ago, as we are beginning to realize returns from the increased investments we have made in both Asia and EMEA over the past year.

We had one customer greater than 10% this quarter. And as discussed last quarter, a majority of the revenue change is due to the new accounting rules that we adopted at the beginning of the year flipped in Q2, making the year-to-date impact of this revenue recognition change less than 3% of revenues.

Today, we have 57 quota-carrying reps on board that drove 89% of the business. Our plan is to continue to invest up to 65 reps over the course of the next six months in all sectors. Our indirect business, which is primarily sales to our analytics service providers, increased over last year, but decreased slightly as a percentage of our total business. But going forward, we expect that this percentage will increase with our expanding NEC relationship.

Our average deal size for TwinFin was $1.6 million, and TwinFin represented 98% of our revenue this quarter. The top four vertical markets this quarter were digital media, telecommunications, financial services, and retail, representing approximately 80% of our business.

I will be referring to non-GAAP figures in the call, unless I specifically say that I am referring to GAAP figures. A reconciliation of these non-GAAP measures to the most recently comparable GAAP measures is available in our earnings press release issued earlier today, which is also posted on the Investor Relations section of our website.

Total gross margins were reported at 65%, down from 68% a year ago. Product gross margins came in at 64%, up from 63% a year ago; and service margins were 69%, down from 77% a year ago.

From a product margin perspective, we have maintained our average selling prices with TwinFin, while seeing stability in our product cost profiles. We have increased our investment in service headcount and have seen increases in our third-party break fix costs as our installed base continues to expand. Both of these contribute to the short-term decline in service margins. However, we expect that the service margin will settle in at the 72% to 73% range as service revenue continues to ramp.

Q2 operating expenses were $33 million, up 24% from $27 million a year ago. Today, we are operating with 469 people, which is up from 392 people a year ago, not including our offshore contractors who represent approximately 80 additional resources. Operating income for the quarter was $8.6 million or 14% of revenue, up substantially from 3.1% or 7% of revenue a year ago in Q2. We realized 8 points of improved leverage in our operating expenses from a year ago. You will see increased investments across all disciplines over the course of the second half of the year, as we position ourselves for our next year – fiscal year '12.

Our tax rate for the quarter was 34% for non-GAAP and 38% for GAAP. We expect our rates for the full year fiscal year '11 to be in the 30% range for both non-GAAP and GAAP.

Net income for the quarter was $5.8 million or 9% of revenue, up from $2.3 million or 5% of revenue from Q2 a year ago. And fully diluted EPS for the quarter was $0.09, up from $0.04 a year ago.

We ended the quarter with $179 million in cash versus $157 million at the end of Q1. For the quarter, we generated $20 million in cash from operations. Included in cash is $30 million of auction rate securities, which is down from $48 million at the end of Q1, as we successfully liquidated $18 million at par during the quarter. Most of our cash is invested in U.S. treasuries and agencies with our principal goal always being preservation of capital.

Accounts receivable DSO was 45 days and we ended the quarter with $32 million of inventory, down from $36 million at the end of Q1. The majority of the inventory on the books is TwinFin, made up of finished goods, systems at partners, our proof-of-concept pool, and some of our development systems. Deferred revenue was $56 million, up slightly from $54 million in Q1. Product deferred revenue was flat, which deferred service revenue increased $2 million.

Turning now to guidance. We continue to see strength in our business across all verticals and most geographies and our expectation is that on the year, we will achieve approximately 30% annual revenue growth over last year. As I indicated previously, we will continue to invest over the course of the second half of this year to further strengthen our position in the marketplace, as we like where we are positioned in the market for next year and beyond. Accordingly, you will see 2 to 3 points of operating margin improvement year-over-year.

I would now like to turn it over for questions. Back to Tony. Thank you.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And your first question comes from the line of Alex Kurtz of Merriman & Company. Please proceed.

Alex Kurtz – Merriman & Company

Yes. Thanks, guys and congrats on the great quarter. Pat and Jim, can you just talk about the yield rates you are seeing from your sales team, and thinking back to the pre-recession, do you think given the pipeline that you can start to hit those kinds of rates again? Obviously this quarter was very strong. Just some color on sort of productivity out of the sales force would be great. Thanks.

Pat Scannell

So if we compare where we are today with where we were at the end of Calendar '08, beginning of '09, this is a different world. We are seeing a return to normalcy, we are seeing consistent performance across the board with the expansion that we talked about in both – in the international arena both in Asia and in EMEA; we are seeing that start to pick up nicely where it now represents 23%. So I think that this is a return to normalcy for us.

Alex Kurtz – Merriman & Company

All right. Thanks, guys.

Jim Baum

Thanks, Alex.

Operator

And your next question comes from the line of Katy Huberty of Morgan Stanley. Please proceed.

Katy Huberty – Morgan Stanley

Hey guys, nice quarter. A couple of questions. On DSOs, we have seen the level come down for a couple of quarters. Is there anything structurally different, given the OEM business or the different partners you are working with, or is this just a sign of consistent momentum and linearity through the quarter?

Pat Scannell

Yes, it's more the latter. And it is consistent linearity, number one; it's customers that are happy with the product paying their bills, number two. And as far as the OEM content of the business, that really hasn't hit the register yet to be a significant portion of driving any type of collection scenarios.

Katy Huberty – Morgan Stanley

Okay. And then, Pat, you talked about support gross margins heading back to the low-70% range. Is that true even if you find success with the professional services business? Would that be a drag longer term?

Pat Scannell

No, I think that the 72% contemplates the addition of the professional consulting services group, and that will start to be a revenue generator fiscal year '12 and the investments that we are making for the balance – for the back half of this year are nominal investments. So that contemplated – that 72% to 73% contemplated those investments.

Katy Huberty – Morgan Stanley

And you think you can get back north of 70% maybe over the next year?

Pat Scannell

Yes.

Katy Huberty – Morgan Stanley

Okay. And then just lastly, I want to make sure I was clear. We talked last quarter about $6 million of product deferred revenue that would drain down from the old accounting method. Did you say that that fully reversed this quarter so the results you put up the next few quarters won't have any positive tailwinds?

Pat Scannell

No. So the $6 million of product deferred revenues, I think still sits on the balance sheet. The – what reversed this quarter, we – if you recall, in Q1, we had a $17 million impact from the accounting change and we had a $14.5 million or $14.9 million impact going the other way this quarter. So the net effect of that was just under $3 million on the year.

Katy Huberty – Morgan Stanley

Okay.

Pat Scannell

So there is – there are still and still is product deferred revenue that will bleed into revenue over the course of the next two quarters.

Katy Huberty – Morgan Stanley

Okay, got it. Thank you very much. And again, congrats on the quarter.

Jim Baum

Thanks, Katy.

Pat Scannell

Thank you, Katy.

Operator

And your next question comes from the line of Nabil Eisheshai of Pacific Crest Securities. Please proceed.

Nabil Eisheshai – Pacific Crest Securities

Hey guys, thank you for taking my question. First, I just wanted to clarify your last comment, Pat, in terms of 200 to 300 basis points of margin expansion in the second half. That's just half over half? Is that – am I understanding that correctly?

Pat Scannell

Yes, that's not what I said. I said 2 to 3 basis points of improvement on operating margins year-over-year.

Nabil Eisheshai – Pacific Crest Securities

Okay, got it. But that's just applying to the second half, right?

Pat Scannell

What's applying to the second half?

Nabil Eisheshai – Pacific Crest Securities

When you say year-over-year, I just wanted to make sure you are talking –?

Pat Scannell

Oh, year – annual – fiscal year '11 over fiscal year '10.

Nabil Eisheshai – Pacific Crest Securities

Got it. Okay. And then on the sales, it sounds like you are going to ramp investment. You have only added two teams so far this year. I think you had said 60 by the end of the year after Q1. Is that still your target, or do you expect that to be higher?

Pat Scannell

We expect that to be higher. As I said in my prepared remarks, it should be 60 to 65.

Nabil Eisheshai – Pacific Crest Securities

Okay. And then lastly, on the customer adds and the deal size, you guys have had pretty good customer adds in the quarter, but a significant portion of the rate – your revenues coming from installed base. Are the new customer adds kind of smaller deals and seeding deals versus what you are seeing in your installed base?

Pat Scannell

Yes, it does vary. And some of those new customers are perhaps less than $1 million in some instances, but they are seeding deals and we do – as evidenced by the repeat business that we are seeing and they do come back in 18 months to a year to two years to come back and purchase again.

Nabil Eisheshai – Pacific Crest Securities

Okay. Would you expect the existing customer business – percentage of business, to go down as most customers move on to TwinFin, and that goes more steady-state, or do you think it will stay at this level?

Pat Scannell

No, I think the 81% is more or less – I think it is anomalous and I think you will see that settle in, in the mid-60s as the business continues to move along. And I think if you look at the last 12 quarters of our business, it has been in the mid-60s with the exception of these past two quarters.

Nabil Eisheshai – Pacific Crest Securities

Right.

Pat Scannell

And these past two quarters has been a large 10% customer in Q1 as we know and a 10% customer this quarter came – which came from the installed base.

Nabil Eisheshai – Pacific Crest Securities

Okay. But that should go back to the more historical rates then?

Pat Scannell

Should, yes.

Nabil Eisheshai – Pacific Crest Securities

Great. Thank you, guys for taking my question.

Jim Baum

Thanks, Nabil.

Operator

And your next question comes from the line of Paul Mansky of Canaccord Adams. Please proceed.

Paul Mansky – Canaccord Adams

Thanks. I want to echo my congratulations on the quarter. As I look at the guidance, obviously you have a track record of bearing on the conservative side, but I want to make sure that we are not missing anything by way of incremental line items that may have you more cautious.

And particularly in the context of what – I mean, you just put up a very, very solid quarter at $64 million. If I look at that 30% annual growth, that implies an average of $63 million per quarter in the back half of the year. Are you intending to signal that type of absolute figure, the deceleration in the back half of the year, are you applying a conservative – an incrementally conservative filter for some reason, or how should we really think about that?

Pat Scannell

Deceleration is probably an overstatement, but I think that we are certainly signaling that the back half of the year would be consistent with the first half of the year, put it that way. We have seen some – again, some 10% deals and large deals that have been in the – both in the first quarter and a 10% deal that happened in the second quarter. So I do think that the 30% or approximately 30% growth does assume that type of quarterly rate. So your interpretation of our guidance is correct.

Paul Mansky – Canaccord Adams

And then – obviously, you mentioned the win rate with respect to Greenplum historically. How does that acquisition by EMC, just in terms of dropping that product under the EMC distribution apparatus, was that weighing on your back half or the potential for any type of sales cycle you are engaged in as people are looking at the product, et cetera, et cetera? Is that factoring into your consideration at all or –?

Jim Baum

It's not, Paul. Obviously, there is some potential for it to elongate sales cycles, but the type of selling process that's required to sell an enterprise analytical database or appliance solution is a fairly complex and sophisticated sales process as you know and I think it's one that while EMC has a very talented sales organization and very good coverage of the enterprise market, it's going to take them quite a while to be able to really get up to speed to effectively sell. So we have not factored that in as a headwind at all in our thinking looking forward.

Paul Mansky – Canaccord Adams

And then lastly for me, what is the current thinking with respect to the unit volume commitment out of NEC over the course of the relationship? I know that you –

Pat Scannell

So the – that is the same as it was when we announced the deal, which is 150 units over the next three years.

Paul Mansky – Canaccord Adams

Perfect. Thank you, again.

Pat Scannell

You are welcome.

Jim Baum

Thank you, Paul.

Operator

And your next question comes from the line of Jayson Noland of Robert W. Baird. Please proceed.

Jayson Noland – Robert W. Baird

Yes, thank you. First question just on the macro; there has obviously been a lot of increased or heightened concerns around the macroeconomic environment. Jim, is your momentum a function of Netezza execution or more awareness of data warehousing or just maybe both?

Jim Baum

Well, I think it's both, Jayson. I mean, we have invested, as we have talked about before, in new processes and people inside the company to deliver pipeline, to generate leads, to generate opportunities in our pipeline.

But I also think that from a more macro sense, the market itself is very visible and – this is what I have said before and I still feel this way, that Oracle has actually been helpful in this regard in really lending credibility and tremendous visibility for the approach of using an integrated hardware/software appliance if you will for these types of applications. But I think it's a combination of those, as well as our incremental sales hiring and prospecting activities that has been generating the momentum in the pipeline.

Jayson Noland – Robert W. Baird

Okay. And last question for me. You may have mentioned this, but I didn't hear any update on entry level. Skimmer product, I'm just wondering if – how that's going and if it's opening doors at new customers.

Jim Baum

Yes, it's going fine. It tends – Skimmer tends to be used as a tool for a development and test environment. So it tends to be sold in conjunction with the TwinFin machine. We continue to work on a few relationships with partners that have – that we hope will give us some channel capability into a lower end of the market. But as our direct sales force takes Skimmer to market, they are generally motivated to sell Skimmer in conjunction with TwinFin.

Now that said, we do see Skimmer used quite a lot in international markets, in particular in Asia – particularly in Asia, because Asia tends to start smaller and then grow over time as we have talked about that phenomenon in Japan in the past.

Jayson Noland – Robert W. Baird

Okay. Thank you, gentlemen. Congratulations.

Pat Scannell

Thank you.

Jim Baum

Thank you, Jayson.

Operator

And your next question comes from the line of Nathan Schneiderman of ROTH Capital. Please proceed.

Nathan Schneiderman – ROTH Capital

Hi, Jim and Pat, thanks for taking my questions. Last quarter, your 10% customer drove $17 million of product revenue. What was the dollar contribution on the product side from this quarter's large customer?

Pat Scannell

I think it was roughly $14 million, just under $14 million.

Nathan Schneiderman – ROTH Capital

Under $14 million? Okay, great. And you told us that you had 28 new customer deals. I was wondering what the number of existing customer deals were – the total number of deals altogether.

Pat Scannell

They were about 30 to 35 TwinFin deals, yes.

Nathan Schneiderman – ROTH Capital

30 to 35? Okay, great. And could you clarify – I was a little confused when you were describing the accounting issue as accelerating $17 million of revenue last quarter, but you had a reversal this quarter of $15 million. I was a little confused on the dynamics there. Could you explain that? And also, what's the implication of this for future revenue either later this year or next?

Pat Scannell

So if you recall, the $17 million of deferred revenue – of revenues that scored, under the new accounting rules got scored in Q1. Under the old accounting rules, that would have been revenue scored in Q2. The revenue that was scored in Q2 gets scored in Q2. So it – the effect of that nets out. So that – when you look at it on a year-to-date basis, the impact is how much revenue, what was the impact of that accounting change on the business – year-to-date on the business, and the impact is that it represented $2.9 million more revenue being scored because of the – because of more revenues in Q1 than reversed out in Q2.

Nathan Schneiderman – ROTH Capital

Okay. Okay, got it. Last quarter, you shared with us that you had a couple of NEC customers already. Could you give us an update on that number? Where do you stand now?

Pat Scannell

So this quarter, we have two additional NEC customers. And again, that relationship is just beginning. So we expect that ramp time – as we had expected with the training and the education of the NEC sales force that that does take time. So we had two additional NEC OEM customers this quarter.

Nathan Schneiderman – ROTH Capital

Got it. And final question for you. On Oracle's Q4 conference call, they seemed excited that they beat you in seven different bake-offs during the quarter. Could you share with us how many times you feel you beat Oracle?

Jim Baum

I don't actually have that number in my head, Nate. As I mentioned, we beat them in some very significant transactions. Our win rate was very good against Exadata and there were some notable deals in financial services and retail where we beat them. But I don't have the number in my head of actual competitive engagements, wins, and losses.

Nathan Schneiderman – ROTH Capital

Okay. Thanks very much. I really appreciate it.

Jim Baum

Thanks, Nate.

Operator

And your next question comes from the line of Rajesh Ghai of ThinkEquity. Please proceed.

Rajesh Ghai – ThinkEquity

Yes, thanks and I add my congratulations.

Pat Scannell

Thanks, Rajesh.

Rajesh Ghai – ThinkEquity

Just a question on the EPS guidance similar to one that was asked by Paul earlier, to – Pat, you mentioned that you expected a 200 to 300 basis point improvement in op margin year-on-year. And if I just look at the op margin that you had in the first two quarters, that's on average around 13% and if I look at your op margin for fiscal '10, that was 7.6%. So do you expect that op margin decline over the next two quarters to get to that 300 basis point improvement year-on-year?

Pat Scannell

We expect a 200 to 300 basis point improvement and I think from a conservative standpoint, that positions us to be able to still invest in the business. So with the revenue discussion that we just had with Paul earlier combined with increased investment that you may see op margins in the second half of the year less than what was generated in the first half of the year.

Rajesh Ghai – ThinkEquity

Okay. And can you share any metrics that reflect the contribution of your new products released this year to year growth and to your pipeline, specifically as it relates to Skimmer, Mantra, and i-Class?

Jim Baum

So the pipeline growth is primarily around TwinFin and Skimmer and again, weighted heavily toward TwinFin. Mantra is continuing to ramp and as you may be aware, we have bundled Mantra with the TwinFin appliances to introduce the capabilities around compliance into the appliance directly. So Mantra is now largely embedded in TwinFin, although we do have some enterprise opportunities and transactions that we have done, but it's a small percentage of the pipeline.

As far as i-Class is concerned, i-Class is a set of capabilities that are available as part of the 6.0 release and so you can't really break them about separately, although we do think i-Class is an important set of capabilities, especially as we market to our partners, as well as end user customers who have a desire to do more sophisticated advanced analytics. So at some level, you should view it as a differentiator for the TwinFin platform.

Rajesh Ghai – ThinkEquity

Okay. And the average deal size has been increasing quite significantly over the past one year if I look at the number that was there. For the July quarter last year, it was $942,000 and this quarter again, $1.6 million. Is that the level of deal size you expect going forward, and what is driving that increase, please?

Pat Scannell

The deal size is since the get-go, and the get-go being when we first started shipping products have consistently been at the $1 million to $1.5 million range. And I think that depending on the mix of transactions, the size of deals that it will stay in that band of $1 million to $1.5 million and there is no one quarter that really dictates the trend.

Rajesh Ghai – ThinkEquity

Okay. And one last question. Two consecutive quarters of 10% customer; what is driving that buying behavior, and do you expect that to occur going forward?

Pat Scannell

Well, I mean, if you look at – this is our 12th or 13th quarter as a public company and of those 12 – out of 13 quarters, we had a 10% customer. It is – in the instances that where the last two recent quarters, it's been customers that have upgraded from Mustang, number one; it's been customers that have made a significant investment in TwinFin. So it's – in every quarter, we do have a 10% customer and we will continue to have that as time goes on. I don't know – could you offer any color on that? Yes, that's it.

Rajesh Ghai – ThinkEquity

All right. Thank you so much.

Pat Scannell

Okay, thanks.

Jim Baum

Thanks, Rajesh.

Operator

And your next question comes from the line of Glenn Hanus of Needham & Company. Please proceed.

Glenn Hanus – Needham & Company

Good afternoon. Congrats, guys. So maybe on the distribution side, could you talk about your progress in the federal sector a little bit? And then with system integrators and other business intelligence ecosystem partners, any particular update you would like to give us there?

Jim Baum

Yes, hi, Glenn. This is Jim. I think in terms of the federal business, we have continued to invest in that business. We have expanded the headcount there slightly. It's one of the areas where we made some headcount investment in the quarter including bringing in some additional resources to help us with the federal specific partners who, as you are aware, tend to operate largely within that ecosystem of the federal government. So that's an area where we have – we continue to see tremendous opportunity and continue to invest in it and work on various opportunities in that space.

Pat Scannell

It was just 10% of our business this quarter.

Jim Baum

In terms of other partnerships you asked about with intelligence vendors and other vendors, I did mention the partnership that we announced during the quarter with Cloudera, which we think over time will be important as an element of integrating with various customers' Hadoop strategies and Hadoop is becoming increasingly popular and we are embracing it through our relationship with Cloudera and other – and through other mechanisms. There is no other news to report on that front other than we obviously continue to be very focused on it and continue to deepen our relationships with all of the major analytics, EPL and DI vendors.

Glenn Hanus – Needham & Company

And then maybe on the competitive front, given Oracle's change in focus a bit, can you talk about whether you are seeing any particular dynamics out in the field that are in effect sort of making your competitive life a little bit easier from that regard?

Jim Baum

Well, the primarily dynamic that you see with Oracle Exadata in the field is that in general – not in every case, but in general, they are focusing much of their effort on the OLTP consolidation opportunity and so there are – they are running a series of plays in the market where they are approaching customers with a value proposition targeted at reducing the cost of running servers that are currently hosting OLTP applications. And the value proposition is to consolidate those servers into a single Exadata environment and thereby reduce the total cost of ownership including maintenance reduction and manpower required to administer the systems and whatnot.

So that's the play that we see them running frequently. As such, they are not as focused on the data warehouse given that – given their focus on OLTP. Where they – where we do encounter them, however, is that in some cases, they will focus on the warehouse, because it's an opportunity in one of their accounts and in some cases, they will even come in with a – an integrated OLTP analytics message and try to convince the client that, in fact, Exadata can solve both problems.

So that's the – that's where we tend to intersect with them most in the market right now with Exadata. With Oracle software, we still see them all the time. That's the large leading incumbent system that's installed.

Glenn Hanus – Needham & Company

And then maybe lastly, have you made it an incremental decision during this quarter to accelerate your investment?

Pat Scannell

It's been – whether it was made this quarter or it's been made – we do second-half reviews that are – that contemplate our forecasts, our pipeline, and so in that second-half review, those decisions were made to accelerate certain investments, yes.

Glenn Hanus – Needham & Company

Okay. Thank you very much.

Jim Baum

Thank you, Glenn.

Operator

And your last question comes from the line of Brad Reback of Oppenheimer. Please proceed.

Brad Reback – Oppenheimer

Hey, guys. How are you?

Jim Baum

Hey, Brad.

Pat Scannell

How are you?

Brad Reback – Oppenheimer

Pat, I think last quarter you talked about the retail business or the retail analytics about 10% of revs. I'm not sure if you gave that same number this quarter.

Pat Scannell

I didn't, actually. It's – it represents about – it's between 10% and 15% of our business this quarter.

Brad Reback – Oppenheimer

Okay. Okay, great. And just to go back to the sort of the 10% customer and the pipeline commentary, you talked about increasing coverage. Just so we are clear, the sense I got from your commentary is that your pipelines are as strong as they have been and have similar makeup, so if you were doing 10% deals historically, it's likely that those are queued up in the pipeline currently.

Jim Baum

I mean, the pipeline has continued to grow. I mean, the coverage has continued to grow. I mean, we measure what we see in the pipeline in various stages of the sales funnel, the sales process if you will, and we track these by industry vertical, as well as by geography. And the answer is yes. I mean, we have seen these metrics continue to grow, and as I mentioned in my prepared remarks, most notably in EMEA and North America.

Brad Reback – Oppenheimer

Great. Thanks very much.

Jim Baum

Okay, Brad. Thank you.

Operator

That concludes the Q&A session of today's call. I would now like to hand the call back to Jim Baum for closing remarks.

Jim Baum

Thanks, Tony. We are obviously – we feel very good about Q2 and our competitive position in our industry and in our markets. And I would like to take this opportunity once again to thank our outstanding employees for their contributions and tireless dedication to Netezza's success, as well as our customers, partners, and shareholders for your continued support. So thank you very much and we look forward to speaking with you next time.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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