Infoblox's (BLOX) Robert Thomas on Q3 2014 Results - Earnings Call Transcript

May.29.14 | About: Infoblox Inc. (BLOX)

Start Time: 16:30

End Time: 17:29

Infoblox Inc. (NYSE:BLOX)

Q3 2014 Earnings Conference Call

May 29, 2014, 16:30 PM ET

Executives

Robert Thomas - President and CEO

Remo Canessa - CFO

Jane Underwood - Senior Director and IR

Analysts

Jonathan Ruykhaver - Stephens, Inc.

Erik Suppiger - JMP Securities

Tejas Venkatesh - UBS Investment Bank

Kent Schofield - Goldman Sachs Group Inc.

Paul Silverstein - Cowen and Company

Sanjit Singh - Wedbush Securities Inc.

Vjay Bhagavath - Deutsche Bank

Amelia Harris - Sterne Agee & Leach Inc.

Jeremy David - Citigroup

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Infoblox's Third Quarter 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). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Ms. Jane Underwood. Please go ahead, ma'am.

Jane Underwood

Good afternoon and thank you for joining us to discuss Infoblox's financial results for the third 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 two press releases, which we released this afternoon. These announcements 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-Q filed on March 7, 2014.

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. Revenue in the third quarter was $61 million which was at the low end of our guidance range of $61 million to $62 million. While we made progress in some areas of the business, we again experienced challenges in closing seven-figure transactions. Specifically, there were two large deals in the northeastern region of the United States where customers simply postponed making purchasing decisions. These transactions remain in our pipeline and we expect them to close within the next few months.

Another issue we faced is that enterprises are placing higher priorities on other IT projects, especially which affects the availability of budget and resources. We believe there are growing opportunities for Infoblox in security but today we are not yet a mainstream player. From a bottom line perspective we continue to achieve a strong gross margin of 79% and reported a better-than-expected operating margin at 6.4% and an EPS of $0.07.

Clearly, our top priority remains reaccelerating revenue particularly product revenue growth. We continue to take actions to better insulate us from deals that slip in a quarter, by focusing more on new customer acquisition related to DDI. We've made good progress in this area which I'll further discuss in a minute. Given our historical nine-month plus sales cycle, it will take at least a couple of quarters before these lead generation activities can be reflected in our revenue results.

In the third quarter we also took steps to streamline our sales management structure, processes and incentives. We added a new Senior Vice President of Global Sales who's solely responsible for expanding our worldwide sales efforts. We also made adjustments to our sales compensation plan to continue to focus on new customer acquisition and product revenue growth.

On a positive note we saw some encouraging signs. First, the changes in our lead generation activities produce good results with a number of new prospect meetings in North America increasing nearly 30% over the prior quarter. The third quarter also marked our strongest quarter for security product sales. Not only did we experience increasing demand for our DNS Firewall and FireEye adapter solutions, but our Advanced DNS Protection or ADP appliance did extremely well.

Approximately half of the organizations that brought our ADP appliance renewed accounts in the quarter, which plays well to our focus on new customer acquisition. The third quarter was the first full quarter of sales for ADP appliance since its launch in January of 2014 and we're off to a good start.

Finally, in the third quarter alone we trained over 200 pre-sale solution architects globally on our security products as part of our channel program. Last month but IDC and Gartner published reports on the DDI market and named Infoblox the market share leader. According to IDC, Infoblox's market share in 2013 grew to 50%, three times more than the number two vendor Alcatel Lucent QIP. IDC also found that the other three major vendors all lost market share. Gartner views Infoblox as the DDI market leader in terms of mainstream brand awareness and estimates we represent 45% of the global DDI installed base.

In the third quarter we have many notable customer wins. I'd like to take a minute to highlight just a couple. The first customer is a large U.S. utility company and a QIP customer. This company had been looking to replace its QIP infrastructure because support for the product was deteriorating and they required a more stable platform. As part of the sales process, the customer also became interested in our security solutions to help protect against external DDoS attacks and internal malware breaches.

The customer's security team was unanimous in support of both our DNS Firewall and ADP solutions, and in particular to provide protection of their nuclear power plants. The customer purchased our Trinzic ADP and Network Insight appliances and DNS Firewall solutions for two large datacenters and approximately a dozen other locations.

The second customer is one of the largest insurance companies in the United States and was another competitive displacement, but this time with Microsoft and Bluecat. The company's DDI infrastructure had become increasingly unpredictable to the point where the customer experienced a major DNS outage which got the intention of the entire company. The customer also complained about poor support as response callback times were very long. The customer purchased our Trinzic appliances and is now in the process of migrating from these two competitors to Infoblox.

In the third quarter we saw an increase in the number of customers including both new and existing experiencing DDoS and other DNS related effects. One existing customer that had a significant malware infestation was a very prominent retailer. This customer saw a large number of DNS queries go to suspicious destinations from their internal network. They purchased our DNS Firewall solution and within four hours of installation, internal uses were secured from going to a potential [botnik] (ph) command and control destinations.

In the quarter we also had a few service provider customers experiencing DDoS attacks. These service providers purchased our ADP appliances which intelligently distinguished between legitimate traffic versus malicious traffic and offers superior protection against DNS based attacks.

Earlier this month we announced that Infoblox is automating network services for enterprises by having integration with the industry's widest range of private cloud platforms, including VMware, Microsoft, HP, CISCO, VMC, CA and ElasticBox. Private clouds are starting to gain traction because they enable agile and scalable delivery of IT services. Gartner predicts that 50% of enterprises will use a combined public private cloud or hybrid deployment by 2017.

By using Infoblox's commercial grade DDI solutions, networking teams will be able to achieve the full potential of private cloud deployments by configuring and managing networks that are scalable, reliable and secure. One customer example of private cloud adoption is with a global telecommunications company which chose Infoblox and VMware's V-cloud automation center to manage and automate their worldwide private cloud infrastructure.

The telco customers are some of the world's largest mobile operators and require fast, flexible, private cloud application services. The customer needs to be able to spin up and take down hundreds or possibly thousands of virtual machines to meet their customers' ever-changing demand. Trying to manually provision and de-provision these many IP addresses within tight service windows would be physically impossible. Infoblox automates the provisioning and de-provisioning of IP addresses and DNS settings for each of these virtual machines, ensuring that VM's can connect to the network.

In closing, while our revenue results and guidance are disappointing, we remain focused on improving sales execution, pipeline depth, new account acquisition and our relevance to secure the trends such as cloud and security. Our competitive position continues to be strong and our addressable market is growing. We believe the long-term opportunities ahead of us far outweigh today's short-term challenges.

Now, I'd like to turn 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'll be discussing are non-GAAP financial results, 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.

Total revenue was $61 million which represents a 5% year-over-year increase and it was flat sequentially. Product revenue in the quarter was $30.8 million or 50% of total revenue which decreased 8% year-over-year and down 3% sequentially.

Service and support revenue was $30.2 million or 50% of total revenue, which represents a year-over-year increase of 24% and a sequential increase of 3%. The increase in our service and 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 62% of total net revenue and was down 1% year-over-year and decreased 6% sequentially. The revenue shortfall in Americas was primarily attributable to the northeastern region and western regions of the United States.

EMEA revenue represented approximately 25% of total net revenue and increased 15% year-over-year, was up 9% sequentially. APAC revenue represented approximately 13% of total revenue and increased 22% year-over-year and was up 17% sequentially. In the April quarter, product gross margin was 79% compared with 78% in the same quarter last year and 79% in the prior quarter.

Services and support gross margin was 80% for the quarter compared with 81% in the same quarter last year and 80% in the prior quarter. As a result, total gross margin in the quarter was 79% compared with 79% in the same quarter last year and 80% in the prior quarter.

In the April quarter, total operating expenses were $44.6 million, which increased $4.8 million year-over-year. As a percent of total net revenue, operating expenses increased to 73% from 68% in the same quarter last year.

On a year-over-year basis, R&D increased 5% and was 17% of total revenue compared with 17% last year. Sales and marketing increased 14% and was 47% of total net revenue compared with 43% last year. G&A increased 16% and was 10% of total net revenue compared with 9% last year.

In the quarter, total operating expenses increased 6% compared with the prior quarter. On a quarter-over-quarter basis, R&D increased 4%, sales and marketing increased 7% and G&A increased 13%. The increases in all three expense areas were primarily related to headcount.

As a percent of total net revenue, operating expenses increased to 73% in the April quarter from 69% in the prior quarter. At the end of the April quarter, our worldwide headcount was 684 employees.

Operating margin for the April quarter was 6.4% compared with 10.8% in the same quarter last year and 10.9% in the prior quarter. Net income in the quarter was $3.8 million or $0.07 per share. This compares to net income of $6 million or $0.11 per share in the same quarter last year. In the prior quarter, net income was $6.6 million or $0.11 per share.

As of April 30, 2014, we had $262 million in cash, cash equivalents and short-term investments. We had net cash provided by operating activities of $9.5 million in the April quarter. Total net deferred revenue increased by $18.3 million when compared to the same quarter last year and was flat compared with the prior quarter. Deferred revenue primarily represents support contracts that amortize over the contract period and to a smaller extent channel inventory and DNS Firewall subscriptions.

Now, I'd like to provide guidance for our July 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 have taken a number of actions to improve sales execution and reaccelerate the company's top line growth. Given our long sales cycle, it will take at least a couple of quarters before improvement can be reflected in our revenue performance.

As a result, for the July quarter, we expect revenue to be in the range of $60 million to $61 million or a year-over-year decline of 3% to 5%. We expect gross margin to be between 78% and 79%. We anticipate operating margin to be between breakeven to 2% and we expect EPS to be between breakeven to $0.02 per share using 56.9 million shares.

For our fiscal year 2014, we expect revenue to be in the range of $245 million to $246 million, operating margin to be between 7.5% and 8% and EPS to be in the range of $0.30 to $0.32, using 57.1 million shares.

Despite the disappointing guidance, we believe there are a number of positives for the company. We are the leader in the DDI market according to both Gartner and IDC. We're also seeing early signs that our lead generation activities are producing good results and our six-month sales pipeline has grown.

While we've seen some deals push out as a result of priorities on other IT projects, especially in security, we believe we have a relative story to tell on how Infoblox play a larger role and where IT dollars are being spent today. No doubt there is more work to be done, but we continue to believe there is a great opportunity before us.

With that, I would like to turn the call back over to Robert.

Robert Thomas

Thank you, Remo. I want to turn to today's other announcement, my resignation from Infoblox as part of an orderly CEO succession plan. I'm extremely proud of our progress and accomplishments over the last 10 years and I'm honored to have the opportunity to lead such a great and talented team of professionals.

At the same time, I'm at a point where I want to move on and transfer Infoblox's home to a new generation of leadership. I realize many people will ask why now? There is never a perfect time for this type of transition, but today we have strong customer relationships, the leading technologies and deep management talent which should provide a great base to drive the next phase of growth for the company.

The Board and I have agreed on a succession strategy which includes immediately appointing a firm to conduct the search for my successor. In the meantime, nothing really changes. It's still business as usual. I remain confident in the company's long-term opportunities and success and will work to ensure a seamless succession process.

With that, Remo and I will be happy to take your questions.

Jane Underwood

Thank you, Robert. That concludes today's prepared remarks. Operator, we would now like to open up the call to analysts questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Jonathan Ruykhaver with Stephens, Inc. Please go ahead. Your line is open.

Jonathan Ruykhaver - Stephens, Inc.

Yes. Good afternoon. Robert, sorry to see you stepping down or announcing your intent to step down, especially at this juncture. Robert, the comment that you made that spending on Infoblox is just not the top priority that you thought it might be would suggest that the market is also not the market that we might all think it is. And given how big you are as a percentage of the total market, and your recent growth would imply that market growth is really only single digit, so I just want to explore in more detail what do you see that makes you think growth will truly accelerate?

Robert Thomas

Well, Jonathan, I think there are a couple of things. First of all, I think we said before that I believe growth in the DDI market is primarily driven by what we spend on demand creation. And I think as we said in the past, if you go back now four quarters or so, maybe a little bit more to the January quarter of 2013 when we first introduced some DNS Firewall products, I think several quarters after that we focused on more security demand generation than we did DDI generation and I think as a result of that, probably the DDI market lost some momentum because we were spending more money on securities than we had on DDI. I don't believe the market opportunity has changed. In fact we just completed an internal survey of the companies we think are targets for us and even if you look at the very top of that pyramid, companies of 50,000 employees or more, there is about 1,500 companies in that category worldwide and we have about 200 of them as customers. But I do think that there is more competition for IT spending and IT resources today than there was maybe two or three quarters ago and I do think even the security has always been a very hot topic and always a segment that IT guys would spend money on, CIOs would spend money on. I think it's become even more important over the last two or three quarters. So I think IT priorities have changed a little bit and the allocation of resources has changed. I don't think it changes the overall opportunity for us but I think as we have seen, it does push out some of our opportunities to a later stage. We had customers say that the budget is approved, I've got the money to spend on the solution for us, but they don't have the resources to implement it and there are other IT priorities that they need to implement first. So I think there are some things that are ahead of us in the queue even when we get budget allocated to us.

Jonathan Ruykhaver - Stephens, Inc.

Can you comment on those deals that slipped from 2Q, have any of those deals closed? And also update us on the activity in the federal vertical, where you saw some weakness in January as well?

Robert Thomas

We've closed from the second quarter. We have closed a couple of those deals that slipped and the other deals that slipped from the second quarter still are in our pipeline and we're still working them. We said, I think on our previous call, that we didn't anticipate the federal deals that slipped to close in either Q3 or Q4 and that's still our belief. I think they have been pushed out a little longer.

Jonathan Ruykhaver - Stephens, Inc.

Have you lost any of those deals in the pipe due to competitive dynamics?

Robert Thomas

No. Of all the deals that we said were pushed out none has been lost to a competitor and none that I know of has been eliminated as a possibility.

Jonathan Ruykhaver - Stephens, Inc.

Okay. All right, I'll let someone else have their shot. Thanks.

Operator

Next, we turn to the line of Erik Suppiger with JMP Securities. Please go ahead.

Erik Suppiger - JMP Securities

Yes, thank you. First off, maybe you can give us a little sense what your security contribution was during the quarter? And can you talk a little bit about how the changes you did and making in terms of incentives and how you're directing your sales organization to focus more on new accounts at this point?

Robert Thomas

So the sales incentives thing first and then Remo, you can talk about what percent of security was during the quarter. At the beginning of Q3 I think we mentioned that we had changed our incentive plan to focus much more on newer account opportunities. And not only were we changing, in other words we pay a guy more money to bring in a new opportunity than to upgrade base customers to other products of ours. But not only did we do that, of course we focused demand generation significantly around DDI and new opportunities as well. So directing the sales guys effort in the field and the thing he spends time on everyday more towards newer opportunities by demand creation and appointments we set up for him. And so those two things we started at the beginning of Q3. I think we're seeing some benefits of that as I mentioned earlier. The number of new name accounts that we called on in Q3 or Q2 was up 29%, so pretty close to 30%. The number of new opportunities that we're working that may not yet have converted into pipeline although some of them have is up as well. And even in Q3, although we can't attribute it to any changes we made at the beginning of Q3, we did sign about the same number of new accounts as we have in the past around the 200 mark, but the bookings contribution of new accounts was up as a percentage over existing customers. And then going into Q4 on the product front, prior to this, a sales guy was rewarded equally for maintenance renewal or product sales and maintenance goes along with that. And so by focusing more on product, we think we will build the product pipeline to a greater extent and encourage sales guys to spend less time on maintenance renewals and more time on new product. And we'll change the compensation plan such that product sales will 3x the value of maintenance whereas there were equal in the past. Remo, could you answer the question on…?

Remo Canessa

From a security perspective, last quarter on a revenue basis, we were right about 1%. This quarter we had a strong security contribution to revenue. It goes between 2.5% and 3% during the quarter.

Erik Suppiger - JMP Securities

Okay. And just a question on the competitive front. Have you seen any change – do you think that Bluecat has made any difference or have you seen any change from any of the emerging players that changed the landscape at all?

Robert Thomas

I think it's certainly not on the Bluecat front. In fact when we compare quarter-over-quarter Q3 over Q2, the actual dollars of business lost Bluecat decreased in Q3 over Q2. I think though that where we are seeing a bit more competition and I think in time it could become greater competition is through Microsoft with Server 2012 as they continue to introduce more IPAM and DNS features. So, existing customers of Microsoft will spend more time looking at their solution rather than not looking at it at all in the past. I wouldn't say that we have lost a lot of business to Microsoft because of that, but I would say there's a risk that we need to follow in the future and make sure we remain extremely competitive with Microsoft and in fact we have an internal plan underway to make ourselves extremely competitive to Microsoft.

Erik Suppiger - JMP Securities

Okay. And any chance the timing on how long the CEO search will take?

Robert Thomas

We haven't – we have just kicked it off. We have chosen the search firm and we've briefed them and they haven't even started I think making calls yet, but they will from now onward. My guess it's going to be somewhere in the four to six-month kind of range, so as far as I'm concerned it's business as usual working through the next two quarters to make sure that the things we've put in place are in fact improving our opportunities, our building our pipeline, that we're doing better on new accounts. So it's working all the things that we have put in place to improve our top line growth over the next two quarters and now expect us to see those things – as I said, it started to take hold already but continue to take more hold of the following two quarters while I'm still at the helm.

Erik Suppiger - JMP Securities

All right. Well, sorry to see you go. It's been good to work with you over the years.

Robert Thomas

Thank you.

Operator

Next, we turn to the line of Amitabh Passi with UBS. Please go ahead.

Tejas Venkatesh - UBS Investment Bank

Hi, Robert and Remo. This is Tejas filling in for Amitabh. Specifically as it relates to the federal vertical, I was curious if you have seen any change in the competitive environment, because I think there was some talk of one of your competitors selling to a Chinese company, wondering if that will open up any opportunities for Infoblox?

Robert Thomas

Yes, one of our competitors did sell to a Chinese company. Although that affects the entire market, enterprise as well as federal and probably more enterprise than federal, I don't know that they're that strong. In the federal space, I don't think we're seeing much change in competition at all.

Tejas Venkatesh - UBS Investment Bank

Got it. And as a follow-up, if you were to rank order a core DDI network automation and security in terms of potential growth rates over the next two years, what would the order be?

Robert Thomas

I think given that we need to continue to see improvement in our pipeline and the demand creation changes we made take effect, in a normalized world where they do take effect, I think the growth in DDI will be significant once those effects take place. I do think as we've said before though that security can be 20% or even 25% of our business in the medium term; medium term meaning two years, two and a half years or so. And we were very encouraged by the last quarter. As we said, we introduced new product called Advanced DNS Protection which is a range of appliances that has built into it a protection against about 10 or 12 different DNS attacks including DDoS protection; so not what DNS Firewall does but covering the other nine or 10 or 12 DNS vulnerabilities. That was all introduced in April. We did a reasonable business in the first quarter with some very, very short sales cycles on some customers. We have a traditionally long sales cycle, about nine months, but we saw some very interesting sales with very short sales cycles three months or less in some cases. Now I don't know that that will be the norm in the security space but the understanding of what product did and the benefit it brought was very quickly understood by some customers.

Tejas Venkatesh - UBS Investment Bank

Got it. Thank you.

Operator

Next, we turn to the line of Kent Schofield with Goldman Sachs. Please go ahead. Your line is open.

Kent Schofield - Goldman Sachs Group Inc.

Great, thank you. If you could talk a little bit about the Microsoft competition; they did some updates to their products towards the end of last year. Can you just give us a sense as to when you talk about seeing more competition from them or can you talk about it from a deal metric standpoint or just give us some idea as to how that dynamic has changed, how it's impacting bringing on new customers or having existing customers add to their current installed base of Infoblox?

Robert Thomas

I don't think it really changes what existing customers do. We find generally that once someone has been bitten by the Infoblox bug and start to install their stuff that it's a bit contagious and they see a lot of benefit and they continue to deploy it over it. As we've shown I think many times with the return rate of customers coming back and buying more. I do think though as Microsoft has added other capabilities that existing Microsoft customers who aren't Infoblox customers are more inclined to look at what Microsoft does have to offer and to spend some time evaluating it. Now I think today we are still a long way ahead of them in what we do in the DDI space. They don't have anything like the Grid, for example. They don't have a single management platform. We give a much wider network view of that environment than they can do. But there's no doubt that when it's installed on a box for free, the customer is going to look at it a bit more closely than he has in the past to see whether it can work. We are developing I think a much more competitive strategy against Microsoft. And when you think of DNS as a vulnerability and more and more companies are starting to see that the whole DNS infrastructure is quite insecure and can allow a lot of people into the organization that they don't want. Installing a secure DNS infrastructure rather than an insecure one, which is what Microsoft has today, can become a compelling thing for people to do. So part of our approach I think as we sell against Microsoft and that's the vast majority of who we sell against in the installed base of Microsoft will be to show customers why a secure DNS infrastructure is much more important than just a DNS infrastructure. So I think we had some very strong competitive advantages but we need to change the playing field somewhat.

Kent Schofield - Goldman Sachs Group Inc.

That's helpful. Can you remind us again from just a tactical standpoint what can Microsoft do in terms of the entire DDI environment versus what you can do? And then again, just maybe some color in terms of where you think we're at with regard to customers evaluating the Microsoft proposition? I mean are we still early days in that and we can expect kind of extended sales cycles as they continue to evaluate that or we – again, did they make some updates in the last two, three, four quarters and they've – now customers have gotten a chance to look at that and there's a potential they start to look more at solutions like Infoblox?

Robert Thomas

I think in the last 12 months or a bit less, Microsoft has filled a couple of holes in their DNS offering that they had in the past and we were often exploiting. As they had no IPAM, for example, in the past and now they do have IPAM. Mind you it's not the kind of comprehensive IP address management that we have and it doesn't contain the same kind of rich data that we have and you can't access a network wide view of it as you can with us using the Grid, but they have made some progress in that case. They have closed some other things, simple things. They didn't have fail over, for example, in the HTP and that was a hold that we could exploit in the past. So there were a couple of things that they have closed and I think they're adding. But if I had to compare their product to ours, our product is a 6.8 version. We've been at it for years. We've added a lot of things, a lot of management capability, a lot of redundancy and so on and Microsoft is about version 1.0. They will no doubt get better but I think we need to be ever vigilant of what Microsoft can do. They are a larger organization with a big and powerful machine and installed in almost every IT shop in the world. So they have a presence there as well. So I think it does become a little bit more difficult to sell against them. But at the end of the day I think if we have the right strategy and have the right kind of approach to what we are selling, we're not just selling DNS and DHCP, but we're selling data management, we're selling a secure environment and we're selling many other things. If we refine that message well, then I think we can prevail.

Kent Schofield - Goldman Sachs Group Inc.

That's helpful. And then last and I apologize, I was a little late joining the call so happy to take this offline if you've already covered it, but can you talk about where Thorsten is in terms of his coming on board and what some of his priorities are on the sales side?

Robert Thomas

This will be Thorsten's first full quarter with us. He joined mid in Q3, so starting this quarter will be his first quarter. He is fully in control of the worldwide sales organization now. So, as you know, Chris Andrews in the past was kind of doing double duty on running support in PS and training and worldwide sales, so Thorsten now is responsible completely for worldwide sales. He's looking at a number of things that I think one of the things that he's having sales guys focus on in this quarter both through the way we manage them, they way we review opportunities and the way we pay them is the product component of what we do and so we are deemphasizing maintenance and support and renewals and so on, much of which follow our product sale and applying much more relevance and dollars to product which is an important part of revenue. If you look at our numbers, we've been a little bit flat and sometimes all down on product in the last two or three quarters as of previous quarters. We need to get that up, so there's a renewed focus on that. He's also instituting a very comprehensive review process for our bigger opportunities. One of the things that we have not done well over the last two quarters is the closing of larger opportunities even though we have many of them, we haven't closed as many as we would expect to close and that trend continued from Q2 into Q3 as we mentioned in the call. There's a much more rigorous approach now to understanding the decision-making process in large opportunities, getting to decision makers earlier in the sales cycle, understanding sooner rather than later what impediments there maybe from getting through the technical recommendation, the budget recommendation to an actual PO. So there's a lot of emphasis on that as well.

Kent Schofield - Goldman Sachs Group Inc.

Thank you.

Operator

Next, we turn to the line of Paul Silverstein with Cowen and Company. Please go ahead.

Paul Silverstein - Cowen and Company

My apologies for bringing up the issue again, I actually listen to all the questions and responses but I just want to make sure I understand with respect to this Microsoft issue which we're really hearing about for the first time in terms of the change in Microsoft going from being a problem that most enterprises who Microsoft in the past which was an opportunity for BLOX to now becoming a competitive threat and you're talking about some market issues in terms of diversion of spend to other priority projects away from DDI in general as opposed to competition. When you discuss the Microsoft issue, is this all perspective or is a – I'm trying to understand to what degree the recent problems that you've already encountered are Microsoft specific, competitive specific as opposed to diversion – your comments about diversion of spent away from DDI in general? Are you telling us that Microsoft is purely a perspective issue that you're leery about and that you have plans in place to address or has that in fact been the primary issue or significant issue over the past several quarters?

Robert Thomas

We've mentioned Microsoft I think at least in the last two or three calls has something that is emerging and something we need to keep an eye on, because they have more functionality and provide more to their customers free of charge than they have in the past. So it's something that we have been watching for a while. And I wouldn't attribute a lot of dollars in actual deals lost because of what Microsoft does today. I don't think they have yet and I don't think we're seeing that yet. I do think though of course that you have to watch that because many people are being caught by ignoring a large competitor entering the market than suffering later on. The browser market is a perfect example of that. So I wouldn't attribute a lot of dollars to Microsoft. It's loss sales to Microsoft. I think it might creep up a little bit but I wouldn't say it's huge at the moment but we need to keep an eye on it. I think the bigger issue is that we are finding today that as we see deals not close in the quarter that get pushed out a little, it's more with other IT priorities and lack of resources in the organization that causes that to happen where other things become a bit more important than us, then that will be done first and they will implement that first and we might get pushed out a quarter or two. I think if we look at several deals in the last quarter that got pushed, none of them was abandoned as a project, none of them was lost to a competitor who came in at the last moment or had a decision reversed or somehow got the deal away from us. A number of them pushed out because we didn't understand the decision making process and we weren't high enough up the tree in the organization to anticipate that there might be a delay in getting the order because there were other things that needed to happen in the C-level offices or somewhere else that we didn't know about. Others were pushed out exactly as I said. They were changes in the IT priority, something became more important. A lot of times it was security related but not all of the time. So it's more the version of IT resources and sometimes budget to other things at the expense of us.

Paul Silverstein - Cowen and Company

Robert, my apologies, but if I can push you. In the case of these slipped deals, the couple of million dollar plus deals, are you telling us that it is not the case, to the best of your knowledge, it's not possible that maybe the slippage is that these guys are evaluating, now that Microsoft has a richer solution relative to what it had previously, that that's not playing into some reevaluation of the direction they want to go in?

Robert Thomas

That sounds like a legal comment to the best of my knowledge…

Paul Silverstein - Cowen and Company

I'm a former lawyer. Sorry, that's how I speak.

Robert Thomas

To the best of my knowledge that is not the case, categorically not the case that someone has said, well, thanks for your $1.5 million quotation but Microsoft has this free and I'm going to go away and review that and see whether I can get (indiscernible) for Microsoft for nothing, no, not the case.

Paul Silverstein - Cowen and Company

Okay. I'll pass it on. Thank you.

Operator

Next, we turn to the line of Sanjit Singh with Wedbush. Please go ahead.

Sanjit Singh - Wedbush Securities Inc.

Thank you for taking my questions. I wanted to get your sense on the channel. A lot of them sell stuff in addition to Infoblox, whether it's security or networking products. And with your sales cycles significantly longer than some of the other product lines that they sell, how do you get the channel to push the Infoblox core products? How do we think about that over the next couple of quarters?

Robert Thomas

Well, I think the short answer is we don't. What you say is absolutely true that our sales cycle is much longer than a channel is accustomed too, our product is more complex than a channel is accustomed too and it's very difficult for one of our channels to find an opportunity on their own, work that opportunity and bring it to closure with little or no hope from us. At channel today is primarily used as part of their demand creation program. So, for example, we would go to one of their channel partners and say that we want to run a seminar on cloud enablement. Can you invite 40 of your customers that have this kind of profile, this size company, this many employees, this kind of IT network, can you invite them along to that so we can talk to them about what they're doing on cloud and how we can participate. And then we would present, we would help qualify. The channel would work with us in trying to solve that but we do a lot of heavy lifting and that's very true of most of our channel today. Now, we do have some channel partners, usually some smaller ones, who are very well versed in our product and who tend to sell a smaller range of products, maybe seven or eight different products rather than 20 or 30 which some of our larger channel guys do and have learnt how to qualify a prospect and to sell. And so we are seeing some people making headway in this space. The bigger opportunity for us from a channel leverage point of view in the future is around security because we have many channel partners who already have security products they sell. They quickly understand how their security products fit into the overall security landscape; were they different shaded from other security products and why that might add value. And so as I mentioned on the call, we trained a couple of 100 solutions architects from their channel in the last quarter specifically in security offering and how to sell it. So I think we might get a bit of lift from the channel in the next quarter or two or three on the security side of things, but it's unlikely we will on the DDI side of things.

Sanjit Singh - Wedbush Securities Inc.

I guess as a follow-up to that, it sounds like currently the business is heavily direct touch. And if we're trying to think about achieving some of these long-term targets in terms of your total addressable opportunity, does it make sense for Infoblox to be part of a larger organization where there's more sales resources, perhaps someone to evangelize the entire space? How do you think about Infoblox as a stand-alone entity, if a lot of the business is so heavily aligned on direct touch?

Robert Thomas

I think making us part of a larger organization is folding us into someone and then assuming that that largest subset – let's say CISCO bought us and CISCO drops 7,000 or 8,000 salesmen running around the country knocking on doors today. I don't think we will see a lot of extra lift from that. It takes about two years for one of our sales guys to get from zero to full productivity and it is because we can't go and hire a sales guy who understands what we do. We really have no true competitors. And what we sell is very different from networking infrastructure, from security, from enterprise software, from anything else. So a sales guy has to learn the business, he has to understand how to sell that to a customer and they can't even see or contemplate how 6,000 or 7,000 CISCO sales guys could be taught to do that in a short space of time and have it as part of the bag to go and sell. So it will be very difficult to do that. I think when we get back to a point where we have increased our pipeline and given ourselves more coverage through pipeline depth and growth and focusing our demand creation around the whole DDI market which is what we have generally done in the past but for some quarters just before this we focused on a security aspect and build the solid platform around that, then you'll see our business go back to what I would call more traditional growth levels. When we are focusing on creating demand in this space, then we will get back to more traditional growth levels. I think the second thing that's important and we're starting to see the very, very, very first early signs of it is that as people start to deploy private clouds, we can build ourselves into a private cloud solution that makes that private cloud more easily implemented, better managed and more reliable. And we mentioned on the call today one customer who has incorporated us and is using this as part of his private cloud deployment. We can build ourselves into projects that have funding today and show that we are either essential or very, very beneficial to that project then I think we can see more leverage and we'll see better sales productivity and better growth as well.

Sanjit Singh - Wedbush Securities Inc.

Thank you, Robert, for the explanation.

Operator

Next, we turn to the line of Vjay Bhagavath with Deutsche Bank. Please go ahead.

Vjay Bhagavath - Deutsche Bank

Yes. Thanks, guys. A quick question for you and a follow-up. I think the question is you mentioned an interesting point, Robert, in terms of some of your enterprise customers currently. I wouldn't want to use the word distracted, but engaged with security implementation that's taking much of their focus and energy. So I think my question is, as you head into the October quarter and into fiscal '15, how do you view the spending on IPAM qualitatively? You think the near-term focus on security would continue through the rest of the year and that would somehow detract them from implementing IPAM, as you said, so I'd like to get your thoughts on that? Thanks.

Robert Thomas

I think the focus on security will continue but I don't think it's an insolvable problem, I don't think it's an either or thing. In other words, if the focus on security continues then will growth be stunted because of it? I don't think that's necessarily the case. I think there are two things that come into play. One, we haven't got the most out of demand generation that we should have in the preceding three or four quarters and we've started to change that as we said at the beginning of Q3 by focusing on what I would call better opportunities for us and more closable opportunities for us. So focusing around larger organizations which we are very lightly penetrated into and focusing on core DDI business and focusing on new accounts. So one of the ways that we can combat a diversion of resources in an IT group to something else, because maybe something has come up and it's been very important for the next month or two or three is to have a bigger pipeline to cover that. So we've found in both Q2 and Q3 that closure rates against our pipeline is not the same as it used to be in the preceding 20 quarters that we've been doing business. We need more pipeline to close the same amount of business today than we did in maybe the last 20 quarters of so of our business. So we can attempt to ensure ourselves against the diversion of resources, problems like talking to more people and having a broader reach and we're doing that. And as I said, we're starting to see at least early positive signs of that to earlier of course to declare victory on it, but we're even seeing early signs of that by an increase in new name accounts and by six month pipeline ticking up reasonable well. On the other side of things, as security does become important, I think whereas with DNS Firewall which was our first security product, you really had to have an Infoblox infrastructure to make the most of DNS Firewall. And as I think we have said on a couple of calls in the past, when we got in to sell to a customer we found that they didn't quite deploy it in the way in which we thought they should employ it, this practice of deployment and the DNS Firewall sale generally turned out to be a 20-30 case rather than 100-150 case. In the newer security products we have added, Advanced DNS Protection and so on, which is much more aimed at external DNS and threats coming from outside the organization through cache poisoning, distributed analysis, many other things, that's the larger sale. It's not having a license, some existing Infoblox's product, it's buying a number of Infoblox boxes to combat that threat. So even if organizations are distracted by security for the next two or three or four quarters, I think today and this is new in the last three months, today we have something that can help play into that space as well.

Vjay Bhagavath - Deutsche Bank

Thanks. A quick follow-up, Robert, is the 300 U.S. enterprise customer opportunity for the Alcatel Lucent QIP product. I think my question is how do you feel about closing on a QIP sales conversion heading into the back half? Would you just qualitatively view this as a handful of QIP customers you could look to convert into the back half, maybe slightly more than that? And the reason I ask you this question is, would the QIP sales conversion be enough of a growth accelerant heading into the back half or is there enough of a sales closing time that would come in the way that the back half would be too soon to close on the QIP customer from a product refresh point of view? Thanks.

Robert Thomas

We typically do five plus QIP customers a quarter that we would convert from QIP. We have seen more renewed interest as QIP has basically have been – Alcatel has abandoned the product and sold it off to someone else. It's a focus for us as well. We are recalling on all the people that had QIP implementations because of that. And in fact one of the case studies we gave in this call in the script was a QIP customer who was worried about the quality of support they were getting and worried about where the product was going and so converted to us. So I would expect that we will see an increase of QIP conversions over time. Even of the 300 or so there in the U.S. we have talked to a lot of them already and we continue to revisit them. So some of them are not a cold start. There are people we have spoken to in the past that know a little bit about. So I think we'll see that number continue to increase throughout this year.

Operator

Next, we turn to the line of Alex Kurtz with Sterne. Please go ahead.

Amelia Harris - Sterne Agee & Leach Inc.

Hi, this is Amelia on for Alex today. Maybe a different take on the challenges you're seeing. Are some of these headwinds related to your top 100 customers and their absorption of existing product, especially through the 2013 investments and you're really waiting for these customers to reinvest? What are your thoughts on that? Thanks.

Robert Thomas

No, I don't think it is. I would say as we have said in the past one of the things we haven't been as good as we should have been at is acquiring new customers. We've had this fairly steady 200 new customers a quarter rate for some time now. And then if you look at the opportunity for us, I think I said earlier that companies have more than 50,000 employees, there are about 1,500 of them and about 200 of them are our customers so we're kind of 15% penetrated into that market. And if you look at the next segment of people with 10,000 to 50,000 employees, there's like 8,000 of those and we got about 700, so about 9% penetrated into that market. So while our customer base is a good source of add-on functionality through security and extending us throughout their network and so on, we are still so lightly penetrated into those markets but we really should be focusing on new account acquisition and a lot of, as we have said, demand generation dollars, the way we're directing our sales force, the way we pay them and so on starting at the beginning of Q3 and extending ad infinitum, we'll be about acquiring new customers because not only does it give us I think a better growth rate when we get that right and we start to pump up the new customers but of course they come back and buy more in the past. The re-buy rate from their customer base is a very, very strong part there, so I wouldn't want to rely upon our existing customer base to fuel their growth forever. We have a lot of untapped potential.

Amelia Harris - Sterne Agee & Leach Inc.

Okay. Thanks.

Jane Underwood

Craig, we have time for one more question.

Operator

Thank you. Our final question then comes from the line of Jeremy David with Citigroup. Please go ahead.

Jeremy David - Citigroup

Hi. Thanks for taking my questions. Robert, sorry to see you go and all the best for your upcoming transition. So my question is about the outlook for services revenue. And the reason I'm asking is that the deferred revenue balance declined slightly quarter-over-quarter and that has never happened before. And Robert, you made some comments on the call that the sales force is now incentivized more on product sales than on maintenance renewals. So should we assume that services revenue can continue to grow at 20% plus, the growth rate that we've been used to going forward or should we expect the slower product revenue growth rate in fiscal year '14 as well as the new incentives to impact the services revenue growth in the next couple of quarters?

Robert Thomas

On the service revenue side related to deferred revenue, the deferred revenue balance basically was flat on a quarter-to-quarter basis. A couple of reasons for that. One reason is our channel inventory which was part of our deferred revenue decreased by about 1.5 million during the quarter. In addition with the lower product revenue that we have or product bookings that impacts the maintenance bookings that we get from those re-products that's been down the last three quarters also. On a go-forward basis I would expect service revenues still to be strong for us.

Jeremy David - Citigroup

Okay, that's helpful. And then we are going too much into fiscal year '15, but how should we think about the margin expansion going forward? So you're guiding to breakeven in fiscal Q4. Is there a sustainable path to double-digit operating margin at some point next year, if not for the full year? And what is the kind of puts and takes around getting back to double-digit operating margin?

Robert Thomas

From a forecast perspective next year we will give the projections on the next call. The comments we made on the last call was that we'd be at the 20%, 22% operating profitability sometime in fiscal 2016. At this point here we're still staying with that 20%, 22% in fiscal 2016.

Jeremy David - Citigroup

Okay, great. And one last one, if I may. You touched on the new reports from IDC and Gartner in your remarks. Those reports also suggest that there's some level of maturation in the market. I think that Gartner used the word relatively mature to describe the DI market, and IDC showed that your competitors collectively are just growing their sales in the mid-single digits last year and in '12 as well. What is missing? What are you seeing that they're not seeing?

Robert Thomas

I don't know. It's a good point because we – I don't know how they come to the conclusion that it's maturing in anyway because when we look at the absolute numbers and I mentioned a couple of them a moment ago, but just let me do it again. In organizations with 50,000 employees or more there are 1,500 of those companies in the world. We have 200 of them as customers and our competitors have less. So there's a lot of opportunity in those markets. And go down a tier to the 10,000 to 50,000 employees is over 8,000 of those companies and we have about 700 of them. So we are only 9% penetrated and our competitors have way less. So I don't know how they come to the conclusion that even at any segment of the market it's maturing, approaching saturation. It's hard to say. We'll question them on that to find out how they came to that conclusion, but the numbers we have would say exactly the opposite.

Jeremy David - Citigroup

Okay. Thank you.

Jane Underwood

Craig, I think we're done with our Q&A

Operator

We have no further questions.

Jane Underwood

Okay, great. 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 May 29, 2014 at 4:00 p.m. Pacific and an audio archive will also be available on our website. Have a great day, and we look forward to speaking to you again. Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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