Informatica's (INFA) CEO Sohaib Abbasi on Q2 2014 Results - Earnings Call Transcript

| About: Informatica Corporation (INFA)

Informatica (NASDAQ:INFA)

Q2 2014 Earnings Call

July 24, 2014 5:00 pm ET

Executives

Cherryl Valenzuela -

Sohaib Abbasi - Chairman, Chief Executive Officer and President

Earl E. Fry - Chief Financial Officer, Principal Accounting Officer, Chief Administration Officer and Executive Vice President of Global Customer Support & Services

Analysts

Matthew Van Vliet - Stifel, Nicolaus & Company, Incorporated, Research Division

Brent Thill - UBS Investment Bank, Research Division

Michael B. Nemeroff - Crédit Suisse AG, Research Division

Raimo Lenschow - Barclays Capital, Research Division

Karl Keirstead - Deutsche Bank AG, Research Division

Stewart Materne - Evercore Partners Inc., Research Division

Matthew Swanson - RBC Capital Markets, LLC, Research Division

Michael Turits - Raymond James & Associates, Inc., Research Division

Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

Kash G. Rangan - BofA Merrill Lynch, Research Division

Abhey Lamba - Mizuho Securities USA Inc., Research Division

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

Steven R. Koenig - Wedbush Securities Inc., Research Division

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

Edward Maguire - CLSA Limited, Research Division

Patrick D. Walravens - JMP Securities LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Informatica Second Quarter 2014 Earnings Conference Call. My name is Crystal, and I will be the operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Cherryl Valenzuela, Senior Manager of Investor Relations. Please proceed.

Cherryl Valenzuela

Thank you. Good afternoon, and thank you for joining us. I'm standing in for Stephanie Wakefield, Vice President of Investor Relations, who is currently on maternity leave.

With me today are Sohaib Abbasi, our CEO; and Earl Fry, our CFO, to discuss our second quarter 2014 financial results. Today's call is being webcast and will also be available for replay on our Investor Relations website at www.informatica.com/investor.

As a reminder, today's discussion will include forward-looking statements, such as our projected financial results for the third quarter and full year 2014, our market and growth opportunities, our growth and investment strategies, our product plans, demand for our products and services, our leadership changes and the future effects of acquisitions and future integration efforts. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today.

For a discussion of these risks and uncertainties, you should review our recent SEC filings, including our most recent report on Form 10-Q. We assume no obligation and do not intend to update or revise any forward-looking statements made during this call as a result of new information or future events.

Also, during today's call, we will discuss non-GAAP financial measures. A reconciliation of GAAP and non-GAAP results is provided in today's earnings release and in the Supplemental Metrics section of our Investor Relations website. We have also included a quarterly financial highlights presentation with historical financials in the Supplemental Metrics section of our Investor Relations website. We hope you find it helpful.

And now, I'd like to turn it over to Sohaib.

Sohaib Abbasi

Thank you, Cherryl. Our second quarter highlights include strong subscription revenue growth of 43% and improved operational discipline of our Asia Pacific and EMEA teams.

In Q2, total revenue grew by 13% to $250.7 million and software revenue grew by 13% to $103.5 million.

Last quarter, we attained an important milestone. For the first time in our history, we attained $1 billion in revenue over the past 4 quarters. Our profitable growth over the last decade is evidence that our Informatica Platform is well aligned with the changing priorities of our customers despite a mixed spending environment across verticals and geographic regions.

Last quarter, at our Informatica World conference, we announced our new Intelligent Data Platform featuring 2 new products: Secure@Source for next-generation data security and Project Springbok for business users to become self-sufficient in data analytics.

Turning to regional performance. I will outline the broader macroeconomic environment, the key demand drivers for our portfolio and the areas for continuing improvement.

In North America, the spending environment was mixed across vertical segments. Our results reflect strong customer demand in health care, driven by the Affordable Care Act; and in the energy and high-tech verticals, fueled by modernization efforts and big data analytics. In contrast, budgetary pressures affected 2 of our typically larger verticals with fewer big deals in financial services and public sector. With strengthened leadership and better alignment across our teams, we expect to continue to improve our results.

In EMEA, we are encouraged by the results of the operational and leadership changes we implemented last year in Southern Europe and in the Central region, and we expect to gain similarly by the more recent leadership changes in the U.K. Last month, I noted 2 common themes in my customer meetings in the U.K., France, Germany, Spain and the UAE. First, across many verticals in these countries, customers identified data management as one of their top IT priorities for regulatory compliance and customer-centricity initiatives. Second, many customers increasingly view Informatica as a more strategic IT partner for adoption of cloud computing, big data and the Internet of Things.

In Asia Pacific, we obtained record results, led by a strong performance by our team in Australia. During my recent trip in June, I was impressed by the caliber of our team in Asia Pacific and was encouraged by my discussions with customers and partners in Australia and the ASEAN region.

Turning to product results. Beyond our core PowerCenter, PowerExchange and Data Quality products, contributions by our newer products continue to diversify our software revenue. In fact, 17 of our 23 deals over $1 million included these new products. I will describe our representative wins to showcase our key growth opportunities: cloud integration, MDM, security, big data and the Internet of Things.

Customers are increasingly adopting Informatica Cloud, which is an acknowledged leader in Enterprise Integration Platform-as-a-Service or Hybrid Integration. Last quarter, one of the top solar energy leaders selected Informatica Cloud MDM to complement Salesforce.com. The leader expects to increase sales by gaining a high-quality, authoritative view of consumers through Informatica Cloud MDM. To further expand our Informatica Cloud offering, last quarter, we acquired StrikeIron to deliver new email and phone validation data-as-a-service.

Organizations across many verticals are choosing Informatica MDM for a broad variety of business initiatives. As an example, the World Bank selected Informatica MDM to manage master data associated with the countries and entities with which it does business. To pursue its worthy mission to reduce poverty by extending loans, the World Bank will use Informatica technology to help deliver high-quality, authoritative data to mitigate the risk of waste, abuse or fraud.

New data privacy regulations are fueling demand for Informatica Data Masking. To comply with South Africa's Protection of Personal Information Act, a leading cable TV provider selected Informatica to protect sensitive data.

In our core data integration category last quarter, customers chose Informatica both for operational data integration projects and for next-generation analytics projects associated with big data and The Internet of Things. The IT services arm of Mitsubishi Chemical Holdings, Ryoka, chose Informatica Data Integration Hub to migrate data from mainframe applications to SAP. Using Informatica, Ryoka expects to reduce IT costs of this modernization initiative.

Finally, a leading energy producer selected Informatica for a big data project associated with an Internet of Things initiative. To help optimize well life cycle data across various shale formations, this leader will use PowerCenter Big Data Edition to ingest and prepare very large volumes of sensor data on Hadoop computing clusters.

Turning to our ecosystem. We continue to strengthen our partnerships to help our joint customers pursue changing business priorities. Last quarter, Xerox Services expanded its partnership with Informatica by selecting Informatica data integration products for its state Medicaid Management Information Systems offering. Our combined offering will help state governments to cost effectively and efficiently process health care and insurance data to comply with the new Affordable Care Act.

In May, we hosted our largest and most successful Informatica World conference ever. As part of our new Intelligent Data Platform, we launched 2 new products: Secure@Source and Project Springbok.

Secure@Source is our next-generation data security product to focus on mitigating the risk of data breaches. The old approach to secure the perimeter and keep intruders out is no longer sufficient. In the new world of pervasive computing, cloud services, mobile devices and sensors, there is no perimeter, and the security threat has evolved from denial-of-service attacks to more devastating data breach attacks. Data security is now a board-level and not just an IT priority. Leveraging Informatica's innovations over the past 20 years in data profiling and metadata technologies, Secure@Source will offer discovery and classification services for sensitive data. And utilizing Informatica's pioneering data linear services, Secure@Source will assess the risks associated with data proliferation. Combining risk associated with data proliferation and data access, Secure@Source will enable security professionals to visualize data security vulnerabilities. By using Informatica's award-winning Data Masking products or third-party products, customers will be able to mitigate these risks.

Project Springbok's goal is to empower business users to become self-sufficient in data analytics. The increasing focus on big data analytics is leading to growing adoption of visualization and Agile analytics tools such as Tableau, QlikTech and MicroStrategy. One of the most daunting challenges for business users using these tools is mastering the complexity of data. As one example, how to combine data from human resource applications such as PeopleSoft and cloud services such as Workday with publicly available data from social media services such as LinkedIn. Leveraging the $2 billion invested in the Informatica Platform over the past 20 years, Project Springbok simplifies the complexity of data through metadata, data profiling, intelligent guidance and crowd-sourced practices. With intelligent guidance, cash flow users can simply curate data, crowd-sourced best practices simplify the task of preparing the data. Best of all, business users can simply prepare the data once using Project Springbok, and then consume it multiple times for analysis using a variety of tools such as Microsoft Excel or Tableau.

To sum up, our broadest-ever product portfolio and innovation roadmap position us to benefit from several long-term growth opportunities. I firmly believe that our opportunity is greater than ever to grow Informatica to a multibillion-dollar organization.

For this exciting next phase in the Informatica journey, I will outline our 3 guiding principles. First, scale our team to build a multi-dollar (sic) [multibillion-dollar] organization; second, continue to develop our organization for more sophisticated portfolio management to pursue our multi-category growth strategy; and third, focus on even greater customer success to further evolve our business model with increasing contributions from consumption-based subscription services.

To implement our long-term plans to build a multibillion-dollar organization, I'll outline 2 organizational changes. While I'm disappointed to announce that John McGee is leaving Informatica for another opportunity, I am thrilled to announce the appointment of Charles Race as EVP to lead our worldwide field operations. Over the past 9 years, Charles has distinguished himself as one of our strongest leaders in sales planning and team development, and has a well-earned reputation for consistent sales execution.

Two years ago, Charles was the key architect for our go-to-market plan. Charles worked with each sales manager around the world to implement our most rigorous sales planning processes and to refine our sales specialization to effectively expand into multiple product areas. More recently, in his role as SVP EMEA Sales, Charles developed an impressive team that continues to deliver improving results. Charles brings broad global experience working with both direct and indirect sales channels to successfully promote our expanding product portfolio in international markets.

As yet another important measure for our long-term growth, I will outline our plans for a future change. I am excited to announce that my valued colleague, trusted advisor and friend, Earl Fry, will transition by the end of the year to a new role at Informatica and dedicate his attention to 2 highly strategic areas: first, to scale our service organization for even greater success; and second, to contribute to our multi-category portfolio and business planning for sustained growth. With his proven business acumen and astute understanding of our portfolio, Earl is uniquely qualified to contribute in this new role. We will commence the search for a new Chief Financial Officer for Earl to transition to this new role by the end of 2014. Earl will continue to serve as CFO until that time.

While we will all miss Earl on these earnings calls, I look forward to working closely with Earl for years to come. And to provide his personal perspective, now I'll turn it over to Earl.

Earl E. Fry

Great. Thanks, Sohaib. I'm actually really excited about the opportunity to work with Sohaib and the management team to turn my attention to focus on areas which can actually more directly help Informatica to scale to be a multibillion-dollar company. And of course, I'll continue in my current role for the time being and will have a very vested interest in ensuring a smooth handoff of my CFO responsibilities as we look to identify a successor by the end of the year.

So back to our Q2 results and our outlook. Our second quarter revenues were $250.7 million, up 13% from last year and slightly above the midpoint of our guidance range. Software revenues were also up 13% to $103.5 million, with the license component up 9% to $87.3 million and subscriptions up 43% to a record $16.2 million.

Service revenues were up 12% to $147.3 million, with the maintenance component up 13% to $112.5 million, and the consulting and education component up 11% to $34.5 million.

We booked 108 deals over $300,000 and 23 deals over $1 million during the second quarter. This compares to 94 deals over $300,000 and 15 deals over $1 million in the second quarter of 2013.

The overall average transaction size for orders over $100,000 increased to $465,000 compared to $441,000 a year ago.

But while our deal metrics were strong during the quarter, we did observe that certain customers, particularly in financial services and particularly domestically, were interested in smaller transactions as opposed to large consolidated purchases.

North America represented less than 64% of our total revenue in the second quarter, while EMEA represented over 24%, and the rest of the world represented 12% of our total revenue in the quarter. This compares to our year-ago second quarter where North America was just over 65%, EMEA was 24%, and the rest of world was a little over 10% of total revenue.

Moving to new license order contribution by vertical industry. And here, we saw some, I think, significant changes. For the first time ever, health care was our highest contributing vertical market in the quarter, followed by financial services and manufacturing. This also marks a rare time in Informatica's history where the financial services industry has not been our top vertical.

As Sohaib mentioned, we saw a mixed customer spending environment in Q2, with strong spending across a variety of commercial enterprises throughout North America, Europe and Asia, but more measured spending out of North America, particularly financial services and public sector.

Non-GAAP gross profit in Q2 was $206.4 million or 82.3% of total revenue compared to 83.1% last year. And software margins were 97.6%, with service margins 71.6% in Q2.

Total non-GAAP operating expenses were $151.7 million or 60.5% of revenue and resulted in non-GAAP operating income of $54.6 million or 21.8% of revenue.

GAAP net income for Q2 was $22.8 million or $0.20 per diluted share. Non-GAAP net income for Q2 was $38.5 million or $0.35 per diluted share, above the midpoint of our guidance range.

As Sohaib noted earlier, we completed the acquisition of StrikeIron in mid-June. StrikeIron's subscription-based revenue model contributed just a negligible amount of revenue in the last 2 weeks of the quarter and was modestly dilutive both to operating margins and EPS in Q2.

Total headcount at the end of Q2 was 3,479, up 139 from the end of Q1 and up 399 from a year ago. Sales and marketing represented the largest portion of the sequential increase, with headcount at the end of the quarter at 1,174, up 55 from Q1 and up 139 from a year ago.

As a reminder, and consistent with our growth and innovation plans, we continue to expect to add headcount in all critical functions through the remainder of 2014.

Turning to the balance sheet. We ended the quarter with over $686 million in cash and investments compared to $730 million in Q1. In Q2, we used $50 million of cash for the acquisition of StrikeIron and used $33 million of cash to repurchase 896,000 shares of our stock, ending the quarter with 111.6 million shares outstanding on a fully diluted basis.

In addition, our Board of Directors recently approved an additional $100 million for stock repurchases, thus, increasing our available stock repurchase authorization to a total of $148 million.

We generated over $39 million in cash from operations during Q2, up from $33 million a year ago. DSOs were 66 days in Q2, up from 62 days a year ago and just outside of our target range of 55 to 65 days due to shipment linearity and a higher mix of international business, which tends to have slightly longer collection cycles.

Based on our Q2 order rates, our potential revenues -- future revenues disclosure, which includes deferred revenue balances as well as orders not yet taken to revenue as of June 30, was $336 million, up 13% from last year. And total deferred revenues were $311 million, up 14% from last year.

Our tax rate for the quarter was 34% on a GAAP basis and approximately 31% on non-GAAP basis. We continue to expect our income tax provision, as well as our GAAP and non-GAAP tax rates, will have some variability and will continue to be very sensitive to our quarterly geographic mix of earnings. We are targeting a tax rate of approximately 34% on a GAAP basis and approximately 32% on a non-GAAP basis throughout 2014.

Turning to guidance. So based on our observations in Q2, we are tempering our near-term expectations for contribution from the financial services sector and tempering our expectations for the seasonal Q3 federal budget flush.

We expect StrikeIron to contribute a little more than $1 million of subscription revenue per quarter and to be dilutive to EPS by about $0.01 to $0.02 per quarter through the remainder of the year.

In addition, we will continue to invest heavily in innovation and new products, services and technologies, and as a result, expect our investments in R&D, excluding stock comp, to be a little closer to 18% of revenue -- total revenue in the third quarter and to be close to 17% of total revenue for the year 2014.

So based on these assumptions, for the year 2014, we are adjusting our expected full year revenue range to $1.03 billion to $1.06 billion and lowering non-GAAP EPS to a range of $1.50 to $1.60 to reflect the dilution from the recent acquisition, continued R&D investment and our tempered outlook for the financial services and federal public sectors.

For the third quarter, we are setting Q3 revenue guidance in a range of $245 million to $260 million, with Q3 non-GAAP earnings per share guidance in a range of $0.30 to $0.35.

As a reminder, our non-GAAP EPS targets do not include the after-tax impact of an estimated $0.04 per share per quarter charge for the acquisition-related amortization of intangibles, acquired technology and tax integration costs; the tax-affected impact of stock comp of approximately $0.11 per share per quarter; and any major acquisition costs and expenses.

So with that, let's open it up for questions. [Operator Instructions] Operator, could we have the first question, please?

Question-and-Answer Session

Operator

Our first question will come from the line of Brent Thill from UBS.

[Technical Difficulty]

Operator

Our next question will come from the line of Tom Roderick.

Matthew Van Vliet - Stifel, Nicolaus & Company, Incorporated, Research Division

It's Matt Van Vliet on for Tom. Just in terms of the larger deal trends, you said 17 of the 23 included some of the newer products. Are you seeing those newer products leading the deal flow and actually kind of leading those sales pitches, or is it something where some of the legacy products are driving that and then able to up-sell on the newer products?

Sohaib Abbasi

Matt, let me make a couple of comments about the big deals. Some of them were led by our core products: Data Quality and Data Integration. A majority of the deals did include one of those products. There were quite a few transactions that we had of our newer products, particularly Master Data Management, but it was across-the-board. Almost all of our product categories were represented by these large transactions. The other comment that I would make about the large transactions was we only had 2 of the top 25 deals in financial services, which is a little more color in terms of the commentary that we had about financial services. Health care was our #1 vertical for large transactions. So we are very encouraged by the demand across a variety of different industries, particularly health care. And at the same time, we are seeing some cautious spending patterns in financial services.

Earl E. Fry

Yes, Matt, maybe just a little more color. Of the 23 deals over $1 million, 9 of them included MDM. And it's probably fair to say that MDM, if not leading, was a very key component in those 9 transactions. So that continues to be a very good area and a consistent area across verticals.

Operator

Our next question will come from the line of Brent Thill.

Brent Thill - UBS Investment Bank, Research Division

Sohaib and Earl, I guess, there's a couple of moving pieces here. One, on the financial statements, clearly, the license sequentially down and deferred down, we don't usually see that. And then you throw in the mix numerous management changes that I thought we were getting to a point where the sales side was starting to effectively taking hold from some of the changes you've made. Now we're going back for another round of changes. So how much would you attribute to the change in the management organization to what happened in Q2, which is clearly probably not where the Street wanted you to be, versus some of the issues as it relates to financial services and what you saw in the field?

Sohaib Abbasi

Brent, I would characterize the changes as -- the circumstances have clearly changed. When we made the change last time, we were trying to recover from the stumble. We are at a new phase. We just achieved the $1 billion mark, and now we're planning for the $3 billion mark. So as I commented on earlier, we have a firm belief in the opportunity for us to establish a multibillion-dollar organization. And we are taking steps now that will help us towards this long-term objective that we have with the multi-category growth, many of those initiatives that I outlined. In terms of Q2 results, I would attribute a lot of our -- the softness to what we saw in financial services. And I highlighted that of the top 25 deals, only 2 of them were in financial services. And typically, the majority of our deals are in financial services, and only one of those was in North America. So there is no doubt in my mind that we could do better from an execution perspective. We did have new reps that we could ramp up, and we could better adjust to what we're seeing, where there's a pattern of customers buying smaller -- pursuing smaller transactions. I'm confident that we will see much better results in financial services by the end of the year.

Brent Thill - UBS Investment Bank, Research Division

Okay. And if I could just quickly ask. Just on Charles, he obviously has been at the company 9 years, but has largely been in Europe. What gives you the confidence in the U.S. that he can continue to make that transition over?

Sohaib Abbasi

Charles was the architect behind our global go-to-market plan. And in that role, he met with every single leader that we had around the world, and he won everyone's confidence and respect. And in fact, the fact that we came very close to achieving our numbers was an indication about how well. We do have a very strong team, a management team in North America. And I had a chance to speak with them earlier today and I spent time with them in the management. We added Steve Millard, who was the CEO of Kognitio and a long-term veteran in the industry. And he will be managing our U.S. commercial business. We strengthened the bench strength. Frank Fallon continues to be at Informatica, very much focused on financial services and public sector. And both of us are very focused on execution. I have no doubt that we have a very strong management team in North America, and Charles will provide very strong leadership globally.

Operator

Our next question will come from the line of Michael Nemeroff from Crédit Suisse.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

First one is on the StrikeIron acquisition. It looks like from the cash flow statement that you paid about $54.6 million. I just want to know if I've got that right. And then also, $1 million a quarter contribution, that, that would imply a pretty healthy valuation. So just curious what the deferred write-down component was. And also, what do you think about the justification on that purchase price?

Earl E. Fry

Sure, yes, that's correct. What you're reading on the cash flows, Mike, is absolutely right. It's a little under $55 million for the acquisition. We had well over half of the revenue stream got hit by a deferred revenue write-down. So of course, we're going to take a more significant hit on that in Q3, Q4, less in Q1 and less as we go into Q2 of next year. So I do expect that by, let's call it, middle maybe Q3 of next year, we should be getting to where it should be neutral to accretive to earnings. But yes, we've got a pretty fair write-down on the deferred revenue component. And hopefully, we'll do a little better than the $1 million-plus per quarter, but that's what's baked into our guidance right now.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

And then one follow-up for Sohaib, if I may. Just on the financial services slowdown, so to speak, and then purchasing in the quarter. I understand that you're tempering the expectations for Q3. Is this a situation in your discussions with some of your larger financial services customers that they anticipate spending would come back in Q4? Or is this some sort of a more systemic approach to lower purchases of your products going forward?

Sohaib Abbasi

Michael, let me provide you with my perspective, and then I'd also like Earl's view on it as well. The conversations that I've had with financial services, there is no doubt that they're prioritizing compliance. And as a result of it, we're benefiting from that. The other trend that I have seen is that they are cautious in terms of the buying cycles, and it's just taking a little bit longer, and in some cases, requiring a few extra steps in terms of approval. The demand continues to be there for our technology. It's just taking a little bit longer and the appetite for the larger transaction is not quite what it used to be.

Earl E. Fry

Yes. And so I completely agree with that. That's what's happening. And translating that to how we thought about that for guidance, we wanted to make very sure that we very conservatively handicapped the current quarter, the third quarter. And I do think both from a sales execution standpoint, sales capacity perspective, and as well as being able to adjust to, in some cases, slightly longer procurement cycles, I think we'll work through that in Q4. So there's probably less handicapping from a guidance standpoint in Q4. So we do expect things to get better by the end of the year.

Operator

Our next question will come from the line of Raimo Lenschow.

Raimo Lenschow - Barclays Capital, Research Division

Earl, we will miss you. The question I had is...

Earl E. Fry

I'm still around, and I'm still going to give you a bad time for the next several months, Raimo. So you're not getting off that easy.

Raimo Lenschow - Barclays Capital, Research Division

Okay, I'm looking forward to that. The question I had is like more around the new products that you launched at your big customer conference in May with Secure@Source and Springbok. How do you -- if you think about these new solutions, they're obviously slightly outside of your core area. How do you think about -- what are they doing to the company in terms of creating a platform for customers and how many -- what else do you need or how many more applications do you need to really -- to kind of be able to go into a customer and talk about a big platform play? In other words, the second question for me is then like, how do you think also then about the balance between like cost and revenue there?

Sohaib Abbasi

Raimo, as you know, we launched the Intelligent Data Platform. And a platform play is always a very long-term play. We remain committed to that. And in the near term, 2015 timeframe, we will deliver new capabilities. Springbok, we expect to deliver later this year. Secure@Source will be available next year. So we have a good stream of new technology that is coming out. These are not -- these are incremental opportunities for us, but they're close enough in adjacent categories. Springbok, we would be partnering very closely with all the Agile BI vendors like Tableau and QlikTech and others, to deliver a new offering to their customers, as one customer described, the data integration for the casual user. And in the case of Secure@Source, we already have an award-winning Data Masking technology. And we do have a natural advantage in our PowerCenter installed base to go in and offer a new capability to secure the data, in addition to integrating the data. And of course, these will help us towards the longer-term platform play. Thank you, Raimo.

Operator

Our next question will come from the line of Karl Keirstead with Deutsche Bank.

Karl Keirstead - Deutsche Bank AG, Research Division

Earl, I just wanted to go back to the revenue guidance. It certainly seems like you're tempering the expectations for the third quarter, and it seems appropriately so. But for the full year, you're really just tightening the range up, you're not really dropping the low end at all, which implies that you're not really tempering your guide for the fourth quarter. So I just wanted to make sure we all understand. What is giving you and Sohaib the confidence that things are going to be better in the fourth quarter? Because this broader trend to smaller deals, I don't know, what's going to cause that to reverse in the fourth quarter?

Earl E. Fry

Yes, Karl. Thanks for actually asking the question that way because, yes, optically you can say we're tightening the range, $10 million at the low end and $10 million at the high end, but also recognize that I think current consensus is at $1.06 billion. So if I'm guiding at the high end to $1.06 billion, then I think inherent in that is, yes, being more conservative on Q3, but I think it's -- but I'm also not expecting things to automatically get back to exactly the same level where consensus is at for Q4. So I do think implied in that is a little more conservative view on Q4, not as much as Q3. And I think part of that goes to that being a quarter where we should see much more balanced contribution. Q3 is one that historically is heavily centered around North America, financial services and particularly public sector, and is always a little light from Europe. So if we're a little more cautious on North America and financial services and public sector, then that would logically follow that we're proportionally a little more conservative on Q3 than Q4, when we expect to get broader not only vertical contribution, but also have greater capacity. Also have more reps that are closer to their quota numbers, so there tends to be -- it's always a seasonally higher quarter, and it's a quarter that we tend to get very balanced geographic contribution.

Karl Keirstead - Deutsche Bank AG, Research Division

Okay. And if I could ask a follow-up, Earl. Honestly, you've been such a respected CFO for Informatica for so long that I just want to shake the tree a little bit on your departure to a new role and ask you, what is it -- maybe Sohaib, you want to weigh in. But what is it that is so imperative about the customer support and professional services part of Informatica that requires your direct attention?

Sohaib Abbasi

Let me comment on that first, and then if Earl has more to add. I know that Earl has earned our highest regard and highest respect and earned all the accolades as one of the best CFOs our industry has ever known. But I would say that Earl is much more than a CFO and has been much more than a CFO to Informatica. Earl is one of the most astute businessmen I have met in my entire career in our industry. And I believe Earl has a lot to offer for Informatica. And our next phase of our growth is a very important phase. For us to go from $1 billion to $3 billion, very few companies have done that, and it takes individuals like the caliber of Earl to help us plan that out. Now in terms of customer success, as our industry shifts from a perpetual-license software to a more subscription-based, the focus on customer adoption and customer success becomes of paramount importance. Earl has led our customer support organization and consulting organization for many years already. One of his best kept secrets, that he is also the EVP of our services organization, and having him devote more of his attention to ensuring customer success and freeing up some of his bandwidth to help us plan out what we do with Springbok, what we do with Secure@Source. The question that Raimo asked, the answer to that question, in terms of what is our long-term play and how do we build a multibillion-dollar organization. I can't think of a more capable individual than Earl to help us formulate that.

Earl E. Fry

I guess, I wish I could say I could do it all and just spend another 20 hours a week and just get everything done. And the fact of the matter is, is there's only so much that one person can do. And quite frankly, that's -- as important as the CFO role is, I think as Sohaib highlighted, where we are in our growth journey, it's going to become more important to make sure that we've got the product strategy right, we've got the go-to-market right, that we're making sure that we're properly looking at how we support customers, as Sohaib said, how we get customers adopting our technology broadly, and also making sure that we have the right partner ecosystem to accelerate that. So I look forward to -- once I can get my CFO duties transitioned -- to working with Charles and the rest of the go-to-market team to make sure that we do a nice job of getting to that multibillion-dollar company.

Operator

Our next question will come from the line of Kirk Materne from Evercore.

Stewart Materne - Evercore Partners Inc., Research Division

I guess just first on the financial services industry. You guys obviously have gone over this a lot in this call, but I just want to get a little bit more granularity because at one point, I think, Sohaib, you mentioned execution. And I guess what I'm struggling with was, if your customers are just downsizing their deals, I mean, are there things you're still not doing from a sales execution perspective? I mean, is there anything you can do better to either, I guess, capture that earlier in the pipeline? You obviously discounted it out for the back half of the year. But I guess I'm just curious because you guys have raised your sales and marketing headcount dramatically over the last couple of years, yet your -- certainly, your yield off that return is still, I think, pretty suspect. And I'm trying to get a sense on, have you still been moving people around. Are people just not tenured enough in some of those seats? So I guess if you could sort of help model [ph] just a few questions.

Sohaib Abbasi

Yes, maybe I can amplify on an earlier comment that I made, which is I expect that the contribution will improve from our financial services group by the end of the year. And let me provide you with why I believe that is the case. We did have new reps that we added. The ramp-up does take time. So you're obviously correct that we did add new reps. And they would become close to being productive, fully productive. And their contribution will go up by the end of the year. Now -- so in other words, I mean, yes, we recognize that there is a change in terms of spending patterns. The demand is still there. Perhaps there's a slight change in terms of how our customers are acquiring software. And at the same time, we recognize that we can do better. Now in terms of how we have been adjusting for it, we have been adding capacity as needed. We have -- we've seen great strength in energy. We've seen remarkable strength in health care. So to some extent, we're keeping a very close eye on all these verticals and being very agile in terms of where we ought to deploy resources.

Stewart Materne - Evercore Partners Inc., Research Division

Okay. And just maybe one follow-up. As you guys make additional investments to try to ramp up to $3 billion, I guess, how should we sort of judge you all on the efficiency or the ROI of those investments? Again, I'd just point to the sales and marketing headcount as an example. You guys have -- I think that's 45% higher than where it was 3 years ago, yet license revenue is almost flat. So implicitly, you'd look at that and say the productivity per sales and marketing employees has gone down pretty significantly. I guess, at what point in time should we expect that to get better? Or I guess, how are you guys judging that internally so that we can get a sense that these investments are starting to pay off, even if they're not showing up directly on, say, license revenue in a given quarter?

Sohaib Abbasi

What I would do is, first of all, I would remind you not to look at the license revenue by itself, but rather the combination of license revenue and subscription revenue. We have made significant investments over the period of time that you mentioned, and we've seen very good growth from our subscription revenue consistently. And if you look at it over the last several years, the compound annual growth rate of that is probably more than 60%. So from that perspective, I mean, you're looking at a business that is evolving from perpetual license to one where it's hybrid. Now our intent is not really to go to a pure subscription because our customers are looking for a Hybrid Integration offering. Their data remains on-premise. Cloud computing will never replace on-premise computing. And the challenge that we're helping our customers is how do you embrace cloud computing without leaving any of your data behind. So the measure -- and then trying to compare the efficiency and productivity of a subscription business with license is like comparing Salesforce.com's operating margin with those of Oracle. So it becomes very difficult to make those comparisons. But I would recommend looking at the holistic view and seeing how 15% of our revenue, software revenue comes from subscription, and it's growing at 43%.

Earl E. Fry

Yes. And obviously, with a different model if you're comparing sales and marketing costs. I'm not sure I'm endorsing this because I'm not sure that this is the right way to look at it, but if you want to simplistically look at it, then you should take some multiple of subscription revenue, add that to license, and then compare sales and marketing cost to that combined total. Again, I don't think that's a perfect measure, but I don't think the productivity -- while I would acknowledge, I think we would all acknowledge that we can do better from a productivity standpoint, particularly in certain regions and geographies. I don't think it's as bad as -- it's not as bad as just looking at sales and marketing cost divided by license revenue. That would be an inappropriate measure.

Operator

Our next question will come from the line of Matt Hedberg from RBC.

Matthew Swanson - RBC Capital Markets, LLC, Research Division

This is actually Matt Swanson on for Matt Hedberg. I got a couple of questions for you. I know you guys have seen some vertical-specific headwinds, but I was wondering kind of 2 questions here. Are you seeing any effect from free ETL tools? And if you see any commoditization from that? And then also, are you seeing any effects in the quarter from Hadoop on deal sizes?

Sohaib Abbasi

We did not see any change in terms of the competitive dynamics. We did not see any higher incident rates against any particular vendor. The majority of the deals continue to be uncontested by any commercial competitor. So there was no effect in terms of commoditization. In terms of Hadoop, we had a larger number of Big Data Edition sales this quarter than we have had ever. So that's a good indicator that our Big Data Edition is gaining traction. And the days of uncertainty about whether Hadoop is an alternative or not are behind us, largely behind us. And I see a lot more opportunities for us to partner with all of the Hadoop distribution vendors moving forward.

Operator

Our next question will come from the line of Michael Turits from Raymond James.

Michael Turits - Raymond James & Associates, Inc., Research Division

Michael Turits. So I hate to comeback to federal and financial services. But in general, it's not as if we're facing, as if you know, the reports are generally that there's a real concern or weakening. I mean, it's gray, but not like in past years in those sectors. So it's not really macro, and you've been doing better in terms of execution. What is it? What's your analysis of what's going on, especially in light of the fact that you've talked about smaller deal sizes? What are the issues? And why do you really think that's happening? And it may be too soon to tell, but maybe you'd take a shot at it.

Sohaib Abbasi

What we talked about was -- I mean, just looking at the deals that we closed, health care is -- we're seeing really very strong transactions, 9, our largest amount of transactions. So if you drill down and try to -- and analyze what is going on, particularly in some specific segments within financial services, customers, in general, last quarter, and it may be an anomaly, just one data point, there were fewer large transactions. Now I did acknowledge that we do have ramping going on in our own sales execution, and I did acknowledge -- or rather, I did state my expectations that we will see much better results by the end of the year. So it's a combination of a change that we have observed in terms of the spending environment in financial services and also our own execution challenges that we are -- that we're confident we will address in the second half of the year.

Michael Turits - Raymond James & Associates, Inc., Research Division

Right. And the same sort of question on fed because, I mean, we've talked to other software companies. They're actually feeling fairly confident about the fiscal fourth quarter flush.

Earl E. Fry

Yes, so that's one. Let me take that one because that one, I think, we're reacting to what our expectations were for the second quarter, and then also how that compared with how we did a year ago. And there, there's a pretty dramatic shift. If I even look at the large transactions that we did, the million-dollar transactions that we did. We had last year in the second quarter, we had 5 public sector transactions over $1 million. In Q2 this past quarter, we had only one. Now some of that you can say might be deal slippage or execution-related. Some of that absolutely is tighter and different spending criteria, particularly related to the defense side of things. So I'm not going to speak to my peers in other companies and what their expectations are, but when I see that kind of change, we're going to be a little cautious on what the expectation is for Q3. Now do have we have a pipeline that looks pretty good? Yes, but we've got recent data points that would suggest that might be a little tougher than normal. So I hope we're wrong. I hope we have a normal budget flush. And if so, that will be a nice, pleasant surprise. But I think that's -- we're going forward, I don't know if I would say with an abundance of caution, but we're taking our recent data points and saying, "What happens if things aren't quite as good as we think?"

Michael Turits - Raymond James & Associates, Inc., Research Division

If I could slip one more in, just sort of mechanical. Just on this quarter, what was the -- you missed a bit on margins relative to the Street. So what was the impact of StrikeIron in the quarter, both in terms of revenue contribution and expense?

Earl E. Fry

So it was negligible from a revenue perspective, less than [ph] kind of plus or minus $0.25 million. It was -- it hurt us by 0.1% or 0.2% on operating income and about the same amount on EPS. So some of it was that. Some of it, obviously, was being a little light on the mix of revenue, coming in a little lighter on license and coming in basically on, on subscription and coming in heavy on services, which in overall -- in an overall case is slightly lower margin obviously than license.

Operator

Our next question will come from the line of Rick Sherlund from Nomura.

Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

Two questions. First, just to go back to financial services. It seems like that industry has been in trauma for so long, it's hard to discern from the press whether things have gotten worse in that sector or not. But I'm just curious what your perspective is in talking to customers. Was there some perceived change in the environment during the quarter? And then second, if you could just give us a sense from the change that you might be anticipating on the execution side? What changes might we look for with the management changes here? And you talked about execution in the second half, what changes should we anticipate there?

Sohaib Abbasi

On the first question, I've spent quite a bit of time meeting with financial services, actually in multiple continents. And what I would say is, it varies by region. In ASEAN countries, obviously it is business as usual. In Southern Europe, it's getting a little bit better. In U.S., it's much harder to actually generalize. I mean, we've had conversations with customers that were prepared to actually do very large transactions a year ago, and those same customers are taking a very cautious stance. Now the high-level conversations about the demand drivers remain the same. Regulatory compliance being a very big part of what they're looking at. They're also looking at customer centricity. But the spend environment, all I could say is, we are watching it very carefully. We have one data point that we talked about, that Earl commented on, that we're taking into account, and we'll continue watching it very closely. I have had conversations with our own team, many of the team members. So we will remain very engaged in terms of understanding what is going on. In terms of execution, Charles is a veteran who knows, and he was very well-regarded by everyone. And I spoke with every single one of his direct, new direct reports, and it is universal. He is well-regarded, well-respected. He knows the organization very well. Our #1 priority is to exceed our internal targets in Q3. And our second priority is to exceeded it for Q4. So the team remains very much focused on making sure that we deliver on our internal expectations. And at the same time, we will be looking at starting to plan for a number of the new growth initiatives.

Operator

Our next question will come from the line of Kash Rangan from Merrill Lynch.

Kash G. Rangan - BofA Merrill Lynch, Research Division

When you look at the Analyst Day, I think there was some interesting disclosure provided for the first time by product area: data integration for warehousing, data integration for other purposes, et cetera, MDM, Data Quality. Could you maybe give us some color on which pockets among the product areas in financial services and federal might have seen that pressure so we could understand how temporary or long-lived this could be? And also secondly, as you look at your longer-term objectives, I think the wish of the company has been to grow faster than it has in the last few quarters. Although your growth rate is pretty respectable, I think you guys have always wished that you could grow faster. As you look out into '15, do you feel like you have -- you're done with your sales and marketing, research and development expenses and investments? Or do you feel like next year could be a continued year of investment that we'll have to delay the margin return into 2016?

Sohaib Abbasi

Kash, I don't have the details in terms of the product mix by vertical, other than for the large deals. I don't think that there was necessarily -- it would be -- the one data point is not sufficient for me to generalize to say that the product by vertical mix changed that dramatically. Now in terms of your question about our expectations, our outlook and our confidence and optimism for our long-term growth remains as high as ever. And we are making investments, as Earl pointed out. In fact, this quarter, our investment in R&D will increase to 18% -- almost 18%, which is one of the highest it's been in a very long time. So we are making all those investments. Now there are a couple of considerations. One is, we know that many of these are long-term bets that we're placing: Springbok, data security, Internet of Things, the platform question that we were asked earlier. These are all long-term bets that we are making. And at the same time, we're shifting towards a business which is more subscription-based, which has its own profitability characteristics. So considering all of that, we are going to be looking very, very carefully in terms of our growth investments that are needed and what the implications are for margins. And we obviously will be going through our planning process over the next 6 months to come up with the right mix, but our focus remains on growth.

Earl E. Fry

And Kash, maybe this doesn't answer your question exactly, but just to give you a little color. Of the 23 transactions over $1 million, and we talked about a nice mix, 9 of them had MDM, we had -- we also talked about manufacturing for one of the first times ever being one of our top verticals, contributing more than 10% of our new license orders during the quarter. And we had 4 of our top 23 transactions being driven by manufacturing organizations. And 3 of those 4 were MDM-led transactions. So I think -- you think about the places where we're seeing good, solid growth are in -- actually in areas that are relatively new for us. So manufacturing for the combination of MDM, combination of PIM, building our credibility in that vertical. And we've talked about retail helping in the last few years. So I think that's one thing that you can -- I think is a good indicator or trend.

Operator

Our next question will come from the line of Abhey Lamba from Mizuho Securities.

Abhey Lamba - Mizuho Securities USA Inc., Research Division

Not to beat the dead horse here, but seeing that financial services is at the bleeding edge of technology adoption, what's the risk that this softness can spread to other industry verticals? And within financial services also, you've pointed to sales execution challenges, however, were there any product-specific issues or spending priority changes or competitive shifts that you kind of noticed in that space?

Sohaib Abbasi

We did not notice any shifts in terms of the competitive dynamics in any of our verticals. I would say that it's questionable whether financial services will lead the way in adoption of the newer technologies. We are seeing a lot of innovation go on in energy: big data, oil well, shale formation, green energy. I singled out health care that there's a lot more innovation. So whereas I do believe, retrospectively looking, you would claim that financial services has been the leading indicator for technology adoption, I'm beginning to wonder whether that will remain the case. And part of it is the great deal of attention that is being paid to regulatory compliance has shifted a lot of their attention away from innovation on to a lot of other areas. So if you look at the early adopters for cloud computing or even for that matter Internet of Things, you'll find that there are a lot more early adopters outside of financial services than within it. But it continues to be our #1 vertical. So there's no doubt in my mind that we will have much better results by the end of the year in financial services.

Operator

Our next question will come from the line of Derrick Wood from Susquehanna.

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

You guys have talked about cloud and on-premise being pretty complementary to each other to-date. I'm wondering if you're seeing any kind of shift in behavior where people are increasingly want to buy via the cloud or via subscription for traditional projects. Because we've seen some pretty big weakness out of IBM and their information management group, TIBCO and some others. So there seems to be other vendors out there that are having some issues with larger on-premise license deals. Are you seeing a change in behavior that could be impacting you guys?

Sohaib Abbasi

Not that would explain the results that we have been reporting. I think, in general, there is a preference by some customers in terms of consumption-based subscription pricing. There's no question about that. The challenge that we are helping our customers with is the fact that they have data that is both on-premise and increasingly in the cloud, and they need to actually ensure that they could integrate and leverage all of that data. So given that our value proposition is that of Hybrid Integration, I believe that will continue to be a net new incremental opportunity for us.

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

Okay. I think you guys operate or manage 2 different sales forces, one for the cloud and one for on-premise. I'm not sure if that's correct, but do you feel comfortable with that approach or would you contemplate doing something different?

Sohaib Abbasi

We have been leveraging both of those sales organizations in pursuing cloud opportunities. And our entire field has an incentive to position the cloud opportunities. It's not -- it's analogous to a specialist model where the cloud salespeople are involved with our field organization. That way, we've got the best of both worlds. We got specialist knowledge of the cloud, and as well as the scale of the entire Informatica sales organization.

Operator

Our next question will come from the line of Steve Koenig from Wedbush.

Steven R. Koenig - Wedbush Securities Inc., Research Division

I'll ask one quick one. Most of my questions have been asked. What I'll ask you is, maybe just elaborate a little bit on how we might expect your growing partnership with Amazon to impact your results next year or beyond. And maybe if you could also address, with that product or the other cloud products, I know it's like comparing apples and oranges, but it seems that there's less profit dollars in the new stuff, so I would love to get your thoughts on that as well.

Sohaib Abbasi

We announced a strengthened partnership with Amazon. We now have a trial version of our offering available with Amazon Redshift, which is one of their best-selling new offerings that would provide analytics in the cloud. To date, Informatica Cloud has focused on the Salesforce.com ecosystem, and we've done very well. We have -- we are, by far, the largest provider of integration technologies for the Salesforce.com customer base, and we're now expanding into new cloud ecosystems, Amazon being at the top of our list, NetSuite, Workday and others. So we believe that by expanding across multiple of those cloud ecosystems, we could accelerate our growth in our core data integration, specifically in the cloud. The operating profitability of all of our subscription services is very different than that with the license business, but we see a lot of growth potential in working very closely with Amazon, as we have with Salesforce and many other cloud vendors.

Operator

Our next question will come from the line of Shaul Eyal from Oppenheimer.

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

Sohaib, you already touched indirectly about the competitive landscape in your reply to a prior question. Can you maybe provide us with some more color as to what's happening maybe with -- versus the IBMs? What's happening with respect to some of the newcomers, companies such as Talend, just as an example. Any shift in that respect? Anything which is also plaguing your business a little bit?

Sohaib Abbasi

We have not seen any shifts. IBM, the majority of our deals still are uncontested by a commercial competitor. We're evangelizing the value of buy instead of build. IBM, we encounter in 15% to 20% of our deals. Our win rates against them continue to be above 80%. In fact, if anything, I believe they've been focused on a lot of other areas outside of our core strength. And we have not seen any difference in terms of other competitors, including some of the open source ones that you've mentioned. In fact, we have -- with the innovation roadmap, we've delivered a lot of new technology, Big Data Edition, that we've had great traction last quarter. We also have delivered Data Integration Hub. So we continue to out-innovate all of our competitors.

Operator

Our next question will come from the line of Ed Maguire from CLSA.

Edward Maguire - CLSA Limited, Research Division

I wanted to come back to the growth in health care and energy and high tech. I know we've talked a bit about the change in the financial services and public sector. But could you discuss at least out looking -- looking forward, what may be the mix in use cases? And I know you've broken out the mix of traditional data warehousing and newer products. Is there -- are there distinct differences that have contributed to that change in vertical mix this quarter and looking forward?

Sohaib Abbasi

In health care, the biggest driver is, of course, the Affordable Care Act. And I gave an example of the partnership we announced with Xerox Services. We had the highest number of million-dollar deals in health care. And that includes our core products, as well as some of our newer products, particularly for privacy. In case of energy and manufacturing, it also includes a mix of our products. I highlighted the big data initiative for an oil and gas company, where they have got sensors in their shale wells and they're using the big data in order to actually decide where to drill next. But I also singled out an energy company that is looking at maximizing their revenue, but with a single view of a consumer, where they're looking at MDM. And in manufacturing as well, there's a healthy representation across all of those -- across all of our products in those new, emerging top verticals.

Operator

Our next question will come from the line of Pat Walravens from JMP.

Patrick D. Walravens - JMP Securities LLC, Research Division

Sohaib, at what point would you consider shifting more to the profitability side of the equation versus growth?

Sohaib Abbasi

At this stage, Pat, we are exploring multiple growth initiatives, the analytics, Springbok products. I talked about cloud and becoming more aggressive. We're also looking at Internet of Things. Security is another space. In my conversations with customers, they're increasingly viewing Informatica as a much more strategic partner for adoption of cloud computing, Internet of Things and big data. I'll give you an example. I was in Europe, I met with one of the top auto manufacturer, and they're looking at the connected car and they're looking at what they ought to do in terms of data services for the cars. So in light of -- and the conversations that I've had with our customers highlight that they recognize that data matters. And for that reason, I am very optimistic despite the fact that we all want to actually return to much higher growth rates much faster. I believe in the opportunity, and we will continue to take our growth opportunities very seriously and continue to be prudent in terms of the investments we're making.

To sum up, I firmly believe that our opportunity is greater than ever to grow Informatica to a multibillion-dollar organization. We are well positioned for sustained growth with our broadest-ever product portfolio, our innovation roadmap and the changes we are applying today. Thank you.

Operator

Ladies and gentlemen, that concludes today's presentation. You may now disconnect. Have a great day.

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