Imperva Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Imperva, Inc. (IMPV)
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Imperva (NASDAQ:IMPV) Q3 2013 Earnings Call November 5, 2013 5:00 PM ET

Executives

Terrence J. Schmid - Chief Financial Officer, Principal Accounting Officer and Treasurer

Shlomo Kramer - Co-Founder, Chairman, Chief Executive Officer and President

Analysts

Saket Kalia - JP Morgan Chase & Co, Research Division

Ben McFadden

Robert P. Breza - RBC Capital Markets, LLC, Research Division

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

Imtiaz Koujalgi - Deutsche Bank AG, Research Division

Jonathan Ho - William Blair & Company L.L.C., Research Division

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Erik Suppiger - JMP Securities LLC, Research Division

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Michael W. Kim - Imperial Capital, LLC, Research Division

Operator

Well, good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Imperva Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] In addition, today's conference is being recorded. I will now turn the conference over to Mr. Terry Schmid, CFO. Please go ahead, Mr. Schmid.

Terrence J. Schmid

Thank you, Kelsey. Good afternoon, and welcome to Imperva's Third Quarter 2013 Earnings Call. We will be discussing the results announced in our press release issued after the market closed today. Again, I am Terry Schmid, Chief Financial Officer of Imperva. With me on the call is Shlomo Kramer, Imperva's Chief Executive Officer.

During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company. Generally, these statements are identified by the use of words such as expect, believe, anticipate, intend and other words that denote future events.

These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements, in the press release and this conference call. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors in Imperva's 10-Q, filed with the SEC on August 8, 2013.

During this call, we will present both GAAP and non-GAAP financial measures. Non-GAAP measures exclude stock-based compensation expenses. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing Imperva's performance.

For complete information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release regarding our third quarter 2013 results. A press release has also been furnished to the SEC as part of our Form 8-K.

In addition, please note that the date of this conference call is November 5, 2013, and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

Lastly, this conference call is the property of Imperva, and any recording, reproduction or rebroadcast of this conference call without the expressed written permission of Imperva is strictly prohibited.

With that, I'll turn the call over to Shlomo, and then I will provide some further details regarding our financials and our forward-looking outlook. Shlomo?

Shlomo Kramer

Thanks, Terry. I would like to thank everyone for joining us today. We are very pleased with the company's execution during the third quarter, which was highlighted by our ability to exceed the top end of our revenue guidance range.

Our strong sales quarter performance was driven by ongoing demand for our comprehensive integrated data center security solution as the number and frequency of attacks targeting high-value applications and data assets remained high globally.

We also benefited from improved sales execution overall, as well as from the changes we began to implement last quarter regarding our European and South American sales infrastructure. This resulted in solid growth across all geographies, especially in EMEA, where revenues increased 73% compared to last year.

Furthermore, the number of deals booked over $100,000 increased 39% year-over-year, while our combined product and subscription revenue grew 33% compared to the third quarter of 2012. As a result, we believe that our strong third quarter performance highlights that the underperformance in our European and South American territories in the prior quarter was not due to any change in our opportunity in these territories or from any issues in the overall economic environment, as the pipeline growth remains solid in these regions.

Taking a look at our overall financial performance, during Q3 2013, our total revenue was $35.1 million, up 33% year-over-year and above our guidance range. This increase was driven by the success in EMEA that I mentioned earlier, and the 45% year-over-year growth in recurring service revenue, particularly subscription revenue, which increased 129% year-over-year and now represents 18% of total service revenue, compared to 11% last year.

Our combined product and subscription revenue during Q3 also grew 33% year-over-year, which we continue to view as a leading indicator of the strength of our business, since a large part of our subscription-based offering is an alternative to our perpetual license offering.

From a profitability perspective, during the third quarter, we reported a non-GAAP operating loss of $300,000 and a non-GAAP EPS loss of $0.01 per share, both above our guidance range. We are pleased with this result since we continue to accelerate our investment in our sales and marketing support and product development infrastructure to further take advantage of the demand we believe we are seeing globally.

In addition, as expected, our gross profit margins rebounded to 80%, from a slightly lower margins we saw in the second quarter of 2013, and we expect that margin to remain consistently around 80% moving forward.

In regard to some of the summary level statistics, during the third quarter, we added 148 new customers compared to 138 during the same period last year. For the 9 months ended September 30, 2013, we added 481 new customers, representing growth of 36% compared to the same period in 2012 and further evidence that our investments are continuing to pay off.

In addition, as I mentioned earlier, the number of deals greater than $100,000 increased 39% to 97 during the quarter. And it is important to note that the dollar value of these large deals continues to grow as well.

We also continued to generate a significant portion of our bookings from follow-on sales to existing customers as they accounted to over 60% of our product and subscription bookings in the third quarter. We continue to believe that our existing customer base is less than 10% penetrated and represents a significant long-term growth opportunity for the company.

Finally, our overall pipeline growth continues a solid trend upwards, and we entered Q4 with a record pipeline. Our pipeline continues to grow at a rate above both our revenue growth and our bookings growth.

From a macro perspective, customer demand was solid across all geographies, and our overall bookings growth once again outpaced revenue growth as our investment in sales and marketing infrastructure continues to pay off.

In the America region, revenue increased 23% during the third quarter as we continue to benefit from the combination of strong execution from our channel partners, as well as the new sales leadership and restructured sales organization in North America that we implemented last year.

In EMEA, we were very pleased with our execution, as our revenue increased 73% year-over-year during the quarter despite the continuing economic challenges in many regions. As I mentioned earlier, the rebound in performance compared to the second quarter was expected due to the continuing solid pipeline growth in the region.

In addition, we believe that the steps we have taken and continue to take in EMEA regarding improved sales execution will lead to further sustained growth, similar to what we achieved in North America during the past year.

As a reminder, we brought in new sales leadership in North America last year and restructured the sales organization, which resulted in strong year-over-year revenue and booking growth in the Americas for the first 9 months of the year.

During the second quarter of 2013, we began instituting similar changes in Europe and South America, where we brought new sales leadership on board in both region, and the new leadership began the process of evaluating and upgrading the organization.

Going forward, we believe that the changes we are making will successfully address the execution issues we discussed last quarter, similar to our experience in North America.

In Asia Pacific, revenues increased 21% year-over-year in Q3, as we benefited from solid execution and strong demand highlighted by booking growth being significantly higher than revenue growth. As a reminder, we are also making additional investments in our sales organization in this region to increase the overall growth rate, evidenced by the addition of new Director of Strategic Accounts for Asia Pacific and Japan, and a new Regional Sales Director for the Pacific, both of whom bring over a decade of account and sales management expertise in the security sector.

Now I would like to provide an update on some of our key accomplishments during the third quarter. In Q3, we continued to see multiproduct deployment expansion within some of our largest accounts. For example, a global Asia Pacific-based financial services company purchased product and services to expand its Imperva deployment.

In addition to professional services, the customer purchased SecureSphere Operations Manager to help streamline the management of their database security deployment, as well as added ThreatRadar Reputation Services to their web application firewall deployment.

A major European bank expanded its web application firewall and ThreatRadar deployment in order to combat fraud and cybercrime on external application. The bank also became a new customer of our database security product, with the intention of reducing risk to their internal databases.

One of the world's largest service providers has continued its worldwide deployments by adding a mix of web security and database security in 2 existing deployments in Europe, as well as adding new database security deployment in Asia.

From a competitive perspective, our win-loss ratio in head-to-head competitive deals remains very strong. Similar to past quarters, we had a number of deals that we won against large competitors, highlighting the value of our integrated solution and the superior level of support we provide on a global scale.

Some of these wins during Q3 included a large government agency with a significant existing F5 load balancer deployment, chose Imperva's web application firewall over F5's application security add-on due to a range of technical and solution breadth advantages. Key technical reasons for the win cited by the customers were Imperva overall threat response capabilities including ThreatRadar Reputation Services, community defense and our ADC security update service.

From a security breadth -- from a solution breadth perspective, our database security solution was regarded as an area of future interest as the agencies continue to mature their data center security portion.

Continuing on the federal front, we beat IBM and McAfee in a primarily database security deal at a Defense Department agency. Key reasons for the win were our hybrid architecture that supports both agent and network monitoring and our superior virtual patching of database vulnerabilities. The customer also purchased our SharePoint solution to protect unstructured data stores in Microsoft SharePoint sites.

On the commercial side, a Fortune 100 media company replaced a third tier competitor's database security solution with Imperva. We beat out both IBM and McAfee for the project, which will expand beyond the initial focus on the payment card industry data security standard to also include Sarbanes-Oxley compliance and other sensitive data with the company.

Similar to last few quarters, we continue to have success with our channel partners, in particular, our hosting provider partnerships. As a reminder, data center hosting provider using Imperva solution to protect enterprises that are utilizing our partner's data centers to host their infrastructure.

In the third quarter, we continued to see solid momentum in these channels, though off of a much larger base, which in part contributed to the new customer growth during the quarter. Specifically, one of our large hosting customers achieved an installed base growth rate of approximately 20% during Q3, which was the continuation of a strong growth trend that began in the third quarter of 2012.

In the last 4 quarters, this partner has increased their installed base of customers by more than 200%. The third quarter was also an exciting quarter for our cloud-based application security product, Imperva Incapsula. During the quarter, Imperva Incapsula was responsible for successfully defending against one of the largest-ever distributed Denial of Service attacks, and we view this as strong validation of the quality and robustness of the solution.

More recently, we've expanded the Imperva Incapsula offering to include simplified layer 7 load balancing, making it directly available as a service from the Incapsula cloud. This is a significant announcement for customers because it dramatically improves website performance time and infrastructure utilization and expands the total available market by completing the application delivery suite, which also includes content delivery and optimization.

We also feel it is significant for the market because it positions Imperva Incapsula to disrupt the existing on-premise load balancer market.

Finally, in regards to the continued acceleration of investment, we had a successful quarter from a hiring standpoint as well. Overall, during the quarter, we increased our headcount approximately 5% worldwide quarter-over-quarter. Some of the key regions added to include both EMEA and Asia Pacific, and we plan to continue to expand our headcount in Q4 and during 2014 to take advantage of global demand.

In summary, we are very pleased with our execution during the third quarter, as evidenced by the solid growth across all geographies, illustrating that we are successfully addressing the sales execution issues that impacted Q2.

Looking forward, Imperva is well positioned to maintain this traction during Q4 and into 2014 due to the strength of our global pipeline. And we will continue to invest in product development and sales and marketing to further grow market share and extend our technology leadership position.

With that, let me turn the call over to Terry.

Terrence J. Schmid

Thanks, Shlomo. I will first start with a more detailed overview of our third quarter financial performance and then provide our outlook for the fourth quarter and full year 2013, as well as some preliminary thoughts for 2014. Following my closing remarks, we will open up the call for your questions.

During the third quarter, revenue came in at $35.1 million, which is an increase of 33% compared to the third quarter of 2012 and just above our guidance range of $34 million to $35 million. As Shlomo mentioned, we saw strengthened performance across all geographies, particularly EMEA.

Services revenue, which represents the recurring portion of our business and consists of maintenance and support, professional services and training and subscriptions, increased 45% to $16.9 million and accounted for 48% of total revenue compared to 44% during the third quarter of 2012.

The growth in services revenue was primarily driven by the 129% year-over-year increase in subscription revenue to $3.1 million. As subscriptions now account for 18% of services revenue, up from 11% last year.

We continue to remain excited about the overall traction we are having with our cloud-based products, evidenced by the strong growth in subscription revenue in Q3 and our bookings growth, which continues to be significantly higher.

As a reminder, during the second quarter, we closed the largest cloud DDoS deal in the company's history with a Fortune 10 company. This multiyear agreement added our cloud DDoS service under their existing on-premise data center security deployment as the company needed to provide Denial of Service attack mitigation for its highly distributed web applications.

In addition, our services and training revenue grew 56% to $2.7 million in Q3 of 2013 compared to $1.7 million in Q3 2012. We believe the growth in our services and training revenue remains directly tied to the continued success we're having in larger accounts.

As a result, our combined product and subscription revenue came in at $21.2 million, which represents growth of 33% compared to the third quarter of 2012.

Product and subscription revenue growth remains increasingly driven by the success of our cloud-based application security products, Imperva Incapsula, which we -- or in fact, during Q3 of 2013, the bookings of our subscription-based application security products for the cloud are once again significantly greater than the bookings of our ThreatRadar services.

It's important to keep in mind that our cloud-based application security products represent a distinct delivery mechanism for bringing our application security products to our customers and are not an adjunct to our perpetual license business.

Our cloud security products not only provide us access to additional market segments such as the SMB market, but we also believe they will continue to become an increasingly important way of delivering application security to enterprises of any size.

During the third quarter, we added 148 new customers overall. This is an increase of 7% year-over-year and highlights the more difficult comparison with our hosting provider channel, which began to have traction during the third quarter of 2012.

As Shlomo mentioned, we still experienced approximately 20% year-over-year growth from this channel, which we were very pleased with. For the 9 months ended September 30, 2013, new customers added increased 36% to 481 compared to the same period in 2012.

Turning now to non-GAAP expenses and profitability, which I remind you excludes stock-based compensation expenses. For the third quarter, gross profit was $28.1 million compared to $21 million in the same period last year. Our gross margin percentage was 80% during the third quarter, consistent with the year-ago period and, as expected, up from 77% during the second quarter of 2013.

In terms of non-GAAP operating expenses, we continued to increase our investments in sales and marketing and research and development compared to prior periods to support future growth, given the strength of our pipeline.

Specifically, sales and marketing expenses increased 47% to $18.5 million and represented 53% of revenue compared to 48% during the third quarter of 2012. Research and development expense increased 23% year-over-year to $5.9 million and accounted for 17% of revenue, in line with Q3 of 2012.

General and administrative expense was $4 million, up 13% year-over-year, and as a percentage of revenue, G&A represented 11% in Q3, down from 13% in Q3 of 2012. As a result, we reported a non-GAAP operating loss of $300,000 compared to a profit of $100,000 last year and above our guidance range of a loss of $500,000 to $1 million.

This led to a non-GAAP net loss attributable to Imperva stockholders of $400,000 or $0.01 per share based on 24.5 million weighted average shares outstanding, compared to a loss of $100,000 or $0.00 per share based on 23.2 million shares last year and above our guidance range of a loss of $0.04 to $0.06 per share.

On a GAAP basis, GAAP net loss attributable to Imperva's stockholders for the third quarter totaled $3.8 million or $0.15 per share based on 24.5 million weighted average shares outstanding. This compares to a loss of $1.9 million or $0.08 per share based on 23.2 million weighted average shares outstanding in the prior year period.

A reconciliation of GAAP to non-GAAP financial measures has been provided in the financial statement tables included in the press release issued today, covering our financial results for the quarter ended September 30, which can be viewed on our website.

Turning to the balance sheet. As of September 30, 2013, we had $106.8 million in cash and equivalents and short-term investments, and no debt outstanding. Our cash balance reflects the use of $4.6 million of cash flow from operations during the quarter.

We ended the third quarter with an accounts receivable balance of $36.7 million, resulting in DSOs of 94, up from 79 days in Q2 and from 93 days during the third quarter of 2012. The sequential increase in DSOs were primarily due to timing, and we expect them to decline slightly in Q4 as we have already collected a significant amount of receivables since the end of the quarter.

Total deferred revenue increased $14.4 million or 37% year-over-year to $52.6 million during the third quarter and $4.3 million or 9% compared to the second quarter of 2013. The growth was driven by our over 90% renewal rates, the growing success of our subscription-based products and continued growth in our installed base and new customer acquisitions.

Now turning to our outlook, starting with our fourth quarter. We expect total revenue to be in the range of $41 million to $42 million or growth of 31% at the midpoint compared to the same period in 2012. Non-GAAP gross margin is expected to be approximately 80%. Non-GAAP operating profit is expected to be in the range of $3 million to $3.5 million. This operating profit reflects additional investments in our sales and marketing and research and development organizations as we begin to make investments for 2014. I will have some brief comments on 2014 later in this call.

Non-GAAP net income attributable to Imperva stockholders, excluding the impact of stock-based compensation, is expected to be in the range of $2.5 million to $3 million or $0.10 to $0.11 per share. This also assumes a provision for income taxes of approximately $400,000 to $500,000 for the quarter and diluted shares outstanding of approximately 26.2 million shares.

From a full year perspective, we are increasing our guidance to reflect the strong performance in Q3 and continuing momentum we are seeing. During the full year 2013, we expect total revenue to be in the range of $136 million to $137 million, which represents year-over-year growth of 31% at the midpoint. This compares to our previous guidance of $135 million to $137 million.

Our non-GAAP gross margin is expected to be approximately 79%. Non-GAAP operating loss is expected to be in the range of $2.1 million to $2.6 million compared to our prior guidance of a loss of $1.5 million to $2.5 million. This still includes an increase in our sales and marketing and research and development investments to take advantage of the demand we are seeing worldwide.

We expect non-GAAP net loss attributable to Imperva stockholders, excluding the impact of stock-based compensation, to be in the range of $2.9 million to $3.4 million or a per share loss of $0.12 to $0.14 per share, compared to our prior guidance of a loss of $0.06 to $0.10 per share. This assumes a tax provision of $1 million to $1.25 million and fully diluted shares of approximately 24.4 million for the full year. We expect capital expenditures for the full year to be in the range of $2.5 million to $3.5 million. Finally, we continue to expect to generate positive cash flow from operations in 2013.

Before turning it over to the operator for Q&A, I wanted to make a few comments on fiscal 2014. While we are still in the early stages of our planning process, our preliminary estimate of full year revenue growth is at least 25%, as we continue to see strong growth in our pipeline. We plan to give an updated view and further details regarding our 2014 expectations on our Q4 earnings call.

In summary, we are very pleased with our third quarter results, which were driven by the combination of ongoing demand globally, high competitive win rates and expansion within existing customers. The growth of our recurring services revenue highlights the increased visibility we have in our business, and we remain well positioned to maintain the momentum due to the strong pipeline of opportunities worldwide.

And with that, we'd be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Sterling Auty with JPMorgan.

Saket Kalia - JP Morgan Chase & Co, Research Division

It's Saket here for Sterling. Hey, Terry, just a quick clarification. Did you see any third-party revenue or costs in the quarter different than what you expect kind of similar to what we saw last quarter? Or was it about in line with what you've seen historically?

Terrence J. Schmid

We didn't have any third-party hardware sales like we did in the second quarter. In some quarters, it's usually a small amount of third-party software sales and we had some of that in the third quarter, but those don't affect margins negatively. Those help margins. So we didn't have anything like the deal that we saw in the second quarter. We don't expect to going forward.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay, got it. And then Shlomo, a lot of the deals that you mentioned in your prepared remarks seem to talk about database monitoring. So I was just wondering if the mix of 50-50 between database and web may be tilted a bit this quarter and how you expect it to end in 2013?

Shlomo Kramer

No. Again, every quarter, there is some fluctuation up and down in application and data security. But in general, when you open a window of time, they grow in lockstep and they remain around equal parts of our books. And we continue -- and we believe it's going to continue like that.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay. And then lastly, you talked about entering the load-balancing market. Can you just give us an idea for how big you think that market might be and what your go-to-market strategy might be there?

Shlomo Kramer

The Incapsula offering has always included capabilities that go beyond security to now general application delivery capabilities. And that's the way that customers are looking to consume this capability in the cloud as a bundle that offers CDN capabilities, acceleration optimization, DDoS protection, web application firewall, as well as load balancing. And right now, we see good demand for these combined capabilities, and we are seeing that is actually -- the Incapsula is one of the fastest-growing pieces of our business. So right now, it looks promising.

Operator

Moving on to Rob Owens with Pacific Crest Security.

Ben McFadden

This is Ben calling in for Rob. You guys clearly saw a reacceleration across the business in the quarter, and I'm just -- I'm kind of drilling down as far as what you saw with the large deals. Maybe you could just talk a little bit about what's driving that? And then did you see a tilt maybe towards existing customers versus new? Or any color you can provide there will be great.

Terrence J. Schmid

As far as existing versus new, we did -- more than 60% of our bookings were from existing customers. Our bookings during the quarter, more than 60%, were existing customers. That's in line with the last couple of quarters that we've seen. In terms of the large deals, what's driving the acceleration there, I think, is, frankly, Imperva's own reputation among the people that are buying products and our customers' willingness to make larger bets and open up larger POs and start larger projects with our products. I think it's a direct result of the success we've had over the last several years.

Ben McFadden

Great. And just curious as far as how you're thinking about sales headcount going into Q4. And I know you're -- sounds like you're concentrating more on the EMEA and the APAC region, but also how you're thinking about it from Americas region, too?

Terrence J. Schmid

We have sales headcount growth. We're not concentrating necessarily on any particular region. Restructuring is really what we've been talking about, in particular for EMEA and South America. But we're growing our sales headcount globally, and we'll continue to do so in Q4 and particularly as we ramp up for the opening of 2014. So those are our investments across the globe that we'll continue to make and accelerate.

Operator

We'll now hear from Robert Breza with RBC Capital Markets.

Robert P. Breza - RBC Capital Markets, LLC, Research Division

Obviously, the bookings growth of 40% was faster than what we've seen from Q4 of 2011. I think in your prepared remarks, you talked about the pipeline growing above bookings growth rate of that 40% so -- and thank you for the 25% growth rate for '14. So as we reconcile that kind of differential, should we expect more subscription revenue going forward? Or how should we think about the mix maybe going into '14?

Terrence J. Schmid

Yes. So the fastest-growing part of the business, not just from a revenue, but from a bookings perspective, is the subscription piece of the business so it's going to -- it's going to outgrow the other portions of the revenue stream, Q4 and end of 2014 and beyond, so you can expect to see that increase as a percentage of the total revenue. It was 18% of the services revenue in the third quarter this year versus 11% last year and nearly 10% of the total revenue stream in the third quarter. So it's going to continue to be a larger percentage of the revenue we report.

Robert P. Breza - RBC Capital Markets, LLC, Research Division

So with that dynamic, Terry, would we expect -- obviously, with more subscription revenues flowing into the revenue stream, should we expect margins to kind of at least qualitatively stay flat or increase slightly? Or how are you thinking about margins qualitatively?

Terrence J. Schmid

I think that we would expect to see margins stay in the 80% range where they are.

Operator

Our next question will come from Shaul Eyal with Oppenheimer & Co.

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

Apologies in advance for some background noise. So second quarter was a little bit of a bump in the road. But within a matter of a quarter, you guys have kind of restructured that. I'm just curious to know, and we have some other companies over the past 6, 12 months kind of have some issues a little bit in Europe, a little bit in Asia. Usually, it took them about 2 quarters to kind of restructure some of their businesses. What have you guys done differently to kind of show this kind of quick jump right back a quarter after kind of fumbling a little bit? And is it something that you have seen already emerging in the first quarter? Or what kind of -- what's the secret sauce behind it?

Shlomo Kramer

So those noteworthy companies you're referring to so I can say what we have done differently. What we've done is what we've said we are going to do in the last call, which is essentially replace the -- we've replaced the leadership with -- that leadership did an assessment of the talent and started upgrading the talent in many cases and improving sales execution in the most basic ways, improve the closure against the pipeline, and we have strong pipeline in these region, improve the work with the channel, improve the other processes that are involved around the sales process so it's kind of the basic stuff.

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

Got it. Thank you for the color about deals greater than 100k, but what's kind of the status, generally speaking, on the ASP arena?

Terrence J. Schmid

Average deal size, there's 2 components here. So our average deal size has been going up slightly over time. It hasn't risen dramatically. We do a lot of deals during the quarter. So deals of all sizes have been growing relatively quickly. So over the course of the year, the average deal size is north of $70,000, has been going up each quarter generally. The other aspect of average deal size will be discounting. And discounting has held steady to maybe a slight improvement, meaning slightly lower discounts over the course of the year.

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

Got it. And those discounts have been again qualitatively in kind of what range, so to speak, just from the normal range?

Terrence J. Schmid

Well, we don't talk about that, but I will just say this, it's not -- there's nothing unusual about our discounting practices, and in fact, we've been steadily getting better. So we have done well though. We're not winning deals because we're lowballing on price at all.

Operator

We'll move on to Nandan Amladi with Deutsche Bank.

Imtiaz Koujalgi - Deutsche Bank AG, Research Division

It's actually Taz on -- it's actually Taz on behalf of Nandan. I have a question about your federal exposure. How much of your revenues are coming from the federal vertical today? And if you guys saw any disruption, given the mess that we saw in the quarter in Washington?

Terrence J. Schmid

No, we still -- we don't disclose the percentage of our revenues that come from the U.S. federal space but they're still fairly small. It's something we've been focusing on, and we've talked about it for a while. And I think we're going to do well there and have success, but it's not something that has been a significant piece of the business for us. So whatever shenanigans the people in Washington are up to this time of the year didn't really affect our business.

Imtiaz Koujalgi - Deutsche Bank AG, Research Division

Looking at your results in the quarter, so you came in above your guidance for both revenue and EPS, but then you still chose to lower the EPS guide for Q4. What changed between now and 3 months ago when you gave us the guidance, that you had to increase your expectations for spending in Q4?

Terrence J. Schmid

2014 planning and what we're expecting to do next year, initial investments for that in, say, R&D and sales and marketing organization.

Imtiaz Koujalgi - Deutsche Bank AG, Research Division

So the spend will go to sales and marketing and R&D, I guess, sales here?

Terrence J. Schmid

Correct, which is the same areas that we've been investing in over the course of this year, those 2 areas. It's the primary focus of where we're putting our money right now.

Operator

Jonathan Ho with William Blair has the next question.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Just wanted to follow up on this line of questioning around the sales and marketing increase in spending. Can you give us maybe a sense of where specifically you're going to be applying the dollars? Is this going to be towards more sales management or is it more direct quota-carrying reps? And just wanted to get a sense of that and perhaps which changes that you've implemented have had the most impact on the business, along the lines of a sales and marketing side.

Terrence J. Schmid

So specifically for the fourth quarter in the sales organization, it's targeted somewhat to sales management but getting more quota-carrying heads into the company and on the street and ready for sales kickoff in the early part of 2014. So their increase is primarily going to quota-carrying reps there. What was the second part of your question?

Jonathan Ho - William Blair & Company L.L.C., Research Division

So just within the changes that you made maybe in the latter part of 2Q and throughout 3Q, which changes had the most impact in terms of on, I guess, the sales and marketing changes?

Terrence J. Schmid

Leadership. Leadership had the biggest impact in terms of improving sales execution in the field. So the leadership team that we put into EMEA has really improved and strengthened the focus the teams have on the deals and what's available and how they're getting close. And that's had the biggest impact.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Got it. And just in terms of the file activity monitoring product, just want to get a sense of whether you're seeing any sort of improvement there or any shift in terms of the relevance to your overall mix.

Shlomo Kramer

Yes. Both on the short term, we're definitely continuing to see improvement and seeing more larger deals in that area, as well as we see this area is strategic long term for the company. This is -- 80% of the data in the data center is unstructured. A lot of the data today in the cloud is unstructured. Big data is unstructured. So both in immediate perspective and long term strategically for the company, this is a very important area for us.

Operator

[Operator Instructions] We'll now hear from Jonathan Ruykhaver with Stephens.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Terry, can you talk about the hosting provider business in terms of revenue recognition? How much is potentially shifting from perpetual license to term structure? Was that an issue in 3Q?

Terrence J. Schmid

It's not an issue. I think that in general, the model that we have going forward with the hosters is more of a subscription-type revenue stream. But I don't anticipate it causing -- being anything problematic for us in results going forward. I don't expect there to be a dip. The business is going well.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

And when you say subscription, does that mean you're booking those deals upfront and then they're carried on the balance sheet and deferred? Or is it off-balance sheet?

Terrence J. Schmid

For the most part, it is -- some part of it is in deferred. Most of those deals we book upfront for an annual booking that we take ratably over 12 months.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Okay. But just to clarify, that is -- that's different from the Incapsula business, the subscription business around amortizing the cost of that perpetual license over, let's say, a 2- or 3-year period. Is that correct?

Terrence J. Schmid

Yes.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

And can you tell us what the license revenue number might have looked like if those deals have been booked? I mean, yes, those deals have been structured as licensed as opposed to deferred?

Terrence J. Schmid

No. It's not something you'd break out. I would -- by the way, I would characterize it this way. I mean, those deals weren't available to us under the perpetual license model. And the reason that this model's working so well is we've come up with a model that works for the hoster business. We're in far larger percentage of their overall customer base that's available to us. These customers that we're signing up now for this -- for a large percentage of them simply weren't available to us under the other model.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Right. Yes, I understand that. I clearly understand it's broadening the market. I was just trying to get a sense for if it would've made a material difference to license revenues, but I guess what you're saying is they wouldn't have purchased the license if you didn't have this type of structure.

Terrence J. Schmid

Yes, not a cannibalization on what we could've done.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Okay, good. And then just the final question I have is, can you provide an update on the partnership with Cisco for delivery the web on the Nexus virtual switch? Is that meeting with your expectations?

Shlomo Kramer

So again, we have a timeline with Cisco, that we are working together towards the delivery around vPath integration and this is working according to plan this time.

Operator

Erik Suppiger with JMP Securities has the next question.

Erik Suppiger - JMP Securities LLC, Research Division

Just wondering, in terms of your outlook of 25%, when are you going to start seeing some of the benefits of the investments you've been making in the sales and marketing? Is that what you think the market growth is? Or do you think that you can start gaining share with some of the additional headcount that you've been adding to sales and marketing? Or how did you come up with the 25% growth?

Terrence J. Schmid

So we -- the at least 25% growth, we came up with based on the visibility we have into our pipeline, and we'll give you more detail on what we expect for 2014 on the Q4 call.

Erik Suppiger - JMP Securities LLC, Research Division

Can you comment as to whether or not you think the market is growing faster or slower than that rate?

Terrence J. Schmid

As we've said in the past, we think the underlying markets we serve are growing about 25% year-over-year, so we expect to grow at least that.

Erik Suppiger - JMP Securities LLC, Research Division

Okay. On the linearity, is -- was the linearity in line with what you were expecting? Or how did you look with -- I think it was 93-day DSOs. Was that in line with your expectations? Or how was linearity in the quarter?

Terrence J. Schmid

The linearity continues to be back-end loaded. It was in line with last year's Q3, so it was still skewed toward the last month, no doubt about it, heavily skewed that way.

Operator

Moving on to Rohit Chopra with Wedbush.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Shlomo, had a question for you and a couple for Terry. There's a lot of noise in the competitive environment. I know you said the win rates are still above 90% but I just wanted to get the sense from you, Shlomo, are you seeing more people at bake-offs? Or is there anything changing in the environment that you're seeing?

Shlomo Kramer

Not really. I think that the major competition comes from the same sources that it came over the last few years. As I've stated then in previous calls, we are now much more active in additional areas such as file and cloud, and this area, the additional competitors that are different. We are the only ones that are able to offer kind of the end-to-end platform but kind of traditional areas, web and database, it's the same players and nothing much changed in the portal of competition there.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Okay. Terry, I just wanted to get a clarification, just on the customer account. It did fall sequentially. Is that a function of seasonality more than anything?

Terrence J. Schmid

Yes. It could be -- any given quarter could -- sequentially, we are not looking to grow the customer count one quarter over the prior one per se. Year-over-year customer account is really what we focus on more.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Okay. And then the last question I had for you, Terry, and I'm going to ask Erik's question in a different way. For the last 3 quarters, the top end of your guidance for the full year has stayed the same, yet investments began -- I'm going to say it's sort of in the May time frame where you announced it. And is there a time frame where people should expect growth that's greater than what you've been projecting, let's say, it was 7 months ago? Is there anything holding you back? Or if these investments weren't made, would there have been an issue? Or if you could just talk a little bit about those investments and why the guidance at the top end has stayed the same, that would be great.

Terrence J. Schmid

I think one of the things we've been talking about is we've been talking about increasing these investments is the time frame that it takes for these investments to become productive, right? You add people to the sales organization and you roll them out into the field and it takes 3 quarters for somebody to be a productive field rep. And not all of them are productive, by the way, and some of them we make changes on. But we expect most of them to be fully productive and ramped up by 3 quarters. So there's a time lag. There's a time lag between the increase in the time that they're adding value to what we're doing. And we're also growing the business off of larger numbers, right? So there's not only the investments to take advantage of the pipeline but we're also growing the business off of bigger numbers. So I think what we're trying to tell you right now for 2014, for example, is we have enough visibility to tell you, just like we did last year, that we're going to grow at least 25% so you can get a feel for what we think what kind of confidence we have going into next year on the revenue side. As far as what we would communicate to you guys with respect to exactly when these investments are going to pay off, I think that the comfort that we have in giving you even that number should be indicative of the fact that we think they are paying off and that we're confident that we're doing the right thing there.

Operator

[Operator Instructions] Rob Owens with Pacific Crest.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

First question is around the 25% growth as you look at '14. Terry, any sense of how the year might play out at a linearity standpoint? Any product releases that might help drive that? Or should it be pretty evenly spread across the year?

Terrence J. Schmid

So obviously, as I said already, we'll give more clarity on 2014 on the Q4 call, so I would reserve that until then.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Okay, fair enough. And then, Shlomo, secondly, around kind of the new product set protecting unstructured data. Can you give us an update in terms of how you're doing, how the product's progressing and any potential releases you're expecting on that front?

Shlomo Kramer

No, we are seeing increased activity and good pipeline growth and larger deals that we are in this pipeline. So overall, we are very pleased with the progress we are doing there. And we believe this can, down the road, become much more significant for the business.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

So relative to significance, and I realize Terry's reserving any guidance on 2014, which we appreciate, but any sense that this could be a 10% kind of number at some point during 2014?

Terrence J. Schmid

I don't think we'd give that kind of guidance on an individual product set like that.

Operator

We'll now hear from Michael Kim with Imperial Capital.

Michael W. Kim - Imperial Capital, LLC, Research Division

Can you talk a little bit about the opportunities you're seeing in the pipeline for cloud DDoS? Are you seeing it primarily with the largest enterprises? Or is the demand environment more broad based? And then behind that, is it your expectation that cloud DDoS will be a primary driver of subscription revenue?

Shlomo Kramer

So the demand for DDoS is across the board. We are seeing demand from the largest enterprises in the world to small organizations that we have an offering for a few hundred dollars a month that includes a DDoS capability. So also very small organizations are interested in DDoS. This is a primary concern to everybody that has an online presence today.

Michael W. Kim - Imperial Capital, LLC, Research Division

And is it your sense that cloud DDoS will be the primary driver into next year for the subscription revenue line?

Shlomo Kramer

Again, I think that our subscription is we have a number of offering, including Imperva Incapsula, and their DDoS is important but web application firewall, general web security, CDN capabilities, load balancing and the list goes on. There's a very rich set of functionality offered for that cloud offering. And beyond Imperva Incapsula, we've got other services, very successful services such as ThreatRadar Community Defense and others. So the range of our offering is much broader than DDoS.

Michael W. Kim - Imperial Capital, LLC, Research Division

Okay. Great. And can you provide an update on your expansion into the mid-market enterprise and SMB channel, particularly through the MSSPs, how that's progressing?

Shlomo Kramer

Yes. So it's going very well. We talked about, for example, one hoster that increased their installed base 20% in Q3 and 200% over the last 4 quarters. And kind of more generally, a big piece of the Incapsula business is mid-market and small organization, and that's one of the fastest-growing pieces of our business so it's going very well.

Operator

[Operator Instructions] There are no further questions at this time. Imperva, I'll turn the conference back to you for closing or additional remarks.

Terrence J. Schmid

Thank you all for joining the call today. We appreciate your continued support and interest in Imperva, and we'll talk to you next quarter. Thank you.

Operator

And again, ladies and gentlemen, that concludes our conference for today. We thank you all for your participation.

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