Commvault Systems Inc (CVLT) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Commvault Earnings Conference.

(Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Michael Picariello.

Sir, you may begin.

Good morning.

Thanks for dialing in today for our second quarter 2018 earnings call.

With me on the call are Bob Hammer, Chairman, President and Chief Executive Officer; Al Bunte, Chief Operating Officer; and Brian Carolan, Chief Financial Officer.

Before we begin, I'd like to remind everyone that statements made during this call, including in the question-and-answer session at the end of the call, may include forward-looking statements, including statements regarding financial projections and future performance.

All of these statements that relate to our beliefs, plans, expectations or intentions regarding the future are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations.

Actual results may differ materially due to a number of risks and uncertainties, such as competitive factors, difficulties and delays inherent in the development, manufacturing, marketing and sale of software products and related services and general economic conditions.

For a discussion of these and other risks and uncertainties affecting our business, please see the risk factors contained in our annual report on Form 10-K and in our most recent quarterly report in Form 10-Q and in our other SEC filings and in the cautionary statement contained in our press release and on our website.

The company undertakes no responsibility to update the information in this conference call under any circumstance.

In addition, the development and timing of any product release as well as any of its features or functionality remain at our sole discretion.

Our earnings press release was issued over the wire services earlier today and has also been furnished to the SEC as an 8-K filing.

The press release is also available on our Investor Relations website.

On this conference call, we will provide non-GAAP financial results.

As a reminder, we adopted the new revenue standard in the first quarter.

The resulting growth rates in Brian's remarks are on a comparable basis as prior periods were adjusted using the new rules.

Please note that as we stated on the fourth quarter call, Commvault adopted the new revenue standard ASC 606 in April 1, 2017.

Our adoption was done on a retrospective basis, so all prior periods in our financial statements have been adjusted to comply with the new rules.

As a result, the resulting growth percentages we will discuss today are on a comparable basis.

The reconciliations between the non-GAAP and GAAP measures can be found in Table 4 accompanying the press release and posted on our website.

This conference call is being recorded for replay and is being webcast.

An archive of today's webcast will be available on our website following the call.

I will now turn the call over to our CEO and President, Bob Hammer.

Thanks, Michael, and good morning, everyone.

And thanks for joining our fiscal second quarter FY '18 earnings call.

And I'd just start by saying that I am disappointed with our Q2 financial results.

Simply put, there are a number of 6- and 7-figure software deals, which we were unable to close, that were being forecasted right up until the last several days of the quarter.

We believe many of these deals will close in Q3 and a majority by the end of Q4.

In fact, some have already closed.

The Q2 results are tied to poor sales execution on large deals, primarily in the Americas.

Our Q2 results were in stark contrast to the excellent progress we made last quarter on key strategic initiatives that have both -- have potential to both accelerate growth and reduce quarterly vulnerability to large deals.

This includes the launch of our Commvault HyperScale Software combined with a new resale agreement with Cisco for the enterprise and our Commvault HyperScale appliance.

Let me briefly summarize our Q2 year-over-year financial results.

Software revenues were up 2%.

Total revenues were up 5%.

EBIT margin was 9.3%.

EPS was $0.21 per share.

Our second quarter was adversely impacted by lower-than-expected close rates on large enterprise deals, particularly in the Americas.

As we have discussed for many quarters, we are currently reliant upon a steady inflow of large 6- and 7-figure deals, which come with additional risk due to their complexity and timing.

The low close rate was specific with no consistent theme, and importantly, was not due to an increase in competitive losses.

We have specific action items that are already underway to address the execution issues that occurred in fiscal Q2.

On the positive side, we saw a good growth in EMEA, continued strength in our cloud business.

And we've launched our Commvault HyperScale out-store software with several marquee wins.

Services revenue also performed better than expected.

And we started -- as we stated in the past, we believe that we are well positioned for accelerating year-over-year services growth in the second half of FY '18.

I'm also pleased with the excellent progress we made on a number of key strategic initiatives, which open up significant market and distribution opportunities, both in enterprise and mid-market.

Particularly on the Commvault Appliance, we expect to be able to make the first shipments in early November, and key channel partners are lined up to support this initiative; and completion of a major resale agreement with Cisco, which was announced earlier this morning.

Cisco will be reselling Commvault HyperScale combined with Cisco UCS hardware under the ScaleProtect with Cisco UCS solution name.

These strategic initiatives are aimed at providing distribution leverage in the enterprise with Cisco and in the mid-market with the Commvault Appliance to our channel partners.

We believe they will start to positively impact our financial results in the fourth quarter of FY '18 and provide a foundation for FY -- fiscal 2019 growth.

I will elaborate on these and other new offerings later on in the call.

We had strong third-party validation of Commvault's technology leadership position from 2 of the industry's leading analysts, Gartner and Forrester.

In August, Gartner positioned Commvault in the Leaders quadrant and the recently released Magic Quadrant for Data Center Backup and Recovery Solutions.

Among the leaders, Gartner positioned Commvault furthest on the completeness of vision.

This is the seventh consecutive year Commvault has been named a leader in Gartner's market evaluation for backup and recovery.

In September, Forrester positioned Commvault as a leader in the Forrester Wave Data Resiliency Solutions.

Both complete reports can be found on our website.

I will now address our current FY '18 financial outlook.

We believe the current Q3 and Q4 FY '18 Street consensus for total revenue is reasonable.

This would imply total FY '18 revenues approaching $708 million or 10% year-over-year growth.

We also believe our newest solutions and enhancements should begin to positively impact revenues in the third quarter.

We expect full year software growth to be in the low double-digit percentage range and full year services revenue growth to be in the high single digits.

Brian will provide more details later in the call.

We are allocating existing resources to take full advantage of our Commvault HyperScale solutions and appliances and to support our expanding partner opportunities with Cisco, Microsoft and key channel partners.

We believe that the allocation of resources tied to the Appliance in key partnerships, including Cisco and Microsoft, will help drive improved pipeline development and ultimately lead to overall productivity and top line revenue growth.

However, in the near term, this will limit our FY '18 EBIT margin expansion.

Given our Q2 results and the need to continue to prudently invest, we now believe FY '18 margins will expand 25 to 50 basis points.

While our strategic fundamentals are strong and our opportunity of success have improved, we still face critical challenges.

Our ability to achieve our growth objectives in the near term is dependent on a steady flow of -- and good close rates of large enterprise, $500,000 to $1 million-plus deals.

These deals have quarterly revenue and earnings risk due to their complexity and timing.

Large deal closure rates remain lumpy, as occurred in Q2.

We are bringing to market many new products, new services, new powerful and simplified user interfaces.

These all come with new pricing models.

We are also moving into new market segments with new strategic partners and more aggressive channel programs.

This is requiring us to execute a complex series of initiatives, which have implied execution risks.

We continue to be in an opportunistic situation in the market.

However, in order to achieve our FY '18 earnings objectives, we need to prudently invest without jeopardizing our ability to achieve our software growth objectives, our more balanced go-to-market objectives and our critical technology innovation objectives.

Our growth for the remaining of FY '18 is primarily based on success with the Commvault Data Platform to gain share in large enterprise accounts with a journey to the cloud and solutions to mitigate and recover from a cyber attack; the release #2 and the release of a significant amount of new products and services, which will begin to have an impact in Q3.

And 3, the potential for improved distribution leverage with strategic channel and service provider partners.

Bottom line, there are lots of moving parts to our game plan.

We expect to have a much better second half of FY '18 and solidify the foundation for FY '19 and beyond.

In summary, our Q2 results were in stark contrast to the excellent progress we made last quarter on key strategic initiatives that have high potential to both accelerate growth and reduce quarterly vulnerability to large deals.

Specifically, the strategic initiatives that we launched in Q2 and in Q3 are designed to provide much more distribution leverage, easier-to-sell solutions for our sales force and channel as well as provide for a stronger mid-market revenue stream to complement our enterprise revenues.

These initiatives also strengthen both our ability to penetrate large enterprises and accelerate growth in the mid-market, which can minimize quarterly risks.

As a result, we believe our ability to accelerate license revenue growth has fundamentally improved.

Additionally, our ability to improve overall growth and increase operating margins is now aided by accelerating growth in maintenance revenues.

Our objective now is to validate all this with much better financial performance in the second half of this fiscal year as well as solidify a foundation for FY '19.

I will now turn the call over to Brian.

Thanks, Bob, good morning, everyone.

And I'll now cover some financial highlights for the second quarter of fiscal 2018.

Q2 total revenues were $168 million, representing an increase of 5% over the prior year period and 1% sequentially.

We reported software revenue of $72 million, which increased 2% year-over-year and down 4% sequentially.

Revenue from enterprise deals, which we define as deals over $100,000 in software revenue in a given quarter, represented 59% of software revenue.

Revenue from these transactions was up 3% year-over-year.

Our average enterprise deal size increased 10% year-over-year to approximately $287,000 during the quarter.

This increase in ASP was offset by a 6% decline in the number of deals.

From a geographic perspective, Americas, EMEA and APAC represented 57%, 29% and 14% of software revenue, respectively, for the quarter.

On a year-over-year growth basis, EMEA and APAC were up 23% and 10%, respectively, while Americas was down 7%.

The revenue mix for the quarter was split, 43% software and 57% services.

Total services revenue for Q2 was approximately $96.1 million, an increase of 8% year-over-year and 5% sequentially.

The growth in total services revenue was primarily driven by a 9% year-over-year increase in maintenance revenue, driven by strong renewal rates.

As a reminder, maintenance revenue consists of customer support and software updates and has historically represented approximately 85% to 90% of our total services revenue.

Moving on to our pricing models.

During the quarter, approximately 69% of software license revenue was sold on a traditional per terabyte capacity basis.

This is down from 72% in Q2 '17 and up from 66% in Q1 '18.

We anticipate that sales of our traditional capacity-based licenses will continue to decline as software license revenue shifts to standalone solution sets in our platform pricing model.

Our subscription-based pricing models introduced in FY '18 continue to gain traction and resonate with customers.

As we noted during our July call, when the dollar volume of these deals becomes more significant, we will provide more metrics around subscriptions.

Now moving on to gross margins, operating expenses and EBIT margin.

Gross margins were 86.6% for the quarter.

Total operating expenses were approximately $127.6 million for the quarter, up approximately 8% year-over-year.

We added 63 net employees in fiscal Q2, ending the quarter with 2,796 employees.

Operating margins were 9.3% for the quarter, resulting in operating income or EBIT of approximately $15.6 million.

Net income for the quarter was $10 million, and EPS was $0.21, based on a diluted weighted average share count of approximately 48.2 million shares.

Let me now touch on our outlook for the remainder of FY '18.

As Bob stated, we believe the FY '18 Street consensus for Q3 and Q4 total revenue is reasonable.

This would imply total FY '18 revenues approaching $708 million or 10% year-over-year growth.

Our expectation is to deliver year-over-year software growth in the high single digits in Q3 and mid-teens in Q4.

Services revenue growth is expected to continue to grow sequentially, with year-over-year growth accelerating in Q3 and Q4.

As a result of the revenue growth in the second half, we expect Q3 EBIT margin to be approximately 13% and Q4 EBIT margin to be approximately 15%, resulting in full year margin expansion of approximately 25 to 50 basis points.

Let me now briefly comment on tax rates and share count.

We will continue to use a non-GAAP tax rate of 37% for FY '18, which approximates our anticipated longer-term tax rate.

We're closely following potential tax reform and will make any adjustments necessary should any legislation be passed.

We anticipate that our diluted weighted average share count for FY '18 will be approximately 48 million to 49 million shares.

Please note that certain senior executives have approximately 300,000 outstanding stock options that will reach the end of their 10-year lives and will therefore expire in the next 6 months.

We expect that all of the stock options will be exercised prior to the restoration.

Now moving on to our balance sheet and cash flows.

As of September 30, our cash and short-term investments balance was approximately $495 million, of which approximately 40% is located outside the U.S. During Q2 '18, we repurchased approximately $11.3 million or approximately 192,000 shares of our common stock at an average cost of $58.64 per share.

We currently have approximately $114 million remaining under our share repurchase program that will expire on March 31, 2018, unless we extend it as we have in the past.

Free cash flow, which we define as cash flow from operations less capital expenditures, was approximately $8.5 million, which was down 56% year-over-year.

We continue to expect full year FY '18 free cash flow to exceed non-GAAP EBIT, as it has in the prior 3 fiscal years.

As of September 30, 2017, our deferred revenue balance was approximately $296 million, which is an increase of 16% over the prior year period and 1% sequentially.

All of our deferred revenue is services revenue, not software revenue.

For the remainder of FY '18, we expect sequential deferred revenue growth to increase in the mid-single-digit percentage range.

As a result, at the end of FY '18, we expect year-over-year deferred revenue growth to be in the low double digits.

For the quarter, our days sales outstanding, or DSO, was 72 days, which is up from 66 days from the prior year.

At September 30, our receivables balance includes approximately $6.3 million of unbilled receivables.

We've included the unbilled receivables balance in our DSO calculation.

The vast majority of the unbilled receivables will be invoiced in the next 12 months.

As noted on our prior earnings calls, in certain situations, we are required under the new revenue rules to recognize revenue in advance of invoicing our customer.

As a reminder, while it is our goal to align revenue and cash flow by collecting cash upfront, this may not be practical or in our best interest in all cases.

If we determine it is prudent for a customer or partner to pay for their commitment over time, it will result in an unbilled receivable on our balance sheet.

Please note that the unbilled receivable balance will likely grow over time and will impact DSO.

I'll now turn the call back over to Bob.

Bob?

Thank you, Brian.

I would like to spend a few minutes reiterating our strategy and providing some details on a record number of new product and service innovations, which we have already launched and will be launching for the balance of this fiscal year.

The major elements of our strategy are: to build upon our continuous success with helping customers on their journey to the cloud, both public and private; increase share in our data management business in both the enterprise and mid-market with expanded and broadened solutions and use cases, including our Commvault HyperScale out (sic) [scale-out] secondary storage for the enterprise and our Commvault HyperScale Appliance for the mid-market; and lastly, we got into cyber threat -- cyber threat mitigation and high volume recovery, assuming a company got hit with a critical cyber attack; expand to outcomes-based services and SaaS; and lastly, open up significant market opportunities with analytic-based solutions.

I will now provide you some details on the new product alliances and services offerings that have been released in Q2 and Q3 or will be released this fiscal year, which will help drive increased business momentum.

These include the Commvault HyperScale Technology, including the Commvault HyperScale Appliance, our new alliance with Cisco and enhancements to our Commvault Data Platform.

Let me first start with the Commvault HyperScale Technology.

Commvault HyperScale Technology is a set of tailored offerings providing scale-out software-defined storage services to customers from the mid-market to the largest enterprises.

Commvault HyperScale Technology solutions brings scale-out infrastructure to the Commvault Data Platform and seamlessly integrates with storage arrays, hypervisors, applications and the full range of cloud provider solutions to support the most diverse and dynamic environments.

Customers can consume Commvault HyperScale Technology in 1 of 2 ways: with a Commvault HyperScale Appliance and with Commvault HyperScale Software.

Commvault HyperScale Software enables organizations to choose hardware configuration sizes and models from leading technology companies, including these initial programs participants: Fujitsu, Cisco, Lenovo, HPE, Super Micro Computer, Huawei and Dell-EMC.

Through the consumption of Commvault HyperScale Software, customers receive validated designs, complemented by best-practice configurations.

This simplified approach helps enterprises match hardware configurations and capacity to their secondary storage needs while accelerating ROI, reducing complexity and adding greater customer value.

Commvault HyperScale Software meets the needs of large enterprises who are looking to move away from legacy infrastructures and integrate public cloud-like technologies to modernize their on-premise data centers.

They're also looking to transform their internal IT infrastructure and operations to mimic the agility, elasticity, scale and operating economics of the cloud.

They want their solutions to lower cost, make it easier to manage and being the integrator of hardware and software.

In support of true hybrid IT environments, Commvault HyperScale Technology is uniquely positioned in the market to protect and securely move workloads across any type of infrastructure, including public cloud, private cloud and on-premise.

The Commvault HyperScale Technology leverages a built-in operating environment, virtualization and storage technologies from Red Hat to provide a robust enterprise-grade foundation.

In relation to any competitive offering, this solution has lower cost, higher functionality, security and scalability built for hybrid IT and cloud environments and includes industry-leading Commvault Data Platform for data protection and data management solutions.

This makes our solution simple and powerful.

It also makes them easier for us to sell and distribute.

Now let me discuss our new alliance with Cisco, which was publicly announced earlier this morning.

We recently entered into a formal alliance with Cisco that allows them to resell Commvault's software.

Today's announcement with Cisco is the first strategic partnership move under the Commvault HyperScale Software reference architecture program.

Combining Commvault data protection software and Cisco hardware, this unique offering is on the Cisco price list and available through Cisco sales teams and extensive Cisco channel network.

The solution is uniquely branded as ScaleProtect with Cisco UCS.

I expect more of these unique offerings from our hardware partners to come.

The Commvault HyperScale Appliance is a new offering from Commvault, which was publicly announced on October 17.

The Appliance offers customers an all-in-one Commvault HyperScale solution for data protection with secondary storage.

Our Appliance is fully integrated software and -- is a fully integrated software and hardware device that is easy to deploy, manage and reduces the integration burden.

The target market for the HyperScale Appliance is in the mid-market, less than 100 terabytes of back-end storage and sold primarily through the resale channel.

The Commvault HyperScale Appliance includes Commvault Data Platform software as the data protection foundation and enables customers to add other modules as their needs expand.

This modularity enables customers to take full advantage of additional Commvault features available now and in the future through simple license key upgrades.

We believe that the Commvault HyperScale Appliance will be a disruptive technology in the mid-market and will also serve as an entry point into larger scale enterprises.

I would also like to discuss the progress we have made with our Commvault Data Platform in general and 2 other new products and services offerings that have either been released or will be released in FY '18, including the Commvault Data Platform enhancements.

We continue to focus on our cloud data management solutions.

Over the last several quarters, we have introduced a significant number of enhancements to the Commvault Data Platform to ensure our lead in cloud data management and protection.

Specifically, customers are demanding holistic and consolidated data protection across their public cloud, SaaS, private cloud and traditional legacy environments.

This requires our Commvault Data Platform to provide seamless, easy management of data through a high degree of automation and orchestration of all the different copies of data in those environments.

In addition, our Commvault Data Platform has been greatly enhanced over the last several quarters to deal much more effectively against cyber attacks, ransomware -- like ransomware and to help companies comply with new regulations on the data, such as the EU's new GDPR or General Data Protection Regulations.

Please note the development and timing of any product release as well as any of its features or functionality remain at our sole discretion.

Before I close, I want to remind everyone about our annual Commvault GO conference.

In addition to our HyperScale Technology, we are planning other key product announcements in the second half of FY '18.

We will highlight these and our ecosystem partnerships at our annual Commvault GO conference, which is scheduled November 6 through 8 at the Gaylord National Harbor Hotel & Convention Center in Washington, D.C. Customer registrations and committed partner sponsorships have been very strong.

Information about Commvault GO can be found on our website.

In closing, our Q2 results were in stark contrast to the excellent progress we made last quarter.

Our key strategic initiatives that have high potential to both accelerate growth and mitigate quarterly vulnerability large deals.

Specifically, the strategic initiatives that we launched in Q2 and in Q3 are designed to strengthen our competitive position, open up new market opportunities and significantly improve distribution leverage.

And those solutions we have launched are easier for our sales force, channel and strategic partners to sell.

Importantly, they will enable our channel partners to provide a stronger mid-market revenue stream to complement our enterprise revenues.

As a result, we believe our ability to accelerate license revenue growth through our sales force -- through sales force productivity has fundamentally improved.

Additionally, our ability to improve overall growth and increase operating margins is now aided by accelerating growth in maintenance revenues.

Our objective now is to validate all this with much better financial performance in the second half of this fiscal year and solidify the foundation for FY '19.

We believe the company is in the stronger strategic and competitive position in our history.

I will now turn the call back over to Michael.

Michael?

Thanks, Bob.

Operator, can we please open the line for questions?

(Operator Instructions) Our first question comes from Joel Fishbein with BTIG.

I just have a couple of quick ones.

First is, how much of the pushout do of you think, Bob, was related to the new product cycle?

Obviously, you had a lot of new announcements today.

And wanted to know what you thought about -- if there was some pause in some of those purchases?

I don't think there was a pause due to the product cycle.

There was some confusion in the market as we moved to these new pricing models that may have delayed some deals out there.

But I don't think it was due to the massive amount of new product we are launching right now.

Okay.

Second follow-up then is that you mentioned on the call that you didn't think it was related to competition.

Number one, what gives you confidence that it wasn't competitive issues?

And number two is, what -- you talked about you're doing some -- taking some steps to fix the execution issues.

Can you give us a little bit more color on what you're doing?

So we've gone through every one of the accounts that pushed, and the vast, vast majority have nothing to do with competition.

I mean, nothing to do with competition.

We have a technical win of just working through the process or companies getting tangled up in our new pricing.

And again, the vast majority of all those accounts that pushed should close by the end of the fiscal year, and many of them will close in Q3, this current quarter.

Regard to sales execution, the misses were isolated to a few key regions in the Americas and one region in APAC.

Many of the Americas teams hit their numbers.

So this is isolated execution.

Strategically, clearly, all of the things we did this quarter, the launches we've been working on for the last couple of years were designed to mitigate something like this, because we are always big deal dependent and we're trying to get -- reduce our dependency on that, even though that will remain our bread and butter.

We are a big enterprise company, but we wanted to get a lot more balance in the mid-market through distribution and give that -- give our channel partners something that was extremely compelling and market leading and easy to sell, which we are doing.

And we wanted to find ways to provide better distribution leverage in the enterprise through key strategic partners like Cisco.

So in summary, Joel, these weren't competitive issues, but they related to many of moves that we're making to strengthen the company.

And two, moves we're making to strengthen some of our, I call it, weaknesses in the market mainly related to distribution leverage.

So the disappointing thing about all of this is that we just nailed our strategic initiatives and stumbled at the last few days of the quarter, which is extremely disappointing to me.

(Operator Instructions) Our next question comes from Abhey Lamba with Mizuho Securities.

Bob, thanks, for giving some additional color on those deals that didn't close.

Can you give us a little more color on any thematic stuff that you're seeing any changes in the market versus last quarter?

Or is it -- or do you still have high degree of confidence in your strategy that you've put in place for rest of the year?

I don't see any of the deals that we missed.

There is no theme.

It's -- this guy didn't sign off, it got stuck here.

There was some more discussion required there.

There was no theme or rhyme in the deals that pushed.

I think the only theme, Abhey, is that we're dependent on these large deals and there's a risk to that.

And that -- when you were here after the roadshows, it's why we have really broadened our strategy to: one, accelerate growth, but mitigate the risk tied to these kind of things in the future.

So the disappointment on the quarter was that we -- our product teams, our channel teams, our partner teams did an awesome job in getting these products to market.

And the other surprising thing is the fast takeup we're seeing on HyperScale.

I mean, we won a lot of, what I call, major marquee customers and there's a massive funnel on that going forward.

So that's all encouraging.

And then we stumble and we miss a quarter, which is disappointing to all of us.

So no, strategically, I feel that better than when you guys were here, because these products are now on the market and we're in motion now.

But it doesn't take away from the fact that we missed the quarter.

Got it.

And quick follow-up on that.

What are you assuming for close rate.

Abhey, Al has got a comment for you.

Yes.

Just to follow up on Bob's comments, again, strategically, we feel really good.

But what we saw that's new, I think, in the quarter is: one, the so-called boomerang effect.

We're doing extremely well in cloud-driven deals, multi-cloud environments.

And now you have the so-called boomerang effect, which is bringing cloud technology and capabilities back on-prem.

So that, obviously, with our HyperScale environment, we're extremely well positioned, point one.

Point two is the changing nature of disasters.

Those are now becoming cyber attacks.

They're malicious.

They come without warning.

And they come across an entire organization versus just a geographical data center.

We're working with several of our large customers in providing new capabilities and new functions and new readiness measures there.

And those 2 things were a couple of things that I would add to what's going on in the market, Abhey.

Yes, those are really good points, Al.

Yes, thanks.

Just a quick follow-up on close rate assumptions for Q3 and Q4 to get to the fiscal 18 guidance?

And that's it for me.

On Q3, Abhey, we still need really good close rates on our large deals.

When you get to Q4, those close -- we don't need as -- we'll have mitigated that somewhat and maybe a lot.

We'll see how we do with the launch of these new products.

But to be clear to everybody, we still need good solid close rates in Q3.

We have a big funnel of large deals, but we need to close them.

Our next question comes from Jason Ader with William Blair.

I guess, first, Bob, on the Appliance with the deal you have with Cisco that was announced, which looks pretty interesting.

What type of impact should we expect from that particular product, I guess, relative to the Commvault-branded Appliance?

And then how do you manage sort of potential channel conflict there where you have Commvault partners that are now competing against Cisco channels for the same product?

Well, they're not competing.

The Appliance is a mid-market product.

It's of less than 100 terabytes Cisco's enterprise.

They're apples and oranges.

So the big enterprise installations with Cisco's UCS are enterprise deals.

So if anything, our Appliance can be used as a -- to actually accelerate the Cisco deals, because the customers who want to use the Appliance for a POC can actually deploy Commvault HyperScale with Cisco UCS and the ScaleProtect product.

And we've seen that already.

I mean, we're seeing some evidence of that already.

So I don't see any channel conflict at all there.

And by the way, Jason, good call.

I mean, you did a good job on your channel check.

So unfortunately, you called it right, right?

Yes.

Well, I mean -- I think you guys, clearly with the Appliance, I think, the game plan to try to mitigate the volatility around large deals makes a lot of sense.

And I can tell your frustration and you now, I know, are working hard to try to change that reality.

And good luck to you guys as you go forward.

Do you think that the Cisco Appliance will be a bigger contributor to the business than the HyperScale-branded or the Commvault-branded Appliance over time?

I think in large enterprises, HyperScale will dominate.

But there are lots of use cases, whether it's remote offices.

Or there are certain use cases where customers want that simple appliance, the Commvault, and they just want to plug it in and use it.

So they both complement each other.

Over the long run, the big HyperScale enterprise probably will outweigh the Appliance.

But they are both very high potential new products.

I mean, from a Commvault standpoint, all the things we've done since we've been running the company, these launches are -- have the -- I'll leave it this way, have the highest potential to change the game of anything we've done in recent memory.

So -- and that, in combination with all the things we're doing with the cloud -- and as Al mentioned, this issue on cyber is becoming a priority one topic for many enterprises.

And we've helped a number of enterprises dig out from under cyber attack.

So these enterprises know how good we are with our platform in terms of both mitigating and recovering from a cyber attack.

So those combinations of things are quite powerful.

And I am confident they'll put us on a really good solid growth and improve sales productivity and earning stream.

It's -- so the only key here is we have aggressive plans.

We like to hit our numbers and be a lot more consistent in delivering them and not have an issue like we had this quarter and missing the number.

One quick follow-up, Al, one quick follow-up for you.

Bob talked about cloud-managed data.

Where do you think your customers are?

And the market is, right now, when it comes to sort of understanding this idea of separation of church and state with cloud-managed data to have basically -- to not rely on the cloud provider to protect the data?

I think particularly...

Are we in the first inning there or is it -- are we further along?

No, we're in the World Series.

It's -- I think with enterprises, that's becoming very clear.

I think with SaaS and some of those type of applications, it's probably second or third inning.

But working even with our partners like Microsoft and AWS, et cetera, there is a clear recognition that you need data protection at a robust level, if you will, beyond just a simple tool set.

That's kind of point one, Jason.

And point two is the number of enterprises that are coming here that have not just a cloud solution, but a pile of point-level solutions is amazing.

And almost everyone is realizing, that is not sustainable.

You can't keep throwing native tool sets and a little bit more infrastructure at this broad, holistic issue.

And so I think that's -- to your point, it's probably second or third inning, but the awareness is picking up dramatically, particularly with enterprise accounts.

Yes, and it's pretty well validated with our partnership with Microsoft.

I mean, they have proven to be a really good partner.

They know where their expertise is and they know where it isn't.

And they're working really closely with us in a very programmatic way with our big accounts to make sure that those accounts are well protected.

They're generally well protected in terms of loss of data, but well protected in the case of a disaster.

So those partnerships are expanding.

And the next wave of those that's going to come in that we can be very clear about is analytics.

Our platform provides an outstanding foundation for business analytics, and we're working with a number of key partners in that regard as well as we add machine learning and enhance search capabilities to the platform, which we'll talk about at GO.

And our next question comes from John DiFucci with Jefferies.

Bob, you said on the last call that some of the large incumbents were doing unnatural things with very large deals in regards to pricing, which we've heard may even be described as irrational.

This quarter, your commentary is more around your own sales execution.

But have these incumbent competitors maintained the pricing practices of last quarter?

And if they have, what, if anything, can you do about that?

Well, they have.

But when you look at the accounts that we've missed, nothing -- none of those deals that slipped had anything to do with that.

So I mean -- I'm serious.

I mean, the -- we do see that behavior, but that wasn't a cause for our quarterly slip.

And yes, I mean, free is not free.

I mean, if somebody says I'm going to give you this for free, at the end of the day, there's a cost of free.

So well, one comment on free is, okay, you get that stuff for free and let us manage the data on top of it, because data management piece and the cloud portability and the DR and ability to do with cyber, those solutions are pretty weak.

So we've been dealing with free from, for example, from Dell-EMC and from EMC in particular for 15 years.

So -- but that is, if you want to see what's their key play, is the bundle, and use that leverage.

Bundle and discount.

Yes, bundle and discount.

Is it an issue?

Yes.

Do we have to deal with it?

Yes.

But we're in a different world.

As long as we articulate our value prop at the end of the day, we can save our customers money versus that solution.

If we're not in there and we're not really clear on what our value prop is, then somebody like that is going to win.

The other issues out there, I'll call it, are relatively significant.

So -- and we can deal with them.

So I mean, that is not the major issue.

That's -- it's in these more in terms of getting Commvault more balanced and these things we just talked about in terms of distribution leverage and building a kind of a more balanced revenue stream between enterprise and mid-market to mitigate something like occurred this quarter.

Okay.

And if I -- I might have a follow-up to that then.

I mean, we continue to hear accolades about your technology and products and not just from the independent research firms that you note in your press release, but also through field discussions.

So if that's all going really well, which it seems to for us and you talk about it as if it is, I believe you said you've already put things in place to improve the sales execution.

But other than the strategic initiatives, it's unclear to me what you've done.

Like, okay, you have things in place now, strategic initiatives, more partnerships, things like that are good, but it sounds like you think there were some execution issues.

Were there any changes?

Yes, beyond that -- there were changes, but I just think -- I don't know how more blunt I can be, is yes, we have the best technology, we have the best services and we have the best support.

But if the sales team doesn't get in there and articulate that and understand what our new pricing is, they're going to screw up.

And what's really disappointing is that we restructured the American sales force, in particular the U.S. sales force.

And in general, they've been good in execution.

And many of the U.S. teams did really well last quarter.

Some teams did not.

And it's pure execution.

But my point is, if you're depending on outstanding execution quarter-on-quarter, you're vulnerable to missing one.

And we have -- we had 6 quarters in a row and we did it through good execution in large deals.

And this quarter, we had a few regions in America that really dropped the ball.

I don't know how clearly I could say it.

And the things we're doing is to help these teams and make it easier for them so that -- through distribution to get more leverage and make it easier to get into these accounts.

We have a bigger funnel and you become more strategic.

But when you start adding the ability to -- the basic foundation for secondary storage and you putting the data platform on there and you providing the agility and management of the cloud and you giving ability to mitigate and recover from a cyber attack, those are all big things.

So it's just -- we're making it easier for our teams and distributors to get the story out.

So I don't know how else I can say it.

They screwed up, period, end of story.

Our next question comes from Alex Kurtz with KeyBanc Capital Markets.

So just looking forward here into the second half, Bob, why not take the consensus number down here?

Why put it -- the quarter dependent on large deals, again, create that risk again going into Q3?

Why not just kind of reset here?

So what was the thinking around that?

It's -- the thinking was that we've got a pretty robust, big deal funnel.

Internally, we did take it down quite a bit, because it's offset by significant increases in services revenue.

So relative to our internal plans, we did take it down.

And -- but to your point, is the risk 0?

No, it's not 0. It's still large deal dependent.

I mean, when you're dealing with deals that are in the multimillions, which we're talking about, or $1 million deals and then a lot of $500,000 deals, I mean, we're dealing with the same issue to a slightly less degree in Q3, because we just have a bigger funnel of these deals going in, some of them because of what happened in the last quarter and they slipped and we're going to close in this quarter.

And we've got, at the margin -- I would say, at the margin, we've got some risk reduction due to the fact that we're -- we'll start shipping appliances here in a couple of weeks.

And we know we've got some momentum on the HyperScale because it's in the funnel and we're closing deals.

That's helping us in the large enterprise.

So we -- the revenues are flat, but we took down our operating margins, because we're investing to make sure that we get these products launched and take advantage of the opportunities we have in front of us here.

So understand the point.

I mean, it's a fair point.

And just last question here.

Historically, you guys give a full year kind of view on the consensus estimate, and then we kind of work through that during the year.

And considering that these large deals aren't going away, which is -- I mean, you're solving strategic problems for large customers.

So I think we all understand that.

Why not move to a model where you really kind of manage the consensus to a point where -- especially going into fiscal '19 where there's just limited risk?

Or are you just looking at high single-digit license growth and really just exclude a higher portion of the large deals versus what you guys have done historically?

Well, with the Appliance, it gives us that luxury.

It will once we get it going.

It's -- look, we've had 6 quarters since we turned and we didn't miss a number.

(inaudible) And this quarter looked really good until 4 days before the end of the quarter.

I mean, it just fell off, when we talk about dropping the ball.

And some of this was pricing confusion, guys just pitching too many -- giving the customers too many alternatives that they're trying to figure out and confused some customers.

So that was an element, not the only element.

It was just an element.

So understand your point.

And before we -- we understand this before we had our issue a number of years ago, which was different than this.

We had 20-some, 26, 28 quarters that we didn't miss.

So -- but we understand what we're trying to do here.

And we like to get on a track as we -- to your point, as we going to at FY '19 there, where we really mitigated those risks.

And I think we have an opportunity to do that now.

Our next question comes from Greg McDowell with JMP securities.

I want to focus specifically on the change in the margin expectation, because as previously mentioned, you're largely expecting the same revenue as you were 3 months ago, and yet you're now expecting only 25 to 50 bps in operating margin expansion.

And in July, you were talking about 170 basis points in operating margin expansion.

So I was just hoping you could expand on what exactly has changed from an expense structure standpoint versus 3 months ago?

Nothing has changed from an expense structure standpoint.

In fact, we've actually mitigated and reduced it.

What's fundamentally changed is that our internal projections had higher license revenues attached to it.

And after the miss, it put us in a different situation.

So that's the fundamental issue.

It's relative to our internal plan, which by the way, was geared and focused all these new product launches.

So we put all that structure in place for the HyperScale and the Appliance and the cyber and all those things that we're doing.

And we dropped the ball in Q2, but that structure is there as we launch these products in Q3 and Q4.

If you want to net it out, that is the reason.

And Brian can give you some other color.

No, I think that's spot on, Bob, with respect to our investment philosophy.

We're targeting numbers internally that were higher.

And it didn't come to fruition in Q2.

But we'll continue to prudently invest in the second half and hopefully achieve these objectives.

And by the way, that investment is really critical to set you up for FY '19.

I mean, you just can't not take advantage of a couple years of work here with big market opportunities that have both sales productivity, total revenue growth acceleration, and concurrently, operating margin expansion.

So that's our game plan.

Our next question comes from Andrew Nowinski with Piper Jaffray.

So in the past when you had some of these sales execution issues, you had increasing levels of attrition and also declines in the sales productivity.

So can you just give us an update on your attrition levels and also where you're at with regard to sales capacity or sales productivity within the U.S?

So our attrition is near all-time low, meaning our attrition rates are low.

And what happened last time is, as you know, we were off a product cycle and we had a significant change in the competitive landscape.

We're on the other side of that curve now.

We've given our sales teams a whole new number of ways to accelerate their growth and hit their numbers.

So we've got the capacity in the field today.

Now we have moved some of that capacity to align with the Cisco partnership, to align with our channel partners on the Appliance and to align with an extending partnership with Microsoft.

So it's a very different situation.

Last time, we had to reorganize the U.S. sales force.

And do a whole new product refresh, et cetera.

So now we're -- those things are basically in our hand.

Concurrent with that, clearly, there are some areas in the U.S. that are not executing and we're focused on those to make sure that selectively, those teams achieve what they need to achieve.

And then I know you said there's no increase in competitive losses in the large deals that pushed.

But you also cited some weakness in the mid-market segment, which I think is where vendors like Veeam and Rubrik are doing pretty well.

So I guess, the new Appliance that you launched should mitigate some of that pressure in that mid-market.

But are you making any other changes to sales incentives or to sales capacity in the mid-market to address that weakness?

Those are the big ones, but there's a whole other series of products that I didn't talk about, because I didn't want to draw on in my earnings call that we'll talk about at GO whether it's related to -- and these are products that have potential in both the mid-market and in enterprise.

And we've talked about cyber.

We talk -- we've talked -- we haven't talked in a little bit.

But we've got new products in dev-test.

I mean, there's a whole series of new products that are both applicable to the enterprise and mid-market.

And those can be sold with the Appliance or they can be sold separately in the mid-market.

So I -- it's not just the 2 that I just mentioned, there's a whole series of others that should help provide mid-market growth.

Our next question comes from Aaron Rakers with Wells Fargo.

Our next question comes from Srini Nandury with Summit Redstone Partners.

Just going back to the strategy for last 3 years.

If we look at over the last 3 years, one of the strategies of the company was to unbundle the solution, making it easier for customers to consume your products.

This means lots of small deals and less reliance on large deals.

2 quarters in a row, you seemed to be relying on closing of the large deals to make the quarter.

I'm trying to understand, has something changed in the business?

How is the traction of the solution bundles going on?

Have you sort of changed the strategy with respect to sales -- with how salespeople are incentivized to push the deals out?

No, I mean, think -- I'll speak and then I'll let Al speak.

I think the -- our mid-market products on a relative basis versus a few years ago have done relatively well and they are a substantial part of our product mix today.

But the momentum in those -- we released a number of products and services for the mid-market, but I think the point is to -- the growth rate of those products have topped off.

It's not that they're not growing.

They're growing at, I'll call it, a reasonable clip, but to hit our numbers, we needed to put more products into those channels to accelerate growth.

And so wasn't that those weren't successful at the time, it's just -- this is another generation to accelerate that.

Al, if you want to...

Yes, that's well said, Bob.

And the only thing I would add is, we've said many times that our strategy in the mid-market focus is around service providers, and that's been a good space for us as well.

That gets kind of hidden in the numbers here, so to speak.

Our next question comes from Eric Martinuzzi with Lake Street Capital.

Yes, wanted to address the services revenue implied in the guide.

If I go back to last year, obviously, FY '17 was a little bit different, because we had the issues of FY '16, which kind of impacted the services progression throughout FY '17.

But just wondering, are we in that -- are we back to a traditional services revenue progression where a Q3 would be up from a Q2 and a Q4 would be up from a Q3?

Yes.

Eric, it's Brian Carolan here.

I would say, yes, we're back on kind of a sequential upward trajectory.

I think we've been talking about this for several quarters now in terms of -- especially as we get through the back half of fiscal '18 and got through many of the programmatic pricing changes we made over the last couple of years.

We will start seeing a resurgence in the services line, and we're starting to see that.

And our next question comes from Aaron Rakers with Wells Fargo.

I'll try again here.

I apologize for that earlier.

I just wanted ask about your opportunity with regard to HyperScale outside of the SMB market or the mid-market.

You've talked a lot about strong funnel or pipeline building for those products.

I'm just curious, as the industry moves to consolidating the multiple tiers and secondary storage, what type of deal size or how would you characterize the deal sizes that you're seeing, albeit early from those solutions?

So I'll open this, Aaron.

Per our dinner we had a couple of months ago, this is a surprise, right?

So I think the encouraging part of HyperScale is that last -- we've been working on this product for about a year.

We really launched it -- we've been in, I'll call it, early beta for a year.

We launched it last quarter.

And we won a number of deals that were part of, I call, 7-figure deals, with big names that you'd recognize right out of the shoot.

And I would say, in discussing these capabilities with senior management of our customers, I thought the receptivity to utilizing our secondary storage infrastructure was surprisingly high, is the way I would describe it.

And that was validated by closing a whole number of deals.

The amount of deals in the funnel today on HyperScale, not the Appliance, but on the big scale-out is very large.

And so it's been relatively easy for us to describe that concept and the benefits, and the product really works.

And the Cisco partnership only enhances that.

So Al, maybe you want to add a little bit more for...

I think that's well said.

And yes, Aaron, remember, the Appliance is targeted for mid-market primarily and remote offices, because it goes to roughly 82 terabytes is the upper limit on our larger Appliance.

Then you can start adding them.

But almost everybody, once you go above that limit, let's call it, 100 terabytes, will move to a HyperScale software solution using hardware of your choice.

Cisco will be the primary choice here.

But as Bob said on the call, there is 6 or 7 other vendors that has been tested and asserted with.

And I think personally that it will be a larger company play as we go along here.

But I would also add, Bob and I have been arguing about this for about 3 months, and what we've determined is we're probably both be wrong and it will be a good thing overall.

Because as Bob said, there's a lot of interplay between the 2 solutions.

And again, the thing to remember, Aaron, is it's the exact piece of software.

So it's just using different hardware environments out there.

The second storage platform is really, to Al's point, is a cloud play, because you're giving the customer, that same agility, high utilization rate economics of a public cloud, but you're also giving him easy migration to the public cloud from that platform.

It's very seamless, the way we manage data.

We don't have to move to HyperScale structure in the cloud.

For example, on Azure, we're using Azure structure, because we are completely seamless in our ability to move to Azure, AWS, Google.

It really doesn't matter to us.

So we don't have to move.

We can use the functionality of our platform, but we don't have to put our, if you want use the term, our HyperScale structure up there.

So it's got massive benefits to the user, makes it easy and gives the user a lot more flexibility in who they choose for their hardware partners.

I mean, there isn't -- Cisco is a good play for us, because Cisco has got a good footprint and they have a great reputation out there and they're going to utilize their sales force and channels to help do this, because we're in good alignment.

But we had one very marquee customer that's using a real off-brand server that we've certified with them.

So it gives the customer the choice of vendor and also gives them complete agility to move to other structures and cloud.

As well as the channel, it gives them choices as well.

As Bob says, they can kind of roll their own, et cetera.

But the big ones, Aaron, when these guys come in, they want to know if they have options on hardware, as Bob just said.

And the other key thing is no lock-in on the back-end.

So all of these environments that we've talked about, all can be intermixed, work with each other.

There is no lock-in on a particular vendor or a particular geometry.

And it also aligns with another key objective of big enterprises dealing with a dozen different point products that are driving them crazy as they try to rationalize their environments and deal with things like GDPR and compliance and cyber.

So they're trying to simplify their environments, and this is really well aligned with those objectives.

At this time, I'm showing no further question.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude the program.

You may now disconnect.

Everyone, have a great day.