Commvault Systems Inc (CVLT) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fiscal Q3 2018 Commvault Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Michael Picariello, Director of Investor Relations. You may begin.

Thank you. Good morning. Thanks for dialing in today for our fiscal third 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 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 in Form 10-K, and our most recent quarterly report in Form 10-Q, 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 call -- our earnings press release was issued over the wire services earlier today and it also been furnished to the SEC as an 8-K filing. The press release is available on our IR website. On this conference call we will provide non-GAAP financial results. Commvault adopted the new revenue standard ASC 606 on April 1, 2017. Our adoption was done on a retrospective basis, so all prior periods in our financial statement have been adjusted to comply with the new rules. As a result, the results and growth percentages we will discuss today are in a comparable basis using the new rules. The reconciliation 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 also 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.

Good morning and thanks, Mike. Good morning, everyone, and thanks for joining our fiscal third quarter FY '18 earnings call.

We made good forward progress in Q3 versus our Q2 results. We had good sequential increase in our software growth, solid billings growth and strong operating cash flow. I'm also encouraged by our progress on certain key strategic initiatives including the launch and early traction of our Commvault HyperScale Appliance and good funnel built with our Commvault HyperScale Software. We expect revenues from these 2 initiatives to possibly impact Q4 '18 revenues.

We also made very good progress on improvement and services revenues. During the quarter we repurchased approximately $80 million or 1.5 million shares of our common stock.

Let me briefly summarize our Q3 financial results. Software revenues were up 13% sequentially and 4% year-over-year. Total revenues were up 8% year-over-year, EBIT margin was 12.2%, EPS was $0.30 per share.

Here are some of the highlights for the quarter. We achieved record quarterly revenue of $180.4 million, highlighted by sequential software growth of 13% and driven by an increase in enterprise revenue transactions. We saw solid billings growth driven by a 19% year-over-year increase in deferred revenue.

We saw good growth in EMEA. We had solid services revenue growth at 12% year-over-year with much improved professional services results. Operating cash flows were $31.2 million, up 17% year-over-year. We continue to make excellent progress with our subscription-based pricing models which now represent approximately 20% of our Q3 and year-to-date software revenue, more than double our historical run rate which is contributing to our growth in deferred revenue.

We had good progress to managing data in the cloud, approaching 200 petabytes in the cloud which is approximately 3X over the prior year. We also successfully launched Commvault HyperScale Appliance which I will discuss later. We are focused on executing a solid fiscal fourth quarter and to strengthen the foundation for revenue earnings growth in fiscal 2019. The objective is to improve our overall growth rate and reduce our dependency for large deals.

As we have discussed for many quarters, we are currently reliant on a steady flow of large 6 to 7-figure deals which come with additional risk due to their complexity and timing. While some deals from Q3 closed during the quarter, several very large deals that got pushed from Q2 did not close in Q3 as we had expected and close rates were at below historical levels. There is potential for some of those deals to close in Q4.

The strategic initiatives that we launched in Q2 and in Q3 are designed to provide a much more -- much more distribution leverage, make it easier for our sales force and channel partners to sell our solutions and to provide for a stronger bid market revenue stream to complement our enterprise revenues. These initiatives are intended to strengthen both our ability to penetrate large enterprises and accelerate growth in the bid market which can reduce quarterly risks. Initiatives are enabled by enhancements to the Commvault data platform.

I am pleased to note that we made excellent progress on the 2 key initiatives that I mentioned earlier, HyperScale and our Commvault HyperScale Appliance which are opening up significant market and distribution opportunities in both the enterprise and bid market. We successfully launched the appliance in Q3. We've had good response from our channel partners and customers. We have a number of orders in hand and will begin to see impact from appliance revenues in Q4 '18. We expect Appliance revenues will meaningfully impact our results in fiscal 2019.

We saw good funnel build tied to our new resell agreement with Cisco for the enterprise. As to remind you, Cisco is reselling Commvault HyperScale Software combined with Cisco UCS hardware under the ScaleProtect with Cisco UCS solution name. We will see an impact from Commvault HyperScale revenues in Q4 '18 and expect Commvault HyperScale revenue to meaningfully impact revenues in FY '19.

For FY '19 we are focusing on driving revenue and increased operating margins by significant improvement in field productivity. In addition to and in combination with those initiatives already launched we are implementing changes in our go-to-market strategy that are specifically designed to drive higher field productivity. They include establishment of a more comprehensive distribution alliances organization.

As we announced last week we recently appointed Owen Taraniuk to head our Worldwide Partnerships and Market Development at Commvault effective immediately. In this new position Owen will be responsible for leading the creation and execution of Commvault's global go-to-market strategy and in direct partnerships. His appointment underscores the company's strategic business initiative to scale the global partner program and drive growth through a focused route-to-market approach.

Secondly, we realigned product and marketing efforts to focus on accelerating revenues through our distribution network. These efforts are enabled by a new user interface, automation and functionality enhancements in our core platform which enable us to provide simplified industry leading solutions for the mid-market.

Thirdly, we are strengthening our bid market channel and strategic alliance coverage primarily through the redeployment of field resources. Fourth, we are focusing on high-impact key alliance partners that are strategically aligned, including Cisco, Microsoft, INFINIDAT, HPE and others that should be announced in the near future.

Fifth, we are accelerating our service provider managed services and SaaS business. We saw strong customer acquisition of our managed services and SaaS business and expect this acceleration to continue through FY '19. We will continue to accelerate the move to subscription pricing. We recognize and are taking action to mitigate market issues tied to the introduction of some of our new pricing models.

I will now address our Q4 and FY '19 financial outlook. As I mentioned earlier, we are pleased with the excellent progress we have made with our transition to subscription-based pricing models. A reputable revenue stream is building somewhat faster than originally anticipated and had a slight dampening effect on in-period recognized software revenue. As such we currently believe year-over-year Q4 software and product revenue will be approximately 10%.

The total Q4 revenue should approximate $187 million which reflects our continued move to subscription-based pricing and recent lower close rates of large 7-figure deals. Brian will expand on this and our anticipated EBITDA margin shortly.

Our HyperScale Appliance solutions and platform enhancements will positively impact revenues in Q4. As I mentioned, we have reallocated existing resources to take full advantage of our Commvault HyperScale solutions and appliance and to support our expanding partner opportunities. The allocation of resources tied to the Appliance in key partnerships will help drive improve pipeline development and ultimately to overall productivity and pipeline revenue growth. As a result, we also believe that the current street consensus for fiscal 2019 total revenue of appropriately $780 million and EBIT of $105 million is reasonable, that would result in margin expansion of approximately 230 basis points.

While our strategic fundamentals are strong and our ability to execute has improved, we still face critical challenges. 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. These deals have quarterly revenue and earnings risk. While we also need to improve our close rates on these deals, large deal closure rates will likely remain lumpy.

We are bringing to market many new products, services and powerful simplified user interfaces. We're 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 do have execution risk.

We are also moving to new pricing models. While we are happy with the progress we are making with subscription pricing, our transition to pricing models has caused some market confusion which we are rectifying. Additionally, the move to subscription while improving our bookings and deferred revenue has negatively impacted near-term license revenue growth.

We are clearly trying to accelerate revenues with new products, services and distribution while at the same time improve operating margins. The objective is being driven by a focused bootstrap effort to improve sales productivity. This effort has timing risks. We continue to be in an opportunity-rich situation in the market. However, in order to achieve our FY '19 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.

So just in summary, our growth for FY '19 is primarily based on continued success with the Commvault data platform to gain share in large enterprise accounts with the journey to the cloud and solutions to help customers mitigate and recover from a cyber attack. Secondly, our Commvault HyperScale Appliance software solutions, updated products and pricing and core data protection in Q1 FY '19 improved distribution leverage with strategic channel and service provider partners and the release of additional new products and services in Q4 '18 and Q1 '19 which will begin to have an impact in the first half a FY '19. We are boosting our efforts to improve operating margins by driving distribution leverage while at the same time protecting our future in analytics. Bottom line, there are a lot of moving parts to our game plan.

In summary, we believe our ability to accelerate license revenue growth has fundamentally improved. We are making very good progress across all aspects of the company by strengthening our competitive technology position, broadening our product line and expanding distribution. In summary, we believe that we are well-positioned going into FY '19 and are building a good foundation for long-term high revenue and earnings growth.

I will now turn the call over to Brian.

Thanks, Bod. And Good morning, everyone. I'll now cover some financial highlights for the third quarter of fiscal 2018.

Q3 total revenues were a record $180.4 million representing an increase of 8% over the prior year period and 7% sequentially. Quarterly billings which we defined as total revenue plus the sequential change in deferred revenue was approximately $192 million, up 13% over the prior year period and 12% sequentially. We reported software in products revenue of $81.4 million which increased 4% year-over-year and 13% sequentially. We are pleased that our continued shift to subscription pricing models is resonating with customers. Subscription-based pricing represented approximately 20% of software revenue on both Q3 and year-to-date fiscal 2018, more than double our prefiscal 2018 run rate. We are encouraged by the growth in this repeatable revenue stream.

Revenue from enterprise deals which we defined as deals over $100,000 in software revenue in a given quarter represented 57% of software revenue. Revenue from these transactions was up 4% year-over-year and 9% sequentially. Our average enterprise deal size increased 3% year-over-year to approximately $268,000 dollars during the quarter. During the quarter approximately 56% of software license revenue was sold on a traditional per terabyte capacity basis, this is down from 68% in Q3 '17 and 59% in Q2 '18. We anticipate that sales of our traditional capacity based licenses will continue to decline as software license revenue shifts to standalone solution steps in our platform pricing model.

From a geographic perspective, Americas, EMEA and APAC represented 50%, 36% and 14% of software revenue respectively for the quarter. On a year-over-year growth basis, EMEA and APAC were up 12% and 5% respectively while Americas was down 2%. The revenue mix for the quarter was split 45% software and 55% services. Total services revenue for Q3 was approximately $99 million, an increase of 12% year-over-year and 3% sequentially. We continue to have strong maintenance renewal rates and our professional services business delivered much improved Q3 results.

Now moving on to gross margins, operating expenses and EBIT margin. Gross margins were 86.6% for the quarter. Total operating expenses were approximately $131.8 million for the quarter, up approximately 9% year-over-year. We added 45 net employees in fiscal Q3 ending the quarter with 2,841 employees. Operating margins were 12.2% for the quarter, resulting in operating income or EBIT of approximately $22 million. Net income for the quarter was $14.1 dollars and EPS was $0.30 based on a diluted weighted average share count of approximately 47.5 million shares.

Let me now briefly comment on taxes and the impact of recent tax reform. For the third quarter we will report a GAAP net loss of $59 million. The GAAP loss was driven by 2 large noncash income tax charges. First, we recorded a $24 million reduction of the value of our deferred tax assets which are future tax benefits as a result of lowering the U.S. corporate income tax rate from 35% to 21%. Secondly, we recorded a $35 million deferred tax provision inclusive of evaluation allowance against the remaining balance of deferred tax assets. We concluded evaluation allowance was necessary as a result of incurring GAAP pretax losses in recent years. This charge has no impact on our income tax return or cash taxes.

As a reminder, we still believe our fiscal 2018 cash taxes due will be approximately $6 million primarily related to state and foreign income taxes. We currently expect fiscal 2019 cash taxes to be approximately $7 million. We are still analyzing the impact of the onetime transition tax on accumulative value of earnings and profits that were previously not repatriated for U.S. income tax purposes. As a result we have not recorded the liability for this tax in Q3 financial statements. However, based on the analysis completed to date we don't expect this onetime transition tax to be significant.

Despite these Q3 accounting charges we believe Commvault will benefit from tax reform and over time we'll see lower GAAP and cash tax rates. For the sake of consistency we will continue to use a non-GAAP tax rate of 37% for the remainder of fiscal 2018. However, based on our initial modeling of the new U.S. income tax reform we currently expect that in fiscal 2019 we will reduce our non-GAAP tax rate from 37% to approximately 27% which should align with our anticipated long-term cash tax rate.

Let me now discuss our shift to subscription-based pricing and its impact on our outlook for Q4 '18. As previously stated, we are pleased with our continued shift to subscription pricing models which now represents approximately 20% of software revenue, again more than double our prefix fiscal 2018 run rate. This repeatable revenue stream is building somewhat faster than originally anticipated. As such, all things being equal, it had a dampening effect on our Q3 in-period recognized software revenue of approximately a few million dollars. This is due to the fact that there was a slightly reduced price of a committed subscription arrangement in comparison to a like-for-like perpetual transaction.

On the positive side, we were able to demonstrate better-than-anticipated growth in billings which was up 13% year-over-year in Q3. The multi-year committed maintenance revenue associated with subscription agreements is generally included in our deferred revenue balance.

As disclosed in our Form 10-Q we also have an off-balance sheet backlog which was approximately $18.6 million as of December 31, 2017, which includes $700,000 of unfulfilled orders for software products. The remaining balance represents unbilled professional services and maintenance support contracts that will be billable and recognizable in future.

For fiscal Q4 we anticipate the move to subscription to continue to occur and adversely impact in-period recognizable software and products revenue. We currently believe that Q4 year-over-year software product revenue growth rate will be approximately 10%. Total Q4 revenue should be approximately $187 million. The implied in-period software growth rate is slightly lower than current street consensus estimates due to our faster-than-anticipated move to subscription-based pricing and recent lower close rates on large 7-figure deals. We believe the move to subscription pricing will benefit us in the longer term by creating a more predictable and repeatable revenue stream and ultimately increase cash flows over time.

We now expect the Q4 EBIT margin percentage to be approximately 13.4% resulting in a full year EBIT margin percentage of approximately 11.2%. After factoring in our recent share repurchases we expect the Q4 weighted average share count to be approximately 48 million shares.

I would also like to remind you about one additional key spending increase in Q4. Historically we see a large sequential increase in employer paid FICA expense in our Q4 because many of our employees in the U.S. reached the FICA limit well before the end of the calendar year. This year we expect our FICA expense in Q4 to be approximately $3.5 million higher than Q3.

I will now address our expectations for FY '19. We believe that current street consensus for fiscal 2019 total revenue of approximately $780 million and EBIT of $105 million is reasonable. That would result in margin expansion of approximately 230 basis points year-over-year.

Please note that recent share repurchases and the transition to a 27% non-GAAP tax rate in fiscal 2019 will positively impact full year fiscal 2019 EPS by $0.20 to $0.25. This assumes a full year weighted average share count of approximately 49 million to 50 million shares.

Our operating margin expectations include the impact of hardware integrated with our Commvault HyperScale Appliance offering that will adversely impact our anticipated FY '19 gross margin percentage by approximately 100 basis points and our EBIT margin percentage by approximately 10 to 20 basis points.

Although we plan to continue to invest and increase operating spend in FY '19 we are taking several prudent measures to control costs and reallocate existing resources. Our objective is to do this in a manner that will not impact our software growth objectives but will provide operating margin leverage in FY '19.

We would like you to keep in mind that fiscal Q1 is usually our most challenging quarter due to seasonality. We expect this trend to continue in Q1 FY '19 as we currently anticipate a sequential decline in both revenue and EBIT. We do anticipate that EBIT dollars in FY '19 will then sequentially increase over the rest of the year.

Now moving on to our balance sheet and cash flows. As of December 31 our cash and short-term investments balance was approximately $446 million of which approximately 40% is located outside the U.S. During Q3 '18 we repurchased approximately $80 million or approximately 1.5 million shares of our common stock in an average cost of $53.40 per share.

Our Board of Directors had decided to extend the expiration date of the share repurchase program to March 31, 2019, and authorized a $100 million increase to the existing share repurchase program so that approximately $134 million is now available.

Please note that certain senior executives and directors have approximately 300,000 outstanding stock options that will reach the end of their 10-year lives and will therefore expire before March 31, 2018. We expect that all of these stock options will be exercised prior to their expiration.

Free cash flow which we defined a cash flow from operations less capital expenditures was approximately $28.5 million during the quarter which was up 17% year-over-year. We continue to expect full year FY '18 free cash flow to slightly exceed non-GAAP EBIT.

As of December 31, 2017, our deferred revenue balance was approximately $308 million, which is an increase of 19% over the prior year period and 4% sequentially. All of our deferred revenue is services revenue not software revenue. We expect Q4 sequential deferred revenue growth to increase in the low to 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 to mid double digits.

For the quarter our day sales outstanding or DOS 71 days, which is up from 68 days in the prior year and down from 72 days sequentially.

That concludes my prepared remarks and I'll now turn the call back over Bob. Bob?

Thank you, Brian. I would like to spend a few minutes reiterating our strategy, talking about where we believe the industry and our market is going and significant near-term adjustments we are making to accelerate growth while at the same time to drive improvements in operating margins.

The headline here is that the best way for us to drive increased short-term revenue growth and earnings growth is to significantly improve sales force productivity with a more efficient go-to-market strategy in our core data protection business.

The deployment of this strategy is helped by our early success with our Commvault HyperScale Software and Appliance and our ability to provide appliance-like functionality in automated data protection software solutions both of which are key enablers for channel-led distribution. This effort will primarily be funded by bootstrap effort of redeploy existing resources.

Let me put this in context to our broader strategy which has been communicated on prior earnings calls. The major elements of our strategy remain intact. They are built upon our continued success with helping customers on their journey to the cloud, both public and private. Increased share in our core data protection business in both enterprise and mid-market with expanded and broadened solutions and use cases including our HyperScale -- our secondary storage for the enterprise and our HyperScale Appliance for the mid-market, cyber tools for threat mitigation and high volume recovery and updated core data protection solutions. We will also expand into outcomes-based services and SaaS. And lastly, we plan to open up significant new market opportunities for the foundation for business and operational analytics.

A larger share our revenues remains tied to big enterprise deals for enterprise-wide data management, the journey to the cloud, the move to more sophisticated data governance to address new regulations like GDPR, the need for a much -- for much better ways to deal with massive cyber attacks and quickly emerging needs tied to business and operational analytics.

Additionally our Commvault HyperScale solutions and partnerships with Cisco and Microsoft clearly are helping to drive growth in the enterprise. While our enterprise focus and strategic elements have not changed, we are executing a more balanced go-to-market strategy by significantly increasing emphasis in the near term in our core data protection business to drive accelerated license revenue growth, to improve field productivity.

Core data protection opportunities are opening up both in the mid-market and enterprise as a result of the boomerang effect of companies establishing on-premise private clouds that have similar economics to public clouds, the increasing need to provide more sophisticated data protection in the public cloud, the near-term accelerating market shift to simpler automated solutions for core data protection, the realignment in the primary and secondary segments of the storage market which makes it easier for us to establish more meaningful strategic alliances like the ones we recently established with Cisco INFINIDAT and HPE.

And lastly our ability to package your marketing-leading solutions in simpler, easy-to-use configurations like our HyperScale Appliance. As I mentioned earlier, a critical element of our go-to-market strategy is the establishment of a much stronger, more comprehensive global distribution organization under Owen Taraniuk who previously was our APAC, Theatre VP.

We have been shifting resources in the Americas to support our distribution initiatives, primarily in support our HyperScale business and our cloud-related programs with Microsoft. We are working on establishing a stronger [programmic] relationship with some of other major cloud providers. Going forward, we will also be establishing more focused efforts in our other theaters in support of our channel partners. We believe these channel partner efforts can drive accelerated growth in the mid-market, increased ability to penetrate the enterprise and reduce quarterly risks. The more focused and efficient go-to-market efforts began in Q3 2018.

I want to talk about services. Another area of potential growth for FY '19 is our services business. We are seeing a turnaround in growth of not only our maintenance business but importantly we are also seeing accelerated growth in our services bookings.

We expect improved year-on-year growth for our professional services business in FY '19. This growth is being driven -- and SaaS businesses.

Now I would like to comment about a significant market trend that we were seeing, that is the transition from information technology to digital technology. We are finding that the increased functionality of the Commvault data platform, including our new automation and simplification is proving to be an increasing strategic advantage as the enterprises transform both their IT infrastructure and the need for a foundation for digital transformation, including the move to the cloud and hybrid IT that require new capabilities and architectures, the demand for simpler more automated bundled hardware and software solutions, new ways to deal with the challenges of cyber and malware attacks, the requirement for new functionality to deal with new governance and compliance requirements like GDPR. And lastly, the need for a strong enterprise-wide foundation for analytics using machine learning and AI.

Commvault has developed significant enhancements to the Commvault data platform as a foundation for business analytics including digitized imaging and IOT. We are engaging with customers to build unique data and business analytic capabilities based on the Commvault data platform. The Commvault data platform is the only single platform in the industry to -- able to address all the major market trends.

In closing, our core strategy, business opportunity and technology position remains solid. We have the strategic assets that we need to take advantage of these opportunities. We are making some adjustments in order to maximize shareholder value by improving field productivity with a more efficient use of our go-to-market and distribution resources. Specifically, we are executing a more balanced go-to-market strategy by complementing our enterprise business with increasing emphasis in the near term in our core data protection business with software and our HyperScale Appliance. The strategy has the potential to mitigate (inaudible) vulnerability to large deals and increase business momentum.

We are strengthening our enterprise business with our HyperScale solutions in partnerships with Microsoft and Cisco and new key partners like HPE and INFINIDAT. In summary, the strategic initiatives that we launched in FY '18 are designed to improve financial performance by strengthening our competitive position, open up new market opportunities and significantly improve field productivity through distribution leverage. Our objective now is to achieve our Q4 objectives and solidify the foundation for FY '19. I will now turn the call back to Michael. Michael?

Thanks, Bob. Operator complete. Please open the line for questions.

(Operator Instructions) And our first question comes from the line of Joel Fishbein from BTIG.

I have 2 questions, 1 for Bob and 1 for Brian. First Bob, I know you addressed the steps you are taking to fix the execution issues on the call. But investors are concerned that you continue to see some push outs. You've had North American sales execution issues for several quarters and you've got, you are talking about lower close rates. How do we know that these issues are fixable and they're not competitive related? What should give us confidence that you have got this under control?

Well, there is 2 things here. One, we are taking specific action, one within the Americas on certain areas of leadership, areas of distribution and some areas in the territories. So those are -- those address specific sales execution issues because our EMEA business by the way is executing quite well. But there are competitive trends in the market that we needed to address. Now -- and that does include simplification, in particularly in the mid-market where customers clearly would prefer simplified solutions, and that is until they figure out they need more complex solutions for governance or cyber or other key elements on how they manage across the -- completely manage across the enterprise and move to the cloud. And we are addressing those issues. Our appliance and HyperScale are designed to provide both distribution leverage and to address shifts in the competitive marketplace. So the answer, Joel, it's a combination of both, it's not just one. And the other thing we are doing is taking another turn. We were successful in our, call it turn one, to get the company back from negative growth to positive on our, I'm going to call them standalone solutions. And we are doing some additional things with our software to make it easier to drive those solutions through the channel. So there is no simple one answer. You got major shifts in the market and we started way, way back when we started to put together our turnaround strategy going back 3, 4 years ago. And the reason we can go into market with HyperScale or HyperScale Appliances or new software or new ways to dev/test or new ways to GDPR all the investments we made over the last several years. So strategically we are in pretty good shape. It is now working through and executing across these elements. So they are in our hands, it is not something that we are missing but we have got -- but some of these initiatives are little bit early on and then we just introduced a lot of this technology a quarter ago and the results have been pretty good.

So I guess that in terms of the push out to the lower close rates based on your commentary it is not necessarily a large competitive issue where some of the other guys in the market are getting stronger and you are getting weaker. Is that how we should take this away or?

Yes, I mean those deals, I mean almost every one of them is still in the funnel. It is agonizingly slow and the point we are making is, internally, is you can't depend on that. It's just -- at least for the near term. I think I honestly believe by the way there is going to be another major shift in market going out a couple, 3 years, tied to things taking place in cyber and analytics. But in the meantime we want to get this company, we want to accelerate growth and we want to improve operating margins in the near term and I think we can do both.

Hey, Brian, just for you real quick. I think investors can understand the shift to the subscription-based model and the impact on near-term results. Obviously that's a good thing over the term, but maybe you could just talk about the components because you said 20% of product and obviously (inaudible) is the components of the recurring revenue story and maybe give us that as a total percentage because obviously the story is becoming much more about recurring revenue model and I think that will be helpful.

Yes, so I mean just to try to answer that in the context to what we said within the script. I mean it is now representing 20% of software revenue. And again, that's double what it was prefiscal 2018. It's also helping to drive growth in deferred. So you can see it show up in our billings growth number that we stated which was up 13% year-over-year. So we were pleased with those stats and also we mentioned that some of these subscription elements will also start showing up in terms of some level of off-balance sheet backlog and we have other things working for us in terms of unfulfilled orders that are also disclosable in the queue. So once you add all those elements together I think we're pleased with the progress we're making on both subscription and the new product offerings that we rolled out.

In addition to that what you don't see, Joes, but it's starting to show up in the numbers is we're seeing really strong growth in our managed service and SaaS offerings which show up in our services line.

And our next question comes from the line of Jason Ader from William Blair.

I have 2 questions, 1 for Bob and 1 for Brian. Bob, just on the lower close rates, I'm assuming that's primarily North America because you talked about the strength in EMEA. Is there any 1 or 2 themes that you can point to, I mean it doesn't sound like it's competitive so much, but why are the sales cycles more extended today than maybe they were several quarters ago. And then for Brian just wanted to talk about the subscription shift, so I will hold off on that.

Yes, by the way I'm going to compliment you, Jason, you are spot on, on your pre-earnings note. So good job.

Broken clock.

Well, I mean I think it you were just spot on, on that note. So yes, the close rate issue is primarily in the Americas. One of the reasons is these are multimillion dollar deals, it's not that EMEA doesn't have multimillion dollars but the Americas has a lot more of them. And each one of them has a story. There is no theme -- in fact there is a lot, there is significant amount of those in the funnel in the Americas for Q4 but we kept our -- we were prudent on our guidance because our history of closing them has not been good but that actually increased quite a bit going into this quarter. So there is no theme. It's not competitive, it's just -- the ones that are in the funnel and closing just dragging up through, so I don't think the competitive landscape was changed at all in the enterprise. In fact in many respects we've gotten stronger not only with our technology but with some of our new partnerships.

And then, Brian, just on the subscription mix, I think I understand it but it is a little confusing because you already did an early adoption of 606 so I would have thought that the subscription mix wouldn't really change that much because you have to recognize the software upfront anyway. So can you just walk through the mechanics there for why it would be driving greater deferred revenue growth and dampening software growth on a like-for-like basis.

Sure. I mean just the pricing economics when you compare a subscription deal, so a committed subscription arrangement. And let's just say for example it's a 3-year commitment, on a like-for-life basis when you compare that against a traditional perpetual transaction it's going to be a little lower, there is a small haircut on that subscription commitment. Now the good news is that it's helping to drive other aspects of our business in terms of repeatable revenue stream, deferred revenue and now fast-forward 3 years from now we are now going to start to have the annuity stream of the subscription deals coming up for renewal. So just again, as we went through this it's been I think faster than expected, we didn't expect it to ramp up this quickly going into FY '18 but we view that as a good thing in the longer term.

It's small but it's a big enough incentive for customers to -- we made it large enough, Jason, for customers to move to subscription versus perpetual. So I don't want to give the impression that it's tiny because it's meaningful to a customer to move to subscription.

And our next question comes from the line of Abhey Lamba from Mizuho Securities.

Bob, just continuing on your answer to previous question about the deals that have slipped. I understand there is no theme but maybe if you can talk about the top 2 or 3 deals that slipped and what's going on, why is it taking as long as it's taking in closing them?

I mean we're not going into naming companies. One company is having a discussion between operations and procurement, so this has nothing to do with Commvault. It's just some internal issues that they are dealing with and until they get resolved we're kind of right in the middle of it and maybe we're through that with that customer we'll see. It's possible that deal will close this quarter. Another customer had a major acquisition, so they put things on hold and so that is opening up. I mean there is no theme to it, just it's very customer specific, so -- yes?

Got it. And In terms of GDPR, I mean we have been hearing about it for some time and you have the products in place. When should we start seeing some meaningful adoption of those products?

I think in the June quarter.

Got it. And lastly, you talked about new pricing models that are causing confusion. Can you just elaborate more on that, what's causing that and what are you doing to fix that? That's it for me.

We went to subscription. We also went from, as we are advancing this platform we went from front-end pricing to back-end pricing on the platform. That caused some issues. Those were the major ones. But Jason Ader hit it pretty well because he must have been talking to few people. But clearly the combination of those changes caused more confusion than help and we are rectifying it.

And our next question comes from the line of John DiFucci from Jefferies.

Bob, can you explain a little bit further when you were talking about strengthening the mid-marketing channel you said you were going to be realigning field resources. Can you give us a little more detail on what that means?

Well, we've done it and not completely but we started it last quarter in the Americas. What we did is clearly we have a -- to get operating margins where they need to be we got to solve the sales and marketing issue, it's too high, right, so -- and so you need higher growth and it's there. So what we did is we started -- we formed a much stronger alliance with Microsoft and we put resources on. We took existing field management reps and moved them to align with some of the things we are doing with Microsoft. We did the same thing for Cisco. And we did the same, we moved resources to align with our channel partners for appliances. So the moves we made, again just to summarize, we moved existing resources for Microsoft, Cisco and the appliance. More to come in terms of some of the other things we are going to do there. Additionally, we needed a stronger more consistent, more efficient go-to-market capability in that mid-market to make it a lot more self-sufficient and drive growth. So because we want our mid-market channel not to have to depend on our sales reps which is expenses and make sure our key sales teams are focused on big enterprise because that's -- the big enterprise is still going to be the major play but we want -- we want more balance, more leverage growth in the mid-market. And when you look at the models, I mean to transition and do this it takes a little while. But I think the market is very receptive to the moves we are making to help them succeed. And we're also -- it's not just people you're moving, you are also making those products easier, simpler to sell so they can be driven through those channels. I mean, so the issue is you can add resources but we're a public company and I'm a large shareholder and to do it effectively, and it's more risk the way we're doing it but it's, I think it's the right way to do it for shareholder value, is to make better use of your existing assets versus adding assets. So that's what we're doing.

And that makes sense. But on the HyperScale launch it's good to hear you're getting traction, I think you said, in orders, but I just want to be clear. I would assume that you really didn't have revenue at all for that yet, is that true in this quarter or have you started to seem material revenue?

Revenue that's going to mean something, yes, we did have orders last quarter but I think in the March quarter you can expect it to be impactful to our revenue earnings growth in the March quarter.

Okay. And if I might just quickly for Brian. Brian, you didn't give a number -- I mean, we go and look at the repatriation of cash, we think -- we come up with a number of about $150 million of extra foreign cash that you'll have access to, to be able to use however you want to use it. Can you talk at all about what you might use that for?

So I think we disclosed this, about 40% of our cash balance is sitting outside the U.S. Our current policy election is that that's permanently reinvested overseas. However, we're going through the exercise now of looking at both the repatriation but also you have to look at local foreign tax laws to see what it costs to move money out of those countries. So while it might be favorable in terms of the U.S. tax reform laws, there still may be some unfavorable foreign tax laws that we still need to go through. We're spread around in 30-plus countries throughout the world, it's a complex study, more to come on that.

So the answer is we don't know how much of that will be available.

Yes.

And clearly, I mean our use of cash, I think we're starting to approach somewhere close to $600 million of what we bought back since we went public and we bought back $80 million last quarter. Our primary use of cash has been for share buyback, and that's likely to be our primary use of cash going forward.

And our next question comes from the line of Alex Kurtz from KeyBanc Capital Markets.

When we look at the fiscal 2019 operating assumptions, could you give us more color on how you guys are thinking about large-deal transactions and sort of close rates versus what you saw in fiscal 2018? The transition to subscription, I know Bob in the past you had mentioned that that may have mucked up some of the deals, some of the new pricing, I was wondering if the subscription adoption is part of your working assumption in the fiscal 2019 guidance? And then my third question is just appliance impact to fiscal 2019, do you really see this is incremental? Is there some cannibalization of sort of existing demand in the market from the appliance launch? So just some color on those items would be helpful.

So on the appliance it's likely to be significant for FY 2019 and, yes, Alex, it will be a combination of new and there will be some cannibalization of data protection, because right now those appliances are mainly targeted against virtualization, data protection. That will change -- because of our breadth and depth of what we can do with the appliance we'll have other use cases that we can go into market with. But for data protection it will be new and will be a cannibalization and it will cannibalize some of our data protection revenue. But net-net, it will be positive. HyperScale is similar, so HyperScale is just much higher scale implementations here. I mean you start getting into petabyte, multiple petabyte you would use our HyperScale software and with solutions like we're doing what Cisco because it's a lot more efficient than just scale-out appliance boxes, doing it that way. And that will be a combination of -- I think it will be less cannibalization and more opening up a new market into big data and some of these other things in the HyperScale software that -- versus the appliance. We also closed a very large multi-petabyte deal recently with HyperScale where the company is using it to mitigate cyber, because we can do things with our software that others can't do in terms of not only mitigating an attack but providing massive fast recovery on hundreds of thousands of servers that do that really quickly and doing that in combination with our HyperScale solutions. So Brian, could you take the...

Yes, go ahead, Brian.

Yes, so Alex, so I think that customers want options, right? So not everyone is going to want subscription, not everyone is going to want perpetual. Our job is to do that in a way that doesn't confuse the market. And I think we've got some great models to offer. And as long as -- it's okay to have a couple different models as long as they're the right fit for the market. So we do see subscription continuing to increase. I don't know it ever -- it's never going to be a complete 180 to 100% subscription, that's not what we're messaging, but it's going to be done in hopefully a very methodical way. We've had some early success with it and we're going to continue to embrace it for the time being and try to hit our near-term and FY '19 objectives at the same time.

I will try to give you some color. Because we are seeing some really good acceleration in managed service and SaaS which will be a lot more meaningful to our FY 2019 results than 2018.

And our next question comes from the line of Aaron Rakers from Wells Fargo.

This is Joe Quatrochi on for Aaron. Just a couple if I could. When I look at your software growth expectations for the fourth quarter, I think going back to last quarter you talked about a mid-teens growth rate. How do we think about the delta there to the 10%, how do we think about the drivers or is it breakdown of subscription versus deal closure rates or is this kind of some changes going on in the sales go-to-market?

Not sure I understand the question. The question is what?

Yes, I mean as we said on the call, so we would expect that again that subscription had a slight dampening effect in Q3 to a tune of a few million dollars, that's kind of embedded into our Q4 guidance expectations. And in the near term we still are relying upon large deal closure rates. We've got a good big deal funnel, but -- and some of the deals from Q2 and Q3 are still viable and it's just a matter of execution at this point. So it's a combination of both the move to subscription and improved and large deal close rates.

And our next question comes from the line of Andrew Nowinski from Piper Jaffray.

I just have 2 questions. So first, your new guidance for software licenses in Q4 still equates to about 15% sequential growth which you haven't even come close to doing in Q4 anytime over the last 10 years. So why would we think the business can significantly accelerate this quarter? And then second, you talked a lot about Cisco being a material contributor in Q4 in FY '19, but what about -- what was the contribution from your other OEM partners like Microsoft and Amazon? And how should we think about the contribution from those 2 in FY 2019?

Andy, we're struggling with the 15% sequential growth a bit. We're seeing something in the mid-single digits in terms of the sequential growth.

Yes, I don't know where you're getting that number, it's nowhere near that.

Okay. Sorry, maybe I have the wrong calculation. Then I guess just as a revision to that question, do you have any color as to what changed from when you talk about doing mid-teens growth on a year-over-year basis in the March quarter versus the 10% percent now, was it just -- something -- anything changed specifically over the last 3 months when you gave that last guidance?

It's subscription and its impact. And we have dampened down our large-deal assumptions for Q4.

And then Microsoft and Amazon?

No, the Microsoft relationship continues to grow extremely well and is becoming more and more impactful. And stay tuned on Amazon, we're doing something with them as well. And when we -- in appropriate time we'll communicate that to the market. And we're doing things with Google also but the difference is we are very programmatic with Microsoft. I mean it's programs, it's -- there is joint marketing efforts, et cetera, we don't have yet that structure with AWS, although our cloud growth is still stronger in AWS than it is with Microsoft in spite of that programmatic, those efforts but -- so we've got, I'd say, good strong positions in both of those and stay tuned on AWS.

And our next question comes from the line of Eric Martinuzzi from Lake Street.

Question on the pace of investment. Historically in a given fiscal year you guys would do a good bit the first half, there'd be kind of a sales and marketing ramp, onboarding of new cohorts of reps and marketing programs, go-to-channel investment, go-to-market investments with channel partners, any change to that historical investment seasonality with FY '19?

Well, we're trying to do this with redeployment of resources versus adding them. And at the appropriate time I'll let you know, but we're going through that exercise right now. So that's what we historically have done. Going into this year we're trying to do it differently because we have the products and channels that are going to enable us to do this differently than in the past years. So directionally it'll be less obviously for us to drive operating margins up, we got to do it more efficiently and we've got the products and the new distribution channels and partners now that'll enable us to execute a strategy like that.

Okay. And then you talked about HPE relationship with -- maybe it was a press release but that's what I hadn't heard you guys talk about historically. Obviously you're working with a lot of partners, the (inaudible), the Microsoft's and AWS and Cisco but HPE was a new one for me. Can you talk about that one a little bit?

Well, what we just announced was our relationship with a managed service businesses which they call GreenLake. But we're broadening our relationship with HPE, so that is the first announcement with them. We are working in a more -- more and more closely in the field with HPE. And I think it's indicative of a broader trend in a market where the major players that we are investing in are either in services like Green Lake or they're focusing more and more on primary and/or on managed services and that aligns well with our capabilities particularly in secondary storage and operations and automation. So yes, and our HyperScale secondary storage.

Well, vendors that have servers and storage (inaudible).

Yes, good point, Alan. What I was just saying is partners like HP that have servers are natural partners for our HyperScale Software.

And that would -- that just -- specifically here we're talking software form factor as opposed to appliance form factor, just...

Correct, that is correct, yes.

And our next question comes from the line of Srini Nandury from Summit Redstone Partners.

Bob, can you talk about the position of Commvault versus your competition, the HyperScale, Rubrik and Cohesity, these newer guys are growing very, very rapidly and are you guys bumping into them at all?

Yes, we bump into them every day. I mean it's at the lower end of the market, we clearly see those competitors out there. And fortunately, we started this program well before they came into market, so we got into market relatively quickly with our HyperScale appliance. I'll let Alan make some comments on that regard as well.

Yes, Bob hit it pretty well. I mean I think as he said they were in a little bit before us. What we have seen out there is we're pleased with our performance and our capabilities and our competitive advantages. We believe we have more to offer for less money, that's simple equation. That doesn't always work. So we're battling a little bit on our, as Bob said earlier on our messaging, on our focus, it's all around data protection and also focusing on all the enhancements and capabilities we've made around simplicity and practicality of solution here. So we're feeling good about where we are. We need to keep being aggressive here particularly as we get into the channel side of the equation. And again, as Bob said all along, strategically, we're in a good place.

So Srini, just to remind everybody that the big issue and the biggest weakness Commvault has is in distribution. And these products are designed -- we want to meet market needs but they -- when we started to embark on this several years ago it was clear we needed products that were much more aligned with the channel. And then you have to put an organization in place that's much stronger for the channel and the incentives that go along with it. So the first thing you have to do is get the product. Then we -- in parallel with that we've established a much stronger channel organization and you got to put those things together, drive it into market, but -- so it's not just technology, it's technology and distribution, and we've addressed both of those.

Thank you. And I'm showing no further questions at this time, this concludes the Question-and-Answer Session and today's call. Thank you for your participation. You may now disconnect. Everyone have a great day.