Commvault Systems Inc

NASDAQ:CVLT

Earnings Call Transcript 2020-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. And welcome to the Commvault Fourth Quarter Full Year 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Mike Melnyk, Director of Investor Relations. Please go ahead, sir.

[Mike Melnyk, Director of Investor Relations]

Good morning. And thanks for dialing in today for our call to discuss our fourth quarter and fiscal year 2020 earnings results. Before we begin, I'd like to remind everyone that the 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 the statements that relate to our beliefs, plans, expectations or intentions regarding the future are 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 risk and uncertainties such as competitive factors, difficulties and delays inherent with 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 our most recently quarterly report on Form 10-Q, and in our other SEC filings, and in the cautionary statements 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 features or functionality remained at our sole discretion. Our earnings press release related to today's announcement was issued over the Wire services earlier this morning and has been furnished to SEC as an 8-K filing. The press release is also available on our Investor Relations website.

On this conference call, we will refer to non-GAAP financial measures. A reconciliation between the non-GAAP and GAAP measures can be found on our website. This conference call is being recorded and a replay is available for webcast. An archive of today's webcast will be available on our website following the call.

With me on the call this morning are Sanjay Mirchandani, President and Chief Executive Officer of Commvault; and Brian Carolan, Chief Financial Officer of Commvault. Sanjay and Brian will each share opening remarks and commentary before we open the call for Q&A.

Now, I'll turn the call over to Sanjay. Sanjay?

[Sanjay Mirchandani, President and Chief Executive Officer]

Thank you, Mike. Good morning and thank you for joining us today to discuss our fourth quarter and fiscal year 2020 results. I would like to begin by extending our thoughts of the millions suffering from the coronavirus and the subsequent economic hardships. Across Commvault, we remain focused on keeping our employees safe and healthy by providing our customers with world-class products and services they expect. In March, we began working from home to prioritize safety. Our employees many of whom were already workers quickly adjusted with minimal disruption to our operations. I would like to thank all our vaulters for stepping up to ensure our business continues without interruption.

I would also like to acknowledge the team's creativity in helping our customers adjust to, to recognizing the pandemic introduced new data challenges for a much larger remote workforce. We created a Commvault's Cares program to provide customers with additional software support and education at no cost until September. This includes offering Metallic endpoints in recovery but unlimited as your backup storage from our good friends at Microsoft. To protect against data corruption, deletion, malware and ransomware attacks. To date, hundreds of customers have accessed free trials and are benefiting from the program. As you know, the pandemic presented some challenges for us.

During the quarter and the economic picture is still evolving. However, we believe the progress we made last year and our ability to help our customers now when they need us most will enable us to weather these challenges and continue leading our industry for the long term. This is reinforced by the improved performance we delivered in two prior quarters. We expected a carry that momentum into Q4 but Covid impacted APJ and EMEA throughout the quarter then extended to the Americas in March. Despite this we close multiple seven-figure deals and won many new customers including McDonald's, Blue Cross Blue Shield Minnesota, the city of Philadelphia, the Polish Ministry of Finance and Shared Services Canada, which provides IT services for the Canadian government.

We launched a targeted competitive switch campaign and kicked off our fiscal year 2021 subscription renewal cycle with two of our largest customers renewing their deals. That said our current outlook for total software and product revenue is more measured than our pre Covid expectations. We've seen a decline in the volume is smaller portfolio transactions due to --slightly due to SMB customers that may be disproportionately challenged. Additionally, we believe customers may defer routine capacity add-ons until economic conditions begin to stabilize. Even with the mission critical nature of our products, we expect new customer signings to remain challenged because they require a higher touch sales process. During the quarter, we made some prudent short-term adjustments to our expense structure to align with the current revenue environment, most notably a temporary reduction of salaries.

Our fiscal discipline and strong financials allow us to confidently make decisions that balance the needs of our customers, shareholders and employees, while remaining focused on a return to growth. Even with the expected pressure, we believe we have the staying power to emerge from this pandemic as a stronger company because of our innovative product strategy, our large and loyal customer base and growing software subscription and recurring revenue base.

Let's discuss each of these. First, our innovative product strategy. We advance our storage and data management vision by integrating Hedvig with Commvault Complete to solve customers' hardest data management problems. This provides customers more choice and flexibility with their data without the large upfront investment with more milestones and use cases coming, we will have additional capabilities just to cross-sell into our customer base. We'll share more on the roadmap in the future. Additionally, we continue to roll out our SaaS solution, Metallic. Customers increasingly want a flexible consumption based and cloud centric solution to support their infrastructure, remote operations and endpoint devices. Metallic meets this head-on and is the ideal platform for our future SaaS offerings.

We also continue to lead when it comes to migrating work loads to cloud. Conservatively, we estimate that our software already manages more than an exabyte of customer data in multi cloud environments. In Q4, we added support for several cloud native applications and expanded on our capabilities to enable customers to accelerate their cloud usage. One of our cloud success stories is McDonald's whose Director of Cloud Services, Douglas Leonard said, we're investing heavily in the cloud to keep our IT operations running. The software solution from Commvault has cut across every use case McDonald's cloud services team has. Commvault solution tunes performance across AWS and Microsoft Azure, cloud service and drives cost savings. McDonald's realizes value from a trusted innovative team with Commvault.

This is the premier example of how we're helping our customers modernize their environments and accelerate their path to the cloud even in the midst of an unprecedented quarter. The second reason we have staying power is our loyal world-class customer base. The majority of which are large, well capitalized enterprises with whom we have long-standing relationships. The average tenure of our customers is nine years and our historical maintenance rates are approximately 90% across our customer base, more impressively it's 97% among our Top 100 customers. Given our diverse base, we're not disproportionately exposed to any one industry having nurtured our customer relationships for decades; we believe our incumbency is an asset. We have the right go-to-market strategy and a keenly focused on our customer success. We just hosted our first ever all virtual sales kickoff and Q1 is off to a strong start.

The third reason we have staying power is our subscription and recurring revenue streams. They're a growth driver for us in fiscal year 2021. In Q4, we added approximately 150 subscription customers and revenues now represent over 40% of our software product revenue.

With fiscal year 2021 is our first full renewal cycle; we are focused on this opportunity.

Now let me turn it over to Brian to give you some detail on our fourth quarter and full year results, as well as our outlook for the first quarter. Brian?

[Brian Carolan, Chief Financial Officer]

Thanks Sanjay and good morning, everyone. Before discussing our outlook, I'll briefly recap our results. As Sanjay discussed, we have demonstrated continued success in our subscription transition by adding approximately 150 additional customers in the fourth quarter. For the full year, subscription revenue exceeded 40% of software and products revenue compared to less than 10% in FY17. As a reminder, we began our transition to a more subscription-based recurring revenue model in FY18. We expect recurring software and products revenue to increase as a percentage of total revenue in FY21 as we capitalized on the renewal opportunity associated with our existing subscription customer base.

Services revenue the majority of which is maintenance accounts for approximately 60% of total revenue. Fiscal fourth quarter services revenue was approximately $98.3 million declining 2% year-over-year and 1% sequentially. On a constant currency basis, fourth quarter service revenue was down 1% both sequentially and year-over-year.

For the full fiscal year, services revenue was approximately $396 million, down 1% year-over-year. FY20 expenses declined 3% year-over-year to $459 million. Over the past several years, we've successfully reduced our underlying operating expense base driven by our deliberate efforts to tighten the cost structure, while continuing to invest in strategic initiatives such as Metallic and Hedvig. Unlike some of our competitors, we are able to fund our future through our profits and cash flows. Free cash flow which we define as cash flow from operations less capital expenditures was approximately $31.1 million for the quarter, representing our strongest cash flow quarter of the year.

For the full year, free cash flow was $85.3 million. We repurchased 872,000 shares for $37.2 million during the fiscal fourth quarter. And 1.7 million shares for $77.2 million during the full fiscal year. Over the past five years, we repurchase over $600 million of our stock representing more than 125% of cumulative free cash flow. We have almost $163 million remaining on our existing share repurchase authorization, which expires March 31st, 2021.

Now I'll discuss our financial outlook for Q1, FY21. Given the uncertainty and limited visibility associated with Covid-19, we are being measured with our outlook. At this time, it's simply not possible to predict when we might return to a more normal business environment. Having said this, we have several factors that provide underlying support for existing revenue base. For example, over 70% of our revenue is recurring in nature. Approximately two-thirds of new software sales are to existing customers and subscription renewals represent a growing and more predictable part of our sales motion. As Sanjay noted, we did see a notable decline in smaller transactions in the last weeks of March as the virus spread and economic shutdowns intensified.

We expect these trends to continue throughout the current quarter and to have a continued dampening effect on our business. For the first quarter of FY21, we expect total revenue of approximately $150 million to $155 million including $58 million to $62 million of software and products revenue. Our revenue outlook is underpinned by the successful renewal of two of our largest subscription customers. These renewals were signed in Q4 before their contract expiration and will represent combined software revenue of approximately $10 million in Q1, FY21.

We are working diligently to exceed our guidance and to deliver year-over-year software revenue growth. In response to Covid-19, we made temporary but prudent adjustments to our expense structure to align with the current revenue environment. With these adjustments our underlying OpEx is down sequentially.

With that we expect Q1, FY21 EBIT line OpEx is down sequentially at 7%. We will continue to won FY21 each of the situation and we are prepared, if necessary. Lastly, our projected share account for Q1 is a --to make 46.4 million shares.

Now I'll turn the call back over to Sanjay for some closing remarks. Sanjay?

[Sanjay Mirchandani, President and Chief Executive Officer]

Thank you, Brian. I joined Commvault with a commitment to return the company to responsible growth and this continues to be our number one priority. During this difficult time, our strong balance sheet, rich technology portfolio and loyal customer base position as well to weather the storm. More importantly, our resilience and response to the crisis is only deepen my conviction in Commvault success for the long run. I'm confident we have the talented team and the focus needed to further strengthen our customer relationships and partnerships during this crisis and seize new opportunities in the future.

I look forward to updating you on our progress in the coming quarters. Now we'll open up the call to questions.

[Operator]

[Operator Instructions]

Our first question comes from Aaron Rakers of Wells Fargo. Your line is now open.

[AaronRakers]

Yes. Sorry about that guys. Maybe the first question if I can, as you start to get more vocal about the subscription renewal cycle into fiscal 2021 and kind of a framework that you just laid out for fiscal 1Q guide. Can you help us understand what the base of businesses that is actually the subscription base that we should think about for the full fiscal 2021? I guess what we're really thinking about is what was the base of subscription revenue that you generated in fiscal 2018 that comes up for the renewal cycle in fiscal 2021?

[BrianCarolan]

Sure. Good morning, Aaron. This is Brian here. Hope you are well. Yes. So as you know, it's early days for us with the subscription renewals but we're off to a good start in Q4 that'll be recognized all we successfully renewed two of our largest [Indiscernible] fiscal Q1. And so just to frame out the opportunity we believe there's about a $50 million software opportunity coming up in FY21. It's mostly weighted towards the second half of the fiscal year. Obviously, this is a new motion for us. We're trying to be prudent with our assumptions and pragmatic about it. So we are on it. We have a dedicated team working hard as part of our customer success organization, team works with customers to optimize their use of our platform and software and strive to strengthen that relationship and contacting that customer well in advance of when that renewal is coming due.

So then it's a great opportunity for us. But we're being measured at this point in time and we think it's going to help us drive more predictable results moving forward.

[AaronRakers]

Okay. Thank you. And a real quick second question through this last quarter last month or so you announced some patent litigation against Cohesity and Rubrik. Can you just help us understand what you're exactly currently seeing in the competitive landscape and the measures you're taking versus to competitors?

[SanjayMirchandani]

I'll take that, Brian. Aaron, I hope you're well as well. I've said this through the course of the year that I've been here that our portfolio, our technology portfolio is second to none. And we continue to invest in our portfolio aggressively. We think we've spent in excess of a $1 billion on our IP as a company and competitively we see not getting the details of the of the lawsuit, but competitively we think our portfolio especially with our focus on cloud, our SaaS capabilities, our software-defined storage abilities; our ability to truly help customers use data would activate are all coming to the core. These are all use cases that are absolutely being are super relevant and customers are talking to us and using our technology for it.

So focus really on our technology making sure that we continue to lead in that space and on the lawsuit really it's -- I don't want to compete against ourselves.

[Operator]

The next question comes from Alex Kurtz of KeyBanc Capital Markets. Your line is now open.

[AlexKurtz]

Yes. Thanks for taking the question and hope everyone's safe and healthy on your end. Just a follow up on Aaron's question just how do you think about sales comp, sales structures you go into this renewal opportunity this year? And then maybe behind that given what you're seeing in challenges in the SMB space, are you going to reevaluate that part of the business right now and how you work with channel partners maybe to lean on them more and maybe refocus some of that selling capacity to the mid market. So kind of two questions there that comp structure and renewals and the approach and then how you're thinking about SMB in the next six months and how you bid to market?

[BrianCarolan]

Sanjay could take the first piece, if you want to take the second piece. So, good morning, Alex. It's Brian here. Hope you're well as well. So with respect to the subscription renewal opportunity and in compensation, we've got very well organized approach internally here. There are incentives in place for our field to be involved and actively involved with these renewals. We have it well segmented accorded to enterprise and SMB and that's also working hand-in-hand with our customer success organization. So it's a multi-pronged approach and we're well aligned and they're incentivized. So we believe this is going to be a good formula for hopefully the fiscal year.

[SanjayMirchandani]

And I'll take the second part. Folks, we are not all in the same location, obviously, so it's a little more hand-holding than usual when we're in the same room. So, Alex, good to hear from you. To your question SMB, non SMB channel, what are we thinking? Where we applying resources? This is a -- it's a great question because all over -- over the course of last year we talked extensively, we shared extensively about our simplify innovate execute model and part of execute was really to make sure we had a customer segment model that leaned on where the opportunity was and where the business was. And where our partners were and so for us our enterprise business is one that be -- we like I shared we've been in that business a long time. We've got great relationships and continue to stay close and as our customers come out of this I think will be good.

On the SMB, our product offerings much like Metallic are very attractive. They're lightweight, they are cloud oriented; they help customers of that size and our service providers are also doing a lot of work with customers in that segment and we're working with them. We've extended our portfolio and made it easy for them to sort of use the technology during the course of this pandemic to our Customer Cares program and we think that our offer, I think that we've aligned well with that And to support the partner channel which is really leading in some of this, we have an ISR team that's active and mobile. So hopefully I answered your question. We feel good about that space.

[Operator]

Our next question comes from Jason Ader with William Blair. Your line is now open.

[JasonAder]

Hey, guys. Hope you're well. First question for me is we are in May 12th now so you're almost a month and a half into the quarter. Can you talk about any change in trend versus March? I mean what are you seeing in the first six weeks of the quarter relative to what you saw in the month of March?

[SanjayMirchandani]

Let me -- sure. Hey Jason. It's Sanjay. So I think it's a great question and we're monitoring this all the time. Talking to channel partners, talking to customers. There have been -- the structural shift in the market if you would. When this -- when all of this first started happening the work from home scenario, our customers were adapting; we adapted I think we've six weeks now into the quarter. I think people are sort of finding their feet in this new world order and in the remote environment. So what we did was we put our Commvault Cares program into place, stay closed with our customers. We're helping them through -- there's an increase in say ransomware and security sort of threats at this stage. We're helping them through that. We're doing -- we're helping them with monitoring because they can't get to there -- because they can't get to their data center sometimes in full force.

And we internally pivoted very quickly as they have as our customers and partners have. So we're doing everything we can to stay close, but there's a lot of conversation about cloud now. More so I think that there's been a fundamental acceleration and customers plans to adopt and embrace public cloud scenarios. Our products, our campaigns and our conversations are all aligned to that. So we feel pretty good. Right now, it's a lightweight cloud oriented and that's where -- that's the next wave, if you would of conversations after the structural shift and work from my home scenarios have been sort of mostly settled.

[JasonAder]

But no material change in terms of the tone of business or anything that --

[SanjayMirchandani]

Well, data protection is high on the list and especially as you have remote workers and new data scenarios. This bubbling to the top, but I think as customers initially had to respond. They have to sort of prioritize what it is and that was working from home, getting the endpoint sort of sorted out. And now we're having conversations again where customers saying, okay, how can you help us? And is it our strategy valid? Do we have gaps? There's expansion opportunities, so the conversations are begin again but it varies. And it's-- it varies by geography and it varies by segment.

[JasonAder]

Okay. Great and then secondly, I think there's been some concern over the last couple of years of some of the very well-funded and aggressive upstarts coming after your base. Have you detected any change in the success rate of those upstarts trying to go after your base just given that there is seems -- there does seem to be an advantage of incumbency right now?

[SanjayMirchandani]

Going after new customers, trying to shift at this -- in this time is hard. It's hard because right now what we're telling our customers is we're here to help you. We are in here to make sure you are secure. We need to make sure that you've got what you need and incumbency matters. I think incumbency is king at these points and having those conversations with customers is what matters. Has -- honestly, Jason, I've always -- I'm a big believer in focusing on the fundamental. Run a good business, get the right balance; have good free cash flow. We've always tried to do the right thing and I'm running a good fundamental solid, fundamentally solid business at this point is key. Customers want us around and that's what we're focused on. Can't speak for the competition.

[Operator]

Our next question comes from Brent Thill of Jefferies. Your line is now open.

[JoeGallo]

Hey, guys. This is Joe on for Brent. Thanks for the question. Given that net new logos will likely struggle in regards that $50 million renewal opportunity, what are the renewal rate assumptions? And then maybe can you walk us through the opportunities for upsell? Is it three years of usage or is there an opportunity beyond $50 million? What were the pricing dynamics with the two large deals that already closed?

[BrianCarolan]

Sure. I'll take that one, Sanjay. Good morning. So as we framed out the opportunity, we are being somewhat measured in our expectations. It's very early for us just to be completely candid. This is the first year of a significant renewal cycle and they typically are three-year contracts. And with the way our recognition model works is that when we secure that renewal, we recognize the upfront software value for the full term of that upfront in the period of sale or upon when the contract comes due. In the case of the two large ones that we renewed in Q4 that will be recognized in Q1. We're not going to get into Zach specifics but I would say they're two of our largest, more tenured customers. This all goes into the customer success discussion. We have regular dialogue and QBRs with them, active dialogue right at the top. And we're pleased with the result of those renewals.

And as we looked out over time, we've got a strong product pipeline and our expectation is to have these upsell and cross-sell opportunities with our new product portfolio that's available. But also coming available later in the fiscal year. So, yes, we're excited but it's early days.

[JoeGallo]

That's awesome. That's helpful. And then I know you guys have a million things to focus on, but maybe just talk about the conversations you had with an activist investor. Are there any incremental changes that you plan on enacting coming out of those conversations or any change in strategy between growth and profitability? Anything would be helpful. Thanks.

[BrianCarolan]

Sure. I'll take that one, Sanjay, if you want. I mean we've had a number of constructive conversations with the investor that you might be referred to, since learning that their investment will always open to shareholder feedback and suggestions and will continue to act in their best interests and our company's best interest. We're not going to get into specifics about those discussions, but I would say they're constructive. And I think their expectations and their wants are the same as ours worldwide in terms of long-term shareholder value and it balance growth profiles and business. And we're excited about the opportunity wants to get through this hopefully temporary period of time.

[Operator]

Thank you. And, ladies and gentlemen, that does conclude our question-and-answer session. This does conclude today's conference call. Thank you for participating. You may now disconnect.