Earnings Call Transcript - CVLT Q1 2023

Operator, Operator

Good day. And thank you for standing by. Welcome to the Commvault Q1 Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to welcome one of your speakers for today, Mr. Michael Melnyk. Please begin.

Michael Melnyk, Head of Investor Relations

Good morning. And welcome to our earnings conference call. I am Mike Melnyk, Head of Investor Relations, and I am joined by Sanjay Mirchandani, Commvault’s CEO, and Gary Merrill, Commvault’s CFO. An infographic with key financial and operating metrics is posted on the Investor Relations website for reference. Statements made on today's call will include forward-looking statements about Commvault’s future expectations, plans, and prospects. All such forward-looking statements are subject to risks, uncertainties, and assumptions. Please refer to the cautionary language in today's earnings release in Commvault’s most recent periodic reports filed with the SEC for a discussion of the risks and uncertainties that could cause the company's actual results to be different from those contemplated in these forward-looking statements. Commvault does not assume any obligation to update these statements. During the call, Commvault’s financial results are presented on a non-GAAP basis. A reconciliation between the non-GAAP and GAAP measures can be found on our website. Thanks again for joining. Now I'll turn the call over to Sanjay for his remarks. Sanjay?

Sanjay Mirchandani, CEO

Good morning. I'm pleased to share Commvault’s record Q1 results. Our subscription software and SaaS strategy is working as customers continue to prioritize data management and protection solutions as they embrace the cloud and hybrid IT. This is reflected in our results, which I will be discussing in constant currency. Total revenue was up 13% year-over-year. Software and products revenue increased an impressive 17%. Metallic is starting to contribute meaningfully to revenue, and we once again delivered profitable growth. Total ARR, a key indicator of our future, continues to be strong, growing 16% year-over-year. Combined subscription and SaaS ARR grew approximately 50% year-over-year and now represents 64% of our total ARR. We have 2.5 times more subscription and SaaS customers than we had two years ago. These are proof points that our strategy is working and that we are their trusted partner for our customers’ large multi-cloud environments. I'd like to share a little bit about why I think we are poised to capitalize on the massive opportunity ahead of us. The past few years have been hard on IT professionals and will continue to be challenging, with rampant data proliferation, a rise in security threats, increasing costs, and resource limitations. As executives prioritize IT projects in this environment, data protection will remain top of mind, especially as mission-critical hybrid solutions continue to grow in the enterprise. This proliferation of data across multiple environments and vendors is what causes data to be more vulnerable. Organizations are looking to consolidate their data management solutions and reduce complexity and costs while protecting their most precious assets. Nobody has the workload breadth and depth to manage this across the entire data state like Commvault. We enable this today. Through the power of AND which offers the best software and SaaS, we provide elegant industry-leading cloud data management capabilities. So customers have the ease and flexibility to use one or both offerings to meet their unique and ever-changing needs. From a single pane of glass, customers can manage their on-prem workloads, like virtual machines, containers, mission-critical legacy workloads and SaaS applications like Office 365 and Salesforce. In fact, approximately 50% of our SaaS customers also use a Commvault software product. Faced with the relentless threat of ransomware attacks, more and more customers are mitigating risk by replacing their multiple point products with Commvault integrated software and SaaS solution for air-gapped ransomware protection. Within months of acquiring TrapX, the solution for advanced threat deception, we reimagined the product and introduced it as THREAT WISE with end-to-end proactive and responsive capabilities to further strengthen our customers’ ransomware protection. The product is currently available in early access via Metallic. Our software and SaaS offerings continue to garner industry accolades and strong ratings for cyber resiliency, governance, and Kubernetes support. In fact, GigaOm recently named us as a frontrunner for Kubernetes and an outperformer for hybrid cloud in its latest Radar reports. It is our continuous innovation that solidifies our position as an industry leader, and it is our robust partner ecosystem that enables us to reach more customers globally. In late June, we announced a strategic partnership with Oracle to offer Metallic globally on Oracle Cloud infrastructure (OCI). With this partnership, Commvault became the first enterprise backup and recovery SaaS provider in the Oracle ISP accelerator program. This will give Oracle customers the performance, security, and trust they need to accelerate their data journey to OCI while leveraging Metallic to protect their most mission-critical workloads on-premises and in the cloud. We expect this partnership to open the door to Oracle's 400,000 plus customers. By adding native OCI integration and support, we now have industry-leading capability across all hyperscalers. With these partners, we're meeting customers where they are with our portfolio of cloud data management solutions. And we are confident this will enable us to further accelerate our growth. Now, I will turn the call over to Gary.

Gary Merrill, CFO

Thanks Sanjay. And good morning, everyone. In my first earnings call as CFO, I'm happy to share that we are off to a solid start to the year after delivering record fiscal ‘22 performance. I will start with a quick recap of the quarter with growth rates on a year-over-year basis unless otherwise stated. We beat all of our guided metrics for Q1 led by total revenue, which grew 8% to approximately $198 million. On a constant currency basis, total revenue increased 13%. Software and products revenue was $92 million, increasing 13% as reported, and growth accelerating to 17% on a constant currency basis. From a geographic perspective, both our Americas and international regions delivered strong Q1 software and products revenue growth. Our Americas region increased 15% driven by large deals as customers are spending on IT transformation projects with data management as a critical element. Our international region, which includes both EMEA and APJ, increased 8%, also driven by strength in larger enterprise transactions. On a constant currency basis, international software and products revenue hit 20% growth. On a consolidated view, the revenue from software transactions over $100,000 increased 24% and represented 75% of software revenue. Average deal size also increased 24% to approximately $379,000. We closed multiple seven-figure deals in the quarter across a variety of industry verticals. Subscription software revenue increased 51% to approximately $75 million. Subscription license sales represented 81% of total software revenue, which is an all-time high and compares to just 60% of total software revenue a year ago. Our progress toward a subscription-led software business has given us more predictability and resilience to our business model. Now moving to ARR, our total ARR increased 12% to $595 million, or 16% growth in constant currency. ARR growth continues to be driven by Metallic and new software subscription business. The combination of subscription and Metallic ARR was up 46% to $378 million, now representing 64% of total ARR, which compares to 59% of total ARR last quarter and only 49% in Q1 of the prior year. For Q1 fiscal ’23, we are exceeding our January 2021 Investor Day targets for 10% compounded ARR growth, which is a meaningful indicator of our future growth potential. Total recurring revenue, which includes subscription software, maintenance support services, and SaaS, grew 20% to $171 million, or 25% growth on a constant currency basis. Recurring revenue represented 86% of total revenue for the quarter, up from 78% a year ago. Now I'll discuss expenses and profitability. We reported first quarter gross margins of 83.6%, which compares to 85% in the prior quarter, and reflects the modest shift in our gross margin profile with the success of our accelerating SaaS business. Total operating expenses were $123 million, an increase of 6% versus Q1 of the prior year and a decrease of 3% sequentially. During the first quarter, we prudently managed our expenses and increased our productivity with our total company headcount roughly flat quarter-over-quarter. We are proud of our track record of responsible growth, which is core to our management philosophy. Non-GAAP EBIT was $41 million, EBIT margin up 20.5%. In Q1, we repurchased approximately 310,000 shares of our common stock for $19 million. We ended the quarter with no debt and approximately $259 million in cash on the balance sheet, of which approximately two-thirds sits overseas. Now, I'll discuss our financial outlook for Q2 fiscal ‘23. We expect Q2 software revenue to be in the range of $80 million to $84 million and total revenue to be in the range of $184 million to $188 million. As a reminder, in recent fiscal years, Q2 is our low point for software revenue. On a constant currency basis, the midpoint of our software revenue guidance would be 12% growth and total revenue would be up 8%. On the expense side, we expect Q2 consolidated gross margins to be flat sequentially at approximately 83%, which includes the impact from our rapidly growing SaaS business. We believe that at current revenue levels, we are nearing the low point for consolidated gross margins, and we expect ongoing improvement as our SaaS business scales. We are closely managing expenses, balancing profitability, while investing in Metallic’s growth initiatives. We expect Q2 operating expenses to be roughly flat sequentially. At the midpoint of our revenue guidance, EBIT margins will approach 17%. Our projected share count for Q2 is approximately 46 million shares. Our transition to a sustainable and profitable recurring revenue model is well underway. Our team is focused on execution, and we're committed to driving responsible growth in the years ahead. I will now turn the call back to Sanjay for some closing remarks.

Sanjay Mirchandani, CEO

Thank you, Gary. Economic uncertainty is top of mind for you as investors, as well as for our customers, partners, and us as a management team. There are two important reasons that I’m confident we have a solid foundation and precedent to manage through this. First, we've been through this before. Commvault has been in business for 26 years, and we have survived and thrived throughout many different economic cycles. We're in a great position as a company, we're profitable, generate significant free cash flow, and have no debt on our balance sheet. Second, protecting data is not a luxury, especially in these times; customers and prospects need to continue focusing on best-in-class data management solutions. Just like the early days of the pandemic, protecting data and reducing costs of inefficient legacy and point solutions are top of mind for decision-makers. Against that backdrop, our team is focused on what we can control—our innovation and execution to seize the opportunity ahead and drive responsible growth as the world's leading cloud data management company. With that, we'll open up the questions.

Operator, Operator

And our first question comes from Aaron Rakers of Wells Fargo.

Aaron Rakers, Analyst

Yes, thanks for taking the questions. I guess I'll just start on just the macro concerns. It looks like your guidance was a little bit below the street expectations. So I'm curious about what you've seen from a demand shaping perspective through the course of this last quarter. And how much conservatism are you kind of baking into that current quarter guide given the macro? Have you seen any deal slippage, any kind of change in the deal pipeline, etc.?

Sanjay Mirchandani, CEO

Aaron, it is Sanjay, how are you? Cool. So I'd like to start by saying that right now we think data protection continues to be mission-critical. And we're in a healthy industry. What we control is the execution, and we're doing well; we just came off a record Q1. Our guidance reflects what we're seeing in the current macroeconomic environment. If you add to that, Q2 is seasonally a low point for the year. You're sort of seeing that in the range we gave you. A little more color: the Americas are strong, but we're closely monitoring Europe. Okay, and FX continues to be a headwind for us, just like any company with a large international presence. We can't control that. So on a constant currency basis, we're guiding Q2 to about 12% software growth and 8% total revenue growth. We think that's pretty good. Gary, anything do you want to add?

Gary Merrill, CFO

Noting Sanjay. Aaron, good to hear from you. A couple of quick things: in Q1, we executed very strongly in enterprise; if you look at the enterprise transactions, it was 75% of our revenue and up 24%. Pipelines going into Q2 are once again at those levels. So we're going to work on controlling the execution. We've adjusted a little bit for FX in the current FX with the euro and the pound now year-over-year down almost 15%. So we know what we have in front of us with the pipeline, and we're going to control the execution against that.

Aaron Rakers, Analyst

Yes, great points. Can you talk a little bit about Metallic? I mean, when I look at your other services growth, I think it was up 97% year-over-year in total. I think you saw north of 100% growth in the Americas in this last quarter. Is that to be taken as largely or entirely growth being driven by Metallic? Just any kind of incremental color you can add on that.

Gary Merrill, CFO

Aaron, I'll start a little bit on the financial piece, and Sanjay can maybe give you some business perspective on Metallic. The growth in the other services is actually driven by Metallic. Last quarter, we disclosed that milestone of $50 million of ARR, and we continue to build off of that. So in Q1, and even as we look into Q2 and the rest of the fiscal year, our growth in net of services will reflect that acceleration of Metallic for sure.

Sanjay Mirchandani, CEO

And I'll just add a little color on sort of picking up where we left off last quarter on Metallic in general. Our strategy is about the power of AND, giving customers the best software combined with the best SaaS. This is something that we keep an eye on; over 50%, roughly 50% of our customers that are Metallic customers also have another Commvault software product. About 30% of Metallic customers also have another Metallic service; there are more than one Metallic service. As we designed it, Metallic continues to be a customer acquisition engine for us. We think it continues to contribute meaningfully for customer flow, revenue, and ARR.

Operator, Operator

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

Eric Martinuzzi, Analyst

Yes, I wanted to dive into the services line a little bit. The implied guide there at $104 million. Given the growth of Metallic, I was expecting that to be kind of up sequentially. What's behind that guide there on the services?

Gary Merrill, CFO

Hey, Eric, this is Gary. I'll jump in. So Metallic’s acceleration we talked about; there's a couple more things in play in that other services revenue. First is current FX rates. Also reflecting what we see from the current FX rates, as about 40% to 50% of our business is denominated in both euros and pounds. Outside of FX, there are a few more things. One is, if you think about our professional services business, we brought pretty massive automation to that business and scale, especially for some of our cloud-enabled services, as well as investing in our channel ecosystem. That business is somewhat right-sized for all the automation initiatives we've driven. And then the third piece is the maintenance support perspective; that's roughly flat. That's our historical perpetual maintenance base, and that business, which is a great cash cow for us, is roughly flat to down as we also look to transition our installed base programmatically to our new subscription offerings to make it even more sticky and repeatable business model.

Sanjay Mirchandani, CEO

And we had a great quarter with that too.

Gary Merrill, CFO

Absolutely.

Eric Martinuzzi, Analyst

Okay, so did you, I mean, you gave three explanations there. Should I assume they're kind of stack ranked on the impact of the FX?

Gary Merrill, CFO

Eric, absolutely. FX is absolutely the biggest driver, and then the other two are about equal.

Eric Martinuzzi, Analyst

Got you. And then, as far as the outlook, are you seeing anything, is part of the outlook anticipating any change in your dependency on your hardware partners and their supply chain issues?

Gary Merrill, CFO

Eric, this is Gary again. From supply chain and hardware, that's pretty much behind us. We manage our business, and make sure that our pipeline coverage ratios can contemplate it, including how we run the business and how we inspect the business. Even as we think about Metallic, it's actually an acceleration for us, as when customers have concerns over supply chain, what we can do with hybrid cloud becomes a great momentum for our Metallic business.

Operator, Operator

And our next will come from Jason Ader of William Blair.

Jason Ader, Analyst

Yes, thank you. Hi, guys. I wanted to ask about the competitive landscape sort of across, let's call it the three major market segments: the high end where I know you run up against a lot of incumbents, the mid-range where I know there's a bunch of new players and then at the low end, seems to be kind of defaulting to managed service providers. So maybe just talk about each of those three segments, and maybe you segment the market differently than I did, but I would love to just get a general update on the competitive landscape.

Sanjay Mirchandani, CEO

Sure. It’s Sanjay. So for the high end, the enterprise, as Gary shared, we had record number of deals last quarter. We see continued traction in the enterprise; that's what we've always strong; our products are seen as extremely valuable and fit for that market segment. We’re seeing a lot more power of AND solutions going in customers that are touching fast alongside more mainstream data center on-premises solutions. So that market continues to be strong; we are taking share from incumbents every day, so that continues to be strong for us. The mid-market is something that we've done well in different parts of the world, like Europe; we do very well with the mid-market part of the US, we did great with the mid-market depending on the vertical, and our solutions - the power of AND solution is really working well there. There, it's almost built for that marketplace in the sense that customers start with a workload or two on-premise, ease their way into Office 365 or VMs in the cloud, and then suddenly they are using both. We're seeing a lot of that now in the mid-market, and it's really beginning to get traction in the mid-market. In the low end, where we weren't historically strong, we're seeing a lot of customer acquisition through Metallic. The relationships with MSPs, the partnerships that we've announced, are all causing us to get a lot of good traction in a market where we were not historically strong. Across the board, we're seeing good traction; the strategy's working; it's different in different segments as to how they absorb the solution. Overall, our market share is up. We think we're doing great.

Jason Ader, Analyst

Excellent. And then just a quick follow-up on the macro commentary. Are your—when you talk about watching Europe, it sounds like North America hasn't changed much. But are you getting a sense from customers in Europe that they might potentially hit the pause button on certain things? Or what specifically are you hearing from customers in your conversations that maybe gives you a little more caution there? Or is it just kind of generic, let's be more prudent because of all of the headlines that we see in Europe?

Sanjay Mirchandani, CEO

I think, what we saw were changes in buying behavior towards the latter part of last quarter. So we're taking a conservative viewpoint going into this quarter. We saw more scrutiny around budgets, for sure, slower purchasing decisions, which led to in some cases longer sales cycles and time to close. The guidance we've given incorporates that because we're seeing the US continue to be strong. Outside of what I just shared, Europe used to be a strong market for us, so we're just keeping an eye on.

Gary Merrill, CFO

One thing I'll add is, what we're seeing, though, is, as Sanjay mentioned some of that scrutiny—we're not seeing the pipeline go away; actually, the pipeline continues to be very strong for us. It’s just making sure that we're being prudent around flow rates.

Jason Ader, Analyst

Got you. Regarding the European customers, do you think they just need a bit more time? What's your perspective on the expected close rates for the upcoming quarters?

Sanjay Mirchandani, CEO

Just to give you, we're not breaking out Europe, but we are saying international, which includes Asia, software revenue last quarter was up 15%. In constant currency, up 20%. Total revenue was roughly 16% up in constant currency, so Europe had a good quarter. We're just saying towards the end of last quarter we saw a little bit of a slowdown in decision-making, not the pipeline as Gary indicated. So we're just taking a more conservative approach on how we're probably thinking through the numbers, but the business is strong. Data protection is top of mind, and we are part of a lot of high-end proof of concepts. So you're lining new customers. We're just taking a conservative viewpoint on what we don't control.

Operator, Operator

And I'm showing no further questions. This concludes today's call. Thank you for your participation. You may now disconnect.