Commvault Systems, Inc. (CVLT) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Commvault Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I’d now like to introduce your host for today’s conference Mr. Michael Picariello. Sir, you may begin.

Good morning. Thanks for dialing in today for our second quarter 2018 earnings call. With me on the call are Bob Hammer, Chairman, President and Chief Executive Officer; Al Bunte, Chief Operating Officer; and Brian Carolan, Chief Financial Officer. Before we begin, I’d like to remind everyone that statements made during this call, including in the question-and-answer session at the end of the call, may include forward-looking statements, including statements regarding financial projections and future performance. All 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 in our most recent quarterly report in Form 10-Q, and in our other SEC filings and in the cautionary statement contained in our press release and on our Web site. The Company undertakes no responsibility to update the information in this conference call under any circumstance. In addition, the development and timing of any product release, as well as any of its features or functionality, remain at our sole discretion. Our earnings press release was issued over the last wire services earlier today and has also been furnished to the SEC as an 8-K filing. The press release is also available on our Investor Relations Web site. On this conference call, we will provide non-GAAP financial results. As a reminder, we adopted the new revenue standard in the first quarter, results in growth rates in Brian's remarks and on a comparable basis as prior periods we're just using the new rules. Please note that as we stated on the fourth quarter call, Commvault adopted the new revenue standard ASC 606 in April 1, 2017. Our adoption was done on a retrospective basis over prior periods and our financial statements have been adjusted to compile with the new rules. As a result, the results in growth percentages we will discuss today are on a comparable basis. A reconciliation between the non-GAAP and GAAP measures can be found on Table IV accompanying the press release and posted on our Web site. This conference call is being recorded for replay and is being webcast. An archive of today’s webcast will be available on our Web site following the call. I'll now turn the call over to our CEO and President, Bob Hammer.

Thanks, Michael, and good morning, everyone, and thanks for joining our fiscal second quarter FY18 earnings call. I will just start by saying that I am disappointed with our Q2 financial results. Simply put, there were a number of six and seven figure software deals, which we were unable to close that were being forecasted right up until the last several days of the quarter. We believe many of these deals will close in Q3 and the majority by the end of Q4. In fact, some have already closed. The Q2 results are tied to poor sales execution on large deals primarily in the Americas. Our Q2 results were in stark contrast to the excellent progress we made last quarter on key strategic initiatives that have both -- have potential to both accelerate growth and reduce quarterly vulnerability to large deals. This includes the launch of our Commvault HyperScale software combined with a new resell agreement with Cisco for the enterprise and our Commvault HyperScale Appliance. Let me briefly summarize our Q2 year-over-year financial results. Software revenues were up 2%. Total revenues were up 5%, EBIT margin was 9.3%, EPS was $0.21 per share. Our second quarter was adversely impacted by lower than expected close rates on large enterprise deals, particularly in the Americas. As we have discussed for many quarters, we're currently reliant upon a steady inflow of large six and seven figure deals which come with additional risks due to their complexity and timing. The low close rate was specific with no consistent theme and importantly was not due to an increasing competitive losses. We have specific action items that are already underway to address the execution issues that occurred in fiscal Q2. On the positive side, we saw good growth in EMEA, continued strength in our cloud business, and relaunched our Commvault HyperScale-out storage software with several marquee wins. Services revenue also performed better than expected and we started -- as we stated in the past, we believe, that we are well-positioned for accelerating year-over-year services growth in the second half of FY18. I'm also pleased with the excellent progress we made on a number of key strategic initiatives, which open-up significant market and distribution opportunities both in the enterprise and midmarket. Particularly on the Commvault Appliance we expect to be able to make the first shipments in early November and key channel partners are lined up to support this initiative. And completion of a major reseller agreement with Cisco, which was announced earlier this morning. Cisco will be reselling Commvault HyperScale combined with Cisco UCS hardware under the scale protect with Cisco UCS solution name. These strategic initiatives are aimed at providing distribution leverage in the enterprise with Cisco and with the midmarket with the Commvault Appliance through our channel partners. We believe that will start to positively impact our financial results in the fourth quarter of FY18, and provide a foundation for FY -- fiscal 2019 growth. I will elaborate on these and other new offerings later on in the call. We have strong third-party validation of Commvault's technology leadership position from two of the industry's leading analysts Gartner and Forrester. In August, Gartner positioned Commvault in the Leaders quadrant in the recently released Magic Quadrant for Data Center Backup and Recovery Solutions. Among the Leaders, Gartner positioned Commvault furthest on the completeness of vision. This is the seventh consecutive year Commvault has been named a leader in Gartner's market evaluation for backup and recovery. In September, Forrester positioned Commvault as a Leader in the Forrester Wave Data Resiliency Solutions. Both complete reports can be found on our Web site. I will now address our current FY18 financial outlook. We believe the current Q3 and Q4 FY18 Street consensus for total revenue is reasonable. This would imply total FY18 revenues approaching $708 million or 10% year-over-year growth. We also believe our newer solutions and enhancements should begin to positively impact revenues in the third quarter. We expect full-year software growth to be in the low double-digit percentage range and full year services revenue growth to be in the high single digits. Brian will provide more details later in the call. We are allocating existing resources to take full advantage of our Commvault HyperScale and Appliances and to support our expanding partner opportunities with Cisco, Microsoft, and key channel partners. We believe that the allocation of resources tied to the Appliance and key partnerships, including Cisco and Microsoft, will help drive improved pipeline development and ultimately lead to overall productivity and top line revenue growth. However, in the near-term this will limit our FY18 EBIT margin expansion. Given our Q2 results and the need to continue to prudently invest, we now believe FY18 margins will expand 25 to 50 basis points. While the strategic fundamentals are strong and our opportunity to success have improved, we still face critical challenges. Our ability to achieve our growth objectives in the near-term is dependent on a steady flow of -- and good close rates because rates of large enterprise $500,000 to $1 million plus deals. These deals have quarterly revenue and earnings risk due to their complexity and timing. Large deal closure rates remain lumpy as occurred in Q2. We're bringing to market many new products, new services, new powerful and simplified user interfaces. These all come with price -- new pricing models. 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 have implied execution risk. We continue to be in an opportunity rich situation in the market. However, in order to achieve our FY18 earnings objectives, we need to prudently invest without jeopardizing our ability to achieve our software growth objectives, a more balanced go to market objectives, and our critical technology innovation objectives. Our growth for the remaining of FY18 is primarily based on success with the Commvault data platform to gain share in large enterprise accounts with the journey to the cloud and solutions to mitigate and recover from a cyber attack. The release number two and the release of a significant amount of new products and services which will begin to have an impact in Q3, and two, the potential for improved distribution leverage with strategic channel and service provider partners. Bottom-line, there a lots of moving parts to our game plan. We expect to have a much better second half of FY18 and solidify the foundation for FY18 and beyond. In summary, our Q2 results were in stark contrast to the excellent progress we made last quarter on key strategic initiatives that have high potential to both accelerate growth and reduce quarterly vulnerability to large deals. Specifically, the strategic initiatives that we launched in Q2 and in Q3 are designed to provide much more distribution leverage, easier to sell solutions for our sales force and channel, as well as provide for a stronger midmarket revenue stream to compliment our enterprise revenues. These initiatives also strengthen both our ability to penetrate large enterprises and accelerate growth in the midmarket which can minimize quarterly risk. As a result, we believe our ability to accelerate license revenue growth has fundamentally improved. Additionally, our ability to improve overall growth and increase operating margins is now aided by accelerating growth and maintenance revenues. Our objective now is to validate all this with much better financial performance in the second half of this fiscal year and solidify the foundation for FY19. I will now turn the call over to Brian.

Thanks, Bob, and good morning, everyone. I will now cover some financial highlights for the second quarter of fiscal 2018. Q2 total revenues were $168 million, representing an increase of 5% over the prior year period and 1% sequentially. We reported software revenue of $72 million, which increased 2% year-over-year and down 4% sequentially. Revenue from enterprise deals, which we define as deals over $100,000 in software revenue in a given quarter, represented 59% of software revenue. Revenue from these transactions was up 3% year-over-year. Our average enterprise deal size increased 10% year-over-year to approximately $287,000 during the quarter. This increase in ASP was offset by a 6% decline in the number of deals. From a geographic perspective, Americas, EMEA, and APAC represented 57%, 29%, and 14% of software revenue respectively for the quarter. On a year-over-year growth basis, EMEA and APAC were up 23% and 10%, respectively, while Americas was down 7%. The revenue mix for the quarter was split 43% software and 57% services. Total services revenue for Q2 was approximately $96.1 million, an increase of 8% year-over-year and 5% sequentially. The growth in total services revenue was primarily driven by 9% year-over-year increase in maintenance revenue driven by strong renewal rates. As a reminder, maintenance revenue consists of customer support and software updates that has historically represented approximately 85% to 90% of our total services revenue. Moving on to our pricing models. During the quarter, approximately 59% of software license revenue was sold on a traditional per terabyte capacity basis. This is down from 72% in Q2 '17 and up from 66% in Q1 '18. We anticipate that sales of our traditional capacity based licenses will continue to decline as software license revenue shifts to standalone solution sets in our platform pricing model. Our subscription based pricing models introduced in FY18 continue to gain traction and resonate with customers. As we noted during our July call, when the dollar volume of these deals becomes more significant, we will provide more metrics around subscriptions. Now moving on to gross margins, operating expenses, and EBIT margin. Gross margins were 86.6% for the quarter. Total operating expenses were approximately $127.6 million for the quarter, up approximately 8% year-over-year. We added 63 net employees in fiscal Q2 ending the quarter with 2,796 employees. Operating margins were 9.3% for the quarter, resulting in operating income or EBIT of approximately $15.6 million. Net income for the quarter was $10 million and EPS was $0.21 based on a diluted weighted average share count of approximately 48.2 million shares. Let me now touch on our outlook for the remainder of FY18. As Bob stated, we believe the FY18 street consensus for Q3 and Q4 total revenue is reasonable. This would imply total FY18 revenues approaching $708 million or 10% year-over-year growth. Our expectation is to deliver year-over-year software growth in the high single digits in Q3 and mid-teens in Q4. Services revenue growth is expected to continue to grow sequentially with year-over-year growth accelerating in Q3 and Q4. As a result of the revenue growth in the second half, we expect Q3 EBIT margin to be approximately 13% and Q4 EBIT margin to be approximately 15%, resulting in full-year margin expansion of approximately 25 to 50 basis points. Let me now briefly comment on tax rate and share count. We will continue to use a non-GAAP tax rate of 37% for FY18, which approximates our anticipated longer-term tax rate. We are closely following potential tax reform and we'll make any adjustments necessary should any legislation be passed. We anticipate that our diluted weighted average share count for FY18 will be approximately 48 million to 49 million shares. Please note that certain senior executives have approximately 300,000 outstanding stock options that will reach the end of their 10 year lives and will therefore expire in the next six months. We expect that all of these stock options will be exercised prior to their expiration. Now moving on to our balance sheet and cash flows. As of September 30, our cash and short-term investments balance was approximately $495 million, of which approximately 40% is located outside the U.S. During Q2 '18, we repurchased approximately $11.3 million or approximately 192,000 shares of our common stock at an average cost of $58.64 per share. We currently have approximately $114 million remaining under our share repurchase program that will expire on March 31, 2018 unless we extend it as we have in the past. Free cash flow which we define as cash flow from operations less capital expenditures was approximately $8.5 million, which was down 56% year-over-year. We continue to expect full-year FY18 free cash flow to exceed non-GAAP EBIT as it has in the prior three fiscal years. As of September 30, 2017, our deferred revenue balance was approximately $296 million, which is an increase of 16% over the prior year period and 1% sequentially. All of our deferred revenue is services revenue not software revenue. For the remainder of FY18, we expect sequential deferred revenue growth to increase in the mid single-digit percentage range. As a result, at the end of FY18, we expect year-over-year deferred revenue growth to be in the low double digits. For the quarter, our days sales outstanding or DSO was 72 days, which is up from 66 days from the prior year. At September 30, our receivables balance includes approximately $6.3 million of unbilled receivables. We've included the unbilled receivables balance in our DSO calculation. The vast majority of the unbilled receivables will be invoiced in the next 12 months. As noted on our prior earnings calls, in certain situations, we are required under the new revenue rules, to recognize revenue in advance of invoicing our customer. As a reminder, while it is our goal to align revenue and cash flow by collecting cash upfront this may not be practical or in our best interests in all cases. If we determine, it is prudent for a customer or partner to pay for their commitment over time, it will result in an unbilled receivable on our balance sheet. Please note that the unbilled receivable balance will likely grow over time and will impact DSO. I will now turn the call back over to Bob. Bob?

Thank you, Brian. I’d like to spend a few minutes reiterating our strategy and providing some details on a record number of new product and service innovations which we have already launched and will be launching for the balance of this fiscal year. The major elements of our strategy are to build upon our continued success with helping customers on their journey to the cloud, both public and private. Increase share in our data management business in both the enterprise and midmarket, with expanded and broaden solutions and use cases including our Commvault HyperScale-out of secondary storage for the enterprise and our Commvault HyperScale Appliance for the midmarket. And lastly regarding to cyber threat -- cyber threat mitigation and high volume recovery and assuming a company that hit with a critical cyber attack; expand to outcomes based services and SaaS, and lastly, open-up significant market opportunities with analytic based solutions. I'll now provide you some details on the new product alliances and services offerings that have been released in Q2 and Q3, all of the release this fiscal year, which will help drive increased business momentum. These include: the Commvault HyperScale technology, including the Commvault HyperScale Appliance, our new alliance with Cisco and enhancements to our Commvault data platform. Let me first start with the Commvault HyperScale technology. Commvault HyperScale technology is a set of tailored offerings providing scale-out software defined storage services to customers from the midmarket to the largest enterprises. Commvault's HyperScale technology solutions bring scale-out infrastructure to Commvault data platform and seamlessly integrate with storage arrays, hypervisors, applications and the full range of cloud provider solutions to support the most diverse and dynamic environments. Customers can consume Commvault HyperScale technology in one of two ways. In the -- with the Commvault HyperScale Appliance and with Commvault HyperScale software. Commvault's HyperScale software enables organizations to choose hardware configuration sizes and models from leading technology companies, including these initial program participants, Fujitsu, Cisco, Lenovo, HPE, Super Micro Computer, Huawei, and Dell EMC. Through the consumption of Commvault HyperScale software, customers receive validated designs complemented by best practice configurations. This simplified approach helps enterprises manage hardware configurations and capacity to their secondary storage needs, while accelerating ROI, reducing complexity and adding greater customer value. Commvault HyperScale software meets the needs of large enterprises or looking to move away from legacy infrastructures and integrate public cloud like technologies to modernize their on-premise data centers. They're also looking to transform their internal IT infrastructure and operations to mimic the agility, elasticity, scale and operating economics of the cloud. They want their solutions to lower cost, make it easier to manage and are going to be in the integrator of hardware and software. In support of true hybrid IT environments, Commvault HyperScale technology is uniquely positioned in the market to protect and securely move workloads across any type of infrastructure including public cloud, private cloud. and on-premise. The Commvault HyperScale technology leverages a built-in operating environment, virtualization, and storage technologies from Red Hat to provide a robust enterprise grade foundation. In relation to any competitive offering, this solution has lower cost, higher functionality, security and scalability, built for hybrid IT and cloud environments and includes industry-leading Commvault data platform for data protection and data management solutions. This makes our solutions simple and powerful. It also makes them easier for us to sell and distribute. Now let me discuss our new alliance with Cisco, which was publicly announced earlier this morning. We recently entered into a formal alliance with Cisco that allows them to resell Commvault's software. Today's announcement with Cisco is the first strategic partnership move on to the Commvault HyperScale software reference architecture program combining Commvault data protection software and Cisco hardware is a unique offering, is on the Cisco pricelist and available through Cisco sales teams and extensive Cisco channel network. The solution is uniquely branded as Scale Protect with Cisco UCS. I expect more of these unique offerings from our hardware partners to come. The Commvault HyperScale Appliance is a new offering from Commvault, which was publicly announced on October 17. The Appliance offers customers an all-in-one Commvault HyperScale solution for data protection with secondary storage. Our Appliance is fully integrated software -- is a fully integrated software and hardware device that is easy to deploy, manage, and reduces the integration burden. The target market for the HyperScale Appliance is in the midmarket less than a 100 terabytes of backend storage and sold primarily through the resale of channel. The Commvault HyperScale Appliance includes Commvault data platform software as the data protection foundation and enables customers to add other modules as their needs expand. This modularity enables customers to take full advantage of additional Commvault features available now and in the future through simple license key upgrades. We believe that the Commvault HyperScale Appliance will be a disruptive technology in the midmarket and will also serve as an entry point to larger scale enterprises. I’d also like to discuss the progress we've made with our Commvault data platform in general and to other new products and services offerings that have either been released or will be released in FY18, including the Commvault data platform enhancements. We continue to focus on our cloud data management solutions. Over the last several quarters we have introduced a significant number of enhancements to the Commvault data platform to ensure our lead in cloud data management and protection. Specifically, customers are demanding holistic and consolidated data protection across their public cloud, SaaS, private cloud and traditional legacy environments. This requires our Commvault data platform to provide seamless, easy management of data to a high degree of automation and orchestration of all the different copies of data in those environments. In addition, our Commvault data platform has been greatly enhanced over the last several quarters to deal much more effectively against cyber attacks, ransomware -- like ransomware and to help companies comply with new regulations on the data such as the EU's new GDPR or General Data Protection Regulations. Please note the development and timing of any product release, as well as any of its features or functionality remain at our sole discretion. Before I close, I want to remind everyone about our annual Commvault GO Conference. In addition to our HyperScale technology, we're planning other key product announcements in the second half of FY18. We will highlight these in our ecosystem partnerships at our annual Commvault GO Conference, which is scheduled November 6 through 8 at the Gaylord National Harbor Hotel & Convention Center in Washington DC. Customer registrations and committed partnerships have been very strong. Information about Commvault GO can be found on our Web site. In closing, our Q2 results were in stark contrast to the excellent progress we made last quarter on key strategic initiatives that have high potential to both accelerate growth and mitigate quarterly vulnerability to large deals. Specifically, the strategic initiatives that we launched in Q2 and in Q3 are designed to strengthen our competitive position, open-up new market opportunities, and significantly improved distribution leverage. The new solutions we have launched are easier for our sales force, channel and strategic partners to sell. Importantly, they will enable our channel partners to provide a stronger midmarket revenue stream to compliment our enterprise revenues. As a result, we believe our ability to accelerate license revenue growth through our sales force -- through sales force productivity has fundamentally improved. Additionally, our ability to improve overall growth and increase operating margins is now aided by accelerating growth in maintenance revenues. Our objective now is to validate all this with much better financial performance in the second half of this fiscal year and solidify the foundation for FY19. We believe the company is in the strongest strategic and competitive position in our history. I will now turn the call back over to Michael. Michael?

Thanks, Bob. . Operator, can we please open the line for questions?

[Operator Instructions] Our first question comes from Joel Fishbein with BTIG. Your line is now open.

Good morning, gentlemen. I just have a couple of quick ones. First is how much of the push out do you think Bob was related to the new product cycle? Obviously, you have a lot of new announcements today and wanted to know what you thought about if there was some pause in front of those purchases?

I don't think there was a pause due to the product cycle. There was some confusion in the market as we move to these new pricing models that that may have delayed some deals out there, but I don’t think it was due to the massive amount of new product we're launching right there.

Okay. Second follow-up then is that you mentioned on the call that you didn't think it was related to the competition. Number one, what gives you confidence to the -- that it wasn't competitive issues. And number two is, what -- you talked about you're doing some -- taking some steps to fix the execution issues. Can you give us a little bit more color on what you're doing?

So, we’ve gone through everyone in the accounts that pushed. And the vast, vast majority have nothing to do with competition. I mean nothing to do with competition. I would -- we have a technical win, which is working through the process or companies get -- getting tangled up in our new pricing. And again the vast majority of all those accounts that pushed should close by the end of the fiscal year and many of them will close in Q3 this current quarter. Regard to sales execution, the misses were isolated to both misquote a few key reasons in the Americas and one in the region in APAC. Many of the Americas teams hit their numbers, so this is isolated execution. Strategically, clearly all of the things we did this quarter -- the launches we’ve been working on for the last couple of years were designed to mitigate something like this, because we're always big deal dependent and we’re trying to get -- reduce our dependency on that. Even though that will remain our bread-and-butter, we're big enterprise company, but we wanted to get a lot more balance in the midmarket through distribution and give that -- give those channel partner something that was extremely compelling and market-leading and easy to sell, which we are doing. And we wanted to find ways to provide better distribution leverage in the enterprise with key strategic partners like Cisco. So, in summary, Joel, these one are competitive issues, but they’re related to many of the move that we're making to strengthen the company. And two, moves we're making to strengthen some of our, I call it weaknesses in the market, mainly related to distribution leverage. So the disappointing thing about all this is that we just nailed our strategic initiatives and stumbles at the last few days for the quarter, which is extremely disappointing to me.

Okay. Thank you very much.

[Operator Instructions] Our next question comes from Abhey Lamba with Mizuho Securities. Your line is now open.

Yes, thank you. Bob, thanks for giving some additional color on those deals that didn’t close. Can you give us a little more color on any thematic stuff that you are seeing, any changes in the market versus last quarter or do you still have high degree of confidence in your strategy that you’ve put in place for the rest of the year?

I don’t see any of the deals that we missed. There is no theme. It's -- this guidance sign off, it got stuck here. There was more discussion required there. There was no theme or rhyme in the deals that pushed. I think the only theme Abhey is that we're dependent on these large deals and there is risk to that, and that -- when you are here for the roadshows, that's why we have really broadened our strategy to -- want to accelerate growth, but mitigate the risk tied to these kind of things in the future. So, the disappointment on the quarter was that we -- our product teams, our channel teams, our partner teams did an awesome job in getting these products to market. And the other surprising thing is the fast take up we're seeing on HyperScale. I mean we won a lot of, what I call, major marquee customers and there is a massive funnel on that going forward. So that's all encouraging and then we stumble and we miss the quarter, which is disappointing to all of us. So, strategically I feel that better than I did when you guys were here, because these products are now on to the market and were in motion now, but that doesn't take away from the fact that we miss the quarter.

Got it. And a quick follow-up on that. What are you assuming for [multiple speakers].

Abhey, Al is going to comment for you.

Oh, I’m sorry.

Yes. Just a follow-up on Bob's comments. Again strategically we feel really good, but what we saw that’s new I think in the quarter is, one, the so-called boomerang effect. We're doing extremely well in cloud driven deals, multi cloud environments and now you have the so-called boomerang effect, which is bringing cloud technology and capabilities back on-prem. So that obviously with our HyperScale environment we're extremely well-positioned. Point one. Point two is the changing nature of disasters. Those are now becoming cyber attack. They’re malicious. They come without warning and they come across an entire organization versus just a geographical data center. We're working with several of our large customers in providing new capabilities and new functions and new readiness measures there and those two things or a couple of things that I would add to what's going on in the market, Abhey.

Yes, those are really good points, Al. yes, thanks.

Yes, thank you. Just a quick follow-up on the close rate assumptions for Q3 and Q4 to get to the fiscal '18 guidance and that’s it for me.

On Q3, Abhey, we still need really good close rates on our large deals. When you get to Q4, those close -- we don’t need as -- we will have mitigated that somewhat and maybe a lot. Let's see how we do with the launch of these new products. Let me be clear to everybody, we still need good solid close rates in Q3. We have a big funnel of large deals, but we need to close them.

Okay. Thank you.

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

Yes, thank you. I guess first, Bob, on the Appliance with the deal you have with Cisco that was announced which looks pretty interesting. What type of impact should we expect from that particular product, I guess, relative to the Commvault branded Appliance? And then, how do you manage sort of potential channel conflict there when you have Commvault partners that are now competing against Cisco channels for the same product?

Well, they’re not competing. The Appliance is a midmarket product. It's less than a 100 terabytes. Cisco's enterprise, they are apples and oranges, so the big enterprise installations with Cisco's UCS or enterprise deals, so if anything our Appliance can be used as a -- to actually accelerate the Cisco deals, because the customer want to use the appliance for a POC and actually deploy Commvault HyperScale with Cisco UCS and the ScaleProtect product. And we’ve seen that already. I mean, we're seeing some evidence of that already. So, I don’t see any channel conflict at all there. And by the way, Jason, good call. I mean, you did a good job on your channel check, so …

Thank you.

Unfortunately, you called it right, right?

Yes. Well, I mean, I think you guys clearly with the Appliance, so I think the game plan to try to mitigate the volatility around large deals, makes a lot of sense and I can tell your frustration and I know you’re working hard to try to change that reality and good luck to you guys as you go forward. Do you think that the Cisco appliance will be a bigger contributor to the business than the HyperScale branded, with a Commvault branded Appliance over time?

I think in large enterprises, HyperScale will dominate. But there are lots of use cases where there it's remote offices or there are certain use cases where customers want that simple appliance -- the Commvault and they just want to plug it in and use it, so they both complement each other over the long run. The big HyperScale enterprise probably will outweigh the appliance, but they are both very high potential new products. I mean, from a Commvault standpoint in all the things we've done, since we -- we’ve been running the company, these launches are -- have the -- I will leave it this way, have the highest potential to change the game of anything we've done in recent memory. So -- and that in combination with all the things we're doing with the cloud and as Al mentioned this issue on cyber is becoming a priority one topic for many enterprises, and we’ve helped a number of enterprises dig out from under the cyber attack. So, the enterprises know how good we are with our platform in terms of both mitigating and recovering from the cyber attacks. So those combinations of things are quite powerful and I am confident that will put us on a really good solid growth and improved sales productivity and earnings stream. It's -- so what really [ph] key here is we have aggressive plans, we would like to hit our numbers and be a lot more consistent in delivering them and not have an issue like we have this quarter and not miss in a number.

And one quick follow-up, Al, one quick follow-up for you. Bob talked about cloud managed data. Where do you think your customers are in the market is right now when it comes to sort of understanding this idea of separation of church and state with cloud managed data to have basically not to -- not rely on the cloud provider to protect the data?

I think, particularly …

The first thing is are we in the first-inning or is it -- are we further along?

No, we are in a World Series. It's -- I think with enterprises that's becoming very clear. I think with SaaS and some of those type applications, it's probably second or third inning. But working even with our partners like Microsoft and AWS etcetera, there's a clear recognition that you need data protection at a robust level, if you will, beyond just a simple toolset, that’s kind of point one, Jason. Point two is, the number of enterprises are coming here that have not just a cloud solution, but a pile of point level solutions is amazing and almost everyone is realizing that is not sustainable. You can't keep throwing native toolsets in a little bit more infrastructure at this broad holistic issue. And so I think that's to your point it's probably second and third inning, but the awareness is picking up dramatically, particularly, with enterprise accounts.

Yes, and it's pretty well validated with our partnership with Microsoft. I mean, they've proven to be a really good partner that they know where their expertise is, I know where it isn't and they are working really closely with us in a very programmatic way for their big accounts to make sure that those accounts are well protected -- its generally well protected in terms of loss of data, but well protected in the case of a disaster. So, those partnerships are expanding. And the next wave of those, that's going to come in that we can be really clear about is analytics. Our platform provides an outstanding foundation for business analytics and we are working with a number of key partners in that regard as well, as we had machine learning and enhancers capabilities to the platform which we will talk about at GO.

And our next question comes from John DiFucci with Jefferies. Your line is now open.

Thank you. Bob, you said on the last call that some of the large incumbents were doing unnatural things with very large deals in regards to pricing, which we heard may even be described is irrational. This quarter your commentary is more around your own sales execution, but have these incumbent competitors maintain the pricing practices of last quarter? And if they have, what, if anything, can you do about that?

Well, they have, but when you look at the accounts that we've missed, nothing had -- none of those deals that slips had anything to do with that. So, I mean, I’m serious. I mean the -- we do see that behavior, but that wasn’t a cause for our quarterly slip. And yes, I mean, free is not free. I mean, if somebody says I’m going to give you this for free, at the end of the day there's a cost for free. So, one comment on free is, okay, you get that stuff for free and let us manage the data on top of it, because the data management piece in the cloud portability and the DR and the ability to deal with cyber, those solutions are pretty weak. So we've been dealing with free from, for example, from Dell EMC and from EMC in particular for 15 years. So -- but that is -- 0if you want to say and what’s their key play is, is the bundle and use that leverage.

Bundle and discount.

Yes, bundle and discount. Is that an issue? Yes. Do we have to deal with it? Yes. But we're not in a different world. As long as we articulate our value prop at the end of the day, we can say our customers money versus that solution. If we're not in there and we are not really clear on what our value prop is, then somebody like that’s going to win. The other issues out there, I will call it are relatively insignificant, so -- and we can deal with them. So, I mean, that is not the major issue that’s -- it's in these more in terms of getting Commvault more balanced in the things we just talked about in terms of distribution leverage and building a -- kind of a more balanced revenue stream between enterprise and midmarket to mitigate something like occurred this far.

Okay. And if I might follow to that then, I think we continue to hear accolades about your technology and products, and not just from the independent research firms that you note in your press release, but also through field discussions. So if that's all going really well which it seems to for us and you talk about it as if it is, I believe you said, you’ve already put things in place to improve the sales execution. But other than strategic initiatives, it's unclear to me what you've done like -- okay, you have things in place now strategic initiatives, more partnerships things like that are good, but it sounds like you think there were some execution issues.

Yes, beyond that …

I mean, where there any changes to [multiple speakers].

… lot of changes, but I’m just being I don’t know how more blunt I can be is, yes, we have the best technology, we have the best services and we have the best support. But the sales team doesn’t get in there and articulate that and understand what our new pricing is, they’re going to screw up. And what’s really disappointing is that we restructured the American sales force, in particular, the U.S sales force and generally they’ve been good in execution and many of the U.S teams did really well last quarter. Some teams did not and its pure execution, but my point is if you’re depending on outstanding execution quarter-on-quarter, you’re vulnerable to miss someone and we haven't -- we had six quarters in a row and we did it through good execution in large deals and this quarter we had a few regions in the Americas that really dropped the ball. I don’t know how clear I could say it and the things we’re doing is to help these teams and make it easier for them so that to -- through distribution to get more leverage and make it easier to get into these accounts we have a bigger funnel and you become more strategic. But when you start adding the ability to -- where the basic foundation for secondary storage and you’re putting a data platform on there and you’re providing the agility and management of the cloud and you’re giving ability to mitigate and recover from a cyber attack, those are all big things. So it's just you’re making it easier for our teams and distributors to get the story out. So, I don’t know how else I can say it. They screwed up. End of story.

Our next question comes from Alex Kurtz with KeyBanc Capital Markets. Your line is now open.

Hey, guys. So just looking forward here into the second half, Bob, why not take the consensus number down here? Why -- what put it on the quarter depending on large deals again create that risk again going into Q3? Why not just kind of reset here. So what was your thinking around that?

It's -- the thinking was that we’ve got a pretty robust big deal funnel. Internally we did take it down quite a bit, because it's offset by significant increases in services revenue. So relative to our internal plans we did take it down and -- but to your point is the risk zero, no, it's not zero, it's still large deal dependent. I mean, when you’re dealing with deals that are in the multimillions, which we’re talking about or million dollar deals are and a lot of $500,000 deals, it mean we're dealing with the same issue to a slightly less degree in Q3, because we just have a bigger funnel of these deals going in, some of them because of what happened in the last quarter and they slipped and we’re going to close them this quarter. And we've got at the margin -- I would say at the margin, we've got some risk reduction due to the fact that we're -- we will start shipping appliances here in a couple weeks and we know we've got some momentum on the HyperScale, because it’s in the funnel and we’re closing deals that’s helping us in the large enterprise. So, we -- that the revenues are flat, but we took down our operating margins because we're investing to make sure that we -- get these product launched and take advantage of the opportunities we have in front of us here. So, understand the point. I mean, it's a fair point.

And just last question here, historically you guys give a full-year kind of view on the consensus estimate, and then we kind of work through that during the year. In considering that these large deals aren't going away which is -- I mean, you’re solving strategic problems for large customers, so I think we all understand that why not move to a model where you really kind of manage the consensus to a point where you especially going into fiscal '19 where there's just limited risk or you’re just looking at high single-digit license growth and really just exclude a higher portion of the large deals versus what you guys have done historically.

Well, with the Appliance it gives us that luxury of will once we get it going. It is -- look we've had six quarters since we turned and we didn’t miss a number. Just hit it. And this quarter looked really good until four days before the end of the quarter, we just fell off [indiscernible] when we talk about dropping the ball and some of this was pricing confusion. Guys just pitching too many given the customers too many alternatives, they’re trying to figure out and it confused some customers. So that is an element. That’s the only element and it was just an element. So, I understand your point and before we -- we understand this before we had our issue a number of years ago, which is different than this. We had 20 some -- 26, 28 quarters that we didn’t miss. So we understand what we're trying to do here and that we like to get on a track as to your point as we go into FY19 where we really mitigated those risks and I think we have an opportunity to do that now.

Thank you.

Our next question comes from Greg McDowell with JMP Securities. Your line is now open.

Great. Thank you very much. I want to focus specifically on the change in the margin expectation, because as previously mentioned you’re largely expecting the same revenue as you were three months ago, and yet you’re now expecting only 25 to 50 bps in operating margin expansion and in July you were talking about 170 basis points in operating margin expansion. So I was just hoping you could expand on what exactly has changed from expense structure standpoint versus three months ago? Thanks.

Nothing has changed from the expense structure standpoint. In fact, we’ve actually mitigated and reduced it. What’s fundamentally changed is that our internal projections and higher license revenues attached to it and after the miss, it put us in a different situation. So that's the fundamental issue. It's relative to our internal plan which by the way was geared and focused all these new product launches. So we put all that structure in place for the HyperScale and the Appliance and the cyber and all these other things we're doing. And we dropped the ball in Q2, but that structure is there as we launch these products in Q3 and Q4. If you want to net it out, that is the reason. And Brian can give you some other color.

No, I think that's spot on, Bob. With respect to our investment philosophy is that we're targeting numbers internally that were higher and it didn't come to fruition in Q2. But we will continue to prudently invest in the second half and hopefully achieve these objectives.

Great. Thanks.

And by the way that investment is really critical for FY19. And when you just can't not take advantage of couple of years of work here with big market opportunities that have both sales productivity, total revenue growth acceleration and concurrently operating margin expansion. So, that’s our game plan.

Our next question comes from Andrew Nowinski with Piper Jaffray. Your line is now open.

Thanks. So in the past when you had some of these sales execution issues, you had increasing levels of attrition and also declines in the sales productivity. So can you just give us an update on your attrition levels, and also where you’re at with regard to sales capacity or sales productivity within the U.S?

So our attrition is near all-time low, meaning our attrition rates are low. And what happened last time is as you know we were off a product cycle and we had significant change in the competitive landscape. We're on the other side of that curve now. We’ve given our sales teams a whole new number of ways to accelerate their growth and hit their numbers. So we’ve got the capacity in the field today. Now we have moved some of that capacity to align with the Cisco partnership to align with our channel partners on the Appliance and to align with an expanding partnership with Microsoft. So it's a very different situation, but -- last time we had to reorganize the U.S sales force and do a whole new product refresh etcetera. So, now we're -- those things are basically in our hand. Concurrent with that, clearly there are some areas in the U.S that are not executing and we’re focused on those to make sure that selectively those teams achieve what they need to achieve.

Okay, thanks. And then, I know you said there is no increase in competitive losses in the large deals that pushed, but you also cited some weakness in the midmarket segment which I think is where vendors like [indiscernible] are doing pretty well. So, I guess, the new Appliance that you launched should mitigate some of that pressure in that midmarket, but are you making any other changes to sales incentives or sales capacity in the midmarket to address that weakness?

Those are the big ones, but there's a whole other series of products that I didn’t talk about, because I don’t want to drawn on in my earnings call. That we will talk about at GO, whether it's related to -- and these are products that are -- have potential in both the midmarket and in enterprise and we are talking about cyber, we talk -- and we talk -- and we have talk it a little bit, but we've got new products in dev/ test. I mean there's a whole series of new products that are both applicable to the enterprise and midmarket and those can be sold as with the Appliance or they can be sold separately in the midmarket. So I -- its not just the two that I just mentioned, there is a whole series of others that should help -- provide midmarket growth.

All right. Thanks, guys.

Our next question comes from Aaron Rakers with Wells Fargo. Your line is now open. If your phone is on mute, please unmute.

Operator, we will just move on.

Our next question comes from Srini Nandury with Summit Redstone Partners. Your line is now open.

All right. Thank you taking my question, gentlemen. I’m just going back to the strategy for the last three years. If you look at over the last three years, one of the strategies of the company was unbundle the solution, making it easier for customers to consume your products. This means loss of small deals and less reliance on large deals. Two quarters in a row you seem to be relying on closing with the large deals to make the quarter. I’m trying to understand has something changed in the business? How is the traction of the solution bundles going on? Is it a change in strategy with respect to sales with how sales people are incentivized to push the deals out?

No, I mean, I think Al will speak and I will let Al speak. I think the -- our midmarket products on a relative basis versus a few years ago have done relatively well and there is substantial part of -- our product mix today. But the momentum in those product -- we release a number of products and services for the midmarket, but I think the point is to -- the growth rate of those products had topped off, some of them are growing, they’re growing at a, I will call it a reasonable clip, but to hit our numbers we needed to bring, put more products into those channels to accelerate growth. And so it wasn't that those weren't successful at the time, it's just -- this is another generation to accelerate that. Al, if you want to …

Yes, I think that’s well said, Bob, and I only thing I would add is we've said many times that our strategy in the midmarket focuses around service providers and that's been a good space for us as well. That gives kind of hidden in the numbers here so to speak.

Thank you.

Our next question comes from Eric Martinuzzi with Lake Street Capital. Your line is now open.

Yes, I wanted to address the services revenue implied in the guide. If I go back to last year, obviously it was -- FY17 was a little bit different because we had the issues of FY16, which kind of impacted the services progression throughout FY17. But just wondering are we in that -- are we back to a traditional services revenue progression where a Q3 would be up from a Q2 and a Q4 would be up from a Q3?

Yes. Eric, hi. Its Brian Carolan here. I would say, yes, we are back on kind of a sequential upward trajectory. I think we’ve been talking about this for several quarters now in terms of especially as we get to the back half of fiscal '18 and got through many of the programmatic pricing changes we made over the last couple of years. We will start seeing a resurgence in the services line and we are starting to see that.

Okay. Thank you.

And our next question comes from Aaron Rakers with Wells Fargo. Your line is now open.

Yes. Thanks, guys. I'll try again here. I apologize for that earlier. I just wanted to ask about your opportunity with regard to HyperScale outside of the SMB market or the midmarket. And you’ve talked a lot about strong funnel or pipeline building for those products. I’m just curious if as the industry moves to consolidating the multiple tiers and secondary storage, what type of deal size or how would you characterize the deal sizes that you're seeing albeit early from those solution?

So I'll open this, Aaron. For our [indiscernible] couple of months ago, this is a surprise, right. So, I think the encouraging part of HyperScale is that -- we’ve been working on this product for about a year. We really launched it. We’ve been in, I will call it early beta for you, we launched it last quarter and we want a number of deals that were part of I call seven figure deals with big names that you had recognized right out of the shoe. And I would say the -- in discussing these capabilities with senior management of our customers, I thought the receptivity to them, utilizing our secondary storage infrastructure was surprisingly high, is the way I will describe it and I was validated by closing a whole number of deals. The amount of deals in the funnel today on HyperScale, not the Appliance, but on the big scale-out is very large, and so that it's been relatively easy for us to describe that concept and the benefits and the product really works and the Cisco partnership only enhances that. So, Al, maybe you want to add a little bit more for Aaron.

Yes, I think that’s well said. And yes, Aaron, remember the appliance is targeted for midmarket primarily and remote offices, because it goes to roughly 82 terabytes is the upper limit on our larger appliance, then you can start adding them, but most everybody one should go above that limit or it's called a 100 terabyte will to a HyperScale software solution using hardware of your choice. Cisco will be the primary choice here, but as Bob said in our call, there are six or seven other vendors that has been tested and sorted with and I think personally that it will be a larger company play as we go along here. But I would also add, Bob and I've been arguing about this for about three months and what we determine is we're probably both be wrong, and it will be a good thing overall, because as Bob said there is a lot of interplay between the two solutions. And again the thing to remember is the exact same piece of software. So it's just using different hardware environments out there.

The secondary storage platform is really to Al's point, is a cloud play, because you're -- you given the customer that same agility, high utilization rate economics of a public cloud which are also giving them easy migration through the public cloud from that platform. It's very seamless. The way we manage data, we are not -- we don’t have to move the HyperScale structure and the cloud for example in Azure, we are using Azure structure. Because we are completely seamless in our ability to move to Azure, AWS, Google, that really doesn't matter to us. So we don't have to move. We can use the functionality of our platform, but we don't have to put our -- if you want to use the term our HyperScale structure up there. So, it's got massive benefits to the user, makes it easy and gives the user a lot more flexibility and who they choose for their hardware partners. I mean, the reason Cisco is a good play for us, because Cisco has got a good footprint and they have a great reputation out there, and they’re going to utilize their sales force and channels to help do this, because we're at good alignment. But we had one very marquee customer that’s using a real off-brand server that we’ve certified with them. So it gives the customer the choice of vendor and also gives them complete agility to move to other structures in cloud.

As well as the channel gives them choices as well. As Bob said, they can kind of roll their own etcetera, but the big ones here, Aaron, are when these guys come in they want to know if they have options on hardware as Bob just said. And the other key thing is no lock in on the back end. So all of these environments that we’ve talked about, all can be intermix, work with each other. There is no lock in on a particular vendor or a particular geometry.

And it also aligns with another key objective of big enterprises dealing with a dozen different point products that are driving them crazy as they try to rationalize their environments and deal with things like GDPR and compliance and cyber. So they’re trying to simplify their environments and this is really well aligned with those objectives.

Okay. Thank you.

This time I’m showing no further questions. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everyone have a great day.