Commvault Systems, Inc. (NASDAQ:CVLT) Q3 2023 Earnings Call Transcript

Commvault Systems, Inc. (NASDAQ:CVLT) Q3 2023 Earnings Call Transcript January 31, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to Commvault Third Quarter 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 may be recorded. I would now like to hand the conference over to your speaker host today, Michael Melnyk, Head of Investor Relations. Please go ahead.

Michael Melnyk: Good morning, and welcome to our earnings conference call. I’m Michael Melnyk, Head of Investor Relations, and I’m joined by Sanjay Mirchandani, Commvault’s CEO; 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 and 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 materially different from those contemplated in the forward-looking statements.

Commvault does not assume any obligation to update those statements. During this call, Commvault’s financial results are presented on a non-GAAP basis. A reconciliation between non-GAAP and GAAP measures can be found on our website. Thank you again for joining us. Now I’ll turn it over to Sanjay for his remarks. Sanjay?

Sanjay Mirchandani: Thank you, Mike. Good morning and thank you for joining us today. Earlier this month, we noted delays and deferrals in our customer spending, which were particularly acute in December. We are not alone. It’s increasingly clear that customers and prospects are more calculated and cautious around spending decisions in the current macroeconomic environment. That said, we have built our company on a foundation of responsible growth for the long run, which we expect will allow us to navigate the current economic environment. There are several solid indicators in the quarter that reflects strength in our future growth potential. For starters, Q3 was the best quarter for new customer wins in five years. Total ARR increased 18% year-over-year in constant currency.

More importantly, subscription and SaaS ARR grew 43% and now represent 70% of total ARR. This bodes well for future expansion possibilities. And we delivered healthy free cash flow growth while steadily returning cash through share repurchases. I’ll discuss Metallic in more detail shortly. But during the quarter, Metallic approached 3,000 customers and is proving to be a powerful customer acquisition and expansion. We also saw very healthy growth in Metallic ARR, which sets up nicely for our next milestone, $100 million in SaaS ARR. The large software deals came in below our initial expectations for Q3. We are confident in our long-term future, because first, data protection remains a strategic priority as customers transition to the hybrid cloud, while dealing with the challenges of ransomware and other risks to their business.

Second, the market views our portfolio as best-in-class. And our customers see us as critical on their journey to the cloud. Perhaps, let’s discuss data protection of the strategic customer priority. The journey to the hybrid cloud is different for every customer and it will be ongoing for years. The pace of change and innovation is constantly accelerated, creating uncertainty for those charts of protecting the data. This is even more pronounced in today’s uncertain environment. Ransomware, skill shortages, supply chain and the evolving macro, these are all threats to organization’s ambitions and objectives. Customers need the flexibility to balance costs and risks to maximize business outcomes. We are uniquely positioned to give them choice and flexibility in how they consume technology required to protect the critical data in this difficult world.

This brings me to my second point. Our portfolio is leading edge and future proof. This has enabled us to win new customers and expand our footprint by offering industry-leading capability, capacity, scalability, and solutions. Our support for new workloads and new environments is unmatched. For instance, as customers build cloud-native workloads and applications, they often use Kubernetes. Our support for Kubernetes is best-in-class. In fact, just last week, Commvault was named a leader and outperformer in the new GigaOm Radar for Kubernetes Data Protection for the third year running. It’s a matter of pride for us that we engineer our products to support and integrate with the broadest ecosystem in the industry. This gives customers peace of mind as they protect the data for applications in the cloud today and as they evolve in the future.

We do this, so our customers don’t have to, and we give our customers the choice of software and SaaS on one platform under a single pane of glass. For instance, the breadth of our Metallic SaaS platform helped us land a new customer, . VistaJet was exploring a significant multi-cloud strategy. Rather than relying in adequate native tools within the cloud, this VistaJet chose multiple Metallic offerings, including Kubernetes backup to strengthen its cyber resilience in the cloud, simplify, and reduce its costs and enable them to pursue their growth ambitions. We also landed a multi-million dollar deal with a large European energy company. We displaced an incumbent vendor to protect on-prem workloads like Oracle and SQL server and safely migrate data to the public cloud, all while reducing the risks of a ransomware attack.

Our competitors could not scale to protect the customers’ vast amount of data. You see these are two customers at different stages of their hybrid cloud journey. One focused on existing on-premise workloads, the other one on multi-cloud. We met them both where they were and we’ll be able to take them to where they want to go. Now a little bit more on Metallic. Our Metallic offerings continue to gain momentum with 70% of Metallic additions in the quarter being new to Commvault. This sets the stage for our robust, cross and upsell motions as we are laser-focused on driving world-class in ARR. In fact, 30% of Metallic customers now have more than one Metallic offering such as our newly released ThreatWise, which is showing good early traction.

Photo by Markus Spiske on Unsplash

Metallic customers are also expanding to new offerings as the workloads grow a change. For instance, Linamar Corporation, a global manufacturing company and an existing Metallic customer recently expanded with Metallic to protect up to 15,000 Microsoft Exchange mailboxes. This is another notable example of how Commvault helps customers protect their data, accelerate their cloud journey, simplify their environment and minimize TCO, be it with software or SaaS or both. Metallic is increasing contribution to customer and ARR, growth is a positive indicator that reinforces that our bet on SaaS is the right long-term move for Commvault. As we close the year, and Metallic becomes a more material part of our business, we look forward to providing more detail at an upcoming investor event.

Now, I’ll turn it over to Gary for a discussion of our financial results.

Gary Merrill: Thanks, Sanjay, and good morning everyone. I will start with a quick recap of the quarter with growth rates on a year-over-year basis unless otherwise stated. Total revenues for the quarter were $195 million, an increase of 1% on a constant currency basis. Software and products revenue for the quarter was approximately $90 million, a decline of 5% on a constant currency basis. The variance against our Q3 guidance was the result of a weaker-than-forecasted enterprise market and execution on close rates. Revenue from large deals, which we define as transactions with greater than $100,000 of software and products revenue was down $10 million versus the prior year and represented 72% of software revenue in the current quarter compared to 76% in Q3 of the prior year.

The average deal size in the quarter for large deals was $312,000. This shortfall in large deals was particularly evident in the Americas, with total software revenue was down 20%. Our international region delivered strong software revenue results increasing 17% on a constant currency basis. On a consolidated view, software revenue transactions under $100,000 increased 6% as we saw a modest acceleration in the velocity side of our software business, driven by new customer transactions. Now that I’ve discussed the large deal headwind, I’d like to provide more color on some positive trends in the quarter, particularly around our subscription and SaaS momentum. Subscription software revenue was approximately $70 million and represented 78% of total software revenue, which compares to only 71% of total software revenue in Q3 of the prior year.

Our subscription transition has been driven by new customer acquisition and the strategic conversion of existing perpetual customers to a subscription model. Services revenue, which includes revenue from our customer support agreements, professional services and Metallic was $106 million, an increase of 7% on a constant currency basis, driven by the continued acceleration of Metallic revenue. From a customer perspective, we had our best quarter for new customer count in many years. We saw new customer growth in subscription software customers, Metallic SaaS customers and the combination of both. As Sanjay noted, we are the only provider that can offer customers the best of software and the best of SaaS. I will now give some insights into our annualized recurring revenue or ARR metrics.

Our total ARR increased 14% to $641 million as reported and 18% year-over-year growth in constant currency. Subscription and Metallic software revenue ARR increased 43% to $443 million and now represents approximately 70% of our total ARR balance. Moving on, I will discuss expenses and profitability. Gross margin for the third quarter of 83% reflects a lower mix of software revenue, first is our Q3 expectations. Total operating expenses were $121 million, down 5% year-over-year. During Q3, our global headcount was down 4% to 2,820 employees compared to 2,933 at the start of the quarter. We are managing our people, facilities and third-party expenses by focusing investments on our most critical priorities. We will continue to evaluate our resource base against the market demand environment.

Non-GAAP EBIT was $38.5 million resulting in an EBIT margin of 19.7%. The decline in non-GAAP EBIT was primarily attributable to our lower software revenue results. Moving on to some key balance sheet and cash flow metrics for the quarter. We ended the quarter with no debt and $273 million in cash, $117 million of this balance or 43% of total cash is now in the United States. Quarter-end deferred revenue was up 20% on a constant currency basis, driven by the continued acceleration of Metallic. Q3 free cash flow was $29 million, up 15%. On a nine month year-to-date basis, we generated $100 million of free cash flow, an increase of 16% versus the same nine month period of the prior year. As a reminder, fiscal second half cash flow will be burdened by approximately $7 million of federal tax payments related to the TCJA capitalization of R&D provisions.

While our software and Metallic models diverge and how they are accounted for in our P&L, they’re both strong cash flow generating businesses. As our Metallic business becomes a more meaningful part of our results, we believe ARR growth and cash flow will be key operating metrics to demonstrate the strength of our business model. During Q3, we repurchased 507,000 shares of our common stock for $31 million. Fiscal year-to-date, we’ve repurchased 1.5 million shares of common stock, returning $90 million to our shareholders, representing 90% of free cash flow. Today, we’re also announcing our intent to sell our corporate headquarters in Tinton Falls, New Jersey and leaseback only a small footprint of the existing space. We believe this is fiscally responsible.

Like many companies in our industry, we have evolved into a more flexible, hybrid workplace. The sales transaction is expected to close in the first half of fiscal 2024 with proceeds of approximately $40 million. Now, I will discuss our outlook for the fiscal fourth quarter. We are diligently monitoring the macroeconomic outlook and customer spending on large transformational projects. We believe, new business may continue to take longer to close, especially if it is part of larger IT consolidation and transformation projects. We expect Q4 software revenue will be flat quarter-on-quarter at approximately $89.5 million. Services revenue, which includes revenue from our customer support agreements, professional services, and Metallic is expected to be approximately $107.5 million with sequential revenue growth driven by our Metallic business.

As a result, fiscal Q4 total revenue is expected to be approximately $197 million. At these revenue levels, we expect Q4 consolidated gross margins to be approximately 82%. We will see some incremental pressure on our gross margins due to the forecasted increase in services revenue, which includes Metallic SaaS as lower margins relative to our current software outlook. Q4 operating expenses are expected to be approximately $122 million, down 3% year-over-year. We expect Q4 EBIT margins will be approximately 19%. We continue to be maniacally focused on managing people, facilities and third-party expenses, balancing profitability, while investing in growth initiatives such as Metallic. Moving to cash flows and share repurchases. We expect cash flows will sequentially improve in Q4 and continue to believe that share repurchases currently represent the best use of excess cash.

Given the year-to-date cash flow results and current U.S. cash balance, our Q4 share repurchases will increase from Q3 levels. Our projected share count for Q4 is approximately 45 million shares. Our team is focused on execution, and we will maintain our responsible growth operating philosophy. I will now turn the call back to Sanjay for his closing remarks. Sanjay?

Sanjay Mirchandani: Thanks, Gary. As a longstanding market leader, we’ve endured economic and technology cycles like this, by supporting our customers wherever they are in their journey. They need the flexibility that only Commvault can provide in today’s difficult world. Over the past two years, we’ve made significant progress in delivering a subscription and SaaS-based recurring revenue model, while continuing to innovate and build our industry-leading products. I’m confident that we’re on track to continue to deliver shareholder value and look forward to sharing more with you at an upcoming Investor Day. Now let’s open it up for questions.

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Q&A Session

Operator: Now, first question coming from the line of Aaron Rakers with Wells Fargo. Your line is open.

Aaron Rakers: Yes, thanks for taking the questions. I guess, I want to start with maybe just thinking about what’s going on in the macro and kind of the impact to your business. Specifically around the renewal opportunity as we start to think about fiscal ’24. What assumptions or what have you seen from a renewal perspective in the business as some of those opportunities come to fruition? Are you seeing any changes of renewal rates, any changes of net dollar retention, or anything you can share on that front?

Gary Merrill: Hi, Aaron, it’s Gary. Good morning. A couple of things.

Aaron Rakers: Good morning.

Gary Merrill: Our renewals, especially related to the software subscription business, they largely met our expectations for fiscal Q3. So, we’re on track with some of the metrics around renewals, both our retention rates that we’ve discussed historically. We are still in those historical ranges, which is good. And as we look forward into fiscal Q4, we have a slightly bigger renewal population quarter-on-quarter, Q3 versus Q4 as well. So, we’re on track there. What really drove the mix, as we talked about in the prepared remarks was really some of those large IT enterprise transformational projects, driven really on the land and expense business.

Aaron Rakers: And as far as kind of those opportunities that pushed out this last quarter kind of delayed, maybe you can help us appreciate what is underlying your assumptions with regards to the guide this quarter around that? Are you expecting those deals to come in into revenue this quarter, or do you see further pushouts embedded in your guidance?

Gary Merrill: Yes. Aaron, so the expectations that we have as we look out into fiscal Q4 is that, the current dynamics that we saw during fiscal Q3 as it relates to the software side of the business. We’re expecting them largely to continue as we move into fiscal Q4. The impact that we saw in some of the multi-year big deal purchasing decisions, we expect that will continue. The deals that pushed in our fiscal Q3, the good news is they’re not lost. The vast majority of them are still in play. We continue to work on them. We continue to dialog with our customers and we expect a good portion of actually to close in this fiscal Q4.

Aaron Rakers: Great. And then just real quickly, the final question. As I look at kind of Metallic, what’s interesting is, you’re talking about what sounds like an acceleration of the ARR momentum relative to, I think last quarter you said 75 and I think exiting fiscal ’21, it was 50 on ARR balanced. If I look at your total kind of recurring services revenue and I strip out the support piece of it, it looks like the Metallic is growing well north of 100%. I just level set us, is that a good way to think about how quickly Metallic is actually growing within that services line?