Commvault Systems, Inc.
Q4 2018 Earnings Call Transcript

Published: 1 May 2018

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Fiscal Year Fourth Quarter Commvault Earnings Conference Call. At this time, all participants are in a listen-only mode to prevent background noise. We will have a question-and-answer session later and the instructions will follow at that time. And as a reminder, this call is being recorded. Now, I would like to welcome and turn the call to Mr. Brian Carolan, Chief Financial Officer. You may begin.

[Brian Carolan:]

Thank you and good morning. Thanks for dialing in to today's call for our fiscal fourth quarter 2018 earnings call. With me on the call are Bob Hammer, Chairman, President and CEO; and Al Bunte, Chief Operating Officer. Before we begin, I'd like to remind everyone that statements made during this call, including in the question-and-answer session at the end of the call, may include forward-looking statements including statements regarding financial projections and future performance. All these statements that relate to our beliefs, plans, expectations or intentions regarding the future are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations. Actual results may differ materially due to a number of risks and uncertainties such as competitive factors, difficulties, and delays inherent in the development, manufacturing, marketing and sale of software products and related services, and general economic conditions. For a discussion of these and other risks and uncertainties affecting our business, please see the Risk Factors contained in our Annual Report in Form 10-K and our most recent quarterly report in Form 10-Q, and in our other SEC filings and in the cautionary statement contained in our press release and on our website. The company undertakes no responsibility to update the information in this conference call under any circumstance. In addition, the development and timing of any product release as well as any of its features or functionality remain in our sole discretion. Our earnings release was issued over the Wire services earlier today and also has been furnished to the SEC as an 8-K filing. The press release is also available on our website. On this conference call, we will provide non-GAAP financial results. Commvault adopted the new revenue standard ASC 606 on April 1, 2017. Our adoption was done on a retrospective basis over all prior periods, and our financial statements have been adjusted to comply with the new rules. As a result, the results in growth percentages we will discuss today are on a comparable basis using the new rule. The reconciliation between the non-GAAP and GAAP measures can be found in Table IV accompanying the press release and posted on our website. This conference call is also being recorded for replay and is being webcast. An archive of today's webcast will be available on our website following the call. I'll now turn the call over to our CEO and President, Bob Hammer. Bob?

[N. Robert Hammer:]

Thank you, Brian. Good morning, everyone, and thanks for joining our fiscal fourth quarter FY 2018 earnings call. On today's call, we will provide an update on a number of business transformation initiatives that have been underway over the past year, which we referred to as Commvault Advance. But first, I'd like to start with comments regarding Elliott Management. Commvault has had discussions with Elliott Management over the course of the past several weeks, discussions that have involved both me and our board of directors. I am pleased to let you know that those discussions have been constructive and have resulted in a joint cooperation agreement announced earlier today in a separate press release. The agreement with Elliott is going to complement Commvault's transformation with a series of governance initiatives that include agreement that the board will appoint two new independent directors prior to the 2018 Annual Meeting of Stockholders. The Commvault board has formed an Operations Committee to identify additional opportunities to further propel Commvault Advance and its profitable growth and value creation objectives. In addition, the company will engage a leading outside consultant to work with the Operations Committee on this review. Elliott has agreed to certain customary standstill provisions. Lastly, we are unveiling new strategic initiatives intended to drive Commvault's next phase of growth. I believe now is the right time to begin the transition to our next generation of leadership. As such, we are beginning a search for a new CEO of Commvault. Typically, such a process will take a few months during which I will continue to remain as Chairman, President and CEO. At its conclusion, it is anticipated I will remain as Chairman of the board. Our dialogue with Elliott show that we are closely aligned on many matters and believe it will enable us to deliver increased value creation for our stockholders and customers alike. Now, let me make some comments about Commvault Advance. Commvault Advance spans a series of initiatives currently underway and still to come that individually and together transform the company and position it for increasing the rate of top line growth and getting Commvault back to sustainable 20% operating margins. Additionally, the goal is to approach 65% to 70% repeatable revenue over the next two fiscal years. Commvault Advance is focused on several key areas. They are

[Brian Carolan:]

Thanks, Bob, and good morning, everyone. I'll now cover some financial highlights for the fourth quarter of fiscal 2018. Q4 total revenues were a record $184.9 million, representing an increase of 11% over the prior-year period and 3% sequentially. Quarterly billings, which we define as total revenue plus the sequential change in deferred revenue, was approximately $203 million, up 8% over the prior-year period and 6% sequentially. As a reminder, our deferred revenue balance consists entirely of deferred maintenance and professional services revenue and not software revenue. For the full fiscal year, we reported total revenues of approximately $699 million, representing an increase of 8% over fiscal 2017. We reported Q4 software and products revenue of $83.5 million, which increased 7% year-over-year and 3% sequentially. For the full fiscal year, software and products revenue was approximately $311.7 million, representing an increase of 7% over fiscal 2017. We are pleased that our continued shift to subscription pricing models is resonating with customers. This consists of both committed and often multi-year subscription sales as well as pay-as-you-go utility type arrangements. As a reminder, under ASC 606, we are generally required to recognize the full amount of the software revenue from a committed subscription arrangement in the period of sale and not over time as was generally the case under legacy revenue recognition rules. Utility arrangements, on the other hand, generally continue to be recognized over time as they are not committed. Subscription-based pricing represented approximately 37% of software and products revenue in Q4, and 25% for all of fiscal 2018. We entered the year with a historical run rate of about 10%. This repeatable software revenue stream continues to build somewhat faster than originally anticipated. All things being equal, we estimate it had a dampening effect of approximately $4 million on our Q4 in-period recognized software revenue. This is due to the fact that there is a reduced price of a committed subscription arrangement in comparison to a like-for-like perpetual transaction. The positive is that we expect to be able to recognize additional revenue at the time of renewal, which is generally three years from the initial sale. When you combine our subscription-based license sales with our other repeatable service revenue streams such as maintenance, managed services and SaaS, we would consider approximately 60% of our total revenue to be repeatable in nature. On a full-year basis, our repeatable revenue streams grew 26% year-over-year. Revenue from enterprise deals, which we define as deals over $100,000 in software revenue in a given quarter, represented 60% of software revenue. Revenue from these transactions was up 5% year-over-year and 9% sequentially. Our average enterprise deal size decreased 6% year-over-year to approximately $264,000 during the quarter. The number of enterprise revenue transactions was a quarterly record, increasing 12% year-over-year and 10% sequentially. During the quarter, 51% of software revenue was sold through our traditional per terabyte capacity models, down from 67% in Q4 2017 and 66% in Q3 2018. Sales of these traditional terabyte capacity models has declined in recent quarters, as we've been transitioning customers to stand-alone solution sets, Appliances and HyperScale solutions, that are also licensed based on the amount of data under management. The capacity measurement for such solutions may range from the number of users, mailboxes, VMs, sockets and operating instances. As a result, our disclosed statistic of terabyte capacity as a percentage of total software revenue is becoming a less meaningful metric to understand the underlying business. From a geographic perspective, Americas, EMEA and APAC represented 56%, 31% and 13% of software revenue, respectively, for the quarter. On a year-over-year growth basis, EMEA and APAC were up 22% and 9%, respectively, while Americas was down 1%. The revenue mix for the quarter was split 45% software and 55% services. Total services revenue for Q4 was approximately $101 million, an increase of 15% year-over-year and 2% sequentially. We continued to have strong maintenance renewal rates, and our professional services business continued to show year-over-year improvement. For the full fiscal year, services revenue was approximately $387.6 million, representing an increase of 9% over fiscal 2017. Now, moving on to gross margins, operating expenses and EBIT margin. Gross margins were 85.2% for the quarter. The cost of hardware related to our HyperScale Appliances is included in the cost of software and products revenue. As sales of these appliances continue to ramp in fiscal 2019, our gross margin percentage will decline. I'll discuss our fiscal 2019 gross margin expectation shortly, as part of my outlook commentary. Total operating expenses were approximately $132.5 million for the quarter, up approximately 5% year-over-year and 1% sequentially. We ended the quarter with 2,839 employees, down 2 from the beginning of the quarter. Operating margins were 12.2% for the quarter, resulting in operating income or EBIT of approximately $22.5 million. Net income for the quarter was $14.5 million, and EPS was $0.31 based on a diluted weighted average share count of approximately 46.6 million shares. Let me now talk about the Q1 2019 and full year FY 2019 outlook. We would like you to keep in mind that fiscal Q1 is usually our most challenging quarter due to seasonality. We expect this trend to continue in Q1 FY 2019, as we currently anticipate a sequential decline in both revenue and EBIT. We currently believe year-over-year Q1 software and product revenue growth will be up slightly, which reflects our continued move to subscription-based pricing. We expect total Q1 year-over-year revenue growth to be in the mid- to high-single digits. We expect the Q1 EBIT margin percentage to be approximately 9.6%. We expect lower revenue growth in the first half of FY 2019 due to the fact that our key initiatives will not offset the move to subscription-based pricing. We expect acceleration of top line software revenues in the second half of FY2019, driven by our key initiatives such as HyperScale, our Appliance, our Cisco partnership, Advanced DR (00

[N. Robert Hammer:]

Thank you, Brian. I will now spend a few minutes on our strategic framework and our positioning for what we see as the current and emerging trends in the market. On the strategic framework, it is important for everyone to understand that we've been executing a strategic framework that we started more than four years ago. That framework has three phases and still provides a blueprint for growing and improving the profitability of our business. The phases are as follows. Phase 1, after we had our situation four or five years ago, when we lost a customer that represented 25% of our revenue, when we exited that strategic partner, we clearly in that phase performed better than the core backup and recovery market and better than our traditional competitors. But the phase one implementation still fell short of our own expectations. Phase 2 is to accelerate growth and profitability in the FY 2018 to 2020 period. This involves repositioning of our products, distribution channel, go-to-market restructuring and operating margin improvement, driven primarily through cost reductions and sales and marketing expense as a percent of revenue. Major elements of Phase 2 are in process as we enter FY 2019. And Phase 3 was to position the company for longer-term growth, which will require further improvements in operating margins, analytics about data, operations and business needs and next-generation architecture for scale and micro services plus fundamental new architectures to deal with new rapidly emerging requirements for massive changes in scale and dealing with issues related to the Internet of Things. The major trends that we are seeing in the market are as follows. Cloud and hybrid IT have gotten mainstream; more and more applications and data will be in cloud architectures, both private and public. The need to migrate and recover data from devastating cyberattacks is not if, but when a cyberattack will occur. Third, the need to deal with more complex compliance imperatives like GDPR. And, four, machine learning and analytics have become table stakes for data management operations, as well as for business analytics. Fifth, environments and operations have an increasing level of complexity. As such, automation and simplicity of solutions is critical. And sixth, Advance's coming to market in compute, network and storage will require many multiple orders of magnitude increases in scale for data management software over the next several years. Commvault's unique architecture and forward thinking puts us in a unique, strong position to address these key emerging trends. We know we are way ahead of competitors in both enterprise and mid-market in providing newly developed, unique automation and orchestration capabilities to securely move, manage data from legacy infrastructures to private clouds, private clouds to public clouds and management of data in multiple clouds. We have recently enhanced our ability to increase share in our core data protection business in both the enterprise and mid-market with expanded and broadened solutions and use cases, including our HyperScale, our secondary storage for the enterprise, our Commvault HyperScale Appliance for the mid-market. This quarter, we will introduce updated data protection solutions including our Appliances, incorporating advanced machine learning for automatic dynamic scheduling, improved operational efficiency and position for faster, automated, dynamic disaster recovery. This quarter, we will also introduce new solutions with advanced machine learning for new cyber solutions, for threat detection and mitigation and high-volume disaster recovery. Next quarter, we will come to market with the most advanced solutions, again, using machine learning and AI for GDPR. We will also expand it to outcome-based services and SaaS. And lastly, this fall, we will open up significant market opportunities with a foundation for business and operational analytics from both major enterprises and the mid-market. We are well prepared for the radical changes required to protect, manage and use data, as a result of the impending changes to compute, network, storage and the Internet of Things. In closing, we have made substantial progress in fundamentally positioning us for our next phase. In this regard, we are well down the path and addressing our low operating margins and have a path designed to get the company back to sustainable 20% operating margins in the relatively near future. Our core strategy, business opportunity and technology position remain solid. We have the strategic assets that we need to take advantage of these opportunities. The strategic initiatives that we launched in FY 2018 are designed to improve shareholder value. We are making good progress across all aspects of the company to improve financial performance by strengthening our competitive technology position, broadening our product line, enhancing expanded distribution and restructuring sales and marketing and driving cost reductions. We clearly look forward to working with Elliott, as we advance the company for improved operating margin performance. I will now turn the call back over to Michael. Michael?

[Michael Picariello:]

Operator, can we please open the line for questions?

[Operator:]

Thank you. Our first question is from Joel Fishbein with BTIG.

[Joel P. Fishbein:]

Good morning, guys. Thanks for all the color. Bob, just one quick word for you just in terms of the general overall demand environment in general and, I guess, two related questions. How are you seeing the competitive dynamics currently? And how was the Q4 for large deal activity, and are there still big deals out there that you guys are positioned for?

[N. Robert Hammer:]

I think the demand in general is solid, Joel. I don't think that's an issue. I haven't seen any signs that there is any demand-related softening. In regard to what's going on generally in the market, in the enterprise, I call it, (00

[Joel P. Fishbein:]

Great, thank you so much.

[Operator:]

Thank you. Our next question is from the line of Jason Ader with William Blair.

[Jason N. Ader:]

Yeah. Thank you. First of all, Bob, I want to congratulate you for all your years of leadership and commend you for putting the company first with this decision. I'm sure it wasn't an easy one.

[N. Robert Hammer:]

No. But you're right, I mean, this is all about Commvault, and it's certainly not about me so...

[Jason N. Ader:]

Great.

[N. Robert Hammer:]

And I think we're clearly aligned with what Jesse Cohn and Elliott want to do. We just need to work together and take the company forward.

[Jason N. Ader:]

Great. Well, I have two quick questions. One is just on product packaging and pricing. You've even working hard at this, as you've noted kind of trying to simplify packaging and pricing over the past few years. But it still seems like there is too much complexity. So, if you had to do it all over again, which just sounds like your – maybe that's what's going on right now. What would you do to make things simpler on packaging and pricing?

[N. Robert Hammer:]

Well, there's no question, Jason, that we as a company got way too complicated, and we made some pricing changes last fall. They basically didn't work, even though there was a lot of thought to it. And we took as a radical step as we possibly could by – and Al can comment on this in a second, but basically converging all our data management products into basically one simple SKU, used for different use cases. So, data management has been radically simplified, our deal desk and the management of those – of that pricing has been significantly simplified. Our Appliance is really simple, our Hyperscale is simple. So, across the board, I think we made some radical changes. Now, they're in market, in final beta stages and we're rolling them out more aggressively this quarter. But everything will be fully in place in early July. So, I think we've made massive changes to that. And clearly, it has been a weakness of the company and we've now addressed it extremely aggressively. And by the way, the simplicity, both product and pricing, was absolutely key to our whole distribution strategy in strengthening our route to the market because, without that, you cannot drive product into market.

[Jason N. Ader:]

Okay. Great. And then, just a second question. I understand you're undertaking some immediate actions to try to optimize the go-to-market side. I guess, what I would be concerned about is, when you have a new CEO coming on board, he looks at the situation and says, no, no, no, that's not what we need to do. So, how do you control that right now without going too far on making changes when you have a new CEO that's probably coming in and may want to have his own game plan or her own game plan?

[N. Robert Hammer:]

Yeah, I understand. The answer is we're driving the company forward. Now, one way of mitigating that is we're right in the final stages of signing up a really well-known third-party consulting company to aid in the process, but we're not slowing it down and trying to anticipate what a new person would do because I'm not sure what that's going to take, three months, six months, nine months, I don't know. In the meantime, we've got to get done what we've got to get done. And so, we are doing it on our own. We are trying to bring this consulting firm in here to start sometime in the next couple or three weeks, hopefully two weeks and we'll drive that in parallel. And I think that should help mitigate any changes in philosophy on who sits in this chair. I'll make the comment. Whoever sits in the CEO chair is the CEO, and that individual, he or she, will make his decisions along with the team. And that's just the way it's going to be, Jason.

[Jason N. Ader:]

All right. Thanks.

[Operator:]

Thank you. Our next question is from Andrew Nowinski with Piper Jaffray.

[Andrew James Nowinski:]

Great. Thanks a lot. Bob, it's been a pleasure working with you over the years as well, and I wish you the best on your next endeavors. I just had a question on the head count reduction. It seems like the 4% head count reduction will not have a meaningful impact on your margin, considering your sales and marketing expenses are way above the peer group at about 52%. However, you're generating a lot of revenue through OEM partners, which should be, I think, an OpEx-light route to market. So, first, can you just give us any color on how we should think about sales and marketing trending over the next few years as a percent of revenue? And then, second, can you tell us how much revenue is going through your OEM partners and whether that requires less OpEx investment to generate a $1 in revenue versus your direct sales force in the channel?

[N. Robert Hammer:]

Well, that is the answer, but that's all – all those are new routes to market whether it's Cisco, HP. That's all beginning. And those are not OEMs. Those are basically strategic route-to-market partners. And over the next month, we'll announce some others that are significant. So, the issue is getting all those new routes to market, those routes up and running because that's the only way you're going to solve the sales and marketing problem. So, we took a – when we launched this, we took a, I'll call it, a first cut of what the organization should look like without blowing it up – without blowing this you know launch up. And then, with the consultant we're bringing in and with our own initiatives, we will figure out ways to get this – I'll put it this way. There is no reason at various different levels of growth why this company can't generate 20% operating margins. And we're taking a pretty significant step, and we'll continue taking steps until we get there. And this should be doable. And as Brian said, we should make a lot of progress this fiscal year. Clearly, I wanted to be exiting FY 2019 at 20%. And it looks like more realistically it's going to be 16%, 17%. But we'll be doing everything we can to get – to make sure we drive our position and growth in margins and reach those levels. It is – there's enough assets here, and we're in strong enough position to do this so – but to answer your question, it's got – the big move is got to be coming from a lot better sales productivity and leverage from the channel along with operating cost savings. But you can't do it with cost savings alone, you've got to solve the channel leverage problem.

[Andrew James Nowinski:]

Okay. Thanks, Bob. And then, just a quick clarification, I guess, with regard to Q4 software revenue coming in a little bit lighter. Was that entirely due to the slight dampening effect from the subscription revenue you had that you talked about? Or were there any deals that actually pushed out into the next fiscal year?

[N. Robert Hammer:]

Well, I mean, if you go by the numbers, we would have hit the number if it wasn't for subscription. But the bottom line is we're not built – what I said on the call is, we were extremely successful with HyperScale and Appliances, but a lot of that went into our installed base. And as we started to expand it out so that the net effect of driving growth, it wasn't enough to compensate for the subscription pricing. So, what we're trying to do as quickly as we can is to move out in the broader market with these products over the next couple of quarters and what I would call accelerate net growth of those products. There's no reason why we can't. And the other thing, as Jason was asking, we've dramatically simplified our core data protection management pricing model. I mean, it's radically – I think we – just round numbers, I think we consolidated five products and 12 SKUs, round numbers into one, very simple model. So, I think that's going to help us as well.

[Andrew James Nowinski:]

Thanks, Bob, and good luck going forward.

[N. Robert Hammer:]

Thanks. Well, the first thing I need to do is to make sure we hit 20% margins before the next guy gets in here so – or the next person gets in here, anyway, yeah.

[Operator:]

Thank you. Our next question is from Aaron Rakers with Wells Fargo.

[Aaron Rakers:]

Yeah. Thanks for taking the questions as well. And also, Bob, I commend you on a tough decision. I guess, the first question I want to just ask back on the subscription revenue line. You've done 37% contribution this last quarter. It sounds like you're assuming that, that goes to a 30% contribution for fiscal 2019. I'm curious, given your efforts and your focus and clearly the adoption of HyperScale, why that 37% wouldn't necessarily continue to go higher. Or what dampens that to a 30% level relative to the 37% contribution in this last quarter?

[Brian Carolan:]

Yeah. Aaron, hi. Good morning. It's Brian here. So, it was 25% for all of fiscal 2018. We're saying we're going to move that to approximately 30% for the full fiscal year 2019. So, yes, we are on a very good trajectory. I think that 37% was stronger than we expected internally. We're not so sure that we can keep that pace up necessarily. But we see this thing moving in the direction of more and more repeatable revenue streams and I think that's the important part is that looking at it holistically with all of our repeatable revenue streams with respect to maintenance, professional services in the form of managed services and SaaS and our subscription base pricing is that, that 60% of total revenue will continue to gradually come up from that level as well.

[N. Robert Hammer:]

The other issue, Aaron, we had some deals that – large deals that skewed that number in fiscal Q4 2018. And those are harder to predict. So, if you exclude those, the 30% is probably a more realistic target.

[Aaron Rakers:]

Okay. Let me ask in maybe a different way then. And going back to Andrew's question, if – what was your assumption of subscription revenue contribution going into this last quarter? Like, relative to 37%, were you assuming that, that would have been 30% or 25% or – I'm just trying to understand again how the trajectory of that business could change depending on those larger deal flows going forward.

[Brian Carolan:]

Yeah. I mean – so, last quarter, it was 21% as I think we disclosed in the call this quarter – this past quarter in Q4 was 37%. Again, 37% was at the high end of any kind of expectations we had internally. It was probably closer to 30% in trying to put a number on it. And also, as I stated on the call is that we had a dampening effect because we moved so aggressively to the subscription pricing of about $4 million of in-period license revenue on a like-for-like basis.

[Aaron Rakers:]

All right. Okay. And then, the other question, I just want to ask. In the prepared comments, there was a comment made about HyperScale and that having some cannibalistic effect on some of the pipeline build. Can you help us understand what that means and what are you seeing on HyperScale deals relative to the ability to maybe attain a wallet share expansion opportunity with those platforms?

[N. Robert Hammer:]

Yeah. I'll speak, and I'll let Al speak in a second, Aaron. We had higher than expected reception both for Appliances and HyperScale for the – these were really the first full quarter of their end market. But a lot of those deals were in our installed base. So, we think of them as an expansion of position in our own installed base because we got secondary storage along with our data management. But a broader channel leverage getting that channel spun off is happening as we speak. It will still take a couple more quarters where we're actually picking up share in the broader market versus increasing our position in our installed base. And, Al, you may want to take this.

[Alan G. Bunte:]

I think the only cannibalistic effect, Aaron, was we pull a lot of data protection with HyperScale. It isn't just HyperScale. It's really a redefined backup and recovery suite. That obviously goes from one bucket to another. Many of our traditional backup and recovery environments have been what we call scale up. And now, as we're moving to scale out environments, it's kind of taking from one bucket to another. But Bob, I think, hit the major points here, Aaron.

[N. Robert Hammer:]

I'll make a point, Aaron. What we're seeing in this – this is not mid-market now. But in the major accounts, it's pretty consistent. It's – I've got a legacy environment. I'm moving into a private cloud, my private cloud and I want to move data to manage over multiple public clouds, and I want a holistic way to do that. And when I'm doing that, it's not just the data protection. It's mitigation across all these infrastructures on cyberattack and the ability to recover a lot. One, mitigate the detection of an intruder, do something automatic, that's why we're using machine learning if an intruder is detected. And thirdly, be able to recover a lot faster and scale across those different environments. That's a pretty common theme of what we're seeing across the world and what these big customers are looking for.

[Alan G. Bunte:]

Yeah. The last piece there, Aaron, too, where HyperScale fits in here, that Bob alluded to, is just performance and speed, let alone cost per terabytes. So, we've seen, what, 5 times to 8 times...

[N. Robert Hammer:]

Yeah...

[Alan G. Bunte:]

The amount of speed increase on the performance level. We've seen things like 9 terabytes an hour in some of our new installed base, and that's massively faster and more efficient than traditional infrastructures out there. So, it all kind of fits together as a point.

[Operator:]

Thank you. Our next question is from Alex Kurtz with KeyBanc Capital.

[Alex Kurtz:]

Thanks for squeezing me in, guys. And, Bob, maybe we'll get to talk to you one more time before the change. But if we don't, you've built quite a franchise here, and congratulations.

[N. Robert Hammer:]

Yeah, thanks. Thanks, Alex.

[Alex Kurtz:]

Yeah. Just really want to narrow down to two questions here, which is HyperScale and the impact of the subscription transition. So, if we look at the fiscal 2019 outlook that Brian's provided, do you think HyperScale ultimately is a net positive or a negative to the fiscal 2019 outlook given what you saw out of Q4? And the same question for subscription transition, how would you quantify for the year, Brian, when we look at the outlook and sort of the impact and the changes as people adopt that kind of a model?

[N. Robert Hammer:]

There is no doubt that growth is going to come from big enterprise deals and HyperScale. It will be a major component in a significant amount of those deals. No question. Secondly, we're going to see significant growth just from our core being able to have – I'll call it a simplified pricing and packaging and partner channel leverage with our core data protection software. And thirdly, the Appliance got exceptionally good reception. And we moved on that product and refined it really quickly, and we're going to be expanding both the footprint on appliances and really ramping up our channel. So, there aren't – the success in driving growth is really tied to a few key things. And the good news is that the partner ecosystem is there. The products are there to achieve these numbers. It's now us – for us to ramp this up and execute it as fast as we possibly can to get the kind of financials that we're looking forward. But there is no doubt that if you look at enterprise, we call it Commvault complete data protection, HyperScale and Appliances. There is the vast majority where the growth will come from as where our focus is going to be. Now, you add machine learning and AI to all of that, which is coming out, which Al and the team will be announcing formally in about two weeks. Those products are done by the way. We just haven't introduced them to the market. They are significant, and there's a couple of years of work tied to those with very special custom designed algorithms and everything else to achieve those results.

[Brian Carolan:]

And, Alex, to your other question just on subscription, I mean, ultimately, the market votes. I mean, we are trying to make things easier for customers and distributors and resellers and partners. And if the market prefers to buy subscription, we are going to offer subscription-based sales to them. So, it's hard to accurately predict that, but we do see this continuing to trend in that direction. And as Bob said, I mean, we were pleasantly surprised by a couple of large deals in Q4. We're not sure if that's a sustainable path. But we do think, in FY 2019, this will continue to shift more towards subscription-based revenue.

[Alex Kurtz:]

But, Brian, if we're to net out your fiscal 2019 outlook – sorry, Bob. But if we were to net out the fiscal 2019 outlook, there is some headwind from subscription, maybe a couple of points of growth...

[Brian Carolan:]

Right...

[Alex Kurtz:]

And, Bob, HyperScale you think will be a net positive not cannibalistic to fiscal 2019 growth?

[N. Robert Hammer:]

Well, what I meant by cannibalistic I mean, (00

[Alex Kurtz:]

Right.

[Brian Carolan:]

And, Alex, you are correct it's going to act as a slight headwind for FY 2019 growth as our – we move to subscription.

[Alex Kurtz:]

Low-single digit headwind?

[Brian Carolan:]

Yeah. That probably sounds accurate.

[Alex Kurtz:]

Okay. Thank you. Thank you, guys.

[Operator:]

Thank you. Our next question is from Abhey Lamba with Mizuho Securities.

[Abhey Lamba:]

Yeah. Thank you, and good luck with the transition here at Commvault, Bob. Going to your comments about the margin commentary you gave a few minutes ago. You have been talking about 20% margin exiting fiscal 2019 for some time. It seems like it's moved by a year now. But why shouldn't your ultimate margin target for the next couple of years be even higher given all the cost actions you're planning to take over the next few quarters in addition to the leverage you can get from the channel?

[N. Robert Hammer:]

Well, one, it should be higher but we first have to get to 20%. But the business should generate a higher gross margin than 20%, I agree with that, Abhey. And we're not exactly a year out and I would say we're two to three quarters behind where we wanted to be here in terms of ramping all this up and getting the – it's not on the product side and we've done really well there and I think we got – finally got our pricing in line, but it's getting these resources behind these routes to market and in place to drive it and that has just taken us a couple three quarters longer than we wanted to drive the result. So, just in summary, I don't think we're that far away from it. And to your comment about, shouldn't the business be able to generate higher than 20%? The answer would be absolutely.

[Abhey Lamba:]

Got it. And secondly, GDPR has been talked about as a driver for some time. Are you seeing some real demand originating from that? And can you cite some examples where you could benefit from it? That's it from me.

[N. Robert Hammer:]

Yeah. I'll let Al take this because we're – we've got a lot of beta going on here and there's a lot of technology here. I mean, everybody talks about GDPR, but really providing a comprehensive solution is not as easy as it sounds. Why don't you take this, Al?

[Alan G. Bunte:]

I think Bob just hit it. With the announcement he alluded to in a couple of weeks we'll be around you know productizing our early GDPR efforts. We've been out in an early adopter kind of beta stage for what a couple of quarters and you'll learn a lot going through that. It's not so simple, it's not easily program-ized because everybody feels like they have a custom approach to dealing with sensitive data governance. But again, we feel like we have the right technologies both for discovering what you have in your organization. We think it's a consolidated approach. We're seeing the competitive offerings out there, tend to do those kinds of things workload by workload or area by area. And again that makes overall company governance very difficult. And lastly, the key is once you've discovered what you have now what you're going to do with it. So, there's a number of let's call it applications and data movement, consolidation and isolating or eliminating, et cetera, et cetera that data, and again that's really the key part of what we call sensitive data governance. We'll see more about this as Bob said this summer.

[Operator:]

Thank you. Our next question is from John DiFucci with Jefferies.

[John DiFucci:]

Thanks a lot. Your changes to sales distribution and marketing seems more focused on channel routes to market. I guess is that through, I mean you've always had some focus there, I know that. But, can you talk at all about your direct sales efforts and how that might change if at all with what you're doing here?

[N. Robert Hammer:]

Well, we've had it. Let me just go back you know four years, five years. Our original strategy was to drive our enterprise business with direct sales force and drive our call it channel with Dell. And that worked and that's why we had 25% operating margins and sustainable 20% growth and 30% on the bottom for seven years or eight years. When that broke, it fundamentally broke because one, we didn't have products aligned to the channels, and second, we really weren't organizationally – we didn't put enough resource behind it. So it worked for about a year, but it tapped out. So, we've always had channels but we haven't had focused resources as these are round numbers and I'll let Alan, Brian chime in. But, round numbers were moving call it 30% or 40% of our resources that were primarily direct into route to market. We've taken existing resources and some ads, but net-net will probably be a net minus into routes to market. This is you know a lot more people on our channel partners, our new strategic alliance partners, our cloud partners and we couldn't do that without having you know these – the major reengineering to our products to make them simple and easy. So, first, you had to start with products and pricing, then you had to build the partner ecosystem, and then you had to ship a massive amount of resources. So, this is not a little change. It is a massive structural change across the company on – first on products and pricing. Again, a series of new routes to market and then shifting resources to that route to market. So, your enterprise direct sales force becomes highly focused on these big major accounts, and then you have a lot more of your route to market, just functional route to market, not touched or managed by a direct sales force. So, it's a – it's not a little change. We've been working on this for quite some time top to bottom and I'll call it this is a major reorganization that we're going through right now and should be pretty well complete by – sometime in July, we should be pretty well through it including bringing in new leaders and drive all of this and everything else, but you're on board by the way. Al, do you want to take?

[Alan G. Bunte:]

I think the other point there, John, is many of the changes that Bob just went through and we've indicated are also complementary to enterprise environments, so.

[N. Robert Hammer:]

Yeah. A good point.

[Alan G. Bunte:]

For instance, our partnerships, Cisco and HPE, those help us tremendously in enterprise environments, point one. Point two is we're putting forward many improvements, if you will in the whole what we call demand bookings process that spans across mid-market and enterprise, things like you know as straightforward as better, simpler demos, more streamlined POCs, et cetera, et cetera. And one other point on enterprise when Bob talks about we've made our products and our pricing much simpler, when you serve both enterprise and mid-markets just so-called dumbing down your UI is not really the answer. So we've spent, what, a year and a half taking apart our whole user experience and everything is outcome based now. And as Bob also said, we're dealing with very complex environments out there and mountains of data. And the bigger the organization, the more complexity you have. So, we solve this simplicity idea with automation, with outcome based policies, with monitoring against those policies and as Bob also indicated now, introducing predictive analytics and/or AI capabilities to spot those needles in the haystack. So all that ties to simplicity but it doesn't necessarily mean it's just dumbed down. So again all these initiatives go across both mid-market and enterprise was the idea here.

[Operator:]

Thank you. Our next question is from Greg McDowell with JMP Securities.

[Greg R. McDowell:]

Great. Thanks very much. I'll start by saying that a 20-year tenure as a CEO of a technology company is simply an amazing feat. Just a few questions for me. First, the senior leadership changes, a lot changing, partnerships, alliances channels. I just want to first ask are those senior leadership changes largely complete or should we expect a lot more to come? And then I have one follow-up.

[N. Robert Hammer:]

Well, the – in the – there are some additional to come by the way – some additions but getting the senior leader for our whole distribution program, that person (01

[Greg R. McDowell:]

That's helpful, thank you. And just one follow-up I want to ask about your capital allocation policies on a go forward basis. Certainly a portion of your shareholder base is advocating for an accelerated share repurchase program. And was just hoping you could elaborate a little bit on your thinking and the board's thinking on is that under consideration? And as you drive towards these increased operating margins, how you're going to put that free cash flow to use? Thanks.

[N. Robert Hammer:]

We've always done that opportunistically, but the answer is the possibility of doing that more programmatically is I'll just say this, is under consideration and was really part of the release in concert with Elliott. So we'll think our through this. We want to do it in a way that doesn't jeopardize the company, but provides for I'd say good governance so that our capital management, so definitely under consideration.

[Greg R. McDowell:]

Thank you very much.

[Operator:]

Thank you. Our next question is from the line of Eric Martinuzzi with Lake Street.

[Eric Martinuzzi:]

A clarification and then a question. Your FY 2019 revenue guide that's approaching 10%, I hear that and I think 7% to 9% growth with an 8% midpoint is that – are we talking about the same thing?

[Brian Carolan:]

I'd it's higher. It's closer to 10%, Eric.

[Eric Martinuzzi:]

Okay. And then, for the – the timeline for the strategic transformation initiative here, I understand you've said, hey, we're going to have this all fully baked and ready to comment on at the time that we report the second quarter financial results, which is pretty much six months from now. I know it's a huge project but given where you are pretty close to selecting the consultants and then I'm guessing you've probably identified the independent directors, I was kind of surprised that we're looking at six months before getting greater clarity there? Can you comment on the timeline?

[N. Robert Hammer:]

Yeah. No, I think we'll comment on every quarter because we're pretty much in gear here with this phase of it and that you can – there's a really high probability as we bring a consultant in there will be some other changes we'll make. But I think the six months issue was realistically the time will take to get all these channel programs significantly impacting our financial results. But this is – we started this, it's really been and we started to make the moves here well over a quarter ago. So yeah, I mean, we'll comment on the next call. We are in motion here and we'll let everybody know where we are along the path. And when we have I think, again realistically, I don't think we'll have results from our interaction with this consultant until sometime the second quarter. So, by the end of the second quarter, we will comment on any additional actions we'll take as a result of that interaction.

[Eric Martinuzzi:]

Okay. Thank you.

[N. Robert Hammer:]

And by the way, the management team here is really enthusiastic about it. It's not something that we are thinking as a – we really think, there is an opportunity given where we are in this transformation to bring this consultant in at a time where they could have – and timing is really good, because we have so many things in place that refining it and optimizing it right now is kind of an optimum time for them to come in and provide some additional perspective.

[Eric Martinuzzi:]

Thank you.

[Operator:]

Thank you. And our last question is from Stephen Bersey with MUFG.

[Stephen Bersey:]

Thanks. Hey, just on the move to subscription. Just wondering if you could maybe comment on the interactions you're having with customers around the subscription option for purchases? So, is it being uniformly embraced or are they still doing evaluations? Is it not a good fit for others? And then also are there any product lines that just don't fit with a subscription model? Thanks.

[N. Robert Hammer:]

All our products basically fit, we are being very aggressive with it from a sales standpoint. We lead with subscription and will back off if it doesn't fit the customer's model. We're not going to jam it into a customer just won't buy that way and some won't for internal reasons, but we clearly lead with that model. And I don't know, Brian, if ...

[Brian Carolan:]

Absolutely, I mean it offers up flexibility and also for competitive displacements if customer is already spending OpEx on a competitor's maintenance support contract, this aligns very well in terms of our subscription based offerings and going in, maximizing the use of OpEx budget as opposed to CapEx, so that flexibility really resonates well.

[N. Robert Hammer:]

And also, it's competitive. It ties into the competitive environment out there.

[Brian Carolan:]

And you want to get out from under this whole maintenance renewal, maintenance re-pricing issue.

[N. Robert Hammer:]

So, there's massive motivation for us to be extremely aggressive in driving this forward. And we know it's got a near-term dampening effect on our results, but it clearly strategically is the right thing to do.

[Stephen Bersey:]

Thanks, guys.

[Operator:]

Thank you. And ladies and gentlemen, this concludes our Q&A and conference for today. Thank you for participating. Everyone, have a great day.