Commvault Systems, Inc. (CVLT) Earnings Call Transcript

Hello, and thank you for standing by. My name is Jenny, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Commvault Second Quarter Fiscal Year 2027 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Michael Melnyk, Vice President of Investor Relations. You may begin.

Good morning, and welcome to our earnings conference call. Before we begin, I'd like to remind you that the 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 these forward-looking statements. Commvault does not assume any obligation to update these statements. During this call, Commvault's financial results are presented on a non-GAAP basis. A reconciliation between the non-GAAP and GAAP measures can be found on our website. Thank you again for joining us. Now I'll turn it over to our CEO, Sanjay Mirchandani, for his opening remarks. Sanjay?

Good morning, and thank you for joining us. Before reviewing the results, I'll take a minute to discuss the broader context. We believe that Commvault at the intersection of long-term market trends that are driving our momentum. Massive data growth IT complexity and AI accelerating innovation and risk at scale. All of this makes the need for resilience more critical than ever. Our platform with United State protection, data security, identity resilience and recovery helps us win customers, deepen relationships and meet evolving enterprise needs. Our strategy is working, we delivered solid results ahead of our guided metrics and build momentum across the business. A few highlights in the second quarter include subscription ARR grew 20% to $1.104 billion. SaaS ARR grew 35% to $454 million. Subscription revenue grew 21% to $269 million, and we generated free cash flow of $71 million in the quarter. [indiscernible] going to scale, expanding margins and generating strong cash flow, we believe the combination reflects the strength of our platform and the durability of our model. And as you'll hear from Gary, we are raising our full year outlook. Which demonstrates our confidence in what lies ahead for Commvault. Before we get into that, let's discuss the growth drivers that featured prominently in our Q2 results. First, subscription customer growth. In Q2, we added over 500 subscription customers, representing 17% growth year-on-year. Enterprises are prioritizing investments in cyber resilience and recovery. Customers are telling us that when disruptions occur, they must be able to operate in the state of continuous business. That's why organizations continue to move away from legacy and point solutions and embrace innovation from Commvault. Case in point, a Fortune 500 insurance carrier wanted to advance resilience and stay ahead of evolving security requirements. The customer does Commvault over the legacy vendor in this multimillion-dollar subscription deal for 3 reasons: One, pharma cyber resilience solution demonstrated exceptional time to recovery at scale, which competitors could not match; we enable the customer to consolidate incumbent vendors and other point solutions on our platform; and three, we help the customer reduce risk and complexity. This leads to our next growth driver, multiproduct adoption. Today, more than half of our managed SaaS customers are using more than one offering from Commvault. This is an important indicator of the opportunity ahead. Our strategy is to add customers and even relationships over time. With nearly half of our managed SaaS customers using just one product, we believe significant expansion potential remains. And as our customers look to reduce complexity and risks, we see more opportunities to deliver value on our platform. We believe this land and expand motion can drive durable long-term growth. In addition to foundational products like M365 protection and Air Gap Protect, customers are rapidly embracing our cloud-centric protection offers like Clumio for AWS and Google Cloud and protection for SaaS like Azure DevOps, Microsoft Dynamics and Google Workspace. As a result, customers are realizing greater value as they expand to Commvault. For example, after assessing recovery objectives and cost requirements, a top 50 global asset management company expanded its portfolio and SaaS footprint with compound. This transaction included Clumio, operational recovery and Air Gap Protect. The customer realized greater storage flexibility and better TCO than its prior multivendor solution. In another example, an existing Clumio customer wanted to consolidate its fragmented data protection architecture, the goal improve visibility and recovery times while reducing costs. To support the customers' evolving needs, we signed a multiyear expansion agreement to protect workloads, including M365, Hyper-V as well as Okta and Active Directory. That totaled into our third growth driver, which is focused on identity resilience and data security. As we've stated in previous quarters, identity is a primary entry point for attackers and a growing area of enterprise risk. Recent data shows that nearly 80% of ransom or attacks start with compromised identities. At the same time, nonhuman identities exponentially outcome or human identities. That's by customers are adopting our solutions to make sure that critical systems are resilient and available after Meta. For example, an existing Commvault customer, one of the nation's largest integrated health care systems, added our active directory offering across its global data centers for faster automated recovery. This was our largest active directory transaction to date and contributed to the ARR growth we're seeing with Identity, which nearly doubled year-over-year. When we look at our growth drivers, the common theme is the same. Customers need to keep critical data, identities, agentive workflows and applications protected and recoverable. This is by Commvault chunks. We're also seeing that our conversations with customers and prospects continue to evolve. They want to know how we can help them deploy AI with confidence while mitigating risks. We'll share more about the growing importance of AI resilience and cyber recovery at our upcoming shift conference in [indiscernible] from November 10 to 12. We will also unveil groundbreaking innovations, new partnerships and feature prominent AI visionaries from Anthropic, AWS, Databricks, Microsoft, NVIDIA and others. We hope you can join us in person or virtually. Before I turn it over to Gary to discuss the financials, I'll leave you with this. We believe that AI creates opportunities to expand our total addressable market as enterprises vessel with more data, more identities and more agentic activity. It's also a great moment to participate in initiatives that advance resilience across the industry. To that end, we are proud to be part of Anthropic Project Glasswing. This expands our use of Frontier AI models to include [ Mitas ]. Finally, we believe our relentless focus on execution will continue to deliver durable, profitable growth and strong free cash flow. This gives us the confidence to raise our full year guidance. With that, I will turn it over to Gary to walk through our results and outlook in more detail.

Thank you, Sanjay, and good morning, everyone. Q2 was a strong quarter with solid execution and continued momentum across our SaaS and term software businesses. All 3 growth pillars contributed to the quarter. New customer additions upselling cross-sell and continued momentum from our newer offerings. First, let me walk through our fiscal Q2 results in more detail. starting with subscription ARR and free cash flow, our North Star metrics. As a reminder, we believe these metrics are best evaluated on an annual basis which aligns with how we plan and manage the business. Subscription ARR increased 20% to $1.104 billion. On a constant currency basis, we delivered $51 million of net new subscription ARR, driven by continued strength in our SaaS offerings and improved performance in our term software business. Notably, our term software business, net new ARR improved to $21 million on a constant currency basis. This was driven by continued strength in new customer wins as well as conversions improving to normalized levels. Our SaaS business contributed $30 million to our net new subscription ARR. As a result, SaaS ARR grew 35% year-over-year to $454 million, reflecting new customer growth, multi-positive expansion from existing customers in double-digit growth in ARPA or average revenue per account. We continue to make steady progress in multiproduct adoption, a core pillar of our growth strategy. As of Q2, 53% of Commvault managed SaaS customers are using two or more products, up from approximately 45% a year ago. Subscription ARR growth continues to be supported by the uptake of our identity resilience, [ Indian's ] data security offerings, which represented approximately 30% of net new subscription ARR. We're also seeing increased contribution from emerging cloud-centric and application-based protection offerings. Subscription net dollar retention for subscription NRR was 113% within our normal operating range. This reflects stronger contribution from new customers relative to expansion across the installed base. Cross-sell remains a key growth driver as both our new and existing customers broadly adopt our platform. Now turning to free cash flow. Q2 free cash flow was $71 million. Driven by strong collections and continued discipline across the business. For the fiscal year-to-date period, free cash flow grew 18% to $122 million. Now I will discuss our second quarter income statement performance. Subscription revenue grew 21% to $269 million fueled by SaaS revenue, which grew 33% year-over-year to $106 million. Subscription revenue represented 86% of total revenue compared to 81% in the prior year. Our other revenue line performed in line with expectations, resulting in total revenue growth of 13% to $312 million. Turning to profitability. Gross margins improved 110 basis points year-over-year to 81.6%. The SaaS gross margins expanded 650 basis points to 70%, reflecting ongoing product optimization and our strategic agreements with our hyperscale partners. Operating expenses increased 9% to $185 million, representing 59% of total revenue compared to 61% one year ago. We continue to invest in go-to-market capacity and strategic product initiatives, including our AI recovery road map while maintaining disciplined cost management across the business. Non-GAAP EBIT was $68 million and non-GAAP EBIT margin expanded 330 basis points year-over-year to 21.9%. Turning to capital allocation. We repurchased approximately 808,000 shares for $109 million during the quarter. We are on track to return at least 60% of annual free cash flow to shareholders while preserving balance sheet flexibility. Now I will outline our guidance for the remainder of fiscal year '27. For fiscal Q3, we expect subscription revenue of $293 million to $297 million, representing approximately 15% year-over-year growth at the midpoint resulting in approximately $339 million of total revenue and EBIT margins in the range of 20.5% to 21.0% in including costs associated with their annual shift user conference that occurs in a couple of weeks. For the full fiscal year 2027, we are raising our guidance. Subscription ARR to the range from $1.205 billion to $1.215 billion. representing growth of approximately 19.2% at the midpoint. Our increased full year subscription ARR guidance implies approximately $195 million in net new subscription ARR. Please refer to our earnings presentation for a constant currency reconciliation of our net new ARR guidance. Subscription ARR will continue to be led by our SaaS offerings. Which we expect will exceed $500 million of ARR by the end of the fiscal year. We are also raising our subscription revenue guidance to a range of $1.127 billion to $1.133 billion, representing approximately 16% year-over-year growth at the midpoint. This will result in total revenue of $1.30 billion to $1.31 billion, reflecting the strategic decline of our legacy perpetual software and maintenance revenue streams. Non-GAAP EBIT margins are now projected to be in the range of 21.0% to 21.5%. We also now expect free cash flow of $255 million to $265 million for the full year. As a reminder, Q4 is generally our strongest free cash flow quarter reflecting the collection of calendar year-end renewals. And finally, from a share count perspective, we project a diluted share count of approximately 42 million shares. In closing, our strong first half results demonstrate our ability to scale the business with discipline. We remain focused on growing net new subscription ARR, expanding margins and generating strong free cash flow as we pursue the opportunity ahead. With that, I will open the call for questions. Operator?

[Operator Instructions] Our first question comes from the line of Todd Weller with Stephens.

Gary, can you talk about the improvement in term license net new ARR you saw in the quarter? And then how are you thinking about the second half of the year and maybe frame for us in 3Q versus 4Q from that perspective?

Todd, thank you. It's Gary. I will answer that. We're pleased with the performance of the improvements that plate on the term software ARR. As we think about the drivers, the drivers was driven by new customers. So what we're seeing in an AI first world are now customers that are prioritizing cyber resilience. And we're seeing that flow through both our on-premise business as well as our term. So the strength in the new customer and then the second tailwind that we're seeing strong execution from our core markets team is now being able to execute and sell our more advanced stock of resilience bundles. So no longer a traditional backup, even acceptable in the market. Customers want the highest tier protection that we offer.

The next question comes from the line of Param Singh with Oppenheimer.

I wanted to understand what's the cross-sell opportunity still left for the identity resilience side, I still see it's early days. I guess so, shouldn't we see a little bit more of acceleration in ARR?

Yes. It's Gary. I'll jump in and get this one on identity. So one, yes, a key foundational pillar of our growth strategy is executing against Identity. And dent maintains to be the primary threat vector that the bad actors will penetrate as they start to get into our customers' environment. From a growth driver perspective, what we saw in the first half was strong results from our identity in business, specifically protecting [indiscernible] that was up nearly 10% year-over-year. So really strong performance there. Now as we think about the second half of the fiscal year is when we see larger renewables and is where we expect to accelerate the momentum on the cross-sell opportunity that you're talking about.

Yes. Param, it's Sanjay. So just giving you a little more color on the how, see what happens and this is -- we announced our identity resilience strategy 2 years ago -- almost 2 years ago. And our premise then and our premise now more than ever has been that identity, you have to protect identity because that's the front door that usually gets exploited. Over 80% of the time, and identity compromises what causes a downstream breach. Our strategy is not just about protecting Active Directory or opto or any other directory system. Our strategy is the tying together the cause effect, what happened at the front end of the identity compromised and what did it do all the way through to the business. So it's the implication. Now with AI that becomes even more prevalent and visible because the agent capabilities of nonhuman identities could cause a lot to happen inside an organization. Our separation from the pack is our ability to tie those together and roll it back at the last known good estate over time with the click of a button.

Really appreciate it. If I could really -- as a follow-up, I'm starting to see very early evidence of Agentic AI traffic picking up in the enterprise. Of course, everyone saw on Anthropics last slide. I want to get a sense from you, is there a time lag for backup and recovery, you see that kind of evidence as well in customer adoption? And how should we be thinking about this?

One of the things that we're going to share quite with that high decile in a couple of weeks at our shift conferences that resilience -- recovery and resilience can't be what it used to be. It has to be active, active discovery and active recovery. And in the era of AI, time is not your friend when things go sideways. So we believe that there is a little bit of time like as people start looking at a genetic rollout. But our message to our customers is think about recovery as you build the AI stack. That's what we're doing internally as well. That's what we're sharing with our customers as well. And the product announcements that we're going to bring out in a couple of weeks around the AI stack are going to be in this mode in this forum because -- the days of saying, I have a backup or long gone. What you really need to say is, I know how to recover my business.

Okay. Next question comes from the line of Howard Ma with Guggenheim Securities.

Sanjay, one for you, and then I have one for Gary. Where would you say we are as an industry on the demand curve for core data protection and resilience that driven specifically by AI projects being done more on-prem? Because if you look at the adjacent markets of server and storage, I mean demand for real-time operational use cases is clearly seen an inflection? So should we -- I mean, this is kind of related to the last question, but more on timing, do you expect us to see a similar inflection point for data protection, operational resilience, but just with the lag?

I think, Howard, good to hear from you, too. I think that the -- so first and foremost, we believe that AI deployments in the enterprise as our customers, we see our customers building AI stacks internally and using them for mission-critical capabilities internally. Those will be hybrid. We sense they will be hybrid. The data estate that they use to train their models to build their applications is hybrid. And our solutioning is hybrid by design. We've always been that way. So what we see is that a very sustainable flow as the TAM increases because we do believe that with AI, there's going to be more data protected, more workloads protected and those new types of data and applications to be protected, and they have to be protected almost real enough time. So we believe that there is -- those are -- that's a natural tailwind inside of the enterprise as new applications are built. When you look at what the frontier models are doing, they're generating a whole new slew of things for customers to deal with, which is not just discovering vulnerabilities, but -- and applying patches, but really making sure that you have sort of a pull of true infrastructure because if you believe that the odds are not in your favor and something might happen, whether it's malicious or not, the best security you can have is your ability to recover. And that's a singular premise by which we are working, and we believe that's a tailwind. We think this is going to have an impact for us, for sure, this is -- right now, we're seeing it sort of indirectly, if you would, which is more workloads, more frequently, more capabilities about getting your data in order for AI applications. And I think in a couple of weeks when we announced our new AI-enabled product capabilities, we should see more of a pickup there -- a natural pickup there.

Sanjay, that's really helpful. For Gary, can you help us think about the variability in SaaS net new ARR? Because if you look at the last 3 quarters, including this one, I believe Q4 was $38 million, and that's a seasonally stronger quarter, but it also had some onetime benefit, I believe, related to Clumio. And then Q1 was seasonally lighter at $25 million, and then you just put up this $30 million or $30.5 million quarter wage by the way, if you add up the 25 and 30, that's in line with your comments about the stronger back half, so back half seasonality. But as we look in the back half, just kind of help us think about what are the puts and takes and how -- given that there's more of a consumption, it's still small, but there is a consumption element to the SaaS line now, like how -- essentially how much potential upside or downside could there be in the back half?

Great question. Thanks, Howard. We're extremely pleased with that business there is up 35% year-over-year. There is some variability quarter-to-quarter. It's foundational to why we guide our ARR business on an annual basis. okay? And that primary reason is our customers are hybrid. So depending on the workloads and the projects, will drive the timing. So even if now you just look at the first half of the fiscal year, so just do half over half, the net new ARR driven by SaaS is up, I think, roughly 18% on a constant currency, first half, the first half. I think that's a key metric. The other key metric is we're tracking ahead of our guidance. We believe we will exceed the $500 million target on SaaS ARR by the end of the year. And the foundation of the guidance raise, so as we raised guidance for the second half, the foundation of that raise was built on both the momentum and the visibility that we have of our SaaS business. So we expect that is going to lead where we will end up as we drive into the second half.

Next question comes from the line of Michael Romanelli with Mizuho.

So it sounds like execution improved from a go-to-market perspective, and you highlighted just better adoption of these advanced cyber resilience bundles. I guess can you just elaborate on a bit on that a bit? And then I guess how would you assess the current go-to-market engine, including pipeline generation, sales productivity and coverage in your view, where does the go-to-market still have the greatest opportunity to improve? And I guess, are there any changes to coverage or specialization planned for the second half? And then I have a follow-up.

It's Gary, I'll jump in and Sanjay, if there's anything you want to add, you can finish it all. A bunch of things impact there on the go-to-market. So first, we exceeded our expectations for Q2. So the beat on Q2 actuals was driven solely to go-to-market execution, okay? Higher close rates year-over-year. So they're really proud of the momentum we had, especially in a period where our fiscal Q2 can be seasonally our latest quarter, we executed through it and delivered really strong. So we're in a good space. We will continue to strategically invest in capacity because we think the opportunity that is out there in the market to continue to accelerate growth there. So we will continue to see it, especially on the cloud and the cloud native side. We are -- we will continue to invest in our Clumio products as Clumio expands workloads, and we look to drive those cloud-native workloads, that will be a key area of investment and continued investment for us.

Yes, Michael, I think Gary summed it up. I would just say that we are really focused on making sure our field, our go-to-market organization is squarely focused on helping customers really build that harness to deploy AI as they build the stack inside of the enterprise. So we're working with them to make sure that right from day 0 that they have resilience or even recovery built right into their pipelines. So that becomes important. And all customers are building these applications are starting with making sure that they have the data staying exactly the way they need it. And there, again, we play a part given what we do. So we're spending time with customers, really helping them see how to accelerate their journey with enterprise-grade AI applications, but in a way that protects them from day 0. And that's the important thing because as I said at an earlier question, you can't look at it as the way you could maybe 5 years ago, which is you have a backstop. Here, you've got to be actively discovering and actively recovering.

Got it. Okay. Super helpful color. And then as a follow-up, you've discussed the growing world hyperscaler ecosystems and cloud marketplaces as those channels, I'm sure, how should investors think about their longer-term contribution to potentially new [indiscernible] acquisition and just overall deal sizes for Commvault?

So hyperscaler specifics, I think what we were focused on. If you think about prioritization of the partner ecosystem, right now, we are investing significantly in co-build, co-market and co-sell with the all of the hyperscalers. Our cloud growth is driven solely through the big 3 hyperscalers, okay? And we are no longer relying just on the Microsoft ecosystem with the momentum that we now have with our Clumio business and what we're seeing there from AWS and GCP, we now have best-in-class cloud offerings for our hybrid customers and cloud need customers across all 3 hyperscalers.

And on the marketplace, it's all about meeting customers where they are. If that's the preferred route or customer wants, we're completely enabled across all platforms and all clouds.

Next question comes from the line of Joseph Gallo with Jefferies.

I just want to follow up on the new customer strength. Any trends or geos or product lands or who you're displacing to call out? And should we expect that to continue in the second half? Or will that be more renewal weighted?

Joe, it's Gary. Very strong new customer across both of the on-premise and the SaaS business. So to give you a little more color to give the next click down on the on-premise business, it's driven mainly this quarter. [indiscernible] rates primarily through the Americas, really driven by the large complex [ 4 type ] companies. Now that drags along with it also the SaaS and cloud business because those deals get done as a hybrid arrangement. So excellent momentum there. on the SaaS business, we are now actually accelerating the percentage of SaaS customers that are net new to Commvault. So in Q2, about 40% of our SaaS customers, were net new to Commvault. And I think that's up compared to like 30% a year ago. So what we're seeing is our ability to land not only on premise hybrid, but also straight to the cloud. We have all 3 motions going.

And I'll supplement that by saying that as customers look at AI across the enterprise, the realization that having point solutions or multiple solutions is not the right answer. And so we're seeing a renewed conversation set of conversations around platform consolidation. And hybrid capabilities, and that plays right to our strength.

Joe, I can hit me probably the second part of your question, to, I think, was about second half contribution as it relates to pricing to the mix between new customers and existing. Okay. The guidance was raised based primarily on the expectation on the cross-sell and longer renewables. So if we keep the momentum up and accelerate new customer along with the anticipated cross-sell expansion opportunity we have in our seasonally stronger second half, that will be a great result.

Gary, that was perfect and it leads into what I wanted to follow up on, which was, okay, you feel like you have great visibility into the second half. Within that renewal pool, especially on term, like are you seeing customers sweat assets or just given all the AI talk and strategic importance are people actually pulling forward?

No. So I'll hit the last piece first. There was no change in the dynamics of the quarter on either push out or pull in. So we have -- we track seasonal metrics on both of those patterns and be within our historical norm. So nothing unusual that happened in fiscal Q2. It was excellent sales execution. From a capital expenditure perspective related to hardware, that ultimately becomes our competitive strength because we work with all of the major storage providers helping our customers prioritize hardware if they need it to match their projects is becoming a natural process for now, right? We're now into now a year almost of some of these supply chain headwinds and now it becomes part of our sales motion. The last piece I want to mention to complement that is also now the flexibility to start to take customers straight to the cloud. So there's many applications now depending on supply and hardware availability that we can also help our customers bypass the on-premise and take those workloads straight to the cloud. So we're also seeing some of that contribution as well.

Next question comes from the line of Shrenik Kothari with Baird.

So just a follow-up to an earlier question on identity. I mean you highlighted this largest Active Directory deal and also identity ARR doubling year-on-year. And then also, including our customers are consolidating Optare. Just wanted to understand, previously, you had carried identity as a relatively lower ASP opportunity. Are you starting to see customers beginning to scale either resilience at a broader sort of enterprise scale? And how often are a cloud-native customer relationship expanding into identity and how quick all of that?

SHrenik, let me -- I was scribbling away. Let me parse down your questions. So the first part is around do we see identity really be -- let me paraphrase, a growth driver? Would that be a fair statement?

Yes. Yes, absolutely.

Okay. So the short answer is absolutely. We are investing in R&D rapidly worth -- around the identity resilience because it's for 2 dose timing, we believe that identity was -- when ransomware was prevalent as the core thing -- as the core work that we were trying to protect against identity became a place that we had to start. We've invested heavily ground up building capabilities on identity resilience, and it's multi-platform. And we will continue to grow that. Then we've made sure that we the value we bring to customers is integrating our ability to discover what the vulnerability or the situation with the identity is and the effect it has on the rest of the organization, data, nondata applications, what have you. So the cause effect becomes very important. In light of the Agentic enterprise, the nonhuman identities are proliferating exponentially faster than human identity. Some different studies will show you 1 to 150 to 200 may be growing, and I believe that will keep growing. And as identities grow and they act on new behalf and they have privileges and they can do things autonomously, the ability for us to have full discoverability and not just say what happened, but we're able to tie back to what you need to roll back and the ability to do a bulletproof rollback becomes the value. And we believe that is where things are going. I don't know if I answered your question, but that's what I tried to.

No, that's super helpful. And just a quick follow-up for Gary. You highlighted double ARPA growth and, of course, module product option increasing too. Just looking at the consolidated subscription ARR it was, say, 13%, still very, very strong, but a modest moderation versus prior quarter, if I saw it right, just how to sort of reconcile those and if you can highlight how the larger multiproduct customers are expanding, if there's anything around the [indiscernible] or annual timing? Just wanted to hear your thoughts.

Yes. I can give a little clarity and dig down in their CX subscription net dollar retention was 113%. So remember that I've talked about a baseline of 114 plus or minus 200 basis points on either side of this fiscal year. So we're operating right in the historical range that we've talked about. We put the definition of net dollar retention in the appendix. It's a cohort analysis from 1 year ago. So therefore, all the momentum we would have seen even over the last 2 fiscal quarters on new customer is not -- that calculation does not benefit from. So what we've seen, which is a little bit of a mix in the first half, the mix has gone more weighted towards new customer relative to the expansion on a relative basis. which drives the minor variability in the number. But we are still comfortable with that 114%, plus or minus 200 basis points depending on the new versus existing mix.