Hortonworks' (HDP) CEO Rob Bearden On Q4 2016 Results - Earnings Call Transcript

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Hortonworks (NASDAQ:HDP) Q4 2016 Results Earnings Conference Call February 9, 2017 4:30 PM ET


Reuben Gallegos - Investor Relations

Rob Bearden - Chief Executive Officer

Scott Davidson - Chief Financial Officer

Rajnish Verma - President & Chief Operating Officer

Shaun Connolly - Vice President, Corporate Strategy


Raimo Lenschow - Barclays

Bill Choi - Wunderlich

Brian White - Drexel Hamilton

Abhey Lamba - Mizuho Securities

Greg McDowell - JMP Securities

Tim Klasell - Northland Capital


Good day ladies and gentlemen and welcome to the Fourth Quarter 2016 Hortonworks Earnings Conference Call. At this time all participants are in a listen only mode, later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] as a reminder this conference is being recorded.

I would like to introduce your host for today's conference Reuben Gallegos, Investor Relations. Sir, you may begin.

Reuben Gallegos

Thank you. Good afternoon, and welcome to Hortonworks' Q4 2016 earnings question-and-answer call. Today, we will discuss the results announced in our press release and prepared remarks issued after the market closed. With me are Rob Bearden, our Chairman and CEO; and Scott Davidson, our CFO; Raj Verma, our President and COO; and Shaun Connolly, our Chief Strategy Officer.

During the call, we will make forward-looking statements regarding future events and views about the future financial performance of the company. The statements that we make today are based on assumptions that we believe to be reasonable as of this date and are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks are described in our press release, and are more fully detailed under the caption Risk Factors in our Form 10-K and our other public filings with the SEC. We undertake no obligation to update these statements as a result of new information or future events.

We will also present both GAAP and non-GAAP financial measures. Non-GAAP measures should not be considered in isolation from, as a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing Hortonworks' performance. A reconciliation of GAAP to non-GAAP measures is included in today's press release.

So with that said, I will turn the call over to Rob for some opening comments.

Rob Bearden

Thanks, Reuben. Good afternoon, and thank you all for joining our earnings call. As always I want to start off by thanking our customers, the open source community and our partners and shareholders for their support. The open source data technology is like Apache Hadoop, Apache Spark and Apache NiFi would simply not have the market penetration they do today without you. I am also very proud of the entire team's execution in Q4. They focused and delivered on operational excellence across the board. So thank you to all at Hortonworks for all your hard work.

I'd also like to welcome Raj Verma who recently joined us from TIBCO where he was the Chief Operating Officer. He has been on the team now for about three weeks as our President and Chief Operating Officer and I am excited to have him here. He brings a very strong enterprise sales marketing and operational expertise to the company and I am looking forward to working with him to continue expanding our business and driving the discipline that will help us scale and achieve our mission of managing the world's data.

So in the past two years since taking the company forward we've advanced to a $200 million revenue run rate, we've scaled over 1000 customers and 2100 partners, and we've introduced multiple innovative products including most recently the industry's first collected data architecture.

And we have been steadfast to our reach in this process delivering value for our customers in a 100% open source model which continues to be the cornerstone of our strategy and our commitment to driving innovation through open source remains a distinct competitive advantage and our customers are embracing this in the marketplace are betting with their dollars as of inspired recent results.

So now for today's call I am going to make some brief remarks on our Q4 and full year 2016 performance. I want to touch on our traction in the marketplace and the points of leverage in our model we're experiencing. And after that Scott is going to discuss our financial highlights for 2016 and our outlook for 2017. So I'm going to start with our record Q4 financial results.

And the fourth quarter was strong with record quarterly revenue of $52 million which was growing 39% year-over-year and our operating billings of $81.4 million growing 56% year-over-year. And we achieved our goal of adjusted EBITDA breakeven in the fourth quarter and demonstrated the leverage in our business.

We also saw continued momentum of large deals during Q4 clearly in line with the contract value greater than $1 million and it is also important to note that over half of those deals included both HDP and HDF. Comparatively in the fourth quarter of 2015 we closed 5 subscription deals over $1 million. And finally, our competitive wins in Q4 have never been stronger and in 2016 the migrations from our competitors' platforms to our connected data platforms has never been higher as well.

So now to touch quickly on some of the market penetration and global expansion we've experienced. As you know today cloud computing IoT and Big data analytics are dramatically impacting the IT architectures and our connected data platforms operate convergence as these three massive growth markets, specifically HDP, HDF, our Azure HDInsight's offering and the Hortonworks data cloud for AWS are all uniquely positioned to enable our customers to manage their data across the data center in the cloud and in the hybrid environments. And we continue to see strong momentum carry through all the key verticals that we've focused on, on a global basis.

And just to touch on a few customer success stories from Q4, the first of which is Black Knight Financial Services. They are the premier brand for technology in the mortgage industry and they are using both HDP and HDF for their LoanSphere Data Hub and this Big Data service enables their clients to optimize and measure the underwriting risk that are associated with their loans. And it is designed to collect and analyze the data across many applications and systems wherein sites are utilized to improve the financial performance by driving proactive decision making.

The next customer that I'd like to touch on is Clearsense who is a Big Data focused healthcare IT company and they are leveraging HDF to ingest the data from several different hospital and healthcare systems into HDP where they run a series of analytics to provide real-time intelligence to proactively address the clinical operational and financial challenges at the point of decision.

And the last I'll touch on is the Q-sign IT [ph] which is one of our customers from the Netherlands and they are using again the HDP and HDF to secure the organization's insides around the cyber threats that they are experiencing as well as the malicious activity on a global scale and what they are doing is they are passing through massive amounts of data and then being able to provide very specific and corrected information which will then remediate some of their security incidents that their customer's could experience.

Now I'm going to turn to turn to some of the points of leverage. And as we entered into 2017 I began to think about the points of leverage in terms of what can be done with some of the foundational work that we developed in the past and I'm going to touch on a few of these. And as you'll recall, coming into the back half of 2016 we began to really refine our sales and go-to-market strategies including how we reallocated some of the dollars between sales and marketing to give us a better coverage model and ultimately it clearly has yielded great results.

And we also focused on hiring new international leadership and became very focused on improving the operational efficiencies within the professional services organization. We've had great results from that and in 2017 we are going to continue to invest deeply and then expand our presence across the international markets. We are going to continue to expand our channel relationships with SIs, ISPs and the OEMs in order to ensure that we're driving more usage and get more leverage from our existing as well as from the new solutions that we've recently announced and offered.

And on the products side our transition to a multiplatform and cloud solution company is now solidly in place and enabled several new ways for us to engage with our customers to monetize On-Premise and that's either in the cloud or in the hybrid environment and some product highlights I'd like to touch on. And I'd like to start with our Azure HDInsight and point out that there was a notable month over month usage growth in Q4 for the HDInsight customers that we're actively engaged with.

The next is the Hortonworks data cloud for AWS which is our new cloud service that we launched in Q4 and this enables us to target now the Amazon Web Services ecosystem with our connected data platform value proposition that drives new levels of usage that are based, whether they are based on-premise or in the hybrid cloud opportunities.

And then the next area that I'd like to point out is around Hortonworks DataFlow platform or HDF and the customer adoption has really accelerated with HDF significantly throughout 2016. It is growing approximately 6x year-over-year and we're continuing to see very robust attach rates of HDF by our existing HDP customers and we're seeing that continue to accelerate.

Last point that I'll touch on is our EDW optimization solution which launched in February and it is really targeted at the Enterprise Data Warehouse and business intelligence market. It is an easy to implement model of eye solution built on HDP.

And as now I'm looking ahead at the developments in the Big Data market. We believe very solidly that we can continue to further leverage our existing R&D investments for utilization across other significant data intensive technologies like artificial intelligence and the machine learning environments where the interest in this continues to grow significantly.

And so in summary I want to wrap up by pointing out how proud of the Hortonworks team I am with their strong performance and the fantastic end of 2016. And we are uniquely positioned at the intersection now of Big Data cloud and the IoT megatrends and we are working extremely hard to meet the demands for our customers who are deploying open source solutions under their next generation enterprise data architecture and we do that spanning both the cloud and the data center. But most importantly, the great news is we're not doing this alone. Again, I want to thank our customers, the open source community, our partners, employees and shareholders.

And that wraps up my remarks and now Scott is going to recap Q4 and the full year 2016 financial highlights. So Scott?

Scott Davidson

Great, so thanks Rob. So I'll start by providing the details on the fourth quarter and full year 2016 performance and then conclude with the outlook for the first quarter and full year 2017. For Q4 2016 total revenue was $52 million up 39% compared to the prior year and support subscription revenue was $35.6 million up 39% compared to last year.

In the fourth quarter 68% of total revenue was comprised of subscription revenue which was similar to the prior year. For full year 2016 total revenue was $184.5 million up 51% compared to the prior year and support subscription revenue with $126.7 million up 63% compared to the prior year. Subscription revenue represented 69% of total revenue which is five points higher year-over-year from a product mix perspective.

In Q2 2016 total operating billings and operating measure representing the collective value of our customer invoices for the period were $81.4 million up 56% year-over-year. For the year total operating billings were $269.9 million up 63% year-over-year. From a deal perspective as Rob touched on we had nine deals over $1 million in the fourth quarter and this was almost twice as much as we had million dollar deals in the comparable in 2015. The dollar-based net expansion rate for was $131% over the trailing four quarters.

International revenue for Q4 accounted for approximately 24% of total revenue and grew approximately 121% year-over-year. For Q4 2016 GAAP gross margin was 65% approximately 7 percentage points higher than the same period in 2015. The change was driven by mix in terms of more subscription revenue and also by efficiencies within our professional services organization. Q4 2016 non-GAAP gross margin was 68% compared to 61% for the same period in 2015. For the full year 2016 gross margin was 61% with non-GAAP gross margin of 64%, both improved year-over-year by 6 percentage points and 7 percentage points respectively.

Turning to the expenses, the operating leverage trend on an absolute basis continues to improve. In Q4 2016 the non-GAAP operative margin improved by approximately 29 percentage points to negative 59%. For the full year 2016 non-GAAP operating margin improved year-over-year by proximally 30 percentage points to negative 80%. In Q4 2016 non-GAAP sales and marketing expense was 21% over the prior year versus revenue which grew 39%.

In Q4 2016 non-GAAP sales and marketing expense as a percent of revenue declined by 12 percentage points compared to the prior year. We've continued to make targeted investments in this area, especially internationally to support sales coverage and associated solution engineers. In Q4 non-GAAP research and development expense increased 16% year-over-year to $15.2 million, primarily driven by headcount while the non-GAAP G&A expense increased by 16% to $11.1 million.

Deferred revenue was $185.4 million at year-end. It increased at 18% over the $156.8 million reported in the September quarter and a 74% increase over the $106.8 million reported in the comparable period of December 31, 2015. Short-term deferred revenue increased 23% sequentially.

Operating cash flow was negative $600,000 which was better than plan and a result of stronger collections related to deals that closed early within the quarter and tighter expense controls. Within Q1 we expect to see negative mid teens operating cash flow as Q1 expenses increased sequentially due to hiring within our sales organizations and sales pickup in addition to the impact from payroll taxes across the workforce. We also continue to target operating cash flow breakeven sometime between Q3 and Q4 of this year.

We exited 2016 with total cash and investment balances of $89.2 million and have access to another $30 million revolving credit facility that we put in place to provide us the flexibility in managing working capital.

Now turning to the outlook, at this point we will typically jump into the guidance, but let me provide some additional commentary that will give you some context as it relates to our guidance. Since going public our operating model has evolved. At that time we offered a single Hadoop based solution which was deployed on-premise and primarily linked to annual support contract.

For customers that required a fully managed service it was HDI and Microsoft Azure. Now let's fast forward to today where we offer a comprehensive connected data platform. Customer use cases are varied and deployment options range from on-premise to hybrid environments and may also span many public clouds.

Customer consumption behavior has evolved as well requiring flexibility cross our respective business relationships with them. This evolution has in fact shaped many of the larger deals that we executed in 2016 including several of the nine deals that we did over a million in Q4 2016. We're now operating a scale with a $200 million a year revenue run rate where these broader deployment and consumption trends impact traditional metrics.

In particular, billings becomes less relevant when renewals and upsells get co-termed, durations change and usage models in the cloud become more prominent. In some cases an isolated billings number may not adequately illustrate the economics of a particular transaction. Even these changes for 2017 were pivoting the guide upon the metrics of revenue and operating margin and we find that these metrics are consistent with our peer group many of which are seeing similar trends in the market and most importantly consistent with how we have evolved to run the business today.

So as of February 9, 2017 we provide the following financial outlook for the first quarter and full year 2017. For the first quarter of 2017 we expect total GAAP revenue of $52 million, GAAP operating profit margin between negative 115% and negative 110% and non-GAAP operating profit margin between 65% and 60%. On a full-year basis revenue between $235 million and $240 million, GAAP operating profit margin between negative 85% and negative 80%, and the non-GAAP operating margin between negative 50% and negative 45%.

I'll just note that the GAAP operating margin outlook includes estimates of stock-based comp, amortization of purchased intangibles in future period and also assumes among other things the occurrence of no acquisitions, other investments or restructuring and no revisions to stock-based comp or related expenses.

That concludes the final recap and let's open it up to Q&A.

Question-and-Answer Session


[Operator Instructions] And our first question comes from Philip Winslow from Wells Fargo Securities. Your line is open.

Unidentified Analyst

Hey, thanks for taking my question, it is actually Michael Barris [ph] on for Phil. Congrats on the quarter guys. I just wanted to followup on sales productivity, obviously you've made some changes to your sales force over the course of the year as you've noted, can you talk about how you see sales force productivity trending throughout 2017 and maybe that's how that's reflected in your guidance? And then I just have one followup after that, thanks.

afor pilots reflected in your guidance and i follow x on making sure that we continue to really really have the proper coverage models that were granting reps faster that we are improving the time of the first deal as well as the time to their second and expansion bill really following our land and expand model and i'm very proud of the teams work that they could include the really refining our overall sales model and sales methodology so that very focused on making sure that our management team has a very definitive and granular quarterly cadence that that insurers that cover the right accounts were engaged with delight customers were getting our reps to the point where they're getting their transactions closed accurately within the quarterly time trying to the were expect the transaction to happen other growing appropriately and then making sure their customers are getting thousand and will be seen by doing that is reducing the time of the rep making the reps more productive overall

Rob Bearden

Yes I mean, we are super focused on making sure that we continue to really, really, have the profit coverage models that we're ramping reps faster, that we are improving the time to their first deal as well as the time to their second and expansion deal, really following our land and expand model.

And I'm very proud of the teams, work that they've put into to really refining our overall sales model and sales methodology so that we're very focused on making sure that we – our management team has a very definitive granular quarterly cadence that ensures that we are covering the right accounts, we’re engaged with the right customers, we’re getting our reps to a point where they are getting their transactions closed accurately within the quarterly timeframe that we’re expecting that transaction to happen, they’re growing appropriately and then making sure that our customers are getting value.

And what we see by doing that is we're reducing the ramp time of the rep, we're making the reps more productive overall. Deal size we believe going forward we’ll continue to expand.

Rajnish Verma

And Michael I’d add to that, there isn’t anything specific in the guidance that has any presumption on dramatic changes as it relates to productivity, the guidance driven especially off of the revenue components coming off the deferred revenue, so there is a line on sight on that regardless of productivity changes. Clearly, it has an impact in sort of future growth, but there is nothing inherent in the guidance that assumes any change from what we've seen historically.

Unidentified Analyst

Got it, thanks for the color. And then just a quick follow up on you EDW solution that you rolled out in February, I wanted to take a little deeper kind of what’s been the early customer feedback on that and how are customers trying to balance their existing kind of legacy EDW with may be kind of a newer EDW based on Hadoop, what sort of dynamics are you guys seeing there?

Rob Bearden

Yes, couple of reports to that question, the first one is we just announced this really in February earlier this month and the interest has been significant, I would classify as and we’re very pleased with the reception that not only from our customer base, but from sort of a new light space which is really the point – of your second point of your question which is the existing EDWs platforms do what they do and they are in place, when they do it very well.

So the new emerging space that has new and different needs that our new offering and solution addresses very well with a lot of flexibility and of course all built on top of HDP. And so that’s a whole new white space for us to again expand HDP into and that’s part of the sales refine that we're really making sure that our team understands and is getting very proficient at selling solutions that we're providing. And that actually what it does is it meets our top line objective which is to help our customers get the value very fast. And that kind of very focused solution helps them get up to speed and running and delivering value to them very, very quickly.

Unidentified Analyst

Got it. Thanks.


And our next question comes from Raimo Lenschow from Barclays Capital. Your line is open.

Raimo Lenschow

Hey, thanks for taking my question. Two quick ones, Scott, I mean since you take away billings and for us it is a forward looking metrics, can you just talk a little bit about to what’s the evolution of the business model maybe we were up kind of timing there because it's obviously that’s was the one forward looking metrics we were using, but I haven’t quite appreciated how much diversity you had gotten in the overall model. May you could just talk more towards what you see in terms of cloud and how much is coming out of the cloud et cetera, just to get us more comfortable around that one and then I have one follow up.

Rob Bearden

Yes, hey Raimo. So he who taketh also giveth because I provided an operating margin and so I guess we’re even. But I hear you. So here is the dynamic and I'll give you a perfect example. So I'm going to answer the questions in reverse. We’ve seen roughly 20, 25% of our business these days that's running in either hybrid and/or cloud models. And so, when we go back to even two years ago on the IPO roadshow as I said in my prepared remarks a predominant amount of our customers were on-prem annual ACV type contracts at that point. So that 25% has happened in the last couple of years.

In those models where there are consumed as you go or pay as you go, the timing of when something is billed whether it be all up upfront over the year or monthly or quarterly changes. And so the other dynamic that we see is as customers just in general get comfortable with sort of pay as you go models in hybrid or cloud or there are other sort of SaaS type providers, at times they'll come through and negotiate deals and they will say, we could pay you upfront or maybe we want to pay you semi-annually or something like that.

So if you take a typical deal that’s $100,000 deal, if you get paid or billed upfront it’s a $100,000 upfront versus semi-annually becomes two deals split in half. And so dialling in what that exact number would be for that particular customer even though the economics may be the same in the end is what’s getting increasingly more difficult to provide and then when you layer in hybrid architectures, it makes the billings metric or a very tight dialled in billings metrics, sort of an optic that is interesting, but not necessarily something we would want to drive to from a better economic deal for the company.

So, better off to sort of drive off a more consistent metrics is what we are seeing with the rest of the companies going through this which is revenue operating margin and sort of focused on that, that’s kind of what’s happening there.

Raimo Lenschow

Okay, perfect. And then with one – if you get in you had to sales, is there any I mean usually new person wants to kind of put his foot down and to do it his way, do you expect any major changes to the sales organization as a result of that, so may be talk to that a little bit? Thank you.

Rob Bearden

Sure, well, Raj is actually the person, Chief Operating Officer and we have some terrific leadership in place right now in the Americas and as we talked about on the last call, the Americas is just lower [ph] and we brought that APAC and EMEA leadership in last quarter and they made significant contribution and impact in the fourth quarter. Raj has met all of the team at this point. Speaking for him a bit since I mentioned this question may be called but we see no evolution or change there with that leadership. They've always executed extraordinarily well.

As we came out in the second half, the leadership team across the America’s was very involved and engaged in making the changes to the model that we made, all executed extraordinarily well really all year, but especially in the back half of the year as you can see by the numbers. And we are just going to continued to do what they've done and help – give them the tools to make them more efficient and bring more leverage.

We’re going to get smarter with things that we do around digital to get more leverage from better managing on the digital side. That work has been well underway and starting to kick in quite frankly. And we’re seeing that the results and benefit of that. We’re going to make sure that we continue to with that team expand into the new channels and continue the great work that’s been done by our channel team to drive deeper engagements with SIs and OEMs and the cloud providers.

We see all of those channels that were getting leverage from that’s equation from a velocity standpoint. So it's about continuing to get leverage from those incremental channels and to get the tools and the managing back to the leadership across the world, the APAC and Americas and let them continue to execute at the high levels they always have.

Raimo Lenschow

Okay, perfect. Thank you.


And our next question comes from Bill Choi from Wunderlich. Your line is open.

Bill Choi

Okay, thank you. Now that revenue takes on added importance and our ability to analyze the business, I wonder if you could oblige just in giving us a longer revenue color. When you mentioned 20% to 25% of the business is hybrid and the cloud is there a way to get relative magnitude of how much this cloud usage pay as you go is the revenue today and kind of run through any unit economics of how AWS marketplace and HDInsight works?

And then lastly on looking at the billings to revenue, what are you doing if they need to shortened the enablement period to reach the subscriptions when you enable customers from large new deployments? Thanks.

Scott Davidson

So, Bill on the question about what composition of revenue comes from cloud based sort of environments it's, the AWS revenue at this point has just literally started. So we just launched it in the tail end of Q4, so it doesn’t have the impact. The Microsoft revenue we haven’t broken that out, but the difference here is really the timing of it. And so when we get to the point where it moves the needle on revenue in terms of GAAP revenue what that composition is, I’m happy to break it out when its material.

It's not material at this point on the revenue stream, but it's absolutely material when you think about what the mix would look like relative to forecasting a billings number. And so, the specific answer to that question is, if I have $100 ACV deal that I bill upfront I can tell you that the billings will be a 100 bucks versus if it goes to Microsoft Azure it's probably one 12th of that. So if I set a target that’s a $100 I’m going to wilfully miss it on a go forward basis, so that's the purpose right, we’re seeing some of that. To answer the question directly on what percentage it does, it’s not material, it is less than 10% at this point.

Bill Choi

Any information on may be unit economics, we know the pricing per quarter when we look at perpetual deployments, but anything else that will help us in looking at unit economics?

Rob Bearden

In what sense when we talk about unit economics of both cloud or yes, go ahead.

Bill Choi

That’s right, so just pure as you go cloud based models pivotal HTN [ph] sites when the usage grows is there a dollar number that you can detach those usage?

Rob Bearden

So we get paid, so two different structures whether its AWS where it’s a revenue share based upon usage on the AWS infrastructure similar to let's say an Apple iTunes account, or Apple app account. So it's somewhere in the 80-20 range in terms of the usage. But the usage depends upon the amount of the data, the size of the machine, there is a lot of variables on that I guess. From a Microsoft perspective, it’s a different solution because it’s a fully managed solution and so it's not just purely based on workloads. We have an arrangement with Microsoft, we're based on usage we get paid per usage hour and we can’t disclose that contractually.

Bill Choi

Okay and then last question about the enablement period shortening the consulting aspects of it to get to subscription faster?

Rob Bearden

So, I’m not sure I understand exactly what you say about getting to subscription faster, may be you can explain that a little bit to me.

Bill Choi

Yes, as you were talking about go-to-market, I’m just talking about the time of customer engagement to setting up the environment to be able to really drive the usage, what if any are you doing to shorten that and accelerate usage faster?

Rob Bearden

So, generally speaking I'd say you know if you look at our mix of business it's been about 80-20 in terms of subscription and professional services. Our larger deals clearly a lot of the million dollar deals even a lot of the 500K plus deals have professional services attached to them. And so in terms of trying to shorten time to value its building best practices and the center of excellence in all the things that you would expect us to do to enable them to stand up that solution quicker and get you their end result which is you know whether it's an analytic solution or managing inventory better what have you, some of what we're - we spent time on in 2015 and 2016 is our vertical solutions groups within our marketing world which has a lot of expertise around our solution engineering team and going to market with specific vertical approaches in those industries in order to shorten time to value. So we’ll have more dollars in terms of investment and focus on that going forward on some of those bigger deals for sure.

Bill Choi

Thank you.


And our next question comes from Brian White from Drexel. Your line is open.

Brian White

Yes Rob, I’m wondering if you could a talk a little bit about HDF and may be provide a little color and what percent of your customer base today's using HDF, I'd just be curious how you’re thinking about this product area for 2017? Thanks.

Rob Bearden

Okay, great we’re incredibly excited about HDF. As you know we part of the company a little over a year ago it’s just a phenomenal team and its a platform that’s opened up a lot of doors and opportunities for us and opened up many revenue streams that we would not have had the opportunity to take with just a, with just HDP so it is more importantly it just increases the time, the value, that the customer gets and it lets us bring their data under management from the point of origin and they manage that data through its entire lifecycle. So it becomes a very strategic cornerstone and the enterprise being able to re-architect their entire data strategy.

And so, if you look in Q4 you just heard Q4 narrative was about 50% of our over half our deals that were over $1 million had HDF in them. And a major position of that may have, percentage of that million dollars was. And then about 25% at this point of our customer base, of our HDP customer base has adopted HDF and in some form. And the being the velocity of that increased quite significantly.

And we are also seeing our competitors' platform adopt HDF as well to be the ingestion engine in the dataflow platform into their platform. So, very excited about it, it's becoming a great revenue stream, but more importantly what it’s really doing is its helping our customers get to time to value much faster and enable them to move their next, move into their next generation modern-day architecture much more nimbly and quickly.

Brian White

And Rob, this announcement to data cloud for Amazon Web services we talked about a little bit here on the call, but is this something the initiative that will matter in 2017 or it will not have a material impact in 2017?

Rob Bearden

Yes, it will be impactful in 2017.

Brian White

Great, thank you.


And our next question comes from Abhey Lamba from Mizuho Securities. Your line is open.

Abhey Lamba

Yes, thank you. Good quarter guys. Rob in terms of your deployment on AWS, how does your version differentiate from Amazon Zone [ph] offering, what should a customer pay for your distribution of Amazon's version on the cloud?

Rob Bearden

Yes, I am going to have Shaun touch on the first part of that and then I'll probably follow with that in a bit.

Shaun Connolly

Yes, this is Shaun Connolly. So as we covered on the call, our approach really is about connecting all of your data and enabling you to analyze that data wherever it may reside. We have strong solutions on Azure what data cloud gives us a first class service on AWS on-prem with HDF being sort of that universal data router that can get the data to all those workloads simultaneously. So that's one element of choice and the ability to run wherever you need run in a consistent way, is one way we differentiate generally.

Form a specifics on the [indiscernible] data cloud for AWS we basically curated very targeted use cases that are well tuned to booted up go to your job shut it down type used cases so data expiration and data science and things like that where it’s the more the self service type of enabler where the data is in Amazon S3 as is back in store. So, things like common security, common metadata management and those types of things that are deep in our platform today as far as enterprise services applying to that area. So, granular security making sure you have data protection around that data. That’s how we will differentiate their versus some of the basic services that they may find there.

Abhey Lamba

Got it and Scott, you talked about heading upgrading cash flow breakeven in Q3 or Q4, how about free cash flows and should we expect it to be consistently cash flow positive beyond that?

Scott Davidson

Yes, I don’t want to talk beyond that yet, Q3, Q4 seems a long way out, but from a - if you think about free cash flow we have been running may be $2 million to $3 million a quarter on CapEx. Q4 was a little light, I think it was under $2 million, but I think once we get to the sort of breakeven number sometime between Q3 and Q4 we will reassess to how much above that we want to punch. If you look at where the investment opportunities are for us one of those being international with the international revenue growing over 120% it may dictate we'll make those decisions when we get there. But we’ve got some big markets as Rob talked about and we know getting to cash flow breakeven is extraordinarily important and we’ll reassess after we fill up that.

Abhey Lamba

Got it and thanks. Let me try it a little differently, do you feel comfortable with the cash balance that you have that we won’t need any more capital raise or do you think organically you are on the right track to kind of built it out from here? That’s it from me.

Scott Davidson

Yes, we feel organically we are on the right track and say there is roughly $89.2 million is what I talk about at year end and we also had the $30 million available from the line of credit to access as well. So if you look what I guided to in terms of burn in Q1 and you can kind of back into the rest of the year, were comfortable with that as of right now.

Abhey Lamba

Thank you.


And our next question comes from Greg McDowell from JMP Securities. Your line is open.

Greg McDowell

Thank you very much. It feels like the velocity of operating margin expansion is may be accelerating as you mentioned in 2016 it was up around 30 percentage points and looking at the guidance it implies 30% to 35% increase. And I was just wondering if you could talk through the gross margin leverage and operating margin leverage in 2017 and whether it attracts similarly to the way that the margin expansion played out in 2016? Thanks.

Rob Bearden

Yes, hi Greg. So, you guys heard me say this before right, 90% of the cost structure here is headcount driven and it comes down to sort of where and how we make those investments and hire people. So, if you think about sort of the gross margin piece specifically 80% of the revenue is tied to subscription. And so, we are different than a lot other software companies right. We sell support subscription and we don’t typically sell a product or license right.

So, a lot of the investment on the gross margin subscription side goes to our team that actually deals with and handles customers day-to-day and solves the problem and exemplifies the value that we actually sell. So the idea around that is, as you bring customers on target similar margins on the subscription side and do it as you bring those customers on and but do it efficiently, so that you shouldn’t see any change on the gross margin side.

On the professional services side, the professional services margins when you look off of a revenue basis tend to oscillate a little bit and I’ve explained that’s related to the fact that we don’t have VSOE and so, the revenue on the services side will come in not as smoothly as if you had VSOE. So when we talk about the gross margin on the services side, we typically kind of look at that against what we build those customers on a daily basis. So when our guys are in there delivering ours, we seek to keep them at somewhere in the 15% to 20% margin range.

There is nothing different in the 2017 model on the gross line which is a long way to kind of get there to tell you we’re going to take what we’ve been doing and keep doing it. So one area where there is some opportunity for continuation of pull through from what we saw in Q4 is on our training business.

Our training business showed huge strides in profitability, it’s a small number, but with the training resources that we had in Q4 we did quite well and so we’ve got opportunities to extend that, so net-net no dramatic changes on the gross side.

On the other line items between R&D, G&A and sales and marketing, most of the investments that we’ve made in the back half of the year has been focused on sales specifically. We reallocated dollars between marketing and sales as Rob talked about and we’ll continue to make investments in sales as I provided commentary on where we are going in Q1 and you might surprise, not be surprised to learn that some of that’s going to be internationally because that’s where we are seeing a lot of Greenfield opportunity.

On the G&A side we got to have the structure to support it, but the biggest projects underway on the G&A side is the 606 implementation for new rev guidance that will take some work in dollars. And then on the R&D side, Rob touched on some really very provocative conversation around some of the new products and solutions that we have created within an existing group or team that hasn’t received incremental investment. So we look to pull through that leverage and it's all targeted frankly to get to that cash flow number that we're talking about between Q3 and Q4. So in sort yes, it should be more of the same, but that’s some of the color around line items if that’s helpful.

Greg McDowell

Yes, totally helpful. Thank you for the detailed response and since you brought up ASC 606 I might as well ask about it and may be some of the puts and takes in your model of how you think about it, whether you want to be an early adopter, see how it plays out, how you know the lack of VSOE plays into the equation? And I know that it's may be a loaded question but anything you could share about 606 as you work with that the orders and such with I think would be helpful? Thanks.

Scott Davidson

Yes, so as my controller likes to tell me, I’ve got now I think its 320 days or something left and countdown clock kind of moves on. We’re not going to be an early adopter I'm comfortable saying that right now. We will adopt it 118 and you will see some of the commentary in our 10-K when we file that as to sort of what our thoughts and approaches are. I think we are a little bit unique in terms of not having VSOE and moving to the standard, so let's sort of bypass and you've heard me say many times, by the time we were to probably establish VSOE to standard changes and there is no difference there.

I think the two areas where you will see, the bigger changes and lot of it is us, but broadly across many other companies is around the definition of sort of identifying these standalone selling prices for products and your revenue streams and everything is tried to support obligations or your obligations which for us are support in professional services. So a lot of the work gets into identifying that and ultimately what may come out of this is some revenue at some companies and we may be one of them, we may get recognized earlier than it had been in the past.

For us things have been deferred a lot more than they normally would have been because of the lack of VSOE, but 606 has some different contours that may change the recognition and timing that may in some cases be earlier. The other big aspect in terms of where it hits a lot of companies including us is today commission expense in our model is expense at the time of sale up front and one of the new contours under 606 is sort of spreading that over a longer period. So it’s going to sort of reduce some of that upfront expense, pushed it over a longer period of time and we could say sort of smooth if you will the expense profile.

But we're sort of - we’re looking at a lot of the different scenarios and spending a lot of time with our audit team, their systems implications to that. And as we move through it we'll give you sort of updates and reports. But it has the biggest implication to what’s sitting in deferred for a lot of companies and that’s where the change is going to have to be identified and scoped and people get comfortable around it. We're a good 300 days away from that.

Greg McDowell

Great, thank you Scott.

Rob Bearden

Right, operator we’ll take one last question please.


Alright and our final question comes from Tim Klasell from Northland Securities. Your line is open.

Tim Klasell

Hey, guys just a quick question, first of all on the large deals, nine this quarter, I know last year was, assuming last quarter was a nice spike and do you think a few of the deals that you have got may be we’re going to close this quarter closed early last quarter, how should we think about that going forward?

Scott Davidson

Yes, I think we were very much just. We’re following our cadence and we closed what were comfortable with the Q3, Q4 and we’re excited about our pipeline for Q1 and its never smooth as you want it to be, but we're - I’m very pleased with the level of inspection and predictability that is coming through the forecast.

Rob Bearden

Tim, I'd just say the big deal like that, I mean they kind of land when they land, its nine versus 10 or 10 versus nine, it’s like sort of we’ll know them down when we get them.

Tim Klasell

Good, good and then international, as you go international does the competitive landscape change, what’s different as far as buying open source solution and services internationally compared to the U.S. and what should we expect to that sort of does it change going forward?

Rob Bearden

Here in many of the international markets especially on the governmental agencies that actually required to look at open sources that is the fault for their solutions, but and so that’s becoming a great opportunity on the government agency side many of those countries. But what we have experienced is that just generally in EMEA, APAC really for that matter too, they are couple of years behind the U.S. in their adoption. But we’ve seen that inflection point in that also have a point to where now it has created – it has become a critical mass of the doctors.

There has been a enough successes across many, many different industries where the use cases are well understood, the text certainly is solid. And now they are moving to take those solutions and put them in a production on a pretty frequent basis and the high velocity basis. And so it's kind of where the U.S. was two years ago and there has been, and now is the time for us to engage in those markets and take advantage of that inflection point that's formed.

We made that first entry with the leadership that we put in place and that EMEA and APAC and the teams there have really, really performed well in Q4. I’m just very pleased about their pipeline for 2017 generally and specially for Q1.

Tim Klasell

Okay, great, great and then one final one. If you take a look at your pipeline you've obviously got a broader solutions set or broader delivery model and options which one or two are growing the fastest, the ones that you are the most excited about for, for this year may be 2018?

Rob Bearden

I’m not exactly sure I understand when you say…

Tim Klasell

Which one do you think will, which new products that’s are delivery models will deliver the most absolute dollar growth in 2017, 2018?

Rob Bearden

That’s like asking me which one my kids are about favoured, we think they are all grey inside.

Tim Klasell

Well, number who comes bigger, some of them run faster there is no favouritism in that.

Rob Bearden

But yes, they all will play their place and they will all come on as you are [indiscernible]. Yes, HDP will still be the mother ship and generate for 2017 the biggest percentage just because that's the market that has them and I think we're going to see it if I were to tell you which one is going to grow the fastest it will be HDF. That’s a $1.4 trillion market IoT market that HDF data flow is positioned squarely in the middle of that streaming opportunity.

And so we're going to see significant growth because we get the leverage from our existing customer base plus that huge trillion dollar market. The reception that we have gotten from our EDW optimization and solution has been phenomenal just in the last few weeks. And so I feel gifted it will exceed our internal revenue projection by how much I don’t know but I have high expectations there. Our teams have done a great job, getting that out into the field.

And then both of our cloud offerings, HDInsight and our Amazon offering we're seeing that very steady, we have talked about the acceleration of growth on the HDInsight customers that were engaged with in the quarter and I think that momentum continues to get and then we've got some other products that we'll be announcing soon that are going to really bring all of this to the next level.

And I think the sky is the limit there for new product offerings that will also ring in particular that we'll be announcing here in the next 90 days or so that we’re very excited about. So it’s not a very - one or the other. They all were still indicated as we anticipate HDP being the core HDF plan that pivot play is probably the highest grower because of its presence and an enabler of those one trillion plus dollar market that it plays in and cloud coming on very strong.

Tim Klasell

Okay, very good. We’ll watch out for those product announcements.

Rob Bearden

Alright guys, well listen hey, we’re going to wrap it up and we really appreciate your time and joining. We’re excited about where the company is and where the market opportunity evolves too and we'll look forward to seeing you all next quarter. Thank you.


Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.

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