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Edited Transcript of CARB earnings conference call or presentation 25-Jul-19 9:30pm GMT

Q2 2019 Carbonite Inc Earnings Call

Boston Jul 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Carbonite Inc earnings conference call or presentation Thursday, July 25, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Folger

Carbonite, Inc. - CFO & Treasurer

* Jeremiah Sisitsky

Carbonite, Inc. - VP of IR

* Stephen Munford

Carbonite, Inc. - Interim CEO & Executive Chairman of the Board

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Conference Call Participants

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* Ben Zion Rose

Battle Road Research Ltd. - Founder, President & Analyst

* Brad Robert Reback

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Brian Jeffrey Schwartz

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Chad Michael Bennett

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Eric Martinuzzi

Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst

* Erik Loren Suppiger

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Jason Noah Ader

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Saket Kalia

Barclays Bank PLC, Research Division - Senior Analyst

* Sarkis Sherbetchyan

B. Riley FBR, Inc., Research Division - Associate Analyst

* Timothy Elmer Klasell

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Carbonite Second Quarter 2019 Earnings Results Conference Call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Jerry Sisitsky. Please go ahead.

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Jeremiah Sisitsky, Carbonite, Inc. - VP of IR [2]

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Thank you, Dawn, and welcome, everyone. With me on the call today are Steve Munford, Carbonite's Interim CEO; and Anthony Folger, our CFO.

Any forward-looking statements in this call are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including financial guidance, outlook, anticipated results and similar items, including without limitation expressions using the terminology may, will, believe, expects, plans, anticipates and expressions which reflect something other than historical facts are intended to identify forward-looking statements.

Forward-looking statements involve a number of risks and uncertainties, including those discussed in the Risk Factors section of our Form 10-K and 10-Q. Actual results may differ materially from any forward-looking statements and the company undertakes no obligation to revise or update forward-looking statements except as required by law.

All the financial figures discussed today are non-GAAP financial measures unless it is stated that the measure is a GAAP number. A reconciliation can be found in our financial results press release, which is available on our IR website. Also posted to our Investor Relations website is our quarterly financials in an Excel version as well as a slide deck that accompanies our financial results conference call.

With that, I'll turn the call over to Steve. Steve?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [3]

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Thank you, Jerry, and welcome. I'm really, really pleased to be here and excited to take on the role of interim CEO. I appreciate the opportunity to help guide the company during this transition period while the Board searches for a permanent CEO.

Today, I would like to share with you 3 themes: first of all, my background and the transition; secondly, comments on the quarter; and thirdly, my priorities moving forward.

Before, we get to these points, I wanted to thank Mohamad. He joined as CEO about 5 years ago and has helped transition this business into what it is today, a leader in data protection and security. We thank him for his contribution and wish him the very best in his next chapter.

For those of you who don't know me, I have been on the Carbonite Board since 2014, serving as Chairperson since 2016. I spent the past 20 years of my career in the security software space with the majority of that in endpoint security. I served as an adviser to Absolute Software prior to becoming the interim CEO last year. From 2005 to 2012, I was the CEO of Sophos, helping to triple the size of the company during my tenure. I've also been involved with a number of security companies at different phases of growth. As a result of that, I'm both excited and confident that I can make an immediate impact as interim CEO.

With the recent acquisition of Webroot, we have the opportunity to disrupt the data protection and security market. We have a great foundation. There's an unmet need in the market, specifically protecting laptops, desktops, servers and critical information stored in the cloud, ensuring that this data is both secure and always available.

In particular, I believe our strength on the endpoint is a competitive differentiator. Customers require integrated and robust data protection solutions to protect all of their critical data, especially at the endpoint, and Carbonite is now uniquely positioned to meet this need.

By tailoring the integration of Carbonite and Webroot, we can be the first to capitalize on this enormous market opportunity, and also believe that there are significant improvements we can make to overcome some of the execution challenges that we've experienced in parts of our data protection business and accelerate our integration plan for Webroot. This is real opportunity for Carbonite and should lead to improved operating leverage and cost efficiencies across the business.

Turning to the quarter, the entire team at Carbonite has accomplished a lot, including delivering strong financial results. Carbonite posted record revenue in the second quarter with non-GAAP revenue of $135 million, up 69% year-over-year. We did that while driving an adjusted EBITDA margin of 29%. We saw a positive momentum in the security software business with our first full quarter of contribution from Webroot, and while total revenues came in within the range of guidance we provided, we weren't as pleased with the execution on the data protection side of things. Anthony will spend more time highlighting that and the impact on our financials for the remainder of the year.

Operationally, during the quarter, we first enhanced our leadership team. We recruited Craig Stilwell to the newly created role of Chief Revenue Officer, and we realigned our organization to be more channel focused, promoting Charlie Tomeo, the Webroot channel leader, to lead all our channel-focused initiatives for both the combined company.

We launched our newest offering, Endpoint 360, which now includes the capability to backup Microsoft Office 365 environments and delivered our first full quarter of the Webroot results and officially welcomed the team to the Carbonite family.

Let's touch a bit on Craig's background and why we think he's such a strong addition to the team. Craig has 2 decades of experience building and leading high-performing teams in channel sales and marketing roles at Citrix. And I'm thrilled to be working with him. Carbonite has grown dramatically in a short period of time, approaching nearly $0.5 billion in revenue. So this time was right for this new role and to bring in executives like Craig who has experience integrating over 40 companies during his time at Citrix. Craig is going to be instrumental to the building of strategies combined with data protection business and new security solutions.

Charlie Tomeo has been promoted to lead our channel efforts across the combined organization and is already starting to have meaningful impact. The channel is critical to our success moving forward, and we are committed to making the necessary investments there. Charlie has been instrumental to the longtime growth of this and success of the MSP channel at Webroot. And I'm looking forward to seeing the impact he can have on the channel of the combined company.

Turning to our new product offering. We had a great success this quarter launching Carbonite Endpoint 360, which protects data across the entire Microsoft 365 suite including SharePoint, OneDrive and Exchange. This solution complements our Endpoint offering perfectly. Ultimately what customers want is a solution that backs up data on the physical device and the data being stored in the cloud.

Lastly, I would like to reiterate how excited I am about the Webroot opportunity. Just a few weeks ago, I had the pleasure of attending the Webroot sales kickup, which brought the worldwide sales and marketing organizations together. The energy in the room and the positive feedback from customers, partners only reinforced our strong belief of the power of the combined combination of Carbonite and Webroot and what we can accomplish together.

In closing, I'm confident really to execute. I intend to provide greater focus on accountability throughout the entire organization. I'm committed to delivering to our profitability targets. This is a great company, and as we know, great software companies are a result of dedicated and talented people. And I want to thank all of the 1,600-plus employees worldwide for their efforts and what they have accomplished, and I look forward to working with them in the next phase of our growth.

With that, I'll turn the call over to Anthony.

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [4]

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Great. Thanks, Steve, and thanks, Jerry. I'd like to take this opportunity to thank Mohamad for all he has done at Carbonite and the positive impact he has had on me personally over the past 5 years. I'd also like to welcome Steve in his new role. Steve and I have worked together for the past 5 years and although I was disappointed learning about Mohamad's departure, I was at the same time thrilled to learn that Steve was stepping in to lead Carbonite through this transition.

I'm certain that with Steve's extensive background in security, he can help to accelerate our strategy, drive greater accountability throughout the business, and I'm happy to partner with him and support the business through this transition.

Now on to financials. Non-GAAP revenue for the second quarter was $135 million, a record for Carbonite and in the middle of the range of guidance that we provided back in May. This represents total growth of 69% year-over-year. The success this quarter was largely driven by the first full quarter of contribution from Webroot, which delivered non-GAAP revenue of $59.8 million, generally consistent with our expectations. Carbonite contributed approximately $75.2 million in revenue for the second quarter, which was below our expectations. As a result of our Q2 performance on the data protection side, we are lowering our full year guidance, which I will detail momentarily.

So what happened? Well, in the second quarter, we experienced challenges in our data protection business related to products and go-to-market effectiveness. Towards the end of the quarter, we determined that the virtual server edition of our server backup product was not at the level of quality that customers have come to expect from Carbonite.

Many of you will remember that this was newly launched in Q3 of 2018 and something we expected to meaningfully contribute to revenue starting in the back half of 2019 and through 2020. While we assessed the best path forward, we have removed any growth expectations associated with virtual server edition from our short-term outlook. Our go-to-market efforts were also challenged in the second quarter.

Compared to Q1, we converted pipeline at a lower rate and also closed fewer large deals. While we saw encouraging results from our channel, it was not enough to offset these challenges. With new leadership in place, we are already taking steps to improve our performance. However, our Q2 trends form a new baseline that we are flowing through our model, resulting in our lower guidance for the year.

Shifting to the financial metrics for the quarter. Adjusted EBITDA was $39.1 million or 29% of revenue, better than the guidance range we provided of $34 million to $36 million. Our gross margin was 82.3%, up 523 basis points over the year ago quarter. The expansion in gross margins was driven by a full quarter of contribution from Webroot and our relentless focus on taking costs out of our data centers and appropriately sizing our customer support organization.

Research and development spend was $26.3 million or 19.5% of revenue compared to 18.4% of revenue in the year ago quarter. This increase was expected as part of the Webroot acquisition. Sales and marketing expense was $35.7 million or 26.4% of revenue compared to 26.6% of revenue in the year ago quarter. G&A spend was $14.4 million or 10.7% of revenue, roughly flat as a percentage of revenue with the year ago quarter. We continued to demonstrate the significant earnings power of our financial model, delivering Q2 diluted net income per share of $0.56, a 26% increase over the year ago quarter and suggesting a run rate north of $2 per share in annualized earnings. CapEx for the quarter was $3.3 million, about 2% of revenue, and our adjusted free cash flow was $24.3 million for the quarter. As a result of the strong adjusted free cash flow and our healthy balance sheet, as planned, we elected to pay down a substantial amount of the outstanding term loan, making an accelerated principal payment of $55 million. As of June 30, we had $83.4 million in cash and equivalents.

Turning now to our outlook. We detailed the execution challenges in our data protection business. And the outlook for our security business is largely unchanged from original expectations. As a result, on a combined basis, we expect organic growth for all of Carbonite to be in the low single-digit range. We feel that this is a very realistic growth rate for the near term with opportunities to build from these levels over time.

While we haven't explicitly provided guidance for 2020, taking our 2019 numbers, adding almost 1 extra quarter contribution from Webroot and applying that expected growth rate is a good starting point. In addition to total growth, I would note that we are very much committed to 2 things: One, maintaining our margin targets; and two, utilizing our strong and consistent free cash flow to repay our outstanding debt.

For the third quarter, we expect GAAP revenue to be in the range of $117 million to $119 million. This includes the impact of purchase accounting adjustments on deferred revenue; non-GAAP revenue in the range of $131 million to $133 million; and adjusted EBITDA in the range of $34 million to $ 37 million.

For the full year 2019, as I noted, we're making some adjustments to our guidance. We now expect GAAP revenue in the range of $443.5 million to $448.5 million as compared to our prior guidance of $457 million to $471 million. We now expect non-GAAP revenue in the range of $477.5 million to $482.5 million as compared to our prior guidance of $491 million to $505 million; non-GAAP gross margin in the range of 80.5% to 81.5%, consistent with our prior guidance; adjusted EBITDA in the range of $132 million to $137 million, also consistent with our prior guidance and up from our original guidance of $129 million to $134 million. For the full year, we expect our effective tax rate on a non-GAAP basis to be approximately 22%. And for the full year, we're using a weighted average share count of approximately 35.5 million.

With that, let's open the conference call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Saket Kalia.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [2]

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Nice to meet you by phone, Steve. So Steve, let's just hit the elephant in the room head on with Mohamad's unexpected departure. And so the question is, how much of this was voluntary versus involuntary? And what is the Board looking for in the next permanent CEO?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [3]

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So first thing, to be very clear, it was voluntary and it was Mohamad's decision. I'm not sure if you've seen the announcement of where he is going, but if you see it, it's very much in the publishing industry and it's a very different type of role in that industry and it really is a different -- it's a change for Mohamad, but it was his decision. On the next CEO, now that we're a $0.5 billion company, we're starting to be much more of a security as well as an operation -- I mean, certainly, an infrastructure company. We'll be looking for someone that certainly has led at scale and has experience in either security or infrastructure software and maybe a public company person or maybe someone that's led at scale privately.

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Saket Kalia, Barclays Bank PLC, Research Division - Senior Analyst [4]

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Got it. Anthony, maybe my follow-up for you just on the core data protection business, maybe 2-parter. So in the SMB subscription part of data protection, can you just talk about retention rates and how they've trended from the first quarter to the second quarter? And then relatedly, in the upfront part of the data protection business, were some of the issues that we've seen there in the past, have those sort of cycled through? Or was that sort of a continued headwind on the data protection part of the business as well?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [5]

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Yes, sure, Saket. I guess, in terms of retention rates, we really have not seen any meaningful degradation in our retention rates. I think we've -- in terms of the dollar retention rate, we have not seen that move up probably as nicely as we would expect, but I think in terms of the customer retention rates, I think trendlines have been fairly consistent and certainly nothing dramatic in the second quarter. As it relates to the upfront business or the perpetual license business, I think it was a continuation of the same trend in Q2. So we did continue to see softness in perpetual, but in fairness, our subscription business was lighter than expected in the second quarter. We were still within our guidance range but our outlook as a result kind of came down a bit.

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Operator [6]

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Your next question comes from Chad Bennett.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [7]

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So Steve, I guess, so you joined the Board effectively the same time Mohamad joined the company and really made the push into making Carbonite a business focused -- or enterprise-focused data protection provider versus consumer. So you've seen kind of the strategy that he put forth over the past 5 years and probably more importantly you approved or saw the transaction -- transactions or the acquisition the company has made over the years. As far as -- I mean you should have all the knowledge in the world on the assets you've acquired. Are you comfortable with the assets you've acquired going back to '15, EVault to Webroot being the most recent one?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [8]

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So a couple of points. First of all, I actually joined a year before, I think, we announced Mohamad or somewhere in that range because I was part of the search committee recruiting Mohamad, but I was very much joined as we began to transition from a consumer company into our focus on SMB. As far as all the acquisitions, you're absolutely right. I was part of the Board approving all those acquisitions. And I think all of them have been successful in different ways, but I would say I'm particularly bullish about what we can do with Webroot and our Endpoint Backup business and the assets that we've acquired over the years to strengthen our Endpoint Backup business. I really do think that combination of those assets for the markets that it serves, but also actually for consumers, is very powerful. And as it relates to Webroot, I've known that company for quite a while. I competed against them when I was at Sophos. In fact, we have partnered with [back in the day] and actually watched the acquisitions they did as they transformed to who they are. So I'm very trustful and knowledgable of them. So in short, yes, I have had a long tenure. I've seen the acquisitions. I think they've been successful, some more so than others, but I'm particularly bullish with the acquisitions as it relates to the Endpoint.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [9]

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Got it. And then, Anthony, maybe a couple for you. So regarding the outlook or guidance change, in particular related to the data protection business, I guess you pointed out the disappointment around the virtual server backup product and just whether it was quality or not gaining traction, which probably goes hand-in-hand. But I mean the $20 million delta for the year on the revenue guide, was your expectation that product was going to do that well? Or is there more to it than that product?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [10]

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Yes, Chad, it's a very good question. And no, that is not entirely focused on the virtual server product. As I mentioned, we did not really see the same volume of large deals close in the second quarter as we had in the first. And we saw our conversion rates running a little bit lower in the second quarter than the first as well. So to me, it didn't feel as though we have really solved some of the go-to-market challenges that we had seen previously. We weren't able to opportunistically close on the larger deals that maybe we had anticipated. And we now have this virtual server edition product that was not going to drive any growth in the second half of the year. And really, those were, I think, all the contributing factors to taking down the outlook. And frankly, wanting to set a baseline, we have new leadership on board with Steve and with Craig. And I think wanting to set a baseline that we feel comfortable achieving and hopefully a baseline that we can move up from over time was really the objective.

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Chad Michael Bennett, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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So have we got answers to why big deals didn't close and why conversion rates weren't what they should have been? Do we have any idea of kind of why those 2 things didn't happen?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [12]

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Yes. I mean I think on the big deal side, this is why we've not wanted to be overly dependent on it. As is the case with a lot of companies, deals push from quarter to quarter, they get spread out, and there's just inherently challenges in predicting how those deals will come in. And I think in terms of the conversion rates, we certainly have seen, I think, more of an impact on the direct side and sort of direct larger deals as opposed to the channel side. And so I think what we have learned, I think, has probably led us to act accordingly in terms of how we allocate resources, which is why I think we're standing firm behind our ability to continue to meet our profitability targets.

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Operator [13]

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Your next question comes from John DiFucci.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [14]

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I guess I have a follow-up to sort of that line of questioning that was just said. Everything, Anthony, you say sounds logical, but it actually sounds really familiar. It sounds like you are saying things like that every quarter, and that's what's been consistent. I'm just curious, is there -- like is there anything else here that could go wrong? I mean there's always something that can go wrong. But I mean you guys -- your stock is trading at a level that on a recurring revenue basis a little over 2x now, after hours down like 20%, and you just have to hit your numbers consistently. I mean unless -- it's -- I wouldn't assume the new product is going to do a lot in a quarter. I wouldn't assume you're going to sign a lot of large deals every quarter. I just -- and I don't really -- I'm not -- I'm trying to understand if there's something else because you'll just keep going down if you keep doing this. But at some point, those numbers, you just have to -- and you don't even have to execute, you just have to beat numbers. And I'm just trying to understand if we are at that point now where you can actually meet your expectations versus consistently miss them. Because you've got to give investors a little bit of confidence to be able to step in. A lot of people are looking at you mainly because you're so cheap, but they're not going to pull the trigger until they feel like you can do what you say you're going to do. Are we there?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [15]

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Yes. John, I share your frustration. I understand. I think our objective was to reset numbers overall to a level where we think they are absolutely achievable. And I think this is a baseline that we're comfortable executing against.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [16]

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John, it's Steve. I'll just chime in a bit as well. You're absolutely right, we've not flattered ourselves with our inability to hit the numbers. And certainly when Anthony and I've been working on this together along with our new CRO, Craig, we understand that, we realize that, and we had a lot of discussions about that. And I think Anthony will give you some color on how we perform to that going forward.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [17]

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I guess maybe just -- because Anthony, you said something about large deals and they didn't -- you didn't sign as many, but you did come within your guidance. Like this quarter's numbers look -- they look okay, they really do. But I guess -- maybe I just want to make sure I understand what you're saying. Are you saying that normally, like, large deals come in right at the end of the quarter, so you get very little revenue in this quarter, but that's what's affecting the future. Is that what you're saying? I just want to make sure I understand it.

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [18]

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Yes, I think that's right, John. I think the -- we've never been dependent on large deals, and we've never made our outlook completely dependent on large deals either, right? So I don't want to lead folks to believe that. But as we mentioned in Q1, we made the number and we made it by being scrappy, right? We got a couple of large deals that put us over the top. We performed okay. In the second quarter, I think we took a step down in terms of just sort of execution and conversion, and we did not close those large deals. And so those large deals do pay a benefit in future quarters, and I think that was certainly part of the challenge.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [19]

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Any assumption in closing large deals in the future?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [20]

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Very little.

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Operator [21]

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Your next question comes from Jason Ader.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [22]

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I want to continue on this thread of the last 2 questions. And just posit the possibility that maybe there's something else going on in the data protection business, maybe it's competitive, maybe it's just changes in the market with the advent of the cloud. You guys have a strong sense of that? I know you're just blaming it on execution. But sometimes execution is linked to other things that are more exogenous variables.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [23]

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Jason, it's Steve. I'm going to start, and then I'm going to let Anthony chime in. Firstly, as you mentioned, the problems that our virtual server launched and us pulling down from the market, I mean, we launched the product in a market that is growing and there's a lot of demand. But we just didn't have the quality we needed. And we need to step up. And that is disruptive and it's, yes, at least part, if not all, the reason for the lower guide. But it's part of that and is disruptive to the sales organization. So that is not less about being in a good market. It's more about not executing on your product strategy. If I look at the majority of our assets, whether it's on the security side or on the data protection side, it's around the endpoint protection, and that we feel very, very strong in both the macro trends, right, as things move to the cloud or client -- sorry, as things move to the cloud and client architecture, protecting both device, endpoint device data and -- from a security point of view and the data in the cloud is really where the pipe is going. And I think our unique ability to do that on both the data protection side and the security side positions us well. There's another part of the data protection business that are growing much quickly, and we know that, and that's why it is our job to plan the right resources to those areas. But I think broadly speaking, the collection of assets that we have in the data protection side and how confidence would we have on the security side are the right assets.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [24]

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And you don't believe that competitive pressure is a factor here?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [25]

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You don't look at that. I think when you don't execute on the product side or you -- you leave yourself vulnerable to competitors. So there are competitors in our market, but I don't look across the board and I can point -- and we can't point to 1 or 2 competitors that have really changed in their offering or what they're doing that's been the cause of being disruptive. We just don't see that in the data. Anthony, I don't know...

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [26]

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I would agree, Steve.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [27]

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Okay. And then, Anthony, just on the -- about the outlook for the -- for fiscal '19. So security outlook sounds like it's unchanged. What is the implied growth rate now for core Carbonite for 2019, just so we're clear about that?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [28]

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Yes. I think the core Carbonite for '19 is probably down a little bit, maybe 1% down. And then to be clear, as you know, we're going to see consumer with a little bit of growth in '19. And I think the expectation is that business overall will be down.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [29]

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Okay. And then to your comment on '20 as sort of thinking about a low single-digit growth rate, that is for the entire business, correct?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [30]

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That's correct.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [31]

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Okay. And what -- I guess if we were to parse that between security and the data protection business, would you expect the security business to grow at a higher rate in 2020?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [32]

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Yes, I think we would, Jason. I think we're going to -- we expect security to continue to grow at a pretty good clip, and we're expecting data protection to be down. That's sort of our short- to mid-term outlook. Obviously, we're not guiding for 2020 right now, but I think we're setting that as sort of our baseline.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [33]

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Okay. So even in 2020, it could be down a bit based upon what you see today?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [34]

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Yes, we'll certainly update folks as we continue to move through the year, but our expectation now is you continue to see data protection down a little bit and security certainly up and consistent with what we've set for expectations around that business previously.

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Operator [35]

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Your next question comes from Eric Martinuzzi.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [36]

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I had a question regarding the maintained adjusted EBITDA for the year. So obviously, given the debt situation you guys have, it's good to see that adjusted EBITDA number be maintained. But given the decline in the revenue and no change in the gross margin, where is the delta there? Where are we kind of making up that what I would assume would be some lost ground? Obviously, you don't have -- there's not -- the variable comp element of the sales and marketing line, we don't have to pay that, but are we cutting other elements of the OpEx?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [37]

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Yes, Eric. I think we are reallocating resources to obviously the areas where we've got growth and growth opportunities. And I think we're getting as tight as we can and as efficient as we can in other parts of the business. I think we're also accelerating the integration with Webroot, and I think we're probably running a little bit ahead of plan or expect to be running a little bit ahead of plan in terms of some of the synergies that we're seeing from that integration. So I think those things combined, I think, give us a lot of confidence that we're going to be able to continue to deliver on the bottom line targets.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [38]

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Okay. And then you've outlined 3 areas for the Q2 disappointment: the product, the pipeline conversion and then the large deals. Where -- you've added your new Chief Revenue Officer. Where is -- his focus obviously and his experience is in maintaining good relations with the channel. Is he going to be addressing all 3 of those issues with the channel? Is he going to be focused more on the large deal side? Where is the initial focus for Craig going to be?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [39]

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So Craig is -- I mean he is in all elements of the core market function and also advances further the need. He's integrated a lot of companies (inaudible) Citrix. So there's never one focus, but there's certainly -- I'll list off a couple. Firstly, integration of the 2 businesses and identifying and building plans to drive not only sales and marketing efficiencies, but also top line synergies. Secondly, he's obviously spending a lot of time in the data protection business and understanding where is those issues around pipeline conversion and how he can be helpful supporting the team as we look to close these large deals. I'm trying to summarize in that way.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [40]

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Okay. So everywhere.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [41]

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Well, I don't think he's quite everywhere. There's integration of the 2 companies and overall pipeline conversion and large deals. It's really kind of back up the weaknesses that Anthony mentioned.

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Operator [42]

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Your next question comes from Brian Schwartz.

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Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [43]

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Anthony, one, just maybe a number if you can give us a couple of the questions earlier. You said you were pulling down probably the second half guidance for the virtual servers. And can you at least give us the revenue component you're pulling out for that piece?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [44]

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Yes, Brian, I think there were a couple of elements that we mentioned in terms of just sort of execution and the product issue on virtual server. And I think of the takedown, maybe a third of it is associated with the product issue. I think our belief in really wanting to ensure that we've got the right baseline around pipeline conversion and large deals is probably another third of it. And then obviously we're trying to set a baseline that we can -- I think that's going to set new leadership up for success and allow us to be very comfortable achieving and sort of growing off of baseline going forward.

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Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [45]

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And then, Steve, switching topics, you're giving an outlook here for, I guess, the core Carbonite business to be down. We've always thought of the consumer business as noncore. Just wondering if there's any plans to undergo a strategic review here of the business and kind of see what you have and what make sense to keep for the future.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [46]

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So the focus right now is integration of the Carbonite business and the Webroot business. As part of that, we're reviewing the combined assets and where we want to focus. But to be clear, I think the consumer business has been -- while it's not the fastest growing, it's been a good contributor to the EBITDA. And also I think there's a lot of opportunity when we -- not necessarily that are parts of investment, but just as we combine the 2 consumer business, there's efficiencies and a lot of cross-sell opportunities so I think we could access, and there's really no plans to do anything with them today. Of course, we always look at the combined businesses and where we want to focus.

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Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [47]

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And then my last question, Steve, if I could just ask a follow-up I guess on that answer then. Can you share with us how you plan to prioritize the management time, the investment strategy, the go-to-market between those 3 different business segments, the data backup, the security business and the consumer moving forward?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [48]

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Yes. I think of it a little differently. I think our core strength and where we see the greatest success to date -- and I think we've got a lot more things we can do -- is around the endpoint protection assets on both sides, right, and that's endpoint protection at the very base level of the consumer side but also for the SMB and moving to the MSP channel. So that's where the focus is. And that's both on the product development, but also on the go-to-market and the sales effort. And then it kind of matches what we're seeing as were competitive engines and the market opportunity, but also where we're seeing success.

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Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [49]

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Maybe if I can just squeeze one last in since it's a public setting here. It sounds like the focus is going to be on the security endpoint, security side. And I'm certainly not an expert in that market, but I do know it's a heavily competitive market, and there's been some recent hot IPOs in that market. Can you maybe share your view then, Steve, how you plan to win and differentiate in that market moving forward?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [50]

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Yes. When I say endpoint, to be clear, it's both endpoint data protection and endpoint security. And you're absolutely right. It's a very competitive market, and there's a lot of interesting new entrants into that market that had successful IPOs recently. But there's a huge market share that's shifting from the legacy players in the market to, I'll call it, next generation or people that have better alternatives to what the legacy players have. And that is what the opportunity is. We see a lot of customers evaluating what they've got today and looking for alternatives. And for the segment of the market, the [nurse suite side], the value proposition of both doing the security and the data backup we think is tremendous, and we're hearing that from customers and hearing that from partners. I mean just think about it. What you really care about is you want to try and protect the machine, but also be prepared. If anything goes wrong you can recover the data and protect the data and get back to normal as soon as you can. Things like ransomware really highlight that need. So yes, it's a competitive market. I believe we have a differentiation, but it's a competitive market because of all the market shifts that's happening.

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Operator [51]

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Your next question comes from Ben Rose.

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Ben Zion Rose, Battle Road Research Ltd. - Founder, President & Analyst [52]

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Steve, wanted to welcome you aboard on your interim role. In the press release, you highlighted the pay down on debt. And I guess my first question is, do you see Carbonite as having plans to accelerate the pay down in debt? And I guess along with that, how are you thinking about additional acquisitions, say over the course of the next year, as you take a look at the operation?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [53]

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I think I'm going to let Anthony first take a stab at that because he's really driving the strategy around our debt repayment, and then I'll chime in at the end.

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [54]

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Yes, sure. So Ben, I think our strategy around repayment of debt is really unchanged. I think all along, we felt that we had the profitability characteristics, the expansion in margin and the cash flow to really accelerate the paydown of that debt. And even with the top line projections coming down this year, I think what we're trying to reiterate is that we are standing behind our profitability targets and our free cash flow opportunity and the fact that we're going to continue to repay the debt aggressively just like we had originally anticipated. As it relates to M&A, I think those 2 questions are linked, right? Obviously, we want to delever quickly, so that we have more latitude to go out and continue to execute sort of total growth M&A strategy. I think we do still have flexibility for some tuck-ins along the way, but delevering quickly I think gives us a lot more flexibility and a lot more latitude to execute that strategy. I'll let Steve continue.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [55]

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I think that's exactly it. Organizationally, we're really at capacity executing on the Webroot acquisition and the other activity we've done over the last 2 years. It doesn't mean that there's not a opportunistic tuck-in acquisition that makes a lot of sense, and we want to add that. But our priority right now is dealing with what we have now and that execution as well as paying back -- paying down debt.

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Ben Zion Rose, Battle Road Research Ltd. - Founder, President & Analyst [56]

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Okay. And then just maybe a follow-up. Even in as much as the anticipated EBITDA margin is very impressive, now that you've had, I guess, a few months to get your arms around Webroot and take a closer look at some of the synergies, really either for Anthony or Steve, what are your thoughts around the extent to which there is further room to integrate the 2 operations and maybe achieve some additional benefits that may not have been identified initially?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [57]

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Yes. I think that there is -- I think we've had a history in terms of the acquisitions we've done of probably overdelivering on cost synergies. I feel comfortable that we're going to be able to do something similar with the Webroot acquisition. I think what you're hearing from us is there really is a commitment to accelerating the integration because we just think it's strategically important. We think it puts us in a better position, strategically differentiates us in the market and just gives the company a much better position to play from. And so, I think by accelerating the integration, for sure we may realize some of those synergies sooner.

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Operator [58]

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Your next question comes from Tim Klasell.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [59]

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Some quick housekeeping questions here. On the security side, how did consumer do relative to the enterprise? And what do you sort of see those growth rates -- individual growth rates as you head into 2020?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [60]

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Yes, Tim. On the security side, the consumer business is still up low single digits, 2%, 3%. And I think that is consistent with expectations and sort of consistent with our short to midterm outlook. On the enterprise side, you've got an endpoint security business and really an MSP channel that is growing well into the double digits, north of 20%. There is also an OEM business in there that's growing high single digits. So overall, I think we're seeing healthy growth on the enterprise side and consistent growth on the consumer side from the security business.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [61]

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Okay. And then jumping over to the protection side, it seems like a lot of the issues over the last few quarters have been on the server side of protection. How big is that anymore? Of the $70-some-million -- of the $75 million in protection, how much of that comes from the server side and how strategically important is that to you going forward?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [62]

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Yes. It is strategically important to the business, and there are growth opportunities in there. But I think that when we break down the data protection revenue, probably more than half of it is on the end. It touches the endpoint. And so when you look at our business overall and you combine security and data protection, you're probably close to 70% of our consolidated revenues touching the endpoint. And so endpoint, to what Steve has been driving, it absolutely is strategically important to us, but the server is also still a good market opportunity and it's not an insignificant piece of our business.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [63]

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And would you say the margins on the book, to me it strikes me as endpoints just typically have much higher margins, obviously on the consumer side. Is that an accurate statement or am I wrong there?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [64]

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Yes. I think it varies. I think there are other factors that will determine profitability beyond just endpoint for our server. There are internal factors like where we're storing the data and other factors as to whether it's endpoint security or endpoint backup or server backups. So I don't think cutting the margin profile between server and endpoint will be as informative as maybe some other cuts.

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Timothy Elmer Klasell, Northland Capital Markets, Research Division - MD & Senior Research Analyst [65]

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Okay. And then one final one here. On the virtual server product, obviously, you've cut off the -- cut the numbers and cut off the growth expectations there. Is there plans to redo and relaunch? Or are you going to put resources towards other areas and just sort of decide that was a market that maybe you don't want to serve anymore?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [66]

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Our current plan is to come back to market, and to be clear we do have the server products. This is the new virtual server product. The plan is to continue to come back to market, but we are evaluating. We are -- as we look at the business and we want it back, we are reevaluating exactly what we want to do there and then that decision could change.

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Operator [67]

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Your next question comes from Sarkis Sherbetchyan.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [68]

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So first with the CEO search, I guess, what kind of leader are you looking to bring to the business? And I suppose what would be their immediate priorities, right? What are they tasked with immediately? And then thinking about kind of the longer-term strategy, I mean M&A was a key component, and it sounds like you guys may continue down that path. So can you just kind of give us a sense for how the strategy could change?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [69]

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Yes, so I would say you're absolutely right there. M&A capabilities and execution has been the [core blocks] and Mohamad was a part of that. If we talk about the key skill sets of the next CEO, we are going through a process of profile right now, but I would broadly say it's someone that has the ability to combine and run a large organization. And of course in that, there's always going to be a portion of the M&A. Go-to-market and market expansion are going to be also very, very important ingredients for this next person.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [70]

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Got it. And just to kind of touch on the prior comments around the newly created and filled Chief Revenue Officer role. I mean if we kind of think about the organization sales function, I guess what other changes are expected from that kind of call it, department, if you will, to capture sales growth? And how do you think about the sales org relative to kind of the product development team? And is there an opportunity to somehow increase the efficiencies between the 2 and the communication between the 2?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [71]

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Yes. I think as far as -- on the go-to-market function, firstly, one of the biggest complex we have is combining these 2 organizations together and ensuring that we're aligned from a go-to-market strategy, that's first of all, all the way to how are we going to market, to what channels, to what types of selling options that we have and to what kind of market we do to generate the leads and the interest of the product. And I would say that is job one for Craig. Within that is how do we balance the resources of the team and where we're getting the biggest ROI on our expenditure and where should we be doubling down and where should we be reducing our efforts. As far as the communication between the product group and the (inaudible) market group, I would say at this point I don't have a lot to comment there, but I also think we earlier -- beginning to this when we announced this acquisition, one of the first things we did is actually combined the product management group, and that's worked out really, really well. So that kind of informs us of kind of we've got to work to do on how we combine the engineering organizations and the rest of the functions. I think the communication that you maybe alluded to between the 2 groups, I don't see any issues there at this point.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [72]

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Good. That's helpful. And then if I kind of switch gears to the guide, I guess if we think about the previous communication on what Webroot would contribute to Carbonite's business, can you kind of walk through the current fiscal '19 guide for sales and EBITDA contribution from Webroot?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [73]

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Yes, Sarkis. I think what's really going to be sort of implied in the guide in terms of Webroot's contribution is going to be something, let's say, in the $180 million to $185 million type range for Webroot. And I think in terms of -- and that includes, let's call it, a $3.5 million to $4 million contribution in the first quarter for that due to the fact that we closed the acquisition on March 26. And I think in terms of the profitability contribution, it's running pretty much where we expected, maybe slightly ahead. So I think still both businesses, Carbonite and Webroot, are demonstrating an ability to expand margins, and I think Webroot seems to be tracking pretty much in line with our expectations.

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Sarkis Sherbetchyan, B. Riley FBR, Inc., Research Division - Associate Analyst [74]

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Good, and last one from me, and I'll hop back in the queue. I think you mentioned you feel pretty confident on accelerating and realizing the synergies sooner from Webroot. If I recall correctly, you had mentioned previously you can extract between $20 million and $30 million of cost savings over the next few years. I guess, are you at liberty to kind of give us an updated figure and/or time line?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [75]

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Yes. I think we had mentioned $30 million over 4 years in terms of the overall cost synergies. I think it's a bit too early. What I would tell you is that for year 1, I think we're running a little bit ahead of plan. I think we're going through an exercise now with -- under Steve's leadership to assess accelerating the integration. And so, we may, I think, demonstrate an ability to accelerate some of those synergies as well, but maybe a little bit too early to get overly precise on that.

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Operator [76]

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Your next question comes from Erik Suppiger.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [77]

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I just want to understand when you talked about accelerating the integration, are you talking about product integration and are you talking about sales integration? Are you thinking that you're going to start seeing synergies from the sales side in terms of additional revenue or is it mostly a cost synergy that you're focused on?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [78]

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The short answer is it's all of the above. So we're absolutely looking to build a combined product road map that really is focused on both the integration and how we get the value of the 2 products and how we can differentiate both the assets. Secondly, it's the sales and marketing, go-to-market motion, how do we want to leverage the respective channels, how do we want to promote cross-sell, upsells. And in doing all that, we do expect there to be some cost synergies. So it's really the threefold. As far as expected top line synergies, I'll let Anthony comment on that.

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [79]

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Yes. We haven't baked any top line synergies into our model, Erik. So we do, to Steve's point, I think accelerating either a product road map and bringing these teams together. Obviously that will result in realizing some cost synergies sooner than expected. And to the degree that we're successful with our integrated product strategies, I think we start to see some top line synergies as well a little bit sooner than anticipated. So I think it is on both sides of the ledger, and it's much to do with timing than anything else.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [80]

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Was there any early signs of synergies across channels in the June quarter?

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Anthony Folger, Carbonite, Inc. - CFO & Treasurer [81]

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Yes. I mean we've begun cross-sell campaigns. I think we've had -- we've seen some good signs early, but it's still -- I mean we're 1 quarter into it. So too early to sort of plant the flag either way. But I think we're encouraged. We're learning a lot. The cross-sell campaigns are underway, and I think there'll be a lot more to come.

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Operator [82]

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Your next question comes from Brad Reback.

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Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [83]

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Steve, how long has the Board been uncomfortable with the company's execution?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [84]

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I'd say it's an open question. Listen, I think, if you look over the past few years, we've been extremely pleased with the value that the company was able to create and specifically a lot of the efforts we've done through M&A. Certainly, over the last couple quarters, there's been some hiccups, and the Board along with management has been focused on how do we remediate and a number of actions to do some things.

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Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [85]

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So what type of actions can you tell us that the Board has taken with or without management over the last 3 quarters to improve execution?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [86]

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So I guess one thing I'll point to is we recognized that we needed to make a change in the go-to-market leadership. We brought onboard Craig, and we're very bullish on what he will be able to do in his new role and what he will be able to do in combining the 2 organizations. Secondly, you heard me talk earlier today about the acceleration of the Webroot and Carbonite integration. And we believe there's a lot of value in the combined organization. And we're certainly -- certainly me and the Board are very encouraged in the respective teams to realize those both operational and top line synergies.

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Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [87]

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And lastly, you weren't uncomfortable given the execution issues that the company faced in the back half of the year that taking on such a large deal as Webroot would add to that complication?

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [88]

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We were very supportive of the management on the strategic rationale for the deal. And we expect it to be very accretive and strategically really valuable to the company. So we did not -- no, we're very, very supportive.

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Operator [89]

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I'm showing no further questions at this time. I would now like to turn the conference back to our speakers.

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Stephen Munford, Carbonite, Inc. - Interim CEO & Executive Chairman of the Board [90]

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Thank you. And I want to thank everyone for joining us on the call, and I look forward to the opportunity to execute with our partners and customers to deliver the results to the shareholders that we talked about today. Thanks very much.

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Operator [91]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.