CommVault Systems (CVLT) N. Robert Hammer on Q1 2017 Results - Earnings Call Transcript

| About: CommVault Systems, (CVLT)

CommVault Systems, Inc. (NASDAQ:CVLT)

Q1 2017 Earnings Call

July 26, 2016 8:30 am ET

Executives

Michael Picariello - Director of Investor Relations

N. Robert Hammer - Chairman, President and Chief Executive Officer

Brian Carolan - Chief Financial Officer

Alan G. Bunte - Chief Operating Officer

Analysts

Joel P. Fishbein - BTIG LLC

Jason N. Ader - William Blair & Co. LLC

Abhey R. Lamba - Mizuho Securities USA, Inc.

Greg R. McDowell - JMP Securities LLC

Srinivas S. Nandury - Summit Redstone Partners LLC

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Alexander Joseph Ljubich - Jefferies LLC

Andrew James Nowinski - Piper Jaffray & Co. (Broker)

Alex Kurtz - Pacific Crest Securities

Jeremy Benatar - Raymond James & Associates, Inc.

Eric Martinuzzi - Lake Street Capital Markets LLC

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2017 Commvault Earnings Conference Call. As a reminder, this call will be recorded.

I would now like to introduce your host for today's conference, Mr. Michael Picariello, Director of Investor Relations. Please go ahead.

Michael Picariello - Director of Investor Relations

Good morning. Thanks for dialing in today for our first quarter 2017 earnings call. With me on the call are Bob Hammer, Chairman, President, and Chief Executive Officer; Al Bunte, Chief Operating Officer; and Brian Carolan, Chief Financial Officer.

Before we begin, I'd like to remind everyone that statements made during this call, including in the question-and-answer session at the end of the call, may include forward-looking statements, including statements regarding financial projections and future performance. All of these statements that relate to our beliefs, plans, expectations or intentions regarding the future are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations. Actual results may differ materially due to a number of risks and uncertainties such as competitive factors, difficulties and delays inherent in the development, manufacturing, marketing and sale of software products and related services and general economic conditions.

For a discussion of these and other risks and uncertainties affecting our business, please see the risk factors contained in our annual report in Form 10-K, in our most recent quarterly report in Form 10-Q, in other SEC filings and in the cautionary statement contained in our press release and on our website. The company undertakes no responsibility to update the information in this conference call under any circumstance. In addition, the development and timing of any product release as well as any of its features or functionality remain at our sole discretion.

Our earnings press release was issued over the wire services earlier today and it has also been furnished to the SEC as an 8-K filing. The press release is also available on our investor relations website.

On this conference call we will provide non-GAAP financial results. The reconciliation between the non-GAAP and GAAP measures can be found in table four accompanying the press release and posted on our website. This conference call is also being recorded for replay and is being webcast. An archive of today's webcast will be available on our website following the call.

I will now turn the call over to our CEO and President, Bob Hammer.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Thanks, Mike. Good morning, everyone. Thanks for joining our fiscal first quarter FY 2017 earnings call. We had a solid start to the fiscal year and have entered Q2 with improved momentum and better linearity. I will provide a brief financial overview and update you on why Commvault is strengthening its position in the industry.

After discussing these items and before I turn it over to Brian, I'll give you a summary of our FY 2017 financial outlook. After Brian's discussion I will update you on the market, our data platform and an overview of new products and services we plan to release over the next six months.

Let me briefly summarize our Q1 financial results. Software revenues were up 13% year-over-year. Total revenues were up 10% year-over-year. EBIT was up 62% year-over-year. EBIT margin was 9.8%, or up 310 basis points year-over-year. EPS was $0.21 per share versus $0.12 in Q1 2016. Cash flow from operations was $24 million. We had good contributions from all three global sales theaters in the quarter.

Commvault has once again earned a Leader position in Gartner's coveted 2016 Magic Quadrant for Data Center Backup and Recovery Software. This is for the sixth year in a row. More importantly, we were positioned highest in ability to execute and the furthest in completeness of vision. We believe that this is a clear, undisputed and important validation that Commvault has the right strategy, the right technology and the right people to execute. Gartner is the leading independent industry analyst firm, well respected for its detailed and thorough analysis of industry trends, products and game-changing technologies.

Commvault continues to be the industry leader because of our consistent ability to lead the industry in innovation; our single code base that enables our solution to scale and provide data management solutions across the enterprise and in the cloud; new flexible pricing and packaging options are exceptional; and comprehensive customer support and our track record of consistently executing on our clear vision.

As I stated during our last earnings call in May, our strategy has two key components: one, to increase market share in our core data management business; and secondly, to expand our market opportunity by using the unique capabilities of the Commvault platform to develop new solutions and services. Our stand-alone solutions have had strong growth and now account for a material part of our business. I will discuss additional new solutions and services we are launching later on in the call.

We are seeing good momentum in our core data management business, both in the cloud and on modern on-premise environments. Data management will remain a key segment of our growth particularly in the cloud, where we are seeing strong quarter-on-quarter growth in the amount of data that is managed by our software in the cloud. Over the past six months, we have seen in excess of 60% increase in the petabytes of data being stored using Commvault software within public cloud environments.

We believe we are well positioned to take advantage of the unique window of opportunity. The market is in a major state of disruption due to the move to the cloud, massive technological shifts in IT infrastructures, the deployment of SaaS-based solutions and the need for more sophisticated business analytics.

Our aggressive early investment approach to provide leading solutions and services to deal with these changes has enabled us to improve our competitive position and increase our market opportunities. We have a clear game plan, built a strong business foundation and have the financial wherewithal to continue to strengthen our position in our core data management business and significantly expand our market opportunities.

The cloud is a catalyst for growth. The move to the cloud has become a major factor contributing to our increased business momentum. IEC reports that public and hybrid cloud usage today exceeds 35% of all IT infrastructure spending and is projected to grow to almost 60% over the next three years.

Commvault solutions and services help customers solve a broad range of critical new problems that they are facing as they migrate to the cloud, as they look holistically to manage data across private, hybrid and public clouds, and deploy new IT infrastructures and applications. A major reason they are choosing Commvault is because of our ability to seamlessly and comprehensively manage data across their on-premise mobile and cloud environments.

This is a significant differentiate (7:46) between Commvault and others in the market. We help customers migrate their data to the cloud providers of their choice, orchestrate data operations in the cloud, like disaster recovery and dev/test and manage data generated by applications in the cloud.

Commvault's competitive advantage helps customers flexibly do that from a single software solution across the leading public cloud providers like AWS and Microsoft and a total of 20-plus providers, including leading managed service providers like Rackspace and Dimension Data, a range of cloud coverage that distinguishes us from any competitor. We see meaningful contributions to license revenue growth from partners such as Microsoft and AWS as well as large global systems integrators.

Let me discuss our improving competitive position. Commvault's increasing pace of innovation, combined with our improving distribution and go-to-market capabilities has enabled us to improve our competitive position against both traditional larger competitors as well as smaller competitors that are only addressing a minor part of complex systematic customer problems. This is evidenced by our 19% year-on-year growth in enterprise transaction revenue in Q1 2017.

Our enhanced and broadening product portfolio is another key factor in accelerating license growth. We expect to further strengthen our competitive position as well as open up new market opportunities with a deep pipeline of additional innovative products and services to be introduced over the next six months. We will provide more detail on our expanding product and services portfolio at our inaugural GO customer and partner conference in October in Orlando, Florida.

I will now address our current FY 2017 financial outlook. Sales funnel inflow grew significantly during the quarter. As a result, we now have a record level sales funnel, which puts us in a better position to achieve our expected FY 2017 revenues and earnings targets.

We had a strong start to Q2 in new bookings, and the result our confidence level and our near term outlook has improved. Increased business momentum combined with progress on our key strategic initiative provides support for Commvault to continue to be aggressive in investing to take advantage of our improved competitive position and expanding market opportunity. It provides a stronger foundation for the second half of FY 2017 and positions us to accelerate revenue and earnings growth in FY 2018. Brian will discuss specific operating margin guidance for FY 2017 later in the call.

Entering Q2, we continue to see sales funnels improving and better linearity. We expect license growth trends to continue through FY 2017. As such, as long as you positively factor in our Q1 2017 results and our Q2 expectations that Brian will address later in the call, we believe that the current FY 2017 Street consensus for both total revenue and EBIT margins is reasonable.

Our internal objective, however, is to achieve results somewhat better than consensus would indicate. We want to remind everyone that even though we believe license revenue growth will be much improved in FY 2017, we expect services revenue to be only slightly up for the year. As a result, earnings growth will be driven by software license revenue growth. We expect maintenance growth to reaccelerate in FY 2018 as a result of FY 2017's license revenue growth.

While our strategic fundamentals are strong and our ability to execute is improving, we still face critical challenges. Number one, achieving our FY 2017 license revenue growth objectives will be dependent in large part on our continuous successful market adoptions of solutions based on our new Commvault Data Platform and associated software and services for deployment to and from the cloud.

While we are winning larger and larger enterprise deals as evidenced by a solid start to Q2, our ability to grow is more dependent on a steady inflow of $500,000 and $1 million-plus deals. These deals have quarterly revenue and earnings risk due to their complexity and timing. Even with improved funnels, large deal closure rates may remain lumpy.

We are confident that we can expand customer value creation through the development of near-term delivery of advanced and additional new solutions and services aligned with emerging customer data architectures such as mobile base, compliance optimized, cloud-based disaster recovery, application lifecycle, dev/test and big data. However, many of these are new stand-alone solutions which we expect will take a few more quarters to have meaningful impact.

We are in an opportunity-rich situation in the market, and will be prudently increasing spending to increasing revenue and earnings growth for FY 2017 to take full advantage of this expanding window of opportunity. As a consequence, there will be a negative impact to our earnings if we miss on our revenue targets.

And, lastly, the macro and political uncertainty, including Brexit – Brian will discuss the Brexit impact to our business later on in the call.

In summary, we had improved revenue and earnings growth in Q1 versus the prior year. In Q2 we were off to a strong start with increased business momentum, which has increased our level of confidence in an improved FY 2017.

We believe that the company is well positioned in the market. We have the best core fundamental technology, validated by leading industry analysts. Our products and support services remain best-in-class, and we are expanding and strengthening key partnerships and strategic relationships. We have a strong new product pipeline. We continue to make progress in executing our strategy that is enabling us to position the company for long-term high revenue and earnings growth.

However, we still have a lot of work to do to achieve high sustainable long-term growth but have the foundation in place to enable us to achieve that objective. I will now turn the call over to Brian.

Brian Carolan - Chief Financial Officer

Thanks, Bob, and good morning, everyone. I will now cover some financial highlights for the first quarter of fiscal 2017. I will state our as-reported non-GAAP results first and also state the year-over-year results on a constant-currency basis where meaningful. FX did not have a significant impact on sequential results.

Q1 total revenues were $152.4 million, representing an increase of 10% over the prior-year period and a decline of 4% sequentially. Total revenues for the quarter were up 11% year-over-year on a constant-currency basis.

For Q1 2017 we reported software revenue of $63.9 million, which increased 13% year-over-year on an as-reported basis and 15% on a constant-currency basis. Sequentially, software revenue declined 13%. We did see a $1.4 million sequential increase in deferred software revenue, primarily related to software tied to our Managed Services SaaS business, which serves as early validation of these new offerings.

Revenue from enterprise deals, which we define as deals over $100,000 in software revenue in a given quarter, represented 52% of total software revenue, resulting in a 19% year-over-year increase. The number of enterprise deals increased 23% year-over-year while our average enterprise deal size decreased 4% to approximately $242,000 during the quarter.

From a geographic perspective, Americas, EMEA and APAC represented 55%, 30% and 15% of software revenue, respectively, for the quarter. On a year-over-year growth basis, Americas, EMEA and APAC software revenue increased 12%, 11% and 22%, respectively.

The revenue mix for the quarter was split 42% software and 58% services. Please remember, services revenue is a combination of both maintenance and support revenue and professional services revenue. Services revenue for Q1 was $88.5 million, an increase of 3% sequentially and 7% year-over-year.

Our maintenance and support renewal rates remain strong. Our maintenance realignment program is tracking well and I will discuss this in a moment. We added approximately 450 new customers in the quarter. Our historical customer count now approximates 23,000 customers. For the quarter, revenue transacted through Arrow was approximately 34% of total revenue.

Now moving on to our pricing models. Our software licenses typically provide for a perpetual right to use our software and are typically sold on a per terabyte capacity basis or a per copy basis or as a solution set. During the quarter approximately 68% of software license revenue was sold on a per terabyte capacity basis. This is down from 70% in Q4 2016.

We anticipate that capacity-based licenses will continue to account for the majority of our software license revenue through FY 2017. Consistent with recent prior quarters, sales of our stand-alone solution sets continue to have a 2x attach rate of sales of other software solutions. These solution sets are generally sold on a per-unit basis and can be individually deployed or combined as part of a comprehensive data protection and information management solution.

Now moving on to gross margins, operating expenses and EBIT margin. Gross margins were 86.8% for the quarter. We expect the full year FY 2017 gross margins to be similar to FY 2016, or approximately 86.5%. Total operating expenses were approximately $115 million for the quarter, up approximately 7% year-over-year and up 4% sequentially. We added 73 net employees in fiscal Q1, ending the quarter with 2,452 employees.

Non-GAAP operating margins were 9.8% for the quarter, resulting in operating income or EBIT of $15 million. Q1 EBIT margins increased by 310 basis points year-on-year and declined 660 basis points sequentially.

Net income for the quarter was $9.5 million, and EPS was $0.21 based on a diluted weighted average share count of approximately 46 million shares. Interest income was nominal in the quarter. While there have been no borrowings on our revolving credit facility, we do incur interest expense related to the commitment fee. We anticipate that we will have nominal net interest income in FY 2017.

Let me now spend a minute on our maintenance pricing realignment that continues to phase in through FY 2017. As previously communicated, approximately 75% of the maintenance renewal dollars come from our enterprise customer install base, and most of the pricing changes are behind us in that segment. We are currently working through the remaining 25% of the maintenance renewal dollars that come from the mid to lower-end of the market. We are about a quarter of the way through this group and should be mostly completed by the end of the fiscal year. Recent feedback on our maintenance realignment strategy from both customers and partners has been very positive.

As previously communicated, for FY 2017, we believe services revenue growth will lag software revenue growth due to prior-year software revenue results as well as the ongoing realignment of our maintenance pricing. We now believe our full-year FY 2017 services revenue will be up slightly due to our overachievement in fiscal Q1.

However, we are forecasting a sequential decrease in services revenue for both Q2 and Q3 2017 primarily from the compounding impact of the maintenance realignment process. FX is also contributing to the sequential decrease. Services revenue should start to increase sequentially in Q4 FY 2017.

As a reminder, we now believe full-year services revenue will be up slightly from FY 2016, which is an increase over previous estimates. Maintenance and support services revenue typically represents approximately 85% to 95% of our services revenue line.

On a sequential basis, we expect Q2 total revenues to increase slightly and EBIT to be roughly flat. We will continue to prudently accelerate investments in order to strengthen our market position in the industry and increase market share. EBIT should improve sequentially in Q3 and Q4 as the year progresses, especially as the top line software license revenue growth rate increases.

As Bob stated earlier, we believe the current FY 2017 Street consensus for both total revenue and EBIT margin is reasonable once you positively factor in our Q1 results and Q2 expectations. Our internal objective, however, is to achieve results somewhat better than consensus would indicate.

Overall, if we are successful with our investment strategy, we believe that there is revenue and earnings upside as compared to current Street consensus and it could set us up for strong results for the next few years. However, there is also investment risk on the downside and there is some uncertainty in the near-term.

Our revenue and margin outlook commentary assumes current FX exchange rates. With respect to the recent news on Brexit and the weakening of the British pound, there should be no significant translation impact on consolidated earnings. However, we are closely monitoring the impact on our business related to sales funnel levels and deal close rates. In summary, the situation is fluid, and it is too early to predict broader Brexit implications.

Let me now briefly comment on tax rates and share count. We will continue to use a pro forma non-GAAP tax rate of 37% for FY 2017, and we anticipate that our annual diluted weighted-average share count will be approximately 46.5 million to 47.5 million shares. We did not make any share repurchases in Q1. We still have approximately $93 million available in our current share repurchase program and will continue to be opportunistic in share repurchases.

Now moving on to our balance sheet and cash flows. As of June 30, our cash and short-term investments balance was approximately $410 million, of which approximately one-third is located outside the U.S. Free cash flow, which we define as cash flow from operations less capital expenditures not related to the new headquarters, was approximately $23 million, and up 14% year-over-year.

Similar to recent fiscal years, we do expect free cash flow to decrease sequentially in Q2 2017, tied to collection of accounts receivable from the respective prior quarters. We expect free cash flow to be sequentially up in Q3 and Q4 2017. As of June 30, 2016, our deferred revenue balance was approximately $248 million, which is an increase of $16 million or 7% over the prior-year period, and up 1% sequentially. Notwithstanding the recent increase in deferred software revenue, the vast majority of our deferred revenue is services revenue, not software revenue.

Consistent with my earlier comments, we expect our maintenance pricing realignment and related services revenue growth rates to have an impact on sequential deferred revenue growth rates throughout FY 2017. We expect deferred services revenue to be roughly flat sequentially in Q2 and then begin to sequentially improve in the second half. At the end of FY 2017, we continue to expect deferred services revenue to be up slightly year-over-year. For the quarter, our days sales outstanding or DSO was 64 days, which is down from 69 days in the prior-year quarter.

That concludes the financial highlights. I will now turn the call back over to Bob. Bob?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Thank you, Brian. I want to spend a few minutes on the current market dynamics, the Commvault Data Platform, as well as a broad range of additional solutions derived from the Commvault platform that will be coming out soon. The IT industry is in the midst of the greatest shift in the last 20 years, encompassing infrastructure and application architecture and deployment of consumption. Commvault solutions and services successfully address the five largest trends impacting the industry and our market space.

These five trends are the movement to the cloud – the adoption of public and hybrid cloud infrastructure architectures as a replacement and/or supplement to traditional IT models.

Secondly, application architecture. Enterprise customers are trying to get the cost and agility advantages of clouds by deploying distributed application architectures that address the demands of mobile Internet of Things and new business service requirements. The implication of these new distributed application architectures is twofold. First, engineering, coding and deployment processes and toolsets are rapidly changing dev/test procedures; and second, emergence of platform ecosystems allowing the sharing of business services, information, business processes and resources.

Thirdly, software as a service, or SaaS. Enterprise adoption of SaaS-delivered solutions continues to accelerate. Gartner reports that SaaS represents 35% of all application revenue and by 2020 will represent almost 50%.

The fourth big trend is big data and analytics. The rapid expansion of big data initiatives in the enterprise and the need for effective analytics and business intelligence outputs from this migration has moved from project to mainstream. The analytics trend has expanded from historical structured information repositories into broader implementations that address multiple types of data and offer distributed processing and repository options. As these technologies move into the mainstream, a clear and growing need which Commvault is uniquely positioned to address is for enterprise grade data management ecosystems that protect, govern, migrate and federate data for search and visualization, integrated with highly cost-effective storage natively integrated with the software management layer.

And, lastly, open infrastructure. The combination of the preceding trends is driving customers to avoid storage and infrastructure lock-in driven by a desire for outcome-based solutions rather than perpetual licensing and proprietary hardware and software.

Commvault's V11 platform offers managed data under an open standards-based platform that is unique in our market segment and underpins the ability to expand our solutions portfolio.

The Commvault Data Platform aligns with the structural changes taking place in the market that I just outlined. This is confirmed by leading third-party analysts, positive support from our partners and from our customers who are choosing Commvault for data management, cloud data migration and federated cloud management capabilities.

Commvault's Data Platform is the only major software platform in the industry whose underlying scale-out capabilities are compatible with the architectures found in highly virtualized environments, public clouds, private clouds like OpenStack and big data infrastructures. As such, our platform can be installed virtually in the cloud to manage data and cloud-based applications and infrastructures.

The Commvault Data Platform is also recognized for its ability to enable secure data portability across cloud infrastructures. We can provide our customers with what they are increasingly asking for, a single view of their data and its content whether it is on-premise, in the public cloud, in a mobile device or in a SaaS application. We also enable our customers to fully orchestrate and automate key processes.

These data and operational management capabilities are critical to governance, compliance and reporting applications. These capabilities translate into tangible returns and flexibility operations and efficiency.

The management of data has become much more complex, and more and more of our customers and partners are looking to Commvault as their key strategic partner. Our platform is becoming the industry standard for enterprises to holistically federate and manage data across all infrastructures. It enables them to have one federated management platform to securely migrate, manage, access and derive more value from data holistically across the cloud, traditional and new IT infrastructures and SaaS-generated data.

I want to talk about our increasing pace of innovation. We have a deep pipeline of additional innovative products and services to help our customers achieve their business and operational objectives.

Over the summer and fall, we plan to introduce a broad range of additional solutions derived from the Commvault platform featuring a new category of cloud-first solutions that will enable enterprise to better manage data created in the cloud, including more comprehensive protection, data lifecycle, disaster recovery, dev/test and secure data portability.

Improved user self-service for users to directly and securely access and manage their data in the cloud. New SaaS and managed services solutions based on the Commvault data platform, comprehensive embedded software defined storage combined with our leading data services.

And lastly, expanded content search and business analytics capabilities. A new category of content-first solutions powered by federated indexing and intelligent search of data sources spanning online cloud and managed copies, which can be coupled to business content management policies to reduce risk, expand collaboration and establish content-oriented retention strategies based on the value of data as compared to just blind copies.

In regard to business analytics, we are introducing an application development capability to enable customers and partners to more easily and quickly develop business analytics applications to derive more value from the data. We believe that our enhanced and broadening product portfolio will help accelerate revenue growth. Please note the development and timing of any product release as well as any of the features or functionality remain at our sole discretion.

In closing, we enter Q2 with an increased momentum and improved outlook which we believe positions Commvault for much better financial results in FY 2017. We have an extensive innovative pipeline of new products and services, which are designed to strengthen our position in our core backup and recovery business and open up new market opportunities.

We continue to make very solid progress in executing our strategy to improve our market position and expand our addressable markets in order to maximize revenue and earnings growth.

I will now turn the call back over to Michael. Michael?

Michael Picariello - Director of Investor Relations

Thanks, Bob. Operator, can we please open the line for questions.

Question-and-Answer Session

Operator

Thank you. And our first question comes to Joel Fishbein with BTIG. Your line is open.

Joel P. Fishbein - BTIG LLC

It looks like you've overperformed again on the operating margin, the EBIT margin side. Was that due to strictly to the revenue outperformance or did you guys hire fewer people than you thought you would in the quarter? And then I have one quick follow-up.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Yeah, I mean in general, Joel, we did a much better job in recruiting in Q1 versus Q4, where we really fell behind. But we had an extremely aggressive plan and we didn't hire to that plan. But in general, it's not the issue it was a quarter ago because we are making substantial progress in recruiting across the board and we're off to a very strong start in recruiting in Q2.

Joel P. Fishbein - BTIG LLC

Okay. Follow-up, Bob, just on the big deals. I mean, you mentioned that the pipeline is really strong. We've heard of several much larger deals, sort of like you had when you guys were executing extremely well. Just love to get any color that you can give us on any of the multimillion dollar deals that are out there that you guys have the opportunity to capitalize on, and also in light of the fact that there might be some distraction from the Dell-EMC transaction that might help you guys out.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, there are very large deals out there, Joel. The question is when and if they will close. But they continue to enter our pipeline so they – let's just put it this way, the opportunity is there. I will say that we started off well in what I call half a million to $1 million deals in Q2, but those big mega-deals, right now they are in our pipeline and we are not forecasting major close rates on those until they happen.

Joel P. Fishbein - BTIG LLC

All right. Thank you very much.

Operator

Thank you. Our next question comes from Jason Ader with William Blair. Your line is open.

Jason N. Ader - William Blair & Co. LLC

Yeah, thanks. Bob, when you talked about linearity, are you talking about linearity for Q2 or Q1? And I have a follow-up.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Linearity for Q2 is substantially improved over Q1.

Jason N. Ader - William Blair & Co. LLC

Okay. So basically you are off to a really good start, and Q1 was kind of typically backend-loaded as a Q1 would normally be?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Correct.

Jason N. Ader - William Blair & Co. LLC

And then maybe for Brian, can you give us a sense of what the U.K. is as a percentage of revenue, and you probably have seen or heard from your folks over there that there is some significant turmoil around the pricing because of the British pound drop. How do you think that might affect your revenues?

Brian Carolan - Chief Financial Officer

Sure.

N. Robert Hammer - Chairman, President and Chief Executive Officer

I will answer part of it. A number of our competitors have raised prices as a result of the drop in the pound. At this point, we haven't made any significant adjustments. I don't know, Brian, what do you think?

Brian Carolan - Chief Financial Officer

Yeah. Hi, Jason, it's Brian here. We do have a natural hedge to a certain extent between the expenses and revenue, so we do not think there is a significant impact on our consolidated net earnings. Historically, the pound does not represent a material portion of our overall consolidated revenue. We do sell in other currencies over in the U.K. Having said that, we are watching it. It is fluid. We are looking at sales funnels. We're looking at close rates. We're looking at pricing. And we're going to continue to monitor it. But for now, we do not see it as a material impact to consolidated earnings.

Operator

Thank you. Our next question comes from Abhey Lamba with Mizuho Securities. Your line is open.

Abhey R. Lamba - Mizuho Securities USA, Inc.

Thank you and congrats on a good start to the year, Bob, and team. A quick question on your 1Q versus your internal plans. Because going into the quarter also you had mentioned that your internal plan was a bit higher than consensus. How did you do in Q1 versus your internal plan?

N. Robert Hammer - Chairman, President and Chief Executive Officer

I would just leave it at we could have executed better. As good as the numbers were, there was opportunity to do better than that. So from an external standpoint these are really good numbers, but we have very aggressive internal plans, Abhey, so I would leave it at that.

Abhey R. Lamba - Mizuho Securities USA, Inc.

Got it. And the dynamics behind deferred (38:38) of $1.4 million in license sales, is it due to some delivery milestones? Or are these solutions would be recognized on a ratable basis, which is causing this type of a move? When will that deferred (38:51) reverse?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, Brian, is going to go into this, but it's obviously pretty significant. That $1.4 million in increased deferred is a significant milestone for us. Brian?

Brian Carolan - Chief Financial Officer

Yeah, so I mean I think – Abhey, this is Brian here. This is just an example of when we're able to combine our new services offerings such as managed services with best-in-class products. This was a large perpetual deal. We'll say it's seven figures that went into deferred software revenue. This was combined with the managed services offering of several hundred thousand dollars. When you do these hybrid transactions under the current accounting rules, you are kind of forced to combine them and spread them over the services offering which will be 12 months for us. So you can look at this and say that, well, it'd be nice to have this as in-period recognition, but we view this as a positive. It's actually validation of our new services offerings. We won a sizable account and built some backlog along the way.

Abhey R. Lamba - Mizuho Securities USA, Inc.

Got it. Thanks. And if I could slide one more, in terms of cloud workloads, what is the competitive landscape there, Bob, that you are seeing? And that's it for me.

N. Robert Hammer - Chairman, President and Chief Executive Officer

I'll answer it and I'll let Al jump in here in a second. But in general, in large enterprises that are trying to implement and manage hybrid clouds in large-scale, we seem to be in a class by ourself and our ability to easily, simply and securely migrate data to the clouds and easily manage and secure data across these different infrastructures and – but this is a significant reason why we are gaining momentum in the market, and I'll let Al expand on that.

Alan G. Bunte - Chief Operating Officer

I think Bob hit it pretty well. I think the only thing I would add is most people these days are looking for hybrid environments, meaning a single federated view to their traditional data centers, their mobile as Bob defined, as well as the newer private-public cloud environments. And we seem to be in a class by ourselves in terms of one federated view, workload portability that's highly automated and highly orchestrated. And even our cloud coverage, I think we have 20 some cloud environments being able to move from cloud to clouds, hypervisors to hypervisors or OS to OS and I think that is all showing up as a big positive.

N. Robert Hammer - Chairman, President and Chief Executive Officer

And this is across a number of different workloads, whether it is data protection and whether it's disaster recovery, whether it is dev/test, it's all seamless. It's all on one code base and it's all on one view of the data. And we have that view inside and across those different infrastructures, which really helps our customers not only execute these strategies but execute them economically.

Operator

Thank you. And our next question comes from Greg McDowell with JMP Securities. Your line is now open.

Greg R. McDowell - JMP Securities LLC

Great. Thank you very much. Two quick questions. First, on the maintenance realignment program, it sounds like great progress has been made so far. I was just hoping we could dig a little bit into thinking about FY 2018 and moving forward and whether longer-term maintenance growth rates return to how they grew historically or if there is something about the public cloud that maybe changes how we should think about the longer-term maintenance growth rates as you get through this maintenance realignment program.

Brian Carolan - Chief Financial Officer

Hi, Greg. It's Brian. I'll take that question. So just to take a half a step back, I mean we are now forecasting an increase in our maintenance services revenue for the year. That is an increase over our prior estimates of being flat for FY 2017. So we are encouraged to a strong start to Q1. The program rollout is going really well. We are getting great feedback and strong renewal rates.

We will see potentially a sequential decline in Q2 and Q3. We do start seeing that turn in Q4 of 2017 with a potential for sequential increase and that should continue through FY 2018. Just keep in mind, however, there is a lag effect and it does take a bit of time for it to ratchet back up to more normalized rates that eventually catch up to the software revenue growth rate, but that does take time throughout FY 2018.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Yeah, Greg, I think you will see your big, as Brian said, you will start to see both the growth and impact on operating margins as we enter FY 2018. I think you get your big swings occur in the second half of 2018 in terms of operating margin leverage as a result of this.

Greg R. McDowell - JMP Securities LLC

Great. That's helpful. And one quick follow-up on the public cloud providers. Some of the work we've done recently suggests that your partnership has strengthened with some of the largest public cloud providers out there, and I was just wondering if you could comment on – a lot of investors ask us if there is a risk that some of these larger public cloud providers build a solution like Commvault that they can then provide themselves. So I was just wondering if you could comment why that would or would not take place and maybe why your partnership is getting so much better with some of these public cloud providers. Thanks.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, there is no question that in both the case of Microsoft and AWS, our partnerships are strengthening because we make it real easy for customers not only to migrate to the cloud but manage their data in the cloud and then federate across different data sets. And I think that will continue for about as far out as we can see. There is no doubt that both Microsoft and AWS will increase functionality; and as they do, as we've done in the past with operating systems, we will adopt – we call it embrace and extend and leverage that increased functionality across our platform.

So we don't view that as a threat. You just have to understand where value comes from and how you extend value being provided by these cloud providers. But somebody building a platform like Commvault, we don't see that as the high priority for the cloud providers. I mean it's important to us as we take the business from where we are to $1 billion or $2 billion, it is – that kind of growth is important for Commvault. It's not as relevant for a Microsoft or an AWS or a Dimension Data or a Rackspace. So we think the opportunity will continue for about as far out as we can see, and we will continue to enhance and expand on it.

Operator

Thank you. Our next question comes from Srini Nandury with Summit Redstone Partners. Your line is open.

Srinivas S. Nandury - Summit Redstone Partners LLC

All right. Thank you for taking my call. Bob, Brian, I know you mentioned in your prepared remarks that the move to the cloud continues to be a major driver for your business, particularly the software side. Can you give us some color on the size of the customers that are moving to the cloud? Is it perhaps the mid-market or is it more in the enterprise side you are seeing this trend?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Seeing it. Yeah, we are seeing it across, but most of our comments are focused on large enterprises, and it's becoming mainstream now. On the flip side of that, almost all large enterprises have legacy applications that cannot be moved to the cloud, so that's why you're seeing these hybrid clouds; because when you have a legacy application that's based on dedicated compute network and storage, you can't translate that into the cloud without rewriting it. So what you're seeing is for the large enterprises, many applications that can be moved to the cloud are being moved or any data that can be moved to the cloud is being considered to be moved to the cloud.

So again, the comments I'm making are primarily tied to large enterprises, but we're seeing similar trends in medium enterprises as well. And Alan, do you want to add anything?

Alan G. Bunte - Chief Operating Officer

No. I think that's right on the money.

Srinivas S. Nandury - Summit Redstone Partners LLC

Okay, Bob, Al, you guys recently lost share in Commvault 11 platform. Can you talk about your conversations with your client base regarding upgrade and so forth? Thank you.

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, I mean, that is the cornerstone of our growth. And I'll let Al comment on this because our innovation rate and breadth and depth with what we are doing with 11 is up substantially from where it was a year ago. And I want you to expand on that.

Alan G. Bunte - Chief Operating Officer

Yeah. So we just really put out our SP4 quarterly release in June. And as Bob said, we have moved to a rapid dev model. It was all built on a services architecture, which we moved to probably late V10. We are seeing that really become valuable in terms of speed and velocity. We are also, as a number of things we are doing, like our admin council there, these are all based on REST APIs. So we've taken a hard API approach to a lot of the developments.

So we are getting leverage from the architecture. We've done a number of things process-wise internally to beef up even our quality, our testing and all of that with this rapid innovation model. And as Bob was alluding to, over a year ago we figured our productivity is somewhere in the range of double in terms of quality output of code. So we've definitely moved into that web scale, modern web dev platform type of approach for development there.

Operator

Thank you. Our next question comes from Aaron Rakers with Stifel. Your line is open.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Thanks for taking the questions, two if I can as well. So first, Bob, I would like to understand a little bit more about your thoughts on large deal pipeline and funnel. I know a couple of quarters ago you even talked about whale-sized deals. Have some of those impacted the reported results to date, and how do you think about those type of deals when you note that the Street is basically reasonable with regards to the expectations? Are those – is that building pipeline factored in at all in the context of the Street being reasonable?

N. Robert Hammer - Chairman, President and Chief Executive Officer

No. They are not built-in, Aaron, and a lot of those deals have moved into smaller deals and really haven't positively impacted our results to date. That's why we don't include them in our Street comments and, quite frankly, we don't build them into our forecasting models because they're just too hard to predict at this point. I mean, that may change but we haven't seen any consistency in our ability to predict those deals. They are there. There are some massive deals out there. But we haven't realized – let me put it this way: none of them had a material impact on our results to date, and we don't expect any of those to have a material impact on our Q2 results either.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Perfect. And then as a second question, the healthcare vertical obviously is an opportunity that you guys have focused on. I am just curious if any update of what you've seen to date and when might that be a notable contribution to the business?

N. Robert Hammer - Chairman, President and Chief Executive Officer

So what we have seen to date is a significant increase in healthcare revenue, but it has come from – for data protection as enterprises see we have the broader capabilities for clinical archive and being able to manage data from companies like Epic, it has clearly helped us in the broader healthcare industry. We have not to date translated that into these really big large opportunities on the clinical and electronic health record side of the business. So we are hitting some really good numbers, but not from a core strategic standpoint, and I think it's going to take us another three or four quarters to get that business to be a significant contributor. So I'll call it FY 2018, Aaron. But in the meantime, we are seeing acceleration in large deals and healthcare, but not on the clinical side.

Operator

Thank you. And our next question comes from John DiFucci with Jefferies. Your line is open.

Alexander Joseph Ljubich - Jefferies LLC

This is A.J. Ljubich, on for John. I'm just wondering for the quarter, you beat Street estimates on total revenue but missed on software revenue, although we understand you don't explicitly guide to software revenue. I was just wondering, was a mix shift to more ratable or subscription-like revenue a headwind in the quarter and is there any way to quantify that impact?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, I wouldn't call it a headwind. If you add it in, we are basically on the number. I think you will see more of those kind of deals come in. I would consider them in general to be additive and not subtractive. In addition to that, in Q1, we took the field out of territory for quite a while for our sales meeting and club, so our time and territory, and we knew this going in, was a lot less, so to achieve these numbers given that fact and we feel pretty good about it. But in general, I think our potential to do – and we don't like to talk about deal slippage because your number is your number. But when you take your field out of territory for a while, you are not going to have as much closure as you would normally. So I would say on balance I think we did okay.

Operator

Thank you. Our next question comes from Andrew Nowinski with Piper Jaffray. Your line is open.

Andrew James Nowinski - Piper Jaffray & Co. (Broker)

All right, thanks. Just two quick questions. So first, I guess, what would it take to get your product license growth in the double digits in the second half of FY 2017, meaning do you need a higher-than-expected contribution from the cloud providers like Amazon and Microsoft and Cisco? Or does your funnel have enough deals to get those growth rates there?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Funnel has enough deals today to get us where we want to go over the next couple of quarters. But it's still dependent on large deal closures, as we said in the earnings script, and most of those deals are – call it on fundamentals tied to data management and data protection on-premise and in the cloud.

In addition to that, we will start to see more and more traction from these new product offerings that we've talked about, like DR and dev/test, the stand-alone solutions and big data, to name those three. So those will incrementally add to license revenue growth over the next few quarters. And then when you get into the second half of the fiscal year, there is no question things like software-defined storage will become more meaningful to our growth.

So we've got a real depth and breadth of capability on the product side and we are doing pretty well on expanding distribution. The number of new distribution partners that we have today versus a year ago is substantial, so I think you will see the license revenue growth being driven by, number one, I call it just core data management and managing data, let's call them hybrid environments in the cloud. I think you will see extension incrementally from new solutions coming in. You will see acceleration from the fact that we have more feet on the street, additional sales capacity and enhanced distribution. So it's coming from all of those different elements and that's why we have a good solid foundation now across the board to execute.

Operator

Thank you. Our next question comes from Alex Kurtz with Pacific Crest. Your line is open.

Alex Kurtz - Pacific Crest Securities

Yeah, thanks. Just following up on that, Bob, around sales force productivity in the Q1 and just overall yield rates versus where you would like to have been coming out of the quarter. I know that you added a lot of capacity over the last year and a half so when you think about getting to the license growth rates that you want in the back half of the year, do you see the right kind of attainment levels in the quarter to sort of give you that confidence?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, I implied that sales productivity was lower in Q1 due to the fact that we took teams out of the field for a long time, which was a fact. So we expect to see sales productivity improve in Q2 as a result of all the things I just mentioned. In addition to that we are doing a lot of other things that will positively impact sales productivity, including our new pricing models and distribution and better enablement and we are tracking that issue across the board.

So the other factor that will impact sales productivity is that we have maturity now in all our theaters. We've restructured the Americas a year ago and that team is on a solid foundation. We restructured our APAC operations, and they are getting up to full capacity and speed, so we're seeing increased improvements in that theater. And we've got some new leadership now in EMEA, so we've got better stability there. And in addition to that, we are adding sales capacity heads and sales engineering support heads in the field to enhance that. Plus we have added overlay teams to help the fields more easily penetrate some of the new markets with our new product solutions and services.

Alex Kurtz - Pacific Crest Securities

All right. Thank you.

Operator

Thank you. Our next question comes from Michael Turits with Raymond James. Your line is open.

Jeremy Benatar - Raymond James & Associates, Inc.

Hi guys, Jeremy Benatar in for Michael. Can you talk about how competition has been down-market against aggressively priced competitors like Veeam? Have you been able to both hold share and grow revenue in that segment? Thanks.

N. Robert Hammer - Chairman, President and Chief Executive Officer

I think over the past year we have clearly – certainly Veeam has become, for us, less of a competitive issue. Let's put it that way. Our growth rates in the mid-market products that compete against Veeam are high, probably higher than Veeam growth rates. So my guess is we're picking up share in that segment of the market.

Operator

Thank you. And our next question comes from Eric Martinuzzi with Lake Street. Your line is open.

Eric Martinuzzi - Lake Street Capital Markets LLC

Yeah. Also on the competitive front, back to the enterprise side, historically it's been EMC and Veritas as competitors. They've both been going through their own internally focused restructuring spinouts, take privates. Any changes in the competitive behavior? Historically EMC had been a user of bundling to win business and then obviously the Symantec/Veritas a large install base. but now as a private company. If you could go a layer deeper on the behavior of those two, I would appreciate it.

N. Robert Hammer - Chairman, President and Chief Executive Officer

We will continue to see aggressive pricing and bundling from EMC. I think that will accelerate with Dell, not decrease. I think the best perspective to have is that since we have been more focused, we are out-innovating those competitors and are better organized in the fields than we were and we have better distribution leverage relative to those competitors than we had a year ago. So at the margin, we are doing a more effective job relative to those traditional competitors.

Eric Martinuzzi - Lake Street Capital Markets LLC

And Veritas?

N. Robert Hammer - Chairman, President and Chief Executive Officer

Well, I mean, what I was saying is if we are out-innovating them and we're better organized than they are, and we're better focused at the margin, we are doing a better job in winning and displacing Veritas accounts than we were a year ago.

Eric Martinuzzi - Lake Street Capital Markets LLC

Okay.

Operator

Thank you. And I am showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.

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