Red Hat (RHT) CEO Jim Whitehurst on Q1 2015 Results - Earnings Call Transcript

Jun.18.14 | About: Red Hat, (RHT)

Red Hat Inc (NYSE:RHT)

Q1 2015 Earnings Conference Call

June 18, 2014 05:00 PM ET

Executives

Tom McCallum - VP of IR

Jim Whitehurst - President and CEO

Charlie Peters - EVP and CFO

Analysts

Kash Rangan - Merrill Lynch

Raimo Lenschow - Barclays

Jason Maynard - Wells Fargo

Siti Panigrahi - Credit Suisse

Matt Hedberg - RBC Capital Market

Heather Bellini - Goldman Sachs

Karl Keirstead - Deutsche Bank

Joel Fishbein - BMO Capital Markets

Brent Thill - UBS Investment Bank

Abhey Lamba - Mizuho Securities

Michael Turits - Raymond James

Brad Reback - Stifel Nicolaus

Scott Zeller - Needham & Company

Gregg Moskowitz - Cowen & Company

Kirk Materne - Evercore

Tim Klasell - Northland Securities

Steve Ashley - Robert W. Baird

Operator

Good day everyone and welcome to Red Hat's First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions) I will be standing by if you should need any assistance.

It is now my pleasure to turn the conference over to Tom McCallum, Vice President of Investor Relations. Please go ahead, sir.

Tom McCallum

Thank you, Liz. Welcome everyone to Red Hat's earnings call for the first quarter of fiscal 2015. Speakers for today's call will be Jim Whitehurst, President and CEO; and Charlie Peters, Executive Vice President and CFO. Our earnings press release was issued after the market closed today and may be downloaded from redhat.com on the Investor Relations page. Also, on this page, you'll be able to find historic reconciliation schedule of GAAP to non-GAAP financial metrics, as well as a schedule on currency rates.

In addition, any forward-looking statements represent our estimates as of today, June 18, 2014, and these estimates or views may change. While the company may elect to update forward-looking statements at some point in the future, we specifically disdain any obligation to do so even if our estimates or views do change. And therefore, you should not rely on these estimates or forward-looking statements as representing our estimates or views at any date subsequent to today.

With that I’d like to turn the call over to Jim.

Jim Whitehurst

Thank you Tom, and let me add my welcome to all of you joining us on today’s call, the first quarter was a strong start to fiscal 2015 and continues its solid momentum with which we exited FY ’14. Our investment strategy which is primarily focused on increasing our sales capacity and driving adoption of our expanding portfolio of technologies, contributed to the strong results that we achieved during the quarter. Some of the highlights include our fastest total revenue growth in five quarters. The eight straight quarter of consistent mid to high teens growth in subscription revenue and the highest deferred revenue growth in three years.

On the customer and partner front the main drivers of this growth was a continued demand for Red Hat Linux, middleware and cloud offerings. This broad portfolio of technologies combined with the cross selling and strong renewals drove increased big deal flow during the quarter. The successful renewal of our largest deals continues to demonstrate the high level of customer loyalty that Ref Hat has earned with IT executives. I’m pleased to announce that we again successfully renewed all 25 of our top 25 deals up for renewal during the quarter. Moreover these top deals at an excess of 120% of their previous annualized value. Also within these deals we saw a number of customers buying multiple technologies from us, including some that purchased five to 10 different technology offerings.

With that overview let me discuss of our recent technology highlights. First in Q1, we held our premier event the Red Hat summit where we experienced a significant increase in the number of CIOs and senior IT executives attending the event. This helped lead to overall record attendance which was up 35% from the previous year. The main theme at the summit in April was the preview of RHEL 7. I’m pleased to share that we official launched RHEL 7.0 last week. RHEL 7 is significant because it was designed to meet both modern data center and next generation IT requirements for cloud, Linux containers and Big Data. As the worlds of physical, virtual and cloud systems converge Red Hat Enterprise Linux 7 delivers a true foundation for open hybrid cloud that will serve as the backbone for future application architectures.

The latest version of our flagship technology has several new features, including enhanced applications development, delivery, portability and isolation through Linux containers across all types of production environment. Security enhanced access for Microsoft Active Directory which further enables customers to build heterogeneous data centers. In addition, RHEL 7 comes with significant enhancements to security, files system, management and performance. A second highlight is our expanded relations with SAP and their HANA in-memory database offering. With the release of Red Hat Enterprise Linux for SAP HANA, our customers can now standardize all their SAP deployments on Red Hat Enterprise Linux. The expanded relationship gives Red Hat even greater access to the SAP portfolio of solutions as well as SAP’s entire ecosystems, systems integrators, ISVs, OEMs and cloud providers. This enables a new space in revenue opportunity for Red Hat. Third, we strengthen our position to deliver software-based storage solutions for Big Data and Open Stack with two recent acquisitions.

In April, we acquired Inktank, a driving force behind the open source project Ceph, the software defined storage space with Ceph and Red Hat storage address has tremendous growth potential. By joining forces with Inktank, Red Hat has expanded its footprint and can offer more comprehensive storage solutions to customers for block, object and file storage. In addition, Ceph block storage technology is integrated into Open Stack and considered the de facto standard by the Open Stack community. Inktank has preexisting partnerships with Alcatel Lucent, eNovance and Dell and its Ceph technology has been deployed in production at Bloomberg, CERN, Cisco and Deutsche Telekom among others.

Today we also announced our intention to acquire Red Hat consulting partner eNovance; a provider of cloud infrastructure services for enterprises and service providers like Red Hat and Inktank, eNovance is at the forefront of the OpenStack community. The company is one of the top 10 contributors to the upstream OpenStack project, and is the only European Gold Member company on the OpenStack Foundation. eNovance has approximately 150 global customers, including Alcatel-Lucent, Cisco, Cloudwatt, and Ericsson. With eNovance as a part of the Red Hat consulting team, we can enhance our consulting resources to be able to reach more customers with world-class OpenStack technologies and implementation services.

In summary, Q1 was a great start to our new fiscal year and we’re optimistic about our outlook for the remainder of the year. Our sales organization is executing at a high level and we believe we’re benefiting from an improved IT spending environment for open source and cloud enabling technologies. At this the same, we remain committed to our strategic investments which are focused on driving further growth in open hybrid cloud computing and big data.

Before turning the call over to Charlie, I want to welcome the teams from Inktank and eNovance to the Red Hat family. I also want to thank all Red Hat associates around the globe for their continued commitment to driving value for all our stakeholders.

With that, let me turn the call over to Charlie.

Charlie Peters

Q1 was a great start to the new fiscal year. It included higher than expected growth in virtually all of our key metrics, strong execution by a global sales organization and early returns on some of the investments we made in our expended technology portfolio. The strength of our first quarter results combined with the ongoing momentum of our business gives us confidence to increase our revenue outlook for the full fiscal year as I will discuss in more detail in a moment.

First let me share with you some of the highlights from this quarter. For the first time in a long time changes on foreign exchange rates had minimal impact on our results when comparing them against Q1 last year, last quarter or against guidance. As a result, I will focus on U.S. dollar results. For those interested in the foreign exchange changes, we have provided a table in the press release that shows the details. Some of the Q1 highlights include year-over-year subscription revenue of 18%, year-over-year total revenue growth of 17%, year-over-year billings growth of 17% which led the year-over-year short-term deferred revenue growth of 18% and long-term deferred revenue growth of 25%, and operating cash flow of $165 million which grew 16% year-over-year.

The sales team did a great job in every region. As Jim discussed, we continue to drive higher levels of large deal activity due to renewal strength and cross selling of technologies. Let me provide you with some additional details on the largest deals closed in the quarter. For the first time in the Q1, all of the deals in our top 30 deal metric were over $1 million. We also had a Q1 record with four deals that were in excess of $5 million and one that was greater than $10 million. Cross-selling was strong with 65% of these deals including one or more components from our group of applications development and emerging technologies offerings such as Middleware, OpenStack, OpenShift, CloudForms on storage, four of these deals were standalone application development and emerging market technologies offerings.

The top three deals came from a wide range of industries. The top verticals were telecom and cloud followed by our broad mainstream vertical. Healthcare was the top segment of the mainstream results. In addition, the government sector had a strong showing in the top deals as that sector continues to recover from last year’s impact of sequestration. Now let’s turn to our financial performance.

On a geographic basis, this quarter produced solid double-digit growth across all major geographies, 56% of bookings came from the Americas, 25% from EMEA and 19% from Asia-Pacific versus a 54%, 25%, 21% split in Q1 last year. The Q1 sales route mix was relatively consistent with 67% from the channel and 33% from our direct sales force versus a 68%, 32% split in Q1 last year. This is close to our long-term annual growth of 70% channel, 30% direct split although one should expect seasonable quarterly fluctuations in this metric.

Our billings proxy which we calculate by adding revenue plus the change in deferred revenue on the cash flow statement experienced this normal Q1 seasonality. The billing proxy was 404 million for the quarter, up 17% year-over-year. On a rolling four quarters basis which we believe is a more appropriate way to evaluate this metric and the one I intend to use going forward, the growth in billing is 18% up from 13% in the year ago quarter showing improving momentum.

Now let shift to the income statement. First quarter revenue was $424 million, a 17% increase year-over-year and 6% sequentially. The main driver of our total revenue growth was subscription revenue of $372 million. Subscription revenue was up 18% year-over-year and it’s important to point out that this renewable revenue stream now constitutes 88% of total revenue. Revenue exceeded our March guidance primarily due to a larger amount of deals closing earlier in the quarter than forecast and an acceleration in the monthly revenue we get from Red Hat’s certified public cloud providers.

At Red Hat summit this year, we shared additional disclosures concerning subscription revenue breakup by technology. We believe these additional disclosures are helpful when analyzing our business, so we’ll now be providing quarterly disclosures of these metrics, specifically the subscription revenue for infrastructure related offerings was $319 million up 14% year-over-year while the subscription revenue for the application development related and emerging technologies offerings was $53 million up 45% and now approximately 13% of total revenue. As a reminder, our infrastructure related offerings include mainly RHEL and RHEL related offerings, while our application development and emerging technology offering includes middleware plus our newer cloud offerings. The training and services component of revenue was $52 million up 9% year-over-year and up 6% sequentially.

Now I’ll discuss the rest of our results on a non-GAAP basis excluding stock compensation, amortization expense and business acquisition related costs starting with gross margin. Subscription gross margin was 94% consistent with Q4, training and services gross margin was 32% also consistent with Q4; our overall gross margin was above 86% again consistent with Q4 and Q1 last year.

Now moving on to non-GAAP operating expenses; Q1 non-GAAP operating expense came in at $277 million in line with expectations and up 23% year-over-year, partly as a result of the timing of this year’s Red Hat Summit in Q1 versus Q2 last year, sales and marketing grew 26%. We also had several other successful marketing events in Q1 that increased expenses including the OpenStack Summit, partner meetings and sales kick offs globally.

Further, we have continued to invest in sales headcount resulting in accelerating bookings, billings and revenue. R&D grew 22% as we ramped up hiring of engineers for our cloud technologies and then as a partial quarter of expenses from our acquisition of Inktank. We continued to show leverage in the G&A line, which increased only 10% from last year. Q1 non-GAAP operating income was $88 million including $1 million negative impact from Inktank acquisition, producing an operating margin of 20.8% and in line with our guidance.

We would expect operating margin to improve each quarter for the rest of the year due to higher revenues and lower event related expenses. Net interest and other income was modestly higher than Q1 last year at approximately $2 million. Our estimated annual effective tax rate was 29% for both GAAP and non-GAAP results. Non-GAAP diluted earnings per share came to $0.34 which is $0.01 above the high end of our guidance range.

Now let’s turn to the balance sheet and the cash flow statement. We ended the quarter with cash and investments of $1.4 billion, after spending $152 million on the acquisition of Inktank and $80 million to repurchase approximately 1.6 million shares of Red Hat common stock. We now have $160 million remaining on our stock repurchase authorization. Quarterly operating cash flow of $165 million was up 16% from Q1 last year, in part due to a healthy opening receivable balance and strong collections. Foreign exchange adjusted DSOs continued to be within our target range of 60 days and down one day from Q1 last year. As a reminder since day sales outstanding is traditionally a measure of receivables compared to billings, our DSO is calculative using our billing proxy.

Total deferred revenue at quarter end was $1.27 billion, an increase of $213 million or 20% above the same quarter a year ago. Current deferred revenue grew 18% and long-term deferred revenue grew 25% from one year ago. Sequentially, and as expected from a seasonality perspective, deferred revenue decreased approximately $17 million from last quarter. Foreign exchange also had little impact on deferred revenue adding only $1.5 million to each of short-term and long-term deferred revenue. The total decrease in deferred revenue without the impact of currency changes was $20 million and can be found on our statement of cash flows.

Now I would like to turn to guidance. Factoring the strong performance in Q1, for purposes of this guidance I have assumed that average foreign exchange rates for Q2 in the balance of the year as they were recently. For example the euro was at $1.36 and ¥102 equaled $1. I am also incorporating estimates related to the Inktank acquisition which closed on April 30th and the eNovance acquisition announced today, both of these companies were very early stage, that company with strong connections to software defined storage and OpenStack.

We expect them to add meaningfully to our OpenStack effort. For the remainder of the year together they should add approximately $2 million of subscription revenue and $8 million of services revenue and have a dilutive impact on non-GAAP operating margins and EPS of 100 basis points and $0.07 per share respectively. With these assumptions in mind, we’re raising our full-year revenue guidance by $30 million to a range of $1.760 billion to $1.785 billion of 16% growth at the top of the range that rounds to 16% revenue growth with or without these two acquisitions. Excluding these acquisitions, we would be raising our guidance for non-GAAP operating and margins and EPS by 50 basis points and $0.05 a share respectively. However, factoring in the expect dilution from these acquisitions results in a revised full year guidance for non-GAAP operating margin of around 23% and EPS in the range of a $1.52 to a $1.54 per share.

Our operating cash flow guidance is unchanged at $580 to $600 million for the year. Clearly, our organic growth is strong and we expect improved performance of the base business to offset more than half of a dilution from these acquisitions. These acquisitions are further steps to strengthen our ability to serve customers in a real enterprise class open stack and open hybrid cloud environment. We expect these investments to pay off for years to come.

For Q2 specifically, I offer the following outlook. Q2 revenue was estimated to be approximately $432 million to $436 million. Operating margin is estimated to be in the 23% area. Interest and other income should be around $2 million and non-GAAP EPS is estimated to approximately $0.38, assuming the same 29% tax rate. Consistent with my past practice I do not forecast quarterly cash flow. However, I would suggest that while estimating cash flow you consider beginning account receivable balance as the starting point in building your estimates.

In summary, we continue to believe that we are well positioned in our quest to serve our customer in the open hybrid cloud. We further believe that our customers will increasingly turn to Red Hat’s innovative technologies and services to help them realize the benefits of cloud computing and big data. Operator I would now like to turn it back to you for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Our first question is coming from Kash Rangan with Merrill Lynch. Please go ahead.

Kash Rangan - Merrill Lynch

I wanted to just ask you little bit about RHEL 7? And Jim, if you look at the Linux market place, Linux has a percentage of overall market that share has been holding pretty steady and granted that you guys have done a phenomenal job in the last three years with RHEL 6 improving your revenue content for server also added to that to JBoss. So as you look forward it feels like Linux as a percentage of the overall server market is not going up as much. And I am curious how you drive the core business growth rate and what are the levers that could help you grow faster than the growth at the overall Linux market. And particular if you can talk to some of the levers that you buy tab on the pricing side as RHEL 7, it feels like RHEL 6 was a big step function from RHEL 5 with respective pricing of key components and the outlook that you’re getting, it feels like you have lesser of it left here, so wondering how you think about driving growth in the core business, granted that the emerging technologies are doing fantastic. Thank you very much.

Jim Whitehurst

First of not sure what your data is on Linux is growing share. I believe it is growing share and over the next five years IDC expected to grow share significantly and the share paid Linux even grow off of that. And those seem like pretty good numbers so the compound annual growth rate they had for paid Linux was solid double digits over the next five years and I think we would agree there’s an opportunity there. With that said I think it comes from multiple areas right, there is still a continued move from main frame in Unix to Linux I was just on the phone today with a massive European customer that is literally just ready to start on the journey right now. We continue to believe we’re taking share from Windows especially with net new workloads. There’s a significant amount of innovation going on, just one example that I mentioned in my prepared remarks, around containers, like containers is basically a Linux only phenomenon and innovation and so we expect to continue to win the majority of net new workloads onto open source platforms and obviously we do a recently good job of monetizing against those. So I still believe share gain is a significant driver of continued growth in the RHEL business, as well as continue to buy up into higher skews. We don’t really have any kind of announcements to make now around pricing or pricing changes around, RHEL 7, so we do believe that it continue to become more core and more strategic to lot of our customer which you know let that value continues to increase, it gives us opportunity whether it was with the add on or with the core product. But I still think that share shift is still a major component of the RHEL growth story.

Charlie Peters

Great. Thanks Jim. Next question please operator.

Operator

And our next question comes from Raimo Lenschow with Barclays. Please go ahead.

Raimo Lenschow - Barclays

Thank you. Can you talk a little bit about the progress you’re making on, around OpenStack in terms of like the message was for this year to work on consulting projects so what decline those reference cases to be able to comps there, have a product out 50,000, 15 and 16. Talk a little bit about the progress you’re making there and what you see in terms of adoptions from clients. Thank you.

Jim Whitehurst

We have a number of OpenStack wins; again most of those start-off small. They are consulting engagements. They are kind of creeping up towards the 100 but not quite there and kind of total deals closed. We have deals closed in every region. We have also just done the two acquisitions to further strengthen our position. They obviously have a set of customers, many of those are joint customers but there are some incremental names that we will be adding to our customer list associated with it. So, it’s really proceeding well. We closed one large deal, a multi-million dollar deal in Q4 and again we have just a number of nice size deals moving forward.

Operator

Our next question comes from Jason Maynard with Wells Fargo. Please go ahead.

Jason Maynard - Wells Fargo

Jim, back at the summit you were talking about how you fell on the distribution side, you needed more depth instead of breadth and Q1 looks like you delivered on some of those goals. I am curious as you look out for the rest of the year how would you sort of grade yourself in terms of progress around achieving real depth and penetration into your accounts and the success you had in Q1, is this sort of early returns, is this sort of scratching the surface where we are in that journey?

Jim Whitehurst

I would say at this point we are in relatively early days, I mean if you look at RHEL penetration in the Global 1000, it’s very, very, very high. We have shown that as we then work with our partners to country on those customers, we generally can expand out our other product categories. The other product categories are nowhere near as penetrated into that account base, so we can continue to drive that. So, that’s a big, big, big opportunity for us as we go forward with all the other product categories. We already have credibility with those customers, so I still would say we are very, very early days especially when you start looking at cloud management, middleware, OpenStack we have credibility but very little progress so far in terms of hitting those customers. So, lot of growth potential there.

Operator

The next question comes from Keith Weiss with Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi, this is [Indiscernible] calling in for Keith. Thanks for taking my question. I have a question on the storage business; first I was wondering if you can may be provide an update on the initial traction around the Inktank acquisition and what customer feedback has been? And then secondly, if you could maybe provide some color on what the growth rates are in that business and what you are expecting for the year?

Jim Whitehurst

Sure, I will start. We have generally gotten very positive comments from customers around the Inktank acquisition, twofold. One is, certainly a lot of our customers were looking at and/or both using Red Hat Storage and Inktank and are pleased to see those things come together to have basically a single vendor to work to drive those roadmaps. So, very, very positive from that regard talking to customers as well as just a bigger more stable name behind the project. I think some of our larger customers a sense of stability around the project, so very, very positive there. It’s very, very early days, Charlie mentioned some subscription numbers. Obviously, the issue there is we start with bookings and those turn into revenue over a longer period of time, so still early days but great traction with customers, great set of dialogues happening. But obviously it’s only been couple of months.

Charlie Peters

Specially the high level of interest with Inktank around OpenStack related customers.

Operator

Our next question comes from Siti Panigrahi with Credit Suisse. Please go ahead.

Siti Panigrahi - Credit Suisse

Hi guys, congrats on the good quarter. Just want to dig little bit more on this eNovance acquisition, they are definitely beside OpenStack, they are very active on OpenStack also they have this minis IT infrastructure. So, just wondering how eNovance acquisition going to expand your open hybrid technology in terms of adoption in terms of OpenShift and other technology besides OpenStack?

Jim Whitehurst

Well first-off I think you rightly identified that eNovance brings some real capability into Red Hat around managing cloud environments and I think that’s something we are asked a lot for our clients about and so they will bring real capability of actually managing OpenStack at scale that we think we can actually scale that capability broadly around the world to our customer base. So, we feel very, very good about that. Yes, I think you are right we do believe that that same technology team, the great group of people can actually be very, very helpful as well looking at things like OpenShift and other cloud technologies to adopt. Just for one example, eNovance was even before these acquisitions a significant Inktank partner, so again it’s bringing these technologies together and their capabilities to help drive more than just our OpenStack offering.

Operator

Our next question comes from Matt Hedberg with RBC Capital Market. Please go ahead.

Matt Hedberg - RBC Capital Market

Yes, thanks a lot guys and congratulations on the quarter from me as well here. Within this offer to find datacenter space, you’ve clearly addressed the compute layer with both RHEL and RHEV and the stores layer with Gluster now Inktank. But I am curious, could you make a bigger splash in the networking layer beyond partnerships with Cisco and they support them this year with your OpenStack?

Jim Whitehurst

We are a significant part of the OpenDaylight project as well. So, we actually do -- and are building our own internal capability as we work with our partners in OpenDaylight as well. At this point we’re not ready to talk about products or what those might look like but we are investing heavily in the technology and when it’s ready we’ll obviously be more involved. That’s still well behind in terms of maturity storage or compute.

Operator

Our next question comes from Heather Bellini with Goldman Sachs. Please go ahead.

Heather Bellini - Goldman Sachs

Great. Thank you so much for taking my question. I had two relatively quick ones the first one is just a bit if you could share with us kind of the top three items being requested from the OpenStack community that you think could help accelerate the pace of adoption? And then just because we’re getting a lot of it from people are weighted to RHEL 7 if you could compare it to other cycles, other releases of RHEL 6 or RHEL 5, how fast do you think you see the pace of adoption for people migrating over? Thank you.

Jim Whitehurst

Yes. Well, I’ll say on OpenStack number one in terms of product feature is installation and management, without a doubt on product feature. And then the rest is really around capability which we talk consulting I mean they’re asking for capability on how to manage work flows processed all of those type things which is obviously one of the reasons we look to acquire eNovance. So those would really be the big wins. And I know management sounds like a broad area I would say if I’d to break that down installer and then just true kind of manageability are the biggest features that we hear about a little bit around HA. But I would say installer management and then broadly around capability around just how do you build run managed around it.

In terms of RHEL 7, we always like to more recognize we sell a subscription to RHEL not to individual versions so the relative uptake is not material directly to our revenues because the subscriber can decide when and how to upgrade versions. I will say I think this version because of some of the new features is likely to move faster, in the sense of things like docker and containers that have been well engineered into RHEL 7 and so I do think we’ll see more of a pickup around cloud deployment models because I think there is more change in RHEL 7 to address cloud deployments than relatively than 5 to 6. So I think it will be faster but again that impacts revenue when people start using more overall so it’s not a direct 6 to 7 having a revenue impact. So we don’t track that quite as carefully as you might think.

Operator

Our next question comes from Karl Keirstead with Deutsche Bank. Please go ahead.

Karl Keirstead - Deutsche Bank

Thank you. You mentioned in your comments two or three times about the strength in the quarter in the cloud revenues and booking. So I wouldn’t mind drilling in a little bit more there and two questions one is exactly where are you seeing that? I know you are certified on a whole bunch of cloud providers. Maybe you could offer little more color where the strength is coming from. And then Charlie if there are any metrics you might give us. I think in last quarter you said that the cloud revenues were at a -- I think at $36 million revenue run rate, up 40%. Maybe you could update those metrics. Thank you.

Charlie Peters

Yes. So just in terms of cloud providers we have now over 50 certified, Red Hat certified public cloud providers that are offering RHEL by the hour, by the day, on a short term basis and that revenue was growing nicely I would say that revenue accelerated from what we’ve talked about last quarter. I’ll come back with the metrics but the second piece that we also have a program called the Cloud Access program so that existing Red Hat customers with paid subscriptions from Red Hat can move their paid subscriptions from their own datacenters into a public cloud that has a Cloud Access program. This quarter, we added the Google Cloud with the Cloud Access program so there is another major cloud provider out there with Cloud Access.

In terms of the metrics you’re right the last time we talked about this what I said was for the fourth quarter we get about $9 million of cloud revenue annualized that go to the $36 million number so your memory is right. All I’ll say on this call is that the growth rate has accelerated and probably the next time we’ll give a metric with only hit the $100 million annualized run rate number. But it’s growing nicely it was definitely one of the reasons why we substantially beat guidance for the quarter.

Operator

Our next question comes from Joel Fishbein with BMO Capital Markets. Please go ahead.

Joel Fishbein - BMO Capital Markets

Thank you. Hey Charlie just a question, you talked a little bit about in the area you comment in the quarter our linearity was better. Can you give us a little bit more color there? And I am curious to see if any deals closed early or you had any pull-ins there?

Charlie Peters

There is no evidence of any pull-ins, but what my commentary was again in terms of the revenue beat -- the cloud beat that I just mentioned is certainly a part of the other paces of linearity, particularly some big deals in the first month of quarter, certainly helped add on a daily revenue recognition and it was a piece of it but, no I’m not aware of any pull-in so to speak.

Operator

Our next question comes from Brent Thill of UBS, please go ahead.

Brent Thill - UBS Investment Bank

Charlie, your call at healthcare, it seems that there is a lot of consolidation, the shift of electronic medical records, can you give us a sense of how sustainable that strength in your pipeline, is it relates to what you saw in Q1 in healthcare?

Charlie Peters

It is interesting because our big four of our records have always been Telco, financial services, government and then a broad media technology kind of vertical, and then we have this other group that we call mainstream accounts and we have kind of grouped healthcare into mainstream. At some point in time as it keeps growing, maybe would be a standalone separate vertical, we wouldn’t call it part of mainstream. I think, what as you point out, healthcare is going through an information technology change. They have been not on the bleeding edge of adoption. That’s for sure. And not like the financial institutions and even governmental. I would expect that over time we are going to see more opportunity for growth in healthcare vertical. But I guess that’s probably what I would say about that.

Operator

Our next question comes from Abhey Lamba with Mizuho Securities, please go ahead.

Abhey Lamba - Mizuho Securities

Thanks and congrats on a good quarter. Charlie I just wanted to -- your comments about cloud revenues, can you talk a little bit about what are the big drivers behind them and if they can have any cannibalistic impact on your enterprise sales. Also with this impact of bringing your own subscription plans that you offer with some of these cloud providers, can that slowdown the growth rates we are seeing in that segment as people kind of bring their own subscription to them?

Charlie Peters

Sure, there’s just a little bit more on cloud providers. I have seen some data from one of the large cloud providers that indicated that in their case majority of the business that they’re getting is from customers that have indicated to them they are first-time users of Red Hat, so they’re net new to us. And that is a really great statistic to the extent that more and more of this business is net new. In other words, customers we might not have otherwise touched, it’s basically another channel of distribution for us. We hope that continues, but what’s driving it is that we have a great brand name built over many years of customer support and a certified ecosystem that many of these customers are using their own data centers so they have a hybrid cloud environment. They want to know that they have the same certification in the Red Hat certified cloud provider. That is what I believe is driving our revenue in the public clouds. The other part of your question is about the cloud access program, meaning, customers that own Red Hat subscription want to actually run it in a public cloud rather than in their data center. We are totally neutral on that. They can run it wherever they like. The price is no different. The public cloud provider is still going to make some revenue in terms of what they charge to simply run for the compute time. But we are neutral in terms of where the customer runs it.

Operator

Our next question comes from Michael Turits with Raymond James, please go ahead.

Michael Turits - Raymond James

Hey guys, two questions. One, can you give us any more details, you talked about strong sales ramp. Can you give us any metrics on how that compares to last year? And also the guidance relative to the acquisitions, there are some industry estimates out there that eNovance might have been doing in the eight figure deal range over 10 million next year. Is there a shift in terms of how you are recognizing that revenue, on the securities right terms or are you exceeding any other businesses, also headcount sales ramping the eNovance?

Charlie Peters

Good questions Michael. On the sales ramp, first of all, since last year we have added quite a number of additional sales people plus we’ve crossed trained a number of sales people. And I believe our sales team are feeling very good, and are probably more confident this year than they were last year because they have been here longer. So I think we feel good about it. They have been working hard trying to build pipeline for future quarters and I believe we have done better with that which is one of the reasons why we have the confidence to raise the revenue guidance range by $30 million. The second question about eNovance; eNovance is a manager services company, and then it run a consulting business. So unlike some other companies that we have acquired that had a subscription business, we’ve deferred revenue, this one did not have deferred revenue too that we needed to write down and then sort of start over again. Inktank did in fact have [indiscernible]. But eNovance, it’s a ongoing business that has customers; we will be working hard with them to make the transition to Red Hat. So the integration process, probably will cause a little bit of disruption for a very short period of time as they get on board to Red Hat and we get going with, particularly with Red Hat OpenStack which is what we’ll be working hard for them to offer consulting services for.

Jim Whitehurst

Well another, recognize we’re also only adding an eight months not a full year of revenue when we close. And second and I can’t speak specifically on eNovance field. But I can definitely speak to large Red Hat consulting engagements, eight figure type of consulting engagements are generally multi-year, there are rarely ever delivered in one year. So we’re talking about eight months of revenue in this year.

Operator

Our next question comes from Brad Reback with Stifel Nicolaus. Please go ahead.

Brad Reback - Stifel Nicolaus

So just a quick question on margins. So it looks like this [indiscernible] where sales and marketing and R&D outgrow revenue. And I understand massive opportunities around some very big things in front of you. But how should we think about that trend continuing and if and when you think it might abate. Thanks.

Jim Whitehurst

I think the product revenue breakdown that we’re not providing may give you some help in thinking about it, because what you see as a very large part of our business that has very consistent growth, largest part of it obviously is the Linux business at 14%. You should assume that that is a very healthy business, it’s doing quite well. The other business this quarter grew at 45%; you could imagine what a P&L might look like for something with that kind of a growth rate. Obviously investment there is higher, the sales investment there is higher and even the R&D as a percentage of revenue is higher but the growth is really going very strong.

So we said at the start of the year that it was our intention to invest and make some conscious decisions to invest this year particularly around OpenStack and some of the newer cloud technologies OpenShift and storage. And I think what you see playing out here in the first quarter is just that. That is what we’re doing. I think we’re following the strategy that we laid out and the results thus far have been very encouraging. And hopefully you’re encouraged by the increased guidance we’re given as well.

Charlie Peters

Just to emphasize that the 53 million of the other revenue bucket that we talked about is also subscription revenues. Yes we’re insisting heavily to get it but the gross margins look pretty similar to our gross margins elsewhere. When you have an opportunity to have a business growing at 53% with high 90s, that’s like 45% to 53 million, 45% at high 90s gross margins. That’s something you should invest pretty heavily in. Without that seen everyone else is private company financials, that’s got to be if it were standalone company that second largest open source company by far.

So with those kind of growth rates and those kind of margins I think it’s only prudent for us to double down and invest heavily to grow those businesses as fast we can.

Operator

Our next question comes from Scott Zeller with Needham & Company. Please go ahead.

Scott Zeller - Needham & Company

At Analyst Day we had some color offered around cross selling of products regarding the top 120 deals. Could you update us on that? I believe you gave us a number for all of fiscal ‘14 but is there any additional color for the current period you could offer.

Jim Whitehurst

Yeah one of the comments that we mentioned was that in the top deals this quarter 65% of them had other products sold, so the infrastructure related it would be sort of the base business and the application development and emerging technologies the rest 65% of the top deals had a combined element. And four of them were standalone application development in emerging technology deals. So I would say the cross selling has gotten better and we have along the way continued to add to the portfolio of things that our sales guys have to sell. So I am looking forward to that continuing to grow and accelerate.

Scott Zeller - Needham & Company

I guess just to follow up; there is no further color though about moving down and the impact there? Was that an annual metric?

Jim Whitehurst

You mean -- that’s the quarterly metric, I am not sure what you’re implying is to give a rolling 12 months metric, I am not intending to do that.

Charlie Peters

The 120 was the top 30 deals over the fourth quarter, so we’re updating with this quarter but yeah we don’t roll down past the top, we don’t do the analysis like that below the top 30 deals.

Jim Whitehurst

But you could do it, since we’ve done that same metric every quarter, if you go back to first quarter of last year drop off the metric from last year and add on the numbers I’ve just given and come to a 12 months metric like that.

Operator

Our next question comes from Gregg Moskowitz with Cowen & Company. Please go ahead.

Gregg Moskowitz - Cowen & Company

Just a couple of quick questions, how many consultants does eNovance have? And then also Charlie was there any change in average contract length versus the prior quarter? Thanks.

Jim Whitehurst

Sure, eNovance brings approximately 110 people with it. And they’re not all in consulting, some are in engineering in fact they’re the seventh largest contributor to the upstream OpenStack project, which we think is another big benefit. I am not sure if we mentioned but there is at least 40 individuals that have good experience with Ceph, so a big help to the Inktank effort. But there is probably over 60 or 70 who have consulting skills that will be a big help, to start with mostly in North America and Europe, but the intention would be to use them further than that.

Charlie Peters

The other question was average contracts.

Jim Whitehurst

The average contract link was just share over 21 months.

Operator

Our next question comes from Kirk Materne with Evercore. Please go ahead.

Kirk Materne - Evercore

Thanks very much. Jim, just around eNovance, can you talk a little bit about just how much the potentially I guess shortages skill, consulting skills around OpenStack is somewhat of a governor on sort of growth in that technology and I guess what you think the combination of eNovance is sort of consultants plus your sales people working together can do the sort of deal cycles, do you think that can compress it pretty significantly? I know you guys did a similar type of deal Amentra of your back in 08, I am just wondering what you’ve sort of learned from that deal in terms of bringing more consulting expertise into the Middleware space? Thanks.

Jim Whitehurst

Well, I think mainly this will allow to do more POCs. This is a different technology than Amentra and Middleware. I don’t want to at this point say it can compress the timing it takes to do a POC, but it certainly will allow us to do substantially more POCs simultaneously, just a one data point on that. We recently had our annual sales presence awards club. And Charlie actually asked the question to the sales people there, how many of you could sell incremental OpenStack consulting if we had more people available and I would say at least half the people raise their hand they could sell more. Now we’ll see when we’re in the marketplace but without a doubt, we’re constrained in our ability to deliver OpenStack by our lack of enough qualified professional services resources. So without a doubt this will allow us to do more, hopefully it will allow us to speed it out the most importantly it will certainly allow us to do more slightly in parallel.

Operator

Our next question comes from Tim Klasell with Northland Securities. Please go ahead.

Tim Klasell - Northland Securities

Yes, just a follow-on question with that. With the Amentra acquisition, it was always sort of a training session and they sort of professional services sort of led product deal by about a few quarters, is that something that we should expect here because of the complexity could be longer?

Jim Whitehurst

I think it will be long. It is a little bit of a different dynamic recognized typically with Middleware deal. The consulting wasn’t doing a POC. It was working to build applications that run on that application infrastructure. So Amentra was doing a fair amount of application development itself is part of that. This is more -- at least for starter we’ll be doing more POCs. So this is our ability to get up and implemented faster. So it is a different sale and a different dynamic around the professional services upfront.

But I don’t think we know is once it’s up and running, will those customers want to keep resources around to help them with this. I think right now eNovance has demonstrated most customers do want to keep some of these resources around to help them longer term, which is a little different than Amentra as well. But again I think this is much less about need to develop the application portfolio like we had too with Amentra. They run on the Middleware a much more about doing the POCs proving it works, getting the processes in place for people to be able to run it, so a little bit of different dynamic.

Charlie Peters

Tim, I would add the following that I think one of the things held back the technology overall is lack of train individuals globally and customers and so as we said I think a quarter ago, we have launched a curriculum of three or four different classes in OpenStack leading to Red Hat a certified engineer for OpenStack type of a certification. And I think as you know we have 50,000 to 60,000 Red Hat certified engineers out there today certified on RHEL. Our goal is to quickly train people globally and have them certified on Red Hat OpenStack.

Tim Klasell - Northland Securities

Okay, good. And then just a quick question on the Middleware office you accelerated nicely Q4, Q1, were there any particular products inside the EAP that drove that or was it pretty broad?

Jim Whitehurst

Just to keep in mind that product grouping is not just Middleware, right. It is some application development and emerging technology. So Middleware is the largest individual component, but there has been good growth of all the technologies including OpenStack, OpenShift, Storigen and certainly Middleware.

Charlie Peters

Yes, I would say on the Middleware side in particular. We just launched our BPM product. It’s one of our fastest product launches ever in terms of uptake of product in size of bookings early on. And the integration products suites [Indiscernible] has done extremely well and continuing to grow nicely as well.

Operator

Our final question comes from Steve Ashley with Robert W. Baird. Please go ahead.

Steve Ashley - Robert W. Baird

Thanks. Just like to go back and just kind of verify something that was said. We’ve talked about strong sales execution, we also talked about expanding sales coverage, and I am wondering I am just trying to parse that, is it just that you have more boots on the street or is there an improvement in the execution of the existing sales force, and if there is, any color on that?

Jim Whitehurst

In my view I think we have both. We definitely have more boots on the street because we have been hiring consistently, but I think our sales guys are more experienced, they are better trained, as I said their confidence level is high, their enthusiasm is high. I think it's a combination of both. So we're very pleased with their performance in the quarter and looking for that continuing.

Jim Whitehurst

Thank you everyone for joining us and we look forward to meeting with a number of you over the next few weeks. Thank you.

Operator

Thank you. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!