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Red Hat (NYSE:RHT)

Q1 2013 Earnings Call

June 20, 2012 5:00 pm ET

Executives

Tom McCallum

James M. Whitehurst - Chief Executive Officer, President and Director

Charles E. Peters - Chief Financial Officer and Executive Vice President

Analysts

Adam H. Holt - Morgan Stanley, Research Division

Edward Maguire - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Stewart Materne - Evercore Partners Inc., Research Division

Heather Bellini - Goldman Sachs Group Inc., Research Division

Kash G. Rangan - BofA Merrill Lynch, Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

Michael Turits - Raymond James & Associates, Inc., Research Division

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Bhavan Suri - William Blair & Company L.L.C., Research Division

Mark R. Murphy - Piper Jaffray Companies, Research Division

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

Richard T. Williams - Cross Research LLC

Gregg Moskowitz - Cowen and Company, LLC, Research Division

James N. Gilman - Drexel Hamilton, LLC, Research Division

Abhey Lamba - Mizuho Securities USA Inc., Research Division

Israel Hernandez - MKM Partners LLC, Research Division

Brent Thill - UBS Investment Bank, Research Division

Operator

Good afternoon. My name is Marvin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Red Hat Q1 2013 Earnings Conference Call. [Operator Instructions] I'll hand the call over to our host, Mr. Tom McCallum. Sir, you may begin.

Tom McCallum

Thank you, Marvin. Hello, everyone, and welcome to Red Hat's earnings call for the first quarter of fiscal 2013. 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 the schedule on currency rates. Various remarks that we may make about the company's future expectations, plans, prospects, including the statements containing the words believe, anticipate, plan, project, estimate, expect, intend or will, constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's most recent annual report on Form 10-K filed with the SEC as well as the safe harbor statement in today's press release. In addition, any forward-looking statement represents our estimates or views only as of today, June 20, 2012, and these estimates and views may change. While the company may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or views do change, and therefore, you should not rely on these forward-looking statements as representing our estimates or views as any date subsequent to today.

With that, I'd like to call the -- turn the call over to Jim.

James M. Whitehurst

Thank you, Tom, and let me add my welcome to all of you joining us on today's call. Red Hat associates around the world continued their solid execution, and we experienced broad, global demand for our community-powered technologies. This resulted in a strong start to our fiscal 2013 with first quarter financial results that were above our expectations. While the macroeconomic environment and exchange rates remain volatile, we delivered good growth across each of our key financial results, including subscription revenue, operating income and operating cash flow.

Let me discuss a few business highlights. First, we experienced solid demand in all major geographies during the first quarter. Red Hat continues to be well positioned as the central connection point between a growing global network of enterprises, partners and open source communities. Customers are using open source technologies to re-architect their data centers and build their private and hybrid clouds. As the global open source leader, we are in a unique position to leverage our strength as this market shift continues. Customers do not want to be locked into proprietary systems or clouds.

Second, we continue to enhance the value of -- our customers receive through their Red Hat subscription. Our customer portal, which is only available to paid subscribers, was designed to empower customers with tools that provide greater capabilities to troubleshoot and collaborate. For the second year since we launched the Red Hat customer portal, we have been recognized as one of the 10 best Web support sites in 2012 by the Association of Support Professionals.

Third, Red Hat was recognized last quarter by Forbes magazine in its Fast Tech 25 companies. This ranking represents their evaluation of best-in-class corporate performers for sales and earnings growth.

And finally, from a renewals perspective, I'm pleased to report that all of our top 25 deals that were up for renewal in the quarter not only renewed, but they did so at a total value of over 120% of the original value. This further validates the high level of value that customers are receiving through their Red Hat subscriptions.

In addition to strong financial results, we continued investing in new growth opportunities around cloud computing and storage during the quarter. We recently released a number of new technologies ahead of next week's Red Hat Summit and JBoss World, our premier open source customer event.

Let me review some of the recent announcements. Within cloud technologies, we announced the general availability of CloudForms, the next step in the management of open hybrid cloud solutions to enterprises. CloudForms is an open hybrid cloud platform built to enable enterprises to create and manage Infrastructure-as-a-Service hybrid cloud with the ability to make self-service computing resources available to users in a managed, governed and secure way. With CloudForms, enterprises can build, control and manage an open enterprise hybrid cloud, providing infrastructure choice spanning across multiple virtualization platforms and extending to public cloud resources.

We also provided a strategy update for OpenShift, our Platform-as-a-Service or PaaS offering that is a leading open cloud application platform for enterprises. We plan on extending the technology to an on-premise PaaS offering. This will enable enterprises to take advantage of the benefits of PaaS while providing a consistent environment for both public cloud and on-premise data center usage. By building on the core technology stack that already powers OpenShift's public cloud PaaS, the enterprise edition will help provide the benefits of cloud computing in a way that maximizes both operational flexibility and application development efficiency. This is a key for enterprises looking to scale, automate and ultimately treat software as services. OpenShift will not only help enable new applications and development models but will benefit customers with legacy infrastructure and out-of-date processes around the existing applications. The 451 Research report group expects the enterprise PaaS market to grow rapidly to more than $3 billion by 2015.

On the public cloud side, we added the Ixonos Elastic Cloud to our growing list of certified cloud partners. And today, we launched JBoss Enterprise Application Platform 6, an ambitious release in every respect, including a major revision of the Java EE platform. EAP 6 is targeted towards a new generation of developers that architect applications for the future, public, private and hybrid cloud deployments. We believe EAP 6 will increase ease of use and operational efficiency along with the flexibility and agility our customers rely on with our middleware technology.

I hope many of you can attend Red Hat Summit next week. We're expecting record attendance, with more registrations still coming in from around the globe. We will be showcasing Red Hat's leadership with innovators, customers and partners, including executive thought leaders from Accenture, HP, IBM, Intel and SAP.

At the summit, you'll hear about emerging technologies, trends that are shaping the future of IT and programs to further strengthen our relationships with our customers and ecosystems. We have built an agenda that centers on transformation, and we'll focus on the challenges customers are experiencing today and into the future. Attendees can expect rich discussion and content on open hybrid clouds, storage technologies and enhancements to our core products.

Before turning the call over to Charlie, I'm pleased that Arun Oberoi has joined Red Hat as Executive Vice President, Global Sales and Services, in May. Arun is a longtime software industry veteran who has led and repeatedly built rapidly scaling businesses, from start-ups to multibillion-dollar organizations.

In addition to welcoming Arun, I also want to thank Mark Enzweiler for his leadership as Interim Acting Head of Global Sales and Services. Under his guidance, Red Hat surpassed the $1 billion mark, and the organization has continued to make positive strides in the marketplace. Mark will resume his role leading the Global Channels organization.

In summary, we're pleased with our position as the world's leading provider of open source solutions, using a community-powered approach to provide reliable and high-performing cloud, virtualization, storage, Linux and middleware technologies. We're optimistic on the growth opportunities in these markets. And next week, you'll hear more about the exciting solutions and programs that will propel further growth.

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

Charles E. Peters

Thanks, Jim. After a couple of quarters of relative currency stability late last year, foreign exchange rates have become volatile again, with most currencies weakening against the U.S. dollar, some significantly. These currency changes do not have much impact on the average rate used for translating the P&L for the May quarter compared to either the Q4 or the rates used for guidance. However, changes in average foreign exchange rates compared to a year ago were significant, as were changes in the spot rates used for translating the balance sheet at May 31 compared to the prior quarter and the prior year. As a result, I will base my comments on U.S. dollar comparisons; but where appropriate, I may add comments in constant currency terms using last year's rates.

The first quarter was a good start to the new fiscal year. On a year-over-year basis, we had 16% billings growth in U.S. dollars and 20% in constant currency; revenue growth of 19% in U.S. dollars or 22% in constant currency; and more importantly, subscription revenue growth of 21% in U.S. dollars and 24% in constant currency. We also had non-GAAP operating income growth of 22% and operating cash flow growth of 38%.

Broad demand for our solutions continues to be evident in our top 30 deals metric, where cross-selling and deal size continues to be strong. The top 30 deals set a Q1 record for deals over $1 million. In the quarter, we had 25 deals of $1 million or greater, nearly double from the prior year first quarter. Two deals were in excess of $5 million. And cross-selling was strong, with more than 40% of the deals including a middleware component and 3 being stand-alone middleware deals. Within the top 30 deals, tech and media and financial services were our top quarter verticals, while we continue to see good progress within management verticals, specifically with a number of large transportation wins.

One of the larger deals this quarter was a significant Windows-to-RHEL migration with a European financial services customer with global operations. This customer is looking to achieve greater security, reliability, scalability and cost savings by standardizing on RHEL in their offices in over 20 countries and across multiple workflows.

Now let's turn to our financial performance. Our bookings metrics demonstrate the breadth of demand we experienced on a global basis this quarter. 55% of bookings came from the Americas, 25% from EMEA and 20% -- excuse me, and 20% from Asia Pacific. In partial answer to the anticipated questions about the European macro environment, 11 of our top 30 deals came from EMEA, where our value proposition is clearly resonating. The Q1 route-to-market mix was 64% from the channel and 36% being generated by our direct sales force versus a 59%-41% split in the fourth quarter.

Our billings proxy, which we calculate by adding revenue plus the change in deferred revenue on the cash flow statement, was $310 million for the quarter, up 16% year-over-year. If one factors in the year-over-year foreign exchange impact on revenue in this calculation, billings grew by 20% on a constant-currency basis for the first quarter. This was a normal seasonal Q1 result, but it was also influenced somewhat by lower growth in services, as we had predicted.

Now let's shift to the income statement. First quarter revenue was $315 million, an increase in U.S. dollars of 19% year-over-year and 6% sequentially. As mentioned previously, that's a 22% year-over-year increase in constant currency. The main driver of our total revenue growth was subscription revenue. Subscription revenue was up 21% in U.S. dollars year-over-year and 7% sequentially, $273 million. It was up 24% on a constant currency basis. Q1 marked our seventh straight quarter of 20%-plus growth rate in subscription revenue. Subscription revenue, which is a renewable revenue stream, constituted 87% of total revenue.

The training and services component of revenue was $42 million, up 8% in U.S. dollars from last year and flat sequentially. Services grew 10% year-over-year on a constant currency basis. Although we guided services revenue growth rates to decline due to the higher utilization of partner services, the growth rate of training slowed slightly more than projected.

Now I'll discuss the rest of our results on a non-GAAP basis, excluding stock compensation, amortization expense and certain facility exit costs, starting with gross margin. Subscription gross margin was 94%, consistent with Q1 last year. Training and services gross margin was 36%, up 300 basis points year-over-year. Overall, gross margin was above 86% for Q1. That's 130 basis points higher than last year. The improvement in overall gross margin resulted mainly from the higher percentage of subscriptions in the mix.

Moving on to non-GAAP operating expenses. We continue to focus spending on growth opportunities. Q1 non-GAAP operating expense came in at $190 million, up 7% sequentially and 20% year-over-year. Sales and marketing and R&D grew as we continued to hire mainly engineers and sales professionals. Q1 also included marketing and program expenses related to the launch of new technologies.

We continue to enjoy a natural foreign currency hedge, primarily as a result of having multiple offshore engineering and support centers, that somewhat mitigates the impact of foreign exchange on our operating income. Not a perfect hedge, but it definitely cushions the impact of currency swings on our profitability. It does not cushion the impacts of revenues reported in U.S. dollars. Using currency rates from Q1 last year, this quarter would have shown revenue $8 million higher, expenses $6 million higher and operating income $2 million higher. Using currency rates from the fourth quarter, this Q1 would have shown revenue $2 million higher, expenses $1 million higher and operating income $1 million higher.

Q1 non-GAAP operating income was $81 million, producing an operating margin of 25.8% and better than our guidance. This margin is higher than originally forecasted, due in part to the revenue beat and the richer gross margin. In addition, overall hiring was approximately 200 associates, about 50 below our target as we continue to be very selective at hiring, taking only the best candidates.

Net interest income was in line with last year and the $2 million which we had guided. Other income includes a $2 million investment gain, which adds about $0.005 to EPS. Our estimated annual effective tax rate was 32% for both GAAP and non-GAAP results.

Non-GAAP diluted earnings per share came to $0.30, which is $0.03 above the high end of our guidance range, up 25% compared to last year. GAAP diluted earnings per share came to $0.19, compared to $0.17 last year. This first quarter included a charge of $3.1 million in connection with exiting one of our 2 existing buildings in Raleigh, North Carolina. We will likely exit the second building in Q1 next year, and we'll probably have a similar exit cost which we record at that time. You'll recall that we announced late last year that we will be moving to a larger building in downtown Raleigh to accommodate our growth. We have negotiated very favorable lease terms on the new facility and received significant incentives from the state, the county and the city in conjunction with this move.

Now let's turn to the balance sheet and the cash flow statement. We ended the quarter with cash and investments of $1.3 billion. In Q1, we used $30 million to repurchase approximately 550,000 shares of Red Hat common stock. The remaining balance of our stock repurchase authorization is now $270 million.

Quarterly operating cash flow of $124 million was up 38% from Q1 last year. An important factor in this result was healthy opening receivables and strong collections. FX-adjusted DSOs continued to be within our target range at 60 days. As a reminder, since days sales outstanding is traditionally a measure of receivables compared to billings, our DSO was calculated using our billings proxy.

Total deferred revenue at quarter end was $913 million, an increase of $127 million or 16% from the same quarter a year ago. In U.S. dollars, current deferred revenue grew 17% and long-term deferred revenue grew 15% from one year ago. FX rates were a significant factor here since total deferred revenue grew 22% on a constant currency basis. Sequentially, deferred revenue decreased approximately $33 million from last quarter.

To isolate the foreign exchange impact, let me break down the components of deferred revenue for you. Short-term deferred revenue, which ended Q4 at $711 million, had a real decrease in Q1 of $11 million and decreased an additional $18 million as a result of changes in FX and spot rates, ending Q1 at $682 million. Long-term deferred revenue, which ended Q4 at $235 million, had a real increase in Q1, up approximately $6 million, but it was more than offset by an additional $10 million reduction caused by changes in FX spot rates, ending Q1 at $231 million. The total decrease in deferred revenue without the impact of currency changes was $5 million and can be found on our statement of cash flows.

Now I'd like to turn to guidance, factoring in the current global macroeconomic environment and weakening of most currencies against the dollar. I don't forecast foreign exchange rates, but for purposes of this guidance, I have assumed the average FX rates for Q2 and the rest of the year are Euro at $1.26 and JPY 80 to the dollar. The Euro has depreciated 6%, and the yen has appreciated 3% from the rates which I used at the start of the fiscal year. All other currencies in which we do business have depreciated against the dollar, including the Australian dollar by 10%, Indian currency by 13% and Brazilian currency by 16%. Comparing the assumed FX -- Q2 FX rates to the average rates in the second quarter last year indicates a 12% headwind for the euro and a 1% headwind for the yen this quarter. Given this backdrop, it should come as no surprise U.S. dollar-translated numbers are lower, and some of you have already begun adjusting your models.

With those assumptions in mind, I offer the following outlook for Q2: Q2 revenue is estimated to be approximately $320 million to $322 million. Operating margin is estimated to be in the 24.5% to 25% area. Interest and other income should be around $2 million, and non-GAAP EPS is estimated to be approximately $0.28 to $0.29, assuming the same 32% tax rate.

Consistent with my past practice, I do not forecast quarterly cash flow. However, I suggest that while estimating cash flow, you use beginning accounts receivable balance as a starting point.

On a local currency basis, there is no reason to update my full year guidance, although it is not possible to say where foreign exchange rates will go as the year progresses. And as I said, some of you have begun to adjust your models for currency swings, while others have not. In the interest of consistency, if you all adjust your models to current FX rates, that would suggest a revised full year U.S. dollar revenue range of $1.32 billion to $1.34 billion. This guidance assumes that the subscription and services revenue percentage split for the year will be in line with what we saw in Q1. The other elements of full year guidance, which I provided on March 28, 2012, do not need to be adjusted at this time.

We have clearly demonstrated that we can perform in up as well as down cycles. Our EMEA business was strong in Q1 with over 20% growth in local currency and had a strong showing in our largest deal list. We continue to gain share as customers move to open source solutions for various reasons, including cost savings.

The current financial turmoil in Europe may be an opportunity for us to gain additional market share, and we intend to work to that end. However, the resulting FX volatility is an outcome which we can't control. We will focus on controlling those things that we can control, such as continuing to invest in our business and managing for growth.

In summary, the company continues to execute well, and our pipeline remains strong. We're off to a good start, and we'll continue to invest in our portfolio of growth opportunities to capture share in the data center. I look forward to seeing as many of you as possible next week at Analyst Day in Boston in conjunction with the Red Hat Summit.

And operator, I would now like to turn it back over to you for the first question.

Question-and-Answer Session

Operator

Our first question comes from the line of Adam Holt with Morgan Stanley.

Adam H. Holt - Morgan Stanley, Research Division

My first question, I guess, is for either one of you. If you look at the adjusted billings growth rate, understanding that at the beginning of the year, it's still at the lower end of what we've seen for the last several quarters from a year-on-year growth perspective. Was there anything in the quarter that was different than you expected from a demand perspective? Or did you see anything from a linearity perspective that was different than you were looking for?

Charles E. Peters

Adam, on a linearity perspective, which is fairly typical, we saw the 25-25-50 kind of a split by month. So nothing there. And as I said in my remarks, the only areas are -- our training was up slightly less than expected. But apart from that, it was a very solid quarter. Really good deal metrics and all the rest.

James M. Whitehurst

Yes. And Adam, just to reiterate, as we talked about before, we don't manage to billings. It's not a necessarily relevant number to us. And we hit our plan on the measures we use internally, which are around bookings. So we felt good about the quarter and are certainly on plan.

Adam H. Holt - Morgan Stanley, Research Division

And if I could just ask a quick follow-up on the product mix. Could you give us a little bit more flavor on how the JBoss suite compared to the core business and whether or not you saw any impact from Gluster to the top line in the quarter?

Charles E. Peters

Sure, thanks. In the -- look, as I mentioned, in the top 30 deal metric, we had a really good middleware showing. 40% of the top 30 deals had a middleware component, and 3 of them were stand-alone middleware deals. As far as Red Hat Storage goes, we -- there's no significant revenue from that yet, and you'll hear more about that this coming week at the Red Hat Summit.

James M. Whitehurst

And just to reiterate, the core Red Hat Storage product has not GA-ed. So it's not -- it's too early for it to have affected revenue.

Operator

Our next question comes from Ed Maguire with CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Yes, I was wondering if you could discuss the impact that you're seeing, at least on the ground, from the investments you've made in some of the emerging markets. I noticed that Asia was 20% of your revenues this quarter. And if you could just comment, there has been some concern about conditions on the ground in Asia as well.

Charles E. Peters

So if you look back historically, what you'll see on our Q1 is the -- our Asian contribution to our total geographic split typically is about 20% each Q1 for the last 3 years. Because of the Chinese New Year and Golden Week, what is normally our fourth quarter for them is generally a little bit weaker because of holiday time, and one of their better quarters is typically Q1. So we had good performance. I think in particular, we saw good performance out of Japan and Australia, New Zealand.

Operator

Our next question comes from the line of Kirk Materne with Evercore Partners.

Stewart Materne - Evercore Partners Inc., Research Division

I guess, Charlie, you guys obviously had a very strong close to the fiscal year, and it looked like the channel was a little bit more pronounced in terms of contributing on bookings this quarter. I guess was there any sort of -- do -- looking back on the quarter now, was any business sort of pulled from 1Q to 4Q? I know when you adjust for FX, the deferred number wasn't way out of the range from what you see normally in the first quarter, but it was down a little bit where is it -- has been more flat q-over-q. So I guess was there any sort of pull into the fourth quarter that didn't sort of translate this quarter? Or was it pretty much just about as you guys expected?

Charles E. Peters

I guess pretty much as expected. And I would say on the split between the channels, it was 64% channel and 36% direct. That's -- that also is fairly typical of a Q1. When Europe and Asia are heavy contributors, more of their business goes to the channels. See, that's what tends to increase a little bit on an overall basis. So there was nothing unusual or unexpected in that result.

Stewart Materne - Evercore Partners Inc., Research Division

Okay. And just on the training being a little bit lower, obviously a really small part of your revenue. But is training not being as high anyway a forward-looking indicator? Or are there just some sort of vagaries in terms of either the regions or sort of the seasonality?

Charles E. Peters

Thank you. I mean, I suspect it may be due to the seasonality. And of all the things, training is probably the most discretionary, so potentially a little bit there. But again, there's nothing that's really out of the realm of normal for us.

Operator

Our next question comes from the line of Heather Bellini with Goldman Sachs.

Heather Bellini - Goldman Sachs Group Inc., Research Division

I had 2, actually. Charlie, one housekeeping one. I didn't hear you say the average contract lines for this quarter. And then the other I had was, can you share these reviews on what contract renewals? When you talk about the 120% aggregate renewal amount of the top 25 customers, is that coming more from the volume of new RHEL licenses? Or is it upward SKU migration? Can you share with us some color around how those are progressing?

Charles E. Peters

Sure. So the first -- to answer your first question, the average deal length is still 21 months. It's been very consistent, that level now for at least, I guess, 5 or 6 quarters in a row. So good consistency on deal length. In terms of the renewals, what we see is generally, customers continue to expand their deployments. And in many cases, they're adding additional things to their existing positions. So just good growth within existing customers.

James M. Whitehurst

Yes, there was a reasonable amount of cross-sell now, especially with JBoss. And I think as we roll out storage and virtualization matures over the next couple of quarters, I think you'll see more of the cross-sell. But a lot of it is just absolute unit expansion as people are still kind of in the early innings of the UNIX-to-Linux migration.

Operator

Our next question comes from the line of Kash Rangan with Merrill Lynch.

Kash G. Rangan - BofA Merrill Lynch, Research Division

And looking at the -- what seems to have been a pretty steady gap between server unit shipments and your billings growth rate, I can think of a few things. I'm just curious to get your take on how these individual drivers are panning out and how much more there is upside. And in particular, what I'm talking about is your ASP uplift from RHEL 6, the free to fee which we have been talking about for quite some time, market share growth, JBoss, RHEL. There are so many things that have been driving that gap between server unit growth and your billings. I'm just curious, which of these have largely played out? Where do you see the changes going forward? Where are the opportunities? I know that's a load, but that's what's on my mind.

Charles E. Peters

I would be -- I'd be surprised, Kash, if it wasn't a load when you ask a question. That was a good question. And all those growth drivers that you mentioned are still playing out. I think that there's really none of them that have -- that are even approaching the yen. So for example, the ASP, which you're referring to there of the pricing change on all of RHEL we introduced about 1.5 years ago, that price change is going to go on and have impacts for probably a number of years, small amount quarterly over a number of years; the UNIX-to-Linux migration is still going; the people re-architecting their data center to get ready for cloud is a driver; the cross-selling of JBoss is a driver; free to fee continues to be a driver. And market share gains, I mean, I had mentioned in my prepared remarks one of our largest deals this quarter was a Windows-to-RHEL conversion, a very important thing. That's market share gain. And we think, as I also said, given the turmoil in Europe and the need for people to save money and cut costs, it -- we have a unique opportunity to offer the value and possibly increase market share gains in a period of time when things otherwise might be -- there's some change going on.

James M. Whitehurst

There's just one last comment there as well. I mean, we are truly in a paradigm shift around computing from client server to cloud. And open source components are the default choice, right? So it's not that we are an alternative in the way we were in the client server world. It's the default choice. And so there's large share gain associated with that when Linux and JBoss are the default choices in that next generation of computing.

Operator

Our next question comes from the line of Walter Pritchard with Citi.

Walter H. Pritchard - Citigroup Inc, Research Division

Two things on the billing. So I guess the question I'm trying to get at, we see the billings, not booking. You see the booking. As you look at the billing, the -- what you generated sales [ph] off of what you booked, I'm just curious if there's any change between the 2 because it -- because it certainly seems like, relative to our expectations, billings are light, and it sounds like from your perspective that the bookings are getting -- a couple of things we see is that the long-term deferred looks like it was down a little bit more than we expected. And your large deals are strong, but that would imply that your -- maybe your smaller deals weren't. I'm just trying to get some more color on that conversion from bookings to billings, because that's we see.

Charles E. Peters

Okay. I mean, that's a good question. And as you know, I typically only comment on bookings once a year at the end of the year, where I'll provide color. But I would add this sort of on a onetime basis. I do not intend to update it. And that is that our bookings did definitely exceed our billings in Q1. We've had that happen on a couple of prior occasions end of Q1, and it's simply a function of the timing in which customers are going to be billed. So I think that, that is a relevant factor of bookings exceeded billings in Q1. So a good question.

Operator

Our next question comes from the line of Michael Turits with Raymond James.

Michael Turits - Raymond James & Associates, Inc., Research Division

Couple of questions. I mean, first, obvious question is that all other things being equal, as a follow-up to Walter's question, we look at the current billings rate and wonder whether that's the new run rate. So again, all other things being equal. But does the mechanics that you just suggested regarding timings on bookings versus billings suggest that we ought to see an acceleration in billings? Because, like Walt said, it's all we see.

Charles E. Peters

Well, the acceleration would imply growth rates from year-to-year. So it also depends upon what the measure is in the prior year. All it means is that there were booking events that happened in Q1, which will have a future billing date. And then we will add to that whatever is billable in subsequent quarters, and that will be the result. But I don't forecast billings, and I don't guide billing. But I was just simply offering some clarification on his question on bookings.

Operator

Our next question comes from the line of Steve Ashley with Robert W. Baird.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

I'd just like to ask, on the large deals, 25 greater than $1 million compared to 14 a year ago. Are all of those billed and reflected in deferred revenue in the period?

Charles E. Peters

The answer to that is no. There were several large deals that would not be billed or totally billed.

Operator

Our next question comes from the line of Matt Hedberg with RBC Capital Markets.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

I think in your prepared remarks, Jim, you mentioned mainstream vertical strength again, I think, highlighting the transportation vertical. I believe you said last quarter in fiscal '12, you saw, I believe it was about a 40% growth in the number of mainstream deals in your top 30. I'm wondering, was there a similar growth rate in 1Q? And I guess again longer term, it seems like a longer-term trend going on. I'm wondering, from your perspective, what's driving this growth in some of these mainstream verticals?

James M. Whitehurst

Yes, I mean, let me try to see if I can pull the exact growth rate across those verticals. Yes, again, we saw very strong showings there. Basically, what happened is financial services and telco and government are early adopters of technology. So years ago, they adopted Linux in their data centers, and those have continued to grow and grow and grow, because we generally land and expand. And the mainstream vertical started later. So just 4 years ago, a lot of the major companies started experimenting. And so we're there and we're expanding now. So those are still kind -- obviously, financial services and others are still growing, but those new verticals, because they started from a lower base, are certainly becoming a larger and larger component as we grow.

Charles E. Peters

I would add, I mean, we basically started 4 years ago with specific internal programs to drive expansion into these so-called mainstream verticals and put a lot of effort in that. And it's definitely having the desired results.

Operator

Our next question comes from the line of Bhavan Suri with William Blair & Company.

Bhavan Suri - William Blair & Company L.L.C., Research Division

One quick question on the renewal rates. For a few quarters now, we've sort of seen renewal rates be north of 130%, and I guess I was a little surprised with the 120%. Is that just seasonality, especially given the big deals, that, that wasn't sort of closer to 130%? Or was there something more broader there? Was there sort of a broader range of those guys renewing?

Charles E. Peters

I think over a long period of time now, that range has been between 120%, 130%. We've had a couple of outliers as low as 105% or 106% one quarter several years ago. We had a high just a few quarters ago of 150%. Simply, it's not totally predictable about, obviously, what they're going to be, but we're very pleased to be in the 120%, 130% range.

James M. Whitehurst

Right now is you're only talking about 25 customers. So there's always just a little bit of lumpiness around it because that is a metric of the top 25 renewals.

Operator

Our next question comes from the line of Mark Murphy with Piper Jaffray.

Mark R. Murphy - Piper Jaffray Companies, Research Division

Charlie, any commentary on the deal pipeline heading into Q2? Is it any better, worse? Any different than seasonal norms or maybe what you would have expected to see coming off of Q4?

Charles E. Peters

I think I said at the very end of my prepared remarks that the deal pipeline was good. What I would just remind people about Q1, and you just go back like historically, and I -- it's sort of Q4, Q1 is a seasonally low quarter for us. And what it typically does after that is Q2 builds on that, Q3 builds on that and Q4 is -- comes to a sort of big result. Historically, that has always been the case. And at the moment, I think our pipeline looks good, and nothing else is surprising. I would also add, relative to the deferred revenue number and the foreign exchange impact on that, I noticed that some of the preview notes that I read that virtually everybody significantly underestimated the impact of foreign currency on deferred revenue. So if we get those adjustments right, that will help. But the other thing I'd also point out on deferred revenue is that 95% of the annual growth in deferred revenue historically has come in the last 3 quarters of our year. So the result we had this quarter seems to me pretty typical.

Operator

Our next question comes from the line of Derrick Wood with Susquehanna International (sic) [Financial].

James Derrick Wood - Susquehanna Financial Group, LLLP, Research Division

I guess staying on that same topic about seasonality, is there any reason to think that you're seeing greater seasonality in your business? I mean, Q3 seemed to be a bit softer than the market expected. Q4 was exceptionally strong. And now Q1 seems -- it seems a little softer. Your message around the secular growth drivers has not changed and seems very well intact. So, I mean, any reason to think that you're seeing greater seasonality and -- with stronger quarters coming in kind of the Q2 and Q4 quarters?

James M. Whitehurst

Well, first off, I'm not sure whether the -- it's not softer. I don't see any softer in the business. I do think in general, as we get more strategic with our customers that we see customers having larger deals with us that purchasing gets more deeply involved in. And those just naturally the way sales force's work seemed to roll into Q4. So I do think as we grow and as some of those deals get more strategic, that was just the nature of the beast in software, especially on the direct side, those things naturally gravitate to Q4s. Everybody needs a deadline. So there is probably a bit of that, that you're seeing as well.

Operator

Our next question comes from the line of Richard Williams with Cross Research.

Richard T. Williams - Cross Research LLC

In your renewals, I had in my notes that you had 130% in terms of the renewal rate over the prior contract amount, and that dropped to 120% in this quarter. Is that a typical sort of seasonal balance? Or is there something else going on?

Charles E. Peters

So -- and as I said to a previous question, no, there's nothing seasonal about that. And anything in the range of 120%, 130% is -- to us seems very good. It's not predictable exactly what that number's going to be. And as I've said, we've had numbers higher than that, we've had numbers lower than that. But it's not seasonal. It just happens to be what -- the top 25 at that particular quarter.

James M. Whitehurst

And again, because it's just 25 deals, there's generally -- I mean, there's still a bit of lumpiness in 25. One big deal that renews at a lower value or renews at a huge increase can kind of skew that a little bit. So it's generally in that same range.

Operator

Our next question comes from the line of Gregg Moskowitz with Cowen.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Jim, I wanted to get a sense maybe of how RHEV 3.0 is doing in the marketplace thus far. And then, Charlie, your hiring, as you pointed out, was a bit light in Q1. Are you still targeting about 1,000 heads this year?

James M. Whitehurst

Yes, well, I'll start off on RHEV. We've gotten very, very strong feedback in the market. If you see what the analysts are saying, the feedback we've gotten from customers and partners, getting some great traction, our deal sizes are increasing solidly there. It just GA-ed, obviously, at the beginning of the calendar year. So a lot of those are working their way through the POC process. But so far, I think we're very, very pleased with the feedback we're getting and the traction we're getting with customers. The second piece was -- what was the -- I'm sorry, what...

Charles E. Peters

Your second question was what?

James M. Whitehurst

Let's go to the next question, please.

Operator

Our next question comes from the line of James Gilman with Drexel Hamilton.

James N. Gilman - Drexel Hamilton, LLC, Research Division

So I just want to verify and then ask a question. Now there's been a lot of discussion around the billings, and I think if I look at it correctly, there's really 2 things that are masking, probably, the business and how well the business is doing. One is -- the one I'm asking is the FX impact. And the other one that may be looking at is because you do have a -- moving into more -- I would say more traditional types of software where you have seasonality. You may have a nice fourth quarter, and it builds from there, which, Charlie, you had mentioned in a couple of questions ago. Is that the -- probably the best way to look at that in your results here for the first quarter?

Charles E. Peters

Well, I mean, certainly, your comment about foreign exchange is right on the money. It's the foreign exchange impact. I always talk about the euro and the yen because those are 2 major currencies. The fact is we do business in many currencies. Almost all the currencies are down significant amounts. And so yes, currency was -- had a big impact on billing. The other thing I would say is you need to look at the subscription revenue and the services revenue, the fact that the service revenue in U.S. dollar terms was 8% growth and in constant currency, 10% growth. Think about the fact that the service revenue typically builds in the same quarter you got revenue. So the fact that services is a little bit lower is going to make the appearance of a lower overall billings growth rate. For us, the important thing has always been subscriptions. We've clearly said on multiple occasions the reason we're in services is to help our customers with subscriptions and to grow subscriptions. So that part certainly doesn't concern us.

James M. Whitehurst

And again, we guided to lower services growth rates this year as part of a strategy to continue to grow services but to rely more and more on partners to help us scale our subscription business.

Operator

Our next question comes from the line of Abhey Lamba with Mizuho Securities.

Abhey Lamba - Mizuho Securities USA Inc., Research Division

Charlie, I know you don't comment on bookings on a quarterly basis. But since you gave us a metric about bookings exceeding billings in Q1, can you help us put that in perspective? What's a normal Q1 trend? Are bookings normally greater than billings always? Or are billings greater than bookings in Q1, and this time, you saw a different trend?

Charles E. Peters

I would say that, generally -- and there's one exception I'll mention. Generally, booking -- billings are higher than bookings in our Q1. There was an exception a couple of years ago when we had a very large deal, which we commented at the time. I think it was 2 years ago...

James M. Whitehurst

Two years ago, yes.

Charles E. Peters

Where we had a very large booking that billed only a small amount in the quarter. So that was the only other Q1 that I am aware of in which bookings actually exceeded billings in a Q1. So this is, I think, an unusual event in that respect.

Operator

Our last question comes from the line of Israel Hernandez with MKM.

Israel Hernandez - MKM Partners LLC, Research Division

Can you provide a little bit more commentary and color around what you saw in Europe during the quarter, particularly among the different regions? Are you seeing the same patterns that you saw in Northern Europe versus Southern Europe that you've seen over the past few quarters? Or are you starting to see some changes due to the uncertainties?

James M. Whitehurst

Yes, I'll start that. Actually, we were quite surprised. Southern Europe was one of our strongest regions of our European regions. We break things out into Northern Europe, Central Europe and Southern Europe. And Southern Europe was actually extremely strong and well ahead of plan, which I do think just reflects the fact that value sells in difficult economic situations. Last year, I think it was more Central Europe that was really the super, super strong, and Southern Europe right now is -- all 3 are doing quite well, but Southern Europe has held in surprisingly better than one would think, given the macroeconomic environment there.

Tom McCallum

I understand there's one more call out there.

Operator

We do have a question from the line of Brent Thill with UBS.

Brent Thill - UBS Investment Bank, Research Division

Charlie, just one thought. We're seeing a lot of subscription coming, starting to give us off-balance sheet backlog quarterly, so you may want to look into that. And I think we'd all love to see that. I guess, Jim, a comment on the new VP of Sales. We all somewhat worry when you bring -- a software company brings in a new VP of Sales and changes that are made. Can you give us a sense of what Arun's plans are in your go-to-market? And any major changes you expect on that route?

James M. Whitehurst

Well, Arun has been here for about a month now. He's very, very familiar with the team. I think he agrees our sales organization's running very, very well. There's no overhauls planned. As we've said all along, when we took our time finding Arun, we have extremely strong sales leadership, and we continue to believe that we do. And I think I can speak for him to say that as well. So I wouldn't expect any significant changes or overhauls. At the same time, I do think he's going to bring a whole set of complementary skills to help us accelerate the growth in the business.

Charles E. Peters

You will have a chance to meet him next week at Red Hat Summit.

James M. Whitehurst

Operator, that's about all the time we have tonight.

Operator

Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation. You may now disconnect.

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