Red Hat's (RHT) CEO Jim Whitehurst on Q3 2017 Results - Earnings Call Transcript

| About: Red Hat, (RHT)
This article is now exclusive for PRO subscribers.

Red Hat Inc (NYSE:RHT) Q3 2017 Earnings Conference Call December 21, 2016 5:00 PM ET


Tom McCallum - VP of IR

Jim Whitehurst - President and CEO

Frank Calderoni - EVP, Operations and CFO


Brent Thill - UBS

Raimo Lenschow - Barclays Capital

Walter Pritchard - Citigroup

Karl Keirstead - Deutsche Bank

Matt Hedberg - RBC Capital Markets

Gregg Moskowitz - Cowen & Company

Michael Turits - Raymond James

Steve Ashley - Robert W. Baird

Heather Bellini - Goldman Sachs

Kash Rangan - Bank of America, Merrill Lynch

Kirk Materne - Evercore ISI

John DiFucci - Jefferies

Keith Weiss - Morgan Stanley

Abhey Lamba - Mizuho Securities

Keith Bachman - Bank of Montréal

Ed Maguire - CLSA

Ittai Kidron - Oppenheimer


Good day, everyone, and welcome to today's Red Hat Incorporation Q3 Fiscal Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during a question-and-answer session [Operator Instructions].

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

Tom McCallum

Thank you, Lynn. Hello everyone, and welcome to Red Hat's earnings call for the third quarter of fiscal '17. Speakers for today's call will be Jim Whitehurst, President and CEO, and Frank Calderoni, Executive Vice President Operations, and CFO.

Our earnings press release was issued today after the market closed and may be downloaded from on the Investor Relations page. Also on this page you'll be able to find a copy of today's prepared remarks, a schedule of currency rates and a slide deck with financial highlights and supplemental metrics that, along with the earnings press release, include a reconciliation of GAAP to non-GAAP financial results.

During this call, we will make forward-looking statements about our future financial performance and other future events or trends, including guidance for the fourth quarter and the full fiscal year. These statements are only predictions that are based on what we believe today, and results may differ materially. These forward-looking statements are subject to the risks, uncertainties, assumptions and other factors that could affect our financial results and the performance of our business and which we discuss in detail in our filings with the SEC, including today’s earnings press release and the risk factors and other information contained in our most recently filed Form 10-K and Form 10-Q. Red Hat assumes no obligation to update any of these forward-looking statements we may make on today’s call.

And with that, let me turn the call over to Jim.

Jim Whitehurst

Thank you, Tom. And let me add my welcome to everyone joining us on today’s call. In Q3, solid execution allowed us to continue to deliver double digit growth in a number of our financial metrics including revenue, non-GAAP operating income and non-GAAP EPS. Some key highlights in quarter include, strong demand for our cloud-enabling technologies, which is reflected in the 32% constant currency growth in our application development related and other emerging technologies revenue. Our continuing customer traction is evident in our top 25 renewals that were up for renewal this quarter; all 25 renewed, and they did so at more than a 120% of their prior annual commitment.

As Frank will describe, we closed many large deals, including some of the largest deals in Red Hat’s history, with strong cross-selling and longer term commitments from our customers. Our customers are increasingly adopting the cloud as part of their overall IP strategy, and are using Red Hat as a partner. We see customers deploying our cloud-enabling technologies both on-premise and in the public cloud. This group of hybrid cloud customers is growing revenue in the aggregate faster than customers that have not yet embraced these technologies. In fact, in Q3, we added hundreds of customer wins with products from our hybrid cloud portfolio, including several OpenStack deals that were over a $1 million. Also of note, we closed our second OpenShift deal over $10 million and another OpenShift deal over $5 million.

In spite of the many positives in the quarter, we faced a few challenges that tempered the growth of some of the items in our reported results. First, some sizeable November deals in the U.S. Federal space have taken longer than initially expected to close, though we expect them to ultimately move forward in the fourth quarter. In addition, similar to the first half of the fiscal year, we were able to secure large multi-year commitments from customers. However, as these deals continue to get larger, sales activity was again more concentrated in the last month of the quarter. And in this quarter, there was a lower level of customers paying upfront for their multi-year deals.

We are adjusting our revenue and cash flow outlook for the year based on these factors. But it’s important to note that we continue to expect full year total revenue growth of approximately 17%, with subscription revenue, which is renewable, growing even faster. We are re-affirming our operating margin for the full year of 23%, and we are forecasting cash flow in Q4 up 22% to approximately 28% from Q4 last year based on confidence of our outlook.

Importantly, for the long run, we remain confident in our competitive position and our ability to drive future growth. In fact, given our visibility into our pipeline and what is already closed to-date, we are confident that we will see a re-acceleration of billings in Q4 into the mid-teens growth rate range and we will end the year with a strong total backlog.

Before turning the call over to Frank to discuss the details of the quarter and our outlook, let me provide some additional business highlights for the quarter. We continue to see momentum with customers and community around our cloud-enabling technologies, including OpenStack, OpenShift, CloudForms and related offerings that our customers are using to build hybrid clouds. Within our top 30 deals, seven included Red Hat OpenStack platform, 5 included OpenShift and 5 included storage.

Starting with an OpenStack customer win, Swisscom has deployed Red Hat OpenStack platform and Red Hat Virtualization to build their newest technology platform, providing the flexibility needed to support ongoing innovation and development across its own organization as well as its customer base. We continue to improve scalability and usability of OpenStack with our recent release of Red Hat OSP 10. Based on the upstream Newton release, OSP 10 drives new features that increase system-wide scalability, ease infrastructure management, and improve orchestration, while also enhancing network performance and platform security. A new five-year lifecycle support offering for Red Hat OSP 10 can help customers achieve the long-term stability required for mission-critical operations.

We also announced a broad alliance with Ericsson to deliver fully open source and production-ready cloud infrastructure, spanning OpenStack, containers, NFV, SDN and SDI. Through the collaboration, we plan to work together to certify Ericsson’s platform and portfolio of solutions.

Red Hat 3scale API Management Platform was positioned in the Leaders quadrant of Gartner’s October ’16 Full Life Cycle API Management Magic Quadrant. Red Hat 3scale API Management Platform complements our existing application development-related and other emerging technologies and strengthens our ability to help simplify and accelerate customers' digital transformation initiatives.

In our storage portfolio, Red Hat Ceph and Gluster storage were both positioned in the Visionaries quadrant of Gartner’s October ’16 Distributed File Systems and Object Storage Magic Quadrant. Red Hat Ceph Storage and Red Hat Gluster Storage are both highly agile solutions that are built to handle different types of demanding workloads.

Before my final remarks, I would like to talk about the leadership transition at the CFO level. Effective in late January, Frank will be resigning to join another company as its CEO. Frank has been able to accomplish a great deal to help advance and scale of our enterprise, as we continue to experience significant growth. I'm grateful that Frank has agreed to stay on until late January and assist with the transition as needed. Upon his resignation, Eric Shander, Vice President of Finance and Accounting and our Principal Accounting Officer, will assume the role of acting CFO. Eric will bring a rich and solid experience base to this role from his work at Red Hat and almost 25 years of experience at IBM and Lenovo.

Frank, I’ve really enjoyed getting to know you and working side-by-side with you. You will be greatly missed, and we wish you nothing but success in your new role. You are a talented business leader and executive, and you’ve left us stronger and well positioned to address the opportunities before us. Thank you, Frank.

In summary, we continue to be pleased with our progress in delivering on our mission to work with communities, customers and partners to create better technology the open source way. I want to thank all Red Hat associates for their continued focus on the success of our customers. I am confident that this team will continue to deliver against our hybrid cloud growth strategy.

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

Frank Calderoni

Thanks, Jim. I would also like to thank everyone at Red Hat, including my teams within finance accounting, operation, IT and global work force solutions. These are some of the best people I’ve ever worked with and I’m very grateful to have gotten to know each and every one of you. I received a compelling opportunity to be a CEO at another company, and I couldn’t turn it down. However, I had thoroughly enjoyed my time as CFO at Red Hat, and I’m confident this company will have continued success.

Let me begin with a summary of Q3 performance. Q3 was driven by strong renewals in our large deals, cross-selling of our cloud-enabling technology, and lengthening of customer commitments to Red Hat. This sales traction is reflected in our deals greater than a million, which are up 20% year-over-year. This is also a reflection of our strategic position with customers as they look to deploy in the hybrid cloud environments using our technologies for years to come.

As Jim noted earlier, the quarter did come with a couple of challenges that affected other metrics. First, we saw a few deals in the Federal space that didn’t close on the timeframe we expected. We believe the proximity of our quarter to the Continuing Resolution legislation, relating to the Federal budget, was a factor. The Continuing Resolution legislation has been signed, and we do expect them to move forward in the fourth quarter.

Second, we closed several large multi-year deals, including two deals over $20 million, which did not bill beyond the first year. As we have stated in the past, customers’ desire to pay beyond one year can fluctuate, and it had an impact on the long-term portion of our billings proxy when this occurs. In Q2, we saw strong growth in our billings proxy due in part to more customers paying upfront for their multi-year contracts, whereas strength in multi-year contracts during Q3 continued more to growth in the backlog.

Third, as Jim noted, we saw our sales activity more concentrated in the last month of the quarter versus our historical norms, similar to the second quarter. We are focusing on improving -- making improvements in linearity, and we believe similar linearity could occur in Q4 from a forecasting perspective. As we build our FY18 plan, we plan to drive better quarterly linearity. Finally, foreign exchange volatility negatively impacted our Q3 revenue by more than $3 million, and our previously implied guidance for Q4 by $16 million, due to the fact that the dollar has strengthened against some of our major currencies since we provided our guidance back in September.

With this information as a back drop, let me provide you some additional information on our quarterly metrics and results. As I just noted, currency rate volatility returned in Q3. Although, there has been some stabilization on rates year–over-year, rates used for Q3 guidance and full year guidance have weakened against the U.S. dollar. So, for this quarter, I provide both U.S. dollar and constant currency, as well as described the impact of the currency rate volatility from our previous guidance assumptions. We have also provided a table of constant currency results in our earnings press release. In addition, for a more detailed view of our results and the reconciliation of our non-GAAP measures to GAAP, please refer to our earnings press release.

We delivered total revenue of $615 million, up 18% or 17% in constant currency. Compared to our September guidance, our result was in the middle of our guidance range, excluding the $3 million impact of FX volatility. Subscription revenue continued to be the largest driver of our growth at $543 million for the quarter, an increase of 19% year-over-year and 18% in constant currency. This renewable revenue stream now constitutes 88% of total revenue, providing a large base for future renewals and up-selling opportunities for new technologies.

We continued to drive high growth across our technology portfolio. Subscription revenue for our infrastructure-related offerings was $431 million, an increase of 16% year-over-year or 14% in constant currency. Our application development-related and other emerging technology subscription revenue was $112 million, an increase of 33% year-over-year or 32% in constant currency. Application development-related and other emerging technologies revenue was approximately 18% of total revenue, that’s up 210 basis-points from a year ago quarter.

On a non-GAAP basis, operating income of $143 million grew 16% year-over-year and non-GAAP operating margin was 23.3%, which is consistent with the operating margin direction we provided on our last call. As a reminder, non-GAAP operating income adjust for non-cash share-based compensation expense, amortization of intangible assets, and the transaction costs related to business combinations. Using our non-GAAP estimated annual effective tax rate of 27%, non-GAAP diluted earnings per share came in at $0.58. This is in-line with our guidance after excluding a $0.03 discrete tax benefit, which brought the EPS reported to $0.61 per share, that’s up 27% year-over-year.

We ended the quarter with cash and investments of approximately $2 billion. We’ve returned $125 million to shareholders in the quarter through the repurchase of approximately 1.6 million shares of stock. Year-to-date, we have repurchased approximately 23% more shares this year than for the full year last year. Total deferred revenue at quarter end was $1.7 billion, an increase of $221 million or 15% over the same quarter a year ago. On a constant currency basis, total deferred revenue was up 14%.

The total change in deferred revenue from cash flow statement which neutralizes most of the impact of currency fluctuations increased by $64 million since the end of Q2. The rolling four quarters billings proxy, which is calculated by adding revenue plus the change in deferred revenue on the cash flow statement for the last four quarters, was $635 million, that’s up 14% on a constant currency basis and 13% U.S. dollar year-over-year.

Operating cash flow of $136 million for the quarter decreased from the year-ago’s Q3 operating cash flow of $148 million. Year-to-date, operating cash flow is $465 million, a 27% non-GAAP annual tax rate, and fully diluted share count of 183 million shares.

For Q4 specifically, this implies the following outlook. We expect revenue to be in the range of $614 million to $622 million. This is up 14% in U.S. dollars, or approximately 16% in constant currency at the high end of the range. We expect non-GAAP operating margin of approximately 24% and non-GAAP earnings per share of $0.61 and 181 million fully diluted shares. Based on my annual guidance, the implied cash flow for Q4 is $305 million to $320 million, or up 22% to approximately 28%. That's a range of 22% to 28%.

Overall, we remain optimistic about the Company’s long-term growth opportunity with our position to serve our customers’ demand for hybrid cloud solutions. We continue to see strong adoption of our hybrid cloud solutions that span both private and public clouds.

And now I'd like to turn it back over to the operator to turn it over to the first question.

Question-and-Answer Session


Thank you [Operator Instructions]. And we'll go ahead and take our first question from Brent Thill with UBS. Please go ahead, your line is open.

Brent Thill

I was just curious, there's some concern around the shift to public cloud. And did you see the pronounced shift that you're seeing in the pipeline that may have caused some of these deals to push? Or is this just timing of transactions, and there's nothing really new competitively that you're seeing?

Jim Whitehurst

Haven't anything to do competitively, we still see really strong growth on public cloud. And yes, I indicated our customers who are working with us around public cloud, are growing faster than our other customers. Really, the only place we saw an issue, as we talked about, was around the continuing resolution. There were a few large public sector deals. Specifically, on the number on -- we call the CCSP program, which is our on-demand public cloud. We said we'll get back to you when we can have a new milestone at $200 million, expecting that to be second quarter-ish next year.


Thank you. We'll take our next question from Raimo Lenschow. Please go ahead, your line is open.

Raimo Lenschow

Jim, can you talk a little bit about the -- we're seeing larger and larger deals that you're signing. But obviously then we've seen like customers not willing to commit upfront. Can you maybe talk a little bit about the nature of these deals? And what's in there, and maybe what's causing people to behave differently than in the past? Thank you.

Jim Whitehurst

Yes, well I’ll get couple of them. And as our portfolio is expanded and as we've had a focus selling beyond rail, we are becoming more strategic in customers’ portfolios. So, they're willing to commit longer periods of time. So, those are committed deals. I think the flip side of that is customers are getting much more used to consumption based models. And so those very-very large deals, they're more comfortable paying a year at a time. I think four or five years ago we’ve done a three year deals, the majority have been paid upfront because they were used to budgeting like they would for a license deal. Now they’re getting more used to consumption-ish type deals. And so they are happy to commit to annual payments. And so that certainly causing. But there are committed deals.

And the one other I would say is as they get bigger linearity, as Frank indicated, get to be more of a challenge. But you get more people involved, and there is a cycle we always try to break of, people willing to push to the end before they buy. And so as the deals get bigger, that’s unfortunately been working against this.


Thank you. We’ll take our next question from Walter Pritchard with Citi. Please go ahead, your line is open.

Walter Pritchard

I guess, Frank, related to the specific question on the longer term, or the less commitment. I do know that your long-term deferred actually grew faster year-over-year than your short-term deferred. And I guess that might tell me that that's actually the long-term, or the longer commitments, are actually still holding up pretty well. And I'm wondering what are we missing when we look at it that way? It seems like that would tell a story of long-term commitments actually doing quite well?

Frank Calderoni

So, I would say overall long-term commitments are doing well. Again, many of those aren’t billing, so they don’t even show up in the long-term deferred. But overall, some are paying and therefore billing, and therefore show, but a lot aren’t, which kind of does mute the relative growth in the long-term deferred versus the strength that we're seeing overall in large deals.


Thank you. And we’ll take our next question from...

Frank Calderoni

And I should also note the government deals that I indicated, the government typically does one year at a time. And so one of the reasons you saw the short-terms deferred issue is those government deals that pushed around the continuing resolution are all -- were all one year deals.


Thank you, Sir. We’ll take our next question from Karl Keirstead from Deutsche Bank. Please go ahead, your line is open.

Karl Keirstead

This question is for Jim or Frank. I know you don’t typically guide on billings growth, but just wanted to ask you about that. We started fiscal ’16, you recall, with the couple of quarters of constant currency billings growth in the 10% range. Then we saw three good quarters, better quarters, in the 15% to 20% range. And this quarter, we’re back to 10%. And I think you’ve guided next quarter back to mid-teens. So, seems to be a wide range. And I'm just wondering whether looking forward the mid-teens billings growth that you guided to for the February quarter is sort of the normal. Or do you expect, given what's happening in terms of invoicing durations that throughout fiscal ’18 10% level might be the new normal? Any color there might be helpful for everybody. Thank you.

Jim Whitehurst

Karl, so as you mentioned, we don’t guide billings, primarily because it's a challenging and you can see based on what you just said, there is a lot of volatility. And because of that, it's hard for us to actually predict that, as if we do get more information overtime and we start to see some kind of a trend, we’ll take that in consideration and use that to try to forecast. But at this point, we feel that probably it wouldn’t be appropriate to provide a range from guidance, or even kind of state what would be a considered trend.

Jim Whitehurst

Yes, Karl, we said over and over again, it's really tough on a quarterly basis, because payment terms can vary a lot. If the two large deals we had is decided to pay upfront, that would have been $27 million or something in that range of incremental billings and long-term deferred revenue. They choose not to. And we, as we've said in the past, we don’t want to give significant discounts for people n pay upfront, because we don’t need cash.

Frank Calderoni

And the other thing too, which comes up, I mean the size of the deals as you start getting larger deals, a deal makes an impact, right. And so whether they’re closing one quarter or another can make a big difference on the bills.


We’ll take our next question from Matt Hedberg with RBC Capital Markets. Please go ahead, your line is open.

Matt Hedberg

I guess, for Jim or Frank. From a high level, and we think longer term here. What’s the right way that we just think about balancing growth, benefiting from clearly cloud business, but also margin improvement longer term? Any sort of framework we should think about there?

Jim Whitehurst

So, I’ll just go back, Matt, to what we had talked about back at our Analyst Day in June. And I know we’ve been getting a lot of feedback from any of you on the sell-side and also on the buy-side, looking at that. And we’re taking that in consideration. Right now, we’re in the midst of planning for FY18. And I should probably saw in the last few quarter, we’ve seen continued slight improvement in the margin, the operating margin. We want to see, again, focused first on the top line growth, emphasizing the new emerging technologies product, that’s where we’re making the investment, that’s we want to see the return to make sure that we can accelerate growth. And with that, we want to make the investments go along with that and then also continue as all of you have asked, to see slight margin improvement as we continue to focus on that. So we’re trying to work through the balance of that whole portfolio for the next year. And as we get more information, I’m sure we’ll share that.


We’ll take our next question from Gregg Moskowitz with Cowen & Co. Please go ahead, your line is open.

Gregg Moskowitz

Just a question for Frank. Just in light of the -- during his appointment this quarter, wondering if there is anymore color that you can give us. And I know this is a typical, but again just under the circumstances, any more color if you can give us on the off balance sheet backlog to perhaps help put this in a little bit better context? Thanks.

Jim Whitehurst

So, as you know, we provide the off balance sheet backlog at the end of the year, which we do and plan to do at the end of Q4. I mean, if you look at some of the dynamics, the kind of what we talked about, we can’t give you an exact number. This quarter, we did see some slight improvement on off balance sheet, which did impact the quarter. But we’ll have to wait and see how that continues to play out to Q4, and then we’ll provide that information at the end of the year.

Frank Calderoni

Yes. And as I said a minute ago, two deals alone were $27 million in growth and off balance sheet backlog. So, we’ll get into lot more detail of that in Q4, we talked about the year.


We’ll take our next question from Michael Turits with Raymond James. Please go ahead, your line is open.

Michael Turits

Just to may be reiterate or ask again what, maybe it’s Karl asked this around. At this point, do you think of the shorter duration as a trend, and whether or not, it’d be logical to think of it as a long term headwind billings growth?

Jim Whitehurst

You mean the longer duration?

Michael Turits

No, the shorter duration, the shorter billings duration, in other words paid [multiple speakers]. I understand the contract duration as well. But it’s a short -- whether or not the shorter billings duration will be a long term headwind to billings growth?

Jim Whitehurst

I would say we need a few more quarters to get a sense. We have two deals of above 20 this quarter. Those are like really, really big once. We’ll have enough experience to say. Going forward, more of those pay a year at a time, or will they pay upfront. So, give us another couple of quarters to kind of see. And all I can say is, right now, they’re kind of a bit volatile and whether they pay or not. And as we kind of -- if we can kind of divine the trend, we’re happy to share that with you as we identify one.


We’ll take our next question from Steve Ashley with Robert W. Baird. Please go ahead, your line is open.

Steve Ashley

What is your assumption around the federal business in the fourth quarter?

Jim Whitehurst

We expect it -- so I’ll say kind of come back to normal, right around change in administration, which is hard to get people to make decisions. And so, it's up $20 million of impact on short-term based on a few large deals that kind of slipped, but that all seem like they’re coming along nicely. And so, you were kind of expecting to be back at business as usual, and kind of back on our plan in the public sector space in Q4.


We’ll take our next question from Heather Bellini with Goldman Sachs. Please go ahead, your line is open.

Heather Bellini

I am just, I guess, trying to understand this a little bit. We’re talking about people are driving up the long term, and people paying these less upfront. But if we really just focus on your short-term billings, which obviously doesn’t matter than, whether someone is paying you more than 12-months upfront, because it's only getting the stuff that’s less than 12 months. You still keep seeing a pretty big deceleration in growth in short-term billings. So I guess I am just trying to think through. If we just take away the long-term deferred aspect, and whether or not you get people to pay you upfront or not that trend seems to be continue to decelerate from what used to be the 20s to this quarter was, I think, it was 14%. And again I think Walter highlighted that long-term deferred are actually growing faster than short-term differed. So, can you help us reconcile all the talk about customers paying you less upfront with what's being indicated by the short-term billing trends, because maybe I just don’t understand this?

Jim Whitehurst

Well, first off and as said there is about $20 million impact that we’ve said associated with the continuing resolution in the government deals, which is several points of growth there. And again, as our cloud business grows, those get paid in a reverse versus upfront, so that’s also a natural drag to that number. But the biggest one quarter hit in terms of the decel this quarter with the $20 million, which is several points of growth just right there. And again, that was all in short-term. But again do recognize our overall business is healthier than you would see in the short-term, because of also the mix of cloud, which is continuing to grow very, very fast and pays in a reverse versus upfront.


We’ll take our next question from Kash Rangan with Bank of America. Please go ahead, your line is open.

Kash Rangan

One thing that crossed our mind is this quarter your currency was a bit of a tailwind. Your constant currency was little bit lower than the reported. So I am curious what is driving the top process behind having a more diminished outlook with respect to the February quarter, maybe I’m not understanding the currency dynamics because it was a tailwind this quarter. And also curious, you talked about linearity changes in the quarter. Was that purely on account of the government deals that slipped? Or were you seeing something post the election cycle that even in the mid-commercial sector that the linearity is turning out to be little bit different, and you don’t anticipate that to change. And if that’s the case, what could be causing that? Thank you.

Jim Whitehurst

Yes, I'll start with the secular linearity, and I'll let Frank take that the currency piece. So, the government deals, there is less there, so they were in the quarter at all, so they don’t actually impact linearity, because we just work there. The linearity overall, and again, we’re continuing to work to improve it. But as the deals get bigger, large deals seem to buyers or programs who want to buy in the last week. Because they believe they get the best terms. And frankly, the two very, very large deals where one was on the last day, and I think that’s a natural buying pattern that we see in technology.

And when our deals were smaller, they kind of flew under the radar. But as they’re getting bigger, we’re getting the same scrutiny than anyone else would be getting on eight-figure deals. And so, we’re working to offset that. So I don’t mean to have that as an excuse. But I don’t get really systemic with what we’re doing or the business, I just think it's as deals get bigger they naturally get more time and attention, and that naturally drives them to end the quarter because that’s when buyers believe they’re going to get the best deals.

Frank Calderoni

I am not quite sure I get your full question on the currency, but let me just provide a little bit of additional information. So, if you look back from a revenue standpoint Q1, Q2, Q3 and then also what we’re assuming for the guide to Q4, and we look at the rates and how they’ve changed over the year. In Q1, we ended up getting business on revenue. We ended up getting a $3 million benefit for revenue. In Q2, we have a $5 million benefit on currency on revenue. In Q3, this past quarter, we had $3 million impact, so hurt to revenue. And then, as we said before, taking the rates that we’re looking at right now for Q4, it's about $16 million.

So, overall, for the year, we will be down, from a currency perspective, of about $11 million for the full year, based on how currency was positive at the beginning of the year, and abruptly changed. And really the change occurred in the latter part of Q3. And you probably know with some of the other software companies that recently announced they talked about same type of impact. When you have this type of model that we have, currency volatilities could have a significant impact, which is why we have been very transparent all along when it works in our favor and then also when it's a hurt at the same time.


We’ll take our next question from Kirk Materne with Evercore ISI. Please go ahead, your line is open.

Kirk Materne

Jim, I was just wondering if you could talk a little bit about the customers that are pushing forward with you all from more of a hybrid perspective. Is there any concentration from verticals? Do you see certain verticals moving at a faster cadence, or certain geographies? I was just kind of curious you mentioned those customers were growing the fastest with you. Could you just maybe provide a little bit more detail where you maybe agents concentration, either from a vertical or geographic basis in terms of taking all of these newer products? Thanks.

Jim Whitehurst

It's really pretty broad. As I said, we literally have 100s of customers this quarter around OpenStack and OpenShift in cloud form. So, it really is broad. And significantly, we actually had over 50 OpenShift deals alone that were six or seven figures, so really strong traction. And obviously that many deals is going to cut across a lot of the sectors. So, it's pretty broad. If I had to call out a couple of sectors, we’re seeing really strong traction in healthcare. I think combination of IoT and connected devices is driving a lot of demand. And so, I would say that standing out is a really super fast growing vertical, financial service has always been strong. They're technically just getting customer customers so we're seeing them. But it'd be hard to actually talk about a specific area because it's just really strong across the board, literally 100s of deals across kind of all the major verticals.


We'll take our next question from John DiFucci with Jefferies. Please go ahead. Your line is open.

John DiFucci

I'm going to come back to the large deals not paying upfront, again is this -- you mentioned a few deals like that. But, is this just from a few deals as was this more systemic, more broadly based across your customer base because I think some of the other questions are trying to get to, was this just a couple of things or was this something that is might affect other companies too? And I guess, Jim, in four of those deals just want to be clear for the years beyond the year one, are they still locked in or are those years optional to pay?

Jim Whitehurst

No, no, no, -- let me start off with the second one quickly. No, those are locked in commitments, right. It's part of a broad strategy we have to help us overtime bring down our overall sales cost to invest a little more time, getting multiyear commitments. Our sales teams cannot either go sell other products or sell it accounts. So, no those are committed. What I'd say overall is, I don't think there's anything systemic. I think it really has to do with larger deals just because of their size or more likely to pay upfront. I mean to pay overtime. So, I guess we see it as a trend in the sense of we had more large deals. And so, typically eight figure deals want to pay overtime versus pay upfront, and we're having more-and-more of those. And so, I wish I could give you a better sense because again we don't have that many of those types of deals.

And I would say overall at kind of $1 million level, those are typically not multiyear deals, or if they are they're still paying upfront. So, I think it has more to do with just the absolute size. And so, again, we're not going to feel to call it a trend, but it wouldn't surprise me that as we do more 20 million plus deals that those will more likely decide to pay overtime. I do believe and again this isn't with great data, this is just talking to customers. I do believe that as customers get more used to consumption models, they're used to paying Amazon, they're used to paying Salesforce and SaaS models. They're getting more comfortable in their budget processes, building in annual payments. We've always sold the subscription, but frankly I think a lot of our customers thought of it like a license instead they would buy long-term and they had budgeted for it that year and that a project.

And you'll pay for project upfront, and yes there was maintenance, but it was mainly budgeted for project. And so they wanted to pay us upfront. More-and-more as people use SaaS, they're paying overtime. And that, again that's anecdotal talking to customers, but I do think budget processes in IT are recognizing that more spins going to OpEx from CapEx. And so, naturally it's less of the discussion that we want to big check upfront, people are getting more used to putting in OpEx and that's probably a trend you'll see across software companies.


We'll take our next question from Keith Weiss with Morgan Stanley. Please go ahead. Your line is open.

Keith Weiss

Thank you guys for taking the question, maybe like broader picture question, you're talking about more seasonality in your quarters in 2Q and seen them more in Q3, and we're talking a lot about really big deals. If we think about the Red Hat business overall, are we just down much more weighted towards big deals? I mean, is there any sort of market that you could give us and what percentage of your business today as it's dependent on the big deals and how is that trended from a year ago or three years ago as this is just some much more big deal oriented company than it was three to five years ago?

Jim Whitehurst

The answer is I don’t think so I mean obviously our deals are bigger because the Company is multiples of the size as it was five years ago. I don’t believe the concentration is changed and we do look at that metric, I get it every quarter, and I haven’t noted anything material in that. I do think there is a dynamic and I've heard talking to other CEOs at renew businesses. It's possible that the deal might slip out of Q1 into the Q2 or it's out of the Q2 into Q3, but nothing ever puts out of the Q4. And so, I think and then once it's in the Q4, obviously it's a renewal that's going to happen on that same dates either one year or three years from now. And so there is just kind of naturally one something gets more backend loaded, it stays there. And so things might slip from again the month one to a month two right.

And so, and then once it gets there, it never renews early it renews on that date. And so I do think there is just a dynamic that's causing a little bit more backend loading as just the deals happen and then they get stuck on that date for renewal. We've experimented around and talked to customers about doing even 11.5 months deal or a 13 months deal or something to move some of those around, but that's kind of playing queues on the margins. I really just do think that because of the renewal nature, once you get the deal stuck towards to the end of the quarter or in the fourth quarter just part to move for that because the compelling event on that is the renewal to re-up the deal.


We will take our next question Abhey Lamba with Mizuho Securities. Please go ahead. Your line is open.

Abhey Lamba

Jim, just wondering up on couple of comments you made, I think you mentioned that you're taking steps to fix a linearity of the business. What exactly are you doing to fix it and how should we kind of -- what are your assumptions for Q4? And also you mentioned as people are asking to pay on consumption basis, so people are asking for payments less than one year as well or is the one year the lowest terms or the shortest terms you guys are offering?

Jim Whitehurst

So couple of things there, I mean what we've been experimenting with so far that's beyond as it's not working great, that's all we've said. We've kind of missed our linearity assumptions, but as we've been paying down to the kind of manager of country, manager levels bonuses around linearity. We haven’t wanted to take out to the individual sales person because at this point we hadn't wanted to kind of get them worried so much about that they are not worried about serving the customer. And so, we've been trying to put in some compensation in kind of the sales manager level to try to drive that behavior, and we're still trying to experiment what's getting it right then we have it quite gotten it right, which is why in Q4, we are assuming linearity that looks more like Q3 which is little worse than our plan, which is the reason we've pulled revenue down a bit for an assumption of worst linearity than we had originally planned.

Frank Calderoni

So, consistent linearity in Q4 as we've seen in Q3 has baked in for the forecast or the guidance that we've provided.


We will take our next question from Keith Bachman with Bank of Montréal. Please go ahead. Your line is open.

Keith Bachman

I also want to ask about billings, it's been the comment you made about customers looking to perhaps pay a bit less. Could you give us any metrics or evidence on what how much billings duration has changed during the course of FY17 versus FY16? Is it months is it longer and is that a way to think about as we try to form our models for next year? As least can you give us first with what they call few step questions? Any kind of thoughts on how without any numbers on the dollars but how might billings duration be at risk if you will or change during the course of that makes us clear? Thank you.

Jim Whitehurst

Yes, so, we are average contract duration with contract not really billing for just 24 months, which is up from 21 months. So, people are making longer term commitments to us. To be blunt part that has to do with how we set our sales comp plans. Part of our strategy to overtime be more efficient with our go-to-market is to sign more long term deals, so we’re not having to spend more time on renewals, but they are locked in. And we emphasize that more in this year’s plan, and so that kind of I guess one of the reasons we’ve gone from 21 to 24. We’re still working on what we do for next year. But I do think as we get bigger and people are building things like OpenShift and OpenStack into their long term infrastructures, they want to do long term deals with us as well. So we have the commercial terms worked out, so I do think you likely to see some elevation, well say it, 24 turning to 23, that’s hard for us to be able to say.

Frank Calderoni

Let me also come back, so just the second part of the last question around consumption model. We typically do at minimum one year deals. There are few specific instances where customers for whatever reason wanted to be out of burst onto a cloud for specific types of workloads where we done some consumption-type related deal. But that’s the small handful of cases that are part of very, very large existing relationships.


We will take our next question from Ed Maguire with CLSA. Please go ahead. Your line is open.

Ed Maguire

I have a question about these very large deals, trying to understand are these coming from customers that are consolidating workloads from other vendors? Are they replacing existing implementations or are these new projects? And also how does this growing proportion of large deals tying with the growing roll of bookings coming from the channel because does have an impact on the sales cycles of these very large deals like 10 million and up?

Frank Calderoni

Sure, well to the answer on the first part of your question is frankly little bit yes, yes and yes. There is no brand new customer who comes in and spends $20 million on it. The typical nature of those large deals are, they include the component of renewal for their existing infrastructure and that typically growing because we continue to take share both in middle ware and then operating systems from our the other players or competitors in those areas. But these large winds almost, always include a significant new infrastructure component, that what make then big either OpenStack or OpenShift. And so again the deal of that size is not, like we had a couple of eight figure OpenShift along deal, but typically that really big deals will be a combination of a renewal that’s it’s growing, plus one at that big new infrastructure again OpenShift it’s kind of normal.

In terms of the channel mix, I don’t note that really changes a lot recognize that’s a measure around fulfillment about half of the channel mix is truly kind of no touch where they are outselling. And that’s obviously we really like that because it's a recently low cost of sale. Another trunk of that is fulfillment, so many of our large customers choose to fulfill through a channel partner for ease of contracting etcetera, etcetera. So really it's not a major impacts on kind of billing your sales cycle on a major way, unless, and overtime it's part of our strategy, we want to move more to channels in a kind of low touch in no such way. And that’s slowly happening overtime.


Okay, sir. We will take our next question from Ittai Kidron from Oppenheimer. Please go ahead. Your line is open.

Ittai Kidron

Couple of questions for me. First on the government business was delay because of their continuing resolution legislation, that legislation was completed in late September, if I am correct. This has been two and a half months now. Can you comment, if those deals that have been delayed because of this have now closed? Should have enough time? And then second regarding OpenStack, in the last couple of months, we have seen several vendors actually exit or significantly reduced their investment in OpenStack area. HP did that and Red did that. We felt a lot of layouts related to that. Claiming that public cloud is now moved too fast for OpenStake whoever closed the gap I know it was one of your key selling points that R&D Investor Event earlier. And so, I guess the question is how is your level of confidence today around OpenStack versus what it was during the Investor Day? And has there anything changed with respect the type of customers that you are seeing actually adopting it?

Jim Whitehurst

So, on the first part of the question about the government deals, as we've mentioned earlier we have high confidence that those deals will close in Q4. So, that's continued to progress whenever you deal with some of the challenges from budget standpoint that delays the whole process, not just a close, and so you have to continue to work that. So, we do base on tracking the progress with the accounting and the customer, we feel confident that those will close in Q4.

Frank Calderoni

And again, there was some missingness around extending the CR which was relatively disrupted, those now being extended to April. And so, we feel comfortable that will allow us to get those deals done. So, and again, the quarter started, I mean this is all September through November was our quarter. And so, the eppiness around that and how long it's going to go where all issues force as well the change in administration, which is frozen a lot.

On your question around OpenStack, frankly, I think some of the pullback is related to exactly what we said in the past. Doing OpenStack and not being in operating system vendor is extremely difficult, and it's not only to be surprising that the people you see still bullish on OpenStack or Red Hat to say in canonical. And we feel very good in our ability to compete with them. We are seeing, as we said a lot of the deal fraction along with it. These are large technically sustaining customers who are also larger users of public cloud. They see us at a workload they find much more economic to run in their own data center.

Again, these are typically things where they are not trying to call other services that might be in the public cloud and they are running it scale. And so, they are very sophisticated and have a good sense of what make sense to run on promise versus what make sense to run in the hybrid cloud. And so, we see really, really good attraction there, and obviously now that we are down to fewer competitors in that space that also helped us with our pipeline and outlook as well. So, we continue to be very bullish on its ruling our portfolio.

Jim Whitehurst

Great. Thank you, Operator. Thank you everyone for joining us. We look forward to speaking to you and happy holiday. Thank you.


This does conclude today's conference. Thank you for your participation. You may disconnect your line at anytime.

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 All other use is prohibited.


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