Red Hat's (RHT) CEO Jim Whitehurst on Q1 2018 Results - Earnings Call Transcript

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About: Red Hat, Inc. (RHT)
by: SA Transcripts

Red Hat, Inc. (NYSE:RHT) Q1 2018 Earnings Conference Call June 20, 2017 5:00 PM ET

Executives

Tom McCallum - VP, IR

Jim Whitehurst - President and CEO

Eric Shander - EVP and CFO

Analysts

Siti Panigrahi - Wells Fargo

Mark Murphy - JP Morgan

Raimo Lenschow - Barclays

Michael Turits - Raymond James

Matt Hedberg - RBC

Jason Ader - William Blair

Keith Weiss - Morgan Stanley

John DiFucci - Jefferies

Walter Pritchard - Citi

Gregg Moskowitz - Cowen & Co

Abhey Lamba - Mizuho Securities

Karl Keirstead - Deutsche Bank

Ben McFadden - Pacific Crest

Heather Bellini - Goldman Sachs

Kirk Materne - Evercore ISI

Operator

Good day, everyone, and welcome to today's Red Hat, Inc Q1 FY 2018 earnings conference call. At this time, all participants are in listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions]

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

Tom McCallum

Thank you, Robbie. Hello everyone, and welcome to Red Hat's Earnings Call for the First Quarter of Fiscal '18. Speakers for today's call will be Jim Whitehurst, President and CEO; and Eric Shander, Executive Vice President and CFO.

Our earnings press release was issued today after the market closed and may be downloaded from redhat.com 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 our 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 our second fiscal quarter and our full fiscal year. These statements are only predictions and are based on what we believe today, and actual 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 are discuss today 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 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 all of you joining us on today's call. The first quarter was a strong start to fiscal '18 and a continuation of last year's momentum.

Our growth is being driven by high levels of customer interest in our broad portfolio of technologies, as well as our growing position as a trusted partner to enterprise customers. Specifically, IT organizations are looking to modernize their IT infrastructure for the hybrid cloud, and they are increasingly turning to Red Hat as a key partner to help them make this transformation. Let me describe a few highlights that illustrate the growing adoption of Red Hat technologies from the quarter.

First, we delivered our highest Q1 total revenue growth rate in U.S. dollars in four years at 19%. Second, subscription revenue for our infrastructure-related offerings, which is mainly comprised of our flagship RHEL technologies is approaching a $2 billion annual run rate, and grew 14% year-over-year in the first quarter. Third, we drove a 40% growth in our application development-related and other emerging technology subscription revenue, which now has an annual run rate of over $500 million. Fourth, we delivered more than 20% growth in our consulting and training services as our customers prioritize their move towards emerging technologies into production. And fifth, our largest customers continue to expand their commitments with Red Hat. All of our top 25 largest deals renewed during the first quarter, and in aggregate renewed more than 120% of their previous annual purchase. This type of momentum around our technologies and services has enabled us to raise our full-year guidance, which Eric will detail in a few moments.

With that overview of our first quarter results, let me discuss some of our recent business and technology highlights from the quarter. First, with our marquee user event, the Red Hat Summit, that was held in Boston, in May, we had record attendance with over 6,000 users, IT decision-makers, and partners, many of whom came to hear how Red Hat could help them with their hybrid cloud containers and DevOps initiatives.

One key theme coming out of Red Hat Summit this year was the high level of customer participation. We had 13 customer keynotes, followed by 65 customer-led breakout sessions, nearly a dozen press releases with customer references, and a doubling of the number of CIO and IT executives attending our Executive Exchange Summit. These global customers came to Summit so they could discuss how implementing Red Hat solutions helped to achieve significant success from a business as well as a social perspective, ranging from the build out of the largest private cloud based on OpenStack at Sprint, to saving lives through technology and community participation in Singapore.

We also had over 100 partner sponsors, of which 37 were new to the Red Hat summit. A key theme among our partners was our joint commitment in expanding relationships with our public cloud partners. We had a high level of participation from many of the largest public cloud providers of the world, including Amazon Web Services, Google Cloud, IBM SoftLayer, Microsoft Azure, and Rackspace.

In addition to promoting the customer benefits of Red Hat solutions running on the public cloud, we also announced an extended strategic alliance with Amazon Web Services to further integrate OpenShift, our container platform, as a service broker to hybrid cloud users. This unique offering will make AWS services accessible directly within OpenShift, allowing customers to take advantage of the broad portfolio of AWS services whether using them on AWS or in an on-premise environment.

In addition to the expanded partnership announcements with a number of partners, we also were able to showcase a number of diverse use cases of our container platform with customers such as Schiphol Airport in Amsterdam, Barclays Bank, BMW, and Disney. Following our summit event, we were a top sponsor at the OpenStack Summit in Boston. We were pleased to see that some of our OpenStack customers, Paddy Power Betfair and UKCloud, were recognized as Super User Awards at the event.

We also launched our latest version of Red Hat OpenStack Platform 11, which is based on the upstream OpenStack release, Octa, the 15th release of OpenStack. One of the key enhancements of this version is to our deployment tool, Red Hat OpenStack Director, which makes deploying and upgrading enterprise production-ready private clouds even easier.

Recently we announced the acquisition of Codenvy, which is a provider of a leading cloud-native development tool. This technology is built on top of the open source Eclipse Che project, and provides cloud based integrated development environment and a workspace management system that enables developers to get up and running more quickly to create modern container-based and cloud-native applications. Codenvy actually started Eclipse Che in 2014, and it has grown in popularity with more than a hundred contributors, more than 4,000 GitHub stars and one million usage hours per month. With this acquisition, Eclipse Che and the Codenvy enhancements will become central to Red Hat's developer tooling strategy, and reinforces our commitment to the developer community.

In summary, as we experienced at the Red Hat Summit, customers are looking more and more at their IT platforms to enable them to compete in digital transformation. We believe Red Hat has the solutions and the talent to help them realize the benefits of modern technologies in cloud computing. Our focus on delivering real results and business value for our customers will help to drive Red Hat's growth into the future.

Before turning the call over, I want to welcome the team from Codenvy into Red Hat, and I also want to thank our 10,000-plus Red Hat associates around the globe for their work in starting our year so strong. Together with the open source community and our business partners, we will continue to push the pace of innovation, and deliver solutions that help our customers capitalize on the power of hybrid cloud strategies.

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

Eric Shander

Thank you, Jim. Let me first thank our customers who continued to allow us to serve them as well as our Red Hat associates around the world who have maintained the momentum from Q4 to deliver a very solid operational and financial start to the new fiscal year.

Strong execution from our sales and services teams combined with solid global demand enabled us to deliver results that exceeded our guidance across a number of metrics. Total revenue was $677 million, above the high end of our guidance, and represent growth of 19% in USD, or 20% in constant currency. We exceeded the high end of our guidance by $27 million, with approximately $4 million due to an improvement in foreign exchange rates, the remaining $23 million of upside was split with approximately half driven by stronger performance and execution from our global sales team, and approximately half driven by additional services mainly supporting our emerging technologies.

Let me provide you with some additional financial highlights of our first quarter performance. In general, currency rate volatility was fairly stable year-over-year in Q1, and the major foreign currencies that we transact business in have improved from our initial guidance in March. So, for this quarter, I will keep my prepared remarks focused on reported USD results, and where appropriate, add constant currency details. In addition, you will find a table of constant currency results in our press release. Also, for a more detailed view of our results and reconciliations of our non-GAAP measures to GAAP please refer to our press release.

Now, let me turn to subscription revenue, which constituted 88% of total revenue in Q1, this was the largest driver of our growth, at $597 million for the quarter, representing an increase of 19% year-over-year. We also continue to drive growth across our technology portfolio. Subscription revenue for our infrastructure-related offerings was $458 million, an increase of 14% year-over-year. Subscription revenue for our application development related and other emerging technologies was $139 million, an increase of 41% year-over-year. Application development related and emerging technologies revenue represent approximately 20% of total revenue, up 320 basis points from the year-ago quarter.

Our services revenue exceeded our expectations, coming in at more than 20% year-over-year growth. This is the result of several customers prioritizing consulting projects around Ansible, OpenStack, and OpenShift faster than we expected. On a non-GAAP basis, operating income of $139 million grew 12% year-over-year, and non-GAAP operating margin was 20.5%. This quarterly result was slightly higher than the operating margin guidance I provided on our last call due primarily to the higher revenue results.

As a reminder, non-GAAP operating income adjusted for non-cash share based compensation expense, amortization of intangible assets and transaction costs related to business combinations. Using our non-GAAP effective tax rate of 27.8% after the impact of certain discrete tax items, non-GAAP diluted earnings per share came to $0.56, which is $0.03 higher than our March guidance, and up 12% year-over-year. We ended the quarter with cash and investments of approximately $2.3 billion while returning $62 million to our shareholders in the quarter through the repurchase of approximately 700,000 shares of stock.

Total deferred revenue at quarter end was $2.1 billion, an increase of $362 million or 21% over the same quarter a year ago. The rolling four quarters billings proxy is calculated by adding revenue plus the change in deferred revenue on the cash flow statement for the last four quarters. On a rolling four quarters basis, the billing proxy was $717 million up 20% year-over-year. Operating cash flow of $258 million for the quarter increased 11% from the prior year quarter, operating cash flow of $232 million, the FX adjusted days sales outstanding was 62 days.

I will now review the metrics related to business momentum in large deals in the quarter. Our geography saw growth in bookings, our geographies continue to see growth in bookings; this quarter, 55% of our bookings came from the Americas, 24% from EMEA and 21% from Asia-Pacific versus a 60%, 21%, 19% split in the first quarter last year.

The Asia-Pacific and EMEA regions have the strongest growth, North America performance was also solid in the quarter offset by the continued external challenges in the LATAM region. The first quarter route-to-market mix was 72% coming from the channel and 28% from our direct sales force compared to a 78%, 22% split in the first quarter last year.

The year-over-year change in mix was driven by a number of large deals that were closed by our direct sales team, our proxy for bookings duration was nearly 22 months. We continue to believe this metric will approach our 21 month historic level as the fiscal year progresses. Starting this fiscal year, we are updating our top deals metric to expand beyond the top 30 deals in a quarter, going forward we will report all deals over $1 million providing visibility to a larger pool of business in the quarter.

To provide some historical perspective, last fiscal year the number of million dollar deals was much higher than the 30 deals we talked about each quarter, the total number of deals over $1 million in a quarter in FY 2017 ranged from 45 to 110 over the course of the fiscal year.

In our Q1 FY 2018 quarter, there were a total of 44 deals over $1 million, within these deals seven were greater than $5 million and four of those were greater than $10 million including one deal greater than $20 million. Of note in the $5 million deal category was our largest deal ever for Ansible. This deal was with the large government agency which will deploy Ansible across several data centers to drive cost savings by leveraging Ansible's automation management capabilities, cross-selling was strong with over 68% of the top $1 million deals including one or more components from our group application development and emerging technologies offerings. Our top verticals within the deals greater than $1 million were financial services, government and other mainstream customers in sectors such as healthcare and retail.

Now, I would like to turn to guidance. Our outlook assumes current business conditions and foreign exchange rates which have generally improved against the dollar since our March guidance, we are raising our full year revenue guidance to $2.785 billion to $2.825 billion up approximately 17% in USD at the high end of the range, approximately half of the $65 million increase in our outlook is being driven by our stronger performance with the remaining balance coming from an improvement in foreign exchange rates.

Due to the increase in forecast revenue, we expect non-GAAP operating income to grow more than our previous guidance while still maintaining a 50 basis point increase year-over-year for a 23.6% non-GAAP operating margin. This forecast assumes additional focused investment in our emerging technologies as well as the effects of our Codenvy acquisition.

We expect full year non-GAAP earnings per share to be approximately $2.66 to $2.70 per share, assuming approximately $2 million per quarter forecast for net other income, an annual effective tax rate of approximately 28%, and approximately 180 million diluted shares. At the top end of the guidance, this would be 19% growth in earnings per share. On a GAAP basis we estimate annual stock compensation expenses of approximately $200 million, and annual amortization expense of approximately $30 million. GAAP fully diluted EPS guidance includes non-cash interest expense related to the convertible debt discount of approximately $20 million. Operating cash flow is still expected to grow in the range of $850 million to $870 million.

For Q2 specifically, we offer the following outlook. We expect revenue to be in the range of $695 million to $702 million, which is up 17% in USD at the high end of the range. We expect non-GAAP operating margin of approximately 24%, and non-GAAP earnings per share of $0.67. Consistent with prior practices, I will not forecast quarterly cash flow, but please note that it can be variable depending upon individual payments or receipts. Similar to the last two fiscal years, we would expect Q2 to be the lowest level for the fiscal year. Overall, our strategy to seize the opportunities around digital transformation and hybrid cloud computing continue to drive strong results for Red Hat.

We're also pleased with our progress to increase our strategic importance with customers. We continue to deliver high-value solutions that help our customers to realize the benefits of a modern cloud-enabled architecture. We believe that our continued success with customers and partners will drive additional value for our shareholders.

Robbie, I would now like to turn the call back to you for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And we can take our first question from Siti Panigrahi with Wells Fargo. Please go ahead.

Siti Panigrahi

Hello. Congrats on the great quarter. First of all, looking at your growth, it's really impressive just emerging technology growth of 41% - 42% in constant currency, but what's impressive is in the infrastructure-related offering, 44% in constant currency. That's been accelerating from last year Q1, and then Q4. I'm just wondering, what's driving at this one, while people are concerned about some kind of slowdown expectation on the Linux side, but it's very impressive to see this growth. I'm wondering is it that the emerging technology as you see traction, is it dragging more Linux revenue or any other factors that's driving Linux, and your expectation going forward.

Jim Whitehurst

Well, look, I think we feel - and I think we said we feel pretty good about low to mid teens on Linux for a while. Recognize, as applications are being modernized to run either in a cloud or on-premise in a more cloud-like environment, one of the first things you do is you move from Windows to Linux or UNIX to Linux. And so that business of just kind of new applications much more likely to be Linux is continuing to drive a tailwind for us there. The cloud business continues to do very well for us. That's primarily RHEL, which is an infrastructure that's immediate revenue recognition. And so the strong growth on the cloud side is also helping that as well. So, as long as workloads - new workloads come online, and as long as more workloads are being modernized we think we still have kind of solid opportunity in the core OS.

Eric Shander

And I would also just add to that - and we articulated this in investor day that the way that we've designed the emerging products where containers are Linux, the new emerging products are built on top of Linux, so you still get Linux as part of the emerging technologies. And as Jim mentioned, as application owners start to migrate over to the newer emerging products we have not, with the case studies that we've seen, we still continue to see a nice healthy momentum in growth in Linux. So we were pleased with the 14% growth that we saw this quarter.

Siti Panigrahi

Great, thank you.

Tom McCallum

Next question please, operator.

Operator

The next question comes from Mark Murphy with JP Morgan.

Mark Murphy

Yes, thank you very much. So Jim, I think seeing this pretty amazing level of acceleration and upside, it's pretty unusual. And it begs the question of what is driving this kind of transformation of the company. And when we speak with your customers and partners their view is that Red Hat is now hitting a stride where you're offering more than just stable enterprise offerings by really introducing excitement, and making all of these emerging technologies become first-class citizens in the ecosystem. And they tend to be talking about OpenShift financeable, and OpenStack, [indiscernible] and everything else. And that that's really driving -- bless you by the way, and that that's driving technology decisions forward. So from your view, is it fair to draw a line between this acceleration in upside we're seeing pretty powerfully in the numbers and connecting it to this transformation of Red Hat through the emerging technology portfolio?

Jim Whitehurst

Yes, I think that's reasonable. I think what's happening is for a long time Red Hat was in the business of offering lower cost alternatives to traditional components of the stack, so EAP to replace WebSphere, WebLogic or RHEL to replace UNIX. And in that world we were very interesting to people in purchasing or people in infrastructure. But now with a portfolio that includes a newer set of offerings, and this is as open source in general becomes more innovative, so things like a container platform or OpenStack or as you said, Ansible, which is core to being able to do DevOps, we're now on the CIO's agenda. And so we have many more senior meetings. We are much more involved earlier on when decisions are getting made on architecture because of that. And that provides a tailwind for our business rules management, or our messaging, all of our other offerings as well.

So, really, I'd call it we've moved from having a seat at the table with the purchasing department to having a seat at the table with the CIO. And that leads to a lot of benefits as we get a chance to show our portfolio more broadly, and we have this larger portfolio that's more kind of strategic because it is more about innovation.

Tom McCallum

Great. Next question please, operator.

Operator

Next question comes from Raimo Lenschow with Barclays.

Raimo Lenschow

Hi, thanks for taking my question, and congrats from me as well. Jim, can I just stay on one of those growth drivers, which is OpenShift. Obviously we had great momentum there. As we talk with customers as Mark does, the one thing that comes out is like your embracing Kubernetes very early gives you a really nice competitive advantage. The one thing is like your competition is just now saying, "Oh yes, that's the one early advantage, but we are going to work on that." How do you see that playing out as like -- is that going to be a level playing field or do you have a first mover advantage that is more defendable in the long-run as well then? Thank you.

Jim Whitehurst

Well, a couple of observations there. I don't know if I'd say first mover helps us. I mean, it's nice that we're first movers. I think more importantly is we have a long track record of being able to commercialize open source and offering supportable platforms over a long period of time. If you look at something like OpenStack, we're actually later into OpenStack, yet I'd argue we kind of clearly have emerged as the leader there. And I think something like Kubernetes, which will be a key component of enterprise infrastructure, people are going to want to rely on someone who knows how to build, deliver, and support and life-cycle this core component infrastructure. So, yes, it's great that we are an early adopter or early to market with it. And we're the second largest contributor upstream, like importantly it's also part of an infrastructure where we have strength in RHEL, we have strength in Ansible, and so we can put together a container platform that uses Kubernetes in a way that I think is hard for anyone else to quite be able to do.

Raimo Lenschow

Great, thank you.

Tom McCallum

Operator, next question please.

Operator

Next question comes from Michael Turits with Raymond James.

Michael Turits

Hi, guys. Great quarter all around. I think the only thing that I've looked at and stood out to me that I had questions about in the guide was the fact that you maintained the cash flow guide, even though EPS came up, and operating income goes up with the same margins in higher revenue. So why are we not raising the cash flow guide, and in particular what are we seeing in terms of the impact of some of those things you called out last quarter's headwinds that's specifically the cash taxes?

Eric Shander

Yes. So, Michael, it's Eric. So I appreciate you asking that question, and I figured you would. First off, I would just say in terms of the cash flow, it's early in the year. As you can imagine, obviously, one quarter in, as we look at -- I mean, clearly as we had mentioned during the analyst day, we do expect obviously some larger tax payments that were going to be due this year from a U.S. perspective in terms of the taxes and the money in terms of where we're earning that money. We did see this quarter, we saw a bit of improvement on linearity, similar to what we saw in Q4. However, I have not seen enough actions to really make it -- it's one or two quarters in, we've got to really see a little bit more sustained improvement on linearity to see if some of these actually are going to be continued trends. So, I guess the way I would just answer your questions, on some of these it's a little bit early in the year.

Tom McCallum

Great. Next question please, operator.

Operator

Next question comes from Matt Hedberg with RBC.

Matt Hedberg

Hi guys, thanks for taking my question. You mentioned the large $5 million-plus Ansible deal. Curious if you could help us with the attach of OpenStack and OpenShift in these large deals, and then maybe just as a quick follow-up to that as a related question. These are larger deal with these two products in particular. How should we think about the relative long-term margin profile of these two versus core RHEL when we get to scale?

Jim Whitehurst

I'll say I'll start with the long-term margin profile while Eric goes through and finds so he can give you the exact steps on the large deals. I would believe that these products long-term have a margin structure that looks similar to RHEL. There are a couple of changes, right. The sales cycle is longer, so there's a bit more upfront in the sales cycle, so the cost of sales there first going in is higher. The flipside is so far our experience is they are very, very sticky, and the renewal rates are higher, and the effort required to renew is very, very low. And so I would expect there long-term, once they are in place, margins to look actually really, really good. So you kind of balance that out. My guess is it should look quite similar.

Tom McCallum

Great. Eric?

Eric Shander

In terms of just the large deals, so what I would say is of the 44 deals over $1 million that we outlined, six of those had Ansible, we had, let's see, five of those with OpenShift, another six for OpenStack, and then nine had storage. So we did see multiple of the larger deals with more than just one technology in them.

Matt Hedberg

Great. Thank you.

Tom McCallum

Next question please, operator.

Operator

Next question comes from Jason Ader with William Blair.

Jason Ader

Yes, thank you, hi guys. How would you say customer behavior is changing, if at all, with respect to the cloud, specifically thinking about the movement of production workloads to the cloud, Jim? And any additional metrics you can share on adoption of RHEL in public clouds.

Jim Whitehurst

So, right now we're seeing a continued movement to cloud, including more production workloads. I think that's overall one of the reasons that you see growth in the RHEL numbers. Now, again, the growth in the RHEL numbers includes two components related to cloud. One is what we call cloud access, which is people taking their RHEL subscriptions and running it in the cloud. We frankly don't -- because we don't track where the subscriptions are run we don't have good data there. But we see it with working with our customers there's a lot of use of RHEL in cloud, and that's obviously for production type workloads. We also continue to see healthy growth in what we call our on-demand, the CCSP business. I think we've said that we expect to see a $200 million run rate in that business in the second quarter. I think we're very confident you will see that in the second quarter. So, again, as more production workloads move to public cloud that generally bodes well for us as people are -- want to continue to have a common operating environment which generally includes RHEL.

Tom McCallum

All right, next question please, operator.

Operator

Next question comes from Keith Weiss with Morgan Stanley.

Keith Weiss

Excellent. Thank you guys for taking the question, and very nice quarter; I wanted to just make sure I understood the new metrics around…

Tom McCallum

Keith, this is Tom. Could you just speak up a little bit, we're having a problem hearing you?

Keith Weiss

Is that better?

Tom McCallum

Yes.

Keith Weiss

So, nice quarter. Just wanted to dig in on the large deal metrics and make sure I'm understanding them right. I think you said it's 44 deals over $1 million in 1Q '18. And last year was a range of 45 to -- forgot the other number, like 100-plus, which would indicate that there was less $1 million deals this quarter than what you did last year in any give quarter in probably Q1. But it sounds like big deals are doing really well from you. So I'm trying to understand that dichotomy of was it just bigger big deals this quarter versus what you saw last year or how should we think about that, those two numbers?

Eric Shander

Yes, so it actually was. So you're right. So last year, it ranged from 45 to 110, depending upon the quarter. And this quarter, while it was 44, we had -- last year we did not have any deals over $20 million in the first quarter. And the deals that were over $10 million we had more this year than we had last year. So the deals were just bigger this year. But again as -- one of the things is as we continue to move on, I mean just the sheer number of large deals that will, just by the law of numbers, will get a little bit harder. But again, that's why we're going to provide more detail in terms of just the top 30 what the total portfolio looks like.

Keith Weiss

Got it. So is it safe to say that the deals over $1 million, while lower in number, are contributing a higher proportion of the value this year versus last year?

Eric Shander

Yes, that's absolutely the way to think of it. Yes.

Keith Weiss

And if I can sneak in one follow-up, $20 million-plus deal, that's an impressive level to hit that kind of deal. Can you give us some -- a little bit more granularity, a little bit more visibility into what makes up a $20 million-plus deal for you guys.

Jim Whitehurst

This one, I would say, is atypical in that it was a very, very large RHEL-only deal. This customer does use other products, so this wasn't an ELA; this is a renewal of just RHEL for one very, very large customer. So that would be atypical. Typically our deals of that size include a lot of other products. And again, this customer does use other products, but in this case this was just a renewal of RHEL.

Keith Weiss

Great.

Tom McCallum

Thank you. Operator, next question please.

Operator

Next question comes from Karl Keirstead with Deutsche Bank. Karl, check your mute function please. Okay, Karl, if you can hear us go ahead and re-queue, we're going to release your line.

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

John DiFucci

Yes, can you hear me okay?

Jim Whitehurst

Yes.

John DiFucci

So, as everybody said here, this is really impressive top line here. And I just, especially given your model, as a subscription model it's surprising to see you exceed by so much. And even those of us that really try to model it, what a waterfall model. It really looks really strong. And I realize you're seeing a lot of traction with the emerging technologies. But at the same time I would assume those larger deals are typically singed at the end of the quarter. So just the one thing, the variable here that sort of makes sense to me is as that cloud is really seeing a lot of traction. You sort of hinted to that Jim, but I'd like you to -- if you can talk a little bit more. You said you have a lot of confidence you're going to hit that $200 million milestone next quarter.

And if you could talk a little bit more about that in public cloud, because you have the partnership with Microsoft now too, and you could be on Amazon, and those are two -- well, in the opposite order, the leaders in that area. If you can talk a little bit about what kind of traction you might be seeing on Azure relative to Amazon, and is that starting to pick up. And am I right to think that some of that upside in the subscription, or at least part of it, is really attributed to cloud?

Jim Whitehurst

I'll start on the cloud piece, and then Eric if you want to walk through a little more detail exactly what led to the revenue versus our expectations. Yes, so first off, we call it the CCSP, so this on-demand part of cloud that's immediate revenue did beat our expectation in the quarter. It continues to grow very nicely even off of a very, very large base. So we're pleased with that result, and that seems to be consistent. And so, knock on wood; we're hoping that's continuing forward. The Microsoft is growing very, very, very fast obviously off of a much lower base, given we've been with Amazon a lot longer. But we're seeing really nice growth in both of those. Recognize too that the more traditional enterprise-type cloud players, like the IBM SoftLayers, et cetera, are also meaningful contributors, and also growing nicely as well. But yes, part of our revenue above our internal expectations was related to that. Eric, you want to talk in more detail?

Eric Shander

Yes. And the bigger piece, John, as I mentioned in my prepared remarks was just the overall services performance. It's hard for us to know when a lot of these projects are actually going to complete. A lot of those actually completed near the very end of this quarter. And we saw a sizable uptick in the consulting projects that the teams were working on, and having customers accepting those right near the end of the quarter. So it was nice favorable surprise for us. I mean, obviously, with services you don't model that through from a billings perspective, but it was -- we take this as very positive because a lot of the services was focused around the emerging technologies. And customers were seeing these projects come to a conclusion, and the services being completed, hence us recognizing the revenue. So a nice sizable increase that was unexpected was really in the services piece. As well as the team did a nice job managing linearity in the quarter through our true business performance.

Jim Whitehurst

Yes, we've talked a lot about linearity, and we actually exceeded our expectations this quarter in month one and month two business, which was good to see.

Eric Shander

That's right, yes.

Tom McCallum

Next question, operator, please.

Operator

Next question comes from Walter Pritchard with Citi. Please go ahead.

Walter Pritchard

Hi, thanks. So Eric, just wondering if you could talk about on the long-term deferred side that was very strong in the quarter. I think even as recently as six months ago there was some question as to sort of how that would trend over time. And I'm wondering do you feel better about projecting out what the contribution of long-term deferred would look like. And just wondering generally, if you could describe what's driving that and what's different versus six or nine months ago when it was going the other direction on you?

Eric Shander

Yes, so every deal is going to be a little bit different. I mean, we did mention that we do expect our overall contract duration to get back to our normal historical levels of 21 months. Some of these longer deals that we signed last year, I mean, clearly some of the big, big deals that we signed last year, I mean, we're obviously looking for similar type deals this year. So I mean to the extent that we can get those as will impact the long-term deferred. But what we see as we kind of look out over the next couple of quarters is we do see a normalization tapering a little bit down off the long-term deferred more so into your short-term deferred. So, hence why the duration would be getting down a little bit beyond the -- below the 22 months down to about 21 months.

Jim Whitehurst

Yes, and I would just add to that. I'd be a little careful drawing too much from a Q1. Obviously we have fewer really big deals in a Q1. And just the lumpiness of who decides to pay on a few big deals, especially in the Q1, can kind of impact that a bit.

Tom McCallum

Great. Next question please, operator.

Operator

The next question comes from Gregg Moskowitz with Cowen & Co. Please go ahead.

Gregg Moskowitz

Okay, thanks very much. Good afternoon guys. Jim, the enhanced AWS functionality with OpenShift that you talked about at Summit is interesting. Just wondering what the early feedback has been on this strategic alliance. Thanks.

Jim Whitehurst

Well, so we've announced that we're working on the tech. We're working with some initial customers around it. So we don't -- it's not [GA'd] [ph] and out yet. I would say the initial feedback from customers has been extremely positive. We had a number of customer say, "Oh my God, this is exactly -- this solves our problem. We had this set of workloads but there's two or three sets of functionality that AWS has that we would like to be able to leverage, and this kind of gives us kind of the best of both worlds. We can decide where we want to run a core workload, yet still tell our developers that they can access features that they want to access." So it's been overwhelmingly very, very positive. I think it also -- it just further solidifies Red Hat's position as kind of a leader in Kubernetes and container platform, so very, very positive so far. Again, just announced recently last month, so I'll feel better when we see a lot more customers actually up and running.

Gregg Moskowitz

Great. Thank you.

Tom McCallum

Next question please.

Operator

We can take our next question from Abhey Lamba with Mizuho Securities. Please go ahead.

Abhey Lamba

Yes, thank you and congrats everybody, definitely a great quarter. Jim, can you talk about any industry verticals or segment that you can call out that are driving the adoption of OpenStack, OpenShift, and other emerging solutions? Are there any specific use cases that have accelerated over the last couple of quarters as your performance has clearly stepped up very meaningfully in the last two quarters?

Jim Whitehurst

Yes. Well, I would say first off, OpenStack is Telco, heavy Telco around OpenStack over the last couple of quarters. And that's again Telcos look to drive 5G and kind of next-generation infrastructure, they want to build it on OpenStack and we're a leader there. So that's been very, very positive.

Looking kind of broadly on OpenShift, I would say Telcos - sorry; financial services would be part of this along. Now, how much of that is just due to the fact that we have very, very strong relationships across financial services? I guess part of that is well as just financial services are often leaders in adoption of technology. The other one I'd call out is I can make a lot of progress in retail with OpenShift as well. I think retail is recognizing the need around analytics to be able to better compete. And so, I think we have some good tailwind with the retailers as well.

Tom McCallum

Great. Next question please, operator.

Operator

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

Karl Keirstead

Thanks. Just a question on the deal performance, it feels like this quarter it wasn't so much the Americas as it was EMEA and APAC, I know the year-over-year compare was a little on the easy side, but maybe Jim for you, were there any changes maybe on the sales leadership front that would have caused this nice uptick in the non-U.S. regions? Thank you.

Jim Whitehurst

No, nothing has changed. We had a very, very stable team. I think all the regions performed well. I mean, obviously there are some secular issues happening in Latin America. Right now Q1 is always really strong in APAC. So that's normal to see it doing well. And so, it was solid performance across the board, and there were significant differences across regions. I'd say EMEA was a bit strong, they had a really, really nice quarter, but I don't think it was - I don't think there's anything systemic associated with it. It was just solid execution.

Karl Keirstead

Got it. Congrats on the results.

Jim Whitehurst

Thank you.

Tom McCallum

Operator, next question please.

Operator

Next question comes from Ben McFadden with Pacific Crest. Please go ahead.

Ben McFadden

Hi guys, thanks for taking my question, I wanted to follow-up on the OpenStack and the Telco commentary; just curious as we think about these six, I believe it was six deals over a million in the quarter that were from OpenStack, how much of those were the larger deals in the quarter? And then maybe just as a follow-up, Jim, could you maybe help us understand how big the opportunity is with Telcos in OpenStack with NFE and 5G because these deals are getting pretty large, and I'm just curious, what's the opportunity for expansion from here? Thanks.

Jim Whitehurst

Yes, sure. So I'm just kind of quickly looking to make sure I don't miss the largest deals, i.e. the five million plus deals did not have a material amount of OpenStack in them. We had some really big wins over the last couple of quarters, and we have three of the four large U.S. Telcos of eight figure OpenStack engagements with us, but those were prior quarters not this quarter. So, the large deals here were not driven by OpenStack.

I think the opportunity is specifically in Telco. I mean it could be massive. I want to be very, very guarded on this, but if you look at a refresh Telco infrastructure for 5G will be hundreds of billions of dollars, not in software, but in total. And you know, assuming OpenStack wins that, and assuming we are a major player there, that can be quite a large opportunity. The eight figure deals that we've announced with various Telcos are really very, very small implementations of either small areas or small components of functionality. So, those could get much, much larger, but obviously much, much larger, you know, the kind of work out exactly what that model looks like. So I think there is a large opportunity there. I wouldn't want to say until we actually start delivering more against it, I wouldn't bank on that one, but yes, there is the potential for a very large opportunity there.

Tom McCallum

Next question please, operator.

Operator

We will take our next question from Heather Bellini with Goldman Sachs.

Heather Bellini

Great, thank you. Jim, I just had a question for you, listening you talk about OpenStack - I'm sorry; OpenShift and OpenStack, it's kind of like two piece choice if we had two, I have you pick one. If you look out three years, which one do you think is going to be a bigger revenue driver and why?

Jim Whitehurst

That's a tough one. And the reason I say that - and I will talk to it little bit; I would say overall if you have put a gun to my head right now, I would say OpenShift, but I would say OpenShift not because necessarily our subscription revenue from OpenShift will be larger, but OpenShift drives the rest of the portfolio in a very meaningful way. Once people aren't using OpenShift is much easier to consume our middleware services. And we've seen really good traction with middleware services after people have adopted OpenShift. So I think as a driver, it's likely to be significant for us.

I think the big unknown with OpenStack is we have 500 enterprise customers up and running on OpenStack, more than that now, but if Telco really happened to take off in the right way, it could be massive, but it's hard to know if or when that could happen. So, if I had to bet right now, I would say OpenShift, but I think they both have very significant opportunities for somewhat different reasons. I think over time, OpenStack will do well in the enterprise, but I think we're going to see the initial adoption in Telco. And so it's a little bit of - does that happen in the next two years or five years, and that's harder to know, where there's so much value in building applications in a containerized way that, you know, OpenShift you can certainly see immediate kind of deal sizes in growth in those businesses pretty quickly.

Tom McCallum

Great, thank you. Next question operator, please.

Operator

Next question comes from Kirk Materne with Evercore ISI. Please go ahead.

Kirk Materne

Thanks very much. Eric, earlier you talked about the services business and why it ticked up a little bit this quarter. Just as we think forward for the fiscal year, it would seem that you don't expect that to continue, and I was just curious, is that partially due to the fact that you feel more comfortable offloading some of those service deals to your partner? Is it just sort of Q1 spike? And I guess, could you just talk to that relative to your margin guidance for the full year, obviously services has a low - has a different kind of gross margin characteristic to it, so could you just sort of integrate that into your answer of those questions? Thanks.

Eric Shander

Sure, sure, Kirk. So what I would tell you is as we look at Q2, we still see continued momentum in the services business, and a lot of this is still continuation of - if you think about lot of the emerging products bookings happen in Q3, Q4, with a lot of the bigger deals, that - as that we're kind of continues to work through, we see continued momentum in services through Q2. I do see that tapering off in the second half of the year a bit. And then, obviously as we look at margins, you know, we've been absorbing quite a few items. I mean, certainly we had some revenue uptick on that, but we've obviously got the impact from Codenv, as well as we're continuing to make the proper investments that we need to in emerging technologies such that we can ensure that we preserve the 23.6% margin, which we - which I originally guided and we're holding to.

Tom McCallum

Great. I think we have time for one more question, operator.

Operator

Okay. We can take our final question from Kash Rangan with Bank of America. Please go ahead.

Unidentified Analyst

Okay, this is Nick [indiscernible] sitting in for Kash. Last quarter you quantified the impact from the cloud on the billings number of $120 million, if you can help us walk through the math, and with $200 million run rate coming in 2Q, could that number be twice as large of last year, i.e. the headwind for billings for fiscal year '18 to be $200 million plus?

Eric Shander

There may have been - we may have done some high level math, if you would have assumed the CCSP activity actually was in a normal subscription business what that would have done to billings. What I would just say is, I don't want to do that for you on this step of a call, I mean if you're going to look at modeling that for this year, I would just take some of our assumed growth rates that we have in our guidance and just applying a lot -- some sort of uplift to that, but - and again in general, as we've said before, the reason that we don't guide on billings is because it is hard to forecast, and you know, like we said, we certainly expect some of the duration to be coming down in some of the deals. So, I would - at this point I would hazard to not want to do a calculation like that.

Tom McCallum

Great. Thank you everyone for joining the call today. We look forward to speaking with you over the next several months, and thank you, and good night.

Jim Whitehurst

Thanks everybody.

Eric Shander

Thanks everybody.

Operator

And this does conclude today's program. Thank you for your participation. You may now disconnect, and have a great day.