Red Hat's (RHT) CEO Jim Whitehurst on Q3 2018 Results - Earnings Call Transcript

Red Hat, Inc (NYSE:RHT) Q3 2018 Earnings Conference Call December 19, 2017 5:00 PM ET

Executives

Tom McCallum - Vice President, Investor Relations

Jim Whitehurst - President and Chief Executive Officer

Eric Shander - Executive Vice President and Chief Financial Officer

Analysts

Mark Murphy - JPMorgan

Matt Hedberg - RBC Capital Markets

Mohit Gogia - Barclays

Siti Panigrahi - Wells Fargo

Kirk Materne - Evercore ISI

Karl Keirstead - Deutsche Bank

Zane Chrane - Bernstein Research

Walter Pritchard - Citi

Gregg Moskowitz - Cowen

Adam Holt - MoffettNathanson

Keith Weiss - Morgan Stanley

Howard Ma - Jefferies

Brian White - Drexel

Parthiv Varadarajan - Mizuho Securities

Jason Ader - William Blair

Operator

Good day, everyone and welcome to today’s Red Hat Incorporated Q3 FY 2018 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] Please note, today’s call is being recorded and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Tom McCallum, Vice President of Investor Relations. Please go ahead, sir.

Tom McCallum

Thank you, Elise. Hello, everyone and welcome to Red Hat’s earnings call for the third 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 maybe downloaded from redhat.com on the Investor Relations page. Also on this page you will 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 and trends, including guidance for our fourth quarter and full fiscal year. These statements are only predictions that are based on what we know 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 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 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. I am pleased to share that Red Hat delivered another strong quarter, with financial results exceeding our guidance across each metric. Demand remains strong for our hybrid cloud technologies and Red Hat is one of the key beneficiaries based on the breadth and depth of our solution portfolio as we have a proven track record of delivering significant business value to our customers.

Red Hat is increasingly viewed as one of the top strategic technology partners to enterprise organizations, which is evidenced by our growing number of seven figure and multi-seven figure transactions. As we look ahead, we believe we are well-positioned to close out the fiscal year on a positive note and we have again increased our guidance for fiscal ‘18, as Eric will detail in a moment.

Some of the financial highlights of the third quarter were subscription revenue growth of 21% year-over-year and our third consecutive quarter of approximately 20% total revenue growth in constant currency. These top line results were driven by: first, consistent subscription revenue growth for our infrastructure-related offerings which include bare metal RHEL, virtualized RHEL and RHEL on the public cloud; second, consistent subscription revenue growth of more than 40% in our application development related and other emerging technology offerings; third, our services revenue growth continues to outperform our expectations as consulting projects for OpenShift and Ansible are driven by high demand for these technologies; and fourth, we achieved strong renewals in our largest customers, including strong growth in the number of deals greater than $1 million as I noted earlier. Overall, we continued to experience strong demand across our broad portfolio of technologies.

Now, let me describe a few business and technology highlights from the quarter. First, we announced the availability of OpenShift Container platform as a service broker that enables cloud native services from Amazon Web Services to be easily provisioned and managed on the platform including AWS compute, database, analytics, machine learning, networking, and mobile application services. Originally, we announced at Red Hat Summit in May, this expanded alliance with AWS and provides customers with a unified view of their own applications and public cloud capabilities. We also made a number of other announcements related to the integration of additional Red Hat Technologies in the OpenShift platform. We have integrated our storage technologies as an enterprise-grade software-defined storage solution built from Red Hat Gluster Storage, which provides container-based storage on both on-premise and on the cloud. In addition, we announced Red Hat OpenShift Application Runtimes or RHOAR. RHOAR is a next-generation set of runtimes for containerized, microservices-based application development. RHOAR stands alongside Red Hat JBoss EAP, leveraging Red Hat’s years of runtime expertise in this brand new offering targeted at cloud-native, DevOps development and micro-services optimization.

Second, we expanded our Certified Cloud Service Provider program including the Alibaba Cloud, which provides a comprehensive suite of cloud computing. Alibaba Cloud is among the world’s top IaaS providers and the largest provider of public cloud services in China. Alibaba Cloud intends to offer Red Hat Enterprise Linux on a pay-as-you-go model in the Alibaba Cloud Marketplace and Red Hat Cloud Access which is our innovative bring-your-own-subscription for our broad portfolio of technologies. This program gives customers additional choice and consistency when deciding on where to build and run their applications. In the coming months, Red Hat solutions will be available directly to Alibaba Cloud customers, enabling them to take advantage of the full value of Red Hat’s broad portfolio of open source cloud solutions.

Third, at OpenStack conference held in Sydney in November, we continued to showcase our technology innovation and numerous customer references. At the conference we announced Red Hat OpenStack Platform 12, the latest version of our massively scalable and agile cloud Infrastructure-as-a-Service. Based on the OpenStack Pike release, Red Hat OpenStack Platform 12 introduces containerized services, improving flexibility while decreasing complexity for faster application development. Also at the OpenStack conference we announced that Insurance Australia Group Limited or IAG is using Red Hat OpenStack Platform to help consolidate and simplify its legacy infrastructure. A trusted partner of IAG for 7 years, Red Hat is now helping IAG use the power of open source technology to bring together disparate data sources into a single, scalable private cloud solution to improve customer experience. This is a great example of how we are able to build off the trust we have established with customers and then help them to enable new innovative technologies to address their cloud initiatives. I am pleased to announce that our long track record of delivering strong growth has enabled Red Hat to be added to the Fortune 1,000 list of the largest companies. I’d like to thank our Red Hat associates around the globe for the exceptional performance that made this remarkable achievement possible.

As we closed out our fiscal year, we are pleased that our fourth quarter revenue outlook will exceed a $3 billion annual run-rate. In addition, we are confident about our growth prospects based on the substantial markets we are addressing combined with Red Hat’s broad product portfolio and strong market position. The execution we are driving today will create additional growth opportunities for our customers and partners in the future.

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

Eric Shander

Thank you, Jim. Let me also add my appreciation for the great execution that our associates around the world delivered during this quarter. This drove another quarter of strong financial results that were above our guidance.

For the third quarter, we delivered a powerful combination of year-over-year growth of 22% for revenue, 25% for non-GAAP operating income and 18% for operating cash flow. This quarter was also consistent with our strong year-to-date results of 20% total revenue growth, 26% non-GAAP operating income, and 21% operating cash flow growth.

Let me provide you with some additional financial highlights of our third quarter performance. In general, currency rate volatility was fairly stable year-over-year in Q3. The major foreign currencies that we transact business in have modestly weakened from the outlook we provided on the September earnings call, but the overall impact was minimal to our results. 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.

Let me start with the income statement. We delivered $748 million of revenue, which was above the high-end of our guidance and represented growth of 22% in USD or 20% in constant currency. We exceeded the high-end of our guidance by $11 million which include a foreign exchange headwind of approximately $2 million due to a weakening of some rates against the dollar. The remaining upside was mainly due to stronger performance and execution by our global sales team and additional services demand for our emerging technologies. Subscription revenue constituted 88% of total revenue in Q3. We also experienced continued high growth across our product portfolio.

Subscription revenue for our infrastructure-related offerings was $495 million, an increase of 15% year-over-year. Subscription revenue for our application development-related and other emerging technology offerings was $162 million, an increase of 44% year-over-year. This past quarter marked the fourth straight quarter of 40% or higher growth in this part of our subscription revenue as demand remains strong for our container, cloud management, middleware and private cloud technologies. Application development-related and emerging technologies revenue represented approximately 22% of total revenue, up 340 basis points from the year ago quarter.

And lastly, our services revenue of $91 million grew 27% year-over-year. As we have seen since Q4 last year, the growth of services continued to be faster than we expected due to additional demand for consulting projects around Ansible and OpenShift. On a non-GAAP basis, operating income of $179 million grew 25% year-over-year and non-GAAP operating margin came in at 23.9%. This quarterly result was 20 basis points higher than the operating margin guidance that I provided on our last call and 40 basis points higher than Q3 last year due primarily to the higher revenue results.

As a reminder, non-GAAP operating income adjusts 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 26.5% after the impact of certain discrete tax items and debt discount expense, non-GAAP diluted earnings per share came to $0.73, which is $0.03 higher than our September guidance and up 20% year-over-year due to the stronger performance in the quarter.

Turning to the balance sheet, we ended the quarter with cash and investments of approximately $2.3 billion, while returning $100 million to our shareholders in the quarter through the repurchase of approximately 800,000 shares of stock. Our total deferred revenue at quarter end was $2.1 billion, an increase of $390 million or 23% over the same quarter a year ago. Our operating cash flow results were also strong. Operating cash flow of $160 million for the quarter was up from $136 million in Q3 last year. This result was driven by higher profitability as well as stronger billings and collections. The FX adjusted days sales outstanding was 60 days, a 2 day improvement from last year. On a rolling four quarters basis, the billings proxy was $776 million, up 22% year-over-year. As a reminder, the 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.

I will now review the bookings metrics related to our business momentum, top renewals, and the million dollar deals in the quarter. We drove solid bookings growth across our major geographies. This quarter, 57% of bookings came from the Americas, 28% from EMEA and 15% from Asia-Pacific, which is relatively consistent with the third quarter last year. The third quarter route-to-market mix was 67% from the channel and 33% from our direct sales force, compared to the third quarter prior year’s split of 72% and 28%. Our proxy for booking duration was nearly 24 months, the same that we reported in Q3 last year. This was however higher than we anticipated due to strong growth of multiyear deals being booked in the quarter.

Looking at the fourth quarter, we continue to expect our bookings duration metric will be lower than last year’s record 25 months. Looking at our top deals, 25 out of 25 of our largest deals that were up for renewal all renewed and did so in aggregate at greater than 120% of their previous value. Our large deal growth in the quarter was strong, with a total of 94 deals over $1 million, up approximately 30% year-over-year. Within these deals, 17 were greater than $5 million which is a record for any quarter. Included in the 17 deals were 4 greater than $10 million with one of those over $20 million. Cross-selling was strong, with over 60% of the top deals greater than $1 million including one or more components from our group of application development-related and emerging technologies offerings. Our top industry verticals within these deals greater than $1 million were financial services, tech and media and other mainstream sectors such as retail, energy and transportation.

Now I would like to turn to guidance. Our outlook assumes current business conditions and foreign exchange rates, which generally weakened against the dollar since our September guidance. For example, our higher outlook for Q4 revenue also includes a $4 million headwind from the foreign exchange rates we used from our previous outlook. For our full year, we are raising our total revenue guidance to $2.906 billion to $2.911 billion, up approximately 21% in USD and 20% in constant currency at the high-end of the range. Given the strong performance so far this year along with our outlook for additional growth and investment, we are modestly raising our non-GAAP operating margin by 10 basis points to 23.9% for the full year.

We are also raising our full year non-GAAP earnings per share outlook to be approximately $2.88 per share, assuming approximately $2 million per quarter forecast for net other income, an annual effective tax rate of 27% and approximately 181 million diluted shares. This guidance also includes a one-time gain on a strategic investment of approximately $0.05 for both GAAP and non-GAAP earnings per share. On a GAAP basis, we expect GAAP EPS to be approximately $2.02 with an estimated annual stock compensation expense of approximately $195 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. And finally, we are also raising our full year operating cash flow outlook to be in the range from $900 million to $910 million.

For Q4 specifically, we offer the following outlook. We expect revenue to be in the range of $758 million to $763 million, which is up approximately 21% in USD at the high-end of the range and 18% in constant currency. We expect non-GAAP operating margin of approximately 24.6% and non-GAAP earnings per share of approximately $0.81 with 182 million diluted shares. GAAP EPS is expected to be $0.54 with 186 million diluted shares. Both GAAP and non-GAAP earnings per share will include the approximately $0.05 gain I mentioned a moment ago. Although one can derive a quarterly cash flow range based on my annual guidance, we will continue our practice of not providing quarterly cash flow guidance.

In Q3, we delivered strong results that reflect the continued adoption of the technologies that address the opportunities around digital transformation and hybrid cloud computing. This momentum will enable us to finish the year with high growth across revenue, non-GAAP operating income and cash flow. We are also optimistic that the execution this year will position us well for the future growth. At this point in time, I would like to turn the call back to Elise for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Matt Hedberg with RBC Capital Markets. Please go ahead.

Matt Hedberg

Hey, guys. Thanks for taking my questions and happy holidays. Jim, we have talked in the past, your Cloud Access program seems to be one of the more strategic sides of your hybrid cloud strategy. I know you have talked about it being difficult to quantify in the past. I am curious I’d love to hear your take on that how it stacks up versus CCSP and is there anything that we can do to maybe in the future give a little better work on the size and magnitude of that business?

Jim Whitehurst

Yes, I think you are still seeing constant currency 14% growth in our infrastructure line and obviously one of the things driving that is both Cloud Access and CCSP. It really take a way for us to decide when and how we can track it and show you more detail on that. Anecdotally, I can say a lot of customers are using the program and we hear very positive things about it again because we don’t track and our customers don’t necessarily want us to track exactly where the subscriptions were a little bit in a tough spot to be able to give you color more than anecdotal, but we will take that as a takeaway if there is a way we can provide you more clarity in that. Unfortunately, it’s just hard to do since we don’t have the exact number ourselves.

Tom McCallum

Great. Next question please operator.

Operator

Certainly. We will go next to Mark Murphy with JPMorgan. Please go ahead.

Mark Murphy

Thank you. Congrats on the solid results. Jim, I wanted to ask you how broad do you think the movement toward containers is becoming globally just because depending on who we talk to there are people I think that containers are either the biggest trends in the software industry or you hear comments that very few companies actually are really going all in on containers. So, I am just curious if you have any personal estimate of what percentage of workloads have been containerized or maybe will be in the very long-term? Thank you.

Jim Whitehurst

Yes, so I think that’s a great question. I will try to get those two different perspectives distinct. What I would say is virtually every major company that we are working with is building a strategy around containers and they are starting to work due to new App Dev at least a portion of that on containers with the intention as long-term the majority of their new App Dev will be on containers. That said, the majority of applications running right now were written more than a year ago right. And so the issue you have is everyone – so, the vast majority probably 90% of our enterprise customers are at some space are starting to deploy containers, but it is a very small percentage of their workloads today because new applications are still a small percentage. So, to me given both the operational benefits and the development benefits we still believe the majority of applications will be containerized and run that way in the long run, but I would say as you said even some of our most advanced OpenShift customers, if you looked, it’s still 10% or less of their total application portfolio growing really rapidly, which is why we see so much opportunity there, but again, it’s everyone is intending to do it at some level of adoption, but it’s just we are still in the very early days. Again, the economic benefit is one of these technologies where it’s cheaper to develop and it’s cheaper more efficient to run on containers, it’s kind of the best of both worlds which is why it does continue to appear to be the biggest trend in technology right now certainly the infrastructure space.

Tom McCallum

Great, thank you. Operator next question please.

Operator

We will go next to Raimo Lenschow with Barclays. Please go ahead.

Mohit Gogia

Thanks, guys. This is Mohit dialing in for Raimo. Thanks for taking my question. So, just staying on containers, I guess so you touched on as to the product adoption that you see forthcoming for that. And I am just curious as to obviously that’s a tailwind for your application development emerging based on your OpenShift product, but you also see adoption of containers providing sustained tailwinds to your infrastructure segment in terms of adoption for Red Hat?

Jim Whitehurst

Well, yes, I mean so containers, let’s be clear, containers are a different way to distribute the Linux operating system, which basically decouples the stuff it touches the hardware, so the host space from the user space. And so it makes the operating system substantially more strategic for customers and it is very much a Linux based set of technologies, I know there are Windows containers, but that’s very much a small edge case. And so the fact that it drives almost 100% share, very, very high share of Linux and because it requires a set of consistency and a long-term lifecycle to run production applications etcetera, etcetera that we are good at we think it’s a long-term tailwind behind us across our portfolio of products.

Tom McCallum

Great. Operator next question please?

Operator

We will go next to Siti Panigrahi with Wells Fargo. Please go ahead.

Siti Panigrahi

Hi, congrats on another great quarter. Looking at your volume and size of large deals that’s very impressive 30% year-over-year growth, but what’s impressive even the $5 million deal versus almost like 13 deals versus 5 deals last year and for last quarter. So, could you give some color what’s driving such a large number of 5 million plus kind of deals, is it mostly on your core Linux or is it something that have you started seeing emerging technology that’s driving? And as a follow-up to services, Eric, you mentioned about some of the demand for emerging technology, is that mostly are you seeing proof-of-concept that’s driving or is it implementation?

Eric Shander

So actually Siti, I think we can probably perhaps maybe answer both of those questions together, because I mean as I had mentioned in the prepared remarks over 60% of our larger deals, Red Hat cross selling in them, it had multiple elements of the technologies. So, certainly, RHEL is in there, but we are seeing good cross-selling of the emerging technologies, certainly OpenShift and Ansible and OpenStack. And as we look at the services activities and I’ve mentioned this before is services is really for us is both a leading and a lagging indicator of a lot of these projects. So we are seeing a fair amount of proof-of-concepts, which are certainly leading to bigger deals, but then we are also seeing, we will sell a subscription and it will include it’s a OpenShift or some of the other emerging technologies in there and then the customers will then engage us to get some support and services around it or training. So, it’s really right now I mean we are kind of looking at the growth then I would tell you a lot of what we are seeing is early proof-of-concept projects on the services side, which is helping driving it, but at the same time too we are also seeing a pickup of actually the deployment of some of the emerging technology too.

Jim Whitehurst

Yes. Just looking through of that 13 deals that were over $5 million or more than that, however, there is a lot of $5 million. I only see one that is kind of just RHEL and kind of the supporting technologies around that. The vast majority have a middleware component, Ansible is taking a bigger role across a lot of the deals, a lot of OpenShift and OpenStack, the price point especially around OpenShift is just much higher for stock compare and so that leads to just kind of discount higher overall dollar amount. So, without a doubt it’s the multiple technologies in the portfolio that’s helping us drive that kind of size deals.

Siti Panigrahi

Great. Thank you.

Tom McCallum

Next question operator please.

Operator

Certainly. We will go next to Kirk Materne with Evercore ISI. Please go ahead.

Kirk Materne

Thanks very much. And I will add my happy holidays to everyone. Jim, you mentioned financial services being strong and I think we have heard that from some other software companies over the last 3, 4 months. I was just kind of curious in your view is this some catch-up spending perhaps that they didn’t get to over the last couple of years that you see these companies coming back to you guys or we had just a complete paradigm shift in terms of the way they think about partnering with you. And so that this isn’t sort of just the period of catch-up spending there is a real tail to this when you look out say 12 to 18 month? Thanks.

Jim Whitehurst

Yes, yes. So recognized, we are a subscription model business and so people are kind of using what they are – what they are consuming, they are paying for what they are consuming. And so I don’t really see a lot of kind of catch-up in that. I think what you are seeing is just as – and this is driven by a bunch of things certainly containers is one of those things. We are becoming more strategic to our customers and so we go to have a discussion about containers and all of a sudden we are selling more EAP and other middleware. Ansible has been a great cross-sell, because it kind of coming into organizations in a different way and really exploded and that allows us to come in and all of these fields are – many of the deals I talked about and we had a 17 of the top deals had Ansible, virtually all of those also brought in other technologies. So, the cross-sell across the technologies is just allowing these to get bigger and specifically in financial services and there are a lot of financial services in that set of numbers. I think the first top three were all financial services. It’s a whole mix of technologies there. None of those are kind of catch-ups they are all just expansion and relationships personally.

Tom McCallum

Great.

Kirk Materne

Thank you.

Tom McCallum

Next question please.

Operator

We will go next to Karl Keirstead with Deutsche Bank. Please go ahead.

Karl Keirstead

Thanks very much. Question for Eric on the seasonality of billings, Eric, as we setup our models to think about the fourth quarter calculated billings, you did caution us that the contract duration could come in, but I guess the other issue too is that in the year ago fourth quarter you guys had an amazing quarter and so the comparison is tough. So maybe the way I want to phrase this is just around seasonality if last year things were quite skewed to fourth quarter, I think something like 36% of your billings last fiscal year dropped in the fourth quarter. Are you expecting fiscal ‘18 to have sort of a similar 4Q skew? Thanks very much.

EricShander

Yes. So, Karl, I appreciate the question. I mean, as you all know and we have said continually, I mean billings are something that’s extremely hard for us to really predict. We are – first up, we are pleased with the billings performance this quarter. What I would say is I mean, we are optimistic as we go into Q4 about the pipeline that we have, but again as we have said before, you do get the situation where when you get near the end of the year depend upon the size of the deals, I mean, from time-to-time we run into situations where a customer may want to only pay one year in advance versus us having to give unusual discounting to get 3 years in advance. So, certainly, we are not going to incent the team to do anything unusual just to get a billing in, but I would just say that we are remaining focused and right now our big thing right now is delivering on the quarter as we get into Q4. So, really don’t want to comment too much in terms of what our expectation is for billings.

Jim Whitehurst

Karl, I mean, billings because we have various terms kind of can bounce around some. So, again that’s why we don’t provide any guidance. What I will say is the big market motion in our business is renewal and up-sell against our big customers. And so obviously last year and how we did last year is important in terms of that base. So, like for instance we talked about last Q3 we had $20 million worth of deals move out of Q3 into Q4. Well, guess what those are now permanently in Q4 and renewing in Q4 right. So, last year is an indicator of the business how that flows through the bookings is a little bit of a looser correlation, because it just depends a lot of billing terms.

Karl Keirstead

Okay, great. Thank you both.

Tom McCallum

Yes thanks, Karl. Operator next question please.

Operator

We will go next to Zane Chrane with Bernstein Research. Please go ahead.

Zane Chrane

Hi, thanks for getting me out. And the question for Jim, I was wondering what are the buying factors that you found are most important to customers in choosing a vendor for their containerized App Dev. Is it having Kubernetes as the orchestration system? Is it pricing? Just kind of what leads customers to adopting OpenShift versus Docker and some of the other container vendors out there? Thank you.

Jim Whitehurst

Well, we have had two main selling points. And I think it’s been a little bit split, one is Kubernetes. Right, without a doubt, people see Kubernetes as the kind of Linux equivalent and always kind of the winning open source technology and orchestrating containers. So, that’s obviously been helpful and is the second largest contributor to the Kubernetes project that’s positioned us well to be able to help drive roadmaps and confidently support our customers there. The other is just lifecycle in the operating system. I mean, I think a lot of people forget that we have only security vulnerabilities. The user space of the operating system is inside the container. People like to kind of abstract and say, oh, the container is the source code for the application, but it’s also all of the user space dependencies. Over, 90% of the security vulnerabilities that are patched in Linux happen in user space. Therefore, if you are going to deploy an application that you plan to run in a production context, you need to make sure you have a vendor who you feel confident can support and patch the operating system components that are inside the container. And so from virtually all of our big customers, they trust Red Hat to do what we have been doing it for a long time. And so that’s a big selling. In fact, we had one significant financial services institution that had gone down another path and their security group ultimately vetoed use of different container technology, because they said well, the operating system components in that, we don’t have a lifecycle or feel confident and support around that. And so they then came in and since have migrated to OpenShift. So, I think again our credibility in the operating system and containers are Linux as well as our credibility in Kubernetes combined or what’s kind of driven our momentum in OpenShift.

Zane Chrane

Thanks very much. Happy holidays guys.

Jim Whitehurst

Yes same to you.

Tom McCallum

Operator next question please.

Operator

We will go next to Walter Pritchard with Citi. Please go ahead.

Walter Pritchard

Hi, thanks. I am wondering Eric if you could talk about from a revenue perspective it seems like you are realizing more revenue in the quarter and showing stronger revenue results. I am wondering if that’s a result of more cloud flow-through it that’s a result of earlier linearity in the quarter in terms of signing contracts just relative to our modeling the last couple of quarters that’s what we have noted?

Eric Shander

Yes. So, Walter, it’s a couple of things. I mean, obviously as we have shown lot of strength in services each quarter, I mean, that’s a contributor we have and as we have been articulating externally that we have been doing a lot of focus around business linearity and we are in fact closing business earlier in the quarter. We have had more on-time renewals than ever which obviously that kind of translates to in-quarter revenue. So, we are seeing improved linearity and again as I mentioned last quarter this quarter as well as certainly Q4 being our biggest volume quarters are really going to test a lot of the management cadence and process improvements that we have made. So before we really kind of say that we are 100% confident that all of the linearity improvements that we have made will be sustainable. We have really got to get through Q4 and see how that shakes out, but we are very optimistic, we saw a nice linearity improvement this year over last year and like I said the services and certainly the CCSP program continues to grow and we’re pleased with the performance of that as well all of that really resulting in a lot more in quarter revenue.

Jim Whitehurst

Yes, Walter, we’ve said that the CCSP business is growing faster than in other part of our business and we disclose other parts of our business that you can see the growth rates pretty solid and that’s all immediately revenue recognition. So that specific component is driving revenue faster than billings, because it’s obviously building arrears.

Walter Pritchard

Great, thank you.

Tom McCallum

You’re welcome. Operator, next question please.

Operator

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

Gregg Moskowitz

Okay, thank you and happy holiday guys as well. Jim, OpenStack is going to meaningful contributor to large deal activity for Red Hat for quite some time and with telcos, obviously a big part of that, but how would you assess the likelihood of OpenStack to be more broadly adopted by enterprises?

JimWhitehurst

Yes, so we expected to be fairly widely adopted by enterprises in the long run, again it’s like any infrastructure technology it’s around and in fact we’ve been investing hard on the telcos side and we’ve talked a lot about our success is there, because it’s kind of the big while deals, but if we look even in Q3, 6 of the top 10 customers deals were non-telco we’re seeing you again solid verticals, we saw 16% of the deals were financial services we thought and services manufacturing median in the entertainment. So again it’s we’re starting to see real growth on the enterprise side and so when you start thinking about on premise you’re either kind of stuck in the old world expense world of VMware or you’re moving OpenStack if you want scale out infrastructure. So it’s doing well and I think we expect that to grow nicely over time. Also the synergy of OpenShift on OpenStack when people are going to deploying new infrastructure for OpenStack versus putting – sorry not for OpenShift rather than put it on an existing infrastructure, we’re seeing a lot of traction attach of OpenStack underneath OpenShift. So, we feel really, really good about our long-term versus these technologies again these are as you add servers retire of their servers it’s more gradual there in the growth that we see in enterprise than we do in telco where does the size of those deals can be enormous.

Gregg Moskowitz

Very helpful. Thank you.

Tom McCallum

Next question please operator.

Operator

We’ll go next to Adam Holt with MoffettNathanson. Please go ahead.

Adam Holt

Hi, guys. Thank you all. Happy holidays. I was hoping to go back to comment Jim that you made about middleware and OpenShift there’s debate in the market about whether OpenShift is good or bad to the JBoss business. We having a view that OpenShift could actually be a positive for JBoss and importance in JBoss business, but I wanted to A see if that’s actually what you’re seeing and B how you see that relationship unfolding over the next couple of years? Thanks.

JimWhitehurst

Yes, so first happy holidays Adam. Yes, look I say the I would say that OpenShift is good for virtually every product in middleware except EAP and EAP is we actually have some good traction there as well, but yes, there is some movement off of JEE as people look at containerize more kind of microservices-oriented architectures. We are seeing really good cross-sell, people have installed OpenShift over time, consume more and more of our middleware services and that becomes more pronounced as people use the stuff longer. So, I think it’s really good long-term for our middleware business. Even for OpenShift what we are seeing is you will get an enterprise who puts in OpenShift and now they are looking to figure out and save more money and they will look and say wow, I have a lot of WebLogic applications around let me get those moved over and obviously those are JEE and so those require EAP. So, I think it’s going to long-term be good for EAP as well, but it’s certainly immediately very good for the rest of the portfolio and we expect that to be true for the long run. Yes, you are exactly right in that as people build modern applications, it’s less likely to be JEE and so yes, one could argue with some net new workloads, it’s a replacement of one versus the other, but if you look at it on the whole, it’s good for the rest of the portfolio and it is driving more share shift from WebSphere and WebLogic to EAP.

Tom McCallum

Right. Next question please, operator?

Operator

Certainly. We will go next to Keith Weiss with Morgan Stanley. Please go ahead.

Keith Weiss

Excellent. Thank you guys for taking the question and very nice quarter. We talked a little bit about telcos and they continued to be a stronger contributor around OpenStack. To what extent is sort of the move towards NFV contributing today or to what extent is this still sort of off on the horizon, particularly when we see sort of the big pickup in large deals that you guys have been seeing?

JimWhitehurst

So, it’s yes and yes in the sense that it does help with large deal traction, I we said we have three of the big four U.S. telcos with 8-figure OpenStack commitments we have had a number of large commitments from the global telcos as well. Frankly that was not a factor in this quarter’s large deal traction just the way those have all seem to cluster around Q4. So, the large deal traction from this quarter wasn’t really driven by telcos trying to quickly look to make sure I didn’t miss any of the very large. There is one the really large deals with the telco, but the telco pipeline and just the way they have all followed they are all Q4 deals. So, the answer is yes, those deals are large assuming that we get what we think we can get as NFV rolls out 5G. We think those could be very, very large deals and a large standalone business on its own and certainly those are big deals, but over the last couple of quarters, the large deal traction is outside a telco.

Keith Weiss

Got it. And then any sense of how the federal business turned out for you guys in the most recent quarter?

JimWhitehurst

It’s very strong. Yes, obviously we had a couple deals last year in the federal space that moved from Q3 to Q4. So those are still in Q4. So given kind of we had strong growth year-over-year and again we still had a very strong quarter this quarter with those big deals in Q4.

Tom McCallum

Next question operator, please.

Operator

We will go next to John DiFucci with Jefferies. Please go ahead.

Howard Ma

Thanks. This is Howard Ma on for John DiFucci. Thanks for taking the questions. So, just a follow-up on the conversation about containers, so VMware and Pivotal recently announced and Google in fact, they announced Pivotal container service. So, we are just kind of curious what are some of the – what’s the value prop of Red Hat, OpenShift versus Pivotal and are you seeing Pivotal more – are they pushing their container service more and just generally what you are hearing in terms of changes on the competitive front? Thank you.

JimWhitehurst

Yes. So, first off, the good news about that is validate the Kubernetes technology, which puts more momentum behind Kubernetes, which is good for us as the largest commercial provider of Kubernetes. So, there is certainly a net positive there competing on a combination of Linux and Kubernetes, which is what a container platform is. We feel very confident kind of competing in that environment, I think we are competing very, very well. PKS, I am not even sure what flavor of Linux is underneath that, but certainly nothing that has the lifecycle and all the other components that RHEL has. And again as far as I know Pivotal is not a material contributor to Kubernetes and so putting together we are happy to compete on that. I think it does provide more interest around Kubernetes, it’s no longer this versus that, it’s Kubernetes and Linux. And again given our leadership position in both of those technologies we think that bodes well.

Tom McCallum

Great. Next question operator, please.

Operator

We will go next to Brian White with Drexel. Please go ahead.

Brian White

Jim, as we look forward here to calendar ‘18 I am wondering what you are most excited about for the New Year and how do you think the year will be different than calendar ‘17 because obviously this year was a phenomenal year for Red Hat, so hats off, but how are you thinking about next year?

JimWhitehurst

We have, but it’s obviously early on, this is a business that moves quickly. So we have several significant drivers of the business, obviously, they move to cloud has allowed RHEL growth to continue at a solid double-digit pace and I think as we look forward, again, not providing guidance at this point, but we see a solid pipeline and ability for RHEL to continue to grow that quickly. Our emerging products, so OpenShift, OpenStack and Ansible are all continuing to grow really, really quickly and as they get bigger certainly we haven’t done all the math as we get in the next year, but if we can maintain those kind of growth rates, it keeps our core growth rate accelerating we’re not guiding to that at this point, but any stretch but one of the things I think you’re seeing our overall growth rates is has accelerated this year because RHEL has stayed constant, our other product growth has stayed constant, because those have gotten bigger, obviously, the mix of the allows the faster growth rate. And so we’re not calling that yet, but right now, we had solid pipelines, lot of momentum, Ansible we haven’t talked a lot about on this call has just been extraordinary technology both in its own commercial traction as well as driving the other products. OpenShift does the same across the middleware portfolio, so we continue to be more bullish than I have ever been about our long-term prospects right now.

Brian White

Great.

Eric Shander

Yes. And Brian, I think the other thing we’d say as we talk to customers and we certainly customers are really putting their hybrid cloud strategies in play for next year and that’s something that plays right into the strategy of how we’ve aligned the products. So I think that’s one of things that gives us a lot of excitement about next year and it’s certainly years beyond, because some of these are going to be certainly multiyear transformations that our customers and industries are going through.

Brian White

Right. Okay, thank you.

Tom McCallum

Operator next question please.

Operator

Certainly. Our next question comes from Abhey Lamba with Mizuho Securities. Please go ahead.

Parthiv Varadarajan

Yes. Thanks. This is Parthiv on for Abhey. I will add my congrats for the quarter. I just wanted to clarify the source of the full year EPS upside. I think you called out $0.05 from a one-time gain. Is there anything else we should be thinking about any cost push-outs to fiscal ‘19 from the fourth quarter?

Eric Shander

No, no cost push-outs. I mean, we have a strategic investment, which is being dispositioned that’s contributing to $0.05, but there is no cost push-outs.

JimWhitehurst

Yes. We have time for one final question.

Operator

Certainly. Our final question comes from Jason Ader with William Blair. Please go ahead.

Jason Ader

Yes. Thank you. Eric, I had one for you just on the operating margin outlook. We had a nice expansion this year. How are you thinking about fiscal ‘19 at this point?

EricShander

Yes. So I was actually surprised Jason that it took this long for somebody to ask the question. So here is what I can tell you is yes we are thinking about the margin for next year. What I will tell you I mean certainly our primary focus is on executing and delivering on Q4 as the priorities certainly how we do in Q4 sets us up for next year. So what we will be doing next quarter as we have traditionally is we provide our guidance for FY ‘19. So at this point, I’d say it’s a little bit premature we are working through some different scenarios of what the various margins may look like based on revenue growth et cetera. But rest assures that as we get into Q4 we’ll provide the FY ‘19 guidance and certainly from a margin standpoint that will be including there, but that at this point our primary focus is on delivering Q4 and then based on how we do there we’ll certainly guide appropriately as we get into FY ‘19.

Jason Ader

I think that’s...

JimWhitehurst

Go ahead, Jason.

Jason Ader

But that’s why nobody asked the question, because you didn’t answer it.

Jim Whitehurst

Well, no Jason, I just want to say thank you to everybody for the support this year, happy holidays and we look forward to speaking to you in the next year. Happy holidays, everyone.

Eric Shander

Happy holidays. Thanks.

Operator

Thank you. This does conclude today’s conference. We appreciate your participation. You may disconnect at anytime and have a great day.