Apptio (APTI) CEO Sunny Gupta on Q3 2018 Results - Earnings Call Transcript

About: Apptio (APTI)
by: SA Transcripts

Apptio (NASDAQ:APTI) Q3 2018 Earnings Conference Call October 29, 2018 5:00 PM ET


Drew Laxton - SVP of Finance & IR

Sunny Gupta - CEO & President

Kurt Shintaffer - CFO


Brad Sills - Bank of America Merrill Lynch

John DiFucci - Jefferies

Brian Schwartz - Oppenheimer

Mark Murphy - JPMorgan

Ross MacMillan - RBC Capital Markets

Mohit Gogia - Barclays

Mike Casado - KeyBank Capital Market


Good day, ladies and gentlemen, and welcome to the Q3 2018 Apptio Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's conference is being recorded.

I'd now like to turn the call over to Drew Laxton, Director of Investor Relations. Sir, you may begin.

Drew Laxton

Thank you. Good afternoon, everyone, and welcome to Apptio's third quarter 2018 earnings call. Joining me on the call today are Sunny Gupta, our CEO; and Kurt Shintaffer, our CFO.

Our press release was issued after close of market and is posted on our corporate website where the call is being simultaneously webcast. The webcast replay of this call will be available under the Investor Relations link of our website at

We will make forward-looking statements during this conference call such as those using the words will, believe, expect, anticipate and similar phrases to convey the information is not historical fact. These statements include our future expectations regarding our financial results and guidance, applications, customer demand, operations, our acquisitions of Digital Fuel and FittedCloud and the potential benefits of such acquisitions and other matters. These statements are subject to risks and uncertainties and assumptions. Please refer to the press release and the risk factors and the documents filed with the Securities and Exchange Commission, including our most recent periodic filing for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements.

During the call today, we will review our third quarter 2018 financial results and discuss our guidance for Q4 and full year 2018. All financial figures we discuss are non-GAAP, except for revenues and balance sheet data. These non-GAAP financial measures, which we believe are useful in measuring Apptio's performance and liquidity, should be considered in addition to, not as a substitute for, or in isolation from GAAP results.

Our non-GAAP measures, except for free cash flow, exclude the effects of stock-based compensation expense, acquisition-related expenses and amortization of acquisition-related intangible assets. We define free cash flow as cash used in operating activities, less purchases of property and equipment. To see the reconciliation between the historical non-GAAP and GAAP results, please refer to our earnings press releases, which are posted on the Investor Relations page of our website.

With that, I'll hand it over to Sunny.

Sunny Gupta

Thanks Drew, and welcome, everyone. I am happy to report strong results for the third quarter, highlighted by 26% year-over-year revenue growth and $4 million of non-GAAP operating income.

We had a solid contribution from a strategic segment, continued strength in our up-sell sales motion, progress addressing global 10,000 customers and our public sector business. I'm also excited about our recent acquisition of FittedCloud, which I will expand on more today.

The move of enterprises towards digital, powered by the adoption of cloud and agile development models is serving as a catalyst for companies of all sizes to adopt Apptio TBM applications. Apptio remains in the unique position to help customers manage hybrid workloads. IT is an extremely complex function in the enterprise and the business of technology cannot be managed on spreadsheets.

I'll discuss four areas in detail today, an update on our strategic segment, up-sell motion, down market expansion strategy and continued innovation and helping IT leaders understand and optimize their cloud spend.

First, I wanted to start by saying we were pleased with the contribution from our strategic segment this quarter. As a reminder, these are customers with over $20 billion in revenue. One of our largest transactions in the segment for the quarter was with a Fortune 5 customer who had an existing relationship with Digital Fuel via a smart employment.

This existing Digital Fuel relationship enabled an easier sales process for our Apptio solutions. The customer who is in the midst of transforming into a digital business, leveraging a hybrid IT model purchased a full cost transparency suite alone with benchmarking and infrastructure insights.

It is important to remember that the strategic segment continues to represent a Greenfield opportunity with over 80% of worldwide logos still available. In addition, there is tremendous potential in the up-sell opportunities within our existing strategic customer base.

This is a segment that we know well as the large complex IT budgets are typically not well-managed on existing ERP and custom business intelligence solutions.

As we think about our overall strategy, we're excited by the ability to up-sell our current customer base of both our land packages and digital fuel customers. For example, two of the original IT Financial Management Foundation or ITFMF, have now nearly doubled their initial ACV due to our up-sell motion.

These customers deployed rapidly and moved forward on the Apptio roadmap towards the purchase of additional modules. There is still additional work to be done, but we are pleased with the pipeline of up-sell business building on these land products.

Another example of our up-sell success from this quarter was a large consumer products company that initially purchased ITFMF in May of this year. We laid out a full Apptio TBM roadmap, but were intentional in solving especially pain point budgeting and forecasting.

We were able to have data flowing within a week on the product by integrating with their corporate planning system and the customer was able to see the value in short order. Because of the quick time to value, the customer secured the budget for purchases of cost transparency, benchmarking and vendor insights.

The corporate CIO has been centralizing portions of the IT budget from the divisional CIOs to gain more scale efficiencies. Cost transparency will provide the divisional CIOs insights into the IT spend savings achieved by the centralization strategy.

The best news of all is that there remains additional product up-sell opportunities with the company. This is good data point in the benefit of quick early wins providing higher customer lifetime value.

We have also had great success with ITFMF starting the initial conversation and leading to a larger sale. This quarter we closed a transaction with a healthcare provider from the upper part of the -- our enterprise segment. We initially pitched ITFMF and the conversation quickly turned to a broader initiative to provide IT cost show back resulting in the sale of a suite of Apptio applications that included cost transparency.

The Digital Fuel business continues to outperform our initial expectations. This quarter, we had an up-sell if IT planning to an existing Digital Fuel customer. As we have stated previously, we felt IT planning was a national up-sell into the Digital Fuel base.

The customer was contemplating building their own solution using a combination of spreadsheets and ERP tools that rapidly saw the value in our IT planning application and the accuracy provided over a homegrown solution. We like what we see -- have seen so far from Digital Fuel and believe that it's considerable opportunity for us going forward.

As we continue to invest in the business to move further down market, let me update you on our current progress. While cost transparency remains our leading application for new logos, ITFMF has become our second leading application and now cloud cost management is showing early signs of success as a standalone initial product.

The success we've seen with smaller land packages has given us continued confidence in our ability to move down market. We currently have several dozen customers that fall below our previously stated target market threshold of $30 million of IT spend.

These customers largely come to us via inbound interest of previous relationships. However, we're adding resources to capture what we are calling the midmarket customer segment. We recently hired a leader for the segment along with a small team of inside sales reps.

Currently they are only selling the ITFMF and cloud cost management packages as the quick time to value for these products has the best midmarket segment fit. We are in the early stages of capturing the mid market and we will update you on the progress in future periods.

As we have spoken about before, the transition to public cloud is a tailwind to our business. According to IDC, cloud spend will reach as much as $554 billion by the year 2021. Apptio is well-positioned to help companies understand their cloud spend and incorporate their hybrid and on-premise infrastructure.

Earlier this month, we announced the acquisition of FittedCloud, a machine-learning public cloud optimization company to accelerate our efforts to optimize cloud spend and resources. Building upon Apptio's cloud cost management offering, we plan to broaden our existing public cloud analytics with deep insights into cloud utilization, rightsizing and spending recommendations.

While financially immaterial, FittedCloud provides us with a natural expansion from a historical cloud cost analytics. The existing customers have found significant savings by rightsizing their cloud spend utilizing the FittedCloud application.

Optimizing and costing are tightly linked in the public cloud space due to the ability to size cloud instances in real time. The optimization and anomaly detection capabilities of FittedCloud will satisfy a common customer request and make our product offerings more broadly appealing.

I am truly excited about FittedCloud's machine learning capability, which we viewed as a key differentiator of the product. These predictive models will allow customers to better provision and optimize their future public cloud spending, allowing for better business outcomes. This product will give us a true try and buy offering, that we believe will help accelerate a down market momentum.

Our CCM module and FittedCloud's capabilities will be packaged as a bundled offering to our customers and can also be up-sold to our existing cost transparency install base.

Before I close, I wanted to make sure you are aware of the DBM conference in Las Vegas next week. We're most excited about the new product announcements we will make. We expect over 1500 technology and finance leaders to join us to share their experience of the DBM and Apptio and discuss the value they’ve derived. The conference will featured some incredible speakers, such as Senior Executives from State Farm, Cisco, NASDAQ, Unilever and Cooper. We will also be holding our Annual Analyst and Investor Meeting on November 7 and believe that some of you will join us.

In summary, I'm pleased with our performance in the third quarter of 2018. We continue to show solid revenue growth as we further expanded our non-GAAP operating income. We continue to have strong belief in our land and expand sales model. We improved our cloud capabilities and met customer demands with the acquisition of FittedCloud.

Moreover, the growth of cloud spending, the complexity of hybrid IT and the shift towards digital and agile, are all serving as market tailwinds for Apptio and I'm excited about the value we can add in these areas. Lastly, our position in the marketplace remained strong.

With that, I'll turn things over to Curt to give you more color on our Q3 financial results and guidance.

Kurt Shintaffer

Thanks Sunny. I'll start by commenting on the Q3 results and then talk about guidance for Q4 in 2018. As Sunny mentioned, we're pleased with the performance of the business in Q3 and continue to take a balanced approach to growth and profitability.

We had solid subscription revenue growth and expanded our non-GAAP operating income. Q3 subscription revenue grew to $49.6 million up by 26% on a year-over-year basis. This topline growth was the result of solid new customer acquisition and net retention, resulting in a trailing 12-month net retention rate of approximately 102%.

Professional Services' revenue grew by 27% on a year-over-year basis to $9.6 million due to strong performance in our core business as well as the Digital Fuel contribution. In total, Q3 revenue increased 26% on a year-over-year basis to $59.2 million.

It is worth noting that subscription billings grew 20% in Q3 and would have been higher if normalized for some delayed billings. As Apptio continues to broaden its customer base, we've seen and expect to continue to see changing billing terms that may impact our quarterly billings, but not necessarily our bookings.

For the remainder of my commentary, unless otherwise noted, I'll discuss non-GAAP results. Our non-GAAP measures except free cash flow, exclude the effects of stock-based compensation expense, acquisition-related expenses and amortization of acquisition-related intangible assets.

In Q3 2018, Apptio's total gross margin was 72%, an increase from last year due to a higher subscription revenue mix and an increase in subscription gross margins, which reached 84% as we realized efficiencies in our hosting operations and customer success organization.

Moving down the P&L, we continue to show increased operating leverage. Q3 2018 R&D expense was 18% of revenue, lower than last year even with increased investments in product innovation. Sales and marketing expense was 37% of revenue, down from 40% last year as we efficiently scaled that part of the business. G&A expense was 10% of revenue as compared to 13% a year ago.

In Q3 2018, we generated $4.3 million of positive operating income, a margin of 7% as compared to an operating margin of 1% in Q3 of last year. Net income per share was $0.05 in the third quarter of 2018 as compared to net income per share of $0.01 in the third quarter of 2017.

It is worth me taking a moment to speak about our expansion of non-GAAP operating income during 2018. We're very pleased with the leverage we've been able to show year-to-date while still growing the topline over 20%.

Previously, we stated that we expected to gain leverage in sales and marketing expense to improve the bottom line in 2018. While we executed on that strategy, you will notice that we've also shown some leverage in our R&D function. These gains were largely a result of differing US-based R&D hiring in anticipation of opening a development center in India, which will have the first hires in the fourth quarter.

Accordingly, you will see some additional R&D spend return in the coming quarters and we do not anticipate expanding our operating income at the same pace in Q4 in 2019.

Turning to cash flows, our Q3 2018 free cash flow was negative $1.1 million as compared to a positive $8.6 million in Q3 2017. Our year-to-date free cash flow was $5.6 million as compared to $8.1 million through September 2017. While we are slightly behind last year, we remain committed to growing free cash flow in 2018. Finally, we ended Q3 2018 with $258 million in cash and investments.

Moving on to guidance, I'd like to update you regarding our outlook for the fourth quarter and full year of 2018. For Q4, we expect total revenue of $61 million to $62 million. Also, as you think about the comparable quarter in 2017, please remember that we had approximately $500,000 in one-time subscription revenue last year and we do not anticipate any nonrecurring items like that this year. We expect to generate Q4 non-GAAP operating income of approximately $1 million.

Based on our Q3 outperformance and Q4 guidance, we are raising our 2018 full-year guidance to total revenue of $233.3 million to $234.3 million. We expect approximately $7.4 million of non-GAAP operating income for the year.

We also wanted to address one accounting change that will happen beginning in the fourth quarter. Historically, we recognize that direct expenses related to the TBM conference in our sales and marketing expense line while the revenue is recognized in our professional services revenue line, resulting in a gross margin increase in the fourth quarter of each year.

Beginning in this fourth quarter, the direct expenses related to the TBM conference will be recognized as professional services cost of goods sold. We expect this to have an approximately $2 million negative impact on services' gross margins in the fourth quarter and a corresponding positive impact on sales and marketing expense. This is strictly an accounting change and does not reflect any change in our overall business.

To conclude, we're pleased with our topline growth, our expanding operating income and how the FittedCloud acquisition will further strengthen our public cloud and hybrid offerings.

And with that, let me turn it back over to the operator for questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Brad Sills of Bank of America, Merrill Lynch. Your line is now open.

Brad Sills

Oh great. Thanks guys for taking my question. Just wanted to ask about Digital Fuel. It sounds like you saw a real nice conversion deal there to the suite. Could you remind us where you are there within that installed base that you've already converted? How much of that is left and where do you see the opportunity for more deals like that?

Sunny Gupta

Yeah hi Brad. This is Sunny. I'll take that. So generally I would say, really pleased with the progress in Digital Fuel that it's certainly doing better than our expectations as we exit the third quarter. Our initial focus on Digital Fuel was to getting to really know these customers and retain the revenue and I think we've done a nice job of about and the good signs for us are we're starting to see us few up-sell now coming into that install base and the primary up-sells are coming through IT planning, also cloud and hybrid offerings are up-sell into that installed base.

It's a handful of customers and then in terms of the conversion, we only have -- we've reported on single conversion and that's very early. So frankly, as I look at the Digital Fuel business in '19 and beyond, it remains a great growth driver for us to drive up-sells, but also conversions over time and frankly there is a pretty decent size disparity between our price point and the Digital Fuel ASP price point. So we feel good about that business as we exit Q3.

Brad Sills

Great. Thanks Sunny. And then one more if I may please just on the move down market into that next segment below the enterprise. Just curious what's the go-to-market focus there? I think you're going to hire some resources there. If you could just elaborate a little bit on your plans to build out that sales organization. Where do you see the near-term opportunity?

Sunny Gupta

Yeah no happy to and we'll talk a little bit more about at our Analyst Day as well, but look, I think what we started to see Brad was quite a handful of dozen plus customers who were organically seeking us out from that segment and buying our smaller land offerings like IT Financial Management and so forth.

So we decided to become more purposeful and so we've hired like an integrated leader right who can help us across our sales, marketing and go-to-market functions and we've started building inside sales force. So this is going to be primarily a insight sales rep driven function.

We just started incubating this in Q3. So it's very early days, but the early signs have been quite positive as we see good momentum building from a pipeline perspective. We call this segment the mid market and there are tons of companies in the space but we've been pretty thoughtful and just not grow that sales headcount too drastically but get enough four to five inside sales reps by the end of the year and then use that to learn and reps are only going to be selling IT Financial Management and the cloud offerings only.

So those are the two land places and over time we'll have an opportunity to expand on top of them. So I'm kind of really excited by what that can mean for us.

Brad Sills

Great. Thanks Sunny.

Sunny Gupta



And our next question comes from the line of John DiFucci of Jefferies. Your line is now open.

John DiFucci

Thank you. My first question for Kurt. Kurt you mentioned something about delayed billings and billings were up 20%, was a nice number, but it sounds like bookings were greater than that. I guess can you just give us some examples of what you're talking about? Are customers asking for less than annual duration and as far as the term in the contracts or at least the billings term?

And then if you could, like what would the ACV bookings growth be if you were to adjust for these factors?

Kurt Shintaffer

John, happy to take that. So what are we describing in the prepared remarks was just as we think about how we try to bring customers on to the Apptio platform is with as little friction as possible. So from time-to-time customers for whatever their own internal reasons are, they will look for some delayed payment terms.

So maybe quarterly, maybe some torts or the split payment where it's not all upfront and we'll take that because we always rather maximize ATV then a specific in-quarter billings and as we think that will further be a bigger part of our business as we go down market and look for billing flexibility as another way to lower the barrier to be an Apptio customers.

And so that's the business dynamic and this is something that every quarter there are small ins and outs. This quarter it was more to the -- it impacted our billings to the negative side, but we were not calling out a specific number because we just think it's really part of the way the business run and consistently we will see swings in 2% to 4% on any given quarter.

If it's much more than that, we'll call it out really specifically like we have with the deal from Q2 that didn't have a $4.5 million billing that it did in the previous year. So we're sort of looking for a threshold to be what's normal run rate business and what's bigger than that and this was fixed into that run rate style business that we have.

Sunny Gupta

John, I'll just add on to what Kurt said, so generally think about it 2% to 4%. The other thing I wanted to kind of add is the bookings is an internal measure, which we don't discuss, but we are not really seeing you asked another part of the question, we are not really seeing any dynamics and the changing of the contract terms at all. So this is strictly just a billings in terms of kind of when they collect the cash. But the rest of the part remains same.

Now as we continue to go down market just like what other companies like Concur and Stuff Saw [ph], we anticipate that those customers may require different billing terms. So this continue changing as we continue building out the company.

John DiFucci

Great. And if I could just so I'm clear on this, the 2% to 4% that's the threshold right. So you kind of see that all the time and if it's I think you said much more than that, that's when you'll sort of call it out. Is that correct and you called it out this quarter.

Sunny Gupta

Well yes. So a little bit different than that. So the 2% to 4% is something that will just happen over time and we might give you some signals like we have, but we'll quantify it in a real -- in a way that allows you to actually normalize in any given quarter if it's much bigger than that threshold.

John DiFucci

Okay. And you're not quantifying into this quarter. So it's not much bigger than that?

Sunny Gupta

That's right.

John DiFucci

Okay. Got it Okay thanks. I guess Kurt, I was going to say could you because Sunny got the first two, and it's on cash flow and cash flow actually declined -- total cash flow declined, is there a huge swing in accounts receivable, of year-over-year of about $12 million to the negative side for this quarter.

And receivables tend to go down, but not like that, but they did. I guess can you tell me sort of -- can you give us any more color around what's happening there and why and should we expect cash for the benefit next quarter because it had such negative -- your collect those receivables next quarter?

Kurt Shintaffer

Yes, so a couple things going on. One does relate to the billings -- the billings anomaly that where we didn't have a corresponding $4.5 million billings in Q2 of this year. So it creates essentially a $4.5 million tough comp in 2018 versus 2017, but also you pointed to the build-up in AR, that's really just a timing thing.

We have virtually no bad debt. We saw a large stable customers and so that will come in and so yeah we'll see a benefit from that build up in AR over time and that's why we still feel good about our full-year free cash flow, the performance we expect from a full-year basis.

John DiFucci

Great. Okay. Great. Thanks a lot guys.


Our next question comes from the line of Brian Schwartz of Oppenheimer. Your line is now open.

Brian Schwartz

Great hi. Thanks for taking my question. Building upon John's question here, maybe you guys can go a little more deeper just then kind of what's going on in the business that we can fix. So when I look at annual revenue guidance, you raised that more than the beat in the quarter. So that's making us all think that the billings number is not necessary telling us what's going on here with the bookings.

So can you maybe talk about how you're tracking on the new business side of things here today and maybe in Q3 specifically versus the plan, thanks?

Sunny Gupta

Yeah so hey Brian, this is Sunny. I'll start and maybe Kurt can add on. So look I think generally we really feel good about how we exited Q3. We feel good about the Q3 billings and obviously even the 20% doesn’t reflect the delayed billings, which kind of Kurt spoke to.

So I won't go too deep into that, but look as we think about the new business coming out of Q3, I would say we had a solid quarter across driven by strategic segment. We had continued traction into the Global 10000 style customers.

We continue to drive IT Financial Management. The Digital Fuel business did well and also the federal business we continue to make steady progress in terms of both new logos and up-sells. So generally when you look at those dimensions, they were all good.

Now remember Q4 is a very large quarter for Apptio and a big part of our business gets done and we are still early into the quarter. So we do feel good about sort of the guidance, which we provided to you for Q4 and the full-year.

Brian Schwartz

Thank you. And then Sunny one follow-up question that I had just was on the federal government opportunity. Can you comment at all at what you're saying in terms of really just the pipeline momentum with they had or maybe any comments on what you're seeing in terms of pilots or the RFP inquiries so far, thanks.

Sunny Gupta

So basically we had a good quarter in Federal in Q3 driven by new logos and up-sells. I think I mentioned this maybe at the last earnings call. We're seeing smaller star deals even though as you all may remember, we had a pretty large deal in Q2, but generally we are seeing more of a land and expand motion.

We have now a couple of dozen agencies who are on Apptio. We have FedRAMP certified, also the TBM mandate from the White House is definitely helping us. Odd efforts are very much oriented around converting the mandate to and automation. So somebody buyer is going to appeal from a start-up perspective.

The pipeline looks really solid as we exit Q3 on the federal government. One of the things we are learning in the public sector space is that the role of working with partners is really, really important and strategic because those people tend to be -- there are lot of different ways for the public sector agencies to procure. So that part is going well.

It's fair to say the flood gates haven't opened up yet, but we just remain pretty bullish on the public sector opportunity and we just think it's going to be a -- continues to be a great growth driver for our business.

Brian Schwartz

Thank you.


Our next question comes from the line of Mark Murphy of JPMorgan. Your line is now open.

Mark Murphy

Yes. Thank you, Sunny, just related to some of the generations that we have seen the stock market, I was definitely curious to get your read on preliminarily when you look at 2019 on how you think CIOs are going to be setting their IT budgets and whether -- I am asking because you have the depth and the breadth of relationships on the TBM Council and elsewhere.

Do you have a sense that they are going to be budgeting a little more cautiously, just given some of the late cycle kinds of concerns that we have seen in the equity market or do you have more of a sense it will be another robust year.

Sunny Gupta

Hey Mark, just talking to a lot of IT leaders continuously and kind of just following some of the spending trends, look, we have not seen any I would say any shift yet given that it's our TBM Council next week. We got 1500 plus people looking forward to engaging with many CIOs on this topic, but we haven't really seen anything change from that perspective.

The second thing I wanted to say is certainly when it comes to Apptio, look we were founded in late 2007, amongst one of the worst economic downturns. Our product market fit was achieved during that time and so we are pretty trusted and tried because fundamentally we help customers optimize their technology spending and in tough times that helps them even more.

So we've currently gone through that cycle. I think from an Apptio perspective, I would say certainly we have lot more customers now. So there are opportunities to expand and then also as you know we continue to balance both the growth and profitability vectors, but strategically we have not seen any indications of any shift yet from our customers at least.

Mark Murphy

Okay. And then as a follow-up Kurt, I guess was there any kind of headwind on subscription revenue? In Q3 sequentially it grew a little less than I think it ordinarily would through the years. I am just wondering was there an FX headwind there or some kind of a timing effect?

Kurt Shintaffer

Yes, so there is a small FX headwind, but it wasn't a big mover. I think if you're thinking about Q2 to Q3 sequential growth, we talked about in Q2 there was about $1 million of one-time non-recurring items that ran through our subscription line. So that certainly created the sequential optic that it's likely what you're seeing there.

Mark Murphy

Okay. Got it. Thank you. Appreciate it.


And our next question comes from the line of Ross MacMillan of RBC Capital Markets. Your line is now open.

Ross MacMillan

Thanks so much. Actually just wanted to clarify something Kurt. You had made a statement earlier I think in the prepared remarks about your subscription billings is growing 20% and would have been higher X the items that John DiFucci asked you about, but I'm not getting to 20%. I am coming to a little bit less than that and so I don't know whether this is the forum to clarify that, but just wanted to make sure that, that 20% wasn't inclusive of those things that would have driven it higher because I was coming a little bit lower than that on subscription billings.

Kurt Shintaffer

Yes, great question Ross and I think it's a good forum for this. So when we filed the Q later this week and you get the benefit of seeing changes in deferred subscription revenues, this is separate from the changes in deferred services revenue, you'll see that our services' deferred revenue decreased by about $1 million.

So this quarter, if you take the total billings less services revenue, to try to approximate subscription billings, it doesn't quite work out when you have the full benefit of what we have, you can calculate it on a nose at 20%.

So that 20% is in before what you could theoretically put add on to that for some of the delayed subscription billings.

Ross MacMillan

Okay. That's helpful. And then maybe just two follow-ups I think both for you Kurt, just on Pro Services last couple of years, I think sequentially it's been up almost 30% into Q4. What your expectation for that and then I know you aren't talking about '19, but obviously where consensus numbers are. I love your preliminary views on kind where consensus estimates are for next year thanks?

Kurt Shintaffer

Yes, so starting with the services, so sequential quarter going into Q4 from Q3, I think our growth I'd expect to be a little bit lower this year than years past. We had such a strong Q3 services revenue, both the core Apptio services as well as Digital Fuel. So that exceeded our expectations.

As we look forward to 2019, we're happy with how we're positioned right now but as we've acknowledged before, Q4 is a really big quarter for us in both the new business entering the your perspective and there's some execution ahead of us.

So we think now is not the time to change your thinking on 2019 because of that work that we have to do to really set ourselves up for the numbers that we want to be able to deliver.

Ross MacMillan

Understood. Thank you.


And our next question comes from the line of Raimo Lenschow of Barclays. Your line is now open.

Mohit Gogia

Thanks guys. This is Mohit Gogia on for Raimo. Thanks for taking my question. I guess question maybe this for Kurt is so you guys bring toward the up-sell opportunity within the customer base and also gave out a net potential number of 1% or 2%.

So I am just wondering is, so that seems to be outperforming for at least a couple of quarters based on what like a midterm expectations you're having sort of communicating to us. I am just wondering, has your view changed as to where that number can trend based on sort of like we go to market motion that you have the new sort of like land and expand products that you have.

So just wondering as to if your view of that net prevention rate and the up-sell opportunity has changed based on the outperformance of absolute portals? Thank you.

Kurt Shintaffer

So I'll take that. So I think what's happening is we're proving what this land and expand opportunity can do for us perhaps a little bit ahead of expectations. So we've always known that we have an opportunity to have significantly higher net retention than we've historically shown as we really get a broader customer base with lots of expand opportunity.

And so we're sitting here 102%, which is a little bit ahead of our expectations and frankly a little bit higher than how we've modeled the business and it's largely through that strength in up-sells.

Sunny Gupta

Yeah and what I am excited by is also that as we start to get new install base, customers going on the new land motions of IT Financial Management cloud offerings, these are just, these products just drastically deploy faster and even though we are three to four quarters coming into that, we are starting to see some up-sells come out of that even before the fourth renewal is coming up.

So that just gives us confidence medium to long term, but the reality is they are very early days. So we got to really just prove it out right and just continue proving it out but that part of the business is trending nicely.

Mohit Gogia

Understood. And I guess just a follow-up question. I know we have discussed this quite a few times, but the subscription billings of 20% this quarter, so it seems like there were some delayed cash collections, which basically impacted that growth number, but if you look and agree that you guys don't really guide on Q4 deferred but does that means we should be aware of some sort of like a better than expected quarter on quarter trend in deferred for 4Q given that this quarter we saw some negative impact? Thanks guys.

Kurt Shintaffer

Sure. So it wouldn’t be material. So most of the deferrals, the billing deferrals reach out into 2019. They do not differ just one quarter into Q4 2018.

Mohit Gogia

Thanks guys. Those are all my questions.

Kurt Shintaffer

Great. Thank you.


[Operator Instructions] Our next question comes from the line of Mike Casado of KeyBank Capital Markets. Your line is now open.

Mike Casado

Hey guys. Thanks for taking the question. Sunny understanding that the FittedCloud acquisition really centers on analytics of public cloud usage. I am curious to what extent you see this acquired machine learning technology impacting the broader portfolio, from a technical perspective.

And I guess specifically what I'm wondering is if the acquisition accelerate the machine-learning investment underlying that early adopter program for federal and ultimately if I could accelerate its broader rollout?

Sunny Gupta

Yeah, happy to take that. Yeah so first of all maybe to start off on FittedCloud since we haven't talked too much on that, I would say this was less than $0.5 million upfront acquisition for us. So pretty small acquisition, but very disruptive technology. So kudos to our team for being able to kind of source and find this unique asset and going to keep that in some of the smartest engineers we've met and very machine learning driven anomaly detection and frankly perfect marriage to our cloud cost management and hybrid offerings.

And one of the things I was excited by from, it was a very young technology, but they had some validated customers that we can extend the machine learning algorithms to a lot of the hybrid infrastructure environments that could be the VMware stack or the Microsoft stack or for that matter the Red Hat stack.

So I think there are a lot of opportunities for us to extend the same algorithms because they do a nice job on the Amazon. So first we are taking it to multi-cloud and then extending it to hybrid and that was one of the things we see, but even on the public cloud machine learning alone, like we just found that nobody else has anything including to what these guys have. So it's a real asset and try and buy. So customers can experience the product come pretty quickly and fit in pretty nicely to our portfolio.

Mike Casado

That makes sense. And then Sunny or Kurt, relative to the first question regarding plans to invest in the approach down market, I believe Kurt you had sounded like a shift in down market customers that were reaching organically. Would that be a fair read on those comments and if so, where are you seeing the incremental demand for ITFMF?

Kurt Shintaffer

Yeah. So let me take that. So I would say yes, as we started selling to the smaller customers, certainly the line we've drawn historically has been $1 billion in revenue and we've shipped plus or minus equates to $30 million in IT spend. It's not a complete exact science, but that's kind of how it equates.

So we started to see customers and lower threshold barriers coming to Apptio even though we were not messily generating demand and there are as you would have imagined, there are tens of thousands of companies below that band.

So we started to think about that hey, we have a really good product market fit. We have a financial management offering because they're planning for every IP shop large or small needs to be done in a services contract and the corporate planning tools are just not adequate right to do the granular and the services-driven planning for IT.

So we thought that hey we have a perfect product that deploys really fast. This is what the customers are resonating with and so is the cloud cost management value proposition. So we decided to be more purposeful and concrete and new go-to-market approach serving those customers with some of the existing products we have and existing packaging and pricing.

Mike Casado

That makes sense. And last one for me, Sunny you framed the server opportunity as really requiring a multi-your build. Just now that we've lapped the federal yearend with FedRAMP in hand for you guys, have your expectations changed relative to the ramp-up of that broader opportunity?

Sunny Gupta

I would say look we are in the three quarters of execution into the public sector space in 2018. We are feeling really good, relative to where we started to three quarters where we ramped and so that's much better than what we expected but the floodgates haven't opened up.

So the timing is what we always think about in context of the public sector opportunities. When is the timing when these floodgates open up, but certainly we continue to think as a key growth driver and a key contributor to our new ACV gold as well as retention as we go into next year.

Mike Casado

Great. Thanks guys.


I am showing no further questions in the queue. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.