Red Hat Inc RHT
Q4 2013 Earnings Call Transcript
Transcript Call Date 03/27/2013

Operator: Good afternoon. My name is Ginger, and I will be your conference operator today. At this time, I would like to welcome everyone to the Red Hat Q4 2013 Earnings Conference Call. All lines have been placed on mute to prevent any background noise.

Thank you. Mr. Tom McCallum, Vice President of Investor Relations, you may begin the conference.

Tom McCallum - VP, IR: Thank you, Ginger. Hello everyone, and welcome to Red Hat's earnings call for the fourth quarter and the fiscal year 2013. Speakers for today's call will be Jim Whitehurst, President and CEO; and Charlie Peters, Executive Vice President and CFO.

Our earnings press release was issued after the market closed today, and may be downloaded from redhat.com on the Investor Relations page. Also, on this page, you'll be able to find a historic reconciliation schedule of GAAP to non-GAAP financial metrics, as well as a schedule of currency rates.

Various remarks we may make about the Company's future expectations, plans and prospects including the statements containing the words believe, anticipate, plan, project, estimate, expect, intend, or will constitute forward-looking statements for the purposes of the safe harbor's provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated in these forward-looking statements as a result of various important factors, including those disclosed in the Company's most recent quarterly report on Form 10-Q filed with the SEC, as well as the safe harbor statement in today's press release.

In addition, any forward-looking statement represents our estimates or views only as of today, March 27, 2013 and these estimates or views may change. While the Company may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or views do change, and therefore, you should not rely on these forward-looking statements as representing our estimates or views as of any date subsequent to today.

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

Jim Whitehurst - President and CEO: Thank you, Tom. Let me add my welcome to all of you joining us on today's call. We capped a successful year for Red Hat with strong sales performance in the fourth quarter. For FY '13 we drove record annual revenue up 17% year-over-year. Record billings proxy up 14% year-over-year and record total backlog, which was up more than 19% year-over-year.

Within that total backlog, the unbilled backlog that is the value of customer contracts to be billed in the future and not reflected in our financial statements increased significantly. The unbilled backlog grew from – to over $280 million, or up 40% as customers increased their commitments to Red Hat technologies in the data center.

The drivers of our growth include large deal traction and vertical expansion, UNIX to Linux migrations. Linux growing faster than Windows, free-to-pay conversions, strong renewals and cross-selling in our top accounts, growth of our middleware solutions, which continue to grow at a faster pace in our core, expansion of our total addressable market, expansion of our wallet share and existing customers and continued addition of new customers, and leadership as a strategic vendor in the re-architecture of the data center for the cloud.

These results were achieved despite a mixed global macroeconomic environment. We now drive 40% of our revenues from outside of the United States and we are continuing to expand our global footprint. I'm pleased to report that all of our major geographic regions delivered double-digit annual billings growth despite some challenging local economies and currency weakness against the dollar.

As we closed out fiscal 2013 and set our sights on fiscal 2014, we're optimistic about Red Hat's future. Demand for our solutions remained strong. Our competitive position remains enviable, our technology roadmap is clear and we're in the early stages of multiple opportunities and substantial adjacent markets.

As Charlie will detail later, we expect Red Hat to again deliver in FY 2014 solid top line growth and continued strong cash flow generation along with focused investments in future growth technologies.

With that overview, let's discuss some of the key customer metrics for the fourth quarter. Our record fourth quarter for both bookings and billings was driven in part by our land and expand strategy. We focused our sales teams on both landing new customers and driving increased wallet share through upselling. Our sales team and channel partners were also focused on ensuring that we have strong renewals with our customer base, in part because renewal time is often a great time to expand the scope of our relationships.

This strategy has worked well and could be seen in the statistics from our top 30 deals this quarter. All of the top 30 deals were greater than $1 million for the second quarter in a row. In fact, many deals below our top 30 exceeded $1 million. Six deals were over $5 million and three were over $10 million, both new records. 50% of the top 30 deals included a middleware component with four all middleware deals in the group. Technology, and media and financial services had the highest representation in the top 30 deals, closely followed by mainstream customers.

Interesting, the largest deal in the quarter and the year was in the health care vertical, a vertical which we believe holds great promise for us. I want to empathize that we now provide innovative solutions to over 90% of the Fortune 500.

Another illustration of the land and expand strategy can be seen in our largest renewals. This quarter we renewed 25 out of 25 of our largest deals up for renewal during the quarter, and all 100 deals for the fiscal year. These top deals grew at 120% of their previous value. Even with some of our largest and oldest accounts, we continued to expand our relationship with newer offerings. One of the deals in Q4 was within early adopter of Red Hat technologies which doubled their purchases with $10 million plus deal. This financial services customer made a significant purchase of both and JBoss middleware.

Now let me update you on some of our progress we've made on our technology initiatives to offer a comprehensive open hybrid cloud solution for our customers. With the open hybrid cloud we are enabling customers the flexibility to build modern IT, while leveraging existing investments.

Our portfolio of technologies are built to serve customers whether they are running traditional bare metal, a virtualized environment or cloud deployments. Here are few of the highlights from the quarter.

First, Red Hat acquired ManageIQ, a provider of cloud management and automation Technology. This technology complements both our Infrastructure-as-a-Service and Red Hat enterprise virtualization solutions.

Our plan is to combine these technologies to offer customers an enhanced open hybrid cloud management portfolio. Second, we announced two new offerings based on our acquisitions, acquisition of FuseSource in September, JBoss Fuse and JBoss A-MQ. Fuse is a flexible open source enterprise service bus, which enables faster integration implementation, and A-MQ provides a standards based high-performance messaging platform.

Our third announcement is the Red Hat Storage Apache Hadoop plug-in, which provides a new storage option for enterprise Hadoop deployment that delivers enterprise storage features, while maintaining API compatibility for the Hadoop community.

Finally, we announced the general availability of OpenShift. The first enterprise cloud on-premise Platform-as-a-Service offering in the industry. Looking ahead to next fiscal year we see significant opportunities to further enhance our current offerings and expand into new growth areas.

First and foremost, we will continue to increase the scale and operational efficiencies of products, including RHEL, JBoss and RHEV for cloud computing. Second, we will continue our efforts to make Red Hat Storage a preferred place to store, scale and secure big data. These efforts have been well-received, and we continue to build our ecosystem. For instance, we recently announced a collaboration with Intel and their Intel Distribution for Apache Hadoop software to jointly innovate and develop enterprise big data solutions through the open source community.

Finally, we continue to aggressively invest in OpenStack and are now the second largest contributor to the project. As with Linux, we believe there is a role for Red Hat to provide an enterprise-class distribution. We have both the expertise and the credibility to do so.

In summary, I'm very pleased with our fiscal 2013 results and achievements. Red Hat is well-positioned to expand our role as a strategic vendor for enterprise customers. Overall, we experienced solid demand in FY'13 for our core Linux and middleware technologies and growing interest in our new technologies and cloud virtualization and storage.

As we look ahead, we expect continued consistent top-line growth and we remain focused on investing in our key growth initiatives. We believe we are uniquely positioned to leverage our market leadership position into multiple major new market opportunities.

Before turning the call over to Charlie, I want to thank each Red Hat associate around the globe for their focus on driving innovation and supporting our customers.

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

Charlie Peters - EVP and CFO: Thanks, Jim. I am pleased to report that we now have 44 consecutive quarters of revenue growth. We also have had record bookings. We also had the largest increase in total backlog in our history including the unbilled portion billable within 12 months and for the year we surpassed the $1 billion mark in both deferred revenue and subscription revenue after passing the $1 billion mark in total revenues last year.

Demand for our core operating systems and middleware technologies continued to be strong despite the challenging global economic environment. Additionally, we have accelerated our sales and engineering investments in new technologies, both organically and through acquisitions that have significantly expanded our addressable market and our strategic position in the data center.

Here are a few of the financial highlights on a year-over-year basis. Q4 subscription revenue grew 20% in constant currency or 19% in U.S. dollars. Full year subscription revenue was up 22% in constant currency and 19% in U.S. dollars. Short-term deferred revenue grew 17% and total deferred revenue grew 15%, both in U.S. dollars.

Unbilled backlog grew 40% to over $280 million and the portion billable within one year grew 50% to over $180 million and we hit new records for quarterly operating cash flow of $137 million and full year operating cash flow of $465 million.

As I've done in other year end calls, I am going to add a few additional statistics about bookings to be clear. Similar to prior years, we will not be updating these booking statistics on a quarterly basis.

First, it should be clear from our comments on backlog that bookings grew faster than billings. The average contract duration for the quarter was slightly over 21 months as customers increased the size and duration of their commitment to Red Hat technologies.

As I've already mentioned, we ended the year with unbilled backlog over $280 million, up significantly from over $200 million last year. Over $180 million of this backlog is expected to be billed during fiscal '14. It's up 50% from the prior balance of approximately $120 million. This significant change in the unbilled backlog is related to the increasing size and the number of large deals with our top customers as Jim described.

As I've mentioned in the past, these large deals will on occasion have shorter billing terms despite the increase in commitment.

As a reminder, bookings that are billed increased deferred revenue, bookings that are not yet billed, increased unbilled backlog. The combination of unbilled backlog and deferred revenue gives us good forward visibility into a significant portion of future revenue.

Our billings proxy for Q4 set a new record of $454 million, up 9% year-over-year against a difficult comparison from last year and also impacted by the growth in the unbilled backlog that I just mentioned.

As a reminder, our billings proxy is calculated by adding revenue to the change in deferred revenue, showed in the cash flow statement, which excludes the impact of foreign currency exchange rates on deferred revenue.

Moving onto bookings by channel and geography, our Q4 bookings mix was 57% from the channel and 43% from direct sales. The higher direct sales percentage in Q4 compared to earlier quarters was also the result of the increase in large deals, mostly handled by our direct sales teams.

For the year, our channel business grew faster than our direct sales, resulting in annual mix of 62% channel, 38% direct, up from 60%/40% last fiscal year. We continue to make good progress on this key initiative to expand our reach to market and moving toward our multiyear goal of 70%/30% split of channel and direct sales.

Our geographic split of bookings was 63% from the Americans, 25% from EMEA and 12% from APAC, compared to Q3 close to 60%, 23%, and 17% respectively. In general, the Americas business which is basically the entire Western Hemisphere, experienced slowly recovering economy in the U.S., but against the backdrop of lingering uncertainty about federal spending. Our Europe team continues to execute well on a challenging economic environment and the APAC business was impacted by the sluggish Japanese economy and a significant weakening of the yen.

Now, let's talk about our financial performance for the quarter starting with revenue. Fourth quarter revenue was $348 million, it's up 17% in U.S. dollars from the prior year and met our guidance despite more than $1 million of foreign exchange headwind from the guidance rates principally from the yen and slightly weaker services business unexpected.

On a constant currency basis, revenue would have been $351 million or up 18% from the prior year. Subscription revenue, which is a renewable revenue stream constituted approximately 87% of total revenue in Q4. Subscription revenue for the quarter was $303 million, up 19% in U.S. dollars from the prior year. In constant currency subscription revenue would have been $306 million, or up 20% from the prior year.

Training and services revenue was $45 million, up 8% in U.S. dollars from the year ago quarter and was down over $4 million sequentially as a result of holiday downtime at customer sites around the globe.

Now I'll discuss the rest of the results on a non-GAAP basis, excluding stock compensation and amortization expense. Overall gross margin was 86% for Q4, up 40 basis points sequentially and up 10 basis points from the prior year due to more subscriptions in the mix.

Subscription gross margin was modestly higher compared to last quarter and last year at 94%. For Q4, non-GAAP operating expense was $216 million, up 2% sequentially and up 21% in U.S. dollars from the prior year. The acquisitions of FuseSource, Polymita and ManageIQ in the back half of the year added $4 million and $8 million to Q4 and full year non-GAAP operating expenses respectively, mainly on the sales and marketing and R&D lines. In addition, we continue to hire aggressively, adding over 240 new employees in the quarter, principally, for sales, engineering and customer support roles across the globe.

Q4 non-GAAP operating income increased 8% from last year, resulting in a Q4 non-GAAP operating margin of 24%, in line with our previous guidance.

Net interest income was $2 million, consistent with the prior quarter and the prior year. Our annual effective tax rate was approximately 28% for both GAAP and non-GAAP results, lower than the 32% rate which we have been estimating in early quarters, primarily as a result of the retroactive reinstatement of the U.S. R&D tax credit that accounted for about 3% of it, and other tax (planning) efforts accounted for the other 1%. This led to a Q4 non-GAAP tax rate that was 18% in order to adjust to this annual rate.

Our non-GAAP diluted quarterly earnings per share is $0.36, up over 24% compared to non-GAAP diluted EPS of $0.29 in Q4 of last year. Fiscal year 2013 Q4 EPS excludes the benefit of approximately $0.03 per share from the retroactive reinstatement of the U.S. R&D tax credit just mentioned.

Now, let's turn to the balance sheet and the cash flow statement. We ended the year with over $1.3 billion in cash and investments. We've repurchased approximately $36 million of Red Hat common stock in Q4 and approximately $120 million for the fiscal year. At February 28, the balance remaining on our stock repurchase authorization was approximately $179 million.

Our day sales outstanding was within our goal range while collections remained strong. DSO was 60 days for Q4 compared to 61 days last quarter and 55 days last year. As a reminder since day sales outstanding is traditionally a measure of receivables versus billing, our DSO calculation is based on our billings proxy, which includes revenue plus the change in deferred revenue from the cash flow statement.

Total deferred revenue at quarter end was $1.09 billion, an increase of $143 million or 15% over the prior year end. Sequentially deferred revenue increased approximately $102 million from last quarter. I'm going to breakdown for you the components of deferred revenue, while factoring in the impact of foreign exchange.

Short-term deferred revenue which ended Q3 at $736 million had real growth in Q4 of $98 million, offset by a reduction of $3 million as a result of changes in FX spot rates ending Q4 that's be $131 million.

Long-term deferred revenue which ended Q3 at $252 million had a real increase in Q4 of approximately $8 million, offset by a reduction of $1 million as a result of changes in FX spot rates ending Q4 at $259 million.

The total increase in deferred revenue without the impact of currency changes was $106 million and can be found on our statement of cash flows. Moving to the statement of cash flows we produced quarterly operating cash flow of $137 million, up 7% year-over-year.

Full year operating cash flow was $465 million, up 19% and above the high end of guidance, provided a year ago. Now I will briefly recap and summarize highlights for the full fiscal year. Revenue grew to $1.33 billion, up 20% year-over-year in constant currency, or up 17% in U.S. dollars. Subscription revenue grew to $1.15 billion, an increase of 22% in constant currency or 19% in U.S. dollars. Non-GAAP operating margin for the full year was 24.6%, reflecting the increased investments in cloud computing and big data technologies, including the partial year impact of integration of three acquisitions. Non-GAAP operating income grew by 9%. Non-GAAP EPS for the full year was $1.23, up 12% over the prior year. Overall, it was a year of solid execution.

Now I want to shift to fiscal year 2014 guidance; for this guidance, I've assumed average foreign exchange rates of $1.29 for the euro and JPY94 to the dollar. Compared to the year just finished, this represents no change for the euro and a 15% weakening of the yen. As in the past, I'm not attempting to forecast foreign exchange rates, I'm simply pegging guidance at this point. With this in mind, we are forecasting total revenue in the range of $1.51 billion to $1.54 billion for fiscal 2014, representing an annual revenue growth rate up to 16% in U.S. dollars. This growth rate assumes that subscriptions will grow at least two times faster than services revenues and our services revenue growth will be around 7% to 8%, which is similar to the services growth rate we saw in fiscal year '13.

As Jim mentioned previously, we plan to augment our portfolio of technologies to add additional virtual storage software capabilities, Infrastructure-as-a-Service based on OpenStack and cloud management technologies utilizing ManageIQ. This will require additional engineering and sales expenditures to begin to realize these new growth opportunities.

Based upon our finish to fiscal year 2013 and our current outlook, we are targeting non-GAAP operating margin around 24% for this fiscal year with plans to modestly improve margins after a lower first quarter.

I'm estimating full year other income which is principally net interest income of approximately $6 million or $1.5 million a quarter. The estimated annual effective tax rate for fiscal year 2014 is 30% for both GAAP and non-GAAP purposes. Assuming a 30% tax rate and approximately 195 million diluted shares, one would estimate diluted non-GAAP EPS (branch to) $1.31 to $1.35 per share.

On a GAAP basis, we estimate annual stock compensation expense of approximately $120 million and annual amortization expense of approximately $25 million. From a cash flow perspective, we anticipate operating cash flow for the full year between $500 million to $520 million.

Additionally, I would expect cash flow of $30 million to $40 million not included in the GAAP operating cash flow, which is related to tax savings from excess tax benefits from stock compensation. This will be recorded in cash from financing activities such as line item that's been recorded on in the past.

For CapEx, we are nearing completion of expansion projects for our three largest facilities in Raleigh, North Carolina; Westford, Massachusetts; and Brno, Czech Republic among others. We originally anticipated capital spending for fiscal '13 to be in the $100 million range, but given construction schedules, we spent only $86 million with the intension of completing the facilities projects in the first half of fiscal '14.

We are estimating capital spending to be in the $75 million range for fiscal '14 as we complete these important projects.

Finally, as we've seen over the last several years, with a recurring revenue model, there is a natural ebb and flow to business from quarter-to-quarter. Bookings and billings historically are lowest in Q1 and then have grown each quarter to the fourth quarter to then repeat the pattern again the following year. The revenue on the other hand has grown every quarter for the last 11 years.

For Q1, we offer the following guidance. Revenue is estimated to be $358 million to $361 million. Non-GAAP operating margin is estimated to be approximately 23.5% as we ramp up investments in newer product areas. The interest income of $1.5 million and a 30% tax rate, non-GAAP EPS is estimated to be approximately $0.30 to $0.31, assuming approximately $195 million diluted shares.

Consistent with my past practice, I do not guide quarterly cash flow, because it can be quite variable depending upon individual large payments or receipts. However, I would say, that it seems likely that last year's pattern of higher cash flow in Q1 than Q2 will repeat given our strong year-end balance sheet.

In summary, we are pleased with the consistency and strength of our results in fiscal year '13. We closed out fiscal year '13 with strong renewals and upselling in our top deals, we had record large deals that are big and keep getting bigger. Record bookings with strong deferred revenue balance (in excess) of $1 billion and a large increase in the unbilled backlog providing even better forward visibility and we continued to invest and make progress in emerging growth areas.

Operator, I'd now like to turn it back to you for the first question.

Transcript Call Date 03/27/2013

Operator: Kash Rangan, Bank of America-Merrill Lynch.

Kash Rangan - Bank of America-Merrill Lynch: Charlie, if you could talk about what is happening from a payment standpoint or customers, the margin, saying that they want to be invoiced for a shorter duration upfront. If it's just a tactical function of what's happened to this quester in the government vertical, if you could you just expand on that. Also, if you saw the change in invoicing happened just in one vertical or was it more broad-based? I also wanted to clarify that your guidance is on a reported basis looking out and not on a constant currency basis?

Charlie Peters - EVP and CFO: So, I think number of you may have questions about the backlog and so just to clarify again the basics, when we get a booking, if we bill it, it goes to deferred revenue; if it's going to turn the revenue within 12 months, it's current deferred revenue, it's longer than 12 months and it's billed upfront. It's in long-term deferred revenue. If we have a three-year deal that bills one year at a time and only the first year is billed then the first year goes in deferred revenue and the balance would go into unbilled backlog. So this unbilled backlog number is important. It's directly connected this quarter to a significant increase in the large deals. As Jim mentioned, we have three deals over $10 million, six deals over $5 million and a substantial number of deals even beyond the top 30 that were over a $1 million, these deals that which have done through the direct sales force typically you're going to have a shorter billing duration. So part of it is that, part of it is the channel mix deals that are done through the channel or always billed upfront. The second question, Kash, about verticals there was nothing unusual about the vertical mix in terms of the payment terms. There was also nothing unusual about payment terms in smaller deals. It was all focused on really good news in some big deals. The third part of your question, about guidance for next year on foreign exchange, I am guiding – my guidance is based upon the foreign exchange rates that I have given as an assumption which was 129 for the euro which is unchanged year-to-year and 94 for the yen which is a 15% weakening of the yen year-to-year. Those are just the two major currencies we do business and probably more than 20 or more currencies. There are a lot of other currencies in the mix but those are the two major ones.

Kash Rangan - Bank of America-Merrill Lynch: I also Charlie, if I could just quickly (qualify). Next year's constant currency growth rate will be better than the reported growth that you are assuming based on your currency. Also should be expect billings to grow roughly in line with revenues next year? That's it from me.

Charlie Peters - EVP and CFO: Yes, on a constant currency basis, the guidance would be higher because the yen has weakened 15%, the guidance rate that I gave. So that is a fair assumption. The Latin American rates have also weakened in double digit territory.

Kash Rangan - Bank of America-Merrill Lynch: The billings growth rate?

Charlie Peters - EVP and CFO: The billings growth, billings as I have said for the last nine years I have been here, I never forecast billings, because it is hard to do. I wouldn't provide a forecast in terms of how it would relate to revenue.

Operator: Jason Maynard, Well Fargo.

Jason Maynard - Well Fargo: I just wanted to follow up on the question around basically the invoicing trends and just to get a little bit more granular in terms of how you're seeing customer relationships to mature. Is this a functioning rise of bigger transaction sizes, do you see this because of the product line is broadening? What are some of the puts and takes as you negotiate with the customer in terms of do you now want to discount for getting the cash up front? How does that negotiation play out and how does it ultimately impact that calculated billings process that we all without really, maybe a using a better word, (assess) on every quarter?

Jim Whitehurst - President and CEO: I'll start and Charlie may want to add to it. First off, we do not discount to get dollars upfront. We have money sitting in the bank, earning almost nothing. It makes no sense to discount just to get the cash coming in upfront. This is mainly as you can get bigger deals, companies don't want to write that bigger check and I think they are beginning to buy into the value of a subscription model. I don't have all the top deals payment terms in front of me but I know the large three deals that were over $10 million, all of those are paying over time versus paying upfront is to make sense these large dollars is becoming a material line item for those companies. They are getting the value of a subscription over time when I pay for it over time. It's more of a large deal thing, I think, than anything else.

Charlie Peters - EVP and CFO: I don't have anything to add. I agree with Jim's comment. It has nothing to do with the smaller deals, it was more a function and we had really strong big deal metrics here.

Jason Maynard - Well Fargo: Maybe if I could follow up just one question on your comment around JBoss in the middleware business. I'd love to get a little bit more color in terms of what you're seeing with customer adoption of your middleware stack. How successful are you seeing that go from maybe being a middle deployment where you've got sort of the maybe some of the (test in depth) type opportunities as we're actually seeing fall on migration from other application servers or if you're seeing it in terms of net new project growth?

Jim Whitehurst - President and CEO: Well, I think we're seeing a couple of things. First off, we've actually done okay for a couple of years with people moving application servers from WebSphere and Weblogic to JBoss. I think one of the things where we're seeing a lot of growth now is actually in the higher value products. We had really growth -- we felt very good about in our BRMS, our rules management, our SOA Platform as well. Fuse, actually we just announced, as I talked about, that ESB product under the JBoss brand, and those are higher dollar deals and now we actually have a number of big companies, you know their name well, that are willing to standardize on JBoss as their middleware platform, where historically it's just been the application server. So, now that we have the portfolio, it's starting to drive kind of real strength in that business from a portfolio perspective.

Operator: Heather Bellini, Goldman Sachs.

Heather Bellini - Goldman Sachs: I had two questions, Charlie. I guess, I was wondering you guys disclosed in your filings how much revenue the U.S. federal government does. I was just wondering how much of an impact was federal in the quarter that just ended. We've been hearing that from a lot of companies obviously. Then when you think about how the quarter progressed, we obviously all know that your quarters and every software companies are back-end loaded in terms of deal signings. I'm trying to get a sense of; do you think the environment improved as the quarter went on, meaning was the weakness more pronounced in January, or was it more pronounced in February? So that's the second question. Then, what have you seen in terms of the deal signing environment and willing to sign deals thus far in March?

Charlie Peters - EVP and CFO: So, first, a couple of things from the commentary that you can probably (deduce) is that for us, the overall business was actually strong. You'd be asked where was the weakness? We didn't see weakness. We had really strong bookings, and the overall performance was sort of as expected, linearity this was more of the quarter for us with kind of how the 20-20-60 kind of a quarter, and as you heard me say before a really smooth quarter for us to be 25-25-50 something more backend loaded just 20-20-60, but this is not unusual. It's still in the range of what's normal. Relative to the federal sector, we had two areas where I think macro was a factor and I suspect every other software company has already experienced the same thing whether they mentioned it or not or is experiencing this kind of first of the federal space. There is no doubt in my mind that the federal budget discussions that have been going on for some time has slowed down buying decisions in the U.S. in the federal government here. We are not aware of losing any business. It's just some time; it's just a little bit slower. The second area that from a macro perspective was evident is Japan. The economy there is a little bit sluggish and again, the evaluating of the yen was pretty significant. Overall, I would say however, view of the business was strong. The message we are trying to get across is the business was good. I know the billing metrics are little different than what you probably had hoped for, but we can't go into a lot of detail to talk about the backlog, you put those pieces together, you get a very good picture.

Jim Whitehurst - President and CEO: In terms of time dynamic, I didn't notice a particular change over the course of January, February or March. I think it's been pretty consistent.

Operator: Raimo Lenschow, Barclays.

Raimo Lenschow - Barclays: Just following on from Heather. If you think about the year, what are the kind of the close assumptions you are making. Are we kind of looking for a slight improvement in things out there and just trying to kind of gauge how your sales force is feeling about the world out there? And then thinking about – and then a second question is, as you think about the larger deals, can you talk a little bit about a perception you are receiving from your customers base around the new products – the new cloud products, like OpenStack et cetera?

Jim Whitehurst - President and CEO: I'll start a bit on that. I think we are not trying to make major macro calls. I would say, this plan which is bottom up region by region, it is assuming kind of a continuing economic environment in kind of single digit IT growth spend that we've been seeing. So there's not a lot of a call of an expectation of an improvement or a decline, it's pretty consistent. In terms of large deals, we certainly are seeing the portfolio effect where the large deals have multiple products. I think with five of the large deals had a RHEV component, we talked about more than that had middleware components in it. The really new products are really new, I mean an example, we have phenomenal (indiscernible) using OpenShift which is our (path) on-premise. I think they are really, really thrilled with it. Frankly, it's a brand new product category. We don't know if that's going to be a massive category or little category. So, customers are seeing – they are really excited about it, but that's just too new to even think about how that could affect billings or revenue in the next 12 months. The OpenStack, we haven't even announced a G8 product, so hard to talk about that at this point.

Operator: Mark Murphy, Piper Jaffray.

Mark Murphy - Piper Jaffray: I want to just follow-up on the question on the government vertical. I think it's historically you are number one or number two vertical. This quarter you called out tech, media and financial services as the top vertical. So I'm curious where did government rank? Can you talk about how it trended year-over-year and just a little more color on, what did you observe relative to sequestration and its impact on federal government behavior. In other words, our projects being postponed for a quarter or too, or do you think that they're being canceled all together?

Charlie Peters - EVP and CFO: Good question, Mark. Yeah, you heard me say at couple of analyst days typically either financial services or government one and two sometimes they switch positions that who's is with number one and two and it is clear that although we had some sizable government deals that were in the top 30, it would not have put them and either this is number one or two position in terms of verticals in the fourth quarter. Finance is still been very strong, tech and media has been strong. I think you heard Jim says, the largest you know for the quarter and for the year within the healthcare sector which is really interesting and I think encouraging because it's a brand, it's not a sort of new sector, but the sector in which we're underrepresented, I mean there are lot of runway there. But part of the question about the sequestration, I mean this has been it's not new, it didn't happened on February 28, they've been discussing budget issues and government shutdowns and sequestration going on for almost more than a year and I'd say in the back half of this year that it has gotten more pronounced. As I said, I don't see us losing deals in the government, we have really good government business and because we have a renewable revenue model, we see the business we have coming back, but I do see -- I believe new projects maybe slug down a bit there, and I'd be surprise of other software companies weren't seeing the same thing.

Mark Murphy - Piper Jaffray: Then just as a follow-up, Jim, I wanted to ask you on the open stack opportunity. Could you size it in terms of revenue potential in the next couple of years, just relative to what you think the revenue potential is for you in the storage and in the virtualization arenas in the same timeframe? Because we've been hearing a lot more about OpenStack, but I don't think there is a real clear understanding of the magnitude of the opportunity there.

Jim Whitehurst - President and CEO: I really wish I had a real crystal ball, right. We can give you a lot more on that at the Analyst Day. What I would say is, there is a significant potential in it. Obviously, in software-defined data center, long term there is going to be significant revenue. How fast that actually develops is another thing. We are working with a lot of early adopter customers on OpenStack and there is a lot of interest in it. So until those things go into production, there just won't be big dollars. So I think if you looked out, if you put a horizon four, five years, it could be much, much larger than the Linux market for sure, but if you ask me over the next 12 months, I can't imagine there will be material revenue, not just for us but for anyone, because as that point it will all be PoCs, just kind of working with customers to operationalize and big checks don't start coming until things go into production.

Operator: Steven Ashley, Robert W. Baird.

Steven Ashley - Robert W. Baird: I guess, I'd just like to drill upon that health care deal. That sounds very interesting. You said, I think, largest deal in the quarter. Just if you could maybe give us some color around what the use case was, what kind of products they might have consumed, what kind of history you had with the customer? Just some general information would be helpful.

Jim Whitehurst - President and CEO: Is that our largest of the quarter, it was the largest deal of the year. It was –it bodes well. Obviously RHN was our management platform, it also was JBoss as well. So it was middleware deal as well. It's a combination of legacy migration as well as (indiscernible) has standard platform going forward for new functionality. So it is a very large customer kind of making the commitments to move from a proprietary platforms and Open Source ones?

Steven Ashley - Robert W. Baird: Then Charlie, you guided revenue for the full year up maybe 14% to 16%, you guided cash flow growth around 8% to 12% or little less. Can you maybe give us some color on why cash flow might be growing slower than revenue in the coming year?

Charlie Peters - EVP and CFO: Obviously, one of the drivers there is going to be the operating profit of net income numbers and with a higher tax rate next year and with a lower operating margin overall next year, I think that both of those things impact that number. There is a lot of other balance sheet assumptions that go into it, but let's say I'd start with your net income growth number.

Operator: Ross Macmillan, Jefferies.

Ross MacMillan - Jefferies: Charlie, I just wanted to drill into the current backlog number. Am I right, you said $180 million, I think that's up from $120 million at the end of last year? So effectively I if took your billings proxy and I added in that $60 million, which wasn't built, but effectively will be recognized to revenue in the next 12 months, that seems to me to be a higher growth rate more like 18% on that sort of bookings proxy, if you will. Am I going about that math in a right way? Is that the right delta, $180 million versus $120 million on the current backlog?

Charlie Peters - EVP and CFO: Just to clarify, the total unbilled backlog was a year ago over $200 million, portion of billable within one year was the $120 million you are describing. The total backlog now is the total unbilled backlog now is over $280 million, and the portion to be built in the next 12 months is over $180 million. So yes, your math was right. There is $60 million more that's going to be billed in the coming 12 months than we had a year ago that was billed in the last 12 months and the reason we went for some length to describe it in our prepared remarks was because of -- the way the billing numbers came out, it was very clear that the strength in the business is stronger than the billings number would make it appear.

Jim Whitehurst - President and CEO: Just one note on your math, that $80 million growth in total we said from over 200 to over 280 is over the course of four quarters. It's not all in the last quarter. Obviously, the vast majority of that comes in the last quarter because that's when these big deals happen, but I wouldn't just add that in total in one quarter.

Ross MacMillan - Jefferies: Understood. That was my second question, which is on the current backlog, I guess -- right now I am just focused on this current backlog, but that delta of 180 versus 120, I'm assuming the majority of that was in Q4, but there could have been some creep through the year.

Charlie Peters - EVP and CFO: That's accurate, yes.

Ross MacMillan - Jefferies: Then just on invoicing duration more generally, is this a trend? So I guess, as we think about that billings proxy and we think about your disclosure around total backlog and current backlog, it feels to me like the -- that backlog disclosure will become incrementally more important. If that's right, are you going to just continue to give us that just once a year or are you going to potentially give us any more color around that as we go through quarters?

Charlie Peters - EVP and CFO: I guess, my comment on the growth of the backlog, I really do believe it's connected with the large deals. So the way to make some -- I suppose some determination on it is, if we have the large deal metric, I think is what's important and we talk about that every quarter, and you can basically add up the large deals for the year. The backlog metric is one that we disclose annually in the 10-K and we'll talk about on the year end call.

Ross MacMillan - Jefferies: Then maybe just one – I know I don't want to get ahead ourselves here in OpenStack, Jim, I'd love to know, when you think of RHEL and what differentiated RHEL in the early days, you obviously had some supports from some big players like IBM, but you did a lot of certification for workloads and I think that really was a big piece what differentiated RHEL. As you think about your flavor of supporting OpenStack, what do you think can differentiate Red Hat's position?

Jim Whitehurst - President and CEO: Certainly I think a certified ecosystem is important and one of the things that we have been uniquely successful doing is building enterprise versions of open sourced product on which people whether there is a hardware or software vendors can certify, recognize certification happens on this, not on code and so having an enterprise version on which people can certify it's importance. We are quite at that. We are working very closely with the whole series of partners on our OpenStack certification program as we speak. We hear a lot more about that over the coming – next several months.

Operator: Kirk Materne, Evercore.

Kirk Materne - Evercore: I guess Charlie, maybe following up on Ross's question just on some of the seasonality on bookings, I think Jim mentioned that a lot of the off balance sheet backlog was booked in the fourth quarter. Given the stock is down because sort of the absolute billings plan, if I take into account that lot of those bookings we've done in the fourth quarter, if bookings actually accelerate from 3Q to 4Q because most of that business was on the fourth quarter, that would seem to be reasonable assumption?

Charlie Peters - EVP and CFO: Bookings historically has always accelerated in our fourth quarter. As I said in my commentary, the pattern of the business has been very consistent year-over-year. The first quarter is the lowest, second quarter is little bit better, third quarter is quite a bit better than second quarter and the fourth quarter usually get back into the same pattern because of the recurring revenue nature of our subscription.

Kirk Materne - Evercore: Then, just maybe one follow-up. You guys, I'm sure, you get a lot of the same questions in terms of the potential decline in the amount of UNIX to Linux opportunity that is out there. I guess when you looked at the fourth quarter numbers or you look at it over a 12 months basis, I guess is there any real – I guess, everybody is thinking there is some sort of (indiscernible) that were coming to you, do you see any real I guess risk of that over the next 12 months or do you still see that as a pretty further opportunity for you?

Charlie Peters - EVP and CFO: Well, I mean I think the health care deal we talked about is a great example. While we've done a lot of work replacing units in areas like financial services and in telecommunication, if we look at mainstream verticals, we are still in the early days with a lot of very large companies, who are kind of well for the late majority and that makes up a big, big, big chunk of the UNIX footprint out there. Those are also typically for us a little bit higher price points as people are looking for kind of the higher levels of service and higher levels of subscriptions. So, I don't think we see at all right now any slowing in that momentum. It's just being moved from the early adopters to the kind of late majority in terms of the customers that are now making those migrations. Good news for us is they are big and so things like healthcare, I think you'll see more deal in sectors like that as we go forward.

Operator: Keith White, Morgan Stanley.

Keith White - Morgan Stanley: Hate to beat a dead horse here, but in terms of just making sure that we're on board with what you're saying in terms of bookings and bookings growth. I think the number I guess talked to you for FY '13 in terms of bookings growth was about 17% versus the 14% billings growth profile. The other got at three percentage point more growth in bookings versus billings. You saw a similar dynamic last year. I guess the question would be, is that three percentage point excess (based off of) full year? Would you expect that – was that prevalent throughout the whole year? Or would you have a bigger sort of variance between the growth rate of billings and bookings in the fourth quarter in particular because, I mean big deals tend to sign in Q4 not just this year, but every year?

Charlie Peters - EVP and CFO: For the fourth quarter clearly was the outlier of the four quarters, because of the significant numbers of large deals in the fourth quarter.

Keith White - Morgan Stanley: Was there a higher prevalence as big deals in this fourth quarter than there was a year ago?

Charlie Peters - EVP and CFO: Yeah. The year ago I don't think we had any deals that were over $10 million. We had, let's say – you've just a fourth quarter statistics there?

Keith White - Morgan Stanley: (indiscernible).

Jim Whitehurst - President and CEO: Yeah, we definitely didn't have the size of these types of deals that again decided to pay over time last year like we did this year.

Keith White - Morgan Stanley: Then just one question on RHEV. How is RHEV doing (another) version 3.0 out there for a while – how is RHEV been tracking versus your expectations since the most recent release?

Jim Whitehurst - President and CEO: I think one of the important points on RHEV of course that five of the top 30 deals have included the RHEV component. To get back to this land and expand strategy, it's getting into these accounts and then grow from there. So five out of the top 30 is a good metric for us.

Jim Whitehurst - President and CEO: I would say, just surprising to me is, we originally thought it was consolidated into our real installed base. Some of our biggest wins are actually though VMware migrations. We had one government win over thousand VMs, moving from VMware to RHEV. I think we love to talk about the feature set. I do think we have a great feature set now, but the economics are still attractive to a lot of people just on the pure dollars and performance basis.

Operator: Edward Maguire, CLSA.

Edward Maguire - CLSA: I was wondering if you could comment, I know you talk a lot about large deals, but could you comment on the renewal trends for your long-tail accountants? I know that over the last couple of years you have been able to pick up a lot of accounts that haven't renewed and I just wanted to get a sense of whether you felt the low-hanging fruit had been plucked there or whether there is still room to go?

Charlie Peters - EVP and CFO: It's a good question and it's important one, because, frankly, from a dollars and cents has a point of view it doesn't make too much difference, because they are really small. But on the other hand, we believe the land and expand strategy get into a small account with $5000 subscription a year from now might be 50 and a year after that it might be a 100 or a couple of hundred thousand. It is important to repaying these customers. So as we have described before, we have employed a third-party renewal company to help with those renewals on a global basis and we have outsourced to them renewals below certain levels in each region and had some very good results with it. So that's been very positive. We also have put in place number of programs internally to improve the data and to go after these accounts and we made good progress. As I say, the amount of dollars today that's for bookings and billings that's resulting us isn't very large, because their small accounts way down the long tail, but it's really important to keep those accounts alarmed.

Edward Maguire - CLSA: Just a follow-up on Ret Hat Storage I know you had a lot of active proof-of-concepts. How close are you to starting to convert some of the PoCs to revenues and can you at least characterize what your expectations may be, if not quantify over the next year, what do you expect from Red Hat Storage?

Jim Whitehurst - President and CEO: Well we've now had several of those PoCs to turn into fixed figure deals. Frankly not seven bigger, but six bigger deals. So we're feeling too early to really say what the conversion rate is going to be on the PoCs, but overall we're pleased with that and recognize there are two steps to turning it into revenue, first is you got to get a bookings and the bookings got to roll the revenue over time. So the plan that we walk through next year with you still is relatively light on the dollars that will close the revenue from storage. We expect to close quite a few more deals but there are still going to be in the low fixed figures, high-five figures for a while as people kind of get used to it, use it more and work to building up over time and now we still have to roll in the revenue 12 months after that.

Charlie Peters - EVP and CFO: We have a new interesting use case this quarter of very large pharmaceutical company that has massive storage requirement and was looking for a less expensive more exceptional way to store information and they've chosen Red Hat Storage. So that's a whole new avenue for us as well.

Operator: Matt Hedberg, RBC.

Matt Hedberg - RBC Capital: You seem to be (detailing the store) where the underlying trends remain pretty positive. I guess, if you back out some of the puts and takes that happened over the course of a year, whether it's payment terms or duration. The underlying trends that you're still seeing suggest that Red Hat can sort of maintain mid-teens or better growth longer term certainly with the additions of some of these newer products here -- out in the future?

Charlie Peters - EVP and CFO: First of all, we've only guided for the fiscal '14 year. We've not provided guidance beyond that. But one of the things I would point out to everybody, both in analyzing the fiscal '13 results and the fiscal '14 guidance, is the growth of subscriptions. It's high-teens growth in both years for growth of subscriptions and that factors out even the currency impact of the yen for the fiscal '14 year. As we said last year, and I'll just reiterate, our strategy on services is to help us enable our customers to do what they want to do and basically, it's to sell subscriptions. So we have been working with our partners to try to enable more partners to be able to deliver the consulting, so that we don't have to do it. It gives more feet on the street to help push subscription. So you should expect that the services business is going to continue to grow probably in the single-digits range for some time. It sort of masked the overall growth rate a little bit, more important part is the higher subscription growth rate.

Operator: Scott Zeller, Needham.

Scott Zeller - Needham: Question on virtualization. Could you give us a sense of the size of the projects you're seeing? There has been discussion about private cloud and the scale of those projects. Could you describe to us whether you're seeing lot of activity for seeding projects that are smaller scale or are you seeing fewer projects that are larger at this stage?

Jim Whitehurst - President and CEO: It's still more smaller scale in seeding. Again the big things that people are talking about, OpenStack with RHEV in those kind of large kind of (datacenter) things, even if the ones where we are working with our LightHouse customers on those things that could be large, those aren't in pay for stage yet, right? Those are still in the work with those customers, in proof of concept and work it out; so the actual real revenue coming in on RHEV, it was in five of our large deals, but they are still typically five-figure, low six-figure kind of deals. They are not the big, big deals. That will really have to wait again related to cloud especially, that'll be once people are putting these things truly into production, which your guess is as good as mine, but it probably won't be in the next couple of quarters.

Tom McCallum - VP, IR: Thank you everyone and I hope we'll see you at our analyst day on June 25th, in New York City. If you haven't registered, please do. Thank you.

Operator: This concludes today's conference call. Thank you for participating. At this time, you may now disconnect.