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Red Hat (NYSE:RHT)

Q4 2013 Earnings Call

March 27, 2013 5:00 pm ET

Executives

Tom McCallum

James M. Whitehurst - Chief Executive Officer, President and Director

Charles E. Peters - Chief Financial Officer and Executive Vice President

Analysts

Kash G. Rangan - BofA Merrill Lynch, Research Division

Jason Maynard - Wells Fargo Securities, LLC, Research Division

Heather Bellini - Goldman Sachs Group Inc., Research Division

Raimo Lenschow - Barclays Capital, Research Division

Mark R. Murphy - Piper Jaffray Companies, Research Division

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Ross MacMillan - Jefferies & Company, Inc., Research Division

Stewart Materne - Evercore Partners Inc., Research Division

Keith Weiss - Morgan Stanley, Research Division

Edward Maguire - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Scott Zeller - Needham & Company, LLC, Research Division

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's Q4 2013 Earnings Conference Call. [Operator Instructions] Mr. Tom McCallum, Vice President of Investor Relations, you may begin your conference.

Tom McCallum

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 historic reconciliation schedule of GAAP to non-GAAP financial metrics, as well as the schedule of currency rates [ph].

Various remarks we may make about the company's future expectations, plans, 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 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 discussed 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 statements represent 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.

James M. Whitehurst

Thank you, Tom, and 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 a -- 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-paid conversions; strong renewals and cross-selling in our top accounts; growth of our Middleware solutions, which continue to grow at a faster pace than our core; expansion of our total addressable market; expansion of our wallet share in 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 derive 40% of our revenues from outside 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 close out fiscal 2013 and set our sights on fiscal 2014, we're optimistic about Red Hat's future. Demand for our solutions remains strong, our competitive position remains enviable, our technology roadmap is clear and we are in the early stages of multiple opportunities in 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 investment 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 are 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 can 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 3 were over $10 million, both new records.

50% of the top 30 deals included a Middleware component, with 4 all Middleware deals in the group. And technology and media and financial services had the highest representation in the top 30 deals, closely followed by mainstream customers. Interesting, the largest deal of the quarter and the year was in the healthcare vertical, a vertical which we believe holds great promise for us. I want to emphasize 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 over 120% of their previous value.

Even with some of our largest and oldest accounts, we continue to expand our relationship with newer offerings. One of the deals in Q4 was with an early adopter of Red Hat technologies, which doubled their purchases with a $10 million-plus deal. This financial services customer made a significant purchase of both RHEL 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're enabling customers the flexibility to build modern IT while leveraging existing investments. Our portfolio of technologies are built to serve customers, whether they're running traditional bare metal, a virtualized environment or cloud deployments. Here are a few of the highlights from the quarter:

First, Red Hat acquired ManageIQ, a provider of cloud management and automation technologies. This technology complements both our infrastructures of 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 2 new offerings based on our 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 class on-premise platform as a service offering in the industry.

Looking ahead to the 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.

Charles E. Peters

Thanks, Jim. I'm 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 in 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 1 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'm 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 increase deferred revenue. Bookings that are not yet billed increase 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 at $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 shown in the cash flow statement, which excludes the impact of foreign currency exchange rates on deferred revenue.

Moving on to 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 an 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 Americas, 25% from EMEA and 12% from APAC compared to Q3 split of 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 European team continues to execute well in 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, that'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 than expected. On a constant currency basis, revenue would have been $351 million or up 18% from the prior year.

Subscription revenue, which is our 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, 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 continued 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 had been estimating in earlier quarters, primarily as a result of a retroactive reinstatement of the U.S. R&D tax credit. That accounted for about 3% of it and other tax planning [ph] efforts accounted for the other 1%. This led to a Q4 non-GAAP tax rate that was 18%, in order to adjust for 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 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 days sales outstanding was within our goal range, while collections remain strong. DSO was 60 days for Q4 compared to 61 days last quarter and 55 days last year. As a reminder, since days sales outstanding is traditionally a measure of receivables versus billings, 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 break down 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 a real growth in Q4 of $98 million, offset by a reduction of $3 million as the result of changes in FX spot rates, ending Q4 at $831 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 3 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 JPY 94 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 2x faster than services revenues and that 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 of 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 in the range of $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 into the line item it's been recorded on in the past.

For CapEx, we are nearing completion of expansion projects for our 3 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 intention 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's a natural ebb and flow to the business from quarter-to-quarter. Bookings and billings historically are lowest in Q1 and have grown each quarter to the fourth quarter to then repeat the pattern again the following year. 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; with 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 continue to invest and make progress in emerging growth areas.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Kash Rangan from Merrill Lynch.

Kash G. Rangan - BofA Merrill Lynch, Research Division

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

Charles E. Peters

Okay, thanks, Kash. So I think a number of people 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 into the deferred revenue. If it's going to target revenue within 12 months, it's current deferred revenue. If it's longer than 12 months and it's billed upfront, it's in long-term deferred revenue. If we have a 3-year deal that bills 1 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 the significant increase in the large deals. As Jim mentioned, we had 3 deals over $10 million, 6 deals over $5 million and a substantial number of deals even beyond the top 30 that were over $1 million. These deals, which are done through the direct sales force, typically are 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 are always billed upfront. The second question, Kash, about verticals, there was nothing unusual about the vertical mix in terms of 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. And the third part of your question about guidance for next year and foreign exchange, I'm guiding -- my guidance is based upon the foreign exchange rates that I've given as an assumption, which was $1.29 for the euro, which is unchanged year-to-year, and JPY 94 for the yen, which is a 15% weakening of the yen year-to-year. And those are just the 2 major currencies, we do business in probably more than 20 or more currencies. So there's a lot of other currencies in the mix, but those are the 2 major ones.

Kash G. Rangan - BofA Merrill Lynch, Research Division

Got it. And also, Charlie, if I could just quickly verify, next year's constant currency growth rate would be better than the reported growth that you're assuming based on your currency? And also, should we expect billings to grow roughly in line with revenues mix here?

Charles E. Peters

Okay. 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 G. Rangan - BofA Merrill Lynch, Research Division

And the billings growth rate?

Charles E. Peters

And the billings growth. Billings, as I've said, for the last 9 years I've been here, I never forecast billings because it's hard to do. I wouldn't provide a forecast on sort of how it would relate to revenue.

Operator

Your next question comes from Jason Maynard from Wells Fargo.

Jason Maynard - Wells Fargo Securities, LLC, Research Division

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 mature, is this a function in your eyes of bigger transaction sizes? Do you see this because the product line's broadening? What are some of the puts and takes and -- as you negotiate with the customer in terms of, do you not want a discount for getting the cash upfront? How does that negotiation play out and how does it ultimately impact that calculated billings proxy that we all, without really maybe using a better word, obsess on every quarter?

James M. Whitehurst

Yes, 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 to -- just to get the cash coming in upfront. This is mainly, as you get bigger deals, companies don't want to write that big a check, and I think they're beginning to buy in to the value of a subscription model. I don't have all the top deal payment terms in front of me, but I know that the large 3 deals that were over $10 million, all of those are paying over time versus paying upfront. It just makes sense, it's large dollars, it's becoming a material line item for those companies. They're getting the value of a subscription over time, why not pay for it over time. So and those -- it's more of a large deal thing I think than anything else.

Charles E. Peters

Just -- I don't know that I have anything to add, I agree with Jim's comment. It has nothing to do with the smaller deals. It was more a function that we had really strong big deal metrics here.

Jason Maynard - Wells Fargo Securities, LLC, Research Division

And maybe if I could follow up just one question on your comment around JBoss and 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 being -- maybe being initial deployment where you've got sort of maybe some of a -- the test and debt type opportunities, this is actually seeing full-on migration from other application servers or if you're seeing it in terms of net new project growth?

Charles E. Peters

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, 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

Your next question is from Heather Bellini from Goldman Sachs.

Heather Bellini - Goldman Sachs Group Inc., Research Division

I had 2 questions, Charlie. I guess I was wondering I mean you guys disclosed in your filings how much of a -- 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. And 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. And then, what have you seen in terms of the deal signing environment and willing to sign deals thus far in March?

James M. Whitehurst

Okay. 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 got, 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 a quarter for us. It was kind of a 20-20-60 kind of a quarter. And I think as you heard me say before, a really smooth quarter for us would be 25-25-50. Something more back-end loaded is 20-20-60. But this is -- it's not unusual, it's still in the range of what's normal. Relative to the federal sector, we had 2 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 the same [ph]. First is the federal space. There's 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're not aware of losing any business. It's just sometimes, 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 the yen -- the devaluating of the yen was pretty significant. Overall, I would say, however, I mean our view is the business was strong. The message we're trying to get across is the business was good. I know the billings metric is a little different than what you probably had hoped for. But we get into a lot of detail to talk about the backlog. If you put those pieces together, you get a very good picture.

Unknown Executive

And Heather, 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

Next question is from Raimo Lenschow from Barclays.

Raimo Lenschow - Barclays Capital, Research Division

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 you feel for this feeling about the world out there. And then thinking about the -- and then the second question is, as you think about the larger deals, can you talk a little bit about the perception you were seeing from your customer base around the new products, the new cloud products, OpenStack, et cetera?

James M. Whitehurst

Yes, I'll start a bit on that. I think we're not trying to make major macro calls. I would say this plan, which is bottom up region by region, is assuming kind of a continuing economic environment and kind of single-digit IT growth business we've been seeing. So there's not a lot of the call [ph] of an expectation of an improvement or a decline. It's pretty consistent. In terms of the large deals, we certainly are seeing the portfolio effect where the large deals have multiple products. I think 5 of the large deals had a RHEV component. We talked about more than that had Middleware components in it. So really new products are really new. I mean, an example, we have phenomenal lighthouse names using OpenShift, which is our PaaS on-premise. I think they're really, really thrilled with it. But frankly, it's a brand new product category. We don't know if that's going to be a massive category or a little category. So customers are seeing -- 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. And, obviously, I'd say OpenStack, we haven't even announced a GA product, so it's hard to talk about that at this point.

Operator

Your next question is from Mark Murphy from Piper Jaffray.

Mark R. Murphy - Piper Jaffray Companies, Research Division

I wanted to follow up on the question on the government vertical. I think it's historically your #1 or #2 vertical. This quarter, you called out tech, media and financial services as the top verticals, 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, are projects being postponed for a quarter or 2, or do you think that they're being canceled altogether?

James M. Whitehurst

Good question, Mark. You've heard me say at a couple of analyst days, typically, either financial services or government are 1 and 2. Sometimes, they switch positions at who's #1 and 2. And it is clear that although we had some sizable government deals that were in the top 30, it would not have put them in either the #1 or 2 position in terms of verticals in the fourth quarter. Finance has still been very strong, tech and media has been strong. I think you heard Jim say that the largest deal for the quarter and for the year was in the healthcare sector, which is really interesting and I think encouraging because it's a brand -- it's not a new sector, but it's a sector in which we're underrepresented. I think we've got a lot of runway there. But part of the question about the sequestration, I mean, this has been -- it's not new. It didn't happen 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 may be slowed down a bit there. And I'd be surprised if other software companies weren't seeing the same thing.

Mark R. Murphy - Piper Jaffray Companies, Research Division

And then just as a follow-up, Jim, I wanted to ask you on the OpenStack 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 the virtualization arenas in the same time frame? Because we've been hearing a lot more about OpenStack, but I don't think there's a real clear understanding of the magnitude of the opportunity there.

James M. Whitehurst

Yes, I really wish I had a real crystal ball, right? We can give you a lot more on that at Analyst Day. What I would say is there's a significant potential in it. Obviously, in software-defined data center, long term there's going to be significant revenue. How fast that actually develops is another thing. We're working with a lot of early adopter customers on OpenStack, and there's a lot of interest in it. But until those things go into production, there just won't be big dollars. So I think if you look out, if you put a horizon 4 or 5 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'll be material revenue, not just for us but for anyone. Because at that point, it's -- it'll all be POCs, just kind of working with customers to operationalize it and big checks don't start coming until things go into production.

Operator

Your next question comes from Steve Ashley from Robert Baird.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

I guess, I'd just like to drill down on that healthcare 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 will be helpful.

Charles E. Peters

Well, it's not only -- it's our largest deal in the quarter, it was our largest deal of the year. And it was both RHEL -- obviously, RHN, which is our management platform, and also was JBoss as well. So it's a Middleware deal as well. It's kind of a combination of legacy migration, as well as their kind of standard platform going forward for new functionality. So it's just a very large customer kind of making the commitment to move from a proprietary platform to an open source one.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Terrific. And then Charlie, you've guided revenue for the full year up maybe 14% to 16%. You guided cash flow growth around 8% to 12%, a little less. Can you maybe give us some color on why cash flow might be growing slower than revenue in the coming year?

Charles E. Peters

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

Operator

Your next question is from Ross MacMillan from Jefferies.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Charlie, I just wanted to drill in to 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. And so effective with the -- effectively, if I took your billings proxy and I added in that $60 million, which wasn't billed 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 the right way? Is that the right delta, $180 million versus $120 million on the current backlog?

Charles E. Peters

Just to clarify, the total unbilled backlog was a year ago over $200 million. A portion of billable within 1 year was the $120 million you're describing. The total backlog now is -- the total unbilled backlog now is over $280 million, and the portion to be billed in the next 12 months is over $180 million. So yes, your math was right. There's $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 into 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.

James M. Whitehurst

So, but just one note on your math, that $80 million growth in total we said from over $200 million to over $280 million is over the course of 4 quarters, right? 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 & Company, Inc., Research Division

Understood. And that was my second question, which is on the current backlog, I guess, right now I'm just focused on this current backlog. But that delta of $180 million versus $120 million, I'm assuming the majority of that was in Q4, but there could have been some creep through the year.

Charles E. Peters

That's accurate, yes.

Ross MacMillan - Jefferies & Company, Inc., Research Division

Okay, that's helpful. And 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. And 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?

Charles E. Peters

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 this -- 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 it on the year end call.

Ross MacMillan - Jefferies & Company, Inc., Research Division

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

James M. Whitehurst

Well, 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 source products on which people, whether those are hardware or software vendors, can certify. Recognize certification happens on bits, not on code. And so having an enterprise version on which people can certify is important. We're quite good at that. We're working very closely with a whole series of partners on our OpenStack certification program as we speak. You'll hear a lot more about that over the coming next several months.

Operator

Your next question is from Kirk Materne from Evercore Partners.

Stewart Materne - Evercore Partners Inc., Research Division

I guess, Charlie, maybe just following up on Ross' 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. And given the stock's down because the sort of the absolute billings print, if I take into account, that a lot of those bookings were done in fourth quarter, did bookings actually accelerate from 3Q to 4Q? Because if most of that business was done in the fourth quarter, that would seem to be a reasonable assumption.

Charles E. Peters

Yes, I mean bookings historically has always accelerated in our fourth quarter. As I said in my commentary, it's a very -- the pattern of the business has been very consistent year-over-year. The first quarter is the lowest; second quarter is a little bit better; third quarter's quite a bit better than the second quarter; and the fourth quarter usually booms. So we get back right back into the same pattern because of the recurring revenue nature of a subscription.

Stewart Materne - Evercore Partners Inc., Research Division

Okay. And then just maybe one follow-up. You guys I'm sure get a lot of the same questions in terms of the potential decline in the amount of UNIX to Linux opportunity there is out there. I guess, when you looked at the fourth quarter numbers or you look at it over a 12-month basis, I guess is there any real -- I guess everybody is thinking there's some sort of ledge that we're coming to. Do you see any real, I guess, risk of that over the next 12 months? Or do you still see that as a pretty fertile opportunity for you all?

James M. Whitehurst

I -- well, I mean I think the healthcare deal we talked about is a great example. While we've done a lot of work replacing UNIX in areas like financial services and in telecommunications, if we look at mainstream verticals, we're still in the early days with a lot of very large companies who are -- kind of walk [ph] on 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 our higher levels of subscription. So I don't think we see at all right now any slowing in that momentum. It's just a move from the early adopters to the kind of late majority in terms of the customers that are now making those migrations. The good news for us is they're big. And so things like healthcare, I think you'll see more deals in sectors like that as we go forward.

Operator

Your next question is from Keith Weiss from Morgan Stanley.

Keith Weiss - Morgan Stanley, Research Division

I hate to beat a dead horse here, but in terms of just making sure that we're all on board with what you're saying in terms of bookings and bookings growth. I think the number that you guys talked to for FY '13 in terms of bookings growth was about 17% versus the 14% billings growth profile. So you have about a 3 percentage point more growth in bookings versus billings. You saw a similar dynamic last year. I guess the question would be, is that 3-percentage-point excess in -- based off of the 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.

James M. Whitehurst

The fourth quarter clearly would be the outlier of the 4 quarters because of the significant numbers of large deals in the fourth quarter.

Keith Weiss - Morgan Stanley, Research Division

Was there a higher prevalence of big deals in this fourth quarter than there was a year ago?

Charles E. Peters

Yes. The year ago, I don't think we had any deals that were over $10 million. We had -- let's see, you have the fourth quarter statistics there?

Unknown Executive

No, I don't, unfortunately, I can follow up with him though.

James M. Whitehurst

Yes, but 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 Weiss - Morgan Stanley, Research Division

Got it, got it. And then just one question on RHEV. How is RHEV doing -- now that you have version 3.0 out there for a while, how has RHEV been tracking versus your expectations since the most recent release?

Charles E. Peters

I think one of the important points on RHEL is that 5 of the top 30 deals had included a RHEV component. And it gets back to this land-and-expand strategy, it's get into these accounts and then grow from there. So 5 out of the top 30 is a good metric for us.

James M. Whitehurst

That was -- surprising to me is we originally thought, hey, let's go sell this into our RHEL installed base. Some of our biggest wins are actually, though, VMware migration. We had one government win over 1,000 VMs moving from VMware to RHEV. I think -- so we love to talk about the feature set, and I do think we have a great feature set now, but the economics are still attractive to a lot of people just on a pure dollars and performance basis.

Operator

Your next question comes from Ed Maguire from CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

I was wondering if you could comment, I know you talked a lot about large deals, but could you comment on the renewal trends for your long KL [ph] accounts? I know that over the last couple of years, you've been able to pick up a lot of accounts that hadn'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's still room to go?

James M. Whitehurst

It's a good question, it's an important one because frankly from a dollars and cents a day point of view, it doesn't make too much difference because they're really small. But on the other hand, if you believe the land-and-expand strategy, you get into a small account with $5,000 subscription. A year from now it might be $50,000; the year after that it might be $100,000 or a couple hundred thousand. It is important to retain these customers. So as we've described before, we have employed a third-party renewal company to help with those renewals on a global basis, and we have sort of 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 a number of programs internally to improve the data to go after these accounts. And we've made good progress. And least to say [ph], the amount of dollars today that -- for bookings and billings today that result from this isn't very large because they're small accounts, way down the long tail, but it's really important to keep those accounts alive.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Great. And just a follow-up on Red Hat Storage, I know you've 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 you expect from Red Hat Storage?

James M. Whitehurst

Yes, well, we now had several of those POCs turn into 6-figure deals, frankly not 7-figure but 6-figure deals. So we're feeling it's 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 2 steps to turning it into revenue. First is you got to get a booking, and then the booking's got to roll into revenue over time. So the plan that we walk through for next year with you still is relatively light on the dollars that'll flow into revenue from Storage. We expand -- we expect to close quite a few more deals, but they're still going to be in the low 6-figures, high 5-figures for a while as people kind of get used to it, use it more and work to build them up over time. And then obviously, they'll have to roll into revenue 12 months after that.

James M. Whitehurst

We have a new very interesting use case this quarter of a very large pharmaceutical company that has massive storage requirements and was looking for a less expensive, more accessible way to store information, and they've chosen to do Red Hat Storage. So that's a whole new avenue for us as well.

Charles E. Peters

That's not the large healthcare deal, that's a different one.

James M. Whitehurst

Yes, [indiscernible].

Operator

Next question is from Matt Hedberg from RBC.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

You seem to be detailing the store [ph] with 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?

Charles E. Peters

Well, 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 we -- 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 and -- 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

Your final question is from Scott Zeller from Needham & Company.

Scott Zeller - Needham & Company, LLC, Research Division

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

James M. Whitehurst

No, it's still more smaller scale in seeding. And then the big things that people are talking about, OpenStack with RHEV in those kind of large kind of data center things. Even if the ones where we are working with our lighthouse customers on those things that could be large, those aren't in the paid-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 5 of our large deals but they're still typically 5-figure, low 6-figure kind of deals. They're not the big, big deals. And that will really have to wait again. Both for -- well, for 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

Well, thank you, everyone. And I hope we'll see you at our Analyst Day on June 25 in New York City. If you haven't registered, please do. Thank you.

Charles E. Peters

Thanks, everyone.

Operator

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

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