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Red Hat, Inc. (NYSE:RHT)

Q4 2014 Earnings Conference Call

March 27, 2014 05:00 PM ET

Executives

Tom McCallum - VP of IR

Jim Whitehurst - President and CEO

Charlie Peters - EVP and CFO

Analysts

Siti Panigrahi - Credit Suisse

Raimo Lenschow - Barclays Capital

Mark Murphy - Piper Jaffray Companies

Gregg Moskowitz - Cowen and Company

Kash Rangan - Bank of America Merrill Lynch

Keith Weiss - Morgan Stanley

Brent Thill - UBS Investment Bank

Michael Turits - Raymond James

Abhey Lamba - Mizuho Securities

Ross MacMillan - Jefferies LLC

Kirk Materne - Evercore Partners

Tim Klasell - Northland Capital Markets

Steven Ashley - Robert W. Baird

Ed Maguire - CLSA

Walter Pritchard - Citigroup

Derrick Wood - Susquehanna Financial Group

Operator

Good day everyone and welcome to Red Hat's Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions) I will be standing by should you need any assistance.

It is now my pleasure to turn the conference over to Mr. Tom McCallum, Vice President of Investor Relations. You may begin, sir.

Tom McCallum

Thank you, Steve. Hello, everyone and welcome to Red Hat's earnings call for the fourth quarter of fiscal 2014. 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 a schedule on currency rates.

Various remarks that 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 by 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 views only as of today, March 27, 2014, 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 disdain 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.

Before I turn the call over to Jim, I'd like to remind everyone and the investment community to register for our April 16th Analyst Day. Analyst Day will be held in conjunction with Red Hat Summit.

And with that, I'd like to turn the call over to Jim Whitehurst.

Jim Whitehurst

Thanks Tom, and let me add my welcome to all of you joining us on today's call. The fourth quarter was the strong finish to fiscal 2014 and it was highlighted by a record number of deals over $1 million and 24% growth in our billings proxy. Fiscal ’14 was a great year during which we produced a record billings proxy up 17% year-over-year, record annual revenue up 15% year-over-year and record total backlog up 14% year-over-year.

The main drivers of this growth in Q4 were the continued demand for Red Hat’s fast growing core platform and application development offerings, including our broad portfolio of middleware offerings.

In addition, our cross-selling efforts resulted in early wins for our emerging technologies which address CIO’s top priorities that are driving the evolution of enterprise computing. This demand led to closing OpenStack, OpenShift and Red Hat Cloud Infrastructure deals in all of our major geographies. These deals covered a broad group of industries from financial services, technology and media, government agencies, research universities, telecommunications, health care, transportation and retail companies.

As Charlie will detail later, we expect Red Hat to deliver continued solid growth in FY15 and we plan to continue investing for the long term with a particular focus on further commercializing and driving adoption of our emerging technologies in cloud computing and big data storage.

Our record quarter for both bookings and billings was driven by strong renewals, further expansion of existing customer relationships, growing traction across multiple offerings, new customer acquisition and broadening of our [outs] to market.

With that overview, let’s discuss some of the key customer metrics from our fourth quarter. Large deal metrics were very strong this quarter, all of the top 30 deals were greater than $1 million for the third quarter in a row. In fact, we’ve closed a record number of deals in excess of $1 million with more than 70 in total. The seven deals that were over $5 million also set a record and two of these were over 10 million.

The growth in our larger deals is not only one of the drivers of our continued solid growth at Rat Hat’s current scale, it’s also is an important validation of Red Hat’s growing strategic importance with customers. A record 65% of the top 30 deals included a middleware component with four all middleware deals in the group.

Cross-selling was even broader in Q4, where 75% of our top deals had a technology component beyond RHEV, including middleware, Red storage OpenShift and OpenStack technologies. Technology and media and telecom cloud had the highest dollar representation in the top 30 deals. Interesting, looking at the number of deals instead of the dollars, the number of deals was evenly split across our top four verticals financial services, government, technology and media and telecom cloud as well as our group of mainstream customers that include customers in health care, retail and travel among others.

Renewals are an important opportunity to expand our relationship with customers for our core technologies as well as emerging ones. This quarter we renewed 24 out of 25 of our largest deals up for renewal during the quarter and 99 out of a 100 deals for the fiscal year. These top deals grew at approximately 120% at their previous annualized value during every quarter this year.

We also saw a number of customers in the top renewals for the quarter by multiple technologies from us demonstrating our expanding relationship with our top customers. The one deal that did not review this quarter is a customer that is competing at a consolidating industry. We are still working with the customer and expect to move forward with a new deal in the future.

Now let me update you on some of the progress we’ve made in our growth initiatives to offer a cohesive open hybrid cloud solution for our customers in new markets. Here are few highlights from the quarter. First, we continue to enhance our core platform and application development offerings for instance the RHEL 7 beta process is moving smoothly as the technology continues to be further hardened. One of the exciting new features of RHEL 7 is Linux containers which have emerged as a noteworthy application packaging and delivering technology combining light weight application isolation with the flexibility of image based deployment methods.

Recently, we announced the extension of our certification program to include containerized applications. The Red Hat container certification ensures the application containers built using Red Hat Enterprise Linux for operating seamlessly across certified container host.

On the application development side, we released eight versions of our middleware offerings over the past year. This quarter the leases included our application performance enhancing JBoss Data Grid 6.2 and JBoss Data Virtualization 6 to help enterprises turn big data into actionable information.

Second, we expanded our relationship with the largest public cloud providers to give us additional ways to reach new customers while also providing existing customers with a certified option to run their applications.

In February, we expanded our partnership with Amazon to their AWS GovCloud so that Red Hat offerings are now available globally across every reach of AWS.

We also continued to add large public cloud providers as we welcomed AT&T services to our certified cloud provider program in Q4.

Third, in addition to the big data announcements around JBoss Data Virtualization 6, we also deepened our strategic relationship with the leading contributor and provider of Enterprise Apache Hadoop Hortonworks. As Hadoop continues to gain traction in enterprise big data implementations, we want to make sure that it is tightly integrated into Red Hat’s open hybrid cloud technologies such as RHEL, OpenStack Platform, Red Hat JBoss Middleware and Red Hat Storage.

Fourth, our progress to commercialize OpenStack continues to advance quickly. We continue to see additional downloads, proof of concepts and deal closing. We are experiencing approximately 3,000 downloads per day, increased commitments to TOCs and we closed dozens of new deals.

Most customers are still in the initial deployment phase but we continue to see six figure commitments for larger deployments and we closed our first $1 million deal. Cross-selling in our top deals was also evident with three of the top five deals having an OpenStack component and two of these deals had an OpenStack and OpenShift component.

We also launched our OpenStack training and professional certification program globally and have already certified hundreds on Red Hat OpenStack with the goal of ramping that number into thousands very rapidly. Further we've hired a number of OpenStack engineers, overlay sales people and consultant that we believe will drive further innovation and adoption of these exciting new technologies.

Fifth, we announced new relationships with Alcatel-Lucent and Dell to bring OpenStack based Network Function Virtualization or NFV for the telecom providers.

There is a major shift in the telecom market as these providers look to save both CapEx and OpEx with software-based solutions in their networks. This market for carrier class technology is new for Red Hat and further expands our addressable market. According to IDC, NFV is the fastest growing piece of the global telecommunications market, and is expected to grow rapidly to more than a $1 billion in the next few years.

As we begin our next fiscal year, we are very optimistic about Red Hat’s future. Our infrastructure related offerings including our core platform continue to have attractive growth opportunities. And our application related offerings including our flagship Middleware offering and our portfolio of emerging cloud technologies are increasingly important contributors to our overall success.

We are addressing multiple areas of IT spend as they are both significant and strategic and we believe we are well positioned to capitalize on this opportunity based on Red Hat’s proven ability to deliver business value to our customers over the long-term.

Before turning the call over to Charlie, I want to thank each of our Red Hat associates around the globe for their continued focus on driving innovation, supporting our customers and delivering strong results for our shareholders. With that let me turn the call over to Charlie.

Charlie Peters

Thanks, Jim. I am pleased to report a strong fourth quarter that demonstrates the continued demand of our offerings, expanding operating systems and middleware and emerging technologies. It also reflects strong execution on the part of our people which resulted in a compelling combination of revenue growth, profitability and cash flow. Here are just a few financial highlights on a year-over-year basis.

First, our billings proxy for Q4 set a new record at $565 million, up 24% year-over-year in U.S. dollars or 26% in constant currency with strong growth in both short and long-term deferred revenue. As a reminder, our billings proxy is calculated by adding revenue to the change in deferred revenue showed on the cash flow statement which Jim highlighted earlier.

Q4 subscription revenue grew 18% in constant currency or 16% in U.S. dollars. Full year subscription revenue is also up 18% in constant currency and 16% in U.S. dollars. Full year non-GAAP operating income grew 15% and we hit new record highs for both quarterly and annual operating cash flow of $185 million for the quarter, up 35% and full year operating cash flow of $541 million, up 16%. And free cash flow grew 21% year-over-year, as CapEx has begun to subside as we predicted.

As I have done on 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, total backlog for the fiscal year was over 1.56 billion, up 14% year-over-year. We define total backlog as total deferred revenue which is build plus the value of customer contracts to be built in the future not reflected in our financial statements.

The total deferred revenue portion for the fiscal year was 1.29 billion, up 18% year-over-year. The portion of total backlog to be built in the future or our off balance sheet backlog was in excess of 270 million compared to in excess of 280 million last fiscal year. It’s important to note that the portion of off balance sheet backlog to be built in the next 12 months was in excess of 190 million, up $10 million from fiscal 2013. These results reflect a mix of business that include a larger number of renewable single year deals and the impact of growing public cloud revenue that is reported in arrears as revenue. The combination of deferred revenue and off balance sheet backlog to be built in the next 12 months gives us very good visibility into a significant portion of fiscal year ’15 revenue which I will discuss in a moment.

Moving onto bookings by channel and geography, our Q4 bookings mix was 56% from the channel and 44% from direct sales. Somewhere into past four quarters, a higher direct sales percentage in Q4 versus earlier quarters was a result of the increase in large deals mostly handled by our direct sales teams. For the year, our channel business grew faster than direct sales resulting in an annual mix of 63% from the channel and 37% direct, up from last fiscal year and moving closer to our multiyear goal of 70%-30% split of channel and direct sales.

Our geographic split of bookings was 61% from the Americas, 26% from EMEA and 13% from APAC compared to a split in Q4 last year of 63%, 25% and 12% respectively, all regions performed well.

Now let’s talk about our financial performance for the quarter starting with revenue. Fourth quarter revenue was 400 million up 15% in US dollars from the prior year and is at the top end of our guidance, despite the slight FX headwind from guidance rate. On a concentrated basis revenue would have been $407 million or up 17% from the prior year. Subscription revenue which is a renewable revenue stream constituted approximately 88% of total revenue in Q4. Subscription revenue for the quarter was 351 million, up 16% in US dollars from the prior year, in constant currency, subscription revenue would have been 356 million or up 18% from the prior year. Training and services revenue was $49 million up 8% in US dollars from a year ago quarter and was down $5 million sequentially as we experienced our normal Q4 holiday downtime which reduces the number of consulting and training delivery days. 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 10 basis points sequentially and up 10 basis points from the prior year due to more subscription revenue in the mix. Subscription gross margin was consistent with last quarter and last year at 94%. The training and services gross margin is 32%, 220 basis points lower than Q4 last year due to the increased hiring of OpenStack consultants and training resources ahead of revenue as we continue to build our global presence in this technology.

For Q4 non-GAAP operating expense was $248 million, up 2% sequentially and up 15% in US dollars from the prior year. We added over 180 new employees in the quarter, aggressively hiring sales and engineering associates including those with skills related to our emerging technologies like OpenStack as I just mentioned.

For the fiscal year we increased our head count about by 14% with greater than 80% of the new associates during sale, engineering, services and support. Q4 non-GAAP operating income of 97 million increased 16% from last year resulting in Q4 non-GAAP operating margin of 24.3%. Net interest income was $2 million consistent with last year.

Our annual effective tax rate was approximately 26% for both GAAP and non-GAAP results which is lower than the 27.5% rate which we had estimated last quarter. This led to a Q4 non-GAAP tax rate which was 24% in order to adjust to this annual rate. Our non-GAAP diluted quarterly earnings per share is $0.39 compared to non-GAAP diluted EPS of $0.36 in Q4 last year. One should note that in fiscal year 2013, Q4, EPS included a benefit of approximately $0.03 per share from the retroactive reinstatement of the US R&D tax credit which is not in this year’s Q4 results. Now let’s turn to the balance sheet and the cash flow statement. We end up the year with just under 1.5 billion in cash and investments. For the fiscal year we repurchased approximately 5 million shares of Red Hat common stock for approximately $ 239 million. At February 28 the balance remaining on stock repurchase authorization was approximately $240 million. Our days sales outstanding improved sequentially in year over year and was within our desired range. Satisfied customers tend to pay their bills on time but slightly better linearity in the quarter also helped. DSO was 58 days for Q4 compared to 62 days last quarter and 60 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 a change in deferred revenue from a cash flow statement. Total deferred revenue at quarter end was 1.29 billion an increase of a $199 million or 18% over the prior year end, sequentially deferred revenue increased approximately a $166 million from last quarter.

Let me break down the components of deferred revenue for you while factoring in the impact of foreign exchange. Short term deferred revenue which ended Q3 at 834 million had real growth in Q4 of a 132 million, and increased to further $1 million as a result of changes in the spot rates ending Q4 at 967 million. Long term deferred revenue which ended Q3 at 290 million had a real increase in Q4 of approximately $32 million with no material impact as a result of changes in FX spot rates, ending Q4 at 322 million. The total increase in deferred revenue without the impact of currency changes was a $164 million and you can find it on the statement of cash flows. Moving to the statement of cash flows we produced a record quarterly operating cash flow of a $185 million, it’s up 35% year over year, full year operating cash flow is $541 million up 16% and well above guidance. This overachievement was driven by strong billings and collections and is more remarkable in light of the negative impact to cash flow of the $10 million payment for U.S. taxes which I mentioned last quarter.

Now briefly recap and summarize highlights for the full year fiscal year. Revenue grew to 1.53 billion up 17% year-over-year in constant currency or up 15% in U.S. dollars. Subscription revenue grew to 1.34 billion an increase of 18% in constant currency or 16% in U.S. dollars. Non-GAAP operating margin for the year was 24.5%, 50 basis points higher than initial guidance, it’s still allowing for further international expansion and continued investment in emerging technologies. Non-GAAP operating income grew by 15%. Non-GAAP EPS for the full year was $1.49, up 21% over the prior year. Overall, it was another great year with strong execution.

I now want to shift to fiscal year 2015 guidance. For this guidance, I have assumed average FX rates of $1.37 for the euro and 102 yen for the dollar. Compared to the year just finished, this represents a 2% strengthening of the euro and a 2% weakening of the yen. Please see our website for other currencies in which we do business. As in the past I’m not attempting to forecast exchange rates, I’m simply pegging guidance at this point. So at these foreign exchange rates, we are forecasting total revenue in the range of 1.730 billion to 1.755 billion for fiscal 2015 representing an annual revenue growth rate up to 14% in U.S. dollars. This growth rate assumes that subscription in services revenues will growth at approximately the same rate.

We expect services will reaccelerate this year as training picks up after the introduction of RHEL 7 and consulting for both Middleware and OpenStack will continue to growth. Our operating margin forecast reflects our plan to ramp up investment in emerging technologies and planned launches of core technologies include RHEL 7. You should expect to see the investment in newer technologies reflected in higher spending and services, support, engineering and sales which due to our subscription model is always ahead of revenue. Based upon our finesse to fiscal year 2014 and our current outlook, we are targeting non-GAAP operating margin around 23.5% for the fiscal year 2015 as we continue to invest for growth particularly around OpenStack.

I am estimating full year other income principally net interest income of approximately $8 million or $2 million per quarter. The estimated annual effective tax rate for fiscal year 2015 is 29% for both GAAP and non-GAAP purposes. One of the primary reasons that the rate is higher in fiscal ’15 is due to the exploration once again of the U.S. R&D tax credit. Assuming a 29% tax rate and approximately $192 million diluted shares, one would estimate diluted non-GAAP EPS in the range of $1.54 to $1.56 per share. On a GAAP basis, we estimate annual stock compensation expense of approximately $135 million and annual amortization expense of approximately $25 million.

From a cash flow perspective, we anticipate operating cash flow for the full year between $580 million to $600 million. This assumes approximately 10% cash taxes. We are forecasting CapEx of approximately $50 million, a decrease of almost $30 million from fiscal year ’14 which reflects the completion of several major facility expansion projects last year and returning to a more normal run rate. This CapEx reduction is a significant boost of free cash flow which should grow upwards to 19% this year.

Finally as we have seen over the last several years with the recurring revenue model, there is a natural ebb and flow to the business from quarter-to-quarter. Bookings and billings historically are lowest in Q1 and then they have grown each quarter to the fourth quarter to then repeat the pattern again in the following year. We would expect the same this year. Revenue on the other hand has grown every quarter for the last 12 years.

For Q1, we offer the following guidance. Revenue is estimated to be $412 million to $415 million. Non-GAAP operating margin is estimated to be approximately 21% as a result of the timing this year of the Red Hat Summit in mid-April, the OpenStack Summit in May combined with sales kick-offs and other major marketing events globally and continued hiring of sales and engineering. With interest income of $2 million and a 29% tax rate, non-GAAP EPS is estimated to be approximately $0.32 to $0.33 assuming approximately 192 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 it seems likely that they multi-year pattern of higher cash flow in Q1 than Q2 will repeat given our strong year-end balance sheet.

In summary, we are pleased by the strength of our results for fiscal year 2014. We are firmly positioned for further growth and profitability in 2015 and beyond by leveraging emerging technologies that continue to expand our addressable market, larger deals, strong renewals, and increasing upsell in our top deals that strengthen our strategic position of our customers, record backlog that provides even better forward visibility, the fastest growing set of core platform in Middleware technologies in the industry, and of course we have a major product refresh cycle this year.

On a final note, I hope many of you will be able to join us on April 16, for Analyst Day at the Red Hat Summit in San Francisco. It’ll be a great opportunity to learn more about strategy, innovation and customer focus. If you are unable to attend in person, we hope you’ll be able to join our live webcast where you’ll be able to access all the information that we present.

Operator, I would now like to turn it back over to you for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Siti Panigrahi from Credit Suisse. Your line is open.

Siti Panigrahi - Credit Suisse

Hi guys, congrats on a great quarter. I just want to dig in, into more into your emerging technology product line. So could you give us a like what’s driving at this time, what you are seeing, and especially OpenStack, you talk about, could you tell us like, what’s the use cases you are seeing and what have you factored in in terms of growth opportunity there in next couple of years?

Jim Whitehurst

Well we're seeing actually -- I kind of I'll say surprisingly strong interest across the board. We certainly have lot of telcos who are looking to build up their public clouds that we are working with on POCs now. They are the most obvious who are going to want to support at OpenStack. We’re seeing across the banking sector, we are seeing it in telecommunications, technology and media. It’s really pretty broad-based on OpenStack.

Now we have some pretty sizeable aspirations in terms of POCs and design wins. We'll have some reasonable bookings this year, but almost no revenue given the lag in the subscription model associated with OpenStack.

Operator

Our next question comes from Raimo Lenschow from Barclays, your line is open.

Raimo Lenschow - Barclays Capital

Thanks, can I speak on that subject too? Let’s talk a little bit. Do you remember last quarter we talked about like this year it is going to be about having the consulting organization kind of working on more projects around OpenStack and then kind of slowly that turns into more standardized product version that can go out there. If you look at the early customer discussions you have at the moment, where are you seeing that? You think that consulting phase, or that’s engagement phase has declined will be there or do you see people making already big commitments here? Thank you.

Charlie Peters

Raimo, I think a couple of things that are important to note. One is on the consulting side that you mentioned. The other is the trending and the certification that we mentioned in the prepared remarks. I think as we said we said, we have hundreds of people already now certified on Red Hat OpenStack, we are expecting it to be thousands and sort of planning on thousands certified, that group of individuals will then go back to their employers and begin to drive that ways the same ways that Red Hat certified engineers did in the early days of Linux. On a consulting side we are seeing good demand for consulting. And as we've also said, we’re beginning to see early days of bookings for subscriptions, but because of the revenue model as Jim mentioned that it will take a while for that to be meaningful in dollars on a subscription side.

Operator

Our next question is from Mark Murphy from Piper Jaffray, your line is open.

Mark Murphy - Piper Jaffray Companies

Jim, I also wanted to ask you about OpenStack; in almost recent survey of Red Hat resellers, the Red Hat OpenStack product actually ranked higher in terms of momentum than any other Red Hat products has in the last three years. So I am curious how you think OpenStack feels at this stage, understanding it’s a very early stage, but in terms of buzz or enquiries, downloads, pilots, RFPs; all those kinds of leading indicators how does that feel relative to how RHEV sales or Gluster sales at this particular stage? And would you say that your conviction in the size of the OpenStack opportunity is changing at all just given what you -- given the commentary that you gave us upfront on the -- in the prepared comments.

Jim Whitehurst

Yes, obviously there is substantially more interest in OpenStack, frankly than there has been in really any products since Linux. There’s a huge need for cloud infrastructure and there are not a lot of alternatives out there, most of the industry has declared that they are behind OpenStack, so you know, there’s just a lot of organic interest where things like RHEV, you know Red Hat had to go out and create it. So substantially more and that’s really what’s driving our relative bullishness in investment in as we go through this year, but yes, a different zip codes than RHEV or Gluster.

Operator

Our next question is from Gregg Moskowitz from Cowen and Company. Your line is open.

Gregg Moskowitz - Cowen and Company

Thank you very and congratulations. Jim you’re seeing at least by all accounts is what we hear a significantly growing business with third party customers that are running virtual instances of RHEL in the public cloud and it all sounds as though OpenShift continues to gain pretty strong momentum there as well. Do you have any sense on the RHEL side, how much of that public cloud business at this point is incremental versus cannibalistic?

Charlie Peters

This is Charlie, we've [indiscernible] couple of statistics, we looked at the public cloud contribution and we're up 40% at the end of the year from where we started from last year in terms of what’s coming from third party customers running virtual instances in public clouds. We have had a discussion with a very large cloud provider indicated to us that about 55% of their workload, they have surveyed their brand new customers to Red Hat the new business and is very consistent, it looks sustainable and growing every month. And as a survey done every quarter and those results are consistent between 55% and 60% of the revenue of the customer count, from those customers revenue are brand new to Red Hat, so it’s great to see.

Operator

Our next question is from Kash Rangan from Merrill Lynch. Your line is open.

Kash Rangan - Bank of America Merrill Lynch

Charlie, I think it’s your 10th year as CFO so nice to see the very consistent execution in the financial results, remember meeting with you the first time when the stock was about 20% of its current level so nice job on that. My question on OpenStack is, when you look at some of the levers you had with RHEL 6 you had a price increase lever for more than two socket servers and I think you had uplift from the fee-to-fee what not. As you look at the RHEL 7 cycle. What are the -- if you can walk through what could be the levers that could help your customer wallet share at a unit level? Where are the incremental opportunity from this cycle versus the last cycle? Thank you very much.

Charlie Peters

Kash, it’s a good question, that's one -- I think the appropriate answer is we’re going to go through in a lot of depth at the Red Hat summit and so we hope you’ll come to get some of the technical side of it. There is some significant differences in the technology from where we are with the RHEL 6, the early feedback in the beta is really good. But I think I’ll leave it at that, and from a pricing perspective we don’t really don’t have anything that we would announce until something was announced.

Operator

Our next question is from Keith Weiss from Morgan Stanley. Your line is open.

Keith Weiss - Morgan Stanley

Thank you guys for taking my question, very nice quarter. In fact it looks like you guys really exited FY14 with a really nice steam, with billings growth accelerating to in the back half like 22% in the back half. Against that sort of 20% plus billings growth in the back half of FY14, the revenue guide for FY14 is 13.5 at the midpoint used to be a pretty big deceleration. Can you help us understand that disconnect? What are you seeing in the business that will cause that type of deceleration into FY15?

Charlie Peters

I think Keith Weiss, I will start with is the total backlog, the deferred revenue plus the off balance sheet backlog the 14% growth there is a pretty good indicator of what you would expect to see in the coming years revenue and so you see a guidance it's very similar, but that’s a reasonable starting point. The newer technologies that we want to invest a lot in are still small by comparison but can be meaningful in subsequent year; the subscription model has expenses at least a year or two before meaningful revenue. But the starting point would be the backlog growth in the prior year.

Operator

Your next question is from Brent Thill from UBS. Your line is open.

Brent Thill - UBS Investment Bank

Just a follow up on the backlog growth. I think in ‘12 and ‘13 you were in high teen backlog growth, and this year you had 14%. Is there something that’s changing in terms of the structure the contract in terms of seeing the decel in terms of growth where you are just kind of working up a much bigger base that would describe that deceleration?

Charlie Peters

Yes, there's probably two things I would point you to, one is the average contract duration is still around 21 months but if you look at the portion that is within 12 months at the end of the year we are at 76% to 24% which is the portion that goes beyond the year, there is a slight difference. In both years, this year and last year it rounds to 21 months, but there is a slight shortening this year that accounts for a part of it.

The second thing I would mention is this idea of the public cloud revenue, it is -- it’s revenue that is reported for activity in the prior month and therefore when the report comes in it’s an immediate billing, there is no deferred revenue, it’s immediate billing and immediate revenue. So maybe a little bit of change coming there as well.

Operator

Our next question is from Michael Turits from Raymond James.

Michael Turits - Raymond James

One billing question and one fundamental question. On the billing side obviously there was very strong bookings quarter close to last year. How much of the strong billings of this quarter was a function of just a billing that got booked in the year ago fourth quarter close? And I’ve got a another question.

Jim Whitehurst

I mean one measure of that is it’s off balance sheet backlog, the total off balance sheet backlog this year was in excess of 270 last year it was in excess of 280 and as I said it’s important to note that the portion billable was in the next 12 months actually went the other way, increased by $10 million, so this year it’s in excess of 190 billable in the next 12 months. So depending upon how you look at that you could say it’s either 10 million negative or 10 million positive to that total billings number, either way it’s rounding error on the total billing for the quarter it would be really good quarter regardless.

Michael Turits - Raymond James

Okay. And then on the fundamental side back to focusing on Linux and we’ve historically asked you about UNIX to Linux migrations. One of the things that turned in the last quarter so was a big pick up and focus from IBM on the move to Linux on power. Any positive impact there at all?

Jim Whitehurst

Well, I mean, it’s great to have them continuing to talk about moving mission critical workloads over, that will clearly have an impact for us. Those were conversations that generally take a while so I wouldn’t say we've seen anything that the numbers yet but it’s great to see IBM recognizing the power of that OS on the power chip. So we should see that in the future.

Operator

Our next question is from Abhey Lamba from Mizuho Securities. Your line is open.

Abhey Lamba - Mizuho Securities

Yes, thanks. Congrats on a good quarter. Charlie just revisiting your revenue guidance comments. I understand 14% backlog growth and that’s where the revenue growth is more or less. But there are some elements that are not in there like cloud revenue you mentioned [indiscernible]. So should we gain, are those numbers too small to make an impact right now and when should we expect those numbers to become meaningful where we start seeing acceleration in revenue growth for you guys?

Charles Peters

Hey, the numbers are still small and off that they are not going to change in a meaningful way of $1.7 billion total number but I think the growth rate we’re seeing there is very good, it continues on that pace it obviously over time it’s going to be meaningful.

Operator

Our next question is from Ross MacMillan from Jefferies. Your line is open.

Ross MacMillan - Jefferies LLC

Thanks. Charlie I am going to have one more go on the revenue guidance. Is there anything you can say about prevailing FX rates and the impact of prevailing rates that would have on the growth rate? And then my follow up would be, Jim, can you just give us a recap on which sort of large tech OEMs have formally agreed to partner with Red Hat around OpenStack certifications? Thanks.

Charles Peters

Yes, the first question on foreign exchange, as I said on pegging this guidance at a rate that has a euro that’s about 2% stronger and a yen about 2% weaker than the last year and those are only two of the currencies they have, its two important currencies for us but frankly if you went through the whole list of currencies which you can do by looking in our website you’re going to see that the Latin American currencies have depreciated significantly 20% plus and the Indian currency, the Australian currency have all depreciated somewhat. So there is -- there probably is some additional FX impact in those numbers, but the two biggest currencies still are going to be the yen and the euro.

Jim Whitehurst

In terms of officially, I mean Dell has gotten fully behind Red Hat’s OpenStack Alcatel-Lucent has as well on the telecom equipment providers, yes we’re working actively with the other major OEMs, I think we’re making great commercial progress is yet to have them say that we’re their only choice, but we’re actively I think making great progress with several of them, come to the summit.

Operator

Our next question is from Kirk Materne from Evercore.

Kirk Materne - Evercore Partners

Hi. Thanks very much guys. By all accounts you guys had a very strong year in terms of Middleware business. I was just wondering could you give us some color on how that’s trending, you’re heading into this fiscal year obviously continue to contribute the same type of growth rate even on larger numbers or I guess just how are you thinking about that heading into fiscal ’15? Thanks.

Jim Whitehurst

That’s a great question and a great setup. Middleware had a great year and for all of you who’ve been waiting for a long time to sign some further breakdown as the number that if you come to Analyst Day on April 16th we’re going to share some further breakdown there. But in summary for this call, Middleware has had a great year, growing quite a bit faster than what I would call the base business or the Linux business.

Operator

The next question is from Tim Klasell from Northland Securities. Your line is open.

Tim Klasell - Northland Capital Markets

Yes. My congrats as well. Just a quick question on linearity and I think Charlie you mentioned that it was more linear than in the past. Are we back to where we were in the pre-financial crisis linearity or may be you can give us some color on that? Thank you.

Charles Peters

Sure. Well, first of all, fourth quarters for us are generally a more linear quarter than any other quarter in the year because a number of companies have the December 31 year end. So, we book a good bit of business in December and then of course because it's our year end, our guys are working hard anyway to close things by the end of February. So, generally is more linear. I went back over the last six years or so and we only had one other year in the last six years that had as good linearity as this year did in the fourth quarter. So, I don’t know whether, Tim, whether it is a sustainable -- you know whether that linearity was a fluke for the quarter or not but we were very pleased to see it and we like that kind of thing.

Operator

Next question is from Steven Ashley from Robert W. Baird. Your line is open.

Steven Ashley - Robert W. Baird

Thank you. Just like to ask a very high level question, if you step way back, you saw you growth accelerating in billings to 20% plus in the second half of the year. What do you think is driving that accelerated growth?

Jim Whitehurst

Well, we just had an awful lot of large deals as Jim mentioned, over 70 deals, over $1 million that’s a substantial jump from where we’ve been. In some cases that’s simply maybe the timing of the deals and the billing terms as we’ve said before. In many cases I would say, you may want to be thinking about fourth quarter rolling average billings number. So, I don’t want people to get euphoric with the 24% but also don’t know think people should get desponded if it’s a lower number, we’ve seen that over the last year or two. As I’ve said billing is one metric, we had a great quarter, the guys really worked hard and we have a lot of big deals. That's kind of it in the nutshell.

Operator

Our next question comes from Ed Maguire from CLSA. Your line is open.

Ed Maguire - CLSA

Hi, good afternoon. I was wondering if you could characterize going back to the core RHEL business, the relative impact of UNIX to Linux and Windows to Linux conversions and also to what extent some of the true-up that you’ve had in the past have played a role in the quarter.

Charles Peters

Sure, so, I mean everybody knows that there is the UNIX to Linux conversion is winding down a bit, if you look, but however if you look at the information from IBC it’s still got a long ways to go. I think it is true that the Windows to Linux conversion is picking up or seeing more of that IBC is predicting that. Another factor that I don’t think we talk about much is the embedded use of Linux and a whole lot of other technologies, we got to have a big effort going on that to increase our sales with manufactures that may use it in an embedded area, so that’s another area the free to pay continues to make progress. So, it’s a number of factors and again, we’ll probably go through this in a lot more depth at the Red Hat summit on April 16.

Jim Whitehurst

Yes, we talked about our large renewal growth at 20% and obviously there is cross-sell in that but there is still core at our core customer solid double digit growth in our renewals and that’s obviously faster than computing growth. And so, that I mean it’s combination of all the above, its new workloads, it’s migrations from Windows, migrations from UNIX, it’s hard for us to break it out in total but we can clearly see that we’re growing share with our core customers.

Charles Peters

And I guess the last thing I’d say it’s also the rapid growth of virtual instances by which we get paid.

Operator

Our next question is from Walter Pritchard from Citigroup. Your line is open.

Walter Pritchard - Citigroup

Hi thanks, Charlie, I wanted you just talk us through. You had a really strong off-balance sheet backlog this year or last year, this year that metric was just flat. You had the billings last year were a little weaker. This year, they're strong, I’m wondering if there is some sort of renewal cyclicality that’s going through those numbers – to help us understand that.

Charles Peters

I think that’s a good question because it is important to note that if you have a three year deal, obviously it’s going to be three years before you see that again and so there is some of that but it happens all the time, it’s hard to identify an individual transaction or even a group of transactions that would be necessarily significant but this is what I refer to as the natural ebb and flow of the business when you have -- we had big transactions three years ago, those big transactions maybe renewing this year. If you didn’t have those and obviously they would not. That renewals and timing is definitely going to be a factor.

Operator

Our next question is from [indiscernible] Deutsche Bank. Your line is open.

Unidentified Analyst

Hi, thanks Charlie, just a couple of questions on the operating margin guidance. I think the street in general was looking for flattish operating margins this year. Looks like it will be down 100 basis points, I’m wondering if your view of your margin projections changed that all during the quarter and if they did what might have been the catalyst for that and a related question is I guess if you’re going to do Q1 operating margins of 21 and in the year of 23-25 they need to reaccelerate after Q1. So, perhaps you could offer little color on sort of the quarterly progression of that margin and spend. Thank you.

Charles Peters

Sure I think that at the end of the Q3 call, I’d try to set the stage for we believe we’ve had a significant growth opportunity ahead of us and some of these new technologies. We made a firm decision in our fourth quarter that is exactly what we want to do. We want to invest and we think we have a reasonable balance of growth and profit but there are times in the market when you have to take, go for it and this is definitely one of them.

So, we are, as I said in my prepared remarks and I think Jim did as well, we are going to be adding engineers, sales people, support people, consultants, trainers to go after this market including OpenStack.

Relative to Q1, there is a whole lot of things that sort of come in together in Q1 that are causing that. Last year our Red Hat Summit was actually in the second quarter, this year it’s in April, so that’s one significant event. The second thing is the OpenStack Summit which is being held in Atlanta in May is sort of a new expense for us and we intend to be present there. And we have a lot of other significant marketing things we are doing in Q1 as well as the hiring. So, that basically sums it up and you are quite right, margin will improve quarterly thereafter and I would assume that that improvement would continue right on into the following year.

Operator

And we'll take our final question from Derrick Wood from Susquehanna. Your line is open.

Derrick Wood - Susquehanna Financial Group

Great, thanks. Just a question on the UNIX to Linux migration phase. There is a lot less UNIX than say five years ago, so should we expect RHEL growth to kind of increasingly be driven by x86 workloads and maybe a little less from UNIX to Linux?

Charles Peters

It’s entirely possible but what you will see here is increased Linux from the Windows conversion, also from embedded as I said and then the virtual instances running either in the datacenter or maybe even a public cloud. I think you are going to find a fair amount of revenue from that. But I do think there is a lot of runway left on UNIX, so don’t sell it short as I said IDC statistics show up a pretty good runway for at least the next five years.

Jim Whitehurst

Well, thank you very much everyone and hope to see you all at Red Hat Summit. If you need any registration information please reach out to myself or Sarah Walas in the Investor Relations. Have a good evening. Thank you.

Operator

Thank you. This does conclude today’s conference call. Please disconnect your lines at this time and please have a wonderful day.

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