Good afternoon, my name is Casey and I will be your conference operator today. At this time, I would like to welcome everyone to the Red Hat Fourth Quarter 2011 Earnings Conference Call. [Operator Instructions] I will now turn the conference over to Mr. Tom McCallum, Vice President of Investor Relations. Sir, you may begin.
Thank you, Casey. Hello, everyone and welcome to Red Hat's earnings call for the fourth quarter and full fiscal year 2011. 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 will 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 and prospects, including the statements containing the words believe, anticipate, plan, project, estimate, expect, intend or will, constitute forward-looking statements for the purposes of the Safe Harbor's provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those disclosed in the company's most recent quarterly report on Form 10-Q filed with the SEC, as well as the safe harbor statement in today's press release.
In addition, any forward-looking statement represents our estimates or views only as of today, March 23, 2011 and these views or estimates 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 it over to Jim.
Thank you, Tom and let you me add my welcome to all of you who are joining us on today's call. Before I begin, I would like to express my deepest sympathies to the people of Japan and our Red Hat Associates and their families. We continue to monitor the situation and are collaborating with our local team on how to best support relief efforts.
Now, I'm pleased to report that our fourth quarter was a strong finish to a record year for Red Hat and above was highlighted by revenue and profitability that were well above our guidance. Here are just a few of our financial highlights. Record billings of $318 million for the quarter, up 31% year-over-year. Q4 revenue was up 25% year-over-year and every quarter this year, we grew faster than 20% on a year-over-year basis. 110 basis point improvement in our operating margin for fiscal 2011, even while we continue to invest aggressively in our key growth initiatives, mainly through hiring in sales and engineering. Finally, we delivered record operating cash flow for the quarter and for the fiscal year.
I want to thank our global team of Red Hat Associates for their strong execution that drove these outstanding results. With record bookings and billings in the fourth quarter, we are on a clear path to becoming the first pure play open source company to achieve $1 billion in revenue during our next fiscal year, a milestone achievement for Red Hat and the open source community.
Red Hat's growth indicates that we are continuing to gain market share. Our growth reflects strong demand from customers who are modernizing their data centers and preparing their infrastructure for cloud computing. The comprehensive portfolio that Red Hat has developed with platform, virtualization and middleware products provides enterprise customers with a foundation to deploy the next-generation IT infrastructure. Red Hat is recognized as one of the leading providers of value among all IT vendors and we believe that we are well-positioned to again deliver double-digit organic growth in fiscal 2012.
Let me now share a few of the business highlights from Q4. First, our platform offerings had a tremendous quarter, with record billings and the highest Q4 growth rate in three years. We experienced broad demand across our top verticals, as well as from new mainstream customers. From a competitive perspective, we won many deals this quarter against other operating systems, including UNIX, Windows, clones and other Linux brands. An interesting example was a win with the Qatar Stock Exchange, where we replaced Windows with RHEL. The customer cited better security and reliability as two of the main considerations. This adds another exchange to the list of the world's equity trading platforms that use Linux.
Our middleware solutions also had a strong quarter as companies reassessed their traditional vendors and are increasingly choosing Red Hat's higher value alternatives. In December, IDC published a commission white paper surveying a number of large U.S. enterprises that switched to JBoss. On average, the companies in the study reduced time and developer hours to develop custom applications. They reduced their infrastructure and management costs and were able to develop 50% more applications per year. Over a three-year period, these companies generated an ROI of over 500% and paid back their initial investments in less than six months.
In the cloud space, we grew the number of customers using our RHEV product to over 500. We announced the availability of RHEL on Fujitsu's On-Demand Virtual System Service. And we closed a renewal this quarter with a large cloud provider that was a 300% increase from their prior commitment.
Moving onto renewals. For the quarter, we renewed 24 of the top 25 deals scheduled to renew this quarter, and those that renewed did so at over 130% of the prior year's value. For the year, we were 99 out of 100, with an upsell of well over 120% of the prior-year value. This clearly demonstrates the value our largest customers see in relationship with Red Hat.
Before turning the call over to Charlie, let me summarize some of the results from our key growth initiatives. As a reminder, these are multiyear initiatives designed to position Red Hat for the future. First, we continue to expand our marketing and commercial capabilities to further drive adoption outside of our core verticals, in industries such as logistics, healthcare, transportation, retail and energy. And for the second year in a row, we experienced over 150% growth within these mainstreams verticals and our quarterly top 30 deals as compared to last year. Second, we are pleased with the results of our free-to-paid conversion program this year.
In the fourth quarter, we had two six-figure deals that included a free to pay component, along with several others that were closed during the year. Our third strategic initiative is to further enhance our routes-to-market distribution model. And I'm pleased to announce that for the full-year FY '11, we reached our goal of a 60/40 split between channel and direct sales. Our fourth and final initiative is to execute on our technology roadmap to enable us to maintain and extend our technology leadership position. This year, we launched several major releases of our core products. In addition to our flagship, Red Hat Enterprise Linux 6 operating system, we launched the JBoss Enterprise application server 5.1. JBoss Enterprise SOA Suite 5.1, JBoss Portal 5.0, Red Hat Enterprise Virtualization 2.2 and our Cloud Foundations strategy. In May, we will hold our Red Hat Summit in JBoss World in Boston where we will be updating our users on new developments in our product roadmap.
In summary, I'm pleased with our fiscal 2011 results. Red Hat continues to gain mind share and wallet share. I believe that Red Hat is well positioned as we are strategically at the center of several major technology trends in the data center. Once again, I want to thank each of our Red Hat Associates around the globe for their hard work that delivered these great results. I'm confident that they will remain focused on delivering value for our customers and stakeholders in the year ahead. With that, let me turn the call over to Charlie.
Thanks, Jim. In the fourth quarter, we experienced strong demand across all geographies and products and solid execution as well. Our report today reflects this with quarterly billings in excess of $300 million, annual billings in excess of $1 billion and deferred revenue of over $750 million. As Jim discussed, we believe that we are clearly on a path to becoming the first, pure-play open source company to achieve $1 billion on revenue. In percentage terms, quarterly billings grew more than 30%, total revenue grew 25%, operating income grew over 30% and operating cash flow grew over 20%, all compared to last year's strong fourth quarter results.
In addition to growing throughout the economic recession, our fiscal 2011 performance shows that Red Hat's value proposition is equally compelling for our customers as the economic climate and IT spending environment improve. Our results also indicate that we continue to gain market share. Importantly, we accomplished these quarterly and annual results while continuing to invest for the future. For example, during fiscal 2011, we added substantially to our engineering support and sales staff, including overlay teams to drive further adoption of our middleware, virtualization and cloud computing solutions.
In total, we ended the year with over 3,750 employees. We also invested in our partner program to expand our international reach. We acquired Makara to build upon our cloud foundation strategy with platform as a service technology and we delivered major releases of our product portfolio. We believe these investments will position Red Hat for continued growth in fiscal 2012 and beyond, which I'll discuss in a moment.
Let's discuss the financial results. We're pleased to report another record quarter for both bookings and billings. Billings growth accelerated each quarter from our first quarter, as we added new customers and expanded our strategic position in data centers around the globe. This acceleration led to Q4 billings growth that was the fastest in 12 quarters. Let me share with you a few of the statistics from the top 30 deals in the quarter.
We had for the first time ever, all of the top 30 deals were greater than $1 million, 67% higher than the previous record. One deal is over $5 million and 11 or 37% of the top 30 deals included the middleware component and five of those were exclusively middleware. We experienced solid demand across all of our core verticals, as well as more mainstream customers such as healthcare and energy. As I've done on other year end calls, I'll add a few additional statistics about bookings.
To be clear, some of the prior years, we will not be updating milestone bookings achievements or reporting booking statistics on a quarterly basis. We had strong double-digit bookings growth every quarter this year, which led to a milestone year of total bookings over $1 billion, up over 20% year-over-year. The average contract duration for the year was very close to last year's, at just under 21 months. But interestingly, we have seen an increase in customer willingness to pay for long-term deals upfront, including long-term deals through channel partners. This change is reflected in the renewed growth and long-term deferred revenue after almost two years with little change. Our off balance sheet backlog, that is the portion of customer contract to be billed in the future, behaved in similar fashion to last year. We ended the year with backlog in excess of $190 million, of which approximately $120 million is expected to be billed in fiscal year '12. As a refresher, bookings that are billed increased deferred revenue and bookings that are not billed increased off balance sheet backlog. It should be apparent that the increase in long-term deferred revenue limits growth of off balance sheet backlog.
Our billings proxy for Q4 set a new record at $318 million, up 31% year-over-year and the highest growth in three years. As a reminder, our billings proxy is calculated by adding revenue to the change in deferred revenue shown on the cash flow statement, which excludes the impact of foreign exchange rates on deferred revenue.
Moving on to bookings by channel and geography, our Q4 bookings mix was 59% from the channel and 41% from direct sales versus a very similar 60/40 split in Q3 and for the year. This split reflects the investment we've made in our channel business over the last few years. Our geographic split remains little changed, with 57% from the Americas, 27% from EMEA and 16% from APAC, essentially in line with Q3's split, which was 56%, 28% and 16% respectively. For the year, we saw strong 20% plus growth in every region.
Now, let's talk about our financial performance for the quarter starting with revenue. Fourth quarter revenue was $245 million, up 25% from the prior year and well above the high end of our guidance, which was $236 million. Strong demand, better linearity and sales execution overall, including better-than-expected up selling and cross-selling were important factors. Subscription revenue for the quarter was $209 million, up 24% from the prior year. Subscription revenue, which is a renewable revenue stream, constituted approximately 86% of total revenue in Q4. Training and Services revenue was $35 million, up 33% from a year-ago quarter and down over $1 million sequentially as a result of holiday downtime in customer sites around the globe. This performance is slightly better than our guidance from the third quarter earnings call.
Now, I'll discuss the rest of our results on a non-GAAP basis, excluding stock compensation expense, amortization expense and for fiscal year '10, a litigation settlement. Overall gross margin was 84.2% for Q4, in line sequentially and down from the prior year due to higher services in the mix and lower services margins overall. Subscription gross margin remained consistent with last year and last quarter at 93.8%. Q4 non-GAAP operating expense came in at $145 million, up 3% sequentially, and up 19% from the prior year. In Q4, we continued to hire aggressively for sales, engineering and support and we've expanded our marketing programs.
Q4 non-GAAP operating income increased 31% from last year, resulting in a Q4 non-GAAP operating margin of 24.9%, up 110 basis points year-over-year. Net interest income was less than $2 million, down approximately $500,000 from the prior year, principally due to lower interest rates. Other income, which is primarily net investment gains and losses and foreign exchange was a loss of approximately $1 million, down $1 million from Q3 and down $5 million from Q4 of last year. Our annual effective tax rate is 30% for both GAAP and non-GAAP results, rather than the 35%, which we have been estimating in earlier quarters. As a consequence, the Q4 tax rate is unusually low at 17% in order to adjust to this annual rate. The lower rate includes the benefit of approximately $0.02 a share from the retroactive reinstatement of the U.S. R&D Tax Credit, which I discussed on the Q3 earnings call. And as well as other changes to our state and foreign taxes, which are likely to be more permanent. I'll discuss this further when I get to guidance. Our non-GAAP diluted earnings per share is $0.26, up 37% compared to non-GAAP diluted earnings per share last year of $0.19 in the fourth quarter.
Now, let's turn to the balance sheet and the cash flow statement. We ended the year with $1.2 billion in cash and investments. We repurchased approximately $11 million of Red Hat common stock in Q4, which brings total purchases to $90 million for the fiscal year. We have approximately $220 million of authorization remaining on our repurchase plan. We are pleased with the consistency of our days sales outstanding, which we believe is a function of the satisfaction level of our customers. DSO was 50 days for Q4 versus 56 days last year. As a reminder, since days sales outstanding is traditionally a measure of receivables versus billings, our DSO calculation includes revenue plus the change in deferred revenue. This improvement in DSO was helped by good sales linearity in the quarter.
Total deferred revenue at quarter end was $772 million, an increase of $126 million or 20% over the prior year end. This increase was $92 million in current deferred revenue and $34 million in long-term deferred revenue. As a follow-up to my comments about bookings and customers' willingness to pay up front, please note that long-term deferred revenue grew 21% for fiscal year '11 compared to virtually no growth last year. Excluding foreign currency rate changes, the year-over-year change in deferred revenue as shown on the cash flow statement was $113 million, that's up 36%.
Moving to the statement of cash flows, we produced record quarterly operating cash flow of $95 million and full year operating cash flow of $291 million, slightly above the high end of our guidance range.
Now, to briefly recap and summarize highlights for the full fiscal year. Revenue grew to $909 million, up 22% year-over-year and above the high end of guidance. Subscription revenue grew to $773 million, an increase of 21%, while services grew 24%, well above the historic services revenue growth rate of 5% to 10%. Non-GAAP operating income grew by 27% and non-GAAP operating margin expanded by 110 basis points to 24.8%. We ramped hiring and investments for growth all year long as we said we would. Non-GAAP EPS was $0.83 and exceeded the high end of guidance of $0.74, which I provided at the start of the year. This beat of $0.09 is roughly half from operating income and half from a better tax situation. Overall, it was a great year. Now, I want to shift to fiscal 2012 guidance. Since foreign exchange rates are still somewhat volatile, let me say that this guidance is based upon yesterday's euro and yen rates. I'm not trying to forecast those foreign exchange rates, I'm simply pegging guidance at that point. While revenue may increase or decrease if foreign exchange rates change, please keep in mind that changes in operating income as a result of currency swings are generally much smaller.
As for guidance, we are forecasting total revenue in the range of $1,050,000,000 to $1,070,000,000 for fiscal 2012, representing an annual growth rate of up to 18% in U.S. dollars. This growth rate assumes that subscriptions will grow faster than services revenue and that service revenue growth will slow. We believe that we can again expand our full-year non-GAAP operating margin and we are targeting approximately 25.7%, while also investing in future growth opportunities. I'm estimating full year net interest income of approximately $6 million or $1.5 million per quarter, which is a very modest reduction from fiscal year 2011. However, please note that I'm not expecting any net investment gains and other income. We have good news on the tax front. Many of the changes in the fiscal year '11 tax rate are likely to positively impact us for a number of years. As a result, the estimated annual effective tax rate for fiscal year 2012 is 31%, 400 basis points lower than most models.
We will continue to report non-GAAP net income and EPS using our expected GAAP tax rate. There is additional good news on the cash tax front. That is, we still expect our cash tax rate to be about 5% throughout fiscal year 2012, principally as a result of stock compensation deductions. We have large tax credits carryforward but due to the amount of stock compensation deductions available, few of these tax credits are likely to be utilized in fiscal year '12, but rather will be carried forward to be used in future years. Assuming a 31% tax rate and approximately 200 million diluted shares, one would estimate diluted non-GAAP EPS in the range of $0.94 to $0.96 a share.
As you work through your models, keep in mind the differences in other income and taxes between fiscal year '11 and fiscal year '12. On a GAAP basis, we estimate quarterly stock compensation expense of approximately $20 million and quarterly amortization expense of approximately $5 million. From a cash flow perspective, we anticipate operating cash flow for the full year of between $330 million to $340 million. I expect additional cash flow of $35 million to $40 million, not included in GAAP operating cash flow, which is related to tax savings from excess tax benefits from stock compensation. This will be recorded in our cash from financing activities line as it has been for the past few years. CapEx is still expected to be relatively modest at less than 5% of revenue in the $40 million or $50 million range.
Finally, looking at Q1, we offer the following guidance. Revenue is estimated to be between $252 million and $255 million. Non-GAAP operating margin is estimated to be approximately 24 1/2% to 24.9%, reflecting higher sales and marketing costs from new hires and costs related to the Red Hat Summit to be held in early May. Using my earlier estimates of quarterly interest income of $1.5 million and a 31% tax rate, non-GAAP EPS is estimated to be approximately $0.21 to $0.22. Consistent with my past practice, I do not guide quarterly cash flow because it can be quite variable depending upon large payments or receipts. Following up on Jim's comments about Japan, let me add that all of our associates are safe and our offices in Tokyo and Osaka are undamaged and fully operational. Customer support for Japan has continued uninterrupted as a result of tremendous work by our associates in Japan and elsewhere. However, many Japanese businesses have experienced problems and others are still assessing the impact. Because of our subscription model, I expect no significant effect on Q1 revenue, but it is probable that we may have some delay in Q1 Japanese billings, possibly up to $5 million. We will assess future quarters as more information becomes known.
To conclude, we are very pleased with our results for the fiscal year 2011 and we believe that we're well-positioned to gain market share and grow. We are continuing to invest in areas, such as virtualization, cloud computing and middleware but we're also prudently managing costs. We are optimistic about this fiscal year and the forward-looking pipeline continues to look strong.
Before turning the call over to the operator, I'd like to remind our financial communities to register for your executive VIP pass to the 2011 Red Hat Summit in JBoss World in Boston, Mass., where we will host a financial analyst meeting on May 4. Operator, I would now like to turn it back over to you for the first question.
[Operator Instructions] Our first question will come from Heather Bellini of ISI Group.
This is Perry Huang for Heather. I just had a question about operating expenses in the upcoming year. You mentioned that there's no significant impact to revenue for Japan in the first quarter. How should we think about OpEx seasonality for the year? Would it be reasonable to think about flexibility with OpEx given changes? Any changes in Japan's revenue or is this still a bit too early to kind of make this sort of decision?
Just in seasonality generally, let me comment, as everyone I think knows, we have seasonality in regards to our bookings and our billings. Our fourth quarters are always the strongest quarter of the year. Our typical pattern is that the first quarter is somewhat lower and it grows from there. It's a very consistent pattern year after year. As regards expenses, I think we have demonstrated that we can manage expenses well in relation to our revenue. And I don't see anything unusual in particular in relation to what's going on in Japan right now would have an impact on Q1 expenses.
Our next question will come from Kash Rangan from Merrill Lynch.
Kash Rangan - BofA Merrill Lynch
One question for you, Charlie, and if I could. A very quick follow-up as well. Last year, when you gave guidance, you sounded pretty conservative and you ended up being -- as I think about two times the growth rate that you originally anticipated. As you look at the guidance this year, you've got server units potentially slowing down. It seems that's the viewpoint that's accepted. How do you feel about the degree of conservatism of your guidance? Maybe there is some one-time or Red Hat specific drivers that help us understand why the revenue growth rate is as high as it is? Related to -- as opposed to server unit growth rate, which many people are looking for sharp deceleration. If you could just touch upon that, that will be great.
Kash, it's also to the question about the server growth rate. Let me just say that the server growth rate is one factor that influences Red Hat. It has becoming a much smaller factor over the years. We have a very large installed base of existing customers, with renewable subscriptions and regardless of what's happening with new business, the renewal business forms a great solid base. In addition to that, we have, I would say, changes and health coming from different sorts of tailwinds. Middleware, growth has been terrific. The offerings are still early on. The free-to-pay initiative has been making good ground. So Kash, to sum up on how I feel about guidance, I believe that first of all, I think our associates this year [indiscernible] terrific job of beating the guidance I gave. The way I give guidance, I think is consistent with the way I provided guidance. At this time, I believe it's consistent with my past practices.
Kash Rangan - BofA Merrill Lynch
And if I could quickly sneak in, RHEL 6.0 is out, are you seeing any improvement in renewals as a result of RHEL 6.0, especially among indirect channel partners?
I think it's too early to see anything specific on RHEL6 around whether that will impact renewals or not. In general, as we continue to improve our systems and processes, we're certainly seeing improvements in renewals. I don't think that you'd ascribe that directly to RHEL6.
Our next question will come from Bhavan Suri from William Blair.
Bhavan Suri - William Blair & Company L.L.C.
You commented about better-than-expected cross-selling and up selling, is that sort of uptick of the middleware products in the RHEL base, that's the big base you've talked about? Or what exactly is that? A virtualization of middleware based. And then sort of why was it better than you expected? Is that some of the sales training that's beginning to pay off now or is there something else there?
I think it's a bit of both. I mean obviously, RHEV, our virtualization is bought by the exact same buyer. So there is some of that. But we saw I think, much better up selling, cross-selling middleware than we've seen in the past. I do think, as Charlie said, we've made some significant investments over the course of last year in overlaid sales force and building out our middleware sales capabilities to work within our existing sales structure. And I think that certainly has led to even better results than we were expecting and certainly, we'd like to see that continue.
Bhavan Suri - William Blair & Company L.L.C.
One quick question on the RHEV side of things, how are you sort of seeing adoption in the data center there? It's great to hear about the public cloud adopters and all the rest of it, but -- sort of can u give us a sense of how adoption's progressing in the private data center or in your corporate customer base?
Well as you can imagine, users of RHEL are very confident in and capable with a KVM or Linux-based hypervisor. So we see a lot of interest and a lot of POCs within our existing install base, which you can certainly imagine. We're also now, I think being pulled into most of what I'd say kind of the new Greenfield opportunities out there. That's really been our focus. We're not trying to get it right at VMware in their installed base. We're really making sure that we're working with our existing great customer relationships and greenfield opportunities. I think that's going quite well.
Our next question will come from Adam Holt with Morgan Stanley.
Adam Holt - Morgan Stanley
I have two questions about your guidance. I know you're not guiding to billings but if you look at the midpoint of the revenue guidance for the year, it's about 17% growth. Generally, what would you expect the relationship of billings growth to be to that revenue? And then I have a quick follow up on cash flow.
Adam, you're right. I'm not guiding on billings growth. Frankly, it's a bit of an unknown at this point. But the bookings and billings historically are better than revenue, which results in the off balance sheet backlog growth and/or the deferred revenue growth. But I don't have a specific number for you for that.
Adam Holt - Morgan Stanley
And then, just I guess a question on cash flow, would also be about relationships. If you look at the cash flow guidance for next year, it implies an acceleration on the growth rate this year, which is terrific. But generally, how should we be thinking about the relationship with the growth rate for cash flow relative to billings. And is there a chance to see potentially cash flow accelerate to be in line with billings or even better than billings overtime?
The principal driver of cash flow growth is coming from the net income growth and the change in the non-cash items on the cash flow statement. If you go back and look over time, you'll find the working capital items, all of them added together and sort of net out at the same number every year. So the growth of the cash flow is principally related to the net income growth.
Our next question will come from Steve Ashley from Robert W. Baird.
Steven Ashley - Robert W. Baird & Co. Incorporated
Circling Back with Japan, you mentioned that obviously given your recurring revenue model, it wouldn't impact the reported revenue but it might have some impact on billings/growth and deferred revenue. Is there any kind of comment qualitatively, quantitatively you could make around what we might expect there?
Well the comment, at least quantitatively Steve is that for the first quarter, what I said was it could have an impact of about $5 million in billings. Now, obviously, it depends how long it takes for the situation there to normalize. Assuming it does normalize in the next quarter or two, it would be our expectation that, that would come back. And to the extent that billings relate to renewals, and there's simply a delay in getting the renewal, those renewals are very likely to come back with the full amount and the retroactive to the point when they should have been received in the first place.
So basically, if someone renews late, we still backdate the start date of the agreement and recognize the revenue along with that. So I wouldn't expect a significant impact on revenue unless there's a macroeconomic impact more broadly associated with this.
Our next question will come from Nabil Elsheshai from Pacific Crest.
Nabil Elsheshai - Pacific Crest Securities, Inc.
So first, you commented on improvement in renewals. I was wondering if you could give us any -- I'm assuming you mean across the board, if you could quantify that and how much leverage you have there going forward, how far you are along on that initiative?
So there have been a couple of things going on for some time. First of all, on the large renewals, we have really outstanding results as we've reported quarter after quarter. And we have talked about some new initiatives to continue to improve the retention rate on the other end of the spectrum, the very small accounts. And so we've done a lot of things to get better data on the customers, greater contact with the customers, third-party assistance in contacting the customers as a way to improve the retention and renewal of the very small accounts to grow them. It's hard to put a precise number on them other than qualitatively, we continue to improve. And we think that's still the case.
Our next question will come from John DiFucci from JPMorgan.
John DiFucci - JP Morgan Chase & Co
I have a question, I guess first question is for Jim. Jim, and it's a question on leverage. Even on the income statement here you beat the top line easily but the bottom line, if you excluded the lower tax rate and the R&D credit was about in line with what you were looking for. And margins were about in line with what you were looking for even though you exceeded the top line. Can you talk a little bit about that? Because it looks like most of that's coming from the sales and marketing side and it looks like you really haven't seen a lot of economies of scale over the last few years from sales and marketing.
I think that as we've always said, we will deliver roughly 100 basis points of margin improvement beyond that, the additional dollars we invest back in the business. And that's a combination of R&D in sales and marketing. One of the things that we were talking about earlier on the call was a significant improvement in cross sell and upsell. And that's directly related to investments we started making in the first half of last year, which are just now starting to show fruition of better cross-selling and by having overlays in middleware. So we have made the strategic decision. I think we've been very, very clear with The Street that we'll deliver margin improvement every year but beyond that, we put the incremental dollars from our performance to work to accelerate the growth of the business. So not seeing leverage is not that we can't create the leverage. It is a strategic decision to invest those dollars back to accelerate our growth.
Our next question will come from Michael Turits from Raymond James.
Michael Turits - Raymond James & Associates, Inc.
Two cash flow questions. First, I think your cash flow guidance is about 15% growth, which is less than 17% revenue. And I know that you're getting less in interest income but you also get a benefit on the tax side, I don’t know if you’re pulling all that down to cash and financing. And first question is, any other reason why we're not seeing that cash flow leverage in that? another cash flow question.
I'll follow-up to the previous answer. The principal driver of the cash flow for us is coming from the net income and the non-cash items related to net income. And it's not directly related to the revenue growth. It's the net income number. The faster we grow, the greater the working capital requirement. If you look at the year-end cash flow statement this year, you'll see a very rapid growth in receivables and a very rapid growth in deferred revenue. All from a cash flow perspective, those two things offset each other. Eventually, they do in fact turn in to cash flow. But the faster you grow, the more you put in working capital. So I guess my advice is to look principally towards net income and the non-cash items that affect net income for that growth.
John DiFucci - JP Morgan Chase & Co
And we talked about this last quarter of there being an increased investment in working capital. So I assume you think that, that will still continue to see with this higher growth, more working capital investment. And then this is just a housekeeping question. Of the $74 million cash increase in deferred revenue quarter over quarter, how much of that was from short term versus long term on the cash flow basis?
For the quarter, it was a $54 million increase in the short-term portion and a $20 million increase in the long-term portion. So that's the $74 million and the currency impact for the quarter added $9 million to the short term and added $4 million to the long term.
Our next question will come from Trip Chowdhry from Global Research.
Trip Chowdhry - Global Equities Research
I have a business model question. Looking at the way the customers are deploying your solutions, one very popular configuration is VMware ESX, I mean the host OS is Linux. On top of that, you have VMware hypervisor. On top of that, you have a lot of Red Hat Linux instances and the other of course is RHEV. I was wondering from Red Hat's perspective, who should we be thinking in terms of the revenues Red Hat gets from these two different and most popular deployments?
Business model perspective, I think in terms of Red Hat Linux, they would be basically the same in terms of revenue and how we'd look at revenue. Obviously, for the long term, having our customers kind of working with us across the range of their infrastructure. So their hypervisor as well, we believe, allows us to add significantly more value to the infrastructure. It's a significantly lower cost alternative, it's a higher-performance alternative. And overall, our business is about taking share in the data center. And the higher value of Red Hat infrastructure can be, the more value we add and the more overall our infrastructure grows. And so we believe that a Red Hat Virtualization solution, which is significantly higher value than its alternative, along with Red Hat Enterprise Linux, is a more powerful model that drives the customer to see the greater value and it still allows us to grow more quickly. But I don't think there's a direct revenue on a specific deal impact.
Our next question will come from Matt Hedberg from RBC Capital Markets.
Matthew Hedberg - RBC Capital Markets, LLC
Charlie, on the call, you talked about strength in the middleware but also slowing services revenue next year. And I guess I'm wondering, historically JBoss during seasonally corresponds with better services revenues. So I'm wondering if you can kind of talk to the dynamics there?
Best way to look at it, if you went back to fiscal year '10, we actually had -- there was no growth. It was dead flat, maybe slightly down to the prior year. And I think part of the growth -- the year-over-year growth we saw this year in percentage terms is simply because it came off a flat base. We're catching up a little bit to what should have happened in fiscal year '10 and then picking up fiscal year '11. We have said for a long time that the reason we are in services is to help our customers with subscriptions and to help drive our subscription business. And a more normal growth rate for our services business is probably closer to 10% and what we saw this year. But what you're saying is correct. Middleware is a services-led business and a fair amount of the services is connected with the middleware business.
And to put it very simply, we could add more services people and grow that revenue faster. The decision on the piece of that revenue growth is where do we need the people to get the optimal leverage between us and our partners to provide the services to drive subscriptions.
Our next question will come from Brad Whitt from Gleacher.
Bradley Whitt - Gleacher & Company, Inc.
Charlie, you mentioned that -- or you definitely saw an increase in your long-term deferred and you saw customers more willing to pay multiyear subscriptions, I guess. I was curious as to whether or not you have had any special incentives in place, either with the channel to your direct sales force to achieve that?
No, there were no special incentives and no special discounts. In fact, a lot of that did come through the channel. I think as we've said before, when business is done through the channel, they're typically collecting upfront and they're paying upfront.
Our next question will come from Derrick Wood from Susquehanna.
Derrick Wood - Pacific Growth Equities
What's the percent of your business that comes from three-year contract durations? And just curious, if you expect tougher comps in renewals in the back half of the year, given the tougher comps off of the slowdown in the second half of 2008?
The mix of the business was about 75% within 12 months, on about 25% that went beyond 12 months, which is a fairly consistent, it's statistic that we've seen all year long. And frankly, the second part of your question, do we expect to continue to see that? At least the duration, that duration has been consistent now for approximately seven quarters, I think. The last time we had something that was radically different, and that was the first quarter of fiscal year '10. So I don't know of any reason at this point why the duration would change. So we would plan on that kind of basis going forward until we see something different.
I don't have the numbers in front of me but your question about would we see harder comps from several years ago, certainly the existing bookings plan, revenue plan, all the guidance that Charlie gave are based on a model that's built up starting off with our renewals. So we have a good sense of what those are and those are built in overall to the plan that Charlie discussed.
Our next question will come from Brent Thill from UBS.
Brent Thill - UBS Investment Bank
Charlie, just on average sales prices, it would seem that as you go up the stack, you're getting more value per customer. I'm curious if you could give us any high-level discernible trends that you're seeing? And Jim, if you could just address the RHEL6 price changes that are taking effect at the beginning this year, the strategy and how you think that's going to impact the model going forward?
The general comment I think on pricing, Brent, is that we sell value and we're not in trying to heavily discount. And so from a pricing perspective, our pricing has been very consistent now for a number of years and we have had some changes on the way we have packaged the product with RHEL5 at one point and of course, now with RHEL6, which is a question you've asked, Jim. But the pricing has been very consistent and as new types of products have grown. Some of the middleware products in the last two years have grown in the mix, some of the pricing has become even a little bit richer. Jim, maybe you want to comment on RHEL6?
Yes. I think the market's actually been pretty accepting of what we've done with RHEL6. And obviously, they were depending on deployments and price increases somewhere more flat. We obviously broke the layered products out separately. I actually think we're seeing customers seeing more value in those layered products because they're now separate, they're called out differently. So I wouldn't have seen any pushback. I think we're certainly hopeful as we get further into this year that we will be able to report some good news in terms of some acceleration because of it. But I think it's still a little too early to tell.
Our next question will come from Brad Reback from Oppenheimer.
Brad Reback - Oppenheimer & Co. Inc.
So I apologize, I missed the beginning of the call. Just a quick question as it relates to the vertical mix in the quarter. Did you see any meaningful changes in billings mix as it relates to some of your mainstreaming efforts?
Yes, we talked about that earlier. We normally talk about our top 30 customers and we saw 150% growth outside of our core verticals. So as we talked about, we think our core verticals, government, telco, tech and media and financial services, those continue to perform well. But our mainstream adoption focused around logistics, around retail, oil and gas, healthcare, we've just seen significant improvement there. I don't think we have -- we certainly don't disclose that number on the whole but it continues to grow and grow nicely. And certainly the more rapid clip than the business as a whole.
Our next question will come from Kevin Buttigieg from Collins Stewart.
Kevin Buttigieg - Collins Stewart LLC
Just a question about the packaging for RHEL6 where you're now preapplying the patches to the cornel and distributing it that way. I know that you talked about making life a little bit more difficult for the clone vendors. But I guess I was a little bit surprised to see that you were I guess, suggestive that you were seeing competition from the clone vendors. Could you just address that, sort of the thought process and the strategy behind that?
I'd say overall, we are the top commercial contributor to most of the components of the Linux cornel and most of the components there and we think we have a lot of value and we want to make sure that, that value is recognized. In terms of competition, I don't think we necessarily saw anything different from before but I'd say better to close the barn door before the horses leave than afterwards. So we continue to enhance our model. We spend a lot of time improving our customer portal. We've done a lot of things to improve the overall customer experience. So we focused a lot on enhancing the value of relationship with Red Hat. And I think this is just more of a way to communicate. There's a lot of value in that relationship.
Our next question will come from Ed Maguire from CLSA.
Edward Maguire - Credit Agricole Securities (USA) Inc.
I'm just wondering if you've seen any changes in the environment since the acquisition of Novell. And I just wanted to follow-up very quickly on Brad's question about verticals. In terms of mainstreaming, whether you're seeing opportunities or competitive displacement, some of your non-mainstream verticals?
Relative to Novell and all the competitors, we have always competed with a number of distributions we hit, we re-compete with free. We have completed very successfully. So no, there's been really no change that we've seen since the transaction, our proposed transactions, with Novell.
Regarding mainstream, it's a typical -- doing a customers is not a Red Hat customer, you typically start with replacing old UNIX systems. You get it in there, people realize "Wow, it's not only cheaper but it also has greater feature functionality and it's more manageable." and you kind of grow from there. So I think you're seeing the same thing with these mainstream customers that we really saw in some of our core verticals a few years ago. We go in and we start off replacing UNIX and then we grow our base from there.
Our final question will come from Tim Klasell from Stifel Nicolaus.
Tim Klasell - Stifel, Nicolaus & Co., Inc.
So first question goes to Charlie. In your cash flow guidance, you sort of mentioned earlier on that people are willing to seem to be returning to paying multiyear commitments up front. Does your guidance sort of assume that trend continues or can you give us some color around that?
In terms of the guidance, what I would estimate for the working capital component again would be if you go back with the last five years in a row, take all the elements of working capital, that's receivables, payables, prepaids, accruals and deferred revenue, add all those together each year, you'll find for three of the last five years, the number came to $85 million. Now if you take all five years together, average them out, it came to $85 million. So I guess if I was just going to guess, I'd pick $85 million for that element and don't try to break it down between current deferred, long-term deferred receivable or anything else. It's just year after year after year, that's the number and that's just building a model based upon history. That's the way I would do it.
Tim Klasell - Stifel, Nicolaus & Co., Inc.
One quick follow-up, of the one of the 100 that did renew this year, are there any circumstances around that, you can give us some visibility into?
The one customer that didn't renew is still a customer. We still are engaged on part of their environment and hope that they will come back on the piece that did renew.
Thank you, operator. I think we're going to conclude the call now. This does conclude our fourth quarter earnings call and thank you again for joining the call and we look forward to seeing you at our Analyst Day in May. Thank you.
Ladies and gentlemen, that does conclude the conference call. You may now disconnect.
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