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Executives

Charles Peters - Chief Financial Officer and Executive Vice President

Paul Cormier - President of Products & Technologies and Executive Vice President of Engineering

Tom McCallum - Investor Relations

Analysts

Trip Chowdhry - Global Equities Research, LLC

Adam Holt - Morgan Stanley

S. Kirk Materne - Evercore Partners Inc.

Brad Reback - Oppenheimer & Co. Inc.

Brent Thill - UBS Investment Bank

Richard Williams - Cross Research LLC

Bhavan Suri - William Blair & Company L.L.C.

Matthew Hedberg - RBC Capital Markets, LLC

Steven Ashley - Robert W. Baird & Co. Incorporated

Edward Maguire - Credit Agricole Securities (USA) Inc.

Derrick Wood - Pacific Growth Equities

Kevin Buttigieg - Collins Stewart LLC

Michael Turits - Raymond James & Associates, Inc.

Bradley Whitt - Gleacher & Company, Inc.

Tim Klasell - Stifel, Nicolaus & Co., Inc.

Nabil Elsheshai - Pacific Crest Securities, Inc.

Marc Griffin - JP Morgan Chase & Co

Mark Murphy - Piper Jaffray Companies

Gregg Moskowitz - Cowen and Company, LLC

Kash Rangan - BofA Merrill Lynch

Red Hat (RHT) Q1 2012 Earnings Call June 22, 2011 5:00 PM ET

Operator

Good afternoon. My name is Tanya, and I will be your conference operator today. At this time, I would like to welcome everyone to the Red Hat First Quarter 2012 Earnings Call. [Operator Instructions] I will now turn the call over to Mr. Tom McCallum, Vice President of Investor Relations. Sir, you may begin your conference.

Tom McCallum

Thank you. Hello, everyone, and welcome to Red Hat's earnings call for the first quarter of fiscal 2012. Speakers for today's call will be Charlie Peters, Executive Vice President and CFO; and Paul Cormier, Executive Vice President and President of Products and Technologies. Jim Whitehurst, President and CEO, is currently traveling on a multi-country trip, visiting customers and partners. Given the importance of the trip, combined with the potential logistic challenges, Jim will not be available for the call. Paul instead will join us on today's call and discuss the product and technology segment of our remarks. Jim will rejoin us on the next earnings call.

Our press release was issued today after the market closed and may be downloaded from redhat.com on the Investor Relations page. Also in this page, you will be able to find Historic Reconciliation schedule of GAAP to non-GAAP financial metrics as well as the schedule 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 Harbors 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 annual report on Form 10-K 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, June 22, 2011, and these estimates or views may change. While the company may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or views do change. And therefore, you should not rely on these forward-looking statements as representing our estimates or views as any date subsequent to today.

With that, I'd like to turn the call over to Charlie Peters.

Charles Peters

Thanks, Tom. I'm pleased to announce that execution was strong in Q1 and resulted in better-than-expected results across all of our key financial metrics. Here are just a few of the highlights on a year-over-year basis: 28% billings growth, our highest Q1 billings growth rate in 4 years; revenue growth of 27%; non-GAAP operating income growth of 28%; non-GAAP earnings per share growth of 33%; total deferred revenue growth of 26%; and operating cash flow growth of 49%. Fiscal year 2012 is off to a great start with broad demand from enterprise customers who are driving a fundamental shift in the delivery of IT services.

Before discussing the detailed financial results and our improved outlook, let me turn the call over to Paul Cormier, who will discuss some of the exciting technologies we introduced this quarter to further enable customers to take advantage of the shift to cloud computing.

Paul Cormier

Thank you, Charlie. In Q1, we had several important technology, partner, product and customer announcements. Many of them were made during our premier user event, the Red Hat Summit and JBoss World, which hosted a record number of attendees in May. The vision for the future that we shared with our customers and partners is one where customers will be able to choose to run their applications on bare metal, virtualization, private cloud or among multiple certified public clouds.

Let me highlight just a few points that further articulate our strategy around the shift to cloud computing and what we are doing to allow Red Hat and our customers to benefit from this important shift. First, we announced Red Hat CloudForms. This offering is designed to bring true Infrastructure-as-a-Service functionality to the CIO for on-premise and off-premise cloud deployment. The goal of this Infrastructure-as-a-Service technology for managing hybrid clouds is to provide companies the ability to maintain significant control over the underlying infrastructure.

CloudForms is intended to be a comprehensive resource management solution that will offer a unique approach to application lifecycle management, dynamic image and template-based application stacks as well as next-generation operational management tools. We are currently working with select customers on this new set of technologies.

Next, we announced OpenShift, a Platform-as-a-Service offering currently available in developer preview format. OpenShift is a set of leading edge cloud services, enabling developers to build, host and readily scale applications in the cloud. This service enables the development and deployment of applications written in multiple frameworks and languages in a cloud infrastructure managed by Red Hat and run on Red Hat technologies. OpenShift is designed for rapid cloud deployment of applications, which can reduce resource needs and time to develop applications as compared with traditional application development.

With a rich choice of frameworks, the Red Hat-certified ecosystem of RHEL and JBoss and the open APIs of Deltacloud, OpenShift allows developers to take advantage of the power of open-source software and what it brings to the cloud. We believe that these new Infrastructure-as-a-Service and Platform-as-a-Service solutions further enhance our position as a strategic vendor for cloud technologies and the clear market leader from an open source perspective.

Within public clouds, we renewed deals and expanded our relationships with a number of large public cloud customers over the last 2 quarters, including an expanded relationship with Amazon Web Services, IBM and NTT. And in Q1, we also announced several new cloud provider wins from around the globe, including Dnshosting.it, an Italian-based cloud data center services provider; Australia-based provider Evolution Systems; Nordic cloud provider Exxonus [ph] and the Cyber Integration Center at Harris Corporation.

We also continued to take a leadership role in driving open source development and standards with a number of our ecosystem partners. In Q1, we jointly announced the creation of the Open Virtualization Alliance, or OVA. The OVA consortium is governed by IT vendors, including HP, IBM, Intel and Red Hat. The consortium is committed to fostering the adoption of open virtualization technologies, primarily Kernel-based Virtual Machine, or KVM, the backbone of Red Hat Enterprise's virtualization. This group of leading IT vendors will encourage interoperability and the expansion of the ecosystem around KVM in order to provide enterprise customers with improved choice, performance and price for virtualization. KVM is being recognized not only as the hypervisor for Linux but, more importantly, the future of open source alternatives for the cloud.

We also continued to invest in and innovate our core products that are the building blocks for a cloud-enabled infrastructure. In Q1, we released the latest version of our award-winning Red Hat Enterprise Linux operating system in RHEL 6.1. RHEL 6.1 provides more enterprise reliability, performance and control throughout the data center. RHEL 6 is already established as a performance leader, serving as virtual guest and hypervisor host.

And finally, I want to recognize our innovation award winners who are clearly driving the leading edge of commercial use of Red Hat technologies. These innovators are reducing costs, creating innovative new products and services and increasing their competitive advantage. From creating innovative computing grids to carving out costs, Red Hat is proud to collaborate with our customers on innovative solutions.

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

Charles Peters

Thanks, Paul. The strong demand we experienced this quarter came in part from enterprise customers who are looking to Red Hat to upgrade and modernize their IT infrastructure. The demand for our solutions is evident in our top 25 renewal metrics and our top 30 deal metrics. From a renewal perspective, I'm pleased to report that all of our top 25 deals that were up for renewal in the first quarter not only renewed, but they did so at a total value in excess of 130% of the original value. The top 30 deals set a Q1 record for deals over $1 million.

In the quarter, we had 14 deals over $1 million or greater, including one deal in excess of $5 million. Cross-selling and up-selling was strong, and all of our top 30 deals in Q1 were above $500,000. Within the top 30, approximately 40% included middleware component, with 5 being standalone middleware deals.

Now let's turn to our financial performance. Bookings from the channel generated 63% of our Q1 volume, and 37% came from direct sales, versus a 59%-41% split in Q1. This split reflects strong execution by our channel team, continuing to drive demand through our partners and strong sales in our government customer base.

In terms of geography, 56% of bookings came from the Americas, 24% from EMEA and 20% from Asia Pacific. I would like to commend our Japanese associates, who, in spite of adversity, did an outstanding job supporting customers and growing their business. Our billings proxy for the quarter was $266 million, up 28% year-over-year. Compared to Q1 a year ago, billings were up $58 million, reflecting the strong sales execution and improved IT spending environment. The billings proxy is calculated by adding revenue plus the change in deferred revenue on the cash flow statement, which eliminates most foreign exchange impact.

Now let's shift to the income statement. First quarter revenue was $265 million, an increase of 27% year-over-year, 8% sequentially and well above our expectation. This sequential growth rate is the highest in 3 years.

The drivers of our total revenue growth were both subscription revenue and service revenue. Subscription revenue was, again, up 26% year-over-year and 8% sequentially to $226 million. Subscription revenue, which is renewable, constituted 85% of total revenue. The training and services component of revenue was $39 million, up 30% from last year and up 10% sequentially. This strong performance included the anticipated seasonal boost, but high demand for training and continued demand for new projects with the consulting component led to better-than-expected results. This is encouraging since this type of business generally leads to additional future subscriptions.

On a non-GAAP basis, excluding stock compensation and amortization expense, overall gross margin was 85% in Q1. Subscription gross margin was 94%. Training and services gross margin was 33%, returning to more normal levels than last quarter and pretty much in line with Q1 of a year ago.

Moving on to non-GAAP operating expenses. We continue to focus spending on growth opportunities. Q1 non-GAAP operating expense came in at $159 million, up 9% sequentially and 26% year-over-year. Spending for Q1 included marketing expenses related to Red Hat Summit and JBoss World. This event was held in the second quarter last year. Also included program expenses for the launch of new technologies, opening sales offices in several additional countries and substantial additions to our sales force.

Q1 non-GAAP operating income was $66 million, producing an operating margin of 25.1%, up 20 basis points sequentially, 30 basis points year-over-year and better than our guidance. Net interest income was in line with last year and the $1.5 million which we had guided. Our estimated annual effective tax rate is 31% for both GAAP and non-GAAP results. Non-GAAP diluted earnings per share came to $0.24, which is $0.02 higher than our guidance and up 33% compared to last year.

Despite higher volatility, the average euro and yen rates for the first quarter were almost right on the foreign exchange rates which we used to set guidance. However, if the first quarter had been at the same foreign exchange rates as Q1 last year, revenue would have been $9 million lower, expenses about $6 million lower than we reported and which would have resulted in about $3 million lower operating income.

Now let's turn to the balance sheet and the cash flow statement. We ended the quarter with cash and investments of $1.27 billion. Since the start of the fiscal year, we have used cash to repurchase approximately 800,000 shares of our common stock for $34 million, including approximately $19 million or 437,000 shares in Q1. The remaining balance of our stock repurchase authorization is now $186 million.

Quarterly operating cash flow of $90 million was up 49% from Q1 last year. An important factor in this result was healthy opening receivables and strong collections. FX-adjusted DSOs continued to be in good shape. They're unchanged at 53 days from the year ago quarter. As a reminder, since days sales outstanding is traditionally a measure of receivables compared to billings, our DSO is calculated using our billings proxy.

Total deferred revenue at quarter end was $786 million, an increase of $160 million or 26% over the same quarter a year ago. Current deferred revenue grew 25% in U.S. dollar terms, while long-term deferred revenue grew 29% from one year ago. Sequentially, deferred revenue increased approximately $14 million from last quarter. As I mentioned earlier, currency volatility has remained high, so let me break down the components of deferred revenue for you.

Short term deferred revenue, which ended Q4 at $573 million, had real growth in Q1 of $3 million and increased an additional $8 million as a result of changes in FX spot rates, ending Q1 at $584 million. Long-term deferred revenue, which ended Q4 at $200 million, had a real decrease in Q1 of approximately $2 million but benefited by changes in foreign exchange spot rates by $4 million, ending Q1 at $202 million. The total increase in deferred revenue, without the impact of currency changes, was $1 million and can be found on our statement of cash flows.

Now I'd like to turn to guidance. First, it goes without saying that the global macroeconomic environment is still troubled and, in many ways, under stress. It is clear that this produces greater uncertainty in forecasting demand and foreign exchange rates. Well, I don't forecast foreign exchange rates, so for purposes of this guidance, I have assumed that foreign exchange rates for the year stay constant at the rates applicable for Q1, which were EUR 1 was $1.43 and JPY 82 to $1. As I mentioned previously, these rates were also very near the rates I used to set guidance at the start of the year.

With those assumptions in mind, I offer the following upwardly revised outlook. Q2 revenue is estimated to be approximately $270 million to $272 million. Operating margin is estimated to be in the 25.4% to 25.6% area, and non-GAAP EPS is estimated to be approximately $0.24 to $0.25 a share, assuming the same 31% tax rate. Consistent with my past practice, I do not forecast quarterly cash flow. However, I would suggest that in your work estimating cash flow, you use beginning accounts receivable balances as a starting point.

As for the full year, given our strong Q1 actual results and Q2 guidance well above expectations, we are comfortable raising our revenue guidance to a range of $1.07 billion to $1.085 billion and our non-GAAP EPS range to $0.98 to $1 a share. Our full year non-GAAP operating margin target of around 25.7% and operating cash flow guidance remain unchanged as it is our intention to continue to invest for growth as we explained at length at our Analyst Day at the Red Hat Summit in May.

In summary, the company continues to execute well and manage for growth. We're off to a strong start, and we'll continue to invest in our portfolio of growth opportunities, including cloud computing technologies. Operator, I would now like to turn it back over to you for the first question.

Question-and-Answer Session

Operator

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

Kash Rangan - BofA Merrill Lynch

Looks like the numbers are pretty solid across the board. I was wondering, Charlie, given that you've beaten cash flows very handily in Q1, you still want to keep the guidance intact. I'm just wondering if you're trying to be just conservative given that we still have 3 more quarters to go or if you're seeing any changes in the cash flow statement ahead that you want to just keep it all under the previous range. And secondly, wondering if you can give us an update on how the nonrenewals are turning out to be renewals. And with RHEL 6 soon underway, could there be a chance that we could experience, say, uptick in the renewal rates since it's a brand-new product with a ton of new functionality? That's it for me.

Charles Peters

Thanks, Kash. You managed to get 3 questions into [indiscernible]. Well done. The first question about cash flow in Q1, we obviously did well in Q1 cash flow, but frankly, I don't forecast quarterly cash flow. But I would say this, that our quarterly cash flow was not necessarily a surprise to me because we started with very high accounts receivable, which was why I was offering a comment about in terms of trying to put together your estimates for quarterly cash flow, use that as a starting point. I don't think it's appropriate at this point to change our full year cash flow estimate. We're only in the first quarter, and as I said, we intend to continue to invest for growth. The second part of your question about renewals, we have consistently done very well on the top renewals. And as we discussed at Analyst Day, we've made many efforts to improve our renewals on the much smaller deals and deals through distribution, and those efforts are continuing. And then the last part of your question about RHEL 6. I think RHEL 6 is off to a good start. I don't know that it necessarily will cause the renewal rate to improve, but we've had a very good renewal rate in any case.

Operator

Your next question comes from the line of Kirk Materne with Evercore Partners.

S. Kirk Materne - Evercore Partners Inc.

I guess my first question, Charlie, was you mentioned Japan in your prepared remarks. Can you -- you're, I think, assuming maybe about a $5 million hit to billings this quarter. Was that the case, or did you sort of outperform that initial guide?

Charles Peters

Japan did very well this quarter. They actually, from a billings perspective, came right back to plan. So we did not have the $5 million billings shortfall that I had talked about on our Q4 call. I would say this, on the Q4 call, I think I made it clear that in our case, it really only was a billing impact and almost no revenue impact. But they did a very good job, and we think that whatever disruption might have been in Japan is behind us.

S. Kirk Materne - Evercore Partners Inc.

Great. And then if I can just add one follow-up question. Just on RHEV, I'm not sure if you guys gave the customer account like you did last year or you're not going to do that anymore. But can you just talk a little bit about your expectations for RHEV in the quarter and sort of how things came in relative to those expectations?

Charles Peters

Yes, I think that as we go forward, the customer account becomes less relevant. But we continue to do well, placing RHEV with our larger accounts. And I think we are making the kind of progress that we anticipated. And Paul, do you want to add a comment?

Paul Cormier

I think the thing to remember about RHEV and the thing we're getting the most interest from RHEV is RHEV is in our installed base, and it's just a natural from moving within the installed base. So I think that's just something to keep in mind, important.

Operator

Your next question comes from the line of Adam Holt with Morgan Stanley.

Adam Holt - Morgan Stanley

My first question is about the geographic split. Obviously, currency played a role in the quarter, but it looks like you had really strong result outside of the U.S. Could you talk a little bit about what you saw in Europe and Asia that drove that strength?

Charles Peters

Sure. Currency on a year-to-year basis certainly was a factor, but relative to the guidance we gave, as I said, we were probably coincidentally, we just had -- we picked the right rates. There was no variance relative to guidance. But having said that, Asia did a good job this quarter. They were 20% of the total, the first time they've been at that level for a little while. As I mentioned to Kirk, Japan was pretty much right on target. We saw good strength in Australia as well. Europe, the European business, the interesting surprise in Europe was on the services side with very strong training business. And that's about all. The U.S. business continued to be good, both commercial and government.

Adam Holt - Morgan Stanley

If I could just ask a real quick follow-up, I think you made a comment, Charlie, that you had a significant increase in sales capacity. Is there any color that you can add to that in terms of either the percentage of growth that you had, the number of people that you added or how we should be thinking about sales headcount going forward?

Charles Peters

Okay. We have fairly consistently now for, I'd say, 4 quarters been adding to our sales force on a global basis. And I'm not going to give any specific numbers about it, but the increases have been fairly consistent and a good number this quarter. But I'm not going to get into specific numbers of sales people.

Operator

Your next question comes from Mark Murphy with Piper Jaffray.

Mark Murphy - Piper Jaffray Companies

I was wondering maybe, Paul, if you can help us. What is growing faster, your public cloud business or your private cloud business? Last quarter, you mentioned a renewal with a large cloud provider. That was a 300% increase, and I'm wondering if that type of business is growing faster for you or the private cloud or data center modernization business, whatever you want to call it. Because I think a lot of your competitors only cater to one of those opportunities, whereas Red Hat is able to straddle both of those markets. And I have a quick follow-up after that.

Paul Cormier

Mark, so I think the keyword you mentioned there was straddle -- the capability to straddle that gap, because we're seeing strong interest in both private clouds as well as public clouds. And so subsequently, customers are really interested in a hybrid environment. And where we have all of the -- most of the major building blocks, whether it's the operating system, virtualization, middleware, to be able to build those private clouds environments as we do today, being able to bridge that gap -- the same set of technologies for public cloud providers, being able to bridge that gap is where we're seeing very strong interest from our customers. So it's really tough to characterize one or the other because most of our customers are interested in being able to run both in a hybrid situation. And so that's the key, I think, and that's why we're seeing strong interest from our customer base because we're able to bridge that so well.

Mark Murphy - Piper Jaffray Companies

Okay. And then Paul, on a related topic, I think we have heard there are about 2,000 packages in RHEL 6, and the response, obviously, has been fantastic. I'm just wondering, how do you balance the phenomenal rate of innovation that you've got and, I guess, the sheer volume of new product that you're producing, versus trying to safeguard against a future bloat in the long run?

Paul Cormier

So I think it's that portfolio of products. I mean, if you look at it, as of RHEL 6, we now have a corresponding set of products that go with it, whether it be high availability and clustering that are able to run on their own axis. And I think that was a lot of the driver, and what we did with the product line in RHEL 6 was be able to separate those out so we could keep that innovation going at the right clip and not have to hold one up for the other. So I think it's the way we integrate the products, but at the same time, it's the way we separate the products as well. They work as well as integrated as they do separately. That gives us the flexibility to keep him going on their own axis.

Operator

Your next question comes from the line of Matt Hedberg with RBC Capital Markets.

Matthew Hedberg - RBC Capital Markets, LLC

Charlie, in a prior question, you talked about the good adoption of RHEL 6. At this point, I'm wondering, could you talk a little bit more, give us a little more granularity on large enterprise adoption? It sort of dovetails on the last question. But how are they -- can you just give a little bit more granularity on how they're adopting and what they're saying about pricing, et cetera, would be helpful.

Charles Peters

Well, I think probably the best statistic would be the top 25 renewals and the top 30 deals, we saw real strength in both of those. And among our customer base, almost all of the Fortune 500 customers would be -- companies would be represented as well as a very long tail of smaller companies and major government entities and private entities. So it's very broad. From a pricing perspective, the price changes that were introduced back in November of last year have been rolled out. I think as we discussed, for an existing customer, they don't really work with the new pricing until renewal time comes. For new customers that have more than 2 sockets, they make choices also of an à la carte type basis with the new structure that we have. And we've had reasonably good feedback, very little negative feedback.

Operator

Your next question comes from the line of Michael Turits with Raymond James.

Michael Turits - Raymond James & Associates, Inc.

Can you -- obviously, the middleware component looks good from the big deal stats. But can you give us some sense of the relative performance of core RHEL versus JBoss and middleware more broadly?

Charles Peters

Yes, I mean, the RHEL business was quite strong. I think you can probably tell by the overall numbers that RHEL was strong since it's a really very large portion of the total business. Having said that, JBoss also performed quite well. They represented 40% of the top 30 deals. So it was really hitting on all cylinders.

Operator

Your next question comes from the line of Derrick Wood with Susquehanna.

Derrick Wood - Pacific Growth Equities

So I'm curious. When the customer’s upgrading RHEL and also choosing new RHEV paid support, do you have a sense for what the average uplift in contract value is versus just a RHEL-only subscription contract?

Charles Peters

Well, it would depend upon the mix of the technology he’s selecting. With the new pricing, he has the ability to pick and choose those bits of the technology that he wants. So it's not possible to come up with sort of a general case. It would have to be far more specific.

Paul Cormier

This is Paul. I think the other thing to remember too and one of the beauties of having a virtualization offerings born out of the same heritage as RHEL is that they can run that across bare metal or virtualization. So it's very rare that it's all one or the other. It's typically a mixed environment, and it’s typically never mixed the same from one customer to the other. But I think that's one of the strengths of it is to be able to cross that chasm across bare metal to virt [virtualization].

Operator

Your next question comes from the line of Ed Maguire with CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc.

First a question for Charlie. When we look at the seasonal expectations for your guidance in the second half, it looks like the, really, with your guidance, the seasonal quarter-over-quarter growth in Q3 and Q4 looks a lot lower than it typically is historically. Any color on this, or is this conservatism?

Charles Peters

First of all, I'd say this about our Q4. I think you know that Q4 is typically -- we have a dip on the services side because of the holiday period. We also have one or 2 days less for subscription revenue in that quarter because there's a fewer number of days. Apart from that, I'd say the guidance I provided was prepared consistent with the way I usually prepare guidance.

Edward Maguire - Credit Agricole Securities (USA) Inc.

Okay. And a question for Paul, since we've got you on the call. Could you comment about the relative contribution from the community from commercial sub ISVs? I see your R&D is ramping slower than revenues overall, but as your portfolio grows, how much investment on Red Hat's part and with the balance of what's coming from the community and some of the commercial contributors to the community? Are you seeing any trends there?

Paul Cormier

Well, I mean, the level of contribution is different from project to project. And I spoke about this actually at the Summit. And the way we develop our products is we typically look at and participate in the best of the best open source communities out there. And over the years, the number of communities, number of projects, has just grown exponentially. And so different from community to community. Our strategy is to integrate the best of the best. So I think it's growing in terms of the leverage we get out of those communities just because of that strategy to bring in the best of the best. By definition, a good open source project has broad community support, and those are typically the ones we pull in and integrate into our commercial solutions.

Operator

Your next question comes from the line of Brent Thill with UBS.

Brent Thill - UBS Investment Bank

In last Q1, you mentioned your contracting, that build was up sequentially. I was wondering if you can just give us a shape of that in Q1. And also, I think government was your biggest vertical in the fourth quarter. Can you just give us a sense of your top 2 verticals this last quarter?

Charles Peters

Sure. So just going back to Q1 a year ago, it was a rather unusual quarter since it represented a quarter in which we booked the largest deal in our history. And so although we had a very strong quarter, we didn't have a deal of that size this quarter to do that to the off-balance-sheet backlog. But having said that, I won't say more about it because the off-balance-sheet backlog number is one which I address usually once a year in the fourth quarter. In terms of the verticals, we had very strong government business and strong business in the financial sector.

Operator

Your next question comes from the line of Tim Klasell with Stifel, Nicolaus.

Tim Klasell - Stifel, Nicolaus & Co., Inc.

Just a quick housekeeping one. Percentage of bookings greater than a year? I didn't hear that on the call.

Charles Peters

21%.

Tim Klasell - Stifel, Nicolaus & Co., Inc.

Okay. That's very consistent. Going back to a prior question, you talk about building up sales in the channel. Is that roughly equal, or are you going to concentrate more in channels or on the direct sales side? What should we expect this year?

Charles Peters

It's good question. I would say that we have been building up sales for some time and growing our channel capabilities. But we've also been adding to direct sales, both direct meaning outside sales on the street and on our inside sales capabilities. We have also regionalized some of the inside sales capabilities to be closer to the people that they support on the outside. And all of those things look like they're improving in effectiveness. We did, this quarter, have 63% of the business come through channel. I don't know if that's a number that we would say we're going to see every quarter. It was a very good channel performance. And as we talked about before, that already exceeds our goal of 60%. So we will be probably reexamining the goal to see if a higher goal for a channel would -- might be appropriate.

Operator

Your next question comes from the line of Kevin Buttigieg with Collins Stewart.

Kevin Buttigieg - Collins Stewart LLC

Paul, I know it's early days now, but with regards to the Deltacloud APIs, is there anything that you're seeing in terms of adoption by the rest of the industry? And what are you doing to encourage adoption of those APIs by the rest of the industry?

Paul Cormier

Well, I mean, I just think that the sheer strategy is one that's resonating well with many members of the industry. I mean, the whole idea of the Deltacloud API is to give the customer the ability to set up choice across both internal cloud technology as well as external cloud technology. So I think we're seeing the interest in that grow because people are tending to agree with that technology as opposed to getting stuck in a vertical stack. So I don't have exact numbers or anything like that, but we're seeing the interest from a community perspective grow. It's a central part of the CloudForms product line. We're working with some selected customers on CloudForms, and that's one of the areas that they're very much interested in. So I think from that perspective, we're pretty happy with it.

Operator

Your next question comes from the line of Brad Whitt with Gleacher.

Bradley Whitt - Gleacher & Company, Inc.

Thanks for taking my questions, and maybe Paul can take this one. I'm just curious, Paul, as to whether or not you think the fact that you have not released a Linux-based console for RHEV, whether or not that's been a possible hurdle for adoption for RHEV. And do you have plans to release that? And if you could give us an approximate release date.

Paul Cormier

It's absolutely on our road map. Whether I think it's a hurdle or not, I don't know. In some situations, a pure Linux shop, sure. I think in a pure Linux shop, people might be more prone to have a Linux-only console. But I wouldn't characterize it as an overall hurdle. It's on the road map. You'll see it in customers' hands over the next few months and will be out in product with it for full availability in this calendar year.

Operator

Your next question comes from the line of John DiFucci with JPMorgan.

Marc Griffin - JP Morgan Chase & Co

It's Marc stepping in for John. I just wanted to follow up a little bit more on the sales guys and you talked about the direct sales. You've talked in the past about hiring more overlay salespeople, specifically focusing on RHEV and JBoss. What's the percentage of the new heads that are just regular direct salespeople as opposed to these overlay? And how is that relationship working out?

Charles Peters

I think it's a good question. We talked at the Analyst Day about the middleware overlay sales team. We did talk some about the virtualization overlay sales team. I don't have any specific numbers or percentages that I think are appropriate to share. But I would say this, that the direct sales guy feet on the street have great relationships with the customers. The overlay people are very helpful, when you get to at the very technical end of the sale, to come in and help close the deal. So it's very much like an investment banking model where you've got the relationship guy and you've got the specialist, and it's been quite effective.

Operator

Your next question comes from the line of Nabil Elsheshai with Pacific Crest.

Nabil Elsheshai - Pacific Crest Securities, Inc.

I was kind of curious just from an R&D and product focus, a lot of the new stuff you announced at the conference and highlighted this morning is more cloud-focused. And I was wondering if you see the opportunity or investing in kind of broadening out your portfolio for more traditional on-premise but open source solution?

Paul Cormier

So the beauty of the cloud technologies is that the cornerstone and the building blocks of the cloud technologies are very similar to the on-premise technologies. So for example, operating system, key to cloud technologies; virtualization, layer key; middleware, extremely key. So we announced OpenShift. The heart of OpenShift is built from JBoss. And so I think having those and having a great installed base and a great community in these on-premise technologies is what's driven that adoption on the cloud side because the technologies are very, very similar. And so we see that as a strength.

Operator

Your next question comes from the line of Gregg Moskowitz with Cowen.

Gregg Moskowitz - Cowen and Company, LLC

First question is for Paul. What kind of uptick have you seen thus far for some of the RHEL 6 add-ons, such as HA, load balancing and resilient storage?

Paul Cormier

I mean, I don't know how to quantitatively put it out there. But from a customer perspective, we've seen a very good reception to it. One big reason, I actually -- somebody asked me this earlier in the call here today. Because we’ve sort of separated these from the cadence of the operating system, we're able to get more innovation in those areas themselves. And so we've got pretty good reception from our customers on that where, for example, with clustering, we can bring that forward on its own cadence now. So from that perspective, we've got good feedback from our customers on the ability to consume it this way and then wanting to consume it that way.

Operator

Your next question comes from the line of Bhavan Suri with William Blair & Company.

Bhavan Suri - William Blair & Company L.L.C.

Just a couple quick questions here. A trend you'd commented on, Charlie, was the prepayment of multiyear subscriptions. Did you continue to see that in the quarter?

Charles Peters

It was not as high as it was in the fourth quarter. And if you look at the breakdown I gave you of the deferred revenue, you see that the long-term deferred revenue declined by $2 million real terms. It’s not much. It’s pretty much the same as it was in Q1 a year ago. But I would say, there's no major changes. There's no reason to think that there's a change here.

Operator

Your next question comes from the line of Richard Williams with Cross Research.

Richard Williams - Cross Research LLC

Could you talk about conditions in Europe and how they may have changed over the last couple of quarters?

Charles Peters

Sure. I mean, obviously, the European Union is going through all kinds of economic issues right now. We read about it daily in the paper. Having said that, what we have demonstrated over a number of quarters is that our business tends to be very resilient in good times and bad times. Our European business actually did fine in the first quarter at 24% of total bookings strength there. The one area which I called out earlier to a question was our training business, which was quite a surprise actually, came in quite strong. I suspect the reason is customers wanting to get educated on RHEL 6 and RHEL 6.1 and other new technologies. But overall okay. I mean, having said that, one of the things that we're watching as well as everybody else is the volatility of the currency there and also just the overall economic situation, given what's going on with Greece and maybe several other European countries.

Operator

Your next question comes from the line of Steve Ashley with Robert W. Baird.

Steven Ashley - Robert W. Baird & Co. Incorporated

My question relates to the new pricing matrix that you've begun offering here recently. Can you give us maybe some comment about what percentage of the demand is for the traditional 2-socket configuration and how much is maybe for something beyond that, which would indicate maybe people are using it to host virtual guests?

Paul Cormier

This is Paul. The bulk of it prior to this day was on the 2-socket side. Frankly, that was one of the big reasons why it wasn't such a big change for our customer base because, at the 2-socket level, it was fairly constant. I think as we go to build-outs now with cloud computing, we think we'll see that go up to the higher level sockets. But from here prior, it's been mostly the 2 sockets, and that's worked in the advantage of that change, and one of the reasons why we thought this was a good time to do that because it was a little impact to the customer base as possible.

Operator

Your next question comes from the line of Trip Chowdhry with Global Equities Research.

Trip Chowdhry - Global Equities Research, LLC

I have 2 questions now, one on competition and another on training. On the competitive front, if you look at your traditional competitors, they were Novell, Microsoft and, to some extent, Oracle Linux. But when we think about your new product offering, like, OpenShift and CloudForms, your competitive landscape really has evolved or changed probably a lot right now and moving forward because the traditional competitors you had are almost irrelevant to the direction in which the IT industry is going. I was wondering, have you reacted or you have put some competitive force to identify who your new competitors may be? And how should we, as investors, think about the new landscape? Then I have a follow-up question.

Paul Cormier

This is Paul. I think you know the new competitors out there. I mean, if you look at it, it's certainly still the ones that you mentioned. But on the private cloud side where we introduced CloudForms, there's a host of startups out there that compete with us. We're going to leverage off our installed base with that. And so that will be our strategy there. Certainly VMware's a competitor of ours. We're in the virtualization space. It's key. It's just part of the operating system now. And so they're certainly one of the key competitors out there. So I think a combination of the ones you mentioned as well as some startups out there as well as VMware, those are the ones that we see ourselves going head-to-head in the customer base with right now.

Trip Chowdhry - Global Equities Research, LLC

Very good. And I have a second question. If you look at your business over the last 8 years, there was a very solid push by Red Hat to make sure they can get as many engineers certified into RHCE certification. And now the scope of Red Hat certification has to expand to include these 2 exciting products you have, OpenShift and CloudForms. So I haven't seen the same momentum in terms of making sure we get 20, 30 person quarter-to-quarter more people certified on the new products also. The reason I say is you have probably about 8 months of window of opportunity to literally capture the future because the competition, as I mentioned, Cisco-certified engineers, Microsoft-certified engineers, are literally looking for jobs right now, and you can be very forceful and probably take those skills into your own domain by having some certifications. Because right now, in the value at least, finding the people with the right skills is a little bit difficult. And I think if we get the same momentum you had, say, 8 years back, getting people certified would be a good strategy moving forward. Wondering what are your thoughts on that.

Paul Cormier

There's a couple of things to remember, and I mentioned this earlier. If you look at these new products out there, whether it's OpenShift, CloudForms, they are built from the current technologies. RHEL is a key piece of the foundation of these products. JBoss is a key piece. Our virtualization is a key piece. So an engineer that’s proficient in the Red Hat technologies today is going to be very, very successful in this new set of technologies, not to mention that you've seen a lot of data out there. There's been a lot of studies cited out there around open source being a key element in building cloud computing. So we think that brings a lot to the table today. Offerings such as the PaaS offering, et cetera, again, JBoss is the foundation of that. But the PaaS offerings are in the first inning. Everyone's PaaS offering is in the first inning of the game. So that's going to continue to evolve as time goes on as well.

Operator

Your next question comes from the line of Brad Reback with Oppenheimer.

Brad Reback - Oppenheimer & Co. Inc.

So Charlie, a quick question. As we think about the improved renewal rates at the low end of the market and the work you're doing there, could that be a step function up in growth, or will it mirror more like the Free to Pay initiative that you guys have undertaken here for a while?

Charles Peters

I would expect it's going to be more incremental improvement and probably something like the Free to Pay. The reason is we have very high renewal rates in the biggest accounts where the bulk of the dollars are. The key thing with the small accounts, they may only have one subscription or maybe 2, 3, 4, 5 subscriptions, is we don't want to lose the customer. It's not so much about getting the next $500 or $1,000 subscription. But it's retaining that customer because that customer may grow to be a guy that's got 100 or 1,000 subscriptions a few years down the road. And so we are getting better with that. But I do think what you'll see there is incremental improvement, not sort of any sort of a step function.

Tom McCallum

Thank you, operator. And thank you, everyone, for joining our call, and we look forward to speaking to you in the future. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Red Hat Management Discusses Q1 2012 Results - Earnings Call Transcript
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