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Executives

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

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

Tom McCallum -

Analysts

Brent Thill - UBS Investment Bank, Research Division

Adam H. Holt - Morgan Stanley, Research Division

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Nabil Elsheshai - Pacific Crest Securities, Inc., Research Division

Philip C. Rueppel - Wells Fargo Securities, LLC, Research Division

Mark R. Murphy - Piper Jaffray Companies, Research Division

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

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

Kash G. Rangan - BofA Merrill Lynch, Research Division

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

Heather Bellini - Goldman Sachs Group Inc., Research Division

Michael Turits - Raymond James & Associates, Inc., Research Division

Richard T. Williams - Cross Research LLC

S. Kirk Materne - Evercore Partners Inc., Research Division

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

Red Hat (RHT) Q3 2012 Earnings Call December 19, 2011 5:00 PM ET

Operator

Good afternoon. My name is Allie, and I will be your conference operator today. At this time, I would like to welcome everyone to Red Hat's Q3 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Tom McCallum, VP of Investor Relations. Mr. McCallum, you may begin your conference.

Tom McCallum

Thank you. Hello, everyone, and welcome to Red Hat's earnings call for the third quarter of fiscal 2012. Speakers for today's call will be Jim Whitehurst, President and CEO; and Charlie Peters, Executive Vice President and CFO. Our earnings press release was issued after the market closed today and may be downloaded from redhat.com on the Investor Relations page. Also on this page, you'll be able to find historic reconciliation schedule of GAAP to non-GAAP financial metrics as well as a schedule on currency rates.

Various remarks that we may make about the company's future expectations, plans 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 provision 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-Q filed with the SEC, as well as the Safe Harbor statement in today's press release.

In addition, any forward-looking statements represent our estimates or views only as of today, December 19, 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 of any date subsequent to today.

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

James M. Whitehurst

Thank you, Tom, and let me add my welcome to all of you joining us on today's call. Market demand for Red Hat remained strong on a global basis, and we continue to gain market share as a result of strong execution and our ability to deliver value to our customers. The combination of these factors contributed to strong year-over-year organic growth across each of our key financial metrics, including billings, revenue, operating income and cash flow, leading to results that were at or above the high end of our expectations for every metric.

Even in a challenging global economy, demand for Red Hat's innovative solutions continue to benefit from customers, who are driving productivity gains and agility across their organizations by investing in their IT infrastructure.

Now let me provide some recent business highlights. Our big news this quarter was the further expansion of our market opportunity and footprint in the data center by entering the storage space via the acquisition of the open source software company, Gluster, Inc. This software-only solution addresses storage of unstructured data spanning from bare metal to virtualized instances and in cloud deployments. This $4 billion addressable market, which is growing rapidly, is a great place for Red Hat to enter the big data world and provide storage in the cloud.

Storage is complementary to our business, fits with our core infrastructure stack and is aligned with our enterprise customer base. Also, the Gluster technology has me excited. It is a software solution for solving the scale-out storage problem. It's open source with a vibrant community and fits well with our cloud vision of being able to deploy applications anywhere. It's already used by companies like Pandora and Limelight [ph] for their unstructured data needs.

Because the IT landscape is changing, storage architectures are changing, too. Traditional hardware-based storage solutions present a problem for customers who are now faced with having to replicate data in multiple cloud, including on-premise and public. There's a need for a common storage solution for customer data, whether that data -- wherever that data maybe. Because Gluster is software-based, it's a great solution for the challenge of storage in the cloud.

For example, you can't ship hardware to Amazon to run on top of their cloud but you can move the Gluster solution into a virtual machine instance running on a public cloud. Gluster provides choice. It's already available on Amazon's Cloud, and we are driving innovation to enable it with other cloud offerings. The Gluster technology, now known as Red Hat Storage, will be a foundation to bring products to market that not only provide a compelling value and performance proposition but solve some of the new challenges of storing the explosion of unstructured data.

I'm pleased to announce that we rapidly completed integration and launched the first Red Hat-branded storage product earlier this month. It is an enterprise-ready product hardened by our engineering team running on RHEL and supported by the broader Red Hat team. It is initially launched in North America, and our plan is to take this product global as we build out our sales and support team over the next year.

Open source technologies like Red Hat Storage are not only disrupting antiquated expensive IT products in the market today but more importantly, they are providing solutions to the new challenges facing enterprises.

On the product front, we also continue to evolve our overall set of core solutions for the data center. We launched the latest version of our flagship operating system, Red Hat Enterprise Linux 6.2. RHEL 6.2 includes significant improvements in virtualization, resource management and high-availability. The enhancements in RHEL 6.2 are designed to increase performance and scalability for running enterprise workloads across physical, virtual and cloud computing environments.

Red Hat Enterprise Virtualization or RHEV 3.0, the next generation of Red Hat's virtualization management product, continues to proceed well through the product delivery process. RHEV 3, which runs as a Java application on JBoss Middleware and RHEL is currently in public beta. The customer reaction has been very positive. Since the public release, we have seen significant downloads from customers who are looking for choice, interoperability and integrated management solutions for their virtual infrastructure. We expect to have general availability of RHEV 3.0 later this quarter.

Also during this quarter, we continued to take an active leadership role in the open-source community. Here are a few highlights. We announced our participation in the Open Compute Project established by Facebook, with the goal to building one of the most efficient computing infrastructures at the lowest possible cost. We released Fedora 16, our community-supported open source Linux distribution. As a vehicle for the initial integration of cutting-edge technology, Fedora enables us to vet nascent capabilities in areas such as cloud and virtualization.

We've also increased our activity in the OpenStack community by way of joining the core development team, integration into Facebook and with the acquisition of Gluster. The Open Virtualization Alliance continues to thrive in support of Red Hat Enterprise Virtualization's core hypervisor technology, KVM, while over 200 industry leaders have joined the alliance in support of KVM since May.

As a final highlight, Red Hat was recognized by Forbes as one of their Top 10 Most Innovative Growth Companies, providing our customers with proven innovative solutions that drive greater performance, increases the loyalty of our customers. This high level of trust and loyalty that Red Hat -- that customers have placed in Red Hat is evident in our largest deals that renewed last quarter. Once again, we renewed 25 out of 25 deals, and they did so at a total value of over 130% of the original value.

This rate of upsell is particularly promising since it includes some of our largest financial services deals from 3 years ago. This is a sector that has not fully recovered from the recession but continues to increase its collaboration and purchases with Red Hat to drive innovation, performance and cost savings.

In summary, we continue to extend Red Hat's market leadership position by providing innovative open source solutions with strong ROIs for the enterprise customer. I want to thank our associates around the globe for their hard work that continue to produce exceptional results for our shareholders.

I also want to recognize Alex Pinchev, our Head of Global Sales, for his service to Red Hat, and we wish him great success at his new position. Alex will be leaving Red Hat next month to become CEO of Acronis, a Red Hat partner.

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

Charles E. Peters

Thanks, Jim. Once again, Red Hat has delivered a strong quarter of consistent growth across all of our key financial metrics. We've continued to see strong demand and return on our investments in sales, marketing and R&D.

Here are just a few of the financial highlights on a year-over-year basis: Organic billings and revenue growth of 23%, total deferred revenue growth of 20%, even faster growth and profitability and cash flow with non-GAAP operating income growth of 36%, non-GAAP earnings per share growth of 40% and operating cash flow growth of 36%. We're continuing to gain market share in the data center. With focused spending and investing in Q3, we continue to demonstrate our ability to deliver expanding profitability and cash flow margins.

These metrics are some of the highest in our sector when compared to other successful software companies when they reach the $1 billion in revenue mark. Our top 30 deal metrics for the quarter provide further evidence of Red Hat's execution. For the fourth consecutive quarter, we set a record for deals over $1 million. 27 of the top 30 deals in the quarter exceeded $1 million, a 69% increase over Q3 of last fiscal year, and 5 deals exceeded $5 million, a new quarterly record.

Approximately 40% of our top deals include a middleware component, with 4 being standalone middleware deals. All 4 standalone middleware deals were over $1 million.

The 3 largest verticals represented within the top 30 deals were financial services, technology and governments around the world. We continue to see large deals and growth potential across a number of verticals, including those that are facing greater macro challenges.

Now let's turn to our financial performance. Channel bookings generated 64% of our Q3 volume, and 36% came from direct sales versus a 57%-43% split in Q2. Several of our largest deals this quarter came through the channel in the Americas, somewhat skewing the channel and geographic mix in that direction.

In terms of geography, 60% of the bookings came from the Americas, 24% from EMEA and 16% from Asia-Pacific compared to 58%-25%-17% split last quarter. We continued to see solid performance in each geography with double-digit growth across all regions. However, as I just mentioned, on a relative basis, Americas was a higher percentage this quarter as a result of a number of large deals and the strength of the U.S. dollar as compared to virtually every other currency.

Our billings proxy for the quarter was $322 million, up 23% year-over-year, representing 6 straight quarters of 20%-plus growth. This is the highest Q3 billings growth rate in 4 years. Average contract duration continues to be approximately 21 months. As a reminder, our 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. Third quarter revenue was $290 million, an increase of 23% year-over-year and 3% sequentially. Revenue growth was driven by both subscription revenue and service revenue. Subscription revenue was up 24% year-over-year and 3% sequentially to $247 million. Subscription revenue, which is renewable, constituted 85% of total revenue. The training and services component of revenue was $43 million, up 18% from last year and up 1% sequentially.

On a non-GAAP basis, excluding stock compensation and amortization expense, overall gross margin was 85% for the third quarter. Subscription gross margin was steady at 94%, and training and services gross margin showed nice improvement to 38% from 33% last quarter. Higher services margin were driven by better performance and better utilization rates in both consulting and training.

Moving on to non-GAAP operating expenses. We continued to increase investments in the business, principally in sales, marketing and engineering, leaving the Q3 non-GAAP operating expense of $169 million, up 5% sequentially and 20% year-over-year. We added over 250 net new employees during the quarter, including over 60 from the acquisition of Gluster.

Q3 non-GAAP operating income was $79 million, producing an operating margin of 27%, in line sequentially but up 260 basis points year-over-year. This was well above our guidance as a result of better performance from our service business and continued operational efficiencies from our G&A team. We are just the beginning of building out our storage effort, and I'll have more to say about this in my comments on guidance.

Net interest and other income of $2 million is in line with guidance and Q3 last year. Our estimated annual effective tax rate, excluding discrete tax benefits, is 31% for both GAAP and non-GAAP results. Non-GAAP diluted earnings per share came to $0.28, which is $0.02 higher than the high end of our guidance and up 40% compared to last year.

Most foreign currencies weakened against the dollar in Q3 and have continued that trend to date. Looking at the impact of foreign exchange in our income statement, if Q3 had been at the same foreign exchange rate as Q2, revenue would have been $5 million higher, expenses $4 million higher and operating income higher -- $1 million higher than we expected -- than we reported, sorry. In Q3 -- if Q3 had been reported using the same FX rates as Q3 last year, revenue would have been $2 million lower, expenses $1 million lower than we reported, which would have resulted in about $1 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 $1.2 billion. Operating cash flow of $97 million was up 36% from Q3 last year. Strong growth in net income and deferred revenue contributed to the strong cash flow performance. FX-adjusted DSO was 60 days, up from last quarter and the year-ago quarter but still within our target range. Accounts receivable and DSO were both up at November 30 due to the large number of high-value deals that closed towards the end of the 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 $820 million, an increase of $134 million or 20% over the same quarter a year ago. Current deferred revenue grew 20% in U.S. dollar terms while long-term deferred revenue grew 19% from one year ago. Sequentially, deferred revenue increased approximately $6 million from last quarter. Exchange rate changes were significant quarter-over-quarter so let me break down the components of deferred revenue for you.

Short-term deferred revenue, which ended Q2 at $602 million, had real growth in Q3 of $25 million and decreased $17 million as a result of changes in FX spot rates, ending Q3 at $610 million. Long-term deferred revenue, which ended Q2 at $212 million, had a real increase in Q3 of approximately $7 million and was hurt by changes in FX spot rates by $9 million, ending Q3 at $210 million. The total increase in deferred revenue, without the impact of currency changes, was $32 million and can be found on our statement of cash flows.

Now I'd like to turn to guidance. Since I do not forecast FX rates for purposes of guidance, I will use FX rates for Q4 based upon where they were yesterday, that is the euro at $1.30 and the yen at JPY 78 to the dollar. Compared to the exchange rates I used when I last gave guidance and the rates used in most recent analyst models of Red Hat, the euro is now 5% weaker and the yen is 1% weaker. Despite the global economic turmoil, continuous stock market volatility and the FX rate assumptions, which I just mentioned, we are raising our full year guidance on several key financial metrics based on year-to-date results and the ongoing momentum of our business.

While these FX rate assumptions negatively impact Q4 revenue by approximately $4 million versus my last guidance, we remain reasonably, naturally hedged with offshore expenses, thus resulting in minimal net P&L impact. With these FX assumptions, Q4 revenue is estimated to be approximately $289 million to $292 million, meaning that despite the currency changes, we still expect to be near the high end of my previous revenue guidance for the full year.

As a reminder, to those of you building models, our service business normally declines sequentially in Q4 as a result of holiday downtime at our customers. We expect the same this year with a sequential service revenue decline of $2 million to $3 million.

Operating income and margins continued to beat our estimates in Q3 and year-to-date. As a result, we are again raising guidance for operating margin and earnings per share. We expect full year non-GAAP operating margin to exceed 26%, a more than 120-basis point increase from the prior year. Q4 operating margin is expected to be approximately 25.5%, reflecting investments as we ramp up our storage business as described in our October 4 conference call.

Q4 non-GAAP EPS is estimated to be approximately $0.26 to $0.27, and full year non-GAAP EPS is expected to be $1.07 to $1.08. Again, we are assuming a 31% effective tax rate, excluding the discrete tax benefit that we recorded in the second quarter.

As you know, I do not guide quarterly cash flow. However, in light of the continued strong cash flow, it appears evident that our annual operating cash flow will exceed $360 million, the previous high end of our guidance. I believe it's appropriate to once again raise our operating cash flow estimate for this fiscal year by another $15 million to a range of $370 million to $375 million.

As a reminder, we will also produce approximately $33 million of additional cash from excess tax benefits from stock compensation deductions, which is included in cash flow from financing activities.

In summary, we continue to execute well and deliver consistent growth in all of our financial metrics. We believe we're well positioned to continue to deliver value and innovation for our customers and results for our shareholders.

Before I turn the call over to the operator, I'd like to remind our financial community about the 2012 Analyst Day, which will be held during Red Hat Summit in JBoss World June 26 to June 29 in Boston. Please save the date and invitations with more details will be forthcoming.

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 Adam Holt.

Adam H. Holt - Morgan Stanley, Research Division

So just to be clear on the billings, it sounds like if we add back the $5 million versus what you guided to, you would have grown billings about 25% in terms of your proxy. So first of all, is that the right math? And secondly, along that line, it's a little bit of a deceleration from what we've seen in previous quarters. Did the quarter play out like you expected relative to what you saw in terms of demand? Or was there anything that might have slowed down a little bit in the quarter?

Charles E. Peters

Just a couple of things, Adam. First on the billing side, I think we've consistently kept our billings proxy as revenue plus the change in deferred revenue off of the cash flow statement. But it's clear that when you have a currency impact like this on a quarter, that you might consider also the change in revenue at least from the point in time that we provided guidance. So I don't think you're out of line with that suggestion. On the part of the question, was anything a little different, you heard me comment in terms of receivables and DSOs being a little bit higher. We had a -- our linearity of quarterly bookings historically in a good quarter is 25%-25%-50% in terms of monthly split. This quarter was more like 20%-20%-60%, a little more back-end loaded, which also might have had some small impact on revenue since we recognize revenue on a daily basis, but apart from that, nothing else.

Tom McCallum

Actually, Adam, I would add to that. We had a weird Thanksgiving holiday with almost a week after Thanksgiving holiday to close the quarter. And we recognize revenue daily so often, we have a lot of deals that are closing on Tuesday, Wednesday before Thanksgiving at the end of a quarter, and we're recognizing revenue for a few days after that. And this time, most deals closed after Thanksgiving in our normal last couple of days of the quarter, which didn't give that same kind of revenue flow that we would have normally seen.

Operator

Your next question comes from Kash Rangan.

Kash G. Rangan - BofA Merrill Lynch, Research Division

It looks like most of your metric seemed to be pretty stellar, and I was just looking to see that given the changes in linearity of your business that you alluded to just a few seconds back, how do you think the pipeline is shaping up for Q4? And that although you don't comment on and you don't guide on billings growth rate, it has been in the 20-plus percent range. How sustainable is this, especially considering that we've had several tailwinds that have been helping us? The JBoss attach rate has been growing higher, the RHEL 6 product cycle has introduced a bit of a boost to your business presumably. I'm just curious to get your take on the sustainability, if you can talk to directionally, of your billings growth rate as we enter next year? That's it.

James M. Whitehurst

As I said in my comments, this is the best Q3 billings growth rate we've had in 4 years, so it was a very strong [indiscernible] to remind everybody that the business -- Q3 and Q4 of our business is always historically very strong. And in terms of some color, in terms of the pipeline, I would say, as I've had for the last probably 4 or 5 quarters in a row, the bookings pipeline remains strong.

Operator

Your next question comes from Mark Murphy.

Mark R. Murphy - Piper Jaffray Companies, Research Division

Charlie, just trying to look ahead to the February quarter, the billings growth year-over-year comparison gets tougher by about 11 points, and I would think that additionally, FX is going to turn into more of a headwind by -- I would think, by a few additional points. And so all else equal, it would seem as though the billings growth should or could decelerate to somewhere under 20%, just given the difficult comparison, and I know you don't typically guide to a billings growth rate but just considering the volatility of the environment, I guess the unknown outcome in Europe and also, there could be a lack of clarity surrounding the hard disk drive availability out there on servers. If you do have any inclination to maybe guide us directionally one way or the other on what we should do for billings next quarter?

Charles E. Peters

Somewhere in your comments, you said that I don't guide for billings and that's true, I don't guide for billings but I would say this, I'll just reiterate what I said in response to Kash. The bookings pipeline is strong. There is no doubt that currencies will be talked about a lot more by all companies now, and it's a factor everyone needs to consider when all you guys are building your models and adjusting your models, I think. I would just -- I would recommend that you do that as well. But I would point you back, we feel very good about the natural hedge we have in our business that we -- our revenues, expenses are naturally hedged to a reasonable degree so that currency fluctuations do not have any significant impact on the net P&L. Clearly, weakening foreign currencies will have an impact on revenue for all companies that have an offshore component. But beyond that, I don't have any more specific guidance on billings for you.

Tom McCallum

And 2 other quick comments. You had mentioned that the disk drive shortage. At this point, we don't see an impact to that. We recognize the majority of our business is coming from servers, either blades or in racks. And so I don't -- we haven't seen any indication that we should see any change in our business due to that. Second, just to emphasize, we don't manage to billings at all. Billings is an accounting number that pops out of our income statement and balance sheet, right. We focus on bookings, which is what business we're bringing in the door, so that's really what impacts our business going forward.

Operator

Your next question comes from Philip Rueppel.

Philip C. Rueppel - Wells Fargo Securities, LLC, Research Division

Jim, you talked a lot about the opportunity for Gluster and the integration strides you've made so far. Could you kind of compare that with some of your other acquisitions? Do you think it's ahead of plan? Do you think the product is as enterprise-ready as some of either JBoss or Quamnet? And kind of maybe contrast the opportunity and the speed at which you could see that opportunity translate into some of these larger deals.

James M. Whitehurst

Well, it is very, very early days, and so it's difficult to put a time line on it. I will say a couple of the reasons that we are, in general, bullish. First off, middleware is a consulting-led sale, and so it's a much longer sales cycle always. And so building up a middleware business takes some time and it relies on professional services and all of the things to build that up. I would say our sales force feels confident it is a similar or same buyer as our core infrastructure, and it has a sales cycle that looks a little closer to our core infrastructure. So again, we're still early days. We've just released our first product but we do believe that the characteristics of the business fit well with the capabilities that we have in our commercial organization. So we're bullish.

Operator

Your next question is from Nabil Elsheshai.

Nabil Elsheshai - Pacific Crest Securities, Inc., Research Division

I guess I'll follow up on the linearity, given the environment. Was the later quarter linearity due to anything on the macro side or anything in particular that's causing people to be more hesitant? And what's your opinion on kind of a year-end budget flush from what you're seeing in your pipeline?

Charles E. Peters

Good question. We didn't see anything that would indicate it's related the macro side. I think Jim, at least for the U.S. market, hit the nail on the head, the timing of Thanksgiving this year and the fact that we had 3 business days, Monday, Tuesday, Wednesday in the following week, meant a lot of business that might have happened in the Thanksgiving week just got pushed into that last week but nothing from a macro's perspective showing up there. I would also -- I guess, I would add this, I refer back to when things -- when economy is weak, we tend to do well. And when economies are strong, we tend to do -- also do well. We simply change the marketing method slightly from how to create value to how we help you save cost and the message resonates with the customers.

Operator

Your next question comes from Richard Williams.

Richard T. Williams - Cross Research LLC

Could you give us color on the geographic breakdown of business and what the tone of business was like?

Charles E. Peters

Sure. Just to reiterate, the geographic split for the quarter was 60% from the Americas, 24% for EMEA and 16% for APAC. So apart from the fact that we had some really large deals, and in the top 30 deal metric you heard me talk about, 5 deals over $5 million and 27 in total over $1 million, a number of those large deals were in the Americas, which skewed it a little bit towards the Americas but it shouldn't take away anything from the performance of the other regions. Every region did well, every region was in double-digit growth, and I would suspect EMEA is probably the region that is on most investors' minds these days. EMEA had a good performance, and their statistic at 24% is very consistent with where they've been for some time.

Operator

Your next question comes from Matt Hedberg.

Matthew Hedberg - RBC Capital Markets, LLC, Research Division

You guys had a tough compare for services revenue both sequentially and year-over-year and they're more aligned -- more or less in line with our expectations here. I know in the past, you've talked about, it, being a good canary in the coal mine for you guys. Do you see anything this quarter here that surprised you? I know, obviously, you guided us down sequentially due to seasonality in Q4, we're kind of wondering about the dynamics of Q3.

Charles E. Peters

The services business has been very strong. I mean, historically, the service growth rate has been 5% to 10%, so the fact that they did 18% revenue growth in the quarter was still quite outstanding. We're still seeing good demand for services, both in training and consulting, and I don't see anything that's apparent in the services business that would indicate anything sort of on a macro basis at this point.

Operator

Your next question is from Michael Turits.

Michael Turits - Raymond James & Associates, Inc., Research Division

Well, first of all, this I just wanted to -- it seems to me, I just want to make sure my math's right. It seems to me that your billings growth rate, if we did constant currency adjustment for revenues as well, because that's not in your billings calc, actually seems pretty consistent over the last couple of quarters, I get to about 22% versus 25% and 23% in the last 2 quarters. So does that makes sense to you guys? It didn't really seem like constant currency, your business actually decelerated any or not meaningfully.

Charles E. Peters

I think your calculations are in the ballpark, Michael.

Michael Turits - Raymond James & Associates, Inc., Research Division

Okay. And then, yes, I can honestly say that there've been a bunch of questions on this for next quarter, but you had a really strong sequential growth in billings last fourth quarter of around 20% but typically you're hanging in there closer to 10%. So should we look at that last year's 20% as the outlier, and that you have a more like normal historical quarter-over-quarter seasonality for billings?

Charles E. Peters

Again, I don't guide to billings but I would say this, keep in mind that one of the things that influences billings is the average duration of the contract, and that statistic has been relatively constant now for some time in the 20-, 22-month range. And to the extent that we're able to bill those same as booked, it should not be a factor in that comparison.

Operator

Your next question is from Heather Bellini.

Heather Bellini - Goldman Sachs Group Inc., Research Division

I was just wondering, Charlie, if you could give us a little bit more color. Your top 25 deals renewed at about 130%, I believe you said. Last quarter, that was about 150%, and I believe you mentioned that, that was driven by about 6 customers. It was more broad-based than what you've seen in the past. And you had also mentioned that it was driven by increased volume as opposed to price increases. I was just wondering if you could characterize the top 25 renewing at 130% for us this quarter in a similar light?

Charles E. Peters

Yes. I think just to kind of reiterate some of the things we said and maybe clarify. The financial services group was well represented in that group and -- this quarter that is, and they were there last quarter as well but they were the largest vertical this quarter. The second largest vertical was technology and after that was government. The 150% number, which was in Q2, was an outlier. I think I have said that to each of you individually and to all investors at various conferences I went to. When we see 2 or 3 quarters in a row at a rate, I'd say, it's a trend. But when you see one that's kind of an outlier like that, I would treat it as an outlier. 130% higher than the prior year is really a strong result, particularly when you consider the type of customer involved there, the financial institutions. So the growth came from expansion of their business, not from price changes.

James M. Whitehurst

And just in general, it was pretty consistent across the mix. Obviously, a few little faster, a few little slower, but it wasn't 2 or 3 deals that blew it out. I mean, it was pretty consistent growth across most of the 25.

Operator

Your next question is from Steve Ashley.

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

I would just like to ask about the long-term revenue opportunity, some of the very new things you have kind of going on here. I mean, we have the Gluster initiative that is obviously very nascent. You have the RHEV business that's up and going a little bit, and then OpenShift is kind of in the wings, ready to go. If you look at those 3 businesses and look out 3 to 5 years, just wondering if there was any kind of qualitative commentary you could give us about what you think the prospects are, which ones of those maybe larger than others?

Charles E. Peters

The best way to address it probably, Steve, and Jim can jump in at some point, is to talk about the size of the addressable market and the fact that we have now products here, open source products, which provide choice and eliminate the lock-in that the proprietary guys are offering, just like we've got in the operating system side, the middleware side. We agree with what you said. Our position there is still young. We've got a lot of work to do. We have not provided any guidance relative to 3 or 5 years. But if you look backward, I would say, to how we grew on the Linux side of how we've grown on the middleware side over the years, I would expect that same sort of penetration in these addressable markets over time. But that's really kind of all the color, at least financially, we can -- I can offer.

James M. Whitehurst

Yes, just a little -- I wouldn't forget middleware in there, too. I mean, we're still in the very early innings there. If you say the server operating system market is nearly a $20 billion business, we still have quite a bit of room left there. The traditional measures of a traditional middleware is a $10 billion business. We're in the very early innings with our portfolio there. Virtualization, you can look at this year, obvious, it's growing rapidly but it's at least a $5 billion business. So a significant area that disrupt there. Just a very narrowly defined unstructured data storage market is $4 billion. Obviously, that's exploding. So you start looking at the total addressable market opportunities for us out there to go disrupt, they're a very, very large markets. And obviously, at our price points, we significantly reduce the size of those markets. But even with modest share gains across there, some of those products, there's a very, very large opportunity out there over the next few years.

Operator

Your next question is from Ed Maguire.

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

Your G&A has really shown quite a bit of improvement. I know Charlie, you'd mentioned that you're going to be investing quite a bit. But is this 8% level a level that you see sustainable and with scale or is there more room to expand this after you absorb Gluster?

Charles E. Peters

I think in the long term, there's no doubt we can continue to make progress there. We've kind of gone in step functions. You may remember just a few years ago, we had some substantial investments there in systems, I think some of that has paid off. We have additional work to do on systems and so, sometimes, will be investments there. We've also had savings in professional fees in that line, which hopefully these things are sustainable.

Operator

Your next question is from Brent Thill.

Brent Thill - UBS Investment Bank, Research Division

Jim, I think you mentioned the word bookings, and I know Charlie, you don't give that number out. But it sounds that if I read between the lines, that you're contracted, not build backlog actually met your forecast for the quarter. We obviously don't see that but it was just a question of invoicing in Q3. Can you just clarify that?

Charles E. Peters

It's a good catch and good question. So once a year, on the fourth quarter call, I provide some additional metrics around the bookings. Just so everyone is in the same place, bookings, we define as the total value of a contract with the customer, billings is obviously only the portions that we bill at that point in time. The difference between the 2 is off-balance sheet backlog, and that is a year-end disclosure requirement and I will comment further on it at the end of the year, as well as provide some additional statistics about bookings at that time.

Operator

Your next question comes from Kirk Materne.

S. Kirk Materne - Evercore Partners Inc., Research Division

I appreciate the extra comments around the Thanksgiving, how that fell this year. I guess just as you guys get into larger deals with more products that become more complex, I guess has the average deal cycle lengthened at all or is some of the, I guess, the timing or the linearity of this quarter just simply more a factor of some of the how the calendar fell in the U.S.? Or should we expect that as these deals get more complex, you guys mentioned the $5 million-plus deals you had, that you could see your linearity becoming a little bit more back-end loaded just given the nature how these deals are getting larger?

Charles E. Peters

What I'd say is that it's kind of like Heather's question about the 150%. This was one quarter which linearity was a little bit longer. We've had several quarters in a row or many quarters in a row, in which it's been more like 25%, 25%, 50%. So at the moment, I would say this. I think the timing of the Thanksgiving holiday this year in the U.S. was part of it, but I think the other part you've hit the nail on the head, these larger deals require greater approval levels usually at the customer. Sometimes, we have to -- or the customer has to track down all their various approvers. It can take a little bit longer, so that may be part of it. But I don't think yet that the linearity this quarter is something you should accept or believe is going to happen consistently. We'll have to see, it's only one quarter.

James M. Whitehurst

And also, on these big, complex, new 7-figure deals, they're not begun at the beginning of a quarter and end at the end of a quarter. These are ongoing long relationships. Some I don't necessarily think the length of time it takes to pull the deals together impacts linearity, but these are just ongoing relationships with these customers.

Operator

Your next question is from Tim Klasell.

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

Most of my questions have been answered, but just on margins, you've guided to about 120 basis points improvement this year despite the Gluster's headwind. Is that something we should think about going forward out multiple years? And where do you think margins ultimately mature to?

Charles E. Peters

First of all, in the short term, we had a conference call on October 4, at the time we acquired Gluster, and I offered some guidance at that point, which was that it's a brand new business. The storage business is a brand new business for us, it's going to require some significant investment for engineering and marketing and sales in particular. And we offered guidance taking margins down for next year somewhere in the 24.2%, 24.3%, somewhere in that neighborhood. We will obviously offer on our Q4 call very thorough guidance on -- of many items in the P&L and maybe even in the balance sheet. Longer term, there's no reason why our business can't continue to be a really top performer in operating margins and operating margin growth just like the other large top performing software companies are. We've basically shown it this year and we can do better but this is clearly a new business and it's in one we want to invest in.

James M. Whitehurst

And just one more comment there. Obviously, we are still growing rapidly, and as you see our billings are larger in absolute terms than our revenues, and our bookings, because of our balance sheet, are even larger than that. If we were at a low growth rate, our bookings and our revenues would be quite similar. So today, we are paying the commercial expenses to generate the bookings and the billings level you see. So just slowing growth rate would drive through a revenue number that was closer to our billings number, right? So if our revenue numbers were billings, already, you would add quite a bit to our margins. And so just as we slow down, there should be significant margin improvement, not that we're planning on slowing down.

Operator

Your final question comes from Gregg Moskowitz.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Charlie, this is the first time that you haven't bought back any shares since the August 2008 quarter. I'm assuming now it's because of the outlay for Gluster. But just wondering, inclusive of the fact that your stock is indicated down somewhat significantly in the aftermarket, what your thoughts are on buyback going forward?

Charles E. Peters

We have an authorization from our board remaining of $168 million. We have demonstrated that we have been willing to buy back shares from time to time. We acquired Gluster this quarter and spent $136 million on acquisition. I think if you go back and look at our track record, you'll find that we have been consistent buyers of our own stock and in particular in quarters in which we did not have acquisitions. But we don't signal ahead of time whether we're buying or not, but we do have an open authorization from our board.

James M. Whitehurst

Thank you, everyone, for joining our call today.

Charles E. Peters

Thank you, happy holidays.

Tom McCallum

Operator, that concludes the call.

Operator

This does conclude today's conference call. You may now disconnect.

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