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Here’s the entire text of the Q&A from Red Hat’s (ticker: RHAT) fiscal Q3 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Question-and-Answer Session

Operator

Operator Instructions

Your first question comes from Jason Maynard of Credit Suisse First Boston.

Q - Jason Maynard

Congratulations, can you hear me, okay?

A

Good morning Jason.

A

I think Jason.

Q - Jason Maynard

Okay great, just to follow-on the comments were on the doubling of off-balance sheet backlog, to start. If that’s the case and obviously billings were down a bit sequentially, if I do, I guess some kind of quick math here, it would seen then that bookings grew probably somewhere in the double-digit sequentially that to seems to make sense?

A - Charles Peters

If we haven’t given any specific guidance about bookings let me just help you on the billings proxy, which will help, once you have the additional facts, you can probably do the math. If you look at our cash flow statement, you can see a change in the deferred revenue there that is almost \$18 million. If you look at the balance sheet, can do the math of change in the deferred revenue on the balance sheet, you’ll find a number that’s smaller than that. And so the obvious conclusion is that the strengthening US dollar have an impact this quarter, and if you do the math rather than put to the agony that you do the math you will get a \$2.3 million difference comes with the impact of foreign currency on deferred revenue this quarter. So, that’s the piece of the puzzle, the second part of the answer on the billings proxy is that we had a number of 1 year deals booked in the quarter in the regions of world where we still do deliver a box product, and did not have the inventory to deliver, so that product could actually be delivered probably in the month of December or January. When you take the foreign currency and you take the change in the, off-balance sheet backlog, and go through the math of the model, I think you get an answer that will give you a bookings result that is online with that we actually did.

Q - Jason Maynard

Great, Okay. Yeah, it seems like that obviously it was, just significantly higher than what the expectations are heading into the quarter. And like to maybe shift gears and ask Matthew a question and talk a little bit about some of the strategy and the positioning that came out in the December 6, press release, around certifying and managing various Open Source stacks and some of the drivers that you are hearing some customers to take on a broader role reporting Open Source in general?

A - Matthew Szulik

Well, Jason one of the things we talked about in our remarks tonight was, in the enterprise, in the Fortune 500 segment, globally to consolidation of vendors being an important driver. As more and more customers who are deploying Open Source software and various permutations of Open Source software, they would like to that to have consistently do business with the vendors that has global reach that has the infrastructure and a relationship with the community members to deliver those certified stacks. So our continued thrust will always be on moving as much of that relationship with the customer online, what perhaps we didn’t communicate well enough is that we have great experience in doing this with the REL4 release that where we have the community, certifying and testing online for their apps in their hardware certification. So we are bringing that technology forward to what we believe is an emerging very positive opportunity for the company to delivery that level of certification and testing across the series of both the LAMP stack and other Open Source technologies on rail.

Q - Jason Maynard

Okay, thanks very much.

A

Thank you Jason.

A

Thanks

Operator

And your next question comes from Brent Thill of Prudential.

Q - Brent Thill

Thanks good afternoon. Just for ’07, I know you have not given specific guidance, but if you can just give us a sense of how to at least think about modeling, cash flow in our margins concerning the strength that you saw in Q3 and through the year?

A - Charles Peters

Yeah, just a kind of recap, what we have said and win, at the Analyst Day in early October, we provided some cash flow guidance saying that our expectation for ’07 fiscal year will be cash flow, and it would be roughly \$1 share, and that’s the only guidance we provided thus far. One thing I would say about operating margin, sorry, with everything that we said that they have the operating margins would like to be in the low 20% range in the 20s. It is clear from our results this quarter that we had very good return on the investments we made in Q3 and Q4 last year where we invested heavily in people and systems. And I just have to say again it’s our intention, we believe, we got very early situation and an emerging growth market where the right stage to do is, to continue to invest, so we will be increasing spending in people and systems. At this point I don’t have any additional guidance other than what I’ve already said relative to fiscal year ’07; I would urge you not to kind of extrapolate Q3 into ’07 at this point. And we will have fairly detailed guidance at the end of the, our Q4 conference call.

Q - Brent Thill

Okay, and Matthew, you mentioned renewal rights were running 95 plus percent that the renewal rates have been very strong, and that was of the top 25 deals. You have mentioned that you do roughly 10,000 deals a quarter. So you apply that across, are the renewal rates just as strong across, the rest of the install base considering you are doing 1000s of deals a quarter?

A - Dion Cornett

Brent, this is actually Dion. We are still putting some systems in place, again wireless to get some better information, beyond some of our largest customers. I mean for the purposes that Matthew gave the 24, 25, as I have said it’s really manual process, but we do dive into the top few dozen are customers and see what happen there. Let me just comment, even the 24th and the 25the is maybe not even representative of our business as a whole, that 25th customer that we did not renew, we were actually the component of a Federal Government projects within one specific agency, and that project did not get refunded, and for the government fiscal year unrelated to Red Hat. The business that we do with that agency overall has been very strong, without that deal. The business had basically doubled over the course of the last year, and even with that deal, well it’s tough to quantify specifically even as the business came to our agencies were directed to resellers. I am probably comfortable saying they are, even our dollars, if we got from that agency except one un-renewed project, unrelated to Red Hat still increase year-over-year. So I think, the good news for us there is that customers are increasingly willing to take chances on Red Hat for large new initiatives and I think it speaks to the growing nature and adoption.

Q - Brent Thill

All right. Thank you.

Operator

Your next question comes from Brendan Barnicle of Pacific Crest Securities.

Q - Brendan Barnicle

Hi guys, I think in the past, you’ve given us some metrics on the non-Linux products in the quarter, do you have that again in this quarter, or when is that?

A - Charles Peters

Just to clarify what we said before, that in the first quarter of this fiscal year, the non-operating system bookings was about 15% of the total, but we also said at the that time, that, that was the only time we are going to talk about, so the revenue on those same items, that will be at least 10% of revenue and the reason is, its still early on in the growth of those products and it’s a little bit lumpy.

Q - Brendan Barnicle

Okay.

A - Charles Peters

The answer is we are not yet at 10% and we don’t have any further breakout at this point.

Q - Brendan Barnicle

Great. On the virtualization, there is a lot to talk about Xen and we are not, this virtualization to get bumbled right into Realtors, is that going to be sold as an add-on feature at some point?

A - Dion Cornett

No I think the debates about Red Hat functionality around virtualization, the hypervisor of the tools and the management services is, I think still in the early planning stages of how we intend, its eventually roll that out, I mean, but I think its safe to say that, we have always believe that, that degree of functionality should be a component of the operating system.

Q - Brendan Barnicle

Should be a core component, so not an add-on feature that you paid severally for, or you just, you may change the pricing on the overall operating...

A - Dion Cornett

As an example the hypervisor like functionality should be a part of the operating system.

Q - Brendan Barnicle

Okay great. And then just a housekeeping, do you have the stock option expense fees for the quarter, so you can put that in the GAAP model?

A - Charles Peters

It wasn’t, there is a non-cash stock option. The non-cash stock compensation expense included in the P&L?

Q - Brendan Barnicle

Right.

A - Charles Peters

That number for the quarter is \$1,299,000 as in the following lines. There is \$87,000 in sales and marketing expense. There is \$99,000 in research and development expense, and there is \$1,113,000 in G&A.

Q - Brendan Barnicle

Got it, thanks a lot.

A - Charles Peters

Okay.

Operator

Your next question comes from Terry Tillman of SunTrust Robinson Humphrey.

Q - Terry Tillman

Well I have a couple of financial questions. Could you remind us, give us an update in terms of the average tenure for your direct sales force and how do you feel now, you are yet at another quarter with a lot of these net hires from the fourth quarter and first quarter, and how do you feel about the productivity of that, much expanded sales force?

A - Matthew Szulik

I am not sure what you mean by the much expanded sales force, Terry. I think the tenure of the sale of the, I should say the productivity of the reps that I have been onboard for more than 6 months is beginning to show some dividends that were reflected in the quarter. But the outbound direct sales force, the size of that sales force has remained steadily constant throughout the last three quarters at a minimum. And I think we are pleased with the rate of penetration, that they are achieving both within the existing installed base that we commented on and the growth opportunities for the, the net new deployment of sales people, in geographies that we didn’t have coverage.

Q - Terry Tillman

Okay, okay thanks. And then in terms of the cash flow question, just to confirm Charlie, in terms of you are talking about a \$175 million in operating cash flow for the full year, is that correct?

A - Charles Peters

Yeah, what Dion said was that, our guidance at this point for the full year would be at least a \$175 million of operating cash flow.

Q - Terry Tillman

Okay, because I mean we have three quarters down, I mean, just a simple math is about \$38 million, so potentially we could be under \$40 million in the fourth quarter, which, that is down I guess from the past few quarters meaningfully.

A - Charles Peters

I guess the only thing I am saying that is, I have said for the last three quarters, I don’t want to provide quarterly operating cash flow, and there is only one quarter to go. The only logical way to do that is to give a reasonable floor.

Q - Terry Tillman

Yeah.

A - Charles Peters

I am not trying to predict what Q4 cash flow is going to be. I am just saying I don’t believe it’s less than \$175 million.

Q - Terry Tillman

Okay fair enough, okay thank you guys.

Operator

Your next question comes from Tim Klasell of Thomas Weisel Partners.

Q - Tim Klasell

Yes. Yes, good afternoon everybody. Just a quick question on the, on the 25% organic growth and you guys mentioned that you believed you, you are grabbing share there. Can you give us sort of an idea of what you think your current market share is and to drive that growth, maybe reflecting towards an earlier question? How much do you think you are going to have to move into sort of newer market for this file system and then, and what have you?

A - Charles Peters

I think the comment there was around all of various operating systems that are out there, right, and our view continues to be, that we have about 80% market share of paid limits and that the bulk of the opportunity for us has been and continues to be UNIX replacements. And so we are clearly taking share from UNIX.

Q - Tim Klasell

Okay very good. And then, the sort of quick follow on the cash flows, can you give us, as more and more of your sales continue to go international and, your direct sales continues to be a significant part. How should we think about seasonality of cash flows i.e. how receivables should fluctuate during the year to sort of help us model out cash flows?

A - Charles Peters

I think the interesting thing about our business is we don’t have a great deal of seasonality. Its actually very small, there is only two minor blips, one is in the European market in the summer, and that’s everyone sees it but perhaps we have such a global business that we have been able to kind of deliver that and pickup cash flow and revenues and booking in other places. So we really haven’t at this point seen a lot of seasonality in the summer.

Q - Tim Klasell

Okay, so working capitals number should stay fairly consistent throughout the year?

A - Charles Peters

Yeah in terms of receivables, DSO as I said, I guess a couple of quarters ago, I think 57 days I am extremely pleased with, it’s much better than most software companies.

Q - Tim Klasell

That’s great, thanks a lot guys. Congratulation on the quarter.

A - Charles Peters

And its 63 I would be still happy.

Q - Tim Klasell

Okay.

Operator

Your next question comes from Chris Kwak of SIG

Q - Chris Kwak

Charlie, just wanted to revisit the balance sheet, specifically the, the short-term deferred revenue, it hasn’t grown this slowly in absolute dollar terms since actually ’03. Wanted to understand why the off-balance sheet bookings that really wouldn’t have an impact on the short-term deferred revenue. So could you may be walk us through why that grew at a very slow rate. And then secondly on the fiscal ’07 question, sounds like we are not going to talk about that too much, but given us the off-balance sheet backlog grew more than anticipated, wouldn’t that argue that dollar per share in operating cash flow should go higher, even though off-balance sheet numbers grew more than expected. So can you walk through those two questions?

A - Charles Peters

We start first with deferred revenue, I’ll go back to the answer I, I tried to do give to Jason Maynard maybe that wasn’t clear enough, but in terms of the short-term deferred revenue, there are couple of components, first of all the foreign exchange changes that is affecting the dollar had an impact on short-term deferred revenue for the quarter. Most of the \$2.3 million that I mentioned would have been in the short-term deferred revenue. And again how you find that number, if you refer to the statement of cash flows to see a change of deferred revenue showing there of \$17.983 million and then if you actually do the math on the balance sheet just looking from quarter-to-quarter about the change on the balance sheet, you will find a number of that is 2.3 million less than that.

Q – Chris Kwak

Right, but if you added that back, that would be just \$10 million increase versus the \$20 million you grew in August, right?

A - Charles Peters

Okay, right. So that’s the first component and then the second component is the, the change in the off-balance sheet backlog. So the other point that I mentioned which is a little bit different this quarter is that we have the experience of very strong bookings in some of the markets where we still provide the goods through a box product. And we did not have the inventory to deliver. So in fact the off-balance sheet backlog did grow, it would be, would be current year or current deferred revenue, had it actually been built and shipped.

Q – Chris Kwak

And what, can you give us a sense of what that, I know that, with that question I have been asked for, but can you give us a sense for how big that was?

A - Charles Peters

No, no. I am not going to get into the detail of that, because when you, we are getting back to the bookings, kind of into the bookings.

Q – Chris Kwak

And the second part of the question.

A - Charles Peters

Just repeat the second part of the question.

Q – Chris Kwak

The second question regarding fiscal ’07 dollar per share and the off-balance sheet backlog. When that imply that as a dollar would probably have to be lifted, somewhat more significantly than you had initially thought, since the Analyst Day.

A - Charles Peters

Not necessarily, I tell you why. Just recall at the start of this year, we started this year, we talked about the expectations for fiscal year ’06. What I said at that point is at the start of the year we already had 40% of my guidance for revenue for ’06 on the balance sheet in deferred revenue. We come to the end of this year, we’ll have to take stock and see where we are. But, there is two parts in it, one is what’s the deferred revenue and how does that move over into revenue, the cash flow from that has already happened. So what’s your looking for in cash flow is the growth in new deferred revenue and then you’re going to subtract from that, how fast we intend to invest in terms of growth in people and systems. What I’ve said is that, I really do think it’s very evident from this quarter and even last quarter’s results that we’ve had great payback in the investments we made in Q3 and Q4 a year ago. And then we need to keep doing that. So we will be investing more. So the cash flow is going to be determined by how much we spend, to get what sort of new deferred revenue.

Q – Chris Kwak

All right. Thank you.

Operator

Your next question comes from Mark Murphy of First Albany.

Q - Mark Murphy

Charlie, this quarter’s cash flow was more driven by the collection of receivables and little lesser by the increase in deferred revenue, if we compare it to last quarter. And so my question is that, do you consider the pipeline looking into Q4, what happened to off-balance sheet? Is that situation likely to reverse itself next quarter?

A - Charles Peters

No, first of all let me not agree with your opening statement, I don’t think that’s actually what happened. I think that the cash flow this quarter was really driven principally by very strong earnings. Our cash flow status pretty simple, its starts with the earnings, the first thing viewed as a biggest item, the second biggest item is going to be the change in deferred revenue and it was again this quarter. And then you have the non-cash items, which don’t tend to change a whole lot quarter-to-quarter and some change in the working capital. But if you look at working capital in total, you have to look at the change in the receivables, the change in the prepaid expenses, the accounts payable and accrued expenses. All of that pretty much netted down to pretty small number. So the true answer about where the cash flow comes from this quarter, it came from very strong earnings performance and a big growth in deferred revenue for the most part. But certainly getting back to the question that was I think it was Tim Klasell asked the question about, about DSOs. We are very pleased with 57 days of DSOs and clearly doing a good job on our receivables reflects happy customers, and big caution efforts and it helps the cash flow. If we have DSOs of 60 again, that’s not a bad performance. Clearly helps 57.

Q - Mark Murphy

Okay so Charlie you do not agree that this, that last quarter the cash flow is driven more by deferred revenue and less by accounts receivable?

A - Charles Peters

I guess I was trying to say, you need to look at working capital in total, you look at last quarter then receivables, receivables had actually a negative impact of \$9.8 million and accrued expenses had a positive impact of \$5 million. the net impact on working capital from those two items. If you look at this quarter and you combine receivables, prepaid expenses and accrued expenses, you are going to get a number that’s somewhat smaller.

Q - Mark Murphy

Correct. And Charlie I just follow-up on a trailing basis now, you are running, cash flow is running at 56% of revenue. Can you help us to understand directionally maybe, how could that percentage trend as we head into FY ’07 and beyond?

A - Charles Peters

I think in terms of actually, providing guidance for, any further guidance on cash flow for ’07. I am going to wait for the, coming to the Q4 conference call. For now I am still happy at least a dollar per diluted share of cash flow, we will just do more work on that. The key drivers again, are obviously what can we do on earnings and then secondly what do we think about bookings and the resulting deferred revenue growth.

Q - Mark Murphy

Okay and then one for Matthew, can you talk about how the Federal Government did in the quarter and was that a bigger factor on bookings in the August quarter or the November quarter?

A - Matthew Szulik

Yeah the Federal Government business was consistent with, has been consistent quarter-over-quarter, it was not significantly more material in the Q2 quarter.

Q - Mark Murphy

Thank you.

Operator

Your next question comes from Rick Sherlund of Goldman Sachs.

Q - Rick Sherlund

Thanks. Charlie, there is earlier question on ESO cost, was the ESOs that you expense, but could you give us the figure for the ESOs that did not show up in the P&L?

A - Charles Peters

Sure, just give me one second.

Q - Rick Sherlund

I think it’s around \$10 million or so.

A - Charles Peters

Yeah, the net number is actually lower. No it’s about \$9.7 million.

Q - Rick Sherlund

That’s after tax?

A - Charles Peters

After tax, correct.

Q - Rick Sherlund

Okay and…

A - Charles Peters

And Rick just to clarify now, to make sure that, that we do the math right, if you’re trying to do a, sort of a hypothetical 123R calculation and you are going subtract that number, make sure you add back the tax affected number that I gave you previously, its already in the financial statement.

Q - Rick Sherlund

Well the 9.7 is just the ESO expense that was not in the P&L or that need to have the additional one point, whatever million on top of that?

A - Charles Peters

I think you go the other way, yeah the 9.7 is not in the P&L but we already have some portion which is in the P&L so you need to back it up.

Q - Rick Sherlund

Right, okay. And also the tax rate on next year, I think you had mentioned before, it was 35% but I am just not sure if that includes your, if we include ESOs next year, I am just not sure where do you going to get this, yeah we will take the tax benefit for that in the P&L. So I am not sure if your 35% tax rate includes tax benefit from ESOs or excludes that?

A - Charles Peters

My guidance to you at this point is that you should assume a 35% tax rate on everything including that stock option expense.

Q - Rick Sherlund

Okay and the, also down the cash flow number. You sound good sequential increases in operating cash flow each quarter along with the revenue in the earning growth in this next quarter your guidance seems kind of conservative to make, we assume the 175, that is very bottom of your range that would imply about 39 million for the quarter versus 54 for this quarter if we assume its, only 54 they get closer to 190, I am just not sure why we wouldn’t expect for the cash flow to grow sequentially if the rest of the businesses was that the magnitude of investment you are talking about for system spending or something?

A - Charles Peters

Well it is, I will say, I am not trying to forecast quarterly operating cash flow and all I gave you was a base number, at least a 175 million. There are reasons why, because spending is going to go up as cash flow could be lower, but I am not trying to predict what its going to be at this point.

Q - Rick Sherlund

But the spending, I am just trying to identify the items, the spending you said with the headcount, but that is already, that’s in our net income number. So I think I already captured that, what are the kinds of spending?

A - Charles Peters

With the investment I talked about was really spending in OpEx, spending in people and spending in information technology make the people more efficient.

Q - Rick Sherlund

Per capital expenditures?

A - Charles Peters

Certainly some capital expense and some of that will be operating expense.

Q - Rick Sherlund

Okay, right, thank you.

Operator

Your next question comes from Brent Williams of Keybanc Capital Markets.

Q - Brent Williams

Okay, why don’t you sort of go back to Brendan Barnicle’s question earlier? On virtualization you mentioned that there is sort of a core virtualization and it should be part of the operating system. But is it reasonable to suspect that there maybe components layered on top of that, that might be an additional product.

A - Charles Peters

I think that’s the smart way to look at it, Brent. I think that’s what Brian Stevens and Paul Cormier have been communicating publicly around the world, but that is the long-term strategy.

Q - Brent Williams

Okay and any color on what long term is, I assume that’s longer than one week, is that one year, two years, one quarter?

A - Charles Peters

Well I think, long-term being defined as 18, 24, 36 months as long as our customers take to deploy the technology and migrate as part as, as it will towards multi-core hardware architectures, the rollout of virtualization, security and management layers et cetera.

Q - Brent Williams

Okay and then, and lets see linearity on subscription signings during the quarter or you seeing, more stuff coming earlier or about the same?

A - Charles Peters

This quarter was about the same as it has been in prior quarter before last quarter. In other words it was more, it was more backend related, you probably recall we had, we made some progress last quarter so in the early was little bit better, and we are kind of back to normal this quarter.

Q - Brent Williams

Okay, that’s it from me thanks.

Operator

Your next question comes from Todd May of Deutsche Bank.

Q - Todd May

Why don’t you guys can talk about the total subscriptions in the quarter?

A - Matthew Szulik

Yeah Todd¸ we have been for the last four conference calls commenting that this is not really relevant metric, we did not use this metric internally that managed to, and we will be just continuing buying this metric going forward.

Q - Todd May

Okay and then can you just talk about the competitive environment with Sun and SuSE?

A - Matthew Szulik

With specifically the Sun, we are both, encouraged and happy that they have validated our resources with respect to the open source development model, being the development model of the future. We are also happy that they acknowledge our success with the company and their conference call talking about open sourcing of all their software. You mentioned, also SuSE there are few hundred other Linux distributions out there, I think the priority for us is just simply to build our brand are positioned for us with the customers and we’ll see our…

A - Charles Peters

Now let me just add Matthew’s, some color on this. Our growing global success continues to come at the expense of all the UNIX franchises. Which remains as a very, very healthy business last year in calendar ’05, ‘04 it was over \$19 billion worth of UNIX related technologies sold globally. So we continue to chuck away that historical installed basis customers migrate to an AMD, Intel, hardware infrastructure and our ability to continue to build a robust service platform around the world franchise continues to provide price performance and service benefits that, it cannot be equaled by the historical UNIX franchises. I think, as we are starting to see, we are starting to get into some of the, what I would describe as the front office applications, as customers now are looking at other contemporary open source technologies like Stateless Linux, as a way to deal with some of the security issues, better management tools in and around Linux that I think we’ll start to see as competing over the next 12 month increasingly more with the historical Microsoft franchise in the front end applications

Q - Todd May

Okay, great. And how is the success against the UNIX vendors come at the expense of one vendor more so than other?

A - Charles Peters

That’s a good question. I would say that certainly the Solaris UNIX franchise is probably been the replacement that we are seeing the greater stuff and increasingly the other UNIX starting to feel other pressure from Linux as well.

Q - Todd May

Okay, great, last quick question, have you discussed when you will at, virtualization into the OS?

A - Charles Peters

I don’t think that we have set a final date for, it’s in the Fedora product right now the Xen layer is in Fedora right now, if you want to download that, and that’s usually a pretty good forward indicator that we can get in terms of testing and integration. But I don’t believe we have communicated a hard, fast date for when that’s going to be available in the real franchise.

Q - Todd May

Okay, last quick question, and for the next version any thoughts on, on a date for them?

A - Charles Peters

I don’t have a date for that.

Q - Todd May

Okay, great, thank you.

Operator

Your next question comes from Heather Bellini of UBS.

Q - Heather Bellini

Hi, thank you I had a couple of questions actually. When you mentioned Matthew that the 10 largest, or 24 of the top 25 deals renewed from last year, what spending levels that they renew it on a percentage basis and then I had a couple of follow-ups?

A - Dion Cornett

Heather this is Dion, so if we include the one government agency that do not renew, even including that the actual dollar value from those 25 contracts last year increase by 14% in this quarter. And so I just want to clarify what that mean, that does not mean our business with these 25 customers increase by 14%, it seems that 14% increase in the revenue associated with that specific order. So there were an example this quarter of a large financial services institution that made the top 25 list last year, they renewed during the quarter the amount that was higher than what they signed up for last year, but this deal was separate did not include with the deal as we actually close with them. So we have then quarters closed over several million dollars. So it’s 14% on apples-to-apples comparison for those particular projects from the year ago.

Q - Heather Bellini

Right, okay so it’s, aggregate of those 25 deals where a million it would have been a \$140,000 if they would have renewed it?

A - Dion Cornett

Correct.

Q - Heather Bellini

Okay. And then the other question, I guess are you seeing a bigger chunk of your large deals you done as multi-year contracts build one year at a time versus paid upfront. Are you seeing the bigger chunk of those deals, given your focus on not offering discounts to bring the cash in upfront, are you seeing a bigger trend towards that, and is there any reason why this trend should change?

A - Charles Peters

I think its safe to say that we actually prefer multi-year contracts done direct before one year at a time, because its makes more sense, and we have been a lot more discipline in pricing to make sure that happens, that we still have a occasions where we, we have a multi-year contract that’s build on advance, but its minority of the situations.

Q - Heather Bellini

Okay, do you use to give a metric in the past of the number of the multi-year deal for people paid upfront, do you still provide some, can you still provide some sort of color on that?

A - Charles Peters

I don’t think we actually able to provide that, what we have provided is the percentage of deals that are beyond 12 months, percentage of bookings beyond 12 months that I believe beyond mentioned in his comment.

Q - Heather Bellini

Yeah, you said, I thought that 3 or 4 quarters ago you gave another metric about the percentage of those deals where people are actually paying up front.

A - Charles Peters

I don’t believe so but it can be determined in terms of dollar, in terms of percentage if we are looking at the balance sheet, looking at the grade…

Q - Heather Bellini

Right.

A - Charles Peters

In a long term to deferred revenue.

Q - Heather Bellini

Okay, then I just had two quick ones, one as a follow-up to Rick’s question again you guys you made the same comment last quarter about investments and we saw the upside in cash flow this quarter, again when you are thinking about the investment you are talking about for Q4 and in the fiscal year ’07, what percentage of the investment or CapEx related versus OpEx related?

A - Charles Peters

Let me just be clear, the investments I am talking about when I am referring operating cash flow are all operating expenses so that would be…

Q - Heather Bellini

Exactly

A - Charles Peters

You put personal cost or other expenses system cost that are expense. In terms of CapEx my view still hasn’t changed there, we are running so far this year a little bit behind my original projection in CapEx through 9 months we have about \$12.4 million, I think our forecast for the full year was originally was \$20 million, we clearly not going to spend 7 or \$8 million in Q4. So we won’t spend \$20 million this year. I still believe that a forecast for CapEx for next year somewhere in excess of 20 and maybe high as 22 to \$24 million is reasonable and we’ll provide a clear guidance on the Q4 conference call.

Q - Heather Bellini

Okay, I guess that’s where it gets a little bit hard than reconciled that \$38 million cash flow implied cash flow number and again, I think what you are trying to tell us you are not guiding the cash flow at all, you are just giving us before which you think is reasonable. But at the same time you see that want a model for your cash flow, but the three quarters done it just doesn’t seem like it would be a stretch given your comments on investing, where that’s already reflected in the net income number plus the type of deferred growth that you should be getting in what’s the traditionally strong Q4, if you look at your past deferred trend, it just seems like, expectations are going to be all over for the board now.

A - Charles Peters

I would just, I would agree with your comments that I am not trying to guide a quarterly cash flow and, I hope expectations won’t be all over the board, I would guide against irrational exuberance.

A - Dion Cornett

Heather, I don’t think as you consider, its very difficult for us to predict cash flow, we do multimillion dollar deals each and every quarter, if some one pays us \$3 million on March 1st or February 28th we have no visibility or control over that, but that’s the \$6 million swing in cash flow for the quarter.

Q - Heather Bellini

Okay and then your off-balance sheet doubled as you said because a lot of one year deals that were booked but not billed. Are you relating to the box product situation you mentioned were the inventory wasn’t ready in some of the emerging countries or where you referring to something else?

A - Charles Peters

No, its principally the former.

Q - Heather Bellini

Okay, will those people pay you cash-on-delivery because that would be a natural boost to deferred thing as well as payments terms over see it are longer, right?

A - Charles Peters

Yes, when we sell a one-year subscription box product it is cash-on-delivery.

Q - Heather Bellini

Okay, great, thank you very much.

Operator

Your next question comes from Trip Chowdhry of FTN Midwest Security.

Q - Trip Chowdhry

Congratulations on this fabulous execution and talking to the customers, I think your customers are actually rationally exuberant, so let me ask few questions that I am getting from the contacts that I have in the industry, regarding your three stacks that you have been talking about LAN stack, Servlet stack and J2EE stack, your closest competitors who happen to be private companies are generating about \$15 to \$20 million run rate for you, how fast do you think Red Hat can execute to overcome your closest private companies?

A - Matthew Szulik

Hi, this is Matthew Szulik, yes, I’m planning on that.

Q - Trip Chowdhry

Beautiful, second, AJAX, the client and the customer base is really asking when will Red Hat even support AJAX stock it is a matured stock that all the people not in place, but how do you think about when you are thinking like this is the right time to deliver a certified stock to the marketplace and push it in your preconfigured stock. When can we as investors or analyst think about AJAX stock being supported by Red Hat, I hope for 12 months, 18 months hope what batch that come in?

A - Matthew Szulik

AJAX especially on the client side has many exciting potential opportunities for Red Hat, as that there is especially in our target market which is the enterprise market, there is a lag time between what is been used for tested and preproduction, and by the time it use into production. So I think we, we will continue to listen to our customers in our marketplace when we think that they directly amount a taxable opportunity, and right now what we think is that opportunity is still early.

Q - Trip Chowdhry

In the international markets very important and very interesting stack is Red Hat Linux and Asterisk open source Voice over IP technology stack. Do you think moving forward back to another stack that probably Red Hat maybe thinking of certifying and pushing it from mass market?

A - Matthew Szulik

Yes.

Q - Trip Chowdhry

Okay, last question, a lot of companies, a lot of countries are creating new data centers specially in, on your region and Asia Pac region, and they almost of 70% heavily Linux Red Hat based, why is it so, and are you doing something specifically in the count management on sales execution, where you have such a disproportionate success in these new data centers that have been created?

A - Matthew Szulik

Well, Trip I’m glad that you highlighted that because I think it first of all, it speaks to the outstanding leadership of the people that are leading those efforts in the respective geographies like Red Hat India. I would give them all the kudos, and their team all of the kudos, they have not only built great brand in those markets, is what we highlighted in our remarks. I think second of all they have done a great job of partnering with the respective hardware and channel partners in that region. And I think the Red Hat GLS program that we have been delivering in those markets now for almost 7 years is producing qualified technical trained talent in market that you described. It’s a combination of all of those.

Q - Trip Chowdhry

Maybe I have one more question, for this completeness. I just downloaded Xen and Fedora, looks very interesting to me and also sense that it is almost technically fall with VMBO from EMC and my experience show that this new product which is Xen Works and Fedora maybe shift by Red Hat probably in August, September timeframe, am I in the right ballpark of how we’re maybe off?

A - Matthew Szulik

Well I think as you might imagine for government encouraging how partnership as soon. But I’m pleased that you are downloaded Fedora and Xen Works. I think the community support in and around that configuration has so far has received a lot of very good support and feedback to us.

Q - Trip Chowdhry

Thank you and congratulations for just fabulous execution here.

A - Matthew Szulik

Thank you Trip.

Operator

Your next question comes from Steve Ashley of Robert Baird.

Q - Steve Ashley

Hi guys, I was just wondering, given the off-balance sheet bookings that didn’t show up in the billings this time, is it safe to say that your book-to-bill ratio was highest this quarter than its probably been in the last this fiscal year and last fiscal year?

A - Charles Peters

Not sure is the highest but I would say it was a good book-to-bill ratio.

Q - Steve Ashley

Okay, and could you give us any color on maybe what the largest book deal was in the period?

A - Charles Peters

I think, we’re in the, something in the neighborhood of \$5 million.

Q - Steve Ashley

Great and then I have a qualitative question regarding your indirect business, you gotten some support now from some of your layer products outside the OS, that some of your indirect partners have started to support it, you started to see any traction and any encouraging sign that you might start getting some indirect revenue from those products.

A - Matthew Szulik

Steve, we are getting good productivity from some of the partners that have been selling the directory technology in the layered products already over the last 2.5 to 3 quarters. So what we see now happening on a local basis especially outside of the United States is the development of the value added vertical suppliers that are starting to build direct vertical solutions either storage implemented solutions around Linux, and in AMD Intel solutions, they are building that competency in that technical delivery force around that configuration. So yes we are starting to see enough tick in that value add …

Q - Steve Ashley

And just lastly at the Analyst Day Charlie, I think you talked about kind of an invisible benefit that you would seem to your cash flow with improving and reducing the number of days it takes to get a bill out the door. Was there any further improvement that you experience in that during the recent quarter?

A - Charles Peters

What I said at the Analyst Day, we had measured at as longer period time as can, will improve it to about 6. I think still on the neighborhood about 6, which means, we still have room to go.

Dion Cornett

Steve, we need to move on. Operator we, we’ll take one more question.

A - Charles Peters

Operator?

Operator

Yes, your next question comes from Chris Russ of Wachovia security.

Q - Chris Russ

Okay, sweet and last isn’t that hey, the gross margin was a record 84%, do you expect further room for improvement there or do you think you’ve reached a near term peak in gross margin?

A - Charles Peters

I think couple of things come in to play, and if you break it down between the two principle revenue streams, the subscription revenues had a 92% gross margin and the services revenue at a 46% gross margin, and clearly what’s happening there is each of them individually grow this quarter, the subscriptions because we delivered more online in the services because we have a better utilization rate, but the primary factor to be honestly is in terms of the overall gross margin improvement is the increasingly rich mix of subscriptions. The subscription business grew by over 50% this quarter, while the services business still had good growth, but didn’t grow anywhere near that pace. So assuming the subscription continue to grow at a much faster pace and services which I think is likely then the gross margin percent in total has further room for improvement.

Q - Chris Russ

Okay and then with regard to competition with Novel/SuSE and do you think they are gaining or maintaining share as you know they just grow 65, 000 subscriptions versus 28,000 in their prior quarter, we just don’t know the ASP, but how would you compare your pricing with Novel/SuSE and how correct is that maybe common pricing, and I know you been competing with them for sometime, but should we be concerned about any more aggressive packets from the pricing point with Novel or do you think its sort of status quo with them?

A - Matthew Szulik

Steve, I think the quarterly performance of the company and the consistent quarterly performance of Red Hat over the past three to four quarters, I think is a just an indication to itself or the value the customers receiving, the rates of renewals, the growth in subs, that continue to improving the operating efficiency of the company, as I stated in my earlier remarks, the customers are now choosing to consolidate their relationships with a global leading provider, and that’s evidenced in our performance relative to competition.

Q - Chris Russ

Okay, great, thanks a lot.

Dion Cornett

Operator that’s, that be all in the call.

Operator

Okay, thank you. This does conclude today conference, you may now disconnect.

Charles Peters

Thank you.

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