Red Hat, Inc. F1Q09 (Quarter End 05/31/08) Earnings Call Transcript

Jun.25.08 | About: Red Hat, (RHT)

Red Hat, Inc. (NYSE:RHT)

F1Q09 Earnings Call

June 25, 2008 5:00 pm ET

Executives

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

Charles E. Peters Jr. - Chief Financial Officer, Executive Vice President

Tom McCallum – Vice President Investor Relations

Analysts

Tim Klasell - Thomas Weisel Partners

Todd Raker – Deutsche Bank

Katherine Egbert - Jefferies and Company

Brent Williams - The Benchmark Company

Analyst for Heather Bellini – UBS Investment Research

Analyst for Sarah Friar – Goldman Sachs & Co.

Mark Murphy – Piper Jaffray

Steve Ashley - Robert W. Baird

Larry Patrone – WR Hambrecht & Co.

Brendan Barnicle - Pacific Crest Securities

Brent Thill – Citigroup

Kirk Materne - Banc of America Securities

Operator

Good afternoon. My name is Don and I will be your conference operator today. At this time I would like to welcome everyone to the Red Hat first quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session.

(Operator Instructions)

Mr. McCallum, Vice President of Investor Relations, you may begin your conference.

Tom McCallum

Hello and welcome to Red Hat's fiscal first quarter 2009 earnings call. 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 www.redhat.com on the investor relations page.

Various remarks that we may make about the company’s future expectations, plans and prospects including statements containing the words believe, anticipate, plan, project, estimate, expect, intend or will constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including in discussions in the company’s most recent annual report on Form 10-K filed with the SEC.

In addition, any forward-looking statements represent our views and estimates only of today, June 25, 2008 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’ll now turn the call over to Jim.

James M. Whitehurst

Thank you Tom. Let me add my welcome to all of you for joining on today’s call. I am pleased to announce the strong start to fiscal 2009 with another solid quarter of growth and operational execution. Our revenue grew 32% year-over-year and was above our guidance. Operating income was up 33% year-over-year and operating cash flow increased 60% year-over-year.

In addition I am pleased with the progress we are making against our top priorities for fiscal 2009 which are: Intensifying our focus on Enterprise Infrastructure Software, improving our internal processes and systems and continuing to build and strengthen our partner ecosystem.

First we continue to align and focus our business on our Enterprise Infrastructure solutions. During the quarter we released the latest version of our award-winning Linux Distribution, Red Hat Enterprise Linux 5.2, which further advances our virtualization capabilities for large enterprises.

We also launched major releases of management products including Red Hat Network Satellite 5.1, which gives customers enhanced comprehensive lifecycle management with tools to manage systems, provision new systems, manage updates and monitor performance and our JBoss Operations Network 2.0 which drives application deployment and simplifies application lifecycle management to enhance enterprise middleware manageability.

We also launched Fedora 9 to the Open Source community. This version of Fedora delivered a number of cutting edge features in enhanced systems management. As you know, Fedora another open source project functioned as a virtual R&D laboratory for our products.

We are off to a good start and on pace to deliver more major product releases this year than in any other period in Red Hat’s history. Our second priority is to improve our internal processing systems. As Charlie will discuss in detail in a moment we continued to drive improvements in our systems and processes this quarter while also launching the first phase of our overall transformation project.

This transformation will focus on building out our customer basing lead to renew processes in addition to other systems that we believe will help Red Hat better scale to $1 billion revenue and beyond in the years ahead.

Finally, our partner ecosystem initiative. We now have over 2,000 global channel partners. Many of these partners are investing heavily in our training and enablement programs to effectively become Red Hat’s quota carrying channel partners.

We also continue to expand the number of JBoss advanced partners who will have the pre and post sale capability to drive additional sales of our middleware offerings. We have appointed both a global head of sales and business development and a global head of channel sales to lead these efforts.

Now let me discuss some of the drivers of Red Hat’s growth. A good indicator of the health in our business as a reflection of the value we deliver to our customer is the fact that all 25 of our top 25 customers renewed this quarter. I am also pleased to share with you the total value of these contracts was approximately 150% of last year’s value largely driven by one customer’s significant upgrade transaction. Customers are realizing substantial benefits as the result of our Enterprise Infrastructure solutions and Red Hat is clearly becoming a strategic IT partner.

For example, one of our renewals with a large national telecommunications provider included a significant expansion of Linux in their infrastructure as well as upgraded services. This customer chose not only to expand their deployment of Red Hat Enterprise Linux but upgraded their subscription to advanced platform to take advantage of virtualization functionalities for their mission critical applications and systems.

They will use REL 5.0 virtualization to take advantage of clustering, load balancing and fail over as well as application mobility. In addition this customer is also working collaboratively with us on enhancing their security functionality using our Open Source solution. This is just another example of Open Source development driving innovation and collaboration with our customers.

Red Hat Enterprise Linux continues to surpass the challenges of our most demanding customers. In fact today the REL platform is the operating system of the world’s fastest computer, IBM’s Road Runner at Los Alamos. As the operating system for this computer, Red Hat Enterprise Linux is helping perform more than a thousand trillion calculations per second.

This quarter we also announced the NYSE Euronext, the largest global exchange group, utilizes Red Hat Enterprise Linux to maintain the reliability, high performance and security of its mission critical financial trading platform. The deployment of Red Hat Enterprise Linux at the New York Stock Exchange Euronext is supporting billions of trading messages per day. To quote a recent interview with NYSE Euronext CIO Steve Rubinow, “Red Hat is as pervasive as water gear. It is part and parcel of everything we do here from a computing standpoint.”

Now this is the type of endorsement we strive for from all of our customers. In addition to our platform successes our JBoss offerings also continue to enjoy strong momentum in Q1 from both a market recognition perspective as well as from a sales perspective. Enterprise Application Platform was named a leader in Gartner’s Enterprise Application Server Magic Quadrant for the third consecutive year.

Also, a recent Forrester’s survey of application development professionals gave JBoss high marks for quality relative to other top application servers.

From a quarterly sales perspective, JBoss continued to grow rapidly and we believe it is on track to achieve our goal of growing twice as fast as the platform business for the year. One quarter after launch JBoss Enterprise SOE platform is also fast star. We have closed several six figure deals with customers who are starting to deploy SOA to simplify their business processes.

In mid-March we acquired Amentra to supplement our middleware consulting. As the market leader in Open Source, Red Hat hears our customers increasingly asking us to help them be more of an advisor to help them understand how to best deploy open source solutions across the enterprise. This quarter our sales team while working on a JBoss expansion opportunity for a major insurance company was able to leverage our new relationship with Amentra. The customer had been running JBoss in development and wanted to integrate their entire infrastructure to JBoss. To finalize the deal our sales team coordinated with Amentra’s consultants to rapidly develop a migration assessment plan for the customer. The result was that we won the largest migration deal in JBoss’ history.

Before turning the call over to Charlie I’d like to share some of my observations from the Fourth Annual Red Hat Summit that was held last week in Boston. This year’s summit had record attendance, up over 50% year-over-year and great sponsorships from our partners. This growth illustrates the broad and growing interest in Red Hat and our Open Source solutions. The majority of the customers I spoke with at the Summit are focused on leveraging their infrastructure. They are tired of the ever-growing infrastructure costs crowding out investment in new functionality.

These customers are very interested in extending the Open Source value proposition to virtualization, middleware and management tools. At the Summit we defined the next phase of Open Source infrastructure solutions required for enterprise adoption and virtualization with a major enabler of Linux automation. Our Linux automation strategy is designed to provide customers flexibility and cost efficiency with a view to any application, any where, any time.

In addition, we announced three strategic initiatives targeting the commercial adoption of next generation virtualization. First, a lightweight embedded Linux hyper visor which is integrated into the Linux kernel. Two, a multi-system virtual infrastructure management solution. Third, a security infrastructure that addresses security concerns for enterprise IT.

Our ultimate goal is to provide the market with end-to-end, comprehensive virtualization capability with the value of an Open Source Solution. On a final note, I’d like to recognize our associates in Japan. For the second consecutive year Red Hat was named the Number One IT Vendor in Japan by Nikkei Market Access in its customer survey release in April.

With that let me turn the call over to Charlie who will review Q1 operational and financial results and provide you with our outlook.

Charles Peters

Thank you Jim. We are pleased to report solid financial results for Q1. Our value message resonates with customers and when combined with our high level of customer service is contributing to the strong demand we continue to experience.

Before taking you through our Q1 results let me update you on the recent progress we made in transforming our infrastructure to support the company’s growth over the $1 billion level in revenue over the next several years. Our primary operational objectives involve driving global consistency in processes and procedures, building additional order capacity and improving our internal systems to more effectively manage the lead to renew process.

We have focused extensively on driving incremental process improvements throughout our operation including reductions in order defect rates of up to 80% in the past year for our America’s region, a reduction of more than 50% in administrative activity time for the sales teams. We have completed the sales automation phase of the transformation with our fourth release in May. Two of our major accomplishments in this program involve releases of increases in sales productivity. We substantially reduced the manual efforts associated with tracking data and creating reports for our channel business which allowed us to invest our time in revenue generating activities.

We also implemented the enhanced lead distribution process which I mentioned was in beta last quarter. This process allows us to pass leads to a subset of our channel partners globally. The number of leads being engaged in our pipeline has increased by almost 30% in the past 90 days as a result of these efforts. We have been very pleased with the initial results in terms of both lead penetration, which is our ability to take action on a lead that we have generated, and lead conversion which measures our ability to convert a lead to a sale.

The conversion rate for leads in our pipeline has improved by more than 7% since our first launch of the sales automation project and we expect continued improvement as we add new partners and further enhance the process.

Currently we are focused on the design phase of our broader transformation project with significant efforts underway in key areas. Our initial areas of focus will include additional tools for our partners, enhanced data structures and improvement in the customer experience. We are evaluating our current channel infrastructure to further enhance tools available to our partners as well as implementing systemic solutions to improve the overall efficiency associated with submitting orders. The DS structure projects involve re-evaluating all of our models to ensure we are capturing the right information about our customers to further improve our ability to provide world-class service and support.

The customer experience has been a key area of focus and we are continuing our efforts to provide service in the languages our customers prefer as well as ensuring the order fulfillment processes are as advanced as our products. True to the Open Source model that drives our business, we are undertaking these initiatives through a process of collaboration with many business partners, associates and customers worldwide.

Now let’s talk about our financial performance.

Q1 was another solid quarter for Red Hat. First quarter revenue was $156.6 million, an increase of nearly 11% from last quarter and 32% from the same quarter in fiscal 2008 and it was above our guidance.

Subscription revenue continued to grow rapidly resulting in $130.7 million in subscription revenue or greater than 7% sequential growth. Year-over-year subscriptions were up 27% and constituted 83% of total revenue. The training and services component of revenue was $25.9 million, up 64% from last year principally as the result of the Amentra acquisition which was completed in mid-March.

As regard to bookings, the channel generated 51% of our Q1 bookings and 49% came from direct sales versus a 54/46% split in Q4. This shift in percentage reflects several large direct deals in the quarter including one eight-figure three year deal which skewed the mix somewhat. Our goal remains to increase the amount of revenues through the channel 60% of total bookings.

In terms of geography, 59% of bookings came from the Americas, 24% from EMEA and 17% from Asia Pacific. This breakdown reflects a solid quarter in the U.S. including the large direct deal which I just mentioned and acceleration in Japan which helped drive APAX results this quarter.

In summary, year-over-year bookings growth, some of which contributed to our deferred revenue balance and some of which built our off balance sheet backlog, was again strong in Q1 following a very strong fourth quarter.

Billings, using our billings proxy, for the quarter was $172.1 million, up 23% or approximately $32 million when compared to the same quarter last year. Please note for these purposes we calculate our billings proxy by adding revenue to the change in deferred revenue shown on the cash flow statement which excludes the impact of foreign exchange rates on deferred revenue. To be clear, billings are not a proxy for bookings. As I noted on the last quarter’s call billings can vary from quarter to quarter and investors may want to consider evaluating this metric on a rolling 3-4 quarter average.

For example, the eight-figure deal which I mentioned earlier only added $2 million in Q1 billings but it will have periodic billings over the next three years.

So now let’s shift back to the income statement. On a non-GAAP basis excluding stock based compensation expense, overall gross margin was 83.6% for Q1, slightly lower than last quarter and last year because of a higher services mix. Subscription gross margin was approximately 93.4%, up 90 basis points from last quarter while training and services gross margin was down from last quarter but in line with Q1 of a year ago.

Q1 non-GAAP operating expense came in at $100.4 million, up $7.9 million from last quarter. The increase in operating expense was attributable principally to the spending of sales, marketing and engineering offsetting some reduction in G&A. Q1 non-GAAP operating income was $30.5 million producing an operating margin of 19.5% compared to non-GAAP operating income of $28.2 million and operating margin of 19.9% last quarter and non-GAAP operating income and operating margin of $23.3 million and 19.6% for the year ago quarter.

Other income net primarily attributable to investment income was $8.4 million, about $1 million short of my guidance reflecting even lower interest rates than I expected when I forecast last quarter. Our non-GAAP tax rate, which reflects actual cash taxes we expect to pay, is still approximately 5% resulting in non-GAAP net income of $37 million. This is lower than last quarter due to the lower interest and other income but it is up 10% from the year ago quarter.

Our non-GAAP diluted earnings per share came to $0.18 which is in line with our guidance for the quarter.

Now let’s turn to the balance sheet and the cash flow statement. We ended the quarter with cash and investments of $1.35 billion. This balance is net of an additional stock repurchase we made in Q1 of $9.1 million for approximately 500,000 shares of our common stock. We also executed a structured stock repurchase transaction in Q1 which settled in cash rather than Red Hat stock resulting in a cash gain of approximately $2 million which is not recorded in the income statement but rather is recorded as a direct increase in equity. I would direct your attention to a line in statement cash flows labeled “Structured Stock Repurchase” which represents this cash gain.

DSO was 60 days and in line with Q4 and Q1 last year and within our target range for this metric. As a reminder, since days sales outstanding is traditionally a measure of receivables versus billings our DSO calculation includes revenue plus the change in deferred revenue. Total deferred revenue at quarter end was $491.8 million, an increase of $128.8 million or 36% over the same quarter a year ago and an increase of 4% over last quarter. Breaking it down further, $351.2 million was in current deferred revenue while $140.6 million was in long-term deferred revenue. To see the change in deferred revenue excluding the foreign exchange impact please refer to the cash flow statement and one will note the increase of $15.5 million which resulted from billings.

Moving to the statement of cash flows, our GAAP cash flow from operations was $63.4 million, up from $39.7 million in Q1 last year. This cash flow growth was approximately 16% higher than Q4 and 60% higher than the prior year. We also continued to generate additional cash from tax benefits related to NOL’s shown under the heading “Cash Flow from Financing Activities.” This quarter we used approximately $37 million of NOL’s related to stock options and the remaining balance of these NOL’s is approximately $190 million.

Now I’d like to turn to guidance. Looking at Q2 we offer the following guidance. Revenue is estimated to be between $162-164 million. I expect a small improvement in operating margin percent. Based on current interest rates other income net will decline to about $7 million in Q2 which I now think is the likely quarterly estimate for the rest of the year. This compares to my estimate last year of approximately $9 million per quarter.

Interest rates have fallen faster and further than I originally estimated and this $2 million reduction per quarter in interest income is worth about $0.01 per share per quarter on EPS and cash flow. Non-GAAP EPS will be approximately $0.18 and non-GAAP tax rate will remain at 5%.

For the full fiscal year we are still forecasting revenue to be in the range of $665-680 million and non-GAAP operating income for the year to grow at approximately the same rate as revenue reflecting our near-term priority of investing the business to deliver strong top line growth in the transformation of the systems and processes to support this growth.

In summary, market demand and our business momentum remain strong and we are in the middle of delivering a range of significant new Enterprise Infrastructure solutions and our unique value proposition continues to be reaffirmed by customers and industry observers. I continue to be optimistic about Red Hat’s outlook.

Before turning the call over to the operator I’d like to extend an invitation to the financial community to attend our fiscal year 2009 analyst day on October 7 in New York City. Invitations and further details will be forthcoming.

Now operator I’d like to turn it back over to you for the first question.

Question-And-Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Tim Klasell - Thomas Weisel Partners.

Tim Klasell - Thomas Weisel Partners

My first question is just a quick accounting question. Charlie in the past you have given us percentage of bookings greater than a year. Can you share that with us today?

Charles Peters

Sure. The percentage of bookings greater than a year is 31%. It has come down a little bit from the past two quarters but it still results in an average contract length in the 22-24 month range.

Tim Klasell - Thomas Weisel Partners

As you are signing some of these larger deals is the trend towards moving to multi-year contracts paid on either an annual basis or a more radical basis, is that picking up?

Charles Peters

Frankly it is hard to say if there is a trend. Some quarters we have more deals that are billed over time like this quarter. I referred to the eight-figure deal where we billed only $2 million in the quarter. Actually there were several very large deals where the billing will probably be more one year at a time. It simply depends on the particular situation of the customer and the needs of the customer and what makes for a reasonable deal.

Tim Klasell - Thomas Weisel Partners

Sort of on a broader product line question what are you guys seeing around advanced platform? As virtualization picks up are you guys seeing that increase as far as a percentage of your deployments or can you give us some color there?

Charles Peters

I think that one of the comments that Jim made is we had a very large deal this quarter that somewhat skewed the top 25 deals. All 25 renewed and what he said is 150% of the value of the prior year. One of those deals was a substantial deal where there was a major upgrade from a basic subscription to advanced platform. So we are in fact seeing that kind of change happen.

Operator

The next question comes from the line of Todd Raker – Deutsche Bank.

Todd Raker – Deutsche Bank

Two quick questions for you. First I just want to make sure on the contract value of the top 25 deals if you backed out the one large deal what would the contract value have been up just on average across the rest?

Charles Peters

Still over 120%. I call it out…it is important that you know that going forward. That is a good question.

Todd Raker – Deutsche Bank

Then, just as a general comment, I’d be curious in terms of any commentary in terms of vertical. Clearly there is a lot of concern around advance spending. You guys have a compelling ROI but what are you seeing in terms of sales cycles and kind of any macro commentary you are experiencing.

James Whitehurst

A couple of comments. Clearly I would say Government and Telco are very strong for us right now so we feel very good about that. Our customers read the papers like everybody else does and folks are nervous but the pipeline continues to look strong, especially in JBoss so we are still feeling quite good.

Todd Raker – Deutsche Bank

Was Government your largest vertical in the quarter?

Charles Peters

Government and Telco were roughly equal in the quarter, both quite strong.

Operator

The next question comes from the line of Katherine Egbert - Jefferies and Company.

Katherine Egbert - Jefferies and Company

I’m just wondering you reiterated your guidance for the year. Are you reiterating the cash flow guidance too and is there something there?

Charles Peters

The only comment on the cash flow guidance I guess the comment I made about the other interest and other income that my estimate now is about $2 million per quarter for Q2, Q3 and Q4, lower because of lower interest rates and that will have an impact of about $0.01 a share on earnings in cash flow. Other than that nothing else changed.

Katherine Egbert - Jefferies and Company

So about $0.01 a quarter so that would be $0.03 on both EPS and cash flow?

Charles Peters

Most likely, yes.

Katherine Egbert - Jefferies and Company

That big eight-figure deal that you signed, was that a renewal?

Charles Peters

That was a renewal and a significant upgrade.

Operator

The next question comes from the line of Brent Williams - The Benchmark Company.

Brent Williams - The Benchmark Company

I have two questions for you. First off looking at the JBoss business qualitatively, can you give us sort of a sense of what the relative growth of that business is as I said qualitatively if not quantitatively versus the core business?

James Whitehurst

What we have said is that we are targeting its growth twice as fast as the platforms business and we feel confident it will do that this year. Obviously that is a pretty reasonable growth rate. In general it is not just the applications platform. As we have said we are very pleased with the SOA suite. Literally we announced that availability to the JBoss world and as we said we signed several six-figure deals literally in the first quarter.

Charles Peters

The JBoss pipeline looks strong across the world in every region right now.

Brent Williams - The Benchmark Company

Not to nitpick, but just to tease our some wording that could be interpreted two different ways Jim on what you just said…you said you were targeting twice as fast as the platform business on track for the year. Was the growth rate anywhere close to 2X on this quarter?

James Whitehurst

Yes.

Brent Williams - The Benchmark Company

That just was ambiguous whether that included this quarter or whether that was later in the year.

James Whitehurst

No, that is including this quarter.

Operator

The next question comes from the line of Analyst for Heather Bellini – UBS Investment Research.

Analyst for Heather Bellini – UBS Investment Research

What was Amentra’s contribution in the quarter? What are you expecting for the rest of the year?

Charles Peters

Just to recap what we said in Q4, our expectation for the quarter is that it will contribute something around $5 million and I also said that we didn’t intend to break it out separately. I will tell you that it contributed more than $5 million and we are very pleased with the performance but other than that I’m not going to talk specifically about Amentra details.

Analyst for Heather Bellini – UBS Investment Research

You mentioned a little bit about people upgrading to advanced platform as they are renewing contracts and moving to REL 5.0. What percent of your deals are on advance platform and how high can that go and over what time period?

Charles Peters

As we have said before one of the real advantages of the subscription model the customers like is they can move to the next version of software or a higher level of software at any time they choose so long as they are a paying customer. So, there was never an expectation that everyone was going to move quickly to REL 5.0 from REL 2, 3 or 4 or whichever version they are on. There is not necessarily an expectation that people will move from immediately from basic to advanced platform. Having said that we have seen very good adoption of REL 5.0 and many customers moving that way and I would say an accelerating number of customers either evaluating or in fact moving to advanced platform. The biggest one is that eight-figure deal we talked about.

Operator

The next question comes from the line of Analyst for Sarah Friar – Goldman Sachs & Co.

Analyst for Sarah Friar – Goldman Sachs & Co.

I have one follow-up on the big deal that you had in the quarter can you give a sense for a customer like that if they are upgrading to advanced platform do they go…how much of their environment do they advance or upgrade to that higher platform? Is it just a small proportion or is it most of it?

Charles Peters

Frankly I don’t know the answer to the question. I think you can tell by the size of the deal and if it is a sizeable transaction but frankly I don’t know what percentage of their environment it is. That is something we could follow-up with you on.

James Whitehurst

Are you asking the size of the percentage of subscriptions of REL or the percentage of servers that would now be running REL?

Analyst for Sarah Friar – Goldman Sachs & Co.

The percentage of servers.

James Whitehurst

That I actually don’t know. We can try to get back to you. I don’t know that number.

Analyst for Sarah Friar – Goldman Sachs & Co.

I was curious if you have a sense for what advanced features if there are any in particular that are really driving…when you see instances that advanced platform is being taken up are you seeing people running virtualization on Linux or some of the other features seem to be driving it or all of the above?

James Whitehurst

Well a number of features but clearly virtualization is the strongest driver. Again, you look at the functionality and the performance and with the major applications and the relative performance it is quite compelling so that is the clear number one driver.

Operator

The next question comes from the line of Mark Murphy – Piper Jaffray.

Mark Murphy – Piper Jaffray

Charlie if we look back historically your billings have tended to be sequentially flat in the second quarter. Last year you actually had a slight decline. Is there any reason to expect a change in that type of seasonality this quarter that we are into now?

Charles Peters

Billings, as I have said on a number of occasions, tend to go up and they tend to go down. The beauty of the subscription model is revenue tends to be a nice straight line but billings does move around a little bit. It is hard to predict to be honest with you. If the eight-figure deal we talked about had all billed in one quarter as opposed to billing over a period of time or a multiple of those deals obviously that can shift things a little bit. So I don’t try to predict billing and that is precisely the reason why I don’t try to predict quarterly cash flows.

Mark Murphy – Piper Jaffray

As a follow-up, Jim your strategy of enticing customers to become engaged in the development process with products like SE Linux and Merge, can you offer any milestones that we can use to evaluate success there or perhaps what percentage of your total development do you think could be done by customers in the future?

James Whitehurst

I guess I could say the best milestone is the GA of Merge. Right? So we have just done it. We are still in the early stages. I look at it as the potential to do that is all upside so as we talked about guidance in sort of current momentum case it does not presume a lot of that for any of that built in. We are in the process now of going through and kind of vetting out and really trying to put numbers against that. At this point we have not built any of that in our numbers. Therefore I really don’t have a good way to give you milestones at this point. That said, I do think it is material and it could be quite, quite large both from a standpoint of finding products that can be commercialized but frankly much more important than that is growing our share significantly of Enterprise Infrastructure even with our existing products.

As people get involved in and understand the value of our products they quickly find out it is not just our operating system is lower cost than Solaris. It is the substantial other components that can now move to commodity whether it is hardware or other components in there so the more we get our other customers involved it is not just let’s find five or six other potential product lines to add, it is actually having them understand the full value of what we provide today and the potential to in a much greater way penetrate customers even with our existing products and other Open Source products as well.

Operator

The next question comes from the line of Steve Ashley - Robert W. Baird.

Steve Ashley - Robert W. Baird

I’d like to drill into the large deals a little bit. Can you give us any qualitative sense of how the amount of billed large deals in the first quarter compared to the fourth quarter?

Charles Peters

Steve just a little more color. We have talked before about the number of large deals and if you put this in our top 30 or so deals we have had about 10 in excess of $1 million which meant we had a lot of smaller deals. A lot of deals in the $100,000 to $1 million. We actually had three mega-deals. I mentioned one of eight-figures. We had two additional ones in excess of $5 million. Just speaking of the three mega-deals the biggest one I mentioned only billed $2 million and the other two, each of which were only $5 million we only billed half.

James Whitehurst

Just commentary, I look at that as a good thing. Over time as the large customers who are putting us in major parts of their infrastructure when they become comfortable signing multi-year deals that are going to bill on an annual basis it is basically saying they have accepted the fact we are going to be a long-term part of their infrastructure and feel comfortable doing that. I actually feel better about customers who are very happy to sign up for multi-year commitments knowing they are going to continue to write checks to us on a periodic basis.

Steve Ashley - Robert W. Baird

How prevalent was JBoss in some of those larger deals? Was that in both?

Charles Peters

The top 30 deals were 100% middleware and there were another 20% of the total of the top 30 deals involved middleware. Basically 10% were just middleware. So they were well represented in our largest deals.

Operator

The next question comes from the line of Larry Patrone – WR Hambrecht & Co.

Larry Patrone – WR Hambrecht & Co.

Jim I think you mentioned earlier that your channel was growing to about 2,000 partners. I wonder if you can give us a sense as to what you have seen for growth in the channel program over the last couple of quarters and is there certain geographies that benefit from that channel growth.

James Whitehurst

Over the last couple of quarters there is no geography that necessarily stands out as growing more quickly. The general commentary has been across the board we have seen a lot of strength with middleware. The Oracle BEA acquisition just led to some dislocation and so it has actually introduced us or partners have come to contact us and so we are getting them up to speed. So especially in the middleware space I would say very, very good momentum getting new partners and getting them trained up. You can see in the numbers, other than the big out layer deal our mix of channel bookings has remained relatively constant but I’d say the activity in signing up has picked up so I would expect to see that shift further towards channel over time.

Larry Patrone – WR Hambrecht & Co.

So are you still seeing…is the BEA acquisition still driving potential partners to you today?

James Whitehurst

Yes. Oh yes. Again, I’m not saying there is anything wrong with the way the acquisition is happening. I think when you naturally in the space go to fewer players surely there are going to be some people bumping into each other and looking around which is certainly to our benefit and continues to be to our benefit right now.

Operator

The next question comes from the line of Brendan Barnicle - Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

On the virtualization front I think last year you had given us some metrics on sort of usage and numbers of folks. I wonder if you had any update on that. Then have you given consideration of taking the virtualization product and spinning that off and selling the hyper visor separately?

Charles Peters

On the update in terms of numbers of customers, no it is still kind of the same answer I gave earlier. Customers can move to higher versions when they want to so I don’t have a precise count for you on that. Specifically on the product plans around virtualization, what we have said last week at the Red Hat Summit and there is a number of press releases and other press stories out there about that. I think I’ll just let that stand. Your best reference would be to just get some of the press releases that are out there.

Brendan Barnicle - Pacific Crest Securities

On the channel side do you see a good transition from direct to indirect and how do you manage that internally with the direct sales force seeing more and more of the business going to the indirect side?

James Whitehurst

Frankly that is one of the beauties of a business that is growing high 20’s or low 30’s range. It doesn’t crowd out. The market is large and growing quickly. Obviously there always is a little bit of channel conflict as there is in any business but it is not like we are in a 5% GDP growth business where the shift actually causes dislocation. At this point we see a lot of potential to continue to grow in absolute dollars our direct business. I think the potential for the channel to grow faster is going to be there.

Operator

The next question comes from the line of Brent Thill – Citigroup.

Brent Thill – Citigroup

Charlie I was wondering if you could update us on the overall pricing environment? What you have seen this year versus comparing or contrasting over the last year or two years?

Charles Peters

I think from a pricing perspective we have maintained our prices and have maintained really the same discounting discipline we have had over the last 3-4 years to be honest with you. I think probably the most significant factor would be not necessarily a price change but a functionality change around REL 5.0 platform where as we have discussed some people are now starting to move up somewhat. From a competitive standpoint we continue to compete very effectively and we continue to use the value proposition with our customers which in this market is a very good sales pitch to have and that is a good performance and value capability to be able to demonstrate.

James Whitehurst

I also want to come back to the earlier question. We did announce an embedded hyper visor last week. So, yes technically we do have a product out there. It is an embedded hyper visor. I don’t want to miss that. We’re not changing anything we are saying.

Operator

The final question comes from the line of Kirk Materne - Banc of America Securities.

Kirk Materne - Banc of America Securities

Jim could you talk a little bit about just how JBoss is progressing internationally? I guess where do you think it is relative to the U.S. business and I assume it is somewhat behind given the go-to-market model JBoss had on a stand alone basis. Can you give us an idea of how you see that ramping up and what sort of the plan is in terms of broader partner adoption over there and can you get it up to speed with the U.S. business over a couple year period or do you think it is going to have to sort of evolve gradually?

James Whitehurst

No, I think there is a clear, very, very fast adoption outside of the U.S. as well. Again, we have picked up a lot of the partners that we talked about in the channel system are global as well. So we are seeing nice pick up there. There was obviously dislocation when we changed models to the Enterprise edition but since we have done that across the board we have seen positive results. We are also getting quite a number of seasoned middleware experienced people in the business. Our head of Japan is an ex BEA person. We have several people in Asia as country managers who have been in commercial organizations in the middleware space. So we are building our capabilities outside the U.S. pretty rapidly. We are adding a lot of partners again both in Asia and EMEA and we are seeing quite a bit of strength there. So, when we talk about these growth rates certainly North America has been strong but the other regions are growing quite rapidly with JBoss.

Again, I just saw a lot more opportunity there but I haven’t seen anything relatively kind of out of line internationally. It actually looks quite good.

Operator

There are no further questions at this time.

Charles Peters

Thank you very much. We’ll be seeing some of you as we get out on the quarter. Thanks a lot.

Operator

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

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