Red Hat Q2 Earnings Call Transcript

123jump.com Staff
18 Oct, 2010
New York City

The open source solutions provider quarterly revenue rose 20% to $219.8 million. Net income in the quarter declined 18% to $23.7 million, which included a one-time tax benefit of $7.3 million. Earnings per share fell to 12 cents from 15 cents per share in the year-ago quarter.

Red Hat, Inc. ((RHT))
Q2 2011 Earnings Call Transcript
September 22, 2010 5:00 p.m. ET

Executives

Thomas McCallum – Vice President of Investor Relations
James M. Whitehurst – President and Chief Executive Officer
Charles E. Peters Jr. – Executive Vice President and Chief Financial Officer

Analysts

Adam Holt – Morgan Stanley
Heather Bellini – ISI Group
Kash Rangan – Bank of America/Merrill Lynch
Sarah Friar – Goldman Sachs
Michael Turits – Raymond James & Associates
Trip Chowdhry – Global Equities Research
John Difucci – J.P. Morgan
Timothy Klasell – Stifel Nicolaus
Edward Maguire – CLSA Securities
Todd Raker – Deutsche Bank
Steve Ashley – Robert W. Baird
Nabil Elsheshai – Pacific Crest Securities
Katherine Egbert – Jefferies & Company
Brent Thill – UBS
Brad Whitt – Gleacher & Company
Joel Fishbein – Lazard Capital Markets

Presentation

Operator

Welcome, ladies and gentlemen. My name is Gerald and I will be your conference operator. At this time, I would like to welcome everyone to Red Hat''s Q2 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers'' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. And we ask that today’s listeners limit themselves to one question. If you would like to withdraw your question, press the pound key. Thank you.

I would now like to turn the conference over to Mr. Tom McCallum, Vice President of Investor Relations. Sir, you may begin.

Thomas McCallum

Thank you. Hello, everyone. Welcome to Red Hat''s earnings call for Q2 of our fiscal year 2011. Speakers for today''s call will be Jim Whitehurst, President and CEO and Charlie Peters, Executive Vice President and CFO.

Our earnings press release was issued after the market closed today and may be downloaded from redhat.com on the Investor Relations page. Also on this page, you will be able to find a historic reconciliation schedule of GAAP to non-GAAP financial metrics as well as a schedule on currency rates.

Various remarks 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 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 factors -- important factors, including those discussed in the company''s most recent Quarterly Report on Form 10-Q filed with the SEC.

In addition, any forward-looking statements represent our estimates or views only as of today, September 22, 2010, and these estimates and views may change. While the company may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates or views do change and therefore, you should not rely on these forward-looking statements as representing our estimates or views as any date subsequent to today.

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

James M. Whitehurst

Thank you, Tom. And let me add my welcome to all of you joining on today''s call. I''m pleased to announce another quarter of strong execution by our Red Hat Associates, which drove financial results well above our expectations.

In the quarter, we saw solid demand for our Open Source products, strong renewals and continued spending on new projects. The combination of strong second quarter results and momentum going into the second half of the fiscal year provides us with the confidence to raise our full year growth outlook, which Charlie will talk more about in detail in a moment.

Here are a few of the financial highlights for the quarter. First, sales execution was once again strong in Q2. Demand for our subscriptions remain strong and demand for services have continued to rebound.

For the second quarter in a row, we delivered 20% year-over-year organic revenue growth. And despite foreign currency headwinds, our revenue growth rates through the first half of this year have outpaced last year''s double digit growth.

Second, we continued to invest in both sales and engineering, allowing us to expand our portfolio of solutions in middleware, cloud computing and virtualization. In addition, we continued to prepare for the public release of Red Hat Enterprise Linux 6 later this year. While our investments in growth initiatives have enabled Red Hat to deliver higher growth rates, we also continue to manage our overall cost structure effectively, which resulted in strong operating income growth and expanded margins.

Third, we continue to see strong renewals in our largest deals. I''m pleased to report that all of our top 25 deals that were up for renewal in the second quarter not only renewed but did so at a total value of over 120% of original value.

The value that customers receive from a Red Hat subscription is key to strong renewals with our large customers and to up selling and cross selling additional products to our large and growing customer base. In fact, this quarter, our largest renewal came from a previous free-to-pay customer who originally signed a large deal three years ago. This customer renewed in Q2 for over 250% of their original order, expanding RHEL in their enterprise while replacing additional free Linux, UNIX and Windows. They also added RHEL Management to achieve an even better ROI on their investment.

Now, let me update you on just a few of the exciting announcements that we made during our last fiscal quarter at our premier user event, the Red Hat Summit and JBoss World. We introduced developments in our Cloud Foundations portfolio that promote consistency between enterprise applications and the cloud. This strategy has received substantial industry support from customers to partners to industry analysts.

As a strategic provider of cloud infrastructure to our customers, our flexible cloud stack will enable customers to build and run applications across physical servers, virtual platforms, private clouds and multiple public clouds. Red Hat Enterprise Virtualization, or RHEV, RHEL and JBoss as critical components of the Cloud Foundations portfolio, will allow end customers, ISV partners and public cloud providers to build and deploy what we believe is the most versatile combination of offerings as this high gross market evolves and matures.

A key differentiator for our comprehensive approach is that it will allow customers and ISV partners to maintain control through interoperability and portability, whether on-premise or across clouds. Customers will be able to leverage their existing infrastructure in a cloud architecture and have a clear runway in the future to set their own course as needed, without the risk of vendor lock-in.

IDC recently completed extensive research regarding enterprise customers’ expectations with the cloud. Their conclusions validate our commitment to open standards and focus on interoperability and portability across clouds.

In addition to next generation cloud technology, flexibility, choice and one of the highest levels of compatibility in the industry, we offer our customers high value and cost savings benefits as they build their clouds. We are making solid progress on our cloud initiatives, starting with Red Hat''s Cloud Foundations. In fact, this quarter, we closed a $1 million plus deal for private cloud management with a customer that is driving the cutting edge of cloud technology.

Our Virtualization Solutions and enabler of cloud computing continue to gain interest in the industry and with customers. We recently announced several deals around the globe. One announced recent win is Qualcomm, who has selected RHEV as a key virtualization platform for its production workload. In less than a year from launch of our RHEV product portfolio, we have announced over 300 customers working with RHEV in both development and production.

Another highlight from the quarter comes from one of our strategic system integrator partners, Accenture. We have been working with Accenture over the past year to help them build an open practice. As part of their due diligence on Open Source software, Accenture performed a study of IP professionals in 300 large organizations in the United States and parts of Europe.

Their findings reveal that Open Source software continues to drive and demand from enterprise customers is growing. A few of the highlights from the study released in August revealed that two-thirds of organizations in the study anticipate increasing their investment in Open Source solutions this year. More than a third expect to migrate mission-critical software to Open Source in the next 12 months.

Also, the benefits of Open Source were not limited to cost savings but respondents cited quality, reliability and security as key benefits from Open Source software. This type of validation is a strong proof point of the types of conversations we have with our customers every day.

In summary, we are pleased with our continued execution around the globe and across products. We are optimistic about the strength of our sales pipeline, our technology roadmap and our ability to drive revenue growth and operating income growth.

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

Charles E. Peters Jr.

Thank you, Jim. This was an outstanding quarter. Revenue grew 20% year-over-year; billings grew 20%, representing the highest growth rate in two years. Non-GAAP operating income grew 25% and we generated $64 million in operating cash flow.

Our strong financial results were driven by solid demand across all products and geographies, new business and renewal business, strong new customer acquisition and continued strength in our services business. We have seen existing customers renewing and growing, and many new customers just starting out. We are also encouraged by the number of customers we see increasing their investments in new projects.

As Jim mentioned, we saw early traction in cloud computing and virtualization with our customers. We are also pleased to report that our global pipeline and renewals remain strong.

This quarter, we had significant number of deals at or over $1 million. The top 30 deals for the quarter included 12 deals of approximately $1 million or greater, with one deal in excess of $5 million and approximately a third of the deals included the middleware component, with three being standalone middleware deals.

Similar to last quarter, we experienced continued strength in our services business due to new project spending and middleware migrations. Approximately one-third of our top 30 deals included a services components, with three of our top deals in the quarter being purely related to consulting, which generally precedes subscription sales.

Billings totaled $233 million, up 20% in U.S. dollars and up 22% in constant currency. This marks the fourth straight quarter of double-digit growth and our highest billing growth rate in two years. As a reminder, our billings proxy is calculated by adding revenue plus the change in deferred revenue on a cash flow statement, which eliminates most foreign exchange impact.

From a bookings perspective, the channel generated 67% of our Q2 bookings and 33% came from direct sales versus a 54%/46% split in Q1. We''re pleased with the strong results from our channel, which include a number of large government and mainstream customer wins, which weighted the result more heavily to the channel this quarter than normal. While the split can vary quarter to quarter, our goal continues to be approximately 60% of bookings from the channel.

In terms of geography, 56% of bookings came from the Americas, 24% from EMEA and 20% from Asia-Pacific. As you can see from the results, our European business remains solid and Asia-Pacific was strong with several large wins in the quarter.

Let me now turn to our P&L. Second quarter revenue was $220 million, an increase of 20% year-over-year, up 5% sequentially and well above our guidance range. Stronger subscription revenue and service revenue both contributed to this growth. Please note, as Jim said, this growth is 100% organic.

Subscription revenue was up 19% year-over-year and 4% sequentially to $186 million. The higher volume of deals as well as better linearity during the quarter, both drove the subscription revenue growth.

Subscription revenue, which is renewable, constituted 85% of total revenue. The training and services component of revenue was $34 million, up 23% from last year and up 12% sequentially.

On a non-GAAP basis, excluding stock compensation and amortization expense, overall gross margin was 85% for Q2. Subscription gross margin was 94% and training and services gross margin was 33%.

We have hired additional consultants to meet the increased demand in our services business, particularly related to training and middleware businesses. As the utilization rates for these new consultants increases, we believe that there can be an improvement in the services gross margins.

Moving onto non-GAAP operating expenses, the total for Q2 was $132 million, up 5% sequentially and up 16% year-over-year. We continue to invest in sales and engineering, specifically within our higher growth areas such as virtualization, cloud computing and middleware. As a result, we grew Q2 non-GAAP operating income by 25% or $11 million higher than the prior year and expanded our non-GAAP operating margin by 100 basis points to 24.7%.

Our interest income was less than last year and slightly below the $2 million that we had guided at the beginning of the year, primarily due to lower interest rates. Other income, primarily investment gains, was approximately $2.5 million lower than last year.

Our estimated annual effective tax rate was still 35% for both GAAP and non-GAAP results. Non-GAAP diluted earnings per share came to $0.19 and was above our guidance. As a reminder, the prior-year quarter included a one-time tax benefit, which added approximately $0.04 a share to non-GAAP EPS last year. Excluding this item from the prior year, non-GAAP EPS increased 19% year-over-year.

One should also note that currency rates have continued to be volatile, especially the euro. Our natural hedge, that is the offsetting of global revenues expenses, continued to provide us reasonable protection from these currency risks. For example, if the second quarter had had the same foreign exchange rates as the second quarter last year, revenue would have been $3 million higher and expenses about $1.5 million higher than we reported, which would have resulted in about $1.5 million of greater operating income.

Now, let''s turn to the balance sheet and the cash flow statement. We ended the quarter with cash and investments of approximately $1.1 billion, up $82 million from last quarter. In the quarter, we repurchased $5 million of common stock for a total of more than $220 million in the past 12 months.

Quarterly operating cash flow was $64 million and in line with our expectations. Foreign exchange adjusted days sales outstanding were 49 days compared to 53 days in Q1 and 54 days in Q2 last year. As a reminder, since days sales outstanding is traditionally a measure of receivables versus billings, our DSO calculation includes revenue plus the change in deferred revenue from the cash flow statement.

Total deferred revenue at quarter-end in U.S. dollar terms was $650 million, an increase of $69 million or 12% over the same quarter a year ago. On a constant currency basis, deferred revenue would have increased $83 million or 14% year-over-year. Current deferred revenue grew 15% in U.S. dollar terms, while long-term deferred revenue grew 3% from one year ago. It''s important to note that the percentage of current deferred revenue has continued to increase even as the total grows, improving our visibility on near-term revenue. On a sequential basis, FOREX added $8 million and $3 million to the growth of current and long-term deferred revenue, respectively, compared to Q1.

Now, I''d like to turn to guidance, which assumes currency rates approximately where they were yesterday. Given our strong performance in the first half of the year, it is clear that your existing full-year revenue estimates are too low. Consequently, we are raising our revenue guidance for the full year from $835 million to $850 million to a tighter range of $877 million to $885 million.

We expect to be able to grow non-GAAP operating income by 22% to 24% year-over-year, while continuing to invest and grow initiatives. Again, that is non-GAAP operating income growth of 22% to 24%. We would expect non-GAAP EPS to be in the range of $0.76 to $0.77.

Our full year operating cash flow guidance remains unchanged at $280 million to $290 million, since we would expect some working capital growth. However, we do expect to produce up to $10 million more than previous guidance in cash from so-called excess tax benefits from stock comp deductions, which will be included in cash flow from financing activities, bringing that full-year number to something in the $40 million to $45 million range.

For the third quarter, revenue is estimated to be approximately $226 million to $228 million. Operating margin is estimated to be between 24.5% to 25% even as we continue to add sales capacity. And non-GAAP EPS for the third quarter is estimated to be $0.19 to $0.20, assuming the same 35% tax rate.

In summary, we continue to execute well and the global pipeline remains strong. We are increasing investments for growth in our core businesses, including opportunities in virtualization, cloud computing and middleware.

Our value proposition is compelling and our business model is strong, providing us good visibility into our renewable revenue base.

Operator, I''d now like to turn it back over to you for the first question.

Question-and-Answer Session

Operator

Certainly, sir. Ladies and gentlemen, if you would like to ask a question, please press star then the number one on your telephone keypad. We again would like to ask that you limit yourself to one question. Your first question comes from Adam Holt with Morgan Stanley.

Adam Holt – Morgan Stanley

Great. Thank you for taking my question. I wanted to drill into the recent strength in the middleware business. First of all, can you comment on how the middleware business grew relative to the broader business? And secondly, did the strength entirely show up in billings in the quarter or is there potentially a phenomenon where bookings outpaced billings, given some of the strength in JBoss? Thanks.

James M. Whitehurst

Thanks, Adam. The middleware business continues to perform quite strongly and relative to the questions about bookings and billings, as I mentioned, many of the services deals are middleware-related and typically precede the subscriptions. So, in terms of the single-year bookings component, there would be a substantial part of that is going to be middleware. In services, probably billings as you go, which means subsequent billings but the middleware business continues to be quite strong.

Adam Holt – Morgan Stanley

And can you put your finger on what you all think is really causing that inflection up to the middleware business?

James M. Whitehurst

I think it''s the value proposition. Frankly, it''s a very compelling value proposition with a high value to the customer, lower cost, better performance and more flexibility. I think we finally reached the tipping point there, where we have the feature set that the vast majority of customers want, with the (inaudible) 5.1 and visibility into the technology roadmap going forward. I think most customers see that we can more than meet their needs today going forward. So we''re really reaching an inflection point where we''re seeing acceleration there.

Adam Holt – Morgan Stanley

Terrific. Thank you.

Operator

Your next question comes from Heather Bellini with ISI Group.

Heather Bellini – ISI Group

Hi. Good afternoon guys. I was wondering, Jim, if you were making a T account of tailwinds and headwinds as you look at Red Hat''s business over the next -- I guess, over your next fiscal years, what could you tell us as the tailwinds that you''re looking for in your business next fiscal year and what''s your confidence level in those tailwinds occurring?

James M. Whitehurst

Well, I think some of the biggest tailwinds from my perspective first is -- we''ve been investing very heavily in our cloud and our virtualization portfolio and that''s been a lot of investment. And really it''s been out in the market less than a year. And so we''re now seeing, as I said before, this year is all about getting customers, getting trial, getting POCs.

So I''d say as we get to next year, you''ll see that turn into real revenues that move the needle. We have RHEL 6 coming out later this year and if you look at the performance there, in terms of the feeds and speeds and the feature set, I feel very, very good about that.

I would say, in general, our efforts that I''ve talked about before on mainstream adoption, when I look at our top 30 customers, I''m impressed to say that many, I have to look as to whether it''s most, fall outside of our key normal categories of financial services and telco and government. So we''re getting some great, whether it''s transportation, whether it''s oil and gas, whether it''s retail. We''re seeing strength across the board, as we really break out from the early adopters into the mainstream. And there''s just a lot of business there.

And finally, we said we still expect JBoss to grow twice as fast as the rest of the business for the year. And then you throw that in with, I guess, cloud as well, obviously, we''ve significantly raised our guidance and we''re seeing a lot of tailwinds behind us.

Heather Bellini – ISI Group

Great. Thank you.

James M. Whitehurst

Thank you.

Operator

Your next question comes from Kash Rangan with Merrill Lynch.

Kash Rangan – Bank of America/Merrill Lynch

Hi. Thank you very much. Jim and Charlie, just was wondering at a strategic level, given that Oracle just announced unbreakable kernel the other day, I''m curious to see how as a management team you think about what that means for your business and any customer feedback you''ve gotten in that regard. And also, if I missed the commentary on free-to-fee conversions, I would love to get a quick update. I think you''ve been giving us an update every quarter on that. That''s it from me, thanks.

James M. Whitehurst

Sure. Well, let me start off on Oracle. You know, I felt like listening to what we heard, it sounded like a repeat of what we heard four years ago. I think we feel very, very good that we know how to compete in this market. We see real value in our value proposition. You know, recognize a key component of our value proposition is bringing a broad certified ecosystem and bringing a new kernel out doesn''t bring that same set of values. So we feel very good about how we''ve competed in the past and how we will going forward. Charlie, you want to…?

Charles E. Peters Jr.

Yes. On the free-to-fee or free-to-pay, as we say now, we continue to make good progress as Jim mentioned that the largest window of this quarter was actually a free-to-pay customer three years ago. So that''s the great validation that they see the value in what we''re doing. And we continue -- we''ve got people engaged in each one of our regions now. We have added a few people in this effort over the year in terms of educating our own salespeople and customers and continue to make good progress.

Kash Rangan – Bank of America/Merrill Lynch

Any stats at all, Charlie and Jim, on how many customers you''ve brought on from the free-to-pay program? I know, you''ve been giving that metric out, if I''m not mistaken, the last few quarters?

Charles E. Peters Jr.

I don''t have any stats on the numbers of customers, but what we''ve said is, in terms of incremental revenue each quarter, it''s typically been in the few millions.

Kash Rangan – Bank of America/Merrill Lynch

Got it. Thank you.

Operator

Your next question comes from Sarah Friar with Goldman Sachs.

Sarah Friar – Goldman Sachs

Terrific. Two quick questions for you. Just on the Oracle topic, away from unbreakable Linux put onto the Solaris side, are you seeing any change in the pace of Solaris replacements of folks shifting off of big boxes onto more commodity x86 of Linux on top? And then on your 300 customers that I think you said are working with you on RHEV, could you talk about how many of those have come in with the IBM relationship, more to give us a sense of the progress of that IBM relationship? Thank you.

James M. Whitehurst

Sarah, on the first part of the question relative to Solaris conversions, probably the best measure is seeing how the other major OEMs are doing, IBM, HP, and Dell, among others, and possibly Cisco. Our business with the OEMs continues to be strong and we feel pretty good about that. Relative to RHEV conversions, we don''t have any specific stats relative to any one of the OEMs. You mentioned IBM, I think, so I don''t have any color to add on that.

Sarah Friar – Goldman Sachs

But just more to give a sense of the relationship, I think you put in place with IBM on the virtualization side, how has that progressed to date and how are you going to market, et cetera?

Charles E. Peters Jr.

Are you talking….

James M. Whitehurst

Are you referring to cloud?

Charles E. Peters Jr.

….their cloud offering?

Sarah Friar – Goldman Sachs

Yeah. Exactly, cloud and all the virtualization piece that you''re adding in underneath, yes.

James M. Whitehurst

When I talk about the customers that we are adding, that would exclude anything around the IBM clouds offering now. The vast majority of the -- well, all of the 300 customers I''m talking about are primarily via our direct sales or via channel partners. That would not include the work we''re doing with IBM.

Sarah Friar – Goldman Sachs

Got it. Okay. So then can you give us a sense of how many customers you have with the IBM cloud offering right now?

Charles E. Peters Jr.

Right but I don''t have those numbers -- I don''t have those.

Sarah Friar – Goldman Sachs

Okay. Okay. Thank you.

Operator

Your next question comes from Michael Turits with Raymond James.

James M. Whitehurst

Michael.

Michael Turits – Raymond James & Associates

Two quick questions, one, how are ASP trends and how is advanced -- the advanced product helping out there and how is RHEV helping out there? And then the second one is, last quarter, you had an eight-figure deal, I think you said, that was booked but not invoiced. How did that impact billings on the quarter? It was a great billings quarter but how much was just a function of that rolling in?

Charles E. Peters Jr.

Okay. Good questions. You''re squeezing in two questions in one but I''ll deal with it.

Michael Turits – Raymond James & Associates

Okay.

Charles E. Peters Jr.

On the pricing part of the question, I think that our pricing has continued to be very consistent. As we''ve said all along, we''ve had a consistent approach to the market in terms of discount strategy and so forth. There has been a number of customers have moved up and in terms of the version of RHEL that they have, the level of support that they''ve bought, I would say overall, the pricing has been quite positive. As to how RHEV impacts that, I think it''s probably still too early to talk about that in terms of the size of that, relative to the overall business today.

The second part of your question, which was about billing and the eight-figure deal that we talked about in Q1, as we described on the first quarter call, there was a large component of that deal was initial services leading to subscriptions and so very little billing, it was about less than 5% of that was built in the first quarter. More of that billing has happened this quarter as the services are delivered and it will continue to be billed over a longer period of time. But it probably added a bit to billing this quarter.

Michael Turits – Raymond James & Associates

Okay. Any way of quantifying that a bit?

Charles E. Peters Jr.

Maybe a couple of million.

Michael Turits – Raymond James & Associates

Great. Thanks very much.

Operator

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

Trip Chowdhry – Global Equities Research

Thank you and, again, congratulations on a very, very solid execution. Two quick questions. First is on the Asia-Pacific region, about two, three years back, we used to hear a lot about Red Flag from China in Linux Systems. And over the recent quarters, we have failed to hear anything from that distribution. Wondering that if Red Hat had anything to do with it or Red Flag itself sort of disrupted?

Second question I had is regarding the virtualization. Are you thinking of certifying your own virtualization stack that can run in a container? And any thoughts you may have on that end? Thank you very much.

Charles E. Peters Jr.

I''ll deal with the first one on Red Flag and then I''ll let Jim deal with the second one on virtualization. So, on Red Flag, I guess my only -- which is a small brand in China, my comment is there are many different brands of Linux around the world. Red Hat has consistently performed well against all of them, regardless of the size of the distribution or the country. And Red Hat has -- Red Flag has not been a significant issue for us in China.

James M. Whitehurst

And Trip, if I think I heard your second question right, were you asking about a container-based virtualization technology? There''s a little bit of work going on, on that in the Linux community. As far as I know, it''s not super, super far along. So, at this point, I think my understanding is we''re watching it and waiting around that. Our full efforts are behind KVM, RHEV. We have tons of momentum around it. We have fantastic support from the broader ecosystem. And so that''s really where we''re spending our time and energies. Next question?

Operator

Your next question comes from John Difucci with J.P. Morgan.

John Difucci – J.P. Morgan

Thank you. Nice job, Jim and Charlie. You seem to be executing really well on your goals here, but cash flow continues to just show sort of modest growth. It is growth but it is somewhat modest. I mean, is there any reason to expect an inflection point at some point over the next year or so? And I -- just one clarification, Charlie, your $280 million to $290 million, I believe you said operating cash flow, does that include the excess tax benefits from stock-based comp or does that not include that that''s in the financing activities?

Charles E. Peters Jr.

Right. So the second part of your question, it does not include that. The excess tax benefits from stock comp deductions are subtracted from operating cash is moved down below, you''ll find it in the Financing section. So that''s in addition to operating cash flow. Relative to the first part of your questions, I would say that it looks like we did about 31% operating cash flow to revenue in the quarter we just reported. And if I look at the two other companies, I''d say salesforce.com and VMware for the quarter, they just were very close in terms of percentage of revenue.

So we feel good about it. And I think that, as we continue to perform, both managing the growth of the business as well as managing the balance sheet, there''s no reason why we can''t continue to grow our cash flow over time.

John Difucci – J.P. Morgan

Okay. But so far this year, your cash flow is actually, I think, maybe down a little bit year-over-year, relative -- I mean, the margins, as you point out, are great but everything seems to be working even in billings, the measure that you''d be wanting to see grow here looks like it continues to grow really strong but I''m just wondering when we could see perhaps an inflection point of that kind of growth down to the bottom line, not on the income statement, but the cash flow statement.

Charles E. Peters Jr.

I think that, as I said, I feel confident that we will continue to grow our cash flow but I don''t have any other specifics to add at this point.

John Difucci – J.P. Morgan

Okay. Thank you.

James M. Whitehurst

Just one broad comment. You know, we are investing very heavily for the future, as we said -- this is back on the P&L side. We''ve committed to increasing operating margin and you see we''re hitting our commitments there. But we are making very sizable investments to generate our organic revenue growth. And so I''m actually quite proud of the returns that we are able to generate while completely organically, while still generating significant returns to the bottom-line as well.

John Difucci – J.P. Morgan

Fair enough. Thanks, guys.

James M. Whitehurst

Next question, please?

Operator

Your next question comes from Tim Klasell with Stifel Nicolaus.

Timothy Klasell – Stifel Nicolaus

Yes, good afternoon, everybody. Nice quarter. Just a quick question on the middleware performance, obviously, very strong there. I believe it was about a year ago you introduced some different versions of JBoss for Web apps and transactional apps and that sort of thing. Can you give us some idea, is it the growth broad-based or is there a particular version that''s really driving that?

James M. Whitehurst

You know, I think if you actually look at usage -- we''ve gotten pretty good usage across all the products. But surprisingly, most of the company, because the whole product line is relatively inexpensive, certainly versus the competitors. Most people are still buying the full product line because they have enough applications where they want to use the full suite. So I''m hearing from customers that a lot of them are using the lighter weights of components, but they are actually paying us for the heavyweight stuff because there are a few applications where they need it and it''s still relatively inexpensive. So, we''re happy to sell them the heavier weight stuff.

Timothy Klasell – Stifel Nicolaus

Okay. Great. Thank you.

Operator

Your next question comes from Ed Maguire with CLSA.

Edward Maguire – CLSA Securities

Hi. Good afternoon. I just had a question about the 300 customers so far for RHEV as well as the pipeline that you have for RHEV. Could you characterize the nature of what you really see as an opportunity? Is it Greenfield or are you engaging competitively for some of your initial wins?

Charles E. Peters Jr.

I would say what we''ve seen thus far is really some of both. In many cases, they are competitive situations but they''re also Greenfield situations within various customers. It''s been a combination of both.

James M. Whitehurst

Yes, just a little bit of color there. Obviously, when you kick off a new product, you need to go out and generate your own demand. So that typically starts with your own sales force and obviously, we primarily address large enterprise customers. And so, obviously, virtually all -- I want to say -- I was guessing virtually all of those customers have prior experience with other virtualization solutions.

So some of those are looking to virtualize their Linux environments and want to use our product set, because they''re familiar with it. Some of them are looking to have two hypervisors to avoid lock-in and we''re a logical second choice and some of them are just looking for a lower cost alternative and so a number of those are competitive. And the vast majority of them are certainly in hybrid environments that would include another virtualization solution as well.

Edward Maguire – CLSA Securities

Great. Thank you.

Operator

Your next question comes from Todd Raker with Deutsche Bank.

Todd Raker – Deutsche Bank

Hi guys. I was hoping you could spend a minute talking about RHEL 6 and what you expect in terms of the impact on the business, maybe just highlight some of the key features. And do you expect it to continue to drive higher subscription or ASP uplift as you go forward?

Charles E. Peters Jr.

What we''ve said so far is it''s in beta, although we''re expecting general availability this year. As we said with RHEL 5 and for that matter, versions before that, what normally happens with a new release is a lot of interest -- customers who are existing paying subscribers can move to the next version at a time of their choosing. And so I wouldn''t expect to see a big bang in terms of immediate change in the business, but the interest level is extremely high and for those who are interested in learning more about the features, the information about the beta is available online.

James M. Whitehurst

You know, I would say one of the most interesting things to me about it was the very significant performance improvements of RHEL 6 versus RHEL 5. It makes the value proposition, especially versus Windows, much more compelling, and obviously, that''s a very large market for us. But there''s a huge performance gap in order of magnitude versus UNIX. So, another 20%, 30% doesn''t matter that much when it''s already in order of magnitude versus UNIX. But we see this as a great opportunity to better address the Windows market, because it substantially differentiates a total cost of ownership, even on an x86 platform versus Windows.

Todd Raker – Deutsche Bank

Okay. Thanks, guys.

James M. Whitehurst

Next question, Operator?

Operator

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

Steve Ashley – Robert W. Baird

Hi. I was just going to ask a question on the middleware business and the professional support and the amount of pre-subscription work you do there. How much of that is being done by Red Hat-related people versus third-party resources and is there an opportunity in the future to build that third-party ecosystem support there? Thank you.

Charles E. Peters Jr.

Steve, this past quarter, because of a significant ramp-up in the volume, we have actually put on some contractors in some regions to help with some of that work. But the vast majority of it is actually done by our own people. We also have a network of value-added resellers that also are able to do some of this work and use a partner ecosystem to help with that.

We also have, in some cases, systems integrators who are very interested in this and capable of doing it and we have tight relationships and that''s a growing relationships with some of the larger systems integrators in this area to help us with the implementation.

Steve Ashley – Robert W. Baird

Thank you.

Operator

Your next question comes from Nabil Elsheshai with Pacific Crest Securities.

Nabil Elsheshai – Pacific Crest Securities

Hi guys. Thanks for taking my question. Since I''m guessing you''re not going to comment on the Tuesday rumors although feel free to prove me wrong -- but I was wondering if I could -- if you could follow-up on the dynamics in terms of the competition with virtualization? What do you see from your customers in terms of their evaluation process? Is it a separate decision-making process for virtualization versus OS or are you seeing them bundle the evaluation and decision-making process together?

James M. Whitehurst

That depends a lot on the customer. What I''ll start off saying is, it is the same decision-maker. So, unlike, say, JBoss, where it took us a couple of years to build out relationships with the assets side of the house, the RHEV or the virtualization decision-maker is the same as the OS decision maker. So, that''s been very, very helpful.

We have a huge base of existing contacts. We have a lot of -- obviously, credibility, running mission-critical applications and so that''s really helped us on the virtualization side. Some of those decisions are bundled, some of them are separate. So it''s definitely the same part of the organization, which I think has helped us to kind of quickly gain credibility and momentum.

Nabil Elsheshai – Pacific Crest Securities

Okay. Thank you very much.

Operator

Your next question comes from Katherine Egbert with Jefferies.

Katherine Egbert – Jefferies & Company

Good afternoon. A couple of quick questions. If I missed it, did you say what the average contract length was in months? And also, what was the foreign exchange impact on cash flow this quarter?

Charles E. Peters Jr.

Right. No, I didn''t say the average contract length, but let me share it. The average contract length was about 21 months and the past couple of quarters, it was about 22 months. There''s a higher proportion this quarter of government business, which is typically single-year booking, which brought it down a bit. Other than that, nothing terribly noticeable about that number. And I''m sorry, Katherine, the second part of your question was…?

Katherine Egbert – Jefferies & Company

Yeah. The currency impact on operating cash flow.

Charles E. Peters Jr.

Are you trying to get to the change in deferred revenue? Is that what it is? The currency impact on operating cash flow -- the operating cash flow was $64 million for the quarter. And as it relates to deferred revenue, there was an $11 million positive impact on deferred revenue this quarter. $8 million of that was in the short-term deferred revenue and $3 million of that was in the long-term deferred revenue.

Katherine Egbert – Jefferies & Company

Okay. I guess I was going to look at the mark-to-market at the end of the quarters on the balance sheet items but it''s okay, I can figure it out. Thanks.

Charles E. Peters Jr.

Okay.

Operator

Your next question comes from Brent Thill with UBS.

Brent Thill – UBS

Charlie, you''ve seen solid year-over-year bookings or billings growth and from a perspective of thinking about the second half of the year, how we should model that? I know you''re not giving us guidance but is there anything in terms of your color that you can help offer to us?

And if I could just follow-up with Jim, just a quick housekeeping question. Is it fair to say that you do thousands of transactions a quarter, just when you talk about transactional volume? I just want to put that in perspective of some of the comments that have been made by other industry observers this week.

James M. Whitehurst

I''ll be happy to comment on both of those. So, on the numbers of transactions, let''s go there first. I mean, in terms of numbers of transactions, they''re -- they are in the thousands, the number of new customers are in the thousands, the number of new customers this quarter alone exceeded 5,000. That''s number of new customers this quarter exceeded 5,000.

And in terms of billings and prospects for Q3 and Q4, the best way to think about it is that there is a pattern to our business. So if you go back and look at prior years, what you typically see is a Q1 that''s a little bit light and Q2 is a little bit better, Q3 and Q4 normally build, and Q4 historically is the strongest quarter of the year for us. As you said, I''m not trying to predict specifically billing at this point for Q3 and Q4 but the historical pattern has played out in prior years, so if I was trying to model it, that''s probably what I would attempt to do.

Brent Thill – UBS

Thanks for the color.

Operator

Your next question comes from Brad Whitt with Gleacher.

Brad Whitt – Gleacher & Company

Thank you, guys. Thanks for taking my questions. Continuing the strength that you''re seeing in the services business, Charlie, would we expect to see normal seasonality in the fourth quarter where it dips down sequentially or how do you consider that in the guidance?

Charles E. Peters Jr.

Just in terms of trying to model your revenue, if that''s what you''re asking, as a reminder, the fourth quarter always has a little bit of a dip, particularly in the services revenue, because both training and consulting see somewhere in the two to three-week time-frame, depending upon what country you''re in, where there''s holiday periods. So if you model that, I would look, again, at the previous few years how Q3 and Q4 services behaved.

And then it kind of goes without saying on the subscription side, although I remind everybody every year, we do our revenue on a daily basis. You need to count the number of days in each quarter. As I recall, I think Q4 has got one less day than Q3. So, you''ll see some pattern that''s there that will help you build your model for Q3 and Q4.

Thomas McCallum

Operator, we have time for one more question.

Operator

Absolutely, sir. Your final question comes from Joel Fishbein with Lazard Capital.

Joel Fishbein – Lazard Capital Markets

Hey, Jim, it''s just a real quick follow-up. You addressed around it, but I just wanted to get some more color around some of your virtualization wins. You''ve talked about some of your high-profile wins. Can you just give us a little bit more color or some more examples of some success stories there, so we can get our hands around it? That''d be great. Thanks.

James M. Whitehurst

Yeah, well, I''ve got to be careful on which customers -- so, let me not mention names. Again, I think it comes in multiple categories. We obviously get a lot of Linux sides of the houses who want to run RHEVs and so we have POCs as we look to expand that out. We have had a lot of customers, again, whether it''s Linux or Windows, who are looking for an alternative. And so what we''re seeing a lot is POCs as people are frankly considering whether us or HyperV makes more sense as an alternative. And so, I''m seeing quite a bit of that. But it''s really cross-industry, cross-geography, a lot of strength in Asia and Europe. Certainly, we see a lot going on here and in Latin America.

So, I don''t see any kind of really good specific trends to give you there. I''m just pleased to see that it''s not just a Linux shop. It''s really pretty broad-based as a lot of people going forward don''t want to have a single solution in their long-term market sector.

Joel Fishbein – Lazard Capital Markets

Well, just as a follow-up, does that mean that we''ll start to see you guys show up, in terms of taking some market share from some of the more well-known players out there, on both the server side and the desktop side? I mean, is that what we should be looking for or will it be slow and steady?

James M. Whitehurst

So, if -- the market data out there says there''s an awful lot of Greenfield opportunity in addition to the share that''s currently held. To the extent that we gain share, it would show as taking share from someone, a piece of the pie. So I think you''ll see us gain share over time, no doubt.

Joel Fishbein – Lazard Capital Markets

All right. Thank you very much.

Thomas McCallum

Thank you, everyone, and thank you for joining us. I''ll turn it right back over to the Operator.

Operator

Ladies and gentlemen, that does conclude today''s Red Hat Q2 2011 earnings conference call. You may now all disconnect.