The following is excerpted from the question-and-answer section of the transcript.
(Questions from industry analysts are provided in full, but answers are omitted - download the transcript to see the full question-and-answer session)
Question: Sarah Friar - Goldman Sachs - Analyst: Good afternoon, guys. Good quarter. Jim, if I could just ask you a little bit about the demand environment, some extra color. Did you actually see customers beginning to pick up on server purchases again or do you think you were benefiting from, again, taking share from other operating systems like Solaris, for example?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Sarah Friar - Goldman Sachs - Analyst: Got it. And then if I could just one follow-up on the geographical split. Did you see anything coming back in EMEA? I know that's been one geography that's appeared to have lagged most and yet we're seeing some early signs that GDP is picking up there.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Sarah Friar - Goldman Sachs - Analyst: Okay. Great. Thank you very much. Good job.
Question: Adam Holt - Morgan Stanley - Analyst: Good afternoon. I'll echo the congratulations. My first question's on JBoss. Sounded like you had good success, particularly with larger deals in JBoss. Does this mean that you think that business has reaccelerated to be growing faster than the core business and maybe talk about the pipeline for the second half there.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Adam Holt - Morgan Stanley - Analyst: Yes, just the pipeline for the back half of the year for the JBoss business.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Adam Holt - Morgan Stanley - Analyst: Terrific. Thank you.
Question: Heather Bellini - ISI - Analyst: Hi. Thank you, Charlie. Hey, I was wondering if you could talk a little bit about the success you've had to date in migrating customers to the advanced platform SKU and give us an idea of what percentage of your customer base had made the move thus far and kind of where you see that penetration rate going. And the follow-up to that would be a little similar to Sarah's question. Would you be more optimistic about the opportunity of migrating your customers to the higher priced SKU versus a pick-up in server shipments over the next couple quarters?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Heather Bellini - ISI - Analyst: The last part was, are you more optimistic about being able to migrate your customers to the advanced platform versus a pick-up in server shipments over the next two quarters or so?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Heather Bellini - ISI - Analyst: Okay. Thank you and congratulations.
Question: Nabil Elsheshai - Pacific Crest Securities - Analyst: I was wondering if you could add a little more color on the virtualization release. You talked about the management tools being incremental charge. Do you have any clarity yet on what the potential impact for that is next year, do you think it's a longer term thing.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Nabil Elsheshai - Pacific Crest Securities - Analyst: Just real quick, on kind of sales force expansion, are you continuing to expand that and at what rate or have you slowed down given the economy?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Nabil Elsheshai - Pacific Crest Securities - Analyst: Do you think the rate will remain roughly consistent or with signs of a rebound are you planning to increase that rate?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Nabil Elsheshai - Pacific Crest Securities - Analyst: Okay. I guess I'll have to come. Thank you.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: John DiFucci - JPMorgan - Analyst: Thanks. Nice job, guys. Looks like a real clean quarter here. But it sounds like your performance has more to do with Red Hat specific factors. You've really bucked a recent trend anyway with a couple of pretty large software companies, Oracle and Adobe reporting at least corporate results that were less than they expected anyway, and we did too. As a follow-up to Sarah, from your assessment, is the environment stable? I mean, you mentioned signs of life. Or does it continue to get tougher and you just have other things happening that are more than offsetting that?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: John DiFucci - JPMorgan - Analyst: Okay. Thank you.
Question: Katherine Egbert - Jefferies & Co - Analyst: Hi, good afternoon. Just two quick questions. The first one is on the operating margin. You've significantly exceeded the 23% that you set for the quarter. Is 23% still the right bogie? You said 100 basis points for the year. Is that 100 basis points every year now?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Katherine Egbert - Jefferies & Co - Analyst: Sure. And then quickly, that combination of operating margin expansion along with recovery in the server OEM shipments, I believe the bulk of your cash flow does come from server OEM payments. Can you tell us in a normal environment with server shipments flat, what would your cash flow have been? It seems like this is a depressed level right now, and it can only go up from here.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Katherine Egbert - Jefferies & Co - Analyst: Okay. Thanks, good job.
Question: Mark Murphy - Piper Jaffray - Analyst: Are you seeing instances where RHEV will be displacing VMware in a customer's deployment or generally speaking is that kind of activity not necessary for you to reach the growth trajectory that you're looking for with RHEV?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Mark Murphy - Piper Jaffray - Analyst: Jim, as a follow-up, the Oracle and Sun Micro transactions being held up by the EU and we're seeing that as causing a very dramatic drop in revenue for sun. From what you can tell, are those sun customers just deferring their spending temporarily and then presumably it will come back to sun when the transaction closes or do you think that they're instead migrating faster off of Solaris and onto Red Hat. Any insight into the recent rate of Unix to Linux migrations would be helpful.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Mark Murphy - Piper Jaffray - Analyst: Thank you.
Question: Brad Sills - Barclays Capital - Analyst: Hey, guys, just a question on the improvement you saw this quarter on the average contract length going up to 22 months. Could you just comment a little bit on was that execution, were there certain measures you took or was it more customers more willing now to sign longer term agreements.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Brad Sills - Barclays Capital - Analyst: Got it. Okay. Thanks. Just a question on JBoss. Are you seeing with the wins that you're seeing this quarter, sounds like an improvement. Would you classify that more as pilot and departmental type wins where there's room for growth going forward or would you say these are more some larger migrations?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Brad Sills - Barclays Capital - Analyst: That's helpful, thanks.
Question: Steve Ashley - Robert W Baird - Analyst: I guess first of all in terms of virtualization, is there any commentary metrics you could give us around what kind of adoption and active your customers are in using RHEL to do virtualization?
Answer By: Tom McCallum - Red Hat, Inc. - VP IR
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Steve Ashley - Robert W Baird - Analyst: Okay.Great.AndthenJBoss,youintroducedthenewkindofJBossEnterprisewebplatform.Anycommentontheearlyresponse to that lighter weight offering?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Steve Ashley - Robert W Baird - Analyst: Thank you.
Question: Tim Klasell - Thomas Weisel Partners - Analyst: Congratulations everybody. Two quick questions, everybody. One on the new 5.4. You're obviously changing the architecture of your virtualization strategy. Where have you been hearing initial interest? Is it the hosting providers, or where does this break you into new ground?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Tim Klasell - Thomas Weisel Partners - Analyst: Then a quick one. How was your government business and what does your government pipeline look like?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Tim Klasell - Thomas Weisel Partners - Analyst: Thank you.
Question: Robert Breza - RBC Capital Markets - Analyst: Just wanted to dig into the large deal you talked about in Europe. Was curious if you could talk about it relative to what they took from the product perspective and maybe just curious what kind of tipped them over to purchase this quarter? Any insight I think would be helpful. Thanks.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Robert Breza - RBC Capital Markets - Analyst: Thank you.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Michael Turits - Raymond James - Analyst: Couple of questions. One, in billings growth, looks like both nominal and constant currency seems to have reaccelerated. Does that feel like we've got a bottom there, we should see billings growth accelerate at this point?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Michael Turits - Raymond James - Analyst: And then another metric that you did give last quarter was current bookings as percentage of total, which had ticked up to 80% but typically you said it was closer to around two-thirds. Where did that go this quarter.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Michael Turits - Raymond James - Analyst: And the last one, just a longer kind of bigger picture question, RHEL is a well deployed operating system for a public cloud computing companies. Are there -- have you seen any pressure on pricing that we should be concerned with as an increasing amount of sales go to public cloud providers?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Answer By: Tom McCallum - Red Hat, Inc. - VP IR
Question: Brent Williams - The Benchmark Company - Analyst: A lot of the sort of detail oriented questions that I wanted to pose have been asked so something very philosophical. I saw an interviewwithLinusTorvaldstheotherdayandhewassuggestingtheideathatinsomerespectsthecoreLinuxkernelisgetting a little bit bloated and that there's so much stuff going in there and I think Linus speaks his mind at any given moment and doesn't bother himself with consistency from day-to-day in his thoughts, but is this reflective of any maturity in the evolution of the kernel technologically. Is that suggesting that a lot more focus is going to surrounding capabilities? Is this indicative of a change in the focus of the kernel development community and can we look at any sort of hints there about where Linux might evolve and how that might end up helping Linux attack new markets or anything like that?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Adam Holt - Morgan Stanley - Analyst: I didn't mean get back in the queue this quickly. I apologize. I had one more question on cash flow. There were a few moving pieces in the balance sheet that had a particularly large impact on cash flow, prepaid in particular and some of the payables. Could you walk through if there was anything unusual in the quarter? Thanks.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Adam Holt - Morgan Stanley - Analyst: Great.
Question: Brad Whitt - Broadpoint AmTech - Analyst: Yes, Charlie, just along those sales lines, I noticed the negative impact from excess tax benefits was less than we had projected and less than it's been in quite a while. Just curious as to how we should think about that going forward.
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Todd Raker - Deutsche Bank - Analyst: Nice quarter. Two quick questions for you. First, from a tax perspective, when do you guys anticipate becoming a full cash tax paying entity? When will the NOLs run out? And then secondly, if you look at the top 25 deals, for the last two quarters you've kind of grown that value over 120%. Can you give us some sense for what's driving that metric? Is it cross-selling incremental products? Is it just more units or selling incremental functionality? That would be very useful if you could give us some insight.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: Aaron Schwartz - Ladenburg Thalmann - Analyst: I was just wondering if you could update us on the growth reinvestment balance, specifically within the JBoss division. I know you've been reinvesting heavily there. Does that continue into next year or do you pull off a little bit and when do you hit the revenue scale to where margins and JBoss start to materially move higher?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Aaron Schwartz - Ladenburg Thalmann - Analyst: Okay. And that's helpful. Thank you. A quick follow-up on the cash flow. Was that the tax benefit that you recorded in the quarter, was that fully reflective in the cash blow? I know it's on the net income but was there an offset somewhere else in net operating cash flow?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Question: David Bayer - Cantor Fitzgerald - Analyst: Hi, thank you for taking the question. Clearly virtualization is beginning to be more widely adopted or at least licensed by the customers and yet we still see a phenomenon in the trade press where it seems like solutions from Citrix, Microsoft and VMware seem to get more press. What efforts is the Company making to sort of increase the awareness of your solution set?
Answer By: Charlie Peters - Red Hat, Inc. - EVP, CFO
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Question: Trip Chowdhry - Global Equities - Analyst: Very good execution. Two questions, first on the cloud computing. I was wondering, where do you see your sweet spot? Is it at the edge or at the core? And the second question I have is regarding appliances. Increasingly, more appliances are using Red Hat as an embedded operating system. And I was wondering if an enterprise has an option whether to install the software on the server or buy an appliance, is the revenue stream the same or is it different in the two situations? Thanks.
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Answer By: Tom McCallum - Red Hat, Inc. - VP IR
Question: Brent Williams - The Benchmark Company - Analyst: Hi, guys. Thanks for taking the question. Could you give us some color on the geographies, what kind of conditions you're hearing from the customers in each?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Answer By: Tom McCallum - Red Hat, Inc. - VP IR
Question: Kevin Buttigieg - FTN Equity Capital - Analyst: Just wondering to what extent you think customers may have been waiting for KVM in order to go to virtualization and do you think that it influences the decision to go to virtualization with KVM relative to how people have been moving to virtualization with Zen support. And I know that you haven't been preselling 5.4 but with its availability so close to the end of the quarter do you think it was a factor at all to the return of large deals in 2Q?
Answer By: Jim Whitehurst - Red Hat, Inc. - President, CEO
Answer By: Tom McCallum - Red Hat, Inc. - VP IR
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