Analyst Conference Summary

conference date: June 19, 2013 @ 2:00 PM Pacific Time
for quarter ending: May 31, 2013 (Q1, first quarter fiscal 2014)

[at the time this is written]
Forward-looking statements

Overview: Continuing strong revenue and profit growth.

Basic data (GAAP) :

Revenue was $363.3 million, up 4% sequentially from $347.9 million and up 15% from $314.7 million in the year-earlier quarter.

Net income was $40.4 million, down 6% sequentially from $43.0 million, but up 8% from $37.5 million year-earlier.

EPS (diluted earnings per share) were $0.21, down 5% sequentially from $0.22, but up 10.5% from $0.19 year-earlier.

Guidance:

Assuming sequentially flat currency exchange rates. Reaffirming full year guidance.

Q2 guidance for revenue is $370 to $373 million. Operating margin near 23.9%. Non-GAAP EPS between $0.32 and $0.33.

There are signs of renewed growth in federal revenues for Q2.

Conference Highlights:

Revenue growth was driven customer demand for Red Hat's high-value open source technology subscriptions. The key strategy is expanding in cloud data center markets. Reaffirming outlook for the year despite currency exchange headwinds and macroeconomic background. Revenue this quarter was reduced by weak Yen and other currencies. Revenue numbers were somewhat better in constant currency than in US$.

Red Hat is now the leading contributor to the OpenStack project and is preparing to bring an enterprise-ready version with RHEL (Red Hat Enterprise Linux) to market. Red Hat Cloud Infrastructure will be released in July.

Non-GAAP numbers: Operating income $87 million. Net income $62, down sequentially from $70 million. $0.32 EPS down sequentially from $0.36, but up from $0.30 year-earlier. EPS was $0.01 above guidance range.

Subscription revenue was $315.8 million, up 16% y/y. Training and service revenue was $47.4 million. There was higher demand for middleware consulting than expected.

Gross margin was over 86%. Non-GAAP operating margin was 23.9%.

Top 25 potential renewals all renewed, averaging 125% of prior value. Top 28 deals were for over $1 million. 2 deals were over $5 million. 60% of top 30 deals had a middleware (JBoss) component, and 5 were stand alone. Top verticals were telecom/hosting/cloud and financial services.

Cash, equivalents and investments balance ended at $1.23 billion. Cash flow from operations was $142 million, a record. $179 million was used for stock repurchases. New $300 million repurchase authorization was made in quarter. $1.06 billion deferred revenue.

Billings proxy was $346 million, up 12% y/y, but down sequentially on normal seasonality.

Cost of revenue was $56.1 million, leaving gross profit of $307.2 million. Total operating expenses were $250.6 million, consisting of: sales and marketing $142.4 million; research and development $73.8 million; general and administrative $34.3 million. Leaving income from operations of $56.6 million. Interest income $1.5 million. Other expense $0.4 million. Income tax provision $17.3 million.

Spending was focused on growth opportunities, with R&D up 27% y/y.

Q&A:

Cloud service providers color? We are doing well with the public cloud providers. We sell instances of Red Hat in their cloud that are consumed by their customers. 2 were in top 30 deals in this quarter.

Linearity in quarter? 20-20-60, which was less linear than typical (accelerating to end). Off balance sheet backlog we give yearly. Billable within 12 months rose to $180 million at end of February. So that should help us when we get to our 4th quarter.

Sales organization for new products? We have been making modifications over the last year and will continue to do that. We are making a substantial investment in Project Lighthouse and channel relationships.

Confidence in increased federal spend? Saw budget related issues in Q1. We have high confidence in an increase in federal business in Q2 due to pipeline visibility. Keep in mind it is a recurring business.

OpenStack timing? Lots of P.O.C.s should be signed this year, but it will be some time before they write even 6-figure checks for software, until they get closer to production. Don't expect any material effect on top-line revenue for at least a year. It will have an indirect positive effect for us before that.

RHEL consumption for customers adding public cloud to their own datacenters? They want consistency in operating systems and it drives more use per customer.

RHEL with AWS? We see it like giving away evaluations. It is the Amazone equivalent. People should not have to experiment much given the certifications.

Middleware? Largest percentage of top deals, and we are taking market share. Will share more on analyst day next week.

Recent acquisitions, progress with? We did three last year: ManagedIQ, Polymeda, and FuseSource. They are being integrated with the Middleware offering; ManagedIQ with CloudForms. We won't be breaking them down separately.

Storage business expectations? It continues to mature, with over 180 POCs there now. One of our top 30 deals had a significant Red Hat storage component.

Drivers behind success with large deals? A very loyal customer base who are growing their infrastructure and adding new services. More on analyst day. Big data workloads are now almost exclusively on Linux, the only question is Red Hat or free.

Size of addressable OpenStack market? Platform demand for application portfolios for this next line of architecture is massive, but how it will work out is hard to say.

8 of top 30 deals in quarter were in EMEA (Europe, Middle East & Africa).

Competition with Ubuntu in general? I don't know of competing against Ubuntu at all. We see Oracle competition now and then. We are seeing less Linux competition than in the past. In cloud people play around with Ubuntu or Fedora, then for production come to Red Hat.

RHEV (virtualization)? 4 of top 30 deals included RHEV, of which one was a seven-figure deal.

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