Analyst Conference Summary

conference date: September 22, 2010 @ 2:00 PM Pacific Time
for quarter ending: August 31, 2010 (second quarter fiscal 2011)

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

Overview: Ongoing ramping of revenue, but not enough to justify today's high P/E. Profits down from year-earlier.

Basic data (GAAP) :

Revenue was $219.8 million, up 5% sequentially from $209.1 million and up 20% from $183.6 million in the year-earlier quarter.

Net income was $23.7 million, down 2% sequentially from $24.1 million and down 18% from $28.9 million year-earlier.

EPS (diluted earnings per share were) were $0.12, flat sequentially from $0.12, but down 20% from $0.15 year-earlier.

Guidance:

Assumes currency stability. Revenue for full year 2010 revenue up to $877 to $885 million. Non-GAAP operating income up 22% to 24% y/y. Non-GAAP EPS $0.76 to $0.77. $280 to $290 million cash flow.

For Q3 revenue $226 to $228 million. Non-GAAP EPS $0.19 to $0.20.

Conference Highlights:

Billings growth rate was the best in two years. Strong renewals (25 for 25 of top customers in quarter) and new projects. Increasing guidance for the year. Continuing to invest in both sales and engineering, resulting in less net income despite higher operating income.

Non-GAAP numbers: operating income $54.3 million up 25% y/y. Net income $36.8 million, down 7% from $39.4 million year-earlier. EPS $0.19. 85% gross margin. Prior year had a one-time tax benefit in the quarter that was included in non-GAAP numbers. Also a negative impact from currency exchange rates.

Operating cash flow was $64.3 million. Cash and equivalents balance was $1.05 billion. Deferred revenue balance was $649.6 million. $5 million of stock repurchased.

Cloud Foundations stack was introduced in the quarter. Key differentiator is that customers can maintain control, interoperability, and portability.

There were 3 large standalone middleware deals in the quarter. About one-third of top deals included services components.

Subscription revenue was $186.2 million. Training and services revenue $33.6 million.

Cost of revenue was $35.7 million, leaving GAAP gross profit of $184.1 million. Operating expenses of $150.0 million included $79.4 million for sales and marketing, $42.4 million for research and development, and $28.2 million for general and administrative. Operating income was $34.1 million. Other income was $2.3 million. Income taxes $12.7 million.

Non-cash share-based compensation expense included in GAAP numbers was $15.7 million.

Revenue by geography: 56% Americas, 24% EMEA, 20% Asia-Pacific.

Q&A:

Middleware business strength? Performing quite strongly. Services deals are often middleware related, and often preceed subscriptions. It is a great value proposition for the customer. We now have the feature set that the vast majority of customers want.

What could help business looking forward? We have been investing heavily in cloud and virtualization, this year is about getting customer trials, next year we should see revenue. RHEL 6 is due to come out later this year. Also we are seeing stength in verticals outside of the early adopters we saw in the past.

Oracle Linux entry? Sounded like a repeat of what we heard four years ago. We are used to competing in this market.

Free to pay progress? Good.

Any shift from Solaris big boxes to commodity machines? Our business with the big OEMs continues to be strong.

Container based Linux technology? Some work in the community, not a priority.

Most customers are using our full product line, with us selling the heavy weight stuff but them using some light-weight (non-paid) components.

Virtualization customers? Some are green field, some are competitive. Initial customers already use Red Hat Linux. Some newer customers are trying to avoid lock in, others are looking for cost reductions with enterprise quality. Virtualization decision makers are usually the same as the OS decision maker, unlike JBoss where usually the applications division makes the decision. Some is as alternative to Windows HyperV, it is not just Linux shops.

The number of new customers this quarter exceeded 5000. The seasonal pattern is that billings build during the year, with Q4 being the historic strong quarter.

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