Analyst Conference Summary

conference date: September 23, 2013 @ 2:00 PM Pacific Time
for quarter ending: Augutst 31, 2013 (Q2, second quarter fiscal 2014)

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

Overview: Continuing revenue and earnings ramp.

Basic data (GAAP) :

Revenue was $374.4 million, up 3% sequentially from $363.3 million and up 16% from $322.6 million in the year-earlier quarter.

Net income was $40.8 million, up 1% sequentially from $40.4 million, and up 17% from $35.0 million year-earlier.

EPS (diluted earnings per share) were $0.21, flat sequentially from $0.21, but up 17% from $0.18 year-earlier.

Guidance:

Full year 2014 revenue range tightened to $1.51 to $1.52 billion. Non-GAAP operating margin raised to 24.5%. Non-GAAP EPS guidance range raised to $1.36 to $1.38. Full year operating cash flow $500 million to $520 million.

For Q3 revenue $381-$384 million. Subscription revenue accounts for all of the growth, with service revenue flat. 24.5% operating margin. Non-GAAP EPS $0.34 to $0.35.

Conference Highlights:

Strong growth in financial metrics were driven by 17% growth in subscription. Red Hat "recently added infrastructure-as-a-service, open software-defined storage and cloud management solutions create a compelling raod map for our customers in the move to cloud computing." Exceded high end of prior guidance. This was despite FX (foreign exchange) negative effects.

Non-GAAP numbers: Operating income $94 million. Net income $68 million, up 10% sequentially from $62 million and up 24% from $55 million year-earlier. EPS was $0.35, up 9% sequentially from $0.32 and up 25% from $0.28 year-earlier.

However, IT spending in Europe grew only at a moderate rate.

RHEL (Red Hat Enterprise Linux) OpenStack Platform (OSP) and Red Hat Cloud Infrastructure were released for general availability in the quarter. Training programs for OpenStack are being rolled out. Early adoption has been strong. Red Hat Storage Server 2.1 was released more recently. Red Hat Certified Cloud Provider program now has over 50 members.

Subscription revenue was $326.7 million. Training and service revenue was $47.7 million.

All top 25 deals renewed in the quarter, at over 120% of the original value. Salesforce.com was a customer that expanded on renewal. First ever 7 digit deal for storage technology. 40% of top 30 deals included at JBoss middleware component. Over 20% had a RHEV (virtualization) component. Government and technology/media were the top verticals.

Cash and equivalents balance ended at $1.29 billion. Deferred revenue was $1.06 billion. $20 million was spent to repurchase stock. $280 million remains authorized for stock repurchases. Operating cash flow was $119 million.

The billing proxy was $376 million, up 8% in U.S. dollars.

Cost of revenue was $55.6 million, leaving gross profit of $318.8 million. Total operating expenses were $263.3 million, consisting of: sales and marketing $144.6 million; research and development $78.3 million; general and administrative $38.2 million. Leaving income from operations of $55.6 million. Interest income $1.5 million. Other income $1.2 million. Income tax provision $17.5 million.

Gross margin was 86.7%, up on improved product mix. Red Hat continued to hire engineers for new products, and 200 new employees total. Operating margin (non-GAAP) was 25.2 %, also improved.

Q&A:

Verticals? Financial was a close 3rd for top deals. With government there is a question over the budget fight coming up. September is likely to be good, but we don't know what will happen after October 1.

Slower billings growth rate? Larger deals are tailored. The two very large deals billed only 15% in the quarter. But the rest went into off-balance sheet backlog for future billing.

In the past you said service revenue was an indicator of future growth. Has that changed? Your comment was accurate two or three years ago. But we changed our service strategy to provide more service to enable partners to deliver more Red Hat product. So we are sacricificing service revenue to allow partners to deliver more services. This should accelerate subscription growth.

Linux workload growth? "We are winning a lot larger share of that new workload." IDC says about 38% of servers are Linux, and about half of that is Red Hat. On the public cloud we are seeing tremendous growth rates, but on a tiny base. We believe most public cloud will be Linux.

Competitive environment? We are very competitive. Salesforce is a long time customer. We compete to win Unix conversions and Microsoft conversions. IBM recently announced they are investing further in Linux.

We don't forecast billings or cash flow on a quarterly basis.

"As our cloud business grows, all of that gets paid after the fact." Companies like Amazon and Rackspace report to us after the fact. "That is revenue that never really bills upfront."

Normal billing percentage for big deals? It depends on the channel used. Usually we bill one year up front, but sometime all up front.

Full year hiring plans are now higher than at the start of the year. But we hired late in the quarter, helping our margin in the quarter. We are not driving for a higher operating margin at the expense of new initiatives.

Mainstream verticals? We had an interesting Railroad application announced recently. Healthcare and retail showed good progress. The volumes just are not as high as the top verticals.

Red Hat Storage? It was a low six figure deal and renewed at multiple millions. They found our technology scaled well. We have over 200 POCs in storage.

European weakness all macroeconomic related? Mostly macro. No significant execution issues. But the pipeline going forward looks better.

Novell SUSE with SAP competition? Any implementation with SAP tends to be a large deal, so we look at that, and seldom see SUSE as a competitor. We are more likely to displace them. They are not a factor in Europe or anywhere in the world.

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