Analyst Conference Summary

conference date: December 19, 2013 @ 2:00 PM Pacific Time
for quarter ending: November 30, 2013 (Q3, third quarter fiscal 2014)

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

Overview: Better than usual quarter, with strong y/y growth.

Basic data (GAAP) :

Revenue was $396.5 million, up 6% sequentially from $374.4 million and up 15% from $343.6 million in the year-earlier quarter.

Net income was $52.0 million, up 27% sequentially from $40.8 million, and up 49% from $34.8 million year-earlier.

EPS (diluted earnings per share) were $0.27, up 29% sequentially from $0.21 and up 50% from $0.18 year-earlier.

Guidance:

Full year 2014 raised to revenue of $1.531 to $1.534 billion. 24.6% non-GAAP operating margin. Non-GAAP EPS $1.46 to $1.48. $500 to $520 million operating cash flow.

For Q4 revenue $397 to $400 million. Operating margin near 24.5%. Non-GAAP EPS $0.36 to $0.38. Assumes 27.5% tax rate.

Conference Highlights:

Exceptional results were led by strong demand for core products: Red Hat Enterprise Linux (RHEL) and JBoss middleware. Billings growth was the highest in 6 quarters.

Deals over $1 million set a record of over 30.

Non-GAAP numbers: Operating income $98 million. Net income $81 million, up 42% from $57 million year-earlier. EPS was $0.42, up 20% sequentially from $0.35 and up 45% from $0.29 year-earlier. Operating margin 24.8%.

Income tax adjustments added $0.04 to GAAP EPS and $0.06 to non-GAAP results. In "constant currency" revenue & etc. growth would have been higher than what resulted from currency exchange fluctuations.

GAAP operating margin was 15.3%.

Subscription revenue was $342.8 million. Training and service revenue was $53.8 million. Public cloud and compliance revenue continued to grow.

OpenStack won a number of large initial deals. New cloud partners have been added in the quarter and after the quarter ended.

100% of top 25 deals renewed, averaging 120% of prior values. Of top thirty deals over half included a middleware component. 11 of the top 30 deals had a RHEV (virtualization) component. Government and financial were the top verticals.

Cash and equivalents balance ended at $1.33 billion. Deferred revenue was $1.12 billion. $40 million was spent to repurchase stock. $240 million remains authorized for stock repurchases. Operating cash flow was $95 million, down 5% y/y due mainly to a build in accounts receivable.

The billing proxy was $453 million, up 19% in U.S. dollars.

By geography: 55% Americas, 29% EMEA, 16% Asia-Pacific. 65% channel, 35% direct sales.

Cost of revenue was $60.4 million, leaving gross profit of $336.1 million. Total operating expenses were $275.3 million, consisting of: sales and marketing $153.5 million; research and development $82.5 million; general and administrative $39.3 million. Leaving income from operations of $60.8 million. Interest income $1.6 million. Other expense $0.4 million. Income tax provision $9.9 million.

Added 225 employees in the quarter.

In Q4 will begin to pay a higher tax rate as tax credits carry forward runs out.

In fiscal 2015 expects a substantial reduction in capital expenditures.

Q&A:

How fast can Linux grow, has it hit the maturity phase? Our largest customers continue to move to RHEL from UNIX. We believe we are winning share from Microsoft. We now have Active Director integration to help us penetrate Windows customers. We are beating Microsoft in cloud. So we see continued RHEL growth "really as far as the eye can see."

Training increase due to RHEL 7 release? It was confined mainly to Europe and Asia, probably not due to RHEL 7.

Long term deferred revenue trends? In Q3 we were affected by a Q2 deal. Revenue growth in this quarter was very broad based with OEMs paid for long term deals up front. The really large deals are sometimes paid one year at a time.

OpenStack buzz effects? We ran full page ads, we are recruiting for our consulting staff. It helps with our branding.

OpenStack translation into revenue? We are very positive about it, but would caution to keep revenue expectations for the next year low. It is a subscription model. It could drive our training numbers higher next year. We honestly just don't know [how fast adoption will take place].

OpenShift? It is seeing very good uptake. A number of large customers are using it, including a major telecom. We are the only company offering a commercial version of OpenShift.

Movement to public cloud providers? Some moving of prior customers to public clouds, some new customers. Cloud Access program allows subscriptions to be moved to the public cloud. More than half our Amazon cloud customers are new for us, many of them smaller SMB accounts.

Server OEMs were a strength for us in Q3, but that may just be a bounce from weakness in Q3.

Storage product functionality? It is an innovators' dilemma. It works extremely well already in specific situations. We are adding features over time, which should expand our addressable market.

Federal demand? 86% of our revenue is subscriptions, we have a recurring revenue model, including our federal customers, who generally renewed at higher rates. One the government shutdown ended it was clearer what the agencies could spend.

Europe, government vs. commercial? In Europe we did a lot of large deals with a large base of customers. Part of the European strength was an increase in the Euro, and most of the business was commercial, not government.

OpenShift, are they existing JBoss customers? Most are probably existing RHEL customers, but then most Fortune 500 companies are RHEL customers.

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