Analyst Conference Summary

conference date: June 18 , 2014 @ 2:00 PM Pacific Time
for quarter ending: May 31, 2014 (Q1, first quarter fiscal 2015)

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

Overview: Revenue continue strong ramp, but not GAAP earnings.

Basic data (GAAP) :

Revenue was $423.8 million, up 6% sequentially from $400.4 million, and 17% from $363.3 million in the year-earlier quarter.

Net income was $37.7 million, down 16% sequentially from $45.1 million, and 7% from $40.4 million year-earlier.

EPS (diluted earnings per share) were $0.20, down 17% sequentially from $0.24, and down 5% from $0.21 year-earlier.

Guidance:

Raising full fiscal year 2015 revenue guidance by $30 million to $1.760 billion to $1.785 billion. Non-GAAP operating margin near 23%, non-GAAP EPS from $1.52 to $1.54. Cash flow $580 to $600 million.

Q2 revenue $432 to $436 million. Operating margin near 23%. non-GAAP EPS near $0.38.

Conference Highlights:

"We closed a record number of first quarter deals of a million dollars or more." 94% of Fortune 500 companies are now Red Hat customers. Revenue and operating cash flow in the quarter were above the high end of prior guidance. Deferred revenue growth was the highest in the last 3 years.

RHEL (Red Hat Enterprise Linux) 7.0 launched last week. RHEL is designed to serve as a backbone for future open cloud architectures. SAP deployments can now be standardized on RHEL. Acquired an open-source storage companies in April, Inktank for $152 million, which will help with OpenStack efforts.

Non-GAAP numbers: Operating income $88 million. Net income $64 million, down 15% sequentially from $75 million, but up 3% from $62 million year-earlier. EPS was $0.34, down 13% sequentially from $0.39 and up 6% from $0.32 year-earlier. Share-based compensation expense excluded from non-GAAP numbers was $28.7 million.

Expense increases included in R&D and due to the acquisition.

Subscription revenue was $372.0 million (up 18% y/y), while training and service revenue was $51.8 million. $319 million was infrastructure-related (RHEL & related) subscription offerings. $53 million was application related (including JBOSS middleware) and emerging technologies subscriptions, up 45% y/y.

Renewed all top-25 deals up for renewal in quarter, and all were over $1 million in value. 4 deals were over $5 million. Many companies (65%) purchased multiple Red Hat technology offerings. Telecom and Cloud were the top verticals. Government and Healthcare were also strong.

Cash and equivalents balance ended at $1.4 billion. Deferred revenue was $1.27 billion, up 20% y/y, but down slightly sequentially. Operating cash flow was $165 million, up 16% from $142 million year-earlier. $80 million was used to repurchase stock in the quarter.

The billing proxy was $404 million for the quarter, up 18% y/y.

Cost of revenue was $64.4 million, leaving GAAP gross profit of $359.3 million. Total operating expenses were $308.3 million, consisting of: sales and marketing $176.8 million; research and development $89,9 million; general and administrative $41.6 million. Leaving income from operations of $60.0 million. Interest income $1.8 million. Other income $0.4 million. Income tax provision $15.4 million.

Operating margin (non-GAAP) was 20.8%. Gross margin was above 86%.

By geography 56% of bookings were from the Americas, 25% from EMEA, and 19% Asia-Pacific.

67% of sales were from the channel and 33% from direct sales. Goal is 70% channel.

Q&A:

Linux steady as a % of market, growth given that? We don't agree that Linux is not growing share, IDC predicts good growth over the next 5 years, with paid Linux growing faster than unpaid. Our growth in RHEL will come from several areas, including migration from mainframe and UNIX; and from Windows. Containers will help us grow. We are not announcing pricing RHEL 7 at this time.

OpenStack? We have had a number of wins, mostly small consulting engagements so far, not to 100 deals closed so far. We have a number of "nice-sized" deals moving forward.

Progress on depth and penetration? We are in early days for going beyond selling just RHEL. It is a big, big opportunity for us, selling other products to current customers.

There is a high-level interest with Inktank OpenStack, but we are just getting started. eNovance will also help with the OpenStack initiative.

Networking layer? We are a significant part of the Open Daylight project. We are building our capabilities, we are investing heavily, but do not have a product announcement yet.

What would increase the OpenStack pace of adoption? Installation and management are key features. Then capabilities for managing workflows and processes. That is why we acquired eNovance.

We sell a subscription to RHEL, not to individual versions. So speed of uptake is not a major factor, subscribers can upgrade at their own pace. But there is much more in 7 to support cloud deployments.

We have over 50 Red Hat certified public cloud providers. Revenue from that is accelerated. We have a Cloud Access programs so customers can move paid subscriptions to cooperating cloud providers.

Linearity in quarter? We had no evidence of pull-ins. But we did have some big deals in the first month of the quarter that helped with revenue recognition.

Healthcare vertical? That is within our mainstream vertical, not a stand-alone vertical yet. We expect to see more use of technology over time for records, and so expect continued growth.

eNovance revenue estimate is for 8 months in fiscal 2015. They are consultants so there is no deferred revenue. They have about 110 employees; a lot are engineers.

Is a lack of OpenStack skills a limiting factor? This is a different technology, we should be able to do more POCs simultaneously after the acquisition. Sales force believes they have been constrained by lack of qualified professional services resources. There is a lack of trained individuals globally.

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