Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
RHT > SEC Filings for RHT > Form 10-Q on 9-Jan-2014All Recent SEC Filings

Show all filings for RED HAT INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for RED HAT INC


9-Jan-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We are a leading global provider of open source software solutions, using a community-powered approach to develop and offer reliable and high-performing operating system, middleware, virtualization, storage and cloud technologies.

Open source software is an alternative to proprietary software and represents a different model for the development and licensing of commercial software code than that typically used for proprietary software. Because open source software code is often freely shared, there are customarily no licensing fees for the use of open source software. Therefore, we do not recognize revenue from the licensing of the code itself. We provide value to our customers through the development, aggregation, integration, testing, certification, delivery, maintenance, enhancement and support of our Red Hat enterprise technologies, and by providing a level of performance, reliability, scalability, flexibility, stability and security for the enterprise technologies we package and distribute. Moreover, because communities of developers not employed by us assist with the creation of our open source offerings, opportunities for further innovation of our offerings are supplemented by these communities.

We primarily offer our enterprise technologies in the form of annual or multi-year subscriptions, and we recognize revenue over the period of the subscription agreements with our customers. We market our offerings primarily to enterprise customers.

We have focused on introducing and gaining acceptance for Red Hat enterprise technologies that comprise our open source architecture. Our operating system, Red Hat Enterprise Linux ("RHEL"), has gained widespread independent software vendor ("ISV") and independent hardware vendor ("IHV") support. We have continued to build our open source architecture by expanding our enterprise operating system and middleware offerings and introducing virtualization, storage, cloud and other offerings.

We derive our revenue and generate cash from customers primarily from two sources: (i) subscription revenue and (ii) training and services revenue. These arrangements typically involve subscriptions to Red Hat enterprise technologies. Our revenue is affected by, among other factors, corporate, government and consumer spending levels. In evaluating the performance of our business, we consider a number of factors, including total revenue, deferred revenue, operating income, operating margin and cash flows from operations.

The arrangements with our customers that produce this revenue and cash are explained in further detail in Part II, Item 7 under "Critical Accounting Estimates" and in NOTE 2-Summary of Significant Accounting Policies to the Consolidated Financial Statements of our Annual Report on Form 10-K for the fiscal year ended February 28, 2013.

In our fiscal year ended February 28, 2013, we focused and expect in our fiscal year ending February 28, 2014 to continue to focus on, among other things, generating (i) widespread adoption of Red Hat enterprise technologies by enterprise customers globally, (ii) increased revenue from our existing user base by renewing existing subscriptions, converting users of free versions of our enterprise technologies to paying subscribers, providing additional value to our customers and growing the number of open source enterprise technologies we offer, (iii) increased revenue by providing additional consulting and other targeted services and (iv) increased revenue from strategic acquisitions and channel partner relationships, including distributors, original equipment manufacturers ("OEMs"), IHVs, ISVs, cloud computing providers, value-added resellers ("VARs") and system integrators, and from our own international expansion, among other means.


Table of Contents

Revenue

For the three months ended November 30, 2013, total revenue increased 15.4% or $52.9 million to $396.5 million from $343.6 million for the three months ended November 30, 2012. Subscription revenue increased 16.5% or $48.6 million, driven primarily by additional subscriptions related to our principal RHEL and middleware technologies, which continue to gain broader market acceptance in mission-critical areas of computing, and our expansion of sales channels and our geographic footprint. The increase is, in part, a result of the continued migration of enterprises in industries such as financial services, government, technology and telecommunications to our open source solutions from proprietary technologies. Training and services revenue increased 8.8% or $4.3 million for the three months ended November 30, 2013 as compared to the three months ended November 30, 2012. The increase is driven primarily by customer interest in new products and technologies.

We believe the success of our business model is influenced by:

the extent to which we can expand the breadth and depth of our technology and service offerings;

our ability to enhance the value of subscriptions for Red Hat enterprise technologies through frequent and continuing innovations to these technologies while maintaining stable platforms over multi-year periods;

our ability to generate increasing revenue from channel partner and other strategic relationships, including distributors, OEMs, IHVs, ISVs, cloud computing providers, VARs and system integrators;

the acceptance and widespread deployment of open source technologies by enterprises and similar institutions, such as government agencies;

our ability to generate new and recurring subscription revenue for Red Hat enterprise technologies; and

our ability to provide customers with consulting and training services that generate additional revenue.

Deferred Revenue

Our deferred revenue, current and long-term, balance at November 30, 2013 was $1.12 billion. Because of our subscription model and revenue recognition policies, deferred revenue improves predictability of future revenue. For example, current deferred revenue provides a baseline for revenue to be recognized over the next twelve months. Similarly, long-term deferred revenue provides a baseline for revenue to be recognized beyond twelve months. Total deferred revenue at November 30, 2013 increased $33.3 million or 3.1% as compared to the balance at February 28, 2013 of $1.09 billion.

The increase in deferred revenue reported on our Consolidated Balance Sheets of $33.3 million differs from the $41.0 million increase in deferred revenue we reported on our Consolidated Statements of Cash Flows for the nine months ended November 30, 2013 due to changes in foreign currency exchange rates used to translate deferred revenue balances from our foreign subsidiaries' functional currency into U.S. dollars.

The increase in deferred revenue of $41.0 million reported on our Consolidated Statement of Cash Flows for the nine months ended November 30, 2013 was driven primarily by the strengthening of our U.S. federal government and European businesses, both of which have faced challenging economic environments in prior quarters.

Subscription revenue

Our enterprise technologies are sold under subscription agreements. These agreements typically have a one- or three-year subscription period. A subscription generally entitles a customer to, among other things, a specified level of support, as well as new versions of the software, security updates, fixes, functionality enhancements and upgrades to the technology, if and when available, and compatibility with an ecosystem of certified hardware and software applications. Our customers have the ability to purchase higher levels of subscriptions that increase the level of support the customer is entitled to receive. Subscription revenue increased sequentially for the first,


Table of Contents

second and third quarters of fiscal 2014 and for each quarter of fiscal 2013 and 2012 and is being driven primarily by the increased use of open source software by the enterprise and our expansion of sales channels and geographic footprint during these periods.

Revenue by geography

For the three months ended November 30, 2013, approximately $178.9 million or 45.1% of our revenue was generated outside the United States compared to approximately $150.0 million or 43.7% for the three months ended November 30, 2012. Our international operations are expected to grow as our international sales force and channels become more mature and as we enter new locations or expand our presence in existing locations. As of November 30, 2013, we had offices in more than 80 locations throughout the world.

We operate our business in three geographic regions: the Americas (U.S., Latin America and Canada); EMEA (Europe, Middle East and Africa); and Asia Pacific (principally Australia, China, India, Japan, Singapore and South Korea). Revenue generated by the Americas, EMEA and APAC for the three months ended November 30, 2013 totaled $249.7 million, $93.8 million and $53.0 million, respectively, which resulted in year-over-year revenue growth in the Americas, EMEA and APAC of 13.4%, 26.5% and 7.8% respectively. Excluding the impact of foreign currency exchange rates, Americas, EMEA and APAC revenue grew 14.1%, 20.7% and 23.9%, respectively for the three months ended November 30, 2013 as compared to the three months ended November 30, 2012. As a result of our subscription-based revenue recognition model, revenue from the Americas continued to be affected by prior quarters' U.S. federal government spending while Japan, which is the largest revenue-producing country in our APAC region, performed well despite a weakened yen.

As we expand further within each region, we anticipate revenue growth rates in local currencies to be similar among our geographic regions due to the similarity of products and services offered and the similarity in customer types or classes.

Gross profit

Gross profit margin increased to 84.8% for the three months ended November 30, 2013 from 84.5% for the three months ended November 30, 2012 due to a favorable mix shift, which increased subscription revenue relative to total revenue. The favorable mix shift was was partially offset by an increase in investments to expand our technical consulting staff.

Gross profit margin by geography

Gross profit margins generated by our geographic segments for the three months ended November 30, 2013 were as follows: Americas-85.0%, EMEA-88.3% and APAC-82.8%. For the three months ended November 30, 2012, gross profit margins generated by our geographic segments were as follows: Americas-84.3%, EMEA-88.4% and APAC-84.9%. Regional year-over-year variations in gross profit margins are primarily due to slight product mix shifts between subscriptions and services.

As we continue to expand our sales and support services within our geographic segments, we expect gross profit margins to further converge over the long run due to the similarity of products and services offered, similarity in production and distribution methods and the similarity in customer types or classes. These geographic profit margins exclude the impact of share-based compensation expense, which was not allocated to our geographic segments.

Income from operations

Operating income was 15.3% and 14.5% of total revenue for the three months ended November 30, 2013 and November 30, 2012, respectively. The increase in operating income as a percentage of revenue was due primarily to savings realized from our general and administrative functions as we continue to realize and leverage benefits from investments made during the prior fiscal year in process and technology infrastructure to support


Table of Contents

our corporate functions. Such savings were partially offset by our continued investment in new and emerging cloud management technologies resulting in increased research and development costs relative to revenue. These investments are described further in our analysis of results of operations below.

Income from operations by geography

Operating income as a percentage of revenue generated by our geographic segments for the three months ended November 30, 2013 was as follows: Americas-20.7%, EMEA-29.1% and APAC-22.8%. For the three months ended November 30, 2012, income from operations as a percentage of revenue generated by our geographic segments was as follows: Americas-21.5%, EMEA-24.2% and APAC-23.2%. Operating margin for the Americas and APAC decreased for the three months ended November 30, 2013 as compared to the three months ended November 30, 2012 primarily as a result of increased investments in research and development to support new technologies such as cloud management. The increase in operating margin for EMEA from 24.2% for the three months ended November 30, 2012, to 29.1% for the three months ended November 30, 2013 was due to reduced operating expense which included the impact of government incentives attributable to hiring in the region.

These geographic operating margins exclude the impact of share-based compensation expense, which was not allocated to our geographic segments.

Cash, cash equivalents, investments in debt and equity securities and cash flow from operations

Cash, cash equivalents and short-term and long-term available-for-sale investments in securities balances at November 30, 2013 totaled $1.33 billion. Cash generated from operating activities for the nine months ended November 30, 2013 totaled $355.9 million which represents an increase of 8.4% in operating cash flow as compared to the nine months ended November 30, 2012. This increase is due to increases in subscription and services revenues, billings and collections during the same periods.

Our significant cash and investment balances give us a measure of flexibility to take advantage of opportunities such as acquisitions, increasing investment in international areas and repurchasing our common stock.

Foreign currency exchange rates' impact on results of operations

Approximately 45.1% of our revenue for the three months ended November 30, 2013 was produced by sales outside the United States. We are exposed to significant risks of foreign currency fluctuation primarily from receivables denominated in foreign currency and are subject to transaction gains and losses, which are recorded as a component in determining net income. The income statements of our non-U.S. operations are translated into U.S. dollars at the average exchange rates for each applicable month in a period. To the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign-currency-denominated transactions results in increased revenue and operating expenses from operations for our non-U.S. operations. Similarly, our revenue and operating expenses will decrease for our non-U.S. operations if the U.S. dollar strengthens against foreign currencies.

Three Months Ended November 30, 2013

Using the average foreign currency exchange rates from the third quarter of our prior fiscal year ended February 28, 2013, our revenue and operating expenses from non-U.S. operations for the three months ended November 30, 2013 would have been higher than we reported by approximately $5.2 million and $2.8 million, respectively, which would have resulted in income from operations being higher by $2.5 million.

Nine Months Ended November 30, 2013

Using the average foreign currency exchange rates for the nine months ended November 30, 2012, our revenue and operating expenses from non-U.S. operations for the nine months ended November 30, 2013 would have been higher than we reported by approximately $14.8 million and $6.3 million, respectively, which would have resulted in income from operations being higher by $8.4 million.


Table of Contents

Business combinations

During the year ended February 28, 2013, we acquired two businesses operating in the middleware space. These acquisitions include technologies that are complementary to our JBoss Middleware technology. One acquisition, which included certain assets and related operations acquired from Polymita Technologies S.L., closed on August 28, 2012. The second acquisition closed on September 7, 2012 and included certain assets and related operations acquired from FuseSource, a division of Progress Software Corporation.

Also, during the year ended February 28, 2013, we completed the acquisition of ManageIQ, Inc. ("ManageIQ"), a Delaware corporation, for approximately $104.5 million in cash. Our acquisition of ManageIQ closed on December 21, 2012. ManageIQ develops, distributes and provides support for enterprise cloud management and automation software. As a result of the acquisition of ManageIQ, operating expenses increased by approximately $2.6 million for the three months ended November 30, 2013 as compared to the three months ended November 30, 2012.

Facility Exit Costs

In December 2011, we entered into an agreement to sublease a building located in downtown Raleigh, North Carolina in which our headquarters are currently located. In connection with the transition to our new headquarters, we have assigned or subleased our existing leases related to the two facilities that previously constituted our headquarters in Raleigh, North Carolina.

In May 2012, we entered into a sublease agreement with an unrelated third-party to lease one of the two facilities that previously constituted our headquarters. As a result, we recognized a loss of $3.1 million for the three months ended May 31, 2012 which represented the excess of our remaining obligation on the space over the agreed sublease income.

We ceased using the remaining facility during the three months ended August 31, 2013 and, as a result, recognized a loss of $2.2 million which represents the remaining costs associated with our exit from the facility. In September 2013, we agreed to assign, to an unrelated third party, our lease related to the remaining facility.


Table of Contents

                             RESULTS OF OPERATIONS

Three months ended November 30, 2013 and November 30, 2012

The following table is a summary of our results of operations for the three
months ended November 30, 2013 and November 30, 2012 (in thousands):



                                                Three Months  Ended
                                                    (Unaudited)
                                         November 30,          November 30,            $               %
                                             2013                  2012              Change         Change
Revenue:
Subscriptions                           $      342,770        $      294,186        $ 48,584           16.5 %
Training and services                           53,766                49,420           4,346            8.8

Total subscription and training and
services revenue                               396,536               343,606          52,930           15.4

Cost of subscription and training
and services revenue:
Cost of subscriptions                           24,544                21,153           3,391           16.0
As a % of subscription revenue                     7.2 %                 7.2 %
Cost of training and services                   35,883                31,965           3,918           12.3
As a % of training and services
revenue                                           66.7 %                64.7 %

Total cost of subscription and
training and services revenue                   60,427                53,118           7,309           13.8
As a % of total revenue                           15.2 %                15.5 %

Total gross profit                             336,109               290,488          45,621           15.7

Operating expense:
Sales and marketing                            153,528               133,792          19,736           14.8
Research and development                        82,519                68,655          13,864           20.2
General and administrative                      39,270                38,122           1,148            3.0

Total operating expense                        275,317               240,569          34,748           14.4

Income from operations                          60,792                49,919          10,873           21.8
Interest income                                  1,579                 1,936            (357 )        (18.4 )
Other income (expense), net                       (440 )                (730 )           290           39.7

Income before provision for income
taxes                                           61,931                51,125          10,806           21.1
Provision for income taxes (1)                   9,906                16,360          (6,454 )        (39.4 )

Net income                              $       52,025        $       34,765        $ 17,260           49.6 %

Gross profit margin-subscriptions                 92.8 %                92.8 %
Gross profit margin-training and
services                                          33.3 %                35.3 %
Gross profit margin                               84.8 %                84.5 %
As a % of total revenue:
Subscription revenue                              86.4 %                85.6 %
Training and services revenue                     13.6 %                14.4 %
Sales and marketing expense                       38.7 %                38.9 %
Research and development expense                  20.8 %                20.0 %
General and administrative expense                 9.9 %                11.1 %
Total operating expenses                          69.4 %                70.0 %
Income from operations                            15.3 %                14.5 %
Income before provision for income
taxes                                             15.6 %                14.9 %
Net income                                        13.1 %                10.1 %
Estimated annual effective income
tax rate (1)                                      27.5 %                32.0 %

(1) Provision for income taxes for the three months ended November 30, 2013 includes a net discrete tax benefit of $4.2 million and the impact of the change in our estimated annual effective tax rate from 30% to 27.5%. See Note
5 - Income Taxes to our Consolidated Financial Statements for further discussion.


Table of Contents

Revenue

Subscription revenue

Subscription revenue, which is primarily comprised of direct and indirect sales of Red Hat enterprise technologies, increased by 16.5% or $48.6 million to $342.8 million for the three months ended November 30, 2013 from $294.2 million for the three months ended November 30, 2012. The increase in subscription revenue is primarily due to increases in volumes sold, including additional subscriptions attributable to geographic expansion, and continuing innovation, which attracts new customers and helps to drive renewals from existing customers.

Training and services revenue

Training revenue includes fees paid by our customers for delivery of educational materials and instruction. Services revenue includes fees received from customers for consulting services regarding our offerings, deployment of Red Hat enterprise technologies and for delivery of added functionality to Red Hat enterprise technologies for our major customers and OEM partners. Total training and services revenue increased by 8.8% or $4.3 million to $53.8 million for the three months ended November 30, 2013 from $49.4 million for the three months ended November 30, 2012. The increase is due to services revenue which increased by 12.5% or $4.3 million as a result of an increase in consulting engagements driven by increased demand for our open source solutions. Combined training and services revenue decreased as a percentage of total revenue to 13.6% for the three months ended November 30, 2013 from 14.4% for the three months ended November 30, 2012.

Cost of revenue

Cost of subscription revenue

The cost of subscription revenue primarily consists of expenses we incur to support, distribute, manufacture, augment and package Red Hat enterprise technologies. These costs include labor related cost to provide technical support, security updates and fixes, as well as costs for fulfillment, physical media, literature, packaging and shipping. Cost of subscription revenue increased by 16.0% or $3.4 million to $24.5 million for the three months ended November 30, 2013 from $21.2 million for the three months ended November 30, 2012. The increase is partially the result of continued additions to our technical support staff to meet the demands of our growing subscriber base for support, security updates and fixes, and includes additional compensation of $2.7 million. The remaining increase is driven primarily by incremental amortization expense of $1.5 million related to technology acquisitions. Gross profit margin on subscriptions remained unchanged at 92.8% for the three months ended November 30, 2013 and November 30, 2012. As the number of open source technology subscriptions continues to increase, we expect associated support cost will continue to increase, although we anticipate this will occur at a rate slower than that of subscription revenue growth due to economies of scale.

Cost of training and services revenue

Cost of training and services revenue is mainly comprised of personnel and third-party consulting costs for the design, development and delivery of custom engineering, training courses and professional services provided to various types of customers. Cost of training and services revenue increased by 12.3% or $3.9 million to $35.9 million for the three months ended November 30, 2013 from $32.0 million for the three months ended November 30, 2012. Costs to deliver our services revenue increased by 15.4% or $3.7 million and relate to additional employee compensation and travel associated with additions to our emerging technologies staff. Total costs to deliver training and services as a percentage of training and services revenue was 66.7% and 64.7% for each of the three month periods ended November 30, 2013 and November 30, 2012, respectively.


Table of Contents

Gross profit

Gross profit margin increased to 84.8% for the three months ended November 30, 2013 from 84.5% for the three months ended November 30, 2012 due to a favorable mix shift, which increased subscription sales relative to total sales. The favorable mix shift was partially offset by an increase in investments to expand our technical consulting staff.

Operating expenses

Sales and marketing

Sales and marketing expense consists primarily of salaries and other related costs for sales and marketing personnel, sales commissions, travel, public relations and marketing materials and trade shows. Sales and marketing expense increased by 14.8% or $19.7 million to $153.5 million for the three months ended November 30, 2013 from $133.8 million for the three months ended November 30, 2012. This increase was primarily due to a $15.9 million increase in selling costs, which includes $11.6 million of additional employee compensation expense attributable to the expansion of our sales force from the prior year and $1.7 million related to travel. The remaining increase relates to marketing costs, which grew $3.8 million or 11.1% for the three months ended November 30, 2013 as compared to the three months ended November 30, 2012. The increase in marketing . . .

  Add RHT to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for RHT - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial Sign Up Now


Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.