Edgar Filing: RED HAT INC

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended November 30, 2017



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number: 001-33162

RED HAT, INC.

(Exact name of registrant as specified in its charter)



Delaware	06-1364380
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

100 East Davie Street, Raleigh, North Carolina 27601

(Address of principal executive offices, including zip code)

(919) 754-3700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of December 29, 2017, there were 177,004,300 shares of common stock outstanding.

Table of Contents

RED HAT, INC.



		Page
CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS		3

	PART I FINANCIAL INFORMATION
ITEM 1:	FINANCIAL STATEMENTS
	Consolidated Balance Sheets at November 30, 2017 (unaudited) and February 28, 2017 (derived from audited financial statements)	4
	Consolidated Statements of Operations for the three and nine months ended November 30, 2017 (unaudited) and 2016 (unaudited)	5
	Consolidated Statements of Comprehensive Income for the three and nine months ended November 30, 2017 (unaudited) and 2016 (unaudited)	6
	Consolidated Statements of Cash Flows for the three and nine months ended November 30, 2017 (unaudited) and 2016 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8

ITEM 2:	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28
ITEM 3:	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	47
ITEM 4:	CONTROLS AND PROCEDURES	49

	PART II OTHER INFORMATION
ITEM 1:	LEGAL PROCEEDINGS	50
ITEM 1A:	RISK FACTORS	50
ITEM 2:	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	70
ITEM 6:	EXHIBITS	71

SIGNATURES		72

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CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

Certain statements contained in this report and the documents incorporated by reference in this report, including in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events based on certain assumptions, and any statement that is not strictly a historical statement could be deemed to be a forward-looking statement (for example, statements regarding current or future financial performance, management’s plans and objectives for future operations, product plans and performance, management’s expectations regarding market risk and market penetration, management’s assessment of market factors, or strategies, objectives and plans of Red Hat, Inc. together with its subsidiaries (“Red Hat”) and its partners). Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “outlook,” “plan,” “project,” “will,” and similar expressions, may also identify such forward-looking statements. Red Hat may also make forward-looking statements in other filings made with the Securities and Exchange Commission (“SEC”), press releases, materials delivered to stockholders and oral statements made by management. Investors are cautioned that these forward-looking statements are inherently uncertain, are not guarantees of Red Hat’s future performance and are subject to a number of risks and uncertainties that could cause Red Hat’s actual results to differ materially from those found in the forward-looking statements and from historical trends. These risks and uncertainties include the risks and cautionary statements detailed in Part II, Item 1A, “Risk Factors” and elsewhere in this report as well as in Red Hat’s other filings with the SEC, copies of which may be accessed through the SEC’s web site at http://www.sec.gov. Readers are urged to carefully review these risks and cautionary statements. Moreover, Red Hat operates in a rapidly changing and highly competitive environment. It is impossible to predict all risks and uncertainties or assess the impact of any new risk or uncertainty on our business or any forward-looking statement. The forward-looking statements included in this report represent our views as of the date of this report. We specifically disclaim any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this report.

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PART I



ITEM 1.	FINANCIAL STATEMENTS

RED HAT, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands—except share and per share amounts)



	November 30, 2017 (Unaudited)			February 28, 2017 (1)
ASSETS
Current assets:
Cash and cash equivalents	$	1,331,172		$	1,090,808
Investments in debt and equity securities, short-term	384,717			369,983
Accounts receivable, net of allowances for doubtful accounts of $2,398 and $2,791, respectively	531,509			634,821
Prepaid expenses	216,036			200,609
Other current assets	41,276			19,481
Total current assets	2,504,710			2,315,702
Property and equipment, net of accumulated depreciation and amortization of $277,411 and $231,533, respectively	201,807			189,629
Goodwill	1,120,957			1,040,709
Identifiable intangibles, net	151,450			137,767
Investments in debt securities, long-term	605,284			672,440
Deferred tax assets, net	108,235			104,833
Other assets, net	67,041			74,105
Total assets	$	4,759,484		$	4,535,185
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	341,596		$	376,957
Deferred revenue, short-term	1,482,428			1,512,762
Other current obligations	1,022			1,354
Total current liabilities	1,825,046			1,891,073
Deferred revenue, long-term	623,150			557,194
Convertible notes	762,367			745,633
Other long-term obligations	115,781			93,965
Commitments and contingencies (NOTES 11 and 12)
Stockholders’ equity:
Preferred stock, $0.0001 per share par value, 5,000,000 shares authorized, none outstanding	—			—
Common stock, $0.0001 per share par value, 300,000,000 shares authorized, 238,617,591 and 236,804,594 shares issued, and 177,002,948 and 176,901,936 shares outstanding at November 30, 2017 and February 28, 2017, respectively	24			24
Additional paid-in capital	2,350,740			2,294,462
Retained earnings	1,624,346			1,352,991
Treasury stock at cost, 61,614,643 and 59,902,658 shares at November 30, 2017 and February 28, 2017, respectively	(2,506,075		)	(2,311,805		)
Accumulated other comprehensive loss	(35,895		)	(88,352		)
Total stockholders’ equity	1,433,140			1,247,320
Total liabilities and stockholders’ equity	$	4,759,484		$	4,535,185

____________________


(1)	Derived from audited financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

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RED HAT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands—except per share amounts)

(Unaudited)



	Three Months Ended						Nine Months Ended
	November 30, 2017			November 30, 2016			November 30, 2017			November 30, 2016
Revenue:
Subscriptions	$	656,832		$	543,318		$	1,890,902		$	1,576,192
Training and services	91,146			71,942			257,227			206,771
Total subscription and training and services revenue	747,978			615,260			2,148,129			1,782,963
Cost of subscription and training and services revenue:
Cost of subscriptions	47,277			40,660			137,234			116,882
Cost of training and services	64,482			49,793			181,938			145,289
Total cost of subscription and training and services revenue	111,759			90,453			319,172			262,171
Gross profit	636,219			524,807			1,828,957			1,520,792
Operating expense:
Sales and marketing	308,388			267,080			883,395			763,583
Research and development	145,580			122,469			424,552			358,750
General and administrative	63,838			54,485			180,430			160,439
Total operating expense	517,806			444,034			1,488,377			1,282,772
Income from operations	118,413			80,773			340,580			238,020
Interest income	4,864			3,346			13,469			10,167
Interest expense	6,180			6,009			18,346			17,820
Other expense, net	(1,187		)	(1,392		)	(3,033		)	(1,860		)
Income before provision for income taxes	115,910			76,718			332,670			228,507
Provision for income taxes	14,604			8,775			61,315			40,607
Net income	$	101,306		$	67,943		$	271,355		$	187,900
Basic net income per common share	$	0.57		$	0.38		$	1.53		$	1.04
Diluted net income per common share	$	0.54		$	0.37		$	1.48		$	1.02
Weighted average shares outstanding:
Basic	177,063			179,233			177,188			180,245
Diluted	186,160			182,682			183,397			183,453

The accompanying notes are an integral part of these consolidated financial statements.

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RED HAT, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)



	Three Months Ended						Nine Months Ended
	November 30, 2017			November 30, 2016			November 30, 2017			November 30, 2016
Net income	$	101,306		$	67,943		$	271,355		$	187,900
Other comprehensive income:
Change in foreign currency translation adjustment	(1,371		)	(17,630		)	53,160			(14,185		)
Available-for-sale securities:
Unrealized loss on available-for-sale securities during the period	(2,206		)	(2,725		)	(1,052		)	(779		)
Reclassification for gain realized on available-for-sale securities, reported in Other expense, net	(1		)	(23		)	(1		)	(32		)
Tax benefit	859			982			350			327
Net change in available-for-sale securities (net of tax)	(1,348		)	(1,766		)	(703		)	(484		)
Total other comprehensive (loss) income	(2,719		)	(19,396		)	52,457			(14,669		)
Comprehensive income	$	98,587		$	48,547		$	323,812		$	173,231

The accompanying notes are an integral part of these consolidated financial statements.

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RED HAT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Three Months Ended						Nine Months Ended
	November 30, 2017			November 30, 2016			November 30, 2017			November 30, 2016
Cash flows from operating activities:
Net income	$	101,306		$	67,943		$	271,355		$	187,900
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	25,588			21,870			71,541			63,732
Amortization of debt discount and transaction costs	5,630			5,453			16,740			16,211
Share-based compensation expense	52,318			54,741			142,983			141,373
Deferred income taxes	273			13,818			7,831			6,199
Net amortization of bond premium on debt securities available for sale	2,113			3,120			6,988			9,954
Other	(214		)	986			1,318			549
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable	(113,898		)	(73,149		)	111,899			86,496
Prepaid expenses	(6,756		)	(18,897		)	(26,026		)	(19,387		)
Accounts payable and accrued expenses	35,559			(4,413		)	(17,771		)	(14,836		)
Deferred revenue	57,275			64,181			(29,017		)	(8,865		)
Other	1,113			706			3,234			(3,868		)
Net cash provided by operating activities	160,307			136,359			561,075			465,458
Cash flows from investing activities:
Purchase of investment in debt securities available for sale	(26,580		)	(118,152		)	(285,773		)	(415,796		)
Proceeds from maturities of investment in debt securities available for sale	130,941			108,722			348,285			378,264
Proceeds from sales of investment in debt securities available for sale	5,293			5,037			19,617			30,205
Acquisition of businesses, net of cash acquired	—			—			(83,965		)	(28,667		)
Purchase of developed software and other intangible assets	(3,426		)	(2,323		)	(12,871		)	(8,712		)
Purchase of property and equipment	(16,587		)	(17,244		)	(68,268		)	(50,436		)
Other	84			(92		)	(105		)	(203		)
Net cash provided by (used in) investing activities	89,725			(24,052		)	(83,080		)	(95,345		)
Cash flows from financing activities:
Proceeds from exercise of common stock options	711			1,205			4,541			3,273
Proceeds from employee stock purchase program	10,575			7,155			33,288			7,155
Payments related to net settlement of share-based compensation awards	(37,807		)	(25,769		)	(86,230		)	(63,245		)
Purchase of treasury stock	(100,000		)	(125,318		)	(237,002		)	(319,182		)
Payments on other borrowings	(346		)	(462		)	(1,207		)	(1,368		)
Other	(6		)	(84		)	(6		)	829
Net cash used in financing activities	(126,873		)	(143,273		)	(286,616		)	(372,538		)
Effect of foreign currency exchange rates on cash and cash equivalents	(2,295		)	(22,925		)	48,985			(8,675		)
Net increase (decrease) in cash and cash equivalents	120,864			(53,891		)	240,364			(11,100		)
Cash and cash equivalents at beginning of the period	1,210,308			970,569			1,090,808			927,778
Cash and cash equivalents at end of the period	$	1,331,172		$	916,678		$	1,331,172		$	916,678

The accompanying notes are an integral part of these consolidated financial statements.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—Company

Red Hat, Inc., incorporated in Delaware, together with its subsidiaries (“Red Hat” or the “Company”) is a leading global provider of open source software solutions, using a community-powered approach to develop and offer reliable and high-performing operating system, virtualization, management, middleware, cloud, mobile and storage 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, the Company does not recognize revenue from the licensing of the code itself. The Company provides value to its customers through the development, aggregation, integration, testing, certification, delivery, maintenance, enhancement and support of its Red Hat technologies, and by providing a level of performance, scalability, flexibility, reliability and security for the technologies the Company packages and distributes. Moreover, because communities of developers not employed by the Company assist with the creation of the Company’s open source offerings, opportunities for further innovation of the Company’s offerings are supplemented by these communities.

The Company derives its revenue and generates cash from customers primarily from two sources: (i) subscription revenue and (ii) training and services revenue. These arrangements typically involve subscriptions to Red Hat technologies. The arrangements with the Company’s customers that produce this revenue and cash are explained in further detail in NOTE 2—Summary of Significant Accounting Policies to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2017.

NOTE 2—Summary of Significant Accounting Policies

Basis of presentation

The unaudited interim consolidated financial statements as of and for the three and nine months ended November 30, 2017 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary for a fair statement of the consolidated balance sheets, consolidated operating results, consolidated other comprehensive income and consolidated cash flows for the periods presented in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Operating results for the three and nine months ended November 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2018. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the SEC’s rules and regulations for interim reporting. These unaudited financial statements should be read in conjunction with the Company’s Consolidated Financial Statements, including notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2017. There have been no changes to the Company’s significant accounting policies from those described in NOTE 2—Summary of Significant Accounting Policies to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2017.

Certain amounts for the three and nine months ended November 30, 2016 have been reclassified to conform to the current year presentation.

Consolidation policy

The accompanying Consolidated Financial Statements include the accounts of the Company and all of its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. There are no foreign currency exchange restrictions that are significant to the Company’s foreign subsidiaries.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from such estimates.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Recent accounting pronouncements

Accounting pronouncements adopted

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”). The FASB issued ASU 2017-09 to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, to a change to the terms and conditions of a share-based payment award. The Company has early adopted ASU 2017-09 as of the second quarter of its fiscal year ending February 28, 2018. The adoption of this update did not impact the Company’s Consolidated Financial Statements.

In January 2017, the FASB issued Accounting Standards Update 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). The FASB issued ASU 2017-04 to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this updated standard, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity also should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if any. The FASB also eliminated the requirement for reporting units with a zero or negative carrying amount to first perform a qualitative assessment. The Company adopted ASU 2017-04 during the second quarter of its fiscal year ending February 28, 2018. The adoption of this update did not impact the Company’s Consolidated Financial Statements.

Accounting pronouncements being evaluated

In August 2016, the FASB issued Accounting Standards Update 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). In November 2016, the FASB issued Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). The FASB issued ASU 2016-15 and ASU 2016-18 to decrease the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in these updates provide guidance on nine specific cash flow issues. The guidance is effective for the Company as of the first quarter of its fiscal year ending February 28, 2019 and should be applied using the retrospective transition method to each period presented. Early adoption is permitted but all amendments must be adopted in the same period. The Company is currently evaluating the impact that these updated standards will have on its consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update 2016-02, Leases (Topic 842) (“ASU 2016-02”). The FASB issued ASU 2016-02 to increase transparency and comparability among organizations with respect to accounting for leases. Under ASU 2016-02, lessees will recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. This guidance is effective for the Company as of the first quarter of its fiscal year ending February 28, 2020. The Company is currently evaluating the impact that this updated standard will have on its consolidated financial statements.

In January 2016, the FASB issued Accounting Standards Update 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The FASB issued ASU 2016-01 to require equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have readily determinable fair values are allowed to be remeasured upon the occurrence of an observable price change or upon identification of an impairment. This guidance is effective for the Company as of the first quarter of the fiscal year ending February 28, 2019. The Company is currently evaluating the impact that this updated standard will have on its consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, now referred to as Accounting Standards Codification Topic 606 (“ASC 606”). The FASB issued ASC 606 to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes the current revenue recognition guidance. This guidance is effective for the Company beginning the first quarter of its fiscal year ending February 28, 2019. The standard must be adopted using either a full retrospective approach for all periods presented in the period of adoption or a modified retrospective approach.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The Company has substantially completed its preliminary assessment of the potential impact that the implementation of this updated standard will have on its consolidated financial statements. With respect to the Company’s software subscription offerings, the Company provides value to its customers through continuous aggregation, integration, testing, certification, maintenance, enhancement and support of the open source technologies that it distributes. The Company currently recognizes subscription revenue ratably over the subscription period. Under the updated standard, these subscription attributes represent a series of performance obligations that are delivered over time, primarily on a stand-ready basis (for example, attributes such as updates, upgrades, and support are not forced upon subscribers but rather made available to subscribers). As a result, the Company believes that its subscription revenue meets the criteria for revenue recognition over time and will continue to be recognized ratably under the updated standard.

The Company also offers professional consulting and training services that are designed to help customers derive additional value from Red Hat technologies. Under the updated guidance, revenue from professional consulting and training services that were previously sold on a standalone basis will continue to be recognized over time as the Company satisfies its performance obligations by delivering such services to the customer.

With respect to customer contracts with multiple elements (such as software subscriptions and professional consulting and training services), under the current standard the Company allocates total contract revenue to each element’s relative fair value when the Company can demonstrate sufficient vendor-specific objective evidence (“VSOE”) of the fair value of at least those elements that are undelivered. For multiple-element contracts in which one or more of the undelivered elements lacks VSOE, the Company defers recognition of any revenue until the elements lacking VSOE have been delivered. However, under the updated standard, the Company will be required to allocate total contract revenue to each element (referred to as a distinct performance obligation under the updated standard) based on either an established or estimated standalone selling price. The Company would then recognize the allocated revenue as each element (performance obligation) is delivered. Because the Company has historically established VSOE for most of its offerings and as a result has not been required to defer a significant amount of revenue due to insufficient VSOE, the Company does not anticipate the updated standard’s requirement to establish or estimate a standalone selling price, rather than defer revenues in the absence of VSOE, to have a significant impact on the Company’s financial statements.

The Company continues to assess the impact of the updated guidance, including for example, any potential changes to and investments in the Company’s policies, processes, systems and internal controls over financial reporting that may be required to comply with new guidance related to variable consideration, contract modifications, allocation of discounts and expanded disclosures. The Company currently expects to adopt ASC 606 using the full retrospective method.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 3—Stockholders’ Equity

The following table summarizes the changes in the Company’s stockholders’ equity during the three months ended November 30, 2017 (in thousands):



	Common Stock		Additional Paid-In Capital			Retained Earnings		Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at August 31, 2017	$	24	$	2,335,518		$	1,523,040	$	(2,425,059	)	$	(33,176	)	$	1,400,347
Net income	—		—			101,306		—			—			101,306
Other comprehensive loss, net of tax	—		—			—		—			(2,719		)	(2,719		)
Exercise of common stock options	—		711			—		—			—			711
Common stock repurchase	—		—			—		(100,000		)	—			(100,000		)
Share-based compensation expense	—		52,318			—		—			—			52,318
Minimum tax withholdings paid by the Company on behalf of employees related to net settlement of employee share-based awards	—		(37,807		)	—		—			—			(37,807		)
Re-issuance of treasury stock under employee stock purchase plan	—		—			—		18,984			—			18,984
Balance at November 30, 2017	$	24	$	2,350,740		$	1,624,346	$	(2,506,075	)	$	(35,895	)	$	1,433,140

The following table summarizes the changes in the Company’s stockholders’ equity during the three months ended November 30, 2016 (in thousands):



	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at August 31, 2016	$	24	$	2,215,856		$	1,219,246		$	(2,047,008	)	$	(69,722	)	$	1,318,396
Net income	—		—			67,943			—			—			67,943
Other comprehensive loss, net of tax	—		—			—			—			(19,396		)	(19,396		)
Exercise of common stock options	—		1,205			—			—			—			1,205
Common stock repurchase	—		—			—			(125,318		)	—			(125,318		)
Share-based compensation expense	—		54,741			—			—			—			54,741
Minimum tax withholdings paid by the Company on behalf of employees related to net settlement of employee share-based awards	—		(25,769		)	—			—			—			(25,769		)
Other adjustments	—		1			(1		)	—			—			—
Balance at November 30, 2016	$	24	$	2,246,034		$	1,287,188		$	(2,172,326	)	$	(89,118	)	$	1,271,802

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table summarizes the changes in the Company’s stockholders’ equity during the nine months ended November 30, 2017 (in thousands):



	Common Stock		Additional Paid-In Capital			Retained Earnings		Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at February 28, 2017	$	24	$	2,294,462		$	1,352,991	$	(2,311,805	)	$	(88,352	)	$	1,247,320
Net income	—		—			271,355		—			—			271,355
Other comprehensive income, net of tax	—		—			—		—			52,457			52,457
Exercise of common stock options	—		4,541			—		—			—			4,541
Common stock repurchase	—		—			—		(237,002		)	—			(237,002		)
Share-based compensation expense	—		142,983			—		—			—			142,983
Minimum tax withholdings paid by the Company on behalf of employees related to net settlement of employee share-based awards	—		(86,230		)	—		—			—			(86,230		)
Re-issuance of treasury stock under employee stock purchase plan	—		—			—		42,732			—			42,732
Other adjustments	—		(5,016		)	—		—			—			(5,016		)
Balance at November 30, 2017	$	24	$	2,350,740		$	1,624,346	$	(2,506,075	)	$	(35,895	)	$	1,433,140

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table summarizes the changes in the Company’s stockholders’ equity during the nine months ended November 30, 2016 (in thousands):



	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at February 29, 2016	$	23	$	2,162,264		$	1,099,738		$	(1,853,144	)	$	(74,449	)	$	1,334,432
Net income	—		—			187,900			—			—			187,900
Other comprehensive loss, net of tax	—		—			—			—			(14,669		)	(14,669		)
Exercise of common stock options	1		3,272			—			—			—			3,273
Common stock repurchase	—		—			—			(319,182		)	—			(319,182		)
Share-based compensation expense	—		141,373			—			—			—			141,373
Minimum tax withholdings paid by the Company on behalf of employees related to net settlement of employee share-based awards	—		(63,245		)	—			—			—			(63,245		)
Other adjustments	—		1			—			—			—			1
Cumulative-effect adjustment from adoption of ASU 2016-09	—		2,369			(450		)	—			—			1,919
Balance at November 30, 2016	$	24	$	2,246,034		$	1,287,188		$	(2,172,326	)	$	(89,118	)	$	1,271,802

Share Repurchase Programs

On June 22, 2016, the Company announced that its Board of Directors authorized the repurchase of up to $1.0 billion of Red Hat’s common stock from time to time on the open market or in privately negotiated transactions. The program commenced on July 1, 2016, and will expire on the earlier of (i) June 30, 2018 or (ii) a determination by the Board, Chief Executive Officer or Chief Financial Officer to discontinue the program. The program replaced the previous $500.0 million repurchase program authorized on March 25, 2015, which was discontinued by the Board effective June 30, 2016.

During the nine months ended November 30, 2017, the Company repurchased 2,318,584 shares of its common stock for $237.0 million under the repurchase program.

From its commencement on July 1, 2016 through November 30, 2017, the Company has repurchased 7,219,233 shares of its common stock under the program. As of November 30, 2017, the amount available under the program for the repurchase of the Company’s common stock was $398.7 million.

Accumulated other comprehensive loss

The following is a summary of accumulated other comprehensive loss as of November 30, 2017 and February 28, 2017 (in thousands):



	As of November 30, 2017			As of February 28, 2017
Accumulated loss from foreign currency translation adjustment	$	(34,624	)	$	(87,784	)
Accumulated unrealized loss, net of tax, on available-for-sale securities	(1,271		)	(568		)
Accumulated other comprehensive loss	$	(35,895	)	$	(88,352	)

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 4—Identifiable Intangible Assets

Identifiable intangible assets consist primarily of trademarks, copyrights and patents, purchased technologies, customer and reseller relationships and covenants not to compete, all of which are amortized over the estimated useful life, generally on a straight-line basis, with the exception of customer and reseller relationships, which are generally amortized over the greater of straight-line or the related asset’s pattern of economic benefit. Useful lives range from two to 10 years. As of November 30, 2017 and February 28, 2017, trademarks with an indefinite estimated useful life totaled $11.7 million and $10.9 million, respectively.

See NOTE 13—Business Combinations for information regarding identifiable intangible assets acquired. The following is a summary of identifiable intangible assets (in thousands):



	As of November 30, 2017							As of February 28, 2017
	Gross Amount		Accumulated Amortization			Net Amount		Gross Amount		Accumulated Amortization			Net Amount
Trademarks, copyrights and patents	$	162,818	$	(67,838	)	$	94,980	$	148,850	$	(59,440	)	$	89,410
Purchased technologies	130,235		(90,143		)	40,092		107,078		(80,536		)	26,542
Customer and reseller relationships	105,810		(93,703		)	12,107		104,438		(88,046		)	16,392
Covenants not to compete	15,669		(14,036		)	1,633		14,081		(12,329		)	1,752
Other intangible assets	8,833		(6,195		)	2,638		8,833		(5,162		)	3,671
Total identifiable intangible assets	$	423,365	$	(271,915	)	$	151,450	$	383,280	$	(245,513	)	$	137,767

Amortization expense associated with identifiable intangible assets recognized in the Company’s Consolidated Financial Statements for the three and nine months ended November 30, 2017 and November 30, 2016 is summarized as follows (in thousands):



	Three Months Ended				Nine Months Ended
	November 30, 2017		November 30, 2016		November 30, 2017		November 30, 2016
Cost of revenue	$	4,674	$	4,578	$	13,524	$	12,734
Sales and marketing	1,592		1,695		4,634		5,515
Research and development	34		34		103		103
General and administrative	2,084		1,690		6,137		5,291
Total amortization expense	$	8,384	$	7,997	$	24,398	$	23,643

NOTE 5—Income Taxes

The effective tax rates for the three and nine months ended November 30, 2017 of 12.6% and 18.4%, respectively, differed from the U.S. federal statutory rate of 35% primarily due to excess tax benefits from share-based compensation, foreign income taxed at lower rates, research tax credits and the domestic-production-activities deduction. Tax expense for the three and nine months ended November 30, 2017 included net discrete tax benefits of $15.5 million and $28.5 million, respectively, primarily related to net excess tax benefits from share-based compensation.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

For the three and nine months ended November 30, 2016, the Company’s then-effective tax rates of 11.4% and 17.8%, respectively, differed from the U.S. federal statutory rate of 35% primarily due to excess tax benefits from share-based compensation, foreign income taxes at lower rates, research tax credits and the domestic-production-activities deduction. Tax expense for the three and nine months ended November 30, 2016, included net discrete tax benefits of $11.9 million and $21.1 million, respectively, primarily related to net excess tax benefits from share-based compensation.

The Company files a consolidated U.S. federal income tax return, as well as separate and combined income tax returns in numerous state and international jurisdictions. The Company is currently subject to examination by various taxing jurisdictions. The Company regularly assesses the potential outcomes of both ongoing and future examinations for the current and prior years, and believes that its provision for income taxes is adequate. The outcome of any one examination is not expected to have a material impact on the Company’s consolidated financial statements. The Company believes that some of these audits and negotiations may conclude during the next 12 months.

As of November 30, 2017, it is reasonably possible that total gross unrecognized tax benefits may be reduced by up to $2.0 million within the next 12 months as a result of statutes of limitations expirations in various tax jurisdictions, all of which would reduce the Company’s effective tax rate.

NOTE 6—Assets and Liabilities Measured at Fair Value on a Recurring Basis

Fair value is defined as the exchange price that would be received for the purchase of an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for such asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. To measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities.

The Company’s investments are comprised primarily of debt securities that are classified as available for sale and recorded at their fair values. Liquid investments with effective maturities of three months or less at the date of purchase are classified as cash equivalents. Investments with remaining effective maturities of twelve months or less from the balance sheet date are classified as short-term investments. Investments with remaining effective maturities of more than twelve months from the balance sheet date are classified as long-term investments. The Company’s Level 1 financial instruments are valued using quoted prices in active markets for identical instruments. The Company’s Level 2 financial instruments, including derivative instruments, are valued using quoted prices for identical instruments in less active markets or using other observable market inputs for comparable instruments.

Unrealized gains and temporary losses on investments classified as available for sale are included within accumulated other comprehensive income, net of any related tax effect. Realized gains and losses are recorded using the specific identification method and upon realization, such amounts are reclassified from accumulated other comprehensive income to Other expense, net. Realized gains and losses and other than temporary impairments, if any, are reflected in the Company’s Consolidated Statements of Operations as Other expense, net. The Company does not recognize changes in the fair value of its investments in income unless a decline in value is considered other than temporary. The vast majority of the Company’s investments are priced with the assistance of pricing vendors. These pricing vendors use the most recent observable market information in pricing these securities or, if specific prices are not available for these securities, use other observable inputs. In the event observable inputs are not available, the Company assesses other factors to determine the security’s fair value, including broker quotes or model valuations. Independent price verifications of all holdings are performed by pricing vendors, which are then reviewed by the Company. In the event a price fails a pre-established tolerance check, it is researched so that the Company can assess the cause of the variance to determine what the Company believes is the appropriate fair value.

The Company minimizes its credit risk associated with investments by investing primarily in investment-grade, liquid securities. The Company’s policy is designed to limit exposures to any one issuer depending on credit quality. Periodic evaluations of the relative credit standing of those issuers are considered in the Company’s investment strategy.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table summarizes the composition and fair value hierarchy of the Company’s financial assets and liabilities as of November 30, 2017 (in thousands):



	As of November 30, 2017			Level 1		Level 2			Level 3
Assets:
Money markets (1)	$	217,456		$	217,456	$	—		$	—
Interest-bearing deposits (1)	59,312			—		59,312			—
Available-for-sale securities (1):
Commercial paper	250,794			—		250,794			—
U.S. agency securities	309,489			—		309,489			—
Corporate securities	620,479			—		620,479			—
Equity securities	721			721		—			—
Foreign currency derivatives (2)	156			—		156			—
Liabilities:
Foreign currency derivatives (3)	(174		)	—		(174		)	—
Total	$	1,458,233		$	218,177	$	1,240,056		$	—

__________


(1)	Included in Cash and cash equivalents, Investments in debt and equity securities, short-term or Investments in debt securities, long-term in the Company’s Consolidated Balance Sheet as of November 30, 2017, in addition to $862.9 million of cash.


(2)	Included in Other current assets in the Company’s Consolidated Balance Sheet as of November 30, 2017.


(3)	Included in Accounts payable and accrued expenses in the Company’s Consolidated Balance Sheet as of November 30, 2017.

The following table summarizes the composition and fair value hierarchy of the Company’s financial assets and liabilities as of February 28, 2017 (in thousands):



	As of February 28, 2017			Level 1		Level 2			Level 3
Assets:
Money markets (1)	$	258,188		$	258,188	$	—		$	—
Available-for-sale securities (1):
U.S. agency securities	327,430			—		327,430			—
Corporate securities	714,993			—		714,993			—
Foreign currency derivatives (2)	135			—		135			—
Liabilities:
Foreign currency derivatives (3)	(160		)	—		(160		)	—
Total	$	1,300,586		$	258,188	$	1,042,398		$	—

__________


(1)	Included in Cash and cash equivalents, Investments in debt and equity securities, short-term or Investments in debt securities, long-term in the Company’s Consolidated Balance Sheet as of February 28, 2017, in addition to $832.6 million of cash.


(2)	Included in Other current assets in the Company’s Consolidated Balance Sheet as of February 28, 2017.


(3)	Included in Accounts payable and accrued expenses in the Company’s Consolidated Balance Sheet as of February 28, 2017.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table represents the Company’s investments measured at fair value as of November 30, 2017 (in thousands):



											Balance Sheet Classification
	Amortized Cost		Gross Unrealized					Aggregate Fair Value			Cash Equivalent Marketable Securities		Investments in debt and equity securities, short-term		Investments in debt securities, long-term
	Amortized Cost		Gains		Losses (1)			Aggregate Fair Value			Cash Equivalent Marketable Securities		Investments in debt and equity securities, short-term		Investments in debt securities, long-term
Money markets	$	217,456	$	—	$	—		$	217,456		$	217,456	$	—	$	—
Interest-bearing deposits	59,312		—		—			59,312			—		59,312		—
Commercial paper	250,794		—		—			250,794			250,794		—		—
U.S. agency securities	312,391		—		(2,902		)	309,489			—		78,231		231,258
Corporate securities	620,121		1,270		(912		)	620,479			—		246,453		374,026
Equity securities	650		71		—			721			—		721		—
Total	$	1,460,724	$	1,341	$	(3,814	)	$	1,458,251	—	$	468,250	$	384,717	$	605,284

__________


(1)	As of November 30, 2017, there were $3.0 million of accumulated unrealized losses related to investments that have been in a continuous unrealized loss position for 12 months or longer. The aggregate related fair value of all investments with unrealized losses was $540.1 million.

The following table summarizes the stated maturities of the Company’s investments in debt securities (in thousands):



	Total		Less than 1 Year		1-5 Years		More than 5 Years
Maturity of current and long-term investments in debt securities	$	989,280	$	383,996	$	605,284	$	—

The following table represents the Company’s investments measured at fair value as of February 28, 2017 (in thousands):



										Balance Sheet Classification
	Amortized Cost		Gross Unrealized					Aggregate Fair Value		Cash Equivalent Marketable Securities		Investments in debt and equity securities, short-term		Investments in debt securities, long-term
	Amortized Cost		Gains		Losses (1)			Aggregate Fair Value		Cash Equivalent Marketable Securities		Investments in debt and equity securities, short-term		Investments in debt securities, long-term
Money markets	$	258,188	$	—	$	—		$	258,188	$	258,188	$	—	$	—
U.S. agency securities	329,617		37		(2,224		)	327,430		—		27,593		299,837
Corporate securities	714,226		1,416		(649		)	714,993		—		342,390		372,603
Total	$	1,302,031	$	1,453	$	(2,873	)	$	1,300,611	$	258,188	$	369,983	$	672,440

__________


(1)	As of February 28, 2017, there were $0.6 million of accumulated unrealized losses related to investments that have been in a continuous unrealized loss position for 12 months or longer. The aggregate related fair value of all investments with unrealized losses was $605.9 million.

NOTE 7—Derivative Instruments

The Company transacts business in various foreign countries and is, therefore, subject to risk of foreign currency exchange rate fluctuations. The Company from time to time enters into forward contracts to economically hedge transactional exposure associated with commitments arising from trade accounts receivable, trade accounts payable and fixed purchase obligations denominated in a currency other than the functional currency of the respective operating entity. All derivative instruments are recorded on the Consolidated Balance Sheets at their respective fair values. The Company has elected not to prepare and maintain the documentation required to qualify for hedge accounting treatment and, therefore, changes in fair value are recorded in the Consolidated Statements of Operations. See NOTE 6—Assets and Liabilities Measured at Fair Value on a Recurring Basis for information regarding the fair value hierarchy of derivative instruments.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The effects of derivative instruments on the Company’s Consolidated Financial Statements are as follows as of November 30, 2017 and for the three and nine months then ended (in thousands):



	As of November 30, 2017						Classification of Unrealized Gain (Loss) Recognized in Income on Derivatives	Three Months Ended November 30, 2017			Nine Months Ended November 30, 2017
	Balance Sheet Classification	Fair Value			Notional Value			Three Months Ended November 30, 2017			Nine Months Ended November 30, 2017
Assets—foreign currency forward contracts not designated as hedges	Other current assets	$	156		$	20,394	Other expense, net	$	309		$	1,589
Liabilities—foreign currency forward contracts not designated as hedges	Accounts payable and accrued expenses	(174		)	35,210		Other expense, net	(678		)	(1,261		)
Total		$	(18	)	$	55,604		$	(369	)	$	328

The effects of derivative instruments on the Company’s Consolidated Financial Statements are as follows as of November 30, 2016 and for the three and nine months then ended (in thousands):



	As of November 30, 2016						Classification of Unrealized Gain (Loss) Recognized in Income on Derivatives	Three Months Ended November 30, 2016			Nine Months Ended November 30, 2016
	Balance Sheet Classification	Fair Value			Notional Value			Three Months Ended November 30, 2016			Nine Months Ended November 30, 2016
Assets—foreign currency forward contracts not designated as hedges	Other current assets	$	132		$	25,849	Other expense, net	$	555		$	2,958
Liabilities—foreign currency forward contracts not designated as hedges	Accounts payable and accrued expenses	(902		)	15,765		Other expense, net	(1,182		)	(2,181		)
Total		$	(770	)	$	41,614		$	(627	)	$	777

NOTE 8—Share-based Awards

The Company measures share-based compensation cost at the grant date, based on the estimated fair value of the award and recognizes the cost over the employee requisite service period, typically on a straight-line basis. The Company estimates the fair value of stock options using the Black-Scholes-Merton valuation model. The fair value of nonvested share awards, nonvested share units and performance share units are measured at their underlying closing share price on the day of grant.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following summarizes share-based compensation expense recognized in the Company’s Consolidated Financial Statements for the three and nine months ended November 30, 2017 and November 30, 2016 (in thousands):



	Three Months Ended				Nine Months Ended
	November 30, 2017		November 30, 2016		November 30, 2017		November 30, 2016
Cost of revenue	$	4,199	$	4,037	$	12,408	$	12,396
Sales and marketing	23,278		26,624		64,708		65,426
Research and development	14,937		13,814		42,603		38,785
General and administrative	9,904		10,266		23,264		24,766
Total share-based compensation expense (1)	$	52,318	$	54,741	$	142,983	$	141,373

__________


(1)	Total share-based compensation expense includes $2.9 million and $2.0 million respectively, of expense related to the Company’s employee stock purchase plan (“ESPP”) for the three months ended November 30, 2017 and November 30, 2016 and $8.8 million and $2.0 million, respectively, for the nine months ended November 30, 2017 and November 30, 2016.

Share-based compensation expense qualifying for capitalization was insignificant for each of the three and nine months ended November 30, 2017 and November 30, 2016. Accordingly, no share-based compensation expense was capitalized during the three and nine months ended November 30, 2017 and November 30, 2016.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

During the three and nine months ended November 30, 2017 and November 30, 2016, the Company granted the following share-based awards:



	Three Months Ended
	November 30, 2017			November 30, 2016
	Shares and Shares Underlying Awards	Weighted Average Per Share Award Fair Value		Shares and Shares Underlying Awards	Weighted Average Per Share Award Fair Value
Service-based shares and share units	699,066	$	120.89	949,421	$	76.19



	Nine Months Ended
	November 30, 2017				November 30, 2016
	Shares and Shares Underlying Awards		Weighted Average Per Share Award Fair Value		Shares and Shares Underlying Awards	Weighted Average Per Share Award Fair Value
Service-based shares and share units	1,585,904		$	101.85	2,017,861	$	75.62
Performance share units—target	261,760	(1)	$	87.99	362,502	$	76.68
Performance share awards	104,362	(2)	$	87.99	140,182	$	76.70
Total awards	1,952,026		$	99.25	2,520,545	$	75.83

__________

(1) Certain executives and senior management were awarded a target number of performance share units (“PSUs”). PSU grantees may earn up to 200% of the target number of PSUs. Half of the target number of PSUs can be earned by the grantees depending upon the Company’s financial performance measured against the financial performance of specified peer companies during a three-year performance period beginning on March 1, 2017. The remaining target number of PSUs can be earned by the grantees depending upon the Company’s total shareholder return performance measured against the total shareholder return performance of specified peer companies during a three-year period beginning on March 1, 2017.

(2) Certain executives were granted restricted stock awards. These shares were awarded subject to the achievement of a specified dollar amount of revenue for the fiscal year ending February 28, 2018 (the “RSA Performance Goal”). If the Company fails to achieve the RSA Performance Goal for the fiscal year ending February 28, 2018, then all such shares are forfeited. If the Company achieves the RSA Performance Goal for the fiscal year ending February 28, 2018, then 25% of the restricted stock vests on or about July 16, 2018, and the remainder vests ratably on a quarterly basis over the course of the subsequent three-year period, provided that the grantee’s business relationship with the Company has not ceased.

NOTE 9—Earnings Per Share

The Company computes basic net income per common share by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common share equivalents consist of shares issuable upon the exercise of stock options or vesting of share-based awards.

The following table reconciles the numerators and denominators of the earnings per share (“EPS”) calculation for the three and nine months ended November 30, 2017 and November 30, 2016 (in thousands, except per share amounts):



	Three Months Ended				Nine Months Ended
	November 30, 2017		November 30, 2016		November 30, 2017		November 30, 2016
Net income, basic and diluted	$	101,306	$	67,943	$	271,355	$	187,900
Weighted average common shares outstanding	177,063		179,233		177,188		180,245
Incremental shares attributable to assumed vesting or exercise of outstanding equity award shares	3,518		2,935		3,281		2,980
Dilutive effect of convertible notes	4,109		514		2,928		228
Dilutive effect of warrants	1,470		—		—		—
Diluted shares	186,160		182,682		183,397		183,453
Diluted net income per share	$	0.54	$	0.37	$	1.48	$	1.02

With respect to the Company’s 0.25% Convertible Senior Notes due 2019 (the “convertible notes”), the Company has the option to pay cash or deliver, as the case may be, either cash, shares of its common stock or a combination of cash and shares of its common stock for the aggregate amount due upon conversion of the convertible notes. The Company’s intent is to settle the principal amount of the convertible notes in cash upon conversion. As a result, upon conversion of the convertible notes, only the amounts payable in excess of the principal amounts of the convertible notes are considered in diluted EPS under the treasury stock method. See NOTE 14—Convertible Notes for detailed information on the convertible notes.

Warrants to purchase 10,965,630 shares of the Company’s common stock at $101.65 per share were outstanding during the three and nine months ended November 30, 2017 and November 30, 2016. For the three months ended November 30, 2017, the warrants were included in the computation of diluted EPS because the warrants’ exercise price was lower than the average market price of the Company’s common stock during the related period. For the nine months ended November 30, 2017, the warrants were not included in the computation of diluted EPS because the warrants’ exercise price was greater than the average market price of the Company’s common stock during the related period.

The following share awards were not included in the computation of diluted EPS because the aggregate value of proceeds considered received upon either exercise or vesting was greater than the average market price of the Company’s common stock during the related periods and the effect of including such share awards in the computation would be anti-dilutive (in thousands):



	Three Months Ended		Nine Months Ended
	November 30, 2017	November 30, 2016	November 30, 2017	November 30, 2016
Number of shares considered anti-dilutive for calculating diluted EPS	353	71	117	938

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 10—Segment Reporting

The Company is organized primarily on the basis of three geographic business units: the Americas (U.S., Latin America and Canada), Europe, Middle East and Africa (“EMEA”) and Asia Pacific. These business units are aggregated into one reportable segment due to the similarity in nature of products and services provided, financial performance economic characteristics (e.g. revenue growth and gross margin), methods of production and distribution and customer classes (e.g. cloud service providers, distributors, reseller and enterprise).

The following summarizes revenue from unaffiliated customers and income (loss) from operations for the three and nine months ended November 30, 2017 and November 30, 2016 and total cash, cash equivalents and available-for-sale investment securities and total assets as of November 30, 2017 and November 30, 2016, by geographic segment (in thousands):



	Americas		EMEA		Asia Pacific		Corporate (1)			Consolidated

	Three Months Ended November 30, 2017
Revenue from unaffiliated customers	$	471,773	$	173,718	$	102,487	$	—		$	747,978
Income (loss) from operations	$	99,937	$	42,086	$	28,708	$	(52,318	)	$	118,413

	Three Months Ended November 30, 2016
Revenue from unaffiliated customers	$	393,589	$	132,568	$	89,103	$	—		$	615,260
Income (loss) from operations	$	87,899	$	22,608	$	25,007	$	(54,741	)	$	80,773

	Nine Months Ended November 30, 2017
Revenue from unaffiliated customers	$	1,373,512	$	477,110	$	297,507	$	—		$	2,148,129
Income (loss) from operations	$	284,229	$	112,333	$	87,001	$	(142,983	)	$	340,580
Total cash, cash equivalents and available-for-sale investment securities	$	1,071,638	$	855,164	$	394,371	$	—		$	2,321,173
Total assets	$	2,877,183	$	1,306,074	$	576,227	$	—		$	4,759,484

	Nine Months Ended November 30, 2016
Revenue from unaffiliated customers	$	1,144,841	$	384,334	$	253,788	$	—		$	1,782,963
Income (loss) from operations	$	229,251	$	76,506	$	73,636	$	(141,373	)	$	238,020
Total cash, cash equivalents and available-for-sale investment securities	$	1,060,721	$	611,380	$	299,269	$	—		$	1,971,370
Total assets	$	2,661,792	$	981,044	$	442,257	$	—		$	4,085,093

__________


(1)	Amounts represent share-based compensation expense that was not allocated to geographic segments.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Supplemental information about geographic areas

The following table lists, for each of the three and nine months ended November 30, 2017 and November 30, 2016, revenue from unaffiliated customers in the United States, the Company’s country of domicile, and revenue from unaffiliated customers from foreign countries (in thousands):



	Three Months Ended				Nine Months Ended
	November 30, 2017		November 30, 2016		November 30, 2017		November 30, 2016
United States, the Company’s country of domicile	$	415,900	$	352,109	$	1,227,645	$	1,024,404
Foreign	332,078		263,151		920,484		758,559
Total revenue from unaffiliated customers	$	747,978	$	615,260	$	2,148,129	$	1,782,963

Total tangible long-lived assets, net of accumulated depreciation, located in the United States, the Company’s country of domicile, and similar tangible long-lived assets, net of accumulated depreciation, held outside the United States are summarized in the following table as of November 30, 2017 and February 28, 2017 (in thousands):



	November 30, 2017		February 28, 2017
United States, the Company’s country of domicile	$	134,943	$	133,492
Foreign	66,864		56,137
Total tangible long-lived assets	$	201,807	$	189,629

Supplemental information about major customers

For each of the three months ended November 30, 2017 and November 30, 2016, the U.S. government and its agencies represented in the aggregate approximately 10% of the Company’s total revenue. For each of the nine months ended November 30, 2017 and November 30, 2016, the U.S. government and its agencies represented in the aggregate approximately 11% and 10% of the Company’s total revenue, respectively.

At November 30, 2017, the Company had one customer whose accounts receivable balance individually represented 11% of total accounts receivable. As of February 28, 2017, no individual customer accounted for 10% or more of the Company’s total accounts receivable.

Supplemental information about products and services

The following table, for each of the three and nine months ended November 30, 2017 and November 30, 2016, provides further detail, by type, of the Company’s subscription and services revenues. Infrastructure-related offerings subscription revenue includes subscription revenue generated from Red Hat Enterprise Linux and related technologies such as Red Hat Satellite and Red Hat Enterprise Virtualization. Subscription revenue generated from the Company’s Application Development-related and other emerging technology offerings includes Red Hat JBoss Middleware, Red Hat Storage, Red Hat Mobile Application Platform and Red Hat cloud offerings such as Red Hat OpenStack Platform, Red Hat OpenShift and Red Hat CloudForms (in thousands):

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	Three Months Ended				Nine Months Ended
	November 30, 2017		November 30, 2016		November 30, 2017		November 30, 2016
Subscription revenue:
Infrastructure-related offerings	$	494,974	$	431,142	$	1,440,383	$	1,261,359
Application Development-related and other emerging technology offerings	161,858		112,176		450,519		314,833
Total subscription revenue	656,832		543,318		1,890,902		1,576,192
Training and services revenue:
Consulting services	69,499		53,517		196,161		155,103
Training	21,647		18,425		61,066		51,668
Total training and services revenue	91,146		71,942		257,227		206,771
Total subscription and training and services revenue	$	747,978	$	615,260	$	2,148,129	$	1,782,963

NOTE 11—Commitments and Contingencies

Operating leases

As of November 30, 2017, the Company had leases of office space and certain equipment under various non-cancellable operating leases. Rent expense under operating leases for the three months ended November 30, 2017 and November 30, 2016 was $12.9 million and $11.8 million, respectively. Rent expense under operating leases for the nine months ended November 30, 2017 and November 30, 2016 was $38.1 million and $32.6 million, respectively.

Product indemnification

The Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party from losses arising in connection with the Company’s services or products, or from losses arising in connection with certain events defined within a particular contract, which may include litigation or claims relating to intellectual property infringement, certain losses arising from damage to property or injury to persons or other matters. In each of these circumstances, payment by the Company is conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, which procedures typically allow the Company to challenge the other party’s claims. Further, the Company’s obligations under these agreements may in certain cases be limited in terms of time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments made by the Company.

It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the facts and circumstances involved in each particular agreement. The Company does not record a liability for claims related to indemnification unless the Company concludes that the likelihood of a material claim is probable and estimable. Historically, payments pursuant to these indemnifications have been immaterial.

NOTE 12—Legal Proceedings

The Company experiences routine litigation in the normal course of its business, including patent litigation. The Company presently believes that the outcome of this routine litigation will not have a material adverse effect on its financial position, results of operations or cash flows.

RED HAT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 13—Business Combinations

Acquisition of Permabit Technology Corporation

On July 31, 2017, the Company acquired the assets and technology of Permabit Technology Corporation (“Permabit”), a provider of software for data deduplication, compression and thin provisioning. Adding Permabit’s data deduplication and compression capabilities to the Company’s Red Hat Enterprise Linux platform will better enable enterprise digital transformation through more efficient storage options.

The consideration paid was $49.8 million in cash. Based on management’s provisional assessment of the acquisition-date fair value of the assets acquired and liabilities assumed, the total consideration transferred of $49.8 million was allocated to the Company’s assets and liabilities on a preliminary basis as follows: $39.4 million to goodwill, $10.4 million to identifiable intangible assets and a nominal amount to working capital. The goodwill acquired is expected to be deductible for tax purposes.

Acquisition of Codenvy S. A.

On June 1, 2017, the Company completed its acquisition of all of the shares of Codenvy S.A. (“Codenvy”), a provider of cloud-native development tools that enable developers to more easily create modern container-based and cloud-native applications. By adding Codenvy to its existing portfolio of developer tools and application platforms, including Red Hat JBoss Middleware and Red Hat OpenShift, the Company continues its efforts to provide solutions that enable developers to create applications for hybrid cloud environments. The Company plans to make Codenvy an integral part of OpenShift.io, the Company’s recently announced hosted development environment for building hybrid cloud services on OpenShift.

During the three months ended November 30, 2017, the Company completed its assessment of the acquisition-date fair value of the assets acquired and liabilities assumed. As a result of the Company’s completed assessment, the total consideration transferred of $34.2 million was allocated to the Company’s assets and liabilities as follows: $25.4 million to goodwill, $11.3 million to identifiable intangible assets and $2.5 million to working capital as a net current liability.

Transaction costs

The Company incurred approximately $1.3 million in transaction costs, including legal and accounting fees, relating to both the Permabit and Codenvy acquisitions. These transaction costs have been expensed as incurred and included in General and administrative expense on the Company’s Consolidated Statement of Operations for the nine months ended November 30, 2017.

Acquisition of 3scale, Inc.

On June 24, 2016, the Company completed its acquisition of all of the shares of 3scale, Inc. (“3scale”), a provider of application programming interface (“API”) management technology. By adding 3scale to its existing portfolio, including Red Hat JBoss Middleware, Red Hat OpenShift and Red Hat Mobile Application Platform, the Company strengthens its enablement of the API economy with simplified cloud integration and microservices-based architectures.

The consideration paid was $29.1 million in cash. Management has completed its assessment of the acquisition-date fair value of the assets acquired and liabilities assumed. The total consideration transferred of $29.1 million was allocated to the Company’s assets and liabilities as follows: $16.9 million to goodwill, $13.1 million to identifiable intangible assets and $0.9 million to working capital as a net current liability.

Pro forma consolidated financial information

Pro forma consolidated financial information for the three and nine months ended November 30, 2017 and November 30, 2016 have not been provided because the acquisitions of Permabit, Codenvy and 3scale would not have had a significant impact on consolidated operating results if the acquisitions had closed on March 1, 2016.

Goodwill

The following is a summary of changes in goodwill for the nine months ended November 30, 2017 (in thousands):



Balance at February 28, 2017	$	1,040,709
Acquisitions	64,837
Impact of foreign currency fluctuations	15,411
Balance at November 30, 2017	$	1,120,957

RED HAT, INC.

NOTES TO CONSOL