| Summary of Significant Accounting Policies | NOTE 2—Summary of
Significant Accounting Policies Basis of
presentation
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 are eliminated
in consolidation. There are no significant foreign exchange
restrictions on the Company’s foreign
subsidiaries.
The
Consolidated Balance Sheet as of February 28, 2015 includes
the effect of retrospective application of Accounting Standards
Update 2015-17, Income Taxes (Topic 740): Balance Sheet
Classification of Deferred Taxes Interest Imputation of Interest
(Subtopic 835-30): Simplifying the Presentation of Debt Issuance
Costs .
As reported Adjustments for Adjustments for Adjusted
ASSETS
Current assets:
Deferred tax assets,
net $ 86,796 (86,796 ) — $ —
Non-current
assets:
Deferred tax assets,
net $ — 98,892 — $ 98,892
Other assets,
net $ 53,243 (18,049 ) (12,463 ) $ 22,731
LIABILITIES
Current
liabilities:
Other current
obligations $ 1,844 (659 ) — $ 1,185
Non-current
liabilities:
Convertible
notes $ 715,402 — (12,463 ) $ 702,939
Other long-term
obligations $ 77,340 (5,294 ) — $ 72,046
For additional
discussion related to recent accounting pronouncements the Company
has either recently adopted or is currently evaluating the impact
from future adoption, see “Recent accounting
pronouncements” in this note. Use of
estimates
The preparation
of financial statements in conformity with accounting principles
generally accepted in the United States of America 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. Revenue
recognition
The Company
establishes persuasive evidence of a sales arrangement for each
type of revenue transaction based on either a signed contract with
the end customer, a click-through contract on the Company’s
website whereby the customer agrees to the Company’s standard
subscription terms, signed or click-through distribution contracts
with original equipment manufacturers (“OEMs”) and
other resellers, or, in the case of individual training seats,
through receipt of payment which indicates acceptance of the
Company’s training agreement terms.
Subscription
revenue
Subscription
revenue is comprised of direct and indirect sales of subscriptions
relating to Red Hat technologies. Accounts receivable and deferred
revenue are recorded at the time a customer enters into a binding
subscription agreement for the purchase of a subscription,
subscription services are made available to the customer and the
customer is billed. The deferred revenue amount is recognized as
revenue ratably over the life of the subscription. Red Hat
technologies are generally offered with either one or three-year
base subscription periods; the majority of the Company’s
subscriptions have one-year terms. Under these subscription
agreements, renewal rates are generally specified for one or
three-year renewal terms. Subscriptions generally entitle the end
user to the technology itself and post-contract customer support,
generally consisting of varying levels of support services as well
as access to security errata, fixes, functionality enhancements to
the technology and upgrades to the technologies, each on an if and
when available basis, during the term of the subscription. The
Company sells its offerings through two principal channels:
(1) direct, which includes sales by the Company’s sales
force as well as web store sales, and (2) indirect, which
includes certified cloud and service providers
(“CCSPs”), distributors, value added resellers, systems
integrators and OEMs. The Company recognizes revenue from the sale
of Red Hat technologies ratably over the period of the subscription
beginning on the commencement date of the subscription
agreement.
Subscription
arrangements with large enterprise customers often have contracts
with multiple elements (e.g., software technology, support,
training, consulting and other services). The Company allocates
revenue to each element of the arrangement based on vendor-specific
objective evidence of each element’s fair value when the
Company can demonstrate sufficient evidence of the fair value of at
least those elements that are undelivered. The fair value of each
element in multiple element arrangements is created by either
(i) providing the customer with the ability during the term of
the arrangement to renew that element at the same rate paid for the
element included in the initial term of the agreement or
(ii) selling the element on a stand-alone basis.
The Company
derives a portion of its revenue from CCSPs that provide public
clouds with and allow users to consume computing resources as a
service. The Company earns revenue based on subscription units
consumed by the CCSP or its end users. These cloud-usage services
began expanding significantly in fiscal 2013 and have continued to
grow.
For periods
prior to March 1, 2015, the Company recognized cloud-usage
revenue upon receipt of usage reports from the CCSPs, which
typically report fees owed to the Company one month or more after
the fees have been earned. Effective March 1, 2015, the
Company believed that it had sufficient historical data and
experience to estimate this cloud-usage revenue and has begun
estimating the amount of and recognizing such revenue in the period
earned. The estimates are based on the historical cloud-usage data
available. As a result of the Company’s transition to
estimating cloud-usage revenue, the Company’s subscription
revenues and pre-tax income for the fiscal year ended
February 29, 2016 included an additional, favorable adjustment
of $5.3 million.
Training and
services revenue
Training and
services revenue is comprised of revenue for consulting,
engineering and customer training and education services.
Consulting services consist of time-based arrangements, and revenue
is recognized as these services are performed. Engineering services
represent revenue earned under fixed fee arrangements with the
Company’s OEM partners and other customers to provide for
significant modification and customization of Red Hat technologies.
The Company recognizes revenue for these fixed fee engineering
services using the percentage of completion basis of accounting,
provided the Company has the ability to make reliable estimates of
progress towards completion, the fee for such services is fixed or
determinable and collection of the resulting receivable is
probable. Under the percentage of completion method, earnings under
the contract are recognized based on the progress toward completion
as estimated using the ratio of labor hours incurred to total
expected project hours. Changes in estimates are recognized in the
period in which they are known. Revenue for customer training and
education services is recognized on the dates the services are
complete. Deferred selling
costs
Deferred
commissions are the incremental costs that are directly associated
with non-cancelable subscription contracts with customers and
consist of sales commissions paid to the Company’s sales
force. The commissions are deferred and amortized over a period
that approximates the period of the subscription term. The
commission payments are paid in full subsequent to the month in
which the customer’s service commences. The deferred
commission amounts are recoverable through the future revenue
streams under the non-cancelable customer contracts. In addition,
the Company has the ability and intent under the commission plans
with its sales force to recover commissions previously paid to its
sales force in the event that customers breach the terms of their
subscription agreements and do not fully pay for their subscription
agreements. Deferred commissions are included in prepaid expenses
on the accompanying Consolidated Balance Sheets. Amortization of
deferred commissions is included in sales and marketing expense in
the accompanying Consolidated Statements of Operations. Goodwill and other
long-lived assets
Goodwill
The Company
evaluates goodwill for impairment during the fourth quarter of its
fiscal year or more frequently if events or changes in
circumstances indicate that an impairment to goodwill may have
occurred. For the year ended February 29, 2016, the Company
elected to perform a quantitative assessment of goodwill for all of
its reporting units. In doing so, the Company compared the
estimated fair value of each of the reporting units to its
respective book value, including allocated goodwill. The Company
concluded that there were no impairments of goodwill.
For the year
ended February 28, 2015, the Company applied its test for
goodwill impairment as permitted by ASU 2011-08, which allows the
Company to first assess qualitative factors to determine whether it
is “more likely than not” that the fair value of a
reporting unit is less than its carrying value. The outcome of
these qualitative tests determines whether it is necessary for a
company to perform the two-step goodwill impairment test as
required in years prior to the adoption of ASU 2011-08.
After
considering such qualitative factors as macroeconomic conditions,
actual or anticipated changes to cost factors (for example, selling
and delivery), overall financial performance and other
Company-specific factors, such as potential changes in strategy,
the Company determined that it was not more likely than not that
any impairment to goodwill had occurred during the year ended
February 28, 2015. Consequently, the Company was not required
to perform the remaining two-step quantitative goodwill impairment
test.
Other
long-lived assets
The Company
evaluates the recoverability of its property and equipment and
other long-lived assets whenever events or changes in circumstances
indicate that an impairment may have occurred. An impairment loss
is recognized when the net book value of such assets exceeds the
estimated future undiscounted cash flows attributable to the assets
or the business to which the assets relate. Impairment losses, if
any, are measured as the amount by which the carrying value exceeds
the fair value of the assets.
See NOTE
8—Other Assets, Net for further discussion of impairment
losses on long-lived assets for the years ended February 29,
2016, February 28, 2015 and February 28,
2014. Cash and cash
equivalents
The Company
considers highly liquid investments purchased with a maturity
period of three months or less at the date of purchase to be cash
equivalents. Accounts receivable and
allowance for doubtful accounts
Trade accounts
receivable are recorded at the invoiced amount and do not bear
interest. The allowance for doubtful accounts is the
Company’s estimate of the amount of probable credit losses in
the Company’s existing accounts receivable. The Company
determines the allowance based on historical write-off experience.
The Company reviews its allowance for doubtful accounts monthly.
Past due balances over 90 days and over a specified amount are
reviewed individually for collectability. All other balances are
reviewed on a pooled basis by type of receivable. Account balances
are charged off against the allowance when the Company determines
it is probable the receivable will not be recovered. The Company
does not have off-balance sheet credit exposure related to its
customers. See NOTE 4—Accounts Receivable for further
discussion on accounts receivable balances. Fair value
measurements
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 market 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. Upon realization, such
amounts are reclassified from accumulated other comprehensive
income to Other income (expense), net. Realized gains and losses
and other than temporary impairments, if any, are reflected in the
consolidated statements of operations as Other income (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 by 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 market 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 market value. See NOTE 18—Assets and
Liabilities Measured at Fair Value on a Recurring Basis for further
discussion on fair value measurements.
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. Internal use
software
The Company
capitalizes costs related to the development of internal use
software for its website, enterprise resource planning system and
systems management applications. The Company amortizes the costs of
computer software developed for internal use on a straight-line
basis over an estimated useful life of five years. The carrying
value of internal use software is included in property and
equipment on the Company’s Consolidated Balance
Sheets. Capitalized software
costs
Capitalization
of software development costs for products to be sold to third
parties begins upon the establishment of technological feasibility
and ceases when the product is available for general release. As a
result of the Company’s practice of frequently releasing
source code that it has developed on an on-going basis for
unrestricted download on the Internet, there is generally no
passage of time between achievement of technological feasibility
and the availability of the Company’s product for general
release. Therefore, at February 29, 2016 and February 28,
2015, the Company had no internally developed capitalized software
costs for products to be sold to third parties.
Property and
equipment
Property and
equipment is primarily comprised of furniture, computer equipment,
computer software and leasehold improvements, which are recorded at
cost and depreciated or amortized using the straight-line method
over their estimated useful lives as follows: furniture and
fixtures, seven years; computer equipment, three to four years;
computer software, five years; leasehold improvements, over the
lesser of the estimated remaining useful life of the asset or the
remaining term of the lease. Expenditures for maintenance and
repairs are charged to operations as incurred; major expenditures
for renewals and betterments are capitalized and depreciated.
Property and equipment acquired under capital leases are
depreciated over the lesser of the estimated remaining useful life
of the asset or the remaining term of the lease. Share-based
compensation
The Company
measures share-based compensation cost as of 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, net of estimated forfeitures. 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
(PSUs”) are measured at their underlying closing share price
on the date of grant. The Company’s share-based compensation
is described further in NOTE 13—Share-based
Awards. Sales and marketing
expenses
Sales and
marketing expenses consist of costs, including salaries, sales
commissions and related expenses, such as travel, of all personnel
involved in the sales and marketing process. Sales and marketing
expenses also include costs of advertising, sales lead generation
programs, cooperative marketing arrangements and trade shows.
Payments made to resellers or other customers are recognized as a
reduction of revenue unless the Company (i) receives an
identifiable benefit (goods or services) in exchange for such
payments that is sufficiently separable from the purchase of the
Company’s products and (ii) the Company can reasonably
estimate the fair value of the benefit identified. Advertising
costs are expensed as incurred.
Advertising
expense totaled $88.9 million, $62.6 million and $53.4 million for
the years ended February 29, 2016, February 28, 2015
and February 28, 2014, respectively. Research and development
expenses
Research and
development expenses include all direct costs, primarily salaries
for Company personnel and outside consultants, related to the
development of new software products, significant enhancements to
existing software products, and the portion of costs of development
of internal use software required to be expensed. Research and
development costs are charged to operations as incurred with the
exception of those software development costs that may qualify for
capitalization. Income
taxes
The Company
accounts for income taxes using the liability method in which
deferred tax assets or liabilities are recognized for the temporary
differences between financial reporting and tax bases of the
Company’s assets and liabilities and for tax carryforwards at
enacted statutory tax rates in effect for the years in which the
differences are expected to reverse.
The Company
continues to assess the realizability of its deferred tax assets,
which primarily consist of share-based compensation expense
deductions, tax credit carryforwards and deferred revenue. In
assessing the realizability of these deferred tax assets,
management considers whether it is more likely than not that some
portion or all of the deferred tax assets will be realized. The
Company continues to maintain a valuation allowance against its
deferred tax assets with respect to certain foreign net operating
loss (“NOL”) carryforwards.
With respect to
foreign earnings, it is the Company’s policy to invest the
earnings of foreign subsidiaries indefinitely outside the U.S. From
time to time, however, the Company may remit a portion of these
earnings to the extent it incurs no additional U.S. tax and it is
otherwise feasible.
Because tax
laws are complex and subject to different interpretations,
significant judgment is required. As a result, the Company makes
certain estimates and assumptions in (i) calculating its
income tax expense, deferred tax assets and deferred tax
liabilities, (ii) determining any valuation allowance recorded
against deferred tax assets and (iii) evaluating the amount of
unrecognized tax benefits, as well as the interest and penalties
related to such uncertain tax positions. The Company’s
estimates and assumptions may differ significantly from tax
benefits ultimately realized. The Company’s income tax
expense and deferred taxes are described further in NOTE
11—Income Taxes. Foreign currency
translation
The Euro has
been determined to be the primary functional currency for the
Company’s European operations and local currencies have been
determined to be the functional currencies for the Company’s
Asia Pacific and Latin American operations, with the exception of
the Company’s operations in Mexico, where the functional
currency is the U.S. dollar. Foreign exchange gains and losses,
which result from the process of remeasuring foreign currency
transactions into the appropriate functional currency, are included
in other income, net in the Company’s Consolidated Statements
of Operations.
The impact of
changes in foreign currency exchange rates resulting from the
translation of foreign currency financial statements into U.S.
dollars for financial reporting purposes is included in other
comprehensive income, which is a separate component of
stockholders’ equity. Assets and liabilities are translated
into U.S. dollars at exchange rates in effect at the balance sheet
date. Income and expense items are translated at average rates for
the period. Customers and credit
risk
Financial
instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash, cash
equivalents, investments and trade receivables. The Company
primarily places its cash, cash equivalents and investments with
high-credit quality financial institutions which invest
predominantly in U.S. government instruments, investment grade
corporate bonds and certificates of deposit guaranteed by banks
which are members of the Federal Deposit Insurance Corporation.
Cash deposits are primarily in financial institutions in the U.S.
and the United Kingdom. However, cash for monthly operating costs
of international operations are deposited in banks outside the
U.S.
The Company
performs credit evaluations to reduce credit risk and generally
requires no collateral from its customers. Management estimates the
allowance for uncollectible accounts based on their historical
experience and credit evaluation. The Company’s standard
credit terms are net 30 days in North America, net 30 to 45 days in
EMEA (Europe, Middle East and Africa) and Latin America, and range
from net 30 to net 60 days in Asia Pacific. Net income per common
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.
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 notes are
considered in diluted earnings per share under the treasury stock
method. See NOTE 22—Convertible Notes to the Company’s
Consolidated Financial Statements for detailed information on the
convertible notes. Segment
reporting
The Company is
organized primarily on the basis of three geographic business
units: the Americas (U.S., Latin America and Canada), EMEA (Europe,
Middle East and Africa) 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, resellers and
enterprise).
The Company has
offices in more than 85 locations around the world. The Company
manages its international business on an Americas-wide, EMEA-wide
and Asia Pacific-wide basis. See NOTE 20—Segment Reporting
for further discussion. Recent accounting
pronouncements
Accounting
pronouncements adopted
In November
2015, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update 2015-17, Income Taxes (Topic
740): Balance Sheet Classification of Deferred Taxes
In September
2015, the FASB issued Accounting Standards Update 2015-16,
Business Combinations (Topic 805): Simplifying the Accounting
for Measurement-Period Adjustments
In April 2015,
the FASB issued Accounting Standards Update 2015-03,
Interest Imputation of Interest (Subtopic 835-30):
Simplifying the Presentation of Debt Issuance Costs
Accounting
pronouncements being evaluated
In March 2016,
the FASB issued Accounting Standards Update 2016-09,
Compensation—Stock Compensation (Topic 718):
Improvements to Employee Share-Based Payment Accounting
The Company is
currently evaluating the overall impact that ASU 2016-09 will
have on its consolidated financial statements. However, a
significant impact will result from changes in how the Company
recognized the excess tax benefits (“windfalls”) or
deficiencies (“shortfalls”) related to share-based
payments. For example, such windfalls and shortfalls are currently
credited or charged, respectively, to additional paid in capital in
the Company’s Consolidated Balance Sheets. Under
ASU 2016-09, these windfalls and shortfalls will be recognized
as a tax benefit or expense, respectively, in the Company’s
Consolidated Statements of Operations. For the years ended
February 29, 2016, February 28, 2015 and
February 28, 2014, the Company recognized net windfalls
totaling $19.8 million, $6.4 million and
$10.1 million, respectively, as additional paid in capital.
Under the updated guidance these amounts would have instead been
recognized as a reduction in tax expense and consequently an
increase in net income.
In addition to
the income tax consequences described above, the excess tax
benefits from share-based payment arrangements that the Company
currently reports as cash flows from financing activities on its
Consolidated Statements of Cash Flows—which totaled
$20.2 million, $5.6 million and $12.8 million for
the years ended February 29, 2016, February 28, 2015 and
February 28, 2014, respectively—will instead, under
ASU 2016-09, be reported as cash flows from operating
activities on the Company’s Consolidated Statements of Cash
Flows.
In February
2016, the FASB issued Accounting Standards Update 2016-02,
Leases (Topic 842)
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
In May 2014,
the FASB issued Accounting Standards Update 2014-09, Revenue
from Contracts with Customers . |
