Red Hat, Inc.’s (RHT) fourth-quarter earnings of 19 cents per share (after adjusting for stock-based compensation, amortization of intangibles and litigation expenses) beat the Zacks Consensus Estimate of 12 cents on increased revenue, particularly from subscriptions. EPS was above the company’s guidance of 15 – 16 cents.

EPS also increased by four cents from 15 cents reported in the year-ago quarter due to higher other income, which was $4.4 million for the quarter, compared to a loss of $0.7 million last year. Thus EPS improved due to better-than-expected investment gains and lower taxes.

The results for the quarter were fueled by economic recovery, particularly in North America and Europe and a strong pick-up in the U.S., improving corporate IT spending environment, new product launches, margin expansion, strong execution and increased customer demand for software solutions.

The company’s EPS guidance for the first quarter and full year 2011 was also above the Zacks Consensus Estimate.

Revenue

Revenue totaled $195.9 million, up 17.8% year over year, driven by strong subscription revenue (accounted for 86.4% of the total revenue) which increased 21.4% from last year. The company also saw strong bookings in the quarter.

Revenue came in above the high-end of the company’s guidance of $191 – $193 million. Subscription revenues were strong for the eighth consecutive quarter on 96.0% renewal rates for the top 25 customers, who renewed at 130.0% of the original deal size. The company’s top 30 deals in the quarter included 18 deals of over $1 million. Moreover, growth was driven by strong bookings and billings of $243 million (18% growth year over year) due to strong customer demand for the Red Hat solution.

The company’s platform business continued to perform well in the quarter. Further, the win from International Business Machines (IBM) on enterprise development and cloud computing with Red Hat enterprise virtualization is a major win for Red Hat and will generate higher revenues.

Also, the company’s middleware solution continues to gain traction as Red Hat began shipping its flagship middleware product, JBoss EAP 5.0, in the quarter and closed a large number of deals of over $100,000 — including its largest JBoss deal of the year, a multi-million dollar deal with a large bank. Further, Red Hat will benefit from strong growth in cloud computing, virtualization and middleware technology.

Around 56% of bookings were converted to revenue, with direct sales accounting for the remaining 44%, reflecting a modest recovery in demand from OEM and channel partners. During the quarter, approximately 59% of bookings came from the Americas, 26% from EMEA and 15% from Asia-Pacific.

We are also positive about the substantial growth in deferred revenue, which increased 19% year-over-year to $645.9 million. However, management said that deferred revenue was hurt by a $20 million currency headwind.

Margins

Gross margin on a non-GAAP basis was flat year over year to 86.0%, despite strong subscription sales, as subscription gross margin remained consistent at 94%.

Operating expenses on a non-GAAP basis increased year over year by 18.5% due to continued investment in R&D, sales and marketing and higher G&A expenses. As a result, operating margin of 23.8% was slightly down (10 basis points) from the year-ago quarter. However, operating income increased 17.2% to $46.6 million year over year in the fourth quarter driven by focused expense management.

Balance Sheet

The company has a strong balance sheet and exited the quarter with $970.2 million in cash equivalents and investments, versus $959.1 million last quarter. Operating cash flow totaled $77.9 million, versus $54.1 million in the previous quarter. The company repurchased 3.1 million shares for $90.1 million. For 2010, Red Hat has repurchased 10 million shares for $236.4 million. The company also authorized a new $300 million share repurchase program.

Guidance

For the first quarter of 2011, Red Hat expects revenue in the range of $202 –$204 million. Non-GAAP operating margin is estimated to be over 24.6%. Non-GAAP EPS is estimated to be approximately 17 – to 18 cents. This is better than the Zacks Consensus expectation of 14 cents a share.

For fiscal 2011, Red Hat expects revenue of $835 – $850 million, representing an annual growth rate of 12% to 14%. Full-year 2011 operating margins are expected to be about 100 basis points better than 2010. Net investment income is expected to be approximately $8 million or $2 million a quarter which is a very modest reduction from fiscal 2010. However, Red Hat does not expect any net investment gains in other income compared to almost $11 million in investment gains in fiscal year 2010.

EPS on a non-GAAP basis is estimated to be approximately 71 cents to 74 cents, assuming a 35% tax rate for the full year 2011. This is up from the Zacks Consensus expectation of 51 cents a share. Operating cash flow is expected to be between $280-290 million. Capital expenditures are expected to be relatively modest in the $30-35 million range.
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