A leading open source solutions provider, Red Hat Inc. (RHT) reported second quarter fiscal 2011 non-GAAP earnings per share (EPS), below the Zacks Consensus Estimate. EPS was in sync with the year-ago quarter. The shares fell 4.37% ($1.68) and closed at $36.75 in regular session.
 
However, revenues beat the Zacks Consensus Estimate and were above the year-ago quarter. Management also raised its guidance for the full year 2011, above the Zacks Consensus Estimate. This pulled up shares by 3.95% ($1.45) in after hours trading to $38.20.
 
The results partially driven by a strong organic revenue growth based on robust bookings and backlog, higher subscription renewals and strong results from the services business. The company faced strong currency headwinds in the quarter, particularly from the Euro.
 
Earnings
 
Second quarter 2011 non-GAAP earnings (including share-based compensation but excluding amortization of intangible assets) of 11 cents per share were below the Zacks Consensus Estimate of 14 cents. EPS of 11 cents was flat year over year.
 
Excluding share-based compensation and amortization of intangible assets, non-GAAP earnings came in at 19 cents per share, down 5.0% from 20 cents in the second quarter 2010. However, earnings per share were 1 cent above management’s expectation of 18 cents, given out last quarter.
 
Revenue
 
Total revenue was $219.8 million, surpassed the Zacks Consensus Estimate of $211.0 million by 4.2% and the company’s guidance range of $210.0 million to $212.0 million. Total revenue increased 19.7% from $183.6 million in the year-ago quarter.  
 
The increase in total revenue was driven by a robust growth in subscription renewals, rebound in demand for services, higher demand for Open Source products and continued spending on new projects, partially offset by foreign currency headwinds. Management pointed out that the revenue growth rate in the first half of 2011 outpaced the double-digit growth rate achieved in fiscal 2010.
 
Red Hat’s top 25 subscription renewals fetched more than 120.0% of their original value in the quarter. The company witnessed strong renewals in its largest deals. In the quarter, Red Hat closed a deal worth over $1 million for private cloud management.
 
Subscription revenues (84.7% of total revenue) jumped 19.1% to $186.2 million from $156.3 million in the second quarter of 2010. Training and services revenues (15.3% of total revenue) spiked up 22.7% to $33.6 million from $27.4 million in the year-ago quarter.
 
Higher renewal rates on large deals and an increasing number of deals were the primary growth drivers. In the quarter, the company had significant number of deals at or over $1 million. The top 30 deals for the quarter included 12 deals of approximately $1 million or greater, with one deal in excess of $5 million, and approximately one-third of the deals were in the middleware business, with three being stand-alone middleware deal.
 
Billings totaled $233 million, up 20% year over year and 22% in constant currency. This marked the fourth consecutive quarter of double-digit growth and the highest billing growth rate in the past two years, management pointed out.
 
Bookings increased significantly in the quarter, with channel contributing 67.0% and direct sales contributing 33.0%, attributable to a number of large government and mainstream customer wins.
 
The Americas, Europe and Middle East Asia (EMEA) and Asia-Pacific contributed 56.0%, 24.0% and 20.0% of the quarterly bookings, respectively, due to strong European business and several large wins from the Asia-Pacific region in the quarter.
 
Margins
 
In second quarter 2011, non-GAAP gross margin (including share-based compensation but excluding amortization of intangible assets) was 84.1%, down 100 bps from 85.1% in the prior-year quarter.
 
Including share-based compensation but excluding amortization of intangible assets, non-GAAP operating expenses soared 18.2% year over year to $146.2 million as a result of continued investments in sales and engineering. However, non-GAAP operating expenses, as a percentage of total revenue, decreased 80 bps to 66.5% in the quarter.
 
Red Hat remains focused on managing discretionary costs effectively while increasing investments simultaneously in growth areas such as middleware, virtualization and cloud computing. Additionally, the company is well on track to roll out Red Hat Enterprise Linux 6 by the end of the year 2010.
 
Non-GAAP operating margin was 17.6%, down 10 bps from 17.7% reported in the year- ago quarter.
 
Balance Sheet and Cash Flow
 
At the end of the second quarter 2011, cash and cash equivalents were $1.64 billion versus $968.0 million at the end of first quarter 2011. Operating cash flow increased sequentially by $3.7 million to $64.3 million. Total deferred revenue at the end of second quarter was $650.0 million, up 3.8% from the prior quarter and 12% from the year-ago quarter. Days’ sales outstanding were 49 days, compared with 53 days in the first quarter 2011 and 54 days in the second quarter of 2010.
 
Guidance Upped
 
Given strong first half 2011 results, Red Hat raised its full year 2011 guidance. The company expects full year revenues in the range of $877.0 million to $885.0 million versus previous expectation of $835.0 million to $850.0 million. Revenues were above the Street projection of $855.0 million.
 
Non-GAAP earnings per share are expected to be in the range of 76 cents to 77 cents versus previous expectation of 71 cents to 74 cents. The Street had been projecting 74 cents in EPS. Management expects non-GAAP operating income to increase year over year by 22% to 24% on a dollar basis.
 
Red Hat continues to expect operating cash flow for the full year between $280.0 million and $290.0 million.
 
For the third quarter 2011, Red Hat expects revenues in the range of $226.0 million to $228.0 million and non-GAAP EPS is projected to be in the range of 19 cents to 20 cents, versus the Street estimate of $216.0 million in revenues and an EPS of 19 cents, respectively. Operating margin is expected to be in the range of 24.5% to 25% and a tax rate of 35.0%.
 
 We believe that strong execution, a huge backlog and continued investments in growing areas will drive Red Hat’s results in 2011. However, foreign currency volatility, primarily due to troubles in Europe and increasing compensation costs, may hurt results. Red Hat faces stiff competition from Microsoft Corp. (MSFT), Novell Inc. (NOVL) and Oracle Corp. (ORCL).
 
We maintain a Neutral recommendation on Red Hat in the long term. The stock currently has a Zacks Rank of #2, a short-term Buy rating.
 
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