A leading open source solutions provider, Red Hat Inc. (RHT) reported third quarter fiscal 2011 earnings (including share based compensation but excluding amortization and litigation expenses) of 15 cents per share, in line with the Zacks Consensus Estimate.
However, revenues of $235.6 million were above the Zacks Consensus Estimate of $227.0 million. Despite this, the shares fell 2.67% ($1.28) and closed at $46.60 in after hours trading.
The results were driven by strong organic revenue growth based on robust bookings and backlog, higher subscription renewals and promising results from the services business.
Earnings
Earnings per share (EPS) of 15 cents increased 15.4% year over year from 13 cents in the year-ago quarter.
Non-GAAP EPS (excluding share-based compensation amortization and litigation expenses) escalated 17.6% year over year to 20 cents in the quarter. This was in line with management’s guidance of 19 to 20 cents, given out in the previous quarter.
The year-over-year EPS growth was driven by strong growth in revenues and higher operating margin expansion in the quarter.
Revenue
Total revenue increased 21.2% year over year to $235.6 million, surpassing management’s guidance range of $226.0 million to $228.0 million.
The year-over-year growth was driven by a robust demand for Red Hat solutions globally. Higher renewal rates on large deals and an increasing number of deals were the primary growth drivers.
In the quarter, the company had a significant number of deals at or over $1 million. The top 30 deals for the quarter included 16 deals of approximately $1 million or greater, with one deal in excess of $5 million, and approximately half of the deals were in the middleware business.
Subscription revenues (84.4% of total revenue) jumped 21.0% to $198.8 million from $164.4 million in the third quarter of 2010. Training and services revenues (15.6% of total revenue) increased 22.7% to $36.7 million from $29.9 million in the year-ago quarter.
Billings totalled $262.0 million, up 20% year over year and 22% in constant currency. This marked the fifth 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 60.0% and direct sales contributing 40.0%, 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%, 28.0% and 16.0% of the quarterly bookings, respectively, due to strong European business in the quarter.
In November 2010, Red Hat launched the latest version of Red Hat Enterprise Linux 6 (RHEL6). RHEL6 provides core improvements for enterprise customers, including enhanced security, scalability, resource management, performance, power management and virtualization. This will drive revenues going forward.
Margins
In third quarter 2011, non-GAAP gross margin (including share-based compensation but excluding amortization of intangible assets) was 83.5%, down 180 basis points from 85.3% in the prior-year quarter.
Including share-based compensation but excluding amortization of intangible assets, non-GAAP operating expenses soared 16.5% year over year to $154.0 million as a result of continued investments in sales and engineering. However, operating expenses, as a percentage of total revenue, decreased 260 basis points to 65.4% in the quarter.
Non-GAAP operating margin was 21.7%, up 440 basis points from 17.3% reported in the year-ago quarter.
Balance Sheet and Cash Flow
At the end of the third quarter 2011, cash and cash and investments were $1.10 billion versus $1.05 billion at the end of second quarter 2011.
Operating cash flow increased sequentially by $6.5 million to $70.8 million. Total deferred revenue at the end of third quarter was $685.2 million, up 11.0% from the prior year-ago quarter. Days’ sales outstanding were 51 days, compared with 48 days in the second quarter 2011 and 54 days in the third quarter of 2010.
2011 Guidance Raised
Red Hat has raised its fiscal 2011 guidance based on strong third quarter results. The company expects full year revenues in the range of $898.0 million to $900.0 million versus its previous expectation of $877.0 million to $885.0 million.
Non-GAAP EPS is expected to be in the range of 78 cents to 79 cents versus previous its expectation of 76 cents to 77 cents. The Zacks Consensus Estimate is pegged at 57 cents. Management expects non-GAAP operating income to expand 100 basis points for the fiscal year.
Red Hat continues to expect operating cash flow for the fiscal year to range between $280.0 million and $290.0 million.
For the fourth quarter of 2011, Red Hat expects revenues in the range of $234.0 million to $236.0 million and non-GAAP EPS is projected in the range of 21 cents to 22 cents. The Zacks Consensus Estimate is pegged at 15 cents. Operating margin is expected in the range of 24.6% to 25% and a tax rate of 35.0%.
Acquisition
Red Hat recently acquired Makara, a developer of deployment and management solutions for applications in the cloud. Makara’s technologies will accelerate the development of Red Hat’s comprehensive Platform-as-a-Service (PaaS) solution as part of its Cloud Foundation portfolio. Red Hat introduced Cloud Foundations in June 2010.
Our Take
We believe that strong execution, a huge backlog and continued investments in growing areas will drive Red Hat’s results in 2011. We also believe the launch of RHEL 6 will drive top-line growth going forward, as more and more enterprises begin to shift to virtualization and cloud computing. However, foreign exchange headwinds and increasing compensation costs could 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 #2 Rank, a short-term Buy rating given higher estimates following third quarter results.
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