Red Hat Reports Mixed 4Q Earnings

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Red Hat Inc. (RHT) reported fourth-quarter 2013 adjusted earnings per share (including share based compensation expense) of 25 cents, beating the Zacks Consensus Estimate of 21 cents per share. On a non-GAAP basis, Red Hat’s fourth-quarter earnings of 36 cents per share increased 24.1% from the year-ago quarter.

Quarter Details

Revenues for the quarter increased 17.1% year over year to $347.9 million but lagged the Zacks Consensus Estimate of $350 million. Including currency related adjustments of $3.3 million, revenues for the quarter increased 18.2% year over year to $351.1 million. Reported non-GAAP revenues also surpassed management’s guided range of $347.0 million to $350.0 million.

The strong year-over-year growth in revenues was primarily driven by a 19% surge in subscription revenues (87.0% of the total revenue). Moreover, revenues from training and services (13.0% of the total revenue) were up 8% on a year-over-year basis.

In the reported quarter, billings increased 9% year over year to $454.0 million. Channel contributed 57.0% of the bookings, while the rest came from direct sales. Geographically, 63.0% of the bookings came from Americas, 25.0% from Europe, Middle East and Africa (“EMEA”), and 12.0% from Asia-Pacific. Additionally, Red Hat secured 30 deals worth over $1.0 million, including 6 deals in excess of $5.0 million and 3 deals were over $10.0 million.

Red Hat’s non-GAAP gross profit surged 17.3% year over year to $299.6 million. Gross margin expanded 10 basis points (“bps”) to 86.1% in the quarter. This was primarily driven by a favorable revenue mix. Including share-based compensation of $2.7 million, gross profit came in at $296.9 million.

Operating expenses on a non-GAAP basis increased 21.3% annually to $216.1 million. The year-over-year growth was primarily attributable to higher sales & marketing (up 18.5% year over year), research & development (up 29.2% year over year) and general & administrative (up 7.1% year over year) expenses. Operating expenses, as a percentage of the total revenue, expanded 210 bps to 62.1% in the quarter.

Non-GAAP operating income increased 8.2% from the year-ago quarter to $83.5 million while operating margin declined approximately 200 bps to 24% due to higher operating expenses.

Red Hat’s non-GAAP net income (excluding share-based compensation and amortization) was $70.1 million or 36 cents per share compared with $57.2 million or 29 cents per share in the year-ago quarter. However, including stock-based compensation of $26.0 million, net income stood at $48.8 million or 25 cents per share.

At the end of the fourth quarter, cash and investments (including long term) were $1.32 billion compared with $1.35 billion in the previous quarter. Cash flow from operating activities was $136.9 million compared with $100.2 million in the previous quarter.

Guidance

For the first quarter of 2014, Red Hat expects revenues in the range of $358.0 million to $361.0 million. Earnings on a non-GAAP basis are projected in the range of 30 cents to 31 cents per share.

Management expects non-GAAP operating margin to be around 23.5%. Red Hat also expects interest income of $1.5 million in the upcoming quarter. Moreover, bookings and billings are expected to be low in the first quarter.

Red Hat also provided guidance for fiscal 2014. Revenues are expected to range between $1.51 billion and $1.54 billion, an approximate growth of 16% from the year-ago period and in line with the Zacks Consensus Estimate of $1.54 billion. Subscription revenues are expected to grow twice the pace of services revenue.

Operating cash flow for fiscal 2014 is expected between $500 million to $520 million. Red Hat expects non-GAAP earnings per share of $1.31-$1.35, ahead of the Zacks Consensus Estimate of $1.01. The company plans to spend $75 million in various projects that are nearing completion.

Recommendation

We expect the investments made by the company to expand its product portfolio through new product launches in the cloud and virtualization segments, and acquisitions are the near-term positives for Red Hat.

Moreover, strong product portfolio will help Red Hat to counter stiff competition from Microsoft Corp. (MSFT), VMware Inc. (VMW) and Oracle Corp. (ORCL) going forward. Moreover, we believe that the customer wins in various verticals and deal wins are expected to be the positive catalysts for the company.

However, we believe that sluggish macroeconomic environment could negatively impact IT spending and significant foreign exchange volatility will act as a headwind in the near term. Moreover, seasonality in the services business and increasing investment may hurt profitability in the near term.

Currently, Red Hat has a Zacks Rank #3 (Hold).

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