Red Hat Inc. (RHT) reported second-quarter 2015 earnings of 29 cents per share (including stock-based compensation but excluding one-time items), beating the Zacks Consensus Estimate by 3 cents. Earnings per share increased 12.2% year over year due to strong revenue growth in the quarter.
Revenues
Revenues increased 19.1% year over year to $446 million and beat the Zacks Consensus Estimate of $435 million. Revenues were in line with the higher-end of management’s guided range of $432 to $436 million.
Subscription revenues (87.4% of revenues) increased 19.2% year over year to $389.5 million. Subscription revenues for infrastructure related offerings (RHEL) increased 16% from the year-ago quarter to $332 million.
Subscription revenues for the application development related and emerging technologies jumped 44% year over year to $57 million.
Training & services revenues (12.6% of revenues) increased 18.2% from the year-ago quarter to $56.4 million.
Billings increased 20% year over year to $465 million. Channel contributed 69% of the bookings, while the rest came from direct sales. Geographically, 59% of the bookings came from the Americas, 24% from Europe, Middle East and Africa (EMEA) and 17% from Asia-Pacific.
Red Hat was able to renew all 25 deals scheduled for the quarter. The top 30 deals were over $1 million in value. Six deals were in excess of $5 million and one deal was greater than $10 million. Cross-selling was strong and top verticals were telecom, government and media.
During the quarter, Red Hat released RHEL OpenStack platform 5.0, its third enterprise version of OpenStack technology. The company launched an open virtual appliance for RHEL OSP and blocked and object storage solution, Inktank Ceph Enterprise 1.2.
During the quarter, Red Hat announced partnership with Cisco Systems (CSCO) and Nokia Corp (NOK).
Margins
Gross margin (including stock-based compensation) contracted 30 basis points (bps) to 85.8% on a year-over-year basis. Subscription gross margin increased 10 bps to 92.9%, while training & services gross margin contracted 260 bps to 32.8%.
Operating expenses as percentage of revenues (including stock-based compensation but excluding one-time items) increased 70 bps on a year-over-year basis to 69.3%.
Both Sales & marketing and research & development expenses, as percentage of revenues, increased 50 bps respectively. General & administrative expense, as a percentage of revenues, decreased 20 bps in the quarter.
Operating margin (including stock-based compensation but excluding other one-time items) contracted 100 bps from the year-ago quarter to 16.2% due to higher operating expense.
Net income (including stock-based compensation but excluding other one-time items) was $52.5 million or 28 cents compared with $47 million or 25 cents in the year-ago quarter.
Balance Sheet & Cash Flow
At the end of the second quarter, cash and cash equivalents were $585.4 million compared with $564.1 million at the end of the previous quarter.
Cash flow from operating activities was $107.7 million compared with $164.6 million in the prior quarter. The company exited the quarter with deferred revenues of $1.25 billion, an increase of 18% on a year-over-year basis.
Acquisition
Red Hat recently acquired FeedHenry, a mobile backend as a service center. The acquisition will enable Red Hat to better support customers' end-to-end mobile applications development, integration and management needs at enterprise scale. FeedHenry is expected to add $1 million to revenues, but it will have a dilutive impact on operating margin of 30 bps and 2 cents on non-GAAP earnings.
Guidance
For the third quarter of fiscal 2015, Red Hat expects revenues in the range of $449 to $452 million. Management expects operating margin to be around 23%. Non-GAAP earnings are expected to be approximately 40 cents per share for the upcoming quarter.
For fiscal 2015, revenues are expected to range between $1.770 billion and $1.785 billion (up from prior outlook of $1.760 to $1.785 billion).
The FeedHenry, Inktank and eNovance acquisitions are expected to negatively impact operating margin. Management expects non-GAAP operating margin to be around 23% for fiscal 2015. Red Hat expects fiscal 2015 earnings in the range of $1.53 to $1.55 (up from $1.52 to $1.54 per share).
Operating cash flow for fiscal 2015 is expected to be between $580 million and $600 million.
Our Take
Red Hat’s raised revenue guidance is a positive. Although acquisitions will hurt margin and earnings in 2015, we believe they are a good addition to Red Hat’s product portfolio and will drive top-line growth over the long term.
Red Hat continues to gain market share and its Linux servers are well positioned to compete with Microsoft’s (MSFT) Windows servers in the enterprise market. We believe that the company has significant growth potential in the public cloud segment over the long term.
Additionally, Red Hat’s strong product pipeline, continuing investments to expand product portfolio and partnerships with the likes of IBM, Dell and Intel will drive overall growth.
However, sluggish IT spending and intensifying competition are the major headwinds in the near term. Also, Red Hat’s strategy of sacrificing service revenues to increase subscription revenues in the long run is expected to hurt top-line growth over the next couple of quarters. This coupled with negative margin impacts from the acquisitions will be an overhang in the near term.
Currently, Red Hat has a Zacks Rank #3 (Hold).
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