Red Hat Beats on Q3 Earnings and Revenues; Guides Well - Analyst Blog

Red Hat Inc. (RHT) reported fiscal third-quarter 2015 earnings of 30 cents per share (including stock-based compensation but excluding one-time items), beating the Zacks Consensus Estimate by 3 cents. Earnings per share remained flat on a year-over-year basis.

Revenues

Revenues increased 15% year over year to $455.9 million and beat the Zacks Consensus Estimate of $451 million. Revenues were greater than the higher end of management's guided range of $449 million to $452 million.

Subscription revenues (86.6% of revenues) increased 15.1% year over year to $394.7 million. Subscription revenues for infrastructure related offerings (RHEL) increased 11% from the year-ago quarter to $333 million. Subscription revenues for the application development related and emerging technologies jumped 45% year over year to $61.7 million.

Training & services revenues (13.4% of revenues) increased 13.8% from the year-ago quarter to $61.2 million.

Red Hat was able to renew all 25 deals scheduled for the quarter. The top 30 deals were over $1 million in value. 12 deals were in excess of $5 million and 3 of these deals were greater than $10 million. Cross-selling was strong and telecom, government and media were the top verticals.

Margins

Gross margin (including stock-based compensation) contracted 40 basis points (bps) to 85% on a year-over-year basis. Subscription gross margin remained flat year over year at 92.8%, while training & services gross margin contracted 320 bps to 30.1%.

Operating expenses as a percentage of revenues (including stock-based compensation but excluding one-time items) increased 40 bps on a year-over-year basis to 68.6%.

Sales & marketing expense, as percentage of revenues, increased 240 bps while Research & Development expense as a percentage of total revenues declined 90 bps on a year-over-year basis. General & administrative expense, as a percentage of revenues, decreased 120 bps in the quarter.

Operating margin (including stock-based compensation but excluding other one-time items) contracted 80 bps from the year-ago quarter to 16.4% due to higher operating expense.

Net income (including stock-based compensation but excluding other one-time items) was $55.6 million or 30 cents per share, which remained flat on a year-over-year basis.
 

 

Balance Sheet & Cash Flow

At the end of the third quarter, cash and cash equivalents were $1.65 billion compared with $585.1 million at the end of the previous quarter.

Cash flow from operating activities was $133 million compared with $107.7 million in the prior quarter. The company exited the quarter with deferred revenues of $1.30 billion, an increase of 16% on a year-over-year basis.

Guidance

For the fourth quarter of fiscal 2015, Red Hat expects revenues in the range of $456 to $459 million while the Zacks Consensus Estimate for the same is pegged at $458 million. Management expects operating margin to be around 23%. Non-GAAP earnings are expected to be approximately 41 cents per share for the upcoming quarter as against the Zacks Consensus Estimate of 27 cents per share.

For fiscal 2015, revenues are expected to range between $1.782 billion and $1.785 billion (up from the prior outlook of $1.770 to $1.785 billion).

Management expects non-GAAP operating margin to be around 23% for fiscal 2015. Red Hat expects fiscal 2015 earnings in the range of $1.57 to $1.58 (up from $1.53 to $1.55 per share).

Operating cash flow for fiscal 2015 is expected to range from $600 million and $610 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 (IBM), Dell and Intel (INTC) will drive overall growth.

However, sluggish IT spending and intensifying competition are 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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