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Red Hat Inc. (RHT - Snapshot Report) reported first-quarter 2014 adjusted earnings per share (including share based compensation expense) of 24 cents, beating the Zacks Consensus Estimate of 22 cents per share. On a non-GAAP basis, Red Hat’s first-quarter earnings of 32 cents per share increased 6.7% from the year-ago quarter.

Quarter Details

Revenues for the quarter increased 15.4% year over year to $363.3 million, which came marginally ahead of the Zacks Consensus Estimate of $362 million. Accounting for currency related adjustments of $6.2 million, revenues for the quarter increased 17.4% year over year to $369.4 million. Reported non-GAAP revenues also surpassed management’s guided range of $358.0 million to $361.0 million.

The strong year-over-year growth in revenues was primarily driven by a 15.9% (17.9% increase when adjusted for currency impact) surge in subscription revenues and 12.5% (13.8% increase when adjusted for currency impact) increase in revenues from training and services on a year-over-year basis.

In the reported quarter, billings increased 12.0% year over year to $346.0 million. Channel contributed 68.0% of the bookings, while the rest came from direct sales.

Geographically, 54.0% of the bookings came from the Americas, 25.0% from Europe, Middle East and Africa (EMEA) and 21.0% from Asia-Pacific. Additionally, Red Hat secured 30 deals worth $1.0 million each, of which 28 deals are worth over $1 million each and the remaining two in excess of $5.0 million. 

Among the secured deals, 60% had a middleware component and five of them were standalone middleware deals. Red Hat’s deals included companies which provide telecom, hosting and cloud services. The quarter also featured Red Hat’s deals with some financial services companies.

During the quarter the company announced new technologies that are to be released in July. These include Red Hat Enterprise Linux OpenStack platform and Red Hat Cloud Infrastructure. Moreover, Red Hat’s OpenShift online Platform-as-a-Service (Paas) public cloud offering was launched during the quarter.

Additionally, Red Hat made significant progress on Red Hat OpenStack Cloud Infrastructure Partner Network which has partners such as Cisco (CSCO - Analyst Report), Intel (INTC - Analyst Report) and International Business Machines Corp (IBM - Analyst Report). It has also reported that companies such Acxiom, NewLease and Verizon Terremark have joined the Red Hat Certified Cloud Provider program.

Red Hat’s non-GAAP gross profit surged 15.2% year over year to $312.7 million. Gross margin contracted 20 basis points (bps) to 86.1% in the quarter. Including share-based compensation of $2.8 million, gross profit came in at $309.9 million with margins of 85.3%.

Operating expenses on a non-GAAP basis increased 18.6% year over year to $225.8 million. The year-over-year growth was primarily attributable to higher sales & marketing (up 17.8% year over year), research & development (up 23.2% year over year) and general & administrative (up 1.2% year over year) expenses. Operating expenses, as a percentage of the total revenue, expanded 170 bps to 62.2% in the quarter. Including stock based compensation of $20.3 million, operating expenses came in at $246.1 million.

Non-GAAP operating income increased 7.1% from the year-ago quarter to $86.9 million while operating margin declined approximately 190 bps to 23.9% due to higher operating expenses. Including stock based compensation of $23.1 million, operating income came in at $63.7 million while margins came at 17.5%.

Red Hat’s non-GAAP net income (excluding share-based compensation and amortization) was $61.6 million or 32 cents per share compared with $57.9 million or 30 cents per share in the year-ago quarter. However, including stock-based compensation of $23.1 million, net income stood at $46.3 million or 24 cents per share.

At the end of the first quarter, cash and cash equivalents were $597.9 million compared with $487.1 million in the previous quarter. Cash flow from operating activities was $142.0 million compared with $136.9 million in the previous quarter.

Guidance

For the second quarter of 2014, Red Hat expects revenues in the range of $370.0 million to $373.0 million. Earnings on a non-GAAP basis are projected in the range of 32 cents to 33 cents per share.

Management expects non-GAAP operating margin to be around 23.9%. Red Hat also expects interest income of $1.0 million in the upcoming quarter. Moreover, management expects federal business to improve during the quarter.

Red Hat also reiterated its guidance for fiscal 2014. Revenues are expected to range between $1.51 billion and $1.54 billion, an approximate growth of 16.0% from the year-ago period.. Subscription revenues are expected to grow at 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 94 cents. The company plans to spend $75 million on various projects that are nearing completion.

Our Take

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, we believe that increase in the customer base in various verticals as well as the deal wins are expected to be the positive catalysts for the company.

However, we believe that the sluggish macroeconomic environment could negatively impact IT spending and significant foreign exchange volatility will act as a headwind in the near term.

Currently, Red Hat has a Zacks Rank #2 (Buy).

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