Red Hat Inc.
/(RHT – NYSE)
/$46.45
Note: More details to come, changes are highlighted. Except where highlighted no other sections of this report have been updated.
Reason for Report: FLASH UPDATE: 1Q14 Earnings
Prev.Ed: May 24, 2013: 4Q13 Earnings Update (broker’s material considered till Apr 5, 2013)
FLASH NEWS UPDATE [Earnings Update in progress; to follow]
Red Hat reported 1Q14 adjusted earnings per share (including share based compensation expense) of $0.24, beating the Zacks Consensus Estimate of $0.22 per share. On a non-GAAP basis, Red Hat’s 1Q14 earnings of $0.32 per share increased 6.7% from the year-ago quarter.
Quarter Details
Revenues for the quarter increased 15.4% y/y to $363.3 million which came marginally ahead of the Zacks Consensus Estimate of $362.0 million. Accounting for currency related adjustments of $6.2 million, revenues for the quarter increased 17.4% y/y to $369.4 million. Reported non-GAAP revenues also surpassed management’s guided range of $358.0 million to $361.0 million.
The strong y/y 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 y/y basis.
In the reported quarter, billings increased 12.0% y/y 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, 60.0% 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, Intel and International Business Machines Corp. 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% y/y 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% y/y to $225.8 million. The year-over-year growth was primarily attributable to higher sales & marketing (up 17.8% y/y), research & development (up 23.2% y/y) and general & administrative (up 1.2% y/y) 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 $0.32 per share compared with $57.9 million or $0.30 per share in the year-ago quarter. However, including stock-based compensation of $23.1 million, net income stood at $46.3 million or $0.24 per share.
At the end of the 1Q14, 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 2Q14, 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 $0.32 to $0.33 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 FY14. 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 FY14 is expected between $500.0 million to $520.0 million. Red Hat expects non-GAAP earnings per share of $1.31-$1.35. The company plans to spend $75.0 million on various projects that are nearing completion.
MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON RHT
Portfolio Manager Executive Summary [Only highlighted material has been changed]
Red Hat Inc. (RHT) is a global leader in providing open source software solutions to enterprises. The companies’ products include enterprise operating platform (Red Hat Enterprise Linux-RHEL), enterprise middleware platform (JBoss Enterprise Middleware Suite), virtualization, cloud and storage solutions.
Key factors for evaluating an investment strategy for Red Hat are:
· Decent FY13 results with 17.2% growth in revenues and 11.8% growth in non-GAAP EPS on a year-over-year basis
· Competitive leverage driven by robust growth potential from open source software solutions, virtualization and cloud computing
· Rapid adoption of Linux from UNIX
Competition: Red Hat competes against bellwethers like EMC Corp (EMC), Hewlett-Packard Company (HPQ), International Business Machines Corp (IBM), Microsoft Corp (MSFT), Oracle Corp (ORCL) and VMware, Inc. (VMW).
Of the 25 analysts covering the stock in the Zacks Digest Group, 15 analysts had a positive stance, while 9 analysts conferred a neutral stance. Only 1 analyst gave a negative rating. Target price ranges from a low of $43.00 to a high of $66.00, with the average price being $59.50. On an average, the analysts expect a return of 25.3% from the stock based on the current price.
Bullish Stance (Buy or equivalent outlook) – 15 analysts or 60.0%: The company’s revenue strength on the back of higher demand for Red Hat's technologies, growing international presence, improving JBoss business, the success of RHEL products to combat the uncertain economic environment, improved customer base and commendable renewal rates place it in a convenient position for further share appreciation. The shift from UNIX to Linux is appreciated by the analysts as it is likely to drive better growth prospects for the company. Strong cash flow and earnings growth prospects are likely to benefit from its cost-reduction efforts. The bullish analysts believe that the new products in the storage, virtualization and cloud computing segments will be beneficial for the company in the long run.
Cautious Stance (Neutral or equivalent outlook) – 9 analysts or 36.0%: These analysts prefer to be on the sidelines given the current premium valuation. The analysts are also wary of the cash flow from operations not being enough to satisfy investors. Moreover, increase in investments to drive product ramp ups may impact margin expansions.
Bearish Stance (Sell or equivalent outlook) – 1 analyst or 4.0%:
Long-Term Outlook: Analysts believe that Red Hat’s dominant market position in the open source solutions market and increasing focus on emerging virtualization and cloud computing technologies position the company for robust growth, going forward. The analysts expect total revenue to increase at a three-year CAGR (2012–2015) of 15.8% and net income to increase at a three-year CAGR (2012–2015) of 12.3%.
May 24, 2013
Overview [Only highlighted material has been changed]
Based in Raleigh, N.C., Red Hat Inc., provides enterprise operating systems, and related software and services based on open-source technology for various enterprises. Red Hat derives its revenues predominantly from the annual and multi-year subscriptions of its technologies. This allows the company to generate a revenue stream throughout the subscription period. The company also generates revenues through service offerings such as training and support. In FY13, Red Hat reported revenues of $1.33 billion.
Red Hat has strategic relationships with International Business Machines Corporation, Oracle Corporation, Sybase, Hewlett-Packard Company, Dell, Fujitsu Limited, Fujitsu, NEC Corporation, and Hitachi. For more information on the company, please visit www.redhat.com.
Key investment considerations as identified by brokerage analysts are as follows:
Key Positive Arguments / Key Negative Arguments· Red Hat’s leading position in the Linux business
· Red Hat’s launch of certification and support services for open-source LAMP (Linux, Apache, MySQL, and PHP) created an additional revenue stream
· The JBoss acquisition is strategically sound as Red Hat will be able to offer a complete stack of open-source solutions. JBoss can also leverage Red Hat’s international presence / · Pricing pressure is expected to affect the company in the near future
· Sluggish macroeconomic conditions and weak IT spending are headwinds for the company
· The company is a late entrant in the virtualizations and cloud computing domain and faces competition from bellwethers like IBM and Oracle
Note: RHT’s Fiscal Year ends on Feb 28.
May 24, 2013
Long-Term Growth [Only highlighted material has been changed]
Red Hat’s EPS is projected to grow at approximately 19.0% over the next five years. According to the analysts, Red Hat is well positioned to achieve higher revenue growth based on a strong and increasing customer base over the long term. Red Hat’s premier product Linux has become a strategic data center asset. Customers are using Linux for critical applications, a trend they expect to continue in the long term. Approximately 25% of Linux is being used for mission-critical, high-performance applications.
The analysts believe that the increasing use of Linux in mission-critical systems and cloud infrastructure, coupled with increasing penetration into original equipment manufacturers (OEMs) and smooth UNIX-to-Linux migration will boost the top line, going forward.
The analysts believe that Linux is usually price sensitive and the company’s base customers appreciate the value provided by the company. The cost effectiveness of Red Hat platform will further allow it to receive higher prices from customers. The analysts also expect the new pricing strategy coupled with continued adoption of Sandy Bridge systems, the upcoming Ivy Bridge and ARM server releases and traction in JBoss to drive approximately 20.0% growth in billings in the long term.
Red Hat Cloud Foundation Edition One is a group of products and services aimed at designing, building, and managing Cloud computing environment. The Cloud Foundation provides products (RHEL, RHEV and JBoss), reference architectures, professional services and training that are needed to build cloud architectures. The analysts believe that these opportunities bode well for the company’s future growth.
Red Hat is increasing its involvement in new technologies such as cloud computing (OpenStack, Cloud Forms and ManageIQ), virtualization and JBoss. The latest version of RHEL 6 has been designed with virtualization and cloud computing in mind, while Red Hat Enterprise Virtualization (RHEV) incorporates both server and desktop virtualization. Moreover, increase in interest for RHEV 3.1 is another positive catalyst for the company. It is a higher-priced tier and has advanced functionality that will suit private/public cloud customers.
The cloud is significant to Red Hat since more workload will move to x86 architecture of RISC and mainframes in areas where the company has high shares. As customers will need more functionality in the cloud, the Red Hat stack affinity for the cloud (unlike traditional vendors) will provide Red Hat with a great value proposition. Moreover, analysts expect Red Hat’s solution for unstructured data solution, Gluster, to be impressive, going forward. However, the analysts believe that Red Hat will face significant competition from Oracle Corp.
May 24, 2013
Target Price/Valuation [Only highlighted material has been changed]
Provided below is a summary of valuation/ratings as compiled by Zacks Digest:
Rating DistributionPositive / 60.0%↓
Neutral / 36.0%↑
Negative / 4.0%↑
Avg. Target Price / $59.50↓
Digest High / $66.00↓
Digest Low / $43.00
No. of Brokers with Target Price/Total / 20/25
Key risks to the target prices are increasing competition from large competitors including Oracle, IBM, and Microsoft; expansion into other software products that could be disruptive; potential maturation of the Linux market; and JBoss and Amentra integration challenges.
Recent Events [Only highlighted material has been changed]
On Mar 27, 2013, Red Hat Inc. announced its 4Q13 results. Highlights are as follows:
· Non-GAAP earnings per share (EPS) increased 24.1% y/y to $0.36
· Revenues increased 17.1% y/y to $347.9 million
Revenues [Only highlighted material has been changed]
According to the company press release, total revenue increased 17.1% y/y to $347.9 million in 4Q13. Including currency related adjustments of $3.3 million, revenues for the quarter increased 18.2% y/y to $351.1 million. Reported non-GAAP revenues also surpassed management’s guided range of $347.0 million to $350.0 million.
Billings increased 9.0% y/y to $454.0 million in 4Q13, reflecting strong sales execution. During 4Q13, Channel contributed 57.0% of the bookings, while the rest came from direct sales. Additionally, Red Hat secured 30 deals worth over $1.0 million, including six deals in worth more than $5.0 million and three deals were well over $10.0 million.
Geographically, 63.0% of the bookings came from the Americas, 25.0% from Europe, Middle East and Africa (EMEA) and 12.0% from Asia-Pacific.