Red Hat’s Q2 Results Beat As Intel, IBM, Cisco, Dell Opted For Its Source Products

The leader in open source software solutions, Red Hat, Inc.’s (RHT) second-quarter results beat consensus expectation of 15 cents per share in earnings and $179.1 million in revenue.

Better-than-expected results were due to the improving IT spending environment and Red Hat’s robust growth potential, new product launches, strong execution and increased customer demand in open source software solutions. Moreover, profitability improved as Red Hat partners, including Intel Corp. (INTC), International Business Machines (IBM), Cisco Inc. (CSCO) and Dell Inc. (DELL) opted for its source products.

Revenues totaled $183.6 million, up 11.7% year over year, driven by strong subscription revenue (accounted for 85.1% of the total revenue) which increased 15.2% from last year. Subscription revenues were strong for the sixth consecutive quarter on 100.0% renewal rates for the top 25 customers, who renewed at 120.0% of the original deal size.

Moreover, growth was driven by the strong bookings and billings. Revenue generated came from bookings (59%) and direct sales (41%). During the quarter, approximately 56% of bookings came from the Americas , 25% from EMEA and 19% from Asia-Pacific. We remain positive on the company’s substantial growth in deferred revenue which increased 17% year-over-year to $580.9 million.

Gross margin on a non-GAAP basis increased 100 basis points year over year to 85.0%, primarily due to strong subscription sales. Subscription gross margin was 93.8%, up 20 basis points year over year.

Despite a year-over-year increase of 10.9% in operating expenses on a non-GAAP basis due to continued investment in R&D, operating margin of 23.7% was up 170 basis points from the year-ago quarter as a result of focused expense management.

Earnings for the quarter improved to 20 cents per share after adjusting for stock based compensation and amortization of intangibles expenses. This was up from 14 cents reported in the year ago quarter boosted by a discrete tax benefit of $7.3 million, which added 4 cents to the earnings.

As a result of the tax benefit, non-GAAP tax rate for the quarter declined to 20% from the company’s expectation of 35%. This led to higher earnings per share. However, the company expects non-GAAP tax rate to be 35% in the second half of fiscal 2010.

Strong Balance Sheet

The company has a strong balance sheet and exited the quarter with $911.8 million in cash equivalents and investments, an increase of $27.0 million from last quarter. Operating cash flow totaled $62.0 million, flat from the previous quarter but up 14% year-over-year. The company repurchased 2.3 million shares for $47 million. Year-to-date, Red Hat has repurchased 5.1 million shares for $94 million.

Decent Guidance

For the third quarter, Red Hat expects revenue to be in the $187 - $189 million range; operating margin is estimated to be about the same as second quarter despite an increase in sales and marketing expense due to the cost of the Red Hat Summit.

Earnings per share on a non-GAAP basis are estimated to be approximately 15 cents to 16 cents. Full-year 2010 operating margins are expected to be about 100 basis points better than 2009.

Outlook

We believe the company’s strong market position, focused execution, strong cash flow, international expansion and proven value proposition will help grow its business in the near term and deliver strong revenue growth beyond fiscal 2010. However, pricing pressure from its major competitors such as Novell Inc (NOVL) and Microsoft Corp (MSFT) may hurt the company’s results in the near future.

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