Highlights From Red Hat's (RHT) Q1 Conference Call: Issues Mixed Guidance for Q2

June 25, 2009 2:39 PM EDT

Red Hat, Inc. (NYSE: RHT) reports Q1 EPS of $0.15, 1 cent better than the analyst estimate of $0.14. Revenue for the quarter was $174 million, versus the consensus of $171.79 million.

Highlights From RHT's Q1 Conference Call:

• (CEO) I'm pleased to announce a start - a strong start to fiscal 2010 as we reported better than expected revenue and EPS in the face of a challenging global economy.
  
• I'm pleased to report that for the fifth consecutive quarter, all of our top 25 deals that were up for renewal, not only renewed, but did so at a total value of over 120% of their original value.
  
• Regarding cloud providers, we are looking to expand upon the success we have had with early cloud providers to new emerging ones. Since 2007 we have had a partnership with Amazon Web Services that continues to grow.
  
• In middleware we unveiled the JBoss Open Choice application platform strategy. With the expanding and rapidly changing landscape of Java for the enterprise, Red Hat's Open Choice strategy aims to provide application developers with the ability to choose the framework, language and programming technologies that best fit the application requirements they're trying to achieve without sacrificing reliability, availability, scalability, or manageability across their projects.
  
• Moreover, JBoss platforms now support a variety of popular programming models including the Spring Framework, Seam and Google (Nasdaq: GOOG) Web Toolkit.
  
• In summary, our business model enables us to deliver solid results in challenging times while continuing to invest in future opportunities. We believe the trends in virtualization, cloud computing and middleware clearly align with our technology road map and extend our technology leadership in the data center.
  
• (CFO) I'm pleased to report solid financial results in Q1. Highlighted by double-digit revenue growth in both US dollars and constant currency. In light of the economic environment, we also remain focused on managing cost and improving efficiencies while investing in important new opportunities.
  
• Combined with Red Hat's strong market position and high level of execution, this focus enabled us to grow first quarter revenue in constant dollars by 17% on a year-over-year basis, assuming Q1 fiscal year '09 average rates, expand the non-GAAP operating margin by 160 basis points year-over-year,
  grow earnings per share by 25%, continue to generate strong operating cash flow and reduce our diluted shares outstanding by 11% on a year-over-year basis, including an additional 2.7 million shares repurchased in the first quarter.
  
• Approximately 30% of these deals included a middleware component with two being standalone middleware deals. Enterprise customers continue to make significant commitments to Red Hat to optimize the performance and efficiency of their IT infrastructure.
  
• Q1 revenue was $174 million, an increase of 11% year-over-year, 5% sequentially above our guidance range. On a constant currency basis, using Q1 '09 average rates, our revenue would have been $8 million higher representing 17% growth.
  
• Regarding bookings, the channel generated 61% of our Q1 bookings and 39% came from direct sales versus a 56/44% split in Q4.
  
• In terms of geography, 53% of bookings came from Americas, 25% from EMEA and 22% from Asia-Pacific. Our billings proxy for the quarter was 177 million, up 3% in US dollars, or 185 million, up 8% in constant currency when compared to the prior year quarter.
  
• Our renewal rates on the larger deals remains very high which are the drivers to reiterating our full year revenue guidance for fiscal 2010.
  
• Subscription gross margin was 94.1%, up 20 basis points, both sequentially and year-over-year.
  
• Q1 non-GAAP operating income was $41 million, producing an operating margin of 23.4%, up 160 basis points year-over-year and down 50 basis points sequentially, slightly better than our guidance.
  
• We ended the quarter with cash and investments of $885 million, which is an increase of $38 million after the repurchase of 2.7 million shares.
  
• Total deferred revenue at quarter end was $567 million, an increase of $76 million or 15% over the same quarter a year ago and an increase of 24 million or 5% over last quarter.
  
• For Q2, Non-GAAP EPS is estimated to be in the 0.14 to $0.15 per share range, assuming the same 35% tax rate. (Consensus is $0.16 for Q2)
  
• For Q2, Revenue is estimated to be approximately 178 to $180 million. (Consensus is $179.09M)
  
• (Q&A) My first question is could you talk - you talked a little bit about the success with the largest -customers that came up for renewal. Can you talk a little bit about the customers outside of the top 25 or 30, what renewal rates were like and maybe a little bit for the total billings, what the mix between new billings and renewals was like in the quarter? (A) First on renewal rates, the only renewal
  rates or statistics that we typically share are those on the largest, but I would add this color, that we have had consistently working on various efforts to incrementally improve renewal rates overall. What we know and we have shared previously is that, where we have direct deals, regardless of the size,
  our renewal rates are quite high. Where we have indirect deals and through possibly multiple layers of distribution, renewal rates historically have not been as good. So over the last couple of years, we've engaged in multiple efforts to gather the data about the end customer, economically incent the partners to help with renewals and various other things to improve that renewal rate. I'm happy to say that we've seen improvement there and those efforts are continuing.
  
• Could you talk a little bit about the differences you saw between large enterprise spending versus the more SMB type spending. Did - were there any shifting around in the quarter? And I guess why I'm asking is SMEs I feel have been more heavily hurt by this downturn so are you starting to see them recover at all? (A) At this point, I would say we have not seen any recovery and we're not trying to call the timing of the recovery, we're planning on the basis that the economic environment is going to stay fairly similar to what it is for the balance of the year. I would say this, Sarah, that like others that have recently reported, we see a longer sales cycle and in some cases additional levels of approval in sales cycle. But that's kind of the way it's been for the last couple quarters, our expectation is that's going to continue for at least a few more quarters.
  
• Sort of want to talk a little about what's changing with the larger deals. Are customers taking just one-year contracts or are they just taking the three-year contracts and just paying on an annual basis? (A)First of all, let me reiterate what I just said at the very end of my comment about the cash flow. I wouldn't draw any longer term conclusions from the Q1 result. We have already seen activity in the month of June which indicates that we may have some movement back the other direction, but specifically what happened in the first quarter is we did have a couple of the longer term deals that decided to pay one year at a time instead of three years upfront. As I said, this doesn't seem terribly surprising in this economic environment.

Red Hat, Inc., together with its subsidiaries, provides open source software solutions to enterprises.

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