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Red Hat sales buck Meltdown

But profits under pressure

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If you had to be one software vendor staring down the economic meltdown, then you would probably want to be Red Hat. If someone else had already chosen to be Oracle. And maybe you'd rather be Red Hat anyway, because size isn't everything.

After Wall Street closed today, Red Hat reported its financials for the fourth quarter and fiscal 2009 year ended February 28, and revenues came in at $166.2m, up 17.5 per cent from the year-ago quarter. Not too shabby considering the quarter featured an extended holiday season and an economic meltdown in full swing.

Subscription sales at Red Hat rose by 14.4 per cent, to $139.4m, while training and services sales were up by 36.8 per cent, to $26.9m. Net income was under pressure in the quarter, however, dropping 27.3 per cent to just under $16m.

But when you look a little closer, the company retired a whole bunch of convertible debentures and has basically made itself debt free. Throughout fiscal 2009, Red Hat has worked hard to get rid of $597m in convertible bonds and has also bought back 22 million of its shares, about 10 per cent of the shares outstanding as fiscal 2008 came to an end. The company has $543m in deferred revenues right now, which is an enviable position for a company of its size, and it has a $190m backlog for services contracts.

For the full fiscal year, Red Hat grew by 24.8 per cent, to $652.6m in total revenues. Subscription sales rose by 20.3 per cent to $541.2m, while services and training sales were up 52.1 per cent, to $111.4m. Net income for fiscal 2009 amounted to $78.7m, up only 2.7 per cent. Red Hat seems to be weathering the economic storm pretty well, even if Wall Street is probably not happy with the earnings.

If that is the case, Red Hat should send Wall Street some mirrors and some get-well-soon cards.

This was Jim Whitehurst's first full year as chief executive officer at the company, and he said in a conference call with Wall Street analysts that he "remains positive" about Red Hat's fiscal 2010 outlook. While open source software is attractive in good times, it is "more compelling in difficult times," explains Whitehurst. "Budgets are tight this year, budgets are set, and we think that is good for open source."

Charlie Peters, Red Hat's chief financial officer, gave a little more color. "Our pipeline looks good - quite strong - and our deferred revenue looks strong," Peters added.

But the economic meltdown is going to make it a little harder for Red Hat to break that $1bn barrier it has its eyes on. Peters said that the state of the global economy and fluctuations in foreign currency exchange rates made it very difficult to provide any guidance, and that's why many companies (in the IT sector and outside of it) have stopped trying to guide. Still, Red Hat is willing to take a stab at it, and Peters said that the company expects sales to grow by between 10 and 13 per cent in fiscal 2010, to between $720m and $735m in total sales and that diluted non-GAAP earnings would come in at between 58 and 62 cents per share.

The company will buy back about 16 million shares in fiscal 2010, boosting those EPS numbers. And it will spend between $25m and $30m in capital expenditures as it improves its own facilities and data centers. For the first fiscal quarter ending in May, Peters said to expect sales in the range of $171m to $173m, and non-GAAP earnings in the range of 13 to 14 cents per share.

Profits are clearly under pressure now and for the rest of the fiscal 2010 year, partly because of the economy and partly because Red Hat has an ambitious roadmap to deliver new releases of its Enterprise Linux stack, including free-standing virtualization tools based on KVM.

But Red Hat has $515.5m in cash and equivalents and another $147.2m in other debt and equity securities, so it is clearly not nervous about the future.

What the company is doing, according to Whitehurst, is getting more aggressive about its free-to-paid conversion program, where it is trying to convince companies that are using its Fedora development distribution, downloaded copies of Red Hat Enterprise Linux, or alternatives such as CentOS to stop trying to support themselves and move over to paid support for the real RHEL.

This marketing program has been running for about five months, and in fiscal Q4, Red Hat closed a six-figure deal involving a self-supporter who switched to paid support and inked a multi-million-dollar, multi-year deal with another company that was also pulling a DIY.

Red Hat is also hoping to expand its sales through channel partners, and Whitehurst said that channel partners pushed 56 per cent of the company's revenues in Q4 and that channel bookings (which are different from revenues) rose by 23 per cent in the quarter. Red Hat has expanded its channel partner base by more than a factor of two in fiscal 2009, up to more than 4,500 partners. Red Hat added over 40,000 new customers last year, according to Whitehurst, and while the company will not talk about renewal rates, subscription sales at the majority of these customers are going to be easy pickings if companies find commercial Linux support useful.

Red Hat's biggest customers certainly seem to. The company renewed all 100 of its top deals in fiscal 2009, and in the fourth quarter, the revenue derived from those renewals was 125 per cent of the rate for the prior year. Big shops expanded their use of RHEL - and they paid for it.

Earlier this week, there were rumors swirling around that Oracle might be tempted to acquire Red Hat, and then, very quickly, the financial analyst community (which probably started the rumor) decided Oracle was not going to do it - at least not now, anyway. With a market capitalization of $2.9bn as the market closed and a premium added on top of it, this would be a doable deal for Oracle - or IBM or EMC, for that matter. But Whitehurst and Peters didn't talk about these rumors. And Wall Street didn't ask. ®

The smart choice: opportunity from uncertainty

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