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Red Hat revenues in 20% climb

Profits feel the pinch

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Commercial Linux and middleware distributor Red Hat revealed its financial results for its third quarter of fiscal 2011 today, and if revenues are any guide, then the company just keeps growing like there never was a recession. That said, Red Hat's profits are under a little pressure, thanks to product transitions, and Wall Street won't be happy about that at all.

In the quarter ended November 30, Red Hat booked $235.6m in sales, up 21.2 per cent from the year ago period. Net income was up 58.5 per cent, to just over $26m, but the company is not really suddenly more profitable. Rather, in the year ago period, Red Hat had $8.75m in fees associated with its settling of a class action lawsuit dating from its restating financial results in fiscal 2002 and 2003 and in the first quarter of 2004. Ignoring the effect of that lawsuit, Red Hat's net income only grew at 17.7 per cent by El Reg's math.

That Red Hat's profits were under pressure is no surprise, given that the third quarter saw the launch of its Enterprise Linux 6 operating system. Red Hat is generating cash and is positioning itself to be the go-to alternative to Microsoft Windows stack, various IBM platforms and WebSphere, and Oracle's Solaris and RHEL clone, also called Enterprise Linux, and WebLogic for operating systems and middleware. And the company will very likely be able to wring more profits out of the RHEL 6 transition in the months and years ahead because as RHEL 6 explained in detail in the wake of the launch of the OS in mid-November, support for the new OS costs more than for RHEL 5. Sometimes a lot more.

For the three month period, Red Hat booked $198.8m in subscription support revenues, up 20.9 per cent, while training and other services revenues rose to $36.7m, a 22.8 per cent increase over the year-ago period.

Jim Whitehurst, president and chief executive officer at Red Hat, said in a conference call with Wall Street analysts that of the top 25 deals that came up for renewal in fiscal Q3, all 25 renewed and the value of their contracts was over 120 per cent of the value of the original contracts for Red Hat products at those companies. So Red Hat's growth is not just in taking over Unix and Windows workloads, but also in taking on extra work at companies that are familiar with RHEL and JBoss middleware. This is not a new trend at all, but rather one that seems to continue at about the same pace, year in and year out, regardless of what the economy is doing.

Charlie Peters, Red Hat's chief financial officer, said in the call that of the top 30 deals that were done in the quarter (including new customers as well as renewals), one deal was worth over $5m and another 15 were in excess of $1m. Over half of the top 30 deals in Q3 had a middleware component, and six of them were for middleware only according to Whitehurst, who did a quick count on the call. The ten largest deals all had operating system, Enterprise Virtualization hypervisor and management tools, and middleware components in the deal.

Peters said that Red Hat's billings grew by 20 per cent in the quarter, to $262m, and that this represented the best billings growth at the company in two years. About 60 per cent of the company's revenues came through channel partners, while 40 per cent came from its own direct sales force. This is a ratio that Red Hat has been trying to reach for years, depending less on direct sales to meet its targets.

Red Hat exited the quarter with $685m in deferred revenues, up 11 per cent from the year ago period, and had $594.9m in cash and $250.5m in debt and equity investments. That cash and investments pile is up 11.1 per cent from a year ago; the company has $230m in authorizations left to buy back its own shares on Wall Street, and it may do that if investors give it a haircut in the next few days because the underlying net income is not growing as fast as revenues.

Red Hat said that the new RHEL 6 operating system generated $10m in revenues "right out of the gate," but reminded investors that a new product launch does not drive revenues directly, as it does for closed source products that have a large license price and a modest support price. Red Hat only sells support, and customers can keep using the old product if they want - up to a decade with extended support contracts. This means customers upgrade to new products when it suits them - and perhaps expand their use of products within their data centers by 20 per cent or so if history is any guide.

The company added that it has over 400 customers using its Enterprise Virtualization hypervisor and management tools, and added 100 of these customers in the quarter. RHEV is based on the KVM hypervisor and is available as a standalone product; KVM is also an embedded hypervisor inside of RHEL 6.

Looking ahead, Peters said that Red Hat was raising its revenue guidance for the full fiscal 2011 year, ending in February. The company now expects sales in the fourth quarter to hit somewhere between $234m and $236m, with non-GAAP earnings of 21 to 22 cents per share. Annual revenues are therefore now $898m to $900m, up from the expected $877m to $885m the company was projecting thirteen weeks ago. Non-GAAP revenues for all of fiscal 2011 are now going to be in the range of 78 to 79 cents per share, if everything pans out the way Red Hat anticipates. We'll see what real net income looks like.

Bootnote: This story originally reported that ignoring the effect of the lawsuit settlement from last year, Red Hat's net income only grew by 5 per cent. This is incorrect. Revisiting the math, the growth rate is actually 17.7 per cent. ®

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