Red Hat Prospers in a Challenging Economy

Red Hat earnings

Red Hat’s CEO Jim Whitehurst has good reason to be optimistic. In his first full year as CEO of the Linux vendor, Whitehurst, a former Delta Airlines executive, has managed to pilot Red Hat into growth territory despite the overall turbulence in the global economy.

While the wider economy is in a slowdown, Linux vendor Red Hat (NYSE: RHT) is bucking the trend with its year-end fiscal 2009 financial results, showing strong revenue gains and adding 40,000 new customers during the year.

The key to success, according to Red Hat executives, is that the company’s software subscription model isn’t being hit strongly by the slowdown in server hardware sales.

For its fourth quarter ending Feb. 28, Red Hat reported revenues of $166.2 million, which is an 18 percent increase over its fourth quarter 2008 tally. For the full year, Red Hat reported a 25 percent gain over fiscal 2008, with total revenue of $652.6 million.

Earnings before charges totaled 22 cents per share, beating Wall Street forecast of 20 cents, according to Reuters Estimates.

Strength in subscriptions

A chief part of the increase came as a result of Red Hat’s subscription-based software platform offerings. The company reported subscription revenue gains of 20 percent on a year-over-year basis, for a 2009 total of $541.2 million.

Looking ahead, Whitehurst provided guidance for double-digit growth of between 10 percent and 13 percent for its fiscal 2010, with a revenue forecast in the $720 million to $735 million range.

“We continue to see strong renewals and growth from our top customers,” Whitehurst said during Red Hat’s investor conference call yesterday. “For the quarter, we renewed all of our top 25 deals scheduled to renew this quarter, and they renewed at approximately 132 percent of the prior year’s value.”

Much of that comes from Red Hat’s efforts to migrate existing customers to higher-value Linux platforms that include virtualization technology. The move toward virtualization is key for Red Hat, which invested heavily in the technology during the last year, acquiring virtualization vendor Qumranet in September for $107 million.

Qumranet was the lead commercial sponsor behind the open source KVM technology that competes against the open source Xen technology currently included in Red Hat Linux platforms. Starting this year, Red Hat plans to introduce KVM to its enterprise customers with an expanded portfolio of virtualization management products.

Analysts on the Red Hat investor call were puzzled as to why Red Hat is growing while the overall server market was down. Red Hat’s CFO Charlie Peters addressed the question by noting that Red Hat isn’t tied directly to the server hardware market for growth.

“We sell RHEL [Red Hat Enterprise Linux] on mainframes, PCs, workstations, and devices as well as servers,” Peters said. “On the server side, our penetration on blades is disproportionately high and faster growing than servers generally. In addition, many of our customers put our software on their existing hardware, which clearly eliminates the need for a new hardware sale — any new hardware sale at all.”

Free-to-paid payoff

Red Hat is also growing its business by migrating users of free Linux — like Red Hat’s own Fedora community distribution — to paid subscriptions. It’s an initiative that Whitehurst first talked about during Red Hat’s third-quarter 2009 call.

And it’s one that still seems to be paying off: Whitehurst said that during the quarter, Red Hat closed a multiyear, multimillion dollar deal as a customer transitioned from free Linux to RHEL, as well as a six-figure conversion deal with another customer.

For Red Hat, such deals are about convincing enterprises that there’s better value in paying for a subscription and getting support for Red Hat, then for them trying to go it alone with free Linux distributions.

“The number of companies trying and experimenting with open source software dwarfs the number buying subscriptions from us,” Whitehurst said. “In other words, there’s a huge market opportunity. No new hardware sales are needed.”

Red Hat’s Fedora Linux alone counts over 12 million installations, while Red Hat’s Enterprise Linux currently hovers around 2.5 million subscriptions.

There are also users of the RHEL clone CentOS as well as other, free Linux distributions that could potentially migrate to Red Hat’s paid subscription support.

“The free-to-pay … is a nascent activity for us, about five months old,” he said. “We’ve got some real focus on it and we think that there is some real traction to gain there, but it still early.”

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