Red Hat Taps New CEO As It Reports Solid Third Quarter

Published: January 8, 2008

by Timothy Prickett Morgan

While IT Jungle was on holiday in late December, commercial Linux distributor Red Hat gave customers and investors something of a surprise when it reported its financial results for the third quarter of fiscal 2008 ended November 30. No, the company's sales were not impacted in any way by the mortgage crisis and the related IT slump in the financial services sector that some vendors are seeing. Sales and profits were up smartly. The surprise was the Matthew Szulik, who has been at the helm of Red Hat for the past eight years, was stepping down as president and chief executive officer.

Given the surprising nature of the move and Szulik's well-known enthusiasm for his three jobs, he offered an honest explanation. "For many months, my family has been challenged by serious health issues," he explained on a conference call with Wall Street analysts. He did not elaborate on which members of his family are ill or the nature of the illness (and that is none of our business anyway). Szulik said that when it became apparent that he needed to be there for his family more than was possible with his three job titles as president, CEO, and chairman of Red Hat, the company's board of directors engaged Nosal Partners, an executive search firm, to find a bunch of candidates to put through the paces to take over the positions of president and CEO.

According to Szulik, the candidate that was "head and shoulders" above the others turned out to be James Whitehurst, who was most recently chief operating officer at Delta Airlines and one of the key people behind its Orbitz online reservation service--the one with the interesting popup games that we all play when we are bored at work. As chief operating officer at Delta, Whitehurst was responsible for a lot of what the airline does--operations, sales and customer service, network and revenue management, marketing, and corporate strategy. While Whitehurst is an operational guy--much as Szulik became when he took over Red Hat eight years ago after Bob Young, the company's founder, decided to go back to publishing in the wake of Red Hat's explosive initial public offering in July 1999--he is also a techie, too. Whitehurst got his bachelor's degree in computer science and economics from Rice University and has a general course degree from the London School of Economics and an MBA from Harvard University. For many years, he worked at the Boston Consulting Group, rising to the position of vice president and director. Significantly for his job interview with Szulik, Whitehurst had four different versions of Linux running on his home network--Red Hat's own Fedora 6 and Fedora 7, Slackware, and an unnamed fourth Linux--probably Ubuntu but maybe Novell's SUSE Linux Enterprise Server or openSUSE.

"The search process was thorough, and we were very pleased with the caliber of the candidates for the role," said Szulik, who did not elaborate on who the other candidates were, except to say that there were plenty of good people interested in the job. "For me, I wanted to find an executive with an open mind," Szulik said. It was also important for a prospective president and CEO to have an understanding and an appreciation of the open source development process and the business model that it can drive. "We are getting am operationally savvy executive who happens to have technical skills," he said. This is apparently in contrast to the other contenders for the job, who did not show an understanding of open source.

It was a good quarter in which to transfer the reins to another president and CEO, and this is clearly something that Red Hat was waiting for. The company wanted to get the JBoss transition behind it, and it now looks like JBoss is integrated and selling well just as Red Hat Enterprise Linux 5.1 is coming to market and driving subscription renewals and new deployments alike.

In the fiscal third quarter, Red Hat's sales rose by 27.9 percent to $135.4 million. Software subscription sales for all products (mostly Linux but also some JBoss middleware and sundry other products) rose by 30.2 percent to $115.7 million. Training and services sales rose by 15.8 percent to $19.7 million in the quarter. Red Hat posted $20.2 million in net earnings in the quarter, up 38.7 percent, and earnings per share of 10 cents, up 25 percent. Red Hat exited the quarter with $1.04 billion in cash and investments, and significantly as the company's chief financial officer, Charlie Peters, pointed out in the call, Red Hat has only $10 million invested in mortgage-backed securities, so its direct exposure to the mortgage and credit crunch crises is comparatively low.

Peters said that Red Hat had broad growth across all geographic regions, all industries, and all customer sizes, and he added that the company had seen no dip in sales among financial services companies. (The financial services sector represents less than 15 percent of the company's business, Peters said.) About 27 percent of the company's sales in Q3 for fiscal 2008 came from EMEA, with 15 percent from Asia/Pacific and the remainder from the Americas. Notably, sales in Latin America, where Red Hat has been organizing itself in the past year, were up 52 percent sequentially. "I think we have a very diversified customer base, and we are in good shape there," Peters said.

Some IT vendors--particularly server makers IBM and Sun Microsystems--get a comparatively large portion of their sales from banking, savings and loan, brokerage houses, insurance, and similar financial services companies. And they have most certainly felt a cooling in sales in recent quarters. Other vendors, such as Hewlett-Packard and now Red Hat, have not been adversely affected by concerns in the housing, real estate, and financial services markets.

As has been the case for years, Red Hat did not discuss how many new subscriptions it has signed up in the quarter or how many renewals it booked from existing customers; it also does not provide any stats on OEM license sales for its products. Since the virtualization-capable RHEL 5.0 was launched in March of this year, everyone has wanted to know how the Advanced Platform edition--the one with unlimited virtual server slices based on the open source Xen hypervisor that has been woven into RHEL--has been selling. Szulik said that Red Hat's long-term goal was for Advanced Platform to comprise 30 percent to 35 percent of its installed base, and later in the call Peters said after a number of questions on the rate of adoption of virtualization technology among the RHEL installed base that it would probably take through next year to get Advanced Platform to hit that rough target of a third of the RHEL installed base. In the fiscal second quarter, Red Hat said that 18,000 of RHEL 5.0 servers had been virtualized, but did not update that figure this time around, either. The important thing is that RHEL Advanced Platform has more goodies and a higher price tag, which means more revenue and profits for Red Hat.

Still, the company is not just banking on its high-end Xen implementation and its ability to support Windows alongside Linux and manage both in a virtualized environment. Red Hat is doing lots of work integrating the KVM hypervisor into RHEL and using the libvirt tools it helped create to offer a "low cost, high value alternative." And, of course, VMware can virtualize Red Hat instances with the several variants of its ESX Server hypervisor, too.

Looking ahead, Peters provided some guidance for fiscal Q4, saying that the company expected sales to fall between $139.5 million and $141.5 million, with around 19 cents per share of non-GAAP earnings. For the full fiscal year, Red Hat said it would do better than its prior guidance, booking sales of between $521 million and $523 million. Peters said that Red Hat would provide guidance for fiscal 2009 when it hosts its earnings call for the first quarter of that fiscal year.

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