Red Hat's Revenues and Profits Up in Fiscal Q3

Published: January 10, 2006

by Timothy Prickett Morgan

Commercial Linux distributor and industry leader Red Hat reported its financial results for the fiscal third quarter ended November 30 just before IT Jungle went on holiday, and to say that its numbers were a lot better than Wall Street expected would be an understatement. Things are looking pretty rosy over at Red Hat, but chief executive officer Matthew Szulik less than a week later decided that beginning this year, he will start using an automatic stock trading plan to diversify his portfolio. You can't blame Szulik for that.

Portfolio diversification is, of course, a perfectly reasonable strategy in a world where public companies exist and where the future is unknown and unknowable. If any Red Hat employee had such a large block of stock and did not diversify, he or she could be made destitute if something really bad happened--as did at Enron, Global Crossing, and other recent busts. Red Hat said in a statement that Szulik's trades of Red Hat stock will constitute no more than 27 percent of his total holdings. Under the Rule 10b5-1 stock trading plan, executives pre-program their sales and they happen regardless of how well or poorly a stock is doing and of what is going on at the company at the time. While I say this is all very reasonable in a world where we buy and sell stocks in companies as a kind of lottery, that is not the same thing as saying that I believe that this is the best way that companies should be constituted and run. I think public companies are slaves to their quarterly results and they have to, by necessity of appeasing Wall Street, make short-term choices that privately held firms would not make. You get a big wad of cash when you go public, but Wall Street owns you.

The good news for Red Hat is that Wall Street is pretty happy with how things are going for the Linux distributor. In the fiscal third quarter, Red Hat booked sales of $73.1 million, up 44 percent from the year ago quarter. Sales of software subscriptions, which are really support contracts for open source Linux and related programs that are part of the Red Hat distributions, grew by 54 percent to $60.2 million. Red Hat only booked $632,000 in sales for embedded Linux products, but that business did increase by quite a bit. Red Hat's retail business, which accounted for 512,000 in the same quarter last year, is gone now. If Red Hat wants to sell on the desktop, as the Fedora project and Red Hat Desktop clearly indicate it does, the odds are that the company will eventually break out server and desktop licenses, much as it used to break out commercial and HPC server sales to show trends in those markets. During the quarter, Red Hat had sales of $12.9 million for training and services, with the vast majority of it for its Enterprise Linux products.

It may be called Red Hat, but what the company and its investors like is black ink. And Wall Street was pleasantly surprised as Red Hat brought in an operating income of $18.7 million in the quarter, up 147 percent from the year ago quarter. The company had $6.6 million in other income (from its investment portfolio) and interest expenses of $1.5 million, yielding an income of $23.9 million. After taxes, net income came to $23.2 million, up 114 percent, yielding earnings of 12 cents a share. Wall Street had been expecting black ink to the tune of 9 cents a share. Right after the earnings announcement, Merrill Lynch raised Red Hat's stock from neutral to buy, and others will undoubtedly follow in raising their ratings for the company's stock if this kind of performance continues.

Red Hat's chief financial officer, Charlie Peters, sure gave Wall Street the nod that this was going to happen. He said in a conference call with analysts that Red Hat expected sales of $77.5 million to $78.5 million in the fiscal fourth quarter ended February 28, with net earnings of 11 cents to 12 cents a share.

As the quarter ended, Red Hat had deferred revenue--sales it made for subscriptions and services over time that it has not booked yet--of $199.7 million, an increase of 64 percent since this time last year. Red Hat has over $1 billion in cash and investments as well, and is poised to make acquisitions or ride out any tough times should they arise.

In a separate announcement, also in December, Red Hat was added to the NASDAQ 100 index of the biggest non-financial stocks. While Red Hat has been public since July 1999 and was by far the biggest big initial public offering at the end of the dot-com boom--in a way, the exuberance over Red Hat was the last expansion of the bubble--it took Red Hat a long time to reach the NASDAQ 100 because that bubble burst and making billions of dollars with open source software--as Red Hat's market capitalization more than six years ago seemed to imply was possible--has turned out to be a lot more difficult than expected. Google, on the other hand, went public in August 24 and was added to the NASDAQ 100 list on the same day as Red Hat, and if anything, Google is at the front end of the next bubble--if one ever materializes. Expedia, nVidia, Cadence Design Systems, Activision, and Monster Worldwide were also added to the list at the same time as Red Hat.