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Volume 5, Number 13 -- April 2, 2008

Red Hat Breaks $500 Million in 2007, Aims 30 Percent Higher in 2008

Published: April 2, 2008

by Timothy Prickett Morgan

Commercial Linux distributor Red Hat closed out its fiscal 2007 year and last week reported financial results for the final quarter and full year. With the absorption of JBoss more or less accomplished and Red Hat the leader in commercial Linux shipments support sales, the company is pressing on to break through the $1 billion barrier in the next few years under the guidance of a new president and chief executive officer, Jim Whitehurst.

That $1 billion target, which was set by Red Hat's chairman, Matthew Szulik, last November, should not be that hard to hit, not the way Red Hat is growing. And based on guidance that Red Hat is giving to Wall Street for fiscal 2008, the company is poised to grow whether the global economies stabilize or slow down, since Linux is one of the tools that companies want to deploy to cut costs or to standardize their IT operations. (One might even make an argument that a bad economy will accelerate Linux sales, in fact, but Red Hat has not been so bold as to wish for that--bad economies being somewhat unpredictable and all.)

In the fourth quarter of fiscal 2007 ended February 29, Red Hat reported subscription revenues of $121.9 million, up 27.1 percent. Training and services revenues in the quarter rose by 29 percent to $19.6 million. Overall sales were up 27.3 percent to $141.5 million. Red Hat had over $200 million in bookings--the first time it crested that level--and had $186 million in bookings in the quarter, which will help drive future revenues as they are recognized. That revenue growth in Q4 came at a cost, however, as the company is spending more on sales, marketing, research, and development areas, so the company's net income (diluted, not basic) came to only $22.9 million, up only 6.8 percent.

Now, under normal circumstances, Wall Street would have given Red Hat's shares a haircut last week because the company did not grow profits hardly at all compared to revenue growth in the fourth quarter. But there are a few things going on here. First, Red Hat's full fiscal 2007 numbers were pretty good. Subscription fees rose by 31.8 percent to $449.8 million, and training and services sales rose by 23.2 percent to $59.4 million, giving the company annual sales of $523 million, up 30.6 percent. For the year, net income was $80.3 million, up 25.8 percent. When you do the math, Red Hat is bringing more than 15 percent of its revenues to the bottom line--something very few companies do, and it did more than 16 percent in Q4. Moreover, this is not a normal economy. When Red Hat said that it was projecting around 30 percent growth in fiscal 2008, Wall Street seems to have cut the company some slack and investors actually drive the stock a little northward. As we go to press on Tuesday afternoon, Red Hat's shares are above $19 a pop and the company has a market capitalization of $3.6 billion.

What really made Wall Street happy, of course, is when Charlie Peters, the company's chief financial officer, said that Red Hat was projecting the same or better revenue growth in fiscal 2008, with sales of between $665 million and $680 million, kissing a growth rate of 30 percent. "From a long-term perspective, there is no change in our belief that the business could ultimately support much higher operating margins," Peters said after giving the 2008 guidance. While that falls short of saying that Red Hat can get back to the incredible operating margins it had when it was a smaller company and just selling Linux support contracts (Red Hat was bringing a quarter of revenues to the bottom line only a few years ago), what Peters said last week in the conference call with Wall Street analysts suggests that the company can generate more cash than it is doing. This probably means more acquisitions and more share buybacks, which of course drive the company's stock up further, generally speaking. The company is already on its way to making more cash, inasmuch as Peters said that revenues for the first quarter of 2008 were projected to be between $152 million and $154 million. He also said that, looking ahead, the JBoss and related middleware business is still growing at twice the rate as the core Linux business at the company, although it is considerably smaller, obviously.

Whitehurst, who is formerly the chief operating officer at Delta Airlines, is still pretty new to the president and CEO jobs, but has plenty of Linux and IT experience. And he is clearly happy to be in a new business. "Coming from the airline business, it is great to talk to customers without having them take your head off," Whitehurst said in the call among lots of laughter. "Relative to airlines and, frankly relative to other software companies, across the board I hear positive things about service, which is phenomenal. The primary thing we hear from our major customers is they value and want even more of a technical relationship."

Red Hat had $678 million in cash as it ended the fiscal year on February 29, up 28.5 percent from the year-ago period. The company also had $312 million in debt securities, and Peters said that over the past few months Red Hat has sold off any asset-backed or mortgage-backed securities, so there are not going to be any future surprises there. And it will not be much of a surprise as Red Hat builds up its services portfolio in fiscal 2008, as it just did with the Amentra acquisition a few weeks ago, adding JBoss implementation services.


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