Red Hat's Profit Growth Stalls in Fiscal Q1, RHEL MRG Launched

Published: July 8, 2008

by Timothy Prickett Morgan

Earlier this year, when commercial Linux and middleware distributor Red Hat closed out its fiscal 2008 year, the company broke through the $500 million revenue barrier and said that it was aiming for at least 30 percent growth in fiscal 2009. Having just finished up its first fiscal quarter, Red Hat is comfortably on its way to meeting that goal, despite the difficulties in several of the world's economies and the intense competition Linux gets from Windows.

Red Hat reported its financial results in the wake of the Red Hat Summit, which the company hosted in Boston, and just after IT Jungle went on hiatus for the July 4th holiday here in the United States. For the quarter ended May 31, Red Hat booked sales of $156.6 million, an increase of 31.8 percent. Software support subscription sales came to $130.7 million in the quarter, up 26.8 percent, while training and other services accounted for $25.9 million, up 63.9 percent. In sort, increased training and services sales saved the company's cookies in the quarter, helping it meet its overall growth goals. Subscription and training/services revenues were much more balanced in the final quarter of fiscal 2008, which ended February 29.

The most amazing thing about companies like Red Hat is how low the cost of delivering the software. In the quarter just ended, those $130.7 million in sales were supported by costs of just $8.96 million, giving the company's Red Hat Enterprise Linux and JBoss middleware a gross profit of 93.1 percent. This is a phenomenal business, especially compared to the relatively meager 32.6 percent gross profit. But, then of course, you have to pay for offices, sales, marketing, research, and development, and in fiscal Q1, that ate up $110.3 million. (Sales and marketing was $59.3 million of that.) Still, Red Hat was able to bring $18.2 million to the bottom line, which is 11.6 percent of overall revenue.

As software companies go, this is not too shabby, but it is not as much (in terms of percent of revenue) as Red Hat could drop to the bottom line only a few years ago. Growth has diminishing profit returns, but in a strictly capitalist system that determines stock price and therefore the value of a public, growth and profit is the only thing that seems to matter. Despite all the good growth on the revenue side, profits were only up 6.3 percent. It doesn't take a lot of imagination to figure out what Wall Street thinks about that. Brokerages and investment bankers like to see net income outgrowing revenue, not the other way around. Having said that, the former, rather than the latter, may be more important and healthier for the long-term viability of a company. (As if most of the people crunching numbers and touting stocks on Wall Street gave a damn about that beyond one 13-week period. Can you say Bear Sterns?) I say do what you think is best for the company, Red Hat. Employing people and creating good software matters to the world. Someone's house in Greenwich or the Hamptons, not so much. . . .

Jim Whitehurst, Red Hat's new president and chief executive officer, and Charlie Peters, the company's chief financial officer, hosted a conference call on June 25 with Wall Street, and said that the company was working on product launches as well as rejiggering its operations so the company could scale. Whitehurst, who is an operations guy and most recently was head of operations at the airline carrier, Delta, knows how to do this. "We are off to a good start and on pace to deliver more major product releases this year than in any other period in Red Hat's history," Whitehurst explained in the call when talking about the company's priorities for fiscal 2009. "Our second priority is to improve our internal processing systems. We continued to drive improvements in our systems and processes this quarter while also launching the first phase of our overall transformation project. This transformation will focus on building out our customer facing and renewal processes in addition to other systems that we believe will help Red Hat better scale to $1 billion revenue and beyond in the years ahead." Wall Street translation: We're going to keep making more revenue, and we will figure out how to get more of it to drop to the bottom line.

One of the products that Red Hat got out the door at the Summit was Version 1 of Red Hat Enterprise MRG, which went into beta in December. Red Hat Enterprise MRG (which is pronounced "merge"), weaves together a number of technologies for running applications that rely on messaging, real-time operating system, or server gridding technologies. (Messaging Realtime Grid.) Not all elements of Enterprise Linux MRG product are ready for prime time, however. Support for the JBoss Enterprise SOA platform running atop the MRG spin of RHEL will be delivered in an upcoming release, and the Condor open source grid management software is only a technology preview inside MRG V1.

Pricing for RHL MRG was not announced, and I am chasing it down now. I will also be taking a closer look at the guts inside this variant of RHEL in a future issue of this newsletter.

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