Red Hat, Reporting Q2, Reorganizes Operations for Growth

Published: October 2, 2007

by Timothy Prickett Morgan

Commercial Linux and middleware distributor Red Hat reported its financial results for its fiscal 2008 second quarter last week, and Matthew Szulik, the company's chairman and chief executive officer, also announced that the company has been working on a reorganization he called "20/20" that will change the way the company does engineering, sales, and marketing for its various product lines in an effort to position itself for growth as it tries to break through the $1 billion sales barrier.

For the second quarter of fiscal 2008 ended August 31, Red Hat had $109.2 million in subscription sales, up 28.5 percent, and training and services sales of $18.1 million, up 22.9 percent. Overall sales in fiscal Q2 rose by 27.7 percent, to $127.3 million. Net income shot up by 64.4 percent to $18.2 million, which works out to 9 cents a share compared to 6 cents a share in the year-ago quarter. Red Hat is brought more than 14 percent of sales down to the bottom line in the quarter, and any time any company does 10 percent, it is a cause for celebration on Wall Street.

Clearly, Red Hat is not reorganizing because it has poor financials, which is why most companies do reorganizations. (In fact, sales for fiscal Q2 were above Wall Street's expectations by a smidgen.) But knowing that Red Hat was going to do a number of acquisitions to move into the middleware and services spaces with the same gusto that it went after commercial, the board of directors at the company approved the 20/20 plan to rejigger Red Hat from a company that is organized according to engineering, marketing, and sales, each with their own managers, to a geographically distributed sales organization with each regional manager responsible for hitting sales and revenue targets and a product development and marketing organization that is organized by product lines, also responsible for hitting market share, revenue, and profit targets. This is how most big IT companies are organized, and the reason this is the case is that only a distributed organization with more authority pushed down into the ranks can make decisions close to the customer base it serves.

"We recognize that we are competing against the best technology companies in the world," Szulik said in a conference call with Wall Street analysts as he explained the new organizational chart, which has not been fully revealed yet.

Szulik did say that to get all of the marketing operations in its three divisions pulling in the same direction, the company has named Michael Chen, currently general manager of its China unit, as the company's first chief marketing officer. Chen joined Red Hat in 2002 as a product manager, and has his MBA from the University of North Carolina and his master's degree in computer network engineering from North Carolina State University; he received his bachelor's degree from Nanjing University in China.

While Red Hat is reorganizing its operations along infrastructure (Red Hat Enterprise Linux and Fedora), middleware (JBoss and other development tools), and services (Red Hat Exchange and Red Hat Network), the company has not yet provided financial details for these new divisions. Doing so will be very interesting, if Red Hat does it. Rival Novell provides a much richer set of financial statistics, but then again, Novell has been a $2 billion company that contracted over a decade and barely found a $1 billion floor thanks to Linux. It has a lot more to prove than Red Hat, in many ways.

According to Charlie Peters, Red Hat's chief financial officer, the company exited the second fiscal quarter with $1.3 billion in cash and equivalents in the bank. The Red Hat board has authorized the company to buy back up to $250 million in common stock and up to $75 million in convertible debentures (due in 2024). Red Hat has approximately 193.9 million shares outstanding at $16.22 a share as the market closed on Tuesday last week (when the financials were announced), yielding a market capitalization of just over $3.1 billion. Looking ahead, Peters said that he expects Red Hat will book sales of between $131 million and $133 million in the fiscal third quarter.

Szulik, while pleased with the integration of the JBoss middleware and development tool products into the Red Hat family over the past year, was not happy with how JBoss sales were accelerating. He told the analysts on the call that JBoss bookings had disappointed him and did not meet his expectations, and said further that he saw no reason why JBoss sales should not grow at twice the rate as Enterprise Linux sales were growing. "We will accelerate JBoss growth in the second half of fiscal 2008," Szulik said, throwing down the gauntlet to his sales people.

As for the effect of the jittery world economies on sales, neither Szulik nor Peters said that they have seen any slow down in demand for Red Hat's products, and both characterized demand as "strong" a number of times on the call. But Szulik did offer a caveat as the call came to an end. "We continue to see pressure on IT spending, and I think open source software is part of that." He added that he is not seeing big increases in IT budgets for calendar 2008 among the customers he talks to, either.

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