Red Hat pinched by muscular greenbacks in Q2

Selling now, investing for then, sitting on a pile of cash

Anyone selling hardware or software overseas as a significant portion of their overall revenues got a haircut in the past few months, and Linux server and Java application server juggernaut Red Hat was no exception.

In the second quarter of fiscal 2013 ended in August, Red Hat's overall revenues grew by 14.7 per cent to $322.6m, while net income actually fell by 12.4 per cent to $35m. Two things hurt that bottom line at Red Hat during the quarter. First, sales and marketing costs were up 23.9 per cent to $123.6m and research and development spending jumped 23.1 per cent to $63.4m.

Second, having the US dollar get stronger and taking off 5.3 points of revenue growth (or about $15m off the top line) at the same time that Red Hat was expanding its portfolio with heavy-duty infrastructure and platform cloud stacks and clustered storage was just unfortunate timing.

But even without those currency effects, Red Hat's profits would have been under pressure because of all of that extra spending.

For the period ended in August, software support subscription revenues rose 17 per cent to $278.8m, and training and other support services rose by a meager 1.9 per cent to $43.8m. At constant currency, subscription revenues rose 22 percent, on par with past quarters.

Red Hat does not break out sales of Linux, JBoss, and other product subscriptions separately – as it probably should by now – to give investors and customers (and competitors and hacks, we presume) a better sense of what is actually going on inside of its biz. But the company does talk about its top deals as a kind of proxy for what is going on with customers who are consuming support services for its various open source wares.

Red Hat CEO Jim Whitehurst said on a call with Wall Street analysts after the market closed that all of the top 25 deals that Red Hat had up for renewal did so, and did so at 120 per cent of the original value of the contracts with those customers.

The cross-selling of RHEL and JBoss continues to pump up sales, too. Red Hat CFO Charlie Peters said on the call that 50 per cent of the top 30 deals the company did in the quarter (which includes renewals as well as new deals) had a JBoss component to the sale, up from 40 per cent in the first quarter of fiscal 2013 ended in May. "The cross-selling continues to be good, and it is driving larger deal sizes," said Peters.

Of those top 30 deals, Red Hat had two eight-figure deals, the first time in its history it had two deals in the same quarter worth more than $10m; 27 deals out of the 30 were for $1m or more, and four were worth over $5m. Of those 30 biggies, four were just for JBoss middleware and related integration tools, so don't think every JBoss deal comes with big Enterprise Linux contracts.

Two acquisitions that Red Hat did in the past month – FuseSoft for its application integration and Polymita for its business process management tools – closed in the quarter for a total of $1m, and did not have a material impact on sales but did take a penny off net earnings. But they are expected to help bolster JBoss sales in the future, which are still dominated by migrations off Oracle WebLogic and IBM WebSphere application server platforms – much as RHEL is driven by migrations from Unix to Linux.

Those two acquisitions added 80 people to the Red Hat payroll in the quarter, and another 220 people were hired in other roles. Peters said Red Hat was on track to add 900 to 1,000 people this fiscal year.

In terms of industry verticals, financial services and government are still the two biggies for Red Hat. Red Hat drove about 34 per cent of its sales directly in the quarter, with the channel picking up the remaining 66 per cent.

The slow growth on the consulting and training services side of the business was absolutely intentional, Peters explained, saying that Red Hat was backing off on the consulting business to let partners get a bigger piece of that action. Fee-earning consultants tend to drive more Red Hat licenses, he said, because they get a bigger piece of the overall action. On the training side, Red Hat figures that travel budgets are not great right now, so it expects for sales to grow in the single digits there.

Red Hat is just beginning to take its Gluster clustered file system to market as Red Hat Storage Server 2.0, and has 30 proofs-of-concept running at the moment. And the company is doing a tech preview of its own OpenStack distro, for which it will sell subscriptions much as it does for the Linux kernel and a stack of a few thousand applications that are rolled up to make an OS. "Applications will ultimately need to be certified against something," Whitehurst said, referring to the OpenStack cloud control freak.

By geography, North America accounted for 58 per cent of Red Hat's revenues, and EMEA brought in 24 per cent with Asia/Pacific following up with 18 per cent. All three regions into which Red Hat carves itself showed double-digit revenue growth, and even the three different regions of Europe – North, East, and South – were all up in the double digits. Peters said that Europe was "holding up very, very strong," which is not something you hear every day in the trade press.

With $869.5m in cash and securities and $704.6m in deferred revenues, Red Hat can afford to take the long view.

Looking ahead, Red Hat expects for sales of between $336m to $339m in the fiscal third quarter ending in November, with non-GAAP earnings per share of 28 or 29 cents. For the year, look for sales of $1.32bn to $1.33bn, with net earnings per share on a non-GAAP basis of between $1.15 and $1.17.

Those are some pretty tight ranges, and it shows just how confident Red Hat is in the next two quarters – regardless of what the US dollar is doing to make Shadowman look smaller. ®

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