Subscription boom boosts Red Hat profit, revenue

The Raleigh, N.C.-based company reported a net loss of $56,000 for the year-ago quarter, but now has reported profitability for four consecutive quarters.

In addition, Red Hat will embark on a major new push this year to expand Linux use on desktop computers, Chief Executive Matthew Szulik said in a conference call Tuesday. "We will enter the Linux client marketplace sometime in 2004," he said. The move that should put pressure on top Linux rival Novell and desktop powerhouse Microsoft.

For the fourth quarter of fiscal 2004, ended Feb. 29, Red Hat earned 3 cents per share, meeting the average expectations of analysts surveyed by First Call. Revenue exceeded the average expectation of $36.7 million.

The company attributed the year's results to its premium Red Hat Enterprise Linux (RHEL) product, which was adopted by customers faster than the company had forecast, Chief Financial Officer Kevin Thompson said in a statement.

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Red Hat first edged into profitability in 2002, but sustained profitability arrived only with the introduction of the company's premium Linux software, which unlike predecessors can't be obtained for free.

The company sold 87,000 new subscriptions for RHEL use and support in the quarter, Red Hat said. The renewal rate for earlier RHEL subscribers was about 90 percent, the company added.

That's more than double the 40,000 subscriptions Red Hat projected three months ago and the 33,000 new subscriptions it had in the third quarter. The average selling price of those subscriptions dropped, though Red Hat said it expects a higher sales volume to more than offset that decrease.

"Don't think of it as a change in strategy," Thompson told financial analysts in a conference call. "We just had an acceleration in our strategy."

For the 61,000 new "enterprise" subscriptions--those taken by business customers--the average selling price was $455 per server per year, Thompson said. That's a decrease from the $524 per server per year average in the third quarter.

The company has a total of 206,000 RHEL subscriptions now. Because customers pay over the course of a year, new subscriptions don't just produce revenue for the quarter in which the deals are signed.

Red Hat signed up 4,000 new customers, Szulik said, including many in Europe and Asia. "We're starting to see positive uptake outside the U.S. on both the server and the client platform," he said. "Over the next five years, the demand for Linux and open-source (software) outside the U.S. will outstrip the opportunity inside the U.S."

By the end of fiscal 2006--two years from now--more than half of Red Hat's revenue will come from overseas, Szulik said in an interview.

For the current first quarter, Red Hat expects revenue between $42.5 million and $43.5 million, which translates to growth between 15 percent and 17.5 percent.

Red Hat's Linux competes with Microsoft's Windows, with products from rival Linux sellers such as Novell, and with versions of Unix--though Red Hat has partnerships with the three top Unix sellers, Sun Microsystems, IBM and Hewlett-Packard. The open-source operating system is under legal attack by the SCO Group, which contends Linux violates its Unix copyrights. But IBM, Red Hat, Novell and others are engaged in an active counterattack.

About 6,000 of Red Hat's new subscriptions were from companies that took advantage of a promotion to upgrade from the earlier line, the company said. Although that promotion ended Feb. 29, another more modest one is coming: "In April 2004, we will launch a migration program for Dell (customers) to move to RHEL," Thompson said.

RHEL is designed for servers--higher-end machines used for networked tasks such as e-mail processing and file sharing. Through a strategy called the Open Source Architecture, Red Hat hopes to expand into higher-end software. All its products can be updated and managed with a gradually more elaborate service called the Red Hat Network.

While Red Hat is growing in the server market, it all but withdrew from its effort to sell Linux for embedded computing devices such as slot machines and video phones. Embedded subscription revenue dropped from $466,000 in the year-ago quarter to $309,000, offset by embedded development services revenue that increased from $1.23 million to $1.42 million.

However, Red Hat has signed a partnership under which Wind River Systems, one of the top embedded computing specialists, will develop and sell an embedded version of Red Hat Enterprise Linux.