Subscriptions Carry Red Hat Through Hard Times

There is a way to make money from Linux even in a down economy — it’s called
subscription revenues.

Linux vendor Red Hat yesterday reported growth in income and revenues on the back of
renewal rates for its Linux support subscriptions. Revenues for the company’s third
fiscal quarter for 2009, which ended Nov. 30, hit $165.3 million, an increase of 22
percent over its third-quarter fiscal 2008
a year ago.

On the net income side of the books, Red Hat reported income of $24.3 million, or 12
cents per share, which is an improvement over the $20.3 million or 10 cent per share it
reported for the same period last year. Minus taxes and other costs, profit totaled 24
cents per share, topping Wall Street estimates of 17 cents per share, according to
Reuters Estimates.

“Starting with a few highlights from fiscal Q3, we continued to see strong renewals
and upsells,” Red Hat CEO Jim Whitehurst told
analysts during the company’s earning call. “We renewed all of the top 25 deals that were
scheduled to renew this quarter and they were renewed at approximately 106 percent of
prior year’s value.”

Red Hat CFO Charlie Peters reported that overall subscription revenue for the quarter
was $135.5 million, up 17 percent year-over-year. Peters also emphasized Red Hat’s
subscription model as a key to continued stable growth.

“Our results demonstrate the strength and predictability of our business and the
continued demand for open source solutions,” Peters told analysts. “Keep in mind that 82
percent of our revenue is recurring and subscription-based. Some of the most
mission-critical trading systems in the world run on Red Hat and more mission-critical
work is moved our way every quarter.”

Among the top deals renewed by Red Hat were three multi-year renewals with large
financial services firms. One of Red Hat’s top 25 deals also includes a one-year
transaction in which the customer moved from a free version of Linux to Red Hat’s paid
subscription model — a sale Whitehurst described as a six figure deal.

Red Hat executives on the analyst call did not specifically identify which flavor of
free Linux had been abandoned through that six-figure deal. Red Hat develops a free
community version of Linux called Fedora, and there are numerous clones of Red Hat
Enterprise Linux as well, including one called CentOS.

“This was not a compliance-related initiative,” Whitehurst said. “This was purely a
getting the customer to understand the value of a paid subscription.”

Peters added that the free-to-paid win in the third quarter wasn’t the first such deal
that Red Hat has had.

Additionally, Red Hat believes there’s a large potential opportunity to move users
from free versions of Linux to paying subscriptions. Whitehurst noted that Red Hat has
over 2.5 million paid subscriptions for Red Hat Enterprise Linux (RHEL). In contrast,
Paul Frields, Fedora’s project leader, recently told that Fedora
over 9.5 million users

“There’s a lot of free RHEL out there. There’s a lot of free, forked versions of RHEL
— the RHEL derivatives — out there, so again as we build it up, we do a bottoms-up
build every year from what our sales force is seeing and what we think we can go get,”
Whitehurst said. “And we do think there’s a lot of opportunity out there.”

He added, however, that it’s difficult to make accurate predictions on the number of
likely candidates to transition from a free user to paying RHEL customer.

“It’s hard for us to ever get those numbers ‘of free users’ synced back up with the
top-down view, other then to say that … there’s a substantial amount out there.”

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