How Red Hat Made Money in 2010

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The past twelve months have been good for Linux vendor Red Hat (NYSE:RHT) as the company grew revenues and income while expanding its product offerings in the cloud and virtualization space. But how did Red Hat grow while others staggered?

During Red Hat’s fiscal 2010 earnings call on Wednesday, Red Hat’s CEO and CFO detailed the steps their company took to leverage open source software to make millions.

For the fiscal year ended Feb. 28, Red Hat reported revenues of $748 million, a 15 percent year-over-year increase from Red Hat’s total revenue in 2009. Net income totaled $87.3 million or $0.45 per share, improvement of 11 percent over Red Hat’s earnings for 2009.

For the fourth quarter of Red Hat’s fiscal 2010, the company reported revenues of $195.9 million, an 18 percent year-over-year increase. That contributed to net income of $23.4 million or $0.12 per share — an increase of 46 percent over the $16.0 million Red Hat reported for the fourth quarter of fiscal 2009. Minus one-time charges, Red Hat’s earnings rose $0.19 per share, ahead of Wall Street estimates of 0.16 per share, according to Thomson Reuters.

Looking ahead, Red Hat CFO Charlie Peters offered full-year 2011 guidance for revenue in the range of $835 million to $850 million, which would represent an annual growth rate of 12 to 14 percent. On a quarterly basis, Peters forecasted first-quarter fiscal 2011 revenue of $202 million to $204 million.

More customer categories for enterprise Linux

There are a number of reasons why Red Hat has grown its revenue over the last year and why its executives are optimistic that growth will continue for its next fiscal year. Red Hat CEO Jim Whitehurst noted during the company’s earnings call that it has been expanding outside of the company’s core market verticals, which include telecom, financial services and government.

“In industries such as logistics, oil and gas, pharmaceuticals, transportation, travel services, retail and energy, we experienced over 150 percent growth within these mainstream verticals in our top deals compared with last fiscal year,” Whitehurst said.

Another key area targeted by Red Hat over the last year has been going after free Linux users in a free-to-paid conversion program. Moving users from free to paid is an initiative that Whitehurst first discussed in Red Hat’s third-quarter fiscal 2009 earnings call as a key initiative for growth in Linux. Over the course of fiscal 2010, Whitehurst said that Red Hat saw good results from its conversion program during every quarter.

“In the fourth-quarter 2010, we had several six-figure deals that included a significant free-to-pay component,” Whitehurst said.

While Red Hat is actively going after free-to-paid Linux users, however, the company conceded that it actually lost one of its top renewal opportunities during the fourth quarter when an unspecified customer went from paid to free.

“The motivation was, I think, one of principally cost, so they found a free alternative they were going to try for a while,” Whitehurst said. “As you may recall from our previous quarter results, we have had over the last 3.5 or so years maybe two-three customers who have done the same thing. Usually in a period of a year, and sometimes even less than that, we are able to bring that customer back. So we are still hopeful this customer will come back.”

Virtualization

KVM virtualization technology is also a key driver for Red Hat’s growth. Red Hat recently announced that IBM had chosen Red Hat Enterprise Virtualization for the new IBM cloud. The move is one that Whitehurst noted will help to create a different ecosystem for KVM than the one generated by the Xen virtualization technology that Red Hat and IBM first backed.

“One of the issues … which has made it difficult to make progress in the enterprise is there are so many flavors of Xen out there,” Whitehurst said. “So I think it is important IBM stood up and said, ‘We are standing behind Red Hat’s KVM. We are not spinning our own. We are keeping this thing together. We are keeping the ecosystem together.’ So there is kind of one enterprise implementation of KVM and I think that is important strategically long-term for us and for KVM.”

Angling to snap up former Unix customers

While Red Hat is growing into new verticals and with the help of virtualization, Whitehurst isn’t specifically targeting Microsoft Windows as the primary target for competitive replacement.

“In general, the key for us is to catch people as they are moving from Unix to Linux rather than having them move to Windows,” Whitehurst said. “So while certainly actual migrations are important, the bigger strategic field of battle and part of our mainstream adoption effort is to make sure when people move mainstream customers from Unix they are moving to Linux and not to Windows.”

Sean Michael Kerner is a senior editor at InternetNews.com, the news service of Internet.com, the network for technology professionals.