Red Hat Subscriptions Beat Street

The Linux provider posts in-line earnings while its subscriptions far surpass estimates.
Publish date:

Updated from 8:34 a.m. EST

Emboldened by a gangbuster increase in enterprise subscriptions, which was spurring its shares higher Wednesday,

Red Hat


is planning to launch a version of Linux for the desktop this year, the company's CEO told


In an telephone interview late Tuesday, CEO Matthew Szulik said Red Hat has a "great deal of interest" in the desktop market and will introduce a desktop Linux product in the calendar year, taking on both



Window's monopoly and emerging Linux rival



. Desktops are a market Red Hat initially started in but switched its focus to enterprise customers and the server market. With Windows commanding more than 90% of the desktop market, Szulik acknowledged Tuesday that the near-term opportunity in that field will be outside the U.S.

"The bulk of the

company's revenue will continue to be on the server side for the foreseeable future," Szulik added.

Szulik also responded to

recent heat Red Hat has taken for its roughly $3 billion market cap -- which is more than 15 times the size of the paid Linux market on the server and desktop in 2007, as forecasted by market research firm IDC. "I think you'd have to show me the number of tech companies that grew their top lines almost 40% year over year," Szulik said, also pointing to the surprising 87,000 new enterprise subscriptions in the fourth quarter.

On the heels of those results, released after the close Tuesday, shares of Red Hat were recently up $2.07, or 10.7%, to $21.48.

"The subscription growth fuels a kind of momentum story," said Deutsche Bank analyst Brian Skiba, explaining the stock's big move. "They're seeing an acceleration of the business."

Sub Growth

Under generally accepted accounting principles, Raleigh, N.C.-based Red Hat reported net income of $5 million, or 3 cents a share, in the fourth quarter, which ended Feb. 29. That compared with a net loss of $273,000, or break-even on a per-share basis, in the same period a year earlier.

Revenue rose to $37 million, up 43% from a year ago and 11% from the previous quarter.

Wall Street analysts expected Red Hat to earn pro forma net income of 3 cents a share on $36.7 million in revenue in the fourth quarter, according to Thomson First Call.

Looking forward, Red Hat expects first-quarter revenue to range from $42.5 million and $43.5 million and first-quarter GAAP earnings of 4 cents a share. That compares to analyst estimates that pegged revenue at $39 million and earnings at 4 cents a share.

Red Hat's 87,000 new enterprise subscriptions in the fourth quarter far surpassed analyst estimates in the range of 40,000 to 45,000. The company also added more than 4,000 new customers in the quarter.

Deferred revenue increased to $70.8 million from $42.3 million at the end of the third quarter. The renewal rate for enterprise Linux was 90% in the fourth quarter.

Total subscription revenue rose to $25.9 million in the fourth quarter -- nearly double from $14.4 million a year ago and up 17.7% from $22 million in the third quarter. Subscription revenue accounted for 70% of total revenue -- a proportion that is expected to move toward 75% in fiscal 2005, CFO Kevin Thompson said on a post-close conference call.

On the flip side, Red Hat reported a decline in average sale price to $455 from $524 in the third quarter. Thompson said that's because as volumes and adoption increases prices will go down.

Although company executives deny it, Skiba believes the price drop and jump in subscriptions also reflects a shift in strategy. "I think first they're probably being somewhat preemptive to Novell's encroachment into the marketplace, which is smart," said Skiba, who has a hold rating on Red Hat. (His firm hasn't done any banking with Red Hat.)

For the fiscal year, Red Hat posted net income of $14 million, or 8 cents a share, compared to a net loss of $6.6 million, or 4 cents a year, in fiscal 2003. Revenue in 2004 climbed 39% to $126.1 million.

Red Hat's results come as the company faces greater competition from Novell, which purchased Linux vendor SUSE Linux late last year and received a $50 million investment from


(IBM) - Get Report


Also Tuesday, Novell announced a new product called Open Enterprise Server to combine its NetWare product with SUSE Linux. In a signal that IBM may remain Linux agnostic, Red Hat announced that it has expanded an agreement with Big Blue to allow its customers to order and receive Linux with IBM Power hardware.

In a note on the new Novell offering, Credit Suisse First Boston analyst Michele J. Laverty predicted that Red Hat share of the Linux software market would fall from 90% to 60% by 2006. (Laverty has a neutral rating on Red Hat and CSFB has done banking with Red Hat.)

One wild card for Linux, meanwhile, is

SCO Group's


legal challenge to the open-source system through suits against IBM, Novell and more recently Linux users

Daimler Chrysler




(AZO) - Get Report

. (Red Hat and SUSE Linux generate revenue from Linux by selling support and services along with the free open-source software.)