Red Hat Earnings Call Insights: Vertical Perspective and Service Workload

Red Hat, Inc. (NYSE:RHT) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Vertical Perspective

Brent Thill – UBS: I’m curious, if you could just walk through the verticals, financial services and government, Charlie, to give us a sense of what you are seeing there; and structurally as we head into the fiscal year end on the government how fixing the pipeline build there?

Charlie Peters – EVP and CFO: From a vertical perspective, in the top deals, although I said government and technology/media were the top two, financial was right there. It was a very close third. So, the financial sector from our perspective is still doing well. The government performance in Q2 was no surprise to us. In fact, I had guided that on the Q1 call. I think the open question to everybody is what happens in the next couple of weeks with the federal government budget deliberations and that’s kind of a wild card. It’s going to affect everybody the same way. I would expect that what happens in most years with the month of September for us and probably for everybody else will still be good in the federal government, and then we’ll see what happens on October 1. I really don’t have any predictions beyond that relative to what’s happening about the U.S. federal budget discussion. However, I would say that the government sector for us has historically been a good sector.

Brent Thill – UBS: Just as a quick follow-up on the billings number, Charlie, relative to history, it’s one of the lowest growth rates you’ve seen in a while. Can you just give us a sense to what you think is going on impacting that?

Charlie Peters – EVP and CFO: Yeah, so the one item I clearly called out is when we have these really large deals, they tend to be much more tailored and negotiated to the specific situation and two of the top three deals as I said total — the two of them totaled over $20 million and billed only 15% in the quarter. So, and obviously, if it doesn’t bill, the alternative is it, it goes into off-balance sheet backlog for a future billing date. So, that has an impact and that was — it was one of the larger items for the quarter.

Service Workload

Heather Bellini – Goldman Sachs: Just a couple in particular. First, I would like to ask Charlie, in the past you guys have said that services revenue was actually a good indicator of future growth in subscription, if I just go back in your transcripts. I’m just wondering kind of if the business dynamics have changed and that’s not the case anymore. And then I guess the second thing just has to do with Linux workload growth, and I’m wondering if you could give us a sense of how – what rate do you think Linux workloads are growing at within the four walls of your customers’ data centers, and what do you think they’re growing at in the public cloud arena?

Charlie Peters – EVP and CFO: I’ll take the first one; services, and I’ll let Jim comment about the service workload – the Linux workload growth. From a services perspective, if you went back probably two or three years ago, Heather, I think your comment is accurate. Probably starting about a year and a half ago what we talked about was the fact that we’ve changed our service strategy and we’re actually devoting time, effort, and resources here to enable our partners to deliver services around the Red Hat products. So we are actually sacrificing services revenue to allow our partners to deliver more services. The theory and the strategy here is to help us accelerate subscription growth down the road for the future. So, nothing’s changed there. We’ve been following that policy now for probably a year and a half, two, and continued along that path. I’ll let Jim talk about the Linux workload growth.

Jim Whitehurst – President and CEO: Yeah. I mean, I think what we’re generally seeing across the board is we’re winning a lot larger share of net new workload. So, as customers’ – enterprises are looking to deploy new workloads, obviously, the choice is Windows or Linux now. And we believe we’re winning a lot larger share of those. And so, a lot of our share take isn’t directly from somebody ripping out a Windows server to put in a Linux server. It’s more – as application since that they’re likely to have been on Unix or Windows and are now more likely to be on Linux. So, the IDC number of roughly 38% of servers, are Linux, roughly half of that-ish are Red Hat, so a little less than 20% of all servers out there. So, there is a lot of growth as we look at how those servers move. Second on the public cloud, we are seeing tremendous growth on public clouds but frankly off of a tiny base. So, we are still on a monthly basis in the single-digit millions on that business. But we are seeing that grow nicely. We always look at that as is that an opportunity or is it a threat and if you look at the numbers I’ve said before, Red Hat represents a little less than 20% of Enterprise servers. I would hazard to say the vast majority of workloads is that some Enterprises go to public clouds are going to be Linux. So, we just need to make sure we win a reasonable share of those and we are still net-net better off. I think that’s happening. That obviously the data we are seeing is from Red Hat customers who are moving their workloads to the cloud and that looks positive. But again its early days and it’s still kind of relatively tiny numbers of Enterprises running workloads in clouds.