Open-source software veteran Red Hat (NYSE:RHT) reported strong first-quarter earnings on Tuesday night, sending share prices more than 10% higher on Wednesday. After the report, I hopped on the phone for an exclusive chat with Red Hat CEO Jim Whitehurst. Here are the biggest takeaways from our call.
Red Hat's first quarter, by the numbers
Red Hat's top-line sales were $677 million, a 19% year-over-year increase. GAAP earnings rose 21% higher to $0.40 per diluted share. Both figures exceeded the top end of management's own guidance, which stopped at $650 million and $0.35 per share, respectively.
Looking ahead, Red Hat set second-quarter revenue and earnings targets ahead of Wall Street's estimates, followed by a 2% boost of the company's full-year sales guidance and 4% higher GAAP earnings targets for fiscal year 2017.
These are strong results for any company, but particularly impressive when you consider that 88% of Red Hat's quarterly revenue is tied to multiyear subscription contracts.
How a subscription-based business can beat sales expectations
"Obviously the question is, in a subscription-model business, how can you beat revenue by that much?" Whitehurst said. "First, services were really strong, and that obviously is immediate revenue as more customers set up and need our help implementing some of these newer OpenShift and OpenStack technologies."
So lots of companies are exploring the OpenShift container platform and OpenStack cloud-computing tools, which leads to some immediate support service sales. It's also a sign of upcoming growth under the subscription header because some of these early jabs at Red Hat's newer technologies should evolve into new subscription deals later on.
But wait -- there's more!
"No. 2, the on-demand part of our cloud business exceeded our expectations, so it's big and as it gets bigger we keep thinking it's going to slow down, but it doesn't," Whitehurst said. "It keeps growing nicely and so that's immediate revenue recognition."
In other words, Red Hat's customers are hungry for cloud-computing solutions on an immediate basis. This is not an OpenStack-branded private cloud platform but a full suite of cloud tools hosted by Red Hat and its many cloud partners. Red Hat has been a champion of hybrid cloud-computing models for years, and the idea of mixing private and public clouds is resonating in the marketplace right now.
Is the public cloud Red Hat's friend or foe?
In fact, Whitehurst wanted to underscore how important the public cloud business has become for Red Hat lately.
"We are highly confident that in Q2 it will exceed a $200 million run rate in recognized annual revenue out of about $2 billion, so 8% of our revenue will be just from the on-demand piece of public clouds," he told me. "That includes our existing customers building and running new workloads on Amazon Web Services or other public clouds which gives us more and more subscriptions, so we feel really, really good about the momentum we have right now even with our core products on the public clouds."
Rather than cutting into Red Hat's sales of traditional data center support contracts, the public cloud business is growing as a separate and complementary operation.
"We think it continues to demonstrate the public cloud as a tailwind, not a headwind for us," he concluded.
The results are showing in black and white on Red Hat's income statements. This company is going places, and the stock will follow. Red Hat shares have gained 42% so far in 2017, and still trade at just 24 times trailing free cash flows.