Friday, March 30, 2012

Red Hat Tipping Point?

Red Hat (RHT), in the year 2000, was going to be another Microsoft. Its open source software, would, in a few years, replace the overpriced, proprietary software known as Windows.

Come Wednesday, when Red Hat reported its fiscal Q4 2012 results (for the quarter ending February 29) and held its analyst call, Red Hat GAAP net income came in at $36 million. Up 7.5% from Q4 2010, to be sure, but dwarfed by Microsoft's Q4 GAAP net income of $6.62 billion.

So Red Hat is still not the next Microsoft. Aside from that, the specialist in open source software is doing very well. Fiscal 2012 marked the first time Red Hat, and the first time a primarily open source software company, showed over $1 billion in annual revenue.

Revenue for the quarter was $297.0 million, up 2% sequentially from $290.0 million and up 21% from $244.8 million year-earlier.

GAAP net income was $36.0 million, down 6% sequentially from $38.2 million but up 7.5% from $33.5 million year-earlier. GAAP EPS (diluted earnings per share) were $0.18, down 5% sequentially from $0.19, but up 6% from $0.17 year-earlier. Non-GAAP net income was $57.2 million, for EPS of $0.29.

A 21% annual revenue ramp rate amounts to explosive growth in this slow-growth environment. Red Hat Enterprise Linux (RHEL) substantially reduces the cost of doing business and has proven itself for more than a decade it critical business environments. For enterprise data centers, switching to Red Hat is an easy decision to make. Along with Linux most companies are going to want RHEV for virtualization of servers and JBOSS middleware for applications.

Where Linux has not caught on is the corporate or home desktop. For practical purposes Red Hat no longer tries to compete in that space.

Note that net income and EPS did not ramp as quickly as revenue. Normally that might be a warning sign, but it is likely to reverse itself at a later point. Red Hat bought a storage software company last fall and has devoted a lot of R&D to getting the product ready and certified for sale. They are also in the midst of a rapid international expansion. There is a lag between setting up an office in a new nation and seeing significant revenues.

It is certainly possible that Red Hat has finally reached a tipping point where it will become the standard provider of operating systems for servers in datacenters and the cloud. In that scenario growth could even accelerate in the next few years.

Still, it would seem that Red Hat at its present price is for the boldest of investors. Currently Red Hat's P/E ratio is 80, compared to 12 for Microsoft and 17 for Apple. Keep in mind that the revenue growth rate for 2011 may not be a good predictor of future growth rates.

Disclaimer: I do not hold a position in Red Hat, or any other company mentioned in this article, though I have in the past. I won't trade Red Hat for at least one week after the publication of this article.

For more detail on Q4 results, see my notes on the Red Hat Q4 fiscal 2012 analyst call.

Keep diversified!

Tuesday, March 20, 2012

Adobe Waiting for CS6

Adobe (ADBE) yesterday reported a Q1, 2012 with only a slight increase in revenue over Q1 2011, with a decline in earnings per share (EPS). I use Adobe as a proxy for the computer software industry, but in this case special factors may have contributed to the poor showing, so the industry as a whole may do better in Q1. Adobe's fiscal Q1 2012 ended March 2, 2012, so it is a frontrunner to firms that report on a regular calendar basis (Q1's ending on March 31).

GAAP revenue was $1.045 billion, down 10% sequentially from $1.152 billion but up 2% from $1.027 billion year-earlier. Net income was $185.2 million, up 7% sequentially from $173.7 million but down 21% from $234.6 million year-earlier. Earnings per share (EPS) were $0.37, up 6% sequentially from $0.35 and down 20% from $0.46 year-earlier.

At the analyst conference call management claimed the poor showing was because of customers beginning to anticipate the future release of Creative Suite 6 (CS6). Creative Suite comes in a variety of flavors incorporating a number of Adobe software products such as the well-known Photoshop and Acrobat. Because the web is transitioning to include mobile devices and a new standard, HTML5, the products for web developers (including page layout, photo, animation, and video editing) are also changing rapidly.

Because of cost issues, developers sometimes do not upgrade to each new version. This was particularly true during the recession. If is possible that management is right in believing that the number of changes has become so great that CS6 will be a must-do upgrade even for customers that have CS5.5 or CS5, much less earlier versions.

The problem for web designers is that the design standards of 3 years ago, where they could count on a (well-designed) site appearing the same to viewers no matter which browser or operating system they used. Now every mobile device has a different screen size and many device users prefer apps, using a mobile web browser only as a last resort. What designers have had to do since the iPhone introduction is either write multiple web pages (one for desktop/notebook screens and one for each mobile device) or include programming on a single page that reformats that page for various screen configurations. Plus they

Given the endless complaining I have heard from fellow designers and programmers, I expect CS6 will be a big hit if it actually delivers the ability to design once and deploy, with minimal changes, to an assortment of devices. On the other hand if they think CS6 fails in that regard, they will probably cherry pick and only upgrade the Adobe software that work well for them.

The lower profits on flat revenues is attributable to up front investment in marketing and readying CS6 for deployment.

A number of pundits declared Adobe dead when Apple refused to support Flash animation on iPhones. So far Adobe is coping well with the new environment. It is the nature of IT things to see rapid die-offs and new growth.

Another area Adobe seems to be doing well in is helping its customers with dealing with another complex area, Internet advertising. A well-designed web page that does not generate ad revenue is not a good ROI. In January Adobe closed its acquisition of Efficient Frontier, which should help keep Adobe in the forefront of this area.

Today Adobe closed down $1.35 to $33.16. Its price to earnings ration was 29.5, which is pretty steep even if you buy the back-with-CS6 story. Adobe's lack of faith in its own future is shown by it's failure to pay a dividend. On the other hand it generated $314 million in free cash flow and ended with a cash balance of $2.8 billion.

CS6 is scheduled for release in late Q2, so probably in May. We will get a little bit of revenue feedback when Q2 results are announced in June.

Disclaimer: I don't have a position in Adobe. I do use some Adobe software, and I am long in a variety of technology stocks that might have relationships with Adobe.

Thursday, March 15, 2012

Dot Hill Expects New OEM Customers in 2012

Dot Hill (HILL) is up today after reporting a poor fourth quarter 2012 yesterday. Q4 results were in line with revised guidance given in February. Today's stock price upside came from new customer sign-ups that management hopes will provide both higher revenues and better margins in 2012.

Dot hill manufactures data storage arrays for the low-end of the enterprise market, selling to OEMs that typically rebrand the devices. A few years ago Sun was their main customer, but Sun dropped them, leading to a crisis. HP is now their main customer. While they are happy with the HP relationship, which was extended for five years last year, management has been building an impressive list of other customers, reducing reliance on HP.

Revenue in Q4 was $47.0 million, down 2% sequentially from $48.1 million and down 28% from $65.4 million year-earlier. Part of the y/y decline resulted from the purposeful ditching of NetApp as a client because NetApp would not allow Dot Hill workable margins.

HP represented 67.5% of revenue in Q4. In Q1 2011, after NetApp dropped out, HP accounted for 76% of revenue. Partly there was a drop in revenue from HP, but mainly their share shrank because Hill's sales to smaller, Tier 2 OEMs grew 40% y/y.

Q4 revenue was also hurt by the Thailand flooding and resulting shortage of disk drives. Hill did not raise its prices in Q4, but did raise prices in February largely because of the higher prices of disks due to the shortage. They estimated they could have generated another $4 million in revenue in Q4 if not for the disk shortages. Q1 also has seen supply shortages, but drives are generally available except for the highest-capacity, newest technology drives. The disk supply issue should be over by Q3.

Autodesk and Concurrent Computer were cited as OEMs signed in 2011 that are seeing sales ramps. Official announcements of newer customers should be coming out as the year progresses.

Finally, new storage arrays that have mid-level enterprise features should be released in the second half of the year. OEMs are already excited about them, but a significant revenue ramp of the new products is probably a 2013 story.

Earnings were disappointing. GAAP net income was negative $6.6 million, non-GAAP net income was negative $1.6 million, but some of the charges were non-cash. Cash flow from operations was positive by $1.1 million.

On the whole Dot Hill management was upbeat, particularly about the second half of 2012. The hope would be that with no disasters, a reasonably healthy global economy, and the ramping of lines at newer OEM customers, Dot Hill will be able to enter an era of sustained profitability. Given that the company is debt free and holds $46 million in cash, and that its market capitalization today is just $82.6 million, Dot Hill is highly speculative, but has a lot of upside potential if management can execute according to plan.

Disclaimer: I am long Dot Hill, and sometimes actively trade in the stock. I won't make HILL trades for 1 week after publishing this article. I do not have positions in any of the other companies mentioned.