Don't worry about Red Hat's 2009 profit decline

Red Hat's profit decline is largely attributable to profit declines outside its core operations

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Let me start by saying that Red Hat's 4Q and full-year core business results were solid. Nicely done.

Full-year revenue was up 2 percent to $653 million. Expectedly, 4Q revenue growth was lower than full-year growth, coming in at 18 percent for $166 million.

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Also as expected, Red Hat reported a 27 percent decline in net income (NI, aka profit) from $22 million in 4Q07 to $16 million in 4Q08. For the full year, NI increased 3 percent to $78 million, well short of the 18 percent full-year increase in revenue. Fear not, the tepid increase in profit does not point to issues with Red Hat's core business: the sale, service, and support of software.

I'd previously covered the fact that nearly half (48 percent) of Red Hat's overall profit came from outside its core business. Specifically, the profit came from interest on cash/bonds, from the sale of investments including equity holdings, and gains from currency transactions. Among these items, interest income appeared to be the largest driver of Red Hat's non-core-business income.

With interest rates declining to generational lows, interest income would take a hit. As a result, with all things being equal, Red Hat's NI would decline. Red Hat said as much in its 2008 annual report (pg 48):

...however interest rate yields on our investments are expected to decline, resulting in reduced interest income

The profit decline is largely attributable to other income declining from $18 million in fiscal 2008 to $5 million in fiscal 2007. This represents a 72 percent decline in profit from outside Red Hat's core business. Of this $13 million year-to-year decline, $4.7 million was attributable to a one-time gain in the sale of Red Hat's equity position in a third-party company (which appears to have been MySQL).

Redoing my analysis of Red Hat's "other income," we see that Red Hat is coming closer into line with software industry peers.