Clad in his pyjamas, Red Hat co-founder Marc Ewing arrived at work at 1100 one day in 1998, unlocked the office for a new employee, and promptly left to go back to sleep.

For a guy who developed the Linux distribution in his spare bedroom it just seemed natural. Today, however, such sleepy days are but a dream at Red Hat.

The company is a powerhouse in the open source community: It owns 80 per cent of the Linux market and posted $400 million in revenue for fiscal 2007 -- a 44 per cent increase over the previous year -- and has $600 million in cash stashed under its blazing red fedora.

Last week’s second quarter 2008 earnings showed a 65 per cent increase in net income and a 28 per cent climb in revenue over the same quarter last year.

But Red Hat is moving out of its Linux operating system comfort zone and everyone from Microsoft to IBM to Oracle to Wall Street seems to be breathing down its neck. The company faces stiff challenges to spread beyond its roots, create a middleware platform, build a developer base and collect a critical mass of partners all so it can turn its IT infrastructure platform strategy to gold.

The challenges start with investments in strategic technology areas led by middleware to support intranets, service-oriented architectures (SOA) and online services; and server and desktop virtualisation as part of Red Hat Enterprise Linux (RHEL) 5, which was released in March.

The company for the first time is courting wayward Java developers, and six months ago launched Red Hat Exchange to certify applications from other open source software vendors and back them with Red Hat support services.

Red Hat also is carrying the torch among its open source peers in denouncing Microsoft’s cross-patent licensing deals with open source vendors such as rival Novell.

In addition, the company has expanded its reach with 58 offices around the globe and is bulking up its client list as evidenced by 42,000 new customers added in fiscal 2007.

And it has started fiscal 2008 with contracts inked by Virgin America, Singapore Airlines, Swisscom, the French Ministry of Education and the Swedish Association of the Pharmaceutical Industry.

“Red Hat in many ways is how we measure success in the open source start-up arena," says Raven Zachery, an analyst with the 451 Group. “It transitioned away from packaged software to enterprise sales earlier in this decade and it paid off. It was a great move. Most of us knew Red Hat as a box on the shelf at CompUSA but now it is the Linux that you run in your data centre."

Indeed, it was a time of prosperity for Red Hat as the company saw yearly revenue grow from $42 million in fiscal 1999 to $400 million in fiscal 2007, an 852 per cent increase.

These aren’t times for reflection, however, as the powerhouse has put itself in front of new obstacles that will determine if it can reach the next plateau.

Wall Street tags Red Hat as being in an investment phase and will harshly judge a less than stellar result to its infrastructure platform strategy around middleware and virtualisation. So far, returns are not good on Wall Street as Red Hat's shares have fallen more than 25 per cent in the past year.

The company is being chided for less than expected first-year results in its middleware business anchored by its 2006 JBoss application server acquisition.

Subscription services for JBoss contributed $23.1 million to the overall revenue increase of $122.3 million last year, which amounts to 18.8 per cent.

In last week’s earnings call with financial analysts, CEO Matthew Szulik admitted he wasn’t happy. “The rate of JBoss bookings and revenue growth has not met my expectations,” he said. “We know we can do much better.”

Red Hat’s revenue, based 100 per cent on its one- to three-year subscriptions for support and its training/consulting services, faces erosion as users get more familiar with Linux, defect to Oracle’s cut-rate operating system support services for Red Hat users, or to services from system integrators.
Such erosion could provide financial pressure as the company has seen its subscription revenue rise from nearly 77 per cent of total revenue in fiscal 2005 to just more than 85 per cent in fiscal 2007, while seeing gross profit margin on subscriptions increase from 91 per cent to 92 per cent over those same years. Combined the two bumped Red Hat’s overall gross profit margin from 80.4 per cent to nearly 84 per cent over that same time period.

New businesses will help stimulate new subscriptions, which entitle users to Red Hat technology and support services in a single bundle.

The company’s middleware venture is wandering into a jungle where vendors, such as IBM, BEA, Oracle and Novell, are all carving out alliances to deflect Red Hat. Ditto in the virtualisation market where VMware is crushing everyone, and Microsoft next year plans to join the fray with the same sort of hypervisor Red Hat built into its operating system.

Company officials say they’ve been here before and won’t flinch.

“That is how Red Hat has grown up, battling titans,“ says Mike Evans, the company’s vice president of corporate development. “We have built out the operating system, we have been building the network management, adding security and other things and it was a big bite for Red Hat to acquire JBoss and get into the middleware market and battle some more titans."

The $328 million JBoss acquisition put the company onto a whole new layer of the software stack, a place it failed to thrive with an earlier project around the Java Open Application Server (JOnAS) that never attracted a legitimate user base.

The current JBoss Enterprise Middleware Platform is about providing a common set of open source tools to create a foundation that will support software components and applications, a similar model Red Hat used with its operating system.

The platform includes the JBoss Enterprise Application Platform, a stand-alone offering that runs on Linux or Windows and the similar Red Hat Application Stack, which comes bundled with RHEL 5. The platform also includes the JBoss Enterprise Portal Platform.

And like the operating system, Red Hat wants to create a JBoss community.

Earlier this year, it established JBoss.org, an open source project to spur innovation that can migrate into the enterprise platform.

The relationship is much like RHEL and Fedora, the open source project around the operating system. Red Hat also built a support structure for patching, upgrades and general maintenance called JBoss Operations Network that mimics its Red Hat Network.
“Red Hat wants to be regarded as an SOA suite powerhouse,“ says Jim Kobielus, principal analyst for data management at Current Analysis. “But the JBoss stack is very much a work in progress and components are missing for them to contend with the likes of Oracle, IBM and BEA."

Kobielus says those components include ETL (Extract, Transform, Load), and event stream processing on the data integration side and business intelligence tools on the portal side.

Red Hat owns up to those challenges as evidenced by its April acquisition of MetaMatrix, a platform for integrating disparate data source into Web-based applications.

Red Hat customers are taking a shine to the JBoss possibilities but also evaluating how the entire open source stack fits together.

“On the application layer with JBoss, Apache Web Server and MySQL, I want to see how Red Hat is making these three separate worlds come together as one offering," says Ravi Simhambhatla, director of architecture and integration for Virgin America. “That is going to be critical for me to make some decision going forward."

To date, Virgin America, which took to the skies for the first time in July, is confident having already built its commerce and corporate infrastructure on RHEL, but its middleware is still in flux as it plans an October migration from Apache Tomcat application server to JBoss.

Red Hat’s efforts to build around JBoss is but one in a set of interwoven transitions designed to create an enterprise infrastructure platform, including its first serious attempt to woo Java developers, its first virtualisation technology and its first marketplace to support a host of open source applications certified to run on that platform.
In fact, Red Hat’s expansion efforts have resulted in a 73 per cent increase in its R&D budget from $40.9 million in fiscal 2006 to $71 million in fiscal 2007. And those numbers are likely to rise in fiscal 2008.

Last month, the Red Hat Developer Studio went into beta. It is a set of eclipse-based development tools that are preconfigured for the JBoss platforms.

“Linux as a server is going well beyond the fringe applications," says Paul Cormier, executive vice president of engineering at Red Hat. “It is going into the core and when you start to penetrate into the core of business applications you need a strong developer platform. That is what this is all about."

It’s also about giving Java developers their first serious Red Hat on-ramp.

The company also is offering a place for those developers to push their applications upstream to Linux users. In March, the Red Hat Exchange went online offering a marketplace featuring more than a dozen open source companies including MySQL, SugarCRM and Alfresco Software. The intent is to attract larger user companies that may have hesitated at open source for fear of dealing with smaller vendors and having to integrate disparate software packages on their own.

The big prise, however, may be virtualisation, which debuted in RHEL 5.

The virtualisation market, while in its infancy in terms of corporate adoption, is a hot topic in corporate data centres.

“One of the most important things for us is to be on the cutting edge with technology efficiencies," says Pete Waterman, principal engineer for Blackboard, which sells and hosts learning software for educational institutions.

The company has been testing RHEL 5 virtualisation for the past six months and is in the process of rolling it out.

“It will let us do almost instantaneous failover, stand up clones of our environment to help with things like fixing bugs, support on-demand dial-up and dial-down of capacity and help cut operational overheard," Waterman says.

These technology changes also mean other big changes that Red Hat will have to pull off in order to prosper.

“The big challenge for Red Hat is moving from an [operating system] distributor to becoming a distributor of an application platform, a virtualisation platform, an SOA platform. Moving into those spaces is not an easy transition," says Denny Fish, senior analyst for infrastructure software and services for financial services firm JMP Securities. “They are selling to different people within an organisation. The [operating system] is often an indirect sale, but with the middleware platform, for instance, you are selling to application developers and systems architects."

The trick, Fish says, will be making the platform attractive to people who have not traditionally been Red Hat’s customers.

What might make Red Hat different in a lot of its competitive situations, however, is that it is doing everything with a true open source commitment.

That attitude is not only appealing to many corporations that are now keenly interested in the benefits of open standards and open platforms, but it helps Red Hat maintain its dominant, and respected, position in the open source world as it provides a foundation to attract others and grow the open source community.

Taking on that leadership position for open source is helping fuel the company’s reputation, insiders say.

“Red Hat’s success is Linux’s success and vice versa," says Jim Zemlin, executive director of the Linux Foundation. “They are a pillar of open source. I’d love to see 10 or 20 more Red Hats."