March 23, 2001 4:30 PM PST

Investors stand behind Red Hat

Investors applauded Linux company Red Hat's fourth-quarter results Friday, but analysts flagged its slowing sales growth as a sign of potential problems.

Shares closed up 66 cents, or 13 percent, at $5.88 on Friday. The previous day, Red Hat posted a net loss of $600,000, or breakeven on a per share basis, on sales of $27 million, besting Wall street expectations of a 1 cent loss. It also raised its profit targets for fiscal 2002.

Red Hat sells a commercial version of the Linux operating system and develops tailored products for embedded devices, enterprise messaging, and database management. Linux, which was initially developed as an open-source operating system, is seen as a strong contender to take on Microsoft's Windows dominance.

Although Red Hat shares gained, analysts warned that slowing information technology spending may be hurting the company.

ABN AMRO analyst Keith Bachman reiterated his "hold" rating on the stock.

Bachman also cited the company's prediction of flat revenues in the second quarter of fiscal 2002. The company said it expects a fiscal 2002 profit of 10 cents a share excluding charges, or 8 cents a share with charges, on sales of $140 million. According to First Call, analysts expected Red Hat to earn 4 cents a share on sales of $152.4 million for fiscal 2002.

This means Red Hat will have three consecutive quarters of declining to flat revenue. "We are concerned that Red Hat might not be able to sufficiently grow revenues to meet its?revenue guidance of $140 million," Bachman wrote.

For fiscal 2002, Bachman raised his operating earnings estimate from breakeven to 6 cents a share and lowered his revenue estimate from $142 million to $135 million.

Analysts also pondered the affect the company's changing revenue stream would have on future quarters. Previously, Red Hat had derived most of its sales through licensing fees. But for the first time this quarter, the company saw a majority of sales come from services, driven by the acquisition of services company Planning Technologies.

"An increasingly services-focused Red Hat reached profitability two quarters ahead of our model," wrote J.P. Morgan Chase analyst Chris Galvin. "However, it is clear that there is flux in the composition of revenue."

The company's lowered revenue predictions are not surprising given the current overall slowdown, Galvin added, but specific to Red Hat, it shows the affect of an increasing amount of services revenue, which by its nature grows more moderately than license-based revenue.

Galvin lowered revenue estimates for fiscal 2002 to $140 million from $149 million. He retained his earnings estimate of 5 cents per share and his long-term-buy rating.

 

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