December 17, 2002 5:47 PM PST

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Red Hat's revenue increased 14 percent to $24.3 million for its third fiscal quarter with a small profit of $305,000, the Linux seller reported Tuesday.

The Raleigh, N.C.-based company's performance for the quarter, ended Nov. 30, did slightly better than projections from analysts surveyed by First Call. Revenue was higher than the consensus expectation of $23.4 million, with break-even earnings per share meeting the estimate.

It's the first time Red Hat has reported a profit using Generally Accepted Accounting Principles (GAAP), according to the company. In the year-ago quarter, it posted a net loss of 9 cents per share on revenue of $21.2 million.

Red Hat sells Linux, a clone of the Unix operating system, and is aiming its flagship Advanced Server product chiefly at business customers who are buying servers. In its most recent quarter, the company introduced two new products: the Advanced Workstation desktop product for technical computer users such as chip designers, and a "carrier grade" operating system for telecommunications companies.

Three months ago, Red Hat said it had sold 8,000 copies of Advanced Server since the product went on sale at the end of May. Tuesday, the company said it sold 12,000 in the third quarter. Red Hat treats revenue from Advanced Server as a subscription, collecting money every quarter for a year for the product.

About 25 percent to 30 percent of Advanced Server customers are existing Red Hat customers that are upgrading, Chief Executive Matthew Szulik said in an interview.

Some analysts are concerned that the Advanced Server product might be expensive for buyers accustomed to Linux's typically low prices.


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"Our industry inputs indicate that some corporate customers are suffering from sticker shock when faced with the Red Hat Advanced Server product. As a result we believe that Red Hat has had to negotiate on Red Hat Advanced Server pricing with customers, possibly resulting in lower (average selling prices) for the product," said SoundView Technology Group analyst Victor Raisys in a recent note. "We believe that many customers may decide that the significantly lower priced Red Hat 8.0 product is 'good enough' for most needs."

Indeed, Red Hat said Tuesday it will split Advanced Server pricing into several categories. Instead of one version, for midrange servers, it will also sell versions for high-end and low-end servers, priced accordingly. "In the future, we will produce a more stratified pricing model," Chief Financial Officer Kevin Thompson said during a conference call.

The average selling price of an Advanced Server subscription in the second and third quarters was $800 to $900 over a year, but it will decrease to $600 to $800 in the future, Red Hat said.

The lowered price won't diminish revenue, though, because reduced selling prices "will be more than offset by an increase in the size of the market opportunity and expansion of other revenue opportunities," Thompson said. The new approach will mean "a significant increase in the number of servers for which the Red Hat Advanced Server is appropriate from a technology and pricing perspective."

The Advanced Workstation version, currently available only for Itanium-based computers from Hewlett-Packard, provides subscription revenue of between $200 and $300 per computer per year right now. The company signed up about 2,000 Advanced Workstation subscribers in the third quarter.

A version of Advanced Workstation for the more widely used Intel Pentium and Xeon computers is due in the first quarter of calendar 2003, Thompson said in an interview. Advanced Server for Itanium is in pilot testing now and is expected in the first half of 2003, Szulik said, with interest from customers running large databases with heavy transaction loads.

Red Hat reported that it generated $1 million in cash from operations. Its overall gross margins were 66 percent.

The company predicted net income of $1.3 million to $2.5 million for the current quarter, which runs through February. Revenue should be between $26.5 million and $27.5 million. Cash generated from operations should increase to between $2 million and $3 million.

"We expect to see strong sequential growth in the fourth (fiscal) quarter of 2003," Thompson said.

In the third quarter, Red Hat acquired a small company called NOCpulse, disclosing Tuesday that the purchase price was $1.2 million and adding that Red Hat is interested in buying more smaller companies.

"The best opportunities are small, talented teams that integrate culturally as well as strategically," Szulik said on a conference call. The company is particularly interested in two areas: managed services that it can offer through its Red Hat Network and security companies, Szulik said.

Red Hat said about 70 percent of its revenue comes from direct sales of products to its customers, but over time, it expects 65 percent to 70 percent of sales to come through indirect sales channels such as its partnerships with IBM, Oracle, Dell and Hewlett-Packard.

Red Hat announced several customers Tuesday, including General Electric, America Online, the United States Automobile Association, Lithonia and Reuters. In the financial services realm, customers include Credit Suisse First Boston, Lehman Brothers, Citibank, UBS Warburg and J.P. Morgan. Toshiba hired the company for embedded software work, while the French government is paying for Red Hat training services.

 

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