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THE DAY AHEAD: Execution worries, CFO search hover over Red Hat earnings

Tech Industry

COMMENTARY -- When Red Hat (Nasdaq: RHAT) reports its fiscal second quarter earnings Thursday analysts will be looking for the subtle items that may indicate the Linux software and services company is juggling too much.

Aside from the usual top-line and bottom-line tallies, analysts are looking for fissures that could indicate problems ahead. Analysts are projecting a loss of 2 cents a share on sales of about $18.5 million to $19 million. And, oh by the way, a new CFO would be nice too.

In July, Red Hat Chief Financial Officer Hal Covert resigned to go to SGI (NYSE: SGI). Covert, who was at Red Hat all of five months, was known as an operational guy. That focus on operations was greatly needed, since Red Hat has acquired three companies in the last 12 months.

With Covert off to resurrect SGI, Walter McCormick, head of corporate development, now acts as the interim CFO. The shuffling has stretched the top management at Red Hat. McCormick used to devote his time solely to operations, but now has split duties, analysts said. Will Covert's departure hurt Red Hat's operational performance?

"I'm looking for revenue traction and to see how they are doing with the operations," said William Crawford, an analyst with Merrill Lynch. "Hal was a good operations CFO."

Crawford said he wasn't expecting a disaster. Even if there were problems, it's unlikely they would show up in Red Hat's second quarter, the slowest of the fiscal year. Nevertheless, analysts will be looking for "hairline cracks" in the quarter.

In other words, you can expect a lot of nit-picking over Red Hat's second quarter.

Prakesh Patel, an analyst with W.R. Hambrecht, downgraded Red Hat to "market neutral" shortly after Covert resigned. The main reason was Red Hat has too many balls in the air to juggle.

Patel is taking a "wait and see" approach. He noted that Covert's departure wasn't the end of the world, but there are a lot of execution worries at Red Hat.

"There's been a lack of visibility about the CFO and future quarters," said Patel.

Although Red Hat execs predicted profits sometime in 2001, there's no quarterly blueprint. Red Hat could turn profitable in the first half, second half or somewhere in between.

Patel said it would be a good time for Red Hat to give more guidance on the profit push. Here are some things to listen for on Red Hat's conference call:

Guidance on upcoming quarters: Red Hat has been open about the goal -- profits -- but hasn't offered a lot of the details. The big picture is nice, but analysts want more granular information.

Execution progress: Red Hat is projecting 100 percent revenue growth year-over-year with an accelerated path to profits. Those lofty goals will require active management of growth and expenses in a changing open source software market. Any hiccup could rattle investors.

Acquisition integration: Red Hat has acquired Cygnus Solutions, Bluecurve and WireSpeed in the last year. The company has to integrate these companies and maintain customer satisfaction.

Employee turnover: The company hasn't had turnover problems historically, but Red Hat has a high concentration of open source software talent. With companies such as Hewlett-Packard (NYSE: HWP), IBM (NYSE: IBM), Dell (Nasdaq: DELL) and Red Hat's traditional foes looking for Linux help, it may not take much to start a bidding war.

New CFO: Analysts want to hear about the CFO search and are clearly hoping for an exec who has a lot of experience with operations and acquisitions.

TDAIN
• Red Hat dips on downgrade, CFO departure
• The Day Ahead: Red Hat steps up profit push
• Subscribe to The Day Ahead>

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