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VA Linux cuts 25 percent of workers, delays profitability

The company misses lowered expectations and warns that profitability will arrive nine months later than planned.

VA Linux Systems missed lowered expectations Tuesday, saying it will cut 25 percent of its staff and warning that profitability will arrive nine months later than planned.

VA, which issued revenue warnings for each of the last two quarters, has had time to grow accustomed to the darker days that have replaced the Linux hype that drove VA's stellar initial public offering. But the news Tuesday was even bleaker for the Fremont, Calif.-based company, which sells Linux-based servers, storage systems and services.

Excluding one-time and acquisition-related charges, VA lost $13.3 million, or 28 cents per share, in its fiscal second quarter. A consensus of analysts expected the company to lose 26 cents per share, according to First Call. In the same quarter a year earlier, the company lost 20 cents per share.

Revenue for the quarter was $42 million, a 111 percent increase over the $20 million in the year-ago quarter but a 24 percent decrease from the previous quarter.

Including one-time charges and amortization of goodwill and of intangible assets, the company lost $74 million, or $1.57 per share.

"The economic slowdown obviously has an impact," Chief Executive Officer Larry Augustin said in a conference call about the quarter, which ended Jan. 27.

Augustin and Chief Financial Officer Todd Schull had several gloomy items to report:

•  A quarter of the company's 556 employees, including engineers, will be laid off as part of an effort to reduce expenses. The company plans to announce later the amount of the charge for the restructuring but said the layoffs will save $5 million per quarter.

•  Gross margins, a key measure of profitability, plunged to 16.1 in the fiscal second quarter from 22.5 percent during the first quarter. "We expect gross margins to be under continuing pressure" because of slowing sales and dropping product prices, Schull said.

•  The company set aside $14 million for inventory it might not be able to sell or might have to sell at lower cost. It also set aside $2.5 million to cover products shipped that customers might not be able to pay for.

•  Profitability is expected to arrive in October 2002, nine months later than previously expected. To reach profitability, VA needs revenue of about $60 million to $70 million per quarter, Schull said, but the company has enough cash to last the longer wait.

Fulfilling its new profitability schedule will be hard for VA Linux, said Prakesh Patel, an analyst with WR Hambrecht.

"It's very difficult to have confidence in the company's ability to meet the targets they've set." Patel said, adding that VA Linux's string of disappointing quarters has turned away many investors. "The company really needs to get some financial performance on the books before investors lose all interest in the stock."

Most of VA's revenues come from companies building Internet infrastructure, which have faced economically strapped times over the past several months. Fifty-four percent of VA's revenue came from this category during its second quarter, a drop from 75 percent in the previous quarter.

Meanwhile, in the past month, Intel has sold off 500,000 shares in VA, according to Securities and Exchange Commission filings.

VA is taking some measures to grapple with the situation. Chief among them is trying to find more big-business customers. Among the new accounts in this category in VA's second quarter were Cisco Systems, Instinet and two unnamed Wall Street financial firms.

VA's sharply reduced revenue forecast shows the company isn't making progress in selling to such corporate customers, Patel said.

"What they really need to do is drive their sales force hard and execute well on their product marketing," said Patel, who has a "neutral" rating on the stock. "They lack relationships at the large enterprise accounts."

Though these big corporate buyers take longer to make purchasing decisions, they typically offer higher profit margins than lower-end customers, Augustin said. However, VA faces more competition in this area from established companies such as IBM, he added.

In addition to the other changes announced Tuesday, the company shuffled high-level managers.

Ali Jeneb, previously general manager of the systems division, has been promoted to president and chief operating officer. Augustin will no longer serve as president and will focus more on VA's strategy.

John T. Hall, formerly vice president of support and professional services, is now senior vice president of marketing. Alan Ibara has been promoted to senior vice president of engineering.

Despite a push to make more money from Linux services--a plan that VA hopes will make it stand out from competitors such as Dell Computer--VA's revenue staple continues to be computer sales.

Of the company's revenue, 81 percent came from computer sales, mostly servers; 11 percent came from its Open Source Developer Network Web site operations; and 8 percent came from professional services.

Staff writer Sergio Non contributed to this report.