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Red Hat reports profit growth

Top Linux seller details its earnings increase after spooking investors with CFO departure news.

Red Hat's net income for its first quarter of fiscal 2005 beat analyst expectations, but revenue didn't increase as much as forecast.

The Raleigh, N.C.-based company's revenue increased 53 percent to $41.6 million, somewhat less than the $43 million average expected by analysts surveyed by Thomson First Call. Net income increased 603 percent from the year-earlier quarter to $10.7 million, or 5 cents per share. Analysts also expected net income of 4 cents per share for the quarter, which ended May 31.

Red Hat shares dropped in recent days--closing at $25.66 Monday and $22.35 on Thursday--after the company announced on Monday the surprise resignation plan of Chief Financial Officer Kevin Thompson. Shares recovered somewhat on Tuesday, when the company tried to reassure investors by showing some of the quarterly results.

And then there's the matter of filling Thompson's seat. "We're looking for somebody that has the experience of managing a larger business"--someone who knows about annual revenue of $750 million, mergers and acquisitions, and international operations, Chief Executive Matthew Szulik said during a conference call. He plans to fill the post by the time the company reports second-quarter earnings in September.

Red Hat's revenue was lighter than expected--and than Red Hat had forecast--chiefly because many of Red Hat's deals arrived at the end of the last month, Thompson said.

In after-hours trading Thursday on Inet ATS, Red Hat shares dropped $1.60 further, or 7 percent, to $20.75.

The company sells annual service and support subscriptions to its Red Hat Enterprise Linux software, a product that includes an operating system and, increasingly, higher-level software for tasks such as running Java programs on servers. Competitors include Microsoft, Unix stalwart Sun Microsystems and Linux rival Novell.

Red Hat sold 98,000 subscriptions in the most recent quarter, an increase of 11,000 over the 87,000 sold three months earlier. However, over that period, the average sale price dropped from $455 per subscription to $430 per subscription.

Of the subscriptions, 75,000 went to conventional computing buyers and 23,000 to Web site hosting companies or high-performance computing users--two classes of customers who buy software in larger quantities and therefore enjoy deeper discounts.

Thompson said Red Hat is pleased with its subscription increases, which tripled over the last six months. "Look at that growth rate. Find us another technology that's growing that quickly," Thompson said.

For the remaining three quarters of the fiscal year, Red Hat expects the subscription price to be about $415 per server per year, Thompson said.

Red Hat hired 50 people in the quarter and plans to hire another 150 to 175 by the end of February, Thompson said.

The company receives revenue over a one-year period, so new subscriptions produce money for more than the quarter in which the deal was booked. In the most recent quarter, Red Hat increased its deferred revenue--money it expects in future quarters--from $70.9 million three months ago to $86.1 million, the company said.

It also generated $30.1 million in positive cash flow from operations.

For the quarter now under way, Red Hat forecast revenue growth from $47.5 million to $48.1 million. Enterprise subscriptions--those excluding Web hosting and cluster computing deals--should grow to 85,000 to 89,000 subscriptions, Thompson said.

Among existing Red Hat Enterprise Linux customers, 85 percent of subscriptions were renewed in the quarter, Thompson said. That should stay the same in the second quarter, but in the long term, he said, Red Hat expects a 75 percent renewal rate.

Red Hat is expanding internationally, with strong sales growth in Asia, Szulik said. For China, a market many computing companies are trying to penetrate in order to profit from rapid growth, Red Hat has expansion plans. "The company is evaluating relationships that would allow us to go into China, where we could partner with government, partner with education, partner with industry, to build a sustainable base of operations," Szulik said.

Szulik said the company also just signed its first reseller deal in Mexico in the last week, a partnership that involves Oracle and Intel.

Red Hat signed a deal with a major telecommunications equipment maker during the quarter. "We believe this relationship could drive thousands of subscriptions per year," Thompson said.

"That deal specifically was a very large-unit deal," Szulik said, so Red Hat's subscription per server will be small--probably in the $88 annual range customers in the Web hosting and cluster computing market paid in the most recent quarter.

Also in the quarter, the company signed a deal with Rackable Systems, Szulik said. And it signed a multiyear contract with Amazon.com to "make Red Hat Enterprise Linux the No. 1 operating system platform," Szulik said.

The Amazon deal is an expansion of an existing partnership, Szulik said, declining to detail terms. The agreement with Rackable Systems involves joint marketing.