Red Hat reports a profit and a purchase

Red Hat's quarterly profit and revenue hit all-time highs, the Linux seller said Thursday, as it announced an agreement to acquire storage specialist Sistina Software for about $31 million in stock.

The Raleigh, N.C.-based company had net income of $4.1 million, or 2 cents per share, for the third quarter of fiscal 2004, which ended Nov. 30. That compared with $214,000 for the year-earlier quarter and matched an average of analyst estimates compiled by First Call.

Red Hat's revenue grew 36 percent to $33.1 million, surpassing the estimates by Merrill Lynch's Jason Maynard, who expected $31.4 million, and W.R. Hambrecht's Sameer Nadkarni, who expected $31.8 million.

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The Sistina acquisition, expected to be complete in early January, will help Red Hat improve storage software in Linux, Chief Executive Officer Matthew Szulik said in a conference call. Red Hat continues to search for other companies to acquire, he added.

Sistina programmers lead the development of Linux's logical volume manager, software that makes computers more flexible by insulating them from changes in storage hardware. In addition, Sistina creates file storage software that can be used to share data across a cluster of database servers.

Better volume management is a major new change to the newly released version 2.6 of the heart of the Linux operating system, and Red Hat has said it's eager to take advantage of the software.

Red Hat sells its Linux software as an annual subscription that includes support and product updates through the Red Hat Network; unlike previous Red Hat products, it requires customers to purchase a separate subscription for each server. The Sistina software will fit into Red Hat's Open Source Architecture, under which the company plans to sell new modules that build on its Linux foundation.

"Total subscription dollars per server and per customer (will increase) by delivering additional customer solutions," Szulik said.

Red Hat sold 33,000 Red Hat Enterprise Linux (RHEL) subscriptions in the third quarter, a 7,000 increase over the quarter ended Aug. 31.

Of the 33,000 subscriptions, 3,000 were earlier Red Hat customers who upgraded to RHEL, Thompson said. The company has sold a cumulative total of about 125,000 subscriptions so far.

Red Hat also had 2,500 new customers in the quarter.

Red Hat expects 40,000 subscriptions in its fiscal fourth quarter, which ends Feb. 28, said Chief Financial Officer Kevin Thompson. Also for the quarter, the company expects net income of $5.5 million to $5.7 million on revenue of $36.2 million to $36.7 million.

Although RHEL 3 is on sale, it won't be certified by key sales channel partners--such as IBM, Hewlett-Packard and Dell--until February or March, Thompson said.

Because the subscription revenue is booked gradually over the course of a year, much of it has yet to arrive. Red Hat said its deferred revenue increased 40 percent by the end of the quarter to $42.3 million.

In addition, Red Hat generated $12 million in cash to its coffers, ending with a cash and short-term investment balance of $329 million.

Red Hat has been criticized by software users who, with the arrival of the RHEL software, no longer are able to obtain a business-ready version of the software at no cost.

But financial analysts have praised the RHEL plan as a way to generate revenue, in particular with the release of a new version in October.

"The release of Red Hat Enterprise Linux 3 is a catalyst for increased subscribers and the company's No. 1 market share position," said Maynard, who rates Red Hat "neutral" in a report this week.

Although Red Hat appears to have achieved consistent if modest profits, it faces several challenges. It's entangled in a high-profile lawsuit in which the SCO Group, owner of several Unix copyrights, sued IBM for $3 billion for allegedly moving Unix technology to Linux against the terms of its contract with SCO.

Red Hat joined the fray with a lawsuit of its own against SCO--a company that itself formerly sold Linux. Red Hat's suit seeks a quick judgment declaring that Red Hat's products don't violate SCO's copyrights or trade secrets.

"The issue of the SCO litigation, although a topic of conversation with (customers), did not inhibit the quarter," Szulik said Thursday. "We anticipate being presented with the facts instead of the rhetoric very shortly," he added, referring to a Dec. 5 judicial order that show which Linux software SCO believes violates its intellectual property rights.

Another challenge comes from Red Hat's top competitor, Germany-based SuSE Linux, which could grow more powerful soon.

Provo, Utah-based Novell plans to complete a $210 million acquisition of SuSE by January, boosted by a $50 million investment from IBM. Analysts expect the buy to boost SuSE's development efforts, expand its available software and increase its presence in the United States.

Szulik said it was too soon to assess the effect of the acquisition but noted that IBM was an early investor in Red Hat. His interpretation of Big Blue's move: "IBM wanted to make sure there were two players in the marketplace in the long term, which is positive for us," he said. "People who work for SuSE contribute to our RHEL 3 product. I think it was IBM showing just good common sense."