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VA Linux Dives 42% on Warning

It failed to predict venture capitalists' distaste for Internet companies and a resulting decline in sales.

Updated from 2:58 p.m. ET

Saying it failed to predict venture capitalists' distaste for Internet companies and a resulting decline in sales,

VA Linux


warned Monday that it would post a bigger-than-expected loss and that its revenue would fall short of analysts' forecasts.

On Wall Street, where VA Linux set a record for its initial public offering less than a year ago, investors unloaded the company's stock. Linux finished down $12.63, or 42%, at $17.38. The stock is now down about 95% from its all-time high of $320, set during its first day of trading in December.

VA Linux, a Fremont, Calif.-based open-source software and server maker, was perhaps the most conspicuous beneficiary of last winter's technology sector gold rush in the stock market. It faulted belt-tightening in the so-called dot-com sector for the wider quarterly loss it now expects.

For the first quarter ended Oct. 27, the company will report a loss of 14 cents to 16 cents a share, compared with the consensus estimate of 9 cents a share predicted by six analysts in a poll by

First Call/Thomson Financial

. Revenue will grow 10% from the $50.7 million reported in the prior quarter, the company said. For the year, revenue will be around $270.675 million instead of the $300.75 million that VA Linux had told investors to expect. The company plans to elaborate on its quarterly results on Nov. 16.

"Although repeat business with our existing customers remained strong during the first fiscal quarter, sales to new customers in the `dot-com' sector were below our expectations," said Larry M. Augustin, the company's chief executive, in a statement. "In particular, the number of new customer opportunities from venture-funded 'dot-coms' declined faster than anticipated."

Since its inception in January 1995, VA Linux's fortunes have mirrored wider trends in technology's perceived value. It approached the stock market last year with few specifics other than its name, derived from the operating system available free on the Internet. At the time, the word Linux seemed to work magic with investors.

"Because we have a limited operating history and because the market for Linux-based systems is rapidly evolving, we may not accurately forecast our sales and revenues, which will cause quarterly fluctuations in our net revenues and results of operations and may result in volatility in our stock price," the company warned in a filing just before its IPO last year with the

Securities and Exchange Commission.

That caveat did not dampen investors' enthusiasm. On Dec. 9, VA Linux notched the largest first-day gain ever for an initial public offering, closing up 698% above its offering price at $239.78.

The company offered 4.4 million shares at $30 a share, raising $132 million. By the market's close that day, that 11% outstanding stake was worth $1.05 billion. The company's total stock market value was $9.5 billion.

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The offering marked the culmination of a series of IPOs that drew ever-increasing enthusiasm for any correlation to Linux, no matter how remote. The day before, shares of

had more than tripled in their first day of trading. VA Linux has since acquired that company.

In the intervening year, many Internet companies have postponed or canceled their initial public offerings, laid off employees and sworn by cost-cutting plans.

VA Linux invested too many of its resources chasing those newly cash-strapped, closely held, venture-funded Internet infrastructure companies, many of which now seem frozen in pre-IPO limbo, said Patrick Fossenier, the company's director of investor relations, in a telephone interview.

"We knew that venture funding had been falling off," Fossenier said. "But it fell off faster than we'd expected. It's not like we don't have other options."

In that specific sector, funding can still be found, said Jeanne Metzger, spokeswoman for the

National Venture Capital Association.

"Venture capitalists, definitely over the last couple of quarters, have been shying away from e-commerce," Metzger said. "However, a very large percentage of venture capital money is going into the Internet infrastructure area."

That trade group, which represents around 420 venture capital firms, issued a report last week stating that in the third quarter of 2000, $7.7 billion was invested in e-commerce and content companies, a decrease of 25.56% from the $10.3 billion invested in the second quarter of 2000. The report shows the largest percentage gain, 48.9%, in a sector simply labeled "non-Internet-related." Those businesses, which do not fit the definition of "companies that provide content, e-commerce, hardware or services to the Internet economy," garnered $7.5 billion in venture capital funding, compared to $5 billion in the second quarter.

For VA Linux, the new target will be large corporate and enterprise accounts with longer sales cycles, Fossenier said. For the time being, the company plans to rely more on sales to its old standby,

Akamai Technologies

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, which provides a global delivery service for Internet content, streaming media and applications. In 1999, sales to that company,





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accounted for 14.5% of revenues. By the first quarter of 2000, that figure was 23.3%.

In the fourth quarter 2000, reported in August, sales to Akamai alone were 21% of revenues, Fossenier of VA Linux said.

Philip C. Rueppel, analyst for

Deutsche Banc Alex Brown

, said the shortfall "doesn't significantly change the outlook for Linux in general or VA Linux in particular."

Rueppel rates the stock strong buy, and his firm co-managed the initial public offering. Of the company's new plan to woo large corporate clients, he said: "I think it's unrealistic to think that a major enterprise like

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is going to shift wholesale to Linux." But if the company could win a small piece of such a client's server business, "it's that kind of customer that's going to bring in a high-profile, recurring revenue stream."