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Updated from 7:22 p.m. EDT

Shares of

Red Hat


were being pummeled after hours, as investors reacted to the news that the company's cash flow and net income dropped sharply in the second quarter and that sales in the third quarter may be slightly below expectations.

Shares were off $3.90, or 14.8%, to $22.42 in recent trading on Instinet.

The Linux software developer posted a second-quarter revenue spike of 52% from the year-ago quarter on strong subscription revenue, but it was offset by stock-option and merger-related expenses.

On a GAAP basis, the company earned a profit of $11 million, or 5 cents a share. on total revenue of $99.7 million. A year ago, the Raleigh, N.C-based company earned $18 million, or 9 cents a share, on sales of $66.7 million.

Cash flow from operations slipped to $43.9 million from $45.8 million a year ago. And on an adjusted basis backing out currency effects and JBoss revenue, billings were down from $115 million in the first quarter to $113 million. Analysts on the call hammered on this point, with Heather Bellini of UBS saying, "Your trailing indicators are up, but the leading indicators

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including billings appear down."

Profit was hurt by a sharp increase in operating expenses, which rose 75% to $73.8 million from $42.2 million a year earlier.

Red Hat said that because of taxes and stock compensation expense between fiscal 2006 and 2007, net income was not directly comparable between these periods.

After adjusting for these accounting differences, non-GAAP adjusted net income for the second quarter of fiscal 2007 was $23.7 million, or 11 cents a share. This compares to non-GAAP adjusted net income of $17.7 million, or 9 cents in the year-ago quarter.

Analysts polled by Thomson First Call were looking for earnings of 10 cents a share before items on revenue of $97.1 million.

CFO Charlie Peters said the just-reported quarter will likely be the "low point" of profitability and cash flow. The major culprits in the slide, were: A loss of productivity as sales people and even engineers took time from their primary duties to learn about JBoss, acquired by Red Hat earlier this year; organizational changes, including a shift in leadership, in the Asia/Pacific area; and a higher proportion of three-year deals in which only the first year of revenue is recognized immediately.

Although revenue in the three-years deals will likely be recognized in the future, operating cash flow is hurt in the short run because fewer dollars go to the balance sheet.

Quarterly gross margin improved to 84% from 82% in the year-ago period.

During the quarter, Red Hat closed its

acquisition of JBoss, an open-source application server company. The company said JBoss contributed $7 million in revenue in the quarter, which was somewhat better than expected, and the new unit is on track to reach its target of $22 million to $23 million in the fiscal year.