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Fiery Talk from Red Hat's Chief

Success may not breed contempt, but it can certainly breed lots of animosity. Just ask the folks at Red Hat (RHAT), the most successful seller of software based on the open-source Linux operating system. In recent months, the North Carolina-based company has been portrayed as everything from a threat to its business partners to a den of intellectual-property thieves.

On Aug. 2, the day before he was to give the keynote address at the LinuxWorld industry confab in San Francisco, Red Hat CEO Matthew Szulik fired back. Szulik spoke with BusinessWeek correspondent Jim Kerstetter about increasing noise from competitors such as Novell (NOVL) and Sun Microsystems (SUNW), what corporate customers really want, and why Red Hat in July restated financial statements. The following are edited excerpts from their conversation:

Q: How serious a threat is Novell? They've got great distribution channels, especially now with their acquisition of European Linux-software company SuSE. How will you keep them at bay?

A: They're a serious competitor, no doubt about it. But Red Hat is a pure play. Our business and the economics of our business are based exclusively on open source, and so the development model that we have is based on that. We evaluated the SuSE acquisition very closely, almost at this time last year. And we chose not to pursue that opportunity.

Q: You looked at buying SuSE?

A: We did.

Q: Why didn't you?

A: The economics didn't work for our business. Our business is increasingly focused on robust [corporate] customer solutions. SuSE was primarily in retail distribution across Germany and [the rest of] Europe. So relative to the other priorities that we had, [including] the difficulty of integrating a company that's more than 3,000 miles away, it didn't match with our business.

Q: Let's talk about Sun. They've portrayed you as the Microsoft (MSFT) of the Linux world. They're saying that because of your strong position in the Linux market, your partner IBM (IBM) will face the same difficulty as it did with Microsoft on the desktop. What do you think of that description?

A: I wish I had Microsoft's balance sheet. I wish that Red Hat had $2 billion to pay [Sun CEO Scott McNealy -- a reference to Microsoft's $2 billion settlement with Sun]. Maybe if we had $2 billion they would keep quiet.

Q: But you're a business partner of Sun. They distribute your software.

A: That's what I thought. I was on a business panel recently with [Sun President] Jonathan Schwartz, and he started that rant. And I said, "What happened? Just a few months ago I was your business partner."

Q: And what did he say?

A: He had some sarcastic answer. Look, we're not focused on that. I hear that stuff. I listened to their earnings call. I'd like to think we approached them for two or three years to work closely with them to build a market. We thought there was great opportunity to expand some of the things they're working on. The desktop. Open-sourcing Java. Developing better network-management services for the customer.

We're very aggressive about trying to work with them. For some reason, that didn't work out. So Sun has taken on a different tone.

Q: But one thing they point out is, well, Red Hat isn't so cheap anymore.

A: I don't think that's the biggest issue for most customers on a percentage basis. My personal discussion with CIOs is that price is the third or fourth priority. Foremost is that the software is distributed as a subscription.

Q: O.K. So you're doing an application server. Why?

A: We're building out that open-source architecture. We announced it a year ago. I think our vision is being manifested right now at (AMZN), on Wall Street. The application server was ripe for commoditization.... What's cool is that we were able to enlist the support of a number of historically proprietary vendors -- BEA (BEAS), Oracle (ORCL), and IBM, to help us develop this.

Q: Why would BEA help you?

A: I think there's a recognition that open source isn't going away. And how do they become a good citizen in the open-source community rather than railing against it? They've taken a pro-open-source position. [BEA CEO Alfred Chuang] has been very pro-active about it. Some competitors in that space either choose to do nothing or choose to rail against it.

Q: You recently had to do some financial restatements. What happened?

A: I knew I was going to get asked this question. PriceWaterhouseCoopers came in and said there was a better way to recognize revenue that was more GAAP-compliant. And after five years of recognizing revenue a certain way, PWC recommended we make a correction, and we changed. Now we've moved to a form of daily revenue recognition, which is quite conservative.

Q: Daily? Can you explain that?

A: In the past, when Red Hat would sell a software subscription, we would recognize the entire month worth of revenue. Now the revenue is recognized on a daily basis, rather than on a month-per-rata basis.

Q: Finally, have you had any luck penetrating the Chinese market?

A: Yes. We're working with Intel (INTC). We're working with Dell (DELL). We're working with Oracle in China. Asia continues to be a very, very important long-term marketplace for Linux and for Red Hat.

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