What does a good soldier do when he's outnumbered and outmaneuvered? He calls in reinforcements, of course. That's why Red Hat (NYSE: RHT ) is beefing up its troops for the coming campaign, at the expense of giving up some ground today.
Red Hat's quarter doesn't look great on the surface, apart from that 44.7% year-over-year revenue spike. Net and operating margins were cut in half, and earnings per share dropped from $0.12 last year to $0.07 this time around. On top of that, half-ton gorillas like Oracle (Nasdaq: ORCL ) and Microsoft (Nasdaq: MSFT ) started flexing their big, hairy biceps at the Linux expert this quarter, with the help of smaller open-source outfits like Novell (Nasdaq: NOVL ) . Oh my.
But Red Hat isn't running scared, at least not publicly. CEO Matthew Szulik spake thusly about the competitive situation:
"We believe recent competitive announcements are expanding the market for open-source software. And based on this quarter's strong bookings, billings, and revenue, we are optimistic that our long-term competitive positioning is being enhanced by the market participation of larger entrants."
Szulik is spinning the Oracle and Microsoft stories as free marketing for Linux in general, serving to expand the whole market rather than grabbing market share from Red Hat. We'll just have to wait and see how that pans out after a couple of full quarters with the new players on the board.
Onward!
In the meantime, those margins are dropping for very good reasons. The company is investing in its future.
Many investors take a look at lower net income figures and run in the other direction. But you gotta dig deeper than that, and put the numbers into context. If an established company like IBM (NYSE: IBM ) or Oracle suddenly doubled its operating expenses, I'd be worried. These guys should have all the infrastructure they need already. Their sales and R&D budgets and staff are already huge, and any significant increases would have to take some time. You just can't find something like 50,000 excellent engineers and get them up to speed on your products in a quarter or two. I'd worry about management's sanity if they tried.
Red Hat is different. It's still a small fish in a big pond, even though it's been in business for 13 years already. Revenues are growing very quickly, and it looks like the management team has decided to make the most of its market opportunity -- right now. That accelerated R&D and sales spending started last quarter, and only intensified in the just-completed one. Capital expenditures also grew faster than operational cash flows.
These are signs of a hungry little fish. Red Hat could rest on its laurels and grow that $1.1 billion cash account some more, but prefers to set itself up for future success instead. If you're a small technology business, like Red Hat, you can't afford not to research your hat off. Then you have to sell those new products to the world -- not an easy task when you're up against marketing juggernauts like the one in Redmond.
Red Hat soldiers on, undeterred, in the face of new market pressures. The company is doing all the right things in my opinion, investing for the long term rather than pandering to short-term expectations. Carry on, soldier.
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