Red Hat (NYSE:RHT) reported results for the first quarter of fiscal 2016 on Thursday night, exceeding both its own guidance and analyst estimates across the board. Business is doing great, but management is still waiting for several major growth engines to kick in.
In the first quarter, Red Hat's revenue rose 14% year over year, or 22% excluding the effects of currency exchange headwinds. At $481 million, this result was head-and-shoulders above Wall Street's $473 million consensus. On the bottom line, adjusted earnings jumped 29% higher to $0.44 per share, again ahead of analysts' $0.41 estimate.
It should be noted that these big beats included a one-time benefit from changes in Red Hat's earned revenue accounting practices, which added $5 million to the sales figures and $0.02 per share to the bottom line. But the company still exceeded expectations, even if you take away these artificial boosts.
"This strong growth reflects in part the demand for our open, hybrid cloud technologies across four footprints: bare metal, virtualization, private cloud, and public cloud deployments," said Red Hat CEO Jim Whitehurst in a prepared statement.
That's great, but I wanted more detail. So I got Whitehurst on a private call, ready to dive deeper into Red Hat's prospects.
The Internet of Things
Red Hat still doesn't break out the Internet of Things as a separate business division, or even as a reportable product line. There are two major reasons for that, according to Whitehurst:
We do have an embedded business where especially the OS is embedded in a lot of different devices out there," Whitehurst told me. "But IoT for us is bigger than that. There's a lot of middleware and messaging tech that's actually a key part of that.
We do think it's a big opportunity which we're now fully understanding how big it could be, and investing into it. So we're investing incremental resources. I think you'll see us talking more about that as we go forward.
It's a newer area for us so we just haven't had quite as much focus as we should.
So, for one thing, the IoT market isn't about a single Red Hat product. Rather, the burgeoning practice of devices talking to other devices creates sales opportunities for a plethora of Red Hat products. From lightweight, embedded operating systems to beefy data analysis systems, with many pieces of computational and messaging glue in the layers in between, IoT helps this company across the board.
Furthermore, the IoT is just getting started. Whitehurst might talk more about this in quarters to come, but it still isn't quite large enough to make a significant difference to Red Hat's operations.
So the quarter's analyst-stumping results didn't rest directly on the Internet of Things. But you can rest assured the $19 trillion economic value that the IoT is expected to unlock over the next five years will lift Red Hat's numbers as well. The company is in on the ground floor of a game-changing macro trend, and investing to take advantage of the long-term opportunity.
An embarrassment of riches
Red Hat is sitting on a veritable gold mine of both real and potential growth drivers. From Big Data to the Internet of Things, from computing containers to software-defined networking, the company can put a finger in many attractive pies. How does it divide its assets and efforts between these golden opportunities? After all, there are only so many hours in the day and so much cash in Red Hat's coffers. "It's hard," Whitehurst said:
We have a very target-rich environment. We have a lot of opportunities. So we think we could be a larger player in Big Data analytics, we could be a larger player in networking and Internet of Things, you know, but we have to kind of limit what we're doing to the things that we think that we can drive and put enough effort in. It's a constant struggle even in areas that we're in, I think we could accelerate our growth by investing further.
At the same time, we want to be prudent, and not try to do too much. Companies often fail when they try to do too much.
So this balance is an art, and I'm not sure we have it exactly right, but we're trying to get the right balance where we're doing enough without overreaching.
It's a nice problem to have, but the overextension risk is very real. Just ask Blockbuster investors, who years ago expected to find a pot of gold in the emerging DVD-by-mail market but found total annihilation instead. Or look at the plethora of restaurant chains that built their footprint growth from borrowed money, only to collapse when the good times stopped rolling. Overshooting is a serious business risk.
It's no different in the software sector. Red Hat is swimming in cash right now -- operating cash flow rose 27% year over year in the first quarter, stopping at $209 million -- but what happens if the company bets the farm on the one market that doesn't pan out? Or, perhaps even worse, pursues every growth opportunity that crosses its path -- distracting itself from the true game-changing opportunities.
Red Hat doesn't want to walk down that dark path, and might miss out on a few juicy markets as a result. As any Blockbuster or Bennigan's investor will tell you, it's better to be safe than sorry. As a Red Hat shareholder, I'm fine with that strategic choice (some other technology giants with sprawling business portfolios should have followed the same example, years ago).
In other news
In Thursday's earnings call, Whitehurst told analysts to look for news on the CFO selection process "next week," and here it is. On Monday morning, Red Hat announced that former Cisco Systems (NASDAQ:CSCO) CFO Frank Calderoni is taking the same title at Red Hat.
Current Red Hat CFO Charlie Peters announced his retirement in December's earnings call. He has served Red Hat for a full decade and at the age of 63 decided to step back and spend more time with his family. During his tenure, Red Hat's annual revenue rose from $150 million to nearly $1.8 billion.
Calderoni, of course, is a superstar in the tech industry. His 30-year career includes seven years as Cisco CEO John Chambers' right-hand man. He was arguably in the running to replace Chambers when his long-awaited retirement arrived, but that job fell to Chuck Robbins, Cisco's senior vice president of worldwide field operations.
With that career advancement option taken off the table, Calderoni is moving to North Carolina to take the job with Red Hat instead. With this top-shelf name behind the financial controls, Whitehurst reiterated his soaring long-term goals.
"We are thrilled to have Frank join Red Hat and help lead the next phase of our growth as we look to go from revenues approaching $2 billion to $10 billion and beyond," Whitehurst said in prepared press materials.
Calderoni was scheduled to join Red Hat on June 22, taking over Peters' title on July 13. There's nothing wrong with long-tenured journeyman Charlie Peters, but this must be seen as a solid upgrade anyhow. Veteran Cisco executives don't just fall from the sky, and Calderoni's career choice is a strong vote of confidence in Red Hat's blossoming business model.
Anders Bylund owns shares of Red Hat but has no other position in any stocks mentioned. The Motley Fool recommends Apple and Cisco Systems. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days.