uploads///Net margins

How Red Hat’s Margin Looked in Fiscal 2Q18

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Oct. 4 2017, Updated 10:38 a.m. ET

Operating segments’ performance

So far in this series, we’ve discussed the factors that enabled Red Hat (RHT) to post better-than-expected fiscal 2Q18 earnings. Infrastructure-related subscription revenues and continued strong demand for RHEL (Red Hat Enterprise Linux) drove growth in the subscription segment, which rose 20% to $637.6 million. Subscription revenues contributed ~88% towards overall revenues.

OpenShift and OpenStack drove growth in the application development and emerging technologies segment, which rose 44% on a YoY (year-over-year) basis to $150.1 million. This segment contributed 21% towards overall revenues. OpenShift enables programmers to write software that can run in a variety of settings like Amazon’s (AMZN) AWS and Microsoft’s (MSFT) Azure. Consulting projects for Ansible and OpenShift drove growth in the company’s Training and Services division’s revenues, which rose 25% to ~$86 million. This segment contributed 12% towards the company’s total revenue.

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Margin expansion and R&D comparison

As the above chart shows, Red Hat’s net margins improved in fiscal 2Q18 on a YoY as well as a sequential basis. Reduction in sales and marketing expenses, general and administrative expenses, and R&D (research & development) expenses helped Red Hat to achieve this.

Reduction in operating expenses to attain cost efficiency is a widely adopted strategy. However, reduction in R&D can cost the company in the long run. Red Hat spends approximately 20.1% of its revenues on R&D. In comparison, VMware (VMW), Hortonworks, and Cloudera, leading players in open source and virtualization space, spend ~21.2%, ~54%, and ~30% of their revenues on R&D, respectively.

Considering growing competition and technological breakthroughs, Red Hat should continually invest in developing cutting-edge and improved technologies. Investment in R&D helps the company maintain a competitive edge, especially in the rapidly growing cloud space.

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