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Can VMware Sustain Its Margin Growth?

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What’s driving VMW’s margin?

VMware (VMW) has maintained strong operating margin growth in the last five years. Despite the rise in the cost of services, higher sales and marketing expenses, and higher research and development expenses, the company was successful in generating strong operating income growth. In the last five years, VMW’s operating income grew at a CAGR (compound annual growth rate) of 9.0%.

Strong growth in revenues, coupled with increased bookings for products and higher renewal services, has increased VMW’s margin in the last five years.

In the chart above, we can see VMware’s operating margin trend in the last five years. During this period, the company maintained an operating margin above 15.0%.

In fiscal Q1 2018, VMW’s operating margin came in at 28.1%, compared with 26.7% YoY (or year-over-year). For fiscal 2018, the company’s operating margin stood at 21.3% against 20.3% YoY.

Fiscal 2018 guidance and headwinds

VMware (VMW) projects its non-GAAP operating margin in fiscal Q1 2019 to be 28.5%. For fiscal 2019, the company’s operating margin is expected to be 33.3%.

In fiscal Q1 2018, the company’s sales and marketing expenses, which comprised of the bulk of its total expenses, grew 12.8% YoY to $729.0 million. In 2018, these expenses reached $2.6 billion, up 10.0% YoY. In the last five years, it increased at a CAGR of 3.4%, mainly driven by the company’s international market expansion strategy.

To remain competitive against other virtual network operators such as Citrix (CTXS), VMW is investing heavily in new product development, which may pressure the company’s margin.

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