SDN, Hybrid Cloud Service, AirWatch Continue To Drive VMware’s Performance

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VMware (NYSE:VMW) announced its second quarter earnings on Tuesday, July 21, reporting 4% annual growth in net revenues to $1.52 billion. [1] In line with the company’s expectations, license booking revenues were up by 4% on a year-over-year basis to $638 million, while services revenues rose by about 14% to $959 million. The company’s non-GAAP net revenues (after adjusting $76 million in payment made for the GSA settlement) were up by over 9% on a year-over-year basis to $1.59 million, which was in line with the company’s expectations. [2]

The company’s software licenses gross (GAAP) expanded by almost 30 basis points over the prior year quarter to 92.8% in Q2. Moreover, the licenses gross margin was slightly higher than the 2014 average of 92.6%. On the other hand, the company generated higher service revenues from hybrid clouds, network virtualization and end-user computing, due to which its cost of services rose by 19% y-o-y to $204 million for the quarter. As a result, the gross margin (GAAP) for the services division was about 90 basis points lower than the year ago period at 78.7%. On the other hand, VMware’s cash operating expenses – including R&D, sales and marketing expenses combined – were only about 2% higher than the year-ago quarter at just over $1 billion in Q2. Consequently, the company’s reported net income was up by 3% y-o-y to $172 million despite a significant rise in cost of services incurred by the company. Moreover, VMware’s non-GAAP adjusted net income was about 13% higher than Q2’14 at $396 million.

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Solid Customer Response For NSX, End-User Computing And Hybrid Cloud

A key area of growth for VMware over the last few quarters has been the VMware NSX, its network virtualization platform, launched by the company in late 2013. The company has seen a strong customer response for the NSX with the number of paying customers rising to over 700 by the end of Q2, up from 400 at the end of December and only about 150 at the end of June last year. Moreover, five out of VMware’s ten largest deals during the quarter included the NSX implementation. VMware’s software-centric approach to networking threatens to cannibalize Cisco’s (NASDAQ:CSCO) market share in the SDN market. According to the company’s estimates, the number of production customers that are currently using NSX are far more than customers using similar products of any competing provider. What makes VMware’s SDN appealing to enterprises is that it allows them to put third-party software on cheap white-label networking hardware, making it potentially much cheaper to implement than installing Cisco’s hardware products, which come with embedded software.

During the quarter, VMware released VMware vCloud Air Advanced Networking Services, which incorporates all NSX services with vCloud Air, the hybrid cloud service. Additionally, the company also announced general availability for hybrid cloud service to Asia-Pacific customers via its location in Australia. VMware’s hybrid cloud business grew by over 100% year over year through the March quarter. Keeping up the trend, hybrid cloud (or vCloud Air) revenues grew by over 80% y-o-y through the June quarter. According to the company’s estimates, hybrid cloud and Software-as-a-Service (SaaS) combined contributed over 6% of VMware’s net revenues in Q2 and through the first half of 2015, up from 5% in 2014 and under 3% of net revenues in 2013.

The third key area of growth for VMware was end-user computing and mobile device management, which was boosted by the $1.5 billion Airwatch acquisition in January last year. The company has since witnessed strong demand for mobility solutions, as evidenced by 50-60% year-over-year growth in end-user computing license bookings through 2014 and in Q1 this year. Keeping up the trend, the company witnessed a 30% year-over-year increase in license bookings for AirWatch in the June quarter. The growth rate was lower than previous quarters mainly due to tougher year-over-year comparisons. Within end-user computing, the desktop-as-a-service business grew by a healthy 15% on a y-o-y basis.

At the end of December last year, the total number of AirWatch customers stood at over 15,000, while net revenues generated through license bookings crossed the $200 million mark in the December quarter. The company has sustained growth in this domain and was recently recognized by IDC as a clear leader in enterprise mobility management domain. [3]

Positive Outlook For Q3

The company expects the strong momentum for end-user computing, the rate of NSX adoption and hybrid cloud services to continue over the coming quarters. Going forward, management expects Q3 revenues to be 9-10% higher than prior year levels at about $1.65 billion. VMware’s services revenue stream is likely to continue to witness a higher growth rate than the revenues generated through license bookings. The company has given revenue guidance license booking revenues to rise by 6-7% on a year-over-year basis to about $680 million, while services revenues could rise by over 10%. In terms of cash flows, the company reported a $75 million payment for the GSA settlement during the quarter, due to which it has lowered its expected cash flow from operations to $1.87 billion, from $1.95 billion previously. [4] Additionally, the company has revised its CapEx guidance to under $350 million for the full year, down from about $400 million stated previously. [2]

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Notes:
  1. VMware Reports Second Quarter 2015 Results, VMware Press Release, July 2015 []
  2. VMware Q2 2015 Earnings Call Transcript, Seeking Alpha, July 2015 [] []
  3. VMware Named A Leader in the IDC MarketScape for Client Computing Software, VMware Blog, June 2015 []
  4. VMware will pay the government $75.5 million to settle an overcharging lawsuit, Business Insider, June 2015 []