VMware (NYSE:VMW) announced solid Q3 results on October 21, as both licenses and services posted a strong growth in revenues while operating margins improved to a record ~34%.  Excluding Pivotal and all other divestitures, VMware’s revenues grew by about 19% y-o-y, accelerating upwards from 15% and 13% in the last two quarters, respectively. The out-performance was driven mostly by growth in new product bookings, which have increased in importance to account for almost 40% of the company’s licensing business. VMware’s license revenues grew by a strong 15% y-o-y and beat the high-end of its guidance.
On the services front, VMware continued to benefit from the stickiness of its enterprise customer base that continues to sign long-term contracts in excess of 24 months. The company earned $725 million from services revenue, which is up 20% from last year excluding Pivotal and divestitures. Rising revenues helped VMware take advantage of economies of scale to defend its high operating margins. Going forward, the company expects its operating margins to be in the range of 34%-35% for Q4, typically its strongest quarter.
With the company announcing strong results in Q3 and revising its guidance upward for the full year, the stock has moved up by around 15% this quarter. VMware’s stock is now trading at around 8% below our $93 price estimate for the company.
Licensing Revenues Show Positivity
VMware generated licensing revenues of about $564 million in Q3, up by 15% from last year and higher than the upper end of the company’s Q3 guidance. The major reason for an increase in bookings this quarter was the success of products other than VMware’s standalone product, vSphere.
The newer products, including vCloud and vSphere with Operations Management (vSOM), contributed over 40% of the license bookings this quarter, which is up from 35% in the previous quarter and 30% in Q3 last year. The company expects these Enterprise License Agreements (ELAs) to continue to account for at least 40% of the total bookings in the coming quarter as well. As a result, the company expects Q4 licensing revenues to be in the range of $670-S690m, which is 10%-11% higher than during the same period in 2012.
New Technologies in the Company Portfolio
Three major focus areas for VMware going forward are Software Defined Data Centers (SDDCs), hybrid cloud and end-user computing. The major advantage of the three businesses being interdependent is that they not only contribute to the revenue individually, but make it easier to generate good margins. For example, the acquisition of Desktone, the industry leader in Desktop as a Service (DaaS) option has an added benefit of hosting the solution on the vCloud Hybrid, making it a cheaper and faster option for the SDDC Architecture and helping customers move their desktop infrastructure to the cloud.
VMware has also introduced new technologies in the vCloud Hybrid service, the virtual SAN Storage solution and the NSX network virtualization platform. In order to take advantage of the new trend of software-defined networking (SDN), VMware launched the VMware NSX. This new solution merges the company’s existing vCloud networking product line with the network virtualization platform of Nicira (which it acquired last year) into a single product family. This has been a successful move so far, with the company gaining around 30 new NSX customers, including JP Morgan. The VMware NSX launch was attended by IT heads of General Electric, Citigroup and eBay, giving early signs of potential success in its network virtualization and SDDC venture.
Expecting a strong 2014, the company has hired more than 700 new employees this quarter alone, targeting sales and product teams in emerging markets as well as for its new technologies. Going forward, the company intends to capitalize on the fast-growing mobile virtualization market and make a successful transition from the client-server environment to the mobile-cloud era of computing.Notes: