VMware Ends The Year On A High Note: Strong Outlook For 2015

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VMware (NYSE:VMW) announced its fourth quarter earnings on Tuesday, January 27. The company reported a 15% increase in net revenues over the prior year quarter to $1.7 billion – slightly higher than the upper end of the guidance given at the end of Q3. Services revenues were up by 16% y-o-y to $926 million while software license sales rose by 13% to $777 million. VMware’s full year net revenues stood at just over $6 billion, which was nearly 16% higher than 2013 revenues. [1]

Software licenses gross margin (GAAP) expanded by 40 basis points over the prior year quarter to 93.6%. On the other hand, as the company generated higher service revenues from hybrid clouds, network virtualization and end-user computing, its cost of services rose by 40% y-o-y to $204 million. As a result, the gross margin (GAAP) for the services division was about 4 percentage points lower than the year ago period at 78%. Moreover, VMware’s operating expenses, including research and development, sales, marketing and other administrative expenses, were 20% higher than the year-ago quarter at $1.1 billion in Q4. Consequently, the company’s reported net income was nearly flat over previous year levels at $326 million. However, VMware’s non-GAAP adjusted net income was about 7% higher than Q4 2013 at $467 million. Similarly, the company’s non-GAAP net income for the full year was about 6% higher than 2013 at over $1.5 billion.

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Hybrid Cloud, SDN, End-User Computing Drive Revenue Growth

VMware’s management mentioned that the company has been focusing on fast-growing segments including network virtualiztion, or software-defined networking (SDN), hybrid cloud services and mobile device management or end-user computing.

Hybrid Cloud

VMware’s hybrid cloud business, which was rebranded vCloud Air in Q3, grew by nearly 80% y-o-y in the second and third quarters. The trend continued in Q4, as the company witnessed  100% y-o-y growth. Moreover, the company furthered its hybrid cloud penetration in the healthcare industry as it closed a large deal with a pharmaceutical company during the quarter. At the end of Q4, hybrid cloud and software-as-a-service offerings combined formed about 5% of VMware’s net revenues, up from under 3% of net revenues in the 2013. Although hybrid cloud is one of the fastest growing sub-segments within the company, management expects a stronger dollar and tougher year-over-year comparisons to limit growth in this segment in the coming quarters.

Network Virtualization

Over the last few quarters, the company has seen a positive customer response for NSX, the network virtualization platform launched by VMware in late 2013. VMware reportedly made significant progress in 2014 through strategic partnerships and reseller agreements with peer technology and networking companies such as F5 Networks (NASDAQ:FFIV), Hewlett-Packard (NYSE:HPQ) and Dell (NASDAQ:DELL). VMware now has over 400 paying customers for NSX, up from 150 at the end of the second quarter and 250 at the end of Q3. Management articulated that NSX is key to large deals, as evidenced by the fact the nine out of VMware’s top 10 deals in Q4 had VMware NSX as a part of the license agreement. The company also closed a $10 million plus all-NSX deal with a global investment bank during the quarter. Similarly, VMware’s flagship storage-attached network platform the vSAN saw its customer base rise up to over a 1,000 paying customers through the year.

AirWatch and End-User Computing

VMware announced the acquisition of mobile device management (MDM) provider AirWatch for over $1.5 billion back in January 2014 in an attempt to add enterprise-mobile management and security to its offerings in the end-user computing space. The company has since witnessed strong demand for mobility solutions, as evidenced by 50-60% y-o-y growth in end-user computing license bookings in both Q2 and Q3. The trend continued in Q4, with a 60% y-o-y rise in license bookings. Furthermore, the total number of AirWatch customers stood at over 15,000 at the end of Q4, while net revenues generated through license bookings crossed the $200 million mark for VMware during the quarter. As a result, VMware is now the clear leader in the enterprise mobile management market domain, with its closest competitor having a customer base of under 8,000 paying customers.

Outlook For 2015

VMware expects 2015 revenues to be 10-12% higher than 2014 at about $6.7 billion. VMware’s services revenue stream is likely to continue to witness a higher growth rate (of about 14%) than revenues generated through license bookings (+8%). The company has given revenue guidance for Q1’15 at about $1.5 billion or about 11% higher than the year-ago period. License booking revenues are expected to rise by 5%-6% on a y-o-y basis, while services revenues could rise by about 13%.

VMware’s non-GAAP operating margin for 2014 was in line with the company’s expectations at 31.1%. The company expects the non-GAAP operating margin for Q1’15 to sequentially decline to about 29.5%. However, VMware’s non-GAAP operating margin for 2015 is expected to be slightly higher than 2014 at around 31.5%. Additionally, the company plans to repurchase shares worth $1 billion through 2015 – up from $700 million in 2014.

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Notes:
  1. VMware Q4 2014 Earnings Call Transcript, Seeking Alpha, January 2015 []