VMware Earnings: Services Drive Growth As License Bookings Slow Down

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VMware (NYSE:VMW) reported its first quarter earnings on Tuesday, April 21st. The virtualization and cloud computing giant reported a slowdown in growth through the March quarter after witnessing 16% annual growth in revenues in 2014 to $6 billion. VMware’s net revenues in Q1 were about 11% higher than year-ago quarter at $1.5 billion, in line with the company’s expectations. The company reported a modest 2% y-o-y increase in product license revenues over the prior year period to $576 million. On the other hand, services revenues were up by 17% year over year  to $935 million. [1]

The company’s software licenses gross margin (GAAP) in Q1 expanded by 25 basis points over the prior year quarter to 91.3%. However, the licenses gross margin was lower 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 28% y-o-y to $193 million for the quarter. As a result, the gross margin (GAAP) for the services division was about 175 basis points lower than the year ago period at 79.3%. Moreover, VMware’s cash operating expenses, particularly sales, marketing and other administrative expenses, were 16% higher than the year-ago quarter at $723 million in Q1. Consequently, the company’s reported net income was nearly flat over previous year levels at $196 million. However, VMware’s non-GAAP adjusted net income was about 6% higher than Q1’14 at $369 million.

Management expects 2015 revenues to be 9-11% higher than 2014 at about $6.6 billion. VMware’s services revenue stream is likely to continue to witness a higher growth rate than revenues generated through license bookings (around 6%). The company has given revenue guidance for Q2’15 at about $1.6 billion or about 9-10% higher than the year-ago period. License booking revenues are expected to rise by 3-4% on a year-over-year basis, while services revenues could rise by about 13%.

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We have a$91 price estimate for VMware’s stock, which is in line with the current market price.

See our complete analysis for VMware here

Continued Growth In Hybrid Clouds, NSX, End-User Computing

Management attributed much of the growth to fast-growing market segments such as hybrid cloud services, end-user computing and network virtualization, now often called software-defined networking (SDN). VMware’s hybrid cloud business grew by over 100% year over year through the March quarter. The company witnessed a similar growth rate in 2014 as well, during which the hybrid cloud business was rebranded vCloud Air. According to the company’s estimates, hybrid cloud and Software-as-a-Service (SaaS) combined contributed over 6% of VMware’s net revenues in Q1.

The other fast-growing domain 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 400 by the end of December, up from 150 at the end of June last year. Moreover, eight 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. 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. Moreover, the NSX can be integrated with vSphere, VMware’s existing server virtualization platform.

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 Q2, Q3 and Q4. 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. VMware was the clear leader in the enterprise mobile management market domain, with nearly twice the customers of its closest competitor. [2] The company has further strengthened its hold on this market space with a 50% y-0-y growth in license bookings during the quarter. Within end-user computing, the desktop-as-a-service business grew by a healthy 15% on a y-o-y basis, while the remaining growth is attributable to AirWatch. 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.

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Notes:
  1. VMware Q1 2015 Earnings Call Transcript, Seeking Alpha, April 2015 []
  2. VMware Q4 2014 Earnings Call Transcript, Seeking Alpha, January 2015 []