VMware Q3 Results: Dell Opts To Keep VMware Independent And Public

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VMware (NYSE:VMW) announced its third quarter earnings on October 20, reporting 10% annual growth in net revenues to $1.67 billion. [1] In line with the company’s expectations, license booking revenues were up by 7% on a year-over-year basis to $681 million, while services revenues rose by about 13% to $991 million. The company’s net revenues on a constant currency basis were up by over 14% on a year-over-year basis, with the highest growth coming from the Asia-Pacific region. ((VMware Q3 2015 Earnings Call Transcript, Seeking Alpha, October 2015))

The company’s software licenses gross margin (GAAP) expanded by over 40 basis points over the prior year quarter to 93.2% in Q3. Moreover, the company generated higher service revenues from hybrid cloud, network virtualization and end-user computing, and services revenues jumped by 13% through the quarter. However, its cost of services rose by only 8% y-o-y to $212 million for the quarter. As a result, the gross margin (GAAP) for the services division was up by about a percentage point over the year ago period at 78.6%. VMware’s cash operating expenses – including R&D, sales and marketing expenses combined – were about 5% higher than the year-ago quarter at just under $1.1 billion in Q3. Consequently, the company’s reported net income was up by 32% y-o-y to $256 million despite a negative FX impact through the quarter.

See our complete analysis for VMware here

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NSX, End-User Computing And Hybrid Cloud Drive Growth

VMware launched its network virtualization platform NSX in late 2013. Since then, the company has seen a strong customer response for NSX, with the number of paying customers rising to over 900 by the end of Q3, up from 400 at the end of December and only about 150 at the end of June last year. VMware released the NSX 6.2 during the September quarter, which contributed significantly to the 100% annual rise in revenue generated through license bookings during the quarter. Industrial applications of the NSX implementation include IT automation and application continuity. Six 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 software-defined networking market. The company expects the solid demand for NSX implementation to continue through Q4 and in the long term.

During the quarter, VMware announced general availability of new hybrid networking capabilities including VMware Hybrid Cloud manager and Advanced Networking Services. VMware realized a 50% year-over-year growth in hybrid cloud and Software-as-a-Service revenues to just over $100 million through the September quarter. According to the company’s estimates, hybrid cloud and SaaS combined contributed over 6% of VMware’s net revenues through the first three quarters of 2015, up from 5% in 2014 and under 3% of net revenues in 2013. After announcing hybrid cloud service in the Asia-Pacific region last quarter, the company announced the addition of three new service locations in the U.S. The three service locations in Texas, New Jersey and Virginia are expected to be functional this quarter.

The other key area of growth for VMware has been 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. VMware witnessed a 30% year-over-year increase in license bookings for AirWatch in the June quarter, which further slowed to about 15% in Q3. The growth rate has been lower in Q2 and Q3 mainly due to tougher year-over-year comparisons. Within end-user computing, the desktop-as-a-service business grew by a healthy 20% on a y-o-y basis. Additionally, the company announced the acquisition of email-startup Boxer at the end of Q3 to boost its end-user computing and mobility management capabilities. [2] At the end of December last year, the total number of AirWatch customers stood at over 15,000, which has risen to about 60,000 end-user computing customers for desktop, mobile, identity and content collaboration solutions combined. 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 Coming Quarters

After Dell completes the EMC acquisition, VMware will continue to function the same way it did when EMC owned 80% of the company. Moreover, management reassured VMware shareholders that VMware’s cash flows or debt capacity will not be used to finance the transaction.

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 Q4 revenues to be 8-9% higher than prior year levels at about $1.85 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 guidance for license booking revenues to rise by 4-5% on a year-over-year basis to about $815 million, while services revenues could rise by over 10%. The company has revised its CapEx guidance for 2016 as the company plans to launch Virtustream, its cloud services business in a 50-50 joint venture by EMC and VMware, in early 2016. Virtustream would require heavy initial investment in terms of both operating and capital expenditures from both parties. VMware expects CapEx to rise to over $620 million for the full year, up from about $350 million expected through 2015. [4] In return, the company expects Virtustream to add a “few hundred million dollars” to its top line next year, with an expected double-digit growth rate.

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Notes:
  1. VMware Reports Third Quarter 2015 Results, VMware Press Release, October 2015 []
  2. VMware scoops up hot email startup Boxer, Giga OM, October 2015 []
  3. VMware Named A Leader in the IDC MarketScape for Client Computing Software, VMware Blog, June 2015 []
  4. VMware Q3 2015 Earnings Call Transcript, Seeking Alpha, October 2015 []