VMware (NYSE:VMW) announced its Q2 earnings on Tuesday July 23, beating market expectations with 11% yearly growth in revenues.  The growth is much higher at 15% excluding the pivotal and other divestitures.
Revenues saw a boost from strong growth in services revenues even as key license revenues showed muted growth during the quarter. Total revenues for the first quarter were $1.24 billion, of which services revenues were $713 million, up 18% on a y-o-y basis. Revenues from enterprise license revenues grew by a modest 2.5% (excluding pivotal, the figure is 5%) to $530 million.  Overall gross margins improved due to the higher contribution from higher margin services business and an improvement in overall average selling prices (ASP). Non-GAAP operating profit (excluding one-time items) was $417 million, an increase of 16% y-o-y. 
What comes as a good sign is that license bookings and total bookings were up 10% and 20%, respectively.  Further, 35% of license bookings in Q2 were from new products like vCloud suite than its standalone established software vSphere. While the overall business environment has been weak across geographies, growth seems to be picking up with Asia leading the charge in bookings. The company is also seeing a good response to its early access program for the vCloud hybrid service, which is expected to become a major growth driver going forward. Further, its efforts to tap the potentially huge network virtualization market through its new product, VMware NSX, are also gaining momentum.
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The company has given guidance for Q3 revenues in the range of $1.27 to $1.30 billion, which was slightly above market expectations. For the full year, VMware now sees revenues of $5.12 billion to $5.26 billion, slightly up from its earlier estimates of $5.12 billion to $5.24 billion. Owing to strong results and improving outlook, the stock rose over 10% post earnings announcement.
We are updating our $101 Trefis price estimate for VMware to reflect the earnings. Below we take a detailed look at key growth drivers for VMware.
Virtualization Market Maturing, But Clients Retention A Positive
According to the latest Gartner report, close to two-thirds of x86 server workloads are now virtualized, trimming the growth opportunities for VMware, the largest player in the market.  Furthermore, tough competition from Microsoft and Citrix has taken some market share away from VMware.
However, the robust growth in services revenues and bookings seem to indicate that VMware is doing a good job of retaining its clients and customers are renewing their long-term contracts with the company. This will provide continued growth in revenues in terms of maintenance and support fees going forward. Total unearned revenue (to be recorded as revenues in future quarters) grew by 22% to $3.6 billion, of which $1.37 billion is long-term. This reflects its overall strong maintenance business.
Further, as aforementioned, its vCloud software continues to see decent growth. According to a recent survey, open source cloud initiatives like Openstack have not received traction as strong as expected.  VMware continues to remain the preferred private cloud supplier with Microsoft coming in at second place.  This should continue to benefit the company as cloud computing continues to grow at a rapid rate.
Network Virtualization And Hrbrid Cloud Priority For VMware
To offset slowing growth in its core business, the company has identified network virtualization and hybrid cloud for future growth. With increasing mobile computing and the bring your own device (BYOD) movement, data traffic has increased substantially. This has put significant pressure on traditional data centers due to the inefficient capacity use of switches (which connect storage hardware with the network through cables). Network virtualization helps resolve these issues and with cost-cutting taking priority for many enterprises, this is expected to gain huge traction, in line with historical growth of server virtualization.
VMware acquired companies Nicira and DynamicOps last year to gain entry into the software-defined networking and software-defined data center space. The company mentioned that it will soon be launching VMware NSX, which merges VMware’s vCloud networking product line with Nicira’s network virtualization platform into a single product family. The product is expected to come as early as August, when the event VMworld will be held. With new innovative products like NSX, we can expect continued growth in VMware’s revenue going forward.
The company has also been focusing on infrastructure as a service (IaaS) vCloud hybrid service. Hybrid clouds are gaining traction as companies can have their own in-house private clouds to retain sensitive data and information and move the rest to a public cloud. Having access to a public cloud helps scale applications easily. The product, which was launched in May and is in an early-access phase, has attracted interest from several major companies. Once launched in Q4 2013 (expected), we expect it to more than offset slowing growth in its core businesses.
While the company has not provided any specific information on its performance in the mobile virtualization market, we remain confident on the prospects of this business. Going forward, the mobile desktop virtualization opportunity could be a much bigger opportunity than desktops. As the workforce becomes more mobile and demands CRM and data services on the move, the mobile desktop virtualization market is expected to see rapid growth. VMware has a partnership with Nimble to deploy virtual mobile desktops that enables employees to access company data securely through virtual snapshots, irrespective of the device used, and we expect this to pay off in the long term.Notes:
- VMware reports second quarter 2013 results, VMware, July 23 2013 [↩] [↩] [↩]
- VMware’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, July 23 2013 [↩]
- Magic Quadrant for x86 Server Virtualization Infrastructure, Gartner, June 27 2013 [↩] [↩]
- Open Source Cloud Is Failing To Gain Traction: Survey, Channel Biz, May 09 2013 [↩]