VMware Earnings Takeaways: Sustained Growth Across Licenses And Services Drives Results

by Trefis Team
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VMware (NYSE:VMW) announce its Q4’16 earnings on Thursday, January 26, reporting a 9% annual increase in revenues to just over $2 billion. [1] In addition to revenue growth, VMware reported a 60 basis points improvement in company-wide gross margin (non-GAAP) for the quarter to 88.4%. As a result of healthier margins and limited increase in operating expenses, VMware’s non-GAAP operating income were up 14% y-o-y to just under $750 million for the quarter. A similar trend was observed for the full year figures, with revenues growing by 8% to $7.1 billion and gross margin (non-GAAP) expanding by 50 basis points to 87.4%. Diluted earnings per share for the quarter and full year were up 13% and 7% to $1.43 and $4.39, respectively.

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Services Business Sustains Growth

VMware’s net revenues were up 9% with both services and licenses segments uniformly driving growth. The licenses business slowed down in the first half of the year, which picked up in the December quarter. According to management, end-user computing license bookings returned to double-digit growth through the fourth quarter and mobility products sales were boosted by the introduction of Workspace ONE. [2] In addition to top line growth, gross margin of the licenses business expanded 60 basis points to 98.4% for the quarter, as shown below. Two key growth areas for licenses were network virtualization platform NSX and hyper-converged software suites including VSAN and VxRail. The company generated roughly $250 million from total bookings of NSX while hyper converged software sales were roughly $75 million. VMware’s NSX had around 1,200 paying customers by the end of 2015, which surged  to around 2,400 paying customers by the end of Q4’16.vmw_q4_e3

Maintenance and professional services revenues were up 10% y-o-y to $1.1 billion for the quarter. Similarly, full year services revenues grew at 9% y-o-y to $4.3 billion. Revenues generated by hybrid cloud and SaaS offerings were largely responsible for strong growth in services revenues. Combined hybrid cloud and SaaS revenues for the full year were up by 40% y-o-y to over $560 million.

vmw_q4_e4

Over the years, VMware’s business has gradually transformed from primarily a software licenses vendor (over half of net revenues from license agreements in 2009) to a services-based model with software licenses revenues falling to around 40% of net revenues in 2015. As a result, VMware’s gross margin has compressed since services typically have lower gross margins than the licensing business. VMware’s gross profit margin has gone down from almost 88% in 2011 to under 87% in 2015. However, VMware reported an increase in Non-GAAP gross margins for both licenses and services division last year. The adjusted gross margin of the licenses division improved by 80 basis points to 98% for the full year while gross margin of the services division was around 50 basis points higher than the comparable prior year period to 80.4%. As a result, the company-wide gross profit margin was up by 50 basis points to 87.4%.

vmw_q4_e1

In addition to an improvement in gross margins, VMware’s operating income also grew at around 9% y-o-y to $2.3 billion through the year. A key contributor was a limited increase in operating expenses (particularly SG&A expenses) for the year. While R&D expenses were up 16% to $1.5 billion for the year, SG&A expenses were flat over the previous year at $3 billion. As a result, the company’s GAAP operating income was up 20% y-o-y to $1.4 billion and non-GAAP operating income rose 9% to $2.3 billion. VMware’s management mentioned that the company aims to further improve its operational efficiency by reducing operating expenses and headcount. Steady revenue growth, healthier gross margins and higher operating efficiency through the year led VMware’s diluted earnings per share to  increase by 7% to $4.39 as shown below.

vmw_q4_e2

Guidance For FY 2018

Going forward, VMware’s fiscal year 2018 will begin on February 4, 2017 unlike previous years. The period from January 1 through February 3 will be a “step up period.” [2] The company expects FY’18 revenues to grow at 7% to $7.6 billion. License revenues are expected in increase 6% y-o-y to just under $3 billion while services revenues while services revenues could increase by around 9% to $4.6 billion. Similarly, Q1 FY’18 revenues are expected to be up by 7% to around $1.7 billion. Non-GAAP diluted earnings per share are expected to be around $4.87 for the full year and just under $1.00 for the first fiscal quarter.

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Notes:
  1. VMware Reports Fourth Quarter and Full Year 2016 Results, VMware Press Release, January 2017 []
  2. VMware Q4 2016 Earnings Call Transcript, Yahoo Finance, January 2017 [] []
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