Steady Growth Across Segments Helps Drive Revenues, Profits For VMware

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VMware (NYSE:VMW) announced its fiscal Q3 earnings on Thursday, November 30, reporting an 11% annual increase in revenues to just under $2 billion. Revenue growth was complemented by improvement in gross profit and operating profit margins, as shown below. As a result, net income per share was up 18% y-o-y to $1.34, higher than the mid-point of guidance provided by the company. There have been two major developments in recent months for VMware. First, the company signed an agreement with Amazon (NASDAQ:AMZN) to integrate its private cloud offerings with Amazon Web Services public cloud for an integrated hybrid cloud platform. Second, it announced its intent to acquire SD-WAN company VeloCloud in order to further assert dominance in the software-defined network (SDN) market (read: VMware’s VeloCloud Acquisition Rekindles SDN Battle With Cisco).

Performance By Segment

VMware’s license revenues were up 14% y-o-y to $785 million, while gross margins for the license business were up a percentage point to 95.2%. The company witnessed particularly strong demand for network virtualization platform NSX, for which total license bookings for were up 100% over the prior year period. Similarly, hyper-converged software suites including VSAN and VxRail also demonstrated strong growth during the quarter, with Virtual SAN license bookings rising by 150% on a y-o-y basis. Earlier this year, VMware reported that total paying customers were up to 10,000 from 5,500 last year.

Services revenues were also up 10% y-o-y to just under $1.2 billion, while the services gross margin (GAAP) improved by 60 basis points for the quarter. Within the services segment, software maintenance revenues rose 8% to just over $1 billion, while professional services revenues were up 20% y-o-y to $168 million for the quarter. According to VMware’s management, hybrid cloud and Software-as-a-Service (SaaS) revenues were also up in double digits to $158 million.

Guidance For Q4’18 & FY 2018

After a successful year thus far, VMware’s management has given positive guidance for the full fiscal year, with net revenues expected to rise 11% to $7.9 billion. Fourth quarter revenues are also expected to be around 11% higher at $2.3 billion. Revenue growth from license agreements has been particularly impressive this year, with the trend expected to continue through Q4 FY’18 as well. Similarly, improving gross margins and disciplined expense management through the year has helped improve the operating margin. This trend is also likely to sustain in the current quarter, due to which the non-GAAP operating profit margin is expected to be over a percentage point higher for the full year. Resulting non-GAAP diluted earnings per share could also be up in double digits for the fourth fiscal quarter and full year.

Please note that all year-over-year comparisons made by the company in its press releases and in this note compare Q3 FY’18 (August to October 2017) with Q3 of last year, which was July to September 2016, due to the company changing its fiscal calendar earlier this year. Beginning Q1 FY’19, the company intends to adhere to ASC 606 accounting standards, which would help reduce its high deferred revenue figures. Furthermore, VMware’s cloud revenues from AWS are also expected to be recognized on a net basis after the adoption of the new accounting practices.

We are in the process of revising our $91 price estimate for VMware’s stock, which is around 20% lower than the current market price. VMware’s stock has risen by almost 50% this year following successive quarters of robust growth and a strong future outlook.

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