5 Things VMware Inc. Management Wants You to Know

By Markets Fool.com

Image source: VMware

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VMware beat Wall Street earnings targets in the recently reported fourth quarter. The virtual computing veteran now boasts a streak of six consecutive earnings surprises. Yet VMware shares have struggled to keep pace with the broad market, down about 18% over the last six months.

The numbers themselves never tell the whole story. VMware management followed up on the fourth quarter report, holding a conference call with analysts. Here are five of the most enlightening passages from the discussion.

Steady hands at the rudder

I'm very proud of our performance in Q4 and 2014.In each quarter, we delivered consistently against our revenue and operating margin guidance as we have done in every quarter since mid-2009. Our level of execution over a sustained period of time is a true testament to the tremendous value of our offerings in the commitment and dedication of our employees and our extensive partner ecosystem.

-President and COO Carl Eschenbach

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Mware President and COO Carl Eschenbach. Source: VMware

Skeptics might scoff at this statement, noting that there is an easy way to meet stated targets in every quarter: simply set them low. It is kind of like handing a shotgun to your management team and then pointing them to a handy barrel brimming with fish.

In particular, VMware avoids potential embarrassment on the bottom line by strictly sticking to revenue and operating margin guidance. If you do the math on these figures to arrive at an implied guidance for the bottom line, VMware could explain away every miss as a case of using optimistic assumptions.

Still, the company landed comfortably above the midpoint of its original full-year revenue guidance of $5.94 billion to $6.1 billion for 2014. This was done in spite of currency-related headwinds, which reduced fourth quarter sales by about one percentage point. And there is something to be said for keeping the train rolling without a single miss against guidance figures for 20 straight quarters, roadblocks notwithstanding.

That is more than dumb luck or clearing a low bar. Steady execution over many years requires a top-shelf management team, and VMware is proving the worth of its C-suite here.

More detail on the currency situation

Turning to guidance, I'll first point out that we expect a couple of unusual items to impact our revenue growth rate for 2015. As most of you know, currency is not normally a sizable impact to VMware. However, in Q4, approximately 70% of our billings were in U.S. dollars and with the dollar reaching a multi-year high with respect to most currencies in 2014, we're not immune from the impact of the dollar appreciation. With this in mind, for the full year 2015, we anticipate currency to have an approximately two percentage point negative impact of total revenue growth and an approximately three percentage point negative impact to license revenue growth.

-CFO and COO Jonathan Chadwick

Currency exchange rates are far beyond its control, but the company can most certainly adjust its guidance models accordingly.

A strong dollar causes a modest amount of pain to the top line. The 30% of revenues that are not collected in dollars are invoiced in Euros, Japanese yen, Chinese renminbi, British pounds, and Australian dollars. VMware does not adjust product and service prices when exchange rates start moving, so the sales recorded in weakening currencies show up slightly smaller on the American income statement.

Management expects these headwinds to remain throughout the first half of 2015 before hopefully fading in the second half. That is not a slam dunk outcome, which explains why VMware surrounded its full-year guidance with a generous margin of error.

It would be a shame to break that streak of meeting guidance targets thanks to unfavorable currency trends, after all.

Other revenue risks for 2015

In addition, as I mentioned earlier, an increasing percentage of our revenue is being driven by hybrid cloud and SaaS revenues which are growing at a very high rate. While this is a positive development for VMware, it also has the impact of recognizing less revenue upfront than otherwise will be recognized as part of a multiyear license deal.

We estimate that this will have a negative impact on total 2015 revenue growth of up to one percentage point and on license revenue growth of at least two percentage points.Taken together, the impact of a stronger dollar and the growth of hybrid cloud and SaaS are expected to reduce our 2015 total revenues by approximately 3 percentage point of growth and are expected to reduce our 2015 license revenues by approximately 5 percentage points of growth from what we would otherwise report.

With that as background, we currently expect total revenues for 2015 to be between $6.64 billion and $6.76 billion, or up 10% to 12% year-over-year. To be clear, without the effect of currency and the impact of our going hybrid cloud and SaaS business, total revenues for 2015 would otherwise be expected to grow 13% to 15% year-over-year.

-CFO and COO Jonathan Chadwick

VMware CFO and COO Jonathan Chadwick. Source: VMware

In plain English, rising hybrid cloud and software-as-a-service sales are moving revenues into a subscription-style model. Instead of recording sales as a one-time item, right at the cash register, VMware collects payments over time on these contracts. That is good for long-term stability and forward visibility, since each customer is committed to a multi-year contract, but it is also a damper for upfront revenue.

This road has been walked by many enterprise software specialists in recent years. A prime example comes from Adobe Software, which started moving its most popular software packages to a subscription-based sales model in 2012. The change immediately stabilized a lagging sales trend, and share prices more than doubled since the company embraced installment terms for software licenses.

VMware is not the first software giant to follow this path, and it will not be the last. But the market does not give out bonus points for originality, so there is nothing wrong with picking up a proven concept.

How unique is the EMC Federation?

We're also seeing more customer interest in the value offered by the complete federation solutions. Our customers are operating in a business environment where disruption has become the norm, and old rigid business models are melting away.

They are increasingly looking to software defined infrastructure and new applications as the basis for business innovation that outsmarts their competitors. This requires a new model for IT that customers see VMware as uniquely being able to deliver.

-CEO Pat Gelsinger

Here, Gelsinger is talking about the appeal of bundling VMware-based IT solutions together with products and services from other pieces of the EMC empire. Data storage giant EMC still holds an 80% ownership interest in VMware. The company also controls security specialist RSA and runs cloud-computing expert Pivotal Software as a joint venture between EMC and VMware.

There is no denying that this impressive suite of modern enterprise IT solutions can hold its own in the marketplace. I am a little bit less sure that Gelsinger's claim holds water when he says that nobody else can deliver a similar package.

For one, networking veteran Cisco Systemsis making a serious push into the same software-defined data center that Gelsinger wants to own. And IBMmay be moving in the opposite direction, starting from a fading hardware foundation with a newfound focus on software and services, but the end result is very similar. And that is just two of the most obvious examples.

The VMware total package may not be quite as unique as its CEO wants you to believe, but there is one more ace up his sleeve.

Is OpenStack a real trump card?

As we discuss our OpenStack offering with customers, it becomes a very compelling offering, because our customers are very large VMware footprints using our networking, computers, etc. as part of that, and this becomes a very easy way for them to extend their offerings to their internal developer teams or other application developers to also offer OpenStack APIs as a way to consume that infrastructure, without in any way altering their underlying networking compute, management security requirements, and all of those are common and broadly deployed.

-CEO Pat Gelsinger

VMware CEO Pat Gelsinger. Source: VMware

Started by NASA and Rackspace Hosting in 2010 as an alternative to proprietary cloud-computing platforms such as VMware, OpenStack has become the cloud-computing product to beat. VMware now sits on theOpenStack steering committee, alongside almost any enterprise software business you would care to mention.

VMware now builds OpenStack support into most of its off-the-shelf products and makes sure to certify new packages against OpenStack requirements. So when clients come looking for a virtual machine platform or a virtual networking protocol to fit their needs, there is no reason not to consider what VMware is selling in that space.

Again, VMware is but one of many major providers in the OpenStack arena. Cisco and EMC are just as committed to OpenStack; Rackspace and IBM sit even closer to the project's inner sanctum; and the list goes on.

Still, VMware is treating OpenStack as an opportunity rather than a threat, and that is the correct approach. If you can't beat 'em, join 'em.

The article 5 Things VMware Inc. Management Wants You to Know originally appeared on Fool.com.

Anders Bylund owns shares of Rackspace Hosting. Why take the back door into OpenStack when you can own the founder and leader? The Motley Fool recommends Adobe Systems, Cisco Systems, Rackspace Hosting, and VMware. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.