VMware's CEO Discusses Q4 2013 Results - Earnings Call Transcript

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VMware (VMW) Q4 2013 Earnings Conference Call January 28, 2014 5:00 PM ET

Executives

Paul Ziots - Director, Investor Relations

Patrick Gelsinger - Chief Executive Officer

Carl Eschenbach - President and Chief Operating Officer

Jonathan Chadwick - Executive Vice President and Chief Financial Officer

Analysts

Brent Thill - UBS

Walter Pritchard - Citigroup

Heather Bellini - Goldman Sachs

Kash Rangan - Merrill Lynch

John DiFucci - JP Morgan

Brian Marshall - ISI Group

Ross MacMillan - Jefferies

Phil Winslow - Credit Suisse

Matt Hedberg - RBC Capital Markets

Daniel Ives - FBR

Michael Turits - Raymond James

Pat Walraven - JMP Securities

Gregg Moskowitz - Cowen & Company

Shaul Eyal - Oppenheimer

Rajesh Ghai - Macquarie

Rob Owens - Pacific Crest Securities

Abhey Lamba - Mizuho Securities

Operator

Welcome, and thank you for standing by. [Operator instructions.] I would now like to turn the call over to Mr. Paul Ziots, Senior Director, Investor Relations. Thank you. You may begin.

Paul Ziots

Thank you. Good afternoon everyone, and welcome to VMware’s fourth quarter 2013 earnings conference call. On the call, we have Patrick Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Executive Vice President.

Following their prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Slides which accompany this webcast can be viewed in conjunction with live remarks and can also be downloaded at the conclusion of the webcast from ir.vmware.com.

We have also included in our earnings release and posted on our website historical data for revenue and unearned revenue, excluding revenues in each period attributable to the products and services attributed to Pivotal Software and the products and services associated with divestitures consummated by VMware in 2013.

On this call today, we will make forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially as a result of various risk factors, including those described in the 10-Ks, 10-Qs, and 8-Ks VMware files with the SEC.

In addition, during today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered in addition to, not as a substitute for, or in isolation from, GAAP measures.

Our non-GAAP measures exclude the effect of our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax on employee stock transactions, the net effect of amortization, capitalization of software, acquisition-related items, and realignment related net gains and charges.

As mentioned, we have presented historical data for revenue and unearned revenue, excluding Pivotal and all 2013 divestitures. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures, in the press release and on our Investor Relations website. The webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link.

Our first quarter 2014 quiet period begins at the close of business March 14, 2014. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2012.

With that, I’ll turn it over to Pat.

Patrick Gelsinger

Thank you, Paul, and good afternoon, everyone. Last week we announced preliminary results for Q4 2013 in conjunction with our announcement of our intent to acquire AirWatch. Q4 was a very strong finish to a great 2013 for VMware, and I’m extremely pleased with our team’s performance this year. Our Q4 total revenue was $1.5 billion, up 20% year over year excluding Pivotal and divestitures.

VMware’s total revenue for the fiscal year 2013 was $5.2 billion, up 17% excluding Pivotal and divestitures. Over the course of 2013, we did exactly what we said we would do in every aspect of the business, including financial performance, attracting and retaining top talent, and, most importantly, bringing breakthrough innovation to market that provides strategic business advantages for our customers.

With our strong performance in Q4, and in 2013 as a whole, we have accelerated VMware’s growth and positioned the company well for a strong 2014. We now have significant customer momentum across all three of our strategic priorities as we continue our focus on leading the industry with the software defined data center, hybrid cloud, and end user computing.

VMware continues to build momentum globally, because we are uniquely positioned to help our customers transform to the mobile cloud era of computing. With our portfolio of solutions that extend from the desktop, to the data center, to the cloud, we are enabling IT teams to liberate resources from their client server environments while building the mobile cloud infrastructure that will power their businesses into the future.

Our strong performance in Q4 and in 2013 is clear validation that our customers have confidence in our ability to help them address the IT requirements of both today and tomorrow. We are laser focused at VMware on three strategic priorities, and we continue to execute well. I’d like to highlight some areas where we made significant progress in 2013 to accelerate VMware’s growth and deliver against our long term strategy.

For the software defined data center, the rate of customer adoption is accelerating, and it is clear that the industry is strongly embracing our SDDC strategy. Carl will provide more detail in a moment on the value that SDDC is delivering for specific customers around the world.

In August, we officially launched NSX, our network virtualization platform, and global brands like McKesson, Starbucks, Medtronic, Best Buy, and China Telecom have spoken with clarity and conviction about how they’re using the NSX platform to make their networks more agile and efficient.

A critical component of SDDC is IT management, and throughout 2013, we grew rapidly, gained share, and added new cloud management capabilities to our portfolio, empowering IT teams to move at a higher velocity to support top priority business objectives.

One of the most exciting milestones in 2013 was our launch of vCloud Hybrid Service in May, followed by general availability in the U.S. in September and beta availability in the U.K. in December. We’ve recently completed the buildout of vCloud Hybrid Service in four U.S. data centers and one U.K. site, and we also secured our first franchise partner in Savvis.

Most importantly, the early response from our customers has been overwhelmingly positive. There is growing consensus that the hybrid cloud will be the delivery platform for the future of IT. No other player in the market is better positioned than VMware to deliver on the promise of the hybrid cloud.

Our end user computing group also put a bold stake in the ground. Just last week, we announced that we have entered into a definitive agreement to acquire AirWatch, the leading provider of enterprise global management and security solutions.

With this acquisition, VMware is adding a foundational element to our end user computing portfolio. With the addition of AirWatch, we will be positioned to accelerate VMware’s long term growth in a significant way by delivering a complete and proven enterprise class solution for empowering the mobile workforce.

Over the course of 2013, we made several significant moves to accelerate our end user computing group. We reinvigorated our EUC leadership team, and continued to gain share in desktop virtualization.

In October, we announced our acquisition of Desktone, making VMware a clear leader in desktop as a service. The market response has been strong, with a rapidly growing partner community including tier one service providers and a strong pipeline of customers modernizing and moving their desktop infrastructure to the cloud.

These are just a few highlights of the many that demonstrate the momentum behind all three legs of our strategy. I couldn’t be more proud of my leadership team and the entire company. We continue to hire the best and brightest in the industry and will continue to make aggressive moves in 2014 because we see the opportunity here and now.

Our industry has entered a dramatic new phase. Customers need to reduce costs in their existing IT environments while simultaneously building out the mobile cloud infrastructure that will power their businesses in the future.

VMware is one of the few companies that can simultaneously help them address these two challenges. Without a doubt, the coming years will be highly disruptive for many in our industry. At VMware, we are uniquely positioned to transform IT once again.

In closing, I’d like to thank our customers, partners, and employees for their passion and engagement in Q4 as we carry our momentum into 2014. I’ll now turn it over to Carl.

Carl Eschenbach

Thank you, Pat. I’m very proud of our performance in Q4 and 2013. We delivered consistently according to our guidance throughout each quarter and the full year. Q4 went as planned. Excluding Pivotal and divestitures, licensed bookings grew in the very high single digits and total bookings grew in the midteens year over year. This is consistent with the guidance commentary that Jonathan provided on the Q3 call.

Consistent with previous quarters, I’ll provide some color on performance across the regions, with growth rates excluding pivotal and divestitures. The Americas region had an especially strong bookings growth of 20% year over year in Q4, fueled by a continued robust uptake of ELAs.

Total bookings for Q4 in EMEA grew in the low double-digits year over year, which we believe reflects continued strong performance versus our peers in a mixed environment. The U.K. had a very strong quarter, as we began to see improvement in the banking and finance vertical.

Adjusting for the effects of currency, Asia Pacific bookings grew in the high teens year over year in Q4. It’s worth noting that total bookings in China were up over 20% year over year in Q4, and up over 20% for each of the last two fiscal years.

One area I would like to highlight is our strong performance in the U.S. federal market throughout 2013. For the full year, we grew total bookings over 25% in what was a tougher vertical for many this year. In summary, we’re growing across all geos in both mature and emerging markets.

In Q4, ELAs continued to be a way for us to extend our strategic relationship with customers. ELAs increase our ability to sell more products and a wider range of products. For example, in Q4 we saw customers begin expanding the content of ELAs to include both NSX and vCloud Hybrid Service in addition to vCloud Suites, Management, Automation, and EUC products.

We had five record highs in Q4 pertaining to ELAs and renewals. First, as we predicted, we had a record quarter for ELAs, representing 40% of total bookings. Secondly, we closed 10 ELAs greater than $10 million. Third, Q4 tied for our highest ever in-quarter renewal rate for ELAs. Our fourth record was our record high in-quarter renewal rate for support. And finally, the average term for support tied, an all-time high, and remains well above 24 months.

In addition, 2013 was a year of great momentum for vCloud Suite and vSphere with Operations Management, as we exceeded our plan for both products. In Q4, management and automation was once again our fastest-growing product group. We had our largest-ever cloud management and automation product launch, which contributed to management license bookings growth of over 40% for the full year 2013.

Even with the success of our management and automation products thus far, we believe our customer base is only 10% penetrated, reflecting ample runway for growth. In addition, for 2013, we more than doubled the number of partners who make it a specific business to sell management and automation from VMware.

We continue to believe that the path to the software defined data center goes through management and automation, and this will continue to be a key driver of our growth in 2014 and beyond.

Turning to our end user computing group, as we expected, licensed bookings returned to strong growth. Worldwide, Q4 licensed bookings grew nearly 30% year over year in Q4, and grew greater than 40% year over year in the Americas geography alone. For the full year 2013 versus 2012, EUC license bookings grew in the mid-teens, which we believe clearly reflects that we are gaining share.

Our pending acquisition of AirWatch brings a number one asset in the enterprise mobile management and security space into VMware and further increases the full range of data center to device functionality we can offer to our customers.

In 2013, VMware also took big steps to present a vision for the future of the data center and the transformation of the network. Our network virtualization platform, VMware NSX, became generally available in October, and we expect NSX will do for networking what vSphere and server virtualization did for compute.

The majority of our NSX pilots have been turning in to sales. As an example, in Q4 the first quarter of availability for NSX, we closed deals with three of the top five global investment banks, and couldn’t be more pleased with this ringing endorsement of our network virtualization architecture.

As Pat mentioned earlier, NSX was also purchased by some of the most respected global enterprise and telecommunications firms, such as McKesson, Starbucks, Medtronic, Best Buy, and China Telecom. The deals we’ve closed in the fourth quarter signal that innovative companies are making the architectural decisions that place network virtualization and the software defined data center at the heart of their data center strategies, and we are winning the architectural battle.

Since general availability in September, customer and partner acceptance of our hybrid cloud position has been nothing short of remarkable. During Q4, we added hundreds of customers to our VCHS business, and we couldn’t be more excited with the level of participation in the U.S. We also announced VCHS market entrance into the U.K., where we saw strong customer demand for our beta in December and anticipate general availability in February.

In addition, we are seeing significant interest from service providers around the world who want to partner with us on our hybrid cloud, and we expect to have important announcements to make during Q1 and throughout 2014 in this regard.

In Q4, we continued to see significant growth in our hybrid cloud, which once again grew over 100% year over year, and now operates in more than 95 countries around the world. In summary, we executed well against our plan for both Q4 and 2013.

We’re pleased with our performance, but even more importantly, we’re energized by the enthusiasm coming out of our customer interactions. As we look into 2014, we have the strongest portfolio of products, services, and solutions for the mobile cloud era that we’ve ever seen. Momentum is with us, and we’re looking forward to the year ahead and beyond.

With that, let me turn it over to Jonathan.

Jonathan Chadwick

Thank you, Carl. We are very pleased with our Q4 and 2013 results, meeting or exceeding our expectations for the quarter and the year. Before I get into more details around Q4 on guidance, I want to summarize how we performed in 2014.

12 months ago, we provided guidance for the full year. Each and every quarter, we did what we said we were going to do according to the plan we laid out. I couldn’t be more proud of how the VMware team executed in 2013. Our goal was acceleration of both license and total revenue growth as the year progressed, and we achieved that goal.

For example, excluding Pivotal and divestitures, license growth accelerated from 1% year over year in Q1 to 18% year over year in Q4. At the same time, we have increased the diversification of our business’ non-standalone vSphere license bookings, and now greater than 45% of total license bookings compared to greater than 30% in Q4 2012.

In addition, non-GAAP operating margin expanded by approximately 160 basis points from 32.4% in 2012 to 34% in 2013, reflecting strong performance of our portfolio while investing aggressively for future growth.

As an example, we increased our investments in sales coverage and product development, with total headcount up, as expected, by 500 people in 2013. We ended the year with approximately 14,300 employees, right on target.

And finally, cash flow from operations was up 34% in 2013, reflecting the continued strength of VMware’s business model.

In summary, we did what we said we were going to do in 2013, and I’m very proud of these results. Given our positive preannouncement of results last week, I’ll now focus on key additional highlights that will be helpful in your understanding of Q4 performance. As Paul mentioned, I’d encourage you to refer to the slides and financial tables accompanying this earnings call for further details on our results.

Diluted non-GAAP EPS for Q4 was up 25% year over year to $1.01, on approximately 434 million shares. Our balance sheet remains strong with cash and short-term investments at quarter end of $6.2 billion, up $337 million sequentially.

Our operating cash flows of $688 million in Q4 were up 40% year over year. We spent $98 million on capex and consequently free cash flow was $590 million, up 44%year over year. Our cash flows all year reflected our robust operating performance, with strong collections activities while continuing to invest in our business.

During the quarter, we repurchased approximately 1.4 million shares of our stock, for a total of $116 million, at an average price of around $82 a share. For the full year, we repurchased approximately 6.6 million shares for a total cash out rate of just over $500 million and an average price of approximately $77 per share.

Total unearned revenue ended the quarter at $4.09 billion, up 18% from Q4 2012, and of which $1.53 billion is long term, up 21% year over year. As expected, approximately 88% of our unearned revenues will be recognized ratably over future quarters. The unearned revenue mix is in line with prior periods, and is primarily a reflection of our strong maintenance business.

Now, I’ll briefly summarize and augment the guidance we provided last week. As I mentioned, we expect revenue for 2014 to be between $5.94 billion and $6.1 billion, or up 14% to 17% year over year. This revenue and growth range includes our expectations of approximately $75 million from AirWatch.

Excluding Pivotal and divestitures, and including AirWatch, our total growth rate for 2014 is expected to be up 16% to 18.5% versus 2013. License revenues for the full year are expected to be $2.55 billion and $2.63 billion, or up 12% to 16% year over year.

This revenue and growth range includes our expectations of approximately $50 million of license revenues for AirWatch. Excluding Pivotal and divestitures, and including AirWatch, our license growth rate for 2014 is expected to be up 13% to 17% versus 2013.

For Q1 2014, we expect total revenue to be between $1.33 billion and $1.37 billion, or up 12% to 15% year over year. This revenue and growth range includes our expectations of approximately $0 to $10 million from AirWatch.

Excluding Pivotal and divestitures, and including AirWatch, our total growth rate for Q1 is expected to be up 16% to 19% versus Q1 2013. License revenues for Q1 are expected to be between $545 million to $555 million, or up 12% to 14% year over year.

This revenue and growth range includes our expectations of a few million dollars of license revenue for AirWatch. Excluding Pivotal and divestitures, and including AirWatch, our license growth rate for Q1 is expected to be up 14.5% to 17% versus Q1 2013.

Finally, and to assist you with our models, I’ll make a comment regarding non-GAAP operating margin seasonality in 2014. As we factor in the full diluted effect of AirWatch from Q2 onwards, we expect Q2 non-GAAP operating margin to be lower than Q1 by 150 basis points to 200 basis points. We then expect non-GAAP operating margin to increase in the second half of 2014, resulting in approximately 31% for the full year of 2014.

Remaining guidance for Q1 and the whole of 2014, and a reiteration of our 2015 and 2016 guidance provided on our AirWatch conference call last week is included in the slide deck posted on our investor relations website.

In summary, we did what we said we were going to do throughout 2013. We accelerated revenue growth, grew operating margin, and generated robust cash flow from operations. We continue to see significant opportunity ahead, and are excited about the prospects for our customers, partners, shareholders, and employees. And with that, I’ll turn it back to Paul.

Paul Ziots

Thanks, Jonathan. Before we begin the Q&A, I’ll ask you to limit yourselves to one question consisting of one part, so we can get to as many people as possible. Operator, let’s get started.

Earnings Call Part 2:

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