5 Things VMware Inc.'s Management Wants You to Know

It has been an eventful few weeks for VMware (NYSE:VMW) investors. The cloud-services provider's parent company, EMC (NYSE:EMC), announced this month that it will join with computer company Dell to create a mega IT giant.

VMware will not be taken private as part of this transaction. Yet the deal has major implications for its business.

CEO Patrick Gelsinger recently held a conference call with investors to discuss the linkup with Dell, along with VMware's latest operating trends. Here are five key points that management made in that chat.

VMware's management team. Source VMware investor presentation.

Optimism on the deal with Dell

"Dell's incredibly strong go-to-market engine will provide us greatly expanded reach to attach and upsell our full portfolio of products and services." --Gelsinger

VMware is forming a joint venture with its parent company aimed at serving the hybrid cloud market. Called Virtustream, the initiative will combine services from VMware and EMC while making use of Dell's selling infrastructure.

Management is optimistic that the linkup could contribute as much as $1 billion of new revenue in the next few years. Gelsinger sees other good aspects of having a parent company that's not publically traded, including the ability to move faster. "We expect to benefit from the decision-making agility that comes from our majority shareholder being privately controlled," he said.

Solid sales and profit growth

"We delivered a solid quarter, with results either in line or above our guidance." --Chief Operating Officer Carl Eschenbach

VMware posted strong third-quarter results, with sales rising by 14% as net income spiked 32% higher. Both the revenue and adjusted earnings figures outpaced management's prior guidance.

The company booked an encouraging acceleration in license revenue growth as the hybrid cloud and software-as-a-service revenue jumped by 50% and grew to over 6% of sales. And operating margin ticked higher, rising to 31.5% of sales from 30.4% last year.

Weak bookings

"Overall, our [global] bookings performance was slightly softer than we planned." --Eschenbach

Image source: VMware.

Detracting from the strong quarterly growth was a worrying slowdown in product bookings. Management explained that these orders came in below expectations for three reasons. First, shifting trends in the IT industry are driving prices lower. Second, speculation about VMware's future as an independent company likely convinced a few customers to hold off on making major commitments to its offerings. And third, weakness in some regional markets, including China, Russia, and Brazil, held down the results.

Still, management was encouraged by the fact that its largest class of orders, enterprise agreements, rose to 33% of all bookings -- up from 29% a year ago.

Financial update

"Our balance sheet remained strong with cash and short-term investments at quarter end of $7.2 billion." --Chief Financial Officer Jonathan Chadwick

VMware generated $321 million of free cash flow in the third quarter, which helped it improve its cash balance to $7.2 billion from $7.1 a year ago. Management still believes the company will produce $1.9 billion of cash from operations this year. And after investing in the business, management intends to use a large chunk of that cash on share buybacks. VMware has spent $1 billion repurchasing stock so far this year, well on its way to hitting its $1.25 billion goal in 2015.

Disruptions on the way

"Although we expect the Dell acquisition of EMC will give rise to significant revenue synergies for VMware over time, we believe it is realistic to anticipate various disruptions in the near term." --Chadwick

Management's outlook for the fourth quarter remains strong: VMware reiterated its forecast for sales growth of as much as 10% while boosting its profitability target slightly, to 32% of sales.

However, it's clear that demand pressures in the industry will crimp results over the coming year. And VMware's prospective customers may choose not to do business with the new, Dell-EMC-VMware entity.

Given the scope of the strategic changes the company is implementing, management gave an early forecast for 2016 that calls for slowing growth and weakening profitability. Yet management believes that represents a short-term hit to the business and that VMware will emerge from this volatile time with a stronger long-term operating position.