VMware: Accounting Playbook Flashes Buy Signal

A confluence of accounting devices is expected to provide a backwash to VMware's reported financial results this year.

The period of the buttons created by the recent change in the company's fiscal year began the quarter ended.

The transition to the new revenue recognition standard next year is expected to add 2 points to the recurrent growth in license revenues this year.

Billing for the 2nd license could increase because the raw tax accounting treatment of the new cloud offering with AWS effectively flows the use of the AWS infrastructure across the declared VMware license category.

In August 2015, we warned VMware (VMW) investors that management's use of abstruse accounting tricks masked a deterioration in the fundamentals of the company and that we correctly qualified the stock as a short. We still believe that the company uses various accounting tricks to shape its reported financial results, but this time we think it will benefit the investor sentiment.

We are very optimistic that VMW will enter the publication of future results, as several neglected financial maneuvers should generate statistics on the revenues and invoices of these licenses this year. We expect short-term licensing and a tail-end of growth in the second half of the year. We do not necessarily believe that the underlying demand trends have increased for VMware, but the reported financial results should be guided by three accounting devices that investors probably do not consider. Here is the book of reading.

1. The Stub

We believe that the April quarter ended recently was significantly disabled by> $ 30 million invoicing billing available for invoice on day 1 of the quarter. This is a business that would naturally have accounted for in January, but was probably pushed in February as management had little incentive to harvest licensing transactions before the start of the new fiscal year.

To recap, VMware changed its fiscal year end from December to January to align with its new parent company, Dell (NYSE: DVMT). From 1/1/17 to 2/3/17 was a transitional reporting period and the next financial quarter began on 2/4/17. In accounting language, this is called a stub period and operating performance during the five-week self-transition period will be included in the first 10-Q of the fiscal year. Management has no obligation to disclose the details of the heel until that time, so we do not expect any mention of the June 1 conference call.

Perhaps the most notorious example of disbursing income from an end period occurred 20 years ago when 3Com merged with US Robotics. One company ended the March quarter and the surviving entity had a fiscal quarter in May. The timing of the transaction resulted in a two-month period and US Robotics delivered only $ 15 million of product in the transition window when its operations were at a sales rate of $ 600 million .

We do not expect that extreme sales will be removed from VMware's five-week period, but the company may have earned> $ 30 million in order backlogs on the first day of the April quarter. A back-shell calculation:

$ 600 million = invoice for reference license if quarter ended March
$ 120M = assume that 20% of licensing is normally done in the first month
$ 30m = assume that ¼ could be pushed to February

This $ 30 million would be comprised of certain ELA royalty payments and partner royalties where the corporation has the flexibility to influence the timing of the reporting. Of course, the number could be higher. The next 10-Q will be an interesting reading.

We do not expect the company to consume the entire backlog in the April quarter as the prudent move would be to move orders from the end of April to the next quarter. We were able to see $ 15 million in upward licensing in the April quarter, consistent with quarterly earnings the Company posted each quarter over the past year.

Our provocative concern with the heel period is supported by an unusual trend in sales promotion activity that we have seen over the past six months. In October 2015, we chronicled the long experience of VMware consistan


The second element we feel out of revenue licensing forecasts this year is a byproduct of the new revenue recognition rule that goes into effect in 2018. The transition to ASC 606 should add 2 points to recurring revenue growth by Licenses this year as the deferral of deferred revenue licensing routine due to lack of VSOE disappear from tricky accounting VMware RPG.

We have previously documented that VMware holds> 50 million initial dollars of deferred revenue dollars as a buffer to manage the quarterly sales licenses declared. The company uses the new promotions of seedlings mentioned above to push this quarantine quarter. The accounting standard governing the postponement will be removed for one year when the ASC 606 arrives.

"While we continue to evaluate the potential impacts of around 606, non-work-related income related to the sale of perpetual license licenses is expected to decline significantly during adoption.At present, we remit all income related licensing The sale of permanent licenses in this case does not meet some criteria for recognition of income. However, in item 606, who generally expect that almost all of the income from licenses related to the sale of permanent licenses are recognized in the - VMware 10-K, page 24

We expect that VMware solved this deferral program during the year, adding 2 percentage points to the annual growth in licensing revenue years. If VMware does not cover this fee, the balance will be converted to cumulative results at the end of the year without being executed in the profit and loss account. Financial managers call these steaming revenues. Since a significant part of the management of incentive compensation is based on revenue growth, it is very unlikely that the company abandoned this.

3. AWS Raw Accounting Treatment

As subtle as accounting tricks, we are likely to be very intrigued by VMware's potential for 2H license bill accounts with the deployment of the new cloud offering with AWS. This is a VMware subscription service sold around the physical infrastructure of AWS. We are not so focused on the idea of ​​a hot new product, but the probable invoice processing for accounting and billing in the VMware license category.

VMware cloud in AWS will have a stack of fully configured VMware software running on AWS real estate and essentially replacing the recently active vCloud air released VMware. Internal business forces never achieved a significant share of the IaaS market, along with all other VMware service offerings, accounting for <10% of total revenue.

"VMware Cloud in AWS is the best public and private clouds that enable our customers to run any application using a standard set of software tools and family in a consistent hybrid cloud environment. Customer interest to date has been positive and We expect to offer this service mid-year. " - Pat Gelsinger, CEO of VMware Calling 4Q16 Profits

If you believe that the demand for the cloud in AWS annihilate from vCloud market to air, taking into account VMware will recognize the total value of AWS orders. Unlike other IaaS solutions with VMware partners, the AWS cloud will be sold and operated by VMware. This distinction is important because the AWS cloud orders will be taken on the basis of gross revenue. The cloud business with other partners are recognized on a net basis, if VMware is a dealer or partner share when it is sold. Gross accountant network is the key here.

On the occasion of the potential contribution of the AWS relationship, we realized the discussion surrounding the VVustream business canceled 18 months ago JV. Although the agreement was never consummated, Virtustream must generate "hundreds of millions of dollars in annual revenue" for VMware with a cloud-like business model in AWS. In this spirit, we have modeled additional cloud pricing numbers in AWS for next year. The company has never driven, so we made the following assumptions:

AWS is a $ 20,000 business on the 2018 calendar
Cloud in AWS accounts for 1% of AWS turnover ($ 200 million AWS)
VMware will get a gross margin of 50% for the cloud in AWS (which means an income of 40