VMware Inc. (VMW) reported a stellar third
quarter 2011, as earnings per share (EPS) escalated 68.0% year over
year and surpassed the Zacks Consensus Estimate by 9 cents. The
better-than-expected results were driven by solid revenue growth,
based on strong global demand for VMware products.
EPS (including stock-based compensation) was 42 cents in the
reported quarter compared with 25 cents in the year-ago quarter.
Excluding one-time items and stock-based compensation, EPS was 53
cents, up 35.9% from 39 cents reported in the year-ago quarter.
Operational Performance
Gross profit (including stock-based compensation) was $817.7
million, up from $622.4 million in the previous-year quarter. Gross
margin was 86.8% versus 87.1% recorded in the prior-year quarter.
The year-over-year decline in gross margin was due to higher
proportion of service revenue in the mix.
Operating income (including stock-based compensation) in the
reported quarter jumped 49.9% year over year to $193.6 million.
Operating margin was 20.5% in the quarter, compared with 18.1% in
the year-ago quarter. The upside was primarily driven by strong
revenue growth and strict cost control measures.
Net income (including stock-based compensation) was $180.0
million, up from $110.4 million in the third quarter of 2010. Net
margin was 19.1%, up from 15.5% in previous-year quarter.
Revenue
Revenues increased 31.9% year over year to $941.8 million,
marginally beating the high end of management’s guided range of
$915.0 million to $940.0 million. The upside was primarily driven
by strong Enterprise License Agreement (ELA) growth, strong demand
in the U.S. and across Asia-Pacific markets, and seasonal strength
with the U.S. Federal Government.
License revenue was up 29.3% year over year to $443.6 million,
and was primarily attributable to strong global demand for vSphere
and VMware’s management tool solutions. ELA were 22% of total third
quarter bookings and included two transactions worth $10 million or
more. The company experienced stronger demand for end-user
computing and management products with the renewals of ELAs.
Services revenue jumped 34.3% year over year to $498.2 million.
Software maintenance and support revenue was $426.8 million, up
35.9% year over year.
VMware stated that with every new license being purchased,
customers continued to buy more than 24 months of support and
maintenance, a reflection of their strong commitment to VMware, as
a core element of their data center architecture and hybrid cloud
strategy. Professional services revenue was $71.5 million, up 25.7%
from the year-ago quarter.
US revenues (47.0% of the total revenue) increased 22.0% year
over year to reach $443.0 million. Similarly, international
revenues (52.0% of the total revenue) witnessed a year-over-year
growth of 42.0% to gross $499.0 million.
Balance Sheet and Cash Flow
VMware exited the quarter with cash and cash equivalents
(including short-term investments) of $3.98 billion, compared with
$3.70 billion in the previous quarter.
Cash from operations was $524.0 million versus $539.0 million in
the prior quarter. Free cash flow was $494.0 million in the
quarter, an increase of 108.0% prior-year quarter.
During the quarter, the company used $365 million in aggregate
for M&A, capital spending and share repurchase program and was
benefited from a tax refund of $100 million from EMC
Corp. (EMC).
Guidance
Management provided robust guidance for the fourth quarter.
VMware expects total revenue to range from $1.03 billion to $1.06
billion, reflecting an increase of 23.0% to 27.0% from the fourth
quarter of 2010. The Zacks Consensus Estimate anticipates revenues
of $1.03 billion, inline with the lower end of management
guidance.
For the fourth quarter, operating margin is expected to increase
sequentially and to range between 30.5% and 31.5%. The GAAP
operating margin for the fourth quarter is expected to be
approximately 10 to 13 percentage points lower than the non-GAAP
operating margin.
Management believes weak technology spending and troubled
macro-economic environment to make 2012 a challenging year for the
company. Management expects first quarter 2012 revenues to decline
sequentially to the range of $1.0 billion to $1.03 billion
(increase of 18% to 22% from the first quarter 2011) from the
fourth quarter 2011.
The first quarter operating margin is anticipated to be below
30% and the GAAP margin approximately 9 to 14 percentage points
lower than the non-GAAP operating margin.
Our Take
VMware has reported strong quarterly results on the back of
higher license revenues and a healthy mix of renewals and new
customer gains. International revenue, particularly from the
Asia-Pacific was strong.
We expect VMware to benefit from increasing adoption of
virtualization and cloud computing technologies. Enterprises that
are shifting to the cloud need proper infrastructure, which VMware
provides through its four key products: vSphere that helps in
coordinating and automating computer storage and networking;
vShields for virtualized Edge functions and security; vCloud
Director to enable cloud functionality; and vCenter Operations
Suite for management.
During the third quarter, the company announced theist new cloud
infrastructure suite and the general availability of VMware
vSphere. Additionally, VMware announced VMware Micro Cloud Foundry,
an open Platform as a Service (PaaS) solution. These new products
are expected to boost VMware’s top-line growth going forward.
However, a sluggish North American and European market coupled
with weak IT spending environment will be an overhang on the stock
over the next 12 to 18 months, in our view. Moreover,
increasing competition from Microsoft Corp. (MSFT)
and Citrix Systems Inc. (CTXS) will hurt
profitability going forward.
We have a Neutral recommendation on VMware over the long term
(for the next 6 to 12 months). Currently, VMware has a Zacks #3
Rank, which implies a Hold rating on a short-term basis.
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