VMware Inc. (VMW) posted second quarter 2011 earnings per share that surpassed the Zacks Consensus Estimate of 31 cents by 3 cents.
Results were positively impacted by revenue growth, as global demand for VMware products remained strong.
Operational Performance
Earnings (including stock-based compensation) increased to 34 cents from 17 cents per share in the year-ago quarter.
Earnings (excluding one-time items and stock-based compensation) of 55 cents climbed 61.6% from 34 cents in the prior-year quarter. The year-over-year growth was primarily attributable to strong revenue growth in the quarter.
Net income (including stock-based compensation) was $145.7 million, up from $71.6 million in the second quarter of 2010. Net margin was 15.8%, up from 10.6% in the second quarter of 2010.
Gross profit (including stock-based compensation) increased 37.2% year over year to $801.4 million. Gross margin increased 30 basis points (bps) year over year to 87.0% in the second quarter of 2011.
Operating income (including stock-based compensation) leaped 73.4% year over year to $201.1 million. Operating margin was 21.8% in the reported quarter, compared with 17.2% in the year-ago quarter. The upside was primarily driven by strong revenue growth and strict cost control measures.
Revenue
Revenues increased 36.7% year over year to $921.2 million, well above management’s guided range of $860.0 million to $880.0 million. The upside was primarily driven by strong Enterprise License Agreement (ELA) growth and strong demand in the U.S. and across international markets.
License revenue was up 43.6% year over year to $464.8 million, and was primarily attributable to strong global demand for vSphere, growth in Enterprise License Agreement (ELA) bookings and renewed deals from customers. ELA exceeded 25.0% of total second quarter bookings and included no transactions worth $10.0 million or more.
Services revenue jumped 30.3% year over year to $456.4 million. Software maintenance and support revenue was $386.3 million, up 33.0% 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.
US revenues (48.9% of the total revenue) increased 35.0% year over year to reach $450.0 million. Similarly, international revenues (51.1% of the total revenue) witnessed a year-over-year growth of 38.0% to gross $471.0 million.
Balance Sheet and Cash Flow
VMware exited the quarter with cash and cash equivalents (including short-term investments) of $3.70 billion, compared with $3.66 billion in the previous quarter.
Cash from operations increased to $539.0 million from $500.5 million in the prior quarter. Free cash flow was $443.0 million in the quarter, versus $473.5 million in the prior-year quarter.
During the quarter, VMware used nearly $600 million in aggregate for mergers & acquisitions, routine capital expenditure, share repurchase and for the purchase of property that related to the Palo Alto campus expansion.
Guidance
Management provided a robust guidance for the third quarter. Accordingly, VMware expects total revenue to range from $915.0 million to $940.0 million, reflecting an increase of 28.0% to 32.0% from the third quarter of 2010. The Zacks Consensus Estimate anticipates revenues of $893.0 million.
For fiscal 2011, VMware raised its revenue guidance and now expects revenues to be in the range of $3.65 billion to $3.75 billion, a growth of 28.0% to 31.0% over the prior year. According to the Zacks Consensus Estimate, revenue for fiscal 2011 is pegged at $3.63 billion.
Management expects license revenue in the third quarter to be down 5.0% to 10.0% sequentially.
VMware expects the GAAP operating margins for the third quarter and full year 2011 to be approximately 11 to 14 percentage points lower than the non-GAAP operating margins.
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.
For the forthcoming quarters, we expect VMware to perform better with higher revenue growth and increasing adoption of virtualization and cloud computing technologies.
Enterprises that are shifting to 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 the recently launched vCenter Operations Suite for management.
We believe VMware is the biggest beneficiary in the adoption of cloud computing and the corresponding shift in IT spending. The server virtualization market possesses huge potential and VMware continues to expand its presence in the datacenter cloud management and security segments.
The company faces competition from Microsoft Corp. (MSFT) and Citrix Systems Inc. (CTXS)
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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