VMware Inc. (VMW) reported third-quarter 2014 non-GAAP earnings (including stock based compensation but excluding all one-time items) of 61 cents per share, which declined 4.7% on a year-over-year basis. However, earnings per share (EPS) managed to comfortably beat the Zacks Consensus Estimate of 54 cents.
Revenues
Revenues increased 17.5% year over year to $1.52 billion and were in line with the higher end of management’s guided range of $1.42 billion–$1.52 billion. Revenues managed to beat the Zacks Consensus Estimate of $1.50 billion. The year-over-year growth in revenues was primarily attributable to strong customer adoption of VMware’s products and services worldwide.
This is reflected in a 13.3% growth in license revenues to $639.0 million and a 20.8% increase in services revenues to $876.0 million in the reported quarter. Among services revenues, software maintenance jumped 21% from the year-ago quarter to $779 million while professional services rose 19.8% to $97 million.
Moreover, strong demand for VMware solutions across international as well as U.S. markets helped revenues. International accounted for 48.5% of net revenue in the reported quarter while the U.S. chipped in with the remnant 51.5% share.
Relative performance wise, bookings grew in EMEA during the quarter. However, in Russia, geopolitical tensions weighed on the bookings performance and it underwent a 50% decline year over year. Bookings registered year-over-year growth in the Asia-Pacific region despite softness in Japan.
Among the product groups, End User Computing (EUC) license bookings (including AirWatch) grew 60% on a year-over-year basis. More than 75% of the company’s vCloud Suite license sales were attached to Enterprise License Agreements (ELAs) during the quarter. NSX gained significant momentum during the quarter. The product has more than 250 paying customers right now.
The hybrid cloud business grew over 80% on a year-over-year basis in the reported quarter. Currently, VMware is listed as one of only five mega providers in Gartner’s 2015 planning guide for cloud computing.
During the quarter, VMware secured three deals greater than $10 million worth. ELA’s accounted for approximately 29% of third-quarter bookings. The company registered its highest-ever renewal support rate in the third quarter.
Recently, the company announced its plan to open a new data center in Germany in order to expand the geographical reach of its hybrid cloud offerings.
VMware recently launched EVO: RAIL, a hyper-converged infrastructure appliance that helps customers streamline the deployment and scale-out of Software-Defined IT infrastructure. During the quarter, the company also unveiled VMware vRealize Suite 6 and vRealize Code Stream 1.0 as an integral part of its endeavors to diversify and expand cloud portfolio.
Margins
Operating margin declined 250 basis points (bps) from the year-ago quarter to 21.5%. Operating profit includes stock-based compensation but excludes one-time items.
The decline in operating margin was due to higher research and development expense (up 90 bps), general and administrative expense (up 50 bps) and lower gross profit (down 220 bps).
Non-GAAP net income (including stock based compensation but excluding all one-time items) was $264.7 million or 61 cents per share compared with $278.9 million or 64 cents reported in the year-ago quarter. Net margin declined 410 bps on a year-over-year basis to 17.5%.
Acquisitions & Partnerships
In an effort to expand and diversify its cloud service offerings, VMware recently acquired CloudVolumes, which is a leading provider of real-time application delivery technology.
During the quarter, the company entered into a joint venture with the likes of Docker, Google and Pivotal to enable enterprises to run and manage container-based applications on a common platform.
Moreover, the quarter also witnessed VMware’s strategic partnerships with Arista Networks, 5F and Hewlett-Packard (HPQ) as well as a technology and global reseller agreement with Dell to deliver NSX solutions worldwide.
Additionally, VMware’s End-user Computing Group recently announced key strategic partnerships with the likes of H-P, Google, NVIDIA and SAP.
Balance Sheet & Cash Flow
VMware exited the quarter with cash and cash equivalents (including short-term investments) of $7.10 billion compared with $6.64 billion in the previous quarter. Cash from operations was $606 million while free cash flow was $506 million in the third quarter.
During the quarter, VMware repurchased approximately 0.4 million shares for around $43 million at an average price of $99 per share.
Guidance
For 2014, VMware forecasts revenues to be in the range of $6 billion to $6.04 billion. The Zacks Consensus Estimate for the same is pegged at $6.02 billion (at the mid-point of the company guided range). Excluding Pivotal and Divestitures, the company expects the mid-point of its 2014 total revenue growth to be approximately 17%.
License revenues for 2014 are expected to be in the range of $2.58 billion to $2.60 billion. Excluding Pivotal and divestitures but including AirWatch, license growth rate is expected to be 14%.
For 2014, non-GAAP operating margin is expected to be approximately 31% while GAAP operating margin is expected to range between 16% and 18%. Management expects the GAAP tax rate to be approximately 0-1 percentage point higher than the non-GAAP tax rate of 18.5%. The company expects to continue its share buyback program in 2014.
Further, management believes that by the end of 2014 VMware operated clouds will be available in over 75% of the world’s cloud market.
For the fourth quarter of 2014, management expects revenues to be in the range of $1.67 billion to $1.71 billion (up 13% to 15% year over year).The Zacks Consensus Estimate for the same is pegged at $1.70 billion. License revenues for the fourth quarter are expected to be $765 million to $785 million (up 11% to 14% year over year).
Non-GAAP operating margin for the fourth quarter is expected to be within the range of 33% to 34% while GAAP operating margin is expected to range between 18% and 22%. Moreover, management also expects to continue its share buyback program in the fourth quarter of 2014.
Our Take
We believe that VMware’s strong product portfolio is a major positive. The company continues to win contracts. Robust international sales will continue to boost the top line, going forward. The acquisitions of CloudVolumes, Desktone and AirWatch will also add to the top line, going forward.
We further believe that the numerous strategic partnerships and accretive acquisitions that the company is entering into will provide a significant boost to its top line going forward.
However, a sluggish IT spending environment and intensifying competition from its peers such as Microsoft Corp. (MSFT), Hewlett-Packard and Citrix (CTXS) are primary headwinds for VMware. Moreover, VMware’s continued investments in the emerging markets, product innovations and acquisitions are expected to weigh on margins in the near term.
Currently, VMware has a Zacks Rank #4 (Sell).
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