VMware Beats on Q1 Earnings, Revs

VMware Inc. (VMW) reported first-quarter 2014 non-GAAP earnings (including stock based compensation but excluding all one-time items) of 56 cents per share, which remained flat on a year-over-year basis. However, earnings per share managed to beat the Zacks Consensus Estimate by a penny.

Revenues

Revenues increased 14.2% year over year to $1.36 billion and were slightly ahead of the Zacks Consensus Estimate. Revenues were toward the higher end of management’s guided range of $1.33 billion–$1.37 billion.

The year-over-year increase in revenues can be attributed to 15.0% growth in license revenues and a 13.7% increase in services revenues. Among services revenues, software maintenance jumped 15.9% from the year-ago quarter, while professional services remained flat on a year-over-year basis.

Moreover, strong demand for VMware solutions across international as well as U.S. markets helped revenues.

In constant currency, the Americas, Asia-Pacific and EMEA total bookings increased less than 10% each on a year-over-year basis. Relative performance wise, the Americas was the strongest region followed by the Asia-Pacific and EMEA.

Amongst the product groups, End User Computing (:EUC) license bookings grew 35.0% on a year-over-year basis while Cloud Management grew over 30.0% in the reported quarter.

During the quarter, VMware secured two deals, each worth more than $10.0 million. Enterprise License Agreements (ELA) accounted for approximately 25.0% of first-quarter bookings.

VMware’s hybrid cloud solutions grew 100% year over year in the reported quarter. In the reported quarter, the company unveiled the Virtual SAN, which happened to be VMware’s first software defined storage product.

During the quarter, VMware formed an alliance with Google to modernize corporate desktops for the Mobile Cloud Era by providing businesses with secure, cloud access to Windows applications, data and desktops on Google Chromebooks.

Also, the acquisition of mobile security firm, AirWatch for $1.54 billion was completed during the reported quarter. With AirWatch having already contributed about $5.0 million to revenues in the reported quarter, we expect this acquisition to be a major catalyst going forward.

Some of the other products launched during the quarter include the likes of VMware Horizon DAAS and VMware Horizon 6. Horizon DAAS would enable simple and flexible delivery of desktops in the cloud while Horizon 6 would deliver published applications and virtual desktops in a single integrated platform.

Margins

Operating margin declined 80 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 general and administrative expense (up 120 bps) and lower gross profit (down 80 bps), which was partially offset by lower research and development expense (down 120 bps) and lower sales and marketing expense (down 20 bps).

GAAP net income was $199 million, which when adjusted for the following items (intangible amortization of $28 million, acquisition and other related items of $24 million and tax of $9.4 million), led to non-GAAP net income of $241.6 million.

Balance Sheet & Cash Flow

VMware exited the quarter with cash and cash equivalents (including short-term investments) of $6.62 billion compared with $6.18 billion in the previous quarter. Cash from operations was $750.0 million versus $688.0 million in the previous quarter. Free cash flow was $673.0 million compared with $590 million in the prior quarter.

During the quarter, VMware repurchased approximately 1.8 million shares for around $169.0 million at an average price of $96.0 per share.

Guidance

For 2014, VMware forecasts revenues to be in the range of $5.94 billion to $6.10 billion. Excluding Pivotal and divestitures but including $75.0 million from recently acquired AirWatch, revenues are expected to grow in the range of 16.0% to 18.5% for 2014. The Zacks Consensus Estimate is pegged at $6.04 billion.

License revenues for 2014 are expected to be in the range of $2.55 billion to $2.63 billion (up 12.0% to 16.0% year over year). Excluding Pivotal and divestitures but including AirWatch, license growth rate is expected to be up 13% to 17% versus 2013.

For 2014, non-GAAP operating margin is expected to be approximately 31.0% while the GAAP operating margin is expected to range between 15% and 18%. Management expects the GAAP tax rate to be approximately 1-2.5 pts lower than the non-GAAP tax rate of 18.5%. The company expects to continue its share buyback program in 2014.

For second quarter of 2014, management expects revenues to be in the range of $1.43 billion to $1.4737 billion (up 15% to 18% year over year). The Zacks Consensus Estimate is pegged at $1.44 billion.

License revenues for the second quarter are expected to be $605.0 million to $615.0 million (up 14.0% to 16.0% year over year).

Non-GAAP operating margin for the second quarter is expected to be within the range of 29% to 29.5% while GAAP operating margin is expected to range between 12% and 15.5%. Management expects the GAAP tax rate to be approximately 1-2.5 pts lower than the non-GAAP tax rate of 18.5%. Moreover, management also expects to continue its share buyback program in the second quarter of 2014.

Our Take

We believe that a sluggish IT spending environment and intensifying competition from its peers such as Microsoft Corp. (MSFT), Hewlett Packard (HPQ) and Citrix (CTXS) are primary headwinds for VMware, going forward.

Moreover, VMware’s continued investments in the emerging markets, product innovations and acquisitions are expected to weigh on margins in the near term.

However, VMware’s strong product portfolio is a major positive. The company continues to win contracts and robust international sales will continue to the boost top line, going forward. Moreover, the acquisitions of Desktone and AirWatch will boost the top line, going forward.

Currently, VMware has a Zacks Rank #3 (Hold).

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