VMware Inc. (VMW) reported strong first quarter 2011 results beating the Zacks Consensus Estimate of 27 cents by a penny. Shares were up $10.73 (12.48%) in after-hours trading.
Operational Performance
Earnings (excluding one-time net item of one cent, but including stock-based compensation) increased 75.0% to 28 cents per share from 16 cents reported in the year-ago quarter.
Earnings (excluding one-time items and stock-based compensation) of 48 cents, were up 50.0% from 32 cents reported in the prior-year quarter. The year-over-year growth was primarily attributable to strong revenue growth in the quarter.
Net income (excluding one-time net item of one cent, but including stock-based compensation) of $118.4 million, increased 82.2% year over year from $65.0 million in the first quarter of 2010. Net margin was 14.0%, up from 10.3% in the first quarter of 2010.
Gross profit increased 32.2% year over year to $693.8 million. Gross margin decreased 70 basis points (bps) year over year to 82.2% in the first quarter of 2011.
Operating income (excluding one-time items) leaped 55.6% year over year to $158.2 million in first quarter 2011. Operating margin was 19.8% in the reported quarter compared with 16.9% in the year-ago quarter. Strong revenue growth and strict cost control were the primary drivers for this upside.
Revenue
Revenues increased 33.2% year over year to $843.7 million, well above management’s guided range of $800.0 million to $820.0 million. The upside was primarily driven by strong Enterprise License Agreement (ELA) growth and new product launches.
License revenues were up 34.2% year over year to $419.0 million, primarily attributable to strong demand in international markets and Enterprise License Agreement (ELA) bookings during the quarter. ELA’s were 22% of total first quarter bookings and included five transactions worth $10 million or more.
Services revenue jumped 32.2% year over year to $424.7 million. Software maintenance and support revenue was $364 million, up 36% compared with the year-ago quarter. VMware cited that customers generally tend to purchase support & maintenance contracts spanning more than 24 months, which reflects a strong customer base for the company’s products.
US revenues (47.0% of the total revenue) increased 26.0% year over year to reach $400.0 million. Similarly, international revenues (53.0% of the total revenue) witnessed a year-over-year growth of 40.0% to gross $444.0 million.
Balance Sheet and Cash Flow
As of March 31, 2011, cash and cash equivalents (including short-term investments) were $3.66 billion compared with $3.32 billion at the end of December 31, 2010.
Deferred revenue (including current portion) was $1.98 billion compared with $1.86 billion at the end of December 31, 2010.
Cash from operations increased to $500.5 million from $357.0 million in the prior quarter. Free cash flow increased to $473.5 million in the first quarter versus $406.5 million in prior-year quarter.
During the quarter, VMware spent approximately $200.0 million for mergers & acquisitions, capital spending and share repurchase program. VMware’s board of directors authorized an additional $550 million of share repurchase (Class A common stock) through 2012, with the sole purpose of partially offsetting the dilution from employee stock issuance.
Guidance
Management provided robust guidance for the second quarter. For the second quarter of 2011, VMware expects total revenue to range from $860.0 million to $880.0 million, reflecting an increase of 28.0% to 31.0% from the second quarter of 2010.
For fiscal 2011, VMware has raised its revenue guidance. The company expects revenue to be in the range of $3.55 billion to $3.65 billion, up from the previous guidance of $3.45 billion to $3.55 billion, a growth of 24% to 28% over the prior year.
Given the strong first quarter results from OEM partners and the large ELAs, management does not expect sequential growth in license revenues for the upcoming second and third quarters of 2011.
VMware expects non-GAAP operating margin for 2011 to expand slightly compared with 2010. Non-GAAP operating margin for the second quarter is expected to be in the range of 28% to 29%, and the full-year 2011 to range from 28.5% to 29.5%.
Our Take
We believe increasing adoption of virtualization and cloud computing technologies will drive growth for VMware over the long term.
Enterprises shifting toward 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.
According to VMware, vCenter Operations Suite achieved strong initial response, which will boost the customer base going forward.
Recently, VMware launched Cloud Foundry, the industry’s maiden open Platform-as-a-Service (PaaS). According to research firm Gartner Inc, 2011 will be the year of PaaS as most of the leading enterprise software vendors are expected to introduce new offerings. With Cloud Foundry, VMware will enjoy a first mover advantage going forward, in our view.
However, we have a Neutral recommendation on VMware over the long term (for the next 6 to 12 months) primarily due to tough competition from the likes of Citrix Systems Inc. (CTXS), Microsoft Corporation (MSFT), International Business Machines Corporation (IBM) and the privately held PARALLELS International GMBH.
Moreover, flat margin prospects and moderating license growth could act as potential headwinds.
Currently, VMware has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.
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