VMware (VMW) reported strong third quarter 2010 results based on robust revenues and operating margin growth, partially offset by weak bookings outlook and a sluggish cash flow growth.
Earnings (including stock-based compensation but excluding one time items) of 24 cents per share were up from the year-ago quarter of 11 cents. Earnings beat the Zacks Consensus Estimate of 22 cents per share.
Robust results at VMware indicate increased growth opportunity and diversity of its products. Moreover the company is benefiting from improving demand, customer wins and geographical expansion.
Revenue
Revenues increased 45.8% year over year to $714.2 million, primarily driven by strong growth from license and services segment. License revenues were up 42.8% year over year to $343.2 million. Services revenue leaped 48.7% year over year to $371.0 million.
U.S. revenues soared 47.0% year over year to $362.0 million in the third quarter of 2010. The strong domestic revenue growth was driven by U.S. Federal sector. International revenues for the third quarter grew 44.0% year over year to $352.0 million.
During the quarter, VMware signed a number of significant alliances aimed at accelerating cloud computing deployment and IT as a Service. VMware signed an agreement with Hewlett Packard Co. (HPQ) to deliver a new virtualization solution and reference architectures.
VMware and NetApp Inc. (NTAP) announced new solutions that will help mid-size enterprises consolidate and virtualize their Windows environment to deliver enterprise-class IT as a Service.
Margins
Total expenses increased 33.0% year over year to $620.1 million in the third quarter 2010. This increase was lower than the 37.0% increase in the previous quarter and 38.0% increase in the year-ago quarter.
Operating income (including stock-based compensation but excluding one time items) leaped 190.0% year over year to $129.2 million as compared with $44.6 million reported in third quarter 2009.
Operating margin was 18.1% in the quarter as compared with 9.1% in the year-ago quarter. Strong revenue growth and strict cost control were the primary drivers for this upside.
Balance Sheet and Cash Flow
As of September 30, 2010, cash and cash equivalents were $2.90 billion as compared with $2.78 billion at the end of June 30, 2010.
Cash flow has been declining which is of concern. Cash from operations was $196.7 million as compared with $216.1 million in the prior quarter and $354.9 million in the year-ago quarter.
Free cash flow increased slightly to $237.2 million in the third quarter of 2010 as compared with $232.4 million in the second quarter of 2010. During the quarter, VMware repurchased $141 million shares under its $400.0 million repurchase authorization as announced in the first quarter of 2010.
Acquisitions
During the third quarter, VMware announced the acquisition of Integrien, a leader in real time application and infrastructure performance analytics software, and TriCipher, a leader in secure access management and enterprise identity federation for cloud hosted Software as a Service applications.
Guidance
Management provided robust guidance for the fourth quarter. For the fourth quarter of 2010, VMware expects total revenue to be in the range of $790.0 million to $810.0 million, reflecting an increase of 30.0% to 33.0% from $608.0 million reported in the fourth quarter of 2009. The Zacks Consensus Estimate for the fourth quarter was at $776.0 million at the time the company reported results.
For the first quarter 2011, management anticipates total revenue to decrease quarter over quarter due to cyclicality witnessed in enterprise software but increase about 25% year over year.
VMware expects full year 2011 revenues to grow 20.0% from fiscal 2010 due to a slowdown in server shipment in 2011 as compared with 2010 and limited visibility. Non-GAAP operating margin in the first quarter of 2011 is expected to decline sequentially.
Our Take
We have a Neutral rating on VMware on a long-term basis (for the next 6 to 12 months) primarily due to a weak cash flow growth. Moreover, VMware also faces tough competition from Citrix Systems Inc. (CTXS), Microsoft Corporation (MSFT), International Business Machines Corporation (IBM) and the privately held PARALLELS International GMBH.
However, we believe VMware has a strong product pipeline and loyal customer base that will boost its profitability in the long term.
Currently, VMware has a Zacks # 3 Rank, which implies a Neutral rating on a short-term basis.
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