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VMware Inc. (VMW - Snapshot Report) reported second-quarter 2014 non-GAAP earnings (including stock based compensation but excluding all one-time items) of 55 cents per share, which declined 9.9% on a year-over-year basis. However, earnings per share (EPS) were in line with the Zacks Consensus Estimate.
 
Shares of VMW were up 3.01% ($3.08) following the release of the second quarter earnings.
 
Revenues
 
Revenues increased 17.2% year over year to $1.46 billion almost near the higher end of management’s guided range of $1.43 billion–$1.47 billion.
 
The year-over-year increase in revenues can be attributed to 15.6% growth in license revenues to $614.0 million and an 18.4% increase in services revenues to $843.0 million in the reported quarter. Among services revenues, software maintenance jumped 20.0% from the year-ago quarter, while professional services rose 8.2% on a year-over-year basis.
 
Moreover, strong demand for VMware solutions across international as well as U.S. markets helped revenues. International accounted for 53.1% of net revenue in the reported quarter while the U.S. chipped in with the remnant 46.9% share.
 
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, EMEA was the strongest followed by the Americas and Asia-Pacific. 
 
Among the product groups, End User Computing (EUC) license bookings (including AirWatch) grew 50.0% on a year-over-year basis while Cloud Management grew over 30.0% in the reported quarter. Hybrid cloud business grew 80.0% on a year-over-year basis in the reported quarter.
 
During the quarter, VMware secured eight deals, each worth more than $10.0 million. In Germany itself, the company closed two of these $10.0 million deals. Enterprise License Agreements (ELA) accounted for approximately 36.0% of second-quarter bookings.
 
Recently, the company announced plans of expanding its operations in the Asian sub- continent. In Japan, VMware formed an alliance with SoftBank to launch its vCloud Hybrid Service while in China it entered into a partnership with China Telecom to launch the same.
 
During the quarter, VMware announced VMware Horizon 6, an integrated solution that delivers published applications and desktops on a single platform. The quarter also witnessed an alliance between VMware and SAP AG for announcing the availability of the SAP HANA platform VMware vSphere 5.5.
 
In the reported quarter, the company announced VMware vCloud Hybrid Service - Disaster Recovery, a new cloud-based disaster recovery (DR) service that provides a continuously available recovery site for VMware virtualized data centers.
 
Margins
 
Operating margin declined 510 basis points (bps) from the year-ago quarter to 19.8%. Operating profit includes stock-based compensation but excludes one-time items. The decline was primarily attributable to the huge expenses incurred for the acquisition of AirWatch. 
 
The decline in operating margin was due to higher research and development expense (up 80 bps), sales and marketing expense (up 160 bps), general and administrative expense (up 100 bps) and lower gross profit (down 220 bps).
 
Non-GAAP net income (including stock based compensation but excluding all one-time items) was $239.3 million or 55 cents per share in comparison to $264.1 million or 61 cents reported in the year-ago quarter. Net margin declined 490 bps on a year-over-year basis to 16.4%.
 

 

Balance Sheet & Cash Flow
 
VMware exited the quarter with cash and cash equivalents (including short-term investments) of $6.64 billion compared with $6.62 billion in the previous quarter. Cash from operations was $409.0 million while free cash flow was $333.0 million in the second quarter.
 
During the quarter, VMware repurchased approximately 2.5 million shares for around $238.0 million at an average price of $96.0 per share.
 
Guidance
 
For 2014, VMware forecasts revenues to be in the range of $5.96 billion to $6.08 billion with $6.02 being the mid-point. Excluding Pivotal and divestitures, revenues are expected to grow in the range of 16.0% to 18.0% for 2014. 
 
License revenues for 2014 are expected to be in the range of $2.56 billion to $2.62 billion (up 13.0% to 15.0% year over year). Excluding Pivotal and divestitures but including AirWatch, license growth rate is expected to be 14% to 16% versus 2013.
 
For 2014, non-GAAP operating margin is expected to be approximately 31.0% while GAAP operating margin is expected to range between 14.0% and 18.0%. Management expects the GAAP tax rate to be approximately 1-2.5 percentage points lower 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 75.0% of the world’s cloud market.
 
For third quarter of 2014, management expects revenues to be in the range of $1.42 billion to $1.52 billion (up 15% to 18% year over year). License revenues for the third quarter are expected to be $630.0 million to $645.0 million (up 12.0% to 14.0% year over year). 
 
Non-GAAP operating margin for the third quarter is expected to be within the range of 29% to 29.5% while GAAP operating margin is expected to range between 11.4% and 15.4%. Other income and expense is expected to be nil in the third quarter. Moreover, management also expects to continue its share buyback program in the third quarter of 2014.
 
Our Take
 
We believe that a sluggish IT spending environment and intensifying competition from its peers such as Microsoft Corp. (MSFT - Analyst Report), Hewlett Packard (HPQ - Analyst Report) and Citrix (CTXS - Analyst Report) 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. 
 
However, recognition of the company by IDC as number one in both worldwide cloud systems management software and worldwide data center automation software is a major positive for VMware. Also, the company featured in Gartner’s Magic Quadrant during the quarter.
 
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 Desktone and AirWatch will also add to the top line, going forward.
 
Currently, VMware has a Zacks Rank #4 (Sell).

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