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VMware Inc. (VMW - Snapshot Report) reported second quarter 2012 non-GAAP earnings of 68 cents, which improved from 55 cents in previous-year quarter. However, including stock based compensation of 23 cents but excluding total one time items of 10 cents and proportionate tax effect of 3 cents, earnings came at 52 cents per share, which comfortably surpassed the Zacks Consensus Estimate by 4 cents.
Earnings surged 33.3% from prior-year quarter driven by solid revenue growth, based on strong global demand for VMware products. The company also announced the acquisition of Nicira for $1.26 billion, a software-defined networking company.
Revenue for the quarter increased 22.0% year over year to $1.12 billion. This was in line with the Zacks Consensus Estimate and higher end of management’s guided range of $1.10 billion-$1.12 billion. The upside was primarily driven by strong growth from the license and services segments. Moreover, strong demand in the international and domestic markets also contributed to the revenue.
License revenue was up 11.3% year over year to $517.2 million, primarily attributable to strong global demand for VMware products. Enterprise License Agreements were approximately 30.0% of second quarter bookings and included four transactions worth $10 million or more.
Services revenue jumped 32.7% year over year to $605.8 million. It includes two segments, namely Software maintenance and support and Professional services. The revenues of these two segments increased 33.0% and 24.0%, respectively.
VMware stated that with the purchase of new licenses, customers continued to buy more than 24 months of support and maintenance. This reflects their strong commitment to VMware as a core element of their data center architecture and hybrid cloud strategy.
US revenues increased 22.0% year over year to reach $551.0 million, while International revenues witnessed a year-over-year growth of 22.0% to $572.0 million in the reported quarter.
Gross profit (including stock-based compensation) increased 22.3% year over year to $979.8 million in the second quarter. Gross margin was 87.2% versus 87.0% in the prior-year quarter. The year-over-year increase in gross margin was due to higher revenue base.
Operating expenses increased 20.4% from the previous-year quarter to $722.5 million due to 14.5% increase in the research and development expenses, 24.9% increase in the selling and marketing expenses and 17.8% increase in the general and administrative expenses. However, operating expenses as a percentage of revenue declined 90 basis points.
Operating income (including stock-based compensation) in the reported quarter jumped 27.9% year over year to $257.3 million. Operating margin was 22.9% in the quarter compared with 21.8% in the year-ago quarter. The upside was primarily driven by strong revenue growth, higher gross margin base and lower operating expenses as a percentage of revenue.
Net income (including stock-based compensation) was $223.9 million, up from $171.5 million in the second quarter of 2011. Net margin was 19.9%, up from 18.6% in previous-year quarter.
VMware exited the quarter with cash and cash equivalents (including short-term investments) of $5.35 billion, compared with $5.23 billion in the previous quarter. Cash from operations was $391.3 million versus $576.6 million in the previous quarter. Free cash flow was $379.7 million in the quarter versus $596.6 million in the previous quarter.
VMware expects total revenue to range from $1.11 billion to $1.15 billion, reflecting an increase of 18.0% to 22.0% over the third quarter of 2011. Moreover, revenue from license agreements is expected to grow in the range of 6% to 13% from the previous-year period. However, management expects services revenue to outperform license revenues in 2012.
VMware continues to increase its investments in emerging markets, product innovations and acquisitions. Increased investments are expected to hamper operating margin expansion for 2012. Non-GAAP operating margin for the third quarter is expected to be within a range of 28.75% to 29.75%.
For fiscal 2012, revenue is expected in the range of $4.54 billion to $4.635 billion, an increase of 20.5% to 23.0% from fiscal 2011, primarily driven by strong license revenue growth, which is expected to increase within 11.0% to 15.0% range. Operating margin is expected in the range of 30.25% to 31.25%.
We believe that VMware’s strong and innovative product pipeline along with its strategic acquisitions will enable the company to drive its top-line growth over the long term. Moreover, the company’s continued strong performance in international markets and focus on emerging markets will also be a crucial factor over the long term, in our view.
However, we believe that sluggish North American and European markets coupled with modest IT spending environment and competition from Microsoft Corp. (MSFT - Analyst Report) and Citrix Systems Inc. (CTXS - Analyst Report) are the headwinds going forward.
We have a Neutral recommendation on VMware over the long term. Currently, VMware has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.