VMware Reports Mixed 4Q

VMware Inc. ( VMW - Snapshot Report ) reported fourth quarter 2012 non-GAAP earnings per share of 81 cents, improving considerably from 62 cents earned in the year-ago quarter. However, including stock based compensation; earnings came in at 51 cents per share, missing the Zacks Consensus Estimate of 54 cents. The year-over-year earnings growth was primarily driven by solid top-line expansion.

Revenues

Revenues for the quarter increased 22% from the year-ago quarter to $1.29 billion and were also ahead of the Zacks Consensus Estimate of $1.28 billion. Reported revenue was at the higher end of management’s guided range of $1.26 billion-$1.29 billion. On a sequential basis, revenues were up 14.2%.

Revenues for the quarter were positively impacted by higher service revenues and license revenues. Moreover, strong demand for VMware solutions across international and domestic markets also helped revenues.

License revenues increased 16.1% year over year to $596.8 million. Enterprise License Agreements (“ELA”) were approximately 33% of fourth quarter bookings, boosted by the prudent mix of new ELAs and renewals.

Service revenues surged 27.4% from the year-ago quarter to $696.4 million. It includes two segments, namely Software maintenance and support (up 27.5% year over year) and Professional services (up 27.1% year over year).

Margins

Non-GAAP operating income increased 25.4% from the previous-year quarter to $423.9 million. Operating income (including stock-based compensation) increased 16.6% year over year to $300.1 million. Operating margin decreased 110 basis points from the year-ago quarter to 23.2% due to higher operating expenses.

Operating expenses (including stock based compensation) increased 23.7% from the year-ago quarter to $993.1 million. On a non-GAAP basis, operating expenses increased 20.4% on a year-over-year basis to $869.3 million. Non-GAAP net income increased 31.2% from the year-ago quarter to $349.3 million.

Balance Sheet

VMware exited the quarter with cash and cash equivalents (including short-term investments) of $4.63 billion compared with $4.39 billion in the previous quarter. Cash from operations was $493.4 million versus $436.2 million in the previous quarter. Free cash flow was $411.7 million in the quarter versus $385.9 million in the previous quarter.

Guidance

VMware expects first quarter revenues to range from $1.17 billion to $1.19 billion, reflecting an increase of 11% to 13% on a year-over-year basis. Moreover, revenue from license agreements is expected to be in the range of $480 million to $490 million. Non-GAAP operating margin is expected to be 30%.

For fiscal 2013, revenues are expected in the range of $5.23 billion to $5.35 billion, an increase of 14% to 16% with license revenue likely to increase in the range of 8%-11%. Non-GAAP operating margin is expected to range between 31% and 32%. Capital expense is expected between $340 million and $380 million.

The company has outlined several restructuring initiatives for fiscal 2013. The company expects to reduce its workforce by 900 and curtail investments in certain non-core areas. Moreover, the company expects a decline in U.S. federal government spending and volatile foreign exchange rates to impact the top line.

Recommendation

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.

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 ) and Amazon.com ( AMZN - Analyst Report ) are the headwinds going forward. Moreover, the company’s continued investments in emerging markets, product innovations and acquisitions are expected to weigh on the margins in the short term.

Currently, VMware has a Zacks Rank #2 (Buy).