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VMware Posts Strong 4Q

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VMware Inc. (VMW - Free Report) reported an outstanding fourth quarter 2011 with earnings per share (EPS) surging 59.2% year over year and handily beating the Zacks Consensus Estimate by 9 cents. The better-than-expected results were driven by solid revenue growth on the back of strong global demand for VMware products.

EPS (including stock-based compensation) came in at 52 cents in the reported quarter compared with 33 cents in the year-ago quarter. Excluding one-time items and stock-based compensation, EPS was 62 cents, up 34.8% from 46 cents reported in the year-ago quarter.

Quarter Details

Revenue increased 26.9% year over year to $1.06 billion, in line with the high end of management’s guided range of $1.03 billion to $1.06 billion and surpassed the Zacks Consensus Estimate of $1.05 billion. The upside was primarily driven by strong Enterprise License Agreement (ELA) growth, strong demand in the U.S. and across the Asia-Pacific markets during the quarter.

License revenue was up 21.6% year over year to $513.8 million, primarily attributable to strong global demand for vSphere, vFabric and Cloud Foundry project. ELA was 30.0% of fourth quarter bookings and included five transactions worth $10 million or more. The company experienced stronger demand for end-user computing and management products with the renewals of ELAs.

Services revenue jumped 32.2% year over year to $546.5 million. Software maintenance and support revenue increased 34.0% year over year to $463.0 million in the fourth quarter of 2011.

VMware stated that with the purchase of new licenses, customers continued to buy more than 24 months of support and maintenance, which reflects their strong commitment to VMware as a core element of their data center architecture and hybrid cloud strategy. Professional services revenue was $83.0 million, up 22.0% from the year-ago quarter.

USrevenues increased 21.0% year over year to reach $531.0 million while International revenues witnessed a year-over-year growth of 34.0% to $529.0 million in the reported quarter.

Gross profit (including stock-based compensation) increased 26.7% year over year to $930.1 million in the fourth quarter. Gross margin was 87.7% versus 87.8% in the prior-year quarter. The year-over-year decline in gross margin was due to higher proportion of service revenue in the mix.

Operating income (including stock-based compensation) in the reported quarter jumped 62.7% year over year to $257.3 million. Operating margin was 24.3% in the quarter compared with 18.9% in the year-ago quarter. The upside was primarily driven by strong revenue growth and strict cost-control measures.

Net income (including stock-based compensation) was $223.4 million, up from $139.2 million in the fourth quarter of 2010. Net margin was 21.1%, up from 16.7% in previous-year quarter.

Balance Sheet and Cash Flow

VMware exited the quarter with cash and cash equivalents (including short-term investments) of $4.51 billion, compared with $3.98 billion in the previous quarter.

Cash from operations was $561.4 million versus $524.0 million in the prior quarter. Free cash flow was $535.3 million in the quarter, an increase of 32.0% from the year-ago quarter. During the quarter, the company repurchased shares of its common stock worth $90 million.


Management provided robust guidance for the first quarter of 2012. VMware expects total revenue to range from $1.015 billion to $1.040 billion, reflecting an increase of 20.0% to 23.0% from the first quarter of 2011. The Zacks Consensus revenue estimate is pegged at $1.02 billion, in line with the lower end of management guidance.

VMware continues to increase investments in emerging markets and product innovation, which will hamper operating margin expansion for 2012. Management expects first quarter 2012 operating margin to exceed the full-year operating margin growth. Non-GAAP operating margin for the first quarter is expected to be within a range of 30.0% to 31.0%.

For fiscal 2012, revenue is expected in the range of $4.475 billion to $4.6 billion, an increase of 19.0% to 22.0% from fiscal 2011, primarily driven by strong license revenue growth, which is expected to increase within 11.0% to 16.0% range.  Operating margin is expected in the range of 29.5% to 30.5% in the upcoming quarter.

For 2012, VMware expects capital expenditure in the range of $325.0 million to $350.0 million.

Our Recommendation

Enterprises that are shifting to the 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 vCenter Operations Suite for management. We expect VMware to benefit from increased adoption of virtualization and cloud computing technologies going forward.

We believe that VMware’s strong innovative product pipeline will drive top-line growth over the long term. Moreover, the company’s increasing focus on emerging markets will also drive its profitability over the long term, in our view.

However, we believe that a sluggish North American and European market coupled with weak IT spending environment will be an overhang for the stock over the next 12 to 18 months.  Moreover, increasing competition from Microsoft Corp. (MSFT - Free Report) and Citrix Systems Inc. (CTXS - Free Report) will remain a deterrent going forward.

We have a Neutral recommendation on VMware over the long term (for the next 6 to 12 months). Currently, VMware has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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