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VMware Q3 Earnings Up Y/Y; Forms Virtustream with EMC

The last few days have been a roller coaster ride for VMware Inc.VMW as the news about its parent company EMC Corporation EMC being acquired by Dell sent shares tumbling.

If this was not enough, along with yesterday's third-quarter 2015 earnings announcement, VMware and EMC further added to investors' concerns. The two entities announced their plans to form a new cloud company by spinning out Virtustream. While the news in itself is no big deal, the timing of this announcement is perplexing as it means that Dell will also have ownership of Virtustream.

Also, its noteworthy that post spin-out, Virtustream's financial results will be consolidated with that of VMware (from the first quarter of 2016). This move, it seems, is an attempt by Dell to reinforce the fact that VMware's business model will not be affected following its acquisition of EMC.

Even a recent Dell blog has stated that "We do not plan to do anything proprietary with VMware as regards Dell or EMC, nor place any limitations on VMware's ability to partner with any other company."

Nonetheless, investors still seemed shaky as evident from a decline of 3.4% in yesterday's after-hour trading session.

Third-Quarter 2015 Details

VMware reported adjusted earnings of 72 cents per share, which increased a robust 28.6% on a year-over-year basis. The company reported non-GAAP earnings of $1.02, an increase of about 18% on a year-over-year basis.

Revenues increased 10.4% year over year to $1,672 million and beat the Zacks Consensus Estimate of $1,666 million. The year-over-year growth was primarily attributable to strong customer adoption of VMware's products and services worldwide.

Revenues from services rose 13.1% year over year to $991 million. License revenues increased 6.6% year over year to $681 million. Software maintenance revenues increased 10.8% year over year to $863 million and professional services sales surged about 32% from the prior-year quarter to $128 million.

The company repurchased shares worth $200 million in the reported quarter.

Margins

Non-GAAP operating margin declined 110 basis points (bps) from the year-ago quarter to 31.5%. The decline was due to higher research and development, general and administrative expenses.

Balance Sheet & Cash Flow

VMware exited the quarter with cash and cash equivalents (including short-term investments) of $7.22 billion compared with $7.08 billion as on Dec 31, 2014. The company reported operating cash flow of $411 million in the quarter, down 32.2% year over year, and free cash flow of $321 million, down 36.6% from the prior year quarter.

Guidance

For fourth-quarter 2015, the company expects revenues to be in a range of $1.825 billion and $1.875 billion. License revenues are expected to be within $800 million to $830 million. Non-GAAP earnings per share are expected in the range of $1.23 and $1.27. Non-GAAP operating margin is expected to be 35%

For 2015, the company expects non-GAAP revenues in the range of $6.605 billion to $6.655 billion (previously provided guidance was $6.575 billion and $6.685billion). License revenues are guided to be between $2.695 billion and $2.725 billion compared with the earlier projection of $2.710 billion and $2.765 billion.

Non-GAAP EPS is expected within $4.04 and $4.08 (up from the earlier expected range of $3.97 to $4.03). Non-GAAP operating margin is expected to be about 31.8% (compared with the earlier guidance of 31.5%). Cash flow from operations is expected to be around $1.875 billion in 2015.

Virtustream Details

EMC and VMware intend to form a new business (branded as Virtustream) that would comprise EMC Information Infrastructure, Virtustream and VMware's strengths. The company will be owned jointly by EMC and VMWare with each having a 50% stake.

Virtustream, which was known for its wide hybrid-cloud product portfolio that is compatible with the entire range of applications, workloads and cloud models, was acquired by EMC earlier this year for $1.2 billion.

Our Take

VMware remains one of the leading companies in the virtualization and cloud computing market. The company's innovative product pipeline, strategic partnerships, continuous contract wins and robust international sales are expected to drive overall results. Additionally, the company continues to make some strategic acquisitions, which have significantly expanded its product portfolio.

Following the closure of the recently announced acquisition deal, EMC's stake in VMware (about 81% of the company) will be owned by Dell. Most importantly, according to the deal, Dell will create tracking stock from 53% of the value of total VMware shares. Dell will retain 80% of VMware shares and other shareholders the remaining 20%, which will be trading as usual.

That is through the EMC acquisition, Dell would be able to get significant control over VMware at a much discounted price. As a result, investors have become jittery regarding the valuation of the company.

In addition, sluggish IT spending and stiff competition remain headwinds. Moreover, VMware's continued investment in the emerging markets, product innovation and acquisitions can weigh on its financials in the near term.

Currently, VMware has a Zacks Rank #3 (Hold). A couple of better-ranked stocks in the same space are Dassault Systemes SA DASTY and Majesco Entertainment Co. COOL , each sporting a Zacks Rank #1 (Strong Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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