Virtualization and cloud-computing giant VMware (NYSE:VMW) is scheduled to announce its Q2 2014 earnings on July 22. The company reported a year-over-year (y-o-y) increase in both of its revenue streams - product license revenues (+15%) and services revenues (+14%) - in the previous quarter. The company's software license gross margins have consistently improved over the last few years, from 87.7% in 2009 to over 90% in 2013. Continuing the trend, the gross margins for software licenses grew to over 91% for Q1 2014 - in line with the company's expectations. VMware expects its margins to remain at nearly Q1 levels for the full year.
VMware's management mentioned that the company's three main areas of focus are software-defined data centers (SDDC), the vCloud Hybrid suite and end-user computing. Software-defined networking and software-defined storage both form an integral part of the SDDC vision articulated by VMware. The company saw a positive customer response for both VMware NSX, the network virtualization platform, and the newly launched Virtual SAN (vSAN) software-defined storage platform during the first quarter. Growing competition from competing virtualization and cloud providers Amazon (NASDAQ:AMZN), Cisco (NASDAQ:CSCO), Microsoft (NASDAQ:MSFT) and Citrix (NASDAQ:CTXS) remain key concerns for the company in the coming quarters. We have a $100 price estimate for VMware's stock, which is slightly higher than the current market price.
High Expectations From Network Virtualization
VMware has dominated the server virtualization market in the last few years, commanding a 55-60% market share in this segment. However, competitors such as Microsoft and Citrix have developed product offerings to compete with VMware's and consequently gained share in the market by offering competitive prices in recent years. Since server virtualization is a maturing market, VMware has shifted its focus to tap into newer market technologies such as network virtualization and software-defined storage. VMware introduced NSX, its own software-defined networking (SDN) platform in late 2013, to establish itself in the fast growing segment. The company reported that it made great progress in the last quarter by signing deals with major clients that included a number of large enterprises in the finance, banking and telecommunications sectors. Management expects SDN to follow a similar trajectory for the company as server virtualization in 2009. Going by that estimate, 2014 should be a highly productive year for the company, as SDN has started gaining traction among buyers.
In June, VMware announced that it has started selling NSX licenses via channel partners. VMware already has about 10 partners on board and the company is looking to add more in Q3. The company is planning to roll out an NSX-competency channel program at the VMworld conference in August to scout for more channel partners . The enhanced security feature on the NSX could become more popular in the long run, and the company expects more meaningful contributions from network virtualization in the coming quarters. A key concern for VMware at this point is Cisco's (CSCO) open-source approach to the SDN architecture, which could be possibly cut into VMware's market if it gains popularity.
Other Areas Of Growth
VMware introduced its Virtual SAN software-defined storage, which is fully compatible with its vSphere virtualization platform, at the end of the previous quarter. This converged infrastructure targets both large enterprises and small and medium businesses. The company had the Virtual SAN license on sale for only two weeks in Q1 and saw a strong response for the product. Management mentioned that the company already closed a sizable deal for a retailer for Q2 in the previous quarter itself.
VMware's vCloud Suite was largely responsible for driving sales during the latter half of 2013. The company saw robust growth (nearly 18%) in services revenues in 2013. The trend continued in Q1, with services revenues rising by 14% over the prior year quarter. VMware's services division is likely to continue to reap benefits from its hybrid cloud offering as the vCloud Hybrid service gains popularity among buyers. The company has now expanded to Asia, with Japan being the third country after the U.S. and the U.K. where VMware will deploy its hybrid solution. The company also signed a deal with China Telecom (NYSE:CHA) to build a hybrid cloud service that will be ready to launch next year.
VMware's acquisition of mobile-device management (MDM) software provider AirWatch for $1.5 billion in January was among the key developments of 2014. The acquisition boosts VMware's MDM capabilities which should help the company to provide virtualization on mobile devices such as smartphones and tablets. The company announced its deal with Box to enhance secure enterprise collaboration across mobile devices for enterprise mobile management. Although this deal will not have any impact on Q2 results, VMware's future seems bright with the progress it has made in mobile-device management and mobile application management. This, combined with its network and server virtualization capabilities, should lead to positive results.
The company has given revenue guidance of about $1.45 billion for the quarter, which is more than a 15% increase over the prior year quarter. The company expects to generate close to $6 billion in revenues for the full year. With a healthy customer response to VMware's new product offerings and the growing services department, we expect the company to meet its guidance.
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