VMware Earnings Preview: Software-Defined Storage, Networking, Hybrid Clouds In Focus
VMware (NYSE:VMW) is scheduled to announce its Q3 2014 earnings on October 21. The company reported a year-over-year (y-o-y) increase in both product license revenues (+16%) and services revenues (+18%) in the second quarter, with net revenues of $1.46 billion for the quarter slightly higher than its guidance range. The company expects its Q3 net revenues to be about 17% higher than the prior year quarter at $1.47 billion, while license revenues are expected to be around $640 million, 13% higher than the year-ago period. [1]
Management mentioned that the company is currently focused on three main areas of growth, namely software-defined data centers (SDDC), hybrid cloud and end-user computing. The company witnessed strong demand for products and services in these domains in the last few quarters, while the continued demand for hybrid cloud and SDDC is expected to drive revenues in the coming quarters as well. As a result, VMware appears on course to meet its full year revenue expectation of $6 billion.
We have a $100 price estimate for VMware’s stock, which implies a 10% premium to the current market price.
See our complete analysis for VMware here
SDN, Hybrid Cloud To Continue Growth Spree
Software-defined networking and software-defined storage both form the core of software-defined data centers, according to VMware. The company saw a positive customer response for NSX, the network virtualization platform launched by VMware in October 2013. VMware reportedly made significant progress in Q2 this year by signing deals with large clients that included a number of enterprises in the finance, banking and telecommunications sectors. The company had more than 150 paying customers for NSX by the end of June, with the networking business generating more than $100 million during the quarter on a run-rate basis. Gaining a large number of customers in a short time has seemingly put VMware in a strong position relative to Cisco (NASDAQ:CSCO), a main competitor in the SDN market (see VMware And Cisco To Fight It Out In The SDN Arena). The company believes that SDN could be a “decade-plus opportunity” for VMware – with a growth rate similar to that witnessed in the server virtualization market in 2009. The company is looking to expand its offerings not just in network virtualization, but also in the network security domain.
Additionally, VMware successfully launched its Virtual SAN (vSAN) software-defined storage platform, which gained more than 300 paying customers by the end of Q2. The Virtual SAN platform can be integrated with VMware’s flagship vSphere hypervisor, making it a converged storage platform, a significant improvement on the standard operating model for storage. As a result, vSAN deployments are expected to rise through 2014, with more paying customers adding to the numbers.
VMware’s hybrid cloud business, which includes our vCloud Service Provider Program and vCloud Hybrid Service, grew by nearly 80% in the second quarter, while cloud management license bookings grew by more than 30% y-o-y. As the company introduced solutions such as Infrastructure-as a Service and Desktop-as-a-Service to customers on its hybrid cloud platform, it re-branded its vCloud Hybrid services to vCloud Air in August. [2]
The company initially announced its seventh production data center in Q2, due to which it expects the company-operated cloud to be available in over 75% of the world’s cloud market by the end of the year. Consequently, the company made efforts to expand internationally by signing deals with service providers across Europe and Asia-Pacific. (See: VMware Expands vCloud Hybrid Operations In Europe And Asia) The company had over 4,000 service provider partners for VMware cloud at the end of Q2, which should help the company reach out to its solid customer base (about half a million in numbers) for further hybrid cloud adoption. Although this is still a nascent market, the company expects a large chunk of customers to start adopting the enterprise class hybrid cloud service.
Strong Outlook For Coming Quarters
We estimate that the adjusted gross margin for VMware’s highly profitable software licenses division rose by 70 basis points from 95.6% in 2012 to 96.3% in 2013. This trend has continued in 2014 thus far, with a slight improvement in margins through the first half of the year. The company-reported gross margin for software licenses in the June quarter was almost 3 percentage points higher than in Q2 2013. VMware expects the gross margins for both licenses and services to remain around Q2 levels through the second half of 2014. [1] We expect a gradual year-on-year increase in gross margin for software licenses in the near term.
The company’s net income was about 25% lower than Q2 2013 at $200 million, which it attributed to higher operating expenses (sales, marketing and administrative) primarily due to the AirWatch acquisition in February. The company intends to continue to invest in newer technologies and next generation products to gain long-term benefits. Despite higher investment, VMware expects its non-GAAP operating margin to be 31% for the full year – about 150 basis points higher than the operating margin in Q2. The integration of technology from the acquisition and related cost synergies could help improve profitability through the latter half of the year.
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- VMware Q2 2014 Earnings Call Transcript, Seeking Alpha, July 2014 [↩] [↩]
- VMware Introduces the VMware vCloud Air Network, VMware Press Release, August 2014 [↩]