VMware warns that revenue may fall for the first time in Q2

Virtualization vendor says sales being hit by economy, transition to new vSphere software

Virtualization market leader VMware Inc. reported a first-quarter profit of $69.9 million on Wednesday, with revenue increasing 7% year to year. But the company said that sales are being hit by the economic recession and warned that it might report its first-ever drop in revenue this quarter.

Revenue for the quarter that ended March 31 was $470 million, just slightly below the average of what financial analysts had predicted, according to figures from Thomson Reuters.

But VMware said that software license sales declined 13% from last year's first quarter, to $257 million, as customers cut IT spending and signed fewer large deals. The drop was offset by a 48% jump in service revenue, which includes software maintenance fees and is becoming a larger part of VMware's business.

The Q1 net income total was up from $43.1 million a year ago. The earnings amounted to 18 cents per share, or 25 cents per share when one-time charges were excluded, the company said. The average estimate from financial analysts was for earnings of 20 cents per share.

The tough economic climate, combined with the transition to a new version of VMware's core virtualization software that was announced Tuesday, will further depress the company's software sales in the current quarter, Chief Financial Officer Mark Peek said in a statement as part of the earnings announcement.

"As a result, we expect our second-quarter revenues will be flat, or even down, compared to the second quarter of 2008," Peek said.

That would be a first for VMware, which has seen its revenue climb every quarter since the EMC Corp. subsidiary went public two years ago. The growth has been slowing, however, as VMware becomes larger and faces increased competition, and the initial wave of virtualization adoption starts to flatten out. (EMC today reported a decline in both revenue and profits during the first quarter, and announced a 5% pay cut for salaried employees.)

On Tuesday, VMware officials said that vSphere, the new "cloud operating system" that adds support for fault tolerance as well as storage and network management capabilities, positions the company well for the future. But in the short term, vSphere, which is due for release by the end of the current quarter, will be a disruption for VMware and its business partners, who will have to recertify their products to work with the new technology.

The other big factor in the weak second-quarter forecast is the economy. "Basically, customers battened down the hatches and were reluctant to spend on anything not operational," VMware CEO Paul Maritz said during a conference call on the results. VMware signed two large enterprise licensing agreements during the quarter, but in general, users are making smaller purchases, he said.

"Despite the quick ROI from virtualization, customers have generally put the brakes on all new investment," Peek added. Sales in Europe were particularly weak during the first quarter, he said.

VMware expects Microsoft Corp. in particular to emerge as a bigger rival over time, via its Hyper-V virtualization software. But Maritz, a former Microsoft executive, said that competition and pricing pressure aren't contributing to the decline in sales that VMware is seeing. "The macroeconomic conditions are the major factor," he said.

Maritz called the first-quarter results "solid" given the challenging economic climate. The company added 11,000 new customers for its existing VMware Infrastructure 3 software during the quarter, he said. About three-quarters of VMware's 350 biggest customers have standardized on the company's technology for their virtualization needs, according to Maritz, who added that some are running more than 5,000 virtual machines in their data centers.

Maritz said that in the coming quarters, VMware plans to introduce new management tools for vSphere that are designed around specific IT "scenarios," such as testing and development, disaster recovery and application management.

"These management suites are important, as they will constitute the new user interface to the vSphere platform and allow customers to get out of the business of managing plumbing and basically focus on the things that are truly business-critical to them," he said. Maritz didn't provide any other details, and a VMware spokeswoman said the company isn't commenting further about the planned tools at this point.

Peek said that VMware is in a strong cash position, with more than $2 billion in the bank. That will enable the company to maintain its research and development investments during the economic downturn, he said.

Copyright © 2009 IDG Communications, Inc.

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