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VMware's Earnings Pop, Outlook Cloudy

UPDATED: Virtualization heavyweight VMware (NYSE: VMW) offered up a mixed bag of results for its second quarter, with revenues up by 54 percent, profit up by 53 percent, and a lowered outlook for the year.

Profit for the quarter was $52 million, or $0.13 per diluted share, up by 53 percent compared to $34 million, or $0.10 per diluted share, for the second quarter of 2007. Overall revenues jumped by 54 percent to $456 million compared to the same time last year.

However, VMware's lowered growth expectations for the full year worried investors. They repeatedly raised questions about the financial results, enterprise licensing agreements (ELAs) and asked whether, as VMware's revenues hit $2 billion, it would suffer from seasonal highs and lows like other software companies in that range.

Mark Peek, VMware's chief financial officer, said during a conference call that customers are taking a little more time to review longer-term contracts. "We're convinced this is due to macroeconomic conditions," he said.

Peek said VMware now expects revenue growth of 42 percent to 45 percent this quarter, totaling about $462 million to $468 million, which are modestly lower than its prior guidance.

The lowered outlook sent VMware's shares down by 13 percent to $33 in after-hours trading today.

Peek admitted that competition from Microsoft, which has ramped up its virtualization efforts, will impact VMware's earnings. "Microsoft will seek to displace our VMware infrastructure in certain accounts, but they have a certain subset of the products we have and their technology is less mature," he said.

"We are not aware of losing any sales to them, but their marketing and sales efforts will have an impact, and we expect 2008 revenues to grow between 42 and 45 percent, and third-quarter revenues to be between $462 million and $468 million because of that," he said.

The results came on the heels of a management shakeup earlier this month at VMware in which the company's CEO, Diane Greene, was ousted and replaced by former Microsoft executive Paul Maritz.

During a conference call today to discuss results, Maritz said VMware is "more than a hypervisor company," referring to the layer of software that isolates the operating system from the hardware in servers, helping to virtualize data center environments.

VMware, he continued, is one of the few companies that can aspire to become one of the strategic IT companies in the industry, by helping customers build datacenter solutions that are more manageable and more flexible.

"Others have referred to this as the datacenter of the future," he added.

VMware is extending its VMware Infrastructure Suite to desktop management for IT, and intends to continue building on that foundation, Maritz said. It is moving into what Maritz described as the third phase of its trajectory, extending its technology and products for more uses and more users.

For starters, VMware is cutting prices to attack the SMB market, which could not afford its prices. It is cutting product prices for customers targeting SMBs.

Taking a leaf out of Microsoft's book, VMware will also make the next release of ESXi, a hypervisor technology released in December, available free. It's now priced at $495 a pop. Microsoft's almost-free Hyper-V hypervisor helped it gain mind share among potential customers and rocked VMware when it was announced.

VMware is also going to strengthen ties with partners who target the enterprise market, and work hard to penetrate the fastest growing economies abroad, such as Asia-Pacific. "We have mainly been strong in the U.S., Europe and Australia," Maritz said.

In addition, VMware will extend its technology to the cloud. It is working with partners like SunGuard, which will use its virtual infrastructure technology to extend disaster recovery services into the cloud.

The company will also implement a hiring slowdown. "We hired about 2,000 people in the last 12 months and it's important to make sure you're digesting that growth," Maritz said. "We'll have a hiring pause and focus only on strategic hires." VMware has already made about 250 strategic hires, Peek said.

The sales force will also find itself under the gun. "We could do things to more cost effectively close the business, we're working with the team to make sure we collectively, not just the sales organization, get behind seizing the opportunities we have," Maritz said.

Maritz also addressed one other area that has worried both analysts and observers -- the possibility that VMware engineers, who were intensely loyal to Greene, would leave. "I've been doing a lot of communicating with employees," he said. "The leadership change is still a concern of mine, and I've been spending lots of time getting to know key technical employees, and am hopeful we'll be able to weather the transition with as little negative impact as we can."

As for the burgeoning competition from Microsoft with its Hyper-V product, Maritz said the key when it comes to competing with Microsoft is "neither to rest on your laurels or get mesmerized. The key is to stay ahead [in the market] and that's exactly what we intend to do."

(Senior Writer Richard Adhikari contributed to this report.)