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VMware's quarter: Services up, licenses down

Underlying VMware's first-quarter results is the fact that the virtualization specialist has seen a big revenue shift toward services--and away from software licenses.

VMware's first-quarter financial results are out.

Revenue increased 7 percent from the first quarter of 2008 to $470 million. GAAP net income for the first quarter was $69.9 million, or 18 cents per diluted share, compared to $43.1 million, or 11 cents per diluted share, for the first quarter of 2008.

These are respectable results, though "analysts, on average, were expecting a profit of 20 cents per share on sales of $474.4 million, according to a poll by Thomson Reuters." Furthermore, guidance was disappointing, Reuters noted:

VMware, majority-owned by EMC, estimated second-quarter revenue to be flat or down from $456 million in the year-ago period. That was below analysts' average forecast for revenue of $501 million, according to Reuters Estimates.

Difficult economic climate or not, this is still a sharp change from VMware's growth rates of a few years back (though to be sure, it's a much larger company now, making it hard to maintain that sort of rate). And some financial analysts are getting grumpy, Reuters reports:

"It's a serious miss. It is not just the magnitude that is troubling. It is the reason they are giving," said Global Equities Research analyst Trip Chowdhry. "There is something fundamentally wrong--either in product strategy or sales execution."

This seems overstated, from my perspective, as a watcher of virtualization, as well as related technologies and companies. VMware, it seems to me, has done a great job--first under founder Diane Greene and now under Paul Maritz--in keeping VMware solidly in front of the virtualization wave and adding value on top of base components that have commoditized to a certain degree. And it's just rolled out an impressive new set of products, vSphere 4--its new Virtual Infrastructure suite.

(Commoditization isn't really the right word for what has happened to the hypervisors that form much of the foundation for server virtualization; however, it's certainly become hard to charge much money for them.)

That said, and top-line and bottom-line results aside, there were some underlying details that caught my eye. That's these, according to VMware's release:

First-quarter services revenues were $213.3 million, a 48 percent increase from last year. VMware's business mix continues to shift, with services revenues becoming a larger proportion of total revenues.

In the first quarter, services revenues were 45 percent of total revenues, compared to 33 percent a year ago. Driven by the challenging macroeconomic environment, license revenues were $257.0 million, a decline of 13 percent from a year ago.

That's a striking shift toward services from product. Contrast this to another large independent software vendor, Oracle, which garnered only 22 percent of its revenue from services in its last fiscal quarter--a figure that is actually slightly down from the year-ago period. In my experience, Oracle's mix is fairly typical of product companies.

This bothers me a bit for a couple of reasons. First, services require a lot of dedicated headcount. They also don't scale especially well--you're essentially renting out people. Contrast this to products; once you cut the CD, you can make as many copies as you want. (Obviously, there are limits to sales channels and so forth, but software licenses are much more scalable.)

The other is that it points to one of the impediments to virtualization growth; it's relatively complex--at least once you get past the consolidate-one-or-two-servers phase. To be sure, some of that services revenue is education (about 10 percent), which is reasonable enough in a technology area that's still young. But a full 80 percent is consulting--which says to me that this virtualization stuff isn't as easy as it should be.