Robin Wauters

According to IDC’s Worldwide Quarterly Server Virtualization Tracker, 16.5% of all new servers shipped in the second quarter of 2009 (2Q09) were virtualized, an increase from 14.5% in 2Q08. However, actual shipments decreased 21.0% year over year to 246,000 physical servers in 2Q09 as customers continue to limit spending on new server hardware relative to last year. Similarly, worldwide virtualization software revenue declined 18.7% year over year in 2Q09 to $344 million. Virtualization licenses did grow quarter over quarter in 2Q09. The server virtualization market continues to shift towards the use of paid hypervisors, with paid virtualization software now running on 60.8% of all new server hardware shipments virtualized in 2Q09, an increase over 57.2% in 2Q08.

“Server virtualization has forever changed how customers manage their datacenters,” said Michelle Bailey, research vice president of Datacenter Trends at IDC. “‘Virtualization First’ is now the default approach for new server deployments at most enterprise IT organizations and is quickly becoming the foundational platform for cloud computing initiatives among service providers. Additionally, growth in emerging regions is accelerating as the economic downturn limits the ability of organizations to raise capital. The next phase in virtualization will require a reinvention of IT policies and procedures and continued adoption of automation tools will be key as virtual machine densities rise and customers find themselves facing virtual server sprawl issues.”

Hewlett-Packard held onto the number 1 spot for worldwide new server shipments virtualized with 36% market share. HP’s shipments declined 18% year over year in 2Q09 but grew 1% sequentially. These results were driven primarily by its x86 Proliant server business. Dell continues to distance itself from the remainder of the field as the number 2 vendor with its market share growing 9% over 1Q09. Dell’s relatively strong performance was driven by growth of Intel-based x86 servers in a weak market. IBM remained in the third position with 15% market share. IBM achieved 14% sequential growth driven by a solid performance from its converged System p and x86-based servers.

VMware continues to hold the number 1 (VMware ESX) and number 2 (VMware Server) virtualization platforms despite revenues declining 22% year over year. This was slightly more than the decline of 21% in total x86 virtualization licenses. Microsoft saw its virtualization license shipments decline 16% year over year, due to the continued depreciation of Virtual Server 2005. However, Hyper-V showed a sharp increase of 54%, one year after its official launch and entrenching itself into 4th place while it cannibalizes itself into the number 3 position, past Virtual Server 2005. Parallels Virtuozzo rounds out the top 5 with license shipments declining 36% year over year. Citrix XenServer showed the largest increase, growing 108% year over year due to the company changing its business model and offering the product for free with certain management functionality. It’s a bold seeding strategy that will see market share gains, but will take some time, if ever, to monetize.

Virtualization licenses represents the amount of virtualization platform shipments for a given vendor in a given quarter. New server shipments virtualized maps the amount of virtualization platforms shipments that are sold directly by the hardware vendors. Virtualized server revenue represents the hardware revenue of new server shipments virtualized. Virtualization software revenue represents the software revenue associated with virtualization platform sales.

IDC’s Worldwide Quarterly Server Virtualization Tracker is a quantitative tool for analyzing the global server market on a quarterly basis. The Tracker includes quarterly virtualization license shipments, new server shipments virtualized, virtualized server revenue and virtualization software revenue, segmented by region, cpu type, vendor, form factor, sockets, virtualization platform, and primary guest operating system.

VMware has announced financial results for the third quarter 2009:

• Revenues for the third quarter were $490 million, up 4% from the third quarter of 2008.
• Non-GAAP operating income for the third quarter was $109 million, a decrease of 5% from the third quarter of 2008. GAAP operating income for the third quarter was $23 million, a decrease of 77% from the third quarter of 2008.
• Non-GAAP net income for the third quarter was $95 million, or $0.24 per diluted share, compared to $93 million, or $0.24 per diluted share, for the third quarter of 2008. GAAP net income for the third quarter was $38 million, or $0.09 per diluted share, compared to $83 million, or $0.21 per diluted share, for the third quarter of 2008.
• Cash and cash equivalents as of September 30, 2009 were $2.2 billion, impacted by $356 million used for the acquisition of SpringSource. Total deferred revenues were $990 million. Compared to the same period a year ago, cash increased 29% and deferred revenue increased 27%.
• Non-GAAP operating cash flows for the quarter were $199 million, a decrease of 6% from the third quarter of 2008. GAAP operating cash flows were $199 million, a decrease of 18% from the third quarter of 2008. For the trailing twelve months ended September 30, 2009, non-GAAP operating cash flows were $898 million and GAAP operating cash flows were $975 million.

US revenues for the third quarter declined 1% to $246 million from the third quarter of 2008. International revenues for the third quarter grew 9% to $244 million from the third quarter of 2008.

Services revenues, which include software maintenance and professional services, were $250 million, an increase of 33% from the third quarter of 2008.

Recent Strategic Announcements and Highlights

• VMware hosted over 12,500 attendees and more than 200 sponsors, Aug. 31 through Sept. 3 at VMworld 2009 in San Francisco. As part of the leading virtualization conference, VMware secured new and expanded support from key partners including Platinum sponsors Cisco, Dell, EMC, HP, IBM, Intel, NetApp, Symantec and Wyse.
• In September 2009, VMware announced the vCenter Family of Products, an expanded set of virtualization management solutions including significant new and enhanced offerings meant to dramatically reduce operational expenses.
• September 1, 2009, as part of the VMware vCloud initiative, VMware announced the support of more than 1,000 leading service providers, including AT&T, SAVVIS, Terremark and Verizon Business to deliver cloud services based on VMware vSphere.
• September 16, 2009, VMware announced the completion of the acquisition of SpringSource. Rod Johnson, founder and chief executive officer of SpringSource, serves as General Manager of the new SpringSource division which will focus on providing developers and customers the best experience for developing modern applications.

Use of Non-GAAP Financial Measures

VMware has provided a reconciliation of each non-GAAP financial measure used in this earnings release to the most directly comparable GAAP financial measure. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered in addition to, not as a substitute for or in isolation from, measures of VMware’s financial performance prepared in accordance with GAAP. These measures differ from GAAP in that they exclude stock-based compensation, amortization of intangible assets, employer payroll tax on employee stock transactions, acquisition related items, the net effect of the amortization and capitalization of software development costs. VMware’s bases for these adjustments are described below.

VMware’s management uses the non-GAAP financial measures referenced in this release and shown in the accompanying schedules to gain an understanding of VMware’s comparative operating results (when comparing such results with previous periods or forecasts) and its future prospects and excludes the above-listed items from its internal operating plans and measurement of financial performance, including budgeting, calculating bonus payments, and forecasting future periods. These non-GAAP financial measures are used by VMware’s management in their financial and operating decision-making because management believes they reflect VMware’s ongoing business in a manner that allows meaningful period-to-period comparisons. As the non-GAAP financial measures exclude expenses that VMware believes are not reflective of ongoing operating results, management believes the non-GAAP financial measures enable management to better analyze trends in its business. When evaluating the performance of our individual functional groups, VMware does not consider the above-listed items that it excludes from its non-GAAP financial measures. Likewise, VMware excludes such items from its short and long-term operating plans. VMware’s management also believes that these non-GAAP financial measures provide useful information to investors and others (a) in understanding and evaluating VMware’s current operating results and future prospects in the same manner as management does, if they so choose, and (b) an additional basis for comparing in a consistent manner VMware’s current financial results with VMware’s past financial results.

In addition to the foregoing, management believes that these non-GAAP measures are useful to investors and others in assessing VMware’s operating performance due to the following factors:

• Although stock-based compensation is an important aspect of the compensation of VMware’s employees and executives, determining the fair value of the stock-based instruments involves a high degree of judgment and estimation and the expense recorded may bear little resemblance to the actual value realized upon the future exercise or termination of the related stock-based awards. Furthermore, unlike cash compensation, the value of stock-based compensation is determined using a complex formula that incorporates factors, such as market volatility, that are beyond our control. VMware does not believe these non-cash expenses are reflective of ongoing operating results.
• The amount of employer payroll taxes on stock-based compensation is dependent on VMware’s stock price and the timing and size of exercise by employees of their stock options and of vesting in restricted stock, over which management has limited to no control, and as such does not correlate to VMware’s operation of the business.
• VMware’s amortization of intangible assets includes the effects of EMC’s acquisition of VMware in January 2004. Also, VMware does not acquire businesses on a predictable cycle. VMware therefore believes that the presentation of non-GAAP measures that adjust for the amortization of intangible assets and the write-off of in-process research and development, provide investors and others with a consistent basis for comparison across accounting periods and, therefore, are useful to investors and others in helping them to better understand VMware’s operating results and underlying operational trends.

  Acquisition related items include direct costs of acquisitions. Examples of costs directly related to an acquisition include transactions fees and due diligence costs. While we believe it is useful for investors to understand the effects of these items on our total operating expenses, these expenses vary significantly in size and amount and are unique to specific acquisitions and as such are disregarded by management when evaluating the Company’s ongoing operating results. Acquisition related items also includes the gain on the Company’s initial investment in SpringSource Global, Inc., which was remeasured to fair value immediately before the Company’s acquisition of SpringSource. Management excludes the impact of such gains or losses on such investments when evaluating the Company’s ongoing operating results. Excluding the impact of the gain on the Company’s initial investment in SpringSource from the Company’s operating results is also important to facilitate comparisons to prior periods.

• The amortization and capitalization of software development costs can vary significantly depending upon the timing of products reaching technological feasibility and the timing of when products are made generally available. VMware believes that by removing the variance in operating results caused by the net effect of the amortization and capitalization of software development costs, the non-GAAP presentation provides investors and others with a basis similar to that used by management for comparing the level of ongoing research and development expenses and related operational trends across accounting periods.