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VMware earnings: Law of Large Numbers hasn't caught up... yet

Everything that goes up must come down. But as experts predicted prior to Monday night’s VMware earnings call, there’s no sign that VMware’s continued gaudy growth numbers will crash back to Earth in the near future.

In the first quarter of 2010, VMware reported $634 million in revenue, up 35% from the same quarter of 2009. In the second quarter of 2010, revenues were $674 million, representing year-over-year growth of 48%.

This, its third, quarter, VMware beat Wall Street projections of $700 million in revenues for the quarter and 42-43% growth with actual results of $714 million, an increase of 46% from the third quarter of 2009.

With plenty of enterprise servers yet to be virtualized and the cloud computing battle just beginning, there’s still plenty more territory for VMware to capture within the enterprise, even as hypervisor competitors have begun to nip at its heels.

However, while growth will continue, even assuming VMware maintains and grows its current revenue rate of $700 million or more (the company gave guidance Monday night for the fourth quarter as between $790 and $810 million, well above previous consensus estimates of $772 million), simple math dictates that the percentage growth will diminish over time. In other words, doubling your money is easier when you have $50 than when you have $5,000.

Despite another solid quarter, VMware officials were careful to caution Wall Street on the earnings call that 2011 might be a year the growth percentages start to shrink. More details will become available in January, according to VMware CFO Mark Peek.

One Wall Street firm, Wedbush Morgan, projects 17% growth for VMware year over year in the first calendar quarter of 2011, and 11% in the second quarter, according to analyst Kaushik Roy. VMware’s Peek told investors on the call to be prepared for a seasonally typical decline in revenues sequentially between the last quarter of 2010 and the first quarter of 2011.

Meanwhile, despite the continued top-line revenue growth, VMware shares took a dip in after-hours trading Monday night when profits didn’t match up with Wall Street expectations. The consensus revenue estimate was low, at $698 million for the quarter, but the expectation was for 35 cents per share of stock in profit. Instead, what VMware delivered was $85 million in net income, or 20 cents per share, according to Generally Accepted Accounting Practices (GAAP). Non-GAAP profits would have been $165 million, or 39 cents per share.

Peek also emphasized that 2011 will be a “year of investment” for VMware, to prepare it for its next phase of growth (I would assume developing virtualization management tools and assimilating Integrien will be priorities there).

To sum up using a sports analogy: if VMware were a baseball team, it would dominate in the playoffs this month, but ownership would warn that next season could turn out to be the proverbial “rebuilding year.”

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