UPDATE 3-VMware software sales fall, forecast disappoints

* Q2 outlook weak; blames economy, software upgrade

* Q1 non-GAAP EPS 25 cents vs Wall St view 20 cents

* Software sales fall for first time in company history

* Shares fall 14 percent after hours (Adds results details, analyst comment; updates shares)

By Jim Finkle

BOSTON, April 22 (Reuters) - Business software maker VMware Inc (VMW.N) warned that its revenue would dramatically miss Wall Street forecasts due to the weak economy and a new product launch, sending its shares down 14 percent.

The 11-year-old maker of virtualization software posted on Wednesday its first-ever decline in quarterly software sales and said the impact of the recession would be exacerbated this quarter by pains associated with a major product upgrade.

VMware, majority owned by EMC Corp (EMC.N), 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.

"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."

Company executives presented a grim picture of the economy, saying customers are not investing in new projects.

"We cannot promise a near-term change from the current tough conditions we are in," Chief Executive Paul Maritz said on a conference call.

"The year started very tough," he said. "There were signs of improving sentiment towards the end of the quarter. It hasn't yet translated into people opening their wallets."

VMware's software lets companies boost the efficiency of severs by running dozens of "virtual" machines on a single piece of hardware.

VMware said the launch of the new vSphere 4 line of virtualization software -- its first major product upgrade in three years -- will upset an already unsettled sales cycle as distributors get accustomed to the new product and customers test new features before getting comfortable deploying them.

Chief Operating Officer Tod Nielsen said he was not sure when the sales cycle would return to normal. "The honest answer is we just don't know," he said in an interview.

Goldman Sachs analyst Sarah Friar said it is not unusual for sales to soften when a company launches a major product upgrade, but the news is still unsettling to investors.