VMware Inc (VMW) 2007 Q3 法說會逐字稿

Thanks so much for holding everyone, and welcome to VMWare's Third Quarter Earnings Conference Call. (OPERATOR INSTRUCTIONS.) And now, at this time, I would like to turn the conference over to Mr. Mike O'Malley, VMWare Investor Relations. Please go ahead, sir.

Thank you, Beau. Good afternoon, everyone. Welcome to VMWare's call to discuss our financial results for the third quarter of 2007. With me on this call are Diane Greene, VMWare's President and Chief Executive Officer, and Mark Peek, VMWare's Chief Financial Officer. Both Mark and Diane will present prepared remarks, and afterwards we will open up the lines to take your questions.

Additionally, we will be presenting slides today. A webcast of these slides can be viewed along with this call at our Investor Relations webpage on VMWare.com.

I'd like to remind you that today's discussion may include predictions, estimates, or other statements that could be considered forward-looking. These statements reflect our opinions only as of the date of this call and involve risks and uncertainties that may cause actual results to differ materially from those set forth in our statements. Information concerning factors that could cause actual results to differ can be found in VMWare's filings with the U.S. Securities and Exchange Commission, including our latest 10-Q. In addition, during today's call we will discuss certain non-GAAP financial measures. 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.

VMWare's Management uses the non-GAAP financial measures to gain an understanding of VMWare's comparative operating results. VMWare's non-GAAP financial measures may be defined differently than similar terms used by other companies and may not be comparable to similarly titled non-GAAP financial measures used by other companies. You can find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures in our press release and our filings with the SEC, including our current report on Form 8-K.

These reconciliation materials along with an archive of this call are posted on VMWare's Investor Relations website. Finally, unless otherwise stated, all comparisons in this call will be in reference to our results for the comparable period of 2006. With that, it is now my pleasure to introduce Mark Peek. Mark?

Thanks, Mike. Good afternoon, everyone, and thank you for joining us today. I am very happy to share our financial results for Q3 2007, our first quarter as a public company and another strong quarter for VMWare. We are pleased with our ability to both invest in the business and deliver strong financial results. For the third quarter, worldwide revenue for the Company was $358 million, growing 90% over the third quarter of 2006. GAAP operating income was $66 million, an increase of 135% from the same period last year. Basic and diluted GAAP EPS was $0.18 compared to $0.06 for the same period a year ago.

Non-GAAP operating income was $91 million, which represents 71% growth from the same period a year ago. Calculated on a non-GAAP basis, diluted EPS was $0.23 compared to $0.11 for the same period a year ago.

I'll now walk you through a more detailed view of our results and the key elements of our income statement, balance sheet, and statement of cash flows. Total revenue was $358 million, 90% growth from a year ago. Revenue consisted of 69% license and 31% services. License revenue was $247 million, an increase of 96% compared to Q3 2006, and a 21% increase over last quarter. For the quarter, license revenue growth was primarily driven by sales of our third generation virtualization software suite, VMWare Infrastructure 3.

For the quarter, the dollar value of orders on license transactions of less than $50,000 was 72% of the dollar value of total orders, equal to a year ago. Although customers [had an] increasing interest in enterprise license agreements, these numbers clearly demonstrate that VMWare continues to be a high volume transaction business.

Services revenue, which includes revenue from both subscription and professional services, was $110 million, an increase of 77%, compared to Q3 2006, and a 19% increase sequentially.

I'd like to make one point of clarity regarding the year-over-year growth rates of both license and services revenues this quarter. The current quarter growth rates were impacted by the mix of license and service revenue a year ago. As we stated in our second quarter 10-Q filing, our fulfillment of VMWare Infrastructure 3 orders in Q2 '06 and Q3 '06 caused the mix in our revenues to be somewhat skewed toward licenses in Q2 2006 and toward services in Q3 2006. As a result, the growth rates for both licenses and service revenues in Q3 of 2007 are not, in our view, representative of the trends we would have expected absent this timing issue. We believe that our Q3 2007 license revenue growth would have been similar to the 88% growth rate experienced for the nine-month period ended September 30, 2007 over the prior year comparable period absent this timing issue.

On a geographic basis, total U.S. revenues for Q3 grew 82% from a year ago to $201 million and international revenue grew 100% to $157 million. U.S. revenue represents 56% of total revenue while international revenue is 44%. We saw strength in all geographies as we continued to invest globally in sales, marketing, and product support.

I'd now like to turn to details on the rest of the income statement. As this is our first earnings call, I want to spend some time today explaining how we look at the business and to set your expectations around how we will report going forward. We, of course, report under Generally Accepted Accounting Principles. However, we view our non-GAAP operating income as the key profitability measure of our financial performance.

In calculating non-GAAP operating income, we make three adjustments to operating income calculated under GAAP, two that increase operating profit and one that generally decreases our non-GAAP results. First, we exclude charges for stock-based compensation calculated under FAS-123(R). Second, we exclude the amortization of purchased intangibles and any write-off associated with in-process research and development of acquisitions. Today most of our purchased intangibles are the result of the required accounting on our financial statements of EMC's acquisition of VMWare in 2004.

Finally, we adjust for the net effect of FAS-86 capitalized software development. The amortization and capitalization of software under FAS-86 can vary significantly depending on the timing of products reaching technological feasibility. We do not believe that the variance in operating results caused by the net effect of applying FAS-86 properly reflects underlying operational trends.

So we subtract the amortization of capitalized software while adding back any capitalized software costs during the period. This adjustment can either be an increase or a decrease to GAAP operating income in any given quarter. As Mike mentioned earlier, the non-GAAP information being shared with you today should be considered in conjunction with our GAAP operating results, which are available in our earnings release and on our website.

Using this approach, our non-GAAP operating income from the third quarter was $91 million, or 25% of revenues compared to $53 million in Q3 of 2006 or 28% of revenues. That's a year-over-year increase in absolute dollars of 71%. Sequentially, non-GAAP operating income increased $17 million and our non-GAAP operating margins remained essentially the same. For a company of VMWare's size with growth rates at these levels, operating margins are going to have some level of volatility. We caution you not to read too much into incremental increases or decreases in our non-GAAP operating margin.

In terms of the cost and expense line items on a non-GAAP basis, total cost of goods sold was $42 million, or 12% of sales, compared to $34 million, or 11% of sales in Q2 2007.

Research and development was $77 million, an increase of 15% sequentially over Q2 2007 and was 22% of revenue for the quarter. As I just mentioned, our calculation of non-GAAP expenses involve subtracting the amortization of capitalized software while adding back any capitalized software cost during the period. At the end of the second quarter, two of our upcoming products, the ESX3i embedded hypervisor and VMWare ESX Server 3.5, reached milestones that required us to capitalize $22 million in non-stock-based software development cost during the quarter. This adjustment reduced our Q3 non-GAAP operating profit by $13 million relative to GAAP.

Moving on, sales and marketing increased to $115 million or 32% of revenue, an increase of 23% sequentially over Q2 2007. G&A increased to $33 million or 9% of revenue, an increase of 18% sequentially over Q2 2007. We continue to invest in our infrastructure to support our growth.

Turning to income taxes, we currently estimate that our GAAP tax rate for the year will be 11%. This is a decline from 17% in the first half of 2007 and primarily reflects the impact of the mix of profitability between the U.S. and international, as well as holding the IPO proceeds in tax-free marketable securities. The Q3 tax rate of 2% reflects a true up to the 11% rate for the full nine-month period. The effect of the Q3 tax rate on basic GAAP EPS was $0.01 and on diluted GAAP EPS was $0.02 during the quarter.

We expect our non-GAAP tax rate for the year to be approximately 16% compared to 23% for the first half of the year. The Q3 non-GAAP tax rate of 7% reflects a true up of the 16% rate for the nine-month period. Applying the 7% non-GAAP tax rate to our results provides a non-GAAP diluted EPS of $0.23 a share on 369 million fully diluted shares. The impact of the Q3 2007 non-GAAP tax rate on our non-GAAP EPS was $0.02 during the quarter. Non-GAAP diluted EPS was $0.11 on 330 million shares outstanding in Q3 of 2006.

Now, let's turn to the balance sheet and our cash flow statement. Our IPO in August resulted in net proceeds of just over $1 billion. Prior to the IPO, we sold 9.5 million shares to Intel Capital for additional net proceeds of $218 million. We used the proceeds of these sales to repay 350 million of principal on the long-term debt owed to EMC. We also used $133 million to purchase our corporate campus in Palo Alto. As of September 30, we had $1.1 billion of cash and marketable securities and $450 million of long-term debt.

Deferred revenue as of September 30, 2007 was $427 million, a year-over-year increase of 104% compared to September 30, 2006. One of the factors driving this growth is the continued trend of customers purchasing multi-year contracts for our service and subscription offerings. During the quarter, the average support contract signed was approximately two years. Deferred revenue includes approximately $45 million of deferred license revenue, primarily related to our beta testing and announcements during the quarter with respect to ESX3i and VMWare Infrastructure 3.5.

Our operating cash flows were $198 million for the three months ended September 30, 2007, compared to using $4 million in operating cash flows for the three months ended September 30, 2006. On a non-GAAP basis we make two adjustments to operating cash flows. First, we adjust for the EMC related balance sheet accounts. We also subtract the amounts capitalized under FAS-86 because these are classified in our cash flow statement as investing activities under GAAP. On a non-GAAP basis our operating cash flows were $137 million for the three months ended September 30, 2007, compared to $56 million for the three months ended September 30, 2006.

Because cash flows can vary based on the timing of the payments of working capital items, particularly the balance sheet effects of EMC related items, it may be more meaningful to look at cash flows over a longer time horizon. On a trailing 12-month basis ended September 30, 2007, our non-GAAP operating cash flows, excluding the effects of EMC related balance sheet accounts and the amounts capitalized under FAS-86, were $471 million, compared to $229 million for the 12 months ended September 30, 2006.

On a fully diluted basis, we ended Q3 with approximately $369 million weighted average shares outstanding. Assuming no additional equity activity, Q4 weighted average shares outstanding would be approximately 402 million shares. These share counts are calculated using the treasury stock method. Based on this method, the Q4 share count could change as additional equity compensation is issued to new employees, or if there are significant changes in our stock price.

We plan on filing our 10-Q with the Securities and Exchange Commission during the week of November 5. We expect the disclosures in the 10-Q will be consistent with our 10-Q for the second quarter.

Consistent with our communications during the IPO road show, we are not providing financial guidance for the fourth quarter and we haven't yet decided what form of guidance we will be providing for 2008. VMWare is the leader in a young, currently high growth industry, and it's extremely challenging to provide guidance in this environment. VMWare will continue to invest in the business as we believe there is significant long-term opportunity in our target markets.

With that, I will turn it over to our President and CEO, Diane Greene.

Thank you, Mark, and let me also welcome everyone to today's conference call. This was certainly a big quarter for VMWare. The company managed to accomplish several high profile activities while continuing to run our high growth business. We moved into our Palo Alto corporate headquarters in July. In August, we completed our IPO. And our current trading price places us as one of the most--the five most valuable software companies in the world.

In September, we held our major annual virtualization conference, VMWorld, at the Moscone Center in San Francisco. Over 10,000 people attended, including 1,800 different partners. Over the course of the quarter we also announced new products in four separate categories and we completed three acquisitions. The quarter closed out with VMWare delivering year-over-year growth of 90% and quarterly revenues of 358 million.

Q3 was also a milestone in that our 12-month trailing revenues exceeded 1 billion for the first time. VMWare and our partners are focused no successfully adding to all customer segments from consumer to SMB to commercial to enterprise and across all industries. We also remain intent on increasing footprint growth within our existing customers by delivering increased ROIs as they standardize on our products and make use of our advanced functionality. There is a growing view that VMWare infrastructure, well into its third generation, is the right foundation for data centers. Our strategy is to cement this by continuing to deliver increasing value to work loads running with VMWare Infrastructure 3, or VI3.

A recent VMWare survey shows that nearly 90% of VMWare VI3 customers have deployed our software and production environments for enterprise applications, databases, and other key workloads, such as Exchange. More than 40% of our VI3 customers have standardized on VMWare for deploying and running their applications.

Approximately 60% of our VI3 customers have deployed VMotion, bringing transparent mobility across physical machines into their production environments. And right now, more than 40% of our VI3 customers are leveraging the high availability and distributed resource scheduling features in their production environments.

At VMWorld, our hardware OEM partners supported us in the announcement of our next generation hypervisor, ESX3i. Servers with embedded ESX3i will be shipped virtualization-enabled, so they can plug and play into any VI3 environment. The first such virtualization-enabled server is expected to ship this quarter. In addition, just a few weeks ago, we announced a significant upgrade in functionality for VMWare Infrastructure 3, including another leapfrog in power savings with our experimental distributed dynamic power management.

We are also quite focused on the growth of our virtual desktop infrastructure, VDI, business. VDI allows end-users to access their desktop from any form factor, from any location, and with or without connectivity. VMWare VDI has unique manageability, availability, and automation benefits that it derives from our highly robust VI3 foundation. VMWare is also enjoying the success of Fusion, our recent entry into the Mac consumer desktop space.

We continue to execute on our strategy of building high quality, high value VMWare infrastructure products and the associated services and training offerings. We test and certify the products for all of our customers' hundreds of possible hardware and software configurations, and we bring our offerings to market with our technology, OEM, channel, and services partners. We see more opportunity than we have staff to build to and market to. Therefore, we also continue our build-out of people and support infrastructure in line with our revenue growth. We have also shifted our growth to a more balanced worldwide distribution.

The IPO brought an upsurge in strong, motivated people wanting to join VMWare. Since the beginning of Q2, we've increased our headcount by about 1,500 to a worldwide total of just under 4,500. We've also had a much easier time acquiring companies. We acquired Dunes, a for-virtual-environment Swiss IT process automation software company; we acquired Determina, a Silicon Valley company with advanced security technology; and last week we completed the acquisition of Sciant in Bulgaria, an engineering outsourcing company that we have been contracting with.

In addition to acquisitions, we've invested in the field overseas. In this last quarter, we were excited to see non-U.S. revenues outpace our growth in the U.S. This is especially evident in countries like Japan, where product and service revenues in Q3 grew by nearly 200%, compared to Q3 2006.

During Q3, we also expanded our distribution channel from 5,000 to over 6,000 resellers. Our technology partnerships continue to grow as well. Since the end of March, we've nearly doubled the number of our technology collaboration partnerships.

Virtualization is driving what is turning out to be a complete refresh of the data center. Processors, servers, storage arrays, network switches, operating systems, system management software, and more recently, application software, are all being optimized for a virtualization-based data center. As businesses look to move to virtualization, they are also taking the opportunity to step back and evaluate all of their systems, software, and processes. We are witnessing a comprehensive refresh cycle, in part funded by the huge cost savings and efficiencies that come with the VMWare infrastructure.

VMWare is leading a young but major industry that has many areas to build on. We and all of our partners are fortunate to be part of this broad information technology opportunity. Thank you, and we're now happy to take your questions.

Before we open the lines up for your questions, we ask you to try to limit yourself to one question. This will enable us to take as many questions as possible. Thank you for your cooperation in this matter. Operator, can we open up the line for questions, please?

My pleasure, sir. (OPERATOR INSTRUCTIONS.) And we'll go first now to Adam Holt with JP Morgan Chase.

Good afternoon. And congratulations on the first quarter out of the box. The two questions that I had were first of all just sort of generally understanding you're not going to give any guidance about the fourth quarter, could you maybe talk about what kind of seasonal trends you usually see in your business? And then, secondarily, could you talk a little bit about what kind of impact we would expect to see from the new OEM product or the 3.5 release in terms of when we should expect to see the financial impact and what kind of impact it could be in terms of how material those products might actually be over the next, say, 12 to 18 months?

I'll let Mark take it, and then I'll chime in.

Yes. Thanks, Adam. From a seasonality perspective, the third quarter has a seasonal effect because of the summer holiday season around the world. And the fourth quarter, of course, has a seasonal effect as IT budgets tend to be spent a bit more. And so, we expect to see some of that seasonality as well.

Yes. We've historically seen seasonality. The EFX--first, the EFX35--you should understand that our products--most of our customers are on S&S - support and subscription, and so that upgrade is free to anybody on subscription. It's got greatly increased functionality driving a lot more value into our product line, and so there will be a lot of value there with new customers and existing customers using additional functionality. EFX3i is new and we don't expect that to rollout in a high impact way that quickly.

And if I could--.

--But we do expect to reach a lot more customers with that product.

And if I could just follow up on the headcount adds. Obviously, you added quite a few folks over the last couple of quarters. If I recall, you're basically at your year-end target already. Does that suggest that you may actually see a deceleration in headcount adds on a going forward basis? Thank you.

Yes. Adam, at the end of the second quarter we had--or at the end of the first quarter we had about 3,000 people. We added 700 in the second quarter and about 600 in the third quarter. And then, we've completed an acquisition here in the fourth quarter. And we expect there to be some deceleration in how quickly we hire people. We had a great opportunity with the IPO this summer to add very strong people to VMWare and we took advantage of it.

Thanks, Adam. Operator, can we get the next question?

We'll take our next question now from John Difucci at Bear Stearns.

My question has to do with large deals. It sounds like about the same portion of revenues came from larger deal signings this quarter. But going forward, as a customer moves more into production, do you typically see that customer--a step function in purchasing VMWare's virtualization software or do you see sort of a piecemeal as--buying licenses as they adopt your product?

Well, we actually--we see both. We see people moving to ELAs and we also see people incrementally expanding their usage. And I thought you were going to go somewhere else, which is to say we are seeing increasingly big deals, but that's balanced out by we have a line of products at different price points for all the different customer segments. And so, we're getting more and more volume in the customer--different customer segments like small/medium-size business.

Great. Operator?

We'll go next now to--excuse me--Toni Sacconaghi at Sanford Bernstein.

Yes, thank you. Just following up on your last comment, Diane. Can you comment on average selling price trends sequentially and year-over-year? If indeed you are seeing adoption from SMBs and some lower volume customers who may not demand the full functionality, are you suggesting that on a per unit basis ASPs might be coming off a little? And secondly, can you comment on the importance, or more specifically, the size of the desktop business?

So in terms of ASPs and where they'll go, we see, as I said, two forces - one where customers are standardizing on the VMWare infrastructure, and so they're buying more and more volume at a time and doing bigger deals--the number of big deals we're seeing is going up. But at the same time, we're broadening our customer base and we have over 20,000 customers. And while we have over 90% of the Fortune 1000, there's a lot of smaller customers, so it's hard to predict. Those two effects could cancel each other out.

Great. Operator?

Oh, I didn't answer his other--.

--I apologize.

Okay. On the size of the desktop opportunity, we see a lot of interest in the desktop opportunity. We have a lot of large installations already out there and there are some 500 million enterprise desktops running. So how many of those and how fast they'll become virtualized is anybody's prediction.

Great. Can we get the next question, please?

We'll go next now to Brent Thrill--excuse me--Brent Thill at Citigroup.

The 96% year-over-year license growth was your strongest in a year and a half. And that was even in the face of the tough comp that you face with the I3. Can you just go through maybe what drove that in Q3, and more importantly, how sustainable you think that growth rate is going forward?

Sure, Brent. One of the key things that we wanted to point out is that we think that the 96% growth rate, when you normalize it for the mix of deliveries that we had in Q2 and Q3 of last year, is really more than 88% growth rate. So it's not really an acceleration in our license revenue. But we think going forward at least for the near term that the mix between license and services will stay relatively constant. But of course, as we add more and more to our portfolio and to longer service agreements, we would expect services to increase over time.

And just a quick follow up for Diane. If you could just comment on the recent Citrix InSource combo. Any impact, if any, you're seeing in the field and just your general thoughts on the combination.

Okay. We haven't seen any impact and VMWare has got a highly robust and functional set of products. In terms of the desktop opportunity, I think that there's just a whole new set of requirements and technologies that our customers are picking up for virtualized desktops. And, while Citrix has been successful in that space, they're on by all accounts less than 10% of the desktops out there. And we see and our customers validate that we have--with VMWare infrastructure we have a phenomenal foundation for doing this.

Thanks.

Great. Next question, please?

We'll go next now to Israel Hernandez at Lehman Brothers.

[Indiscernible] and congratulations, everyone. I just had a quick question on the pro forma tax rate, which I think you indicated will be 16%. Is that what we should be thinking about as we model out 2008 and beyond for the effective tax rate?

Yes. The non-GAAP tax rate is 16% for the year is what we're forecasting for all of 2007. And it's highly sensitive to the mix of profitability that we have between the U.S. and all of our other international operating income. So, yes, we would anticipate that we'll help you with that number going forward. But at this point, I think that the 16% rate is a good proxy for the future.

Thank you.

We'll go next to Kash Rangan at Merrill Lynch.

Hi. Thank you very much. I'm just curious to get your thoughts on the Citrix InSource--not just the acquisition, the impact on your business, but I think they have been making the claim that there's a fair amount of overlap in the channel partners that they work with vis--vis VMWare. Any thoughts on that overlap in the channel? Do you think that's meaningful at all in your view? And secondly, I'm just curious to get a little bit more perspective on the investing in the business comment. Where should we expect these investments to roll through as the next few quarters progress? And consequently, where should you be expecting the leverage from those investments? Is it more channel productivity or more product development productivity, sales productivity--in whatever way you would like to qualify or explain that, that would be great. Thanks.

Okay. Well, in terms of--our channel is now, as I said, over 6,000 strong. And I'll also mention that we have--often times when customers run Presentation Server from Citrix they put it in VMWare infrastructure. So we had historically had a strong partnership with Citrix. Our channel--I'm sure there's overlap, but we are--have a very strong channel with extensive programs and I don't--I think it's not an issue. Perhaps it's an issue for someone trying to compete with us. I don't know.

In terms of investments and where we're putting them, we're putting them definitely in the field, we're putting them in marketing. We also continue to organically and through acquisitions grow our product portfolio, also investing in internal infrastructure. In terms of what results we'll see, I think if you look at how we bring out products, it's a very regular track record to bring out the new pretty high value of products and that's just going to continue and that's from the ongoing investment. The--I think you'll see expansion in the volume space. We're investing heavily in that. And so, you should see that.

And then, also as a clarification, should we expect you to continue the digressive product bundling strategy, adding more value, while not charge a whole lot higher--is that the product pricing strategy as you go forward in the next 12 months? And also, clarification from Mark - should we expect often margins to be relatively stable and not going higher as a result of what we just talked about? That's it for me. Thanks.

So in terms of our pricing and bundling strategy, we will continue to put more and more value into the different price point bundles that we have today. That said, we're also introducing higher value products that are separate from those bundles.

And from a--Kash, from an operating margin perspective, throughout this year we've been targeting in the mid-20% range. And although I caution people to get--not to read too much into incremental increases or decreases in operating margin, we see that that is a very comfortable place for us to both grow the--grow and invest in the business while providing a good return.

Thank you. Next question, please.

We'll take our next question now from Jason Maynard at Credit Suisse.

Good afternoon, guys. I just had a question about the balance sheet and kind of the flows on deferred revenue. Can you maybe just walk through what we should expect kind of on a seasonal basis? And this quarter's growth wasn't up as much from Q1 to Q2, and just maybe kind of understand sort of the dynamics that are playing out there.

Sure. On deferred revenue, there is a seasonal effect to deferred revenue. As we mentioned, the third quarter we were working with the fact that it was the summer holiday season at least in the northern hemisphere. And we would expect that deferred revenues will increase during the fourth quarter as we have the seasonality during the fourth quarter.

Is that just primarily around maintenance bookings then?

Yes. Well over 80% of our deferred revenue is around subscription--S&S.

Okay. And on the P&L, what percentage of revenue was subscription and services? I've got a couple--.

--We don't breakout services revenue separately and include it in services--I mean, we don't break out PSO revenue separately from subscription revenue, but it is in the services line.

Thanks. Could we get the question, please?

[With] a question now from Phil Rueppel at Wachovia.

Yes. Thanks. Good afternoon. Could you give us a little bit more color on the partnership ecosystem that you've developed? You mentioned the 6,000 in the channel. Is that something you're aggressively going to continue to add? You've done a lot over the past year. And then, on the technology front, can you talk a little bit about how the investment by Cisco and Intel has either enhanced the technology relationship or partnership you have with those particular vendors? Thanks.

Okay. So in terms of the channel, I mean, our channel is quite well developed at the high end. It's in the low end where we're aggressively building out for smaller companies and you'll see continued growth in our channel there. The ecosystem is doing well. We're really doing more and more--well, I would say for our channels, but also for our technology--the people we collaborate with on the technology front, and that's across the board. As I said, that group just about doubled since March. So in terms of the Intel and Cisco relationships, we are partnering with them very closely on the technology front, but--and we have basically since 1999 with Intel and relatively more recently with Cisco, but both partnerships are going very well.

Great. Thanks very much.

We'll go next to Todd Raker at Deutsche Bank.

Hey, guys. Two quick follow up questions on the financial side. First, around the deferred revenue discussion, I think you commented on the call that there was a deferred license number of about 46 million in that. And how should we think about that going forward? And then, secondly, just a quick question. Do you guys price in U.S. dollars globally? And can you just kind of comment on FX impact?

Sure, Todd. On deferred license revenue, we have been disclosing each quarter what our deferred license revenue is. And as I mentioned earlier, overall our deferred revenue is well above 80% in S&S. So looking forward, license revenue will always be a component. You should think of license revenue as really backlog that we have that will be usually recognized sometime within the following year, but typically most of it in the following quarter, so it gives us some visibility into what next quarter's revenues are going to be like.

From a currency perspective, we price all of our products in U.S. dollars, and so there is no impact on revenue from the weak dollar. And from an expense perspective, we do have operating expenses in all the major currencies, and that had about a $2 million negative impact on operating expenses this quarter.

We have time for one more question.

And that last question will come today from Heather Bellini at UBS.

I was wondering if you could talk a little bit about penetrating the SMB market, if you could give us an idea how you would size that opportunity versus the enterprise, and kind of the gating factors in terms of gaining further traction there. Thank you.

Well, really what we've done is we've gone in and understand--understood where our value maps into that segment of the market. And earlier this current quarter we announced a package--a VMWare infrastructure package for the SMB that we believe--well, we're already seeing good traction with that. And we--but we're not in the mode of sizing that market in terms of what we'll be doing there. But we're very encouraged by what we see. And we're approaching it with a very leveraged model. We also believe ESX3i coming embedded on the servers is going to be helpful in that market.

Great. Thank you.

Okay. Thank you very much. Thanks very much for your interest in VMWare and we'll look forward to speaking with you next quarter.

And again, that does conclude VMWare's Third Quarter Earnings Conference Call. We thank you all for joining us and wish you all a great afternoon. Goodbye.