VMware Inc (VMW) 2007 Q4 法說會逐字稿

Good afternoon. Welcome to the VMware fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

At this time, I would like to turn the call over to Mr. Mike Hasse, VMWare's Investor Relations. Please go ahead sir.

Thank you. Welcome to VMware's call to discuss our financial results for the fourth quarter and full year 2007. With me on this call are Diane Greene, VMWare's President and CEO, and Mark Peek, VMWare's CFO. 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 at our Investor Relations webpage on www.vmware.com.

I would like to remind you statements made in today's discussion that are not statements of historical fact are forward-looking statements subject to the Safe Harbor Provisions under Federal Securities laws. These statements are based on current expectations as of the date of this call, and are subject to uncertainties and changes in condition, significance, value, and effect, as well as other risks detailed in documents filed with the SEC, including our quarterly report on Form 10-Q for the period ended September 30, 2007, that may cause actual results to differ materially from those set forth in our statements.

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. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in our earnings releases for the periods ended September 30, and December 31, 2007, and in the webcast slides available on the Investor Relations page of our website. The slides and telephone replay will be available for the next 90 days. To listen to the replay please call 719-457-0820, and provide the following passcode, 3788546.

A couple of housekeeping items. We will be filing our 10-K with the SEC during the week of February 25th. For your planning purposes, our first quarter quiet period begins at the close of business March 10th. Finally, unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2006.

With that, let me hand it over to Mark Peek.

Thanks, Mike. Good afternoon everyone, and thank you for joining us today. I am very happy to share our financial results from the fourth quarter and for the full year of 2007. I will also be providing our financial outlook for 2008. This is another strong quarter for VMware, as we successfully closed a year in which we grew revenues 88%, delivered non-GAAP operating margins within our target range, and entered 2008 with a strong balance sheet.

For the fourth quarter worldwide revenue for the quarter was $412 million, growing 80% over the fourth quarter of 2006. Revenue consisted of 69% license and 31% services. License revenue was $284 million, an increase of 75% compared to Q4 2006. Licensed revenue growth was primarily driven by sales of our third generation Virtualization software suite, VMware Infrastructure 3.

GAAP operating income was $76 million, an increase of 109% from the same period last year. Diluted GAAP EPS was $0.19 compared to $0.09 for the same period a year ago. Non-GAAP operating income was $108 million, which represents 72% growth from the same period a year ago. Calculated on a non-GAAP basis, diluted EPS was $0.26 compared to $0.15 for Q4 2006.

Total revenue for 2007 was $1.33 billion, up 88% from 2006. The revenue mix consisted of 68% license and 32% services. GAAP operating income for the year was $235 million, an increase of 95% from 2006. Diluted GAAP EPS for 2007 was $0.61, compared to $0.26 for 2006. Non-GAAP operating income in 2007 was $338 million, which represents 77% growth from 2006. Calculated on a non-GAAP basis, diluted EPS grew 95% to $0.82 a share, compared to $0.42 in 2006.

For 2007 licensed revenue was $905 million, an increase of 84% compared to 2006. In 2005 to 2006 license revenue grew 71%. Service revenue consisting of support, subscription, and professional services was $421 million, an increase of 98% from 2006. Fourth quarter services revenue was $128 million, an increase of 90% compared to Q4 2006.

Total U.S. revenue for 2007 grew 84% from a year ago to $721 million, and international revenue increased 94% to $605 million. For 2007 U.S. revenue represented 54% of total revenue. U.S. revenues for Q4 grew 67% from a year ago to $215 million, and international revenue grew 96% to $197 million. U.S. revenue represented 52% of total revenue in Q4. We saw strength in all international markets as we continued to invest globally in sales, marketing, and product support.

As a reminder, all of our sales are in U.S. dollars, and so our growth rates reflect no benefit from currency translation. The Q4 dollar value of licensed orders on transactions of less than $50,000 was 58% of the dollar value of total licensed orders. This compares to 65% in Q4 of last year. Increasingly customers see the value on standardizing on our VI3 solution architecture throughout their organizations.

We see that customers have had an increasing interest in enterprise license agreements, with a typical service contract length of three years. We view our solid long-term relationships with our customers as being healthy for the business. Although our overall transaction size is increasing, we continue to be a high-volume transaction business, as evidenced by the nearly 60% of our license order dollar value resulting from transactions under $50,000.

In connection with the segment disclosure in our annual audited financial statements, we are providing a breakout of 2007 license revenue into two product categories. Visualization platform products and Virtual infrastructure management and automation. Visualization platform products include our ESX Server Hypervisor, VMware Workstation, and other foundational products used to build visualization solutions.

The ESX Hypervisor provides the core visualization functionality, and the enabling capabilities for our Virtual Infrastructure Management and automation products. Virtual Infrastructure Management and automation products such as VMotion, Virtual Center, High Availability, Distributed Resource Management, and Online Backup, that leverage the unique benefits of our Visualization platforms,. to automate tasks such as Resource Management, availability, mobility, security, and desktop management.

In 2007 platform products represented 38% of licensed revenue, compared to 57% of licensed revenue in 2006. For 2007 infrastructure management and automation products represented 62% of licensed revenue, an increase from 43% in licensed revenue in 2006. We believe this trend clearly demonstrates that our customers increasingly value the ongoing operational benefits, and return on investment they receive from our infrastructure automation and management products.

I would now like to turn to the details on the rest of the income statement. 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. As a reminder, in calculating our 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. Here 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 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. Our non-GAAP operating income for the fourth quarter was $108 million, or 26% of revenues, compared to $63 million in Q4 of 2006, or 27% of revenues. That is a year-over-year increase of 72%.

For a company of VMware's size with growth rates at these levels, operating margins are going to have some level of volatility. As we are continuously investing in the long-term opportunity, we caution you to not read too much into incremental increases or decreases in our non-GAAP operating margin. In terms of the cost and expense lines on a non-GAAP basis, the year-over-year comparisons are less meaningful so the following comparisons are sequential to Q3 2007 as a percentage of revenue.

Total non-GAAP costs of revenues revenues was $49 million, or 12% of revenues, consistent as a percentage of revenue to Q3 2007. Non-GAAP research and development was $93 million, or 23% of revenues, a modest increase in percentage terms from Q3. Non-GAAP sales and marketing expenses were $129 million, or 31% of revenue, a modest decrease as a percentage of revenue from Q3, and non-GAAP G&A increased to $33 million, or 8% of revenue, also a modest decrease as a percentage of revenue from Q3 2007.

Moving forward we will continue to invest in our infrastructure to support our growth. In closing 2007, we adjusted our annual tax rate to 9% for GAAP, and 14% for non-GAAP. This adjustment benefited diluted EPS for both GAAP and non-GAAP by $0.01 during Q4.

Now let's turn to the balance sheet and our cash flow statement. Our cash balance as of December 31st, increased by nearly $100 million from Q3, to $1.2 billion. Long-term debt remained at $450 million. As of December 31, 2007, deferred revenue was $553 million, a year-over-year increase of 80% compared to December 31, 2006, and a $126 million sequential increase from Q3. 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 25 months. Deferred revenue includes approximately $54 million of deferred licensed revenue. We recognize revenue and deferred revenue from our X86 system vendor partners in arrears, when they make binding loyalty reports to us. The OEMs typically report one to two months in arrears. As a result, licensed revenue and deferred services revenue from the November/December timeframe will be recognized in Q1 of 2008.

Q4 reflects revenue and deferred revenue reported during the quarter from OEM bookings in August and September. Like last quarter, there is some sequential increase expected which will benefit Q1 2008. Our GAAP operating cash flows were $164 million for the quarter, compared to 125 million in operating cash flows for Q4 of 2006.

For 2007 our GAAP operating cash flows were $552 million, compared to $280 million in 2006. On a non-GAAP basis, we historically adjusted for the EMC related balance sheet accounts. We did that because of the relatively large swings in the size of our intercompany balances with EMC, prior to becoming a public company. We are now regularly clearing these intercompany accounts.

On a non-GAAP basis, we reduced our GAAP operating cash flows, by subtracting amounts capitalized under FAS-86, because these are capitalized in our cash flow statements as investing activities. On a non-GAAP basis, our operating cash flows were $149 million for the quarter, compared to 121 million for Q4 2006. Because cash flows can vary based on the timing of the payments for working capital items, we believe it is more meaningful to look at cash flows over a longer time horizon.

For 2007 our non-GAAP operating cash flows were $504 million, compared to $247 million for 2006, an increase of 104%. On a fully diluted basis, weighted average shares outstanding for Q4 were 403 million. These share counts are calculated using the Treasury stock method. Based on this method the Q1 '08 share count could change as additional equity compensation is issued to new employees, or if there are significant changes in our stock price.

I will now provide you with our financial outlook for 2008. Last quarter we provided you with guidance on our non-GAAP operating margins and certain other items, including share count to calculate EPS and stock-based compensation. We have decided to continue to provide this form of guidance, as well as revenue and tax rate guidance for the full year 2008.

I would like to remind you that our guidance constitutes forward-looking statements under the Federal Securities laws, and reflects VMware's expectations as of the date of this conference call. Actual results may differ materially from those projected, due to a number of factors including the factors referenced in our press release, and in the slides available on our website accompanying this call, as well as the other risk factors detailed in our filings with the Securities & Exchange Commission, including our most recent periodic report on Form 10-Q for the period ending September 30, 2007.

Revenue for 2008 is expected to grow approximately 50% compared to 2007. Our expectation for revenue growth considers a number of factors. The increasing size of our revenue base, an increasing number of competing companies marketing their intent to introduce visualization products, and our continued strategy to make VMware technologies a new platform for data center virtualization through broad proliferation.

It is also important to remember that all of our sales are U.S. dollar denominated, and our expected growth rate does not reflect any benefit from currency translation. Consistent with 2007 our non-GAAP operating margin for 2008 is expected to remain in the mid-20s percent range, after taking into account our adjustments to GAAP operating income previously mentioned, and which would have similar proportional effects.

For Q1 2008 our non-GAAP operating margin is likely to be sequentially lower than in the fourth quarter. This is consistent with the seasonal, sequential decline we experienced in the first quarter of 2007. The Q1 2008 fully diluted share count is anticipated to be approximately 400 million shares. Approximately 3.5 million of our employee shares will become eligible to trade during Q1. That should also be the case in each of Q3 and Q4, while approximately 11 million shares will become available in Q2, due to vesting of options granted at the time of the IPO. Stock-based compensation expense for 2008 is anticipated to be between 170 million $200 million.

For Q1 2008 stock-based compensation is expected to be approximately $40 million. Our GAAP tax rate for 2008 is expected to be between 17 and 19%. Our tax rate reflects the repeal of the U.S. R&D credit, which had a benefit of approximately 4 points in 2007. Adjustments we would typically make to a non-GAAP tax rate, would include stock-based compensation, amortization of intangibles, and FAS-86 capitalization, representing approximately 1 to 2 percentage points.

With that, I will turn it over to Diane Greene.

Thank you, Mark, and let me also welcome you to today's conference call. VMware's fourth quarter and full year were outstanding, and the Company continues to execute well on our considerable opportunities. We grew revenues 80% year-over-year in Q4. We grew annual revenue 88% to $1.3 billion, and we exited Q4 with a run rate of $1.6 billion. We are pleased with our growth overall and internationally. It was especially strong in eastern Europe, Japan, and China.

From the desktop to the data center, we are delivering value to our customers through new and existing products and services from VMware, as well as those from our large ecosystem of partners. We are seeing strong customer adoption on many fronts. Virtualization is becoming increasingly strategic to our customers, and the virtual data center is proving to be a better way to run their businesses. Customers around the world are standardizing on VMware virtualization to reduce capital and operating expenses, ensure business continuity, strengthen security, and go green.

Customers are also investing more in VMware. 70% of our 20 largest deals in Q4, were from customers who have been with us for longer than three years. Today more than 85% of VMware Infrastructure customers are running production level environments on VMware, and more than 50% are running enterprise applications on VMware. These transactions are part of a larger trend of VMware becoming the trusted infrastructure for running businesses more efficiently and cost effectively. We now have more than 100,000 enterprise customers, and the number of VMware Infrastructure customers roughly doubled in 2007.

Now I would like to talk about how we are growing the business through investments in partners, people, and products. We have substantially increased our focus on the distribution channel, and our support for it. We added nearly 4,000 new channel partners in Q4, many of them with a commercial and SMB focus.

Through our frictionless on-boarding process, we are now at nearly 10,000 channel partners. We are also in the process of rolling out some new and rewarding channel friendly programs. More than 100 technology partners were added to our co-development programs in Q4, bringing the total number now to more than 400. These relationships add significant value to our platform, and make the benefits of virtualization for our customers go much further.

In December, we announced a comprehensive support agreement with SAP. They will fully support Windows and Linux-based SAP solutions, running on VMware ESX Server in production environments. This adds to support from other leading vendors, such as IBM Software.

Internally we added over 500 people in Q4. We ended the year with more than 5,000 people. All are focused on leveraging our expertise, and doing everything we can as a team to extend our industry, impact, and leadership.

I am also pleased to report that three new executives joined VMware in Q4, bringing us invaluable experience and talent in product development, marketing, and IT. We also closed the acquisition of Sciant in Q4, and just announced Foedus and Thinstall. These acquisitions give us important new capabilities, in terms of virtual infrastructure development, application virtualization, and VDI professional services Best Practices for our channel partners.

Our products continue to receive accolades across all categories. VMware's products received more than 30 awards for excellence in 2007, and in year end roundups. There is one publication award in particular that I think says a tremendous amount about the breadth and depth of VMware.

Redmond Magazine gave VMware four #1 award recognitions. VMware's ESX Server, our Hypervisor was named #1 in reliability. The mainframe was #2. VMware workstation our desktop product was rated #1 for usability and manageability. VMware Fusion, our Mac product won 'Biggest Wow' in an IT product, and finally VMware was named the #1 overall breakout technology.

VMware clearly has stellar product development, and our growth is fueling this valuable core competence. We are focused on developing high-value products for our customers, that also enhance the offerings of our partners. VMware's view of virtualization is broad. We are now delivering all of the building blocks for a complete virtual data center, one that will automatically and transparently map applications to whatever hardware resources they need, and from any location.

VMware is continuing to aggressively get our products out into the market, both free and revenue generating. We are making the necessary investments in training our customer-facing teams and partners, to be successful selling them. Today is actually the start of VMware's Annual Sales Kick-off, where our sales team now several thousand strong, will get trained on new products and go to market programs, so that together with our partner channels, they can make the most of the opportunities for VMware solutions.

In February, we will host the first large scale European virtualization conference, VMworld Europe in Cannes, France. We expect more than 4,000 customers and partners across Europe to get hands-on experience with our solutions. VMware is feeding the market with award-winning free products. VMware's Server was downloaded more than 2.2 million times in 2007. The VMware Player was downloaded upwards of 1.8 million times.

Separately, in its first five months on the market, our Fusion virtualization product for the Mac sold more than 200,000 copies, and it achieved 46% retail market share in Q4 according to MPT data. VMware's embedded Hypervisor ESX3i was shipped to the OEMs at the end of the year. Servers containing 3i are set to ship in Q1 and Q2. The embedded approach makes virtualization plug and play for our customers. For our partners and for VMware, it will accelerate adoption of ESX partitioning and provisioning functionality, and make it easier for customers to upgrade to the automation, management, and business continuity features of our full virtualization solutions.

VMware has unique advanced features that customers want. And APIs that integrate well with our third party management functionality. VMware is building upon our third-generation ESX Hypervisor, with new products from us and from our partners, to offer highly differentiated solutions for customers. Our Hypervisor is #1, in terms of reliability, interoperability, scalability, and functionality, and every product built on it augments this differentiation. Let me elaborate on each of these.

As an example of reliability VMware has a large pharmaceuticals customer that has run production environments virtualized for several years now. They have an instance of VMware EFX server, that has run continuously for 1,140 executive days without a single reboot needed. It was finally brought down recently when the physical server was decommissioned.

The small 32-megabyte footprint of ESX3i reduces security risks, and VMware offers a dynamic patch management capability. ESX, particularly ESX3i, is also you utterly simple to install and bring up. VMware ESX's interoperability is the result of a huge investment VMware has made in labs. ESX is tested and certified for roughly 250 different types of servers, more than 260 different types of storage arrays, more than 60 different operating systems, and more than 700 virtual appliances.

Our differentiation does not stop at the Hypervisor. We enable our customers to dynamically allocate resources, and to migrate workloads across a pool of server, storage, and network devices. Our suites of management and automation software increase the productivity of IT administrators, by automatically controlling VM sprawl, and enabling business users to self-provision capacity on demand in the data center. Our suites of business continuity and availability software bring unprecedented simplicity to the task of delivering high service levels, for mission-critical software applications.

Technical differentiation is critical for us, but what truly matter sincerely what our customers are putting into dollars and cents. Our customers tell us that VMware products allow them to support two to three times the number of application workloads per administrator, and they do this using four to ten times less data center capacity, than would be required in a non-VMware environment.

For 2008 the VMware product roadmap is strong. First, the recently launched VMware Infrastructure 3.5 and ESX3i gets us off to a great start. They deliver advanced features like live migration of storage, distributed power management, and automated patch management. Over the course of the year, we will continue to broaden and deepen our end-to-end virtualization based solutions, in areas that include both desktop and the data center.

You may have already seen one example of these solutions in the recent beta of our Stage Manager product, it streamlines and accelerates the process of staging applications into production. We have also shipped the beta of Site Recovery Manager, and Advanced Solutions for automating the configuring, testing, and deployment of disaster recovery for production workloads. We are also about to ship a major rev to our Virtual Desktop Infrastructure Suite, CDI, with our virtual desktop manager product.

In 2008 you will see more solutions from us and our partners around business continuity, desktop management, and security, as well as a preview of a new and major release of VMware's flagship Infrastructure Suite. Our customer value proposition is growing dramatically. VMware products allow both critical and mundane error-prone tasks to be automated and optimized, bringing IT people to address more sophisticated problems, without having to worry about inevitable human error.

Automation is the next stage for Virtualized Infrastructure. Much like going from a written ledger to an electronic spreadsheet, VMware is taking our customers, and leading our competitors to a new era, where IT infrastructure is much simpler to manage, much leaner on resource and maintenance requirements, much greener, and much, much more virtual.

Our vision of self-managing IT infrastructure is gaining momentum. It is very exciting for the Company, to see our customers benefiting, and our partners building around it. We are looking forward to our most successful year yet. Thank you very much.

Okay, thanks. Why don't we begin the Q&A process?

We will go first to Brent Thill with Citi.

Thanks. Mark, regarding the deferred revenue component you mention that lagged, if you look at the impact for Q1, can you just walk through what type of sequential improvement you would expect in Q1? I know you are not giving guidance for Q1, but just help us better understand from a modeling perspective what happens there?

Sure, Brent, the question is really around the recognition of our OEM revenue, which we do in arrears, so we have a one to two-month lag, depending on the OEM partner, as to when it will be recognized, and with the fourth quarter, we believe that this number was greater than what it was in the third quarter, so we will have some uplift in the first quarter.

As you look at the year going forward, we have guided to approximately 50% revenue growth, and as you think about the calendarization and the scale of our business, you would expect that that growth would be higher in the early quarters than it will be in the later quarters.

Okay. Just a quick follow-up on the embedded 50% growth, what are you baking into the pricing environment? Do you expect prices to hold, or soften due to some of the new competitive threats for '08?

We have continuously tried to hold our prices at the same level, and add features to the various price points that we have had in our products, and so we are not baking in a price decrease as a result of competition.

Thanks.

Next to John DiFucci with Bear Stearns.

Thanks. I understand the pressure you are under to sort of give guidance, and I think it actually helps to tighten the dispersion investments out there. I am curious, Mark, Diane, how you can give guidance, revenue guidance for the year when things are changing so quickly, that you have six-month sales quotas rather than annual? Just maybe you can sort of, does that tell us something about your confidence in guidance, or I don't know if you can comment on that please?

Well, I will just say that we have had six-month quotas for sales folks at VMware since the beginning of VMware, but we have always internally had twelve-year guidance.

John, as we were planning the business, we look at trends. We certainly take a fresh look every six months as we determine sales quotas, but we do have to plan the business on a longer-term time horizon, and like any kind of estimate, the confidence we have in the early quarters is greater than it is in the later quarters, and our thought process around providing guidance, ties back to a couple of things.

One is that EMC provides consolidated guidance. They own 85% of the Company, and so they are providing guidance on an annual basis. So it doesn't necessarily make sense that we wouldn't provide some kind of guidance on our own, and as we look ahead, it is just important we thought to help give some indication of where we thought the business was going, and the 50% guidance is largely based on the scale of our business.

Okay. Thank you. Just one quick follow-up, Mark. The taxes payable to EMC, is something that was a lot greater than, or the impact on cash flow was greater than we thought it would be, at least our model this quarter. Is there any way you can help us to model that? Are you going to continue to try to pay down that balance?

Yes. We are filing a consolidated return in the U.S. with EMC, and as a result as the quarters go on, we true-up that estimate, but our intent is to pay down those balances as they come due, and to do them each quarter.

Okay. Thanks a lot.

Next to Toni Sacconaghi with Sanford Bernstein.

Thank you. A couple of questions, please. It looked like in the fourth quarter that your U.S. revenue growth was considerably slower than your international revenue growth by about 30 percentage points. Up until this quarter, the growth rates had been rather in line.

Can you talk about what you might be seeing in the U.S. or what you saw in the U.S. in the fourth quarter? Was it any incremental weakness that is economic, or are you just that much bigger in the U.S. and your opportunities are more limited? Can you comment on that, and I have a follow-up, please.

Okay. It is a combination of factors. One is that we are larger in the U.S., and the initial release of VI3, there was more of an interest and uptake in the U.S., so it is a more difficult comp in the U.S. on our overall growth rates, and secondly, I would point to the overall strength that we experienced internationally in Europe and in APAC. We are very pleased with the results internationally.

But do you think there was actually something, in terms of linearity of demand in the quarter, that you were experiencing because you had some pretty tough VI3 comps last quarter, still had very strong growth in the U.S., but you had a big divergence in growth this quarter. Can you give us a little more color on whether you saw linearity over the course of the quarter, in terms of strengthening or weakening in the U.S.?

The quarter was actually relatively consistent. We do have a higher volume of sales and bookings in the back month of the quarter in particular, but we didn't see any particular weakening of U.S. in any particular period throughout the quarter.

Okay. And then can you comment a little bit about next year? Obviously services revenue you have 500 million in deferred revenue, you talked about a two-year average life, so you will have that a lot of that revenue in the bag for 2008, services revenue by its very nature should decelerate much more modestly, so are you really talking about implied in your guidance services revenue growth, that is obviously considerably above that 75 or 80%, and licensed revenue growth that is considerably below that which maybe is 35%, and is that how we should be thinking about it, and it certainly does feel like a pretty dramatic deceleration in license growth?

Toni, I think that as you look at the trend over time, this quarter licensed growth 75%, services growth 90%, and a reminder that as we pointed out during the third quarter's, that there were some anomalies in the growth rates due to Q3 of 2006.

If you look at our deferred, our current deferred revenue as of the end of the year, it would imply that about 18 to 19% of our total guided revenue of about 50% growth will roll through, and most of that would be services, on the services line, so you would expect that next year as we look at the full year, and look at the splits between services and licenses growth, that services growth will become a bigger portion of the overall revenue.

And your belief on the deceleration and license revenue, implicit in that is license is going to grow slower, and you are going to have a deceleration from I think in the 70s, correct me if I am wrong, this year, to likely something in the 30s just by that math that you outlined, and again, your belief is that principle reason is scale rather than anything else?

Our principle reason around revenue growth rate to 50% is scale, and we are not providing a breakout between services and revenue on that guidance.

Thank you.

We will go next to Israel Hernandez with Lehman Brothers.

Hello, everyone. Can you speak to your expectations for 2008 between platforms and the automation group? You are breaking out the revenues on a reported basis, but at least qualitatively how should we be thinking about the growth rates of those two product offerings?

As you saw the fairly dramatic change in the percentage of revenue that came from automation versus platforms, we expect both to grow. They are typically part of bundled suites.

What we are seeing however, is that our customers are very much valuing the infrastructure management and the automation products, and we would expect that to continue to grow as a percentage of overall revenue.

We have seen a steady shifting of revenue into the full suites, over and above the Hypervisor.

So you expect the growth rates then to be much higher, materially higher in automation and management tools, than on platforms for 2008?

I think that if you, it is somewhat of a question since we are bundling the products together, and so what customers are actually buying is a suite of products, so it is really a condition of how the individual pricing of the products is broken down, but since the mix is going to shift, you would expect the growth rates to be somewhat different as well.

Great. Thank you.

We will go next to Adam Holt.

Good afternoon. I had a couple of questions about the large deal activity, and the impact on deferred revenue. You noted in your prepared comments that you saw strength in enterprise license agreements, and saw the percentage of deals over 50,000 increase.

Can you talk about how those ELAs are actually flowing through deferred revenue, and flowing through the numbers, and secondly and along that line, it looked as if the percentage of deferred licensed revenue actually declined on a sequential and a year-over-year basis, and I was wondering why that would have been in the context of the very strong large deal activity?

First let me address the ELAs. We break out orders under $50,000 from a license perspective, and the one thing that I just want to make sure I clarify, is that the orders in excess of $50,000 are not all ELAs. In fact, a large majority of the orders that are above 50,000 are in fact not ELAs, but sales of individual suites of products.

The way that the revenue is recognized on the ELAs in most cases, is that we recognize the license revenue up front, and then the portion that is related to services or subscriptions is over a three-year period of time, so it will end up in the balance sheet as either current or noncurrent, depending on when we ship the actual license.

Okay. If I could just ask a follow-up on the second part of the question. Deferred as a percentage, deferred license revenue as a percentage of total deferred, looked like it was down a little bit on a year-over-year basis and sequentially. Any reason that would be in the fourth quarter in particular? Is that just an anomaly that we will expect to see head back in the other direction in Q1?

On the deferred license revenue, it is first of all not tied to the ELAs at all, and so it really has very little to do with the size of the transaction, but it is more tied to the marketing promotions that we are doing in any particular quarter, and typically we will ship most of that revenue in the following quarter, so this quarter we ran promotions near the end of the quarter related to our VI starter kit, so from quarter to quarter, there will be some variability in our deferred license revenue.

Terrific.

Thank you. We will go next to Kirk Materne, Banc of America Securities. Your line is open, sir. Please check your mute button. We will go next to Kash Rangan with Merrill Lynch.

Thank you very much. Just wanted to clarify the percentage of license revenue that are going from arrears revenue recognition, maybe Mark, if you can quantify what percentage of license revenues are actually coming from OEMs, that can help us better understand how much of that indeed is being impacted by this arrears flow through from Q4 into Q1, and I have a follow-up question as well.

Kash, we are not breaking out revenue by any of our particular channels. As we have stated in the past, what we saw in the third quarter is that there was a shift in the percentage in the channel that was from OEM relative to the rest of the partner channels, that had a modest impact on the Q3 results as you saw, and that carried forward into the fourth quarter.

But the trend line is that OEMs are definitely getting to be a larger percentage of your license revenues, therefore this lumpiness probably becomes more and more exaggerated if the OEMs are becoming larger as a percentage of licensed revenues, right?

Yes, to the extent that that grows.

And second comment on the growth rate, licensed revenue growth rate, if the service revenue growth rate even slowed down a little, but we are talking significant deceleration in license revenue, and I am wondering, just given the growth rate of the company over the last three years, if you were to look 80 to 90%, all of a sudden dropping down to 30 to 40%, that doesn't add up to me, maybe if you can help us understand if it is largely due to conservatism, that is completely understandable, but just drop the deceleration in the face of what has been a pretty solid growth for the past three years, it just doesn't seem to add up. Maybe we are missing something, and if you can clarify, both you and Diane, that would be great. Thanks.

I think your question is around the growth rates and license versus services for 2008.

In a relative sense license revenue growth rate expectation for '08, relative to where it has been in '07, '06, '05. Understandably a lot of it is due to scale, but the magnitude of the deceleration you are talking about, it just doesn't jive with people's expectations, and I am wondering if it is just plain old conservatism with macros and other things that are related to forecasting revenues for the Company with a limited public history, or if there is something else?

On our revenue guidance is largely based on scale, and largely based on providing guidance for the entire year, and with the conditions that I called out in the prepared remarks as well.

As we look ahead to 2008, we are very bullish on the Company and where it is headed, and the demand for our products, and so the split is between license and services, and how that will change over time is really entirely due to scale.

And, Diane, maybe --

Due to scale, and also this is a market we have to watch how fast it is going to grow. We see great demand, but we have to see how fast the overall market grows as well.

How do you feel comparatively with [Mark Sascung] of HyperV, I know you still have the lead over the competition and what not, but are you seeing any impact in sales cycles currently, and maybe even the March quarter, June quarter?

We are not. In fact, some of our customers have evaluated HyperV, and have told us they see absolutely no reason to switch. I think Info World actually called it analogous to VMware Server 1.0, but not as polished which is our free product. Certainly customers ask about the competition, but it is not delaying sales.

Great. Thanks a lot.

We will go next to Todd Raker with Deutsche Bank.

Quick question. First as cited in the commentary, that the average support contract was 25 months this quarter. Can you give us a sense, in terms of how that has trended over the last few quarters, and how you would see that going forward?

Sure, Todd. We had, it has been going up. I think at the end of the third quarter,we said it was 23 to 24 months, approximately two years, and in the first quarter it was approximately 19 months.

Okay. If I sign a three-year support contract, is it cash up front, or are there installment payments associated with these?

It is cash up front.

Okay. A second question, could you guys just generally give us a sense for how meaningful the desktop opportunity could be in '08?

We are not anticipating the desktop opportunity to be huge in '08. It requires a pretty major refresh of people's hardware infrastructure, and we don't anticipate it growing that rapidly in the '08 timeframe.

And certainly in our guidance we are not anticipating an uplift, a significant uplift from desktop.

Great. Thanks, guys.

We will go next to Brent Bracelin with Pacific Crest Securities. Your line is open. Please check your mute button. We will go next to Jason Maynard with Credit Suisse.

A follow-up on the deceleration and the growth rate into '08, is there anything from an economic perspective that might be cautioning your view, because even if you take sort of the Q4 number in license revenue, and flow it through the quarters, it just seems that a drop off into maybe the high 30s or 40% range is fairly extreme, given what you have talked about previously in the market.

Jason in planning the business, one of the earlier questions was on six month versus annual guidance. As we look forward into 2008, we are certainly trying to plan the business in a way that allows us to sustain the investments that we are making, and there is nothing that we are taking from a perspective of forecasting the economy, or where it will go other than what we have seen over the last six months, and looking at demand.

Again, the 50% growth rate that we are forecasting, is largely a function of us becoming a very large software company. Through September 30th of 2007 was the first time we hit the $1 billion run rate on a trailing twelve-month basis. When you look at approximately 50% growth for 2008, that is essentially doubling the size of the Company in five quarters.

Okay. Maybe just a follow-up on the services side. As you sort of embark on this next leg of your story, can you maybe talk about the role of your services organization to try and drive both direct license sales, as well as maybe training partners and things of that nature? What role will that play, in terms of helping increase the growth rate down the road?

Well, services are something that we work with our partners, our channel partners on to offer them added value, and they appreciate it greatly, so it helps drive our sales through the channel, and so we invest a lot in training and developing services for them, and certainly we are increasing our partnerships, with people like the system integrators where we are for larger scale deals, that will certainly drive sales.

We will go next with Keith Bachman with Bank of Montreal.

Thank you. I have two questions if I could. Could you talk about how you think deferred revs will grow in '08, and related to that is how you think the cash flows will grow in in '08, and if you are unwilling to give numbers, I would like to get some context related to the revenue growth targets that you put out, please. Thank you.

Our deferred revenue we continue to expect to grow at a healthy rate. If you look at just the sequential growth in external bookings looking at revenue versus the change in deferred revenue in Q4 over Q3, we grew at 46%, and as we said, we grew deferred revenue for the year at 80%. The continued trend that we have seen in individuals, or in Corporations signing up for multi-year subscription agreements is going to continue to increase deferred revenue.

And so just to be more specific, you anticipate that deferred revenues will grow faster than revenues?

We are not giving guidance on the balance sheet.

Okay. How about any commentary on the cash flow, please?

On the cash flows, certainly cash flows will be enhanced by increases in deferred revenue and multi-year S&S, but we are not going to provide a cash flow forecast with working capital items or CapEx items.

Okay. Thank you.

Our next question, Heather Bellini with UBS. Your line is open. Please check your mute button. We will go next to Tom Curlin with RBC.

Hi. Good afternoon. Can you hear me?

Yes.

Just coming back to the really the same issue that we have heard several times, to model out a 50% year-over-year growth number for this coming fiscal year, either the business can sell rates very rapidly in the next couple of quarters, or over the course of the year, down to say 30, 40%, so I understand the scale commentary, but you represent most of your market as of today.

Are you saying that you think your end market is decelerating down to a 30, 40% growth rate by the end of '08 on a year-over-year basis, or is something else happening like, for example, with [square]?

No. What we are doing with approximately 50% growth for 2008 is to give you an indication of where we think we are headed, and the overall size of the company, and that it is largely scale.

If you take that in concert with our operating margin guidance, it will help you to paint a little bit of a picture, with respect to how we are viewing the upcoming couple of quarters, and then we will have better visibility as the year goes on.

So the operating margin guidance is for mid-20s is consistent with the guidance you have given in the past, if I am correct, right? That hasn't changed.

That is correct. What I am suggesting is that if you look at the exit rates on our operating expenses for the fourth quarter, it will help you consider what our operating expenses will be for the first part of 2008 as well.

I understand that. On the top line, how do you recommend that we get you to 50% year-over-year? I assume that that is not falling off a cliff, so we are going to have to decelerate the revenue down to 30 to 40% year-over-year growth by the end of '08? Is that an appropriate approach?

The approach would, you are each going to have to take your own approaches as to how you look at our guidance, but with the mid-20s operating margins, and those investments, you would certainly expect higher growth rates in the early quarters and the back quarters.

Do you feel any pressure, with respect to your guidance to contemplate the perception impact it might have on your parent company's core growth rates, if you guided higher?

No. We have been building our guidance independently of EMC.

Okay. Thank you.

Next to Dan Renouard with Robert Baird.

Thanks. I guess my question would be along the lines of your ELAs, and you have had a pretty big focus on driving ELA adoption in the enterprises that you sell to. Maybe you could talk about for 2008, would you expect that to be a continued focus and emphasis in your sales group?

With ELAs most of our customers don't just jump into an ELA. They have had a repeated history of buying product from us on a PO basis, so it is largely dependent upon customer demand, but certainly as we develop relationships with our customers, both our salesforce and our customers have an interest in ELAs, and so I would expect that you will continue to market and develop the ELA program, and that it provides, we think it is very healthy for the the Company, because it does provide a long-term buy-in, and broader proliferation of our products across our customers.

We do also see that when a customer buys an ELA they tend to deploy much more broadly, and what we see when a customer deploys broadly, is they get accelerating benefits on their ROI, and so we do encourage our customers to do this.

Great. If I could add one quick follow-up, are you expecting your CapEx needs to be lower this year than some of the build out you did in '07?

Although we are not providing CapEx guidance, I will say that we are continuing to expect to invest, and as we add people, and as we continue to expand internationally, we will still see the need to invest in capital, and so I wouldn't expect significant free cash flow benefit from lower CapEx in 2008.

Thank you.

We will take our last question from Philip Rueppel with Wachovia Securities.

A couple of things. One on the desktop opportunity, I know you have mentioned that there is little revenues that will be realized. Are you going to continue to ramp investment, and what can we expect to see from a cost perspective associated with the desktop? Is the partner channel going to be expanded with a special channel, or are we just going to continue to see organic investments in R&D and sales?

On the desktop opportunity, we are certainly ramping investment. I mean, we do have large deals that we are doing there, and we are increasing the number of deals we are doing there, so we can ramp the investment, and as you probably noticed that we are also broadening our definition of the desktop opportunity, with our acquisition of the application virtualization company, Thinstall.

In terms of channel we are finding a lot of tremendous synergies with our existing channel for the desktop opportunity. We are ramping our ability to educate people, and that was why we purchased Foedus, which specializes in services around the desktop opportunity.

Okay. And finally on pricing, I know you mentioned that you hadn't really seen any change in pricing. Built into your guidance for '08, are you expecting any additional price pressure when you do have competition from say, Microsoft in the second half, or do you think the new releases and sort of your product position will allow you to, are you forecasting the ability to maintain ASPs?

We do think that we can maintain our prices. We entered the year with the 3.5 announcement, which brought several, three major new areas of functionality in at the same price point, and we anticipate continuing that over the course of the year.

Great. Thank you very much.

We have no further questions.

So I wanted to thank everybody for joining us today. VMware starts 2008 with over 100,000 customers, 500 technology and consulting partners, and nearly 10,000 go to market partners, more than 5,000 employees.

As others begin to enter the market, VMware and our partners are continuing to broaden and deepen, our highly reliable end-to-end virtualization solutions. Our vision for the virtual data center is today delivering tremendous value to our customers, and our product pipeline for 2008 promises to deliver much more. Thank you again. I look forward to speaking with you soon.

Ladies and gentlemen, this concludes today's conference. You may disconnect.