VMware Inc (VMW) 2010 Q2 法說會逐字稿

Welcome to the VMware second quarter 2010 earnings call, and thank you for standing by. At this time, all participants are in a listen-only mode. (Operator instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Now I will turn the meeting over to Mr. Mike Haase, Vice President of Investor Relations. Sir, you may begin.

Thank you, and welcome to VMware's second quarter 2010 earnings conference call. On the call, we have Paul Maritz, our CEO; Tod Nielsen, COO; and Mark Peek, CFO. Following their prepared remarks, we will take your questions.

Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Statements made on this call include forward-looking statements, such as those with the words will, believes, expects, continues and similar phrases that denote future expectation or intent regarding our financial outlook, product offerings, customer demand and other matters. These statements are based on the environment as we currently see it and are subject to risks and uncertainties. Please refer to the press release and the risk factors in documents filed with the Securities and Exchange Commission, including our most recent reports on Form 10-Q and Form 10-K, for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such 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 GAAP measures. Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax and employee stock transactions, the net effect of amortization and capitalization of software and acquisition-related items. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures, in the press release and on the investor relations page of our website.

Our second-quarter quiet period begins at the close of business September 16, 2010. Also, unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2009. For your planning purposes, VMworld 2010, the industry's leading virtualization conference, takes place at San Francisco's Moscone Center August 30 through September 2. As part of this, we will be hosting our first analyst day on August 31 at the same location. We plan on sending more details around registration, agenda and logistics next week.

With that, let me hand it over to Mark.

Thanks, Mike, and good afternoon, everyone. VMware had a great second quarter with record revenue, operating profit and trailing 12-month free cash flow. Our business was strong across all geographies, transaction types and products.

During the quarter, we continued to see strong demand in the SMB-focused vSphere packages, which were a factor in achieving a record number of transactions in the quarter. With this increase in transaction volume driven by small- and medium-sized business, the blended ASP per vSphere unit declined sequentially by $100. However, we displayed strong discipline around discounting as ASPs in our enterprise products increased modestly.

Customers continue to adopt the vSphere platform as a strategic investment that delivers substantial cost savings, improved efficiency and flexibility for their business. Our message is clear and is resonating with our customers as they begin the journey to the private cloud. Cloud computing is not a destination, it is an architecture. The foundation of that architecture is vSphere, which enables customers to leverage their existing IT investment and greatly simplify their data centers while providing the flexibility to take advantage of the offerings from vCloud providers.

In early April we acquired certain of the management products, technology and people from EMC's Ionix group. We are very pleased with the integration process and recently announced the integration of two of Ionix's products into our management portfolio. We also closed the acquisitions of Gemstone and RabbitMQ. We want to welcome the more than 400 people from these three acquisitions to VMware.

In addition to acquisitions, we are continuing to invest in our core virtualization products to maintain and extend our multi-generational lead over commodity virtualization offerings. Last week, we released vSphere 4.1. With this release we not only added functionality and performance to our enterprise SKUs, but we introduced VMotion to the SMB packages. So today, at very low price points, customers have the advantage of this mature, robust technology.

We also introduced per-virtual-machine pricing for our management products. This will allow customers to scale into management offerings more aligned to their specific usage. We do not expect a material near-term financial impact from these changes.

We ended the quarter with $2.8 billion of cash, cash equivalents and short-term investments and $1.5 billion of deferred revenue. Strong operating performance and capital efficiency led to trailing 12-month free cash flows of just over $1 billion, growth year over year of 33%. We are pleased with the quarter and want to thank all of the people at VMware, our partners and our customers.

Now I'll walk you through the details. Total revenue for the second quarter was $674 million, up 48% from a year ago. Total license revenue was $324 million, an increase of 42% from the second quarter of a year ago. Demand was strong across all global regions and customer segments. In Europe, despite the growing macroeconomic concerns, demand remained strong. However, we are cautious about Europe as we look at the second half of 2010. Large markets such as Germany and the UK were down sequentially from Q1. However, France, Ireland and Russia were up sequentially.

In the Asia-Pacific region, we saw strong demand across geographies, including China, Japan, India and Australia, with total bookings for the region increasing more than 80% year-over-year. We are beginning to see more interest in ELAs from our customers in this region, with enterprise license volumes at a new high. This is another indicator that our investment efforts in the global markets are bearing fruit.

The Americas were strong across the board. In Latin America, bookings increased 85% year-over-year. In the US, we are seeing enthusiastic demand for Essentials and Essentials Plus, primarily in the SMB markets. We're also progressing very well with our ELA renewals and pleased that customers are typically renewing their ELAs at a dollar value more than the original deal. The total order value of renewed ELAs for the quarter exceeded the original contract value.

Software maintenance and support revenue was $290 million, an increase of 54% from last year. As expected, our back maintenance revenue decreased sequentially. The maintenance recovery program has now been in place for over a year, and we expect back maintenance for the balance of 2010 to be lower compared to the same period in 2009. As in previous quarters, customers continue to buy, on average, more than 24 months of support and maintenance with each new license purchase, illustrating their strong commitment to VMware as a core element of their IT infrastructure.

Professional services revenue was $60 million, an increase of 54% from last year and up 11% sequentially. The increase was largely due to incremental services revenue from our M&A activity and customer training related to vSphere deployments. We do not envision strong growth in our PSO revenues as we continue to invest in our partners and the ecosystem to broadly offer the best set of solutions to our customers.

US revenues increased 43% from a year ago to $334 million, representing half of total revenue. International revenue grew 53% to $340 million, driven by strong demand across geographies, particularly Australia, France, China and Japan. Enterprise license agreements were approximately 20% of total bookings, and transactions with order values less than $50,000 represented approximately 44% of total bookings.

I will now provide some details on our operating expenses. Unless otherwise noted, all references to our expenses and operating results are on a non-GAAP basis, which are reconciled in the press release tables and posted on our IR website. Total operating expenses, including cost of services and cost of license, increased 6% sequentially to $487 million, driven largely by increased headcount and our 2010 merit increase that took effect at the beginning of the second quarter.

During the quarter we added over 850 people, approximately half of them from the acquisitions of Ionix, Gemstone and RabbitMQ. In addition, we continued to add people in sales and marketing to support increased volume and geographic expansion. Our core engineering and product groups also grew organically as we continued to invest in innovate.

As a percentage of second-quarter revenue, cost of revenues were 12.6%, a sequential increase of 40 basis points, largely due to increased M&A and headcount expenses in professional services.

Second quarter R&D expenses increased sequentially to $136 million or 20.2% of revenues as compared with 19.5% in the first quarter of 2010. The increase reflects the addition of people from our acquisitions as well as organic growth for our core virtualization, Spring and Zimbra businesses. Sales and marketing expenses were $215 million or 31.9% of revenues compared with 31.6% in the prior quarter. The increase was largely due to continued geographic investments and larger marketing spend, particularly in the SMB and desktop.

G&A expenses were $51 million or 7.6% of revenue compared to 9.1% of revenue in the first quarter. The sequential decline was largely due to reductions in various corporate expenses and higher Q1 expenses due to our first-quarter global leadership meetings and 2010 kickoff events. Our operating profit measured on a non-GAAP basis increased 7% sequentially to $187 million or 27.7% of revenue. This beat our forecast range, due primarily to operating leverage from our revenue performance. The net impact of currency during Q2 was not significant. Second-quarter M&A activity was dilutive versus Q1 by approximately 150 basis points.

The non-GAAP diluted EPS was $0.34 a share on 422 million diluted shares. The share repurchase program did not have an impact on EPS during the quarter.

Now onto our balance sheet and cash flow statement -- our balance sheet remains strong with cash, cash equivalents and short-term investments at quarter end of nearly $2.8 billion, about flat compared to the prior quarter. You'll notice that our short-term investments increased significantly and the cash and cash equivalents declined. As part of our investment strategy, we have begun utilizing outside money managers to help manage our short-term investments that continue to require investment-grade quality with relatively short duration.

During the June quarter we used approximately $375 million for M&A activity, capital spending and our share repurchase program.

During the first quarter we announced authorization to repurchase up to $400 million of our Class A common stock through 2011. The objective of the VMware program is to partially offset the dilution from employee stock issuance. Through the first half of 2010 we purchased $145 million of our Class A stock. During the second quarter, we completed our acquisition of several management products from the EMC Ionix portfolio for $175 million.

Total deferred revenues were $1.5 billion, up 58% from the same period last year and an 8% sequential increase. Over 90% of our deferred revenue was recognized with the passage of time or the delivery of professional services revenue. The remainder is solely tied to product release events.

At the end of the quarter we had approximately 8200 people, an increase of 1100 from the beginning of the year. About half of them are from our first-half M&A activity. Without reference to mix of organic or M&A, we expect that we will continue to add headcount at a similar pace in the second half of the year. Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock compensation, were $261 million for the quarter and $1.1 billion for the trailing 12 months. Free cash flows for the quarter were $232 million and $1 billion for the trailing 12 months. Free cash flow per diluted share was $0.55 for the quarter. Free cash flow per diluted share for the trailing 12 months was $2.42.

As we've mentioned, free cash flow per share can be volatile in the short-term, so we believe looking at it over a trailing 12 months is a better indicator of progress. Comparable cash flows were negatively impacted by a difficult comp as last year we collected $88 million from EMC in an income tax refund. We're paying increasing attention to the metric as a measure of financial progress in our business, as it balances operating results, cash management, capital efficiency and share dilution.

The fully diluted share count increased to 422 million shares for the second quarter, driven by the impact of higher share price on the calculation of dilutive securities. We expect our third quarter 2010 diluted weighted average share count will be approximately 430 million shares, and for the full year we expect the diluted share count will be approximately 425 million shares.

Before I hand it off to Tod, I want to share with you how we are looking at the business to give you some assistance in developing your estimates for the second half of the year. Although we saw a positive momentum in the business during the quarter, there are four items I want to call out as you consider our guidance. First, the US dollar has strengthened significantly against the euro, pound sterling and Aussie dollar during the second quarter, which negatively impacts our top-line license revenue when converted from local currency. Second, like the rest of the world, we have renewed concern about the macroeconomic environment, particularly in Europe. Third, we repackaged our flagship vSphere product and, while adding significant new performance to the Enterprise and Enterprise Plus package, we also migrated VMotion into lower-priced packages. Although we expect the reduced average ASP will be offset by increased volume, we cannot be certain that will occur.

Finally, the US federal government is carefully reviewing its IT spend leading into the fiscal year end, and we are not yet certain what, if any, impact this will have on our federal business.

Despite this backdrop, given the strength we are seeing in our business, third quarter revenues are expected to be within a range of $680 million and $705 million, or year-over-year growth of between 39% and 44%. We expect license revenue to be flat to slightly down from Q2. Revenue from our recent M&A activity represents low-single-digit percentage of our guidance.

Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call, we expect the third quarter non-GAAP operating margins to be within a range of 26.5 and 28%. We expect our GAAP operating margin to be approximately 14 to 15 percentage points lower than our non-GAAP operating margin. We have established a high bar, given our performance over the past three quarters relative to expectations. The fourth quarter of 2010 is a much more difficult year-over-year comparable than the first half, as Q4 2009 included the impact of our promotion to upgrade customers to Enterprise Plus, and, as mentioned, we are in a very different currency environment from a year ago.

We are currently planning on 2010 revenue of between $2.725 billion and $2.8 billion, or growth of 35% to 38% compared to last year. From a margin perspective, we will continue to invest organically and possibly through acquisitions. Our current expectation for the full-year non-GAAP operating margin is a range of 27% to 28%, but this could be disrupted by future M&A activity. We expect our 2010 GAAP operating margin to be approximately 13 to 14 percentage points lower than our non-GAAP operating margin.

To summarize, we are very pleased with our execution and solid performance in the first half of 2010. We continue to manage our resources prudently while making the key investments necessary to maximize our long-term growth and free cash flow per share.

Tod?

Thanks, Mark; good afternoon. It appears the technology industry continues to be broadly benefiting from pent-up customer demand, and VMware is no exception. But as we look at our second-quarter performance, VMware also benefited from strong field execution around the world and solid product line performance across all customer segments. As we hit the midpoint of 2010, I am very pleased with the progress we have made operationally, within R&D and across our go-to-market efforts.

We are working to establish a solid foundation that will enable VMware to support significant growth moving forward. A few highlights from the first half of the year that I like to call out include our customer count continues to grow with VMware, now serving more than 190,000 customers worldwide, up from 170,000 six months ago. We are making progress with industry analysts. Gartner recently positioned VMware as the sole leader in their Virtualization Magic Quadrant and signaled the tight linkage between virtualization and cloud computing.

vSphere Essentials units are growing at 100% sequentially, indicating solid traction in the SMB market. Our SpringSource division is doing well, posting their best quarter ever and signaling that we are effectively growing near-term revenue while advancing our strategy to position Spring as the programming model for the cloud. As you will recall, we announced two important partnerships with Google and salesforce.com that pivot on the technology and community associated with our SpringSource efforts. And, lastly, services attach rates, either our own or our ecosystems, are increasing, demonstrating our shift to a more consultative, enterprise-oriented engagement model.

These are just a handful of examples illustrating VMware is growing stronger and leading the industry into the next era of computing. As our portfolio grows both organically and through acquisitions, our field is engaging with customers across a wide spectrum of opportunities. One example -- a large financial services company is a longtime VMware virtualization server consolidation customer. As they progress on their virtualization journey, they are making investments to enhance quality of service for their millions of users. As such, we are working with them to create a modern architecture that will provide them benefits of cloud computing.

In this pursuit, they have signed a large ELA in the second quarter and are taking advantage of much of our portfolio, including vSphere, vCenter, View and SpringSource. Our operational progress and strengthening customer relationships are absolutely essential as we expand our business. The launch of vSphere 4.1 earlier this month illustrates how we are executing on all cylinders to ensure that VMware is the source for customers, including those moving to the cloud.

Beyond the significant technical advancements of vSphere 4.1, like better scale and improved performance which extend vSphere's technical capabilities further into a class by itself, we also announced some strategic moves to expand our go-to-market efforts and further align our business model with customers' needs. For example, we introduced a per-VM licensing model for our management products. This new model aligns license costs to the number of virtual machines being managed rather than to the physical hardware. As virtualization and cloud computing become prevalent models of IT infrastructure, the virtual machine is rapidly becoming a standard measure of infrastructure deployments. In a virtualized environment, the hardware configuration is abstracted, and the physical compute resource required can change frequently, due to the virtual machine migrations across the data center, thus making hardware-based licensing difficult to manage.

A virtual machine-based license model offers customers better alignment between software costs and benefits delivered. We also expect this model will better support customers' needs as workloads move across diverse hardware configurations, including multiple CPU scenarios, without incurring additional costs. In discussions with customers and industry analysts about this pricing model change, the feedback has been very positive. Our per-VM pricing will be in effect on September 1 for VMware vCenter management products only.

Next, we have quickly integrated the Ionix management products we acquired from EMC in April, launching them with vSphere 4.1. This broadened our management portfolio to deliver a more complete set of solutions to automate the management of dynamic virtualized systems. Specifically, we launched vCenter Configuration Manager and vCenter Application Discovery Manager, both former Ionix products.

Another exciting announcement we made this month will further expand our value proposition and reach to the SMB market with vSphere 4.1. As we've mentioned before, in general the SMB market, once it begins the virtualization journey, moves along at a much faster pace than enterprise [does], partly because they have fewer servers, but also they have fewer people, processes and cultural implications to deal with as they transform their IT departments. Our pricing and packaging of vSphere 4.1 for the SMB market significantly changes the game for smaller organizations that want to experience high-value virtualization from the market-leading and proven vendor.

Analysts surveyed have acknowledged that well over half of the smaller organizations that are adopting server virtualization highly desire disaster recovery and business continuity capabilities. Beyond the proven functionality we provide today to the SMB market, we are now expanding the value proposition of vSphere 4.1. Specifically, we have made vMotion available within our Essentials Plus SKU. We have seen tremendous momentum with our Essentials products in the first half of 2010, and I expect this move will pay dividends in the form of further customer acquisition and expansion in the SMB market.

Now turning to our desktop business, we continue to hold high expectations for the desktop virtualization market, yet it remains difficult to predict at what pace customer interest and evaluations will turn into accelerated buying. We are seeing Windows 7 upgrades and the proliferation of new end-user devices such as the iPad and smart phones, are fueling public discussion and customer interest. However, no single technical or economic tipping point is emerging as the accelerant to VDI adoption.

What is emerging is a trend where IT executives are exploring much broader architectural implications of managing users in dramatically different ways. Many customers are not looking at a traditional product feature cost/benefit analysis, but rather asking larger questions about how they're going to manage users in a dramatically changing world defined by mobility, ubiquitous computing and increasing end-user demand and expectations. We believe this bodes well for VMware as we further position our desktop strategy within the context of these broader requirements and architectural changes. We will be advancing our offerings with the public availability of our next version of View, View 4.5, planned for the third quarter, as well as helping our customers navigate the end-user computing journey at our user conference, VMworld in San Francisco in five weeks and then Copenhagen in October.

Overall, I'm very pleased with our execution and results in Q2. From an operations perspective, our goal is to consistently strike the right balance of delivering on our quarterly plans while building the foundation of our business that will allow us to scale and grow over the coming years, all while maintaining excellent customer engagement and service that keeps our customer satisfaction scores among the highest in the industry.

Finally, I'd like to especially thank our customers, our employees around the world and our partner community for a great first half of 2010. With that, I'll hand the call over to Paul.

Thanks, Tod. Tod and Mark have given you a good overview of our second-quarter performance. On a broader level, we continue to execute on our three-layered strategy of, firstly, infrastructure; secondly, applications; and, thirdly, end-user or desktop computing. Our investment in the first layer, infrastructure, is designed to allow customers to modernize their infrastructure, run it and manage it more efficiently and build true secure private clouds for their existing applications and bridge those clouds to the external cloud and generally operate in a more businesslike way, behaving as internal service providers.

In this context, we are particularly pleased with the release of vSphere 4.1. It's a great product. It's tangible evidence for the commitment of our vSphere team to deliver a series of high-quality releases as we seek to flesh out the secure private, public or hybrid cloud. vSphere is now amongst the most sophisticated pieces of software in the world, and being able to deliver it with quality in a predictable way is no small achievement. It's this kind of execution that will allow us to stay ahead. We will now move to release a series of products that will fill out the additional aspects of the secure cloud, specifically security and management services, and we expect to have a full roster of announcements from both ourselves and our partners at VMworld at the end of August.

At the second or application level, we seek to allow customers to write, run and manage new applications more efficiently and take full advantage of modern cloud infrastructure, infrastructure not only from VMware, but from other providers as well. We have continued to fill out the space there too. The acquisition of Gemstone takes us into the sophisticated distributed data caching services business, and of note were the announcements that Tod mentioned with salesforce.com and Google. These partnerships are important, as they underscore role new programming frameworks in the Spring framework, in particular, will play in providing an open layer for new applications in the private and public cloud.

At the third layer, the end-user or desktop level, we seek, as Tod noted, to build upon the current model of desktop virtualization and speak to the need of enterprises to focus more on managing users and spend less time managing devices, particularly in a world where endpoint devices are becoming increasingly heterogeneous. We'll be providing a path to our customers whereby they can move forward in an evolutionary way from their current Windows-centric environments and, in this context we are looking forward to the release of 4.5.

As Marc said, we will continue to make the investments needed at each of these three layers, mainly through organic development, but also through focused technology acquisitions. By doing this, we believe we can provide the bridge for our customers from today's world of IT to tomorrow's world of IT as a service.

Finally, we look forward to spending time with you and providing additional background at the analyst event that we are planning for VMworld in San Francisco at the end of August.

With that, I guess we'll open up for questions.

Operator, let's start the polling process, please.

(Operator instructions) Kash Rangan, Merrill Lynch.

Thank you very much, nice quarter. As you give consideration for the first half of the year, clearly the results are very impressive. There has been a big rebound in the server market. How does your business look as you start planning for 2011? Should we expect continuation of these kind of growth rates, or should we expect some moderation, given that you have tougher comps for the server market ahead? That's my question, thank you.

Hi, Kash; this is Mark. Certainly, the first half of 2010 we saw a rebound in the economy, and we, like most of the IT industry, benefited from this rebound. Server growth rates are in the 20% range. They are forecast to grow at somewhat similar rates, although moderating a bit in the second half. The early indications for 2011 on server growth rates is that they will decline somewhat significantly in 2011.

That said, our business, although it's influenced by server growth and also is impacted by installed bases which are moving to virtualization. And then, on the other side of that is enterprise agreements that we've sold in which companies have inventoried some of their licenses.

So, certainly, the growth rates for 2011 -- we're not going to give guidance at this time. We've just finished planning the second half of 2010. We continue to be on six-month quota assignments, but we'll give you more color as the year progresses.

Derek Bingham, Goldman Sachs.

Hey, gentlemen, congratulations on the quarter; I have a two-parter on ELAs. One is, you had mentioned that they're coming in typically over the size of the initial contract value. So I just wanted to be clear. When you are referring to that, you are just referring to the maintenance renewal portion of that contract that's coming in larger than the complete contract value that was signed in the first place. And then I'm also just curious about what color you can give us in terms of any kind of associated license sales when you are doing those ELA renewals in terms of how much people are increasing their deployments and buying new platform licenses or SKU upgrades, new management tools, desktops, etc.

The first point, just to clarify -- when we said it was more than originally, it's not just the maintenance and renewal, but it's the original value of the ELA. So in an original ELA, there is a license component and then maintenance component, and the renewals are coming in greater or more than 100% of the original ELA value. This is partly due to further expansion of more servers or more of the original product expanding its reach or scope within the customer. But, as you mentioned, it's also a result of additional products or upgrades being brought into the mix.

So the example I talked about was a financial services company that started off with our vSphere product and has now moved to View and SpringSource and expanding that way, and we are seeing that trend across all of our ELA renewals.

Walter Pritchard, Citigroup.

I'm wondering if you guys can talk a little bit more in detail about the comment you mentioned about your margin targets with -- I guess the potential that there could be disruption from M&A. And I'm wondering -- you know, you had a little bit of disruption in the first half of the year. I'm wondering, do you contemplate disruption of that magnitude, or is it possible that you guys would consider doing deals that are larger than what you've tackled so far?

Walter, this is Mark. We guided 27% to 28% for the full year, and with the caveat that that could be disrupted by M&A, but not that we hadn't planned M&A in addition to the margins that we were currently targeting. In the second quarter, we did have about a 150-basis-point sequential change in margins as a result of M&A. But as a reminder, in addition to Ionix, Gemstone and Rabbit, that also includes a full quarter of Zimbra in the quarter.

And then just one follow-up, Mark -- on the currency, I think I heard you say that there was no impact from currency. And yet I -- I mean, we all did see currency weaken pretty significantly. And I'm wondering, was that a comment on year-over-year currency, or was that on the sequential impact from currency?

It was really a comment on year-over-year currency. And we had -- remember that a lot of our operating costs are in those local currencies, and so we benefited from that end. And then, when you're thinking about the top-line revenue, it's only the portion of license revenue recognized in the period that is in the four currencies in which we are operating.

Brent Thill, UBS.

Mark, you saw a nice acceleration in deferred revenue, up 58% year-over-year. I was curious if you could just comment on what the role of the ELAs had with that versus increasing transaction volume, and what seems a combination of both. But if you could just give us a sense -- and as you [said] in the second half of the year, I would assume that many of these ELAs that you started back in 2007 are going to continue to come up for renewal. So how should we expect a continuation of that deferred trend in the second half of the year?

Well, certainly, most of deferred revenue is driven by the maintenance component of all of our transactions. And across the board, we have seen transactions coming in at more than two years of maintenance. So companies are taking advantage of modest discounts that we'll give to add on an additional year of maintenance. And we bill and collect those within 60 days. This quarter, ELAs ticked up sequentially. They had been in the mid-teens in Q1. They were at 20% during this quarter. But, that said, even the transactional business through the channel has multiple years of maintenance associated with it. And your second part of your question?

Just in terms of how you are viewing the second half of the year for ELAs in terms of the renewal rate. Is there anything that changes in the second half in terms of the dynamics on the renewals?

We are just beginning -- this is really our second data point on ELA expirations within a quarter. We really started the ELA program in the first quarter of 2007. Most of them are set at about three years. Some companies will vary outside of that norm. But there are more expirations coming up in the second half of the year, and so we'll have more data for you as the year progresses.

Thanks.

Adam Holt, Morgan Stanley.

The European business seemed like it was strong in the quarter. You obviously called out a number of countries that were particularly strong. Yet, the commentary for Q3 reflects, I guess, increasing concern about the environment. Did you see any change in Europe that would lead you to that, or are you just being a little bit more cautious with respect to the guidance? And, are you assuming that the demand environment is a little bit weaker in Q3 than it was in Q2, in particular in that geography?

When we look at -- this is Tod -- when we look at the results and the performance in Q2, we certainly saw solid performance across the entire region of EMEA, and the transaction business and ELA business and the like. I think the conservative guidance is, we watch the news and we hear what's happening in Germany and Greece and Spain and some of the concerns. We just want to be cautious, but we look at our performance and results in Q2, and we were definitely pleased with the way we were able to execute in EMEA.

And one thing that I would add to that is that, as a result of the summer slowdowns in Europe, there will be this trend where companies will come back, begin their own planning exercises for the back part of the year, and with uncertainty -- in their businesses, becomes uncertainty in ours as well.

Mark, if I could just ask a quick follow-up on margins -- if you net up a dilution this quarter, your margins were 29.5%, ahead of where you guided to for the year. You've talked about a 30%-plus long-term operating margin. Is that still the mindset that we should be thinking about in terms of longer-term margins, or are you maybe a little bit ahead of that kind of longer-term goal in the current trajectory? Thanks.

Well, first and foremost, we're going to invest in the business organically, through technology acquisitions, and take advantage of the opportunities that we have in front of us and so we are not margin-oriented. Certainly, longer-term, 30% plus is something that we should be able to achieve if we execute on the growth in the business, but first and foremost, and what drives the margin performance over a year ago is the growth that we've had in the deferred revenue and the renewals that come with it that we've put on the balance sheet.

Great, thank you.

John DiFucci, JP Morgan.

Thank you -- Mark, when you gave guidance for this quarter, for the second quarter, you said license would be down sequentially; and obviously, we saw it up, so you guys did a great job here. But I'm just curious; can you just refresh us why you thought you would see a decline in the quarter when you and just about everybody sees a sequential uptick into the second quarter?

And I guess, sort of an add-on to Adam's question, why would you assume license to be flat in this quarter when you typically see growth? Is it just being cautious about Europe, which sort of sounds like what Tod was saying?

Well, walking into the second quarter, we had benefited from some fairly large enterprise agreements in Q1. And so, as we looked at our pipeline, we weren't expecting to have quite the strength that we had in enterprise agreements in the second quarter that we had. You may recall, we did a plus-$10 million deal in Europe. We also had some OEM carryover in the first quarter, which we didn't carry over into the second quarter, and so that was really what our guidance was about as we looked at Q2.

As we think about the third quarter, we are saying flat to slightly down, largely because of Europe and the slowdowns that we expect to see in Europe, as well as we benefited in APAC from the year ends in Australia and other regions, and so we don't expect to have the strength in our international geographies in Q3 that we had in Q2.

Thanks; if I could just make one quick follow-up, you said that headcount in the second half -- you said headcount in the first half was plus 8200, and you expect -- I just wanted to clarify that you'd expect something similar in the second half. Does that include any M&A, or is that excluding any M&A?

Well, what I wanted to indicate -- directionally, we are going to continue to invest in the business organically. We're not going to forecast the M&A, but we added 1100 people in the first half of the year. About half of those were through M&A, but we've demonstrated that when we make the decisions to hire, we can execute on the hiring and that we are a very attractive place for people to come to work, and that we are able to attract top talent. And, as long as we can attract top talent and put them to work productively, we are going to go ahead and hire.

Brian Marshall, Gleacher & Company.

Great, thanks; hi, guys, nice quarter. I was wondering if you could discuss a little bit about some of the trends that you're seeing in VDI, Virtual Desktop Infrastructure. Based upon some of the checks that I've done recently, it sounds like calendar year 2011 could actually be the year where this actually starts to be pretty material for some people, including yourselves. Just wondering if you could comment on that as well.

Sure, this is Tod. As I think we said in the past calls, there's a strong interest in VDI, desktop virtualization, in general. We've, in some quarters, had as much as 60% of our proof-of-concept resource focused on desktop and desktop virtualization. With Windows 7 and those sort of rollouts and upgrades on the horizon, there's definitely a strong interest, as many customers are saying, if they're going to make the upgrade to Windows 7, they're going to make a transformative change, like a desktop virtualization effort as well.

So I'm a little bit cautious to declare 2011 the year of the desktop since for the last few years it's been declared the year of the desktop, but we're optimistic on the opportunity.

That said, as I mentioned in my prepared comments, we are seeing a change or a slight mindset shift where people are trying to look beyond just VDI and consider how they are going to deal with the proliferation of devices that are out there. And a theme we are hearing from customers is, help me manage users, and then the devices will take care of themselves. And so we are thinking through our strategy, and we'll be rolling out our direction and vision about how we're going to address this opportunity and the chance to meet these needs.

Great, thanks, Tod; and the final question, I guess with regards to ELA trends, sort of a follow-up question -- basically, do you think that there's going to be a material dynamic there where we see large enterprise customers as well as federal guys be pretty strong when it comes to renewal of those ELA contracts, and potentially see some weakness from some of the small- to medium-sized enterprises that sort of bit off more than they could chew three years ago and haven't -- I think Mark mentioned that they have inventory left.

At this point in time, we track most of our ELAs that we've done. We have assigned a technical resource to them, and we get a quarterly report on the progress of their use and consumption and where they are in their virtualization journey. And we are not seeing trends of smaller customers are struggling relative to bigger customers. But across the board, we are seeing customer satisfaction and progress through the journey and don't expect anything except for them to follow the trend we've been seeing the previous few quarters, which is folks will renew at greater than 100% of the regional value of the ELA.

Well done, thanks.

Heather Bellini, ISI Group.

I was wondering if you could talk a little bit about the attach rate for management products, if you could help us ascertain that; and also, what type of impact you think per VM pricing that you mentioned will have on the contracts value for those customers, once the pricing change goes into effect. Thank you.

Heather, this is Mark. The attach rate on management products is -- we've seen improvement, and we are pleased with what we've seen. We are also adding to the portfolio of management products. The per-VM pricing is something that we introduced in, really, response to how customers consume the products and to make it easier for them to consume and to build their own ROIs on the value proposition that it adds.

At this point, we don't expect it to have a material impact on the near-term economics for us, but certainly we introduced per-VM pricing to help both us and our customers.

Scott Zeller, Needham & Co.

Another question about Europe -- could you give us some color around the activity due to pent-up demand and how much of that still remains as you look forward to the second half of the year versus a strong data center refresh activity, for instance?

Well, it's a little bit harder to tell as the year progresses how much of it is pent-up demand versus changes to the businesses. Europe for us typically has not been a large enterprise license agreement market, so we have many more distributors and resellers in Europe, and it tends to be very regional and very segmented. And so it's a little bit harder for us to get an overall view of the macroeconomic. We've seen more enterprise agreements, and certainly we are focusing our customers, now that they are on the journey of virtualization into the private cloud, to enter into ELAs. But as we enter into the back half of the year, we're just being cautious really based on the macroeconomic trends and looking at our own pipelines.

Thank you.

Kaushik Roy, Wedbush.

Thanks, and congratulations again. Can you quantify in any way the license revenues you are getting from the desktop, or can you give a little bit more color on the type of environment or the traction you are getting on the desktop? Thank you.

Kaushik, we don't break out license revenues by product category. What we have seen is, particularly in enterprise agreements, is that we will add to an enterprise agreement VDI and view. We are seeing traction, as Tod had mentioned, and pleased with the traction, but we are not going to break out the specific license revenue.

When do you expect the VDI to be material? Could it be Q4, or like (technical difficulty) Q2?

That's hard to say, partly because of the steam and the momentum we have with vSphere, but the desktop wins we are getting are deploying -- I met with a number of customers in Q2 that purchased and are in the early phases of their deployments and, as they roll them out, it will just be a matter of time before it kicks into the additional licenses and we see that impact.

Okay, thank you.

Jayson Noland, Robert Baird.

Great, thank you; just a question on SMB with the new price point and feature set bundle. I guess this is partially in response to Microsoft; when we hear about success from Microsoft, it's in SMB and fairly rare. But I'm curious what sort of penetration you think you have in SMB versus enterprise and what sort of market share you have in SMB versus enterprise.

This is Tod; so, historically, we've made this move throughout the years where we've taken some of our core features and we've cascaded it down the waterfall to the SMB type SKUs. So the move for VMotion was one we've planned on doing and executed with the release of 4.1.

As far as the success in SMB, we've been incredibly impressed with the traction. We are getting 100% growth in the units sequentially, and the Essentials products is a great testament to the opportunity we have in that space and the success we've been getting, and not just in the US, but around the world.

And so, as far as market share gains, we look at the reports and where it goes. What we are seeing -- you assume Microsoft is seeing similar stuff. It's a great opportunity for us to continue to grow and expand our reach, and with this move that we have made with 4.1, we expect good things in the future.

Thanks, guys, congrats on the quarter.

Operator, we are going to take two more questions, please.

Rob Owens, Pacific Crest Securities.

Great, thank you very much. I wanted to drill down a little bit into View 4.5 and some of the functionality associated with that in terms of personalization or client-side hypervisor. Although the product hasn't been released, I think it has been reported that these things have potentially slipped out. I was just curious how critical or how crucial you think that type of functionality is to the long-term success of View 4.5; thanks.

Okay, I'll do some work here, this is Paul. There are really two things there, one is client-side hypervisor. We are supplying client-side functionality with our off-line View capability, which comes as far as part of 4.5. The feedback that we got from our customers is the market is not ready yet for a bare metal, naked hypervisor, and instead we are supplying essentially a Windows within Windows hypervisor, which gives us much better coverage of the installed base, in particular. The challenge with a bare metal hypervisor is, how do you address the installed base? So we made that change based on customer feedback.

In terms of the persona functionality, we think it's important. As you said, we are moving to place the emphasis increasingly on allowing our customers not to have to worry about the peculiarities of devices, and worry more about equipping their employees with a certain set of functionality, applications and information, and mapping that to whatever particular device that they have. So, that's an area we invest in and where you can expect to see some very interesting announcements from us down the road.

And, along those lines, Paul, PC over IP -- are you happy with where it is now? Is there more work to be done on that front?

We are very happy with it. There's always more work to be done on everything. But as far as the protocol itself is concerned, very pleased with where it is.

Michael Turits, Raymond James.

Two questions; one on ELAs, one on pricing. On ELAs, I know that you said that your average -- (inaudible) [length] for overall is 24 months. Are you still holding at three years for most of the ELA renewals? And then I have another question.

The blended averages more than 24 months. I didn't look at the Q2 data, but I believe that is the case, that we are doing about three years of maintenance on the ELA renewals.

Okay, and secondly, on the vSphere pricing, you've gone to VM-based for the management piece, but obviously not for vSphere itself. Are you starting -- despite the strength in licensing this quarter, are you starting to see any negative impact on licensing as customers start to move up to six-, eight- and 12-core chips? And, if so, might you move there -- might you move to per-VM pricing overall at some point?

This is Tod again. I would say the answer to that is no. What we're finding as customers have progressed down the virtualization journey, is they move towards phase two and phase three of the journey. It's really less about consolidation ratios and more about just the quality of their IT infrastructure and business continuity and agility and the like. And so, I don't foresee us, at the core infrastructure layer with vSphere, going to a per-VM type model. It makes sense for customers at some of the management and products, and arguably VDI is a per-VM model today as well, but it doesn't really make sense at the infrastructure level for us.

Great, thanks very much.

Okay, that concludes the call. Thank you, everyone, for participating.