VMware Inc (VMW) 2010 Q3 法說會逐字稿

Welcome to the VMware third 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. Mr. Haase, you may begin.

Thank you and welcome to VMware's third quarter 2010 earnings conference call. We will have prepared remarks from Tod Nielsen, our COO, and Mark Peek, our CFO. Paul Maritz, our CEO, is still out of the country following VMworld Europe in Copenhagen last week, but he is on the phone and will join Tod and Mark for the Q&A session.

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 and 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 and not as a substitute for or an 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.

The webcast replay of this call will be available for the next 30 days on our Company website under the Investor Relations link. Our fourth quarter quiet period begins at the close of business December 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. With that let me hand it over to Mark.

Thanks, Mike, and good afternoon, everyone. Driven by a strong product portfolio and great field execution, we once again set new records in revenue, non-GAAP operating profit and trailing 12-month free cash flows. Business was strong across geographies, transaction types and products.

We saw continued momentum of vSphere as customers adopt the vSphere platform as a strategic investment that delivers substantial cost savings, improved efficiency and business agility. Our customers also are looking to VMware to help make cloud computing a reality. VMware is enabling the delivery of IT as a service using our evolutionary approach based on the vSphere platform. It is clear that virtualization is the platform for the cloud and vSphere is the cornerstone enabling customers to leverage their existing IT investment and greatly simplifying their data centers.

In July we successfully launched vSphere 4.1. In September we released View 4.5. Customer feedback and early adoption has been very positive on both products. We're also making solid progress in our desktop business. Desktop license bookings exceeded 10% of total license bookings in the US during the third quarter and year-to-date. In Q3, we acquired Integrien, a leader in realtime application and infrastructure performance in analytic software. We also acquired TriCipher, a leader in secure access management and enterprise identity federation for cloud-hosted SaaS applications. While these acquisitions will not add significant short-term revenue, they accelerate the expansion of our platform as we continue to build out the stack for this next era of computing.

We ended the quarter with $2.9 billion of cash. Strong operating performance and capital efficiency led to trailing 12-month free cash flow growth of 39% to $1.1 billion or $2.51 per share. So all told we had a great September quarter. On behalf of our long-term shareholders and management team, thanks to all of the people of VMware, our partners and our customers.

Now I'll take a few minutes to walk you through the details. Revenues for the third quarter were $714 million, up 46% from a year ago, or 47% measured on a constant currency basis. License revenues were $343 million, an increase of 43% from the third quarter of a year ago. Demand was strong across our global regions and customer segments. On the product side, the growing interest in our desktop solutions led to record quarterly desktop license revenues. With the release of vSphere 4.1, we changed our packaging to move certain features including VMotion to Essentials Plus, one of our SMB focused vSphere offerings. This resulted in a shift within our SMB skews from Essentials with a list price of $4.95 to Essentials Plus with a list price of $34.95. We also saw strong demand for our Enterprise packages. As a result of making greater functionality available to smaller customers, our overall ASPs per unit increased during the quarter. Average ASPs also benefited as a result of dogged discipline around discounting.

US revenues increased 47% from a year ago to $362 million, representing slightly more than half of total revenue. In the Americas, the US Federal business was very strong as the government continues on its virtualization journey in an effort to contain and manage both capital and operating costs while maintaining high confidence in security and reliability. Demand in Latin America, especially within Mexico, Brazil and Argentina, continued to be robust with third quarter bookings up over 100% year-over-year.

International revenues grew 44% to $352 million driven by strong demand across geographies. In Europe, despite the ongoing macro economic concerns, demand remains strong especially in the UK and Germany. We also made significant progress in Eastern Europe and Russia. We once again saw strong demand across the Asia Pacific region including China, Japan and Australia. Total bookings for the region increased more than 50% year-over-year. We have also experienced increased interest in Enterprise license agreements from our Asia Pacific customers. Enterprise license volumes are up triple digits year-to-date in China and Japan compared to the same period in 2009.

Globally, Enterprise license agreements were approximately 20% of total third quarter bookings. We continue to progress well with ELA renewals. Customers renewed their contract at a higher dollar value than the original agreements, and on average with a maintenance term of three years.

Software maintenance and support revenue was $314 million, an increase of 48% from last year. In Q3, back maintenance was down slightly from a year ago. This was expected as the program has now been operating six quarters and we have done a good job getting customers current who had lapsed on their maintenance agreements. We expect back maintenance for Q4 to be lower compared to the same period of 2009. 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 data center architecture and longer term IT strategy.

Professional services revenue was $57 million, an increase of 55% from last year. The year-over-year increase was largely due to incremental services revenue from our M&A activity and customer training related to vSphere deployments.

Although we're pleased with our financial results and operational progress during the first three quarters of 2010, the year-over-year comparables we now face are more difficult. There are three things I want to call out as you consider our fourth quarter guidance. First, in Q4 2009, we had a very successful promotion on Enterprise Plus upgrades which drove over $100 million of upgrade bookings. Second, we continue to be concerned about the macro economic environment particularly in Europe as well as the impact of currency volatility on customer purchasing patterns. Finally, we're still uncertain as to the longer term impact of our Q3 products repackaging design and we're not convinced that the increase in ASPs we saw in Q3 is a trend or a mix shift that we'll see again in Q4.

With this backdrop, we expect fourth quarter revenues to be within a range of $790 million and $810 million, or year-over-year growth of between 30% and 33%. Revenue from our 2010 M&A activity to date represents low single-digit percentage of our guidance. The results for the first three quarters together with our Q4 guidance imply a 2010 growth rate of 39% to 40% for total revenues.

I'll 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 5% sequentially to $510 million driven largely by increased head count. During the quarter we added approximately 500 people with about 100 people coming from Integrien and TriCipher. We ended the quarter with approximately 8700 employees.

Third quarter R&D expenses were flat at $136 million or 19% of revenues as compared with 20.2% in the second quarter of 2010. Although the total number of employees in R&D increased during the quarter, an intense focus on management of contractors and seasonally lower benefit costs such as FICA drove flat operating expenses for the group.

Sales and marketing expenses were $230 million, or 32.3% of revenues, compared with 31.9% in the prior quarter. The increase was largely due to additional head count, continued geographic investments and marketing events such as VMworld during the quarter.

G&A expenses were $57 million, or 8% of revenue, compared to 7.6% of revenue in the second quarter. The sequential increase was largely due to an increase in bad debt expense and funding of our charitable foundation during the quarter. G&A head count was essentially flat.

Our operating profit measured on a non-GAAP basis increased 9% sequentially to $204 million or 28.6% of revenue. This beat our forecast range due primarily to operating leverage from our revenue performance. The net impact of FX during Q3 was a negative 38 basis points to our non-GAAP operating margin.

The non-GAAP diluted EPS was $0.39 on 427 million diluted shares. The share repurchase program did not have an impact on EPS during the quarter. Fully diluted EPS did benefit by $0.01 as a result of a decrease in our tax rate. The non-GAAP tax rate for the fourth quarter is anticipated to be 20% and for the full year 2010 at 21%. This is down from our prior guidance of 22% due to the mix of operating income between the US and international.

Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call, we expect the fourth quarter non-GAAP operating margins to be within a range of 29% to 30%. We expect our GAAP operating margin to be approximately 15 to 16 percentage points lower than our non-GAAP operating margin.

Now on to our balance sheet and cash flow statement. Our balance sheet remains strong with cash of $2.9 billion, up more than $100 million compared to the prior quarter. During the third quarter, we used approximately $300 million in aggregate for M&A activity, capital spending and our share repurchase program.

During the first quarter of 2010, we announced authorization to repurchase up to $400 million of our Class A common stock through 2011. The objective of the VMware repurchase program is to partially offset the dilution from employee stock issuance. In the third quarter, we repurchased $141 million of our Class A stock and through the first three quarters of 2010 we repurchased a total of $286 million.

Total deferred revenues were $1.5 billion, up 52% from the same period last year and a 2% sequential increase. Over 90% of our deferred revenue is recognized with the passage of time or the delivery of professional services.

Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock compensation, were $268 million for the quarter and $1.17 billion for the trailing 12 months. Free cash flows for the quarter were $237 million and $1.05 billion for the trailing 12 months. Free cash flow per diluted share was $0.56 for the quarter. Free cash flow per diluted share for the trailing 12 months was $2.51. 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. 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 427 million shares for the third quarter driven by the impact of a higher share price. We expect our fourth quarter 2010 diluted weighted average share count to be approximately 430 million shares and for the full year we expect the diluted share count to 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 for next year. 2011 will be a much more difficult comparable than 2010 and we expect server shipments to grow more slowly in 2011 relative to 2010. For the first quarter of 2011, we're currently planning for total revenues to be down sequentially from Q4 or just under 25% growth year-over-year. This is consistent with cycles commonly seen in Enterprise software. The non-GAAP operating margin in the first quarter of 2011 is also expected to decline sequentially.

We'll talk more about 2011 in January, however as we go through our 2011 planning cycle, it will be a year of significant investment with little if any operating margin expansion. Though we will have a tough revenue comparable from 2010 and inherently limited visibility at this time, I believe we can deliver 20% growth in 2011. I will provide more information in January after we report our Q4 results and have completed our 2011 go to market plans.

To summarize, we're very pleased with our execution and solid performance. 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. Let me turn it over to Tod.

Thanks, Mark. Good afternoon, everyone. We are pleased with our strong third quarter performance driven by product momentum, cost control and seamless execution across all regions and product segments. As Mark mentioned, revenue grew 46% to $714 million. Operating margins came in at 28.6% despite the closing of two new acquisitions and the further integration and additional investments for acquisitions we made in the first half of the year. And for the third quarter in a row, ELA renewal rates were high and the total dollar value of renewed ELAs exceeded the value of the original agreements.

Demand for our vSphere products remains strong. Enterprise and Enterprise Plus unit and dollar sales were once again very strong. Coupled with the Essentials Plus performance, we saw a sequential increase in our blended ASPs. Our go to market investments in key international markets are paying off as we continue to see momentum in Japan, China, US Federal, Russia and Latin America among others. In particular we experienced triple-digit year-over-year orders growth in Russia, a market we are committed to serving as we believe there is a significant long-term potential which we are just beginning to tap.

Regarding the desktop market opportunity, our ability to turn customer interest and evaluations into design wins and purchases is improving as our desktop business posted record quarterly license revenue. In the third quarter, we closed a seven figure desktop ELA with 6,000 feet with one of the largest automotive parts suppliers in the world. This particular customer has been a very satisfied vSphere customer and is now leveraging their expertise and installed base of vSphere to enable their desktops. As we have mentioned before, we are still at the early stages of the desktop market opportunity. These are good signs that VMware is well positioned to capture our fair share of the VDI market over the coming years and we are bullish on the desktop opportunity.

We also made significant announcements at VMworld 2010 where over 17,000 attendees including partners and customers gathered in San Francisco to share best practices and technologies enabling cloud computing. Last week, in Copenhagen, Denmark over 6,000 attendees came to experience VMworld Europe. At both events, we presented a vision for IT as a service and the emergence of a new IT stack that drives innovation across three core areas, including infrastructure, application platforms and end user computing. The reaction to our vision was very positive. With over 23,000 people attending VMworld globally, the momentum we take forward is strong.

At the infrastructure level we announced a new product called VMware vCloud Director, a new solution focused on helping customers build private clouds for both delivering and consuming IT services. We are receiving positive response from customers including Sabre Holdings, which is using vCloud Director to transform how they deliver IT resources to the business. Sabre is calling vCloud Director a game change.

We also announced a set of new products call VMware vShield, our security offerings for virtual and cloud environments that deliver better security than traditional physical offerings at a fraction of the cost.

We now have the solutions to enable our customers and service provider partners to deploy and operate with standard infrastructure, a hybrid cloud environment. A hybrid cloud is the union of a private cloud with services from the public cloud. We believe the hybrid cloud model will deliver the best economics and most agility for customers over the coming years.

For developers, we launched VMware vFabric, the first cloud application platform that leverages the spring framework along with a suite of technologies, some of which we acquired over the last few quarters. The result is an application platform tuned for VMware virtualized environments as well as cloud scale, but engineered with openness as a foundation component to allow our customers to have the ability to select whatever technologies they prefer.

On the end user front, we announced general availability of View 4.5, the first Enterprise class solution that delivers rich virtual desktop experiences online or offline. As I mentioned briefly earlier, View 4.5 is a solid step forward and customers are reacting positivity to the improved security, lower operating costs and simplified desktop administration and management. We believe desktop virtualization and VDI is an important step in a broader, user centric approach to personal computing. But VDI is just the first step. VMware's vision is to ensure secure access to applications and data from any device, where and when a user needs it. We previewed an effort called Project Horizon at VMworld to illustrate a view into how we see this market evolving.

On the M&A front, we closed the acquisitions with Integrien and TriCipher during the quarter and I want to welcome the nearly 100 employees from these companies to VMware. During 2010 we have closed seven M&A transactions and successfully integrated over 600 employees from these acquisitions.

In summary, we are pleased with our overall execution in the third quarter and believe we are strengthening our position as the central vendor enabling the next generation of computing. We expect a good finish to 2010 and are excited about the prospects of 2011 and beyond. I'd like to thank our customers, VMware employees and our incredible ecosystem of partners for their continued support and commitment. Now lets turn the call over for questions. Paul, Mark and I are available to answer your questions.

All right. Operator, can we begin the polling process, please?

Thank you, we will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Heather Bellini of ISI Group. Your line is open.

Hi. Thank you. I was wondering if you could you discuss the ELA renewal opportunity that's in front of you in the fourth quarter of this year, and contrast that with the level up for renewal in the third Q-- third quarter that just ended? And also if you could compare it to the fourth quarter of last year since that seems to be something people are pretty fixated on? Thanks.

Thanks, Heather. ELAs renewals overall have been progressing and tracking very well and we expect the volumes to continue to increase. Certainly Q4, the volumes that are available for renewal are more significant than they were in the most recently completed quarter and we have them built into our pipeline as we look forward to guidance. Compared to Q4 of 2009, we didn't have that much ELA renewal volume in the pipeline at the time.

We started the ELA effort in earnest in the 2007 timeframe and typically the ELAs have a three year term to them, so it's this year and beyond that we're starting to see them come up renewal.

Yes, the reason why I ask is just because a lot of people are fixated on the change in deferred to this quarter and looking at your bookings number and I think some people look at that. And I guess maybe if you could share with us how you felt you did in bookings versus your plan?

Sure. I mean the quarters were-- Q3 and Q2 were sequentially pretty close to each other and we compared the plan. We had a very solid quarter. We beat our expectations on the revenue side. As I mentioned our discounting was held well in check. And so we weren't stretching at the end of the quarter to get deals closed and have a real strong pipeline headed into the fourth quarter, which is why we were able to take up our guidance.

Great. Thank you.

Our next question will come from Israel Hernandez of Barclays. Your line is open.

Good afternoon, everyone. Just wanted to dig down a little deeper on some of your comments around Europe. I think last quarter there was some patchy softness and this quarter you didn't give us any growth rates but you did for some of the other geographies. So can you maybe speak to what you're seeing in Europe and what still gives you some of that caution in the-- that you gave in your prepared remarks? Thanks.

So I will start off on that. The -- we just got back from Europe last week and saw in Q3 solid performance where we hit our plans and our expectations. We called out Germany and the UK on the call as far as doing well. And we're just cautious about the macro environment looks like there. But we're very pleased with some of the emerging markets like Russia as well and our business is doing quite well there.

Did you see any shift in any larger deals closing maybe during the quarter or with respect to your pipeline, [Bill] are you seeing any changes there among your large deals?

We are starting to view more of ELAs. Historically the European business for us has been more of a transaction channel business. And as the team is getting in place, we are doing more ELAs or larger deals than we've done historically. But I'm trying to think right now if there was any this quarter that stood out, and I can't think of one off the top of my head.

Great. Thank you.

Our next question will come from John DiFucci of JPMorgan. Your line is open.

Thank you. Mark just to follow up to Heather's question, you said bookings were about-- well you actually said revenue came in according to plan, but booking were actually down about 5% sequentially versus up about 15% last year, and keep in mind that we realize that last year coming out of a recession and so that obviously had an impact, but the prior two years in this quarter it was flattish, I think it was maybe flat to down a percent. Just given the momentum you've shown it just -- I think that's what she was getting at, that's where people are sort of focused on. And given that you're signing more ELAs in international markets, Tod just said both in Europe and I think you said in prepared remarks in Asia/Pac, I'm just -- is this -- if you can comment on that, if we're -- the bookings being down 5% I think that's why your stock is weak today after the close, and if you can just give a little more color on that, that might be helpful.

Sure, John. Yes, it's-- we were -- we were actually pleased with the quarter from a bookings perspective across the board. We hit our plans in each of the geographies, and again we had a real strong focus on our discounting from a, particularly from an ELA perspective, yet we still had about 20% of our total bookings in Enterprise license agreements. And so we carry a strong pipeline into the fourth quarter, and we're overall pleased with the quarter.

Maybe just a quick follow up to that, was there any change in the duration of the average duration of your contracts across the board?

No, it was actually very consistent from where it's been over the last several quarters. So about -- it's over 24 months in total per license and ELAs were approximately three years.

Okay. Great. Thank you.

Our next question will come from Derek Bingham of Goldman Sachs. Your line is open.

Hi, everybody. I wanted to ask you, it sounded like you had spent a lot more time on this call on VDI than you have before. I just wanted to get a little more granularity on that, I mean is it safe to say that you saw some meaningful acceleration in that business in the third quarter? And is that kind of the start of an inflection here?

Yes, we certainly saw positive momentum on the desktop opportunity and strong results. As we said repeatedly that is an emerging market opportunity and whether -- or when it's going to tip we're not sure but we're encouraged with the sales results. And we can feel the momentum with View 4.5 coming out and our offline support, seeing strong customer interest and we're bullish on that desktop opportunity.

Just on the deferred questions that people have been asking about, was there any dynamics in terms of the percentage of that deferred balance that comes from license revenue from Q2 to Q3?

No, there wasn't really much change to it at all. It continues to be less than 10% of overall deferreds and there really wasn't a significant change.

Okay just had one big picture one, if I could squeeze it in. And I know you kind of fairly routinely survey your customers about kind of how penetrated they are by virtualization, I'm just curious if there's anything new kind of over the last three months in terms of some of your inquiries or work with your customers about where you think we are in the penetration cycle? And kind of related to that, what's the latest release of vSphere has done in terms of opening up your addressable market for what kind of can be virtualized as a percentage of people's total environment?

There's been no change within the quarter for sure with respect to the percent virtualized. As we said in the past that in 2010 the average has been about 25% or so of virtualized in general is where customers are. The thing we're finding with vSphere 4.1, even 4.0 for that matter, is how we've pushed some of the capacity constraints and performance issues so that tier 1 applications are definitely being virtualized for those customers that are in the 40%, 50%, 60% virtualized approach. So we still have a lot of runway and opportunity ahead of us there and we're encouraged that vSphere is enabling it.

One study we did in March of this year, actually in March of 2007, we asked customers what their target percent virtualized was. And in 2007 they said gosh, if we could be 50% virtualized, that'd be great. We asked that same question again this year and the results came back and said they want to be 90% virtualized as far as their target. So as they get more experience with it and build out their expertise and see the value they want to continue to move along the journey.

Thanks, Tod. Thanks, Mark.

Our next question will come from Brent Thill of UBS. Your line is open.

Thanks. Mark you mentioned ELAs are renewing at a higher dollar volume than the original contract. Can you give us a sense of kind of where the average deals are coming in, are they coming in 10%, 20%, 30% higher? Some other software companies have given us metrics to give us a sense of where this number is coming in. And then if you could also address your operating margin comment, you mentioned little to any margin expansion for 2011. And I guess from just a perspective, what changes in your expense structure for 2011 that will cause this? You saw meaningful margin improvement this year so far, so why won't that continue through for 2011? Thanks.

Sure. First comment just on the size of-- or relative size of ELA renewals, I'm going to keep it at this point just at they're increasing at more than 100%. It still is pretty early in the cycle. We've just gone really through the-- quarters one, two and three. Q4 is where the volume begins to pick up a bit more, and so I think it's just a little premature on our part to start to call the number out. And there's been some volatility in each quarter but each quarter has been more than the original license amount.

With respect to margins, it's early in our planning cycle and we continue to believe that there's an awful lot of opportunity ahead of us and we don't want to constrain our future revenue growth and some of the product opportunities and market opportunities we have by focusing too much on margin expansion at this point. And so I just wanted to signal that it's early. We'll talk more about margins and revenue in January. But at this point, we see a lot of investment on our plate. It'll largely come through products and engineering as well as continued market expansion in the field.

And the only other comment I would add is on the ELAs, is that it's encouraging to us that as we renew these ELAs not only are people looking at adding additional CPUs for [vSphere], but they're also looking at be it desktop or management or even the application platform with the Spring stuff as additional components of ELAs.

Great. Thanks.

Our next question comes from Walter Pritchard of Citi. Your line is open.

Hi, thanks, two questions. First I was wondering if you could just talk a little bit more detail on the 2011 sort of initial bar of 20% growth? And talk to us a bit about sort of any color on license versus the maintenance component? And then help us think about new product contribution there versus sort of growth that you think you can generate from the more traditional sale of capacity around vSphere that driven most of the Company's growth thus far?

Sure. Certainly in 2011 we anticipate greater contribution from the non-vSphere products, desktop management, really across the board. It's very early for us in our planning cycle and frankly we're really just finishing up, wrapping up a successful Q3 looking forward to the fourth quarter in which there's an awful lot of work and an awful lot of seasonality to be done. So I just wanted to put down the 20% bar as you guys are thinking ahead to your models, certainly as a bar that I think is achievable.

And then just relative to maintenance I know as we look into over the last few quarters you've had some recapture of back maintenance. And should we expect that you have a tougher comp on the maintenance side and that we actually see maintenance grow a little bit slower than the 20%?

Not necessarily. I mean the deferred revenue from maintenance should give us a bit of a tail wind. We'll continue to work the lapsed maintenance contracts and the maintenance agreements. We expect that to be down in the fourth quarter a year-over-year basis by a bit because the program has been in place for some time.

Great. Thanks a lot, Mark.

Our next question comes from Kash Rangan of Merrill Lynch. Your line is open.

Hi. Thank you very much. Just to get into the deferred revenues a little bit. It looks like your ELAs as a percentage of bookings are fine, unchanged, but there-- could there be something going on on the broader server market? Can you talk about the massive catch up spending that people have put in place over the past few quarters? And where are we in the cycle of that catch up spending of servers, which is some sense are correlated to-- or your licenses are correlated to that server growth. Can you talk to the market dynamics there? And also secondly and finally, the Per VM pricing, it's encouraging to see some of your products being priced that way. How realistically can that new pricing model help your revenue growth in fiscal 2011? Thanks, that's it.

Yes, just on the overall dynamics of server shipments versus license revenue, we're certainly out from a license revenue growth perspective outpacing server shipment growth at this point. And it's going to be-- although directionally server shipments are very important to our longer term growth, there is going to be some lumpiness and we expect to outpace it over time either from the sale of enterprise license agreements or from refresh of boxes that were sold in previous quarters. Longer term, as we look ahead to 2011 the forecasts are that server shipments will go down, and so we're building that into our plans and into the early look at 2011 revenues.

One of the other things you said to address the Per VM but then also on the server shipments, is we announced at VMworld that we hit a tipping point in Q3 that more virtual machines are being deployed or shipped or virtual work loads than physical servers. And so I believe it was IDC that came out with that study, and so going forward expect that acceleration to continue. On the we see it going forward that acceleration to continue.

On the Per VM pricing, we did roll that out in Q3. We've seen positive customer response to it and as we continue to execute with our management products we expect that will be a good way to bring additional revenue to our mix. As you know right now the management products are still getting started and have a lower penetration than we would like. And so as we improve in that business, the Per VM pricing should certainly help us.

Thanks, Tod. Mark just to clarify, you said server shipments down but you must have meant slowed down in several growth rates and (inaudible).

Just the growth rate slowed.

Okay, got it. Thanks.

Our next question comes from Gregg Moskowitz of Cowen. Your line is open.

Okay, thanks very much and good afternoon. And I guess this question is for Tod. We've seen a survey or two that indicates that as customers start to reach 30% to 40% of physical servers virtualized that there can be some customer pause due to in part management complexity and clearly VMware is continuing to grow at a very healthy rate. Your building on your management tool kit you just referenced. But I was curious if you're seeing that at all anecdotally within your customer base and if so, how you approach that?

Yes, so right about the 30% virtualized point, customers realize that they're doing much more than just installing software, but they're actually transforming the way they run their business and approach IT. And so in the triangle of people, process and technology, at about 30% virtualized they need to make sure they've the right processes in place and change management and people. And so we've got some professional services offerings that VMware conducts as well as our ecosystem of partners that can go in and help customers get through that and then get to the other side. When I meet with customers, it's rare for me to find a customer or meet with a customer that's only 40% virtualized because 40% is simply a milestone on the way to 100%. But at 30%, it's not uncommon for me to see them all the time and we help them address these core issues.

Lastly on this from a sales perspective we've actually helped provide our sales force with some tools mapping wherever a customer is on the journey. So if they're 10% or if they're 30% or if they're 50% virtualized, the sales person can go in, ask the appropriate questions, be aware of what potential stumbling blocks or issues they may have and help the customer get over those to continue on down the path.

Okay. Thanks, Tod, that's helpful. But just a quick follow up for Mark. Naturally this is the first full quarter with a year-over-year FX effect and I know you broke out the margin component, just curious in terms of the top line effect if that was meaningful at all?

It was about 1%. And just a reminder for us, it's really just the international license revenue that is impacted at least in the current quarter from a currency perspective.

All right. Thanks very much.

Our next question is from Adam Holt of Morgan Stanley. Your line is open.

Good afternoon. You mentioned in your prepared comments that some of the ASP improvement you saw in the third quarter may not necessarily continue. I guess I was wondering was there anything specific to the third quarter that you thought was sort of unique, if you will, that may not continue? And what underpins the guidance for the fourth quarter with respect to ASPs?

Sure, Adam. During the third quarter, we were actually a little bit surprised at how well Essentials Plus performed relative to Essentials and there's a fairly significant gap in ASPs between the two products. We attribute that to the fact that the VMotion was moved down to Essentials Plus. We're assuming that we'll lose some of that ASP as we built our guidance because we don't know what the fourth quarter will hold and in fact we'd like to see a little bit more mix shift into Essentials.

Terrific and if I could just ask a quick follow up on cash flow. It looked like a relatively material change in other assets impacting cash flow in the quarter, could you just give us a little bit of detail on what was the driver there?

It's-- actually I'm going to have to get back on the a little bit later on the call on it.

Terrific. Thank you.

Our next question comes from Shaul Eyal of Oppenheimer. Your line is open.

Thank you. Hi, good afternoon, guys. Want to go back to kind of 2011 being more of a year of investment, do you see M&A being part of this kind of investment phase, and if so, is it going to be similar to what we have seen so far recently small tuck in acquisitions or it could be bigger things to come?

Yes, this is Tod. We talked about our [dual] new stack with the three layers of our approach end user application, platform and infrastructure. And in 2011, it won't be surprising if we continue to do acquisitions to accelerate our opportunity in this space. VMworld I came up with a phrase, our acquisition strategy is really one of organic accelerants in that we buy, have been buying smaller companies that we bring in, we then add resource to and further accelerate our opportunity in the market. I don't envision us doing anything big or substantial that would follow the same sort of path that we have done this year as far as acquisitions for next year.

Got it. And in terms of more hiring, do you have some sort of a maybe magic number, what kind of 2011 could look like from a head count perspective?

Right now we're still looking at our-- building our 2011 planning process and so we're getting the bottoms up assessment later this week from all of the teams and taking a look at it. I am not sure if we've got a number that --

Not ready at this time to give guidance on it. On the question on other assets and the change during the quarter and the impact on the cash flow statements, part of it is related to VMworld Europe and the prepaid marketing that we have around it which was conducted in our early Q4 this year, which wasn't the case a year ago, as well as some investments that we're making in our go to market relationships with those-- with the sales force.

Thank you.

We're going to-- Operator, we're going to take two more questions, please.

Thank you, sir. Our next question is from Phil Winslow of Credit Suisse. Your line is open.

Hi, guys. Most of my questions have been answered, but just to focus back on the Enterprise Plus and just obviously there's been a big push over the past-- well since last April, migrating your customers up there, but what percent of your install base to you think is on Enterprise Plus right now, and where do you think you're kind of heading? Thanks.

Gosh, I don't know the number that's on Enterprise Plus market. We haven't broken out-- from an installed base perspective we had in Q4 of last year, we ran a promotion since Enterprise Plus was really a new SKU for us as a result of the vSphere release. And we're very successful in that promotion, had over $100 million of bookings related specifically just to the Enterprise Plus upgrade. And so our-- as our customers sort of move on the virtualization journey, they're migrating toward Enterprise Plus for those that have acquired it. We also had strength in overall bookings for the quarter in Enterprise Plus relative to Enterprise, but we're not breaking out specifically the numbers for each SKU.

Great. Thanks, guys.

Our final question comes from Michael Turits of Raymond James. Your line is open.

Hey, Mark, Michael Turits. Question for you, last quarter you mentioned one of the potential headwinds for revenue growth or license growth in 2011 being the amount of licenses that have been inventoried in ELAs. So I'm wondering what you think the impact will be as those ELAs start to anniversary as we get through the beginning of 2011? And also if there's any potential impact as we go to bigger multi core processors, if that's hurting license given that we're not on a Per VM license model there yet?

Yes, it's-- as we look ahead to vSphere license growth and sometimes the disconnect that you see between server shipments and processor shipments and license growth is the fact that Enterprise agreements are in part by a forward yet a commitment by our customers to the vSphere platform. We work very closely with our customers and to make sure that they have the tools and the intellectual property to continue to deploy the number of licenses then they purchased. And so we monitor it carefully, and as we're seeing from the renewals of the Enterprise license agreements, so far it really hasn't been a significant concern. Certainly the more powerful processors you need sort of a fewer licenses to do more virtual machines, but where-- but customers also finding ways to consume those virtual machines. And as Tod mentioned, today we have more VMs being deployed than actual servers.

The other thing I'd add is we track very carefully not only the consumption or the usage and deployments of vSphere, but also the features they're deploying. And in our ELAs, we're seeing strong adoption of our fall tolerance capability and high availability in some of our more advanced features that move well beyond just a hypervisor that showed us the robustness of their usage and that also consumes CPU and core and continues that virtuous cycle.

Okay. Great. Thanks, guys.

Great. Thank you very much. That concludes the call.

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