VMware Inc (VMW) 2011 Q2 法說會逐字稿

Welcome to the VMware second quarter 2011 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. I will now turn today's meeting over to Mr. Mike Haase, Vice President of Investor Relations. Mr. Haase, you may begin.

Welcome to VMware second quarter 2011 earnings conference call. On the call, we have Paul Maritz, our CEO, and Mark Peek our CFO. Following their prepared remarks, we will take 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 offering, customer demand, and other matters. These statements are based on the environment as we currently see if, 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 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, acquisition-related items, and the gain from the sale of our investment in Terremark.

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 third quarter quiet period begins at the close of business September 16, 2011.

For you planning purposes, VMworld, the leading virtualization in cloud infrastructure event of the year will be held in Las Vegas from August 29 through September 1. As part of VMworld, we will be hosting our analyst day on Tuesday, August 30.

Finally, unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2010. With that, let me hand it over to Mark.

Thanks, Mike, and good afternoon, everyone. The financial and business results of our second-quarter clearly exceeded our expectations. We achieved record revenue, non-GAAP operating margin, and non-GAAP operating cash flows driven by strength across geographies and record ELA bookings as a percentage of total bookings. The quarter also benefited from a sequential decline in unearned license revenue. Now for the financial highlights.

Total second-quarter revenues increased 37% year-over-year, and license revenues increased 44%. Our non-GAAP operating margin was a record 31.6%, and benefited from the strong sequential increase in license revenue. We expect margins to return to below 30% in the third quarter.

Trailing 12 months free cash flows were $1.6 billion, an increase of 56% from a year ago. Our balance sheet remains strong, with cash and investments of $3.7 billion and unearned revenues of $2.1 billion. Our results speak to the value of our products. VSphere is the most trusted, widely deployed virtualization platform in the world. Last year, we announced VSphereFive, and a comprehensive suite of cloud infrastructure technologies to not only help customers virtualize their cloud applications, but also help them build and operate modern data centers with cloud architectures.

With the introduction of VMware VSphere Five, VMware is evolving the product's licensing to lay the foundation for customers to adopt a more cloud-like IT cost model based on consumption and value, rather than physical components and capacity. We are extending our focus beyond delivering virtual infrastructure with VSphere to complete cloud infrastructure suite. We expect these new releases to become generally available in Q3.

With nearly 200 new and enhanced capabilities, VSphere Five will continue to set the standard in virtualization, delivering better application performance and availability for business critical applications, while automating the management of an increasingly broad pool of data center resources. Paul will speak more to VSphere Five and cloud infrastructure technologies.

As I mentioned during last quarter's call, we integrated more than 300 people from EMC's Mozy and cloud services group in April to further strengthen our cloud initiative. We also closed the acquisitions of SlideRocket, SocialCast and Shavlik during the quarter, and welcomed about 200 employees from these acquisitions to VMware.

Finally, we announced the acquisition of Digital Fuel, which closed in early July. We are very pleased with our results for the first half of 2011, and want to thank all the people of VMware, our partners, and our customers. Now I will walk you through the financial details.

Total revenues for the second quarter were $921 million, an increase of 37% from a year ago, or 35% on a constant currency basis. The quarter was characterized by strong demand in the US and across our international markets. License revenues were $465 million, up 44% from last year, driven largely by strong global demand for vSphere, record ELA bookings as a percent of total bookings, including several deals that renewed early, and a net decline of $11 million on earned license revenue.

License growth on a constant currency basis was 40%. Enterprise license agreements exceeded 25% of total second-quarter bookings, and no transactions exceeded $10 million. We were pleased to see a healthy mix in the quarter from renewals as well as new ELAs. In addition, we continue to see stronger demand for our end-user and management products as customers renew their ELAs.

Blended ASP's increased during the quarter, driven primarily by good discounting discipline in the field and higher ELA volumes, which tend to include our highest end SKU, Enterprise Plus.

Our end-user computing business continues to progress well. In the second quarter, we were pleased to have a solid number of View desktop virtualization wins and follow-on business across geographies and verticals, including our largest View deal to date, with a very large North American retail pharmacy chain and a major mobile carrier in China.

We're also seeing continued traction for our management products, including Vcloud Director and Vcenter Operations. Much of the increased interest for our management tools is being driven by the buildout of private clouds within our customers' data centers.

US revenues increased 35% year-over-year to $450 million. International revenues were $471 million, an increase of 38% compared to the second quarter of 2010. Demand in our Asia-Pacific region was particularly strong, led by year-over-year growth in Australia Japan, and China. We are very pleased with our progress in growing our global market presence. The investments we have made and will continue to make in our international market expansion are clearly paying off.

Software maintenance and support revenue was $386 million, up 33% compared to last year. Customers continue to buy, on average, more than 24 months of support and maintenance with each new license purchased, illustrating their strong commitment to VMware as a core element of their data center architecture and hybrid cloud strategy.

Professional services revenue was $70 million, up 17% from last year. The increase was driven primarily by our continued M&A activity and a higher attach rate for professional services with large deals. Total unearned revenues ended the quarter at $2.1 billion, up 5% sequentially and 41% from a year ago. The complexity of our unearned revenue has increased over time as a result of acquisitions, an expanded product portfolio and a broader range of pricing and packaging alternatives.

Over 80% of our unearned revenue represents software maintenance that will be recognized ratably with the passage of time. Approximately 12% of unearned revenue is software license revenue, which will be recognized either ratably upon product delivery, or upon product release. In addition, approximately 7% of unearned revenue is the result of prepaid professional services, including training, which is recognized as the services are delivered.

Although we are pleased with our record second quarter financial results, our license revenue growth clearly benefited from a good number of ELAs that renewed early. We will not have this benefit in the third quarter, and would expect ELA bookings to decline as a percentage of total bookings. And, with our recent announcements of vSphere Five and cloud infrastructure suite, there is also the potential for short-term disruption in the sales process and close rates, as our extensive set of ecosystem partners begin the go-to-market transition.

In addition, while the third quarter is traditionally strong for the US federal government, growing uncertainty related to the federal budget has caused us to revise our earlier estimates downward for this sector. For this backdrop, we expect third quarter revenues to be within a range of $915 million and $940 million, or year-over-year growth of between 28% and 32%.

License revenues in the third quarter are anticipated to be down 5% to 10% sequentially from the very strong second quarter. For the year, we are expecting total revenue of between $3.65 billion and $3.75 billion, or growth of 28% to 31% compared to 2010.

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.

Our Q2 operating profit measured on a non-GAAP basis was a record $291 million, or 31.6% of revenue compared with 29.9% in Q1 2011, and 27.7% in Q2 2010. The increase was primarily driven by operating leverage on our license revenue growth. Our non-GAAP results exclude the $56 million gain we realized from Verizon's second-quarter acquisition of Terremark.

During the second quarter, we added over 1000 employees, approximately half through acquisitions and Mozy. We ended the quarter with approximately 10,400 employees, up 1400 from the beginning of the year. We expect to continue to hire at a brisk pace in the second half of 2011.

Diluted non-GAAP EPS was $0.55 per share on 430 million diluted shares. Our non-GAAP tax rate was 20%. The GAAP tax rate was 10.6%. We continue to expect the non-GAAP tax rate to be approximately 20% for 2011. The GAAP tax rate is expected to be 4 to 6 percentage points lower than the non-GAAP rate.

Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call, we expect our operating margins in Q3 to decline sequentially to between 28% and 29%. The decline is primarily the result of increased expenses associated with our increased headcount and recent campus expansion.

For the full-year 2011, we expect the non-GAAP operating margin to approach 30%. The GAAP operating margins for the third quarter and full-year 2011 are expected to be approximately 11 to 14 percentage points lower than the non-GAAP operating margins.

Although there is opportunity to expand margins at this level of scale, we fundamentally believe it is the wrong approach at this time, and are building our investment model assuming we will continue to hire high-quality engineering talent and rapidly expand our international market opportunity. The opportunities we are seizing and the investments they require are not trivial. Expect us to continue on a rapid M&A and hiring pace, which can cause lumpiness in our quarterly financial results.

Now on to our balance sheet and cash flow statement. Our balance sheet remains strong with cash and short-term investments at quarter end of $3.7 billion. During the quarter, we used nearly $600 million in aggregate for M&A, routine CapEx, the purchase of property related to our Palo Alto campus expansion, and our share repurchase program. The expansion of our Palo Alto campus included $225 million for the acquisition of a land lease with Stanford for 70 acres, which provides us the opportunity to add about 1,000,000 square feet adjacent to our existing Palo Alto campus over time and as needed.

Our Palo Alto campus is now 100 acres, and provides us with the necessary room to expand for the foreseeable future. For your planning purposes, capital expenditures related to our campus expansion will be approximately $50 million in the second half of 2011. This will be a multi-year project, and we believe it is a great investment in one of the best locations for engineering and innovation in the world.

Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs, and excess tax benefits from stock compensation were $539 million during the second quarter, and $1.8 billion for the trailing 12 months. We adjust our operating and free cash flows for excess tax benefits because it converts to cash or reduces our tax liability.

Free cash flows for the quarter were $443 million. Total capital expenditures were $95 million, of which $53 million was related to our campus expansion. For the trailing 12 months, free cash flows were $1.6 billion. Free cash flow per diluted share was $1.03 for the quarter, and $3.64 for the trailing 12 months.

As we have mentioned, free cash flow per share can be volatile in the short-term, so we believe looking at it over a trailing 12-month period is a better indicator of progress. As referenced earlier in the second half of 2011, free cash flows will be impacted by the planned $50 million in capital expenditures related to the design and renovation work related to our campus expansion.

The fully diluted share count increased to 430 million shares for the second quarter. We expect our share count will be within a range of 430 million and 440 million shares for the balance of the year.

To summarize, we are very pleased with our execution and solid second quarter 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. Paul will now make a few remarks before we take questions.

Good afternoon. I would like to give you an update on our product and M&A activities over the previous quarter. As Mark noted, we took a big step forward with the release of vSphere Five into production. This is a major release in several dimensions. In terms of vSphere itself, the release provides major new functionality in terms of scale and automation.

To highlight just a few new features, we can further scale to handle the heaviest workloads, providing virtual machines with up to 1 terabyte of virtual memory and up to 32 virtual CPUs. We can optimize storage usage and performance with the automatic and dynamic placement of virtual machines. We have significantly improved the ability of vSphere to run workloads in a nonstop fashion, and we significantly improved the automatic installation and configuration of vSphere itself.

All of this has been done in partnership with the growing ecosystem of over 500 hardware and software partners, who directly interact with and/or certify with vSphere. Equally importantly, we announced the creation of the industry's first complete cloud infrastructure suite, comprising vSphere itself, vCenter Site Recovery Manager for cross data center business continuity, vShield for virtualized security and edge functions, vCenter Operations for modern infrastructure management and monitoring, and vCloud Director for multi tenant provisioning of resources, policy certing and self-service.

The strengthening of vSphere will enable us to accelerate our customers on the journey to high levels of virtualization. And this suite will allow us to amplify the value they derive from their virtualized infrastructure. We've also increased our focus on SMB. As part of vSphere Five, we will be releasing a virtual stores appliance that will unlock many vSphere benefits for smaller customers who can't afford the cost or complexity of an external storage array.

We announced the acquisition of Shavlik Technologies, who has been our partner on VMware Go, which is our SMB targeted online infrastructure services offering. With the moment of the Mozy cloud storage service to VMware, we can expect to be able to further strengthen our offerings in the SMB space.

With vSphere Five, we also announced that we are replacing the previous limits on the number of CPU cores per license, and instead using, as a metric of scale and value, the total amount of virtual memory being actually used across an entire group of physical machines. We believe that this is a better metric for the future, as customers move to operating in a more cloud-like way. Customers which to pay for what they are actually using and have the license-cost scale with actual load,

There has been a fair amount of debate and comment on this since we announced vSphere Five last week. A lot of it stems from the confusion of physical RAM, which is fixed and which we do not use as a metric, with pooled virtual memory that varies with load. We believe under the new model, 95% of our customers will see no change to their licensing costs.

It's only as customers move to very high levels of consolidation and start driving the infrastructure to high levels of utilization, driving the associated incremental value that licensing cost will commensurately scale. We are working closely with our customers to explain this, provide background material, and get their feedback.

Moving up the stack in functionality, we delivered 2 major releases in the dimension of our higher level application platform and development capability. We released vFabric Five, the next iteration of our middleware collection, further optimizing it for the virtualized environment. We released CloudFoundry, our next-generation environment for developing and deploying applications written to higher-level frameworks in the cloud. Both of these releases have been well received by the developer community, with over 25,000 developers signing up for CloudFoundry.

In the area of end-user computing, we continue to invest in our View VDI solution, as Mark noted, seeing success there. We will have more news about View enhancements to share at VMworld in late August.

Further in the end-user space, customers are going to need solutions for securely providing capabilities to end-users in a world that is increasingly (inaudible) mobile, and social oriented, and is no longer solely dominated by Windows-based PCs. In preparation for this, we also announced the standing up of our Horizon App manager service, and the acquisition of SocialCast and SlideRocket, all of which speak to providing new capabilities to fulfill and manage user needs in a post-PC world.

Finally, I would like to note that vSphere Five is our third release of vSphere since 2009, and is a testament to the hard work and discipline of our development teams. Putting out these releases on schedule with high-quality, in partnership with a large ecosystem is no small achievement. It is their effort that is enabling us to stay ahead of our competitors. And with that, we will open up for questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Adam Holt of Morgan Stanley. Your line is open.

Thank you and terrific quarter. My first question is about the pull forward early renewal on some of the ELAs. Why do you think that would happen, and do you think there might have been any forward buying in front of the Five release?

Adam, we have seen a pattern of some forward buying on ELA and ELA renewals in particular over the last several quarters. But as we looked at the pipeline for Q3, we had anticipated some renewals that we thought would occur in the July/August time frame that occurred at the end of June as we closed. We don't think it's really fully related to the 5.0 release, but there may have been some anticipation of it.

And just a quick follow-up on Five, historical releases have been, in some cases, pretty significant catalysts. What impact do you expect Five to have on license revenue over the next several quarters? And if the price increase is relatively small at the high-end, does that factor even at all into your forward thinking on guidance? Think you.

As we look at 5.0, and it's really quite similar to 4.0 with the exception that we don't -- we haven't added a top-end SKU with Enterprise Plus. And so we really don't anticipate a big uplift, particularly in the second half of 2011. All of our customers who are current on maintenance are entitled to the 5.0 release, and as a result, we expect them to be in test and [depth] for some time before they put them into production.

Great, thank you.

And our next question comes from Israel Hernandez of Barclays Capital. Your line is open.

Good afternoon, guys, and congratulations on the quarter. With respect to the ELA pool in the back half of 2011, is there anything we should be thinking about, given that we will be anniversarying the back half of the 2008 ELAs when the economy just started to fall apart? Just trying to get a sense for what that pipeline shakes out in the renewal pool. And also, as a follow up with respect to Europe, obviously it is on everybody's mind. Did you see any changes in linearity during the quarter? Seems like sales are pretty solid, but curious as to what you saw toward the end of the quarter.

Among the ELA pool it is the three-year anniversary, and our ELAs typically run on three-year cycles. We had some very large ELAs that closed in the fourth quarter of 2008, and we don't anticipate that they will be in for renewal in Q4 of 2008. So it's factored into our guidance and why we believe ELAs as a percentage of total bookings, there will be some softness in the second half of 2011. With respect to Europe and our linearity. Our quarters, first of all, continue to be very back-end loaded and particularly with the strong ELA performance in the second quarter, this was even more so. And we continue to be cautious on Europe, given the economies and some of the sovereign nation concerns that exist, and the fact that in many cases, the verticals are dominated by the governments. If you think of healthcare and education in particular in Europe, those are sectors that the government has a significant influence on.

Great, thank you.

And our next question comes from Kash Rangan of Merrill Lynch. Your line is open. Mr. Rangan, your line is open.

Hi, thank you. Sorry for the background noise, I am on a plane. Looking to make this quick. Paul, I think you said on the vSphere Five launch that you expect 50% of workloads to be virtualized by the end of this year. I'm wondering how should we look at that relative to the growth rate that the Company has been putting up, which has been very solid. What does that mean in terms of the future of growth opportunities in terms of magnitude that are still left ahead? Because a 50% cut off seems to concern some. I was just looking to get your comment on that. And as it relates to the guidance mark for you, it looks like you're talking about a few risk factors out there, but your guidance actually sounds very good. I'm wondering if you can give us a little bit more color on those issues that might -- you might be thinking about in Q3 as it relates to the pricing, the channel training, the macro, et cetera. That's it for me.

Sure. This is Paul, Kash. Actually what I said at the launch was that if you believe the analysts' figures, sometime over the next 12 months or so, we are likely to cross over the 50% threshold. That's, we believe, fundamentally good news. Remember that we essentially drive our business out of the applications that are running on virtualized infrastructure. And as such, we have both the existing pool of applications to address, as well as new applications that are coming into the pool all the time. So that pool is not static. The pool is itself growing.

Secondly, with the introduction, in particular of the suite (inaudible) and other investments we are making, we are seeking to not only accelerate our customers' investment and virtualization, but actually amplify it by being able to offer additional functionality to enable them to get additional value out of their virtualized infrastructure. So, we are seeking to both accelerate and amplify.

Thirdly is that we believe that we still have untapped markets, particularly in the SMB space and in new geographies of the world. So, it's for that reason that over the last, as Mark said, over the last several years, we've been investing and will continue to invest in particular the developing economies of the world. And with the acquisitions and developments we have announcing now are increasing our focus on the SMB-end of the market. Mark?

Kash, on the guidance, a quarter ago, we had indicated that we believed the second and third quarters would be very close from a license bookings perspective. But given the strong license bookings that we had in Q2, we just wanted to highlight a couple of items. First, we had deferred license revenue decrease by approximately $11 million. We don't expect that to repeat itself in the third quarter. We also had a FX tailwind of about $11 million in the quarter, and so we have taken that out as we have factored in guidance.

We also -- as we looked at the pipeline and looked at the ELAs as they are playing through, and then factored in that this is the US Federal Government's year-end, and that there a lot of questions about the budget and the impact that the budget will have on IT spending. Internally, as we have thought through the process, we have brought down our expectation on the US Government bookings. Those are the major influences of our guidance. But overall, it's an increase in guidance modestly from where we were a quarter ago.

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

Hi, thanks. Two questions, Mark, quickly on FX. Was that the sequential impact on FX, the $11 million to revenue?

Yes.

Great. And then, Paul on vFabric and vSphere, v Five, you guys have slowly but deliberately been moving towards trying to bring Java workloads onto the platform. And I'm wondering, with the confluence of vFabric, a new release there, as well as vFive. I'm wondering if you could articulate, are you at the point now that you think you'll see an acceleration in job workloads on the VMware platform?

You're right, that we are working towards that end and vFabric included is one of its' features. So optimizations for a Java running on vSphere, as well as we continue to invest in the Spring Framework and the combination of the Spring Framework with the CloudFoundry. But I think it would be fair to say we are still plowing the ground there. And we expect those investments to pay off well over the longer-term. But we are still in the development phases of the market.

Great, and then just a quick follow-up on that. I know you have a partnership with salesforce.com in that area with the imports. And I'm not sure that it's your business to comment here or if this is a Salesforce issue. Just wondering where that is from a rollout perspective, and do you still expect now, with the Cloud Foundry in the market to pursue that partnership on VMForce?

We had always expected VMForce to be based on the technology that is inherent in Cloud Foundry. And we do still expect to have a partnership and a tie between the Salesforce environment, and the Cloud Foundry/VMForce environment. So that is still on the plate.

Great, thanks a lot.

And our next question comes from Phil Winslow of Credit Suisse. Your line is open.

Hi guys, great quarter. Just have a question on the Cloud Director. What's been the feedback of that so far? And also the acceptance and where that's standing in relation to your expectations when it was launched? Thanks.

As part of the upcoming suite of products we are putting out, we are revving vCloud Director. So there will be a new version of vCloud Director that will come out and will include some critical functions that we think that will open up additional markets. In particular, it will have a feature called linked clones, which is one of the key features that is in our very popular Lab Manager product, which is used for test and development environments. So, we expect to see strong acceptance of the vCloud Director and our private cloud solution, particularly in the test and development arena where we have been missing this one feature to date. At the same time, our vCloud partnerships, which are partnerships of external service providers, continue to grow at quite a strong rate, and we have over 1000 service providers transacting off our VSP license, which is the special license that we provide toward service providers. We see a bright future for the products, and we are continuing to basically enhance it and take it forward as part of the overall suite.

Great, thanks, guys.

And our next question comes from Brent Thill of UBS. Your line is open.

Thanks. Paul, just on the vSphere Five, what market do you think opens up a new opportunity for you? There seems to be a lot of new storage features. Can you talk through -- I know there is a lot of features. But is there a particular market that you are excited that this really opens that wasn't available to you before? And I had a quick follow-up for Mark.

It's really a combination of opening up new-use cases, which then enables our customers to make -- take greater advantage of the virtualized approach to infrastructure across the board. So, what you have seen us do is strengthen features, both at the very high end to allow us to, as I said, address tier one mission-critical loads more effectively than we did in the past. And at the low end, with the inclusion of things like the virtual storage appliance allow us to scale down into an even smaller customer environments. But across the board, what we're trying to do is to increase the level of automation. Because at the end of the day, beyond saving customers' capital expense, the bigger goal is to save our customers operational expense. They fundamentally want infrastructure just to be something that figuratively speaking, they can forget about. And, that's where we are working towards.

Okay. And Mark, just back to the Adams question on early ELA renewal. There is very few case studies we can find the software industry where people renew early. And I guess one of the reasons can be potentially these customers are expanding their deployments quicker than they thought, so they are going to renew earlier because they are taking more products. Is that a factor that played in where you saw them coming in and taking more, so they just said, hey we are going to renew early?

Brent, it's a combination. One is the need for additional licenses. Second is just adding different products to their infrastructure as they move along the virtualization journey. And so maybe have moved from test and dev to low production, and now putting a higher level workloads into production, and then using our management tools. And then of course the sales effort on our part with desktop products as well.

Thank you.

And our next question comes from Heather Bellini of Goldman Sachs. Your line is open.

Hi, great, thank you and good afternoon. Paul, I guess I was just wondering what a typical ELA looks like today for an advance customer, versus maybe what the conversation you are having with them last year, the same type of customer and how the conversation has changed, and what the products that they are adding on might look like today versus a year ago? Thank you.

I think to make really a dramatic difference, you probably need to go back two years or three years. Two to three years ago, it was purely about vSphere as a technique of saving capital expense, just putting the hypervisor on the hardware and getting greater server consolidation. Now the discussion is much more about how do we do computing. So as Mark said, we are seeing an increasing percentage of our ELAs, including the adjacent products, the management suite, the VFabric view etc. So it reflects customers looking at this as rather than a simple ingredient into their environment, it's actually looking at this as a foundation that they're going to do a bunch of things on. And that's led to the dynamics that Mark was just talking about in terms of our ELAs.

And I guess then the follow-on to that would be, when you think of the enhancements that you just announced last week, do feel like if you were to fast-forward the clock a year, that we'll be talking about the same thing? That your expectations are is that they will be even adding more adjacent products than what they even would be today, given what you have just put out?

I certainly hope so, and what we are trying to do is to make it easier for customers to do that. We're trying to build out a suite of products so that they don't have to go through a very complex ala carte integration process. That they can have key products for all the key major functions and get those easily. And certainly as I said, we are moving to both an accelerate and amplify strategy. So we're trying to make it easier for customers to continue to use virtualization to use their infrastructure more efficiently, but later make it easier for them to buy the amplification [dimension], which is really about operational simplicity.

Great, thank you very much.

Our next question in queue come from John DiFucci of JPMC. Your line is open.

Thank you. Mark, you mentioned the potential for disruption due to the consumption-based pricing that you just announced. And Paul, you made some comments about it. Talked about the discussion that's happened since then, which was just recently. You also mention that 95% of customers should see no change in pricing, but I just want to make sure I understand that. You say that as customers start to drive infrastructure to higher levels of utilization, do you expect customers to benefit once that happens? In other words, are they going to see lower pricing than they would have seen if they had CPU-based pricing? Or is that one they actually achieve that no change in pricing?

This is Paul. What we're trying to do is to gradually shift to using metrics that reflect the actual value and usage that the customer is getting out of the software, as opposed to just how much hardware they have packed underneath it. And that is the whole direction that we believe the cloud, in general, is leading us. It's "pay by the drink" rather than necessarily having to over provision everything up front. So we'd already announced a step at VMworld of last year when we announced that essentially our adjacent products in the managing space et cetera would be based on a per virtual machine pricing. And what we are now seeking to do is introduce that same concept into the core underlying vSphere itself. So it's not so much that we are trying to necessarily give customers either a better or worse deal. We're trying to basically change the metric that we use to measure value.

And that makes sense. And if you listen -- as I know you do, and I listen to customers too. And they actually are looking for vendors such as yourself to go towards a consumption-based pricing model. At the same time, I've read some of the discussion out there on this point, and there is a lot being said, and a lot of it isn't positive. And I'm just curious, because when I do talk to people, they want to see this kind of thing. And it makes me think that they think they're going to just be paying more. But your point about 95% are going to see no change, I just wanted to make sure I understood that. Are they going to see no change when they eventually get to these higher levels of utilization, or are they going to see that right from the start?

From our calculations is, the thresholds we have set are such that most customers today, with their workloads, will see no change. They won't require to pay us any more money. At the high end of the market, where people move to really squeezing every last drop out of their environments and getting very high levels of utilization out of the infrastructure, that's when the pricing will start to scale up. It's our belief that is actually a fair bargain to make, because they will only encounter that once they really start to get value out of the whole approach of the cloud-based computing model.

And that makes sense. I appreciate that. Just one quick one for Mark, just a follow-up to [Izzie's] question, Mark on EMEA. And you said business is strong across all GOs. But international, I think grew 38% verses the US 35%. And you actually called out APEC as being particularly strong. Can you break out EMEA for us on a growth rate or even roughly break it out within that international?

We don't break it out as a separate segment, so that we are not caught in the cycle of calling it out each quarter. But EMEA had a quarter that was very close to where we had planned, maybe actually even a bit of pull ahead on the ELA front. We just have broader macro concerns around some of these sovereign nation issues that have been, that are frequent in the news.

And I concur with that too. Thank you. Nice job you guys.

And our next question comes from Robert Breza of RBC. Your line is open.

Hi, thanks for taking my questions. Mark, can you comment on your talk about the market transition as being a risk? I would think with the ELA and the strength you're seeing on the ELA side, the market transition would be a little bit alleviated for customers. But can you talk to us on how you see that concern, and what you're doing to mitigate it? Thank you.

Part of the shift in the license pricing is that we have to train our ecosystem. And we are a highly leveraged business. We still do over 75% of our sales on an indirect basis. So as we -- we are not only training our own direct field and sales staff, but also training our partners and our customers. And as there has been some debate and discussion about the pricing and shifting from a per processor model with core limitations to a virtual memory, and we just anticipate that it's going to take us some time to work through that transition.

Great, thank you. Nice quarter.

Operator, we are going to take two more questions. Thank you.

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

Thank you, and congratulations as well on a very strong quarter. With vSphere Five, the pricing for essentials plus will be, I believe, $1,000 higher per CPU than it was under vSphere 4.1. Clearly that would seem to reflect a lot of optimism around the SMB segment. But if you could perhaps speak to your expectations around buying behavior in the SMB, as well as elasticity of demand and the value of (inaudible) you have there, that would be helpful.

As I said earlier, we have been gratified by the success that we've seen with these three essentials, clearly delivering a lot of value to customers. And with the new features coming in, we think that the price is justified.

Maybe just a quick follow-up for Mark. Your sales and marketing costs went up much less sequentially in Q2 than it did in 2009 and 2010, even though generally you had a bigger jump in license revenues and bookings. Just was wondering why that was the case?

I'm sorry, Gregg, was it sequential change?

Correct Mark, sequential.

Part of it is just, I think, a better balance in the quota setting that we did during the quarter, and making sure that we were fairly compensating our reps across the overall distribution and not having the high overperformance in smaller subsectors. And that's really been the primary driver. And then also looking at sales and marketing costs, on the marketing side and how we spread those out throughout the year, and that we are in a better rhythm I believe, on our sales and marketing efforts.

Great, thanks guys.

And our last question will come from Michael Turits of Raymond James. Your line is open.

Hi guys. You talked about the ELA, someone asked about the ELA pool at the end of the year. Can you review what you think happens in terms of the pool or backlog of the ELAs as it gets to the end of year. And if it does go down into next year, and there are fewer ELA renewals, what's the impact -- is there a potential impact on cash flow, since those term lengths tend to be longer than average maintenance contracts?

Yes, if you go back in time, and we've been disclosing our ELAs as a percentage of total bookings, you can get a general idea as to the size of those pools on a quarter-to-quarter basis. As with many in the industry, and really across the world, Q4 of 2008 was difficult, but then led into a very challenging Q1 of 2009. And so you can get some general sense as to the ELAs, the dollar value of the ELAs that will renew in those periods. We are generally collecting cash within 60 to 90 days after the ELA is closed, so there's also a bit of a lag there. So there will be some impact on cash flows out through at least the second quarter of 2012.

My question was less on collections, but on term length. Maybe I'm wrong, but I think the term length tends to be longer and is paid up front on the ELAs than on non-ELAs.

Yes, the average maintenance length across all licenses sold is 24 months, and we require one year with each license sold, regardless of the channel. For ELAs, it tends to be three years.

And if I could have a follow-up after that. You talk -- obviously, there's a lot more being done outside of vSphere, a really, really big range of products. Is there any way we can begin to quantify how big a piece the non-vSphere products are taking up in terms of bookings to product?

Again, as it really relates to overall bookings, vSphere and the suite of products around vSphere are a significant majority of our business, and we're not yet at the place where we need to break out individual layers as segments.

Okay, great, thanks very much guys. Great quarter.

Okay, thanks very much, everyone. And we'll look forward to seeing you at VMworld.

Thank you for participating.