VMware Inc (VMW) 2012 Q1 法說會逐字稿

Welcome and thank you for standing by. At this time all participants are in a listen-only mode until the question-and-answer portion of today's call.

(Operator Instructions)

Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Mike Haase, Vice President of Investor Relations and Treasury. Sir, you may begin.

Welcome to VMware's first quarter 2012 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, believe, 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, 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 on 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 60 days on our Company website under the Investor Relations link. Our second quarter quiet period begins at the close of business June 15, 2012. Finally, unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2011. With that, let me hand it over to Mark.

Thanks, Mike, and good afternoon, everyone. The financial and business results for our first quarter 2012 were once again strong. We achieved record non-GAAP operating margin and free cash flows driven by strength across our product offerings and record international revenues. Total first quarter revenues increased 25% and license revenues increased 15% compared to the same period last year. Our non-GAAP operating margin was 32.6% for the quarter. Trailing 12-month free cash flows were $2.1 billion, an increase of 53% from a year ago. Our balance sheet remains strong, with cash and investments of $5.2 billion, and unearned revenue of $2.8 billion.

Customers continue to move along the virtualization journey and migrate from virtualizing their test and development environments and simpler Tier 3 apps to more mission critical applications including databases, ERP systems, e-mail, and collaboration systems. Global demand for vSphere continues to be strong with a new release expected to be launched in the second half of the year. We are pleased to see so many customers utilizing our management and automation solutions as they build out their data centers into private clouds.

During the quarter, we updated our VirtualCenter Operations Suite, a comprehensive management portfolio designed to help customers deliver IT as a service by simplifying and automating the operations of virtual and cloud environments. Demand for VC Ops since its original release one year ago has been strong and feedback from our most recent release has been encouraging. This month, we recognize the one year anniversary of our Cloud Foundry project. As an open platform as a service, Cloud Foundry is designed to run on a wide variety of environments protecting developers from being locked into any one particular cloud provider. As of last week, we had over 75,000 downloads of the Cloud Foundry client and the Micro Cloud Foundry. This open-source project continues to see ecosystem adoption as signified by over 3,300 followers.

The VMware Service Provider program continues to grow with over 8,000 partners across 150 countries and includes a cross-section of small, medium, and large service providers working with us to provide hosted IT services based on VMware solutions. Most recently, we added AT&T to our list of cloud service partners utilizing VMware cloud solutions, joining Bluelock, Colt, CSC, Dell, Optus, SingTel, SoftBank, and Verizon. Four of the five leaders in Gartner's 2011 Magic Quadrant for Public Cloud Infrastructure as a Service offer cloud service based on VMware.

This week, we rolled out My VMware, a new system that helps our partners and customers manage their license and support entitlements. In development for over a year, My VMware is an integrated self-service account -based portal that is focused on simplifying and streamlining customer interactions with VMware. This is part of our ongoing effort to make it as easy as possible for our customers and partners to do business with us. We are pleased with our start to 2012 and want to thank all of the people of VMware, our partners, and our customers.

Now I'll walk you through the financial details. Total revenues for the first quarter were $1.055 billion, an increase of 25% from a year ago. The impact of foreign currency year-over-year was negligible. Total international revenue represented a record 54% of total revenue. Demand in our Asia-Pacific region was particularly strong driven largely by fiscal year-end spending in Japan. License revenues were $482 million, up 15% from last year, driven by strong demand in our international markets and strength across product offerings during the quarter. License growth on a constant currency basis was 14%. Enterprise license agreements were 22% of total first quarter bookings and included two transactions of $10 million or more. For comparison, we had five transactions of $10 million of more in the first quarter of 2011. Blended vSphere ASPs were down from the previous quarter, reflecting strong demand for our two SMB SKUs, Essentials and Essentials Plus. In addition, our ELA bookings, which tend to include our higher-priced Enterprise SKUs, were sequentially lower as a percentage of total bookings. This is not surprising, given our normal seasonality. However, the average ASP for our Enterprise SKUs, Enterprise and Enterprise Plus increased slightly compared to Q1 2011.

We are also pleased with the level of customer demand for our management and automation tools. Solutions such as vCloud Director and vCenter Operations are seeing solid traction in the market. Much of the increased interest for our management tools is being driven by the build-out of private clouds within our customers' data centers. As customers continue to virtualize their data centers with vSphere, their interest level in our management and automation tools tends to increase. Our cloud application platform business is seeing solid demand with adoption by some of the largest customers looking to build their next-generation applications, using our vFabric and GemFire solutions. In the first quarter, we also had a solid number of desktop virtualization wins across geographies and verticals. Our recurring business continues to track well, as existing customers continue to buy additional View licenses. We also saw healthy demand from new customers. We anticipate an updated version of View to be launched later this year.

US revenues increased 21% year-over-year to $485 million and international revenues were a record $570 million, an increase of 28% compared to the first quarter of 2011. Strong demand in Japan and China led our growth in the Asia-Pacific region. Growth in Europe was led by strong demand in the United Kingdom. We are very pleased with our progress in growing our global market presence. Investments we have made and will continue to make in our international market expansion are clearly paying off and we will continue to invest in these markets in 2012.

Software maintenance and support revenue was $492 million, up 35% compared to last year and our renewals bookings were at a record percentage of total quarterly bookings. We expect maintenance revenue to continue to grow at a faster rate than license revenue in 2012. Customers continue to buy, on average, more than 24 months of support and maintenance with each new license purchased, illustrating that a strong commitment to VMware is a core element of their data center architecture and longer-term private and hybrid cloud strategy.

Professional services revenue was $81 million, up 33% from last year. Total unearned revenues ended the quarter at $2.8 billion, up 4% sequentially and 42% from a year ago. Long-term unearned revenue is now more than $1 billion, and has increased 52% from last year. 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. Approximately 80% of our unearned revenue is software maintenance and will be recognized ratably. Approximately 13% of unearned revenue is software license revenue, which will be recognized either ratably, upon product delivery, or upon product release. Our unearned license revenue at the end of Q1 represents the largest percentage of total unearned license revenue in any Q1 since we went public. Increasingly, unearned license revenue is recognized ratably, which now represents over 50% of the total unearned license revenue balance. In addition, approximately 7% of unearned revenue is the result of prepaid professional services, including training, which is recognized as the services are delivered.

We had a very good first quarter, as we benefited from strong demand in our international markets, across products, and the seasonality of our OEM partners. However, we remain cautious about the macroeconomic environment, US federal spending outlook, and the volatility we are observing in the world economy and individual sovereign nations. With this backdrop, we expect second quarter revenues to be within a range of $1.1 billion to $1.120 billion or year-over-year growth of approximately 19.5% to 21.5%. Second quarter license revenue is anticipated to increase within a range of 10% to 12%. For the year, we are expecting total revenue of between $4.525 billion and $4.625 billion or growth of approximately 20% to 23% compared to 2011. License revenue for the year is anticipated to increase within a range of 12% to 16%. As mentioned last quarter, we expect the linearity of 2012 license revenue by quarter to be similar to 2011. We currently anticipate third quarter license revenue to be approximately flat sequentially from Q2.

I'll now provide some details on our operating margins. 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 Q1 operating profit measured on a non-GAAP basis was a record $344 million or 32.6% of revenue, compared with 31.9% in Q4 2011, and 29.9% in Q1 2011. On a trailing 12 month basis, our operating margins were 31.6%, reflecting the economics of the software license business model. Year-over-year, operating margins benefited 58 basis points from foreign exchange rates.

We ended the quarter with approximately 11,800 employees, up 600 from the beginning of the year. We had targeted a higher Q1 headcount, which was responsible for some of the overperformance in operating margin. We are in a rapidly changing and dynamic environment and see significant opportunities in the adjacencies to the vSphere platform so you should expect VMware to accelerate hiring throughout 2012 to take advantage of these opportunities.

Diluted non-GAAP EPS was $0.66 per share on 433 million diluted shares. Our non-GAAP tax rate was 18%, and the GAAP tax rate was 14.5%. We expect the non-GAAP tax rate to be approximately 18% for 2012, and the GAAP tax rate to be approximately 3 to 4 percentage points lower than the non-GAAP rate. In January, I said we are not planning for operating margin expansion in 2012. We see significant long-term growth opportunities and will continue investing in our product development, global market expansion, and go-to-market to take advantage of them. We anticipate the ramp of our investment spending to accelerate during the second half of 2012.

Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call, we now expect our non-GAAP operating margin for the second quarter to be within a range of 30.5% to 31.5%. For the full year, we expect the non-GAAP operating margin to be with in a range of 30.25% to 31.25%. The GAAP operating margins for the second quarter and full year 2012 are expected to be approximately 12 to 15 percentage points lower than the non-GAAP operating margins. As a result of our annual equity refresh program, we expect stock-based compensation expense to increase to over $100 million per quarter for the remainder of the year.

Now, on to our balance sheet and cash flows statement. Our balance sheet remains strong with cash and short-term investments at quarter-end of $5.2 billion, up $700 million sequentially. During the quarter, we used $34 million in capital spending. We did not repurchase any shares during the quarter. However, we currently have open authorization to repurchase up to $685 million of our common stock. Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock-based compensation, were $630 million for Q1, and $2.3 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. As mentioned last quarter, our total expected CapEx for 2012 is approximately $325 million to $350 million, which includes the continued build-out of our Stanford Research Park campus.

Free cash flows for the quarter were $597 million, and $2.1 billion for the trailing 12 months. Free cash flows per diluted share were $1.38 for the quarter and $4.79 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 is a better measure of our progress than quarterly. Also, when we look at anticipated cash flows for 2012 compared to last year, keep in mind, we plan to invest about $100 million more in CapEx this year. In addition, last year our cash flows benefited from the collection of tax receivables of more than $300 million, which covered both 2010 and 2011 tax years. Our tax receivables are dependent on various factors, including tax deductions for equity-based compensation and the continuation and timing of the federal R&E tax credit.

The fully diluted share count was 433 million shares for the first quarter. We anticipate our second quarter and full year 2012 diluted share count will be approximately 435 to 440 million shares. To summarize, we are very pleased with our execution and solid first 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. Now, I will hand it over to Paul.

Thanks, Mark. As you can tell from Mark's remarks, we laid a firm foundation for 2012 despite lingering concerns about the fragility of the macroeconomic environment. We believe that this foundation reflects the validity of our basic thesis that our customers want, on the one hand, to achieve greater efficiencies under their existing IT operations, and on the other hand, free up the resources to transform their applications and business models for the future. And we are shaping both our products and our go-to-market investments to support these challenges. To achieve infrastructure transformation, we continue to invest first and foremost in products for the backend or the data center, centered on vSphere and the vCloud suite of infrastructure and management products for the private and public cloud. We are also investing in front-end infrastructure, building off our VDI View investments, providing a suite of products for the secure automated provisioning of end-users in the post-PC age.

As Mark noted, we updated our vFabric and Cloud Foundry products, which are targeted at application renewal and we are anticipating further significant enhancements in all three of these major dimensions during the course of the year. In addition, we are responding to demand from our customers to address the operational, process, and people aspects of operating infrastructure in a modern cloudlike manner, and are thus introducing a set of professional services offerings under the label Accelerate Advisory Services. The IP behind these services will be available to our (inaudible) Customers are investing in IT for the longer term and we are certainly primary beneficiaries of this and are thus ourselves investing for the longer term. But it should be noted that concerns about the macro environment, particularly in Europe, are still with us and there is definite caution in our customers, with a careful scrutiny of deals.

This will be my last earnings call with Mark. I think we've now done 16 of these calls together and I would like to thank him for all he has done for us at VMware. If my memory serves me correctly, we've been able to meet or exceed our basic revenue and margin guidance for over 12 consecutive quarters now, and this is in no small part a testament to Mark's leadership and wisdom. Equally importantly, Mark has built a strong finance team. They, combined with the three experienced CFOs that serve our Board of Directors, will stand us in good stead for the future. So, thanks Mark, we will miss you. Although you will no doubt have the pleasure of taking questions in a future capacity for many of the same folks on this call.

Lastly, I'd like to welcome Carl Eschenbach who is sitting in on this call and who is stepping up to a COO role. Carl has grown our sales from millions to billions and our customer operations team to its present 6,000 strong level. As our Company grows, it is good to be able to call upon his skills and experience. So with that, we'll open up for questions.

(Operator Instructions)

The first question is from Heather Bellini. Your line is open. Heather Bellini, your line is open. Okay, the next question is from Brian Marshall. Your line is open.

Great. Thanks. Have a question with respect to ELA adoption for your management tools and automation. If you did roughly $60 million in management tools and automation revenue in the quarter, that is kind of my calculation -- I estimate that roughly 30% of the ELAs have been attached to that management tools and automation. Can you talk about if those numbers are roughly accurate, how that has progressed throughout the year? Thanks.

Yes, Brian, this is Mark. Overall, we don't break out product revenues by category. Management products in general are about 10% of overall license bookings and certainly, particularly in more mature markets and with customers who have been through the virtualization journey, as ELAs renew, we have a strong attach rate with management and automation products, but other than that we are not getting into the specifics of attach rates or percentages.

But safe to say that the management tools and automation is mostly associated with the ELA business today?

Yes, they are more closely associated with enterprise license agreements as opposed to single unit channel sales.

Great. Thank you.

Next question is from Kash Rangan. Your line is open.

Hello. Thank you very much. I will miss talking to you, Mark, on this call. One question for you on the management bookings. I think last quarter, too, it was about the 10% range and I am just curious if we should be expecting this to trend higher because the opportunity for management tools is arguably earlier in its maturity phase and when should that start to kick in and when therefore could we expect to see reacceleration of license revenues? That's it for me. Thank you.

Thanks, Kash. Again, the management tools do associate more closely with ELAs, both new ELAs and ELA renewals. This quarter, the ELA percentage of total bookings was 22%, which is down sequentially and really somewhat seasonally, when you consider the maturer markets, the US and Australia, in particular. And so, I don't have a guidance for you as to when management will kick in to be a larger percentage of overall license bookings. But it is safe to say that we are optimistic about those product offerings and the building off the vSphere platform.

Got it. Thank you very much.

The next question is from John DiFucci. Your line is open.

Thank you. I have a two-part macro question. Mark, you mentioned Europe and federal government as two areas that you are keeping an eye on and perhaps could see some weakness from, I guess we have seen some weakness from already. You did say international strength was driven by a strong APAC but you did say Europe did grow due to UK strength. I was just wondering if you could give us -- quantify that in any way about Europe? I know you don't normally break that out, but I assume it did grow because you said it did, but, and I assume it grew less than Asia PAC so could you give us anything more on that and then also you did not mention financial services and I know it is a seasonally slower first quarter here, but can you give us any gauge on that vertical because we've been hearing of some pressure on budgets out of the financial services companies? Thank you. Hello? Hello? I am not sure if I am on, here. Hello? Hello?

Public sector in general as we are entering an election year and so there is additional uncertainty as a result and as we look at the forecast on the business, we are just approaching that with a certain amount of caution. And then -- okay -- sorry on this end we are experiencing a little bit of technical difficulties. I'm not sure that -- I'm not clear that you are hearing is, but I'm now I'm really sure that you are.

Hello, Mark? Can you hear me now, Mark? It is John.

Hello, John.

Okay, I'm sorry, I don't know, did you hear my full question because then it kind of went dead silence. It's kind of like whenever I speak, people stop listening, but, I just wondered if you heard my full question.

I think I did. I got -- so in summary, yes, strength in APAC really based, really a strong quarter in Japan as they went through their year-end budget flush. In Europe, we did -- we continue to be really cautious given macroeconomic conditions and the fact that in many sectors in Europe, it is really the governments that are spending the money if you think about education and healthcare, in particular. But it was a good quarter for us, particularly in the UK. And then you had asked the question, I also believe, about the financials. And, as you know, we don't give any particular information on any one vertical in our business, but the financials continue to be an important set of customers for us and it is part of the overall macro as we look at guidance going ahead for the year.

Okay. Okay. Thank you.

The next question is from Laura Lederman. Your line is open.

Yes. Thank you for taking my questions. Like to talk a little bit about desktop virtualization. You talked about how much the management tools of bookings but can you talk a little bit about desktop. And another desktop-related question, can you help us understand a little bit about where you're successful -- is that largely also on ELAs or is it spread equally between ELA in non-ELA business? Just give us a little color on desktop? Thank you.

Sure, Laura. Overall, the end-user computing group was again approximately 10% of overall license bookings during the quarter and it is a mix of leverage off of enterprise license agreements both new and renewed agreements, but also a bit more sales through the channel than we experience from the management products.

And a related question as well -- can you talk a little bit about big deals on the desktop side, in other words, or are you mainly selling it to less than 10,000 seats or are you also selling a lot of big multi tens of thousand seats deals, as well.

Well, for the most part, what we are doing is that there will start with proof of concept on desktop and then you'll go into larger and larger accounts. We certainly have 10,000 seat plus transactions with the View, but for the most part they are transactions that are smaller than that.

Thank you so much. I appreciate it.

The next question is from Adam Holt. Your line is open.

Hello. Thanks. Mark, first of all, congratulations on the new opportunity.

Thank you.

You had another good ELA quarter despite a difficult renewal comparison on the renewal ELAs. Can you talk a little bit about the mix between new ELAs and renewal ELAs and were you able to grow renewal ELAs on a year-on-year basis?

Well, Adam, we don't break it out specifically, but we look at all of the opportunities and just as a reminder, in a perfect linear world, an ELA will renew in the quarter in which it expires, but the actual behavior that we see is that frequently any ELA that closes in a given quarter, there is some lag of a quarter or up to several quarters from when that ELA expired, and as we work through the sales process with our customers. And so, the mix of new ELAs and renewed ELAs will shift from quarter to quarter and overall, what we try to give is just the percentage as it is of the weight to total bookings.

Okay, that is helpful, and just a quick follow-up on margins. The increase for the year for margins looked relatively modest, relative to the outperformance in Q1. You're accelerating expenditure throughout the year. Maybe just walk us through where those dollars are going and kind of connect the dots on what we saw in Q1 upside versus the year on margins. Thanks.

Sure, and so first on a year-over-year basis, we had about a 58 basis point help from currencies in the operating margin. And then as I mentioned in the prepared remarks, we didn't hire completely to plan from where we guided in the first quarter. And so, we are not pulling back from our overall hiring and in fact have a good ramp as we begin the second quarter and move through the year. And as well, we are going to continue to invest in products and we believe we have a lot of opportunity in each of the three layers and management and we are continuing our hiring. I think when you look at our open reqs, you can see that we haven't pulled back from that hiring and then we continue to also expand in our go-to-market strategies both internationally and domestically.

Great. Thank you.

The next question is from Mark Moerdler. Your line is open.

Thank you. Two quick questions on here. The first one is, you were discussing the headcount and the fact that there is a bit of it sound like of a delay of it, is this due to some form of a change in the competitive dynamics for hiring or in terms of the type of people you were hiring that would cause you not to be able to bring on the people that you had expected? And the second for Paul is, can we get a sense of how you are doing now with Mark about or shortly going to be leaving, in terms of the process, et cetera, for a replacement, if a replacement is possible for Mark, but a replacement?

Yes, so Mark, first, just on headcount, it is not so much a change in the competitive dynamic and we are actually pleased with our overall attrition rates because they have not changed appreciably in the quarter as well. But I think it is much more just about the ramp that we experience as we enter the quarter and that much of our hiring is done in a variety of markets both here in Palo Alto and across the country but also internationally. And so, I think we just may have been a little bit overly optimistic as to how quickly we could on-board people.

So, this is Paul, I will comment briefly about plans going forward. As I noted, we are blessed with having very strong folks underneath Mark, in each of the key financial disciplines of accounting, planning, and revenue. So, we are -- and also having three very experienced CFOs looking over our shoulders on our Board of Directors, gives us the luxury of being able to be thoughtful and careful about choosing a replacement for Mark going forward. So we are going to go about that in a deliberate and thoughtful process, knowing that we've -- right now, Mark is leaving us with a pretty tight ship and a very good team, which gives us that luxury.

Thank you.

The next question is from Walter Pritchard. Your line is open.

Hello. Thanks, guys. On the management side, we heard you mention the 10% and it weighted more towards ELAs but I'm wondering bigger picture on the management. I mean, if we look at Microsoft, for example, we think that management revenue versus their server business is about 15% of the opportunity, meaning $0.15 on the dollar that they get in management. I'm wondering if you guys have thought about how big the opportunity is for management versus your server market?

This is Paul, I will jump in and take that one. We actually see ourselves as really participating in a broader opportunity which is data center automation, so we see both our vSphere products and our so-called management products as addressing a common underlying need, which is to fundamentally automate operations in the data center. So, we don't necessarily think of our world as splitting neatly into an infrastructure opportunity and a management opportunity here. We see those things as very closely connected to each other and what you will see us do moving forward is, in fact, move towards a sales motion where we are selling a suite of products that includes the core underlying infrastructure capabilities, security, management, and other functions as well. So, what we look at really is the opportunity to grow our business to provide what we call the software-driven data center where we use increasingly standardized or hardware plus software to deliver a new level of automation in the data center in the form of private and public clouds. And we are pretty confident that that market is a market that is going to grow very strongly, so we see that our old infrastructure business has a lot of growth potential associated with it and we don't need to necessarily break it out into infrastructure versus management versus security, et cetera, et cetera.

Got it and then just, Mark, one question for you. I think we just calculated from the commentary you gave around deferred license revenue, that you drew that down by about $14 million sequentially and I think you drew that down by a similar amount last year in March and I am wondering if we look at deferred license revenue in your expectation throughout the year, should we expect that you generally draw that balance down in the first half of the year and then build that balance back up in the second half like happened in fiscal '11?

Well, Walter, it is one of the most difficult balances that we have to forecast and we try to provide a bit of color around deferred license revenue. If you look at it from a pure license bookings perspective of what the revenue we reported versus deferred license revenue, we grew about 16% this quarter, year-over-year. And rather than give sort of specific guidance as to where we think it will be, I will say in the second quarter, that it is not a material component of how we guided for revenue for the second quarter and to the extent that there are larger growths in that balance, yes, they will tend to happen in the second half.

Great, thanks a lot. And good luck, Mark.

Thank you.

The next question is from Heather Bellini. Your line is open.

Yes, hello. Apologize for the technical difficulties before. But I was wondering, Paul, if you could share with us when did you start to see the momentum built in regard to virtualizing tier-one apps? I don't know that you've called that out on your call before and I guess the follow-up would be what caused people to get more comfortable with this and then finally how big of an opportunity do you think it is?

Sure, we've seen or we've been basically predicting that people will start to move towards virtualizing their tier-one applications simply because once you get up to the 50% plus level of virtualization, you've got to start tackling your tier-one apps and, as you know, many of our customers are now at that point or accelerating beyond it which means that they've done all of the quote unquote easy stuff and now they are tackling their mission-critical, business-critical applications. So we see that continue to be a major theme and focus as customers go forward. We've got a lot of experience doing that right now. We can make that experience available to them and, whereas before, I think it was considered sort of somewhat avant-garde to virtualize your mission-critical application, it is rapidly becoming something where you're considered the exception if you're not going in that direction.

So that has been a positive trend, now, people that do take it with an appropriate degree of care, so that it does take longer to get those mission-critical applications virtualized, but we see all of our core customers now really aiming to get to very, very high levels of virtualization -- way in excess of 50%. Which is why we think that, one, we still have a lot of growth ahead of us just in terms of virtualizing applications, both existing applications and the new applications that are coming into the pool as people develop and deploy new applications. And then, secondly, to build on that foundation of virtualization by providing the automation for the data center that I was talking about and stressing again that we see this is automation which is a combination of infrastructure plus management plus security plus other functions in the data center. So, you heard me say before that I think we have both a breadth and a depth opportunity -- breath in terms of the percent of virtualization and depth in terms of the additional functionality and automation that we can sell even to our existing customers.

Great. Thank you.

The next question is from Rick Sherlund. Your line is open.

Thanks. Yes, two questions. First, Mark, on ELAs, you mentioned sometimes these renew possibly earlier. I'm wondering if there is anything unusual you are anticipating for Q2 in terms of ELA renewal activity. And second, for Paul, on OpenStack, I noticed that IBM and Red Hat recently joined that initiative and you talked about kind of the breadth and depth of your data center automation and I'm kind of curious how often is OpenStack come up as a competitive consideration, as you're talking about infrastructure and management and how you might expect that to develop over time?

Yes, Rick, on ELA renewals, the tendency we see is actually more -- ELAs probably half plus will renew in the quarter in which the expiration comes up and it is more frequent that they will renew late as opposed to renew early, just from a -- if you think about a customer, buying patterns and buying habits, that makes a lot of sense and also our field is disciplined to think through the customers and the clients that are in either the renewal phase or maybe that haven't renewed from previous quarters. So, as we look ahead we have a fairly good look into our pipeline as to who is coming up for renewal or who hasn't yet renewed.

This is Paul, addressing your point about OpenStack. So, at this point, we are certainly aware of OpenStack and aware that there is a fair amount of interest in it from various parties in the industry, which is not surprising, given the importance of this fundamental trend where customers are going to move to operating in a cloud-like manner, both in their internal data centers and the public data centers. So, it is highly unlikely that we would be left alone to or have that opportunity all to ourselves. That being said, OpenStack at this time compared to the vSphere environment is still relatively immature. We see it more interest in the public cloud space than we do in the private cloud space at this point in time. And we continue to believe that our greater near-term challenge will probably come from Microsoft. But that being said, when we have these large industry transitions, our history teaches us that typically or in the long-term, your toughest competition comes from a new company building on new technology and for that reason we certainly take all of the competing cloud technologies very seriously and spend a lot of time thinking about them, analyzing them, and it is for that reason that we are constructing the series of investments that we will be bringing to market this year and in the subsequent years.

Paul, is your anticipation that the integration with vSphere and the integration would offer some leverage in the data center automation?

Yes, I mean, the fact that a substantial portion of the world's largest companies and substantial portion of the world's survey applications today are already running on a vSphere substrate, and therefore the opportunity to provide additional automation and security and other functions into and around that substrate is a very real one for us and that constitutes the so-called depth opportunity that I said earlier that we have.

Thank you.

The next question is from Brent Thill.

Thanks. Mark, congrats on the new role, good luck in Pleasanton. Just on the license guidance for the year, you left it relatively unchanged. Other than tough license comps, are there any other changes we should be aware of on the license side this year, in terms of how you're thinking about the forecast?

No, Brent, as we looked at the results of Q1 and the movement through to the forecast for the second quarter, I think it just felt like keeping the guidance, the growth rates, at least, at the top end, at 16%, seemed the prudent thing to do, and then we brought the floor up from 11% to 12%.

Okay, and for Paul, are there any new markets that you feel are opening faster for you or on the other side are there markets that you thought may have been bigger but you're not seeing open as quick? Just trying to get a sense from your seat what you are seeing this year from a high-level perspective?

Yes, sorry, I'm having to switch my mike offer mute. I think the two interesting trends that I am seeing is a deepening qualitative realization amongst customers that they are going to need to do something different to achieve the operational efficiencies that they want going forward and that is going to mean making some hard choices and leaving some things behind, potentially, and sort of this notion that they can move forward by taking a traditional enterprise systems management and just sprinkling it more of it on top of all of the animals in their zoo, probably isn't going to work. That to really achieve the fundamental efficiencies of operating in a cloud-like manner, they are now going to have to make real choices and real plans and we are trying to respond to that, not only with our products, but also as I said with our professional services offerings.

So, that is a qualitative change that we are seeing right now and I think that that bodes well for the next several years as people really try and achieve more fundamental efficiencies. At the same time, people are realizing that the competitive environments demand that they need to respond with new applications, new experiences for their customers. And that is an opportunity we believe for the investments that we have been making in the programming frameworks, in Cloud Foundry, in our GemFire data fabric technologies, et cetera. Now those will take longer to show up in our bottom line results, but the good news is that we believe that is another fundamental trend that will stand us in good stead in the longer term. And I think the only other comment is one that we've made several times already which is the macro environment, there is still this underlying nervousness about it and that could still affect our results going forward, but the bottom line is, is we think we are aligned with these two major trends in the industry.

Thank you.

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

The next question is from Phil Winslow.

Hello. Thanks, guys. It's Phil Winslow, Credit Suisse. Two quick questions. First just to Mark on the balance sheet. One of the things that you mentioned, too, is just the long-term deferred revenue mix which does just continue to trend higher here, guys committing to you for obviously more years. How do you expect that to continue to trend over the course of this year and is there a certain level of mix of deferred that you think that balances out? And then Paul, just another question on vCloud Director. I mean, obviously you are trying to leverage your positioning and just the virtualized data center and vSphere to run private clouds and theoretically, to leverage private cloud position into influencing the public cloud, whereas other folks are trying to come from the public cloud down, so to speak. How do you think about your positioning versus those others there? Thanks.

Yes, Phil, on the overall deferred revenue, we are seeing more of a trend towards longer term and it is just expected over time. It is a combination of most ELAs are -- they start at three years and some are extending longer and then if you think of an ELA renewal, those can tend to be a larger percentage of maintenance and so there is just less license to be recognized up front on some of the renewals.

Yes, this is Paul. Just responding to your question about, is it private cloud outwards or public cloud inwards. We believe that you've got to do both. Now, clearly our greatest strength today is in the private cloud space, but on the other hand, I think it is underappreciated how successful we are being in the public cloud space at this point in time. We have a special license that public cloud providers can operate off, which is more of a rental license, where we get paid as they get paid. So we have pretty accurate statistics coming in on a quarterly basis of what is happening in that marketplace and at this point we have well over 1,500 service providers who are actively transacting off that license. And we actually think that if you look at that pool of virtual machines, if you like, that are being hosted by those service providers, that they are actually the fastest-growing single segment in the public cloud space at the moment, growing at well over 100% a year, so very strong growth there and we continue to conclude new partnerships with people who are going to be working with us in the public cloud space. So, we believe in the long run that you've got to do both and that is our strategy.

Great. Thanks, guys.

And the final question is from Jason Maynard.

Hello, guys. First for Paul, speaking of large zoo animals, Microsoft actually got a new products coming to market that are, I think it's fair to say, better than they have had in years past, and I'd just be curious to first get your take on what impact do you think the new Windows server product will have in terms of selling management tools and also just how System Center 2012 plays into that equation given that the early reviews have been pretty good. And then I had a quick one for Carl, since you are here, I'm curious if the North American performance of kind of low 20% growth versus the international of 28% is the right way for us to think about the delta between the two regions broadly, and if there was anything in North America, Management change, leadership stuff, in the last quarter that maybe contributed to that number being a little bit lower? And, Mark, you will be missed and welcomed. Thanks.

Okay, let me jump in there quickly and address the Microsoft question. Clearly, as I said before, we take them very seriously and have spent a lot of time looking at their products. And for the four years that I have been here at VMware, been asked this question fairly regularly and basically would give the same answer today as I did in the previous years, which is, you can only have a right to exist in this business if you continue to innovate and move the ball forward. And that is exactly what we have been doing. We have worked very hard to be able to put out a new release of our product every year and turn our crank faster than we think our competitors are turning their crank and stay ahead on a terms of value of what we can offer to the customers. And we believe that we continue to be in that position even with Microsoft's new offerings coming to market, I presume later this year.

And Jason, it is Mark, we don't have Carl on a mike and -- but he and I have sat next to each other for the last five years and talk at least daily and there really isn't a significant structural change that has occurred. It is really just part of our success and, as Paul mentioned, I think on one of his very early conference calls is that VMware started out by a company that focused on English language speaking countries and we've thoughtfully been investing in the international markets and so it is just an expectation as we grow that there will be a broader split between international and US revenues.

Okay. Thank you.

With that we are going to end it. Thank you.

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