VMware Inc (VMW) 2012 Q2 法說會逐字稿

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation. we will conduct a question-and-answer session. (Operator Instructions). Today's conference is being recorded. If there are any objections please disconnect at this time.

At this time for opening remarks and introductions I would like to introduce your host, Mike Haase, Vice President of Investor Relations and Treasury. Thank you. You may begin.

Welcome to VMware's second-quarter 2012 earnings conference call. On the call, we have Paul Maritz, Pat Gelsinger and Carl Eschenbach. 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 expectations or intent regarding our financial outlook, business acquisitions, product offerings, customer demand and other matters. The 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 transaction, 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.

A webcast replay of this call will be available for the next 60 days on our Company website under the Investor Relations link. Our third-quarter quiet period begins at the close of business September 14, 2012. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2011.

Finally, as a reminder, our Analyst Day will be held August 27 in San Francisco as part of VMworld which runs August 27 through the 30. With that, let me hand it over to Carl.

Thanks, Mike, and good afternoon, everyone. The financial and business results for our second-quarter 2012 were once again strong, despite the tough market conditions. Driven by strength across our product offering and solid growth across geographies, we achieved record quarterly results in total revenue, license revenue and non-GAAP operating income.

Total second-quarter revenues increased 22% and license revenues increased 11% compared to the same period last year. Our non-GAAP operating margin was 31.9% for the quarter trailing 12 months free cash flows were $2 billion, an increase of 29% from a year ago. Our balance sheet remains strong with cash and investments at quarter end of $5.3 billion and total unearned revenues of $2.9 billion.

Our customers continue to move along the cloud journey by increasingly virtualizing their mission-critical applications and building out their private clouds. Global demand for vSphere continues to be strong with a new release expected to be launched in the second half of the year, and the attach rate for the vSphere adjacencies continues to be robust.

Our VMware service provider program is tracking well as public cloud providers continue to leverage our cloud infrastructure platform for their service delivery. We continue to add key partners to the program and are seeing healthy growth.

We also closed the acquisition of Wanova, Cetis, and Ithaca during the quarter and welcomed about [60] new employees from these acquisitions to VMware.

Last week, we closed the acquisition of DynamicOps and today we announced the acquisition of Nicira. We anticipate Nicira to close sometime in 2012. Paul will speak more about these acquisitions later.

We are pleased with our results for the first half of 2012 and want to thank all of the people at VMware, our partners and our customers.

Now I will walk you through the financial details.

Total revenues for the second quarter were $1.123 billion, an increase of 22% from a year ago. Total revenue growth on a constant currency basis was 23%. International revenues represented 51% of total revenue. License revenues were $517 million, up 11% from last year, driven by strong demand across product offerings during the quarter. Licensed revenue growth on a constant currency basis was 13%.

Enterprise license [and] agreements were slightly under 30% of total second-quarter bookings nearly matching our record percentage from Q4 2011. We had a healthy mix of new ELAs as well as ELA renewals in the quarter and we continue to seek very nice attach rates of non-vSphere solutions to our ELAs. We closed four transactions of $10 million or more during the quarter. For comparison, we had zero transactions of $10 million or more in the second quarter of 2011.

Given the tough market conditions and the increased customer scrutiny around their IT investments, our continued strong ELA results reflect the confidence customers show in the VMware platform. Blended vSphere ASPs were up from the previous quarter, reflecting higher ELA volumes which tend to include our highest end SKUs.

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 customer's data centers.

As customers continue to virtualize their data centers with vSphere, their interest level in management automation tools tends to increase. And with the acquisition of DynamicOps, we believe our position is strengthened as the infrastructure in management vendor of choice for cloud computing. DynamicOps enables provisioning and management of IT services across heterogeneous environments, VMware-based private clouds, public clouds, physical infrastructure, multiple hypervisors and Amazon web services.

Our cloud application platform business had record demand in the second quarter with continued adoption by some of the largest customers looking to build their next-generation applications.

In fact, one of our $10 million plus orders was driven largely from our cloud application platform products including vFabric and GemFire. This was a large and very complex solution sale to a long-standing vSphere customer.

In the second quarter, we also had nice growth from our end user computing solutions, including a solid number of desktop virtualization wins across geographies and verticals. Our repeat business continues to track well as existing customers continued to buy additional licenses. We also saw healthy demand from new customers.

View 5.1 was launched last May and is performing well. The acquisition of Wanova further enhances our competitive positioning with centralized image management of both physical and virtual desktops. The Wanova Mirage solution also completes our vision of extending VDI to Oakley executed and off-line use cases.

Mirage is enabling seamless two-way replication of managed Window images, applications and persona between the data center and the physical laptop as well as delivering them for execution as virtual machine on Windows, Mac with VMware Fusion and Linux.

US revenues increased 22% year over year to a record $551 million and international revenues were a record $572 million, also an increase of 22% compared to the second quarter of 2011. Strong demand in Japan and China led our growth in the Asia-Pacific region. We have been quite pleased with our results in the Asia-Pacific region and are seeing increased opportunities for larger deals.

Our results in Europe were mixed. Demand in several countries were slower than expected whereas we saw healthy demand in the United Kingdom, France, and Russia. We are also seeing a nice expansion of our ELA business within many of EMEA's emerging markets. And in Latin America, demand continued to be strong, particularly in Brazil.

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, and we are continuing to invest in these markets in the second half of 2012. Software maintenance and support revenues were $519 million, up 34% compared to last year, and we expect maintenance revenue to continue to grow at a faster rate than license revenue. 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 long-term private and hybrid cloud strategy.

Professional service revenues was $87 million, up 24% from last year. Total unearned revenues ended the quarter at $2.9 billion, up 5% sequentially, and 42% from a year ago. Long-term unearned revenue is $1.1 billion and has increased 52% from last year. The complexity of our unearned revenue has increased over time as a result of acquisitions and 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 our unearned revenue is software license revenue, which will be recognized either ratably upon product delivery or upon product release. Increasingly, unearned license revenue is recognized ratably which now represents over 50% of the total unearned licensed revenue balance.

In addition, approximately 7% of unearned revenue is the result of prepaid professional services including trading, which is recognized as the services are delivered.

We had a very good second quarter as we benefited from increased demand across geographical markets. We also benefited from near record ELAs as a percentage of total bookings. We do not anticipate having this benefit in the third quarter and expect ELA bookings to decline as a percentage of total bookings.

In addition, while the third quarter is traditionally strong for the US federal government spending, we remain cautious and have revised our earlier estimates downward for this sector.

We also remain cautious about the potential for slower IT spending especially within the European markets and foreign exchange headwinds. Despite these macro concerns, our deal pipeline remains very strong and we expect to have a solid second half of 2012. Demand for vSphere remains solid and we are seeing increased opportunities for larger deals that also include management and automation solutions, cloud application solutions such as vFabric and GemFire, and desktop virtualization.

Our deal opportunities are more complex but are also larger. With this backdrop we expect third-quarter revenues to be within a range of $1.110 billion to $1.150 billion or year-over-year growth of approximately 18% to 22%. Third-quarter license revenue is anticipated to be within a range of $470 million to $500 million, growth of approximately 6% to 13% compared to last year.

This is a sequential decline from the second quarter, but in line with our 2011 seasonal pattern. For the year, we are expecting total revenues of between $4.540 billion and $4.635 billion or growth of approximately 20.5% to 23% compared to 2011. License revenue for the year is anticipated to increase within a range of 11% to 15%, reflecting our expectation of a seasonally strong fourth quarter. The revenue impact from the Nicira acquisition is expected to be negligible in 2012.

I will 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 Q2 operating profits measured on a non-GAAP basis was a record $358 million or 31.9% of revenues compared with 32.6% in Q1 of 2012 and 31.6% in Q2 of 2011. Year-over-year second quarter operating margins benefited by 124 basis points from foreign-exchange rates. We ended the quarter with approximately 12,700 employees, up 1,500 from the beginning of the year.

We are in a rapidly changing and dynamic environment, and see significant opportunities in the adjacencies to the vSphere platform and in our emerging markets. So, you should expect that VMware will continue to hire throughout 2012 and take advantage of these opportunities.

Diluted non-GAAP EPS was $0.68 per share on 435 million diluted shares. Our non-GAAP tax rate was 18% and the GAAP tax rate was 10.5%. We expect the non-GAAP tax rate to be approximately 18% for 2012 and the GAAP rate to be approximately 4 to 6 percentage points lower than the non-GAAP rate.

As mentioned in our past two earnings call, we are not planning for operating margin expansion in 2012. We see significant long-term growth opportunities and will continue to invest in our product development, global market expansion and go-to-market to take advantage of that. We anticipate the ramp of our investment spending to continue during the second half of 2012.

Taking into account our adjustments to GAAP operating income that might disclose at the start of the call and incorporating our recently announced acquisition of DynamicOps and Nicira, we now expect our non-GAAP operating margin for the third quarter to be within a range of 28.75% to 29.75%. For the full year, we expect the non-GAAP operating margin to be within a range of 30.25% to 31.25%. The GAAP operating margins for the third quarter again taking into account the announced acquisition of DynamicOps and Nicira, and their impact on stock-based compensation and the amortization of intangibles, are anticipated to be approximately 15 to 18 percentage points lower than the non-GAAP operating margins.

The full-year 2012 GAAP operating margin is anticipated to be approximately 13 to 15 percentage points lower.

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 $5.3 billion, up more than $100 million sequentially. During the quarter, we used nearly $325 million in aggregate for M&A, capital spending, and our share repurchase program. Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock-based compensation, were $424 million for Q2 and $2.2 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. Our total expected CAPEX for 2012 is approximately $320 million to $340 million which includes a continued buildout of our Stanford Research Park campus.

Free cash flows for the quarter were $380 million and $2 billion for the trailing 12 months. Free cash flows per diluted share was $0.87 for the quarter and $4.63 for the trailing 12 months.

As we have mentioned, free cash flow per share can be volatile in the short term, so we believe that looking at it over a trailing 12 months is a better measurement of our progress in quarterly. Also, when we look at anticipated cash flows for 2012 compared to last year, keep in mind that 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. For 2012, we are expecting to pay US federal and state income taxes to EMC and are therefore not expecting any collection of tax receivables this year. Our tax receivables are dependent on various factors, including tax deductions for equity-based compensation and a continuation and timing of the federal [R&E] tax credit.

The fully diluted share count was 435 million shares for the second quarter. We anticipate our third quarter and full year 2012 diluted share count will be approximately 435 million to 440 million shares.

To summarize we are very pleased with our execution and solid second-quarter performance. We continued to manage our resources prudently while making the key investments necessary to maximize our long-term growth and free cash flow per share. And despite the macro uncertainty and the potential for slowing global IT and federal government spending, we anticipate a solid second half of 2012.

We hope to see many of you at VMworld in San Francisco August 27 through the 30 and our financial Analyst Day on August 27.

Before I hand it off to Paul, I would like to first thank him for his leadership over the last four years. Paul will certainly be missed. But as he reminded us last week, he is not going far and he will come to our Board meetings with lots of questions.

I would also like to welcome Pat to VMware and to our call. Pat, I look forward to working with you moving forward.

Now I will hand it over to Paul.

Thanks, Carl. As Carl described, we are pleased with our performance during the second quarter despite continued macroeconomic fragility. The strength in our ELA business is a testament to the long-term value customers place on our solutions.

The constant theme of my remarks in quarters past has been the advancement of our three layered strategy which is designed to position VMware to benefit from big changes that will transform the IT landscape. The first sea change is the remaking of the data center as we move towards the software defined data center and a cloud approach to doing things. The second is the advent of new approaches to developing and reviewing applications. And the third is the need to support corporate end-users in a multi-device, post-PC world.

At the upcoming VMworld convention that is to be held in San Francisco and Barcelona, we will outlined advances in each of these dimensions. I am pleased to report that our internal product teams have been very busy and the full breadth and depth of what they have been doing will be impressive. In particular, we will be describing complete integrated solutions for building and managing clouds -- private or public.

Before I turn to today's big news, Nicira, I want to note several smaller but important technology acquisitions that add breadth and depth to our product line. The first is Wanova which fits into our strategy for provisioning and the support of end-users. The Wanova technology makes thick or thin Windows devices manageable in a very flexible and centralized way. This solution complements our view product line and fits into our emerging horizon portfolio of multi-device end-user solutions.

The second acquisition was Cetis, an early phase company addressing real-time cloud-based analytics. This acquisition will strengthen our cloud applications platform.

The third acquisition is DynamicOps. This technology allows us to broaden our cloud infrastructure management and enables service requests to be provisioned across not only vCloud and vSphere, but across heterogeneous clouds and physical infrastructure. DynamicOps is already in use at many of our largest customers and we look forward to extending its appeal in use.

Now to Nicira, our largest acquisition to date in terms of the price tag. Where does our appetite for such a large bite come from? It comes from the first of the big forces at work that I noted earlier. Our strategy is to be the leader in providing the software ingredients of the software-defined data center. The whole data center industry is in the midst of a transition towards an architecture comprised largely of standardized hardware building blocks, that run under the control of layers of software.

This approach provides a significant advance in terms of data center automation, increasing not only scale and efficiency but agility too. One just has to look inside the data centers of the leading public cloud services to see this beginning to play out. Indeed, VMware helped lay the foundation for the seachange by pioneering server virtualization. By turning physical servers into software entities we were able to transform server automation and provisioning.

Now similar changes are starting to roll through other data center functions. By extending the virtualization approach to these functions, it will be possible to create virtual data centers on demand, largely in software. VMware has already started work on network virtualization in the context of our vSphere and vShield products.

With the acquisition of Nicira, VMware becomes well-positioned to provide virtual network functionality not just in the context of vCloud and vSphere, but to be able to provide it to other heterogeneous non-vSphere based pools of infrastructure as well. This represents a deepening and a broadening of our strategy.

Now this movement toward the software defined data center and software defined networking does not remove the need and opportunity for others in the industry to participate. We will continue to maintain our open approach and provide access to our networking technology and our APIs to our partners to allow them to add new value through both hardware and software enhancements, as well as by providing compatibility with existing systems. In this context, we look forward to continuing to work closely with Cisco and other ecosystem partners.

This will be my last call with you as CEO of VMware. I would like to thank the team here at VMware and in particular my partner, Carl Eschenbach, the members of our executive staff and the whole VMware community for their support and for the privilege of working with them.

As we noted last week this transition is made possible by three factors. Our business is fundamentally strong. We have a great leadership team in place at VMware. And we have in my friend and colleague of 30 years, Pat Gelsinger, a great leader to succeed me.

Lastly, you may remember that my arrival at VMware for years ago coincided with the start of the global economic meltdown. I am not sure I can assure you that my transition on will usher in the global recovery, but one can always hope.

Before opening up for questions I would like to invite Pat to say a few words and introduce himself.

Thank you, Paul. While I am not yet officially a part of the VMware team, Paul and Carl suggested I sit in on the call today to reaffirm the smooth transition we are committed to achieve. It is an honor to be asked by Paul, Joe, and the Board to step into the CEO role of VMware.

While Paul leaves enormous shoes to fill, I am excited with the opportunity to work hard to try to fill them. VMware is running extremely well as seen by this quarter's great results. I am excited about their strategic directions.

As Joe commented, in the executive transition call last week, the time for transition is from a position of strength and VMware is definitely in that position as I step into this role. I look forward to working closely with our customers, partners, and employees going forward.

With that let me hand it back to Mike.

Thanks, Pat. Operator, we are going to begin to join a process. Also for listeners, we are going to have three additional attendees on the Q&A part, three of our Finance Vice Presidents, [Robin Cisco], Pete Godbole and Francois De Lapin. Thanks. Let's begin the process.

(Operator Instructions). Kash Rangan, Merrill Lynch.

Thank you very much and apologies for the overhead noise here. Just some thoughts in follow-up to the question that I asked when you posted your call when Pat and Joe conducted a conference call. Pat and Paul, how do you see sell cycles changing as you uncover these large opportunities? Certainly you have talked about large deals in the pipeline and as as you roll forward in management and automation, hot should we think about new [can] ahead of you total available market and how you are going to be executing differently with your sales operations? That is it for me. Thank you.

Actually the best person to answer that question is Carl. Carl, do you want to jump in there?

Sure. Thanks, Paul. Thanks, Kash.

So as it relates to sales cycles we are selling a much more complex solution into the market and, specifically, around ELAs that include many of the adjacencies that we often speak about -- specifically management automation tools, some of our layer 2 assets that we have as well as our view components. And as these solutions sales become more complex the sales cycle at times may take a little bit longer.

At the same time if you look at the results from our ELA success here in Q3, we were very pleased to see that we had a solid quarter in ELA execution and we anticipate that moving forward.

As it specifically relates to your second question, around a total addressable market opportunity, as we look at software defined data centers and software defined networking, we clearly see a big Tam out there which is one of the reasons we went ahead with the acquisition of Nicira.

Brent Thill, UBS.

Paul, just on the acquisition, clearly a pretty big number. I'm just curious if you could just give us your sense of any other metrics on the run rate and maybe walk through what the competitive environment looks for them in this segment?

Two points there. One is is obviously where this acquisition was made because of its strategic value as opposed to its current revenue value. We believe that this Company VMware was founded because it was able to be early on a leader in the virtualization server space, and that has built a company of enormous importance and value in the industry. We see similar forces at work here as we move towards the software defined data center and we saw tremendous strategic value in being able to claim a position of leadership as we move into these new phases or of the softly defined data center.

So, obviously, given the size of the price tag, we believe that this is of the utmost strategic importance going forward.

And Paul, just as a follow-up from the competitive side. Are you seeing anyone else in the market that is doing something similar?

Yes. One of the other things that attracted us is that this asset was clearly a leader in this space. In that sense we believe it was a somewhat unique asset and we believe that this is going to strengthen our competitive position generally.

John DiFucci, J.P. Morgan Chase.

My question has to do with licensed growth. You did about 15% growth in the first quarter, 11% in the second quarter, reported anyway. I guess question is probably for Carl. I guess Carl, what gives you the confidence that you can get you can do 11% to 15% for the year especially given what you have referred to many times on the call as a decelerating demand environment. I know you spoke about your pipeline, but maybe you can give us perhaps more color around that to give us a little more confidence. Because it sounds like you are getting -- you have to put up a pretty strong fourth quarter.

Yes, sure. So, 90 days ago we had a different view of the world and the market specifically in Q3, when we said we would be sequentially flat from Q2 to Q3. But with the continued uncertainty in the macro that we are facing, specifically in Europe, we had originally thought that the government spend would pick up going into Q3, which it traditionally does because it is their fiscal year end.

We've revisited that earlier estimate and we have taken it down internally. The fact that we see traditional seasonality in Q3 compared to Q2 has taken us in a line to say our Q3 number will not be sequentially flat. In fact, it will be down from Q2 to Q3. With that being said, it is in line with what we saw last year. Last year we saw about a 5% deceleration in license in Q3 compared to Q2 and that is exactly where we have guided this year.

As it relates to Q4, again, we have a very robust pipeline. Q4 has -- always has been historically obviously the biggest quarter of the year for technology companies and we are no different. We also are excited about the lineup coming out of VMworld and we will have a lot of momentum as we head into Q4.

And lastly if you look at our growth that we are thinking about for Q4, it is in line with what we've seen from a Q3 to Q4 perspective over the last one to three years. So again, it goes back to the strength of the pipeline; it goes back to VMworld momentum. And it goes back to the fact that we expect [you] forward as we have always seen a flush of budgets as people spend money that they have in excess as they exit a fiscal year.

That's very helpful. Thank you. If I might just a quick follow-up. You did mention I think throughout the call I think just recently, with several acquisitions I believe it is four, and I know Nicira was certainly strategic value. However I believe [Rack Space] was using them and I assume others. What kind of a benefit recent license might we expect from all these acquisitions realizing there's mostly strategic value here, but there has got to be some kind of contribution to help some?

Obviously in the long-term -- sorry, this is Paul jumping in there. Obviously in the long term, we believe these will have enormous paybacks. But at this point in time, we are doing these to strengthen our technology portfolio and position ourselves for the future. So we are not expecting a significant revenue contribution this year. But in the years, subsequent to that, obviously, we believe in that.

Adam Holt, Morgan Stanley.

Thank you. I am actually going to ask two follow-up questions. One on Nicira and then one on the model, if I can. On Nicira there's no doubt that this market has got tremendous potential. But it's also a very early marketplace. Can you maybe walk us through what you saw or maybe some customer examples that got you comfortable with the maturity of the technology, certainly relative to some other nascent offerings as well?

Obviously Nicira is a company we have been aware of for some time. And we have got to know them over the last several quarters and had developed a deepening appreciation for both the people and the technology that they have there.

Now the fact is is they have customers who are starting to prove out this technology at scale in their data centers. They are in the data centers of many of the service providers -- Rack Space was already mentioned -- as well as starting to make inroads into our more advanced and thinking customers. So we see this playing out in a similar way to which we saw server virtualization play out which is the technology started coming to the more advanced forward-thinking customers.

And in that context being an early leader in these emerging spaces is incredibly important and we believe that establishing a position of early leadership here will pay off just as it paid off in server virtualization.

That is helpful. And then just on the model looked like you had a very strong quarter for ELAs. Looked like you potentially had a very strong quarter for new ELAs. Can you just talk a little bit about the dynamic between new business within the ELA -- ELAs this quarter versus, say, renewals in the quarter? Thanks very much.

As I said in my prepared remarks we were really pleased with the results of our ELA in the quarter -- ELAs in the quarter, powered by three ELAs of greater than $10 million as compared to none. I'm sorry four compared to none last year. And three of those four were net new ELAs and one was a renewal.

So both new ELA business was extremely healthy to your point and the renewal business remained healthy as well. This only shows the fact that customers continue to see the long-term value of our platform and are buying into two- and three-year ELA terms with us to continue to build out both their private and hybrid cloud platforms.

Heather Bellini, Goldman Sachs.

Good afternoon. I had two questions. The first one was what percentage of license bookings were related to management and also to end user computing? Those are stats you have given out in the past. And then, also, I don't know, Paul, if this is a question for you, but how do you see your success in the virtualization layer and the growing presence of customers using your automation solutions, helping to position you for the SDN space. I'm wondering how to you see those other two layers as a competitive advantage and how you see them, the solutions, getting sold over time? Thank you.

I will take the first question. As you know, we don't break out individual products or product suites like management or end-user computing, particularly View, but we have said in the past that we have been happy with our attach rate as a percentage of license and it was about 10% for each -- both management and end user computing. And that is about exactly what we saw this quarter as well. Paul, on the second question.

So, Heather, as you've heard us say before, we believe at the end of the day we are in the data center automation business. And to be in the data center automation business, one has to be able to speak to the automation of all the key functions in the data center.

So, having the ability to play in the software defined networking space we see is very important when you combine it with our traditional strengths in server virtualization and in management and in other areas, such as security, which we are addressing through our vShield products. So we believe that success in the long run comes through the coordination of all of the factors that play in the data center. And as such this is a very important step in that direction.

And I guess, Paul, just to follow up was the networking space a bottleneck in the past for people modernizing their data centers to get to where you envision them needing to be?

Yes. Particularly as you move to larger scale data centers. The networking has proved to be a real issue that has to be addressed which is why you see this technology being adopted, first in the data centers, the public cloud data centers that already have to have confronted these issues.

Walter Pritchard, Citigroup.

Two numbers questions. First, just curious. The long-term deferred revenue here continuing to grow a lot faster than the short-term deferred revenue and I'm wondering is licensed amendable driver of that long-term deferred revenue number?

I'll take that. So it is a combination of things. As we do more ELAs, they include typically two and three years of maintenance which drives our longer term revenue deferral. As well as more and more about ELAs have aspects or characteristics of them that have us taking the license revenue ratably over time. And they are two determining factors in the growth of the long-term unearned revenue.

And then, just on the linearity in the quarter, looks like DSOs spiked up a bit, the AR balance is a little higher than we were expecting. I'm interested if you could comment on what you saw throughout the quarter and was it a more backend-loaded quarter than you typically have seen in a Q2 or any other quarter?

Yes, the reason you saw that spike up is not from any deterioration in our receivables, it is actually due to the strong billings that we had coming out of Q4 which makes our cash receivables and collectibles in Q1 strong. And here in Q2, obviously, the bookings weren't as strong as they were coming out of Q1 as they were compared to Q4. And that is what is driving the difference of a couple of days in the DSOs.

Rick Sherlund, Nomura.

There were some press reports earlier I wanted to get you to comment on about possibly spinning out some of the cloud assets.

Two points. First of all, just want to draw a line under the fact that we see the cloud investments we've made such as cloud foundry as being absolutely critical and if anything we intend to put further emphasis behind those assets going forward.

Second point is as I transition out from the CEO role here one of the things I am going to be doing is thinking about actually is to how to use those assets even more effectively in the future and there's more thinking to be done on that front. But we have no specific plans at this point in time.

Okay and just on the ELA environment, sometimes when things get tougher in the economy, ELAs are the areas that you see some increasing sales cycles. People cut back, yet in the quarter it looks like ELAs did quite well. It sounds like you are a little more cautious about ELAs going forward. Is that -- does that reflect in the environment?

I think it is a couple of things. Again, I think seasonality has us being a little bit cautious as we enter into Q3. We typically see a decrease in our ELA as a percentage of total bookings as compared to Q2. But again, I think we were pretty pleased with the fact that while some of these larger deals are getting scrutinized by another set of eyes in our customers, we were still able to close the business in a timely manner which shows the value of the platform and the fact that the customers wanted to commit to long-term agreements with VMware, despite the tough economical challenges they are faced with today.

Phil Winslow, Credit Suisse.

Just got a question on the management tools side and, particularly, vCloud Director. Just wondered if you could give us an update there just this quarter and then as you look into the second half of this year and the next year, how you are expecting those test environments in that pipeline to translate into bookings revenue?

As I said earlier, we don't break out specific product lines as a percentage of license, but I did say that we were very pleased with the adjacency attach rate on ELAs and non-ELAs, specifically around management and automation. We are pleased with the uptake of vCloud Director and we are really excited with the fact that we are bringing in DynamicOps to manage more than just VMware environments as well.

So those two combinations, those two as a combination gives us a lot of excitement as we look at the second half of the year. And we believe the attach rate to ELAs could only strengthen moving forward.

Take that as well. This is Paul. This is an area where we continue to move the ball down the field and as was noted in our earlier remarks, come to VMworld's this year we expect to see really interesting new functionality disclosed then.

Brian Marshall, ISI Group.

Congratulations on the Nicira's transaction. It is obviously pretty exciting. Our understanding is basically their solution decouples the application from the network and basically cuts that fiscal IP address link from the VM to the physical network itself. Therefore, is this kind of viewed more of a business [velocity] play as opposed to a CAPEX or an OpEx play? And if that is the case, is that why some of the partners that you have today on the networking side might not view this transaction in all that unfavorable light? Thanks.

As I said earlier, this is ultimately all about automation. What people want to do is to be able to synthesize pools of infrastructure on the fly to satisfy the needs of a particular set of applications or a customer and to be able to then reconfigure that as business needs change. So within a world where automation is the goal, as I said earlier that doesn't preclude the need or the opportunity to have specific solutions that can work along with the basic layer of control that is providing the automation. So we don't see this as a zero sum gain by any manner of means.

Mark Moerdler, Sanford Bernstein.

This series looks like a really interesting acquisition. So how do you plan to rationalize the sales model of the cloud-enabling technologies you have already acquired and are acquiring between some being open source, some license and maintenance? What is your sense of what is going to be the right methodology?

I can jump in there and handle that. We are ready have a blended strategy where we use both traditionally licensed software and open source software. So that is nothing new. And I think everyone in the industry today to a greater or lesser extent has to deal with that. But the thing at the end of the day is is the customer getting value and they can get that value from either purchasing the software or purchasing the support that goes around that software or purchasing got value-added components that plug into that.

So we already have that aspect to our product line. We are able to deal with it in a fairly straightforward way. Generally received positive reaction from our customers and we don't expect that to change.

Do you think that will be a similar type of mix in the cloud?

Yes and as I said, I think everyone has had to come to grips with that. There are some things that have to be supplied if you want them to become widely adopted through an open-source model. But there always has to be value added. At the end of the day, our salaries have to get paid one way or the other. And customers realize that and they are willing to pay for additional value.

Laura Lederman, William Blair.

When you look at the software to find networking space, do you think we are three years from general acceptance where it is not just large service providers in the most forward-looking type of organizations? And maybe we can talk about the lifecycle of that type of product and when you see it being more mainstream or any way you wish to outline how you expect it to happen over time?

Obviously we are on day one of this acquisition so it's a little early to give you specific time frames here. But as with any new technology, we see it operating into either people who have an immediate overwhelming need for it today or into more forward-thinking customers who anticipate their needs for it, and start moving early. And we see this technology unfolding exactly that way. We see it going into large-scale service providers who have an immediate need for it, and we see it starting to go into forward-thinking corporate customers.

Whether that is going to be a two-year cycle or a three-year cycle, I can't say to you today but the one thing I can say with absolute certainty that this is the tide coming in.

Have customers asked you for this type of technology? Is it something that has been coming up a lot when you are talking to more forward-looking customers, let's say, in financial services or their industries?

It is coming as you said from the two constituencies that I said and it was exactly the same thing with virtualization. Customers didn't ask us for virtualization 12 years ago.

Operator, we are going to take two more questions.

Jason Maynard, Wells Fargo.

I have a question probably for both Paul and Pat. And following up on this thread, taking Nicira out of the equation for a second, what percentage of let's just say the traditional networking space do you think OpenFlow could realistically address within five years question mark and then the follow-up question to that would be, Google has been a big proponent of this and if you look back over the last couple of months, they have even had a lot of public events where they have been talking about their own implementation.

And one of the bottlenecks it sounds like has been there is no white box networking champion. There isn't somebody who provides just a basic switch with merchant silicon to actually provide, if you will, the building block.

And I am curious how do you see that playing out in terms of your own rollout and go to market with customers? Is that something that VMware would potentially do. Is it something that EMC does? Does this sit inside of a VCE or is there a third-party ecosystem that you think could emerge to address that issue?

Thanks, guys.

Maybe I will start and Paul might help. But with regard to the size of this market, I think it is very early to put a particular tam on it. Overall the networking market has pretty well diagnosed how large it is. And this is not so much about changing how the networking market operates today, but creating a layer of agility and management control for these large-scale service providers for the future.

And in that sense, I think there has been much written that would say it is all about commoditizing today's hardware and we actually take a very different view of that. It is about creating this automation and this next layer of flexibility for these large-scale service providers. And that is why we are finding this to be such an interesting opportunities so complementary to the value proposition that VMware has been pursuing in the past. With regard to white box networking and some of those types of things that have been discussed, we have no plans in that area whatsoever.

Shaul Eyal, Oppenheimer.

Good afternoon. One quick question on your relations with Cisco. You know, Nicira, I think given some of the chatter in the Bay Area seems to be one of the companies that could be described as being disruptive to fiscal strategy and what is fiscal's involvement with you guys. How would you describe this business triangle between the three companies?

First of all as I said earlier we don't see this as a zero sum game particularly if you take Pat's previous remarks. This is really about building of a layer on top of existing and future network functions and there is always going to be the opportunity for people who can do things well within their layer to reach up and ask the automation layer to delegate a task to them and have that task performed and accelerated in a superior way.

So we see the opportunity here really to continue to build and extend the ecosystem rather than this as being something that is an A versus B approach.

Thank you for that and good luck.

Thank you.

Okay, thank you. That will end the call.

Thank you for joining today's conference. That does conclude the call at this time. All participants may disconnect.