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VMware (NYSE:VMW)

Q2 2011 Earnings Call

July 19, 2011 5:00 pm ET

Executives

Paul Maritz - Chief Executive Officer, Director and Member of Mergers & Acquisitions Committee

Mark Peek - Chief Financial Officer and Co-President of Business Operations

Michael Haase - IR

Analysts

Adam Holt - Morgan Stanley

Brent Thill - UBS Investment Bank

John DiFucci - JP Morgan Chase & Co

Heather Bellini - Goldman Sachs Group Inc.

Philip Winslow - Crédit Suisse AG

Walter Pritchard - Citigroup Inc

Michael Turits - Raymond James & Associates, Inc.

Robert Breza - RBC Capital Markets, LLC

Israel Hernandez - Barclays Capital

Gregg Moskowitz - Cowen and Company, LLC

Kash Rangan - BofA Merrill Lynch

Operator

Welcome to the VMware Second Quarter 2011 Earnings Call, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn today's meeting over to Mr. Mike Haase, Vice President of Investor Relations. Mr. Haase, you may begin.

Michael Haase

Welcome to VMware's Second Quarter 2011 Earnings Conference Call. On the call, we have Paul Maritz, our CEO; and Mark Peek, our CFO. Following their prepared remarks, we will take questions. Our press release was issued after close of market, and is posted on our website where this call is being simultaneously webcast.

Statements made on this call include forward-looking statements such as those with the words will, believes, expects, continues and similar phrases that denote future expectation or intent regarding our financial outlook, product offerings, customer demand and other matters. These statements are based on the environment as we currently see it, and are subject to risks and uncertainties. Please refer to the press release and the risk factors and documents filed with the Securities and Exchange Commission, including our most recent reports on Form 10-Q and Form 10-K for information on risks and uncertainties that may cause actual results to differ materially, from those set forth in such statements.

In addition, during today's call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware's performance, should be considered in addition to and not as a substitute for or an isolation from GAAP measures. Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax and employee stock transactions, the net effect of amortization and capitalization of software, acquisition-related items and the gain from the sale of our investment in Terremark. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures, in the press release and on the Investor Relations page of our website.

The webcast replay of this call will be available for the next 30 days on our company website under the Investor Relations link. Our third quarter quiet period begins at the close of business, September 16, 2011. For your planning purposes, VMworld, the leading virtualization and cloud infrastructure event of the year will be held in Las Vegas from August 29 through September 1. As part of VMworld, we will be hosting our Analyst Day on Tuesday, August 30.

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

Mark Peek

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

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

Trailing 12-month free cash flows were $1.6 billion, an increase of 56% from a year ago. Our balance sheet remains strong, with cash and investments of $3.7 billion and unearned revenues of $2.1 billion.

Our results speak to the value of our products. vSphere is the most trusted, widely deployed virtualization platform in the world. Last week, we announced vSphere 5 and a comprehensive suite of cloud infrastructure technologies to not only help customers virtualize their cloud applications, but also help them build and operate modern data centers with cloud architectures. With the introduction of VMware vSphere 5, VMware is evolving the product's licensing to lay the foundation for customers to adopt a more cloud-like IT cost model based on consumption and value rather than physical components and capacity. We are extending our focus beyond delivering virtual infrastructure with vSphere to complete cloud infrastructure suite. We expect these new releases to become generally available in Q3.

With nearly 200 new and enhanced capabilities, vSphere 5 will continue to set the standard in virtualization, delivering better application performance and availability for business-critical applications while automating the management of an increasingly broad pool of data center resources. Paul will speak more to vSphere 5 and cloud infrastructure technologies.

As I mentioned during last quarter's call, we integrated more than 300 people from EMC's Mozy and Cloud Services group in April to further strengthen our cloud initiative. We also closed the acquisitions of SlideRocket, SocialCast and Shavlik during the quarter, and welcomed about 200 new employees from these acquisitions to VMware. Finally, we announced the acquisition of Digital Fuel, which closed in early July. We're very pleased with our results for the first half of 2011 and want to thank all the people of VMware, our partners and our customers.

Now I'll walk you through the financial details. Total revenues for the second quarter were $921 million, an increase of 37% from a year ago or 35% on a constant currency basis. The quarter was characterized by strong demand in the U.S. and across our international markets.

License revenues were $465 million, up 44% from last year, driven largely by strong global demand for vSphere, record ELA bookings as a percent of total bookings, including several deals that renewed early, and a net decline of $11 million on earned license revenue. License growth on a constant currency basis was 40%.

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

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

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

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

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

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

Professional services revenue was $70 million, up 17% from last year. The increase was driven primarily by our continued M&A activity and a higher attach rate for professional services with large deals.

Total unearned revenues ended the quarter at $2.1 billion, up 5% sequentially and 41% from a year ago. The complexity of our unearned revenue has increased over time as a result of acquisitions and expanded product portfolio and a broader range of pricing and packaging alternatives. Over 80% of our unearned revenue represents software maintenance that will be recognized ratably with the passage of time. Approximately 12% of unearned revenue is software license revenue, which will be recognized either ratably, upon product delivery or upon product release. In addition, approximately 7% of unearned revenue is the result of prepaid professional services, including training, which is recognized as the services are delivered.

Although we are pleased with our record second quarter financial results, our license revenue growth clearly benefited from a good number of ELAs that renewed early. We will not have this benefit in the third quarter and would expect ELA bookings to decline as a percentage of total bookings. And with our recent announcements of vSphere 5 and cloud infrastructure suite, there's also the potential for short-term disruption in the sales process and close rates, as our extensive set of ecosystem partners begin to go to market transition. In addition, while the third quarter is traditionally strong for the U.S. Federal Government, growing uncertainty related to the federal budget has caused us to revise our earlier estimates downward for this sector.

With this backdrop, we expect third quarter revenues to be within a range of $915 million and $940 million, or a year-over-year growth of between 28% and 32%. License revenues in the third quarter are anticipated to be down 5% to 10% sequentially from the very strong second quarter. For the year, we are expecting total revenue of between $3.65 billion and $3.75 billion or growth of 28% to 31% compared to 2010.

I'll now provide some details on our operating expenses. Unless otherwise noted, all references to our expenses and operating results are on a non-GAAP basis, which are reconciled in the press release tables and posted on our IR website.

Our Q2 operating profit, measured on a non-GAAP basis, was a record $291 million or 31.6% of revenue compared with 29.9% in Q1 2011 and 27.7% in Q2 2010. The increase was primarily driven by operating leverage on our license revenue growth.

Our non-GAAP results exclude the $56 million gain we realized from Verizon's second quarter acquisition of Terremark. During the second quarter, we added over 1,000 employees, approximately half through acquisitions and Mozy. We ended the quarter with approximately 10,400 employees, up 1,400 from the beginning of the year. We expect to continue to hire at a brisk pace in the second half of 2011.

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

Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call, we expect our operating margins in Q3 to decline sequentially to between 28% and 29%. The decline is primarily as a result of increased expenses associated with our increased headcount and recent campus expansion. For the full year 2011, we expect the non-GAAP operating margin to approach 30%.

The GAAP operating margins for the third quarter and full year 2011 are expected to be approximately 11 to 14 percentage points lower than the non-GAAP operating margins. Although there is opportunity to expand margins at this level of scale, we fundamentally believe it is the wrong approach at this time and are building our investment model, assuming we will continue to hire high-quality engineering talent and rapidly expand our international market opportunity. The opportunities we are seizing and the investments they require are not trivial. Expect us to continue on a rapid M&A and hiring pace which can cause lumpiness in our quarterly financial results.

Now on to our balance sheet and cash flow statement. Our balance sheet remains strong with cash and short-term investments at quarter end of $3.7 billion. During the quarter, we used nearly $600 million in aggregate for M&A, routine CapEx, the purchase of property related to our Palo Alto campus expansion and our share repurchase program. The expansion of our Palo Alto campus included $225 million for the acquisition of a land lease with Stanford with 70 acres which provides us the opportunity to add about 1 million square feet adjacent to our existing Palo Alto campus over time and as needed. Our Palo Alto campus is now 100 acres and provides us with the necessary room to expand for the foreseeable future. For your planning purposes, the capital expenditures related to our campus expansion will be approximately $50 million in the second half of 2011. This will be a multiyear project, and we believe it is a great investment in one of the best locations for engineering and innovation in the world.

Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock compensation, were $539 million during the second quarter and $1.8 billion for the trailing 12 months. We adjust our operating and free cash flows for excess tax benefits because it converts to cash or reduces our tax liability. Free cash flows for the quarter were $443 million. Total capital expenditures were $95 million of which $53 million was related to our campus expansion. For the trailing 12 months, free cash flows were $1.6 billion. Free cash flow per diluted share was $1.03 for the quarter and $3.64 for the trailing 12 months. As we have mentioned, free cash flow per share can be volatile in the short term so we believe looking at it over a trailing 12-month period is a better indicator of progress. As referenced earlier in the second half of 2011, free cash flows will be impacted by the planned $50 million in capital expenditures related to the design and renovation work related to our campus expansion. The fully diluted share count increased to 430 million shares for the second quarter. We expect our share count will be within a range of 430 million and 440 million shares for the balance of the year.

To summarize, we are very pleased with our execution and solid second quarter performance. We continue to manage our resources prudently while making the key investments necessary to maximize our long-term growth and free cash flow per share. Paul will now make a few remarks before we take questions.

Paul Maritz

Good afternoon. I would like to give you an update on our product and M&A activities over the previous quarter. As Mark noted, we took a big step forward with the release of vSphere 5 into production. This is a major release in several dimensions. In terms of vSphere itself, the release provides major new functionality in terms of scale and automation. To highlight just a few new features, we can further scale to handle the heaviest workloads, providing virtual machines with up to 1 terabyte of virtual memory and up to 32 virtual CPUs. We could optimize storage usage and performance with the automatic and dynamic placement of virtual machines. We have significantly improved the ability of vSphere to run workloads in a nonstop fashion, and we've significantly improved the automatic installation and configuration of vSphere itself. All of this is being done in partnership with a growing ecosystem of over 500 hardware and software partners who directly interact with and/or certify with vSphere.

Equally importantly, we announced the creation of the industry's first complete cloud infrastructure suite, comprising vSphere itself, the vCenter Site Recovery Manager for cross data center business continuity, vShield for virtualized security and edge functions, vCenter Operations for modern infrastructure, management and monitoring and vCloud Director for multi-tenant provisioning of resources, policy setting and self-service. The strengthening of vSphere will enable us to accelerate our customers on the journey to high levels of virtualization and the suite will allow us to amplify the value they derive from their virtualized infrastructure. We've also increased our focus on SMB. As part of vSphere 5, we'll be releasing a virtual storage appliance that will unlock many vSphere benefits for smaller customers who can't afford the cost or complexity of an external storage array.

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

For vSphere 5, we also announced that we are replacing the previous limits on the number of CPU cores per license, and instead using, as a metric of scale in value, the total amount of virtual memory being actually used across an entire group of physical machines. We believe that this is a better metric for the future as customers move to operating in a more cloud-like way. Customers wish to pay for what they're actually using and have the license cost scale with actual load.

There has been a fair amount of debate and comment on this since we announced vSphere 5 last week. A lot of it stems from the confusion that physical RAM, which is fixed and which we do not use as a metric, with pooled virtual memory that varies with load. We believe under the new model, 95% of our customers will see no change to their licensing costs. It's only as customers move to very high levels of consolidations and start driving their infrastructure to high levels of utilization, deriving the associated incremental value that licensing costs will commensurately scale. We're working closely with our customers to explain this, provide background material and get their feedback.

Moving up the stack in functionality, we delivered 2 major releases in the dimension of our higher-level application platform and development capability. We released vFabric 5, the next iteration of our middleware collection, further optimizing it for the virtualized environment. We released Cloud Foundry, our next-generation environment for developing and deploying applications written to higher level frameworks in the cloud. Both of these releases had been well-received by the developer community, with over 25,000 developers signing up for Cloud Foundry.

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

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

Finally, I would like to note that vSphere 5 is our third release of vSphere since 2009. And as a testament to the hard work and discipline of our development teams, putting out these releases on schedule with high quality, in partnership with a large ecosystem is no small achievement. It is their effort that is enabling us to stay ahead of our competitors. And with that, we'll open up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Adam Holt of Morgan Stanley.

Adam Holt - Morgan Stanley

My first question is about, I guess, the pull forward early renewal on some of the ELAs. Why do you think that would happen? And do you think there might have been any forward buying in front of the 5 release?

Mark Peek

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

Adam Holt - Morgan Stanley

And just a quick follow-up on 5. Historical releases have been, in some cases, pretty significant catalysts. What impact do you expect 5 to have on license revenue over the next several quarters? And if the price increase is relatively small at the high end, does that factor even at all into your forward thinking on guidance?

Mark Peek

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

Operator

And our next question comes from Israel Hernandez of Barclays Capital.

Israel Hernandez - Barclays Capital

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

Mark Peek

On the ELA pool, it is the 3-year anniversary and our ELAs typically run on 3-year cycles. We had some very large ELAs that closed in the fourth quarter of 2008, and we don't anticipate that they will be in for renewal in Q4 of 2008 so it's factored into our guidance. And why we believe ELAs as a percentage of total bookings, there will be some softness in the second half of 2011. With respect to Europe and our linearity, our quarters, first of all, continue to be very back-end loaded and particularly with the strong ELA performance in the second quarter. This was even more so, and we continue to be cautious on Europe given the economies and some of the sovereign nation concerns that exist; and the fact that in many cases, the verticals are dominated by the governments. If you think of healthcare and education, in particular in Europe, those are sectors that the government has a significant influence on.

Operator

And our next question comes from Kash Rangan of Merrill Lynch.

Kash Rangan - BofA Merrill Lynch

Paul, I think you said on the vSphere 5 launch that you expect 50% of the workload to be virtualized by the end of this year. But I'm wondering how should we look at that relative to the growth rate that the company has been putting on which has been very solid. What does that mean in terms of the future growth opportunities, in terms of magnitude that are still left ahead? Because the 50% cutoff seems to concern some of us, just looking to get your comment on that. And as relates to the guidance, Mark, do you -- it looks like talking about a few risk factors out there, but your guidance actually sounds very good. And I'm wondering if you can give us a little bit more color on those issues that you might be thinking about in your future as it relates to the pricing, the channel training, the macros, et cetera?

Paul Maritz

This is Paul, kasha. Actually what I said at the launch was, with vSphere, I believe the analyst figures is some time over the next 12 months or so we're likely to have cross over the 50% threshold. That said, we believe fundamentally good news. Remember that we essentially drive our business out of the applications that are running on virtualized infrastructure. And as such, we have both the existing pool of applications to address, as well as new applications that are coming into the pool all the time. So that pool's not static, the pool is itself growing. Secondly, with the introduction, in particular, of the suite now and other investments we are making, we are seeking to not only accelerate our customers' investment in virtualization but actually amplify it by being able to offer additional functionality to enable them to get additional value out of their virtualized infrastructure so seeking to both accelerate and amplify. Thirdly, is that we believe that we still have untapped markets, particularly in the SMB space and in new geographies of the world. So it's for that reason that over the last, as Mark said, over the last several years, we've been investing and will continue to invest, in particular, developing economies of the world and with the acquisitions and developments we've announced now increasing our focus on the SMB end of the market. Mark?

Mark Peek

Kash, on the guidance. A quarter ago, we had indicated that we believe the second and third quarters would be very close from a license bookings perspective. But given the strong license bookings that we had in Q2, we just wanted to highlight a couple of items. First, we had -- deferred license revenue decreased by approximately $11 million. We don't expect that to repeat itself in the third quarter. We also had an FX tailwind of about $11 million in the quarter. And so we've taken that out as we've factored in guidance. We also, as we looked at the pipeline and looked at the ELAs as they are playing through and then factored in that this is the U.S. federal government's year end and that there are a lot of questions about the budget and the impact that the budget will have on IT spending, internally we have, as we've thought through the process, we've brought down our expectation on the U.S. government bookings. Those are the major influences of our guidance. But overall, it's an increase in guidance modestly from where we were a quarter ago.

Operator

And our next question comes from Walter Pritchard of Citi.

Walter Pritchard - Citigroup Inc

Two questions. Just, Mark, quickly on the FX. Was that the sequential impact on FX, the $11 million? Onto revenue?

Mark Peek

Yes.

Walter Pritchard - Citigroup Inc

Great. And then, Paul, just on vFabric and vSphere v5, I'm just wondering, you guys have sort of slowly but deliberately been moving towards trying to bring Java workloads onto the platform. And I'm wondering, with the confluence of vFabric, a new release there as well as v5, I'm wondering if you could articulate sort of are you at a point now that you think you'll see an acceleration in Java workloads on the VMware platform?

Paul Maritz

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

Walter Pritchard - Citigroup Inc

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

Paul Maritz

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

Operator

And our next question comes from Phil Winslow of Crédit Suisse.

Philip Winslow - Crédit Suisse AG

Just had a question on vCloud Director, just what's been the feedback of that so far? And also just sort of the acceptance and kind of where that's standing in sort of just in relation to your expectations when it was launched?

Paul Maritz

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

Operator

And our next question comes from Brett Thill of UBS.

Brent Thill - UBS Investment Bank

Paul, just on vSphere 5, what market do you think opens up a new opportunity for you? There seems to be a lot of new storage features. Can you just talk through -- I know there's a lot of features, but is there a particular market that you're excited that this really opens that wasn't available to you before? And I had a quick follow-up for Mark.

Paul Maritz

Well, it's really a combination of opening up new use cases which then enables our customers that may take greater advantage of a virtualized approach to infrastructure across the board. So what you've seen us do is strengthen features, both at the very high end that allow us to, as I said, address Tier 1 mission-critical loads more effectively than we did in the past and at the low-end with the inclusion of things like the virtual Storage Appliance allows to scale down even smaller customer environments. But across the board, what we're trying to do is to increase the level of automation because at the end of the day, beyond saving customers' capital expense, the bigger goal is to save our customers' operational expense. They fundamentally want infrastructure just to be something that, figuratively speaking, they can forget about. And that's where we're working towards.

Brent Thill - UBS Investment Bank

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

Mark Peek

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

Operator

And our next question comes from Heather Bellini of Goldman Sachs.

Heather Bellini - Goldman Sachs Group Inc.

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

Paul Maritz

Well, I think you can make really a dramatic difference. You probably need to go back 2 years or 3 years. 2 to 3 years ago, it was purely about vSphere as a technique of saving capital expense, just putting the hypervisor on the hardware and getting greater server consolidation. Now the discussion is much more about how do we do computing so we're -- as Mark said, we're seeing an increasing percentage of our ELAs, including the adjacent products, the management suite, the vFabric View, et cetera so it reflects customers looking at this as rather than a simple ingredient into their environment, it's actually looking at this as a foundation that they're going to do a bunch of things on. And that's led to the dynamics that Mark was just talking about in terms of our ELAs.

Heather Bellini - Goldman Sachs Group Inc.

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

Paul Maritz

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

Operator

And our next question into comes from John DiFucci of JPMC [JPMorgan Chase].

John DiFucci - JP Morgan Chase & Co

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

Paul Maritz

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

John DiFucci - JP Morgan Chase & Co

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

Paul Maritz

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

John DiFucci - JP Morgan Chase & Co

That makes sense. Just one quick one for Mark. Just to follow up to [indiscernible] question, Mark, on EMEA. And you said business was strong across all geos, but you see international I think grew 38% versus U.S., 35%. And you actually called out APAC as being particularly strong. Can you break out EMEA for us on a growth rate or even roughly break it out within international?

Mark Peek

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

Operator

Our next question comes from Robert Breza of RBC.

Robert Breza - RBC Capital Markets, LLC

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

Mark Peek

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

Operator

Our next question comes from Gregg Moskowitz of Cowen.

Gregg Moskowitz - Cowen and Company, LLC

With vSphere 5, the pricing for Essentials Plus will be, I believe, I think $1,000 higher per CPU than it was under vSphere 4.1. Clearly, that would seem to reflect a lot of optimism around the SMB segment. But if you could perhaps speak to your expectations around buying behavior in the SMB, as well as elasticity of demand and the value profit you have there, that would be helpful.

Paul Maritz

Well, as I said earlier, we've been gratified by the success that we've seen with vSphere Essentials, clearly delivering a lot of value to customers. And with the new features coming in, we think that the price is justified.

Gregg Moskowitz - Cowen and Company, LLC

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

Mark Peek

I'm sorry, Greg, was that the sequential change or the?

Gregg Moskowitz - Cowen and Company, LLC

Correct, Mark. Sequential.

Mark Peek

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

Operator

And our last question will come from Michael Turits of Raymond James.

Michael Turits - Raymond James & Associates, Inc.

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

Mark Peek

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

Michael Turits - Raymond James & Associates, Inc.

I guess my question is less on collections that are on term length because I think, maybe I'm wrong, but I think the term length tends to be longer and is paid upfront on ELAs than on non-ELAs.

Mark Peek

Yes, the average term, the average maintenance length across all licenses sold is 24 months and we require 1 year with each license sold regardless of the channel. For ELAs, it tends to be 3 years.

Michael Turits - Raymond James & Associates, Inc.

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

Mark Peek

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

Paul Maritz

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

Operator

Thank you for participating.

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