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VMware (NYSE:VMW)

Q1 2012 Earnings Call

April 18, 2012 5:00 pm ET

Executives

Michael Haase -

Mark S. Peek - Executive Officer

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

Analysts

Brian Marshall - ISI Group Inc., Research Division

Kash G. Rangan - BofA Merrill Lynch, Research Division

John S. DiFucci - JP Morgan Chase & Co, Research Division

Laura Lederman - William Blair & Company L.L.C., Research Division

Adam H. Holt - Morgan Stanley, Research Division

Mark L. Moerdler - Sanford C. Bernstein & Co., LLC., Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

Heather Bellini - Goldman Sachs Group Inc., Research Division

Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

Brent Thill - UBS Investment Bank, Research Division

Philip Winslow - Crédit Suisse AG, Research Division

Jason Maynard - Wells Fargo Securities, LLC, Research Division

Operator

Welcome, 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 would now like to turn the call over to Mike Haase, Vice President of Investor Relations and Treasury. Sir, you may begin.

Michael Haase

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.

Mark S. Peek

Thanks, Mike, and good afternoon, everyone. The financial and business results of 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 to 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 the new release expected to be launched in the second half of the year. We were 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 Virtual Center 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 VCOps since its original release 1 year ago has been strong, and feedback from our most recent release has been encouraging.

This month, we recognize the 1-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. 4 of the 5 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 customer to 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 were 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 $1,055,000,000, 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 2 transactions of $10 million or more. For comparison, we had 5 transactions of $10 million or more in the first quarter of 2011. Blended vSphere ASPs were down from the previous quarter, reflecting strong demand for our 2 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 Enterprise SKUs, Enterprise and Enterprise Plus, increased slightly compared to Q1 2011.

We're 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.

U.S. 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'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, 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 their strong commitment to VMware as 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 and expanded product portfolio and a broader range of pricing and packaging alternative. 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. 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, U.S. federal spending outlook and the volatility we're observing in the world economy and individual sovereign nations. With this backdrop, we expect second quarter revenues to be within a range of $1,100,000,000 to $1,120,000,000 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're 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 we'll 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 within 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 onto 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 and 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 months 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 million to 440 million shares. To summarize, we're 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.

Paul A. Maritz

Thanks, Mark. As you can tell from Mark's remarks, we laid a firm foundation for 2012 despite lingering concerns about fragility of the macroeconomic environment. We believe that this foundation reflects the ability 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 back-end or the data center, centered on vSphere and the vCloud suite of infrastructure and management products for the private and public cloud. We're also investing in front-end infrastructure, building off our VDI View investments providing a suite of products with a 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 3 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 aspect of operating infrastructure in a modern, cloud-like manner, that does introducing a set of professional services offerings under the label Accelerate Advisory Services. The IP behind these services will be available to our [Audio Gap] 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 their careful scrutiny of deals.

This will be my last earnings call with Mark. I think we have now done 16 of these calls together, and I would like to thank him for what 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 a no part -- no small part a testament to Mark's leadership and wisdom. Equally importantly, Mark has built a strong finance team. They, combined with the 3 experienced CFOs that serve in our Board of Directors, will stand us in good stead for the future. So thanks, Mark. We will miss you, but though you will no doubt have the pleasure of taking questions in a future capacity from many of the same folks on this call.

Lastly, I'd like to welcome Carl Eschenbach, who's 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's good to be able to call upon his skills and experience. So with that, we'll open up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question's from Heather Bellini. Okay. The next question's from Brian Marshall.

Brian Marshall - ISI Group Inc., Research Division

I 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 -- it's kind of my calculation, I estimate that roughly 30% of the ELAs are actually -- or 30% of the ELAs have an attached to that management tools and automation. Can you talk about, if those numbers are roughly accurate, how it's progressed throughout the year?

Mark S. Peek

Yes, Brian, this is Mark. Overall, we don't break out product revenues by category. Management on 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 renewal -- renew, we have a strong attach weight -- rate with management and automation products. But other than that, we're not getting into the specifics of attach rates or percentages.

Brian Marshall - ISI Group Inc., Research Division

It's safe to say that the ELAs or most -- or the management tools and automation is mostly associated with the ELA business today?

Mark S. Peek

Yes, they're more closely associated with Enterprise License Agreements as opposed to single unit channel sales.

Operator

Next question is from Kash Rangan.

Kash G. Rangan - BofA Merrill Lynch, Research Division

One question for you on the management bookings. So I think last quarter or 2, it was about the 10% range. Just curious if we should be expecting this to trend higher because the obviously, the 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.

Mark S. Peek

Thanks, Kash. Again, the management tool 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 U.S. 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's safe to say that we're optimistic about those product offerings and the building off the vSphere platform.

Operator

The next question is from John DiFucci.

John S. DiFucci - JP Morgan Chase & Co, Research Division

I have a 2-part macro question. Mark, you mentioned that Europe and federal government is 2 areas that you're keeping an eye on and perhaps you could see some weakness from there. But I guess we have seen some weakness from there already. You did say international strength was driven by strong APAC, but you did say Europe did grow due to U.K. strength. I just wondered if you could give this -- I mean, 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 can you give us anything more on that? And also you did not mention financial services. And I know it's 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 financial services companies?

[Technical Difficulty]

Mark S. Peek

Public sector in general as we are entering an election year, and so there's additional uncertainty as a result. And as we look at the forecast on the business, we're just approaching that with a certain amount of caution. And then -- we're okay? Sorry, I understand we're experiencing a little bit of technical difficulty, so I'm not sure that -- that clear that you're hearing us, but now I'm pretty sure that you are.

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's 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 U.K. And then you'd asked the question -- and also I 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's part of the overall macro as we look at guidance going ahead for the year.

Operator

The next question is from Laura Lederman.

Laura Lederman - William Blair & Company L.L.C., Research Division

I'd like to talk a little bit about desktop virtualization. You talked about how much the management tools are 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 and non-ELA business? Just give us a little color on desktop.

Mark S. Peek

Sure, Laura. Yes, overall, the end-user computing group was 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 experienced from the management products.

Laura Lederman - William Blair & Company L.L.C., Research Division

And a related question as well, can you talk a little bit about big deals in the desktop size, the numbers, are you mainly selling it to less than 10,000 seats or you're also selling a lot of big, multi -- tens of thousands seats as well?

Mark S. Peek

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

Operator

The next question is from Adam Holt.

Adam H. Holt - Morgan Stanley, Research Division

You had another good ELA quarter despite a difficult renewal comparison on the renewal of 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?

Mark S. Peek

Well, Adam, we don't break it out specifically, but we look at all of the opportunities. And just as a reminder, the ELA -- in a perfect linear world an ELA will renew in the quarter at which it expires, but the actual behavior that we see is that frequently the -- any ELA that closes in a given quarter, there's 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 of it as the way to total bookings.

Adam H. Holt - Morgan Stanley, Research Division

Okay, that's 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 the expenditures 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 vSphere and margins?

Mark S. Peek

Sure. And what -- 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're going to continue to invest in products, and we believe we have a lot of opportunity in each of the 3 layers and management, and we're continuing our hiring. I think when you look at our open recs, 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.

Operator

The next question is from Mark Moerdler.

Mark L. Moerdler - Sanford C. Bernstein & Co., LLC., Research Division

Two quick questions on here. The first one is, you were discussing the headcount and the fact that there's a bit of -- it sounds 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 are 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're 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?

Mark S. Peek

It's Mark. First, just on headcount, it's not so much a change in the competitive dynamic and our -- and we're actually pleased with our overall attrition rates because they haven't changed appreciably in the quarter as well. But I think it's much more just about the ramp that we experienced 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 it's -- I think we just may have been a little bit overly optimistic as to how quickly we could on-board people.

Paul A. Maritz

So this is Paul. I will comment very briefly about plans going forward. As I noted, we're blessed with having very strong folks underneath Mark here in the -- in each of the key financial disciplines of accounting, planning and revenue. And so we are -- and we're also having 3 very experienced CFOs looking over our shareholders there on our Board of Directors. It gives us the luxury of being able to be thoughtful and careful about choosing a replacement for Mark going forward. So we're 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.

Operator

The next question is from Walter Pritchard.

Walter H. Pritchard - Citigroup Inc, Research Division

On the management side, we heard you mentioned the 10% and it weighted more towards ELAs. But I'm wondering bigger picture on management. I mean, as we look at Microsoft, for example, we think that management revenue versus their server business is about 15% of the opportunity, meaning 15 cents 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?

Paul A. Maritz

Yes, this is Paul. I'll jump in and take that one. We actually see ourselves as really participating in a broader opportunity, which is data center automations. 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 very closely connected to each other, and what you'll see us do moving forward is, in fact, move towards sales motion where we're selling a suite of products that includes the core underlying infrastructure capability, security, management and other functions as well. So what we look at really is this the opportunity to grow our business, to provide what we call the software-driven data center where we use increasingly standardized hardware plus software to deliver a new level of automation at the data center in the form of private and public clouds. And we're pretty confident that, that market is a market that's going to grow very strongly. So we see there are -- our overall infrastructure business has a lot of growth potential associated with it that we don't need to necessarily break it out into infrastructure versus management, versus security, et cetera, et cetera.

Walter H. Pritchard - Citigroup Inc, Research Division

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. But I think you drew that down by a similar amount last year in March. And I'm wondering if we look at deferred license revenue and 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?

Mark S. Peek

Well, Walter, it's one of the different, 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, you'll see in the second quarter that it's not a material component of how we guided for revenue for the second quarter. And to the extent that there are larger growth in that balance, yes, still tend to happen in the second half.

Operator

The next question is from Heather Bellini.

Heather Bellini - Goldman Sachs Group Inc., Research Division

I was wondering, Paul, if you could share with us when did you start to see the momentum build in regard to virtualizing Tier 1 apps? I don't know that you've called that out on your call before. And I guess, the follow-up would be what's caused people to get more comfortable with this? And then finally, how big of an opportunity do you think it is?

Paul A. Maritz

Sure, sure. The -- we've seen or we've been basically predicting that people will start to move towards virtualizing their Tier 1 application simply because once you get up to the 50-plus percent level of virtualization, you've got to do -- you've got to start tackling your Tier 1 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 the "easy stuff" and now they're tackling their mission-critical, business-critical applications. So we see that to 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 applications, it's 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 do take it with appropriate degree of care, so 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 and -- 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. And so you heard me say before that I think we have both the breadth and the depth of opportunity. Breadth in terms of the descent of virtualization and depth in terms of the additional functionality and automation that we can sell even to our existing customers.

Operator

Our next question is from Rick Sherlund.

Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

Yes, 2 questions. First, Mark, on ELAs, you mentioned sometimes these renew possibly earlier, I'm wondering if there's anything unusual you're 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 the kind of the breadth and depth of your data center automation. And I'm kind of curious how often does 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?

Mark S. Peek

Yes, Rick, on ELA renewals, the tendency we see is actually more -- ELA is -- probably half plus will renew in the quarter in which the expiration comes up. And it's more frequent that they'll renew late as opposed to renew early, just from if you think about the 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's coming up for renewal or who hasn't yet renewed.

Paul A. Maritz

This is Paul addressing your point about OpenStack. So at this point, we're certainly aware of OpenStack and aware that there's 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 trying 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 have that opportunity all to ourselves. That being said, OpenStack at this point compared to the vSphere environment is still relatively immature. We see that 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, nearer-term challenge will probably come from Microsoft. But that being said, when we have these large industry transitions, our history teaches us that typically your -- 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's for that reason that we're constructing the series of investments that we'll be bringing to market this year and in the subsequent years.

Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division

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

Paul A. Maritz

Yes, I mean, the fact that a substantial portion of the world's largest companies and substantial portion of the world's server 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 we -- I said earlier that we have.

Operator

Our next question is from Brent Thill.

Brent Thill - UBS Investment Bank, Research Division

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 of this year in terms of how you're thinking about the forecast?

Mark S. Peek

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

Brent Thill - UBS Investment Bank, Research Division

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 it open as quick? Just trying to get a sense from your -- what you're seeing this year from a high-level perspective?

Paul A. Maritz

Yes, I think the 2 interesting trends that I am seeing is a deepening qualitative realization amongst our customers that they're going to need to do something different to achieve the operational efficiencies that they want going forward. And that's 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 traditional enterprises, just 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're now going to have to make real choices and real plans. And we're trying to respond to that not only with our products, but also, as I've said, with our professional services offerings. So that's a qualitative change that we're seeing right now and I think that bodes well for the next several years as people really try and achieve more fundamental efficiencies. At the same time, people are realizing 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've been making in the programming frameworks in Cloud Foundry, in our GemFire data fabric technologies, et cetera. Now those will take longer there to show up in our bottom line results, but the good news is that we believe that's 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's still this underlying nervousness about it. And that could still affect our results going forward. But the bottom line is, is we think we're aligned with these 2 major trends in the industry.

Operator

The next question is from Phil Winslow.

Philip Winslow - Crédit Suisse AG, Research Division

This is Phil in for 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 just continue to trend higher here. Guys will come to you for obviously more years. How do you expect that to continue to trend over the course of this year? And is there are certain level of sort of mix deferred that you think that balances out? And then, Paul, just another question on vCloud Director. I mean, obviously, you're trying to leverage your positioning in just the virtualized data center in the vSphere to run private clouds, and then theoretically, to leverage the private cloud positioning to influencing the public cloud, whereas the other folks are trying to come from sort of the public cloud down, so to speak. How do you sort of think about your positioning versus those others there?

Mark S. Peek

Yes, Phil, on deferred revenue -- overall deferred revenue, we are seeing more of a trend towards longer term, and it's just expected over time. It's a combination of most ELAs are -- they start at 3 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's just less license to be recognized upfront on some of the renewals.

Paul A. Maritz

Yes, this is Paul. Just responding to your question about the private cloud outwards public cloud inwards, we believe that you've got to do both. Clearly, our greater strength today is in the private cloud space, but on the other hand, I think it's 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's 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 these service providers, that they are actually the largest, fastest -- sorry, the fastest single -- fastest-growing single segment in the public cloud space at the moment and 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.

Operator

And the final question is from Jason Maynard.

Jason Maynard - Wells Fargo Securities, LLC, Research Division

First, for Paul, speaking of large zoo animals, Microsoft has actually got a couple of new products coming to market that are, I think it's fair to say, better than they've 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 it -- early reviews have been pretty good? And then I had a quick one for Carl since you're 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 2 regions broadly? And if there's anything in North America, management change, leadership stuff in the last quarter that may be contributed to that number being a little bit lower? And Mark, you'll be missed and welcomed.

Paul A. Maritz

Okay, let me jump in that 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 4 years that I've been here at VMware, I've been asked this question fairly regularly and basically I 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's exactly what we've been doing. We've 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 -- in 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.

Mark S. Peek

And Jason, this is Mark. We don't have Carl on a mic, and -- but he and I have sat next to each other for the last 5 years and talk at least daily. And there really isn't a significant structural change that's occurred. It's 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's focused on English-language-speaking countries, and we've thoughtfully been investing in the international markets since it was just an expectation as we grow that there will be a broader split between international and U.S. revenues.

Paul A. Maritz

And with that, we're going to end it. Thank you.

Operator

Thank you for participating in today's conference call. You may disconnect at this time.

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