VMware, Inc. Q4 2007 Earnings Call Transcript

Jan.28.08 | About: VMware, Inc. (VMW)

VMware, Inc. (NYSE:VMW)

Q4 FY07 Earnings Call

January 28, 2007, 5:00 PM ET

Executives

Michael Haase - IR

Mark Peek - CFO

Diane Greene - President and CEO

Analysts

Brent Thill - Citigroup

John Difucci - Bear, Stearns & Co.

Toni Sacconaghi - Sanford C. Bernstein & Co.

Israel Hernandez - Lehman Brothers

Adam Holt - JPMorgan

Kash Rangan - Merrill Lynch

Todd Raker - Deutsche Bank

Jason Maynard - Credit Suisse

Keith Bachman - Bank of Montreal

Thomas Curlin - RBC Capital Markets

Daniel Renouard - Robert W. Baird & Co.

Philip Rueppel - Wachovia Capital Markets

Operator

Good afternoon. Welcome to the VMware's Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

At this time, I would like to hand the conference over to Mr. Mike Haase, VMware's Investor Relations. Please go ahead, sir.

Michael Haase - Investor Relations

Thank you, and welcome to VMware's call to discuss our financial results for the fourth quarter and full-year 2007. With me on this call are Diane Greene, VMware's President and CEO; and Mark Peek, VMware's CFO. Both Mark and Diane will present prepared remarks, and afterwards we will open up the lines to take your questions. Additionally, we'll be presenting slides today. A webcast of these slides can be viewed at our Investor Relations webpage on vmware.com.

I'd like to remind you that statements made in today's discussion that are not statements of historical fact are forward-looking statements, subject to the Safe Harbor provisions under Federal Securities Laws. These statements are based on current expectations as of the date of this call and are subject to uncertainties and changes in conditions, significance, value and effect, as well as other risks detailed in documents filed with the SEC, including our quarterly report on Form 10-Q for the period-ended September 30, 2007 that may cause actual results to differ materially from those set forth in our 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, measures of VMware's financial performance prepared in accordance with GAAP. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in our earnings releases for the period-ended September 30 and December 31, 2007 and in the webcast slides available on the Investor Relations page of our website. The slides and the telephone replay will be available for the next 90 days. To listen to the replay, please call 719-457-0820 and provide the following passcode, 3788546.

A couple of housekeeping items, we will be filing our 10-K with the SEC during the week of February 25. And for your finding purposes, our first-quarter quiet period begins at the close of business March 10. Finally, unless otherwise stated all financial comparisons in this call will be in reference to our results for the comparable period of 2006.

With that, let me hand it over to Mark Peek.

Mark Peek - Chief Financial Officer

Thanks, Mike. Good afternoon, everyone, and thank you for joining us today. I'm very happy to share our financial results from the fourth quarter and for the full year of 2007. I will also be providing our financial outlook for 2008. This was another strong quarter for VMware, as we successfully closed the year in which we grew revenues 88%, delivered non-GAAP operating margins within our target range, and entered 2008 with a strong balance sheet.

For the fourth quarter, worldwide revenue for the company was $412 million, growing 80% over the fourth quarter of 2006. Revenue consisted of 69% license and 31% services. License revenue was $284 million, an increase of 75% compared to Q4 2006. License revenue growth was primarily driven by sales of our third-generation virtualization software suite, VMware Infrastructure 3.

GAAP operating income was $76 million, an increase of 109% from the same period last year. Diluted GAAP EPS was $0.19 compared to $0.09 for the same period year ago. Non-GAAP operating income was $108 million, which represents 72% growth from the same period a year ago. Calculated on a non-GAAP basis, diluted EPS was $0.26 compared to $0.15 for Q4 of 2006.

Total revenue for 2007 was $1.33 billion, up 88% from 2006. The revenue mix consists of 68% license and 32% services. GAAP operating income for the year was $235 million, an increase of 95% from 2006. Diluted GAAP EPS for 2007 was $0.61 compared to $0.26 for 2006. Non-GAAP operating income in 2007 was $338 million, which represents 77% growth from 2006. Calculated on a non-GAAP basis, diluted EPS grew 95% to $0.82 a share compared to $0.42 in 2006.

For 2007, license revenue was $905 million, an increase of 84% compared to 2006. In 2005 to 2006, license revenue grew 71%. Service revenue, consisting of support, subscription and professional services, was $421 million, an increase of 98% from 2006. Fourth quarter services revenue was $128 million, an increase of 90% compared to Q4 2006.

Total US revenue for 2007 grew 84 % from a year ago to $721 million, and international revenue increased 94% to $605 million. For 2007, US revenue represented 54% of total revenue. US revenues for Q4 grew 67% from a year ago to $215 million, and international revenue grew 96% to $197 million. US revenue represented 52% of total revenue in Q4. We saw strength in all international markets as we continued to invest globally in end sales, marketing, and product support. As a reminder, all of our sales are in US dollars and so our growth rates reflect no benefits from currency translation.

The Q4 dollar value of license orders on transactions of less than $50,000 was 58% of the dollar value of total license orders. This compares to 65% in Q4 of last year. Increasingly, customers see the value in standardizing on our VI3 solution architecture throughout their organizations. We see that customers have had an increasing interest in enterprise license agreements with a typical service contract length of three years. We view our solid long-term relationships with our their customers as being healthy for the business. Although our overall transaction size is increasing, we continue to be a high volume transaction business as evidenced by the nearly 60% of our license order dollar value resulting from transactions under $50,000.

In connection with the segment disclosure in our annual audited financial statement, we are providing a breakout of 2007 license revenue into two product categories, virtualization platform products and virtual infrastructure management and automation.

Virtualization platform products include our ESX Server Hypervisor, VMWARE Workstation, and other foundational products that are used to build virtualization solutions. The ESX Hypervisor provides the core virtualization functionality and the enabling capabilities for our virtual infrastructure management and automation products. Virtual Infrastructure Management and Automation products include products such as VMotion, VirtualCenter, High Availability, Distributed Resource Management, and Online Backup that leverage the unique benefits of our virtualization platforms to automate tasks such as resource management, availability, mobility, security, and desktop management.

In 2007, platform products represented 38% of license revenue compared to 57% of license revenue in 2006. For 2007, Infrastructure Management and Automation products represented 62% of license revenue, an increase from 43% in license revenue of 2006. We believe this trend clearly demonstrates that our customers increasingly value the ongoing operational benefits and return on investment they received from our Infrastructure Automation and Management products.

I would now like to turn to the details on the rest of the income statement. We of course report under generally accepted accounting principles. However, we view our non-GAAP operating income as the key profitability measure of our financial performance. As a reminder, in calculating our non-GAAP operating income we make three adjustments to operating income calculated under GAAP, two that increase operating profit and one that generally decreases our non-GAAP results.

First, we exclude charges with stock-based compensation calculated under FAS 123R. Second, we exclude the amortization of purchased intangibles and any write-offs associated with in-process research and development of acquisitions. Today, most of our purchased intangibles are the results of the required accounting on our financial statements of EMC's acquisitions of VMware in 2004. Finally, we adjust for the net effect of FAS 86 capitalized software development. Here, we subtract the amortization of capitalized software or adding back any capitalized software costs during the period. This adjustment can be either an increase or a decrease to GAAP operating income in any given quarter.

As Mike mentioned earlier, the non-GAAP information being shared with you today should be considered in conjunction with our GAAP operating results, which are available in our earnings release and on our website.

Our non-GAAP operating income for the fourth quarter was $108 million or 26% of revenues compared to $63 million in Q4 of 2006 or 27% of revenues. That's a year-over-year increase of 72%. For a company of VMware’s size with growth rates of these levels, operating margins are going to have some level of volatility. As we are continuously investing in the long-term opportunity, we caution you to not read too much into incremental increases or decreases in our non-GAAP operating margins.

In terms of the cost and expense lines, on a non-GAAP basis, the year-over-year comparisons are less meaningful and so the following comparisons are sequential to Q3 2007 as a percentage of revenue. Total non-GAAP cost of revenues was $49 million or 12% of revenues consistent as a percentage of revenue to Q3 2007. Non-GAAP research and development was $93 million or 23% of revenues, a modest increase in percentage term from Q3. Non-GAAP sales and marketing expenses were $129 million or 31% of revenue, a modest decrease as a percentage of revenue from Q3. And non-GAAP G&A increased to $33 million or 8% of revenue, also a modest decrease as a percentage of revenue from Q3 of 2007. Moving forward, we will continue to invest in our infrastructure to support our growth.

In closing 2007, we adjusted our annual tax rate to 9% for GAAP and 14% for non-GAAP. This adjustment benefited, diluted EPS for both GAAP and non-GAAP by $0.01 during Q4.

Now, let's turn to the balance sheet and our cash flow statement. Our cash balance as of December 31 increased by nearly $100 million from Q3 to $1.2 billion. Long-term debt remained at $450 million. As of December 31, 2007, deferred revenue was $553 million, a year-over-year increase of 80% compared to December 31, 2006 and a $126 million sequential increase from Q3. One of the factors driving this growth is the continued trend of customers purchasing multi-year contracts for our service and subscription offerings. During the quarter the average support contract signed was approximately 25 months. Deferred revenue includes approximately $54 million of deferred license revenue.

We recognized revenue and deferred revenue from our x86 system vendor partners in arrears when they make binding royalty reports to us. The OEMs typical report one to two months in arrears. As a result, license revenue and deferred services revenue from the November, December time frame will be recognized in Q1 of 2008. Q4 reflects revenue and deferred revenue reported during the quarter from OEM bookings in August and September. Like last quarter, there is some sequential increase expected, which will benefit Q1 2008.

Our GAAP operating cash flows were $164 million for the quarter compared to a $125 million in operating cash flows for Q4 of 2006. For 2007, our GAAP operating cash flows were $552 million compared to $280 million in 2006.

On a non-GAAP basis, we historically adjusted for the EMC related balance sheet accounts. We did that because of the relatively large swings in the size of our inter company balances with EMC prior to becoming a public company. We are now regularly clearing these inter-company accounts.

On a non-GAAP basis, we reduced our GAAP operating cash flows by subtracting amounts capitalized under FAS 86 because these are classified in our GAAP cash flow statements, as investing activities. On a non-GAAP basis our operating cash flows were $149 million for the quarter compared to a $121 million for Q4 of 2006. Because cash flows can vary based on the timing of the payments for working capital items, we believe it is more meaningful to look at cash flows over a longer time horizon. For 2007, our non-GAAP operating cash flows were $504 million compared to $247 million for 2006, an increase of 104%.

On a fully diluted basis, weighted average shares outstanding for Q4 were 403 million. These share counts are calculated using the treasury stock method. Based on this method, the Q1 '08 share count could change as additional equity compensation is issued to new employees or if there are significant changes in our stock price.

I will now provide you with our financial outlook for 2008. Last quarter, we provided you with guidance on our non-GAAP operating margins and certain other items, including share counts, calculated EPS, and stock-based compensation. We have decided to continue to provide this form of guidance as well as revenue and tax rate guidance for the full-year 2008. I would like to remind you that our guidance constitutes forward-looking statements under the Federal Securities laws and reflects VMware's expectation as of the date of this conference call. Actual results may differ materially from those projected due to a number of factors, including the factors referenced in our press release and in the slides available on our website accompanying this call, as well as the other risk factors detailed in our filings with the Securities and Exchange Commission, including our most recent periodic report on Form 10-Q for the period-ending September 30, 2007.

Revenue for 2008 is expected to grow approximately 15% compared to 2007. Our expectation for revenue growth considers a number of factors. The increasing size of our revenue base and increasing number of competing companies marketing, their intent to introduce virtualization products, and our continued strategy to make VMware technology the new platform for data center virtualization through broad proliferation. It is also important to remember that all of our sales are US dollar denominated and our expected growth rate does not reflect any benefit from currency translation.

Consistent with 2007, our non-GAAP operating margins for 2008 is expected to remain in the mid-20% range after taking into account our adjustments to GAAP operating income previously mentioned and which would have similar proportional effect. For Q1 2008, our non-GAAP operating margin is likely to be sequentially lower than in the fourth quarter. This is consistent with the seasonal sequential decline we experienced in the first quarter of 2007.

The Q1 2008 fully diluted share count is anticipated to be approximately 400 million shares. Approximately 3.5 million of our employee shares will become eligible to trade during Q1. That should also be the case in each of Q3 and Q4, while approximately 11 million shares will become available in Q2 due to vesting and options granted at the time of IPO.

Stock-based compensation expense for 2008 is anticipated to be between $170 million and $200 million. For Q1 2008, stock-based compensation is expected to be approximately $40 million. Our GAAP tax rate for 2008 is expected to be between 17% and 19%. Our tax rate reflects the repeal of the U.S. R&D credit, which had a benefit of approximately 4 points in 2007. Adjustments we would typically make to non-GAAP tax rate would include stock-based compensation, amortization of intangibles, and FAS 86 capitalization representing approximately 1% to 2% points.

With that, I will turn it over to Diane Greene.

Diane Greene - President and Chief Executive Officer

Thank you, Mark, and let me also welcome you to today's conference call. VMware's fourth quarter and full year were outstanding, and the company continues to execute well on our considerable opportunities. We grew revenues 80% year-over-year in Q4. We grew annual revenue 88% to $1.3 billion, and we exited Q4 with a run rate of 1.6 billion. We are pleased with our growth overall and internationally. It was especially strong in Eastern Europe, Japan, and China.

From the desktop to the data center, we're delivering value to our customers through new and existing products and services from VMware as well as those from our large ecosystems of partners. We are seeing strong customer adoption on many fronts. Virtualization is becoming increasingly strategic to our customers, and the virtual data center is proving to be a better way to run their businesses. Customers around the world are standardizing on VMware visualization to reduce capital and operating expenses, ensure business continuity, strengthen security, and go green.

Customers are also investing more in VMware. 70% of our 20 largest deals in Q4 part were from customers who have been with us for longer than three years. Today, more than 85% of VMware infrastructure customers are running production level environments on VMware and more than 50% are running enterprise applications on VMware. These transactions are part of a larger trend of VMware becoming the trusted infrastructure for running businesses more efficiently and cost effectively. We now have more than 100,000 enterprise customers, and the number of VMware infrastructure customers roughly doubled in 2007.

Now, I would like to talk about how we're growing the business through investments in partners, people and products. We have substantially increased our focus on the distribution channel and our support product. We added nearly 4000 new channel partners in Q4, many of them with our commercial and SMB focus. Through our frictionless onboarding process, we are now at nearly 10,000 channel partners. We're also in the process of rolling out some new and rewarding channel friendly programs. More than 100 technology partners were added to our co-development programs in Q4, bringing the total number now to more than 400. These relationships add significant value to our platform and make the benefits of virtualization for our customers go much further.

In December, we announced a comprehensive support agreement with SAP. They will fully support Windows and Linux based SAP solutions running on VMware ESX server in production environment. This adds to support from other leading vendor's such as IBM software.

Internally, we added over 500 people in Q4. We ended the year with more than 5000 people. All are focused on leveraging our expertise and doing everything we can as a team to extend our industry impact and leadership. I am also pleased to report that three new executives joined VMware in Q4 bringing us invaluable experience and talent in product development, marketing, and IT.

We also closed the acquisition of Psion in Q4 and just announced Foedus and ThinStall. These acquisitions give us important new capabilities in terms of virtual infrastructure development, application, virtualization, and VDI professional services desk practices for our channel partners.

Our products continue to receive accolades across all categories. VMware's products received more than 30 awards for excellence in 2007 and in year-end roundup. There is one publications award in particular that I think says a tremendous amount about breadths and depths of VMware. Redmond Magazine gave VMware four Number 1 award recognitions. VMware's ESX Server or Hypervisor was named Number 1 in reliability, the Mainframe was Number 2. VMware Workstation, our desktop product, was rated Number 1 for usability and manageability. VMware Fusion, our Mac product, won biggest wow in an IT product. And finally, VMware was named the Number 1 overall breakout technology.

VMware clearly has stellar product development and our growth is fuelling this valuable core competence. We're focused on developing high value products for our customers that also enhance the offerings of our partners. VMware's view of virtualization is broad. We are now delivering all of the building blocks for a complete virtual data center, one that will automatically and transparently map applications to whatever hardware resources they need and from any locations.

VMware is continuing to aggressively get our products out into the market, both free and revenue generating, and we are making the necessary investments in training our customer facing teams and partners to be successful selling them. Today is actually the start of VMware's annual sales kickoff where our sales team now, several thousand strong, will get trained on new products and go-to-market programs, so that together with our partner channels they can make the most of the opportunities for VMware’s solutions.

In February, we will host the first large-scale European virtualization conference, VMworld Europe in conference. We expect more than 4000 customers and partners across Europe to get hands-on experience with our solutions. VMware is ceding the market with award-winning three products. VMware Server was downloaded nearly 2.2 million times in 2007 and the VMware Player was downloaded upwards of 1.8 million times. Separately, in its first five months on the market, our fusion virtualization product for the Mac sold more than 200,000 copies and it achieved 46% retail market share in Q4 according to MTT data.

VMware's embedded Hypervisor, ESX 3i, was shipped to the OEMs at the end of the year. Severs containing 3i are set to ship in Q1 and Q2. The embedded approach makes virtualization plug and play for our customers. For our partners and for VMware, it will accelerate adoption of ESX partitioning and provisioning functionality and make it easier for customers to upgrade to the automation management and business continuity features of our full virtualization solutions. VMware has unique advanced features that customers want and APIs that integrate well with our third-party management functionality.

VMware is building upon our third generation ESX Hypervisor with new products from us and from our partners to offer highly differentiated solutions for customers. Our Hypervisor is Number 1 in terms of reliability, interoperability, scalability, and functionality, and every product built on it augments this differentiation. Let me elaborate on each of these.

As an example of reliability, VMware has a large pharmaceutical customer that has run production environments virtualized for several years now. They have an instance of the VMware ESX Server that has run continuously for 1140 consecutive days without a single reboot needed. It was finally brought down recently when the physical server was decommissioned. The small 32-megabyte footprint of ESX 3i reduces security risks and VMware offers a dynamic patch management capability. ESX, particularly 3i, is also utterly simple to install and bring up. The VMware ESX's interoperability is the result of a huge investment VMware has made in labs. ESX is tested and certified for roughly 250 different types of servers, more than 260 different types of storage arrays, more than 60 different operating systems, and more than 700 virtual appliances.

Our differentiation does not stop at the Hypervisor. We enable our customers to dynamically allocate resources and to migrate workloads across a pool of servers, storage, and network devices. Our suites of management and automation software increased the productivity of IT administrators by automatically controlling VMs for all and enabling business users to self-provision capacity on-demand in the data center. Our suites of business continuity and availability software bring unprecedented simplicity to the task of delivering high service levels for mission-critical software applications.

Technical differentiation is critical for us, but what truly matters is what our customers are putting in to dollars and cents. Our customers tell us that VMware products allow them to support two to three times the number of application workloads per administrator, and they do this using four to ten times less data center capacity than would be required in a non-VMware environment.

For 2008, the VMware product roadmap is strong. First, the recently launched VMware Infrastructure 3.5 and ESX 3i gets us off to a great start. They deliver advanced features like wide migration of storage, distributed power management, and automated patch management. Over the course of the year we will continue to broaden and deepen our end-to-end virtualization based solutions in areas that include both desktop and the data center. You may have already seen one example of these solutions in the recent beta of our Stage Manager product. It streamlines and accelerates the process of staging applications into production. We have also shipped the beta of Site Recovery Manager, an advanced solution for automating the configuring, testing, and deployment of disaster recovery for production workloads. We are also about to ship a major rev to our Virtual Desktop Infrastructure 3, VDI, with our Virtual Desktop Manager product. In 2008, you will see more solutions from us and our partners around business continuity, desktop management, and security, as well as a preview of our new and major release of VMware's flagship infrastructure suite.

Our customer value proposition is growing dramatically. VMware products allow both critical and mundane error-prone tests to be automated and optimized, putting IT people to address more sophisticated problems without having to worry about inevitable human error. Automation is the next stage for virtualized infrastructure. Much like going from a written ledger to an electronic spreadsheet, VMware is taking our customers and leading our competitors to a new era where IT infrastructure is much simpler to manage, much leaner on resource and maintenance requirements, much greener, and much, much more virtual. Our vision of self-managing IT infrastructure is gaining momentum.

It's very exciting for the company to see our customers benefiting and our partners building around it. We are looking forward to a most successful… our most successful year yet. Thank you very much.

Michael Haase - Investor Relations

Okay, thanks. Why don’t we begin the Q&A process?

Question and Answer

Operator

We will go first to Brent Thill with Citi.

Brent Thill - Citigroup

Thanks. Mark, regarding deferred revenue component that you mentioned that lagged, if you look at the impact for Q1 can you just walk through what type of sequential improvement you would expect in Q1? I know you are not giving guidance for Q1, but just help us better understand from a modeling prospective what happens there?

Mark Peek - Chief Financial Officer

Sure, Brent. The question is really around the recognition of our OEM revenue, which we do in arrear since we have a one to two-month lag depending on the OEM partner as to when it will be recognized. And with the fourth quarter, we believe that this number was greater than what was in the third quarter. We will have some uplift in the first quarter. As you look at the year going forward, we have guided to approximately 50% revenue growth. And as you think about the calenderization and the scale of our business, we would expect that that growth will be higher in the early quarters and it will be in the later quarters.

Brent Thill - Citigroup

Okay. And just a quick follow-up on the embedded 50% growth, what are baking into the pricing environment? Do you expect prices to hold or soften due to some of the new competitive threats for '08?

Mark Peek - Chief Financial Officer

We are… we have continuously tried to hold our prices at the same level and add features to the various price points that we have had in our products. And so we are not baking in a price decrease as a result of the competition.

Brent Thill - Citigroup

Thanks.

Operator

We will go next to John Difucci with Bear, Stearns.

John Difucci - Bear, Stearns & Co.

Yes, thanks. We understand the pressure you're under to sort of give guidance. I think it actually helps to tighten the dispersion and the estimates out there. Just curious Mark, Diane, how you can give guidance… revenue guidance for the year when things are changing so quickly that you have six-month sales quarters rather than annual, just… maybe you can sort of… does that tell us something about your confidence in guidance or… I don’t know if you can comment on that, please?

Diane Greene - President and Chief Executive Officer

I'll just say that we have had six months quoted for sales for VMware since the beginning of VMware, but we have always internally had [inaudible] year guidance.

Mark Peek - Chief Financial Officer

John, as we were planning the business we look at trends. We certainly take a fresh look every six months as we determine sales quarters, but we do have to plan the business on a long-term time horizon. And like kind of estimate, the confidence we have in the early quarters is greater than it is in the later quarters. And our thought process around providing guidance ties actually to a couple of things. One is that EMC provides consolidated guidance. They own 85% of the company, and so they are providing guidance on an annual basis. And so it doesn't necessarily make sense that we wouldn't provide some kind of guidance on our own. And as we look ahead, it was just important we thought to help give some indication of where we thought the business was going in and the 50% guidance is largely based on the scale of our business.

John Difucci - Bear, Stearns & Co.

Okay, thank you. And just one quick comp follow-up, Mark. The tax is payable to EMC. It's something that was a lot greater than… or the impact on cash flow was greater than we thought it would be, at least in our model for this quarter. Is there any way you can help us to model that? Are you going to continue to try to pay down that balance?

Mark Peek - Chief Financial Officer

Yes. We're filing the consolidated return in the US with EMC, and as a result… as the quarters go on we true up that estimate, but our intent is to pay down those balances as they come due and to do them each quarter.

John Difucci - Bear, Stearns & Co.

Okay. Thanks a lot.

Operator

We will go next with Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford C. Bernstein & Co.

Yes, thank you. A couple of questions please. It looks like in the fourth quarter that your US revenue growth was considerably slower than your international revenue growth by about 30 percentage points. Up until this quarter, the growth rates have been rather in line. Can you talk about what you might be seeing in the US and what you saw in the US in the fourth quarter? Was it any incremental weakness that is economic, or are you just that much bigger in the US and your opportunities are more limited? Can you comment on that? And I have a follow-up please.

Mark Peek - Chief Financial Officer

Okay. It's a combination of factors. One is that we are larger in the US. In the initial release of VI3, there was more of an interest in uptake in the US and so the… it's a more difficult comp in the US on our overall growth rate. And secondly, I'd point to the overall strength that we experienced internationally in Europe and in APAC. We are very pleased with the results internationally.

Toni Sacconaghi - Sanford C. Bernstein & Co.

But do you think there was actually something in terms of the linearity of demand in the quarter that you were experiencing, because you had some pretty tough VI3 comps last quarter, still had very strong growth in the US, but you have this big divergence in growth this quarter? Can you give us a little more color on whether you saw any linearity over the course of the quarter in terms of strengthening or weakening in the US?

Mark Peek - Chief Financial Officer

The quarter was actually relatively consistent. Our… we do have higher volume of sales and bookings in the back month of the quarter in particular, but we didn't see any particular weakening of US in any particular period throughout the quarter.

Toni Sacconaghi - Sanford C. Bernstein & Co.

Okay. And then can you comment a little bit about next year? Obviously, services revenue you have $500 million in deferred revenue. You talked about a two-year average life. So you are going to have a lot of that revenue that's in the bag for 2008. Services revenue by its very nature should decelerate much more modestly. So are you really talking about implied in your guidance services revenue growth that's obviously considerably above that 75% or 80% and license revenue growth that's considerably below that, which maybe is 35%? And is that how we should be thinking about it, and it certainly does feel like a pretty dramatic deceleration in license growth?

Mark Peek - Chief Financial Officer

Well, Tony, I think that as you look at the trend over time this quarter, license growth 75%, services growth 90%, and a reminder that there… as we pointed out at the third… during the third quarter that there were some anomalies in the growth rates due to Q3 of 2006. If you look at our deferred… our current deferred revenue as of the end of the year, it would imply that about 18% to 19% of our total guided revenue of about 50% growth will roll through on… and most of that would be services on the services line. And so you would expect that next year as we look at the full-year and look at the splits between services and the licenses growth that services growth will become a bigger portion of the overall revenue.

Toni Sacconaghi - Sanford C. Bernstein & Co.

And your belief on that deceleration in license revenue, so the implicit in that is license is going to grow slower. Again you are going to look… you are going to have a deceleration from I think in the 70s, correct if I'm wrong, this year. So likely something in the 30s just by that math that you outlined. And again your belief is that principal reason is scale rather than anything else.

Mark Peek - Chief Financial Officer

Yes, our principal reason around revenue growth rate of 50% is scale, and we are not providing a break-up between services and revenue on that guidance.

Toni Sacconaghi - Sanford C. Bernstein & Co.

Okay. Thank you.

Operator

We will go next to Israel Hernandez with Lehman Brothers.

Israel Hernandez - Lehman Brothers

Hello, everyone. Can you speak to your expectations for 2008 between platforms and the automation group? Are you breaking out the revenues on a reported basis? But at least qualitatively, how should we be thinking about the growth rates of those two product offerings?

Mark Peek - Chief Financial Officer

As you saw the fairly dramatic change in the percentage of revenue that came from automation versus platforms, we expect both to grow. They are typically part of bundle suites. What we are seeing however is that our customers are very much valuing the infrastructure management and the automation products, and we would expect that, that will continue to grow as a percentage of overall revenue.

Diane Greene - President and Chief Executive Officer

We have seen a steady shifting of revenue into the full suites over and above the Hypervisor.

Israel Hernandez - Lehman Brothers

So will you expect the growth rates then to be much higher or materially higher in automation and the management tools than on platforms for 2008?

Mark Peek - Chief Financial Officer

I think that if you… it is somewhat of a question since we are bundling the products together and the… so what customers are actually buying is a suite of products and so it is really a condition of how the individual pricing of the products is broken down. But since the mix is going to shift, you would expect the growth rates to be somewhat different as well.

Israel Hernandez - Lehman Brothers

Great, thank you.

Operator

We will go next to Adam Holt.

Adam Holt - JPMorgan

Good afternoon. I had a couple of questions about the large deal activity and the impact on deferred revenue. You noted in your prepared comments that you saw strength in enterprise license agreements and we saw the percentage of deals over 50,000 increase. Could you talk a little bit how those ELAs are actually flowing through deferred revenue and flowing through the numbers?

And secondly and along that line, it looked as if the percentage of deferred license revenue actually decline on a sequential and a year-on-year basis. Ad I was wondering why that would have been in the context of the very strong large deal activity?

Mark Peek - Chief Financial Officer

Yes. First, let me address the ELAs. We break out orders under $50,000 from a license perspective. And the one thing to… that I just want to make sure I clarify is that orders in excess of $50,000 are not all ELAs. In fact… a large majority of the orders that are above 50,000 are in fact not ELAs, but sales of individual suites of products. The way that the revenue is recognized on the ELAs in most cases is that we recognize the license revenue upfront and then the portion that is related to services, the subscription is over a three-year period of time. And so it will end in the balance sheet as either current or non-current depending on when we ship the actual license.

Adam Holt - JPMorgan

Okay. And if I could just ask a follow-up on the second part of the question, in deferred as a percentage of… deferred license revenues as a percentage of total deferred, it looks like it was down a little bit on a year-on-year basis and sequentially. Is there any reason that would have been in the fourth quarter in particular? Is that just an anomaly that we will expect to see sort of head back in the other direction in Q1?

Mark Peek - Chief Financial Officer

On the deferred license revenue, first of all, it is not tied to the ELAs at all, and so it really has very little to do with the size of the transaction. But it is more tied to the marketing promotions that we are doing in any particular quarter and typically we will ship most of that revenue in the following quarter. And so this quarter, we ran promotions near the end of the quarter related to our VI starter kit. And so from quarter-to-quarter, there will be some variability in our deferred license revenue.

Adam Holt - JPMorgan

Terrific. Thank you.

Operator

We will go next to Kirk Materne, Banc of America Securities. Your line is open, sir. Please check your mute button.

We will go next to Kash Rangan with Merrill Lynch.

Kash Rangan - Merrill Lynch

Hi, thank you very much. Just wanted to clarify the percentage of license revenues that are coming from arrears to revenue recognition. Maybe, Mark, if you could quantify what percentage of the license revenues are actually coming from OEM, that could help us better understand how much of that indeed is being impacted by this arrears of flow through from Q4 into Q1? I have a follow-up question as well.

Mark Peek - Chief Financial Officer

Okay. Kash, we are not breaking out revenue by any of our particular channels. The… as we have stated in the past, what we saw in the third quarter is that there was a shift in the percentage in the channel that was from OEM relative to the rest of the partner channel and that had a modest impact on the Q3 results as you saw and that carried forward into the fourth quarter.

Kash Rangan - Merrill Lynch

But the trend line is that the OEMs are definitely getting to be larger percentage of your license revenues. Therefore, this lumpiness probably is… becomes more, more and more exacerbated if the OEMs are becoming larger as a percentage of license revenues, right?

Mark Peek - Chief Financial Officer

Yes. To the extent, yes… to the extent of that growth.

Kash Rangan - Merrill Lynch

Okay. And the second comment on the growth rate… license revenue growth rate, the services revenue growth rate has even slowed down a little. We are talking significant deceleration license revenue. And I am wondering, just given the growth rate of the company over the last three years, if you were to look at 80% to 90% all of a sudden dropping down to 30%, 40%, that doesn't add up to me. Maybe if you can help us understand if it’s largely due to conservatism, I think that's completely understandable, but it just dropped that deceleration on us in the face of what has been pretty solid growth for the past three years. It just doesn't seem to add up. Maybe we’re missing something. If you can clarify, both you and Diane, that would be great. Thanks.

Mark Peek - Chief Financial Officer

I think… so Kash, I think that your question is around the growth rates at license versus services for 2008.

Kash Rangan - Merrill Lynch

In a relative sense, license revenue growth rate expectation for '08 relative to where it has been in '07, '06,'05. Understandably, a lot of that is due to scale, but the magnitude of the deceleration that you're talking about, it just doesn't jive with people's expectations. And I'm wondering if it's just plain old conservatism with macros and other things that are related to forecasting revenues for a company with limited public history or there is something else?

Mark Peek - Chief Financial Officer

No it's… our revenue guidance is largely based on a scale and largely based on providing guidance for the entire year and with the conditions that I called out in the prepared remarks as well. We’re… as we look ahead to 2008, we are very bullish on the company and where it has headed, and the demand for our products. And so, the splits between license and services and how that will change over time is really entirely due to scale.

Kash Rangan - Merrill Lynch

And Diane, maybe--.

Diane Greene - President and Chief Executive Officer

Due to scale and also due to market, we have to watch how fast it is going to grow. We see great demand, but we have to see how fast the overall market grows as well.

Kash Rangan - Merrill Lynch

How do you feel competitively with [inaudible] to HyperV? I know you still have the lead over the competition and whatnot, but are you seeing any impact in sales cycles currently and maybe even in the March quarter, June quarter?

Diane Greene - President and Chief Executive Officer

We are not, in fact some of our customers have evaluated HyperV and have told us they see absolutely no reason to switch. I think InfoWorld actually called it analogous to VMware Server 1.0, but not as polished which is our free product. Certainly customers ask about the competition, but it's not delaying sales.

Kash Rangan - Merrill Lynch

Great. Thanks a lot.

Operator

We will go next to Todd Raker with Deutsche Bank.

Todd Raker - Deutsche Bank

Few quick questions. First, I think you cited in the commentary that the average support contract was 25 months this quarter. Can you give us a sense in terms of how that has trended over the last few quarters and how you would see that going forward?

Mark Peek - Chief Financial Officer

Sure, Todd. We had… it has being going top. I think at the end of the third quarter we said it was 23 to 24 months, approximately two years, and in the first quarter it was approximately 19 months.

Todd Raker - Deutsche Bank

Okay. And if I sign the three-year support contract, is it cash upfront or there are installment payments associated with these?

Mark Peek - Chief Financial Officer

It is cash upfront.

Todd Raker - Deutsche Bank

Okay. And then a second question, could you guys just generally give us a sense for how meaningful the desktop opportunity could be in '08?

Diane Greene - President and Chief Executive Officer

We are not anticipating the desktop opportunity to be huge in '08. It requires a pretty major refresh of people, sort of hardware infrastructure, and we don't anticipate it growing that rapidly in the '08 time frame.

Mark Peek - Chief Financial Officer

And certainly in our guidance, we are not anticipating an uplift from… significant uplift from desktop.

Todd Raker - Deutsche Bank

Great. Thanks, guys.

Operator

We will go next to Brent Bracelin with Pacific Crest Securities. Brett, your line is open. Please check your mute button.

We’ll go next to Jason Maynard with Credit Suisse.

Jason Maynard - Credit Suisse

Hi, guys. Just a follow-up on the deceleration in the growth rate into '08, is there anything from an economic perspective that might be cautioning your view because even if you take sort of the Q4 number in license revenue and flow it through the quarters, it just seems that a drop-off into may be the high 30s or 40% ranges is fairly extreme, given what you've talked about previously in the market?

Mark Peek - Chief Financial Officer

Well, Jason in planning the business, and one of the earlier question was six months versus annual guidance, as we look forward into 2008 we are certainly trying to plan the business in a way that allows us to sustain the investments that we are making. And there is nothing that we are taking from the perspective forecasting the economy or where it will go out of this and what we have seen over the last six months in looking at demand. But again, the 50% growth rate that we're forecasting is largely a function of us becoming a very large software company. Through September 30 of 2007, it was the first time that we get the billion dollar run rate on a trailing 12-month basis, and so when you look at approximately 50% growth for 2008 that's essentially doubling the size of the company in five quarters.

Jason Maynard - Credit Suisse

And then, maybe just a follow-up on the services side. As you sort of embark on this next leg of your story, can you maybe talk about the role of your services organization to try and drive both direct license sales as well as maybe training partners and things of that nature? What role would that play in terms of helping increase the growth rate down the road?

Diane Greene - President and Chief Executive Officer

Well, services are something that we work with our partners… our channel partners on to offer them added value and they appreciate it greatly. So it helps to drive our sales through the channel, and so we invest a lot in training and developing services for them. And certainly, we are increasing our partnerships with people like the system integrators where for larger deals will certainly drive sales.

Operator

We will go next with Keith Bachman with Bank of Montreal.

Keith Bachman - Bank of Montreal

Thank you. I have two questions if I could. Could you talk about how you think deferred revs will grow in '08 and related to that is how you think the cash flows will grow-in in '08? And if you're unwilling to give numbers, I would like to get some context related to the revenue growth targets that you put out, please. Thank you.

Mark Peek - Chief Financial Officer

Our deferred revenue we continue to expect to grow at a healthy rate. If you look at just the sequential growth in external bookings looking at revenue versus the change in deferred revenue in Q4 over Q3, we grew at 46%. And as we said, we grew deferred revenue for the year at 80%. The continued trend that we have seen in individuals and in corporation signing up for multi-year subscription agreement is going to continue to increase deferred revenue.

Keith Bachman - Bank of Montreal

And so just to be more specific, you anticipate that the deferred revenues will grow faster than revenues?

Mark Peek - Chief Financial Officer

We are not giving guidance on the balance sheet.

Keith Bachman - Bank of Montreal

Okay, and then how about any commentary on the cash flow please?

Mark Peek - Chief Financial Officer

On the cash flows, certainly cash flows will be enhanced by increases in deferred revenue and multi-year SnS. But we are not going to provide a cash flow forecast with working capital items, the CapEx items.

Keith Bachman - Bank of Montreal

Okay. Thank you.

Operator

We'll go next to Heather Bellini with UBS. Heather your line is open. Please check your mute button.

We'll go next to Tom Curlin with RBC.

Thomas Curlin - RBC Capital Markets

Hi, good afternoon. Can you hear me?

Mark Peek - Chief Financial Officer

Yes.

Thomas Curlin - RBC Capital Markets

Just coming back to really the same issue that we've heard several times, to model out a 50% year-over-year growth number for this coming fiscal year, either the business decelerates very rapidly in the next couple of quarters or over the course of the year down to say 30%, 40%. So I understand that scale commentary, but represent most of your market as of today. Are you saying that you think your end-market is decelerating down to a 30%, 40% growth rate by the end of '08 on a year-over-year basis or is something else happening like, for example, would scare?

Mark Peek - Chief Financial Officer

No. What we are doing with approximately 50% growth for 2008 is to give you an indication of where we think we are headed and the overall size of the company and then it's largely scale. If you take that in concert with our operating margin guidance, it will help you to paint a little bit of a picture with respect to our viewings in coming couple of quarters, and then we'll have better visibility as the year goes on.

Thomas Curlin - RBC Capital Markets

So the operating margin guidance of mid-20s is… that's consistent with the guidance you have given in the past. I think… I'm correct, right, that hasn't changed?

Mark Peek - Chief Financial Officer

That's correct. What I'm suggesting is that if you look at the exit rates on our operating expenses for the fourth quarter, it will help you consider what our operating expenses will be for the first part of 2008 as well.

Thomas Curlin - RBC Capital Markets

I understand that, but on the topline how do you recommend that we get you to 50% year-over-year. I assume that that's not falling off a cliff. So we're going to have to decelerate the revenue down to 30%, 40% year-over-year growth by the end of '08. Is that the appropriate approach?

Mark Peek - Chief Financial Officer

Well, the approach would… you are just going to have to take your own approach as to how you look at our guidance, but with the mid-20s operating margins in those investments, you certainly expect higher growth rates in the early quarters and the back quarters.

Thomas Curlin - RBC Capital Markets

And do you feel any pressure with respect to your guidance to contemplate the perception impact it might have on your parent company's core growth rates, if you guided higher?

Mark Peek - Chief Financial Officer

No. We've been building our guidance independently at EMC.

Thomas Curlin - RBC Capital Markets

Okay. Thank you.

Operator

We'll go next to Dan Renouard with Robert Baird.

Daniel Renouard - Robert W. Baird & Co.

Hi, thanks. I guess my question would be along the lines of your ELAs and you have got a pretty big focus on driving ELA adoption in the enterprises that you sell to. Maybe you could talk about that for 2008, would you expect that to be a continued focus and an emphasis in your sales group?

Mark Peek - Chief Financial Officer

With ELAs, most of our customers don't just jump into an ELA. They've had a repeated history of buying products from us on a PO basis. So it's largely dependent upon customer demand, but certainly as we develop relationships with our customers, both our sales force and our customers have an interest in ELAs. And so I would expect that we'll continue to market and develop the ELA program and that it provides… we think it's very healthy for the company because it does provide a long-term buying and broader proliferation of our products across to our customers.

Diane Greene - President and Chief Executive Officer

And we do also see that when a customer buys an ELA they tend to deploy much more broadly, and what we see when our customer deploys broadly is they get accelerating benefits from… on their ROI. And so we do encourage our customers to do this.

Daniel Renouard - Robert W. Baird & Co.

Great. And if I could ask one quick follow-up, are you… is your CapEx… are you expecting your CapEx needs to be lower this year from the buildout you did in '07?

Mark Peek - Chief Financial Officer

Although we are not providing CapEx guidance, I will say that we are not… we are continuing to expect to invest and as we add people and as we continue to expand internationally, we will still see the need to invest in capital. And so I wouldn't expect significant free cash flow benefit from lower CapEx in 2008.

Daniel Renouard - Robert W. Baird & Co.

Great. Thank you.

Operator

We'll take our last question from Phil Rueppel with Wachovia Securities.

Philip Rueppel - Wachovia Capital Markets

Yes, couple of things. One, on the pipe… on the desktop opportunity, I know you have mentioned that there is little revenues you’ll be realizing. Are you going to continue to ramp investment and what can we expect to see from a cost prospective as associated with the desktop? Is a partner channel going to be expanded with a special channel or are we just going to continue to see organic investments in R&D and sales?

Diane Greene - President and Chief Executive Officer

On the desktop opportunity, we are certainly ramping investment. I mean we do have large deals of that we're doing there and we are increasing the number of deals we're doing there. So we can ramp the investment and you probably noticed that we are also broadening our definition of the desktop opportunity with our acquisition of the application virtualization company, ThinStall. In terms of channel, we're finding a lot of tremendous synergies with our existing channels for the desktop opportunity. We're ramping our ability to educate people and that was why we purchased Foedus, which specializes in services around the desktop opportunity.

Philip Rueppel - Wachovia Capital Markets

Okay. And finally on pricing, I know you've mentioned that you haven't really seen any change in pricing. Built into your guidance for '08, are you expecting any additional price pressure when you do have competition from, say, Microsoft in the second half or do you think new releases and sort of you products division with allow you to… are you forecasting the ability to maintain ASPs?

Diane Greene - President and Chief Executive Officer

We do think that we can maintain our prices. We entered the year with the 3.5 announcement, which brought several… three major new areas of functionality and at the same price point and we anticipate continuing that over the course of year.

Philip Rueppel - Wachovia Capital Markets

Great. Thank you very much.

Operator

We have no further questions.

Diane Greene - President and Chief Executive Officer

So, I wanted to thank everybody for joining us today. VMware starts 2008 with over 100,000 customers, 500 technology and consulting partners, and nearly 10,000 go-to-market partners, more than 5000 employees. As others begin to enter the market, VMware and our partners are continuing to broaden and deepen our highly reliable end-to-end virtualization solutions. Our version… vision for the virtual data center is today delivering a tremendous value to our customers, and our product pipeline for 2008 promises to deliver much more.

Thank you again. I look forward to speaking with you soon.

Operator

Ladies and gentlemen, this concludes today's conference. You may disconnect.

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