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VMware (NYSE:VMW)

Q2 2012 Earnings Call

July 23, 2012 5:00 pm ET

Executives

Michael Haase

Carl M. Eschenbach - Co-President and Chief Operating Officer

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

Patrick P. Gelsinger - Chief Executive Officer of VMware

Analysts

Kash G. Rangan - BofA Merrill Lynch, Research Division

Brent Thill - UBS Investment Bank, Research Division

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

Adam H. Holt - Morgan Stanley, Research Division

Heather Bellini - Goldman Sachs Group Inc., Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

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

Philip Winslow - Crédit Suisse AG, Research Division

Brian Marshall - ISI Group Inc., Research Division

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

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

Jason Maynard - Wells Fargo Securities, LLC, Research Division

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

Operator

Welcome and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If there are any objections, please disconnect at this time. At this time for opening remarks and introductions, I would like to introduce your host, Mike Haase, Vice President of Investor Relations and Treasury. Thank you. You may begin.

Michael Haase

Welcome to VMware's Second Quarter 2012 Earnings Conference Call. On the call we have Paul Maritz; Pat Gelsinger and Carl Eschenbach. Following their prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Statements made on this call include forward-looking statements such as those with the words will, believes, expects, continues and similar phrases that denote future expectation or intent regarding our financial outlook, business acquisitions, 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 and 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 third quarter quiet period begins at the close of business September 14, 2012. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2011. Finally, as a reminder, our Analyst Day will be held August 27 in San Francisco as part of VMworld, which runs August 27 through 30.

With that, let me hand it over to Carl.

Carl M. Eschenbach

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

Total second quarter revenues increased 22% and license revenues increased 11% compared to the same period last year. Our non-GAAP operating margin was 31.9% for the quarter. Trailing 12-month free cash flows were $2 billion, an increase of 29% from a year ago. Our balance sheet remains strong, with cash and investments at quarter end of $5.3 billion and total unearned revenues of $2.9 billion. Our customers continue to move along the Cloud journey by increasingly virtualizing their mission-critical applications and building out their private clouds. Global demand for vSphere continues to be strong, with a new release expected to be launched in the second half of the year and the attach rate for the vSphere adjacencies continue to be robust.

Our VMware Service Provider Program is tracking well as public cloud providers continue to leverage our cloud infrastructure platform for their service delivery. We continue to add key partners to the program and are seeing healthy growth. We also closed the acquisition of Wanova, Cetas and Ithaca during the quarter and welcomed about 60 new employees from these acquisitions to VMware. Last week, we closed the acquisition of Dynamic Ops and today, we announced the acquisition of Nicira. We anticipate Nicira to close sometime in 2012. Paul will speak more about these acquisitions later.

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

Now I will walk you through the financial details. Total revenues for the second quarter were $1,123,000,000, an increase of 22% from a year ago. Total revenue growth on a constant-currency basis was 23%. International revenues represented 51% of total revenue. License revenues were $517 million, up 11% from last year, driven by strong demand across product offerings during the quarter. License revenue growth on a constant-currency basis was 13%.

Enterprise License Agreements were slightly under 30% of total second quarter bookings, nearly matching our record percentage from Q4 2011. We had a healthy mix of new ELAs as well as ELA renewals in the quarter, and we continue to see very nice attach rate of non-vSphere solutions to our ELAs. We closed 4 transactions of $10 million or more during the quarter. For comparison, we had 0 transactions of $10 million or more in the second quarter of 2011.

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

We are also pleased with the level of customer demand for our management and automation tools. Solutions such as vCloud Director and vCenter Operations are seeing solid traction in the market. Much of the increased interest for our management tools is being driven by the build out of private clouds within our customers' data centers. As customers continue to virtualize their data centers with vSphere, their interest level and management automation tools tends to increase. And with the acquisition of Dynamic Ops, we believe our position is strengthened as the infrastructure and management vendor of choice for Cloud Computing. Dynamic Ops enables provisioning and management of IT services across heterogeneous environments, VMware-based private clouds, public clouds, physical infrastructure, multiple hypervisors and Amazon Web Services.

Our Cloud Application Platform business had record demand in the second quarter, with continued adoption by some of the largest customers looking to build their next-generation applications. In fact, one of our $10 million-plus orders was driven largely from our Cloud Application Platform products, including vFabric and GemFire. This was a large and very complex solution sale to a long-standing vSphere customer.

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

View 5.1 was launched last May and is performing well. The acquisition of Wanova further enhances our competitive positioning, with centralized image management of both physical and virtual desktops. The Wanova Mirage solution also completes our vision of extending VDI to locally executed and off-line use cases. Mirage is enabling seamless 2-way replication of managed window images, applications and personas between the data center and a physical laptop, as well as delivering them for execution as virtual machines on Windows, Mac with VMware Fusion and Linux.

U.S. revenues increased 22% year-over-year to a record $551 million, and international revenues were a record $572 million, also an increase of 22% compared to the second quarter of 2011. Strong demand in Japan and China led our growth in the Asia Pacific region. We have been quite pleased with our results in the Asia Pacific region and are seeing increased opportunities for larger deals. Our results in Europe were mixed. Demand in several countries were slower than expected, whereas we saw healthy demand in the United Kingdom, France and Russia. We are also seeing a nice expansion of our ELA business within many of EMEA's emerging markets. And in Latin America, demand continued to be strong, particularly in Brazil.

We are very pleased with our progress in growing our global market presence. The investments we have made and will continue to make in our international market expansion are clearly paying off, and we are continuing to invest in these markets in the second half of 2012. Software maintenance and support revenues were $519 million, up 34% compared to last year. And we expect maintenance revenue to continue to grow at a faster rate than license revenue.

Customers continue to buy, on average, more than 24 months of support and maintenance with each new license purchase, illustrating their strong commitment to VMware as a core element of their data center architecture and long-term private and hybrid cloud strategy. Professional Service revenues was $87 million, up 24% from last year.

Total unearned revenues ended the quarter at $2.9 billion, up 5% sequentially and 42% from a year ago. Long-term unearned revenue is $1.1 billion and has increased 52% from last year. The complexity of our unearned revenues has increased over time as a result of acquisitions, an expanded product portfolio and a broader range of pricing and packaging alternatives. Approximately 80% of our unearned revenue is software maintenance and will be recognized ratably. Approximately 13% of our unearned revenue is software license revenue, which will be recognized either ratably, upon product delivery or upon product release.

Increasingly, unearned license revenue is recognized ratably, which now represents over 50% of the total unearned license revenue balance. In addition, approximately 7% of unearned revenue is a result of prepaid professional services including trading, which is recognized as the services are delivered.

We had a very good second quarter as we benefited from increased demand across geographical markets. We also benefited from near-record ELAs as a percentage of total bookings. We do not anticipate having this benefit in the third quarter and expect ELA bookings to decline as a percentage of total bookings. In addition, while the third quarter is traditionally strong for the U.S. Federal government spending, we remain cautious and have revised our earlier estimates downward for the sector. We also remain cautious about the potential for a slower IT spending, especially within the European markets and foreign exchange headwinds.

Despite these macro concerns, our deal pipeline remains very strong, and we expect to have a solid second half of 2012. Demand for vSphere remains solid, and we are seeing increased opportunities for larger deals that also include management and automation solutions, cloud application solutions such as vFabric and GemFire and desktop virtualization. Our deal opportunities are more complex, but are also larger.

With this backdrop, we expect third quarter revenues to be within a range of $1,110,000,000 to $1,150,000,000 or year-over-year growth of approximately 18% to 22%. Third quarter license revenue is anticipated to be within a range of $470 million to $500 million, growth of approximately 6% to 13% compared to last year. This is a sequential decline from the second quarter, but in line with our 2011 seasonal pattern.

For the year, we are expecting total revenues of between $4.54 billion and $4.635 billion or growth of approximately 20.5% to 23% compared to 2011. License revenue for the year is anticipated to increase within a range of 11% to 15%, reflecting our expectation of a seasonally strong fourth quarter. The revenue impact from the Nicira acquisition is expected to be negligible in 2012.

I will now provide some details on our operating margins. Unless otherwise noted, all references to our expenses and operating results are on a non-GAAP basis, which are reconciled in the press release tables and posted on our IR website. Our Q2 operating profits, measured on a non-GAAP basis, was a record $358 million or 31.9% of revenues, compared with 32.6% in Q1 of 2012 and 31.6% in Q2 of 2011. Year-over-year second quarter operating margins benefited by 124 basis points from foreign exchange rates.

We ended the quarter with approximately 12,700 employees, up 1,500 from the beginning of the year. We are in a rapidly changing and dynamic environment and see significant opportunities in the adjacencies to the vSphere platform and in our emerging markets. So you should expect that VMware will continue to hire throughout 2012 and take advantage of these opportunities.

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

As mentioned in our past 2 earnings call, we are not planning for operating margin expansion in 2012. We see significant long-term growth opportunities and we'll continue to invest 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 continue during the second half of 2012. Taking into account our adjustments to GAAP operating income that Mike disclosed at the start of the call and incorporating our recently announced acquisition of Dynamic Ops and Nicira, we now expect our non-GAAP operating margin for the third quarter to be within a range of 28.75% to 29.75%. For the full year, we expect the non-GAAP operating margin to be within a range of 30.25% to 31.25%. The GAAP operating margins for the third quarter, again taking into account the announced acquisition of Dynamic Ops and Nicira and their impact on stock-based compensation and the amortization of intangibles, are anticipated to be approximately 15 to 18 percentage points lower than the non-GAAP operating margins. The full year 2012 GAAP operating margin is anticipated to be approximately 13 to 15 percentage points lower.

Now onto our balance sheet and cash flow statement. Our balance sheet remains strong, with cash and short-term investments at quarter end of $5.3 billion, up more than $100 million sequentially. During the quarter, we used nearly $325 million in aggregate for M&A, capital spending and our share repurchase program. Non-GAAP operating cash flows, which exclude adjustments for capitalization of software development costs and excess tax benefits from stock-based compensation were $424 million for Q2 and $2.2 billion for the trailing 12 months. We adjust our operating and free cash flows for excess tax benefits because it converts the cash or reduces our tax liability.

Our total expected CapEx for 2012 is approximately $320 million to $340 million, which includes the continued build out of our Stanford Research Park campus. Free cash flows for the quarter were $380 million and $2 billion for the trailing 12 months. Free cash flows per diluted share was $0.87 for the quarter and $4.63 for the trailing 12 months. As we have mentioned, free cash flow per share can be volatile in the short term, so we believe looking at it over a trailing 12 months is a better measurement of our progress than quarterly.

Also, when we look at anticipated cash flows for 2012 compared to last year, keep in mind that we plan to invest about $100 million more in CapEx this year. In addition, last year our cash flows benefited from the collection of tax receivables of more than $300 million, which covered both 2010 and 2011 tax years. For 2012, we are expecting to pay U.S. Federal and state income taxes to EMC and are therefore not expecting any collection of tax receivables this year. Our tax receivables are dependent on various factors, including tax deductions for equity-based compensation and the continuation and timing of the Federal R&E tax credit.

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

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

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

Before I hand it off to Paul, I would like to first thank him for his leadership over the last 4 years. Paul will certainly be missed. But as he reminded us last week, he's not going far and he will come to our board meetings with lots of questions. I would also like to welcome Pat to VMware and to our call. Pat, I look forward to working with you moving forward.

Now I will hand it over to Paul.

Paul A. Maritz

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

A constant theme of my remarks in quarters past has been the advancement of our 3-layered strategy, which is designed to position VMware to benefit from big changes that will transform the IT landscape. The first change is the remaking of the data center as we move towards the software-defined data center and a cloud approach to doing things. The second is the advent of new approaches to developing and renewing applications. And the third is the need to support corporate end-users in a multi-device post-PC world. At the upcoming VMworld conventions to be held in San Francisco and Barcelona, we will outline advances in each of these dimensions.

I'm pleased to report that our internal product teams have been very busy, and the full breadth and depth of what they have been doing will be impressive. In particular, we'll be describing complete integrated solutions for building and managing clouds, private or public.

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

The second acquisition was Cetas, an early phase company addressing realtime, cloud-based analytics. This acquisition will strengthen our Cloud Applications Platform.

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

Now to Nicira, our largest acquisition to date in terms of the price tag. Where does our appetite for such a large bite come from? It comes from the first of the big forces at work that I noted earlier. Our strategy is to be the leader in providing the software ingredients of the software-defined data center. The whole data center industry is in the midst of a transition towards an architecture comprised largely of standardized hardware building blocks that run under the control of layers of software. This approach provides a significant advance in terms of data center automation, increasing not only scale and efficiency, but agility too. One just has to look inside the data centers of the leading public cloud services to see this beginning to play out. Indeed, VMware helped lay the foundation for this sea change by pioneering server virtualization. By turning physical servers into software entities, we were able to transform several automation and provisioning.

Now similar changes are starting to roll through other data center functions. By extending the virtualization approach to these functions, it will be possible to create virtual data centers on-demand, largely in software. VMware has already started work on network virtualization in the context of our vSphere and vShield products. With the acquisition of Nicira, VMware becomes well positioned to provide virtual network functionality not just in the context of vCloud and vSphere, but to be able to provide it to other heterogeneous non-vSphere-based pools of infrastructure as well. So this represents a deepening and a broadening of our strategy.

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

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

As we noted last week, this transition is made possible by 3 factors: our business is fundamentally strong; we have a great leadership team in place at VMware; and we have made in my friend and colleague of 30 years, Pat Gelsinger, a great leader to succeed me.

Lastly, you may remember that my arrival at VMware 4 years ago coincided with the start of the global economic meltdown. I'm not sure I can assure you that my transition onward will usher in the global recovery, but one can always hope.

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

Patrick P. Gelsinger

Thank you, Paul. While I'm not yet officially part of the VMware team, Paul and Carl suggested I sit in on the call today to reaffirm the smooth transition we are committed to achieve. It is an honor to be asked by Paul, Joe and the board to step into the CEO role of VMware. While Paul leaves enormous shoes to fill, I'm excited with the opportunity to work hard to try to fill them. VMware is running extremely well, as seen by this quarter's great results and I'm excited about their strategic direction.

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

With that, let me hand it back to Mike.

Michael Haase

Thanks, Pat. Operator, we're going to begin the Q&A process. Also for listeners, we're going to have 3 additional attendees on the Q&A part, 3 of our Finance Vice Presidents: Robynne Sisco; Pete Godbole and Francois Delepine. Thanks. Let's begin the process.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Kash Rangan with Merrill Lynch.

Kash G. Rangan - BofA Merrill Lynch, Research Division

Just some thoughts and follow-up to the questions that I asked when you hosted your call when Pat and Joe conducted the conference call. Pat and Paul, how do you see sales cycles changing as you uncover these large opportunities? Certainly, you talked about large deals in the pipeline. And as you roll forward with management and automation, how should we think about the new TAM ahead of the total available market? And how are you going to be executing differently with your sales operations?

Paul A. Maritz

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

Carl M. Eschenbach

Sure. Thanks, Paul, and thanks, Kash. So as it relates to sale cycles, we are selling a much more complex solution into the market and specifically around ELAs that include many of the adjacencies that we often speak about, specifically management automation tools. Some of our Layer 2 assets that we have, as well as our View components. And as these solution sales become more complex, the sale cycle at times may take a little bit longer. At the same time, if you look at the results from our ELA success here in Q3, we were very pleased to see that we had a solid quarter in ELA execution and we anticipate that moving forward. As it specifically relates to your second question, around the total addressable market opportunity, as we look at software-defined data centers and software-defined networking, we clearly see a big TAM out there, which is one of the reasons we went ahead with the acquisition of Nicira.

Operator

Our next question comes from Brent Thill with UBS.

Brent Thill - UBS Investment Bank, Research Division

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

Paul A. Maritz

Well, 2 points there. One is it's obviously where this acquisition was made because of a strategic value as opposed to its current revenue value. But we believe that this company, VMware, was founded because it was able to be, early on, a leader in the virtualization server space, and that has built a company of enormous importance and value in the industry. We see similar forces at work here as we move toward the software-defined data center. We saw tremendous strategic value in being able to claim a position of leadership as we move into these new phases of the software-defined data center. So obviously, given the size of the price tag, we believe that this is of the utmost strategic importance going forward.

Brent Thill - UBS Investment Bank, Research Division

And Paul, just as a follow-up on the competitive side, are you seeing anyone also in the market that's doing something similar?

Paul A. Maritz

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

Operator

Our next question comes from John DiFucci with JPMC.

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

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

Carl M. Eschenbach

Yes, sure. So 90 days ago, we had a different view of the world and the market, specifically in Q3 when we said we'd be sequentially flat from Q2 to Q3. But with the continued uncertainty and the macro that we're facing specifically in Europe, we had originally thought that the federal government spend would pick up going into Q3, which it traditionally does because it's our fiscal year-end. We've revisited that earlier estimate and we've taken it down internally. The fact that we see traditional seasonality in Q3 compared to Q2 has taken us in a line to say our Q3 number will not be sequentially flat. In fact, it will be down from Q2 to Q3. With that being said, it's in line with what we saw last year. Last year, we saw about a 5% deceleration in license in Q3 compared to Q2, and that's exactly where we've guided this year. As it relates to Q4, again, we have a very robust pipeline. Q4 is always had been historically obviously the biggest quarter of the year for technology companies, and we're no different. We also are excited about the lineup coming out at VMworld and we'll have a lot of momentum as we head into Q4. And lastly, if you look at our growth that we're thinking about for Q4, it's in line with what we've seen from a Q3 to Q4 perspective over the last 1 to 3 years. So again, it goes back to the strength of the pipeline, it goes back to VMworld momentum and it goes back to the fact that we expect Q4 as we've always seen a flush of budgets as people spend money that they have in excess as they exit a fiscal year.

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

Yes, that's very helpful. If I might, just a quick follow-up. You did mention I think throughout the call I think just recently, I think it's -- with several acquisitions, I believe it's 4, and I know Nicira was certainly a strategic value, however, I believe Rackspace was using them and I assume others. What kind of a benefit at least in license might we expect from all these acquisitions, realizing there's mostly strategic value here, but there's got to be some kind of contribution to help some.

Paul A. Maritz

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

Operator

Our next question comes from Adam Holt with Morgan Stanley.

Adam H. Holt - Morgan Stanley, Research Division

I'm actually going to ask 2 follow-up questions: one on Nicira; then one on the model, if I can. On Nicira, there's no doubt that this market's got tremendous potential. It's also a very early marketplace. Can you maybe walk us through what you saw or maybe some customer examples that got you comfortable with the maturity of the technology certainly relative to some other Nascent offerings as well?

Paul A. Maritz

Well, obviously -- this is Paul, Nicira is a company we have been aware for some time and we have got to know them over the last several quarters and had developed a deepening appreciation for both the people and the technology that they have there. Now the fact is as they have customers who are starting to prove out this technology at scale in their data centers, they're in the data centers of many of the large service providers. Rackspace was already mentioned as well as starting to make inroads into our more advanced and forward-thinking customers. So we see this playing out in a similar way to which we saw server virtualization play out which the technology starts to come into the more advanced, forward-thinking customers. And in that context, being an early leader in these emerging spaces is incredibly important and we believe that establishing a position of early leadership here will pay off, just as it paid off in server virtualization.

Adam H. Holt - Morgan Stanley, Research Division

That's helpful. And then just on the model, it looked like you had a very strong quarter for ELAs. It looked like you potentially had a very strong quarter for new ELAs. Can you just talk a little bit about the dynamic between new business within the ELAs this quarter versus, say, renewals in the quarter?

Carl M. Eschenbach

Yes, sure. Thanks, Adam. So as I said in my prepared remarks, we were really pleased with the results of our ELA -- ELAs in the quarter, powered by 3 ELAs greater than $10 million as compared to none -- I'm sorry, 4, compared to none last year. And 3 of those 4 were net new ELAs and 1 was a renewal, so both new ELA business was extremely healthy to your point and the renewal business remained healthy as well. This only shows the fact that customers continue to see the long-term value of our platform and are buying into 2- and 3-year ELA terms with us to continue to build out both their private and hybrid cloud platforms.

Adam H. Holt - Morgan Stanley, Research Division

Our next question comes from Heather Bellini with Goldman Sachs.

Heather Bellini - Goldman Sachs Group Inc., Research Division

I had 2 questions. The first one was what percentage of license bookings were related to management and also to end-user computing? Those are stats you guys have given out in the past. And then also, I don't know, Paul, if this is a question for you, but how do you see your success in the virtualization layer and a growing presence of customers using your automation solutions helping to position you for the SDN space? I'm wondering how you see those other 2 layers as a competitive advantage and how you see them, the solutions getting sold over time.

Carl M. Eschenbach

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

Paul A. Maritz

Sure. So Heather, the -- as you've heard us say before, we believe at the end of the day, we are in the data center automation business. And to be in the data center automation business, one has to be able to speak to the automation of all the key functions in the data center. So having the ability to play in the software-defined networking space we see as very important when you combine it with our traditional strength, in server virtualization and in management and in other areas such as securities which we're addressing through our vShield products. So we believe that success in the long run there comes through the coordination of all of the factors that play in the data center, and as such, this is a very important step in that direction.

Heather Bellini - Goldman Sachs Group Inc., Research Division

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

Paul A. Maritz

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

Operator

Our next question comes from Walter Pritchard with Citi.

Walter H. Pritchard - Citigroup Inc, Research Division

Just 2 numbers questions. First, just curious, the long-term deferred revenue here continue to grow a lot faster than the short-term deferred revenue. And I'm wondering, is license a meaningful driver of that long-term deferred revenue number?

Carl M. Eschenbach

I'll take that, Walter. So it's a combination of things. As we do more ELAs, they include typically 2 and 3 years of maintenance, which drives our longer-term revenue deferral as well as more and more of our ELAs have aspects or characteristics of them that have us taking the license revenue ratably over time. And they are 2 determining factors in the growth of long-term unearned revenue.

Walter H. Pritchard - Citigroup Inc, Research Division

Great. And then just on the linearity in the quarter, looks like DSO spiked up a bit. The AR balance was a little higher than we were expecting. How much -- Carl, if you could comment on what you saw throughout the quarter and was it more a back-end loaded quarter than you've typically seen in a Q2 or any other quarter?

Carl M. Eschenbach

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

Operator

Our next question comes from Rick Sherlund with Nomura.

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

There were some press reports earlier. I wonder if I could get you to comment on -- about possibly spinning out some of the cloud assets?

Paul A. Maritz

Rick, this is Paul. Two points, first of all, just want to draw a line under the fact that we see the cloud investments we've made such as Cloud Foundry as being absolutely critical, and if anything, we intend to put -- further emphasize behind those assets going forward. Second point is as I transition on from the CEO role here, one of the things that I'm going to be doing is thinking about actually as to how to use those assets even more effectively in the future and there's more thinking to be done at -- on that front. But we have no specific plans at this point in time.

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

Okay. And just on the ELA environment, sometimes when things get a little tougher in the economy, ELAs are the area that you see some increasing sale cycles. People cut back in the quarter. It looks like ELAs did quite well. It sounds like you're a little more cautious about ELAs going forward. Is that reflecting the environment?

Carl M. Eschenbach

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

Operator

Our next question comes from Phil Winslow with Crédit Suisse.

Philip Winslow - Crédit Suisse AG, Research Division

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

Carl M. Eschenbach

As I said earlier, we don't break out specific product lines as a percentage of license. But I did say that we were very pleased with the adjacency attach rate on ELAs and non-ELAs, specifically around management and automation. We are pleased with the uptake of vCloud Director and we're really excited with the fact that we're bringing in Dynamic Ops to manage more than just VMware environments as well. So those 2 combination -- those 2 as a combination gives us a lot of excitement as we look at the second half of the year. And we believe the attach rate to ELAs could only strengthen moving forward.

Paul A. Maritz

This is Paul here. This is an area where we continue to move the bull down the field. And as was noted in our earlier remarks, come the VMworlds this year, we expect to see really interesting, new functionality disclosed then.

Operator

Our next question comes from Brian Marshall with the ISI Group.

Brian Marshall - ISI Group Inc., Research Division

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

Paul A. Maritz

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

Operator

Our next question comes from Mark Moerdler with Sanford Bernstein.

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

Nicira looks like a really interesting acquisition, guys. So how do you plan to rationalize the sales models of the cloud-enabling technologies you've already acquired and are acquiring between some being open-source, some license and maintenance? What's your sense of what's going to be the right methodology?

Paul A. Maritz

I can jump in there and handle that, just -- we already have a blended strategy where we use both traditionally licensed for software and open-source software, so that is nothing new. And I think everyone in the industry today to a great or lesser extent has to deal with that. The thing at the end of the day is, is the customer getting value, and they can get that value from either purchasing the software or purchasing the support that goes around that software or purchasing value-added components that plug into that. So we already have that aspect to our product line. We're able to deal with it in a fairly straightforward way. Generally receive positive reaction from our customers and we don't expect that to change.

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

Do think that'll be -- it's a similar type of mix in the cloud?

Paul A. Maritz

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

Operator

Our next question comes from Laura Lederman with William Blair.

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

When you look at the software-defined networking space, do you think we're like 3 years from general acceptance where it's not just larger service providers and the most forward-looking type of organizations? So maybe we can talk about sort of the life cycle of that type of product and when you see it being more mainstream or in any way wish to kind of outline how you expect it to happen over time.

Paul A. Maritz

Obviously we're on day 1 of this acquisition, so it's a little early to give you specific time frames here. But as with any new technology, we see it spreading into either people who have an immediate, overwhelming need for it today or into more forward-thinking customers, who anticipate their needs for it and start moving early. And we see this technology unfolding exactly that way. We see it going into large scale service providers who have an immediate need for it and we see it starting to go into forward-thinking corporate customers. And whether that's going to be a 2-year cycle or a 3-year cycle, I can't say to you today but the one thing I can say with absolute certainty that this is the tide coming in.

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

Have customers asked you for this type of technology? Is it something that's been coming up an awful lot when you're talking to more forward-looking customers who are paying financial services or other industries?

Paul A. Maritz

It's coming, as you said, from the 2 constituencies that I said. And -- but it was exactly the same thing with virtualization. Customers didn't ask us for virtualization 12 years ago.

Operator

Our next question comes from Jason Maynard with Wells Fargo.

Jason Maynard - Wells Fargo Securities, LLC, Research Division

I have a question probably for both Paul and Pat. And sort of following up on this thread, taking Nicira out of the equation for a second, what percentage of -- let's just say the traditional networking space, do you think OpenFlow could realistically address within 5 years? And then a follow-up question to that would be Google's been a big proponent of this. And if you look back over the last couple of months, they've even had a lot of public events where they've been talking about their own implementation. And one of the bottlenecks it sounds like has been there is no white box networking champion. There isn't somebody who provides just the basic switch with merchant silicon to actually provide, if you will, the building block. And I'm curious, how do you see that playing out in terms of your own rollout and go to market with customers? Is that something that VMware would potentially do? Is that something that EMC does? Does it sit inside of VCE or is there a third-party ecosystem that you think going to emerge to address that issue?

Patrick P. Gelsinger

Well, maybe I'll start and Paul might help. But with regard to the size of this market, I think it's very early to put a particular TAM on it. Overall, the networking market has pretty well diagnosed how large it is, and this is not so much about changing how the networking market operates today, but creating a layer of agility and management control for these large-scale service providers for the future. And in that sense, I think there's been much written that would say it's all about commoditizing today's hardware, and we actually take a very different view of that. It's about creating this automation and this next layer of flexibility for these large-scale service providers. And that's why we're finding this to be such an interesting opportunity so complementary to the value proposition that VMware has been pursuing in the past. And with regard to white box networking and some of those types of things that have been discussed, we have no plans in that area whatsoever.

Operator

Our final question comes from Shaul Eyal with Oppenheimer.

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

One quick question on your kind of relations with Cisco. Nicira, I'm thinking given some of the chatter in the Bay Area seems to be one of the companies that kind of could be described as kind of being disruptive to kind of Cisco's strategy and kind of what Cisco's involvement with you guys. How would you kind of describe this kind of triangle between the 3 companies?

Paul A. Maritz

This is Paul. First of all, as I said earlier, we don't see this as a zero sum game. Particularly if you take Pat's previous remarks, this is really about building a layer on top of existing and future network functions. And there's always going to be the opportunity for people who can do things well within their layer to reach up and ask the automation layer to delegate a task through them and have that task performed in an accelerated, superior way. So we see the opportunity here really to continue to build and extend the ecosystem rather than this as being something that is an a versus b approach.

Michael Haase

Okay. Thank you. That will end the call.

Operator

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

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