Jul 22, 2009
Executives
Michael Haase - Vice President of Investor Relations Paul Maritz - President and Chief Executive Officer Tod Neilsen - Chief Operating Officer Mark S. Peek – Chief Financial Officer
Analysts
John Difucci - JP Morgan Adam Holt - Morgan Stanley Kash Rangan - Merrill Lynch Brent Thill - Citi Walter Pritchard - Cowen and Company Keith Bachman – Bank of Montreal Aaron Schwartz - Ladenburg Thalmann & Co. Scott Zeller - Needham & Company
Operator
Good afternoon and welcome to VMware’s second quarter 2009 conference call. Today’s call is being recorded and all lines have been placed on mute to prevent any background noise.
After the speaker’s remarks there will be a question and answer period. At this time I would like to turn the call over to Mr.
Mike Haase, Vice President of Investor Relations.
Michael Haase
Thank you. Good afternoon, everyone, and welcome to VMware’s second quarter 2009 earnings call.
With us today are Paul Maritz, President and CEO, Tod Neilsen, our COO, and Mark Peek, our CFO. Following our prepared remarks we will take your questions.
Please note that this call is being simultaneously webcast on our Investor Relations website. Our press release was issued today after the close of market and is also posted on the website.
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. This includes statements with the words will, believes, expects, continues, and similar phrases that denote future expectation or intent.
This includes but is not limited to statements regarding our financial outlook, future product offerings, and projected demand. These statements are based on current expectations as of the date of this call and are subject to uncertainties and changes in condition, significance, value, and effect, as well as other risks detailed in documents filed with the Securities and Exchange Commission, including our annual report on Form 10-Q for the period ending March 31, 2009 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.
Our non-GAAP financial measures differ from GAAP in that they exclude stock-based compensation, amortization of intangible assets, the write off of in-process research and development, employer payroll tax on employee stock transactions, and the net effect of the amortization and capitalization of software under statement of financial accounting standards number 86. You can find additional disclosures regarding these non-GAAP measures including reconciliations with comparable GAAP measures in our earnings release for the period ended June 30, 2009 and on the Investor Relations page of our website.
The webcast replay of this call will be available for the next 30 days on our company website under the Investor Relations link. For your planning purposes, VMworld will be held in San Francisco August 31 through September 3 and we’ll be mailing the registration information within the next couple of days.
Our third quarter quiet period begins at the close of business September 16, 2009. Also, unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2008.
With that, let me hand it over to Mark.
Mark S. Peek
Thanks, Mike. Good afternoon everyone and welcome to our second quarter earnings call.
VMware delivered a solid quarter in what continues to be a challenging economic environment. The highlight of the quarter was the general availability and release of vSphere on May 21.
With vSphere, we once again demonstrated that no enterprise software company in the world can compare with VMware’s quality and the tremendous value we deliver to our customers. Tod will cover the vSphere launch in more detail in a few minutes.
Let me first walk you through some of the financial highlights before going into the details. Non-GAAP operating cash flows for the quarter were $233 million, an increase of 19% from the second quarter of 2008.
Our trailing 12 months non-GAAP operating cash flows were $910 million. We now have $2.3 billion in cash and cash equivalent and $934 million in deferred revenue.
Revenues for the second quarter were $456 million at the high end of our planning estimates when we reported to you three months ago. Non-GAAP operating margins came in at 21%.
Our non-GAAP diluted EPS was $0.20 per share. I’ll now provide a bit more detail on the quarter.
Revenues for the second quarter were $456 million, flat from a year ago. We’re quite pleased with our results given this tough environment and the relation to our expectations a quarter ago.
Last quarter I noted several variables that could impact our near term business. These included reduced capital spending for new IT projects, difficult comparables to Q1 due to our seasonal OEM business, and the two very large ELAs that closed in the first quarter.
Finally, the uncertainty with respect to the impact of the vSphere launch would have on our sales cycle. Our second quarter results reflect the continued uncertainty in IT spending.
License revenue for the quarter was $228 million and ELAs as a percentage of total bookings were approximately 15% compared to approximately 20% a year ago. But despite the economic environment, we did an excellent job in seamlessly transitioning from VI3 to vSphere 4.
Our customers’ commitment to VMware remains very strong. An illustration of this is evident in our strong software maintenance renewal rate.
Likewise, renewal bookings grew 57% compared to the second quarter of 2008, a strong indicator that customers are satisfied and getting value from our solutions. Total services revenue was $228 million, up 32% from last year.
The software maintenance portion of our services revenue was $189 million, up 39% compared to last year. Professional services revenue was $39 million, up 8% from last year.
While it is our belief that license revenue will accelerate as the economy improves, we’re pleased with the strength of our services revenue. It is clear the global economy has not yet recovered and there is still some uncertainty.
In a recent survey of 150 CIOs of large businesses, 40% expected some downward revision in their budgets in the second half of 2009. That said, there were some signs that customers were moving on with business, even if it was buying just enough just in time.
Our overall ELA activity level was strong with a large number of small and medium sized deals closed. As a percentage of total second quarter bookings, ELAs declined to approximately 15% down from last quarter and a year ago.
This was largely due to the fact that we did not have some of the very large deals seen in past quarters. With companies being more reserved in the sizes of their purchases, we were also pleased with our high volume transaction business.
Orders less than $50,000 represented more than 50% of the total value of total orders for the first time in over two years. Our overall activity level continues to be strong, but closing larger deals remains a challenge.
Geographically, total revenues from the US declined 3% year-over-year to $234 million and international revenues grew 3% to $222 million. Although in general business conditions were difficult these past 12 months, we have experienced double digit year-over-year bookings increases in key international markets such as China, Japan, Canada, Brazil, and the UK.
In general, although our visibility is improving somewhat, it does not appear the global economies will be a significant positive catalyst in the second half. Now turning to operating expenses.
Unless otherwise noted, all references to our expenses and operating results are on a non-GAAP basis which are reconciled in the press release tables on our IR website. Total operating expenses including cost of goods sold increased 3% sequentially to $359 million driven primarily by adding nearly 200 employees, most of them in customer facing roles and product support, and in our emerging market field organizations.
Tod will discuss this more fully in a few minutes. Operating margins for the second quarter were 21.1%.
The quarter benefited by almost $4 million or 80 basis points from a change in the useful lives of certain fixed assets. During the quarter we successfully transitioned to billing and collecting in local currencies in connection with the vSphere launch.
This is a very important milestone and transition for VMware and took a lot of work to execute smoothly. The change is good for our customers and partners and will help protect us against some of the margin volatility going forward.
As this transition occurred late in the quarter, it did not have a meaningful impact on revenue and as a result did not offset the negative impact the weak dollar had on our international expenses. Our operating margin was negatively impacted by over 100 basis points of currency compared to last quarter.
As a percentage of second quarter revenue, costs of revenues increased sequentially to 12.5% from 12.3%. As stated in our last earnings call, we had expected the amount of capitalized software to decline over the next several quarters while amortization recorded in cost of license revenues would increase, all of this having no impact on our non-GAAP results.
During the second quarter we capitalized on a GAAP basis $18 million pursuant to FAS 86 including $3 million of stock based comp and $15 million in cash salaries. Second quarter R&D expenses totaled $109 million or 24% of revenues compared with 23.7% in the first quarter of 2009.
R&D expenses in dollar terms actually declined from the first quarter. Sales and marketing expenses were $154 million or 33.7% of revenues compared with 29.7% in the first quarter.
The increase was largely due to the weakening of the US dollar, the launch of vSphere, and additional customer face and head count in emerging markets. G&A expenses declined $1 million to $40 million or 8.7% of revenue compared to 8.6% of revenue in Q1.
Our operating profit on a non-GAAP basis declined 14% from a year ago to $96 million or 21.1% of revenue. Our non-GAAP tax rate in the quarter was 18% and the non-GAAP diluted EPS was $0.20 per share on 396 million diluted shares.
The change in the useful lives of certain fixed assets I described earlier did not have an impact on EPS. We continue to expect our tax rate to be between 20% and 24% for the year meaning the H2 tax rate will increase over H1.
Now on to our balance sheet and cash flow statement. Our balance sheet once again strengthened with cash at quarter end of $2.3 billion, a sequential increase of $244 million.
We remain invested in short term cash and cash equivalents and have not experienced any declines in valuation of our holdings. We are also becoming more efficient in our capital spending and our net fixed assets declined for the second consecutive quarter.
Although capital spending may vary from quarter to quarter, we are monitoring this closely as we understand the bow wave effect on expenses of current period capital spending on future quarters. Second quarter depreciation and amortization was 12.5% of total non-GAAP operating expenses compared to 11.5% a year ago.
Total deferred revenues increased 2% sequentially to $934 million. Our net accounts receivable declined $7 million from last quarter and our DSO including the change in deferred revenue is approximately 50 days.
Throughout the global credit crisis we have done a solid job of managing our cash. Non-GAAP operating cash flows which exclude adjustments for capitalization under FAS 86 and excess tax benefits from stock compensation were $233 million for the second quarter, an increase of 19% from Q2 2008.
Part of the strong quarterly performance was an $88 million reduction of our income tax receivable. This variability is one of the reasons we focus more on our trailing 12 month operating cash flows.
On a trailing 12 month basis, non-GAAP operating cash flows were $910 million, an increase of 35% from the same period ended June 2008. For the same period free cash flow increased 115% to $754 million.
A notable milestone is that our GAAP operating cash flows exceeded $1 billion on a trailing 12 month basis. Our full time head count at the end of the second quarter was approximately 6900 people and grew by nearly 200 people from last quarter.
During the quarter we conducted our first equity refresh since the IPO and granted employees approximately 4.1 million stock options and 2.2 million restricted stock units. We expect that our diluted weighted average share count for Q3 will be just over 400 million shares.
On a GAAP basis the impact of the refresh is to increase our equity compensation expense by approximately $7 million a quarter. Before I hand it off to Tod, I want to share with you how we are looking at the business to give you some assistance in developing your estimates.
IT spending for 2009 will be slower than many predicted at the beginning of Q2. For example, in a late June report on regional IT spending, research from Gartner said IT spending will fall by 6% in 2009 compared to a previously forecasted decline of 3.8%.
Our customers’ appetite for Cap Ex outlays for hardware is dampened by the economy. This tends to negatively impact virtualization demand as some customers choose to virtualize their data centers during a hard wire refresh cycle.
However, we expect modest sequential improvement from the OEM channel as a result of the seasonality and our revenue recognition method. The value of vSphere is becoming apparent to our customers and the channel and those under current maintenance have received the product and are beginning to test and deploy.
VSphere is rock solid and has a tremendous value proposition but macro factors are unlikely to make it a near term revenue catalyst. Although we are cautious about the economy, we are beginning to get somewhat better visibility into our business and believe that Q3 will tend to follow our historic seasonal patterns.
Over the last several years our bookings for Q2 and Q3 have been very similar. Because of our large deferred maintenance base, we expect third quarter revenue to be approximately flat to last year.
We are planning on a range between $465 million and $480 million. We now also expect the full year 2009 to grow 1% to 3%.
Barring any unusual items, we believe that our third quarter non-GAAP operating margins won’t drop below 20% and could be as high as 22% after taking into account our adjustments to GAAP operating income that Michael Haase listed at the start of the call. We expect our GAAP operating margin to be approximately 18 percentage points lower than the non-GAAP margin.
With that I’ll turn it over to Tod.
Tod Neilsen
Thanks, Mark. Good afternoon.
As Mark outlined, I’ll provide you with an update on the VMware vSphere 4 launch including reaction from customers and the industry at large. I will also share some color on the operational improvements we are making to ensure VMware is best equipped to serve our growing customer base for the long term.
As we mentioned on last quarter’s call, vSphere is the product that formally transforms virtualization from being simply a Cap Ex play into being a fully fledged system software play helping customers reduce both their capital and operating expenses. It is important to understand that vSphere represents not just a significantly forward in terms of functionality, but also marks an evolution in how VMware interacts with and serves its customers.
We delivered vSphere just eight weeks ago on May 21. This was a milestone in that it was one of our biggest steps forward from both a technology and operational alignment standpoint to date.
In preparation for vSphere, over the past 6 months we have literally touched almost every aspect of our business operations. This effort has allowed us to drive important improvements to our execution capabilities.
At the same time, we also succeeded in delivering second quarter results at the high end of our revenue expectations. Some of the operational aspects of our business we improved include the following: we expanded our field and partner enablement programs, including a new partner portal.
We expanded and revitalized our customer support organization. We’ve re-engineered our software licensing technology and entitlement policies.
We put in place a new organizational structure aligned around geographies and product business units. We’ve transformed our order to cash processes so we can now conduct business in local currency.
We enhanced our software maintenance renewal processes and efforts. We defined a consistent set of our messages for our various routes to market and we’ve localized many of our customer facing portals.
As you can see, it has been a very busy six months, but let me drill into a couple of the components. Specifically, I’ll briefly touch on field and partner enablement as well as our support initiatives.
We’ve recently launched our second generation partner program and portal where we have enhanced a relationship with our over 22,000 partners. This new program allows us to more effectively segment, train, serve, and enable them, and it allows us to use fewer resources than required before.
At the same time, this program allows us to identify and spend more time with our most impactful channel partners, and yet continue to empower all of the partners with the support they need to be successful. To date, we have rolled out vSphere enablement programs to our entire field, trained most of our top partners, including thousands of individuals, as well as executed launch events in every major theater.
Another key area we’ve transformed is with respect to our customer service organization. We’ve made investments to ensure a smooth uptake of vSphere by increasing our front line customer support team by approximately 20%.
We were able to ensure the rise and demand on this team as a result of vSphere was handled flawlessly. To measure our efforts here, we had a third party gather customer satisfaction scores and those continue to hit industry highs.
Customer satisfaction is important to us for two primary reasons. First, it is a critical component of our customer for life expansion efforts and second, customer satisfaction plays a role to encourage a long term annuity through software maintenance renewals which we experienced this quarter with very positive renewal rates.
Also relevant to renewals, this quarter we initiated a back maintenance program focusing on the smaller tier customer segments where transactions are typically $10,000 and below. Renewals of some of these customers may have been lost in the jet stream of the tremendous growth we have experienced over the years.
Early indications are that these customers are very interested in renewing and they appreciate the new program that is focused on helping them get current on their software maintenance. A great measure of customer commitment is the length of the maintenance contract purchased when they buy software licenses.
Most enterprise software vendors sell a one year maintenance contract with their software licenses and at the end of that year the vendor attempts to renew the contract. In our case, the average maintenance contract term in Q2 was more than double this industry average, clearly a strong signal of the commitment customers are making to VMware.
Beyond the positive indicators of our customer satisfaction scores and renewal improvements, we are experiencing heavy downloads of vSphere trials. We have recorded nearly a quarter of a million downloads in just eight weeks and are seeing a great deal of activity around upgrades and deployment on our customer forms.
Now I should mention that these 250,000 downloads represent real actions proactively taken by individuals to try the product. This is as opposed to other vendors that push their product out to list and claim those numbers as downloads.
I’d like to share one interesting early customer win story. This came from an event I hosted in Sydney, Australia the day after we launched vSphere.
I was sitting in the audience and the chief technology officer of Melbourne IT was addressing the nearly thousand attendees at the local launch event. He went on to say that he was a vSphere beta customer and was very impressed with the product.
In fact, he was so impressed that same day, the day we shipped the product, he decided to do a rolling upgrade of his 3,000 servers with vSphere and he did it during business hours. Now this is clearly not the typical deployment cycle for IT, so I went up to him afterward and asked him if there was any impact to his business.
He said there was. The impact was that the servers are now faster, they have 30% better consolidation ratios, and it is more resilient and fault tolerant than ever.
He went on to say that this was one of the easiest upgrades he’s ever gone through. Again, this is definitely not the typical scenario for an enterprise software upgrade but it is a great story and an indication that vSphere has the potential to be something very special.
So overall, I am very pleased with how the organization delivered vSphere and kept a laser focus on execution to ensure our customers a successful today and over the long term. VMware is maturing as an organization in direct response to the demands of our customers.
We are continuing to invest across our business in the services and expertise required to satisfy the demand and market opportunity. Customers are no longer just looking at VMware for technology.
They are looking at VMware as a resource aligned with their most important investments. In response, we will work to develop the expertise and operational fortitude required to help nurture them along the virtualization journey.
I’ll now hand the call over to Paul.
Paul Maritz
Thanks, Tod. As both Mark and Tod have noted, we managed to return a solid quarter despite undertaking a very large product transition.
As early feedback coming in from our customers and our ecosystem partners has been very positive, it’s in particular gratifying to see that there are approximately 1,000 ecosystem partners which range from very large server vendors to small ISVs have been working hard at certifying their products and are leasing new products that work with the vSphere foundation. This is a key step on the journey we’re offering to our customers to allow them to not only operate their computing equipment much more efficiently but to do so more flexibly and in fact open up future bridges to the cloud.
So building on this foundation, we’re going to be releasing a series of complimentary products over the coming quarters that fall into three basic categories. Firstly we’re releasing a series of management add-ons that speak to common usage scenarios such as test and development, application or SLA level management, business continuity, and the internal cloud.
These products not only enable operational benefits that customers can get out of the virtualization journey but they will speak to the maturity of the product line we have. No other virtualization vendor has anything close and the first of these products have in fact been released this month.
Secondly, we are building up to the release of the next major version of our desktop virtualization product suite, VMware View, which will incorporate the new protocol that we have been jointly developing with Terradicci. This release will also take full advantage of the performance and scalability of the underlying vSphere foundation.
Early customer looks at this release have been incredibly positive and it is interesting to note that in recent Goldman Sachs and Morgan Stanley CIO surveys, VMware was in fact ranked as the leading candidate to supply desktop virtualization. Thirdly, we continue to work with our service provider partners who are building public clouds based on vSphere.
These service providers include some of the most respected names in the industry and they will be offering a full range of cloud offerings based upon vSphere. We plan to have a set of announcements around this theme on or before VMworld at the end of August but I’ll not steal our own thunder before then.
Returning to a theme from our earlier calls, we continue to build out our management team. In this regard we have been recently joined by Mark Egan as our new CIO.
Mark has previously served as the CIO at Symantec. We’ve also been joined by two senior R&D managers.
[Baliz Kadanish] comes to us from Mercury where he was VP for R&D and he will be leading a new initiative focused on application level provisioning and management. Zahid Hussain comes to us from Brocade and he will serve as the leader of our core vSphere development team.
We’ve also been joined by three senior engineers from Google, including two gentlemen who prior to their Google lives were distinguished engineers at Microsoft and Tibco respectively. In summary the economy remains muted.
Chairman Bernanke warns us that no sharp recovery can be expected and we will thus continue to contain our costs while focusing on key investments and ensure that we are well-positioned for the recovery when it does come. But fundamentally we are optimistic that vSphere and the set of products that we are releasing on top of it are going to serve us well in the future.
With that, we’ll now open up for questions.
Operator
(Operator Instructions) Your first question comes from John Difucci – JP Morgan.
John Difucci - JP Morgan
The first question is for Mark. Mark, when I look at the margin and look at the margin guidance and you guys have been doing a lot.
Margins are down year-over-year a bit but at the same time a lot has been going on, the economy one thing, the launch of vSphere, but at the same point, at this point I would think that some of those expenses, you can’t control the economy, we all know that, but some of those other expenses you can, and vSphere is out there now. I’m just curious on your margin guidance, what’s in there?
I think non-GAAP margins this quarter were something like 21%, a little over that? You said 20% to 22%.
Is there something happening there that I’m missing as to why it wouldn’t start to I guess creep up some?
Mark S. Peek
Part of the sequential increase that we expect in expenses is the carry forward for a full quarter of the 200 people we added in support and in the field organizations as well as the additions that we’re making in our engineering teams that Paul mentioned in his remarks. Remember we’re also facing the bow wave of depreciation from past quarters and we won’t lap that for at least another couple of quarters.
It had a 100 basis point impact in Q2 and we expect some additional impact in the third quarter.
John Difucci - JP Morgan
So it sounds like as Paul mentioned, Mr. Bernanke doesn’t expect any type of sharp improvement in the economy but 20% plus margins are pretty decent but are you preparing for when that does come or is it that you think perhaps… I can imagine that VMware is something that provides ROI for somebody so do you think perhaps the top line could improve here going forward?
Mark S. Peek
We’ve provided our guidance for the second half of the year and certainly as we think about margin expansion that has to be led by revenue growth. We still view ourselves as first and foremost a growth story that is going to grow through top notch development not only of vSphere but of adjacent products.
John Difucci - JP Morgan
A quick follow up for Tod. Tod, you mentioned the maintenance program and I’m just curious that the back maintenance program and it sounds like it’s for mostly smaller customers but can you give us some kind of gauge as to what kind of impact that might have, even just the number of smaller customers you might have out there, and also on the two year maintenance contracts, I’m just curious, is the cash typically paid up front on that or is the cash still collected annually?
Tod Neilsen
On the two year maintenance the cash is collected up front and then the revenue is of course recognized over the term and as far as magnitude, I’m not going to break out what the impact or the potential is for the back maintenance but we are encouraged and it’s factored into our guidance.
Operator
Your next question comes from Adam Holt - Morgan Stanley.
Adam Holt - Morgan Stanley
You mentioned that it was pretty late in the quarter that vSphere shipped, so the impact was relatively modest, but I was wondering if you could maybe comment on what you did see from an early perspective relative to mix out of the enterprise plus SKU drive via the majority of share and were you able to actually get any price improvement within the early deals?
Mark S. Peek
On the early shipment of vSphere, we were actually quite pleased with the breadth of the products that shipped. As you recall we broadened our set of SKUs from 3 to 6 including essentials and enterprise plus and we saw a nice balance among all the SKUs and overall that has kept our ASPs at the old VI 3 level plus a little.
Adam Holt - Morgan Stanley
If I could ask a follow up on the Q3 guidance, it looks like you’re guiding license revenue or the implied license revenue to be up sequentially historically. You’ve sort of talked about Q3 and Q2 being roughly similar.
Maybe if you could give us a little bit of a sense for what gives you confidence that you’re actually going to see a sequential improvement in license revenue if that’s the right premise and maybe touch on what you sort of are thinking about with the ex 86 market and some of the other elements there.
Mark S. Peek
On license revenues sequentially, if you think about the midpoint of the range and the fact that implies that bookings will essentially be flat quarter-over-quarter, it also implies sequential license revenue will be flat so we expect some additional uptick in maintenance and revenue during the quarter which allows us at the midpoint to be flat to Q3 of last year. From the ex 86 perspective, if you’ve seen server shipments and monitor them as closely as we do… We are frequently part of a data center refresh and so there’s certainly some impact to us as to when shipments aren’t happening.
Operator
Your next question comes from Kash Rangan - Merrill Lynch.
Kash Rangan - Merrill Lynch
I have a question on the pricing. I know you introduced the pricing of vSphere and it looks like customers that have several props or machine kind of a set up, it looks like the pricing comes down a little bit for customers that have more simple configurations.
It looks like it could be a price increase. I’m wondering what feedback have you picked up on the new pricing for vSphere and how should we think about your SKU mix because you did introduce Vmotion and one of the lower end SKUs as well, not so much as the highest end SKU.
How does it all shake out with respect to… It looks like there’s a lot of moving variables in your pricing versus volume mix as you give your guidance and ponder what the license revenue outcome could be from Q3, Q4. I was just curious to get your thoughts on a different component of the mix that goes into the license and revenue outcome.
Tod Neilsen
The key thing we’re hearing from customers is that the value of our solution and what we provide so as we’ve added more features and functionality in enterprise plus like our tolerance and high availability and some of the additional features and capabilities there, customers are valuing that tremendously. Mark mentioned the essential SKU.
We’re seeing a good response to that SKU. It’s focused on small and medium business and so we think that the additional SKUs are going to be able to maintain the mix of ASPs similar to what we’ve had in the past.
For the most part, our customers are very encouraged by what they see in vSphere and are looking at how they can use vSphere to reduce their operational expenses and it’s not just simply a price and Cap Ex play but it really is how they can transform their data centers to take advantage of the solution.
Kash Rangan - Merrill Lynch
Also second to the follow up, I have spent much time in Europe. It looks like other companies are noticing some deterioration in Europe and some improvement in the Americas so I was wondering what you’re seeing in Europe or if you have any comments around that.
Mark S. Peek
Europe has been a bit behind the US particularly from an enterprise license perspective and so we saw more larger deals in the US but we were really pleased with the rollout of vSphere in Europe and some of the momentum in the transactional business.
Operator
Your next question comes from Brent Thill – Citi.
Brent Thill - Citi
Mark, you mentioned you’re seeing somewhat better visibility. I’m wondering if you could just elaborate on what you’re seeing.
Are you seeing closed rates starting to improve? I think you had a couple of large deals in Q1 but I think you mentioned you didn’t see that.
It sounds like a steadier stream of smaller transactions that perhaps are giving you some signs of better visibility. Can you just elaborate on what you’re seeing?
Mark S. Peek
Brent, with respect to visibility, as I mentioned in my prepared remarks, more than 50% of our total orders were from the transactional business so we have a bit better visibility into the channel and we’ve done a good job of training the channel on vSphere and they’re very enthused about going out and talking to customers about it so first of all it’s the channel business. On the enterprise business, as we entered the quarter, we were coming off the tailwind from the two large transactions that we did with the US military and we didn’t have as strong a pipeline of big deals.
As we enter Q3, we certainly have a pipeline and we’re not again seeing the very super large deals at this stage, but we’re encouraged by our customers’ interest in vSphere.
Brent Thill - Citi
A question for Paul. If you could just help us frame the opportunity with VMware View, just trying to get a sense of separating the hype from the reality of what’s happening in this space.
I think certainly we’ve gotten a lot of questions on this.
Paul Maritz
I think there are two points to make here. One is that we are seeing across the board a very strong interest from customers.
Every meeting I have with a CIO now, desktop virtualization is on the agenda and they want to talk about it and that is borne out by the number of proofs of concepts that we see underway in our customers and the percentage of presales time that is being absorbed by the desktop, fully 20% or 30% of our SE’s times is actually taken up in talking to people about the potential of the desktop. So on the one hand there’s tremendous interest here.
On the other hand it’s clear that beyond the initial set of customers who have very strong interest in doing this mainly for security and compliance reasons, people who want to do this for economic reasons is using this as a lower cost way of provisioning end user computing. That’s going to take a while for them to get comfortable to really understand all the issues involved and actually get into production so we view this as incredibly important with tremendous amount of potential but it’s really going to be into 2010 and 2011 I think before we start to show a significant impact in terms of large amounts of revenue.
But it is an incredibly important area and one that we continue to invest very strongly in and the initial interest is confirming that is a good investment to make and it’s also heartening as I said in the CIO surveys to see us being recognized as a leader in that space. If you really talk about true desktop virtualization as opposed to some of the older Citrix terminal time sharing solutions, we are the clear leader in that space.
Our desktop virtualization revenues are ahead of any other vendor at this point in time and we have the recognition of leadership there.
Operator
Your next question comes from Walter Pritchard - Cowen and Company.
Walter Pritchard - Cowen and Company
I’m wondering if you guys could give us just the deferred license revenue and what that did in the quarter?
Mark S. Peek
Deferred license revenue was $934 million and that was up 2% sequentially during the quarter. As Tod mentioned in his remarks, our maintenance on licenses was averaging about two years.
Walter Pritchard - Cowen and Company
I guess I was just talking about the deferred license fees --
Mark S. Peek
Deferred license revenue was really approximately flat and didn’t have an impact on the quarter.
Walter Pritchard - Cowen and Company
Could you help us understand as you get into the ELA renewals which by our calculations start later this year and into next year, just give us a sense of timing there, that opportunity there, as well as the impact on license and service bookings as you get into that period.
Mark S. Peek
We began to sell enterprise licenses in earnest in Q3 really of 2007 and most of those enterprise agreements were three years so we still have a year to run before many of the renewals occur. But certainly as we renew and as we look at those enterprise agreements, we’ll be working with the customers on their existing deployments selling new licenses to them, selling the management products as well as desktop opportunities.
But the renewals of ELAs is really coming more in volume a year from now.
Operator
Your next question comes from Keith Bachman – Bank of Montreal.
Keith Bachman – Bank of Montreal
First a clarification. Just on license revenue, I’m not sure why license revenue wouldn’t be up sequentially.
If your OEM service ship units were up for all the OEMs for March or will be from March to June and recognizing that in arrears, why wouldn’t that cause license revenue to be up sequentially from June to the September quarter?
Tod Neilsen
Part of it is mix and so we’re providing a range of guidance and in the second quarter we expected license revenue to have somewhat of a tailwind effect sequentially from Q1 and we expect a bit of positive push from the OEM in Q3. That said, server shipments have been down in both sequential quarters and so it isn’t as rich in the mix as it has been historically.
Keith Bachman – Bank of Montreal
Let me ask my follow up question to Paul if I could. Going back to desktop virtualization, my bank is certainly looking at it in earnest for next year and I’m just wondering if you could give any quantification on how you think it could impact VMware and as part of that question, are you getting any sense that it’s going to include notebooks or is it primarily a desktop play?
Paul Maritz
I’m going to answer those questions in reverse order. There are solution, a VMware solution, does envisage including notebooks in the solution, so we are providing a common framework where people can provision both in clients and so called [inaudible] or notebooks in a more effective way.
In terms of the impact as I’ve said, it’s hard to tell exactly when the steep part of the growth curve will kick in. We’ve had significant success to date with companies who are motivated not only by lower provisioning costs by also by security and compliance reasons.
In fact I think we had two of our ELAs this past quarter were primarily driven by desktop virtualization so there is the early adopter phenomenon happening there. But when the bulk of the entities are not driven purely by security and compliance reasons as financial institutions are start to kick in, that’s going to take a little while yet because we have to prove out the economic value proposition and we need more history here because a lot of customers in fact quite frankly don’t have a good handle on what the baseline is.
They can’t tell you what it costs to provision a desktop today so we’re having to work with them and develop the turn on investment models and we need a bit more history to really make those models have credibility.
Operator
Your next question comes from Aaron Schwartz - Ladenburg Thalmann & Co.
Aaron Schwartz - Ladenburg Thalmann & Co.
Mark, I had a question on the cash flow. Obviously you’ve pointed out the impact from the tax receivable and I know there’s a lot of moving parts on a quarterly basis but can you help us out with how we should think about that going forward?
If we’re not looking at trailing 12 months cash flow, maybe forward 12 months cash flow, can you help us out at all with the guidance on that tax benefit?
Mark S. Peek
Operating cash flow obviously is a combination of our operating profits and the components of receivables. What drives our positive cash flow over operating profits is multi year maintenance.
As Tod mentioned, we collect our maintenance up front and so as we typically sell more years of maintenance when we’re doing an ELA if that mix shifts a little bit then we expect a little bit of a downtick in the growth and deferred revenue. So as you’re looking at your models, one of the things to consider is just the mix between ELAs and the transactional business.
Aaron Schwartz - Ladenburg Thalmann & Co.
I guess specifically to that $88 million that you pointed out in the quarter, is that something that you would expect to sort of repeat or should that… Can you help us out at all there? It’s very difficult to model that line item.
Mark S. Peek
It’s really our tax… this year our receivable that we had on taxes and it’s largely dependent on… it builds up throughout the year and then is either paid or collected as we file our tax return and so this year the timing of that was to be a receivable that was collected during the second quarter; however, that had a negative impact on cash flows over the past three quarters and so you’ll see that now sort of build up as a negative against cash flows in each sequential quarter.
Aaron Schwartz - Ladenburg Thalmann & Co.
So should we expect that to be collected again next year in Q2?
Mark S. Peek
Again, it depends on our results.
Operator
Your next question comes from Scott Zeller - Needham & Company.
Scott Zeller - Needham & Company
Thanks. As we look forward, there’s been some commentary about some stabilization and improvement in visibility.
If there were to be budget flush at the end of this year, when would you expect those deals to actually get into full swing in the field? Would you see them as early as the third quarter or would there be a last minute phenomenon in 4Q?
Tod Neilsen
I’d expect it to be in Q4 time frame. We’re fortunate in that our sales cycle on average doesn’t have to be as long as many enterprise software vendors and so I think as each customer were to say they have some funds they want to flush that they could quickly work with us to do that in the Q4 time frame.
Mark S. Peek
Thank you.
Michael Haase
Okay, great. That concludes the call.
Thank you very much for your participation.