The introduction of x86 servers in the 1980s provided a low-cost alternative to mainframe and proprietary UNIX systems. The broad adoption of Windows and the emergence of Linux as server operating systems in the 1990s established x86 servers as the industry standard. x86 server shipments represented 93% of new servers in 2006 according to IDC. The growth in x86 server and desktop deployments has introduced new operational risks and IT infrastructure challenges.

IDC estimates the installed base of x86-based servers in 2006 at 24.8 million units, growing to 38.2 million units by 2010. According to IDC, worldwide shipments of x86 servers are expected to increase from 6.9 million units in 2005 to 9.3 million units in 2010. IDC estimates that the percentage of all new x86 server shipments running virtualization software will increase from 5% in 2005 to 17% in 2010, which implies a compound annual growth rate of approximately 41%.

Desktop virtualization provides organizations with the ability to manage desktop deployments through the use of virtual machines running on centralized server farms in the corporate data center or IT-managed desktop-based virtual machines. For server-based desktops, users access these desktops remotely from a desktop or a thin client using a remote display protocol. The centralized management of desktop deployments enables organizations to significantly improve the efficiency of desktop installations, upgrades, patches and backups.

Desktop virtualization also enables organizations to package an IT-managed desktop within a secured virtual machine and deploy it to an unmanaged physical desktop, which can greatly reduce the manageability challenges associated with remote access deployments. IDC estimated that the installed base of business client PCs reached 489.7 million as of December 2006.

The Company’s Player is a free virtualization platform that enables individuals to run virtual machines on their desktops but does not allow virtual machine creation. The Company’s Workstation is a desktop virtualization product for software developers and enterprise IT professionals who need to run multiple operating systems simultaneously on a single desktop.

The Company’s Server is a free virtualization platform that enables simple partitioning of a server into multiple virtual machines. The Company’s ESX Server is its enterprise-class virtualization platform that runs directly on the hardware with its own microkernel and requires no third-party operating system.

The Company’s Virtual SMP enables a single virtual machine to use up to four physical processors simultaneously, thereby allowing customers to run processor- and resource-intensive applications in virtual machines. The Company’s VMFS is a clustered file-system and volume manager that enables multiple ESX Servers to safely, efficiently and reliably share block-based storage.

The Company’s VirtualCenter provides a central point of control to provision, monitor and manage a virtualized IT environment. The Company’s VMotion allows users to move virtual machines with running applications and operating systems from one physical machine to another with no service interruption or data loss.

The Company’s Capacity Planner is a hosted application that enables the service providers to perform capacity assessments onsite at a customer facility. The Company’s Converter enables customers to quickly and reliably convert local and remote physical machines into virtual machines.

The Company’s Virtual Desktop Infrastructure (VDI) enables companies to host individual desktops inside virtual machines running on centralized servers in their data center.

The Company’s Lab Manager automates the setup, capture, storage and sharing of multi-machine software configurations for development and staging environments.

Cost of revenues were $123.4, $65.2 and $45.4 in 2006, 2005 and 2004, representing year-over-year increases of 89% in 2006 and 44% in 2005.

Research and development expenses were $148.3, $72.6 and $43.9 in 2006, 2005 and 2004, representing year-over-year increases of 104% in 2006 and 65% in 2005.

Sales and marketing expenses were $238.3, $125.0 and $60.0 in 2006, 2005 and 2004, representing year-over-year increases of 91% in 2006 and 108% in 2005.

Investment income was $3.3, $3.1 and $0.1 in 2006, 2005 and 2004, respectively.