Our database server is currently a physical server however I am in the process of moving to a SQL 2005 virtual server soon.  I will not be putting it into the same virtual server -- having database and web server on the same server is not a good idea, definitely should keep them separate (and not because of processor usage, although that is a concern, it is more the security issue).  Our setup currently has only a single virtual machine running our DNN instance though we are going to add another server or two soon and load-balance it.  We have already ran a couple of VMs in a test environment with load-balancing and are just waiting for the "right" moment to make the switch (I'm currently converting all my modules to ASP.NET 3.5 and want that done and over with first).