VMware Inc (VMW) 2012 Q4 法說會逐字稿

Welcome and thank you for standing by. At this time, all participant lines are in a listen-only mode. After today's presentation, you'll have the opportunity to ask questions. (Operator Instructions). Today's conference call is being recorded. If you have any objections to this, please disconnect at this time. Now, I will turn the call over to your host, Mr. Paul Ziots. Sir, you may begin.

Welcome to VMware's fourth-quarter and full-year 2012 earnings conference call. On the call, we have Pat Gelsinger, Carl Eschenbach and Jonathan Chadwick. 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.

The 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, 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 of our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax and employee stock transactions to 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 replay of this call will be available for the next 60 days on our company website under the Investor Relations link. Our first-quarter 2013 quite period begins at the close of business on March 14, 2013. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2011.

With that, let me hand it over to Pat.

Thanks Paul and good afternoon everyone. 2012 was a strong year for VMware with solid Q4 results despite a tough economic environment. We do not take this momentum for granted, and I would like to first thank all of the people at VMware, our partners and our customers for their passion, engagement, and support throughout the year.

Total revenue for 2012 increased 22% to $4.6 billion with license revenue up 13% to $2.1 billion and non-GAAP operating margins up by 140 basis points.

Unlike most vendors, VMware challenges the status quo. By finding new ways to solve complex IT problems, we have helped more than 400,000 customers save billions of dollars, dramatically increase the agility of their IT environments and significantly improve business outcomes.

We see a tremendous market opportunity in 2013 and beyond as we focus on what our customers value most, VMware's role as a pioneer or virtualization technologies that simplify IT infrastructure from the data center to the virtual workspace. In 2013, VMware will execute against three growth priorities in support of our unique role in the industry and the core opportunities we see ahead -- the software defined data center, hybrid cloud, and end-user computing. In the software defined data center, we will continue to deliver innovations in networking, security, storage, and management as powerful as those we lead and continue to lead in server and desktop virtualization delivered simply through the vCloud suite.

For hybrid cloud, we will enhance our ability to deliver a compelling set of enterprise class cloud services that will allow customers to run any application anywhere on and off premise as they choose. And in end-user computing, the Horizon suite will deliver on our vision of a virtual workspace for both existing PC environments and emerging mobile devices in a secure enterprise environment.

As we enter Q1, we are actively focusing our investments and resource to capitalize on these opportunities. And by definition, there areas we plan to deemphasize across the business to do this.

One thing I've learned over the years is the importance of prioritization and execution. So, I have been working with my leadership team to ensure we have the right level of resources in the proper places for 2013 and beyond.

This focus on prioritization includes a two-tiered realignment process. First, a portfolio rationalization in favor of our differentiated strengths and the products our customer base and prospects care about most. The decision to commit our Cloud Application Platform efforts to the Pivotal Initiative is an example.

And second, a realignment of resources as we scale back in some areas of the business and increase prioritized investments across geographies, product groups, and operations. This includes shifting talent to new roles that support our core growth opportunities as well as some targeted headcount reductions.

Focusing our talent and resources through realignment is a responsible and healthy course of business. That said, these are plans that impact our people and we make them with careful thought and respect. Jonathan will provide more detail on the realignment process in his section of this call.

To be clear, VMware has invested considerably, having added over 6700 people over the last three years to accelerate our growth opportunity. We will continue to grow, invest and hire in 2013 in support of our focused growth priorities. For example, we expect to close fiscal year '13 with headcount up by approximately 1000 people. You will also see us continue M&A activities and strengthen alliances, again in support of our focused growth priorities of the software defined data center, hybrid cloud and end-user computing.

Looking at 2013 in perspective, we aren't out to make our customers' environments incrementally better. We will radically change them by solving the hardest infrastructure problems in elegant, simple and powerful ways.

Our aspirational goal is to become the greatest infrastructure software company of this decade -- $10 billion and beyond -- by delivering software innovations that bring agility, efficiency and choice to our customers while simplifying everything about infrastructure and IT.

To help give you a deeper understanding of our software innovations and strategies, it is my pleasure to invite you to join us or the EMC and VMware Strategic Forum on March 13 in New York which we will host for analysts and investors. At this forum, my management team and I will discuss our strategies for the software defined data center, hybrid cloud and End-user computing strategies as well as provide more information about the Pivotal Initiative.

With that, I'll turn it over to Carl.

Thanks Pat. As an 11-year veteran, I have to say we've become more aligned than ever since Pat joined VMware a short five months ago. Both the CEO and CFO transitions have been seamless and we are focused, motivated and ready to execute in 2013.

I want to start by thanking all of the people at VMware, our partners, and our customers for contributing to the strong financial results in 2012. Our financial performance was driven by our product performance and it was an outstanding year on many fronts, including the introduction of new products such as VMware View 5.1, which simplifies the delivery of a desktop with better total cost of ownership and the vCloud suite, which I'll speak more about in a moment.

Throughout the year, we made six acquisitions and welcomed employees from ITHC, Cetis, Wanova, DynamicOps, Pattern Insight, and Nicira.

We also continue to expand our international footprint in customer-facing activities, particularly in key markets such as China, Japan, Eastern Europe, Russia and Latin America. All of this was accomplished while maintaining our high standards of product and service quality. In 2013, we will continue to be aggressive with investments in the areas supporting our priorities of software defined data center, hybrid cloud, and End-user computing.

In Q4, we benefited from a full quarter of availability of the vCloud suite, our first solution to deliver the software defined data center. The vCloud suite integrates VMware's leading virtualization, availability, networking, security, and management portfolio into a single SKU, and simplifies customers' adoption of cloud era technologies. We exceeded our bookings plan for vCloud suite in Q4, and as expected, most vCloud suite bookings were in ELAs.

The vCloud suite comes in three flavors -- standard, advanced and enterprise. Our high-end enterprise version with a list price of $11,495 per CPU had more bookings in Q4 than either the standard or advanced versions. vCloud enterprise suite now includes vCloud Automation Center, formerly DynamicOps, which allows customers to rapidly deploy and provision cloud services across private and public clouds, physical infrastructures, hypervisors, and public cloud providers. In addition, nearly 1000 existing vSphere Enterprise Plus customers took advantage of our free upgrade offer to vCloud suite standard and by doing so acquired additional management and network virtualization capabilities.

Customers are buying our vCloud suite for three primary reasons. The first reason is because customers understand and buy into our vision of the software defined data center, and they believe the vCloud suite is the best way to participate in that vision.

The second reason is that, as our customers are deploying more mission-critical and Tier 1 applications, they require higher levels of SLAs. The vCloud suite combines better management, automation, high availability and security functionality meeting these service levels all in a single solution.

The third reason is because of the significant return on investment and convenience customers enjoy when purchasing cloud infrastructure and management capabilities in a single SKU with simplified entitlement at favorable prices.

As expected, blended ASP for vCloud suite were more than three times the blended ASPs for vSphere in Q4. We were also pleased that blended vSphere ASPs were higher in Q4 as compared with Q3.

In Q4, our management products and EUC products combined were once again greater than 20% of total license bookings. This figure does not include management products which are bundled into the vCloud suite SKUs.

Note that, moving forward, we expect to sell more and more of our management products as part of the vCloud suite, which will make this figure less relevant. We had continued success in the quarter with our vCenter operations management suite and vCloud Automation Center, which are both sold as part of the vCloud suite as well as outside the suite. The vCenter operations management suite is one of our fastest growing products since vSphere and investments in our channel recruitment enablement and sales incentive during 2012 have been paying off.

Sequential license bookings for vCloud Automation Center grew significantly in Q4, which was the first full quarter since closing our DynamicOps acquisition. VCloud Automation Center has been gaining traction, particularly well with our financial services customers, and is now a standard component in vCloud suite enterprise, which is our high-end suite offering.

In 2013, we are also making large investments across the board in End-user computing go-to-market activities, including increased focus on verticals such as financial services, the public sector, and healthcare. While we were pleased with record US revenues of $639 million in Q4, at a growth rate of 20% year-over-year, our Q4 US bookings did not come in at the levels we expected for either our ELA or transactional businesses. Generally speaking, we saw weakness across the US as a whole. As an example, despite our federal business performing better in Q3 than we had expected, for the full year of 2012, federal bookings were down versus 2011.

Our international revenues in Q4 also reached a record level of $654 million, which is an increase of 24% as compared with the fourth quarter of 2011. Strong demand in Japan and China once again led our growth in the Asia-Pacific region and we continue to see increased opportunities for larger deals in these countries and many others. Weakness in Australia was once again an exception in Asia-Pacific due to a struggling economy.

European bookings were slightly higher than expected in Q4 as we executed well on selling the vCloud suite and we witnessed a small budget flush at the end of the year. We believe the budget flush occurred because, throughout 2012, European companies were protecting their capital budgets and had pent up technical demand. Bookings in Germany were strong, while Russia bookings were lower than we had expected.

Jonathan will speak to the revenue guidance in a few minutes, but from a bookings perspective, we expect stronger growth in the second half of 2013 versus the first half of 2013 on a year-over-year comparison basis.

Enterprise license agreements were approximately 33% of total fourth-quarter bookings, a record high, although we did not close any ELAs greater than $10 million as we would normally expect to do in Q4 for the US. This is about 9 percentage points above Q3 and slightly higher than the 8 point sequential increase from Q3 to Q4 last year.

We had a healthy mix of new ELAs as well as ELA renewals in the quarter, and we continue to see a very nice attach rate of non-vSphere solutions to our ELAs. As I indicated earlier, vCloud suite is mostly sold via ELAs. And in fact, 75% of vCloud suite bookings in Q4 were associated with ELAs. Given the ongoing tough market conditions and increased customer scrutiny around their IT investments, our continued strong ELA results reflect the confidence customers show in the VMware platform.

Now, turning to our transactional business, although we had solid bookings in both unit volume and dollar value in Q4, our transactional business did not grow at nearly the same rate as our ELA business. Over the next year, we are putting in place programs to help drive additional transactions via our channel partners. We are also working with our channel partners to increase uptake of our adjacent products.

For the fourth consecutive quarter in 2012, we achieved an all-time high in percentage of renewals within the quarter for our support business. This reflects a vote of confidence from our customers in our products, solutions, technical support, and upcoming product enhancements.

Our VMware service provider program once again tracked well in the quarter as public cloud providers continue to leverage our cloud infrastructure program for their service delivery. We believe this ecosystem of providers is second only to Amazon in public cloud market share, and this program is one of the faster growing parts of our business with bookings growth of over 50% for the full year 2012 as compared to 2011.

You heard Pat emphasize hybrid cloud as one of our priorities for 2013. With our partners, we will be expanding our capabilities aggressively in 2013, building on our private cloud footprint with an ever-richer set of complementary public cloud service offerings. This is exactly what our customers tell us they desire, a compatible, high-quality, secure and resilient hybrid cloud platform.

As Pat mentioned earlier, network virtualization is one of the next big steps for our customers on the path to the software defined data center. And I'm very pleased with the progress we have made expanding our portfolio in this area, most recently with the acquisition of Nicira in Q3. We also took important steps in the fourth quarter to best align our engineering and go-to-market efforts to take advantage of our early lead in this space.

In addition, I'm happy to announce that we expanded our leadership strength with the appointment of Steve Mullaney, former CEO of Nicira, as Vice President and General Manager of our Network and Security Virtualization Group. And most importantly, I am excited at the benefits we are delivering to our customers. I'd like to share a couple of examples from two leading innovative customers.

EBay, a longtime VMware customer, is leveraging network virtualization to dramatically improve what they call speed to innovation by delivering self-service on-demand clouds for their application developers. Provisioning of the network used to take one week or more, and now that time has been reduced to 30 seconds. This means more productive developers turning out more innovative applications faster for the eBay marketplace. Network virtualization is transforming eBay's business.

Rackspace, the second-largest public cloud in the world, has been in production with their open-static cloud running on Nicira since August of last year. They continue to grow their cloud every month, and this is a real testament to the scale and production quality of open-stack and our network virtualization platform.

Importantly, these types of customers will be critical to our efforts to accelerate adoption over the coming years. I'd like to remind you that, though we are early in this market, we are excited that the proof of concepts customer interest, design wins, and momentum is very similar to where we were in the early days of server virtualization. We are particularly encouraged by the number of proof of concepts and trial started in Q4 with some of the largest enterprise and service provider customers in the world. We will continue to provide updates on our progress over the coming quarters.

Now, over to Jonathan for the financials and guidance.

Thanks Carl. I'm very proud to have joined the VMware team, especially at this point in time with such significant opportunity ahead. It's been an incredible first three months and through Pat, Carl, the management team, the Board of Directors and all the employees I've had the pleasure of interacting with, I've seen firsthand just how the culture of VMware inspires people and enables great accomplishments.

As Pat and Carl said, we completed a strong Q4 in 2012, accomplishing what we said we would do despite the tough economic environment and achieving solid results for license revenue, total revenue, and non-GAAP operating margin. We are very proud of these results.

Total revenues for the fourth quarter were $1.29 billion, while total revenues for the full year 2012 were $4.61 billion. Revenues for both the fourth quarter and the full year increased 22% from a year ago or 23% on a constant currency basis. In 2012, US and international revenues each increased by 22%.

License revenues rose 16% year-over-year in Q4 to $597 million and 13% for the full year to $2.09 billion. Software maintenance and support revenues increased 28% in Q4 to $591 million and 31% for the full year to $2.15 billion.

Customers continue to buy on average more than 24 months of support and maintenance with each new license purchased, which demonstrates a strong commitment to VMware as a core element of their data center strategies. Professional services revenue were $105 million in Q4, and $365 million for the year, up 27% year-over-year and up 28% for the full year.

I'll 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 and are reconciled to our GAAP results in the press release tables and posted on our Investor Relations website. Our Q4 operating profit measured on a non-GAAP basis was $424 million, or 32.8% of revenue, as compared to 32.2% in Q3 and 31.9% in Q4 2011. Year-over-year operating margins benefited 14 basis points from foreign exchange rates. Our non-GAAP operating margin exceeded our expectation in Q4 due to overachievement on revenue and good ongoing expense controls. Non-GAAP operating margin was 32.4% for the full year in fiscal 2012.

We ended the year with approximately 13,800 employees, up roughly 2600 employees from the beginning of the year and nearly 500 from the beginning of the quarter.

Our non-GAAP tax rate was 18.3% for 2012, and our GAAP tax rate for the year was 16.5%. We saw a slight uptick in our Q4 2012 non-GAAP tax rate to 19% as our US profitability improved slightly.

Diluted non-GAAP EPS for Q4 was up 31% to $0.81 a share on 433 million shares. Diluted non-GAAP EPS for 2012 was also up 31% to $2.85 a share on 434 million shares.

Now, moving on to our balance sheet and cash flow metrics, our balance sheet remains strong with cash and short-term investments at year-end of $4.63 billion, up $236 million quarter-over-quarter. Our operating cash flows remain strong as well and were $493 million for Q4 and $1.9 billion for 2012.

BSO was 60 days in Q4 compared to 53 days in Q3. The increase reflects the timing of billings during the quarter and higher mix of ELAs that Carl mentioned. These tend to be larger deals completed later in the quarter.

Our total CapEx spending for 2012 was $234 million. We continue to work on our Palo Alto and Bangalore campus expansions, projects which will continue into 2013.

Free cash flows were $412 million in Q4 and $1.66 billion for 2012 as a whole. As a reminder, last year, our cash flows benefited from the collection of tax receivables of more than $300 million which covered both the 2010 and 2011 tax years. We expect to be at a net payment situation going forward.

During the quarter, we repurchased approximately 1.8 million shares of our stock for a total of $161 million under our share repurchase program at an average price of $87.83 per share. Over 2012, we repurchased approximately 5.1 million shares for total cost of $468 million.

Total unearned revenue ended the year at $3.46 billion, up 28% from the end of 2011, an increase of 16% quarter-over-quarter. Long-term unearned revenue is now approximately $1.26 billion as customers continue to purchase multiple years of maintenance and as more unearned license revenue is recognized over time. Nearly 80% of our unearned revenue is software maintenance and it will be recognize ratably. Approximately 13% of unearned revenue is software license revenue which is recognized either ratably or upon product delivery. At the end of Q4, over 50% of the total unearned license revenue balance is to be recognized ratably. And in addition, approximately 7% of unearned revenue is the result of prepaid professional services, including training, which is recognized as the services are delivered. So considering all these elements, approximately 87% our total deferred revenues are to be recognize ratably.

Now, turning to 2013, we are going to be making investments in our top priorities across product groups, certain geographies, and in operations. We are very focused on the opportunities presented by the software defined data center, End-user computing and the hybrid cloud. We see these as being large, important markets of VMware and we are investing for the long-term.

At the same time, we continue to examine our investment portfolio and plan to reduce our investments in certain non-priority areas. Over time, these actions will allow us to focus on accelerating top and bottom-line growth. These actions fall into two main categories. First, as part of our Pivotal initiative with EMC, we expect to commit the existing technology, people, and programs from both companies focused on Big Data and Cloud Application Platforms under one organization. We will be providing a more comprehensive update on this at EMC VMware Strategic Forum on March 13. We are not providing any guidance with respect to the changes associated with Pivotal prior to that event.

Our second set of plans involves realigning other investments across the portfolio. As we invest in our core opportunities, we plan to scale back resources in other areas of the business. This includes shifting talent to new roles that support our core growth opportunities as well as targeted reductions of approximately 900 people. Some of these will be position eliminations associated with streamlining operations and some will result from targeted product actions. Products we will deemphasize include SlideRocket and other products which are not central to what our customers value the most from VMware. We expect to record a charge associated with this action of between $90 million and $110 million with the majority expected to be taken in Q1 2013.

Despite these changes, we expect to be up approximately 1000 heads over the course of 2013, excluding the effect of Pivotal. Now, putting this in perspective, VMware has increased its workforce by over 6700 people over the course of the last three years. While these choices are often tough, we know that this is healthy for our business and an important step as we plan for the long-term.

Now, moving to specific guidance for the upcoming year. As we look at 2013, we see at least four factors impacting our business. The first is the macroeconomic environment. As Carl mentioned, we experienced general weakness across the US in Q4 2012, and our federal government bookings declined for the year overall. Europe's relatively stronger performance in Q4 appears to have been the result of some pent-up demand preceding customer expectations of a tough 2013. We remain concerned about the region overall. In addition, foreign exchange rates are likely to be a revenue headwind at least for the first quarter.

The second factor impacting our business in early 2013 is a tough compare with large deals. In Q1 2012, we booked two deals for a total of approximately $40 million. Given the current spending environment and looking at our pipeline, we do not anticipate closing deals of this size in Q1.

The third factor is associated with our ELA renewal opportunities. We expected a tailwind opportunity due to ELA renewal opportunities in 2013. However, about two-thirds of these opportunities become available in the second half of the year.

The fourth factor is related our decision to reduce investments in certain non-core areas, as I mentioned earlier. This realignment of investments is good for our business in the medium and longer term. However, some of these actions will impact revenue in the short-term and this is factored into our guidance for 2013.

In addition, while we are not providing any guidance with respect to changes associated with Pivotal at this time, we did take into account potential impacts on customer engagements during the first half of the year. With this backdrop, we expect stronger growth in the second half of 2013 versus the first half of 2013 on a year-over-year comparison basis. For the full year, we expect total revenues to be within a range of $5.230 billion to $5.350 billion, or a growth of between approximately 14% to 16% over 2012. Full-year license revenues are anticipated to grow between 8% and 11%. Total revenues for Q1 are expected to range from $1.170 billion to $1.190 billion, a growth of approximately 11% to 13%. We currently anticipate Q1 license revenue to be between $480 million and $490 million.

As Pat said, we see a tremendous market opportunity ahead and we will make continued investments throughout the year related to product development and global market expansion. Consequently, and taking into account our adjustments to GAAP operating income that Paul disclosed at the start of the call, we expect the non-GAAP operating margin for 2013 to range from 31% to 32% and Q1 non-GAAP operating margin to be approximately 30%.

GAAP operating margins for the first quarter are expected to be approximately 20 to 23 percentage points lower than the non-GAAP operating margins. And for 2013, GAAP operating margins are expected to be approximately 15 to 17 percentage points lower than the non-GAAP operating margins.

For 2013, we expect CapEx to be between $340 million and $380 million as we continue to build out our Palo Alto and Bangalore campuses.

We estimate our non-GAAP tax rate will be 18.5% for the full year and the GAAP tax rate to be approximately 5 to 7 percentage points lower than the non-GAAP rate. For Q1, we estimate our non-GAAP tax rate will also be 18.5%, but because of the reenactment of the R&D credit for 2012, the GAAP tax rate will actually be a benefit of approximately 17%. And finally, we anticipate our first-quarter 2013 fully diluted weighted average share count to be between 433 million to 435 million shares.

And with that, I'll turn it back to Paul.

Thanks Jonathan. Operator, we're going to begin the Q&A process. Let's begin.

(Operator Instructions). Adam Holt, Morgan Stanley.

Hi, thank you. I had a couple of questions about the guidance. The color on sort of the factors around Q1 is helpful, but you are guiding to what looks like a quarter-on-quarter decline that's bigger than we saw even in the first quarter of 2009. I wanted to clarify. One, so you are excluding any lost revenue from Pivotal even though you're not quantifying it. And two, as you look at the puts and takes and some of the other drivers for the conservatism, could you maybe quantify how you're thinking about the different elements?

This is Jonathan. Thanks for the question. Just taking them into pieces, so just to be clear, we have not included any specific guidance with respect to Pivotal, so I will be updating you, as Pat said, at our VMware EMC analyst day on March 13, so you should see sort of business as normal, if you like, for Pivotal. That's important to understand.

The second thing is yes, as I have looked at the overall plan, working with Pat and with Carl and the rest of the management team, the guidance takes into account the macroeconomic situation that we described and that we've experienced. It also clearly takes into account the Q3/Q4 bookings performance. Obviously, bookings is a leading indicator as to how revenue tracks. We also see in Q1 in particular some tougher compares. As I mentioned, we saw a particularly strong performance in a couple of ELAs in Q1 '12 totaling around $40 million, which right now we are not forecasting that sort of level of individual deal when we look at Q1.

So I figured -- or I looked at those various things, we certainly looked at it in the context of first half/second half as well, and hopefully you saw this but we do anticipate an accelerating growth pattern over the course of the year. But the first half does take into account those various factors.

And then finally, I think there's going to be some distraction as we work through the Pivotal activities as we finalize that structure and as we also work through some of these realignment activities as we set ourselves up well for not just the tail end of 2013, but also the longer-term opportunity.

So I guess, if I would net all that out, it reflects my approach, certainly the management team's approach, but I will want to be as open and transparent as possible. But I guess if I was to provide you an exact summary, I would consider myself to be conservative but realistic.

If I could ask a quick follow-up on margins, it looks like, if you net out the 900 lost heads, and then add 1000, you are at best sort of growing your headcount at 15% year-on-year, kind of in line with the midpoint of the revenue guidance. Can you walk us through why margins would be down on a year-on-year basis? That's it, thanks.

I'll take that one as well. The first thing to bear in mind is we are going to be investing over the course of the year, and you correctly picked up -- we are investing a net about 1000 heads, even taking into account this action we talked about today. However, we've also added 2600 people over the course of 2012, so we've got the full impact of that investment we've made already going into 2013. That puts a little bit of pressure on operating margin, especially in the first half. We also anticipate we won't see the full OpEx benefit of all of the headcount actions and the realignment activities probably until the second half as some of the realignment activities, while planned, won't be completed in the first half, most will, but we expect some of that to continue, especially as we think about geographical activity over the course of the year. So all of that is considered in the operating margin guidance as we thought about the profile for the first half and the second half.

Thank you.

Heather Bellini, Goldman Sachs.

Thank you for taking our questions. This is Sonya Banerjee on for Heather. In terms of first-quarter guidance, just to quickly touch on the maintenance and services component there, so just following on to Adam's question, if you're looking for a high teens sequential decline on the license piece, what are the puts and takes on the services line in terms of maintenance and the pro-services piece there?

Then more at a high level for the full year, given license guidance, it seems like -- what are the specific milestones that we need to see you guys hit on your new more recent initiatives in order just re-accelerate growth?

Maybe I'll start and I can let Pat or Carl add color. This is Jonathan again. Again, when we think about the year overall -- I just want to make sure we've all heard this -- I think the first half is probably more challenging but we do see activity towards the second half driving towards a stronger performance overall.

You certainly heard the guidance with respect to license. And remember the S&S or the service and support growth in revenues clearly reflects bookings that we took over the course of the latter part of 2012 as well. So we would anticipate, again, the second half to be stronger as we think about the overall profile of the quarter. License and overall bookings growth for Q1 does certainly reflect some of those year-over-year compares that I mentioned earlier on. Carl, do want to add anything to that?

Yes. As far as metrics, I talked about in my prepared remarks the success we had around the vCloud suite in Q4, which was our first full quarter of having that in the market. And as I indicated, it was ahead of our booking expectations that we had internally, which shows a demand and the customers' confident in VMware to deliver software defined data center.

The other metric I would look at is the attach rate of the suite to enterprise license agreements, and we continue to see a high attach rate to that ELAs with the suite itself.

And then the third metric, we're starting to look at metrics that actually are outside of just pure revenue, like things around the Nicira platform where we are seeing customer adoption and proof of concepts take place around network virtualization as we look at the early stages of the adoption of network virtualization in the market. So we will continue to think of other metrics to share with you to ensure that you guys have a better understanding and view and perspective of how we are defining success internally as customers adopt our solutions.

Thank you Sonya. Next question please.

Kash Rangan, Merrill Lynch.

Thank you very much. I just wanted to clarify your guidance for fiscal '13 does include Pivotal or does not include Pivotal? And then I have a follow-up.

Pivotal is included in the numbers we've shared. So in other words, we have not updated any of these numbers assuming Pivotal to be taken out. These assume business as normal, if you like. And again, we will provide more specific guidance as we work through, with EMC, the exact form of the Pivotal arrangement going forward. That's the update, one of the updates we will be giving on March 13.

And when I look at the seasonality of license revenues, if you were to grow 10%, if you're going to be down sequentially more, it looks like the growth in second half is looking like 19%, 20% roughly in license growth rate. So can you walk me through if that assumption is, broadly speaking, correct you talk about your second-half acceleration? And what exactly are the dislocations we are working through in Q1 and Q2 time frame that shifts that growth rate to second half, barring the tough comparison to the two large deals in first quarter? I guess I'm struggling to understand what exactly is -- what else could be behind the conservative guidance for the first half beside the tough comparison. Thank you.

Again, first of all, when we developed the plan for the total year in the first half/second half, the first thing we obviously had to look at is how did bookings perform over the course of Q3, Q4 in particular when we think about license.

The macroeconomic environment, the fact that the federal bookings performance overall for the entire year in FY '12 was basically down, the nature of strength in the European segment, in particular in Q4, felt somewhat temporary in the second -- more of a one-off budget flush for us. And then as we start to think about the -- so that gives some challenge the first half.

The second half I think reflects what we consider to be the opportunity around things like the ELA tailwind, as we I think all understood, given the fact that 2010 did see a heavy or a significant level of ELAs. Two-thirds of that opportunity, as we've analyzed it further, becomes available in the second half. So that combined with what we are forecasting today to be an improved macroeconomic environment gives us cause for optimism as we approach the second half.

I think you are being a little bit aggressive on the overall -- or you're over-interpreting on the license acceleration on a year-over-year basis. You look at the second half, again, we guided, as I described to earlier on, to 8% to 11% for the total year, certainly starting off Q1 a little bit softer than that.

And then the other thing I would just say, as we continue to work through some of these realignments and the pivotal activity, we think that's going to provide some clarity more towards the second half as well. So there's three or four factors there that I think are important to bear in mind as we approach the second half.

Got it, thank you very much.

Next question.

John DiFucci, JPMorgan.

I have a quick question for Pat, and then a quick follow-up for Jonathan if I might. Pat, headcount reductions are typically dramatic measures for a company. But by the end of the year, I understand your headcount is going to be up 1000, so it sounds like you are really getting the right people in the right places. But is it also something to do with the near-term macro backdrop that you hope will improve throughout the year?

No, it's associated with getting the right people aligned with the priority areas that we've described. As we began the Pivotal Initiative, we clearly see that there is a set of things that we have underway that aren't clearly aligned with those priorities. So we are getting people online with those priorities, clearly having added, as we said on the call, 6700 people over the last three years, they are refining where those headcounts are located vis-a-vis those key priority areas. It is a great opportunity for us to get the entire company aligned with the great growth opportunities that we see in these three areas, STDC, hybrid cloud, EUC, for 2013 as a really foundational year and then our long-term growth based on that.

Okay. Great. If I might for Jonathan or maybe Carl, the ELA renewals that you did close this quarter, was the size relative to the original deal about the same percentage greater than the original deal on average as it's been historically? There's a lot of if's in there, but typically I believe you've said in the past that you typically sign renewals and the size of that deal is typically a percentage greater than 100%. Were these deals this quarter, because the ELA renewal is a big part of the conversation out there in the investment community anyway -- was the percentage the same percentage greater than 100% than it has been in the past?

Thanks John. This is Carl. I'll take that question. Yes, we did not see any change to our ELA renewal rates in Q4. As I indicated in my remarks, we had 33% of our total bookings come through ELAs, and that included the renewals in the quarter. And of those renewals that we did have, it was still, on average, greater than the original dollar value of the ELA that we transacted. So we were pleased to see the customers continue to believe that VMware is the platform of choice to build out their cloud infrastructure. And we did not see any degradation in our ELA renewal rates or the dollar value associated with those ELA renewals.

But Carl, just to be clear, was it -- let's say -- I'm just going to throw out a number, 120% is what you usually see. Was it 120% this quarter? Was it 125%? 115%? Was it less or greater than what it normally is as a percentage of the original deal?

Yes, so John, I think in the past, in an analyst day, I articulated it was greater than 100%, and it was again greater than 100%. We don't give details of the exact percentage. But as I said earlier, there was no change in our renewal rate or the dollar values associated with those renewal rates around ELAs.

Thanks Carl.

Brian Marshall, ISI Group.

This is Stephen Patel calling in for Brian Marshall. Now that you are beyond the 50% penetration rate on server virtualization, can you discuss a little bit how the opportunity differs on the next 25% to 30% of the market? You alluded a little bit to a richer upsell opportunity for some of these customers, virtualizing Tier 1 apps. I was wondering if you could talk a little bit more about that.

Thank you. So first there's a range of estimates. You have 50%, 60% virtualized and workload stay. Our expectation is we can continue to drive that number, and we do see that we can take it to 90-plus%, so even in core virtualization, we believe we're far from done.

We do also see that this provides -- think of it as a springboard for these additional areas of the software defined data center. We are clearly in the good numbers that we saw with the management suite this quarter where we really can grow these adjacencies based on the success of the core virtualization opportunity. And we see that being the case for management, network security, storage, and availability. So overall, we do see that opportunity to expand from that strong footprint. So Carl, anything to add to that?

The other thing I would say, Pat, is, as customers look to virtualize their next set of applications, those applications are typically mission-critical in Tier 1 applications, which do require a much higher level of service, and that is what customers can get through the vCloud suite. So in a lot of our ELAs and the renewals of ELAs in Q4, customers were buying the suite. In fact, as I articulated, we sold more of the high-end suite than anything else because they wanted to truly build out a private or hybrid cloud and get the first-generation, if you will, software-defined data center solution from VMware because those more mission-critical applications require higher levels of service.

Brent Thill, UBS.

Thanks. Carl, just on the bookings for the US, can you drill on a little bit further? You mentioned (inaudible) was weak, but can you give us a sense what happened in some of the other areas like financial services? Did you see that same type of weakness fall through? And I had a quick follow-up.

Sure. Thanks. So our US business definitely experienced macro headwinds within the quarter. The budget flush that we typically see in Q4 did not materialize, and it certainly didn't materialize to the extent we saw it in Europe. And that was impacted across both our transactional business as well as our ELA business. So we definitely saw a headwind there.

Specific the Financial Services segment, for the most of the year, we had a very solid Financial Services business, and in Q4 we did indeed see it come down on a year-over-year basis.

And then the last thing I would say is we have made significant changes in our US go-to-market coverage model that segments our customers in a different way, and it gives us a better coverage and alignment to our customers based on their size. This was a transformation that took place in 2012, and we expect the full impact of these changes to ramp throughout 2013. And with this change in execution and coverage model, we hope to offset some of the softness in the macro we saw throughout Q4 in 2012.

Philip Winslow, Credit Suisse.

I just want to spend a moment on the transactional business. You mentioned some strength in the ELAs but then obviously the base of ELA is falling in the first half here. I'm wondering if you could comment on the transactional business you saw in Q4 in terms of just pricing as well as competition? And then as you would look into the first half here, what are you sort of embedding from a transactional business perspective relative to the ELAs? Thanks.

Yes, thanks. So I talked about the transactional business probably for the first time in quite some time on our call here, because we did see some softness in the transactional business. And we think that had more to do with the macro than anything else. And the reason I say that is because the transactional business is primarily driven by our channel, so it's an indirect model for us. And when you see slowness in the transactional business, it typically calls out something going on more in the macro than from an execution or a coverage model perspective.

With that as a backdrop, going forward, we are putting in place a number of programs with our partners to help drive the transactional business in a new direction. This will include changes in how we price our products, the promotions we give to our channel. And I think thirdly, most importantly, based on the success we have seen around the vCloud suite in the enterprise segment, we will be doing some creative packaging with our core vSphere product as well as other management solutions to drive the better attach rate so we are not selling what we call naked vSphere into the market. So, we are encouraged about some of the programs we are launching in 2013, and we do expect and anticipate them to have an impact on our transactional business with our partner community going forward.

Walter Pritchard, Citigroup.

Thanks. Just one question for Pat, and one question for Jonathan. For Pat, on the competitive side, I'm wondering -- or maybe Carl -- could you talk about what you're seeing out of Microsoft? I know they're giving some qualitative metrics around their virtualization business here, nothing that we can really be able to use to understand their traction, but I just wanted to understand what you're seeing from them in the market. And then I just have the follow-up for Jonathan.

Sure. Actually, I'll take this and then if Pat has any color, he can chime in. So first of all, I would say, from Microsoft, as you all know, this is probably the third time in the last seven or eight years we've now heard that Microsoft has a good enough hypervisor solution for the enterprise.

And if you look at VMware and our focus, it's really on driving an automated data center through our software defined data center solution. At this time, we have not seen any impact from Microsoft in the launch of their new product, either in our ELA business or, if you will, in our transactional business which was evident by us being able to get a 3X higher ASP from the vCloud suite.

And if you just look at the standalone vSphere business on a sequential basis quarter-over-quarter, our ASPs actually went up from Q3 to Q3. And you would've thought that, if we were seeing any significant impact from our competition, that would not have occurred. So, we are pleased with our ability to focus on bringing value to our customers. We are really focused on driving a different level of virtualization outside of just compute and drive an automated data center with our three-pillar strategy around the software defined data center of compute storage network and automating that through the use of software.

Just to emphasize, we really do, with our highest level customer relationships, we don't see Microsoft as a competitor. The conversations that we have are transformative, architectural, and about these new legs of the software defined data center. And that's what gives us great optimism for the multi-year future of VMware.

Jonathan, just a question on cash flow you gave us. There are some puts and takes here. It sounds like some tax things we should be mindful of in 2013. Any tighter color you can give us around what we should expect for operating cash flow in 2013, or at least how it may relate to what we expect from a profitability perspective?

We don't go ahead on cash flow, as you know. So what I would share is our trailing 12 month cash flows generally should be in line with our probability growth. As you know, we have to take into account timing of orders and cash collections and one-time impacts. Clearly, in the first half, the cost of the realignment and rebalancing actions is going to have an impact. We certainly want to treat any impacted employees with the most respect and we want to make sure we are also dealing with them in an appropriately -- an appropriate fashion. So, that's going to have an impact on cash flows in particular in the first half. We haven't given much guidance beyond that specifically. I do think it's an important metric for the Company, both free cash flows and operating cash flows. But I'll probably ask you to look at profitability as a good proxy over time for how that should grow.

Mark Moerdler, Sanford Bernstein.

This is [Emily Chen] for Mark. A question on desktop virtualization. Where do you think we are in the adoption curve? And how is VMware doing in terms of the marketplace and in terms of how it's doing versus other vendors in the space. Thanks.

Pat, why don't you start and then I'll follow-up.

Sure. Overall, we are seeing the space for desktop virtualization is actually a very ripe one as customers now have proven the technology in certain narrow segments and is now expanding to be a very broad category for them to deploy a much more efficient model for desktop and for a variety of reasons. And now it is a very cost effective storage cost, right, maturity of the management tools, etc.

Also I would emphasize that, for us, this space is one where it's about the entire end-user experience, including our soon-to-be-announced mobile Horizon suite which extends our value proposition from the PC through the entire set of end-user compute devices as well. So, we see this as a launching point for a broader strategy for VMware into the future.

But Carl, a few specifics behind that?

Yes, thanks Pat. So it's clear that, as we look at the market, there is a transformation taking place in end-user computing, and we believe 2013, this will become more evident as the cost of the solution and platform and the data center continues to come down, especially around storage and networking, as Pat indicated.

As a company, we have decided to invest in a go-to-market strategy that will help VMware accelerate our solutions into the market. And we believe, with this investment in 2013, we can actually grow faster than the market and even take share from the competition.

Thank you Emily. Before we conclude the call, Pat will be making some closing comments.

Thanks Paul. As we close, just a few final points. First, on behalf of the entire VMware leadership team, thank you all for being with us. I'm sure you get a real sense today that we are taking decisive action to focus our innovation and business operations around key high-growth opportunities that VMware is uniquely positioned to lead across the IT sector. Our strategies are laser-focused on what our customers and prospects value most from VMware, helping them simplify the virtualization and cloud journey through our software defined data center strategy, enabling enterprise hybrid, cloud environments that provides flexibility and choice, and helping to empower their people with a virtual workspace that serves today's multi-device realities. We are very excited and I personally am very excited about our future. And again, we look forward to sharing our vision strategy and innovation focus with you at our upcoming EMC VMware Strategic Forum. I wish you all the best and look forward to seeing you all very soon. Thank you.

Thank you for your participation on the conference call. At this time, all parties may disconnect.