VMware Inc (VMW) 2014 Q2 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions)

Today's conference call is being recorded. If you have any objections, you may disconnect at this time.

I will turn the meeting over to Mr. Paul Ziots, Vice President of Investor Relations. Thank you. You may begin.

Thank you. Good afternoon, everyone, and welcome to VMware's second-quarter 2014 earnings conference call.

On the call we have Pat Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Executive Vice President. 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. Slides which accompany this webcast can be viewed in conjunction with live remarks and can also be downloaded at the conclusion of the webcast from IR. VMware.com.

We've also included in the earnings release and posted on our website historical data for revenue and unearned revenue, excluding revenues in each period attributed to the products and services contributed to Pivotal software, and the products and services associated with the divestitures consummated by VMware in 2013.

On this call today, we will make forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially as a result of various risk factors, including those described in the 10-Ks, 10-Qs, and 8-Ks VMware files with the SEC.

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 an addition to not as a substitute for or an isolation from GAAP measures.

Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation, amortization of acquired intangible assets, employer payroll tax and employee stock transactions, the net effect of amortization and capitalization of software, certain litigation and other related items, acquisition related items, and realignment related net gains and charges.

As mentioned, we have presented historical data for revenue and unearned revenue excluding Pivotal and all 2013 divestitures. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in the press release and on our Investor Relations website. The webcast replay of this call will be available for the next 60 days on our Company website under the Investor Relations link.

Our third-quarter 2014 quiet period begins with the close of business September 12, 2014. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2013.

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

Thank you, Paul, and good afternoon, everyone.

Our second-quarter results are strong, and I'm very pleased with the team's performance. Our total revenue for Q2 grew 18% year over year, excluding Pivotal and divestitures. In addition, order flow improved in Q2 reflecting a number of larger deals. Carl will cover this in more detail in just a minute.

We continue to deliver the results we said we would deliver. Our road map of product innovation is unparalleled, and we are attracting and retaining the brightest and the best talent in the industry. VMware is uniquely positioned as IT transitions from client server computing to the mobile cloud era. Our solutions offer an efficient path to the future without sacrificing the vital needs for security, availability, and compliance required by all businesses.

We're committed to providing our customers with the openness and choice of a software defined future, where all core components are virtualized, infrastructure is highly automated and delivered via software, and customers aren't locked into closed proprietary technologies. We do this from devices to data centers across private, public, and hybrid clouds all within the same secure and consistent environment.

At VMware, we are laser focused on our three strategic priorities: the software defined data center, hybrid cloud, and our end user computing business. We are extremely pleased with the performance of our growth businesses, which made significant progress in accelerating our growth and delivering against our long term strategy. Customer momentum and adoption continues to build across all areas of our software defined data center portfolio. We're particularly pleased with the increased production use of our network virtualization solution, VMware NSX, with more than 150 paying customers.

In April, we appeared in Gartner's data center networking Magic Quadrant furthest in the completeness of vision access in this space, the first time that a software vendor has ever been included in this Magic Quadrant. In addition, we are seeing significant recognition of our strategic position in this market from our other industry players. These factors have contributed to accelerated engagement from customers as they look to take advantage of the unique benefits offered by a truly software defined alternative to networking.

Q2 also saw continued momentum for our cloud management offerings with IDC identifying VMware as number one in both worldwide cloud systems management software and worldwide data center automation software. These reports echo what we hear from our customers and prospects, that VMware provides a comprehensive portfolio of management products, purpose built for the cloud with an open and end-to-end cloud management approach.

In our first quarter of VSAN sales, we saw rapid uptake with more than 300 paying customers already utilizing the platform and more than twice the previous number of VSAN ready nodes now available from partners. We also built upon our continued leadership and compute virtualization with the expansion of our longstanding relationship with SAP, the announcement that SAP HANA platform is now virtualized and available to customers using VMware vSphere 5.5.

We continue to rapidly expand the global footprint of our vCloud Hybrid Service. Last week I was joined by Ken Miyauchi-san, COO at SoftBank, to announce a joint venture in Japan, which launches our first vCloud Hybrid Service in Asia. This service will [GA] in Q4 and is already available as a private beta.

I was also joined by [Yang Gee], general manager of China Telecom's cloud computing branch, to announce a partnership for China Telecom to provide hybrid cloud services for the China market to be available in early 2015. We also announced our seventh production data center, and, by the end of the year, we expect a VMware operated cloud will be available in over 75% of the world's cloud market.

With approximately 4,000 service provider partners, a VMware cloud will be available in essentially every market on the planet. We are not stopping there. We are committed to the continued expansion of our global footprint for hybrid cloud services and to provide our 500,000 customers the best and fastest path to an enterprise class hybrid cloud.

We also have seen exciting progress within our end user computing business unit. It's now five months since we acquired AirWatch, the leading provider of enterprise mobile management and security solutions. Coming off of this acquisition, we are seeing burgeoning demand for our AirWatch by VMware solutions with customers numbers increasing from 10,000 at the end of 2013 to approximately 13,000 today.

In addition, Gartner continues to recognize our leadership in this market, placing AirWatch by VMware as a leader in their enterprise mobility management Magic Quadrant and positioning us for the second year in a row furthest in the ability to execute axis.

In Q2, we also launched Horizon 6, an integrated solution that delivers published applications and desktops in a single platform. Horizon 6 is the industry's most comprehensive desktop solution with centralized management of any type of enterprise application and desktop, including physical desktops and laptops, virtual desktops and applications, and employee owned PCs.

As I mentioned earlier, we are in the early stages of a tectonic shift transitioning from the previous client server platform to the mobile cloud era. Every customer I meet feels like the pace of technological change is faster than ever before. Software is being used to efficiently manage companies, and it has become the heart and soul of new companies and new ventures within existing companies. Customers are realizing the dramatic benefits of a new software defined model for IT, and VMware delivers exactly that.

By making IT dramatically more fluid and automated, we ensure that customers can boldly deliver the apps that deliver revenue, differentiation, and loyalty, faster and more reliably than ever.

I'll now turn it over to Carl to talk more about our business performance in Q2. Carl?

Thank you, Pat.

We delivered a strong quarter in Q2 as we continue to execute against our three growth priorities, the software defined data center, hybrid cloud, and end user computing. Operationally, we are executing against our short term goals as we build a deep foundation for VMware's future.

The increased time we spent in enabling our sales force in Q1 clearly paid off in our results for this quarter. Our global sales team continues to be more confident in selling our powerful lineup of solutions. We are also pleased to see the channel enablement activities targeting our newer products gain significant traction during the quarter. The channel, alongside our direct sales force, is now better trained and equipped to sell our next generation products than ever before.

I came away from Q2 even more confident that we are seeing universal interest and excitement across our global customer and partner base regarding our next generation products. As our customers increasingly embrace the vision and opportunity presented by the software defined data center, we are seeing sales of our new products continue to ramp and customers continuing to move forward from buying purely standalone vSphere to purchasing our suite and additional products, such as network virtualization. These newer products, coupled with our strong presence in cloud management, end user computing, and compute virtualization, position VMware with the strongest array of product offerings in our history.

Moving on to the Q2 details, we are pleased with our overall sales performance. We saw solid year-over-year growth in EMEA and the Americas this quarter. APJ was slightly down this quarter. I'll provide more detail in a second. Overall, we performed well on multiple fronts.

Q2 was the highest ever end-quarter renewal rate for support and a consistently high in-quarter renewal rate for ELAs in terms of number of deals renewed. The average term for support remained well above 24 months. Approximately 37% of total Q2 bookings were ELAs, which was the second highest quarter contribution ever.

We closed eight deals greater than $10 million in the quarter, close to an all time high for deals of this size. Our strength in ELAs and renewals reinforces VMware's role as a long term strategic partner to our customers and their commitment to our software defined data center strategy.

While we're pleased with the rebound of our ELA sales from Q1, I'd encourage you to continue to look at our business in aggregate, mainly because we see multiple selling mechanisms, such as subscription, gradually coming into the mix. Increasingly, what we are selling is more important than the selling mechanism itself. While ELAs are a good mechanism for introducing newer products to customers, we are also seeing customers explore a choice of buying models, and we expect that this will continue to evolve.

Moving to regional performance, our Q2 bookings growth was highest in EMEA followed by the Americas. We were pleased with the consistent broad based growth in EMEA, particularly across Central Europe.

In Germany, we closed two of the greater than $10 million deals, and we are pleased with the progress of the leadership transition mentioned in the Q1 call. In the Americas, we had an outstanding quarter in the state, local, and education sector, as we benefited from this segment's year-end budget flush. Notably, two of the eight ELAs greater than $10 million closed during the quarter were from the US led sector.

In APJ, we saw Q1 weakness in Japan continue into Q2. In Australia, we had solid results but a tough compare due to a large ELA one year ago in Q2 FY13. Meanwhile, growth in China remained very solid, which is encouraging given the challenges that some of our peers are seeing.

I'll make a few comments here about Q3. We expect a strong US federal quarter driven by a particularly large federal ELA opportunity that we have been engaged on for almost a year. We continue to expect a modestly improving global economic backdrop similar to the one we anticipated when full year guidance was provided at the start of the year and typical seasonality in EMEA.

Taking a look at product groups, end user computing, including AirWatch, grew license bookings over 50% year over year in Q2. The core of VMware sales forces increasingly leveraging EUC and bringing the expanded portfolio of products to our enterprise customers. Once again, we believe our EUC desktop business continued to take share from the competition and grew at double digits. We saw strong momentum from Horizon desktop-as-a-service, our cloud based desktop service introduced in Q1.

AirWatch had a very strong quarter, continuing to build upon its leadership position and remaining number one in market share and enterprise mobile management and security. We announced a significant milestone in our operational integration plan since the AirWatch acquisition less than six months ago.

Effective July 1, the AirWatch enterprise mobile management platform became available on the VMware price list to our global network of more than 75,000 partners. We expect this change will accelerate our joint go-to-market efforts and bring deeper collaboration between the VMware and AirWatch sales forces.

In Q2, we had a number of key end user computing wins. In addition, we continue to expand our end user computing ecosystem with the recent announcement of a new partnership with Box to enhance secure enterprise collaboration across mobile devices for the next generation enterprise mobile management.

Cloud management grew licensed bookings greater than 30% year over year in Q2. This growth was helped by approximately 50% of our ELAs containing vCloud suite. We continue to see momentum with both our vCloud suite and vSOM offerings as both are direct sales force and the channel work towards making the no naked vSphere vision a reality.

In addition, by increasing cost transparency and business value, our ITBM solution is enabling us to improve our position with CIOs and CFOs. Our cloud managements penetration has risen to 12% of our install base leaving us plenty of room to grow. While standalone vSphere sales continue to shift to the suite, our strategy is working. VMware solutions, such as vCloud Automation Center, are becoming an industry standard for cloud automation and management.

We were particularly pleased that vSphere was once again a leader in the Gartner's Magic Quadrant for X86 server virtualization infrastructure for the fifth consecutive year. Standalone vSphere sales continue the shift we have been driving over the past 18 months to make compute a critical part of the suite offerings. With our high penetration across workloads, our strong renewal rates, and expanding product set, we see vSphere as a uniquely positioned strategic platform for expansion into adjacent virtualization product categories such as network and storage.

Our network virtualization platform, VMware NSX, gained significant momentum in Q2. Pat spoke about the recognition by Gartner of VMware's visionary leadership in data center networking. Customer interest is also very high.

Being in the market for only two years, and only since October with NSX, we are pleased to say that our networking business is now at a greater than $100 million total annual sales run rate. With currently over 150 paying customers and traction across all geos and verticals, we are closing key architectural wins as customers look to transform their networking operations in a similar way they did with compute through the use of vSphere and server virtualization.

As we look to move beyond the first 100 customers to the next 1,000, we are broadening the NSX sales channel through the addition of NSX to VMware's price lists and increased channel enablement activities. This is a decade plus opportunity for VMware, and contrary to what you may have heard from other vendors, this momentum is real, and traction is occurring right now. Our customers are embracing the NSX solution, not only as a network virtualization platform, but as a network security one as well.

Overall, we're seeing our customers value the NSX platform to deliver layer 2 through 7 services, but in particular, what is clearly resonating with our customers is the value it brings from a network security perspective. Although still early, we are finding the use of microsegmentation to be a new operational model for security and potentially to be a killer use case for the adoption of NSX.

Moving to Virtual SAN, we couldn't be more pleased with the product's performance in its first full quarter of availability. While the numbers are still small, we well exceeded our internal plan for licensed bookings. We are seeing successes across a wide variety of industries, market segments, and geos. VSAN already has several hundred paying customers reflecting the applicability of the product to VMware environments.

We closed a large storage-only ELA with a large retailer using Virtual SAN for remote store locations, and we also closed a VSAN driven ELA with a large software customer for a caching service using a simple to manage consolidated server and internal storage platform. Virtual SAN is a great example of how the vSphere platform offers an opportunity for us to expand into adjacent markets.

Virtual SAN is deeply integrated with VMware vSphere and the entire VMware stack providing a unique hypervisor converged storage tier that drives a radically simple operating model for storage. We look forward to sharing more information about the power behind this new simplified operating model at VM World in August.

Turning to our third key business, hybrid cloud, our vision of a hybrid cloud world is being adopted by customers as they increasingly seek to combine their on-premise investments with the best that the cloud has to offer. We grew our hybrid cloud business, which includes our vCloud service provider program and vCloud Hybrid Service offerings, nearly 80% year over year. We have approximately 4,000 partners as part of our hybrid cloud network, and we continue to see rapid acceleration of our enterprise customers adopting our vCloud Hybrid Service.

I am pleased to note that we have seen significant momentum in our first quarter of offering vCloud Hybrid Service disaster recovery. Early customer adoption has been extremely positive, exceeding our internal expectations.

In Q2, we also announced with Pivotal the first enterprise class hybrid platform-as-a-service on vCloud Hybrid Service. This is significant because our solution makes it possible for new and existing applications to run on the same platform as customers have on-premise, simplifying the transition to a hybrid cloud. This distinguishes VMware from the competition as providing the only commercially supported cloud foundry platform as a service solution from Pivotal available in hybrid cloud deployments for customers to drive rapid innovation and fast time to market.

In summary, we had a strong Q2. Our investments in enabling our sales force and channel around our new growth products and market opportunities is clearly paying off. We are delivering industry changing innovations in the software defined data center, hybrid cloud, and end user computing, and our customers and partners are excited to continue the journey with VMware.

With that, let me turn it over to Jonathan.

Thank you, Carl.

We're very pleased with our Q2 financial results meeting or exceeding our revenue and non-GAAP operating margin guidance for the quarter. Q2 total revenue was $1.457 billion, $12 million above the midpoint of our guidance range, and up 18% year over year when excluding Pivotal and divestitures. Licensed revenue of $614 million exceeded the midpoint of our guidance and was up 17% year over year, excluding Pivotal and divestitures. Total reported revenue grew 17% year over year in Q2, with licensed revenue up 16%.

We remain especially pleased with the increasing breadth and diversification of our business with non-standalone vSphere licensed bookings now greater than 50% of total licensed bookings, up from more than 35% in Q2 2013. Having passed the 50% mark, we have clearly established our compute capabilities as a platform for expansion into new markets such as management, networking, storage, and hybrid cloud. As a result, we are seeing strong growth in our new product areas and their contributions to our total sales. I'll be sharing more detail around this in our upcoming Analyst Day later in August.

As expected, Q2 non-GAAP operating margin was 29.4% reflecting the addition of AirWatch to VMware in late February. Given the momentum we're seeing in our next generation products and the rapid changes in the market, we expect to continue to invest heavily in our newer business areas, while maintaining our clear leadership in key areas such as compute to virtualization.

Diluted non-GAAP EPS for Q2 was $0.81 on approximately 434 million shares. Overall, Q2 was the strong P&L performance of the Company. We are proud of these results.

I'll now focus on key additional highlights that will be helpful in understanding our Q2 performance. Our balance sheet remains strong with cash and short term investments at quarter end of $6.6 billion, flat sequentially. In Q2, our operating cash flow is $409 million, and free cash flow is $333 million. This performance was consistent with our commentary in Q1.

During the quarter, we repurchased approximately 2.5 million shares of our stock for a total of $238 million at an average price of around $96 per share. Total unearned revenue ended the quarter at $4.39 billion, up 22% from Q2 2013, and of which $1.68 billion is long term, up 23% year over year. As expected, approximately 88% of our unearned revenues will be recognized ratably over future quarters. The unearned revenue mix is in line with prior periods and is primarily a reflection of our strong support business.

It's important to note that the participation and renewal rates for our support business remain high and that customers enjoy significant ongoing value from VMware, including all future product updates and upgrades. In effect, this model is a great combination of a perpetual license business with the ongoing revenues and cash flows associated with a subscription to future upgrades and updates. I'd encourage you to refer to the slides and financial tables accompanying this earnings call for further details on our results.

Now turning to guidance, we are maintaining the midpoint of full year 2014 revenue guidance of $6.02 billion, and narrowing the range to be between $5.96 billion and $6.08 billion, representing year-over-year growth of between 14.5% and 17%. Excluding Pivotal and divestitures, we continue to expect the midpoint of our 2014 total revenue growth to be approximately 17% with a narrowed range of between 16% and 18% versus 2013.

Likewise, we are also maintaining the midpoint of full year 2014 licensed guidance at $2.59 billion, and narrowing the range to be between $2.56 billion and $2.62 billion, or up 13% to 15% year over year. Excluding Pivotal and divestitures, we continue to expect the midpoint of our 2014 licensed growth rate to be approximately 15% with a narrowed range of between 14% and 16% versus 2013.

We also continue to expect that non-GAAP operating margin for 2014 will be approximately 31%. We now expect other income and expense for the full year 2014 to be approximately $5 million of income. Remaining guidance for 2014 is included in the slide deck posted on our Investor Relations website.

For Q3 2014, we expect total revenue to be between $1.48 billion and $1.52 billion, up 15% to 18% year over year. Licensed revenues for Q3 are expected to be between $630 million and $645 million, up 12% to 14% year over year. We expect non-GAAP operating margin for Q3 to be the same as Q2. And finally, other income and expense is expected to be approximately zero in Q3.

In summary, we are continuing to execute in our strategy, and our Q2 results reflect this. We are successfully extending our revenue streams into areas such as network and storage virtualization, mobility, hybrid cloud, and cloud management. We are pleased to see the results of our continued investments in these newer areas begin to pay off.

The significant changes in our industry make this an unprecedented time in history. We now have the fullest portfolio of products in the Company's history and are uniquely positioned to bring value to our customers, partners, and shareholders.

In closing, I'd like to remind you that in conjunction with VM World, we are hosting our annual financial Analyst Day on August 25 in San Francisco. If you have not registered already and would like to attend, please contact our investor relations team.

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

Thanks, Jonathan. Before we begin the Q&A, I'll ask you to limit yourselves to one question, consisting of one part, so we get to as many people as possible. Operator, let's get started.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Brian Marshall, ISI Group.

Can you talk about the relationship of ELAs as a percent of licensed bookings last quarter at 25%, how that went down, and resulting this quarter, we saw very solid increased traction with respect to some of the new initiatives or irons in the fire like VSAN and obviously NSX, which probably the customers increased about 50% the way we calculate it sequentially? Can you talk a little bit about that relationship, and if that volatility is something that we should expect going forward? Nice quarter. Thanks.

Thank you very much, Brian. This is Pat. I just want to emphasize what a solid performance by our team. I am quite proud of them overall, and as your question highlights, is the strength of the growth businesses, as well. I'll let Carl tackle the bulk of the question that you had, Brian, but great to hear from you, and thank you for the congratulations.

Hi, Brian.

As it relates to ELAs, as we expected we saw a real solid bounce back in the ELAs in Q2 representing 36% of our bookings in the quarter, second highest only to Q4 where it was 40% of our bookings. As we had indicated on our Q1 earnings call, our ELA business did not perform as expected, and we thought a lot of that was self-induced because the incremental time that we put into it, enabling and educating our field in our channel to be capable to be selling all of our new products into the market throughout 2014. From our perspective those enablement activities and that increased time we spent clearly paid off in our Q2 performance around ELAs, and we expect it to carry us throughout the rest of the year.

As related to some of the other products you mentioned, VSAN and NSX, as you saw this quarter we tried to provide a little bit more color on each of those products, and how they're being received by the market. As we'd indicated we're seeing strong uptick, at least initial uptick, in our first full quarter of VSAN, and NSX as we had indicated more than 150 paying customers and $100 million run rate clearly indicates that we are doing well with some of our new and emerging products as we take them to market.

Thank you, Brian, and next question, please, and one question per person. Thank you.

Kash Rangan, Merrill Lynch.

Hi. Thank you for taking my question.

Toggling between two earnings conference calls. Congratulations on new quarter. Could you talk about the commentary on bookings. I believe that Q1 you had very good billings, but you expressed some disappointment with how your bookings came along. Could you talk about how that turned out in Q2? I would imagine that bookings rebounded in Q2, but I just want to get that confirmation from you folks, as opposed to the reported billings which look very impressive. Thank you.

Yes, Kash, this is Jonathan. Thanks for the question.

As you know we shared that metric fairly consistently actually through the last few quarters, mainly because we'd seen it as being an important indicator where there was a significant difference, and partly because we were seeing softer external billings calculation numbers compared to what we were tracking to internally. We had been sharing that metric with you, and obviously that was what gave rise to some of the commentary around bookings last quarter.

I'm pleased to share this quarter there was pretty much a large, it was a convergence between those numbers. They were largely the same, internal and external. Going forward, to anticipate your next question, what we'll be sharing with you would be appropriate color with, I know Pat and Carl feel the same way as I do, appropriate transparency and color on the business as it helps you understand what's going on. I'm pleased to say this particular quarter the numbers were very similar. We were pleased with Q2 results, and clearly as you saw with some of the data points we're sharing the strategy is starting to execute well.

Thank you, Kash. The next question, please.

Brent Thrill, UBS.

Carl, just on the slips Q1 deals you highlighted, did the majority of those deals actually come in, in Q2 or are some of those still in the queue for the back half of the year?

Yes, thanks, Brett.

Let me reiterate what we mentioned coming out of Q1, and the three reasons we saw the softness in our bookings and why we were transparent about it. First, we saw increase in seasonality from Q4 to Q1 after a really strong Q4 performance of 40% ELAs. We talked about the fact that we did have less selling days in the quarter because we chose to enable our field and make sure they were enabled and capable of selling the robust portfolio of products we had coming into the year.

Then the third thing we did talk about was the fact that a few deals did slip from Q1 into Q2 and if you recall, on the Q2 earnings call, I'd indicated some of those had actually already closed by the time we got to our earning call for Q1.

With that as a back drop, as we went into Q2, and we looked at the guidance we provided, we did see a strong ELA pipeline that materialized for us throughout the quarter. Both new ELAs were strong, and our renewal of ELAs in the given quarter were strong, as well. A strong pipeline going into the quarter, a large number of the deals that slipped did close in Q2, which is what drove the 36% of our bookings coming from ELAs in the quarter. A really solid quarter around the world by our teams executing and continuing to drive ELA business for the Company.

Thank you, Brent. Next question, please.

Raimo Lenschow.

Thank you and congratulations from me, as well. Just a quick question on cash for Jonathan, you mentioned the reasons why the second half is better, but Q2 seemed a little bit weaker than the Street had modeled. Can you just give us a little bit of comfort again why the full year numbers are still the full year numbers, and how that's going to change in the second half? Thank you.

Raimo, I remember what we talked about for the full year coming out of Q1 was a range of $2.55 billion to $2.75 billion, so that I think is broadly in line. We talked pretty extensively at the end of Q1 about the ELA bookings shortfall compared to our own internal plan, and at that point I'd adjusted the range by just over $100 million to reflect that range I've just given you.

I don't actually think people should be surprised. I know that most people didn't actually adjust their Q2 models. We don't guide quarter-by-quarter obviously given the lumpy nature of cash flow, cash flows in general, so hopefully that's giving you a sense. What you're seeing in Q2 is very much a reflection of the commentary we shared in Q1.

Thank you. Next question, please.

Heather Bellini, Goldman Sachs.

Hello. This is Justin on for Heather. A quick question on the SDN market, there's been a lot of back and forth from you guys and Cisco. Just trying to get a better understanding the primary reason why you guys might win a deal versus them, and perhaps lose versus them? It would be helpful, thanks.

Sure. Let me start on that one. As we said in the commentary that Carl and I gave, we had a strong quarter for NSX, 150 paying customers, $100 million run rate. Really what customers are seeing is the power of the software defined data center strategy, and this contrasted with the HGC as we've said. Use cases like microsegmentation really show the power of this approach, things that literally cannot be achieved by any other approach delivering radical improvements in the security of applications and east-west traffic flow efficiencies.

Now that said as we've said before, we love Cisco gear. We don't need them to lose and many NSX customers are using it, so we really see this as an opportunity for customers to take advantage of a new technology, network virtualization. We are out to win in that game, and do it on the best gear that's available in the industry.

Thank you very much.

Next question, please.

Phil Winslow, Credit Suisse.

Hello. Congratulations on the great quarter. I just have a question on your two new products NSX and VSAN. Obviously, it's pretty impressive the VSAN customer count number that you had, considering the fact this has only been available a little over a quarter at 300. NSX, you mentioned that 150. I'm wonder if you could just compare and contrast how you think about the near term ramp of these two versus the long term opportunity that each one provides? Thanks.

Yes. Hi, Phil. This is Carl. I'll start, and then, Pat, maybe you can add some color as well.

When we think about both of these market opportunities, when we look at it over the next three years, they're relatively the same size and scope for us for both VSAN and NSX as we calculate our TAM for these two markets. To your point in our first full quarter with VSAN, we have seen quite a bit of success. We beat our internal plan in metrics, and people see the advantage of leveraging local disc and Flash on their existing servers, and the change of the operating model for people now who were once just deploying VMware in virtual machines to simultaneously deploy VMware in virtual machines and storage on local discs in their existing server footprint. There's a change in the operating model that our customers are really starting to enjoy, and we saw that play out in a number of larger deals as well as in a very transactional business model for us around VSAN.

In NSX, as Pat had just indicated we are pleased with the traction in the market. We believe we're the only viable, shippable product that's ready for production scale in the market today. Our customers are starting to implement this in many different areas whether it's in test and dev, or new greenfield software defined data centers, or in production in some cases. We're starting to see this become a true platform for delivering the software defined data center with the NSX platform.

With that, I'll turn it over to Pat, and see if he wants to add some more color about these two exciting products we brought to market last quarter.

Just to add a bit to that and as Carl said, the TAM opportunity as we've laid it out is very similar for the two, and VSAN is a more transactional sale, which really is exciting to us to really bring energy to our transactional channel. The NSX product line is a more architectural sale. It's a much more strategic, typically a higher end sale. When I'm talking to my VSAN team I'm telling them they better go faster than the NSX team. When we're talking to the NSX team, we tell them they better go faster than the VSAN team, and it really is great to see them race into the marketplace with exciting new technologies.

I'd also emphasize that both of these levers the foundation of vSphere. That's really to us the powerful thing about the SDDC is that our networking opportunity, our VSAN opportunity, and our management opportunity gets to build on the foundation, the momentum of our 40 million VMs, our 500,000 customers, and really springboard to deliver the SDDC at scale in the marketplace.

Thank you, Phil. Next question, please.

Walter Pritchard, Citi.

Hi, thanks. Carl and Jonathan, I'm wondering if you can talk a little bit about, I know you're not guiding to 2015, but if we look forward to 2015, you do have the trough in the ELA renewal cycle back that you had back in 2012 repeating itself again. You do have these new products, which it sounds like based on the progress you're making in this quarter Q2 you're quite happy with their progress.

I'm just wondering, you set a picture up over a year ago talking about accelerating growth into 2015 on a three-year plan. I'm wondering if you're comfortable reiterating that, or if you could talk to how things may be different than when you originally first saw that back a year ago?

Walter, thanks for the question.

I'll start, and I'll hand over to Carl just perhaps to talk about again some of the underlying trends that we're seeing. I think that it's premature for us to talk about 2015 at this point. Allow us to go through Analyst Day coming up here, and also as we get closer to 2015 we'll give you, obviously, a ton more specificity.

We're certainly pretty encouraged by the momentum we're seeing. We're starting to see the evidence shown up what we were planning for. We're seeing momentum on NSX as expected, and the momentum you've noted with respect to customer momentum. The momentum getting above $100 million annual sales run rate is an important milestone for us.

We were planning for much of this as we were anticipating the momentum through the year, and it's encouraging to see it. It's definitely encouraging and pleasing to be able to share those metrics for us, but it's way premature for us to talk specifically about 2015 at this point.

I think the last point I'd just make is clearly when you're in early stage markets like these are, and we do consider them to be multi-year, decade plus like opportunities for us in both cases, for the two you've mentioned, you're going to see some volatility. You're going to see some lack of predictability in those first few quarters and even the first few years, and we're in those early stages.

Our momentum seems to be good. We certainly feel very good compared to the competition, and I think we're positioned well, but let us get closer to FY15 before we start talking any more detail.

The only other thing I'd add, Jonathan, is we were very pleased with the quarter from an end user computing perspective. We saw very solid performance in the first full quarter since the acquisition with our AirWatch business, and we continue to believe we took share in the end user computing space specifically the VDI market.

The last thing I'd address, you talked about what's the ELA opportunity as it relates to 2015? We're not going to provide a lot of detail about 2015 and ELA opportunity, but what I can tell you is the opportunity from a dollar value is larger than we saw in 2014. We'll take all that into account as we get closer to 2015 and provide guidance for the year.

Larger the growth rate year-over-year is less, but it's still an opportunity.

Thank you, Walter. Next question, please.

Keith Weiss, Morgan Stanley.

Excellent. Thank you for taking the question, and nice quarter. I was wondering if you could talk a little bit about the actual revenue and licensed revenue contribution from AirWatch, and how well have you guys been able to integrate AirWatch sales into a broader horizon since you see a sales cycle?

Maybe I'll talk about our numbers first of all, just to clarify what we've been saying about AirWatch and then Pat or Carl will add, if I left anything out. As I said last time or last quarter, we're not going to be specifically breaking out AirWatch numbers going forward. We went into pretty extensive disclosure last quarter of what we predict from AirWatch, and I'd just refer you, Keith, back to some of our very specific disclosure we shared with respect to revenue expectations.

I was pleased to see in this, the first full quarter of AirWatch that they did great. It's always challenging as a smaller company coming into a larger Company to navigate the waters, but they've done a really good job, so congratulations out to Alan and John in particular and the whole team there. The performance [over] was largely in line with the guidance I shared with you last quarter, so that I think gives your sense of how they actually did.

We'll continue obviously to give you appropriate color as we talk about the end user computing business which is where it's being integrated into under Sanjay Poonen. I think overall some of the statistics that we shared, we saw customer count up almost over 80% year-over-year, now approximately 13,000 customers. They've added a record device count this quarter, 1.2 million additional devices under management now in Q2. Again, very good progress we're seeing. No signs of integration disruption which you often see with transactions like this. I think we're off to a good start.

Yes. I'll just add a few comments.

We just completed our operational Board of Directors, the management construct we used to carefully manage that integration process last week. I'll tell you the team is excited. They're winning in the marketplace. It feels like we are increasing the separation between us and number two, and the rest of the pack, so we're feeling very optimistic about how well that is going.

As we indicated, we just price listed it for our broader channels, so we're expecting to see that acceleration as we bring the broader VMware channel and sales force to bear on the product line. The opportunity here, we are really thrilled with, and many of our big customers now that we're able to start bringing this forward are just doing massive projects, taking advantage of mobility. Overall, we're quite excited. Their entry into VMware and leadership team there, their passion for this segment is really unbridled.

Thank you, Keith.

Excellent, thank you.

Next question, please.

Gregg Moskowitz, Cowen and Company.

Okay, thank you very much. Congratulations on a very solid quarter. I had a question for Pat. There's been a lot of recent discussion about containers and dockware more specifically, and I'm wondering, do containers present some risk to the usage of VMs in certain types of work loads? What's your perspective on that?

Yes. Thanks for the question, Gregg and very simply put, no. We don't think of containers as a replacement. We don't see it as an either/or, but it's clearly a both/and opportunity. We see the future as both. Clearly the VM provides a proven model for security, networking, resilience, compliance, management, orchestration really being that infrastructure for both old and new applications, where containers give an opportunity for an efficient model for next-gen or third generation applications, but don't address many of these core needs of infrastructure, isolation, and security.

We see this as a huge opportunity for us to further extend the value of the vCloud suite, the hybrid cloud, delivering this common platform for today, as well as tomorrow's application. Maybe the analogy would be that it's like the JVM of many years ago. It's this higher level container structure, or the JAVA virtual machine that gives you an efficient model for new app development, but it needs the infrastructure components that the VM offers.

You're going to hear us talk a lot more about this at VM World, and we have some exciting things that we'll be discussing in this area coming up because we really do see it as an opportunity. It's clearly a both/and environment as we go forward.

Thank you.

Thank you, Gregg. Next question, please.

Shaul Eyal, Oppenheimer.

Thank you. Hello. Congratulations on my end as well on the strong performance. Pat, in your prepared remarks you made some indirect comments on your competitors, what some of them are saying in the marketplace. What is happening on the competitive landscape versus guys like Microsoft that also reported strong results just right now, and maybe just in one word your thoughts on the Apple and IBM enterprise mobility announcement from last week? Thank you.

On the Microsoft situation, not a lot has changed. They continue to be competitive. We continue to see them as really the prime competition for the private cloud environment. We'd emphasize that we are no longer just a hypervisor. It's about the SDDC, and we talked about strength of management, networking, and storage as a result, and how we're really changing that competitive battlefield. We continue to see that we rarely, if ever, lose versus them in that regard.

Overall, not much has changed, and as we've really talked about, the virtual machine is really this Goldilocks zone that allows us to move into these new areas very effectively. On the broader competitive environment, everything for us, yes, it's a competitive environment. We are in this place where the industry sees so much going on that there are these challenges that we're facing, but the answer is, and I think as our numbers have shown, we're continuing to ride these environments extremely well and deliver extraordinary value for our customers.

With respect to the Apple, IBM announcement, it was somewhat surprising I think for the industry overall to see these two companies come together. Our perspective is that it really accelerates the position of the Apple business in the business environment at the application level, and given the leadership position that AirWatch has as the MEM environment for that, we see that as a positive force. It's going to accelerate the benefits of that for enterprise customers for which we are clearly the mobile enterprise management solution of choice. We think that all in all, it's going to be a good opportunity for us to accelerate our position.

Thank you.

Next question, please.

Rob Owens, Pacific Crest Securities.

Thank you much. On the EUC side of your business, you talked about success with VDI with AirWatch. Are you seeing this as discrete opportunities? Are people looking at deploying this more strategically in terms of mobility? Just looking for more broad market color. Thanks.

Yes. As I indicated earlier, Rob, we saw a very solid quarter from AirWatch continuing to grow at the rates that we expected and maintaining their number one market position in enterprise mobile management and security, and VDI continues to we believe take market share from the competition.

With that being said, we are hearing from our customers that they believe we have the most holistic, if you will, desktop to device platform for managing and securing any type of device people want to use to get access to their enterprise applications which is why this quarter we're rolling out a new Horizon 6 suite bundle that includes everything we've traditionally brought to market around VDI, management of VDI, management of existing, or if you will traditional, desktops. Now we're including the AirWatch platform as part of, if you will, the Horizon suite as well.

Clearly our customers are driving us in that direction. We believe we have the most holistic management platform to address both the mobile world we're living in today and the existing desktop that resides in enterprises both today and then beyond.

Thank you, Rob. Next question, please.

Matt Hedberg.

In your prepared remarks, you highlighted customers are exploring some other purchasing models, such as subscription. I guess I'm wondering how should we think about that in term of your long term growth? I believe you said it's going to be more of a gradual impact, but should it cannibalize licensed revenue or is this going to be more additive in total?

Matt, this is Jonathan. Thanks for the question. If you go back to what I shared at Analyst Day I think this time last year and you took that very illustrative model and projected it forward, I don't think it's being cannibalistic. Well, I think it's going to be both. It's really about substitution and customer choice, and I think you'll see somewhere it's clearly additive.

An example of where it's clearly additive I would say is in the mobile space. AirWatch clearly has an opportunity to continue to be number one in the marketplace, and it's clearly doing a really nice job of executing. Their business model is both a perpetual licensed model and a subscription model. vCHS, our hybrid cloud solution, is clearly subscription model.

That's another example of it being additive, depending on your perspective of are we talking about workloads moving off-premise, and whether those are additive or not. Clearly it's an additive opportunity when I think about the overall opportunity ahead.

Then to the extent we provide other licensing models as we go forward, providing customers choice, for example, we've been doing some term licenses for NSX. We've actually been seeing customers increasingly want to see that consumed as a perpetual license. I think of it more as being additive in our overall business model. We just want you to be taking a look at the overall list of different ways that customers are consuming our businesses, and as we go forward, we certainly see it being a gradual but steady mix shift.

This is a topic that we'll cover more at the financial Analyst Day, as well, coming up at VM World.

Thank you, Matt. Next question, please.

Rajesh Ghai, Macquarie.

Yes. Thanks for taking my question.

I appreciate the color and commentary on the strength in the vCloud hybrid services business. I was wondering if you could share any metrics related to the penetration of the cloud hybrid services into your vSphere install base. How many of your 500,000 customers are looking at it, or using it versus how many have migrated to a competing alternate such as Amazon?

Thank you.

Yes. I'll start, Rajesh, and then I'll let Pat add some color.

As we had indicated in the prepared remarks, our cloud business, which consists of our vCloud Hybrid Service and our VSPP partner network around the world, grew greater than 80% on a year-over-year basis, so really solid growth. While it's still early days of the vCloud Hybrid Service in the market, we are seeing very good uptake of our enterprise customers who have an interest to seamlessly federate their workloads both on-premise and off-premise with a common management platform for both. We're in the early days, but we're quite proud of our performance, and we're not standing still either.

We're continuing to, if you will, go around the rest of the world like our market entry in the UK. Last week, we announced two strategic partnerships in Asia with our vCloud Hybrid Service as it relates to China and Japan markets. We're very pleased with the early adoption of the program and the platform.

I do think it's important to note that in our prepared remarks we talked about more than 4,000 VSPP partners around the world who are delivering cloud based services on top of our platform, and we see them as a true extension of our vCloud Hybrid Service, creating what we believe is the largest hybrid cloud infrastructure network globally.

Pat, anything to add?

The thing that really is resonating with our customers is this idea of hybrid, and with that, that we're giving them another layer of choice where they can literally choose where they run their work loads at any time of the day or night and the flexibility to compatibly and securely move them across those environments. Focusing on our customer base, delivering a hybrid alternative, and having this vast partner ecosystem, we really believe gives us a very unique strategy into this very rapidly growing but still very infant enterprise cloud market.

As you saw by the announcements last week as we extended to worldwide that enthusiasm now really is setting us apart on a global basis. You'll continue to see announcements, new service, new partnership opportunities, as we go through the year.

Thank you, Rajesh. Last question, please.

Michael Turits, Raymond James.

Thanks. Let's bounce back to ELAs this quarter, was just wondering if we should expect a similar skew in terms of second half, first half, and ELA bookings this year as last year?

Michael, this is Carl. I'll take that.

As you know, we don't guide on ELAs, but we do expect to see a solid second half as it relates to ELAs against total bookings. I would expect to see your traditional seasonality of Q3 where it may not be as strong as Q2 or Q4, but when we look at our ELA business holistically, we do expect to have a solid second half. Our 2014 ELA renewal opportunity was slightly greater in the second half than it was in the first half of the year.

We are confident that our customers are looking at us in a very strategic way as are having deep architectural conversations with them as to what their next generation data center looks like. We continue to talk to them about entering into multi-year agreements to help them with their journey to the software defined data center. With that backdrop, I would expect a solid second half of the year from an ELA perspective.

Thanks, Carl.

Thank you, Michael, and before we conclude Pat will have a final comment.

Thank you very much, Paul.

In summary, we're seeing strong momentum across all three of our strategic priorities, and I'd like to thank our customers, partners, and employees for their passion, support, and engagement as we build on this momentum into the second half of 2014. I hope to see many of you at the financial Analyst Day we are holding as part of VM World, our annual industry conference taking place in San Francisco at the end of August, a must-attend event for anyone in IT infrastructure. Thank you very much.

That concludes today's conference call. Thank you for participating. You may disconnect at this time.