VMware Inc (VMW) 2015 Q2 法說會逐字稿

Good day, and welcome to the VMware second quarter 2015 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Paul Ziots, Vice President, Investor Relations. Please go ahead, sir.

Thank you. Good afternoon, everyone, and welcome to VMware's second quarter 2015 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 Chief Operating Officer. 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 have also included in our earnings release and posted on our website, a reconciliation of GAAP to non-GAAP data for constant currency growth in revenues, plus sequential change in unearned revenues for Q2 2015 and Q2 2014, excluding the reduction of revenues due to the GSA settlement in Q2 2015.

On this call today, we will make forward-looking statements that are subject to risks and uncertainties. The 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 in addition to, and not a substitute for, or in 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 on 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, and as mentioned the reduction of revenues due to the GSA settlement in Q2 2015. 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 2015 quiet period begins at the close of business, September 15, 2015. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2014. With that, I'll turn it over to Pat.

Thank you, Paul, and good afternoon, everyone. Our second quarter results are solid, following a solid start to the year in Q1. Q2 non-GAAP revenue was at the top of our guidance range, representing growth of 13% year on year on constant currency, and we exceeded our non-GAAP EPS guidance for the quarter.

Earlier this year, we outlined our One Cloud Any Application Any Device strategy, and announced the industry's first unified platform of virtualized compute, network and storage for the hybrid cloud. This quarter, we outlined the next phase of this strategy with new solutions, services, and partnerships for business mobility that enable organizations to transform their business processes. Some of the highlights included the introduction of VMware Identity Manager, the industry's first identity-as-a-service offering integrated with our leading enterprise-class mobility management and security platform, which provides IT with a central place to manage end user provisioning, access, and compliance.

We also announced further commitment to Apple devices on the iOS platform, with plans to deliver application configuration templates and vertical solutions. In addition, we were delighted to welcome 15 new partners including DocuSign, Dropbox and MicroStrategy to the ACE program, which provides a set of open and vendor neutral standards for developing secure mobile applications. Overall, our EUC business performed particularly well this quarter, including strong performance with our AirWatch offering.

It has also been an exciting quarter in the area of clouds services, as we continue to expand our offerings around the world. Complementing the VMware's vCloud Air network of service providers, we announced general availability of a new VMware-operated location in Australia, which provides customers with a local Asia Pacific hybrid cloud service that helps address local compliance and data locality needs.

This service was launched in partnership with Telstra, a great example of a customer strongly aligned with all members of the EUC federation. Carl will talk about a number of the large wins we enjoyed this quarter, which includes some key federation level wins. We continue to see increased opportunities to deliver superior value to our joint customers.

In April, we announced two new VMware open source projects designed to enable enterprise adoption of cloud-native applications. Project Lightwave, an enterprise identity and access management solution which also enables scalable security for containers, and Project Photon, a Lightweight Linux operating system focused on container and cloud-native applications. Together, these projects are already helping customers develop, run, and manage secure cloud-native applications.

Building on these announcements, we recently unveiled two new technology previews designed to streamline cloud-native application development and deployment. VMware AppCatalyst delivers an API-driven environment to developer laptops, and Project Bonneville will enable seamless integration of Docker Containers into VMware vSphere. These innovations will help enterprises develop, run, and manage secure cloud-native applications, from building them through a simple and easy to use development tool, to running Docker Containers securely in production on a VMware vSphere. This continues to deliver on our vision of containers without compromise, which you will hear more about during our upcoming VMware World conference.

We also saw some very successful deployments of VMware Integrated OpenStack, with a number of the major accounts integrating our OpenStack offering with their vSphere-based enterprise infrastructure. We made several key partnership announcements this past quarter, and I wanted to take a moment to just mention a few. Intel Security and VMware announced an integrated solution based on the VMware NSX network virtualization platform to provide Intelligent Intrusion Prevention Services, IPS, for the protection of east-west traffic within the data center.

Recently, Check Point Software and VMware announced an expanded collaboration to extend comprehensive best-in-class security to enterprise private cloud environments. We have continued to build on our support of network function virtualization in the telco space which I talked about last quarter. Ooredoo Kuwait has successfully deployed both NFV and IT applications on a single unified cloud based on the vCloud for NFV. And last week, we announced that Internet Initiative Japan Inc. has selected the platform for a new virtual CPE service they are launching later this year.

Our technology leadership and customer momentum continues to be recognized by leading industry analysts. Some of the key reports published in Q2 included Gartner recognizing AirWatch by VMware as a leader, with the Highest Ability to execute in its 2015 Magic Quadrant for Enterprise Mobility Management. VMware has been positioned as a visionary in their 2015 Magic Quadrant for Data Center Networking, and in their Magic Quadrant for Cloud Infrastructure as a Service Worldwide.

Last week, Gartner published its latest x86 Server Virtualization MQ. For the sixth year in a row, VMware is placed as a leader, with both the highest ability to execute and highest completeness of vision. IDC also recognized VMware in a number of reports, including positioning us as a leader in their 2015 Marketscape for Worldwide Client Computing Software. We were particularly pleased that IDC recognized the AirWatch by VMware as number one in both market share and revenue in their EMM market share report.

Once again, we are expecting well over 20,000 attendees for VMware World in San Francisco, which kicks off on August 30. With this year's theme, Ready for Any, VMware World attendees will enjoy a week of in-depth training, hands-on experience, breakout sessions, and networking opportunities with industry experts. I hope to see many of you at our financial analyst meeting on August 31, which we are holding as part of VMware World San Francisco.

I will now turn it over to Carl to talk more about the business performance in Q2.

Thank you, Pat. We delivered a solid quarter in Q2, and our customer operations teams around the world did a good job closing large deals. We remain optimistic about our market opportunity around our three strategic businesses, hybrid cloud, software-defined data center, and end user computing. Taking a look at our Q2 regional bookings performance on a constant currency basis in relative terms, Asia Pacific performed best, followed by the Americas and EMEA. In Asia Pacific, we were particularly pleased with our performance in Japan and southeast Asia.

For the first time though, we saw a significant slowdown in our China business. We expect this weakness to continue into the second half of the year. In the Americas, we were pleased with our performance across our enterprise segment, partially offset by weakness in Brazil. In EMEA, we were pleased with our business in northern Europe. Our year-over-year compare was difficult in Germany, due to two large transactions a year ago. Russia continued to be challenging due to the economic environment.

In Q2, we saw solid execution in our large deals. Enterprise agreements were approximately 39% of total second quarter bookings, which was the second highest quarter contribution ever. This is up from approximately 37% last Q2. This strong performance demonstrates customers' commitment to investing in VMware's expanded solution offerings.

We closed seven deals at or over $10 million in the quarter, and had a healthy mix of new enterprise agreement, as well as EA renewals. New EAs continue to be over 50% of total EAs. Our large deals increasingly include components across our business. For example, 9 of the top 10 deals contained EUC, and 5 of our top 10 deals contained NSX. This reflects the strategic value our customers rely on from VMware.

One example of the strategic value was the closing of a large strategic agreement with Mizuho Bank, one of the largest banks in Japan, by helping their project to develop and deploy a new infrastructure for their core banking system. VMware was pleased to renew our business relationship with the United States Postal Service in Q2. USPS is a long-time customer who has utilized VMware software for a variety of needs. The new enterprise agreement includes the vCloud Suite, NSX, Horizon desktop virtualization, AirWatch for Enterprise Mobile Management, and vCloud government service for hybrid cloud connectivity.

The new software from VMware provides organizations, including the Postal Service with the ability to be more agile, increase performance, and increase their security posture at a time when the threats are becoming more pervasive every day. End-User computing continued their market momentum with an especially strong performance in Q2. End-User computing including AirWatch, grew license bookings 30% year over year in Q2 on a constant currency basis. The Desktop license business grew over 15% year over year on a constant currency basis, and we believe we once again gained share from the competition during the quarter.

AirWatch grew license bookings over 60% year over year in Q2 on a constant currency basis. We believe we remain the clear leader in enterprise mobile management. In Q2, our End-User computing sales growth benefited from the leverage due to our integration of AirWatch into VMware, including greater reach due to VMware's global presence, leverage from our robust channel and access to enterprise accounts via our sales force. The success is demonstrated through AirWatch being in a number of our larger EAs for the first time, and mobility being a door-opener to the CIO's office.

Cloud management saw solid license bookings growth in Q2, helped by strong double-digit year-over-year growth from vSphere with operations. We were particularly pleased with our vSOM growth, driven by our continued ability to execute on our no naked vSphere strategy. Our cloud management penetration is now nearly 16% of our installed base, leaving plenty of headroom for growth.

We saw continued momentum in Q2 for network virtualization solution, VMware NSX. Looking back at the first half performance of NSX, we are pleased we nearly our doubled license bookings versus the same period of last year. Our pipeline continues to grow, and the number of customers doing proof-of-concept continues to accelerate every quarter. The number of NSX paying customers has now increased to over 700, versus over 150 a year ago. We believe the number of production customers using NSX far outweighs that of any competitor.

The predominant pattern in our production deployments has been network automation and micro segmentation, where micro segmentation has served as the initial purchase justification. In Q2, we expanded our partnership with SAP to include networking with NSX. SAP plans to deploy NSX to accelerate network provisioning, increase flexibility, and implement a new level of security with micro segmentation.

Summarizing a few other product areas, our Virtual SAN customer count has increased to over 2,000, versus over 1,000 just two quarters ago. In relation to hybrid cloud, in Q2 we saw continued strengthening with a number of key service provider partners. One of those partners, Telstra, will be leveraging VMware's software-defined data center architecture to deliver infrastructure-as-a-service for both internal IT consumption, and public-facing IAAS services. Our relationship with Telstra is off to a good start.

In Q2, we completed the incorporation of the VMware NSX into vCloud Air, with the release of VMware vCloud Air advanced networking services. This allows seamless environment extensions, fewer network or architectural conflicts, and the ability to run any application workload anywhere.

In conclusion, we are excited about the future, and are well-positioned to lead the industry with the most complete portfolio in the Company's history. We continue to make investments in enabling our sales force and channel around our new growth products and market opportunities. We remain confident about our opportunities for the second half of 2015 and beyond.

With that, let me turn it over to Jonathan.

Thank you, Carl. We are pleased with our Q2 performance, as our non-GAAP total revenue hit the top of our revenue guidance, and we exceeded on non-GAAP EPS guidance. In addition, licensed bookings beyond standalone vSphere were greater than 60% of total license bookings, up from greater than 50% in Q2 2014, and up from more than 35% two years ago. We continue to diversify our business, expanding our portfolio of products for enabling the software-defined enterprise.

Q2 total non-GAAP revenues were $1.6 billion, up 13% year over year on a constant currency basis, or up 10% as reported. Q2 license revenues were $638 million, up 9% year-over-year on a constant currency basis, or up 4% as reported. Revenues from our hybrid cloud and SaaS offerings were better than 6% of our Q2 non-GAAP total revenues, with a growth rate of over 80% year over year. Diluted non-GAAP EPS for Q2 was $0.93 per share on approximately 427 million shares, and as planned continue to reflect the dilutive effect of the acquisition of AirWatch in 2014.

During the quarter, we repurchased approximately 4.7 million shares of stock for a total of $412 million. Over the first half of 2015, we have bought back over 10 million shares for a total of approximately $850 million. As I mentioned six months ago, we set out to repurchase over $1 billion of stock this year, with the intent that this would be weighted towards the front end of the year. Given the activity so far, we now anticipate that we will buy back approximately $1.25 billion of stock over the full year 2015.

Our balance sheet remains strong, with cash and short-term investments at quarter end of $7 billion. Total unearned revenues ended the quarter at $4.8 billion, up 10% from Q2 2014, with $1.8 billion in long-term unearned revenues up 7% year over year. We are aware that many of you use the calculation of revenue plus sequential change in unearned revenue as an estimate for bookings. To help you with this calculation this quarter, we have once again included a table with growth rates for these calculated figures in our financial statements. The table is also in the slide deck accompanying this call.

To summarize this data, in Q2 the growth rate for non-GAAP total revenues, plus change in unearned revenues was approximately 5% year over year. The growth rate for license revenues plus change in unearned license revenues was approximately 9% year over year. The growth rates adjust for the impact of currency on revenues and unearned revenues.

Turning to guidance for 2015. For total non-GAAP revenues and for license revenues, we are reiterating the midpoints of prior guidance and tightening the ranges. We expect non-GAAP total revenues for 2015 to be between $6.575 billion and $6.685 billion, or up 9% to 11% year over year. On a constant currency basis, this would be up 12% to 14% year over year. We expect licensed revenues for the full year to be between $2.710 billion and $2.765 billion, or up 5% to 7% year over year. On a constant currency basis, this would be up 9% to 11% year over year.

As a reminder, we continue to monitor the effect of growth on our hybrid cloud and SaaS businesses. We see opportunities for faster progress in this category than we anticipated at the start of the year. We're tracking this carefully, given the solid growth we continue to experience, and the opportunities we have for expanding this business going forward. We will spend time discussing additional growth drivers for this portion of our business at our financial analyst meeting on August 31.

For 2015, we continue to expect full year non-GAAP operating margin to be approximately 31.5%, which balances some margin expansion against continued investment in our growth businesses. As a reminder, we are planning for AirWatch to be EPS neutral exiting the fourth quarter of 2015. This means that we expect AirWatch to begin contributing profits in 2016, although not at the same level as our corporate average.

Regarding cash flow from operations, while we managed cash flow well in Q2, we made an unplanned payment of over $75 million related to the General Services Administration settlement. Taking this into account, we are lowering our cash flow from operations expectation for 2015, from approximately $1.95 billion to approximately $1.875 billion. In addition, we now expect capital expenditures to be approximately $350 million for the year, or approximately $50 million less than prior expectations. There are no other changes to our cash flow outlook for 2015.

We are modeling a share count of approximately 427 million shares for the year, and are raising our non-GAAP EPS guidance for the year by approximately $0.02 a share, to be between $3.97 and $4.03 per share.

Shifting to Q3 2015, we expect total reported revenue to be between $1.645 billion and $1.665 billion, or up 9% to 10% year over year. On a constant currency basis, this would be up 12% to 13% year over year. Licensed revenues for Q3 are expected to be between $675 million to $685 million, or up 6% to 7% year over year. On a constant currency basis, this would be up 10% to 12% year over year. For Q3, we expect non-GAAP operating margin to be approximately 31%, and non-GAAP EPS of between $0.98 and $1.00 per share. Remaining guidance for Q3 and 2015 is included in the slide deck posted on our Investor Relations website.

In summary, we are pleased with our solid Q2 performance following a solid Q1, and we look forward to seeing you on August 31 at our financial analyst meeting at VM World.

And with that, I will 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 can get to as many people as possible. Operator, let's get started.

Thank you.

(Operator Instructions)

We will take the first question from Heather Bellini from Goldman Sachs.

Great, thank you. I wanted to ask a question about the ELA renewal cycle. Obviously, you always have one going on. You have a particularly large one coming up in calendar 2016.

I was wondering if you could talk about the importance of these big cycles, in terms of getting customers to broaden their product portfolio? How do you see it as an opportunity to expand the product footprint that your customers have? Thank you.

Thank you very much, Heather, for the question. Always great to have you on the call.

Maybe before we get started into the Q&A, as we said during the prepared remarks, our second quarter results are solid, following a solid start to the year in Q1. And we do see, and glad for your question, Heather, great progress in the newer products, with license bookings now beyond standalone vSphere over 60% of total license bookings, up from just 35% two years ago. So overall, a great progress overall.

And Carl, maybe you can comment a bit more on how we see the ELA cycle affecting the new products, and the rest of the year?

Yes, sure. Thanks, Pat and thanks, Heather for the question.

So as a quick reminder, Heather, its important to note that greater than 50% of our enterprise agreements are actually new ones. And our customers see enterprise agreements as a good buying vehicle to get frictionless access to our technologies for their future needs. Our enterprise agreement renewals are important to us as you can imagine, and there are quarters where we have more opportunity to renew these deals versus others. We have had a really good track record of renewing our EAs in the quarter that they expire.

In some cases, we pull them in early, in other cases they go from one quarter to the next. But overall, if you look at our ability to renew our enterprise agreements, it's very good.

As far as getting our new products into enterprise agreements, I would say both net new enterprise agreements and the renewal of enterprise agreements are absolutely a key mechanism for us to get our newer technologies into our customer's hands. And a lot of our larger deals as I indicated in my prepared remarks, includes some of the newer products. For example, 9 of the top 10 deals included End-User computing, 5 of our top 10 deals this quarter included NSX.

We had a number of deals that also included AirWatch, now that our sales teams are driving AirWatch into the market in conjunction with the rest of the VMware portfolio. And we are even seeing the inclusion of vCloud Air. So and we do see, both net new and the renewal of EAs as a key mechanism of getting customers our newer technologies.

Thank you, Heather. Next question, please.

We'll take our nest question from Brent Thill with UBS.

Thank you. Just as it relates to the government business, you are coming into an important period in the year. I'm curious, there was obviously a lot of concern from investors around the government contract, and you have been pretty clear that you are still doing a lot of business on a standalone basis with each division. But how that is tracking, and what your view is headed into the September fiscal year end?

Yes, so thanks for the question, Brent. Let me take that. This is Carl.

Before I talk in specifics about the federal business, I think some late flashing news is the fact that today, actually today the government released a DoD virtualization FRI to the market, that was very similar to the JLO that they released earlier this year that people responded to. And releasing as an RFI allows both VMware and our partners to respond to the RFI, which is very heavily driven towards to a VMware solution set. But it always allows the rest of the market to look at what the government is looking for across their virtualization environment.

Once the RFI is responded to at some point, the government will then ultimately issue an RFP for their virtualization solutions as a whole. And as we said in the past, we at VMware don't dictate or drive the timing of this, but we will continue to work with our friends at the government, as they look to bring this to market and closure in the future.

In the meantime, we continue to work very closely with the government. We had a really solid Q1 in our government and federal business. We had an okay quarter in Q2.

But probably what we are most excited about is the pipeline that we built in Q2, as we head into the very large, which is large buying season in Q3 because it's the government's fiscal year end. So we are looking forward to a big Q3 from the federal government, and we have deep meaningful relationships, and we are very pleased with our federal business, and continue to focus on it, both in Q3 and beyond.

Thank you, Brent. Next question, please.

Our next question from Phil Winslow with Credit Suisse.

Thanks, guys. Congrats on a good quarter.

You talked about a lot of underlying metrics that are positive obviously on the new businesses, NSX and vSAN, and obviously Carl just commented on the ELA portfolio for the second half. But I guess the question ultimately, when you look at your second half guidance, it does calls for accelerating your license growth. So when you do look through your portfolio, heading into the second half, what gives you the confident in that accelerating license growth? Is it a particular product such as NSX or vSAN, or is it the renewal portfolio or just maybe help us parse that through?

So Phil, this is Jonathan. Let me just take that and I will ask Carl to give a little bit more color.

As we've previously stated, not just actually this year, but frankly the last two years, second half is shaping up to be stronger than the second half. We saw the similar performance in 2013 and 2014, obviously we executed in both of those years. We are seeing somewhat increased seasonality.

Some of the factors that are coming into this, as you would expect, as we are transitioning from being a very singularly product focused company to a broader portfolio products. We are seeing stronger growth, and in our products, obviously expect the dollar value of those to have an effect. The EA renewal cycle as we approach the second half also is expected to have something of an impact.

And as a reminder, currency is expected to have a bigger impact in first -- sorry -- but over the course of the year as well. So that acceleration, those three or four factors haven't really changed, consistent with what we have been saying, and frankly consistent with what we were saying over the last couple of years and what we have seen, frankly. Do you want to add to that, Carl?

Yes, so let me give a little color around our newer products, or what we call our growth or our emerging products.

When we look at in aggregate, our newer products, and we are very pleased with the growth rates we are seeing on year-over-year basis. And as you could expect, some of them are actually growing faster than others. But as whole, we are very pleased with the growth rate.

If I were to just double click on that slightly further, in Q2 we were very pleased with our AirWatch business. It continues to grow rapidly for us. And we also saw good growth in vCloud Air, our hybrid cloud solution, and solid growth around NSX which now has more than 700 customers, and vSAN which has more than 2,000 customers.

So in aggregate, we are very pleased. Again, some are growing faster than others. But we think we are going to see the impact of these in the second half and beyond.

Thank you, Phil. Next question, please.

We will take the next question from Kash Rangan from Merrill Lynch.

Hi, thank you, guys. I know sometime back, you talked about a target for ELA as a percentage of bookings. Can you just give us an update? I think sometime back you said 60%, 70% or so.

And also, what are your goals for non-vSphere billings or bookings as a percentage of total billings in the next few years? Thank you.

Kash, this is Jonathan and Carl and Pat, obviously weigh in as you see fit.

But I think what we have shared in the past, is we wouldn't be surprised if we saw ELAs as a percentage of revenue, percentage of bookings at -- excuse me, getting as high as 50%. That is as far as I think we said we would see. Again, I think there is a lot of space between 39% and 50%. But, again, the way we are seeing customers continue to engage deeply with us would suggest that is certainly a possibility.

And then I think I shared as recently as -- I think, Paul, it was last analyst day, we were talking about the potential for the mix, and our goal coming from non vSphere products and a license billing perspective getting north of 80%. I mean, frankly our goal ultimately is to get completely away from selling what we call naked vSphere. That will show up as that number approaches 80% and goes frankly even beyond that. There is no reason why theoretically, that shouldn't be ultimately 100%.

Thank you, Kash. Next question, please.

We'll take our next question from Walter Pritchard with Citi.

Hi, thanks. For Jonathan, it feels like in your forecast, I mean, you had very strong large deal activity. I think you mentioned seven deals greater than $10 million, and you were slightly ahead of your license guidance.

I just want to get a sense as to how you are forecasting large deals as we go into the second half? Are you sort of forecasting this level of elevated large deals to be able to hit the guide, or do you have more of a margin for error as you built the forecast for Q3 and Q4?

Well, it's a great question. Again, the way the process works is, we will take the overall forecast we get from the field. Carl and I look at that overall. We're looking at that pipeline, we're looking at conversion ratios, we're looking at large deals specifically.

And as we've talked about in the context often, over the last few months associated with the federal deal, no one particular deal is something that's predicating or driving our guidance overall. We are looking at all of that as we've looked at our mix overall.

As is typical, we are expecting a strong ELA cycle in the Q4 time frame. Q3, we're expecting as Carl has just talked about a stronger federal cycle. We take all of that into account, as we lay out our flows over the course of each and every quarter that we are facing.

So I wouldn't say that we are tied to any one particular deal cycle or any one particular deal. We are certainly expecting a strong ELA cycle as we approach our fiscal fourth quarter, but nothing particularly abnormal in that regard I wouldn't say.

Great. Thank you, Walter. Next question, please.

We will take our next question from John DiFucci with Jefferies.

Thank you. I am going to skip the ELAs for a second. But I would like to talk a little bit about the integrated OpenStack.

You guys have been talking about that, and we are hearing a lot about OpenStack in the field. If it works, it makes a ton of sense.

But when you work with OpenStack, because there are others that just talk about the pure open source, OpenStack, which is a really tough problem to solve. When you work with OpenStack, how much of the solution is the VMware and other proprietary software relative to -- versus open source technology? I know I am not looking for an exact number, but it just seems like a difficult problem to solve with pure open source technology, and I'm just curious as to how much you have to contribute to make it work?

Yes, it's a great question, and thanks, John. This it is Pat, and I'll take that one.

In general, what customers have found is taking all of the pure open source technologies, implementing OpenStack with that. They found it's just immature and very difficult to stand up, and particularly quite labor intensive for them, requiring fairly large numbers of high quality engineering folks. So it's just a hard thing to go build a parallel silo.

Our strategy has been, add the OpenStack components on top of the VMware ingredients. So taking all of those pieces that are part of it, like Newtron, adding the Nova management layer, adding the storage components, adding those APIs. But building it on the world-class NSX vSphere technologies, et cetera.

And that combination allows them to fully leverage everything that they are doing in that environment, and not stand up a parallel environment. And the result is they get rock hard, and they get all of these new APIs on top of it. So it enables CIOs to say yes to their developer communities very easily.

And this quarter, we saw a good momentum. We had one of the world's largest sportswear retailers stand up very effectively their OpenStack environment. Amadeus in Europe stood up their OpenStack environment. Sunguard AS stood up their OpenStack environment, all of those building on top of their VMware installed base, and having very rapid ability to get that operational in their environment.

And that has just stood very starkly. This happens in days. That has taken, in some cases years for people to stand up the alternative. This is really enabling the ITs with a powerful new set of capabilities, and we are quite pleased with that momentum, and a good pipeline of activities for the second half of the year.

So Pat, how much --?

One thing I would add, Pat covered most everything, but John the one thing I would add, is we see a lot of customers who go out, and attempt to stand up an OpenStack cloud themselves. And it's quite often, if not very often they come back and ask for our help, either to build out an entire VMware stack, or build out an entire VMware stack with our WMware Integrated OpenStack solution, because they underestimated the complexity of building it themselves. So it oftentimes, boomerangs back to us and we have those conversations quite frequently.

And maybe, John, I think you are trying to probe just how much of code and those pieces. Off the top of my head, I don't have a good answer to that. But maybe we will follow-up with you and give you a more precise understanding of that.

But these are substantial pieces from OpenStack, combined with the very substantial pieces that are in place with the VMware stack today. And we will give you more clarity on that, as a follow-up.

Great. Thank you.

Thank you, John. Next question, please.

We will take the next question from Raimo Lenschow with Barclays.

Hey, thanks for taking my question. The first one is, if you look at the pipeline, growing on the ELA side, and if I look at where this strong performance was this quarter, can you talk a little bit about what you see in customer conversations, in terms of cycle? Do people feel better, and hence, spending looks a little bit better? That's the feeling I got from you guys, from SAP early on this morning.

And then maybe, a quick one for Jonathan. If I look at cash, cash flow this year, there is a lot of factors that will impact you negatively. How do I think about it in 2016? Is that all going to be a tailwind, or maybe just quickly walk us through, to make sure that we model this correctly? Thank you.

That is two questions, Raimo. Can you pick one? I hate to be the bad guy here.

Sorry, take the second one maybe, I'll follow up.

Thank you.

Okay. Cash flow, is that right?

Yes.

All right. So we obviously identified another item this year, the GSA item, the settlement, which as you obviously picked up, went out as a payment this quarter -- $76 million roughly being paid out. Raimo, I don't want to comment extensively regarding 2016 at this point, when we are only halfway through 2015. But in the context of 2015, remember there is three or four things now that drove our cash flow growth rate down in 2015, and I will just recap those.

The AirWatch founder payments, the GSA item we just talked about, tax and foreign exchange all became headwinds to growth. As I break that down, as I think about what is recurring and what is the new level we are at, the AirWatch founder payments and GSA both become tailwinds, as they largely go away. We will have a small $25 million to $27 million payment in Q1 of 2016 for AirWatch. I hope we don't have another GSA settlement, so at that point, both of those items, largely speaking should not re-occur in 2016.

When I think about tax and foreign exchange headwinds, those really reflect the new normal. They were headwinds to growth as they increased substantially. They will continue. We obviously continue to pay tax at these new levels, but we don't expect them to increase at the same rate. But they won't reverse completely, as some are currently modeling, so I'd just encourage you to think and model accordingly.

And finally, as I think about cash flow growth overall, cash flow growth roughly at the same level of operating income growth, when we're in a normalized environment is how I would think about it. And just to clarify my humor, I was trying to inject a little bit of humor. Pat was giving me a look when I talked about the GSA settlement. That was obviously a one-off item, and we don't see any further recurrence of that at this point.

(multiple speakers) Sometimes I have to translate for the Americans.

Thank you for understanding on the one question, the next question, please.

We will take the next question from Matt Hedberg with RBC Capital Markets.

Thanks for taking my question. Your hybrid cloud service seems to be doing really well, yet you are taking your CapEx expectations down by $50 million. I'm wondering what is driving that, and how should we think about your CapEx build as your infrastructure continues to expand with some of these additional services?

Yes, Matt, I will take that, and Pat, maybe if you want to add as well. But we started out the year with a number of capital projects, not just around our hybrid cloud business build out occurring, obviously, as I think you probably have seen or are aware, we had a large campus build out over the last few years.

We also were building out a number of other office locations, including our Bangalore facilities. As we have managed our budgets over the course of the year, and as we have managed the flow, those have enabled us to tighten our CapEx outlook for the year.

We have invested heavily in the first half, with respect to the hybrid cloud build out, so I wouldn't read anything into it in terms of a slow down. Again, our model is one of taking pods, getting those deployed in a fairly deterministic manner, as we are deploying just ahead of demand and that model, I think, is moving ahead quite well.

We invested heavily in the first half as we were expanding geographically around the world, in places like Australia and Japan, in particular. We are largely embedded in those territories right now, and now we're on to the expansion as we think about matching the growth rate of the business overall. So I feel very comfortable with that $350 million CapEx forecast, as opposed to the $400 million we talked about just a quarter ago.

Maybe, just to add a little bit, as Jonathan said, we have planted flags geographically. Now we are growing the capabilities in those geographies, and filling those infrastructure, and now they become more run rate build outs. The service itself is growing very nicely.

Key things this quarter, and things like launching DR version 2, database as a service, the integration of NSX for hybrid and networking capabilities, is a huge differentiator. And now, some of our largest customers in the cloud area are uniquely taking advantage of that.

And as we mentioned on the overall financials, the hybrid cloud and SaaS 6% of total revenue, and growing at over 80% per year. So, these are really starting to become capabilities that the market, our customers and will start incrementally influencing our financials.

Great, thank you, Matt. Next question, please.

We'll take our next question from Keith Weiss with Morgan Stanley.

This is Stan Zlotsky in for Keith Weiss.

Jonathan, I wanted to take a step back and get your take on the levels of investment that will be needed, call it, over the medium term. You talked a couple quarters ago about trying to figure out the right level of investment as you ramp up your hybrid cloud and SaaS offerings from a professional services standpoint, as well as from a CapEx standpoint. Given that we are a couple of quarters in to your build outs, do you have a view of what professional services look like? I'm really getting to, what we should think about in terms of longer term operating margins.

Yes Stan, thanks for the question. We have over the last two years or so, and Carl can comment as well on this, in even more detail, but we have invested heavily in PSO. We have over 1,700 people now, professionals in our global PSO organization.

As you will appreciate, PSO in general, compared to a software margin business, is a lower margin. All of that is encompassed in our gross and operating margin results, and the operating margin outlook we shared. I do see the opportunity for operating margin expansion as we get into 2016, but we are balancing -- we are balancing all the investments as we think about the newer growth areas, newer product areas that we are investing in.

I think we will continue to manage that. Some of the other areas of investment that you have seen, AirWatch, one of the biggest areas of investment we've had over the course of the last two years, obviously dampened operating margin performance. But really doing a nice job, as we are tracking right to strategy. In fact, as you heard on the call, slightly above in Q2.

We're still on track for EPS neutrality in Q4 2015 with the view of bringing AirWatch to being profit generating as we get into 2016. It will still be below our corporate average in terms of overall operating margin.

When I look at all those things, PSO, AirWatch, the other emerging businesses, the balance we are striking here, and I think we're doing a pretty good job of it, is operating margin return to the bottom line, with the need to investment in growth businesses that are going to be around for many, many years.

Specific to the PSO, as Jonathan said the last couple of years, we have invested heavily in our PSO go-to-market strategy, and brought a lot of consultants and solution architects on board. One of the reasons for that, as you all know, we brought a number of new technologies to market, and when you introduce a new technology, there are times when you need to make sure that you are investing ahead of the curve to have the service capabilities to implement them for the customers.

As time goes on, though, we expect to leverage all the IP that we have built around our professional services engagement, and leverage it by giving it to our channel and our partners. As we do that, and they become more skilled to implement our newer solutions, in return, we should get better operating margin lift as a Company, as we outsource a lot of that service delivery to our partner community.

Thank you. Next question, please.

We will take the next question from Michael Turits with Raymond James.

Fantastic to see not only the quarter but the reiteration for the full year. The billings growth is still lagging the revenue growth, and I understand there are tough comps, but is there any impact at all from duration, on ELAs and ELA renewals? Are they perhaps shortening and is that affecting billings or duration okay and it's just the tough comps?

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

When we look at the duration of both our ELAs as well as our maintenance and our renewals of our support and subscription business, we have seen no material change whatsoever here in Q2, it's been very consistent to what we've seen over the last many quarters. We are very pleased with how customers continue to renew agreements with us, both on the maintenance side as well as enterprise agreements. And there has been really no change at all in our durations of the contracts with our customers.

On the billings, side you probably saw long-term deferred revenue grow at a slightly slower pace than overall deferred. And when we have unpacked that number inside the overall deferred revenue, you do see an element of PSO in there, as well. Even though we have been investing in this particular quarter, which you saw a slightly lower attach rate of long-term PSO, deferred revenue to ELA. That was basically the driver there, Michael.

Thank you, Michael. Next question, please.

We will take our next question from Abhey Lamba with Mizuho Securities.

Carl and Pat, of all the connect merging initiatives that you have in place currently, we look NSX, and V Cloud Air, which ones do you expect to be more impactful to your revenues and bookings in the next 12 months to 18 months? And how does that change if we think the next three to five years? It would be helpful if you can stack rank them in terms of their ability to move the needle for you. Thanks.

I will give you the CFO's view, then I'll ask the CEO to comment as well, more strategically. We are not going to stack rank them. I get this question periodically, as well, and as I know you appreciate, these are earlier stage and therefore subject to significant variability as we think about what can actually occur.

What we are really excited about, if I picked the top three right now, I would say VCA, as you've seen, is trying to really fire nicely. NSX continues to show very solid growth. We saw over 700 customers now cumulatively, and AirWatch, our mobility solutions, really just had a phenomenal quarter.

As we track into 2016, I think all three of those, I would expect to be significant growth drivers as we go forward. But I don't want to take that away from the rest of our product portfolios as well, but those three jump to the top of the mind.

Nothing would be surprising. These are early market products. The longer they have been in the market, the more we've matured the selling motion, and started to build customer base, they're getting bigger respectively.

AirWatch already had a reasonable run rate when we acquired it, and we've seen phenomenal success at accelerating that. Jonathan commented on NSX and on V Cloud Air. VSAN is clearly trailing NSX, but it's just a year less mature in the marketplace.

And I would also add to that list the success in management and the management product line is the most mature of those, has become a very standard element of our product offering through VSAN, V Cloud Suite, stand alone management sales. We have continued, and again, we were recognized by IDC this last quarter as number one in cloud management, with a substantial market sale lead over number two and three. So, of them, clearly management is the largest and most mature, but as we have discussed, the others are starting to contribute, and we expect that to continue to enhance the overall financial picture in 2016 and beyond.

Thank you, Abhey. Next question, please.

We will take our next question from Gregg Moskowitz with Cowen.

Your US reported revenues were dragged down, obviously, by the GSA settlement. Excluding that, you grew your US revenues by 20% year-over-year, and that's even with federal not having a great quarter and Brazil being weak. This question is probably for Carl, but just wondering can you elaborate on what drove most of the strength in US enterprise this quarter? Thanks.

To your point, we were very pleased with our results in Americas. We had a solid performance in our enterprise segment which is our largest accounts, which is where, as you can imagine, a lot of the enterprise agreements come from. We did a very good job of renewing enterprise agreements in the quarter that came up for renewal. As well as continued to drive our newer products into that, if you will, bigger segment of customers.

At the same time, when we went down market, if I look at the Americas business, if I look at our mid-market or our commercial business as we like to call here it internally, Gregg, we saw very good growth in that business,. And I would say the other area of success, is we saw good growth specifically in the vertical of financial services. So, when I look at the Americas, another solid performance, highlighted and driven by our enterprise agreements across the board, and a particularly good quarter in financial services for us out of the Americas.

Don't forget, Gregg, obviously the impact of foreign exchange is going to show up most in the international segment. So to the extent of things are coming from Europe in particular, you've got a significant dandruff, as all the impact is going to be in that category.

That's a good point.

Thank you, Gregg. Thank you. Next question, please.

We will take the next question from Nehal Chokshi with Maxim Group.

Thank you. On the infrastructure automation opportunity landscape, can you help size up the competitive landscape that you are seeing, especially in the context of why you think VMware will win, given Microsoft has the Azure asset, complete software stacks of leverage and new taxes recently showing up, albeit still almost nominal. But seems to have hyper conversion infrastructure opportunity that does truly converge all three layers together. I know you do have the ego realm, but just talk about where VMware's competitive position stands with respect to these major competitors, and why you will win?

Maybe a couple of aspects, and Carl, maybe you can answer this.

From a cloud management perspective, obviously, as I have already noted, IDC sees us as number one, so we have a high market share. We also have very strong growth rates, as measured by IDC. Their estimate was a 36% year-on-year growth rate. High market share, high growth rate.

What we find is that, given the vSphere installed base and the presence that we have in enterprise customers, our ability to sell them, or upsell, or add to and manage the environments that they already have with us in that environment is a very natural selling motion, and a very natural value proposition for our customers, as we are progressing.

Furthermore, we have committed ourselves to a heterogeneous management strategy which allows us to be managing in multi-cloud environments, both on and off premise, including AWS and Microsoft du jour. We manage those environments, and given the strong initial installed base we have, that has been warmly received by our customers as well, as they are buying into that management stack. Simply put, the presence that we have, the installed base, leveraging that into this new area of management is a very natural for our customers and for our sellers.

Furthermore, the leadership position that we have is building on itself as more and more of the ecosystem is now partnering with us to support that management offering, building on it, build SI momentum, solutions on top of that, VCE Vblocks building on top of that. Plug-ins for VSAN, all of those are reinforcing that momentum that we are seeing in the marketplace in a very positive way.

The only thing I would add, Pat as it relates to competition. The competition for our infrastructure automation and orchestration tools is really against the traditional enterprise systems management platforms out there. And those platforms are big homogeneous infrastructure software packages, not built for the Cloud Air. I think we are effectively competing, Pat, and that's why we are the number one player in cloud management.

The key thing, I think, Pat, that you said, which just underscores why our customers are adopting this platform so aggressively is the fact that we do support and manage heterogeneous cloud environments. So I think you covered it really well, Pat.

Thank you, Nehal. Time for one last question. So, the last question, please.

We will take our next question from Rajesh Ghai with Macquarie Capital.

Thanks. A number of Tier 1 telcos around the world have announced plans to replace a lot of their legacy carrier infrastructure with virtualized x86 based infrastructure running virtual network functions. I'm curious what sort of traction you are seeing from this, and what sort of pipeline you have at this point in time, from what I believe could be some very significant spend?

We are quite excited. Generally this category is called NFV, is how the industry is referring to it, network functions virtualization.

For us, it's just a perfect match, because all of the technologies that we have built for the software defined data center now are leverageable into this large market, the telco service provider infrastructure, that we have never participated in before. We laid out our strategy for this at Mobile World Congress earlier this year, announced new products like OpenStack with VIO for the NFV marketplace.

In Q1, we announced Vodafone as the first production deployment of NFV based on VMware. As I commented earlier, Ooredoo and IIJ in Japan announced deployments with us in Q2, and the pipeline for the rest of the year is really building nicely.

If you think at the highest level, they want to virtualize their infrastructure and get rid of the silos of gear, just like the data center has done over the last decade, so it's very analogous. This is a large potential.

But I would also temper your expectations for how fast this delivers. Telco infrastructure moves slowly, and design wins will be slow and long, and the deployment cycles will be long. But when you get in that market, also, the continuing ability to service and deliver it is also long, as well. So, we are quite excited about it.

We built the specific business unit. One of our senior leaders is driving that, and we are quite excited about this long-term potential.

Thank you, Rajesh. I think before we conclude, Pat was going to make a final statement.

Thank you very much, Paul, and for all the good questions in the conversation today. In closing, our Q2 performance was a solid follow-on to a solid Q1. We look forward to seeing you at VMworld and at the financial analyst meeting that we'll conducting at VMworld on August 31. Thank you very much.

That does conclude today's conference. We thank you for your participation.