VMware Inc (VMW) 2018 Q3 法說會逐字稿

Good day, and welcome to the VMware Third Quarter Fiscal Year 2018 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 Third Quarter Fiscal 2018 Earnings Conference Call. On the call, we have Pat Gelsinger, Chief Executive Officer; and Zane Rowe, Executive Vice President and Chief Financial 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.

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 that VMware files with the SEC. We assume no obligation to and do not currently intend to update any such forward-looking statements.

In addition, during today's call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware's performance, should be considered in addition to, not as a substitute for or in isolation from GAAP measures. Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation; amortization of acquired intangible assets; employer payroll tax on employee stock transactions; acquisition, divestitures and other related items; and can include non-GAAP tax rate adjustments. 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.

Webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link. Our fourth quarter fiscal 2018 quiet period begins at the close of business, Thursday, January 18, 2018. Year-over-year comparisons of quarterly financial results included on this call compare results for VMware's fiscal 2018 third quarter, August 5 through November 3, 2017, to VMware's fiscal 2016 third quarter, July 1 through September 30, 2016.

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

We are very pleased with our Q3 results, which continue to be driven by broad-based strength across the product portfolio and in all 3 geographies. Revenue grew 11% with a non-GAAP earnings growth of 17% year-over-year to $1.34 per share.

Our strategy to transition from a compute virtualization company to providing a broad portfolio of products and services across cloud, mobile, networking and security is proving successful as we continue to drive forward with our plan. Factors contributing to our strong Q2 results include a cloud strategy that continues to resonate with customers, excellent go-to-market execution across all geos, and a favorable market environment for enterprise software both on-premises and hybrid cloud.

Given our annual industry conference, VMworld [Lands] in Q3 annually, our volume of news is always higher this quarter. This year proved to be one of our finest VMworld seasons ever. I am particularly excited about the new products and services we have introduced this past quarter, demonstrating our commitment to innovation and solving complex customer problem. We welcomed over 77,000 customers, partners and influencers to VMworld U.S. 2017 and VMworld 2017 Europe as well as our successful vForum series across Asia-Pacific over the last few months. During the course of these events, we announced technology advancements across our entire portfolio.

We were particularly pleased to announce in partnership with Amazon Web Services initial availability of VMware Cloud on AWS in the AWS U.S. West region. VMware Cloud on AWS brings VMware software-defined data center to the AWS cloud, allowing customers to run applications across operationally consistent VMware vSphere-based private, public and hybrid cloud environments and optimize access to AWS services.

And just this week at AWS re:Invent, we announced another milestone service, featuring expansion to the AWS U.S. East North Virginia region and a rich set of capabilities and add-on services that will enable customers to migrate, run and protect production workloads at scale. In addition, we unveiled the VMware Hybrid Cloud Extension service designed to accelerate the movement of workloads, enabling migration and dynamic hybrid workload balancing. It also provides seamless interoperability across VMware environments. Hybrid Cloud Extension service is initially available from IBM, a key design partner, and OVH. Earlier this week, we announced availability with VMware Cloud on AWS. The service will accelerate onboarding of workloads to VMware Cloud on AWS and VMware Cloud provider platform partner clouds.

At VMworld, we also introduced new VMware Cloud services that enable end-to-end visibility into cloud usage, cost and networks with consistent networking and security across public clouds and on-premises environments. For example, we unveiled VMware Discovery, which allows the organization of cloud resources in ways that mirror business needs; VMware NSX cloud, a service that provides consistent networking and security for applications running in multiple private and public clouds via a single management console and common API; and Wavefront by VMware, a metrics monitoring and analytics platform that handles the high-scale requirements of modern cloud native applications.

Building on the core VMware vSphere franchise, we unveiled 2 new offerings: VMware AppDefense and Pivotal Container Service. VMware AppDefense is a breakthrough solution for securing applications running on virtualized or cloud environments. VMware is committed to flipping the conventional approach to security from what we call chasing bad to instead making security intrinsic in the IT environment and, therefore, ensuring good. AppDefense helps to deliver on this commitment with an intent-based security model that focuses on what the application should do. We believe it will do for compute what VMware NSX and micro-segmentation has done for the network, enabling lease privilege environments for critical applications.

Secondly, we joined forces with Pivotal Software, another member of the Dell Technologies family, in collaboration with Google to unveil Pivotal Container Service, or PKS, an innovative VMware offering jointly designed to deliver an enterprise-ready Kubernetes solution integrated with VMware software-defined data center infrastructure. Pivotal Container Service is purpose-built to deliver Kubernetes that is easy to deploy and operate, developer-ready, all while addressing the operational needs of IT. Additionally, according to IDC's second quarter 2017 Worldwide Quarterly Converged Systems Tracker, VMware, based on sales of hyper-converged solutions running VMware VSAN, was the largest hyper-converged infrastructure software vendor during the first half of calendar year 2017.

We were excited to announce the intent to acquire VeloCloud Networks, a provider of industry-leading, cloud-delivered, software-defined wide-area network technology, or SD-WAN for short, for enterprises and service providers. Once the acquisition closes, VeloCloud will enable VMware to build on the success of its industry-leading network virtualization platform, VMware NSX, and expanded networking portfolio to address end-to-end automation, application continuity, branch transformation and security from data center to cloud to Edge. This acquisition will also further enable VMware to lead the industry transition to a software-defined future and help customers bring their businesses into the digital era. The acquisition is expected to close in Q4 of fiscal year '18.

In closing, customers are increasingly turning to VMware to help them run, manage, secure and connect their applications across all clouds and all devices. We also continue to see strong, broad-based growth across our portfolio, and we continue to innovate, bringing new products and services to market. We are confident in our strategy and optimistic about the momentum across our growth businesses.

I'll now turn it over to Zane to talk more about our business performance in Q3. Zane?

Thank you, Pat, and thanks to all of you for joining us today.

We had a solid third quarter, which reflected continued strength across the portfolio and customers' commitment to VMware as a strategic partner for both on-premises and hybrid cloud software solutions. Total revenue for Q3 grew 11%, and license revenue increased 14% year-over-year. Hybrid cloud and SaaS represented over 8% of total Q3 revenue, with our VMware Cloud Provider Program, which was formerly known as vCloud Air Network, once again growing 30% year-over-year.

Non-GAAP operating margin for the quarter was 34.8%, and non-GAAP EPS was $1.34 per share, up 17% year-over-year on a share count of 413 million diluted shares.

Cash and short-term investments totaled $11.6 billion, with approximately $3.4 billion in domestic cash.

Unearned revenue at quarter end was $5.6 billion. $2.1 billion of this amount was long term. Our strong Q3, which included the DXC enterprise agreement mentioned on the last call, had a growth rate for total revenue plus the sequential change in total unearned revenue of 21%; and a growth rate for license revenue plus the sequential change in unearned license revenue of 16% year-over-year. As you may recall, the DXC enterprise agreement, which we booked at the beginning of Q3, will contribute over $100 million in revenue over the next several years, beginning in Q4.

SMS bookings growth was also strong in Q3 as this recurring business benefited from continued high renewal rates as well as the support services attached to new license bookings. NSX license bookings grew over 100% year-over-year in Q3. The DXC enterprise agreement included a large commitment to NSX, underscoring the strategic importance of NSX to our customers.

We also announced the VeloCloud acquisition this quarter, which further enhances our network strategy by extending our network capabilities from the data center to branch and end point implementations. VSAN license bookings once again grew over 150% year-over-year, driven by strong performance for both VSAN and hyper-converged storage software offerings, including VxRail. EUC license bookings for the quarter were up over 40% year-over-year, driven by growth in the mobile businesses, including Workspace ONE, which securely delivers and manages any application on any device.

Total compute bookings were up 11%, with compute license bookings up in the mid-single digits year-over-year. Total cloud management bookings were flat, with cloud management license bookings down in the low single digits year-over-year, a result of less management software tied to specific large deals in this quarter versus a strong Q3 last year.

Customer enthusiasm for our new VMware Cloud on AWS hybrid cloud service continues following the initial launch at VMworld and announcement of new service capabilities at the AWS re:Invent conference earlier this week. The hybrid capability this service brings to our customers is currently having a positive impact on their purchase decisions for our hybrid cloud and on-premises software. We'll add additional geographies and service capabilities over the upcoming year. And while we expect strong customer adoption, we don't expect a material impact on either fiscal '18 or '19 revenue while the service ramps. Revenue for VMware Cloud on AWS will be recognized on a net basis upon adoption of the new accounting standard, ASC 606 in Q1 2019, meaning we will recognize software revenue net of the underlying AWS infrastructure cost.

In Q3, we completed a $300 million repurchase of Class A common stock from Dell Technologies, which was announced on last quarter's call. In addition, we completed $555 million of stock repurchases in the open market during Q3. At the end of the quarter, we had just over $1 billion remaining on our stock repurchase authorizations.

Turning to guidance for fiscal 2018 and our initial thoughts on fiscal 2019. We have been pleased with our growth trajectory this year. Taking into account stronger-than-expected Q3 results as well as continued momentum in our outlook for Q4, we expect total revenue for fiscal 2018 to be $7,875,000,000. This reflects a growth rate of approximately 11% year-over-year. We expect license revenue for fiscal '18 to be $3,155,000,000, up approximately 13% year-over-year. Taking into account our stronger-than-expected Q3 operating profit, we now expect non-GAAP operating margin for fiscal '18 to be 33%. Non-GAAP earnings per share for fiscal '18 is expected to be approximately $5.13, with a diluted share count of 412 million shares. With the strong bookings performance for fiscal '18, we're also raising guidance with cash flow from operations for fiscal '18 to $3.1 billion.

For Q4, we expect total revenue to be $2,263,000,000 and expect license revenue to be $1,028,000,000. Q4 revenue guidance takes into account our license backlog at the end of the third quarter. License backlog is the license portion of any unfulfilled orders at quarter end. We exited Q3 with approximately $90 million of license backlog, comparable with the Q2 ending level. For Q4, we expect non-GAAP operating margin to be 36.9% and expect non-GAAP earnings per share to be $1.62 on a diluted share count of 409 million shares.

For fiscal 2019, we expect the continuation of the strength we've seen this year and are planning on total revenue growth of approximately 10% year-over-year. We expect non-GAAP operating margin to be approximately 32.5%. Consistent with our philosophy of balancing growth with investments, we will further invest in R&D and go-to-market functions for growth areas, such as NSX, our plans for SD-WAN with VeloCloud, VSAN as well as VMware Cloud on AWS and other cloud services.

All guidance for fiscal '18 as well as our initial thoughts for fiscal '19 are based on the current ASC 605 accounting standard. As we've mentioned previously, we will adopt ASC 606 accounting standards using the full retrospective method beginning in Q1 fiscal 2019. While we continue to evaluate the impacts of adopting ASC 606, we expect the deferral of license revenue in connection with the sales of on-premises licenses to decline. Therefore, the license revenue and license bookings will have a tighter correlation for our on-premises software sales. As a result, we expect our deferred license revenue to decline upon adoption of ASC 606. Also, commission expenses under the new accounting standards will be recognized over a longer period of time. Currently, a substantial amount of our commission expense is recognized at the time of sale. For our fourth quarter call, we will provide Q1 and FY '19 full year guidance as well as relevant historical compares under ASC 606.

In summary, we delivered another strong quarter thanks to our loyal customers and partners and their commitment to our platform as well as strong execution by the VMware team. We continue to innovate and invest in our product and service portfolios in order to help our customers leverage the capabilities of hybrid cloud and to generate growth and value for our shareholders.

With that, I'll turn it back to Paul.

Thanks, Zane. (Operator Instructions) Operator, let's get started.

(Operator Instructions) We will take our first question from Kash Rangan with Bank of America.

Congratulations, nice to see double-digit growth rate here. Curious how we should think about the VMware business model. It doesn't have to be next year or a year after, but as you look at software companies and the industry have generally moved towards more subscription, I know VMware is more infrastructure and have your own limitations there. But as you embark upon this partnership with AWS, how does the future business model of VMware look? And I've got to believe that as customers embark on building out the data centers, if they start to see AWS as the national extension of that footprint that there's a national force that makes your business -- new business going forward also become more subscription-like. As you look 3 or 4 years out, what does your business model look like in terms of the recurring nature of your revenue and your ability to sustain this kind of growth rate? That's it for me, the only question, Paul.

Kash, thank you for the question. Happy holidays to you and everybody else in the call as well. I think that was actually about 6 questions compressed into 1, but we'll try to frame a good way to think about it. Clearly, as an infrastructure for software company, we, like everyone else in the industry, are increasingly seeing the as-a-service portion of our business. And we saw good growth in that area of our business again this quarter. Clearly, we see these new areas, these new products, some of those like NSX, VSAN having strong on-premise components, but increasingly even in the case like NSX cloud, a cloud component to that as well. So clearly, we see the as-a-service piece of the business accelerating. We also commented as well that the VMC, the VMware Cloud on AWS, while we don't expect that to be a material this year or next year, we see there's a high-growth potential. That, combined with our VMware Cloud services that we announced as well and the increasing shift of, like, our VMware Cloud partner program as well as our end-user computing business products increasingly as SaaS components as well, all of those will be favoring that side of the business. But as a software company, we're going to continue to focus on the software and the net billing aspects of that for VMC continue to focus on a high-margin software growth rate. And as we said, we do expect that we can provide leverage in the business over time even though, as you've heard on the call today, we have great investment opportunities that we're going to focus on and continue to drive that growth rate over a sustained period. Zane, other thoughts?

Sure, Pat. Kash, I would just add that obviously, with our initial view on FY '19, at 10%, as Pat mentioned, that doesn't include a lot of the additional investments that we're making in the SaaS area. So we're excited -- while it's not material for next year, we're excited about the growth rate beyond that for the business.

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

In terms of the billings growth that you guys put up this quarter, 20%-plus billings (inaudible) 21%. We haven't seen that from you guys for a while. Part of it comes from a buildup of long-term deferreds. Was that all on the DXC contract? Or are you guys getting further penetration more broadly with enterprise license agreements that are building up that long-term deferred?

Sure, I'll start. The DXC agreement definitely had an impact. I'd say that was several points of the growth you see. It was actually fairly broad-based across a number of products and categories. So we're very excited about the strategic benefit we get from DXC. But then even more broadly, you see our EAs at 42% this quarter, which are -- represent a nice increase on a year-over-year basis.

And overall, I'll just add that we're just seeing strength in the business as customers are making bigger, long-term commitments. All of the renewal aspects were great this quarter, the EA numbers, big, strategic commitments. The breadth of EAs representing essentially all of the strategic products and the new growth areas as well was well represented in those large EAs, as we reported here. So clearly, the DXC deal, right, was the biggest deal ever and that contributed in a unique way. But every metric, even if we factor that out, continue to perform very well this quarter.

We will take our next question from Karl Keirstead with Deutsche Bank.

This is for Zane. Zane, I noticed you didn't give operating cash flow guide for fiscal '19, but is there any way you could give us any kind of a range or modeling advice if you'd like? And I guess, the spirit of the question is at least through the first 9 months of fiscal '18, your operating cash flow growth has been extraordinary, plus 23%, and that equates to 42% operating cash flow margins. I don't think anybody is modeling that for fiscal '19, but maybe you could just help us understand what factors might have driven that great performance this year that might be nonrecurring so we don't get ahead of our skis in modeling fiscal '19.

Sure, Karl. Yes, it's a great question. And as you point out, while we're not offering operating cash flow guidance for next year, we think that this year, albeit at a higher growth rate, was indicative of what we call sort of a normalized year. There are a couple elements of changing the fiscal years that would drive, I think, some benefits. We've also got a little bit of movement on the expense side. But as you think about ongoing cash flow, I would encourage you just to think about sort of bookings in the business. We've obviously had very strong bookings, DXC being one of the highlights of this year. We saw this year as a very strong bookings year, but as we look into next year, we feel confident with the momentum that we've already built through the course of this year and that continuing into next year. So while the revenue guide is at 10%, I would highlight just looking at the business and the growth in the business, we'll obviously give a lot more color on operating cash flow on our next call but I just wanted to give you a sense for where the business is right now.

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

As Keith mentioned, the billings and license billings accelerated second consecutive quarter. It was kind of surprising and impressive at the same time. Guidance was strong; and even with the DXC, even if you, like, back that out, still really good numbers here. So I just want to make sure I understand it, we understand it, as we model your business going forward. Is this really the steady foundation of compute that's now being supplemented in a more significant vein with NSX, VSAN, end-user computing and management tools? Or is it more of a baton passing, where we had thought compute -- or you had thought anyway at one time that compute would start to wane a little bit and these other areas would start to pick up. Is that happening right now? Are we starting to see that and those other barriers are just picking up in a very significant way or more significant way than they had been? Or is it just compute still remain steady in these areas are continue to pick up? You're doing this on big numbers.

Yes. Thank you, John. And we really view it as balanced performance across the portfolio, where compute is foundational but allows us to build and accelerate these new growth areas. And as we indicated, we had very solid performance on compute again this quarter, beating our guide by 1 bp. And the benefit of that is a broad installed base that we get to sell into with VSAN, with NSX, with management. It also (inaudible) a platform that we extend into the cloud with the VMware Cloud on AWS offering. I'd also emphasize this quarter that the key new announcements that we rolled out at VMworld this year, the VMware Pivotal Container Service, further enhances the value of vSphere. The AppDefense adds a security component to vSphere. All of the new offerings specifically toward IoT and NFV also build on vSphere. So we're continuing to enhance the value of the existing franchise even as we extend that to be delivering value in considerable new areas as well. So overall, we view it as balanced performance, foundational and extending into these new areas.

John, I would just add that we're not changing -- albeit the fact that we beat it this quarter, we're not changing our longer-term view on compute, which we offered up last quarter.

We will take our next question from Mark Murphy with JPMorgan.

Pat, I'm wondering if the approach with the 5G or NFV wave of business is feeling any more tangible to you since you're on the heels of this large telecom win that you landed recently. And also, seeing signs of some of the telecom providers starting the early stages of rolling out 5G, I believe, in a few U.S. cities next year, you had previously spoken to that as -- I believe, as a 2019 or 2020 type of crescendo. So I'm just curious if you're any more confident in how that is taking hold.

Thank you, Mark. And maybe a few general comments here. I think the broad time line is approximately what I said before, right, where most people will be doing their overlay deployments, specific services, et cetera. And those are going to happen starting this year, some next year, a bit of acceleration in '19, but the real crescendo occurs with the 5G build-out, which we think is 2020, 2021. And that's going to continue to accelerate as we get to 5G really starting to occur. We're very pleased with the progress that we're making. We now have their, what's called, VNFs, virtual network functions. Think of it as dedicated telco applications. We're now across 50 of those that are validated and available for the VMware platform. We now have over 350 million subscribers that are running some service over a VMware-hosted NFV infrastructure. We launched the next version of our OpenStack platform for NFV architectures. With Dell, we released the Dell EMC NFV-ready bundle for VMware. So all of these are just saying, "Boy, we're making very solid progress." While we don't have new names, like Vodafone, to put on that list, we also had several major wins this quarter as well for new accounts that we're able to add to our list of NFV wins. So overall, we're feeling very good about the momentum. It also reinforces the strategic partnership that we have with service providers, which is really important to us because of things like VeloCloud -- well, maybe half of that business will go through, and with service providers. So building that stronger relationship with them is quite important to many of our areas of our business going forward, and this was a good, solid progress quarter for us in this area. And in Q1 as well, we have the big Mobile World Congress, and that's probably where more of the news will come out of the next phase of this journey.

We will take our next question from Raimo Lenschow.

Just a quick question and no long speech. Can you talk a little bit about the adoption pattern you see from the early customers around VMware on AWS after a ramp-up on new regions. Like how does it work? Is it like test and development? Is it a couple of workloads? What are you seeing from those guys?

Yes. Thank you, Raimo. Overall, the enthusiasm remains very high and as we're converting beta customers into early users on the platform. We announced the GA2, as we call it, the second version of the product at re:Invent this week, right, which opened up the second availability zone, larger clusters, new billing models, vMotion with stretched networking, DR use cases with Site Recovery Manager and A to Z -- AZ to AZ replication, the Hybrid Cloud Extension. All of these, I'll say, just sort of fill out the product now that it really is suitable for enterprise production. So most of what we've seen so far is really tested as POC work, but we're now seeing with the capabilities that we just launched this week that it really is enterprise, production-grade offering. And the enthusiasm that customers have for this ability to have a familiar VMware tool and operational experience seamlessly extended to the cloud, we expect that the production use cases will start to ramp quickly as we go forward.

We will go next to Heather Bellini with Goldman Sachs.

Yes. I had a question, Pat. You, very early on this year, called a much better IT spending environment that obviously proved to be very correct. And you also talked about that hybrid seemed like it was going to be here for longer. And so you were kind of benefiting on both sides, right, the cloud side that you're helping to enable as well as on-premise. And I'm just wondering, as you look forward to next year, kind of what are your conversations with customers telling you about the transition to the cloud? How long it's going to take? And how that might be helping these ELA renewals that seem to be doing so well for you?

Yes. Thank you, Heather. And clearly, the IT spend, as you say, that's materializing. And tech is breaking out of tech, it's been as I've described it. And also, we've been speaking about hybrid for a while. And now the industry, right, is reflecting that hybrid is very real and this idea or replatforming applications is much harder. And it's not a student body, right, to the cloud. We'd also emphasize that some of the new IoT and Edge use cases tend to bring things back on-premise, where now customers sort of say, "Oh, I can't round-trip to the cloud if I need this latency or have that amount of bandwidth as well." So we believe all of these indicate a very robust hybrid environment, where it's going to be a combination of on-premise as well as in the cloud, private and public. And that ability for VMware to sit in the middle of that, we think, is a very positive realization. That's clearly some of the VMware Cloud on AWS. Many of our partners, like IBM and OVH, are clearly now being able to see that in their customer behavior that this hybrid use case is very powerful. And it gives customers just a whole lot more flexibility. It makes their on-premise, private cloud more efficient. It makes their ability to scale into the public cloud seamless without replatforming the applications. They get access to new cloud native services in a holistic way. So their business case improves, their ability to support their customers improve, and they don't have to invest in replatforming applications. It really is a win-win-win for them, and I believe this will be essentially the model of IT for the next decade or 2 if not ad infinitum into the future.

We will go next to Mark Moerdler with Bernstein.

It's actually Tim Thornton on for Mark Moerdler. I had a quick question on VeloCloud. I was wondering, is any expectation included in your guidance? And then could you just dig in a little bit more about how you view that opportunity in conjunction with NSX?

Yes. Let me start and then I'll let Zane comment on the guidance aspect to it. But overall, we're quite excited about VeloCloud because our vision with NSX was that virtualized, software-based networking redefines how networking is done, right, redefined how it's done in the data center, how it's done between data centers, between the data center and the cloud that it delivers new services and security and routing. And all of these things move into the software layer. And we're -- obviously, as the numbers we saw for this quarter, we are making great progress on executing that NSX vision. But what VeloCloud offers is really NSX everywhere. It allows us to stretch it to the branch into the WAN, and this is a powerful additional element of the market. And many customers are looking to, right, transform their branches where they need to securely support applications. They need to redefine what's in the branch. They're looking for more effective means for what are traditionally dedicated or MPLS circuits that they've had in the past. So the value proposition of VeloCloud and the whole SD-WAN category is very exciting. And we've gotten -- VeloCloud, before the acquisition, has had a lot of momentum and excitement from enterprise as well as service provider customers. This is a powerful extension of the NSX vision. And it really, for us, becomes NSX everywhere. And that's the path that we're on, and VeloCloud helps us accomplish that.

Tim, I'll just add that it is included in our guidance. We don't break out VeloCloud, but it is included both whatever incremental revenue we'd expect to get from the acquisition as well as the investment base, obviously not material for FY '19 but we're quite excited about the opportunity beyond that.

We will take our next question from Philip Winslow with Wells Fargo.

This is actually Michael Baresich on for Phil. I just wanted to circle back to the partnership with AWS. It's clearly resonating with customers, but as you said, it's not quite materially contributing to revenue yet. But are you seeing customers who otherwise aren't yet using AWS be more willing to buy on-prem now that they have this easy on-ramp to the cloud even if they're not currently planning on using the hybrid service? And then just as a quick follow-up, you've had some really strong international growth the last couple of quarters. Can you maybe double-click on some of those individual markets?

So on AWS, clearly, AWS is now used by enterprise customers. And it's pretty rare that you won't find an enterprise customer who doesn't have at least some amount of experimentation going on with AWS. So the presence of VMware [on account] is almost 100% and AWS having at least some level of test, experimentation, right. It is very high. And what we're finding is we're able to present this holistic, elegant strategy for a cloud and multi-cloud future. Customers just get more comfortable with their VMware investments. They say, "Oh, I get it. I have greater flexibility to invest on-premise, and you can seamlessly take me to the public cloud. Wow, that's powerful and that builds my strategic confidence in my on-premise investments that I'm making in VMware." And obviously, we built credit mechanisms and other things like that, that we have that they can also benefit from that financially as well as technically and strategically as they go to the cloud. And we also expect that some of the early use cases that we're seeing with our VMware Cloud customers, whether it's cloud migrations, data center expansion, flexible on-demand capacity. It might be geo capacity expansion, where -- boy, I don't want to build or have -- continue to operate in a certain geography. Some of it's just early POC test and dev as they're kicking the tires. We also see those early use cases essentially across every vertical, right, media, entertainment, professional service providers, state, local governments, pharmaceuticals, industries, universities, et cetera. So it's really broad-based in that sense as well. So basically, everywhere there's a VMware customer, they're interested in exploring what this might look like.

Michael, I'll just add before Paul cuts you off. We saw a strong balanced growth across all 3 of the geos. In particular, EMEA had a standout quarter. So congrats to the EMEA team. We also saw growth in 9 of our top 10 countries. So overall, well-balanced and strong growth around the globe.

Thank you, Michael. And before we move on, I think we want to also give a shout-out to Phil Winslow, who I just learned shortly before our call, he and his wife -- or his wife gave birth to a healthy, new baby, amazing. So congratulations, Phil.

We will go next to Brad Reback with Stifel.

Zane, if we think about the margin contraction year-over-year on the '19 guide, how much of that is specifically tied to VeloCloud? And how much of it's just reinvestment into the broader business?

Brad, yes, sure. I'll tell you there's no change in our management philosophy as we think about balancing revenue growth with an operating margin growth. And as you saw this year, in fact, we outperformed our original guide. And the guide for FY '19 is actually at a higher level than our original guide for this year. VeloCloud is not a significant part of that at all. It's the investments we're making and the number of the growth businesses that we've highlighted and seen great success in. It's also a number of the investments we've made in a number of our cloud businesses and continue to make in those cloud businesses. So we're actually very excited about the 10% revenue growth that we -- that our initial view has for FY '19. And we think the margin, the operating margin, is actually really solid considering that growth.

Yes. And I'll just add to that. Overall, the growth that we're seeing in the business areas is justifying, if not demanding, investments to really go materialize those growth potentials. And we have great conviction in the business. We're getting great strategic resonance from our customers, and we're starting to build the next longer-term investments as well with NFV, IoT as well as SD-WAN and VeloCloud. So it's feeding the growth engines that are performing as well as starting to lay the seeds for the longer term as well.

We will take our next question from Michael Turits from Raymond James.

I wanted to ask about ELAs and what are the -- how the ELA cycle looks into '19, whether the growth rate in ELAs will be at, above or below. And sort of part of that, when you look at the 2 big deals which you did in August, which I assumed were ELAs, whether or not we should really look at those as something that pulled forward this year or not or whether that's just part of the run-rate business.

Sure, I'll start and then Pat can maybe give some color on sort of the broader ELA business. As we look at from a renewals perspective, much like we saw this year for FY '19, we'd expect ELA renewal opportunity to be of greater value than we saw this year. So we're very pleased, obviously, again at 42%, pleased with the strategic opportunities we have on our ELAs and have been growing the ELA as a percent of our total mix at a faster pace than what we've seen historically. As we look at that renewal opportunity, we see it increasing next year.

Yes. And I think we've seen that while we had a unique bump from '15 to '16 to just the amount, overall, every year, the amount of EAs is increasing, right, which is increasing that long-term opportunity for us. But to us, it's really more important that is the long-term strategic commitment that we're seeing from customers that really count, whether buying into more of our products or buying into it on a longer-term basis. As you saw on the numbers, just the effectiveness that we're getting with NSX, EUC, VSAN into the EAs is really quite stunning.

We will go next to Adam Holt with MoffettNathanson.

This is Ray McDonough on for Adam Holt. My question surrounds NSX, which obviously accelerated $2.5 billion in the quarter, and I know you called out a large deal benefit. But is there any more color you can provide on the size of deals you were seeing compared to a year ago as that product has matured a bit and how you see the growth there progressing in fiscal '19 as you look at the opportunities to extend the platform with VeloCloud?

Overall, Q3 was really an exceptional quarter for NSX, uniquely benefited by the DXC deal. But even if we factor out the DXC deal, we had very good performance in NSX. We're now over 3,100 customers. I don't actually know -- maybe, Zane, you can answer if the deal size has gotten bigger or smaller there. But overall, it remains focused on higher-end, larger deals, most of those through EAs. It's very much a transformational business. I'd also emphasize that NSX is essentially part of everything that we do, the Pivotal Container Service that we announced for developer-ready infrastructure. It's built into the VMware Cloud on AWS, our new vCloud services with NSX cloud. So it really is everywhere. And the VeloCloud further extends that, as we've already commented. The use cases continue to broaden even though the security benefits around micro-segmentation are -- continues to be the #1 driver of NSX to-date. But the use cases are broadening as customers get comfortable with the technology for application acceleration, multi-data center connectivity, pathway to the public cloud. So overall, it's really benefiting in many aspects. And as you note, the DXC deal was critical as part of the Vodafone deal but across many different vertical segments. In the regulated industries and health care, we're seeing strength as well. So we believe that this is a continued growth opportunity for us into next year and well beyond that because at 3,100 customers, we're thrilled. But we believe that this becomes tens and hundreds of thousands of customers over time because the value of virtual networking is really everywhere in the industry.

Ray, I'll just add, we've been, as Pat mentioned, pleased with the deal size as well as the number of returning customers with the products. So it's accelerating in adoption. It's being enhanced even within the same customers. The growth, as Pat pointed out, with or without the DXC deal was still solid. So we forget about the product of this year and next.

We will go next to Brad Zelnick with Credit Suisse.

There's a lot of good news to congratulate you on. So nice job, guys. Coming out of VMworld, you've really done quite a bit to make security even more focused with AppDefense and other features across the portfolio. My question, how do you see the role of traditional network security in the cloud? And specifically, containers will require segmentation. Do you think traditional firewalls have a place there? Or is there more security inherent within container technology and within NSX and NSX-T, which customers will rely on?

Yes. And overall, as you said, we're taking more aggressive steps to build more security into the infrastructure products that we provide, NSX with micro-segmentation, VSAN with encryption, multi-factor authentication with EUC, now AppDefense in the core compute. So that idea of building in security is a key aspect to our strategy. The second aspect is, we'll say, as we are turning the security model on its head. As opposed to chasing bad, ensuring good and being able to detect deviations from good, we're finding it's a lot easier to do than finding that little piece of bad. So overall, we have a very aggressive view of what we're going to accomplish in the security industry overall and really delivering our customers. As I said, boy, I think the tech industry has failed our customers in the area of security, right. They're spending more and losing more, right. Something is clearly wrong that we have to address with the new approach. So we're quite excited about the things that we're doing there. As your question sort of focuses on with the traditional security technologies, we think all of them really need to be reconsidered in a software-driven, multi-cloud world. And traditional hardware-centric firewall vendors are reconceiving their products as software opportunities that become more service-focused over time. I mean, every one of those traditional hardware-oriented, network security capability needs to be reconceived in a multi-cloud, software-driven way into the future. And some of those, we'll be baking in but we continue to see in -- like our partnership with Palo Alto Networks, Check Point and others, we're also partnering with them how we deliver east-west firewalls, as they're called, in conjunction with their north-south firewalls, which may be hardware but increasingly will be software-based over time. So I think overall, that software continues to be, right, a big and important market for customers. But we collectively, as an industry, need to approach it differently, and VMware is stepping forward into that domain in a pretty aggressive way.

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

Even as we're prominently featured at re:Invent this week, it was great to see some of the new features and availability zones. But I was curious, at VMworld Europe, you talked about an expanded partnership with IBM. Can you comment a little bit more about that relationship and really how it really broadens out your hybrid cloud sort of approach?

Yes. Thank you, Matt, and great to hear from you. Overall, the IBM partnership, you could think about it in a couple of different dimensions. One is IBM Cloud building more and more VMware-based offerings, and we position them as one of our key partners for the VMware Cloud Foundation. And IBM is having accelerated success of their customers on IBM Cloud with the VMware software stack. So that's going very well, great growth rates. I think we're now at 1,400 plus customers with IBM. Second dimension of that is then saying the new service areas that we're building with them. And for instance, the last question around AppDefense, we're partnering with IBM and their QRadar offering to build and enhance our security offerings with the AppDefense and QRadar. We've also launched new services with them, and one of those that we are very excited about at VMworld Europe is what we call the Hybrid Cloud Extension, this ability to operate, really transform existing environments into new modern data centers as well as in the new modern clouds as well as fully enable a dynamic hybrid experience where workloads truly are being optimized, right, on a minute-by-minute, day-by-day basis across environments. And IBM has stepped forward as a partner with us in that area in a big way both on the cloud side as well as a system integrator with their global technology practice as well. So overall, we're just thrilled with that momentum that we're seeing with IBM and multiple dimensions and really hats off to the great way that they're leaning into the partnership with us.

We will go next to Gregg Moskowitz with Cowen and Company.

Zane, your net DSOs were much lower than usual this quarter. I'm sure the DXC deal helped quite a bit there, but can you talk about linearity of this quarter more broadly as well as your DSO expectations going forward?

Gregg, we're clearly benefiting from -- in the case of the third quarter, the DXC agreement helped there but also just linearity. As you shifted to the new fiscal year, that's clearly helped with DSOs. So we're expected to normalize a little more as you think about some future DSOs, but at least for this quarter, we benefit from a number of deals that happened early in the quarter.

We will go next to Keith Bachman with Bank of Montreal.

I wanted to ask about compute, which had another very solid quarter. And it sounds like in the dimensions of your guidance for next year of 10%, it sounds like you expect total compute to grow -- continue to grow low single digits. I just wanted to clarify that was the expectation. And Pat, really for you, what do think is driving that ongoing benefit or strong results in compute? This year, it seems like a lot of companies, VMware, Red Hat, Microsoft, even Oracle are benefiting from renewed spending for on-premise infrastructure across the board. Do you think that continues into what would be calendar year '18? Or do you think there's a little bit more cloud momentum, so to speak, for VMware in particular?

So Keith, this is Zane. I'll start. You're exactly right. As we think about our initial view for next year within that 10% revenue growth estimate, we believe compute will be in the low single digits in aggregate. So that's the view we have today.

Yes. And with regard to compute longer term into the future, I mean, a few comments. First, if we go back 3 years, right, many of our customers, "Boy, I'm going to get to the cloud really quickly, and I don't need this on-premise environment anymore." Then they looked at their application portfolio, "This is -- oh, wow. I've got to replatform those. I've got to refactor those applications. This is heavy. This is hard. This is slow." And that's led to, I'll say, a very -- I'll say, a more intelligent, competent, right, balanced conversation with customers as they say, "Boy, here are the exciting new things. I might do cloud only. But boy, there's a lot of these things that I really am not going to transform or rebuild an application that has been curated over the last 3 decades, right. I'm not going to be able to lift and shift that as I might thought." So it's become a very, I'll say, thoughtful conversation with customers now in a very balanced way. And we think as they're now really understanding their overall application portfolio and how they embrace new container-oriented and micro-services-oriented approach but it complements with their investments and how they might containerize existing apps and services as well. So overall, we expect this is actually going to be a fairly balanced conversation for multiple years to come, right, as people need to refresh their on-premises environments. They're going to be able to think more holistically about how they move to the cloud with new tools like the VMware Cloud on AWS, the Hybrid Cloud Extensions that we've asked. They have powerful ways to, I'll say, move to the cloud in a multi-cloud way on their own schedule without having to make, I'll call, a bad investment and refactoring applications they don't get value from even as they embrace new cloud capabilities and services as well. So overall, I think this is going to last for multiple years into the future. And as I commented earlier in the Q&A, things like IoT will actually be driving things from the cloud onto premise. And you might have noticed that we did a proof of concept demonstration this week as a tech preview with Amazon of bringing Greengrass on-premise and being able to take a service that was only available in the public cloud, all right, on the Amazon, the Greengrass services for IoT and Lambda functions and bring that back on-premise. And I think that also tends to demonstrate the longer-term view of a balanced hybrid cloud environment is the answer today and for what I believe will be decades into the future. And as a result, we expect that the compute franchise will be available from us on-premise -- and that's going to be strong, but also increasingly available from cloud providers as well, like Amazon, like IBM that we just referred to on our 4,100 other service providers. And that gets to be more valuable on these balanced use cases for the future.

We will go to Abhey Lamba with Mizuho Securities.

I'm just going to follow up on earlier -- to Karl's question about cash flows for next year. Zane, are there any kind of one-time things that we should be thinking about from this year as we are thinking about next year's cash flows? Or should we just be thinking about the bookings you indicated earlier?

Abhey, it's a good question. As I mentioned earlier, I would say think about there are a number of elements moving around this year, as you would expect in any year, but there are no sort of one-time call-outs that we haven't called out already. So as you look at the business in future years, we think generally speaking, cash flows will align with the business growth that we expect for future years. I'm happy to give you more color on that on our next call.

And in closing, some very solid third quarter. We raised guidance for the year. We set expectations for fiscal '19. Our strategy is resonating with customers. We're optimistic about the momentum across our growth businesses. And we sure appreciate all of your time and interest in joining our call, and we wish you all a happy holidays as we finish out a great year for VMware. Thank you.

Ladies and gentlemen, this will conclude today's conference call. We thank you for your participation, and you may disconnect at this time.