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VMware, Inc. (NYSE:VMW)

Q2 2013 Earnings Conference Call

July 23, 2013 05:00 AM ET

Executives

Patrick P. Gelsinger - CEO

Carl M. Eschenbach - President and COO

Jonathan C. Chadwick - EVP and CFO

Paul Ziots - Director, Investor Relations

Analysts

Brian Marshall - ISI Group

Raimo Lenschow - Barclay's Capital

Kash Rangan - Bank of America Merrill Lynch

John DiFucci - JPMorgan Securities

Brent Thill - UBS

Phil Winslow - Credit Suisse

Heather Bellini - Goldman Sachs

Jason Maynard - Wells Fargo Securities.

Rob Owens - Pacific Crest Securities

Shaul Eyal - Oppenheimer & Company

Matt Hedberg - RBC Capital Markets

Gregg Moskowitz - Cowen & Company

Rick Sherlund - Nomura Securities

Patrick Walraven - JMP Securities

Michael Turits - Raymond James

Daniel Ives - FBR Capital

Operator

Welcome, and thank you for standing by. At this time, all participant lines are in a listen-only mode. (Operator Instructions) Today’s conference call is being recorded. If you have any objections, please disconnect at this time.

And now, I’d like to turn the call over to your host, Paul Ziots, Director, Investor Relations. You may begin.

Paul Ziots

Thank you. Good afternoon everyone and welcome to VMware’s second quarter 2013 earnings conference call. On the call, we have Pat Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Executive Vice President. Following their prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast.

Beginning this quarter, slides which accompany this webcast can be viewed in conjunction with live remarks. It can also be downloaded at the conclusion of the webcast from ir.vmware.com. Now that we’re finished with all realignment related divestitures, we’ve also included in our earnings release and posted on our website six quarters of historical data for revenue and unearned revenue, excluding pivotal and all 2013 divestitures, such as Shavlik and Zimbra.

This is to just those of you who routinely estimate bookings or billings by adding our revenue to the sequential change in unearned revenue each quarter. You should be aware that beginning with Q3, we’ll be providing forward-looking guidance during earnings webcasts only and guidance will not be included in earnings press releases as been our practice in the past.

Statements made on this call today include forward-looking statements, such as those with the words will, believes, expects, continues and similar phrases that denote future expectation or intent regarding our financial outlook, product offerings, customer demand and other matters. These statements are based on the environment as we currently see it and are subject to risks and uncertainties. Please refer to the press release and the risk factors and documents filed with the Securities and Exchange Commission, including our most recent reports on Form 10-Q and Form 10-K for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements.

In addition, during today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered in addition to, not as a substitute for, or in isolation from, GAAP measures. Our non-GAAP measures exclude the effect of our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax and employee stock transactions, the net effect of amortization and capitalization of software acquisition-related items, and realignment related net gains and charges.

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

Our third quarter 2013 quiet period begins at the close of business September 16, 2013. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2012.

With that, I’ll turn it over to Pat.

Patrick P. Gelsinger

Thank you, Paul, and good afternoon, everyone. Q2 was a strong finish to a solid first half of 2013 for VMware. I’m very pleased with our team’s performance. Q2 total revenues grew 11% year-over-year and exceeded the high-end of our guidance range and non-GAAP operating margin of 33.5% reached a record high.

Excluding pivotal and divestitures, total revenues grew at even faster rate of 15% year-over-year. The Company is aligned and focused. We’re now substantially completed with our realignment activities. With these actions behind us, the energy and momentum of VMware's building as we focus on driving growth in the second half of 2013 and beyond. Looking ahead we see tremendous opportunity based on our unique role in the industry.

We congratulate pivotal on the successful launch and are proud to be a big evolved stakeholder and an exciting new IT segment. VMware continues to succeed because we’re uniquely positioned to help our customers move from the client server era to the mobile cloud era of computing. Each new era requires a new generation of infrastructure for the enterprise.

VMware is positioned to deliver this information as we have the most comprehensive solution for the private public and hybrid cloud. We do this with the richest ecosystems of partners in the industry and with increasing multi-cloud support, giving our customers both a choice and agility. Importantly, as we help customers bridge to this new mobile cloud world, we also help them capture significant cost savings by modernizing our existing applications in client server investments. Thus, our strategy is aligned with the IT requirements of both today and tomorrow. Our strong performance in Q2 is a clear validation of our customer’s belief in this vision.

Our continuing goal is to power people and organizations by radically simplifying IT through virtualization software. We intend to realize that goal by focusing on a combined $50 billion addressable market opportunity across three strategic growth priorities; software defined data center, hybrid cloud, and end user computing. In Q2, our products that extend the portfolio beyond stand-alone vSphere represented more than 35% of license bookings.

I want to share with you some concrete examples of how we’re driving momentum and customer adoption in each of our three strategic growth areas. For the software defined data center, Carl will give details on the great momentum we’re seeing with vCloud Suite and our channel oriented bundle vSOM or vSphere with operations management. Both of these demonstrate the increasing value our customers are capturing as we broaden our product portfolio.

We are also seeing the industry strongly embrace our SDDC strategy. During Q2, we announced an SAP strategic partnership. VMware will sell SAP HANA and Core applications as a subscription service on vCloud Hybrid Service and on premise with the vCloud Suite. We also gave momentum in network virtualization with the announcement that NTT Communications will deploy VMware Network Virtualization as a core technology for its new cloud service. In addition, we’re pleased with the incremental opportunities presented to us by open stag and our ability to capture this opportunity.

Our second growth area is vCloud Hybrid Service, which delivers a public cloud infrastructure as a service that is completely interoperable with existing VMware virtualized infrastructure. In May, we launched an early access program for vCloud Hybrid Service and the program is generating tremendous interest from our customers. At the same time, we achieved greater than 100% bookings growth year-over-year and our VMware Service Provider Program or VSPP, which enables partners to build and manage VMware compatible cloud computing services on top of VMware technology.

At end user computing, our Horizon View virtual desktop infrastructure product was granted Target Platform status by Epic Systems. This is a significant partnership as Epic offers an integrated suite of healthcare software to large healthcare organizations and VMware is the only VDI provider to achieve Target Platform status. We already have 12 customers running Epic on VMware View including Providence Health Systems, Kettering Health Systems and Hackensack Medical Center.

We're also excited to announce later this month a new version of our Horizon Suite. These are just a few examples of many we can point to as prove points that all three legs of our strategy are gaining momentum. Overall, our new products that extend the portfolio beyond standalone vSphere demonstrated strong double-digit growth, clear evidence that we are continuing to accelerate customer adoption.

In closing, I'd like to thank our customers, partners and employees for their passion and engagement in Q2 as we continue to execute against our aspirational goal of becoming the greatest infrastructure software company of this decade. I hope to see many of you at our annual VMworld event during the week of August 26th in San Francisco and at our financial Analyst Day on Monday, August 26th. We have a lot of exciting product and partner announcements to share at VMworld.

I'll now turn it over to Carl.

Carl M. Eschenbach

Thank you, Pat. I couldn't be more pleased with our performance in Q2. Following a solid Q1, we delivered another strong quarter in Q2 and continue to execute against our three growth priorities; the software-defined data center, hybrid cloud and end user computing. We saw strong alignment to these priorities across all functions in the company and across our partner community. Operationally, we are consistently meeting our short-term goals as we continue to build a deep foundation for VMware's future.

Getting into the details, Q2 was a strong quarter for bookings. Results were in line or above expectations in all three of our geographic regions; Americas, EMEA and Asia-Pacific. Removing the effective pivotal and our 2013 divestitures, we saw Asia-Pacific lead the way with year-over-year growth of total bookings in excess of 40%. The Americas demonstrated strong growth of approximately 20% and EMEA grew in the mid teens despite the economic situation across much of Europe.

We also continued to receive high marks on customer satisfaction. Supporting our own customer satisfaction reports, the May 2013 tech vendor Net Promoter Score from Temkin which surveyed over 80,000 large North America companies ranked VMware as the highest Net Promoter Score amongst a list of 54 technology vendors. VMware's rating was well above our industry peers and competition.

Overall, we're outperforming on multiple fronts. We closed six deals above $10 million and our field teams around the world did an outstanding job of closing ELAs. Approximately 37% of total Q2 bookings were ELAs which is a record high for any quarter. Furthermore Q2 was the highest ever in quarter renewal rate for ELAs in terms of number of deals renewed. Approximately 75% of vCloud Suites were sold with ELAs. We believe this strong performance across our ELAs and vCloud Suites is a clear indication of our customers' long-term commitment to VMware and the software-defined data center strategy.

Our professional services business was also a strong performer in Q2. Increasingly customers are leveraging VMware as a strategic enabler to help them through the transition that Pat mentioned earlier from a client server to a mobile cloud era. They're looking to VMware to help them design and implement many aspects of the software to find data center. We also continue to see a solid tax rate of professional services to our ELA business.

Our overall ASPs have gone up both on a year-over-year and sequential basis. vSphere with Operations Management or vSOM contributed to an improvement in our transactional business in Q2. In its first full quarter of availability ASPs for vSOM tracked at approximately 1.3 times the ASPs for vSphere standalone. As a result, our transactional business ASPs have gone up sequentially. Our strategy to strengthen the channel and broadly see the market with our management products is off to a good start.

Our support and subscription in quarter renewal rate reached an all-time high for any Q2 and the second highest rate of all time. This is a strategic part of our portfolio. It's highly profitable and a reflection of strong ongoing customer commitment to VMware. Management automation and license bookings were our strongest growing product area this quarter and we are pleased with the sales teams and the channels capability to sell our management solutions. As VMware's customers become more virtualized, their needs increase for management, automation and operations products.

Our customers continue to share with us their desire to get these products from their existing data center virtualization partner. vCenter Operations Management suite remains our largest management product followed by vCloud Automation Center. Increasingly management is helping to drive adoption of the software-defined data center. This is reflected in the fact that a larger and larger portion of management is sold within vCloud Suite and vSphere with Operations Management.

Based on the opportunity in front of us and the traction we have seen to-date, we will be building out a significant managers' specialist sales organization in the second half of 2013. Our end user computing license bookings were up in the mid teens year-over-year. This falls upon mid teens year-over-year growth performance in Q1. We continue to make investments across the board in end user computing go-to-market activities.

Our teams have done a great job around the world hiring top talent, many of whom have come from established companies in the industry. Our investments in the area are paying off and we believe we're continuing to gain market share. We also continue to be excited about our large service provider and enterprise customer proof-of-concepts underway in network virtualization. Our success rate in these proof-of-concepts continues to be very high.

Last quarter we had design wins with NTT, WorldPay and a number of others. Unlike many technologies in the marketplace, our NFS technology is in production and used today in supporting some of the largest appointments in the world and large customers such as Intel, Rackspace, Colt, NaviSite, and eBay. As Pat said, initial customer interest in vCloud Hybrid service is high. Customers like Nexon, a free-to-play online game company that is 100% virtualized on vSphere, Digital River, the revenue growth experts in global cloud commerce and Harley-Davidson dealer assistants are just a few of the examples of early access customers. These customers want a seamless extension of their private cloud to the public cloud built on the trusted foundation of vSphere.

In addition, our VMware service provider program once again tracked well in the quarter as public cloud providers continued to leverage our cloud infrastructure program for their service delivery. As we've stated previously, we believe this ecosystem of providers is second only to Amazon and public cloud market share in this program is one of the fastest growing parts of our business with bookings growth once again of over 100% year-over-year.

In summary, we executed well in the first half of 2013 and are entering the second half of the year with strong momentum. We're delivering industry changing innovation in the software-defined data center, hybrid cloud and end user computing, and we're pleased that customers are expressing significant excitement about our product deliverables later this year. Our leadership team is focused, energized and ready to deliver a strong second half for our customers and partners, our employees and our investors.

With that, let me turn it over to Jonathan.

Jonathan C. Chadwick

Thank you, Carl. We are very pleased with our Q2 results meeting or exceeding our goals for the quarter. Our strategy is in place and we are executing the plan we have shared with you. Starting with revenues, Q2 total reported revenue growth of 11% year-over-year exceeded the high end of our guidance and license revenue $531 million came near the upper end of our guidance, up 3% year-over-year.

Excluding pivotal and all divestitures, total revenues grew 15% year-over-year in Q2 accelerating from 13% in Q1 and license revenues grew 5% year-over-year up from 1% in Q1. Also note that currency negatively impacted both license and total revenue year-over-year growth rates in the quarter by approximately 1%. Services revenue grew 18% year-over-year reflecting robust maintenance and services performance and ongoing momentum in subscription type businesses.

Moving to operating expenses and profitability, unless otherwise noted all references to our expenses and operating results are on a non-GAAP basis and I’ll reconcile to our GAAP results in the press release tables and posted on our investor relations website.

Operating margin was 33.5% a record high for any quarter in VMware’s history another top end of our guidance range. Diluted non-GAAP EPS for Q2 was up 16% year-over-year to $0.79 a share on 432 million shares. We ended the quarter with approximately 12,900 employees which is down slightly from the beginning of the quarter and takes into account the transfer of pivotal employees. We have substantially completed our realignment plan outlined in January and are now focused on continuing investment into our top strategic growth areas, the software defined data center, end user computer and the hybrid cloud.

Now moving to our balance sheet and cash flow metrics, our balance sheet remained strong with cash and short investments at quarter end of $5.323 billion up $386 million sequentially. Our GAAP operating cash flows remained strong as well, and with $534 million up 36% year-over-year. Our total cash spending on CapEx was $75 million and free cash flow was $458 million in Q2, up 32% year-over-year. I’ll remind you that cash flow can be lumpy and I’ll talk more about this when I get to guidance.

During the quarter we repurchased approximately 1.6 million shares of our stock for a total of $120 million under our share repurchase program. At an average price of about $73 a share. Total unearned revenue ended the quarter at $3.6 billion up 22% from Q2, 2012 of which $1.37 billion is long-term. Note that this reported number is after the removal of $101 million of unearned revenue in Q2, 2013 associated with the formation of pivotal and our divestitures. Of the $101 million, $39 million was unearned license revenues.

Approximately 88% of our unearned revenues will be recognized rapidly over future quarters. The unearned revenue mix is in line with prior periods and it's primarily a reflection of our strong maintenance business. Customers continue to buy on average more than 24 months of support and maintenance with each new license purchased which demonstrates a strong commitment to VMware as a core element of their data centers strategies.

Before I move to guidance I am going to expand on our earlier bookings commentary. We were very pleased with our bookings performance in the quarter; many of you routinely estimate bookings or billings by adding our quarterly revenue to the sequential change in unearned revenue each quarter. Over time these calculated bookings and associated growth rates have been a reasonable proxy for our actual bookings. That being said the divestitures in 2013 have made like-to-like growth rates comparison difficult. Since the business realignments have had some impact in our reported revenue and also our reported unearned revenue numbers.

The revenue and unearned revenue tables accompanying the press release should help you understand the underlying growth rates better. I’ll also share that excluding pivotal and divestitures our license bookings for Q2 once again grew at a rate of greater than 10% year-over-year and our total bookings grew to a rate of greater than 20% year-over-year. A significant portion of the double digit bookings increase is as a result of our success in products beyond standalone vSphere. This includes management and automation, end user computing, vSphere with operations management, vCloud Suite and the VMware service provider program.

In Q2, end user computing bookings were once again greater than 10% of total license bookings. In total including EUC over 35% of our license bookings in Q2 were from these product areas beyond standalone vSphere. This figure is up from approximately 25% in Q2, 2012 and reflects the significant uptake in our newer products including the success of our Suite strategy with vCloud Suite and vSOM. So again we're pleased with our bookings growth overall and the momentum in our Suites and newer products.

Now moving to guidance, given our strong performance in Q2, we’re increasing the high end of our guidance for the full-year to $5.260 billion for a range of $5.120 billion to $5.260 billion representing year-over-year growth of 11% to 14%. Excluding pivotal and our divestitures our total revenue growth for 2013 is expected to be between 15% and 18%. License revenue is expected to grow 6% to 10% for the full-year as reported and 8% to 12% excluding pivotal and divestitures.

We expect non-GAAP operating margin to be in the range of 33% to 34% for the full-year. As a reminder we intent to continue to invest in our strategic priorities and still expect headcount at the end of 2013 to be up by approximately 500 people from the start of the year. GAAP operating margins for 2013 are expected to be approximately 12 to 15 percentage points lower than non-GAAP operating margins. We continue to project that our non-GAAP tax rate will be 18.5% for the year and we anticipate that our 2013 fully diluted weighted average share count will be between 431 million to 435 million shares.

Regarding cash flows, why we do not provide cash flow guidance, I’ll say that I am comfortable with the range of $2.1 billion to $2.35 billion for total operating cash flow for 2013 but I want to emphasize again the cash flow can be lumpy from quarter-to-quarter due to various factors including the timing of tax payments, linearity of bookings and other factors. In addition we continue to expect capital expenditures on a cash basis to range between $330 million and $370 million for the year.

Total revenues for Q3, are expected to range from $1.270 billion to $1.300 billion or a growth of between approximately 12% to 15%. We currently anticipate Q3 license revenue to be between $535 million and $555 million representing growth to between 9% and 13%. Excluding pivotal and divestitures total revenue growth for Q3 is expected to be between 17% and 20% and license growth is expected to be between 12% and 16%. We expect operating margin in Q3 to be in the range of 32.5% to 34%. We see a tremendous market opportunity ahead and continue to make investments in product development and regional expansion.

GAAP operating margins for the third quarter are expected to be approximately 12 to 15 percentage points lower than non-GAAP operating margins. For Q3 we estimate our non-GAAP tax rate to be 18.5% and we anticipate our third quarter 2013 fully diluted weighted average share count to be between $431 million to $435 million shares.

In summary we are very pleased with Q2. Our goal is predictable, consistent growth accelerating throughout the year and we saw that in Q2. We had strong bookings performance. We added to our deferred revenue and we delivered strong cash flow and operating margin. We expect Q3 growth will be higher than Q2 and we have set a solid base in the first half of 2013 leading into a stronger second half.

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

Paul Ziots

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question will come from Brian Marshall of the ISI Group. Your line is open.

Brian Marshall - ISI Group

Great, thanks guys. It looks like I’m going to return in the back half of the year to double-digit license revenue growth. Can you talk a little bit about the visibility you have in this rebound and it will great if you could perhaps give a little color on how ELA renewals are going to play a part of that process and how this is going to impact the overall license revenue growth in the back half. Thank you.

Patrick P. Gelsinger

Great, thank you Brian this is Pat, as we start the Q&A time I just want to again emphasize how proud I am of the team and the performance in Q2. As we look to the second half as you’re questioning here Brian, we see that the first half has just presented us with a great opportunity to enter that second half with significant momentum and that’s across the entire business and across all of the geographies. There are few specific points from that first half obviously as we look to the second half growth are beyond the standalone vSphere but it was very strong and as that continues to be a stronger portion of our overall bookings we also see that there is significant ELA opportunities and our Q2, ELA performance as Carl commented upon clearly gives us confidence about the ELA cycle as we go into the second half of the year. So those combinations ride the momentum, ride the ELA opportunity and beyond vSphere products clearly presents us with a great opportunity to deliver on exactly what we said we would, right? And the second half acceleration and our Q2 is clear evidence that we're on track for that.

Paul Ziots

Thank you.

Jonathan Chadwick

I'd like to just add a couple of things. Thanks for the question, Brian. So we also are continuing to see our go-to-market investments payoff, specifically in Asia-Pacific in the emerging markets like China and Japan and Southeast Asia. And also we are excited about the investment we made in the first half of the year around our end user computing go-to-market and we expect to see acceleration in that business in the second half of the year as well. And as we've always indicated, we do expect to see an acceleration in the federal business in the second half of the year, primarily in Q3 due to it being fiscal year end and based on our pipeline we do expect that to be the case. So when you combine all that with what Pat had mentioned around the momentum coming out at Q2, we feel very confident in our guidance for the second half of the year.

Paul Ziots

Thank you, Brian. Next question, please.

Operator

Our next question comes from Raimo Lenschow of Barclay's. Your line is open.

Raimo Lenschow - Barclay's Capital

Thank you and congrats on a great quarter. I just wanted to dig a little bit deeper, Carl, you mentioned already on the end user computing for the second half. Can you just talk a little bit about the drivers there? I mean one thing I would assume is that you start building up the sales force in Q4, Q1. I mean if I do the mechanics, they should start getting productive in the second half. Is there lots of ways to think about that second half momentum there and what are you seeing in terms of pipeline build there? Thank you.

Carl M. Eschenbach

Yeah, sure. You're indeed right. Our investments in end user computing are clearly starting to pay off. Once again in Q2 we saw mid teens growth in bookings in end user computing. That's following on similar growth in Q1. And as we go to the second half of the year, we absolutely expect our end user computing sales force and the specialization sales force that we've build out there to have an impact and that is clearly one of the drivers of how we see acceleration in the second half taking place. It is around end user computing and we're excited about the pipeline that we're starting to build and I would say the teams around the world have done an amazing job of hiring some great talent from the market and both from some of the industry veterans out there as well as some of our competitors are joining us because they see the opportunity that VMware represents in the end user computing space as we go forward.

Paul Ziots

Thank you, Raimo. Next question, please.

Operator

Our next question comes from Kash Rangan of Merrill Lynch. Your line is open.

Kash Rangan - Bank of America Merrill Lynch

Hi. Thank you very much. When I did the adjusted bookings calculation or billings growth calculation, it looks like it came in the high 20s that looks very strong, but my question is again related to the management and automation opportunity, Pat, could you comment on how long is it going to take for mainstream adoption of management and automation and where would you like your business to be in terms of percentage of new business billings coming from management and automation one, two years? What are your longer term targets for that? Thank you very much.

Jonathan C. Chadwick

Kash, this is Jonathan. Let me just quickly clarify. So as we do the bookings calculation, you should come up to a number north of 20 if you do the calculation but not high 20s, so we can help with that offline if you like, but just for everybody's benefit, we are seeing total bookings north of 20. And then Carl, do you want to take the second part?

Carl M. Eschenbach

Yeah. Hi, Kash. How are you doing? Hope you're well. So, we see significant opportunity around management, automation and orchestration as indicated by us in my prepared remarks saying it's a fastest growing product line. And because of that we've decided to actually invest in our go-to-market for management and automation in the second half of the year in a very similar way that we did with end user computing in the first half of the year. So we are very pleased to see the growth and that's without a specialized sales force, so going forward we expect to see continued growth. Also we're very excited to see the uptick and the continued growth of both of our vSOM product which launched for the first time in Q2 as well as our vCloud Suite because as you know a lot of our management and automation products are part of those suites or bundles and we saw great traction within the quarter. So all of that combined with our go-to-market efforts that we're going to be building around with management and automation gives us a lot of confidence that we will continue to see that grow into the future.

Paul Ziots

Thank you, Kash. Next question, please.

Operator

Our next question comes from John DiFucci of JPMorgan. Your line is open.

John DiFucci - JPMorgan Securities

Thank you. First of all thanks for all that supplemental information at the back of the press release. It's really helpful giving everything that's happening at VMware. So when I exclude things that are no longer part of VMware, I come up with license bookings growth of about 13%, Jonathan, which is pretty impressive here. There's a lot of confusion I think in the investment community about what the opportunity is left in your core business? I think that said, license bookings outside the core of vSphere accounted for about 35% of license bookings. I guess my question is what does this mean for the core of vSphere business? We know that the x86 workloads are somewhere north of 60% have already been virtualized. That doesn't mean that the compute capacity or the number of cores have been virtualized is anywhere near that, but it also implies that the core growth here was less than 13, but we don't know. If you could just maybe shine a little bit of light for a – I'll just stop talking here.

Jonathan C. Chadwick

John, let me just confirm that if you do a calculation you're in the right range by somewhat numbers we've shared and I do appreciate you making the comment about the detail we provided in the press release. That's a lot of quarters' update and I'm glad it was helpful. And I'll start and ask Carl to help me here. Overall, our strategy as we've laid out is to focus on the delivery of the broader than just vSphere opportunity. And with that, we expect that strong installed base that we have through the [springboard] for the rest of the vCloud Suite, vSOM and increasingly deliver in software-defined data center going forward and hence the individual components become less important as the emphasis shifts to focus on the overall software-defined data center. And as such it really is largely a, just breaking out with the components of that would be which increasingly becomes more and more arbitrary as the real value is delivered and that complete set of technologies coming together. We will say that the growth continues inside of the core – the amount of sockets, the amounts of our core vSphere business has continued to grow. Carl commented on the increase in the ASPs per socket. There's just clear evidence of the strategy playing out as well and overall we do believe that the strength of the opportunity for us is to move into these new areas which we saw substantial growth in this quarter.

Patrick P. Gelsinger

Carl, additional comments.

Carl M. Eschenbach

Yeah. John, let me just reiterate a couple of things there because I do think it's important that we do view the core vSphere business as an opportunity for growth in the future. And one of the ways we measure that is by actually the unit growth year-over-year and within the quarter we did see solid growth in vSphere units year-over-year. That combined with the fact that we saw an increase in our ASPs both sequentially on a year-over-year basis means we're getting more per socket for license sold. And when you combine all of that, John, and you combine the fact that vSphere is always included in both our vSOM Suite as well as our vCloud Suite solutions, we're very bullish on the opportunity for the core vSphere business to continue to grow in the second half of the year.

Paul Ziots

Thank you, John. Next question, please.

Operator

Our next question will come from Brent Thill of UBS. Your line is open.

Brent Thill - UBS

Good afternoon. Jonathan, if you go to your Q4 implied license guidance that would effectively put you back on par with coming out of the recession in '09. You haven't seen that type of license reacceleration. I'm curious that I think a number of clients believe that that still the stretch. Why do you feel like it's not a stretch from what you're seeing, from the data that you're seeing internally?

Jonathan C. Chadwick

Brent, thank you for the question and it's sort of a follow-up to the very first question we were asked. Again when you look at the acceleration we've seen and the performance we've seen in Q2, the year is playing out as we said it would and we're executing as we expect and it's important and this is why to John's question just previously why we've shared the data underlying our growth rate and the core parts of our business that are our asset pivotal and after, the divestitures. We've spent a lot of time over the last six months preparing ourselves for the opportunity ahead and by focusing ourselves on software-defined data center, end user computing and the opportunities presented by the hybrid cloud. The underlying growth rates in our business are accelerating. We saw license bookings growth north of 10%. You will calculate a number roughly around 13% from the data we’ve shared. And we’ve also seen total bookings in excess of 20% this quarter. These are all signs of momentum and indicators of why we think the back half will continue to perform. So, the year is playing out as we anticipated and we’re confident with the guidance we’ve given.

Paul Ziots

Thank you, Brent. Our next question please.

Operator

Our next question is from Phil Winslow of Credit Suisse. Your line is open.

Phil Winslow - Credit Suisse

Hi, guys. You obviously mentioned an expectation for strength in the ELA business going into the second half. Just kind of two questions beyond that, first on just the transactional side sort of what did you see this quarter and just your outlook there for the second half. And then, as far as the ELA business goes into sort of what's embedded in expectations, how much of there is based kind on just obviously a strong renewal cycle but also sort of a strong renewal cycle plus up sell of vCloud’s, where you gaining sort of acceleration or just versus the first half or any commentary would be great.

Paul Ziots

Phil, I hate to be a stickler here, but would you like the ELA side or the transactional side. We’re going to keep it to one per person for the call to get through as many as we can.

Phil Winslow - Credit Suisse

I guess, we’ll do ELA then.

Paul Ziots

Thank you.

Carl M. Eschenbach

So, hey Phil, this is Carl. So first, let me just can reiterate something we said, and I guess Jonathan, Pat and I have all said we were pleased with all the aspects of our business in Q2 both our ELA business and our transactional business. Our ELA business in Q2 represented 37% of our bookings which was an all time high. And another point that I mentioned in my prepared remarks was the fact that we had our highest ever in quarter renewal rate of ELAs which is a very positive sign that our customers are looking to invest and strategically align with us for their ongoing datacenter needs. I also talked about the fact that we had six deals greater than $10 million in the quarter, four of them were actually renewals. So customers continue to renewal with us on an ongoing basis, so that was a very strong sign. And as you know in any given quarter ELA business can be lumpy, but across the world I was very pleased with the team’s ability to execute and drive ELAs to closure in the quarter and we did see a very nice attach rate of vCloud Suites to our ELAs, about 75% of our vCloud Suites actually were in conjunction with ELAs. So our strategy to drive ELAs with vCloud Suite is paying off. If you take that momentum coming out of Q2 and look at the second half of the year, but we had indicated about two thirds of our ELA renewal opportunity would take place. We feel very confident in the second half guidance and we do expect to have a very strong ELA renewal cycle in the second half of the year. It's also important to note that the ELA renewal’s right, are only one portion of our ELA business. We’re actually seeing more and more customers enter into ELAs for the first time as they become more virtualized and look for more management and automation solutions, they’re actually now entering into multi-year enterprise agreements with us to get all of their needs for a two to three year horizon.

Paul Ziots

Great. Thank you for understanding Phil on the one question. Let’s go to the next question please.

Operator

Certainly. Our next question comes from Heather Bellini of Goldman Sachs. Your line is open.

Heather Bellini - Goldman Sachs

Great. I’ll take the transactional side of the business. It looks like you guys saw a slight improvement in the year-over-year growth rate this quarter versus last. I guess, I’m just wondering if you could share with us what type of growth range you think is reasonable for the transactional business in the second half of the year, and I guess specifically I’m wondering if we should start seeing accelerating growth in this segment on a year-over-year basis now that vSOM is in the market and appears to be gaining some good initial traction. Thank you.

Carl M. Eschenbach

Yeah, Heather let me take that, this is Carl. So, as I indicated in our prepared remarks our overall ASPs were actually up year-over-year and sequentially, and our transactional ASPs were up sequentially which was a good sign for us and that was off the back of a strong first quarter of availability of our vSOM bundle which is vSphere with vCloud operations management. So we’re very pleased with our results in Q2. As you know we don’t provide any type of specific guidance around our transactional business or our ELA business for that matter, but we clearly based on results in Q2 expect to see some continued incremental growth and improvement in our transactional business in the second half of the year. And as I said earlier when you’re growing your units as well as you’re increasing your ASPs that is a good sign that the health of the transactional business is in place.

Paul Ziots

Thank you, Heather. Next question please.

Operator

Our next question comes from Jason Maynard of Wells Fargo. Your line is open.

Jason Maynard - Wells Fargo Securities.

Hey, guys good afternoon. Carl, just one question for you, there’s a perception in the market place, clearly that VMware is having a harder time making the transition if you will to this level above the core of vSphere product line and I know vSOM being out is going to be a good thing. But if you go talk to some of the relative, some of the more early edge customers, they’re all looking to move towards OpenStack and there’s a lot to talk about if you were replicating a Google or Facebook like infrastructure, how do you position effectively or how do you tell that story that VMware is not if you will just locking you into this proprietary vStack and there are advantages against this growing movement around OpenStack? Thanks.

Patrick P. Gelsinger

Sure. Let me start and then I’ll – Jason, and then I’ll turn it over to Carl to add to it. An OpenStack has clearly speaking on a topic of many of our customer conversations and as VMware’s goal is to be this cloud infrastructure software leader we’ve also made clear statements that we are building a strategy that will support OpenStack in a very effective way, and we call it our component strategy where we are embracing the OpenStack APIs, adding them to our product and then selling our best in class common technologies into this OpenStack framework. And while it's early and the OpenStack offering is immature we see this as an incremental opportunity largely to these large scale internet providers and service providers that they’re looking for this OpenStack environment unless we can sell our additional best of class technologies into that environment.

We’ve made a number of announcements around vSphere, around management and of course our networking products as embracing this strategy. And as a fact we looked carefully at the OpenStack customers those who have publicly made some statements around OpenStack and our business grew for year-on-year by the quarter and the first half not only grew with them but in fact grew faster than the rest of VMware’s business. So as a result we’ve seen that our customers really are embracing this strategy and we’re having great success in selling those component strategy into OpenStack unless the options that we’re giving them where the flexibility of choice is being quite effective to-date.

Carl M. Eschenbach

Yeah, Jason I think the other part of your question was, how are we transitioning, transforming, re-evolving our sales force and our channel to sell more solution oriented products into the market and I’d say its going actually quite well, and we look at through multiple ranges. If you look at it through the vCloud Suite lens, right, for the fourth consecutive quarter, our vCloud Suite has actually performed from a booking space above our internal plan, which means both our direct sales force and our channel are becoming more and more skilled at selling the four software defined data center suite. So that’s number one.

Number two, we’ve put in place a large enablement plan both for our own sales force and the channel. And an indication of that is last quarter we brought our top partners from around the world together and did nothing, but spend time in talking to them about how to sell the vCloud Suite and specifically sell the software defined data center component. So, I’m bullish on the fact that we’re enabling our direct sales force and our channel to be more skilled at selling the complete solution that we have associated with the vCloud Suite.

Paul Ziots

Thank you, Jason. Next question please.

Operator

Our next question will come from Rob Owens with Pacific Crest. Your line is open.

Rob Owens - Pacific Crest Securities

Great. Thank you very much. I want to ask a little bit about the hybrid cloud, which you’re seeing in terms of early adoption from your successes and also what pricing looks like as it seems some of the competition has been cutting pricing fairly aggressively? Thanks.

Patrick P. Gelsinger

So our early response from the hybrid cloud has actually been very strong from customers. And as we said, we’re in the early access program and thus we’re still very early in this, but we’ve had overwhelming interest from customers to be part of that program. Its still very early, but their response to it clearly gives us an indication at this idea of a transparent hybrid cloud the ability to manage same security, same policies, flexibly move across that environment for both their existing work loads and their emerging work loads has been highly effective and as a result we believe that we really have hit the nail on the head with the value proposition that the enterprise customers are interested in. Carl a few points to add?

Carl M. Eschenbach

No, I think Pat you hit most of them. I do believe we’ve a unique offering in the market and we’re truly the only company out there that can deliver a hybrid cloud in a seamless way for enterprise class customers. So we are working hard to enable our sales force and our channel to be capable of selling this and it goes into full GA in Q4. And as you indicated, Pat, the early interest in vCloud hybrid service is quite strong and our pipeline continues to build as we head towards general availability in Q4.

Paul Ziots

Thank you, Rob. Next question, please.

Operator

Our next question comes from Shaul Eyal of Oppenheimer. Your line is open.

Shaul Eyal - Oppenheimer & Company

Thank you. Hi. Good afternoon. Congrats on a very excellent quarter. Back on Thursday your only runner up in the server virtualization market reported mixed results at best I think also in the server and tools division. What are you seeing from your perspective as it relates to kind of the competitive landscape?

Patrick P. Gelsinger

Thank you, Shaul, and I assume you're referring to Microsoft in that and frankly the competitive dynamic hasn't changed at all as we see Microsoft. When we go head to head with them, we rarely if ever see ourselves losing. We tend to see them compete at the low end of the marketplace where we have offerings and more limited vSphere conditions or product line additions at the lower end of the marketplace. And as we focus more and more in the differentiation of the complete software-defined data center as we've doing, we see the differentiation that we have been more substantial in increasing compared to Microsoft or other competitors and thus we continue to execute our playbook and given our results, I think they speak for themselves vis-à-vis Microsoft or anybody else.

Paul Ziots

Thank you, Shaul. Next question, please.

Operator

Our next question comes from Matt Hedberg of RBC Capital Markets. Your line is open.

Matt Hedberg - RBC Capital Markets

Thanks guys. In terms of software-defined data center, I'd love to hear maybe some early customer feedback as well as how the sales force ultimately is going to be [incentivized] facilities, products and maybe how it should contribute to your large deal portfolio?

Carl M. Eschenbach

Hi, Matt. This is Carl. Thanks for the questions. So, as I indicated earlier, this is the fourth quarter we've had the vCloud Suite in the market and for the fourth consecutive quarter we beat our internal plans. So clearly there's customer demand and pull from the market. And as I said, we continue to enable and bring skill set to both our direct sales force and our channel to get them better positioned and skill to drive the software-defined data center value proposition into our customer base. As far as ELA, if you will, implementations, we have a number of customers that implemented the entire suite and are starting to see, if you will, the first generation of the software-defined data center through the vCloud Suite. And at the end of this year we expect to showcase a number of customers who have implemented the entire suite and share the success of what we're doing with the vCloud Suite.

Paul Ziots

Thank you, Matt. Next question, please.

Operator

Our next question comes from Gregg Moskowitz of Cowen. Your line is open.

Gregg Moskowitz - Cowen & Company

Okay. Thank you. Carl, your comment earlier about seeing more and more customers enter into ELAs for the first time with, I would imagine comes a surprise to most of the people on the call. Can you just discuss the type line as well as the overall opportunities for getting more of your large customer install base to embrace ELAs?

Carl M. Eschenbach

Yeah, so to be honest, Gregg, I don't think it should be that big of a surprise. You've seen our ELA business continue to grow throughout the years and it really is driven by the adoption of virtualization as more and more customers become more virtualized, they're looking for the full suite of solutions from VMware. And when they do that, they mostly enter into an ELA so they can get frictionless deployment of our technology on an ongoing basis. So we're not surprised. We're seeing more and more customers enter into ELAs with us. And when you combine that with the success of our renewal rates, the ELAs that expire either in quarter or within the year, we're very pleased with our ELA business and we expect this will be a big portion of our success going forward. So it's not a surprise to us and we're delivering to our customers a very good solution that they're interested in and it shows a strong commitment from our customers to strategically align with us over a two to three-year horizon.

Paul Ziots

Thank you, Gregg. Next question, please.

Operator

Our next question is from Rick Sherlund of Nomura. Your line is open.

Rick Sherlund - Nomura Securities

Thanks. I had a question that's on your market opportunity going forward. I'm wondering if you could characterize for us maybe what percentage of your vSphere market is running a broader suite solution and maybe some idea of the road map going forward in terms of product deliverables as you deliver more on software to find storage and software to find networking, when would we expect to see more products flow and revenue generation from those products?

Patrick P. Gelsinger

Let me – maybe I will address somewhat the sequencing of the technologies in SDDC and then let Carl add a few comments on the vSphere opportunity specifically in the SDD and the size of that SDD you see opportunity. Overall, what we said is, we see this as a very large expansion of our market as we move into networking, security, storage availability and management of automation. Clearly the management and automation, we’re still very early in that attach rate and that’s the fastest growing one, so that one is now becoming substantive as part of our product revenues. Here we see networking and security that as we've [indiscernible] before in that area that this year is about those early lighthouse wins and getting early traction and we really don’t expect that to be a meaningful contributor on revenue until beginning in ’14 and beyond.

Storage right is of those elements will be the latest one, as we’re just beginning to deliver those technology this year at VMworld. So we really don’t expect that to contribute substantively to our opportunity right until the later part of ’14 or into ’15 when that starts to pick up. So each of these will have their natural gestation cycles, but vSphere the most mature management network security and then a storage and availability in that order over time. Carl?

Carl M. Eschenbach

Yeah and I think the other question Rick was specifically about the opportunity for vSphere and how are we doing and upgrading them either to vSOM or vCloud Suite. And I’d say at this point, right, although we’ve had a lot of success with vCloud Suite and now with vSOM last quarter. We see a significant opportunity to go and upgrade our install base of vSphere, which you all know is very rich out there and these additional solutions going forward. And I can tell you we’ve a very low penetration rate at this time with both vCloud Suite and vSOM, so we see a rich opportunity going forward to upgrade them to a lot of the components of the software define data center.

Paul Ziots

Thank you, Rick. Next question please.

Operator

Our next question is from Patrick Walraven of JMP Securities. Your line is open.

Patrick Walraven - JMP Securities

Great. Thank you. You know Pat, one comment that I hear increasingly from portfolio managers is that they don’t or they worry about only names they compete with the Amazon web services. They look at what Amazon did to the retail industry and they worry, maybe they'll do something similar to IT. He just address the high level, how you would respond to those concerns. Thank you.

Patrick P. Gelsinger

When we’ve launched our vCloud Hybrid Service, we’ve explained very clearly to the market why this is different and unique for the enterprise customer. The enterprise market is very amateur for taking advantage of any public cloud and there is a whole bunch of reasons for that around FLAs, around GRC, around proprietary interfaces. And what they really want is a team of hybrid cloud. They’re not interested in a public cloud that doesn’t allow them flexibility to move back and forth, be able to address today’s applications as well as tomorrow. And this for us is the opportunity. And as we were still early, we don’t have all of the financial metrics to demonstrate this, but I will tell you from the customers that we have interacted with, their response to this messaging has been overwhelmingly positive. And we really believe that positioning for the enterprise customer is unique and powerful and they’re looking at us as a trusted partner to deliver the software defined data center. On-premise in the cloud and in federation with each other, the hybrid cloud service of tomorrow.

Patrick Walraven - JMP Securities

Thank you, Pat. Next question please.

Operator

The next question is from Michael Turits of Raymond James. Your line is open.

Michael Turits - Raymond James

Yes. My question is by ELA. The question has been asked before from a metric perspective, where you’re coming in on ELA is relative to that was sort of benchmarking of a 120% of new ELA value versus old. Is that about what you’re coming in and has that been increasing – that increase this quarter versus last quarter?

Jonathan C. Chadwick

Michael this is Jonathan. Thank you for the question. What we’ve consistently said is that ELAs renewal rates have stayed very consistent. Obviously, we talk this quarter about a strong quarter for renewals, but we also said consistently on a 12 months basis, the overall renewal value is over a 100% and what’s we shared in the past and I can tell you today that metric is as truly today as it has been. So, as Carl shared with you on this call, we’ve been very encouraged by the renewal experience this quarter, which is one of a – number of reasons why we’re very confident about the back off of the year as well.

Paul Ziots

Thank you, Michael. I think we’re going to have one last question. So, the last question please.

Operator

Certainly. Our last question comes from Daniel Ives of FBR. Your line is open.

Daniel Ives - FBR Capital

Yes. Thanks. Maybe from a high level, I mean obviously there's been a lot of transition with the new management team, your new people in different places, talk about may be the organization today, VMware relative to where it was six months ago Pat, from how you see it?

Patrick P. Gelsinger

Sure. Thank you very much, Daniel. Clearly the industry is in a period of transition and VMware has laid out and we’ve really asserted a set of changes that we need to make to focus VMware and with that we’re actively strengthening our leadership team internally and externally, we’re attracting new talent, we’ve added over 500 people in the first half of the year to the Company, a very quality people, we have a fabulous campus that we’re building out here. We continue to be viewed right as a serial innovator in the industry of disruptive and radical technology and this focus effort has brought just incredible clarity to the organization right of what we’re out to accomplish in the industry and with our customers. And as I said at the outset, the momentum is building and the Company is focused and excited as we never had been before.

Paul Ziots

And before we conclude, Pat will have some final remarks.

Patrick P. Gelsinger

So in closing, I’m very pleased with our team’s performance in Q2. We exceeded the high-end of our total revenue guidance. We achieved a record non-GAAP operating margin and overall we’re executing to the plan we shared with you. The Company like the last question asked, we’re aligned, focused, the energy and momentum is building as we focus on the second half of ’13 and beyond. We invite you again to VMworld. I look forward to seeing you all there. We appreciate your time and thanks for joining the call today.

Operator

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

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Source: VMware, Inc. (VMW) CEO Discusses Q2 2013 Results - Earnings Call Transcript
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