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Executives

Paul Ziots - Director, Investor Relations

Patrick Gelsinger - Chief Executive Officer

Carl Eschenbach - President and Chief Operating Officer

Jonathan Chadwick - Executive Vice President and Chief Financial Officer

Analysts

Raimo Lenschow - Barclay's Capital

John DiFucci - JPMC

Kash Rangan - Merrill Lynch

Brent Thill - UBS

Brian Marshall - ISI Group

Rick Sherlund - Nomura

Walter Pritchard - Citigroup

Abhey Lamba - Mizuho Securities

Matt Hedberg - RBC Capital Markets

Shaul Eyal - Oppenheimer

VMware, Inc. (VMW) Q3 2013 Earnings Conference Call October 22, 2013 5:00 PM ET

Operator

Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions) Today’s conference is being recorded. If there are any objections, you may disconnect at this time.

I’d now like to introduce your host for today’s conference, Paul Ziots, Senior Director, Investor Relations. Thank you. You may begin.

Paul Ziots

Thank you. Good afternoon everyone and welcome to VMware’s third quarter 2013 earnings conference call. On the call, we have Patrick Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Executive Vice President.

Following their prepared remarks, we will take questions. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Slides which accompany this webcast can be viewed in conjunction with live remarks and can also be downloaded at the conclusion of the webcast from ir.vmware.com. We have also included in earnings release and posted on our website seven quarters of historical data for revenue and unearned revenue, excluding pivotal and all 2013 divestitures.

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 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 fourth quarter 2013 quiet period begins at the close of business December 16, 2013 unless otherwise stated all financial comparisons in this call will be a reference to our results for the comparable period of 2012. With that I will turn it over to Pat.

Patrick Gelsinger

Thank you Paul and good afternoon everyone. Q3 was a strong quarter for us, as we continued our solid performance for all three quarters of 2013. I’m very pleased with our changed performance and the quarter played out largely as we expected. Q3 total revenues grew 14% year-over-year above the midpoint of our guidance range excluding pivotal and divestitures, total revenues grew at an even faster rate of 19% year-over-year.

Q3 license revenues excluding pivotal and divestitures grew 17% year-over-year exceeding the high end of our guidance range. Non-GAAP operating margin reached 33.9%. VMware continues to build momentum globally because we’re uniquely positioned to help our customers transform to the mobile cloud era of computing. With our portfolio of solutions that extend from the desktop to the data center to the cloud we’re enabling IT teams to liberate resources from the client server environments while building the mobile cloud infrastructure that will power their businesses into the future. Our strong performance in Q3 is clear validation that our customers have confidence in our ability to help them address the IT requirements of both today and tomorrow. Across the business we’re laser focused on delivering unique customer value in three strategic growth areas, software defined data center, hybrid cloud, and end-user computing. These three focus areas are powerful individually but also produce significant advantages for VMware by leveraging synergies across these three inter-related businesses.

For example we recently announced our new desktop as a service offering using technology from our Desktone acquisition. One of the keys to that offering is our ability to host that solution in our vCloud Hybrid service which in turn leverages all the speed and cost benefits of our software defined data center architecture. We’re excited about our acquisition of Desktone as they are the industry leader in desktop as a service. Together VMware, Desktone are well positioned to help our customers quickly modernize and move their desktop infrastructure to the cloud. At VMware we’re delivering against the vision for the industry that is backed up by bold customer centric innovation that will radically transform IT again. At VMworld in the United States and VMworld in Europe last week we engaged with more than 31,000 customers and partners a record attendance. We announced three game changing technologies in vCloud Hybrid service, our Virtual SAN Storage solution and our NSX network virtualization platform. In addition, we also announced an entire refresh of our industry leading cloud management suite, this was the single most impressive and impactful display of VMware innovation in the 10 year history of VMworld.

We demonstrated that the software defined data center is real with strong customer momentum. We laid out our comprehensive vision for the SDDC approximately 1 year ago and we’re now delivering concrete business value and differentiated solutions against that vision. As part of our NSX launch we were joined by IT leaders from Citigroup, eBay and General Electric, three iconic global companies whose executives spoke with conviction about how network virtualization is critical important to speeding innovation as they focus on networking as the next step on their path to the software defined data center. A critical component of SDDC is IT management and we continue to show how traditional IT management practices are giving way to automation enabling IT teams to move at a higher velocity to support top priority business objectives. VMware now ranks number one worldwide in cloud management according to IDC.

In addition to expanding our product portfolio we have been adding significant depths to our leaderships bench, Sanjay Poonen joined VMware from SAP in July to lead our end user computing business. Sanjay Mirchandani joined us from EMC to lead our Asia-Pacific and Japan business and Tony Scott joined VMware in August as CIO having previously served as CIO at Microsoft and the Walt Disney Company. In fact we have aggressively added talent across all levels of the organization with 700 net new employees hired into VMware in Q3 alone. This is the bottom line. VMware is attracting world class talent and our engineering teams continue to deliver breakthrough innovations that drive deep business value for our customers. In closing, I’d like to thank our customers, partners and employees for their passion and engagement in Q3 as we carry our momentum into Q4 and set ourselves up for 2014.

I will now turn it over to Carl.

Carl Eschenbach

Thank you, Pat. I couldn’t be more pleased with our performance in Q3. We built on the momentum of Q2 and delivered yet another strong quarter. Q3 went largely as planned removing the effect of pivotal and our 2013 divestitures both license bookings and total bookings grew in the high-teens year-over-year. For the third consecutive quarter in 2013, we are very pleased with this balanced performance across all three regions. Total bookings in each of our regions, the Americas, Asia-Pacific and EMEA grew in the mid to high-teens year-over-year in Q3.

I would also note that due to our success in helping customers both dramatically save cost and build architectures for the future we exceeded our expectations for the U.S. federal business in Q3. This was in part due to closing the largest ELA in our company’s history this quarter with the U.S. Army. This was a consolidation of what would have otherwise been a number of smaller ELAs, and a deal we had been tracking for a few quarters. We were pleased with our team’s ability to execute in what was otherwise a challenging federal environment. Excluding the U.S. Army deal, our federal business was flat year-over-year. In addition, we had record attendance at VMworld in the U.S. and VMworld in Europe. We couldn’t be more pleased with the energy and excitement of our customers and partners at both of these events. We expect to touch another 27,000 customers and partners during our vForums across Asia-Pacific and Japan.

Overall, we are outperforming on multiple fronts. We closed five deals above $10 million and once again our field teams around the world did an outstanding job of closing ELAs. Approximately, 33% of total Q3 bookings were ELAs and Q3 was VMware’s second highest in quarter renewal rate for ELAs in terms of number of deals renewed. In addition, for the fifth consecutive quarter, our vCloud Suite sales exceeded our internal plans. We also saw vSOM or vSphere with Operations Management exceed internal plans once again in the second full quarter on the market. We are continuing to make progress with our strategy to strengthen the channel and broadly see the market with our operations in management products. The combination of vCloud Suite and vSOM is enabling our customers to make long-term investment decisions with VMware and to partner with us as we take them on the journey to the software-defined data center. As we do this, we are seeing overall increases in our ASPs.

Our professional services bookings growth in Q3 was once again solid. Our customers continue to use VMware’s professional services as a strategic enabler as they make the transition from a client server environment to the mobile cloud era. Our support and subscription in quarter renewal rate was the second highest rate of all-time. This is a strategic part of portfolio. It’s highly profitable and a reflection of strong ongoing customer commitment to VMware. Management and automation license bookings were once again our strongest growing product area this quarter.

As VMware’s customers become more virtualized and adopt a private and hybrid cloud strategy that is designed to deliver more business agility, their needs increase for innovative industry defining 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. Customers are also integrating management products in more parts of the business as a wider range of decision-makers are purchasing management functionality from VMware, including CIOs, CFOs, VPs of IT finance, VPs of operations, etcetera. We continue to work closely with VPs of infrastructure who had been traditionally purchasers of our management products. Based on the opportunity in front of us and the traction you’ve seen to-date we will continue building out a significant management specialist sales organization throughout the remainder of FY ’13 and into 2014. And as we announced last week in Barcelona w will be releasing new versions and updates to the entire management portfolio for vCloud, vSOM and standalone sales. These portfolio updates include major new releases for our vCloud automation center and IT business management solutions and significant updates to vCenter operations management and vCenter Log Insight solutions. These new releases significantly help continue VMware’s market momentum and leadership.

Turning to our end-user computing business after two consecutive quarters of year-over-year license bookings growth in the mid-teens our end user computing license bookings were down year-over-year, with a decrease in the low single digits in Q3. However, we believe we continue to gain market share as a result of our continuing investments such as building out an end-user computing specialist sales force in all three geographies. For example, in IDCs October 2013 Asia-Pacific Client Virtualization market analysis VMware was the market share leader in 2012 by a margin of nearly 10 percentage points and IDC expects VMware to grow market share by more than any other vendor in 2013.

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 this proof of concepts continues to be very high. Unlike many technologies in the marketplace our NSX technology is in production use today and supporting some of the largest deployments in the world. We saw strong NSX momentum coming out of VMworld and delivered more than 5000 hands-on labs associated with NSX. We also announced the general availability of NSX worldwide and an impressive list of over 30 partners that are aligned with us.

Our hybrid cloud business, including VSPP grew once again at more than 100% year-over-year, following the U.S. availability of vCloud hybrid service, we recently announced the opening of our second and third data centers in the U.S. In addition, we announced our plans to bring vCloud hybrid service to the United Kingdom as data in Q4, with availability in Q1 of 2014. Customer interest remains high because VMware is the only company positioned to deliver a seamless extension from the private to the hybrid cloud. In summary, we executed against plan in Q3. We’re pleased with our performance, but even more importantly, we’re energized by the enthusiasm coming out of our recent customer interactions at VMworld. We’re delivering industry changing innovations in the software defined data center, hybrid cloud and end-user computing, and our customers and partners are excited to continue the journey with VMware. With that let me turn it over to Jonathan Chadwick.

Jonathan Chadwick

Thank you Carl. We’re very pleased with our Q3 results meeting or exceeding all of our key goals for the quarter. We’re executing the plan we have shared with you and the year continues to play out as we expected. Q3 total reported revenue growth of 14% year-over-year was above the midpoint of our guidance range. License revenues of $564 million were up 15% year-over-year and exceeded the upper end of our guidance. Excluding pivotal and all divestitures total revenues grew 19% year-over-year in Q3 accelerating from 15% in Q2 and 13% in Q1, license revenue growth accelerated to 17% year-over-year up from 5% in Q2 and 1% in Q1. Overall services revenue grew 13% year-over-year excluding pivotal and all divestitures services revenue grew 20% year-over-year. Moving to operating expenses and profitability. Unless otherwise noted, all references to our expenses and operating results are on a non-GAAP basis and are reconciled to our gap results in the press release tables and posted on our investor relations website.

Operating margin was 33.9% another high end of our guidance range for Q3. We continue to invest in our business and we’re pleased to see that total headcount increased by almost 700 heads [ph] to a total of just over 13,600 heads at the end of September. These investments were primarily targeted to sales coverage, including our sales specialist and emerging market teams and the product teams from management, networking, hybrid cloud and end user computing. Diluted non-GAAP EPS for Q3 was up 20% year-over-year to $0.84 per share on approximately 433 million shares.

Now, moving to our balance sheet and cash flow metrics. Our balance sheet remained strong with cash and short investments at quarter end of $5.8 billion, up $514 million sequentially. Our operating cash flows remained strong as well and were $637 million, up 46% year-over-year. Our total cash spending on CapEx was $94 million and free cash flow was $543 million in Q3, up 50% year-over-year. Our cash flows this quarter reflected our robust operating performance with strong collections activities and lower expenses.

During the quarter, we repurchased approximately 1.2 million shares of our stock for a total of $90 million under our share repurchase program at an average price of around $74 per share. Total unearned revenue ended the quarter at $3.64 billion, up 21% from Q3, 2012 and of which $1.41 billion is long-term. Approximately, 89% of our unearned revenues will be recognized rapidly over future quarters. The unearned revenue mix is in line with prior periods and is 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 the strong commitment to VMware as the core element of their data center strategies.

Before I move on to guidance, I will provide some further updates regarding our product portfolio. As was the case in Q2, a significant portion of our high-teens year-over-year bookings increase in Q3 is as a result of our success in the category of products beyond standalone vSphere. This category includes management and automation, end user computing, vSphere with Operations Management, vCloud Suites and the VMware Service Provider Program. In Q3, over 40% of our license bookings were from these product areas beyond the standalone vSphere. This figure is up from approximately 30% in Q3 of 2012 and reflects the significant uptake in our newer products including the success of our suite strategy with vCloud Suites and vSOM. So again, we are pleased with our bookings growth overall and the momentum in our Suites and newer products.

Now, moving to guidance. Since Q3, total revenues finished according to our expectations. We are maintaining the midpoint of full year 2013 guidance of $5.190 billion and narrowing the range to between $5.175 billion and $5.205 billion representing year-over-year growth of 12% to 13%. Excluding pivotal and divestitures, our total revenue growth for 2013 is expected to be between 16% and 17%. Given our strong license revenue performance in the third quarter, license revenue for the full year is now expected to be within the range of $2.255 billion and $2.275 billion representing 8% to 9% growth as reported and 10% to 11% excluding pivotal and divestitures. In both cases, this represents an increase in the midpoint of guidance by approximately one half of a percentage point.

In addition, given our strong operating margin performance in Q3, we now expect non-GAAP operating margin to be approximately 34% for the full year. While this is ahead of the target we have shared previously, we 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 13 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 shares to 435 million shares.

In regard to cash flow, given our strong cash flow performance this quarter we are raising the range of our outlook for 2013 operating cash flow and increasing the midpoint by $175 million. Our new outlook for 2013 operating cash flow is between $2.3 billion and $2.5 billion. As a reminder, 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. And at this stage we continue to expect capital expenditures on a cash basis to range between $330 million and $370 million for the year. Total revenues for Q4 are expected to range from $1.450 billion to $1.480 billion or a growth of between approximately 12% to 14%. We currently anticipate Q4 license revenue to be between $670 million and $690 million representing growth of between 12% and 16%. Excluding pivotal and divestitures total revenue growth for Q4 is expected to be between 18% and 20% and license growth is expected to be between 15% and 19%.

I will make two additional comments on revenue, firstly we expect a fairly flat year-over-year performance in the U.S. Federal and continue to monitor any potential effects of the U.S. government shutdown. And secondly given the typical seasonal strength of Q4 we’re expecting to build both license deferred and total deferred revenue but at a lower sequential dollar value increase as to compared with last year. We expect non-GAAP operating margin in Q4 to be in the range of 35% to 36%. We see a tremendous market opportunity ahead and we will continue to make investments in product development and sales expansion. GAAP operating margins for the fourth quarter are expected to be approximately 9 to 12 percentage points lower than non-GAAP operating margins. For Q4 we estimate our non-GAAP tax rate to be 18.5% and we anticipate our fourth quarter 2013 fully diluted weighted average share count to be between 431 million to 435 million shares.

Finally I will share some early comments about 2014 more detailed guidance will follow in January. We continue to see the opportunities to grow total revenues in the range of approximately 15% year-over-year. We also remain focused on our non-GAAP operating margin plan previously shared with you at the strategic forum in March and again at Financial Analyst Day in August and we expect the total year non-GAAP operating margins to come in at approximately 34%. GAAP operating margins for 2014 are expected to be approximately 10 to 14 percentage points lower than non-GAAP operating margins. This reflects continued investments in our business given the growth potential we see ahead.

As a remainder Q4 is typically our seasonally strongest quarter with Q1 typically being our seasonally slowest. With that in mind as we look specifically into Q1, 2014 we do expect to see slightly more pronounced seasonality than we experienced in Q1 2013. While we’re not prepared to specific guidance for Q1 at this time for modeling purposes on as reported basis, we are assuming approximately 1 percentage point greater sequential declines in both total and license revenue in Q1, 2014 over Q4, 2013 as compared with the sequential declines for Q1, 2013 over Q4, 2012.

Given these revenue trends and the investments we continue to make, we also expect to see non-GAAP operating margins for Q1, ’14 in the range of about 32% to 33%.

GAAP operating margins for Q1 are expected to be approximately 10 to 14 percentage points lower than non-GAAP operating margins. I encourage you all to model accordingly and I will provide more specific guidance for 2014 in conjunction with our Q4 earnings call in January. In summary we’re very pleased with Q3 our goal was to achieve significantly accelerated revenue growth and we did that in Q3, in addition we delivered strong cash flow and operating margin performance. We continue to see significant opportunities ahead and are excited about the prospects for our customers, partner, shareholders and employees. And with that I’ll turn it back to Paul.

Paul Ziots

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Raimo Lenschow. Your line is open.

Raimo Lenschow - Barclay's Capital

Can you talk a little bit about, I mean everyone else around you have been missing numbers now this earning season if I look at your geographies that looks fine. You know your geographic performance looks fine. Can you tell me what’s different with you guys and maybe talk a little bit about the visibility of that the ELA contracts are given to you as part of that. Thank you.

Patrick Gelsinger

Thank you, Raimo. I will start with that and then ask Carl to chime in on the ELAs. Overall, just as we get started, I just want to reemphasize again how proud we are of the balanced performance across the company products, marketing and then balanced execution across all the geos. And as I said in my formal remarks, Raimo, we see VMware as what’s uniquely positioned to help transition customers through this mobile cloud era of computing over enabling IT to liberate resources from today’s client server environments saving them money so they can invest in the future. In particular, coming off of VMworld, we just saw extraordinary response to the overall software-defined data center vision and strategy and this is resonating powerfully with customers really increasing the strategic relationship that we are building with them is clearly seen by our ELA performance. Carl?

Carl Eschenbach

Yes. So specifically on ELAs, once again we had another solid quarter in ELAs booking 33% of our total bookings in the quarter coming from ELAs. And this is a trend that we continue to see happening as we go forward. We are seeing a common pattern of our customers who have become highly virtualized want to move into a more strategic level of engagement with VMware, in this case ELAs as they want to get access to more of the technology and solution to help them build a software defined data center in the future. As we look forward to Q4, we expect to see seasonality strength in the ELA business and we wouldn’t be surprised if that gets upwards of 40% of our total bookings in the quarter. And the year is playing out as we expected around the ELAs as we said we saw strength in the second half of the year from ELAs, which would drive the increase in our bookings in revenue as compared to the first half of the year.

Paul Ziots

Thank you, Raimo. Next question please.

Operator

Thank you. Our next question comes from John DiFucci with JPMC.

John DiFucci - JPMC

Thank you. And Jonathan thanks for the detail on the guidance. That’s really helpful. But I guess my question is probably for Pat or Carl, I mean, you have a lot going on at VMware and you went through a lot of it on the call, but vSphere, your core virtualization market product is still the majority of your business today. I realize it’s less so as time goes on, but if you had to characterize where you were in the x86 compute capacity that still need to be virtualized. Where might that be? I mean, there is a lot of talk that 70% to 75% of x86 workloads have been virtualized. And I think you come up with the numbers similar to that, but you don’t get paid based on the number of workloads that gets virtualized, you get paid based on the number of CPUs that gets virtualized or the number of – the amount of compute capacity. And I guess even roughly where that might be relative to that 70% to 75%?

Patrick Gelsinger

Yes, thanks John. And the important thing to view is, is that this entire view of our position into the enterprise customers as they continue to virtualize is really a platform for us to broaden the overall position that we had with the software-defined data center technologies and it’s the springboard for management, networking, stores and the complete set of things that we are offering and we really see that as a lot of the strength that we are seeing in our customer, our relationships. With respect to the server virtualization, specifically maybe Carl, you can add a few more specific comments there.

Carl Eschenbach

Yes. And specifically John in server virtualization, I think you guys all understand the penetration rate that we had in the market and the percentage of workloads that are virtualized out there in data center today. And as Pat indicated, we see this as a strong foundation for us to build upon for the software-defined data center. At the same time, we see a rich opportunity going forward for the non-virtualized workloads, because they are most mission-critical Tier 1 applications and we do know that as people look to virtualize the remaining workloads in their data center, they are looking for more high availability, disaster recovery business continuity solutions and they are also looking for different levels of how to manage and operate in this new world of the software-defined data center. So widely adoption of the remaining workloads to a virtualized state maybe slower than that first 60% or 70% we have picked up over the last decade. We actually see a significant up-sell opportunity as we grab to those mission-critical workloads in the future.

John DiFucci - JPMC

And if I might just one quick comment, is it fair Carl to assume that the remaining workloads have to be…

Paul Ziots

John, I am sure we can take your additional question later. We are just trying to be fair to everybody. My apologies. Next question please.

John DiFucci - JPMC

Understood.

Operator

Thank you. Our next question comes from Kash Rangan with Merrill Lynch.

Kash Rangan - Merrill Lynch

Hi. Thank you and congratulations on achieving the improbable of reacceleration which many people doubted. My question was on the ELA side if you look at the 2014 the shape of 2014 relatively to 2011 renewals, are we also setup for another back unloaded year such as so that we went through and also if you could comment about new ELAs, it looks like the numbers keep getting bigger, bigger, commenting on new ELAs and how you expect that to pan out next year would be great. Thank you.

Jonathan Chadwick

Well let’s talk about the strengths of the ELAs overall and I’ll start and we can talk about the renewal cycle in particular. So as you know we have seen a strong opportunity coming into 2013 for the reasons I think we’re all aware of which is the renewal cycle for ELAs in particular from 2010 to 2013 giving us in particular I think a strong opportunity going into the back-half of 2013 and we have certainly seen that we saw that to an extent in Q2, we’re expecting to see it also going into Q4. I think the important point though as we look at 2014 is we continue to track renewal opportunities, the overall dollar value for renewals goes up just not at the same rate as it did from 2012 going into 2013. So it's going to be a driver of growth just not be [indiscernible] growth drivers we think about the opportunity ahead. I think you know the overall opportunity about ELAs as Carl talked about continues to be very strong and showing the strategic relationship, we’re engaging with the customers.

Patrick Gelsinger

Thank you Kash. Next question please.

Operator

Thank you. Our next question comes from Brent Thill with UBS.

Brent Thill - UBS

For Carl just on the end-user computing business, you mentioned bookings down what do you see these change in that business for you that to get more momentum, it seems like you’re gaining traction on the product side but what needs to kind of kick for this market is really becoming straining from your perspective.

Carl Eschenbach

So first of all as you know the first half of the year was quite successful for end-user competing business in both Q1 and Q2 we grew the business in our mid-teens and I would like to point out in Q3 both our EMEA and APAC regions were up you know double digits again year-over-year. Well, what we did not see in Q3 which we traditionally see is any large if you will VDI sales in the Americas and with Americas being the largest percentage of our overall bookings from a region perspective if we go and execute on EUC business in that respective region, it could have a slight impact for the quarter and that’s what we saw.

At the same time I think it's important to know as we look at our Q4 both U.S. and worldwide pipeline it looks extremely strong and we expect to bounce back here in Q4 with another solid quarter in end-user computing and lastly as I said in my prepared remarks, we continue to invest in our end-user computing business both on the go to market side as well as on the product side and as we continue to invest we still believe we are taking market share from the competition and as long as we’re doing that those investments will not stop. With that I'd like to turn it over to Pat and allow him to give some more color on end-user computing as a whole and why it's so strategic to us going forward. Pat?

Patrick Gelsinger

You know I just want to emphasize that we do see this as one of the three strategic legs of our overall strategy, EUC and the overall businesses strategically important to us now and into the future and in the Q3 we demonstrated that really by bringing on a powerful new leader and Sanjay Poonen to drive that business for us as well as our Desktone acquisitions. So we’re investing and really believe that we’re setting out for this being one of the growth drivers of VMware into the future.

Paul Ziots

Thank you Brent. Next question please.

Operator

Thank you. Our next question comes from Brian Marshall with ISI Group.

Brian Marshall - ISI Group

Question with respect to your counter ’14 total revenue guidance of about 15% year-over-year. We forecasted the continued strength on ELA renewals is definitely going to continue throughout 2014 I think the new ELA signs will be strong as well. Can you talk a little bit about what that 15% overall revenue growth is predicated on with respect to transactional business because obviously that’s being moving in the wrong direction as off late. Thanks guys.

Jonathan Chadwick

So I’m not going to breakout specifically what we’re assuming around transaction business in ELAs I think the overall growth opportunity we continue to see being out there are 15% is predicated on continued strength around vCloud Suite, continued strength and penetration around end user computing and the penetration just broadly of what we are seeing in the software-defined data center opportunities. In particular, the growth drivers around management and automation, we expect those to continue well into 2014. There is no question ELAs and the strategic impact those have on us and our relationships with our customers will be – we expect them to be a bigger growth driver, but I look at the overall business and those core drivers, especially when I think about the balanced penetration we are seeing across all of our geographies as well. Those are the main things I am tracking Brian as I think about the 15% for next year.

Brian Marshall - ISI Group

Thank you.

Paul Ziots

Thank you, Brian. Next question please.

Operator

Thank you. Our next question comes from Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

Hi, thanks and congrats guys on a great quarter. Just want to focus in on the management tools, you commented on both vCloud Suite and vSOM, I am wondering if you could just compare and contrast it too in terms of the adoption rates you are seeing especially versus your expectations, but as you think about the second half and sort of next year how should we think about the sort of two combined and then maybe one versus the other? Thanks.

Carl Eschenbach

Yes. So Phil, this is Carl. I will take that. So first of all, as I indicated in my prepared remarks, the management in cloud management business is still one of our fastest growing product areas in the company. And we continue to see that in Q3. And we expect to see that here in Q4. One of the ways we can see that pretty easily is just look at the strength that we are seeing in our vSOM business, which is vSphere with Operations Management as well as our vCloud Suite, which a large percentage of the vCloud Suite is comprised of our cloud management products. So we see customers continuing to invest in our cloud management solution.

The last thing I would say is as we spend time with our customers and may become more highly virtualized, we can continue to hear feedback that they would absolutely want to see a solution from the company who is leading their virtualization efforts in their data center when it comes to cloud management and we think that’s why we are seeing the growth we see today overall in cloud management. And then lastly as Pat and I both indicated in our prepared remarks, we see this as a rich opportunity for us going forward. And just last week in Barcelona, we announced the broadest upgrade as well as new products around our cloud management pipeline that we have ever done in the history of the company and it was received quite well. And based on that, we will continue to invest in a go-to-market strategy that will allow us to grow our current market position in cloud management, because we see the richness of the opportunity ahead of us.

Phil Winslow - Credit Suisse

Thanks, Carl.

Paul Ziots

Next question please.

Operator

Thank you. Our next question comes from Heather Bellini with Goldman Sachs.

Heather Bellini - Goldman Sachs

Hi, great. Thank you for the question and thanks again for the detailed guidance for Q1 as well, Jonathan. My question is you guys have mentioned the success of the suites and the add-on products and you commented that just helping to drive ASPs higher. I am wondering if you could help share with us what the typical up-sell is that you are seeing as customers move one from standalone vSphere to vCloud and also as we see the transactional customers adopting vSOM, so put both of those kind of what’s the typical uplift you are seeing in pricing now that you guys have a few quarters under your belt? Thank you.

Carl Eschenbach

Yes, hi, Heather. This is Carl. I will take the first part of that question. Once again, we saw a 3x increase in ASP when we sell the vCloud Suite into the market. And so our strategy of selling a suite in a solution purposely built to the software-defined data center is paying off and is clearly having impact on our ASPs overall. And in the given quarter in Q3, our ASPs were up both year-over-year and quarter-over-quarter driven by the success of vCloud Suite and now vSOM in its second full quarter in the market. Jonathan, anything to add?

Jonathan Chadwick

The only thing Heather I would just add to that and it’s one of the things we have been thinking about as we think about ASPs in general, our product portfolio is becoming pretty broad at this stage. And as you know, our strategy is to suitify and to bundle into pretty sophisticated packages what we are driving today and so ASPs at an average level. And I again just want to reiterate Carl’s comment that we are up year-over-year and quarter-over-quarter when you look at our overall ASPs, but ASP commentary frankly is becoming a little less relevant for us especially as we bundle and provide more and more of our offerings in suites overall. But again we were pleased with the performance but don’t hand everything you’re doing based on just ASPs.

Paul Ziots

Thank you Heather. Next question please.

Operator

Thank you. Our next question comes from Ross MacMillan with Jefferies.

Ross MacMillan - Jefferies

I have a question maybe for Carl. As you do more of these suites for vCloud and as you think about the bundle you know you had a strong year in ELAs. I’m wondering if that transactional business because less of an important metric because more of your customers are consuming incrementally under ELA. I was just wondering if you could comment on that and how we should think about that transactional business going forward given some of these trends. Thanks.

Carl Eschenbach

So first of all I think it's important that we look at the overall growth of the business and in this case growth our bookings you know 19% on a year-over-year basis I think it's a solid indication that our strategy is paying off and looking at it through just ELAs versus the transactional nature of our business is probably not the best way to look at it because as I said earlier our customers are more and more willing and wanting to engage in a ELA discussion with us because they can get access to more of the components they need to deliver the software defined data center.

Specific on the transactional business it is still very important, it's actually very strategic because it's sees the market which ultimately allows us to upsell to an ELA over time and we think about the transactional business we really think about it in two different ways. Number one, with this our unit growth book like and number two what is the channel skill set to be able to sell the vCloud suite and vSOMS and we think our channel is actually becoming quite skilled, they are selling vSOM and vCloud suite which is you know evidenced by us stating for Q3 both of those platforms beat our internal expectation and when we look at our units which is another indication that it's the transactional business. We were pleased to say that our units were up double digit year-over-year. So again, I don't think it's one or the other, but when you take them in a combined fashion both ELAs and the transactional business, the way to measure our success going forward really is the overall growth of the business and in this case we think a 19% growth in bookings was a really solid quarter.

Patrick Gelsinger

Thank you Ross. Next question please.

Operator

Thank you. Our next question comes from Rick Sherlund with Nomura.

Rick Sherlund - Nomura

I was wondering if you could address the pattern that you have increasing your specialized sales force, as you look at over the next year so what proportion do we think will be specialized in? What do you see is the main benefits of that?

Carl Eschenbach

Sure so let me start and then I’m going to ask Pat to comment as well. So today we have three years at specialized sales force, number one our EUC business, number two our network virtualization business associated with NSX, number three our vCloud hybrid service business where we have a specialized sales force who are skilled at selling more of a service orientation as opposed to a product or license sale and lastly you know as we announced in Q2 we have decided to put a specialized sales force in place around management and automation because we see our cloud management business growing as I said earlier is one of our fastest growing businesses. And we look at these specialized sales force as an augmentation to the core sales force that VMware has and we bring in people with domain specific knowledge of each of these technologies and then in a lot of cases we focus on technical talent because we think it's the technical folks in these sales organization, my guess ease in professional services who brings incremental value to our core sales force. So that’s our philosophy and the mentality and it's working out well in 2013 and we expect a lot of those investments this year to pay off for us in 2014. Pat any color?

Patrick Gelsinger

Yeah as we think about these new areas that w going into we see it as just absolutely critical that we get unique focus in those areas, so as we’re looking at a hybrid service, as we’re looking at EUC, as we’re looking at networking we’re absolutely focused on having people who are both experts in that domain and uniquely focused on accomplishing our strategic objectives there while simultaneously making sure that we enable our core sales motion as Carl has said to be able to carry that load as part of our core suites overtime and we feel like that combination of making both of those work will become fundamental strategic advantage allowing you to see that acceleration in these new areas in ’14. ’15 and beyond.

Paul Ziots

Thank you Rick. Next question please.

Operator

Thank you. Our next question comes from Walter Pritchard with Citigroup.

Walter Pritchard - Citigroup

Hi. Another ELA question, I am wondering if over time you need to evolve to a program where you give customers sort of more flexibility and annual payments as opposed to it and right now most of your deals are three-year upfront and I understand you do have an annual plan, but it is quite a capital expense upfront and just wondering how you are thinking about that on a longer term basis as far as driving ELAs even higher than where they are today?

Patrick Gelsinger

So Walter thanks for the question. At this point, while we do a certain number of one-year term deals. Typically, what we are seeing is ELAs continuing to attract a lot of value from a customer perspective. And we have been very, I think successful in selling on an average three-year transactions. Customers have been paying upfront for those. And it’s one of the significant drivers of cash collection. So speaking as the CFO, I have to say from my perspective, I like that model and will obviously manage our customer demand appropriately, but frankly that model I think is something we want to continue as much as possible.

Paul Ziots

Thank you, Walter. Next question please.

Operator

Thank you. Our next question comes from Abhey Lamba with Mizuho Securities.

Abhey Lamba - Mizuho Securities

Yes, thanks and congratulations. Pat, following up on your earlier comments, can you update us on your strategy with Desktone? Are you planning to offer these desktops as a service directly to customers or will you supply technology to partners and have them hosted? And how does this technology help out with the ROI argument for virtual desktops? Thanks.

Patrick Gelsinger

Yes, great question. And Desktone had a very successful business model working with the range of service providers. And we reinforce that relationship at our VMworld in Barcelona and how important that --was. And we expect that those are going to continue if not accelerate going into the future. We do expect that. So we will augment that with a vCHS, our hybrid cloud host of service over time, but priority one is to continue to expand the business model that Desktone has been successful with to-date. Also with respect to the financial model, we do think it is critical to the adoption of VDI to continue to work on the financial model and many customers find that they are upside down today due to different aspects of the cost model and thus by improvements in things like our storage cost area, things like flash-based storage making a big step there for hosted and I mean for on-premise, but also vCHS, we expect that the Desktone type service from a cloud operation will have very compelling TCO model for customers as well. Carl, anything to add?

Carl Eschenbach

Yes. One last thing is to your earlier point, we are all working hard as an industry to reduce the cost of VDI, because historically it’s been a little bit capital intensive and hard to justify desktop and VDI virtualization. And as we move to this new cloud model based on our Desktone acquisition, it moves to an operating expense as opposed to the capital expense, which many of our customers are in favor of as well as they look to get VDI services to a cloud provider as opposed to a capital intensive acquisition for their own data center.

Paul Ziots

Thank you, Abhey. Next question please.

Operator

Thank you. Our next question comes from Shebly Seyrafi with FBN.

Shebly Seyrafi - FBN

Yes, thank you very much. So you mentioned that your federal business ex the U.S. Army was flat and EMEA was up I think at double-digits, but some of your peers I believe were seeing more challenges in the region. So if you can talk a little bit about your outlook for federal and EMEA in Q4 and whether any of these were factors in the expected larger decline sequentially in the first quarter of 2014? Thanks.

Carl Eschenbach

So let me start in reverse order if that’s okay, Shebly. So first of all regarding Europe in Q3, we were very pleased with our performance in the region despite the tough economic headwinds I think we are all facing across Europe. And in nearly every major country in Europe, we actually grew the business on a year-over-year basis and I would like to call out specifically in Germany, France and Russia, we had very solid quarter. So our performance in the region we thought was just outstanding considering the challenges the region is facing and we continue to execute despite some of those economic environments we are all faced with across Europe. And we have taken into consideration that you know that as we looked at both our Q4 guidance as well as with Jonathan spoke about for Q1 in a full year of FY ’14, as it relates to Federal again I think we’re all aware of some of the challenges we have been facing across the IT industry as a whole for all of that FY ’13 in Federal and for us to come out and deliver the quarter we did really as a testament to how well our teams executed in Q3. We did see a small budget flush and I think because of the strong ROI and the value we bring to our customers like the Army deal they were willing to spend money with VMware to help them save money in the future. The deal itself the largest deal we talked about in my prepared remarks was actually a combination of a number of smaller ELAs that we have tracking so the large ELA was something we had visibility into for multiple quarters. And it was one of the reasons we had success overall in Q3. Now when we look at Q4 we have factored in our federal business in Q4 which as you could imagine is typically seasonally down from Q3 to Q4 and right now we’re not planning for any growth on a year-over-year basis when we look at our guidance for Q4 from our federal business and with that as a backdrop I don’t think I can really comment on the outlook of Q1 or FY ’14 on the federal business. We’re just focusing on Q4 visibility that we have here today.

Paul Ziots

Thank you Shebly. Next question please.

Operator

Thank you. Our next question comes from Matt Hedberg with RBC Capital Markets.

Matt Hedberg - RBC Capital Markets

Sounds like adoption of NSX has been strong. I’m wondering if you can give us any feedback from early adopters such as the ROI or perhaps maybe the impact to legacy networking vendors. Thanks.

Jonathan Chadwick

Sure, let me start from that one. Overall the response coming off of VMworld to NSX overall has been extraordinary. In fact we would say that’s in many respects it was hit of the show and VMworld, the enthusiasm around NSX was really spectacular and I think this emphasizes overall both bundled as part of the VMware staff as well as Multi-Hypervisor, multi-infrastructure it really is a software defined data center technology that provides customers choice, where we saw a huge resonance from our customers about that. We had over 30 partner commit to supporting of the platform as well which shows very much the industry embrace of the technology. As we said before we do see this excitement around network virtualization. It will have an impact on how networking is built and architected overtime but given the strong embrace that we saw from the partner community, yes we truly are thrilled by the opportunity that this presents to not just VMware but overall the industry’s embrace of this new technology area.

Carl Eschenbach

Can I just add one another thing, it's very important as I talked about the financial analyst day that we appreciate from a growth driver, revenue driver perspective where we’re looking at this has being a driver through to starting in a big way, bigger way in 2015 and beyond. So, we’re seeing very, very strong interest from many of our customers as Pat has talked about what is important to look at growth driver, you know period of time for this to be a growth driver in 2015 and some of specific big customers that we had VMworld, Citigroup, eBay, GE are our main brands who are standing and saying this is an exciting new technology. So overall we’re just thrilled.

Paul Ziots

Thank you Matt. I think the next question is need to be our last question. So the last question please.

Operator

Thank you. Our last question comes from Shaul Eyal with Oppenheimer.

Shaul Eyal - Oppenheimer

As you guys think about the shift to the management, to the automation tools, the vCloud, what you see current market says in terms of current penetration rates, are we in the first, second or kind of third innings of that stage?

Patrick Gelsinger

Overall if you think about the industry for cloud management it really is changing the entire way that IT is built and operated today. We see this as still being very, very early and the overall penetration of cloud management tools as replacing the overall way that management was done in the past something we highlighted extensively at VMworld. It's old versus new model for cloud management. So in that context we say it's our first inning maybe second but certainly not more than that as there is extraordinary amounts of installed management tools that are yet to be replaced, modernized and extraordinary IT efficiencies resulting from this world of automated provisioning big data and telemetry and the opportunity to bring our financial management against it.

Shaul Eyal - Oppenheimer

Thank you.

Paul Ziots

Thank you, Shaul. Before we conclude, Pat has some final comments.

Patrick Gelsinger

Yes, thank you all. In closing, I am very proud of our team’s performance in Q3. We delivered breakthrough innovation, attractive world class talent and continue to build momentum as we help our customers transform to the mobile cloud era of computing. We appreciate your time and thank you for joining us today.

Operator

Thank you for joining today’s conference. That does conclude the call at this time. All participants may disconnect.

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