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VMware (NYSE:VMW)

Q4 2013 Earnings Conference Call

January 28, 2014, 5:00 p.m. ET

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

Brent Thill - UBS

Walter Pritchard - Citigroup

Heather Bellini - Goldman Sachs

Kash Rangan - Merrill Lynch

John DiFucci - JP Morgan

Brian Marshall - ISI Group

Ross MacMillan - Jefferies

Phil Winslow - Credit Suisse

Matt Hedberg - RBC Capital Markets

Daniel Ives - FBR

Michael Turits - Raymond James

Pat Walraven - JMP Securities

Gregg Moskowitz - Cowen & Company

Shaul Eyal - Oppenheimer

Rajesh Ghai - Macquarie

Rob Owens - Pacific Crest Securities

Abhey Lamba - Mizuho Securities

Operator

Welcome, and thank you for standing by. [Operator instructions.] I would now like to turn the call over to Mr. Paul Ziots, Senior Director, Investor Relations. Thank you. You may begin.

Paul Ziots

Thank you. Good afternoon everyone, and welcome to VMware’s fourth 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 our earnings release and posted on our website historical data for revenue and unearned revenue, excluding revenues in each period attributable to the products and services attributed to Pivotal Software and the products and services associated with divestitures consummated by VMware in 2013.

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

In addition, during today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered 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 on employee stock transactions, the net effect of amortization, 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 first quarter 2014 quiet period begins at the close of business March 14, 2014. 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 Gelsinger

Thank you, Paul, and good afternoon, everyone. Last week we announced preliminary results for Q4 2013 in conjunction with our announcement of our intent to acquire AirWatch. Q4 was a very strong finish to a great 2013 for VMware, and I’m extremely pleased with our team’s performance this year. Our Q4 total revenue was $1.5 billion, up 20% year over year excluding Pivotal and divestitures.

VMware’s total revenue for the fiscal year 2013 was $5.2 billion, up 17% excluding Pivotal and divestitures. Over the course of 2013, we did exactly what we said we would do in every aspect of the business, including financial performance, attracting and retaining top talent, and, most importantly, bringing breakthrough innovation to market that provides strategic business advantages for our customers.

With our strong performance in Q4, and in 2013 as a whole, we have accelerated VMware’s growth and positioned the company well for a strong 2014. We now have significant customer momentum across all three of our strategic priorities as we continue our focus on leading the industry with the software defined data center, hybrid cloud, and end user computing.

VMware continues to build momentum globally, because we are 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 are enabling IT teams to liberate resources from their client server environments while building the mobile cloud infrastructure that will power their businesses into the future.

Our strong performance in Q4 and in 2013 is clear validation that our customers have confidence in our ability to help them address the IT requirements of both today and tomorrow. We are laser focused at VMware on three strategic priorities, and we continue to execute well. I’d like to highlight some areas where we made significant progress in 2013 to accelerate VMware’s growth and deliver against our long term strategy.

For the software defined data center, the rate of customer adoption is accelerating, and it is clear that the industry is strongly embracing our SDDC strategy. Carl will provide more detail in a moment on the value that SDDC is delivering for specific customers around the world.

In August, we officially launched NSX, our network virtualization platform, and global brands like McKesson, Starbucks, Medtronic, Best Buy, and China Telecom have spoken with clarity and conviction about how they’re using the NSX platform to make their networks more agile and efficient.

A critical component of SDDC is IT management, and throughout 2013, we grew rapidly, gained share, and added new cloud management capabilities to our portfolio, empowering IT teams to move at a higher velocity to support top priority business objectives.

One of the most exciting milestones in 2013 was our launch of vCloud Hybrid Service in May, followed by general availability in the U.S. in September and beta availability in the U.K. in December. We’ve recently completed the buildout of vCloud Hybrid Service in four U.S. data centers and one U.K. site, and we also secured our first franchise partner in Savvis.

Most importantly, the early response from our customers has been overwhelmingly positive. There is growing consensus that the hybrid cloud will be the delivery platform for the future of IT. No other player in the market is better positioned than VMware to deliver on the promise of the hybrid cloud.

Our end user computing group also put a bold stake in the ground. Just last week, we announced that we have entered into a definitive agreement to acquire AirWatch, the leading provider of enterprise global management and security solutions.

With this acquisition, VMware is adding a foundational element to our end user computing portfolio. With the addition of AirWatch, we will be positioned to accelerate VMware’s long term growth in a significant way by delivering a complete and proven enterprise class solution for empowering the mobile workforce.

Over the course of 2013, we made several significant moves to accelerate our end user computing group. We reinvigorated our EUC leadership team, and continued to gain share in desktop virtualization.

In October, we announced our acquisition of Desktone, making VMware a clear leader in desktop as a service. The market response has been strong, with a rapidly growing partner community including tier one service providers and a strong pipeline of customers modernizing and moving their desktop infrastructure to the cloud.

These are just a few highlights of the many that demonstrate the momentum behind all three legs of our strategy. I couldn’t be more proud of my leadership team and the entire company. We continue to hire the best and brightest in the industry and will continue to make aggressive moves in 2014 because we see the opportunity here and now.

Our industry has entered a dramatic new phase. Customers need to reduce costs in their existing IT environments while simultaneously building out the mobile cloud infrastructure that will power their businesses in the future.

VMware is one of the few companies that can simultaneously help them address these two challenges. Without a doubt, the coming years will be highly disruptive for many in our industry. At VMware, we are uniquely positioned to transform IT once again.

In closing, I’d like to thank our customers, partners, and employees for their passion and engagement in Q4 as we carry our momentum into 2014. I’ll now turn it over to Carl.

Carl Eschenbach

Thank you, Pat. I’m very proud of our performance in Q4 and 2013. We delivered consistently according to our guidance throughout each quarter and the full year. Q4 went as planned. Excluding Pivotal and divestitures, licensed bookings grew in the very high single digits and total bookings grew in the midteens year over year. This is consistent with the guidance commentary that Jonathan provided on the Q3 call.

Consistent with previous quarters, I’ll provide some color on performance across the regions, with growth rates excluding pivotal and divestitures. The Americas region had an especially strong bookings growth of 20% year over year in Q4, fueled by a continued robust uptake of ELAs.

Total bookings for Q4 in EMEA grew in the low double-digits year over year, which we believe reflects continued strong performance versus our peers in a mixed environment. The U.K. had a very strong quarter, as we began to see improvement in the banking and finance vertical.

Adjusting for the effects of currency, Asia Pacific bookings grew in the high teens year over year in Q4. It’s worth noting that total bookings in China were up over 20% year over year in Q4, and up over 20% for each of the last two fiscal years.

One area I would like to highlight is our strong performance in the U.S. federal market throughout 2013. For the full year, we grew total bookings over 25% in what was a tougher vertical for many this year. In summary, we’re growing across all geos in both mature and emerging markets.

In Q4, ELAs continued to be a way for us to extend our strategic relationship with customers. ELAs increase our ability to sell more products and a wider range of products. For example, in Q4 we saw customers begin expanding the content of ELAs to include both NSX and vCloud Hybrid Service in addition to vCloud Suites, Management, Automation, and EUC products.

We had five record highs in Q4 pertaining to ELAs and renewals. First, as we predicted, we had a record quarter for ELAs, representing 40% of total bookings. Secondly, we closed 10 ELAs greater than $10 million. Third, Q4 tied for our highest ever in-quarter renewal rate for ELAs. Our fourth record was our record high in-quarter renewal rate for support. And finally, the average term for support tied, an all-time high, and remains well above 24 months.

In addition, 2013 was a year of great momentum for vCloud Suite and vSphere with Operations Management, as we exceeded our plan for both products. In Q4, management and automation was once again our fastest-growing product group. We had our largest-ever cloud management and automation product launch, which contributed to management license bookings growth of over 40% for the full year 2013.

Even with the success of our management and automation products thus far, we believe our customer base is only 10% penetrated, reflecting ample runway for growth. In addition, for 2013, we more than doubled the number of partners who make it a specific business to sell management and automation from VMware.

We continue to believe that the path to the software defined data center goes through management and automation, and this will continue to be a key driver of our growth in 2014 and beyond.

Turning to our end user computing group, as we expected, licensed bookings returned to strong growth. Worldwide, Q4 licensed bookings grew nearly 30% year over year in Q4, and grew greater than 40% year over year in the Americas geography alone. For the full year 2013 versus 2012, EUC license bookings grew in the mid-teens, which we believe clearly reflects that we are gaining share.

Our pending acquisition of AirWatch brings a number one asset in the enterprise mobile management and security space into VMware and further increases the full range of data center to device functionality we can offer to our customers.

In 2013, VMware also took big steps to present a vision for the future of the data center and the transformation of the network. Our network virtualization platform, VMware NSX, became generally available in October, and we expect NSX will do for networking what vSphere and server virtualization did for compute.

The majority of our NSX pilots have been turning in to sales. As an example, in Q4 the first quarter of availability for NSX, we closed deals with three of the top five global investment banks, and couldn’t be more pleased with this ringing endorsement of our network virtualization architecture.

As Pat mentioned earlier, NSX was also purchased by some of the most respected global enterprise and telecommunications firms, such as McKesson, Starbucks, Medtronic, Best Buy, and China Telecom. The deals we’ve closed in the fourth quarter signal that innovative companies are making the architectural decisions that place network virtualization and the software defined data center at the heart of their data center strategies, and we are winning the architectural battle.

Since general availability in September, customer and partner acceptance of our hybrid cloud position has been nothing short of remarkable. During Q4, we added hundreds of customers to our VCHS business, and we couldn’t be more excited with the level of participation in the U.S. We also announced VCHS market entrance into the U.K., where we saw strong customer demand for our beta in December and anticipate general availability in February.

In addition, we are seeing significant interest from service providers around the world who want to partner with us on our hybrid cloud, and we expect to have important announcements to make during Q1 and throughout 2014 in this regard.

In Q4, we continued to see significant growth in our hybrid cloud, which once again grew over 100% year over year, and now operates in more than 95 countries around the world. In summary, we executed well against our plan for both Q4 and 2013.

We’re pleased with our performance, but even more importantly, we’re energized by the enthusiasm coming out of our customer interactions. As we look into 2014, we have the strongest portfolio of products, services, and solutions for the mobile cloud era that we’ve ever seen. Momentum is with us, and we’re looking forward to the year ahead and beyond.

With that, let me turn it over to Jonathan.

Jonathan Chadwick

Thank you, Carl. We are very pleased with our Q4 and 2013 results, meeting or exceeding our expectations for the quarter and the year. Before I get into more details around Q4 on guidance, I want to summarize how we performed in 2014.

12 months ago, we provided guidance for the full year. Each and every quarter, we did what we said we were going to do according to the plan we laid out. I couldn’t be more proud of how the VMware team executed in 2013. Our goal was acceleration of both license and total revenue growth as the year progressed, and we achieved that goal.

For example, excluding Pivotal and divestitures, license growth accelerated from 1% year over year in Q1 to 18% year over year in Q4. At the same time, we have increased the diversification of our business’ non-standalone vSphere license bookings, and now greater than 45% of total license bookings compared to greater than 30% in Q4 2012.

In addition, non-GAAP operating margin expanded by approximately 160 basis points from 32.4% in 2012 to 34% in 2013, reflecting strong performance of our portfolio while investing aggressively for future growth.

As an example, we increased our investments in sales coverage and product development, with total headcount up, as expected, by 500 people in 2013. We ended the year with approximately 14,300 employees, right on target.

And finally, cash flow from operations was up 34% in 2013, reflecting the continued strength of VMware’s business model.

In summary, we did what we said we were going to do in 2013, and I’m very proud of these results. Given our positive preannouncement of results last week, I’ll now focus on key additional highlights that will be helpful in your understanding of Q4 performance. As Paul mentioned, I’d encourage you to refer to the slides and financial tables accompanying this earnings call for further details on our results.

Diluted non-GAAP EPS for Q4 was up 25% year over year to $1.01, on approximately 434 million shares. Our balance sheet remains strong with cash and short-term investments at quarter end of $6.2 billion, up $337 million sequentially.

Our operating cash flows of $688 million in Q4 were up 40% year over year. We spent $98 million on capex and consequently free cash flow was $590 million, up 44%year over year. Our cash flows all year reflected our robust operating performance, with strong collections activities while continuing to invest in our business.

During the quarter, we repurchased approximately 1.4 million shares of our stock, for a total of $116 million, at an average price of around $82 a share. For the full year, we repurchased approximately 6.6 million shares for a total cash out rate of just over $500 million and an average price of approximately $77 per share.

Total unearned revenue ended the quarter at $4.09 billion, up 18% from Q4 2012, and of which $1.53 billion is long term, up 21% year over year. As expected, approximately 88% of our unearned revenues will be recognized ratably over future quarters. The unearned revenue mix is in line with prior periods, and is primarily a reflection of our strong maintenance business.

Now, I’ll briefly summarize and augment the guidance we provided last week. As I mentioned, we expect revenue for 2014 to be between $5.94 billion and $6.1 billion, or up 14% to 17% year over year. This revenue and growth range includes our expectations of approximately $75 million from AirWatch.

Excluding Pivotal and divestitures, and including AirWatch, our total growth rate for 2014 is expected to be up 16% to 18.5% versus 2013. License revenues for the full year are expected to be $2.55 billion and $2.63 billion, or up 12% to 16% year over year.

This revenue and growth range includes our expectations of approximately $50 million of license revenues for AirWatch. Excluding Pivotal and divestitures, and including AirWatch, our license growth rate for 2014 is expected to be up 13% to 17% versus 2013.

For Q1 2014, we expect total revenue to be between $1.33 billion and $1.37 billion, or up 12% to 15% year over year. This revenue and growth range includes our expectations of approximately $0 to $10 million from AirWatch.

Excluding Pivotal and divestitures, and including AirWatch, our total growth rate for Q1 is expected to be up 16% to 19% versus Q1 2013. License revenues for Q1 are expected to be between $545 million to $555 million, or up 12% to 14% year over year.

This revenue and growth range includes our expectations of a few million dollars of license revenue for AirWatch. Excluding Pivotal and divestitures, and including AirWatch, our license growth rate for Q1 is expected to be up 14.5% to 17% versus Q1 2013.

Finally, and to assist you with our models, I’ll make a comment regarding non-GAAP operating margin seasonality in 2014. As we factor in the full diluted effect of AirWatch from Q2 onwards, we expect Q2 non-GAAP operating margin to be lower than Q1 by 150 basis points to 200 basis points. We then expect non-GAAP operating margin to increase in the second half of 2014, resulting in approximately 31% for the full year of 2014.

Remaining guidance for Q1 and the whole of 2014, and a reiteration of our 2015 and 2016 guidance provided on our AirWatch conference call last week is included in the slide deck posted on our investor relations website.

In summary, we did what we said we were going to do throughout 2013. We accelerated revenue growth, grew operating margin, and generated robust cash flow from operations. We continue to see significant opportunity ahead, and are excited about the prospects for our customers, partners, shareholders, and employees. 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 we can get to as many people as possible. Operator, let’s get started.

Question-and-Answer Session

Operator

[Operator instructions.] Your first question comes from Brent Thill with UBS.

Brent Thill - UBS

Carl, you mentioned NSX starting to have an impact on ELAs. Just curious if you could give us a sense of what type of impact you’re starting to feel. And maybe more for Jonathan, your view in terms of a full year of the NSX contribution. I know a lot of investors have a lot of questions around this. Any color you can add would be helpful.

Patrick Gelsinger

I’ll just get us started here by just first welcoming everybody to the Q&A session, but overall, emphasizing just how happy we are with overall Q4 performance, and just how strong a finish it was to the year, and just how we’re building momentum across all of the areas of the company.

And one of those of course was NSX, that you’re asking about, and Carl, maybe you can give a few more comments on it. But just overall, we really feel like, as Carl said in his formal remarks, the architectural winds are shifting in our favor as we see the adoption of some of these brand names, three of the five largest banks. I mean, this is really a powerful transition that’s underway. Carl, a few more details?

Carl Eschenbach

To answer your question specifically, you asked about NSX and ELAs, and NSX just came to market, as you know, and was released in Q4. And we saw a nice uptake of NSX becoming part of our ELAs. In fact, in a number of ELAs, NSX was actually driving the ELA itself, as people really view VMware rounding out all three pillars of the software defined data center, from compute to now networking, and ultimately storage.

So NSX is a driver of ELAs, and again, we’re pleased with the uptake of NSX and ELAs within the quarter. So strong performance overall from NSX, and as Pat said, people truly do see this as an architectural shift in how networking will be deployed in the future, and NSX as being part of their decision on how they’ll do that.

Jonathan Chadwick

And to specifically address your question, we still expect 2015 to be the year where we expect to do more meaningful revenue growth contribution in terms of overall contribution to our performance. We’re really pleased, as both Carl and Pat have pointed out, with the as-expected progress with the architectural wins. And those are the key things to watch right now, key architectural wins, key logos, key names, and we performed as we expected, and probably a little bit better, actually, which is great.

Operator

The next question is from Walter Pritchard with Citigroup.

Walter Pritchard - Citigroup

Jonathan, I’m wondering if you could walk us through, just on the license deferred revenue. Obviously that account has moved around a lot historically. It looks like, even if I adjust for Pivotal, it was up about half on a sequential basis of what it was a year ago in the fourth quarter. And I’m wondering if you could talk through that, and also what sorts of things impact that account as we look at it.

Jonathan Chadwick

I think the key thing to know is, if I step back and look at overall bookings numbers, which obviously feed into overall deferred, I just want to point out that the overall bookings did grow very solidly in that midteens growth rate, which is fairly consistent with our guidance going into 2014.

License does reflect the first full quarter of the vCloud Suite in 2012, in Q4. And again, as Carl pointed out, the strong performance we saw in ELAs, and particularly in ELA renewals in Q4, with over 40% of our bookings being ELAs in Q4, plus a significant in-quarter renewal rate of ELAs.

Don’t forget there’s a higher maintenance mix in our ELAs when they first come through from a renewal, especially if we’re doing second or third time renewals. And nine of our top 10 ELAs were renewals this quarter. So those top 10 ELAs we talked about were renewals. That’s good. It shows the overall strength of our relationship with our customers. It is a slightly higher weighting towards maintenance overall, which is why I mentioned the overall bookings number. But I couldn’t be more pleased with how the overall bookings and license performed in Q4.

Operator

The next question is from Heather Bellini with Goldman Sachs.

Heather Bellini - Goldman Sachs

I guess the first one is related to [bigger] seasonality on license in Q1. Jonathan, knowing that you came in at the high end of your range, I think there’s some questions, just due to seasonality being a little bit more than what you thought when you guided to it sequentially back on the Q3 call.

And then the second question is really for Pat or Carl. You talked about, I believe, management being 10% penetrated, as I believe the quote you gave. What percentage of your install base do you think that product set applies to?

Jonathan Chadwick

Because you asked that question just a couple of days ago, I am going to repeat the answer I gave at the time. The main reason for Q1 in particular appearing like it’s seasonally slightly deeper is because we beat in Q4. We had a stronger performance in the overall year, than we expected just three months ago, which is really gratifying to see, and our guidance for Q1 and the full year is entirely consistent with what we anticipated seeing there. So it’s really a question of a stronger compare in the Q4 period reflecting the strong Q4 2013 results.

Patrick Gelsinger

And with respect to management, we have this mantra of no [unintelligible] here. Because we really believe that the management tools apply to essentially 100% of the customers, and the point of the 10% is obviously up from the 5% that we cited six months ago. We’re clearly making progress. But the runway is the rest of the 90%, and that’s what we’re excited about, that we have a long way to go. And it’s not even one management tool, but as we broaden our management suite, we’re selling more of the management tools, provisioning, operations management, financial management, application management. We have a long, long way to go in this category.

Operator

The next question is from Kash Rangan with Merrill Lynch.

Kash Rangan - Merrill Lynch

It looks like you delivered what you told us in the beginning of the year. That’s great. On the license deferral, Jonathan, can you tell us if we should stop expecting this dynamic to continue? I can clearly see that you had a tough comp to your [unintelligible] introduction Q4 2012. Was it just that? Or is there some other change in the way you are billing your customers, customers you’re perhaps booking but not billing? And if you could just add some clarity there, recognizing that your overall bookings growth rate did accelerate. Can you help us understand if we should not have those kinds of expectations about license billings the way your quarters have played out?

Patrick Gelsinger

I just wanted to echo your first comment. We did what we said we would, through the year. And while there was skepticism on our ability to ramp our growth rate over the course of the year, we delivered on that, or exceeded it, every quarter of the year. And I just couldn’t be prouder of my team and the leadership here, to be able to both predict that and then execute against it through the year. So with that, Jonathan, if you could address the specific question?

Jonathan Chadwick

As I think about the coming up year, the year ahead of us, I think you should still expect to see license and growth in deferreds over the course of the year, much like you’ve seen in the past. There will clearly be an effect of an ELA cycle from renewals coming into 2014. We saw an effect of that performance in Q4, higher ELA percentage from a renewal perspective, higher ELAs overall. In particular, from a renewal perspective, you see slightly lower mix of license. But overall bookings, and overall license growth, should continue to contribute to deferred revenue.

Kash Rangan - Merrill Lynch

So license billings should continue is what you’re saying? Because it’s more of a tough comp, but you should be able to continue to defer more and more onto the balance sheet, from licensing?

Jonathan Chadwick

I would look at the flow that we saw over the course of this year. You’re clearly seeing some quarters where we had a little bit more, but we added some less. I’d look at the overall growth and I’d come back to our revenue guide for the entire year. And clearly, you don’t grow revenue without growing bookings. So that’s the net I would step away with.

Carl Eschenbach

The only thing I’d add there is I think just looking at what our deferred is each and every quarter can be challenging, because depending on the composition of an enterprise license agreement we do with the customer, we may take more of the license revenue in a given quarter. Or if it’s a ratable deal, some of it gets pushed out, and then gets on the balance sheet and becomes part of deferred. And really, the composition of the ELAs is really what drives a lot of what’s on the balance sheet versus what goes to deferred in any given quarter. So I think we have to be a little bit careful as to how we look at deferred and back into what our external bookings are.

Operator

The next question is from John DiFucci with JP Morgan.

John DiFucci - JP Morgan

I have a question about end user computing. You just had a huge quarter this quarter, and that was after last quarter being flat. I think Carl said you’re gaining share, and we all know you’ve been investing quite a bit here, and way before AirWatch. Just curious, is this more a result of that investment and execution on that investment working at this point? Or are there any secular changes that are suddenly happening in the market?

Carl Eschenbach

If you recall, in Q3 we said our bookings on our end user computing business were actually slightly down year over year. And now they’ve bounced back and grown at 30% in Q4, on that year over year basis, and up 40% in the Americas. Just shows that we did have a strong pipeline coming out of Q3 as we had indicated, and we expected to have a strong quarter here in Q4.

When you combine that with what we have done on the investment front, to exactly your point, we have invested in the go-to-market strategy significantly in 2013. And a lot of those investments are starting to pay off, and we’re starting to see the productivity ramp out of all of those investments.

And the last thing I would say is if you just look in Q4, with the acquisition of Desktone, and the recent announcement of our acquisition of AirWatch, we fundamentally believe no one has a stronger portfolio to service the end user computing market than VMware going forward.

Patrick Gelsinger

The one other thing that we think is giving us more strength and momentum is the enthusiasm of the new leadership team. And Sanjay, plus the key executives that he’s added to the team, combined with the sales investments that Carl mentioned earlier clearly are just producing a lot more momentum in this category, and we think that’s sustainable. And also, the leadership team that gave us the confidence enough to move forward with the AirWatch acquisition.

Operator

The next question is from Brian Marshall with ISI Group.

Brian Marshall - ISI Group

Jonathan, the operating margin guidance throughout the year was helpful. I was wondering if you could help us with how you view revenue seasonality throughout calendar ’14, in addition to that.

Jonathan Chadwick

I’m not actually going to comment specifically on the back half of the year at this point, but perhaps just to help you out, the way I think about Q2, and assuming the midpoint of our Q1 guide, I would expect sequential growth of around 9-10%, excluding AirWatch, for license, and just over 6%, again excluding AirWatch, for total. So again, just to give you a sense of how I think about Q2 sequential growth rates. And we’ll clearly update you more as we exit Q1 in just 90 days here.

As a further reminder, don’t forget we are expecting to close AirWatch in Q1, and I just want to point out, clearly you noticed it, but if others would just make sure they’re going to the slide deck we had accompanying this call. We gave very specific guidance with respect to what do we expect for AirWatch from a revenue contribution perspective.

Paul Ziots

And just to clarify, it’s the footnotes in slide 11, for anyone that wants to go directly to it.

Operator

The next question is from Ross MacMillan with Jefferies.

Ross MacMillan - Jefferies

Jonathan, coming into 2013, I think we all knew there was a fairly strong yearly renewal that came from roughly the 2010 period, because of the three-year nature of those contracts. Could you just comment on how you think the 2011 yearly renewals play out in 2014? And I guess are you still anticipating that ELAs as a percentage of total bookings will continue to increase?

Jonathan Chadwick

I think there’s probably three or four points I want to make on ELAs. And Carl, feel free to jump in, obviously. But first is, as we’ve continued to experience, in other words we continue to enjoy, ELAs very, very strategic for us, indication of deeper relationships with customers, generally three years in length, or thereabouts, 40% of our total bookings in Q4. As Carl and I, and Pat, have commented, we can see this getting towards the 50% level, probably over the next 12 to 24 months.

The in-quarter renewal rate was one of the highest, if not the highest, we’ve seen with respect to renewals. The renewal opportunity in dollar terms in 2014 is higher than the renewal opportunity we even had in 2013. The dollar renewal volume is higher in 2014 than it was even in 2013. The rate of increase over 2013 is a bit lower as a percentage, but still, the dollar value is very encouraging.

And then last but absolutely not least, I just want to point out that the new ELA mix is actually greater than 50%. So while renewals are a great way for us to have that ongoing recurring relationship with customers, that new ELA opportunity continues to be very strong. So hopefully that helps you think about 2014 the right way.

Operator

The next question is from Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

I want to talk about management and vSOM versus vCloud, just in terms of what you saw this year, adoption of those two. I know one was launched before the other, but as you’re thinking about 2014, which of those two do you have higher expectations for, and why?

Carl Eschenbach

Throughout the year, we’ve been giving you updates on how well both vCloud Suite and vSOM has been performing, and in Q4, we saw another strong quarter of adoption of both of those, if you will, suites. vCloud Suite continues to be sold with ELAs.

Approximately 50% of our ELAs included vCloud Suite, and about 70% of the dollars associated with vCloud Suites were in ELAs as well. So strong adoption of ELAs associated with vCloud Suite. So the notion of the software defined data center, and getting all the components of it, is resonating with our customers and they’re locking us into longer term agreements around those ELAs.

As it relates to the vSOM uptake, we continue to see our channel become more skilled. And I will use the reference that Pat did earlier, at selling non-naked vSphere. And they do continue to sell vSAN into the market at a very aggressive rate, and the adoption has been really strong throughout both Q2, Q3, and Q4. And we expect that to continue as we head into 2014.

Operator

The next question is from Matt Hedberg of RBC Capital Markets.

Matt Hedberg - RBC Capital Markets

Clearly you guys are having success with NSX, which is great to hear. My question is in regard to vSAN, which I believe is still in beta. I’m wondering if you could give us an update on that product, and potentially how disruptive that could be as well.

Patrick Gelsinger

vSAN is in beta. It has gotten tremendous response from customers. And the place that it has just been so spectacular has been the v admin is able to execute managed storage as just part of a normal workflow. And that’s just been that elegance and simplicity. It’s been extremely well received by customers. It will go GA this quarter, so we are expecting an acceleration of that product, given how well the beta has gone.

And as we’ve said, we expect it to ramp over the course of the year and really start to materially contribute next year to revenue growth. But we do expect that customer uptake for it and the focused use cases around VM-driven storage, for low tier use cases, test embed, [VDI], and other things that we’ve seen from our customers has clearly resonated for that value proposition, which we do expect to grow over the next couple of releases of that product.

Operator

The next question comes from Daniel Ives of FBR.

Daniel Ives - FBR

Could you just talk about Pivotal and your thoughts about how that’s ramping?

Carl Eschenbach

EMC will probably cover this a bit more tomorrow on their call, but from our perspective, we’ve been very pleased with how Pivotal is ramping. We have, in Q4, announced two different types, if you will, go-to-market partnerships with Pivotal. The first is we will take their platform as a service and deliver it behind the firewall as a VMware SKU. So if someone wants Cloud Foundry behind the firewall in their own data center, VMware can deliver that.

Secondly, we have announced that the Pivotal platform will run on top of our vCloud Hybrid Service, which allows us to offer a [pas] platform on top of our infrastructure as a service vCloud Hybrid Service. So we’re very pleased with our partnership with Pivotal, their growth. And we’re excited to take them to market, both behind the firewall and in the public cloud going forward.

Operator

The next question is from Michael Turits of Raymond James.

Michael Turits - Raymond James

I was wondering if you’re able to give us any more granularity into AirWatch on more of a pro forma basis? $75 million contribution, maybe how much was the writedown, and what the bookings look like, so we could get more sense of what the growth really is?

Jonathan Chadwick

You know, at this point, it’s probably premature for us to do that. We did talk about 2012 being in excess of $100 million bookings run rate for AirWatch. And I also shared just a few days ago that it’s clearly a high growth business. Remember, they’ve added over 10,000 customers in a relatively short space of time, 1,600-plus employees. So if you take that $100 million and stretch it back just a few years, you can get a sense of the momentum and the growth rate that they’ve been enjoying.

Clearly going into 2014, we’re going to have just a partial year. We are going to have a lagging indicator, being revenue. And I want to get through the close of the acquisition before we give you any more granularity as to how they’re going to perform, especially given purchase accounting on the close of the deal as well. So stay tuned on that.

Operator

The next question comes from Pat Walraven with JMP Securities.

Pat Walraven - JMP Securities

Pat, moving to the big picture here, what key points would you make to investors who worry about competition from Amazon Web Services?

Patrick Gelsinger

As we think about the entire cloud services space for enterprise customers, this is immature. And customers, there’s a lot of tire kicking, a lot of experimentation and test and dev. So overall, anybody in the enterprise space, this is still very early days.

With that, what we’ve said is VCHS is very uniquely focused for enterprise use cases. It’s a truly seamless hybrid cloud. And that value proposition of a hybrid cloud that’s an extension of what they’re doing on premise, with the 40 VMs that we have running on the VMware software stack today, common management, security, networking, and all of those attributes, as we’ve described, they’re just dramatically differentiated from AWS or anybody else in the marketplace.

So while generally we see this large pool of public cloud services, our position is quite differentiated, and that is resonating with customers. And we do expect there will be some competition with AWS over time for different workloads and customers. But today we’re largely pursuing different customers with different value propositions. And as Carl mentioned in his comments, we’re seeing extraordinary response from those customers.

Paul Ziots

I think Jonathan wants to just make a slight alteration to the prior comment.

Jonathan Chadwick

Michael, in my enthusiasm for the AirWatch business I just got slightly ahead of myself. So it’s 2013 that we were estimating $100 million. Still extremely strong progress, greater than $100 million in 2013 with respect to AirWatch.

Operator

The next question comes from Gregg Moskowitz with Cowen & Company.

Gregg Moskowitz - Cowen & Company

Just a follow up for either Pat or Carl on VCHS. And I know it’s early, but you guys mentioned you did add hundreds of customers in Q4. Can you give us a little color on the types of engagements that you’re having with customers so far, and whether you’re seeing more interest so far in dedicated workloads or in virtual desktop?

Carl Eschenbach

We are seeing interest from our customers on multiple dimensions. Number one, they’re interested in just running capacity on demand in a multi-tenant environment. At the same time, we are seeing customer demand for a dedicated private cloud instance on top of vCloud Hybrid Service. So we actually are seeing both the operating models for the public cloud come through from our customers.

What I think we’re probably most interested in and excited about is the fact that we’re getting big brand name logos to adopt vCloud Hybrid Service as their public cloud offering, and truly create the hybrid cloud that no one else has, that allows them to very easily federate their workloads with the common underlying architecture, from management, to networking, to compute, to security. And that’s what our customers are telling us they like most about that.

And I should also point out that that is without us having a lot of new services on top of the platform that we’ll bring to market this year, including a platform as a service, with Cloud Foundry, including desktop as a service with Desktone. We are just coming out of beta on DR as a service, so if our customers want to back up in their VMs into our public cloud offering. So we’re seeing a lot of excitement from our customers, even before we get a lot of these rich services on top of vCloud Hybrid Service that will all come over the next couple of quarters.

And then the last thing I would say is we mentioned that we went into beta in London, in the U.K., with our vCloud Hybrid Service. And very quickly after announcing our beta, it filled up with some of the largest brands and logos in the U.K. market, which again showed strong demand for our hybrid service on a global basis.

Patrick Gelsinger

And just two other comments to add to that. One is that as we are gaining momentum on the vCloud Hybrid Service, the partnership discussions are gaining momentum as well. And as we said in our formal remarks, we expect to have a number of service provider announcements this quarter and through 2014, as those relationships and that value proposition is so distinct that we’re seeing service providers really anxious to participate and extend or global footprint as a result.

And the last comment here is we really think about vCloud Hybrid Service, our franchise partner relationships, as well as VSPP, as a holistic view of our hybrid cloud. And that business grew over 100% year over year in Q4, and this is demonstrating the strength of the value proposition that VMware has for the public cloud, and really reaching into the enterprise customers in a unique way.

Operator

The next question is from Shaul Eyal with Oppenheimer.

Shaul Eyal - Oppenheimer

Question on the desktop, on the VDI product. I know it’s a small contributor of overall revenue, but any color you can share with us on that would be greatly appreciated.

Carl Eschenbach

I’d mentioned this earlier, if you recall, in Q3 we said our bookings on EUC were just slightly down. But we also indicated that we had a very strong and robust pipeline as we headed into Q4. And it played out exactly as we expected. We grew the business 30% year over year in Q4, really off the back of a strong performance in the Americas, which grew the business 40% in Q4 alone.

And we are absolutely seeing customers continue to adopt VDI to help modernize their desktops. And we do believe we are taking market share against the competition, growing at 30% on a global basis, growing at 40% in the Americas, is actually faster than the market’s growing in general. So we feel like we’re doing quite well, and our investments that we made in 2013 on the go-to-market side are truly starting to pay off for us in Q4 in 2014 and beyond.

Patrick Gelsinger

My update as well, on that, is the desktop service, or the Desktone acquisition, which beat our estimates in Q4, and really has a very substantial pipeline as we go into 2014. So we feel like this is another area of unquestioned leadership for VMware, and another opportunity for us to extend our strategic partnership with our channel as well as our service provider partners.

Operator

The next question is from Rajesh Ghai with Macquarie.

Rajesh Ghai - Macquarie

I just wanted to delve a little deeper into the comment around the 10% penetration of management automation. Is that by customer, or is that by the installed base of virtual machines? And how do you really calculate it, given that you have such a wide spectrum of management automation products, staring from vSOM, on the low end, to the vCloud Suite in its entirety?

Jonathan Chadwick

Just to restate the stats, what we’ve talked about is, as we’ve looked at the installed base, and the opportunity to attach the installed base of CPUs out there, we’re estimating that we’re now 10% or less penetrated with management products. And that includes management products sold on a standalone basis, or sold as part of vSOM, or sold as part of the vCloud Suite. So it’s a little bit hard to estimate it with precision, but the main point here is, as Pat pointed out, it’s not 90%. We’ve got 90% of the way to go, and the penetration rate at this point, along with the momentum we’ve been seeing with the attach rate, shows that we’ve got a good growth driver and a driver for 2014 and beyond.

Carl Eschenbach

I would like to add that we’ve brought a complete refresh of our cloud management and automation platform to market in Q4, our largest refresh of that platform ever. And we have seen really good uptake by our customers throughout the quarter, especially in our ELAs. And also, I’d like to add that IDC, in their latest research paper, talked about VMware being the clear cloud leader for management automation, and that’s a great sign for us, as our customers who are highly penetrated with VMware and vSphere are moving now and adopting the rest of our management automation platform as well.

Operator

The next question is from Rob Owens of Pacific Crest.

Rob Owens - Pacific Crest Securities

As you guys look at some of your new opportunities through NSX and VCHS, which do you think could be larger for 2014? And at what point do you think we get some material contribution from either category?

Jonathan Chadwick

You know, when I think about the revenue contributors against 2014, I’d come back to the same drivers we’ve been talking about in terms of material contributions: end user computing, for all the reasons we’ve talked about, even before AirWatch; the refresh of the product line, the significant investments we’ve made from a go-to-market perspective, and the refresh of the leadership team, Sanjay in particular coming in. That, I think is a very, very significant driver of growth, continuing for us in 2014. We’re very, very pleased with the progress we’re seeing there.

That’s one.

Management, as we just talked about, growing very healthily this quarter and continuing into 2014. And again, I think the key thing to understand from a VCHS perspective, even vSAN, as we move to GA, and as we think about NSX moving from architectural wins with dollars attached to them, these are really things going to be contributing in a more material nature as we think about 2015. The key thing is penetrating the marketplace today and starting off from a low base, but seeing what we predict to be relatively significant growth, but off a lower base, contributing more materially in 2015 and beyond.

Patrick Gelsinger

And I’ll just add, if we could take you back to the [TAM] analysis that we had given you at last year’s financial analyst day, the TAM opportunity in the networking area was, we estimated, on the order of $8 billion. The TAM opportunity in the storage area was a similar size. The TAM opportunity that we saw in the hybrid cloud was on the order of $16 billion. So clearly the hybrid cloud of that TAM is the largest incremental one, even as it materializes over ’15, ’16, and beyond, as we see that occurring. But these are all independently very large market opportunities that we’re pursuing. So even though the revenue contributions in ’14 are modest, the incremental growth opportunity for us, ’15, ’16, and beyond, is very substantial.

Paul Ziots

I think it was $14 billion, Pat, but it’s been a little while since we put that out there, for hybrid cloud.

Operator

The next question comes from Abhey Lamba from Mizuho Securities.

Abhey Lamba - Mizuho Securities

Carl, I think you touched upon this a little bit. Clearly end user computing is a big area of focus for you. Can you give us more color on your go-to-market strategy for those solutions? Are you reaching out to the same groups who make decisions on the server infrastructure, and they’re influencing end user computing? Or are you building new relationships within the company? It could be helpful if we could get some color on selling [motion] and strategies for both desktop and mobility on the server side.

Carl Eschenbach

As you know, we invested pretty heavily on the go-to-market side of EUC last year, hiring hundreds of people to help us deliver our platform into the market. And when we sell into the market, we’re actually selling into two different folks. First, there’s the infrastructure folks who have now taken over responsibility for end user computing. Or, we sell to an end user computing organization who’s responsible for desktops and mobility.

And one of the things that led us so attractively to AirWatch is we started to really dive deeper and really engage with the end user computing community inside of our customers. We were winning VDI deals, but we were not participating in, if you will, mobility opportunities, which every time we asked them, who are you looking at, and who may you be going with, the name AirWatch came up, which is what led us to the strategic acquisition of AirWatch to round out our end user computing portfolio.

So net-net, we’re selling to multiple people in the account, either infrastructure people who’ve taken over responsibility for end user computing or there is an end user computing organization itself that does exist in a lot of the large enterprise accounts globally.

Paul Ziots

Before we conclude, Pat will have final remarks.

Patrick Gelsinger

Thank you all for the good questions. In closing, I’m just proud of our team’s performance in Q4 in 2013. In 2014, we will continue bringing breakthrough innovations to market as we help our customers transform to the mobile cloud era of computing. We appreciate your time today. Thank you very much for joining us.

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