VMware (VMW) CEO Pat Gelsinger on Q4 2015 Results - Earnings Call Transcript

| About: VMware, Inc. (VMW)

VMware, Inc. (NYSE:VMW)

Q4 2015 Earnings Conference Call

January 26, 2016 5:00 PM EST

Executives

Paul Ziots – Vice President-Investor Relations

Pat Gelsinger – Chief Executive Officer

Carl Eschenbach – President and Chief Operating Officer

Jonathan Chadwick – Chief Financial Officer and Chief Operating Officer

Analysts

Brent Thill – UBS

John DiFucci – Jefferies

Walter Pritchard – Citi

Philip Winslow – Credit Suisse

Heather Bellini – Goldman Sachs

Kash Rangan – Bank of America

Mark Murphy – JPMorgan

Keith Weiss – Morgan Stanley

Michael Turits – Raymond James

Karl Keirstead – Deutsche Bank

Keith Bachman – BMO

Operator

Good day and welcome to the VMware Q4 and Full Year 2015 Earnings Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Paul Ziots, Vice President of Investor Relations. Please go ahead, sir.

Paul Ziots

Thank you. Good afternoon everyone, and welcome to VMware’s fourth quarter 2015 earnings conference call. On the call, we have Pat Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Chief Operating Officer. Following their prepared remarks, we will take questions.

Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. Slides which accompany this webcast can be viewed in conjunction with the live remarks and can also be downloaded at the conclusion of the webcast from ir.vmware.com.

We’ve also included in our earnings release and posted on our website a reconciliation of GAAP to non-GAAP data for constant currency growth in revenues plus sequential change in unearned revenues for Q4 2015 and Q4 2014. 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. We assume no obligation to, and do not currently intend to, update any such forward-looking statements.

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

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. A 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 2016 quiet period begins at the close of business March 15, 2016. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2014.

With that, I’ll turn it over to Pat.

Pat Gelsinger

Thank you, Paul, and good afternoon everyone. We thank you as always for your interest in VMware. We have quite a bit to cover on today’s call. Specifically, we will be addressing our results for the quarter and our outlook going forward. In addition, we’ll discuss the steps we are taking to best align VMware for the future, especially in the area of cloud computing and a management change.

Let me start with an overview of our results. Q4 was a solid finish to 2015. For the full year, we grew total non-GAAP revenue 13% in constant currency to over $6.6 billion and we increased non-GAAP earnings to $4.06 per share. We were especially pleased with the growth across our portfolio of emerging products and businesses including NSX, end-user computing, and Virtual SAN. All of these businesses demonstrated strong growth in both Q4 and for the full year, underscoring the momentum behind our new focus areas.

We believe they will also contribute to our bookings growth rate exceeding our revenue growth rate for 2016. Here are some highlights. Our end-user computing business crossed $1 billion of total bookings joining both compute and management as $1 billion businesses for VMware. AirWatch ranks as a leader in The Forrester Wave Enterprise Global Management in Q4 2015 and was the only company to receive the highest score for customer confidence in vision as well as for enterprise app extensibility.

In networking, we had a stellar year growing NSX over 100% year-on-year and bringing our total annual bookings run rate to well over $600 million. We believe our emerging networking business will be as transformative to the entire networking and security industries as vSphere has been to the compute and server industries.

Our vSAN products are now well over $100 million in annual bookings run rate and we just released major updates to our Management Suite, vRealize 7. As one of the largest software companies in the world, these results demonstrate the strong demand we’re seeing for VMware’s core and emerging products in an evolving marketplace for IT solutions. Carl and Jonathan will provide some specific commentary in these and other products in a few minutes.

Today, we want to provide further clarity around our cloud strategy. While the cloud is fast becoming mainstream we are only just starting to see the significant implications for IT. Multi-cloud environments are becoming the norm. Customers are increasingly looking for solutions that work across clouds and across devices and most companies now have meaningful portions of infrastructure, which they do not operate or own.

We believe that VMware is uniquely positioned to help our customers manage these highly complex multi-cloud and multi-device environments, using the unmatched power of our software defined approach. There are three components of VMware’s expanded cloud strategy. The first part of our cloud strategy is focused on a extending our leadership in the private cloud, the foundation of our business. With our SDDC technologies, we have helped our customers to transform their datacenters.

During 2015, we saw a significant increase in customers deploying the entire VMware SDDC stack of compute, networking, storage and management. These SDDC technologies are the basis for the power for hybrid cloud capabilities our customers use to extend their private cloud workloads to and from the public cloud and to help them run, manage, secure and connect all their applications across all clouds and all devices.

The second part of our strategy is our focus on how the customers extend their private cloud workloads into the public cloud. Our vCloud Air Service and vCloud Air Network partners are both examples of this. I’d like to take a moment to clarify our strategy for vCloud Air; the service will have narrower focus providing specialized cloud software and services unique to VMware and distinct from other public cloud providers. We will aggressively provide these innovations to our vCloud Air Network partners helping them to accelerate their growth.

VMware is creating cloud software and cloud services for cloud providers. It’s important to note that given that’s narrower focus, we believe the capital expenses we’ve already invested in vCloud Air will be adequate for our needs and that we expect our vCloud Air service to be accretive by the end of 2017.

The third part of our strategy builds on lasts year’s technical preview of NSX connecting and securing end-points across our range of public clouds including Amazon Web Services. Later this year, we will be introducing a new NSX offering, which will enable customers to create secure and encrypted overlay networks across public clouds including AWS and Azure and On-Premise Data Centers.

This new services will provide unparalleled connectivity, security and visibility across multi-cloud IT resources regardless of whether, the underlying infrastructure is VMware based or not. I’m pleased to announce that we’re already offering the first set of limited trials for this service operating on top of Amazon Web Services.

We’ll be investing in similar ways across our portfolio of products to extend their functionality to work with native public cloud applications. As an example of this, we will extend the capabilities of vRealize automation to manage applications built on Azure, in addition to AWS and on other cloud services.

At the center of our business, Mobility Portfolio, AirWatch secures and manages the delivery of cloud applications to users across a world of heterogeneous devices. VMware’s new multi-cloud and multi-device strategy will transcend the limitations of individual cloud services by providing customers with the ability to run, manage, secure and connect all their applications across all clouds and all devices. VMware will also continue to support EMC’s Virtustream service, which is focused on supporting mission critical workloads in the cloud and Virtustream will continue to be an important vCloud Air network partner.

I’d like to turn now to our announcement regarding our CFO’s succession. I regret to announce that Jonathan Chadwick has decided to leave VMware and expand his advisory roles working with a number of companies as a non-executive board member. I have greatly appreciated, Jonathan as a partner and leader at VMware for the past three years. We will listen and we all wish him continued personal and professional success.

I’m very pleased to let you know that Zane Rowe will be joining as our new CFO, replacing Jonathan. Zane brings a wealth of executive experience from prior leadership roles at Apple, United Airlines, Continental Airlines and of course most recently as CFO of EMC. Jonathan and Zane have been collaborating ever since Zane joined EMC and they are committed to ensuring a seamless handoff through Q1 with Zane assuming full responsibility as of March 1.

Before Jonathan gets into the details, I want to make a few high level comments on guidance. As I talked about earlier, we are seeing strong growth across our full portfolio of emerging products. We’ve recognized that our blockbuster compute products are reaching maturity and will represent a decreasing portion of our business going forward, even as they continue to be a powerful springboard for building our new businesses.

As you all know, we continue to grow our newer product areas. 2016 will be a key transition year as we expect the effect of our new products to outweigh the decline in our compute products. With this as a backdrop, in 2016, we expect both total and license bookings to exceed revenue growth by 3 to 5 percentage points as we build our deferred revenue for accelerated growth in 2017 and beyond. We are also keenly focused on our overall business model and managing our investments between existing product lines and new initiatives.

So today, we also announced an internal restructuring and reduction in work force, which will help us to align our resources with our most important priorities. Jonathan will provide more details about these adjustments and their financial impact. VMware has been in the journey of transformation from relying on the singular and almost unprecedented success of vSphere to becoming a multibillion dollar software company with a full suite of SDDC, EUC and cloud offerings.

I appreciate that 2015 was a challenging time for VMware investors. I know many of you have sought additional clarity about the implications of Dell’s planned merger with EMC. We believe our expanded relationship with Dell will be very positive for our customers and for our shareholders. Michael Dell has reached out to our major partners to assure them that VMware will continue to invest in its strong independent partner ecosystem.

Over time, we see significant revenue upside from up selling our full portfolio of products and services to Dell’s new equipment sales and from accessing their incredibly strong SMB go-to market engine. During 2016, we expect our bookings growth to outpace revenue growth as we build our momentum for accelerated growth in 2017 and beyond. We are confident about the outstanding value we can uniquely offer customers in their multi-cloud and multi-device environments.

I’ll now turn it over to Carl to talk more about our business performance in Q4.

Carl Eschenbach

Thank you, Pat. We delivered results either in line or above our guidance. I’m proud of how our teams around the world executed in Q4, particularly their ability to close large deals. We remain pleased with the increasing breadth and year-over-year growth of our newer offerings. We were able to deliver solid bookings results in the quarter in the phase of continued shifts we all had been experiencing as an industry for quite sometime.

VMware’s value proposition around the private cloud, software defined data center, and business mobility continue to resonate with our customers around the world last quarter. We did see what I would describe as a modest budget plush at the end of December, which allowed us to drive a strong enterprise agreement quarter. We did continue to see weakness in China, Russia, and Brazil.

These three countries alone post a two point headwind to our overall bookings growth in the quarter. Taking a look, at our Q4 regional bookings performance on a constant currency basis in relative terms EMEA performed best followed by Americas and Asia Pacific. Note all closed metrics that I will reference on this call are in constant currency terms. In EMEA, we were pleased with our overall business across Europe with the strongest bookings coming from Central Europe, particularly Germany, which were powered by some larger deals.

We also experienced strength in the UK. As I indicated earlier, Russia continued to be challenging due to the economic environment. In the Americas, stronger performance in the U.S. was partially offset by weakness in Latin America, particularly Brazil. The U.S. enterprise and healthcare markets performed well in the quarter. In APJ, we saw good bookings results out of India, Japan and Southeast Asia offset by continued weakness in China as experienced by many of our peers. Total bookings in China were down nearly 40% year-over-year.

We saw a strong execution in our large deals in Q4, enterprise agreements were approximately 42% of total fourth quarter bookings. This was our highest EA quarter in VMware’s history and up from approximately 39% last Q4. This strong performance demonstrates commitments by our customers to invest in VMware’s expanded solutions offerings. We closed six deals at or over $10 million in the quarter and had a healthy mix of new EAs as well as EA renewals. Our end quarter renewal rates for EAs were equal to our record high and our large deals once again included a strong mix of our newer technologies.

For example, all of the top ten deals contained EUC, nine of the top ten deals contained NSX and six of our top ten deals contained vSAN. This reflects the increasing strategic value our customers rely on from VMware. Our end-user computing business continued its market momentum with a strong performance in Q4. End-user computing including AirWatch grew license bookings over 20% year-over-year in Q4.

For 2015, EUC total bookings grew over 30% year-over-year and we are now over $1.2 billion annual run rate. We believe we continue to gain share against the competition in both desktop and mobile, and in 2016 our EUC license bookings could surpass that of our nearest competitor. I’m pleased to say that we now have over 62,000 end-user computing customers across our desktop, mobile, identity and content collaboration solutions.

Breaking down our Q4 EUC business a bit further, the desktop business once again grew license bookings double-digits year-over-year. AirWatch grew license and subscription bookings nearly 50% year-over-year in Q4. For 2015, our AirWatch total bookings grow over $370 million, which we believe makes us the clear number one in the enterprise mobile management space.

Looking back at 2015, our end-user computing business made significant contributions to our overall business. I would like to thank the team for their hard work and commitment to making VMware a powerful force to be dealt with in end-user computing and enterprise mobility.

I’ll now switch for a moment to our software-defined data center, or SDDC products. Our total compute bookings were roughly flat year-over-year in Q4. This includes our support and subscription business and reflects the extraordinary participation and renewal rates that we enjoy with our customers.

Compute license bookings declined in the low-double digits year-over-year and management license bookings grew in the low-teens year-over-year in Q4. Our newer high growth SDDC product, which includes NSX and vSAN grew license bookings robustly. We expect license bookings growth in 2016 from our faster growing newer SDDC products in aggregate to more than offset the decline of compute. Our cloud management penetration is now over 17% of our installed base, up from 14% in Q4 2014, still leaving plenty of headroom for growth.

We saw continued momentum in Q4 for our network virtualization solution, VMware NSX. We are pleased to say that total NSX bookings more than doubled in the second half of 2015 as compared to the first half. We are now well over $600 million annual total bookings run rate versus over $200 million last year at this time.

Based on these results in both Q4 and 2015, it is obvious that our investment in a specialized network and security sales force is paying off. We will accelerate our investment in this specialized sales force throughout 2016. In Q4, the number of paying customers increased over 1,200, over a third of which are repeat customers with multiple NSX purchases.

As I indicated earlier, nine of our top ten enterprise agreements included NSX. We are seeing many of the largest companies in the world recognized VMware’s NSX as the clear industry leader for network virtualization. We had a number of big NSX deals in the quarter, the biggest being with a large automobile manufacturer. Another example of our momentum behind NSX is with Sabre, the leading technology provider to the global travel industry. Sabre is using NSX in production with customers of its intelligence exchange platform.

They choose NSX for its improved network security, streamline networking policies, and significantly increased speed to market for their customers. They expect their NSX environment to grow extensively as more of their airline customers adopt their new intelligence exchange platform. We continue to see increasing production use of NSX. These appointments are across a wide variety of use cases in the three broad categories of IT automation, security including our micro-segmentation capabilities and application continuity. We remain confident regarding our future opportunities in the networking space and seeking extraordinary strong pipeline heading into 2016.

Summarizing a few other product areas, our hyper-converged offerings based on VMware Virtual SAN experienced significant traction. Specifically, our Virtual SAN business saw successes across a wide variety of industries, market segments, and geos. In Q4, total vSAN bookings grew nearly 200% year-over-year, and customer count has increased to over 3,000 versus over 1,000 a year ago. We are now well over $100 million annual run rate per total bookings.

With our next release of vSAN in Q1, we expect our momentum to build given the powerful new enterprise capabilities, the product brings to market. Taking into account, the hardware associated with running the Virtual SAN software and our current booking to run rate, we believe we are the industry leader in the hyper-converged offerings measured both by software and as an appliance.

Last quarter, we expanded our partnership with Kroger, one of the world’s largest grocery retailers. Kroger will leverage VMware’s Virtual SAN software-defined storage technology do help further reduce their operating costs in IT footprint in their stores. Kroger expects to realize a compelling ROI from vSAN and vSAN is a key component of their thin at the edge initiative.

Turning to the hybrid cloud. Total bookings for vCloud Air Network grew in the low-teens year-over-year. We continue to see significant interest from cloud and service providers around the world, who want to take advantage of our hybrid cloud technologies. Jonathan will provide more color on vCloud Air in a moment.

As we look into 2016, we are excited about the future of VMware. The performance of our new products in Q4 gives us confidence and momentum as we head into the New Year. Before turning it over to Jonathan, I would like to thank him for his business partnership over the last three years. I wish him all the best to see embarked upon his next journey. I would also like to welcome Zane to the VMware team. Having known and worked with Zane for quite some time, it is clear to me he’s certainly a welcome addition to our team.

With that, let me turn it over to Jonathan.

Jonathan Chadwick

Thank you, Carl. Our Q4 in 2015 results met or exceeded our revenue and operating margin guidance for the quarter and the year. Before I go into detail in Q4 and guidance for 2016, I want to summarize how we performed in 2015. 2015 non-GAAP total revenues grew 13% year-over-year in constant currency or 10% as reported.

License revenues grew 9% year-over-year in constant currency in 2015 or 5% as reported. Our non-GAAP operating margin for the year was 31.8% and our non-GAAP EPS for 2015 was $4.06 per share. For the full year 2015, our hybrid cloud and SaaS offerings represented just over 6% of non-GAAP total revenues with a growth rate of nearly 80% year-over-year versus 2014.

License bookings beyond standalone vSphere ended the year at greater than 65% of total license bookings, which is up from greater than 30% three years ago, when we began to aggressively expand to new product areas. As we expected standalone vSphere continues to decline in year-over-year terms as well as a percentage of our business.

Before I get into Q4 results, I’ll highlight Carl’s statement of in 2016 we expect dollar growth in newer products SDDC license bookings including from NSX and vSAN will be greater than the dollar declining compute. I will comeback to this point again and I’ll provide guidance in a few minutes.

Turning to Q4. License revenues were $825 million, up 11% year-over-year on a constant currency basis, or up 6% as reported. Q4, total revenues were $1.9 billion, up 12% year-over-year on a constant currency basis, or up 10% as reported. Diluted non-GAAP EPS for Q4 was $1.26 per share or approximately 423 million shares.

In Q4, as we committed two year ago. AirWatch became neutral to non-GAAP EPS, in fact AirWatch was slightly profitable in the quarter. We’re proud of the performance of the entire AirWatch team, as they achieve this important milestone along with the significant bookings growth mentioned by Carl.

Our balance sheet remained strong with cash and short-term investments at quarter end of $7.5 billion, up 6% from Q4 2014. Total unearned revenues were $5.1 billion, up 5% from Q4 2014 and $1.8 billion of this is long-term.

The 2016 guidance, our first point tab, we currently estimate currency will have approximately half percentage point negative impact to both total and license revenue. For the purposes of guidance, we are applying an average U.S. dollar to Euro rate of $1.10. Obviously if this changes our assumptions around currency effects could change and we’ll update you accordingly.

With that as a background, we expect total revenues for 2016 to be between $6.785 billion, and $6.935 billion or up 2% to 4% year-over-year. Without the effect of currency, total non-GAAP revenues for 2016 would otherwise be expected to grow 2% to 5% year-over-year.

License revenues for the full-year are expected to between $2.660 billion and $2.760 billion both reported in constant currency, this is approximately flat year-over-year at the midpoint of our guidance range. You will calculate it that our total revenue growth to exceed our total bookings growth for each of the past six quarters. And that license revenue growth equaled or exceeded license bookings growth in the five of the past six quarters.

While we had a good finish to the year, we were not able to build deferred license revenues for 2015. This reflects the revenue recognized in 2015 or previously deferred revenue combined with our bookings performance throughout the year. As I covered earlier, we are expecting to see a key transition in 2016, with license bookings growth in 2016 from our faster growing newer SDDC products in aggregate to more than offset the decline of compute.

As Pat stated at the beginning of this call for the full year 2016 we are expecting total and license bookings growth to exceed total revenue growth by approximately 3 to 5 percentage points. This is being driven by growth in newer SDDC products including NSX and vSAN, as well as our end-user computing and vCloud Air Network businesses. As a result, we expect to resume building deferred license revenues in the second half of 2016.

For the full year 2016, we expect non-GAAP operating margin to be approximately 31.5%. Excluding vCloud Air, our non-GAAP operating margin is expected to be approximately 33.5% for the full year 2016. We all know that we are separately disclosing the effect of vCloud Air that is expected to have on various financial metrics in 2016 on a slide in the deck accompanying this call.

In addition, as Pat stated we’ve recently initiated resource realignment and restructuring plan. We are restructuring approximately 800 jobs over the course of the first half of 2016 and are reinvesting the associated savings in field, technical and support resources associated with our growth products. We expect to take a GAAP charge of between $55 million and $65 million in the first half of 2016 associated with this action.

Regarding taxes for 2016, we expect a non-GAAP tax rate to be approximately 20%. This reflects a greater mix of revenue and profits in the U.S. which puts an upwards bias on our tax rate which is somewhat offset by the permanent reinstatement of the R&D tax credit in late 2015. Moving to cash flow, we’re expecting that cash flow from operations will be approximately $2.25 billion or a growth rate of approximately 18.5% year-over-year. We now expect capital expenditures to be down slightly from 2015 approximately $270 million. As a result, free cash flow will be approximately $1.98 billion for 2016 or up 26.5%.

Now I want to discuss share repurchase for a moment. In Q4, we repurchased just under 1 million shares of stock for approximately $75 million, which brought total repurchases for 2015 to 13.5 million shares totaling $1.13 billion. This was slightly less than the $1.2 billion in repurchases we had planned for in 2015. As the proposed Dell-EMC merger reduced the number of days we could be in the market during Q4. We got a lot of comments from shareholders requesting that we engage in a substantial share repurchase program. We hear you.

Right now, we’re subject to a number of legal and regulatory constraints. Our Board and management are actually working the issues and we’ll get back to you as soon as we can. For modeling purposes only, we have included the impact of a share repurchase program equivalent to our average annual repurchases over the last three years were approximately $800 million, weighted towards the back half of the year.

This results in a share count of approximately 423 million shares for the year and a non-GAAP EPS range of between $4.07 and $4.16 per share. For Q1 2016, we expect total revenue to be between $1.55 billion and $1.60 billion or up 3% to 6% year-over-year on both a reported basis and in constant currency. License revenues for Q1 are expected to be between $555 million to $585 million. At the mid-point, this implies a decline of approximately 1% year-over-year or approximately flat year-over-year on a constant currency basis.

For Q1, we expect non-GAAP operating margin to be approximately 28% and non-GAAP EPS between $0.83 and $0.85. As in prior years, we expect our operating margin performance to reach a seasonally strong high in the fourth quarter and to be seasonally lowest in Q1. We’re investing in our growth areas such as NSX in the first part of 2016 and expect to see the full benefit of the restructuring I mentioned in the back half of the year. We encourage you to model the year accordingly as you take into account our full year and first quarter guidance. As always, remaining guidance for Q1 in 2016 is included in the slide deck posted on our Investor Relations website.

In summary, I want to thank the entire VMware team for a good finish through a very busy 2015. It has been my great pleasure for being part of the team for the past three plus years. And I want to wish Zane the very best of luck in the role going forward. We’ve worked closely together since he joined EMC and I know he will do very well.

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

Thank you. [Operator Instructions] And we will now go to Brent Thill with UBS.

Brent Thill

Thanks, good afternoon. Jonathan, just on the guidance, can you just talk through a little bit about how you are taking the macro and new account versus some of the internal operational metrics that you look at on the guidance? Tim Cook had mentioned on the Apple call about unprecedented conditions everywhere they look. Are you seeing the similar things that Tim is talking about? And how do you factor that into the guidance? Thank you.

Pat Gelsinger

Brent, thank you for the question. And first, as we start the Q&A just – it’s good to be back talking to the analyst community and the investor community and thank you for the time and interest today. It's a great pleasure to be able to layout a clear view of our going forward strategy in the multi-cloud and multi-device world right well and so how we see this 2016 as being a critical transition year and setting up for the long-term growth of the company. With that the guidance question is very appropriate, Brent, Jonathan if you could fill in the specifics.

Jonathan Chadwick

Yes, sure, and I'll ask Carl to add on specifics around the macro. As we said on the Q3 call, we’d expect to see higher bookings growth overall in the second half. While we did see growth, we didn't see it meet our internal expectations. And that that obviously had an impact specifically on the macro. What we talked about was in Q4 alone, the BRIC countries, although the Brazil, Russia and China in particular caused a 2 point headwind in and of themselves. So that is something we are continuing to track and that is definitely a co-factor as we think about the guidance overall that we've given and go into more detail, but I think that addresses your macro question overall.

Paul Ziots

Thank you, Brent. Next question please.

Operator

We’ll now go to John DiFucci with Jefferies.

John DiFucci

Thank you. My question is for Carl. Carl, I think you’ve scared a lot of people on the last call when you talked about a massive secular shift on the last earnings call because as you know the stock trades – stocks usually trades on fundamentals, but there is a lot happening with VMware, right. We all know that. And fundamentals aren’t always would seems to be driving the stock. But when you talk about a massive secular shift and put it in those kinds of words, I think you’d scared a lot of people for good reason. And in this time – in this call, you did talk about the secular shifts we've all been dealing with for a while, and it sounded like you sort of soften that.

So I just want a little clarification on that. And I mean listen, we know it’s challenging out there. We know people are moving to sort of public cloud, workloads and all of that. But can you talk to us a little bit more – give us a little more color of how you’ve positioned VMware for that and the like I don’t know your customer base is typically enterprise for instance while though you do have some midmarket and maybe the midmarket goes first. What are you seeing in regards to this secular shift? And is it something that we should be – certainly something we should be thinking about, but is this something that that is going to have a very significant impact on your business over the next year?

Carl Eschenbach

Yes, thanks, John. So, first of all I didn’t mean to scare you or anyone on the last call. So, let me give you some additional color as to how we’re thinking about some of these transitions we’re seeing in the industry. So, first, I just say everyone, not just VMware is experiencing significant transitions in our industry today. And in fact we at VMware – we’ve been speaking about this secular shift, one from client server to mobile cloud for quite some time. And that is no longer a prediction, but is now seen clearly by all in the market. So, I think it’s something everyone is seeing.

As we think about our business, John, we believe we’re firmly planted on both sides of that shift. We’re helping our customers to transform their existing environments. And as we do that we believe it gives us a tremendous potential for upside growth in areas like network, storage, and management, some of them are highlighted in my prepared remarks. We also believe we’re firmly established on the other side of that shift in mobility and cloud, especially with some of the additional strategies that Pat laid out today. For example, the NSX strategy we laid out is a clear opportunity for us across multi-cloud world that we live in going forward.

And over the last few months, John, I will tell you as you would expect we’ve been out in front of our customers on a global basis and our customers are clearly and increasingly looking to us as a strategic advisor to help them navigate the transition I think we’re all experiencing in the industry. And we’ve been watching and tracking quite closely a number of both industry analyst reports and financial reports that talks about IT spending trends, and even CIO surveys in 2016. And just about everyone, VMware is viewed as one of the top strategic IT vendors for our customers.

So, we think, we’re in a very good position. And based on this strategy, we laid out today and I’ll ask Pat to give a little bit more color in a momentum, John, we’re seeing in our newer products. We really believe our position will only be strengthened both in 2016 and beyond. And Pat, may be you can give a little more color on some of the announcements you made today around our cloud strategy.

Pat Gelsinger

Yes, and thanks for the question, John. And clearly as we’ve described in my formal comments, we see VMware as multi-cloud and multi-device strategy that we layout transcends the limitations of any individual cloud service. We provide customers the ability to run, manage, secure, connect applications across clouds, across devices and we do that through what we’re doing with private cloud, where we have clear momentum in our SDDC technologies.

And the Carl’s subscription today on the call of the very powerful momentum we’re seeing in these is very strong evidence of the momentum we have in private cloud extending the SDDC with our cloud offerings with the rich partnerships with our vCAN network as well as the vCloud Air strategy we described today. And finally and may be most significantly on today’s call is this ability to connect, secure, and manage across all clouds with NSX, vRealize and AirWatch across clouds and devices and our ability to do NSX, vRealize, on AWS, Azure and other public clouds is clear evidence, right, of the strength of our cloud strategy going forward.

Paul Ziots

Thank you, John. Next question please.

Operator

We will now go to Walter Pritchard with Citi.

Walter Pritchard

Hi, Carl, I guess probably a question for you. I’m wondering you’ve made some comments on the call, last quarter, talking about customers having some architectural uncertainty and that impacting spending. And I’m wondering, it’s been three months, you’ve been through Q4, which is a big quarter. Have you at all changed your view on that dynamic that you described last quarter?

Carl Eschenbach

Yes. So, as I just mentioned kind of a follow-on question to the one I just got from John, Walter, clearly the industry as we’ve all seen, this isn’t a VMware phenomenon that’s going to a transition. But in Q4 I must say I was very pleased with our ability to execute and close larger deals as customers thought about what does their new architecture for the future look like. And they see VMware as I tried to describe, right, sitting on both sides of the shift that’s taking place were helping them to transform their data center and they’re also looking to us for guidance on how to leverage public and hybrid cloud solutions going forward.

So in Q4 based on our execution, I think, we did quite well. Our enterprise agreements were up to a record 42% of total bookings in the quarter. And I’m not going to say that we didn’t see customers take an extra look at every capital expenditure they’re making or before they move into a large enterprise agreement with someone like VMware. They clearly have done that. But, overall, I think our customers are seeing VMware’s strategy and vision come together and we’re executing on a lot of our newer products as you heard in my prepared remarks, which are in a number of the new ELAs and renewal ELAs. So I think our sentiment coming out of Q4 and the strength of our EAs gives us confidence in our ability to continue to be relevant for our customers in the future.

Paul Ziots

Thank you, Walter. Next question please.

Operator

We will now go to Philip Winslow with Credit Suisse.

Philip Winslow

Hi. Thanks guys for taking my question. Walter just asked about just the trends of the core businesses and some of the things you mentioned of – various kind of moving parts influencing that, but if I look at some of your new areas that you called out, you know, NSX and then vSAN, I guess how would you sort of compare and contrast sort of where we are in terms of those sort of taking off and the feedback from customers in terms of just adoption rates there and how you think about it through 2016 and sort of beyond relative to some of these called feeling out headwinds that people are making right now between public cloud, private hybrid and there’s two kind of curves. How should we think about those and how do you guys think about those?

Pat Gelsinger

Yes, maybe sort of a little bit broader context to the answer to start with, Phil. Overall we just had tremendous momentum in the newer products in Q4, and as Carl touched on in his formal remarks, NSX, vSAN, AirWatch, very strong quarters. As we said, clearly as we said 2016 is this transition year where we see the effects of those emerging markets and the strength of those offsetting the shifts in the core business that we’ve been working through and this is a powerful trend for us as it sets up a long-term growth in 2017 and beyond. Right, and as we are making that shift, we see that the strategy that we laid out for private cloud, extending that into the public cloud in the multi-cloud strategy is extremely well-positioned for what customers are looking for on both sides of that trend as Carl has described. Carl, maybe a few more specifics on the emerging products.

Carl Eschenbach

Sure. So Phil, as you know, for a number of years we’ve been expanding our product portfolio outside of compute, and it’s been a big strategy of ours to sell no more naked vSphere as we got into these new products and we’ve talked about a transition that would happen. It wasn’t a matter of, it was a matter of it, it was really about when we’d start to see our newer products offset some of the decline we saw in our compute business.

And coming out of Q4 we saw a significant strength as Pat indicated in things like vSAN, NSX, AirWatch our VCloud Air network once again saw strengths. So all of these newer products are starting to resonate with our customers, and we believe that growth in FY16 will outpace the decline that we expect to see in the stand-alone compute. So we are pretty excited about these newer opportunities and we think that transition is well underway based on the results coming out of Q4.

Paul Ziots

Thank you, Phil. Next question please.

Operator

We will now go to Heather Bellini, with Goldman Sachs.

Heather Bellini

Great. Thank you. I was just wondering, Pat, if you could give us a sense of how big of a drag you see the core compute business impacting your license in total revenue guidance for 2016. Can you give us an idea of the magnitude of the decline that you’re expecting in that for those line items? Thank you.

Pat Gelsinger

Sure, thank you Heather and great to be talking to you again. In the compute space, on premise compute is the maturing market. And inside of that maturing we have very high market share, but also high penetration. The total compute bookings were approximately flat in 2015, there continues to be a huge cash flow generator and a strong driver rate of return bookings and by driving extraordinary renewal rates. The new compute licenses did decline year-on-year, which we expect that trend to continue as we go forward, and they were largely offset by the new product areas, and we do see that transitioning in 2016 as we’ve described. And it sets us up well for the long-term growth. Jonathan, anything else you want to add to that.

Jonathan Chadwick

I think I would just add that we did see good strong growth in some of our combined products. If you remember our strategy overall has been to sell no more naked vSphere and while the ongoing deceleration standalone vSphere was a little bit more pronounced in Q4 which drove the decline that Pat just talked about in overall compute, we saw growth in vCloud Suites and in vSAN, which both of which include Virtustream as you know. So I think that’s a strong indication that, our overall combined product and packaging strategies are working as we think about the newer drivers of our growth going forward, Heather.

Paul Ziots

Thank you, Heather. Next question please.

Operator

We will now go to Kash Rangan with Bank of America.

Kash Rangan

Hey, guys. Thanks you for taking the time to walk through the model transition. So if I understand right, the decline is going to be outpaced by the growth, and to be followed by re-acceleration in calendar 2017, how confident you feel about your assumptions that this increase in the new business can continue to outpace the decline in the core of vSphere. Or is there risk that vSphere could decline even more that you could be in for a couple of years of this transition as supposed to one year of the transition? Thank you very much.

Pat Gelsinger

Yes, Kash, obviously there is unknowns on the marketplace, but given the strength we ended Q4 of the year with the new product growth is really on a strong trajectory at this point. And as they continue to grow we’re confident and as Carl mentioned in his formal remarks, we have an extraordinary pipeline for NSX as one example as we begin the year momentum in all of the growth product areas, and we are now as Jonathan just described on vCloud Suite, vSAN. We’re pretty well-versed and how the compute trajectory looks for the forward. We feel very comfortable with the trajectory, we have the transition year in 2016 and the acceleration of long-term growth. Carl?

Carl Eschenbach

I think Pat, I think you’ve covered it. Based on that Q4 momentum you just spoke about, Pat, we believe particularly things like [indiscernible] and NSX have reached the size and growth rate to become meaningful to our overall bookings in 2016. So I’m – as Pat said, we can always think about some different dynamics in the market, but based on what we are seeing coming out of Q4, we think the growth in these newer products will absolutely offset the decline in compute that we saw exiting 2015.

Paul Ziots

Thank you, Kash. Next question please.

Operator

We will now go to Mark Murphy with JPMorgan.

Mark Murphy

Yes, thank you very much. Pat, regarding your public cloud strategy with vCloud Air, I wanted to ask you to the extent that, that has not generated the same level of visibility or excitement with your partners and customers just relative to what you’ve seen out of NSX and vSAN. I’m wondering to what factors you would attribute that difference, and why did you decide to shift that to a narrower focus rather than perhaps doubling down on your vCloud Air investments.

Pat Gelsinger

Yes. We look carefully, and after the considerations and after we had the Virtustream joint venture considerations, yes, we decided that our focused strategy was the best use of our capital investments right of our unique focus on services that are highly differentiated for VMware customers. And as we describe the hybrid services around data center extension hybrid networking disaster recovery. These are unique services. We also have a great deal of interest from our vCloud network partners in those services.

So our go forward strategy is want to focus on those services, our best highest right most important customers directly, but indirectly, extraordinary amplification through the broad vCloud Air Network. And this I will also point out vCloud Air Network is a significant expanding profitable and growing business area for VMware and that’s we are increasing confidence that we can amplify our unique investments through that broad vCloud Air Network.

Paul Ziots

Thank you, Mark. Next question please.

Operator

We will now go to Keith Weiss with Morgan Stanley.

Keith Weiss

Excellent, guys. Thank you for taking my question. VMware and more broadly EMC is going through a lot of changes right now, and that always runs the risk of execution challenges and the challenges in keeping to people focus. Anything that we should be aware of in terms of increased attrition within employees or increased disruption that you guys have been experiencing in Q4, as work towards the [indiscernible] or anything we should be aware of on a going forward basis in terms of extraordinary execution risk given sort of the disruptions taking place in your business?

Pat Gelsinger

Yes, thank you. I think there is always questions around talent. We’re so focused on our talent and our people. Talent wants to be part, right. And people want to be part of a company that they are passionate about the vision, right. They like who they are working with the problems that they are working on, and VMware is that place. And we continuously focus on making it the kind of place that people have the problems and the opportunities that they want. What we’ve seen is that as we’re laying out the strategy for the future, right.

People are excited about that. We also see that our product strategy and we’re coming up on a major cycle of product announcements as well has our product teams enthused for the year as well. We’re about to go into our leadership in sales kickoff as well, right. We’re firing up for our 2016 vision that you heard us describe today. We believe that we are now well-positioned to execute on this year and set up for long-term growth in the future and we have the people, resources and the passion to accomplish that.

Paul Ziots

Thank you, Keith. Next question please.

Operator

We will now go to Michael Turits with Raymond James.

Michael Turits

Hey, guys. I’m Michael Turits. What are the - saw this as the guidance I think was free cash flow at $1.98 billion. I know you are guiding to lower CapEx probably than we had originally thought of prior to the original Virtustream as announcement. But either way it looks like very solid guidance and yet. We’ve had free cash flow disappointments in the past. So, given the fact that the income statement is being guided lower, what gives you the confidence that you can do this free cash flow number?

Jonathan Chadwick

I was going to bring this up if you didn’t ask me, Michael. So the way I would think about this is, don’t forget in 2015, we had a pretty soft cash flow guide, mainly driven by a number of one-time items. Just very quickly the foreign exchange conversion of overseas receivables during a pretty tumultuous year in the foreign exchange markets. The AirWatch operating cash flow impact associated with earn outs on the transaction, and the GSA settlement that we talked about in I think Q2, these all items had a particularly large impact in 2015.

And to a larger extent they are reversing. They are going away in 2016. So as you appreciate also cash flow is a function of billings, less expenses. It doesn’t get more simple than that. Bookings and therefore billings little bit lower than we planned in 2015 that had an impact and while we managed cost carefully during the year that affected operating cash flow. When we think about that going next year, we’re taking actions as you picked up to manage our cost base, so you’ll see a healthy return to positive cash flow in 2016.

We see the bookings transition, the Carl and Pat have talked about. And then as we think about the free cash flow, there are a number of things to think through here. One is, we’re thinking a far more targeted approach with respect to vCloud Air, reality is we deployed a fair amount of asset base over the course of the last couple of years and while it has never been a significant CapEx investment. We’re very confident to the next year plus we’re going to be position to leverage the existing build out the next couple of years.

The other thing is on the CapEx side, larger facility costs are behind us. In particular around the world our Palo Alto buildings and Bangalore buildings are complete. And then you have picked up that the big delta between the last time we talked to you and this time is ultimately not participating in the Virtustream joint venture. And that’s a significant elimination in our CapEx forecast. So the key thing though is that the outlook for 2016 for both OCF and FCF shows significant improvement in both measures. I want to point out we’re actually above our cash flow guide for this year. And so as we think about 2016 that 26% or just over 26% free cash flow growth I feel very confident about.

Paul Ziots

Thank you, Michael. Next question please.

Operator

We will now go to Karl Keirstead with Deutsche Bank.

Karl Keirstead

Thank you. Patrick, Jonathan, just generally on the growth margin trade-off, despite the material deceleration and revenue growth that you’re guiding to in 2016, you’re actually guiding the operating margins roughly comparable to 2015 and not that far off your prior guidance. So coupled with the headcount actions you’re taking and slimming down vCloud Air. It seems to me that you’re making operating margins a bigger priority than trying to accelerate the top line growth in 2016. Is that the right way to summarize a lot of the data you’ve given us here? Thank you.

Jonathan Chadwick

Yes, I think it’s a balance, right, but we’re certainly focused on both top and bottom line. And you’re right. I guided to 31.5% non-GAAP operating guide for 2016. And obviously, last quarter, just to recap, we talked about 28% reflecting the CSP or the cloud services business with Virtustream. So, we’re at 31.5% for the year. We’ve spent a lot of time as a team planning our investment strategy to reflect where we want to invest for the long-term.

We are specifically reinvesting the resources that are associated with the headcount reduction into the areas of growth for us NSX, vSAN, our storage business and also into AirWatch. These growth businesses as we talked about are approaching key inflection point. We’re encouraged by that momentum. So, we’re managing top and bottom line. I’d say it’s a consistent balance. And I think we’re doing as reasonable job as we can. You’re right, given the revenue outlook, but I think the top-line is something we’re investing for as we think about that balance. So, I feel good about how we’re guiding for the profit for the year.

Pat Gelsinger

I’d just add to that a little bit. We do expect that as a software company one as we continue to scale and grow the company that we can expand our operating margin profile over time.

Paul Ziots

Thank you, Karl. I think we have time for one more question. So, well, let’s make this is the last question please.

Operator

And we’ll take our last question from Keith Bachman with BMO.

Keith Bachman

M&A – in the context of the question is twofold. Number one, if I think about the last couple of years, the long-term revenue outlook I think has come down a bit, particularly as we reflect on the guidance that you just gave. The second is you now have – or presumably going to have a different parent company out there with Dell and EMC. And so how do you think about M&A as you look out over the next 12 months with that as a backdrop? Is M&A is one of the ways you think about to try to reaccelerate growth more specifically? Thank you.

Jonathan Chadwick

Yes, our M&A strategy, excuse me – the M&A outlook that we have is unchanged in the sense that we continue to look for M&A right to complement for our organic growth in R&D as an opportunity to expand the company, right. As Dell has clearly communicated, the VMware cash flows will be used by VMware and we think that M&A use of those cash assets is an important aspect of our capital allocation strategy. And against the strategy that we’ve laid out, we fully believe that we’ll be taking advantage of M&A to fill in and expand our strategic opportunity going forward.

You know I’d also point out that the M&A track record, we’ve had over the last several years, is extremely strong and the two areas – the two of the areas we highlighted of our accelerating growth this year both NSX from Nicira, and AirWatch are our direct results of inorganic moves that we made and now they are paying off handsomely going forward. So our strategy is unchanged, right. The strategy will be to continue to do M&A to fill in and to drive accelerated growth over time and we’re excited about those opportunities and always on the prowl for what they might be.

Paul Ziots

Thank you, Keith. Before we conclude, Pat has a few final comments he’d like to make.

Pat Gelsinger

Yes, thank you very much. And again, we appreciate you joining the call today. Q4 was a solid finish to 2015. We’re pleased with the growth and the momentum behind the newer products as we’re able to describe today. We also look forward to providing customers additional value through this extension of our strategy in the multi-cloud and multi-device way as we outlined on the call today. Thank you again and great to be talking to you.

Operator

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation.

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