VMware's CEO Discusses Q1 2013 Results - Earnings Call Transcript

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Executives

Paul Ziots - Investor Relations

Pat Gelsinger - Chief Executive Officer

Carl Eschenbach - President and Chief Operating Officer

Jonathan Chadwick - Chief Financial Officer and Executive Vice President

Analysts

Kash Rangan - Merrill Lynch

John DiFucci - JPMorgan

Heather Bellini - Goldman Sachs

Phil Winslow - Credit Suisse

Brent Thill - UBS

Keith Weiss - Morgan Stanley

Walter Pritchard - Citigroup

Operator

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

And now, I would like to turn the call over to your host, Mr. Paul Ziots. Sir, you may begin.

Paul Ziots

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

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

In addition, during today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered in addition to, not as a substitute for, or in isolation from, GAAP measures. Our non-GAAP measures exclude the effect of our GAAP results of stock-based compensation, amortization of intangible assets, employer payroll tax and employee stock transactions, the net effect of amortization and capitalization of software acquisition-related items, and realignment costs. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in the press release and on the Investor Relations page of our 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 second quarter 2013 quiet period begins at the close of business on June 14, 2013. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2011.

With that, let me hand it over to Pat.

Pat Gelsinger

Thanks, Paul and good afternoon everyone. Q1 was a solid start to the year despite a mixed economic environment. I am very pleased with my team’s performance this quarter particularly in light of recent results from many of our industry peers. Total revenues for Q1 increased 13% for $1.19 billion with a non-GAAP operating margin of 32.5%. Looking ahead we see tremendous opportunity based on our unique role in the industry. VMware’s vision is to empower people and organizations by radically simplifying IT through virtualization software. Our customers are looking to us to help them solve some of the toughest challenges in IT and simple and elegant ways thereby delivering new levels of efficiency control and agility.

To do this we will continue to introduce new innovations and offerings that will empower IT as a broker of services that’s why the speed of business and competitive advantage. This vision is based on a laser focus on what VMware does best and our ability to enter 2013 execution ready looks full strategic alignment across the leadership team. Our realignment actions are ahead of schedule and nearly complete and we’re proud of the VMware team for navigating these changes so well. We have focused the entire company around our innovation priorities without skipping a beat on business results throughout the realignment. This includes the successful integration of our cloud application platform assets into the new pivotal organization under Paul Martiz’s leadership.

We’re excited to engage with Pivotal as a strategic partner and investor and congratulate the new team as they hit the ground running. Based on this operational momentum execution in Q1 and our view on the macro-economic conditions for the year we believe we’re on track to achieve the full year FY ’13 guidance provided at our strategic forum for investors on March ’13. Jonathan will detail these areas and (inaudible) FY ’13 expectations again during his section of the call.

VMware strategy is firmly in place with our three growth priorities, software defined data center, hybrid cloud and end user computing serving as the core missions that will drive our execution for 2013 and beyond. We’re on a multi-year journey as we guide our customer’s technology and business transformation. We believe this IT transformation presents VMware with a $50 billion total addressable market opportunity by 2016. With this core strategy and market opportunity in mind I would like to double click briefly on our momentum, our perspective on the industry and the increasing role we play with in the IT sector.

First we’re pleased with our continued progress with the software defined data center opportunity, we continue to deliver innovations and networking securities, storage and management as powerful as those that we lead and continue to lead as server virtualization comprehensively deliver through the vCloud suite. Extending our network footprint we recently outlined our intentions to merge the VMware vCloud networking and security product line with the Nicira network virtualization platform into the single product family based on a common technology foundation to be named VMware NSX. We’re also set to further deliver against the software defined data center architecture in the second half of the year with broader software defined storage solutions for stand-alone products and within the vCloud suite. Our unique ability to radically simplifying our customer’s day to day operations through the software defined data center is enabled by closely weaving management and automation innovation as part of the vCloud suite. We’re happy with our progress with these solutions including early customer response to our recently announced vSphere operations, management solution.

And while the large majority of customers prefer an integrated cloud offering from VMware some consider assembling a cloud solution using multiple technologies to help them manage an automate those complexity we engage across the rich eco-system of vendors and open source solutions. We see OpenStack emerging as a framework for assembling a cloud infrastructure and intend to enable our best of breed networking, compute storage and management technologies to be integrated into OpenStack and other environments thereby extending the addressable market opportunity for VMware while providing additional choice for our customers. For example, last week we announced these for your support as a virtualization platform to the latest OpenStack release. Further expanding on the software-defined datacenter opportunity and on VMware is it built to offer customer’s choice we have seen significant interest for both customers and partners in response to our intention to extend this architectural approach into a hybrid cloud service offer. This new offering will extend the value of VMware from the inside out, leveraging a common management, orchestration, networking, and security model into the public cloud without requiring changes to existing applications.

As we outlined at the strategic forum, we expect to launch VMware vCloud Hybrid Service mid-year and intend to make it available through our existing service provider channel, systems integrator and outsourcing partner ecosystem to accelerate customer’s journey to the cloud. We have created the new hybrid cloud services business unit, and recently welcomed cloud services veteran, Bill Fathers as Senior Vice President and General Manager.

And finally, we are aggressively moving forward with our end user computing business, a natural extension of the core principles of virtualization to create a truly virtual workspace for seamless connection across any device, any workload, and any cloud. The VMware Horizon 3 is a comprehensive platform for workforce mobility using virtualization to transform silos of data, applications, and desktops, and to centralize the IT services. As a result, IT can easily provision manage and deliver applications to end users on the devices of their choice.

Over 500,000 customers won their business on our infrastructure supported by one of the richest ecosystems on the planet, and over 36 million virtual machines supporting both foundational and mission-critical apps won on VMware’s platform. This puts VMware and our customers in an enviable leadership position as the industry moves from the client server era to the mobile cloud era. VMware is the virtualization software infrastructure company, and the only company capable of providing an end-to-end infrastructure solution designed to bridge our customers, legacy client server apps and desktops to the next-gen apps for the mobile cloud world.

We continue to execute against our strategy and our position in the market is clear as we embark on this multi-year journey with our customers. We don’t take this position for granted. And again, I would like to thank our customers, partners, and our people for their passion and engagement as we lead into our aspirational goal of becoming the greatest infrastructure software company of this decade.

With that, I’ll turn it over to Carl.

Carl Eschenbach

Thanks Pat. I would also like to congratulate employees and partners for achieving Q1 performance in conjunction with simultaneous execution of both the pivotal transition and our broader realignment efforts. As indicated in our last earnings call, I have never seen VMware more focused. Our three growth priorities, the software-defined datacenter, hybrid cloud, and end-user computing have alignment across all functions in the company as well as our partner community. We continue to build our industry thought leadership, which is evident by the industry support of the software-defined datacenter launched at VMworld last August.

Operationally, we are consistently meeting our short-term goals as we build a deeper foundation for VMware’s future. We continue to bring world-class software engineers, executives, and broad-based talent into VMware while simultaneously building an environment for our employees that foster both personal and professional growth from training and development programs to our focus on giving back to the communities we serve. We view these investments as a fundamental win-win for VMware, our employees and our customers. And we will continue to build these programs in support of our aspirational goal to add just reference to become the greatest infrastructure software company of this decade. As per the results this quarter, we are pleased with our performance in Q1 and delighted with the team’s execution, particularly in light of new expectations for the U.S. and Europe along with uncertainty in the U.S. federal government standing due to the sequestration. Results were in-line with our expectations in all three regions. The Americas, EMEA and Asia-Pacific. This performance was a result of solid execution across the entire company, our customer operations teams around the world did an outstanding job closing ELAs and what is typically a seasonally tough quarter for technology companies. Q1 was a second full quarter of availability for the vCloud suite. We exceeded our internal bookings plan in Q1 and as expected approximately 75% of vCloud’s suite bookings were part of enterprise license agreements. Customers are excited about the tremendous efficiency benefits they are realizing from the suite, for example Symantec Corporation uses vCloud suite and has been able to reduce the time it takes to create environments from 20 to 30 hours down to just 10 to 15 minutes. Symantec has now deployed over 145,000 virtual machines leveraging the vCloud suite.

Enterprise license agreements were approximately 29% of total first quarter bookings, this is up from approximately 22% last Q1 and demonstrates customers commitments to investing in VMware’s expanded solution offerings. We were able to accelerate and close two ELAs greater than $10 million in the quarter had a healthy mix of new ELAs as well as ELA renewals and continue to see a nice tax rate of non-vSphere solutions to our ELAs.

As we expected blended ASPs for vCloud’s suite were more than three times of blended ASP for vSphere in Q1 which is a strong indication of the incremental value VMware brings to customers with one integrated suite comprised of vSphere, management and automation and network and security functionalities. We’re very pleased with renewal rates within the quarter as we achieved an all-time high in percentage of renewals with any Q1 and the second highest in quarter renewal rate of all-time. This reflects a vote of confidence from our customers and our products and solutions, technical support and upcoming product enhancements.

The momentum in continued strength of renewals across our ELA and renewals businesses reinforces VMware store as a long term strategic partner to our customers. Transactional bookings were up modestly year-over-year despite the effect of softening X86 server shipments on our OEM business. We are pleased by initial customer reaction to the recent launch of vSphere operations management and vSphere data protection at our partner exchange event in February where we hosted more than 4100 registered attendees from partners around the world.

We continue to put in place programs to help drive additional transactions via our channel partners and also continue to work with the channel partners to increase uptake of adjacent products. Q1 was a strong quarter for our management and automation product lineup. Standalone, management and automation license bookings were up double digits year-over-year. This does not take into account management and automation functionality sold within the vCloud suite. It is important to note that vCloud suite and vSphere operations management or vSom become an increasingly large portion of our total license bookings, stand-alone management and automation bookings must be viewed in conjunction with vCloud suite and vSom in order to understand our expanding footprint in this product area. vCenter operations management suite continues to be one of VMware’s fastest growing products since vSphere and our investments in channel recruitment enablement and sales incentive had been paying off. vCloud automation center has been gaining traction particularly well with our financial services customers. vCenter operations management suite and vCloud automation center work in both vSphere and non-vSphere environments.

Our end-user computing license bookings were up in the mid-teens year-over-year. We continue to make investments across the board in end-user computing go-to-market activities, including increased focus on verticals such as financial services, the public sector, and healthcare. In Q1, we launched an integrated VMware Horizon Suite, the industry’s most comprehensive platform for workforce mobility. We are pleased with the initial response to the suite as both existing and new customers look to leverage Horizon functionality to serve their end-user needs.

As Pat mentioned earlier, network virtualization is one of the next big steps for our customers on the pack to the software-defined datacenter. We expect to launch NSX in the second half of 2013, and it will represent the full potential of network virtualization working across VMware and non-VMware hypervisors and cloud management systems, as well as underlying networking hardware. By virtualizing the network, VMware NSX will allow customers to accelerate application deployment, lower both capital and operational cost, and transform network operations in a non-disruptive manner. We are aggressively aligning all assets in go-to-market efforts to take advantage of the strong demand for a significantly better approach to networking enabled by virtualization.

And I am very pleased with the reaction from customers who are on the leading edge of adopting this next wave of virtualization technology, in addition to existing companies such as Rackspace and eBay, Intel, NaviSite, a Time Warner company, and Colt, a major European service provider or a few of the companies currently deploying are actively exploring proof-of-concepts with VMware’s network virtualization technology. As I said on previous earnings calls, we are in the early days of this market, but I am increasingly bullish on the opportunity to monetize our lead in virtualization of the network. And we will continue to provide updates on how this market is evolving over the coming quarters.

Our VMware Service Provider Program once again tracked well in the quarter as public cloud providers continue to leverage our cloud infrastructure program for their service delivery. As we have stated previously, we believe this ecosystem of providers is second only to Amazon in public cloud market share, and this program is one of the fastest growing parts of our business with bookings growth over 100% for Q1 2013 versus Q1 2012. In addition, as we laid out at our recent strategic forum event in March, our customers want to leverage cloud and cloud services for both existing applications as well as next generation applications, and they want to do it in a way that’s consistent in how they manage, operate, and deliver IT services today from their existing datacenter.

Our partner community has also been telling us that as they talk to VMware’s customers, there is a big desire of VMware public cloud offering that is in synchronization with what they are running in their datacenter today. Because we already had been successful in the private cloud, we want to extend upon that success and move to a hybrid cloud offering, where we see a massive market opportunity in satisfying customer demand. We plan to launch VMware vCloud Hybrid Services on May 21 and look forward to providing more detail about these services at that time.

In summary, our Q1 operational momentum and results put VMware in a solid position to achieve our business technology and financial goals for 2013. Our large and solid base gives us an exciting opportunity to demonstrate our commitment to helping customers transform the way they deliver IT services through innovation and world-class support. We are pleased that our customers are expressing excitement about our product deliverables later this year. These new products include the next generation of vSphere, vCloud Operations Suite, Horizon Suite as well as VMware NSX for network personalization, vSOM for storage virtualization, and vCloud Hybrid Services, all of which are in customers’ hands with beta versions.

Our operational momentum is strong and our leadership team is focused. We’re energized for a strong for a strong 2013 for our customers and partners, our employees and our investors. With that let me turn it over to Jonathan.

Jonathan Chadwick

Thanks Carl. As Pat and Carl said we accomplished what we said we would do in Q1 despite a mixed economic environment and achieved solid results for license revenue, total revenue and non-GAAP operating margin. Total revenues for the first quarter were $1.19 billion up 13% from a year ago on both the U.S. dollar and constant currency basis. U.S. revenues increased by 17% and international revenues increased by 9% year-over-year. License revenues rose in Q1 to $488 million near the high end of our guidance range. Software maintenance and support revenues increased 23% to $605 million year-over-year. Customers continue to buy on average more than 24 months of support and maintenance with each new license purchased which demonstrates a strong commitment to VMware’s core element of their data center strategies. Professional services revenues were $98 million in Q1 up 21% year-over-year as customers increasingly leveraged our professional services expertise for architecture leadership when embarking upon cloud implementations. We’re also pleased with the progress we’re making in product areas beyond stand-alone vSphere. In Q1 end-user computing license bookings were once again greater than 10% of total license bookings, when combining EUC license bookings and additional license bookings outside stand-alone vSphere such as management and automation and vCloud suite, greater than 30% of total license bookings in Q1 came from products outside our stand-alone vSphere offerings.

I will now provide some details in our operating margins unless otherwise noted all references to our expenses and operating results are on a non-GAAP basis and our reconciled with our GAAP results in the press release tables and posting on investor relations website. Our Q1 operating profit measured on a non-GAAP basis was $388 million or 32.5% of revenue as compared with 32.8% in Q4 and 32.6% in Q1 2012.

Our non-GAAP operating margin exceeds our expectation in Q1 due to slightly higher than anticipated revenue and good ongoing expense controls. We ended the quarter with approximately 13,000 employees down roughly 800 from the beginning of the quarter. This reflects the net impact of our realignment actions initiated in Q1. Our non-GAAP tax rate was 18.5% for Q1. On a GAAP basis we had an income tax benefit of $9 million reflecting the retroactive reinstatement of the R&D tax credit in Q1. Diluted non-GAAP EPS for Q1 was up 11% year-over-year to $0.74 a share on 433 million shares. Now moving on to our balance sheet and cash flow metrics, our balance sheet remained strong with cash and short investments at quarter end of $4.94 billion up $306 million quarter-over-quarter. Our operating cash flows remain strong as well, and with $676 million up 17% year-over-year.

DSO was 57 days in Q1 compared to 60 days in Q4; the improvement reflected record collections from our seasonally strong Q4 plus strong cash collections performance in the quarter. The quality of our receivables portfolio remains high. Our total cash spending on CapEx for Q1 was $78 million as previously noted we’re continuing to build out of our Palo Alto campus which will continue through 213.

Free cash flows were $599 million in Q1 up 10% year-over-year. During the quarter we repurchased approximately 2.4 million shares of our stock for a total $182 million under our share repurchase program at an average price of $77.5 per share. Total unearned revenue ended the quarter at $3.49 billion up 24% from Q1 2012 and an increase of 1% quarter-over-quarter. Long term unearned revenue is now $1.3 billion as customers continue to purchase multiple years of maintenance and as more unearned license revenue is recognized over time.

80% of our unearned revenue is software maintenance and will be recognized ratably. 13% of unearned revenue is software license revenue, which is recognized either ratably or upon product delivery. At the end of Q1, over 50% of the total unearned license revenue balance is to be recognized ratably. And in addition, 7% of unearned revenue is the result of prepaid professional services, including training which is recognized as the services are delivered. Considering all of these elements, 88% of our total deferred revenues are to be recognized ratably.

Now, I would like to make a few comments about the calculated bookings figures, which many of you routinely calculate by adding our quarterly revenue to the sequential change in unearned revenue each quarter. Typically, these calculated bookings and associated growth rates have been a reasonable proxy for our actual bookings and actual bookings growth rates over time. In Q1 however, these calculated growth rates were significantly lower than our actual growth rates. This is due to a number of factors, which include the removal of unearned revenue associated with the VMware Protect business we exited as part of our realignment activities as well as the timing of OEM bookings. Given these various items, we want to make clear that our actual license bookings of Q1 grew at a rate of greater than 10%, and that our actual total bookings also grew at a rate of greater than 10% in Q1.

Now, turning to a couple of operational updates, at this time, our headcount realignment activities are ahead of schedule and nearly completes. Additionally, we expect any remaining product divestitures to conclude over the next few months. I would like to thank all of our employees for their focus and dedication in accomplishing the fastest and most effective realignment project I have ever seen. Regarding pivotal, consistent with what I have communicated previously, the transaction became effective on April 1, which is the beginning of our fiscal second quarter. This means you will still see pivotal assets and employees included in our Q1 financial statements. Approximately, 500 employees are transferring from VMware to pivotal in Q2. As I mentioned on March 13 in our strategic forum, substantially all revenues and cost associated with our contribution to pivotal will be eliminated from VMware’s P&L statements from Q2 onwards. Furthermore, you will see the effect of approximately $70 million in unearned revenue transferred from VMware to pivotal in our Q2 balance sheet. Approximately, $32 million of this unearned revenue is unearned license revenue.

Now, moving to guidance, as we noted 90 days ago, when we first provided our 2013 outlook, we see an uncertain economic outlook for the upcoming year. Since the time of that call, a number of our peers have made similar observations. We remain cautious in the short-term, and our 2013 revenue guidance remains in the range of $5.120 billion to $5.240 billion, or an increase of 11% to 14%. This revenue guidance takes into account the removal of pivotal revenue from Q2 onwards. As a reminder on an apples-to-apples basis, our total revenue growth for 2013 would be between 14% and 16% when taking into account the removal of pivotal from both 2012 and 2013. In addition, our original guidance for 2013 included approximately $110 million of pivotal related revenues associated with Q2 through Q4 2013. On March ‘13, we removed this $110 million from our 2013 guidance. We noticed that many of you have not fully removed this $110 million from your models and do suggest you consider doing so at this time.

Switching to license revenue, our growth expectation for the full year remains within the range of approximately 6% to 9%. As I mentioned on March 13, this takes into account the removal of pivotal revenues from Q2 through Q4 of 2013, but of course includes pivotal revenues for the entirety of 2012. On an apples-to-apples basis, our license revenue growth for 2013 would be between 8% and 11% when taking into account the removal of pivotal from both 2012 and 2013.

Regarding operating margins as you now know we experienced stronger non-GAAP operating margin results in Q1 that anticipated. Taking into account our adjustments to GAAP operating income that Paul discussed at the start of the call and the pivotal related assets which moved from VMware to Pivotal on April the 1st, we now expect non-GAAP operating margins to be in the range of 33% to 34% for the full year which is up an additional 50 basis points in the range we provided on March 13.

GAAP operating margins for 2013 are expected to be approximately 12 to 15 percentage points lower than non-GAAP operating margins. We expect head count at the end of 2013 to be up by approximately 500 people from the start of the year. This takes into account approximately 500 people that we transferred to pivotal in Q2 as well as the impact of our realignment activities. At this time we continue to project that our non-GAAP tax rate will be 18.5% for the year. We anticipate that our 2013 fully diluted weighted average share count to be between 431 million to 435 million shares and expect capital expenditures on a cash basis to range between $330 million and $370 million.

Total revenues for Q2 are expected to range from $1.210 billion to $1.240 million or a growth of between approximately 8% to 10%. We currently anticipate Q2 license revenue to be between 515 million and 535 million. On apples to apples basis our total revenue growth for Q2 would be between 11% and 14% after taking into account the removal of pivotal from both 2012 and 2013.

Please note that deferred revenue will be reduced by approximately $100 million in Q2, approximately $70 million is attributable to the pivotal transaction but balance of approximately $30 million takes into account anticipated remaining divestitures of businesses under our realignment plan. As Pat said we see a tremendous market opportunity ahead and we will make continued investments throughout the year related to product development and global market expansion. Consequently in taking into account our adjustments to GAAP operating GAAP we will discuss at the start of the call. We expect that non-GAAP operating margin for Q2 to range from 32.5% to 33.5%.

GAAP operating margins for the second quarter are expected to be approximately 12 to 15 percentage points lower than non-GAAP operating margins. For Q2 we estimate our non-GAAP tax rate to be 18.5% and finally we anticipate our second quarter 2013 fully diluted weighted average share count to be between 431 million to 435 million shares.

And with that I will turn it back to Paul.

Paul Ziots

Thanks Jonathan. Operator we’re going to begin the Q&A process. let’s begin.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will come from Kash Rangan of Merrill Lynch. Your line is open.

Kash Rangan - Merrill Lynch

I was curious on your guidance for the rest of the year. Obviously it plays a very significant reacceleration to the business in the second half of the year, can you speak to the different factors that give you confidence in the second half pick-up in the business and also if you could catch up on OpenStack there is a lot of flood in the marketplace regarding OpenStack and a complete removal of the virtualization and the management layer with an OpenSource product. You seem to indicate that there is more of an interfacing strategy with a framework not exactly a product, if you can just clarify on that these two items that will be great. Thank you very much.

Pat Gelsinger

Before I let Jonathan pick up on the reacceleration and I will take the OpenStack, if you want to make few general comments as we start the Q&A first I’m just very pleased with our team performance in Q1, results were in-lined with expectations across all of our regions indicating very balanced performance. Our product machine is performing very well. We started the year on very solid footing maintained our guidance for the year. Right, this is a very solid way to begin to 2013, and I am very proud of our year for doing that. Jonathan, maybe you want to take on the question of the acceleration in second half.

Jonathan Chadwick

Sure. Hi Kash. So, second half growth, I mean, the drivers really have not changed from what we shared in just 90 days ago. As we talked back then, we continued to make investments in both our product portfolio and also in our go-to-market activities, in particular, emerging markets, but also in our end-user computing dedicated sales teams. We do as many of you also track, we do see an ELA tailwind opportunity in the second half of 2013. Frankly, we are also looking for a little bit of a modest uptick with respect to the economy, and in particular, we are looking forward to the federal third quarter helping the second half. And then finally, I mean, not least of which, we have had a solid start to the fiscal year. So, we believe our solid bookings performance in Q1 gives us a nice foundation on which to build the full year.

Kash Rangan - Merrill Lynch

Thanks. And Pat, you are going to talk about OpenStack?

Pat Gelsinger

Yeah, very specifically. First, with respect to the overall OpenStack environment for large majority of our customers simply wants an integrated solution and for that the VMware stack overall remains the choice of the vast majority of our customers. However, what we do see is the emerging framework of OpenStack for customers to assemble their own cloud infrastructure, e.g., for those who want to build their own. And our intention is to enable our best of breed, to sell our best of breed networking compute, storage, and management technologies into that open framework into that OpenStack environment. We see this is expanding the addressable market for VMware and further providing additional choice, the key value of VMware to our customers. As an example of that last week, Kash, we announced the vSphere support as part of the latest release of OpenStack with the release. And within that specifically, there is no compute virtualization called for an OpenStack, that’s left as an open choice. And now we are delivering vSphere as a preferred solution inside of that OpenStack environment. And this presents additional monetization opportunities for our paid for compute networking storage management software technologies into that OpenStack environment.

Paul Ziots

Thank you, Kash. Next question please.

Operator

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

John DiFucci - JPMorgan

Thank you. My question is international revenues only grew 9% year-over-year which implies that international license probably declined. Is this really just macro issues or is there something else happening in the international markets? And if it is macro what gives you the confidence, and I guess this is some follow-up to Kash’s question. What gives you that confidence to maintain your annual guidance, especially if some of that is partially due to pick up in emerging markets as Jonathon just said?

Carl Eschenbach

Jonathan, maybe you want to begin with this one. But I would also emphasize as we said. We saw very balanced performance, our bookings performance and growth across the world was very balanced. So, many of those economic factors we were able to muscle through and see very good performance across all of our GEOs. So, Jonathan a bit more color on international?

Jonathan Chadwick

Sure, Carl, but let me dive in as well at the end. So, John just to reiterate and restate the numbers, so for Q1 revenues, we saw the U.S. up 17% year-over-year and international was up 9% year-over-year. The international revenues do reflect something of a mixed bag as you think about at various stages, but in particular, we are obviously seeing softer revenue growth coming out of the European, which frankly just reflect the broader macroeconomic conditions in that region, while bookings overall did perform above plan, obviously the lower growth rates reflect the macroeconomic environment. And then secondly, frankly the international revenues this quarter had a little bit of a tougher compare year-over-year, they were up 28% in Q1 2012, so that had an impact as well. So, Carl, then if you want to add on the regions?

Carl Eschenbach

Yes, John. I just want to highlight a couple of things in our international business, particularly out of the APJ region, which continues to be the fastest growing region in the world for us and we saw continued strength come out of China. We’re very pleased with their performance once again and we were very excited to see a nice rebound in our Australia, New Zealand which we have mentioned in the prior calls had been slowing a bit but we saw a nice rebound this quarter which gives us really you know good reason for optimism as we look at the international market. As far as the guidance in the (inaudible) year despite the potential slow-down in international because of Europe. It's important to note that we did bake that into all of our operating plans and models internally and we have taken into account the tougher economic environment we’re faced within Europe.

John DiFucci - JPMorgan

If I could just follow-up for Jonathan, you said that license booking were up 10% on you had the issue this quarter with the pivotal transaction and the sale for tech business. Can you tell us the exact impact or the license differed license from those two issues or even cumulatively.

Jonathan Chadwick

John we did not break out the impact on any particular elements specifically on license and those were just two examples in any particular quarter as you know, there can be timing difference it's not one off differences and the two examples I shared were just examples of what we have seen this quarter. I do think it's important know that we’re going to see a similar impact in Q2 as I explained in my prepared remarks. In Q2 we’re seeing a specific removal of pivotal deferred revenues and also deferred revenues associated with some of our other business divestiture activities, so the key thing though is that bookings for both license and total on a year-over-year basis for Q1 were up over 10% year-over-year.

Operator

Our next question will come from Heather Bellini of Goldman Sachs. Your line is open.

Heather Bellini - Goldman Sachs

I had a couple of questions, the first one I was wondering Pat or Carl if you can talk a little bit about the transactional side of the business and some of the changes you have made and introduced at the partner conference in Q1. How faster than impact can these changes have on that part of the business, I mean should we start this really get a view from you in the second half of the year, so can you talk a little bit about the progression of the ramp that you expect to see and then also given there is so much confusion about the 2K license guidance I might have missed this but can you give us the specific impact on 2K license guidance related to pivotal because I have to think that’s one of the reasons why you’re stock is down 7% or 8% in the aftermarket and people didn’t adjust their numbers if you said if you can just give us some clarity. I think people might be able to then judge the business on an apples to apples basis if you don’t mind.

Carl Eschenbach

So let me start off talking Heather specifically about the transactional business. As I said in my prepared remarks the transactional business did experience modest growth year-over-year, in the early indications we’re getting from the market with the recent introduction of vSom production which vSphere plus operations management has been very encouraging both from the customer demand as well as the excitement we’re seeing from our channel to sell this into the market as a complete suite of solution going forward. Also we continue to invest in our channel, we continue to invest in ways to drive to transactional business to our partners by increasing potential margins if they can enjoy by selling our transactional solutions and I think as we get into the second half of the year you will start to see the impact of all of these changes and modifications we’re making to the transactional business model like vSom become more relevant and we will provide you more color on that as we get into the second half of the year. And one last point I would make is we indicated that our OEM business had an impact on our overall transactional business in Q2 because when we look at the transactional business it includes our OEM business and we did experience a slight decline in our OEM business which is correlated in directly related to the X86 server shipments in particularly we saw the decrease in Europe.

If we were to exclude the OEM business from our transactional business the transactional business would have even been up slightly greater. Greater. Jonathan?

Heather Bellini - Goldman Sachs

Before we just slide over to Jonathan to answer the pivotal impact on Q2, Carl, I guess one follow-up would be what type of ASP uplift should we be expecting from the vSOM product versus the typical transaction business you are doing maybe 12 months ago?

Carl Eschenbach

So, we need to get into this a little bit further meaning selling the vSOM into the market before we can provide any color around it. We have provided color around the vCloud Suite and indicate that the vCloud Suite has a 3X uplift over traditional vSphere standalone, but as a vSOM product, we need to get another quarter under our belt before we can provide the same type of color going forward.

Heather Bellini - Goldman Sachs

Okay, thank you.

Jonathan Chadwick

Yeah, and Heather on the overall just to restate the Q2 guide, reported revenues on an overall basis 8% to 10%, but as on an apples-to-apples basis 11% to 14% taking out pivotal.

Heather Bellini - Goldman Sachs

Yes, the people we need the license impact.

Jonathan Chadwick

Yes, we did not break that out overall, but you should assume.

Heather Bellini - Goldman Sachs

I know you didn’t, but I am just telling you from the probably 50 e-mails in my inbox, that’s what people are looking for.

Jonathan Chadwick

Yes, the reported guide that we gave you was zero to three. You should assume it’s going to be slightly higher than that, but that’s the extent of what we have said.

Heather Bellini - Goldman Sachs

Thank you.

Paul Ziots

Thank you, Heather. Next question?

Operator

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

Phil Winslow - Credit Suisse

Hi, guys. Just a couple of quick questions. Just first on the business, I am wondering you can provide some more color in terms of what you have been saying, in terms of vCloud Suite adoption, particularly with the net promotion you have been drawing in the past two quarters? And then also just the pipeline, then two just quick housekeeping items, first, what was the FX impact this quarter and how you think about that for next quarter and also a couple more of these businesses that you divested like the Protect business, how is that affecting the revenue guidance for that this year? I am assuming that’s included in the numbers as well even though it’s small? Thanks.

Pat Gelsinger

Carl, you want to start?

Carl Eschenbach

Yes, let me just provide some additional color, if you will, Phil as it relates to the overall business and how we saw the quarter unfolds. So, first of all, as Pat said we were very pleased with the performance across all three regions. And we were particularly pleased with the sales execution that we saw around the world and to be able to get 29% of our bookings coming through ELAs in Q1, which is typically a tough seasonal quarter for technology companies just shows the sales execution and how we performed around the world. So, we are very pleased with sales execution across all the three regions. As far as the vCloud Suite as I indicated in my prepared remarks, about 75% of the vCloud Suite was sold into ELAs, which is exactly what we had expected and this was the second full quarter of us having the vCloud Suite in the market. And in both Q4 and Q1, we were pleased that our internal bookings be our internal plan for the vCloud Suite. So, the adoption and update from our customers has been even stronger than we would have expected showing improving that customers look to leverage as a powerful platform around software-defined datacenter we are bringing to market through the integrated suite known as vCloud Suite.

Pat Gelsinger

Yes. And on the FX question, Phil, frankly we did not see a significant impact on overall growth rates in Q1, and as you will note, I said that was reported and constant currency was the same. And remember that about 70% or thereabout, approximately 70% of our billings were actually in U.S. dollars today. So, we do see a modest headwind, but not significant frankly with respect to overall top line performance in the second quarter. So, overall, we are not at this point seeing a significant impact on foreign exchange.

Paul Ziots

Thank you, Phil. And in the interest of time, let’s just take one question from the remaining folks. So, next question please?

Operator

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

Brent Thill - UBS

Thanks. Pat, just on the public cloud operators, I believe Carl mentioned bookings were up about 100%, can you just give us more color on your progress into that channel and any color will be helpful? Thank you.

Pat Gelsinger

Sure. Carl, do you want to discuss that?

Carl Eschenbach

Yes. So, as I indicated Brent in my prepared remarks, we did see 100% growth in our VSPP which is our VMware Service Provider Program bookings in the quarter which shows our continued growth in offering a public crowd through our strategic partners around the world and at the same time as you know. We introduced the notion of VMware entering the market with a hybrid cloud solution called vCloud hybrid service at the strategy day in New York back in March and as Pat and I have been touching a lot of customers in the last few weeks, I can tell you there is very much a level of excitement from our customers and partners about VMware entering the market with a VMware branded hybrid cloud service and we will be providing a lot more detail around this on May 21st when we do the official launch of this hybrid cloud service at that time. Pat anything to add in what you’re experiencing from customers?

Pat Gelsinger

Just echoing Carl’s comments that the customer interest in our insight, out strategy for our hybrid cloud service visibility of being able to have a compatible cloud environment that extends their internal private cloud into the public cloud, this idea is resonating very strongly and the interest that we’re seeing from that, the beta customers that we’re putting on the service today are reaffirming that our strategy is strong and it meets the unique need in the marketplace and again being reinforced by our channel partners we think that this is on track for really have the very differentiated positioning to meet a growing interest in public and uniquely hybrid cloud service market.

Operator

Our next question will come from Keith Weiss of Morgan Stanley. Your line is open.

Keith Weiss - Morgan Stanley

I wanted to dig into that figure that you gave 30% I believe of license bookings were outside of the core vSphere suite. Just one clarification in that does that include vCloud as well in that number and the actual question outside of the clarification is can you give us a sense of how that number has changed overtime and maybe where that was a year ago and maybe where that was in Q4?

Pat Gelsinger

As we laid out in the strategy day we see that we’re broadening the VMware opportunity and in particular with software defined data center and network storage management, hybrid cloud service and end-user computing and thus we’re extending from really a compute virtualization market to the $50 billion plus (inaudible) that we laid out for this broader market opportunity and this idea of giving this metric, this 30% greater than 30% metric to us is important to help you have evidence that we’re accomplishing that evolution of our business model and that’s why we’re giving this a new indicator and one that you can expect to see from us going forward. Jonathan maybe a bit more color.

Jonathan Chadwick

So the total license bookings contribution from outside standalone vSphere is a metric, we will continue first of all to share with you going forward and as you would expect the growth rates that we have been seeing from the average outside of just standalone vSphere have generally speaking being growing at a fast rate. So the percentage penetration has been picking up over the course of the last few quarters. I think it's important that we continue to focus on that because our strategy continues to be to bring suites to the market and also to provide bundle offerings. We’re not just about stand-alone vSphere anymore.

I’m going to take the opportunity to just spend one second just to clarify the answer that I gave on license, revenues for Q2 in response to Heather’s question I said modestly up and I’m going to specific the exact amount just to remove any confusion. So we expect on apples to apples basis but license revenues taking out the effect of the full year of Pivotal year-over-year we will be up to 5% which compares to 0% to 3% roughly while the guidance range we gave on a reported basis. So hopefully that helps clarify again up to the 5% for Q2 year-over-year license growth.

Operator

Our next question will come from Walter Pritchard. Your line is open.

Walter Pritchard – Citigroup

Just wondering again on the 30% in talking about the vSphere businesses, thinking about the second half, do we need to see vSphere actually return to growth? It looks like vSphere probably didn’t grow in the quarter given that mix and the overall especially license growth rate of slightly positive. I’m wondering do we, should we think about vSphere here as sort of a business that won't grow going forward and we need to see those other products drive the growth or do you expect the vSphere returns to growth in the second half to help drive that reacceleration that you are guiding to?

Pat Gelsinger

Carl, maybe want to take that one?

Carl Eschenbach

Yeah, well, thanks for the question, because I do think it’s important that we clarify how we think about vSphere today and going forward. vSphere is a core component of our compute strategy. And as you could expect, it is part of all of the suites that we are bringing to market, specifically the vCloud Suite and now the vSOM solution. So, when we think about vSphere, we think it now about – we think about it in the context of providing a full solution for our customers. We are now looking at as a standalone basis. One of the reasons we are not is because a lot of the people who would traditionally just buy vSphere are now buying the vCloud Suite and vSOM. So, therefore, the metric around standalone vSphere is no longer as relevant as it was in the past.

Paul Ziots

Alright, Walter, thank you for the question. Before we finish, Pat is going to have a few closing remarks.

Pat Gelsinger

Thank you, Paul. As I begin, I am very pleased with our team despite a challenging environment we performed at the high end of our revenue guidance, exceeded our already raised margin guidance and are well on track for the year with our next generation products that are clearly aligned with our three focused growth strategies. We appreciate your time and thank you for joining us today.

Operator

This concludes today’s conference call. Thank you for your participation. And at this time, all parties may disconnect.

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