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Edited Transcript of VMW earnings conference call or presentation 26-Nov-19 9:30pm GMT

Q3 2020 VMware Inc Earnings Call

PALO ALTO Nov 27, 2019 (Thomson StreetEvents) -- Edited Transcript of VMware Inc earnings conference call or presentation Tuesday, November 26, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Patrick P. Gelsinger

VMware, Inc. - CEO & Director

* Paul Ziots

VMware, Inc. - VP of IR

* Zane C. Rowe

VMware, Inc. - CFO & Executive VP

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Conference Call Participants

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* Brad Alan Zelnick

Crédit Suisse AG, Research Division - MD

* Brent John Thill

Jefferies LLC, Research Division - Equity Analyst

* Gregg Steven Moskowitz

Mizuho Securities USA LLC, Research Division - MD of Americas Research

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* Jason Noah Ader

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* Karl Emil Keirstead

Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst

* Kasthuri Gopalan Rangan

BofA Merrill Lynch, Research Division - MD and Head of Software

* Keith Weiss

Morgan Stanley, Research Division - Equity Analyst

* Keith Frances Bachman

BMO Capital Markets Equity Research - MD & Senior Research Analyst

* Mark Ronald Murphy

JP Morgan Chase & Co, Research Division - MD

* Matthew George Hedberg

RBC Capital Markets, Research Division - Analyst

* Michael Turits

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst

* Philip Alan Winslow

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Raimo Lenschow

Barclays Bank PLC, Research Division - MD & Analyst

* Stewart Kirk Materne

Evercore ISI Institutional Equities, Research Division - Senior MD

* Walter H Pritchard

Citigroup Inc, Research Division - MD and U.S. Software Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to today's VMware Third Quarter Fiscal Year 2020 Earnings Call. As a reminder, today's conference is being recorded. And at this time, I'd like to turn the floor over to Paul Ziots, Vice President of Investor Relations.

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Paul Ziots, VMware, Inc. - VP of IR [2]

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Thank you. Good afternoon, everyone, and welcome to VMware's Third Quarter Fiscal 2020 Earnings Conference Call. On the call, we have Pat Gelsinger, Chief Executive Officer; and Zane Rowe, Executive Vice President and Chief Financial 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 live remarks and downloaded at the conclusion of the webcast from ir.vmware.com.

On this call today, we will make forward-looking statements that are subject to risks and uncertainties. These forward-looking statements include statements regarding VMware's proposed acquisition of Pivotal. Actual results may differ materially as a result of various risk factors, including risks related to our ability to consummate the Pivotal acquisition as planned as well as additional risks 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 on our GAAP results of stock-based compensation, amortization of acquired intangible assets, employer payroll tax on employee stock transactions, acquisition disposition and other items, including the gains or losses on Pivotal's software and discrete items impacting our GAAP tax rate. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures, in the press release and on our Investor Relations website. The webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link.

Our fourth quarter fiscal 2020 quiet period begins at the close of business, Thursday, January 16, 2020.

With that, I'll turn it over to Pat.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [3]

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Thank you, Paul. Q3 was another solid quarter for VMware, and we're pleased with our results. We continue to see traction and customer momentum in support of VMware's vision to deliver a software architecture that enables any app, on any cloud, delivered to any device.

In Q3, total revenue increased 12% year-over-year, with non-GAAP earnings per share of $1.49 per share. We are thrilled to welcome Carbon Black to the VMware family, and we remain on track to close the acquisition of Pivotal by the end of the fiscal year.

Customers have resoundingly affirmed that both acquisitions will offer tremendous value as we help them with their digital transformations. We recently hosted over 65,000 customers, partners and influencers at our VMworld 2019 and vFORUM events, demonstrating strong momentum in support of our strategy.

Having traveled through all these regions recently, I've been delighted by our team's strong execution and the enormous customer interest and market potential for our solutions globally.

The bespoke, fragmented security solutions of today have failed our customers, offering us a security industry that is ripe for disruption. With Carbon Black now a part of the VMware family, we're simplifying security by making it intrinsic across the key control points of endpoint, workload, network, identity and analytics, and Carbon Black accelerates our efforts here. With Carbon Black, VMware is now poised to take a significant leadership role in security for the new age of multicloud, modern apps and modern devices. We view security as an essential and common thread throughout our offerings. Carbon Black, together with the security-driven value-add from our networking with micro-segmentation, end-user computing, cloud and compute offerings, in aggregate, represents approximately $1 billion of business for us this year.

With this acquisition, we launched a new security business unit, including Carbon Black in our app defense offerings under the leadership of former Carbon Black CEO, Patrick Morley, as General Manager. Since the close of the acquisition, we announced multiple new Carbon Black cloud solutions and an enhanced partnership with Dell, making Carbon Black cloud the preferred endpoint security solution for Dell commercial customers. We believe the combination of Carbon Black and VMware will bring a fundamentally new paradigm to the security industry.

Another highlight of the quarter was the unveiling of Tanzu, a portfolio of products and services designed to transform the way enterprises build, run and manage software on Kubernetes. We also announced and began customer beta for Project Pacific. This breakthrough rearchitecture of the VMware vSphere platform will transform vSphere into a Kubernetes-native platform which will enable enterprises to seamlessly add Kubernetes to their existing environments, operate containers and VMs on common infrastructure, accelerate development and operation of modern apps in vSphere, while continuing to take advantage of existing investments in applications, technology, tools and skill sets.

By utilizing innovations from both VMware and Pivotal, VMware will be positioned to deliver the most comprehensive enterprise-grade Kubernetes-based portfolio for modern applications, helping customers to succeed at each step of their cloud-native journey.

We continue to execute against our multicloud strategy as we drive and expand our cloud partnerships to offer our customers choice and flexibility. VMware Cloud on AWS is now available in the Stockholm region, bringing the total number of available global regions in Europe to 5 and globally to 17 in just over 2 years. I was delighted to have firms, including IHS Markit, Japan Airlines and Samsung SDS join us on stage across VMworld Europe and our vFORUM events to provide testimonials of the success they're seeing with our cloud strategy and offerings, including VMware Cloud on AWS.

We also further expanded our partnership with Microsoft to deliver greater impact to customers across client, cloud and data initiatives. News included the introduction of VMware Workspace ONE for Microsoft Endpoint Manager to enable modern management for Windows 10; Azure VMware Solutions momentum with new industries and geographies; the addition of new cloud migration capabilities with VMware HCX; and the ability to extend Azure to the branch and edge with VMware SD-WAN by VeloCloud.

We continue to see some of the world's largest companies commit to the VMware enterprise-grade solutions. We're seeing particular strength in the financial sector, including JPMorgan Chase and one of the largest financial institutions in Europe, having increased their investments in VMware technology. Lenovo's investment at VMware during Q3 includes strategic collaborations across multiple countries and regions, including China, and spans the VMware portfolio, including cloud and hyper-converged infrastructure offerings.

In the telco and communications service provider space, I was also thrilled to personally announce our expanded multicloud partnership with Deutsche Telekom, IT service provider T-Systems and further adoption of our telco offerings, including Millicom and NTT DOCOMO. As customers are looking to their 5G buildout, we see increasing interest in VMware solutions as key enablers of this critical transition.

Before I hand the call over to Zane, I want to announce that Maurizio Carli, Executive Vice President of Worldwide Sales and Services, will be transitioning his role at the end of the fiscal year. Maurizio has made a significant impact on the company since he joined nearly 11 years ago. And on behalf of VMware, I want to thank him for his many contributions in making VMware the great company it is today.

Maurizio will continue with the company serving as a strategic adviser. Jean-Pierre Brulard, who has also been with the company for 11 years and currently leads VMware's EMEA sales team, will assume the global sales leadership role beginning at the start of fiscal year '21.

In closing, Q3 was another solid quarter for VMware. I am very proud of our team for these results and pleased with the meaningful expansion of the VMware portfolio with Carbon Black, then later this year with Pivotal. Thank you very much. Now let me hand it over to Zane.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [4]

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Thank you, Pat. We're pleased with our financial performance and execution this quarter, which resulted in total revenue growth of 12% and license revenue growth of 10% year-over-year.

Our hybrid cloud subscription and SaaS recurring revenue grew approximately 40% year-over-year and represented over 13% of total revenue in the quarter. We continue to invest in our fast-growing cloud businesses, and we expect that Carbon Black, along with our Tanzu portfolio, including Pivotal, will further accelerate our influence and impact in the security and developer communities as well as meaningfully increase our hybrid cloud subscription and SaaS revenue.

Q3 non-GAAP operating income was $759 million, resulting in a non-GAAP operating margin of 30.9%. Non-GAAP earnings per share was $1.49 on a total share count of 414 million diluted shares. We ended the quarter with $7.9 billion in unearned revenue and $2 billion in cash.

Growth in the revenue, plus the sequential change in unearned revenue for the quarter, was 18% year-over-year or an increase of 12%, excluding unearned revenue assumed in the acquisition of Carbon Black. Growth in license revenue, plus the sequential change in unearned license revenue, was 21% year-over-year or an increase of 13%, excluding unearned revenue assumed in the acquisition.

We closed the Carbon Black acquisition on October 8. The beginning unearned revenue balance from the acquisition was $151 million. Carbon Black contributed over $10 million in total revenue in the quarter post acquisition.

At quarter end, we had license backlog of $33 million and total backlog of $71 million. RPO, which includes our committed and noncancelable future revenue, was $8.5 billion.

We had a strong quarter across our product and solutions portfolio in Q3 with 6 of our top 10 customers purchasing the VMware Cloud Foundation solutions stack. This platform solution consists of the full software-defined data center stack and is offered on private clouds, public clouds as well as partner-managed clouds.

NSX license bookings were up 50%. vSAN license bookings were up over 35%. And EUC license bookings once again increased over 20% year-over-year this quarter. Core SDDC continued to perform well, with core SDDC license bookings up in the high single digits year-over-year and total core SDDC bookings up in the mid-single digits.

Compute license bookings grew in the mid-single digits, with total compute bookings up in the low single digits year-over-year. Management license bookings increased in the mid-teens, with total management bookings up 11% year-over-year.

In Q3, we repurchased $242 million in stock and ended the quarter with a little over $1 billion remaining under our current repurchase authorization, which extends through the end of FY '21.

Turning to guidance. For the full year, we are projecting an increase in total revenue to $10,100,000,000, up 12.5% year-over-year. This includes the addition of Carbon Black's financials post close, which accounts for the largest portion of the revenue increase. We expect license revenue of $4,245,000,000 for FY '20, up 12% year-over-year. We expect non-GAAP operating margin to be 33% and expect non-GAAP earnings per share of $6.58 on a diluted share count of 416 million shares for the fiscal year.

Cash flow from operations has been updated to include the impact of acquisition and integration costs of approximately $100 million related to our most recent acquisition announcements. As a result, cash flow from operations is expected to be $3,850,000,000. We expect free cash flow of $3,570,000,000 for fiscal '20.

Moving to our Q4 guidance. License revenue is expected to be $1,390,000,000, an increase of 13% year-over-year, and total revenue is expected to be $2,950,000,000, up 13.8% year-over-year. We expect non-GAAP operating margin of 37.6% and non-GAAP EPS of $2.16 per share on a diluted share count of 414 million shares.

We expect the proposed acquisition of Pivotal to close before fiscal year-end, and we will update you on its impact on the quarter and the upcoming fiscal year on our next call.

As I mentioned on our last call, due to common control accounting rules upon the close of the acquisition, we will recast VMware's historical financials to include Pivotal. Detailed guidance for Q4 and the full year is contained in the slide deck on our website accompanying this call.

Now as we look to our next fiscal year, we're expecting the strengths we're currently seeing in the business to continue. Preliminarily, we're planning for a fiscal '21 total revenue growth rate in the low double digits, not including the impact from the proposed Pivotal acquisition. We also expect hybrid cloud subscription and SaaS to drive much of the future growth of the business and show a significant increase in its percentage mix of total revenue.

In FY '21, we will continue to invest incrementally in our fast-growing hybrid cloud subscription and SaaS portfolio. While these incremental investments will drive operating income expansion, we expect they will impact next year's operating margin by up to 2 percentage points, including Carbon Black.

In closing, we are pleased with our Q3 financial performance and the ongoing strength of the business. Our customers are depending on us to assist them navigating their digital transformation and multicloud journeys using our broad product and solutions portfolio, and we're seeing this in our financial results.

The investments we are making in and the strength of our growing hybrid cloud subscription and SaaS businesses will drive sustained performance and growth for us.

I'll turn it back to Paul before we begin with the Q&A.

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Paul Ziots, VMware, Inc. - VP of IR [5]

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Thanks, Zane. 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And first, from Wells Fargo, we have Phil Winslow.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [2]

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And congrats on another strong quarter. Just a question for the team. I mean we've seen -- we have numbers from Gartner and IDC that have been relatively weak on the server shipment side, and then we've seen mixed results from hardware, networking and storage vendors. But if I look at your compute bookings, still strong growth in NSX, vSAN, similar high-growth rates. Really, the question is what's sort of driving that gap, that delta between, call it, the high-level trends and obviously, the strong growth that VMware is seeing?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [3]

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Hey, thanks, Phil, and we are pleased with the quarter and the continued good performance. As we look at your comment on the gap, we've just -- and as we said in the past, we've just historically not seen a strong correlation between our business and the hardware spend cycles, which just tend to be a lot more cyclical in nature. Also, the SDDC growth is driven largely by workload growth. And SDDC just has a very compelling customer ROI that even in pretty much any economic environment, they see very substantial TCO. And also, we'd say the breadth and depth of our portfolio as we increasingly see the hybrid cloud and SaaS component of it, now 13% of revenue and growing at approximately 40%.

Increasingly, we're seeing that growth beyond the private cloud or the data center and into the hybrid and public cloud offerings as well.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [4]

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Hey, Phil. This is Zane. I'll just add. As you point out, we saw really good booking strength in the quarter. And we have a solid guide for the rest of the year. I talked about RPO, which, for the third quarter, was $8.5 billion, which has also grown nicely year-over-year, reflecting the ongoing strength of the business. So yes, we feel good about the guide. We feel good about our pipeline heading into Q4.

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Operator [5]

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Next, we have Matt Hedberg with RBC Capital Markets.

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Matthew George Hedberg, RBC Capital Markets, Research Division - Analyst [6]

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Congrats again on the quarter. I have a product question for Pat on Tanzu. Can you talk a bit more about, just at a high level, what this means for developers really in a hypercloud architecture built on Kubernetes? And maybe a little bit more on the timing of Project Pacific.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [7]

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Yes. Thanks, Matt, and anxious to talk anytime I get about Tanzu. We're really excited about the capabilities. And we really see this coming together and as we would say, that this bridge between the developer and the operations world and Kubernetes is playing this critical bridge between those. And as I've said, maybe since Java, we've not seen a technology or the VM itself as important as Kubernetes.

We've been working on Project Pacific now for several years, and we really see this ability to combine containers and VMs in a consistent operating environment, gives customers the best of both worlds, security, scalability, compliance, agility and speed from containers for a new workload development.

And the Tanzu portfolio brings together this comprehensive developer-centric Kubernetes portfolio, building from Heptio, and we're excited to bring the Pivotal assets, the PaaS and the PKS offerings, but also then to be this next layer of how infrastructure is operationalized and automated. And we expect the customers are going to pick Kubernetes and our offering of making this intrinsically available into the core vSphere offering, really will be this unique bridge between those 2 worlds.

Also, the Tanzu portfolio is focused on multicloud offerings with Tanzu Mission Control and building on Heptio, which will allow us to embrace public and private as no one else can. So overall, we've seen extremely positive response from the market on Tanzu. We've seen both Mission Control as well as Pacific are now in beta with customers, which has been oversubscribed. So we've seen a lot of customer interest in this, and we're quite looking forward to the next major version of vSphere, including these capabilities.

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Operator [8]

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And next question will be from Kash Rangan with Bank of America.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [9]

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Congratulations on yet another very nice quarter. Pat, we do a survey every 6 months. We speak to people. And this time, surprisingly, one of the top 3 priorities was server virtualization. I'm curious to get your take, especially as you look at the gap between server shipments and your own performance. Are we likely to see the beginning of a halo effect, given all the strategic initiatives that VMware's pursuing on the technology side, that, that makes you look more like the new world and less so of the old world? Not to put words in your mouth, but just curious how VMware also broadly fits into this world of DevOps, where you have a lot of cloud monitoring companies, cloud management companies. What are VMware's plans to attack that market because you have a significant installed base and you could do some really big strategic bets here?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [10]

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Yes. Thank you, Kash. And we really see ourselves in this hybrid cloud, a multicloud world, as quite uniquely positioned. And on the hybrid cloud world, what we're seeing customers do is they want to migrate to the cloud. And in some cases, you'll hear them talk about cloud-first or their cloud migration strategies. But to do that, they run into this brick wall that how do they replatform their applications. And for that, the VMware hybrid cloud is just like the easy button. It allows them to migrate, save money in the process, really create this highly efficient hybrid cloud environment. And those are many of the success stories of our VMware Cloud on AWS offering.

But then as they've done that now, we also say we enable you to modernize. We give you the ability to refactor those applications, rebuild them, invest in them as your business justifies and as your business needs, right, for you to satisfy your digital transformation objectives. And for that, the Tanzu capabilities I was just describing really are the easy button for them to do that as well and doing that in a very cloud-native manner, embracing the latest developer technology. So we see it as this ability to migrate and modernize, do it with hybrid cloud and multicloud. Vmware is just positioned to be able to do those things as no other vendor is, and we're really seeing a very positive response from customers as they start to understand the benefits of that and going faster into their future as well as to do so efficiently.

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Operator [11]

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Next is from Walter Pritchard with Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [12]

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Maybe a question for Sanjay Poonen, if he's on the call. I'm wondering you've -- Zane, you were talking up the SaaS and hybrid, especially next year. Maybe an update on the VMC bookings performance, sort of how that's coming in, maybe any order of magnitude, size. And as it relates to the comment about most of the growth being driven by that stream, how does VMC play into that as you look into next year because you've got other revenue streams like Pivotal and I guess, Carbon Black that are in there as well?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [13]

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Yes. I'll start on that one. Walter, always good to hear from you. And generally, we've continued to see momentum in our VMC on AWS offering. As I said, we announced the next region this quarter with the Stockholm region. We're now at 17 and really have a good global footprint as we saw at VMworld and vFORUM. And the expanded customer references like Pfizer, IHS Markit, Japan Airlines, Samsung, these are just world-class names that are viewing this as a critical part of their strategy.

On the expanded ecosystem, we rolled out cloud competency partners, ISVs. We're seeing our VCPP partners now begin reselling and making this part of their offerings as well. And really, as I was just commenting on the last question, this ability to migrate to the cloud in a highly efficient way is really being seen as a powerful tool for our customers as they look to their hybrid and multicloud futures. Zane?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [14]

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Yes. Walter, I'll just add. As you point out, the 40% increase we saw this quarter, we expect that strength to continue well into next year. The outlook that we gave does anticipate a material increase in the hybrid cloud subscription and SaaS category, of which VMC is an important part. And as we said all along, VMC not only helps within that category, but also, quite frankly, helps with all of our products, including VCF and many others that are on-prem as well. So there's definitely a halo effect when we think about the VMC opportunity, and it's one of the many growth areas we have between VMC, VeloCloud, Health as we look to see our increase in hybrid cloud and subscription and SaaS grow nicely into next year.

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Operator [15]

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Next, we have Mark Murphy with JPMorgan.

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Mark Ronald Murphy, JP Morgan Chase & Co, Research Division - MD [16]

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I'll add my congrats. Pat, I was wondering if you can offer any thoughts on the U.S. Department of Defense's $10 billion JEDI contract, which is being awarded to Microsoft as of now rather than Amazon? And are you optimistic that VMware could play a role in that contract or in other government projects since you're the critical hybrid partner for all 3 of the major public cloud platforms?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [17]

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Yes. Thank you, Mark. And we'll just say, overall, that we're following the JEDI event closely as I'm sure many of you are as well. And we're looking forward to getting to the eventual outcome of the appeals process. We'd also point out that the JEDI contract vehicle itself is one of many, right? And this represents just a piece of a much, much broader set of cloud opportunities in the government.

Overall, we're well positioned with our current partnerships, and we do expect that through those partnerships that we'll have a thriving government business, both on-premise as we have had as well as in hybrid and cloud offerings.

As you note, given our very high market share in the government, our hybrid cloud is uniquely valuable to government customers. And as we've discussed in the past, we've seen extremely high interest from CIOs in the government as they see huge value for this, really, this ability to migrate to the cloud, as I was commenting earlier in the Q&A session.

So we really see that we have great opportunity in the government and with our hybrid cloud offerings in the government space in the future.

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Operator [18]

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Next, we have Karl Keirstead with Deutsche Bank.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [19]

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My question is for Zane. I'd just like to clarify the impact that the inclusion of Carbon Black is having in your guidance. So for the fourth quarter, where you guided to license of $1.39 billion and total revs of $2.95 billion. Is the change from the implied prior guidance entirely Carbon Black's? In other words, is for Q4 on the rev side, is that a guidance reaffirm? And then for fiscal '21, where you guided to low double-digit growth, safe to assume Carbon Black is kind of 1% to 2%. Is that the right way to back into organic? And then lastly, operating margins, a 2% hit. Is that entirely due to Carbon Black? Or is your organic operating margins going to be down?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [20]

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Hey, Karl. So I'll take that one question, the multipart question. So starting with the fourth quarter, it's a reaffirm and a small increase based on the strength we're seeing in the rest of the business as well. So I'd say the increase in total revenue for the fourth quarter, which obviously amounts to 10.1 for the full year is primarily driven by the addition of Carbon Black, although there's a little bit more that we've got in there as well. So Carbon Black is a big contributor to the increase.

But again, if you recall, the guide also highlighted some of the growth that we're anticipating for the second half of the year based on what we said last quarter. So we feel really good about the pipeline heading into the fourth quarter and the solid guide for the year.

As we move to FY '21, again, this is our preliminary view of FY '21. I'll be offering a lot more guidance on our next call. The combination we've talked about being approximately 2 points, the combination of both Carbon Black and Pivotal, with the recast and the restatement of Pivotal, the large part of that -- those 2 points is actually attributed to Carbon Black on a year-over-year basis. So you're correct in calling out the Carbon Black portion being a big contributor on a year-over-year basis to the organic growth if you think about the growth of the business, excluding Carbon Black.

And then on the operating margin, when -- we've given you some guide for the combination of both acquisitions. I'd split the 2 points in 2, one being the incremental investments that we continue to make in our high-growth areas, with the "organic" hybrid cloud subscription and SaaS businesses, businesses like VeloCloud, Cloud Health and our VMC businesses that are contributing to the vast part of the 40% growth that we saw even this quarter. And then the other portion is attributable to rolling Carbon Black into the financials as you look at a year-over-year basis.

So hopefully, that gives you, at least at a high level, a general sense for how we're thinking about the strength that we're seeing this year moving into next.

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Operator [21]

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Next, we have Raimo Lenschow with Barclays.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [22]

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Can I just ask around the security? Now that Carbon Black has closed, and Pat, you had some time to talk with customers, like how comprehensive of a solution are your customers expecting from you, just endpoint or like obviously, you have the NSX virtual firewall, et cetera? Like so what's the -- what was the reception from the customer base in terms of how broad they want to see you in that space?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [23]

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Yes. The enthusiasm for Carbon Black is high, and the strategy of intrinsic security has resonated very well. And just to reinforce that a bit, this idea that we're going to build security into the infrastructure, we're going to build it into vSphere, we're going to build it into NSX as we've been doing with micro-segmentation, but further enhance it with Carbon Black, build it directly into Workspace ONE and really bring security and management together.

And somewhat on the client space, some -- when we laid out our AirWatch strategy a number of years ago, we said we were going to bring Workspace ONE, we're going to bring mobile and desktop together. Well, we're going to redefine the category again. We're going to bring management and security together into a client offering, and we're going to tie that together with an end-to-end set of cloud analytics. And that comprehensive strategy, as we've laid that out, people have resonated to very well.

Now obviously, we're just getting started on this journey. We're just bringing the first offerings into the marketplace. The strategy people immediately say, when I stand up and describe how the security industry is broken, everybody just nods their heads, absolutely, help me, right, in this regard. So we'll really see that the response to the strategy is good. The early response from customers is very positive. And you've even seen capabilities like Dell saying this is a key part of our preferred Unified Workspace offering. So we're starting to see the partners respond to that strategy as well.

But it's early days. We've got a lot of work to do, but I couldn't be more pleased. And obviously, with Patrick Morley and the Carbon Black team, the formation of our new security business unit, we think we are well off the starting blocks in an exciting race to not just deliver an exciting new capability to VMware, but redefine a broken industry.

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Operator [24]

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Next, we have Brent Thill with Jefferies.

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Brent John Thill, Jefferies LLC, Research Division - Equity Analyst [25]

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Zane has alluded to the 50% growth in NSX. And I was wondering, Pat, if you could just talk to what you're seeing in deal sizes and kind of attached with the rest of the portfolio.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [26]

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Yes. Overall, we were super happy with NSX. And obviously, the growth is being accelerated by VeloCloud and the inclusion of Avi into the platform. Eight of our top 10 deals included NSX and VeloCloud. This vision of the networking and security further reinforces the last point of security becoming intrinsic. We also had a great product announcement quarter for new capabilities, NSX Intelligence, the launch of IDS and IPS, the integration of Avi and load-balancing into the platform.

And as I described at VMworld, greater than 50% reduction in CapEx and OpEx, that customers are really now buying into the strategy that, in networking, it's time to replace hardware with software, and that is resonating in the marketplace. And I think the great results this quarter are clearly demonstrable of that resonance.

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Operator [27]

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Next, we have Keith Weiss with Morgan Stanley.

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Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [28]

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A follow-on to an earlier question on operating margins. How should we think about kind of the longer-term trajectory on operating margins, particularly in light of the hybrid, SaaS businesses growing really well and becoming a better part of -- a bigger and bigger part of the overall revenue mix? Is there a kind of bottoming out at some point in the future we should think about in terms of when sort of those impacts kind of normalize?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [29]

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Yes. Keith, this is Zane. We're -- as you would expect, we balance both the top line and the bottom line in both the perpetual business as well as the hybrid cloud and SaaS businesses, and we think there's tremendous value to be had in both.

Obviously, initially, the hybrid cloud and SaaS businesses grow from a lower base, but we see no reason why they couldn't be growing and ultimately get to the margins that you've seen at the company historically out of the perpetual businesses. And we've got examples of that within the company where they're growing up to those levels with our portfolio of more mature hybrid cloud and SaaS businesses. So as we grow, we see tremendous value in that. We see value in growing the operating income line as well as reaching higher operating margin lines as we take on the higher growth with that category.

Obviously, as you would expect, we've taken -- we'll take a couple of points off the top as we include the acquisitions as well as we continue to grow and invest in some of the high-growth areas that we're seeing in the company already. You've got 40% growth in the category. So we take a long-term view of that growth and the investments in the strategy behind all that. So we feel like those margins individually will continue to grow and obviously have an impact on the broader operating profile and growth profile of the business. But we feel very good about the return on investment we're getting in that -- in those areas.

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Operator [30]

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Next, from Goldman Sachs, we have Heather Bellini.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [31]

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I just wanted to ask a question, Pat. You've always done a great read on the IT spending environment and have called it out when it's been getting better, when it's been getting worse. You obviously have a really good track record, just given the breadth of the product portfolio. I was just wondering if you could share with us what are you seeing as we close out this calendar year and kind of what's your -- what are you thinking in terms of next year's IT spending growth rate versus what we're going to end up seeing in calendar '19.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [32]

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Yes. Thanks, Heather. And my view really hasn't changed from what we discussed last quarter. We continue to see a great interest in digital transformation by customers. And there's areas of concern, areas of positiveness. And I'd say we continue to take a pretty centrist view of those as we look out into the future.

And I think our Q3 performance globally was a great representation of that. Between VMworld Europe, Asia and U.S., I've been in all 3 geos since we spoke last, been getting too many air miles in as a result. And I'll just say, digital transformation is alive and well. Customers believe it's the key to their future. And the VMware offerings continue to have great resonance to them on a global basis. So we feel very solid about that outlook.

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Operator [33]

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Next, we have Kirk Materne with Evercore ISI.

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Stewart Kirk Materne, Evercore ISI Institutional Equities, Research Division - Senior MD [34]

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Pat, I was wondering if you could just talk about your partnership with GCP a little bit. I realize it's early days on that front. But just any sort of incremental takeaways since the last time we heard from you. And just maybe some thoughts on whether or not the acquisition of CloudSimple by Google maybe helps accelerate that partnership now that there's obviously a lot more resources behind that, that particular firm.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [35]

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Yes. Thank you for that. And overall, I'd say we feel good about our overall portfolio of cloud partnerships. Obviously, Google, that offering is soon to come to the marketplace. There's solid interest in the offering. We have a good pipeline of customers. We do see the CloudSimple acquisition as a good move for them to accelerate their capabilities. And there's no change in VMware's support of CloudSimple as a VMware Cloud Verified partner in the marketplace. And clearly, we've seen global interest as Google is driving a more aggressive buildout of their capabilities for their enterprise customers of Google Cloud. And as part of that, the VMware offering really does have great resonance by mutual customers.

So we're looking forward to this in the marketplace. CloudSimple was good. But we always put it in the context of having the most complete set of partners on the planet, Amazon, Azure, Google, Oracle, IBM partnership, the 4,300 VMware Cloud partners worldwide. Now we're almost 100 Cloud Verified partners and seeing global strength in that community. And clearly, VMware's multicloud and hybrid cloud strategy is unrivaled in the industry.

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Operator [36]

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Next, we have Brad Zelnick with Crédit Suisse.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [37]

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Zane, just to put a finer point to a prior question on margins, in the proxy filed around the Pivotal acquisition, you've laid out 2 scenarios showing revenue and operating margins for differing mixes of hybrid cloud and SaaS. And I appreciate Pivotal and Carbon Black are not included in this, but being that those acquisitions should be accretive in year 2, is it fair to say that the trough in margins should be somewhere around 31% as the business model transitions, as it was laid out in that proxy?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [38]

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Hey, Brad. I'll give some color. I mean I wouldn't -- those -- what you read in the proxy are obviously typically forecasts done with a number of embedded assumptions for a variety of purposes. So I wouldn't read into what's in there versus what we offer for guidance. And as you know, what we typically do is give you the current year, and then in the third quarter, I'd like to give you at least a sense for where things are heading.

Everything is very dynamic, and where we stand today, we believe there's tremendous opportunity in those hybrid cloud subscription and SaaS businesses. So I think it would be premature for me to say sort of at what point we bottom out, given the fact that we're always looking at that trade-off between top line growth and operating margin and where we have conviction around long-term value for shareholders. So as we manage those dynamics, we're at a point right now where in addition to Carbon Black and the Pivotal acquisition, we still see tremendous opportunity and benefit in continuing to invest in the businesses that are fast-growing. It just so happens, those happen to be our hybrid cloud and SaaS businesses, which is why I alluded to the fact that we're going to continue to invest into those next year. The Carbon Black element is essentially taking the P&L of Carbon Black and layering it in while we integrate it into the company. So that's the dynamic you see as we've called out up to 2 points of operating margin impact on that part of the business.

I wouldn't want to go into it much further than that, candidly, just because when you've got a business that's growing 40%, you essentially want to continue to feed that. And I did point out that Pivotal will be -- we will be recasting our financials with Pivotal. So you would expect to see our history change as it relates to the Pivotal acquisition, and that will impact the year-over-year impact of both revenue as well as our operating margin impact related to that Pivotal acquisition.

So hopefully, that gives you a little bit more color into how we're thinking about the opportunity in the acquisitions. Again, I would separate that from what you've observed in the proxy filing.

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Operator [39]

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Next, we have Michael Turits with Raymond James.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [40]

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Pat, I'd like to come back to VMC again. Can you just update us on what the use cases are, if they're the same as they've been or if they're expanding? And are you doing anything -- changing anything in go-to-market around VMC, whether it's leadership, whether it's channel in order to expand those use cases?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [41]

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Yes. In terms of use cases, I'll say they're continuing to build out the use cases that we've described them before, right, data center extension, right, I want more capacity; data center evacuation, I'm getting out of a data center and I'm making a choice to a new data center location; DR, as a use case; and the one that I think I commented on last quarter was VDI, right, where customers are saying this is the best way for me to run VDI.

Now we do expect that as -- particularly with our Tanzu announcement and the increasing focus that we have on new developer opportunities, that we're also going to begin to start layering into that new application development as well, where people actually start saying my new hybrid cloud or my new Kubernetes build environment will land into a VMware Cloud Foundation or VMware Cloud offering, and our unique ability to have those being hybrid will be very effective.

So those are sort of the use cases. We're seeing customers resonate to those. And now as the offering is maturing in the marketplace, we're just seeing people get more comfortable saying, "Oh, this is a good data center strategy for me to start layering in. Maybe I'm going from 3 to 2 data centers, and this becomes my third and I'm going to have 2 availability zones, so it becomes my third and my fourth. So I become more resilient in the process."

Since I'm introducing this data center, which essentially has elastic capacity, I can run my private clouds more aggressively in terms of their use case. And as a result, I'm going to make the total more efficient than they ever were before and drive my private cloud data center from maybe 30% or 40% utilization to 70% or 80% utilization and drive an aggregate reduction in the cost of my footprint. And in many cases, we've seen customers who have -- as I joke, right, DR is like the fifth priority in the top 3 things CIOs get done, right? So just always this thing that you're trying to catch up.

Well, now if you have an operational hybrid cloud environment, (inaudible) active environment that is far more DR-capable than ever before. So those would be some of the meat-and-potatoes use cases that we're seeing for VMC. But I'll say we've seen everything. And some of the customers today are already viewing this as their target development environment because now they see this multicloud strategy that I've laid out. They've also seen the ability to access some of the VMware Cloud services that enable Amazon services as well with VMC, and they're excited about some of the new offerings like Dimension, where we're now starting to say we're going to manage from the cloud into your on-premise as well.

Overall, a key piece of our comprehensive hybrid cloud, multicloud strategy.

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Operator [42]

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Next, we have Keith Bachman with Bank of Montreal.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [43]

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For both Zane and Pat, I wanted to ask you about EUC had license bookings increase over 20%. Could you revisit how, with the addition of Carbon Black, the standalone EUC category may get some boost? Or how should we be thinking about that as we look over the course of FY '21?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [44]

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Yes. Well, overall, we're super pleased with our EUC performance. We've continued to see this idea of the digital workplace platform really resonating with digital transformation, which includes employee experience. We continue to see great response from Forrester and Gartner with our strategy. And as I said earlier in the call, like we redefined the EUC category from mobility and desktop into one, Carbon Black is now going to become management and security, and it's redefining that category again. And that idea really resonates with customers because sometimes they're finding they have 10, 15, even 20 agents running on their clients. It's just outdated bloatware. And we're going to walk into that and help clean up a lot of that historical mess that they're having.

So overall, this strategy for us is resonating. And while people don't replace their workspace solution quickly, as you see, we're just quarter-by-quarter racking up good, consistent double-digit 20% growth rates that shows we're gaining share. Customers are resonating with the strategy. And we believe that Carbon Black coming into that is going to be a meaningful accelerant.

The other aspect of Carbon Black, their focus really has been more on PC replacement of antivirus. And we've just launched our Workspace ONE offerings recently for the Microsoft Windows 10 environment. So this really is a key element to accelerate that aspect of the strategy.

You also saw that we announced expanded partnership with Microsoft in terms of window endpoint management being now well integrated with Workspace ONE. So the cohesion of all of those pieces coming together, we think, gives us a very nice overall offering in the marketplace.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [45]

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Keith, I would just add, on our next call, we'll get into more detail on how you could think about the combination and obviously, the synergies between EUC and Carbon Black. But as Pat points out, there are many of those, so I'd say, at the highest level, it's included in my general guide for FY '21 as well as where we've called out the 2 points of growth attributable to Carbon Black as we continue to integrate it with the rest of the company over the upcoming year.

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Operator [46]

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Next is Jason Ader with William Blair.

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Jason Noah Ader, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [47]

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If I could just play devil's advocate on Project Pacific, why would I want to integrate VMs and containers in the same management platform? Wouldn't that add a layer of complexity for running my containerized apps?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [48]

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So much not the case. And imagine that you're wanting to do some new application development in containers, but you might have a decade or 2 of existing applications, right? And you have to make those 2 worlds work together, right? Are you going to stand up a unique management environment just for those container workloads, right? And right, this idea that I can bring these together seamlessly with a new modern Kubernetes management environment and manage my virtual machines through that and now maybe I have a big stateful application, why would I ever put that in a containerized environment, right, and get no incremental value from it? I probably made it worse in the process of doing that, right? And now I get this ability to seamlessly intermix those 2 worlds. This is a powerful accelerant.

Also, every CIO on the planet realizes the challenge that he has bridging between the infrastructure and operations world and the developer and DevOps world. This is like the magic bridge between those 2 worlds. And we're thrilled to see us with ability to bring those 2 together in a highly efficient way. And literally, the millions of people that operate VMware environments today are becoming Kubernetes-enabled tomorrow. And that is a powerful force that's going to say we can now go to our dev and DevOps teams with a modern, most industry-compliant upstream Kubernetes-compatible environment and now present to them a Kubernetes environment or as I've called it, a dial tone, just land your Kubernetes workloads here, we got you.

This is a powerful bridge between those 2 worlds. And as we've demonstrated in Project Pacific, not only is it not a detriment, in fact, we run containers faster than bare metals or a Linux-only environment because of the huge efficiencies that we've built into the VMware environment over time. So now I get security, I get management, I get operational consistency. I got the most modern development environment, DevOps worlds, bridging between these 2 worlds, this is powerful. And that's why we saw extraordinary enthusiasm as we rolled this out to the marketplace at VMworld and vFORUMs.

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Paul Ziots, VMware, Inc. - VP of IR [49]

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Thank you, Jason. I think that may have been Pat's favorite question today. Let's appreciate it. We have one more person in queue. So this will be the last question, please.

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Operator [50]

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And that will be Gregg Moskowitz with Mizuho.

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Gregg Steven Moskowitz, Mizuho Securities USA LLC, Research Division - MD of Americas Research [51]

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All right. Perhaps, this will be Zane's favorite question of the day. So Zane, you had previously referenced a bit of a headwind on revenue growth from the mix shift to SaaS. And I was just wondering if you had an estimate for that as it relates to either Q3 or FY '20 as a whole.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [52]

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Yes. It's a great question. I'm not sure it's as good as Pat's. But as we called out, as we called out in the third quarter, it was more pronounced on the license revenue side, and what we've generally done is steered you more towards total revenue and with the strength we've seen in the third quarter, candidly, in both categories. I mean as you know, hybrid cloud subscription and SaaS, while we get the bookings now, we recognize the revenue over an extended period of time. And that's sort of the nuance when you're thinking about the balance between license revenue versus hybrid cloud subscription SaaS. That's sort of the balance that we were contemplating in the third quarter. And we mentioned, with that strength, we saw the guide continue through the year.

So there's always a little bit of headwind, especially as you're growing that just because you essentially recognize the revenue slightly differently. We wouldn't call it out specifically as far as a percent because I think all of our -- when we think about those businesses, they're all in different points on the maturity curve. But in aggregate, you're right, there's always that balance when you're considering a perpetual model versus the SaaS model, but we're comfortable with that balance. We've maintained the annual guide. We feel good about the trajectory heading into next year.

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Paul Ziots, VMware, Inc. - VP of IR [53]

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And before we conclude...

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [54]

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Thanks, Gregg.

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Paul Ziots, VMware, Inc. - VP of IR [55]

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Thank you, Gregg. Before we conclude, I think, Pat, you may have a final comment.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [56]

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Yes. And I'll just say I'm very proud of our team for delivering another very solid quarter for VMware. It's great to have Carbon Black now as part of VMware. And we're, as a result, accelerating our efforts to simplify security for our customers. We're excited about the anticipated closing of Pivotal in Q4, which really helps us to be positioned to deliver the most comprehensive enterprise-grade Kubernetes-based portfolio for modern applications. And finally, we're looking forward to updating you on our progress on the next call, and we wish all of you a very happy Thanksgiving. Enjoy the time with your family and friends.

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Operator [57]

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And once again, ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect.