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Edited Transcript of VMW earnings conference call or presentation 22-Aug-19 8:30pm GMT

Q2 2020 VMware Inc Earnings and Definitive Agreements to Acquire Carbon Black Inc along with Pivotal Software Inc Call

PALO ALTO Sep 9, 2019 (Thomson StreetEvents) -- Edited Transcript of VMware Inc earnings conference call or presentation Thursday, August 22, 2019 at 8:30:00pm 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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* Alexander Kurtz

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* 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 Frances Bachman

BMO Capital Markets Equity Research - MD & Senior Research Analyst

* Mark L. Moerdler

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Matthew George Hedberg

RBC Capital Markets, LLC, Research Division - Analyst

* Michael Turits

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

* Nehal Sushil Chokshi

Maxim Group LLC, Research Division - MD

* Raimo Lenschow

Barclays Bank PLC, Research Division - MD & Analyst

* Walter H Pritchard

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

* Xiaocon Liu

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the VMware Second Quarter Fiscal Year 2020 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Paul Ziots, Vice President of Investor Relations. Please go ahead, sir.

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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 Second 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 as well as a separate slide deck providing information on our proposed acquisitions of Pivotal Software and Carbon Black 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 acquisitions of Carbon Black and Pivotal. Actual results may differ materially as a result of various risk factors, including risks related to our ability to consummate the acquisitions 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 Software; and discrete items impacting our GAAP tax rate. You can find additional disclosures regarding these non-GAAP measures, including reconciliations of comparable GAAP measures in the press release and on our Investor Relations website. A webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link. Our third quarter fiscal 2020 quiet period begins at the close of business Thursday, October 17, 2019.

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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Thanks, Paul. As digital transformation accelerates in enterprises, we see 3 secular trends becoming stronger. First, multi-cloud is the new model for enterprise IT. Second, digital transformation is driving accelerated pace of cloud-native app development. Last but not least, as businesses move applications to the cloud and access it over distributed networks and from a diversity of endpoints, security has become a significant challenge and priority.

To address these trends, we are thrilled to announce our intent to acquire Pivotal and Carbon Black. It's an exciting day for VMware as these acquisitions address critical priorities of CIOs and will meaningfully expand our ability to power our customers' digital transformation.

Next week at VMworld, we will be announcing major expansions of our Kubernetes and modern apps portfolio and how Pivotal completes that strategy. Together with Heptio and Pivotal, VMware will offer comprehensive Kubernetes-based portfolio to build, run and manage modern applications on any cloud.

Specifically, Pivotal has over 350 customers and is used by many of the largest companies and governments worldwide, including 1/3 of the Fortune 100 today. Their customers have seen a significant acceleration in the delivery of modern applications. Many of our largest customers run Pivotal Software at scale on VMware and have seen a significant acceleration in their delivery of modern applications. Having jointly delivered multiple versions of PKS to our customers, their message is clear: they want to see the 2 companies come closer together as a single entity. By doing this, we can accelerate the benefits to existing Pivotal customers. And with VMware's installed base, reach and credibility, we believe we can massively accelerate customer adoption.

Pivotal is a platform leader, offering a set of developer technologies and strategic services that is transforming how the world develops software. Pivotal's developer community has an estimated 3-plus million developers. Spring Boot is now downloaded over 75 million times per month and is the most popular Java developer framework today. Pivotal Labs and Pivotal's platform led the market to containerized application and has enabled developers to quickly and securely get code from development to production. Today, over 750,000 application instances run on Pivotal's platform across all customers.

Kubernetes is driving the biggest shift in enterprise architecture since Java, virtualization and cloud. And Pivotal has begun a major shift to Kubernetes. Developers are adopting Kubernetes because they want to shift software faster and more frequently with the goal of better customer experiences and ultimately drive business growth. IDC estimates that over 500 million new apps will be built in the next 5 years using cloud-native methods and tools. The winners in multi-cloud Kubernetes will, therefore, be those that excel at meeting the needs of developers as well as meeting the needs of enterprise IT. Pivotal is bringing their expertise and outstanding developer experiences to the Kubernetes platform.

VMware has increased its Kubernetes-related investments over the past year with the acquisition of Heptio to become a top 3 contributor to Kubernetes. And at VMworld next week, we will describe a major R&D effort to evolve VMware vSphere into a native Kubernetes platform for VMs and containers. With VMware's enterprise installed base, reach and credibility, we believe we can massively extend the customer potential.

The opportunity is clear and significant. The transition to Kubernetes is underway, and the time to move decisively is now. With the acquisition of Pivotal, VMware will go from the best infrastructure software company to the best infrastructure and developer software company. We can now serve our customers from hypervisor to developer tooling as they embark on the journey to cloud and undertake the biggest modernization in history. We are proud to bring this company into VMware.

Now let's talk about Carbon Black. As enterprises increasingly become digital, cybersecurity and protection of enterprise apps, data, network, end points and identity is a primary concern across the C-suite and Boards. Yet, as I have said before, the current cybersecurity industry is simply broken and ineffective with a plethora of fragmented tools, bloatware agents and no cohesive platform architecture. But today, we are taking a huge step forward in security by bringing Carbon Black into the VMware family to deliver an enterprise-grade platform to protect workloads, applications and networks from device to cloud.

Carbon Black has created an innovative, cloud-native security platform, leveraging an AI-powered data lake, which today sees and stops approximately 1 million cyber attacks per day. Carbon Black's smart, lightweight agent provides comprehensive protection of end points and defense against a variety of threats and breaches. Carbon Black is rated leader by industry analysts with more than 5,600 customers. Carbon Black's assets are complementary and synergistic to existing VMware security products: AppDefense, Workspace ONE, NSX and Secure State.

Building on our existing partnership, the combination of these assets will create a highly differentiated, intrinsic security cloud platform with extraordinary telemetry and network effects. We intend to create deep integrations, agent-less on the server workload side while also collapsing end point management and end point security into an industry-first unified workspace solution. We also plan for integrations with NSX and Secure State, leveraging our unrivaled position in workloads through our unique position in the network and through our extensive end point footprint, we can uniquely and radically reduce the attack surface, thereby intrinsically preventing many sophisticated attacks and automating threat response.

The distribution and enterprise reach of VMware, Dell and Secureworks will further accelerate the adoption of Carbon Black in the enterprise, both through direct selling and through our vast partner networks. With this acquisition, VMware will be able to take a significant leadership position in security for the new age of multi-cloud, modern apps and modern devices.

Now let's recap Q2. In Q2, we demonstrated solid performance across our diverse product portfolio and in all 3 geographies with good rebuilding of momentum in the Americas. Total revenue for the quarter increased 12% year-over-year with non-GAAP earnings of $1.60 per share. On the hybrid cloud front, VMware Cloud on AWS is now present in 16 regions globally with the addition of Seoul and São Paolo AWS regions in the quarter. We are seeing customers who initially made smaller deployments in VMware Cloud on AWS grow those investments. Key wins this quarter include IHS Markit and Equinix who is deploying VMware Cloud on AWS and is also building a number of compelling use cases to help customers operate in a hybrid and multi-cloud world.

Additionally, we are seeing early customer traction for Azure VMware solutions, which is a comprehensive software-defined data center leveraging VMware Cloud Foundation that is sold and supported by Microsoft on their Azure cloud. Within the first 2 months, 20 customers have been onboarded, including Gap and Dot Foods.

In July, Google Cloud and VMware announced Google Cloud VMware Solution, a new service that will allow organizations to run VMware Cloud Foundation in Google Cloud platform. VMware Cloud Foundation serves as the hybrid cloud infrastructure across multiple cloud models, including: one, customer-managed clouds on custom-built and hyper-converged solutions; two, partner-managed clouds such as IBM, Azure and now Google Cloud along with our cloud-verified partners; and three, VMware-managed clouds with AWS and Dell EMC. Customers such as Comcast and FedEx are taking advantage of VMware Cloud Foundation to help build out their cloud infrastructure.

We also continue to help customers operate in a multi-cloud world. Earlier this month, we unveiled VMware HCX Enterprise, which accelerates large-scale live migrations of VMware vSphere and now non-vSphere workloads to help customers operationalize multi-cloud and hybrid cloud transformations.

We are also rapidly building out the CloudHealth platform, including recent customer wins with [Bear], Discovery Limited and Moody's. In Q2, VMware Secure State was made available on CloudHealth by VMware. Secure State solves problems such as those recently seen in the industry, providing a security solution for DevOps-friendly cloud-native applications. CloudHealth is addressing the most pressing customer challenges around multi-cloud visibility, cost, security, automation and governance.

The networking and security portfolio continues to demonstrate strong momentum. Our customers are leveraging NSX across the data center and cloud, VMware vRealize for management and visibility and VMware SD-WAN by VeloCloud for their distributed business requirements. This quarter, we also added Avi Networks, a leader in multi-cloud application delivery services. This natural addition to the NSX platform further enables VMware to bring a software-based solution to a multi-cloud world. In Q3, we also acquired Veriflow to augment our vRealize network and site platform.

We saw accelerating momentum for our Workspace ONE platform this quarter as we continue to help customers provide employees a great digital experience across all apps and devices while maintaining the highest security standards.

Finally, in addition to the acquisitions we announced today, in Q3, we acquired Bitfusion, which enables VMware to make GPU and FPGA capabilities efficiently available for AI and machine learning workloads in the enterprise. We also acquired Uhana, which brings AI techniques into VMware software approach for the telecom industry, helping them accelerate their journey to 5G.

And with that, I'd like to 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. I'll begin discussing our Q2 results and then follow up with more detail on the financial impact acquiring Pivotal and Carbon Black will have on our business. We're pleased with our performance in Q2. We reported 12% year-over-year growth in total revenue and license revenue driven by strength across our broad products and solutions portfolio in all 3 geographies.

Our cloud businesses once again performed very well, with hybrid cloud subscription and SaaS revenue accelerating to over 40% year-over-year. We expect Pivotal and Carbon Black to meaningfully accelerate future growth in this recurring revenue category, which comprise of 12.5% revenue in Q2. Our second quarter non-GAAP operating margin of 32.9% was in line with guidance and reflected continued investments in our strategic cloud initiatives. Non-GAAP earnings per share for the quarter was $1.60 on a share count of 416 million diluted shares.

Unearned revenue at quarter end was $7.5 billion and cash and short-term investments totaled $2.9 billion. Growth in total revenue plus the sequential change in total unearned revenue for the quarter was 17% driven in part by momentum in our hybrid cloud subscription and SaaS businesses. License revenue plus the sequential change in unearned license revenue grew 12% year-over-year. At quarter end, we had license backlog of $13 million and total backlog of $117 million. Over time, one of the metrics that will better reflect the growth of our hybrid cloud subscription and SaaS businesses is RPO, or remaining performance obligations. RPO captures all of our committed and noncancelable future revenue, both billed and unbilled, including future revenue related to our growing hybrid cloud subscription and SaaS businesses. RPO at quarter end was $8.05 billion.

Our broad products and solutions portfolio performed very well in Q2. Core SDDC license bookings grew in the high single digits year-over-year, with total core SDDC bookings up 11%. Compute license bookings grew in the mid-single digits, with total compute bookings up 12% year-over-year. And management license bookings increased in the mid-teens, with total management bookings up 10% year-over-year. NSX license bookings are up over 30%, and vSAN license bookings grew over 45% year-over-year.

We were pleased with the performance of our SaaS offerings in Q2, especially within our end-user computing business. License bookings for EUC accelerated to a growth rate of 20% year-over-year primarily driven by growth of Workspace ONE. In Q2, we repurchased $446 million in stock and ended the quarter with approximately $1.3 billion remaining under our current repurchase authorization, which extends through the end of FY '21.

Turning to guidance. For the full year, we continue to expect total revenue growth of 11.8% year-over-year to $10.030 billion, excluding the Pivotal and Carbon Black acquisitions. While our full year total revenue guidance remains unchanged, the increasing momentum in our hybrid cloud subscription and SaaS businesses for which revenues recognized over time is driving a slight change in our license revenue mix. As a result, we now expect license revenue of $4.215 billion for FY '20, up 11.3% year-over-year.

The strength of the overall business, including services allocation of hybrid cloud subscription and SaaS, PSO and software maintenance, is contributing to total bookings and total revenue strength and offsetting the timing impact on license revenue for the full year. We continue to expect a non-GAAP operating margin of 33% for FY '20 and expect a small increase in non-GAAP earnings per share to $6.54 on a diluted share count of 417 million shares. Cash flow from operations is expected to be $3.950 billion and free cash flow is expected to be $3.630 million, unchanged from our prior guidance.

Moving to our Q3 guidance. As bookings from hybrid cloud subscription and SaaS generally convert to revenue over a longer period of time as compared to our on-premises software sales, we expect license revenue mix to be impacted in Q3 as we do for the full year. License revenue in Q3 is expected to be $950 million, an increase of 7.5% year-over-year. And total revenue is expected to be $2.4 billion, up 9.3% year-over-year. Strength in overall bookings is expected to continue in Q3. We're forecasting growth in total revenue plus the sequential change in total unearned revenue to be approximately 13% year-over-year in the quarter and up about 2 percentage points versus Q3 FY '19.

For Q3, we expect a non-GAAP operating margin of 30.3% and non-GAAP EPS of $1.42 per share on a diluted share count of 416 million shares. Detailed guidance for Q3 and the full year is contained in the slide deck on our website accompanying this call.

Turning to Pivotal and Carbon Black. We believe these acquisitions will help us accelerate delivery on our portfolio strategy in the areas of building and protecting any app on any cloud and any device. These acquisitions will also accelerate the growth of our subscription and SaaS revenue. Adding both to our portfolio will be of mutual benefit. In particular, we will deepen Pivotal's and Carbon Black's penetration with enterprise customers by leveraging the VMware and Dell Technologies' go-to-market capabilities and breadth of technology solutions.

We expect Pivotal and Carbon Black together will add more than 2 points of revenue growth and over $1 billion in mostly hybrid cloud subscription and SaaS revenue to VMware's total revenue in year 1 and meaningfully increase our total revenue and hybrid cloud subscription and SaaS to over $3 billion in year 2. We expect the combination of Pivotal and Carbon Black together to be operating income positive in year 1 and both cash flow positive and EPS accretive in year 2. The integration of these 2 businesses into the VMware franchise will both enable accelerated top line growth as well as allow these businesses to grow globally and operate at scale.

With regards to Pivotal, VMware has agreed to acquire Pivotal at a blended price per share of $11.71 comprised of $15 per share in cash to public stockholders and VMware's Class B common shares in exchange for Pivotal Class B common shares held by Dell Technologies at an exchange ratio of 0.055 VMware shares for each Pivotal share. The transaction has an enterprise value of $2.7 billion. Dell Technologies will receive approximately 7.2 million shares of VMware Class B common stock. In aggregate, this results in an expected net cash payout for VMware of $0.8 billion. The impact of the equity issued to Dell Technologies would increase its ownership stake in VMware by approximately 0.34 percentage points to total of 81.09% based on the shares currently outstanding. VMware currently holds 15% of outstanding shares of Pivotal. Once closed, we will update VMware's historical financial statements to reflect the historical performance of Pivotal.

With regard to Carbon Black, VMware has agreed to offer $26 per share in cash to Carbon Black's stockholders, which equates to an enterprise value of $2.1 billion. This results in an expected net cash payout for VMware of $1.9 billion. In total, we expect net cash outlay of $2.8 billion for both acquisitions, and we're comfortable with the total funding requirements to close. We have the flexibility to fund the acquisitions through cash on our balance sheet and access to short-term borrowing capacity. We anticipate both acquisitions will close in the second half of FY '20.

We expect to complete our existing buyback authorization of approximately $1.3 billion by the end of fiscal '21. Additional details on both acquisitions can be found in the press releases and Q2 earnings slide deck accompanying this call as well as a separate slide deck for the proposed acquisitions.

In closing, we are pleased with our solid Q2 financial performance and the ongoing strength of the business. These acquisitions will drive incremental top line growth in our hybrid cloud subscription and SaaS businesses as well as tightly integrate with and benefit our existing products and solutions. The combination of Pivotal and Carbon Black will contribute to our operating income in year 1 and be accretive to EPS and free cash flow in year 2, helping drive value for VMware while addressing 2 of our customers' most strategic priorities.

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

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [5]

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Thanks, Zane. The acquisitions announced today will advance our goal of offering more comprehensive and trusted cloud-agnostic solutions. Pivotal strengthens our ability to help our customers build modern apps with velocity and efficiency, and Carbon Black strengthens our ability to protect enterprise applications and workloads with an intrinsic security platform. With both companies, we will be the only vendor able to deliver software solutions that enables customers to build, run, manage, connect and protect any app on any cloud and any device. We look forward to welcoming our customers, partners and industry peers to VMworld next week where we will showcase our strategy and unveil new offerings and updates across the portfolio and the ecosystem. Thank you.

Over to Paul to manage the Q&A.

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Paul Ziots, VMware, Inc. - VP of IR [6]

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Thanks, Pat. (Operator Instructions) Operator, let's get started.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Raimo Lenschow from Barclays.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [2]

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Interesting times at VMware. Can I ask on Carbon Black, please? How do I have to think about the deal? Is there kind of -- is this kind of like an EUC extension to have like a more broader portfolio? Or is this VMware moving more into that security space, and hence, kind of, over time, we think about the buildup of the security portfolio even further? Can you help me understand that, please?

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

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Yes. Thanks, Raimo, and I'll start on this one. And you really want to think about it as the latter. This is VMware building a security cloud platform, and we expect that there's integrations across our portfolio that will be benefited by the Carbon Black technology. And first, we're excited about Carbon Black. We see that the technology that they've built, the position that they have as a player in the security industry is a strong one. But in addition to that, we see that the opportunities for integrations on NSX; on AppDefense, an area that we were already working with Carbon Black to enhance our AppDefense technology and core vSphere; and of course, in the light-powered agent becoming an integrated solution with the Workspace ONE offering. Together, VMware and Carbon Black, we think, will uniquely provide customers advanced threat detection, in-depth app behaviors insights to prevent sophisticated attacks and accelerate responses across that platform.

And as I said, in my prepared remarks, Raimo, we really think the security industry is broken, right? This idea of individual products that are bolted on and patched on is just ineffective for customers. And today, we're launching a major step to deliver an end-to-end intrinsic security platform, and we see the Carbon Black assets as a huge accelerant and complement to our offerings to do exactly that.

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Operator [4]

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We'll take our next question from Karl Keirstead from Deutsche Bank.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [5]

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Zane, on the decision to guide down on license revs for the second half, do you mind just repeating the explanation so we're all clear? And then perhaps -- and a related question to Pat. Pat, last quarter, you cited some macro uncertainty and you flagged the Americas sales reorg. I'm just wondering, from your perspective, did either of those couple of issues perhaps play into the decision to revise your outlook on the license growth side in the second half?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [6]

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Sure, Karl. I'll start. As I mentioned, we're very pleased with the bookings strength we've seen in our hybrid cloud subscription and SaaS portfolio. But with that, it just drives a slight mix shift in revenue because, as you know, in the subscription or SaaS business, you tend to recognize that revenue over a period of time. And with the third quarter and the strength we expect to see in the fourth quarter with some of the other attributes, be it PSO strength as well as some of the renewal strengths we're seeing, we do have a period in the third quarter where we don't have that growth, as you've seen it before. But we believe we'll make it up in the second half of the year given the strength we've seen in RPO, which as I mentioned, was about $8 billion at the end of the quarter as well as the strength we continue to see on the bookings side. So it's really that hybrid cloud and SaaS timing and when you recognize that revenue that's driving the change in mix between license and total revenue.

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

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And as we consider the overall economic outlook, we'd simply no, this is really a mix item that Zane has described for the third quarter and license expectation as we see an increasing focus on our hybrid cloud and subscription products. We do believe that as we see that second half outlook, that there is uncertainty in the macro environment, and nobody is immune from that. We have continued to see good performance by our team. And as we noted in the formal remarks, we have seen a very nice reacceleration in our Americas business. They're performing very well, and we expect that the reorganization that we did last quarter has already started to produce results. And those will accelerate as we go through the year and into next with the productivity that we expect as a result.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [8]

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And Karl, just to give you an example on the mix shift, I just wanted to add, if you just took a look at our EUC business, which is seeing strength throughout the course of the year, if we had the same ratio of SaaS bookings as we had last year, we would have double-digit total revenue and double-digit license revenue growth in the third quarter year-over-year. So it's simply that mix shift.

And of course, we're pleased with the growth we're seeing in that category because you ultimately get that revenue, but it's just over a slightly longer period of time. But we think the bookings growth is incredibly strong in that category and then more broadly across the portfolio.

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Operator [9]

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We'll take our next question from Kash Rangan from the Bank of America Merrill Lynch.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [10]

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I'll stick to one question with multiple parts, Paul. The question is with regards to Pivotal, what are the things that the VMware management -- congrats on the Carbon Black acquisition, by the way. With Pivotal, what are the things that VMware can do to Pivotal either structurally from a technology perspective to position it better given all the disruptive trends that are happening in that space, coupled with what could you do from a distribution standpoint? Because VMware typically has been just infrastructure, you getting into apps developed, which is a completely new buyer -- new segment of the market. So how are you thinking about this transition? What are the things that you're going to be doing differently?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [11]

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Yes. Thanks, Kash. And overall, we believe that the developer space is going through a massive transition, and we view Kubernetes as this important strategic shift, as I said, in my formal remarks, significant as virtualization, cloud, and Java. And with that, what we see is the opportunity to be this full-stack provider, and we believe we need to own and control an end-to-end Kubernetes platform that allows us to build, manage and run Kubernetes environment and maybe somewhat analogous to compute. We have a full stack with VMware vSphere and vCenter or networking with NSX, a full stack of capabilities. And we believe this ability to own that full stack is something that gives us great market opportunity. Also, we've clearly heard from customers who are demanding this move. Pivotal, the 350 customers, their penetration in the Fortune 100 today, combined with the learnings that we've done with them and the 250-plus PKS customers, they're asking us to make this move to bring this together.

And we also see, as you suggest in your question, that the go-to-market synergies will allow us to go faster. And while we've sort of taken the Heptio technologies and we'll be describing acceleration of how we embed this in the core VMware platform at VMworld next week, we believe we have the opportunity to bring these next-generation developer platform and infrastructure services all based around Kubernetes to a much, much larger market that was ever possible before. And that's where VMware's enterprise credibility and reach will come to a great benefit, and we believe this will be a great acquisition for us and for our customers and for our shareholders.

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Operator [12]

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We'll take our next question from Mr. John DiFucci from Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [13]

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My question is for Pat. Pat I sort of -- I get the Pivotal acquisition, but I'm having a hard time with the Carbon Black acquisition. I mean you said the security industry is broken. And I get that Carbon Black's part of that next-gen player in corporate end point. But it really -- it's -- I don't think it's considered the cream of the crop out there, and that's kind of what you've done in the past when you do things like this, like I think of Nicira, which became important to security. It wasn't at first, but it became that. And that was transformative. This is something -- I'm just struggling with it because this is a really competitive market, and there's some players out there like CrowdStrike and others. And that one is -- Carbon Black has struggled at times. And I'm just wondering what all this means buying this asset now.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [14]

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Yes. We believe that the opportunity is a market in disruption. The security market is going through a massive transformation. Legacy players are being disruptive. There is a major shift in the characteristics of the market.

We also did a very in-depth analysis and diligence process with regard to the underlying technology of Carbon Black, and we came away very satisfied as they are making their move to a cloud-delivered service and capability. They're growing nicely in their cloud offerings.

We also saw the synergy benefits. And I'll remind you that we're working with Carbon Black for the last 2 years around AppDefense. So we've really been derisking this acquisition for the last 2 years as we've been getting to know them and start building shared go-to-market with them.

And I'll also remind you, John, that when we acquired AirWatch, they were not #1. They became #1 in the hands of VMware as we improved their execution, their scale and distribution as a result. And that was clearly a case where it was who will emerge as the winner. And today, it's very clear that we emerge as the winner in taking that asset forward. And we firmly believe that we can do that again with Carbon Black.

I'd also emphasize that we're -- as I said in my earlier remarks, John, we're integrating it into NSX, into vSphere, into Workspace ONE. We have strong points of synergy. Collectively, we believe we'll have more telemetry, more visibility, more data across that spectrum than any other vendor in the industry.

And finally, as we look at the enterprise distribution capacity of VMware as significant, as an accelerant, but also with Dell. And this is an area where Dell and their end point offerings is very substantial. And as we've done in our partnership with Dell in other regards we believe that we have reach into market that no other vendor has. We believe that, fundamentally, customers want a different answer in the space. The market is not being effective today. We need a platform approach. Customers have been buying and spending way too much on security, getting way too little security as a result. And this is an opportunity to change that market entirely. And we're thrilled to have the asset to make a bold move in the space.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [15]

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John, I would just point out, as you would expect, we've done a fairly thorough review on the financials. And we believe strongly that adding both Carbon Black and Pivotal to the portfolio not only helps the portfolio, but also helps the individual companies. And we think it will be well integrated, and these are 2, obviously, strategic areas that we think will drive significant incremental growth and value to the enterprise, so we feel comfortable with it.

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Operator [16]

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We'll take our next question from Mr. Walter Pritchard from Citi.

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Walter H Pritchard, Citigroup Inc, Research Division - MD and U.S. Software Analyst [17]

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Zane, a question for you on the hybrid SaaS piece, understanding your guidance in the future will include the Carbon Black and Pivotal, which will impact that. But if we just look at the core, I think it's 12.5% or so. That's accelerating now. I mean how do you think about the progression of that sort of move to subscription? How much of that is cannibalistic to licensing? How should we expect -- I mean we've seen a lot of companies kind of go through this over time. How should we expect that to suppress license growth as we look out the next several years?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [18]

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Yes. Walter, it's a great question. I mean we've looked at it very carefully. And obviously, it is a balance. There aren't a tremendous amount of products today that we're selling other than the EUC portfolio where you have those levers to pull in one versus the other. And obviously, I gave you the example of EUC where we've consciously leaned heavily on SaaS. We believe it would generate incremental long-term value to that part of the portfolio.

We continue to believe that we can grow both the perpetual side of the business as well as grow the SaaS side. And with the acquisitions today, as you point out, we believe it's not only going to add top line growth, but meaningfully change the dynamic of the company into more of a SaaS -- subscription and SaaS franchise. And we're encouraged by what we've seen in the early uptake in that area.

So I'd say today, we'll get into this a little bit more as we give you more guidance for future years. Obviously, this will take a large step-up in hybrid cloud subscription and SaaS as a category. I mentioned it's growing over 40% this quarter. We would expect to continue to see nice growth in this area even as you consolidate the 2 acquisitions. And then we expect to achieve a blended growth rate of both parts of the portfolio for many years to come, and that's part of the reason behind both the Carbon Black and Pivotal acquisition you see today.

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [19]

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Yes. And as we said, we expect this to take us to over $3 billion of hybrid cloud and SaaS revenue in year 2, right? And that our estimates places us firmly in the top 10 of IaaS, PaaS providers in the industry. This is becoming a very real portion of VMware's business, revenue and strategy going forward. And as you saw this quarter, it's growing very nicely before the acquisitions, and the acquisitions will only accelerate that portion of our business.

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Operator [20]

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We'll take our next question from Mr. Matt Hedberg from the RBC Capital Markets.

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Matthew George Hedberg, RBC Capital Markets, LLC, Research Division - Analyst [21]

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Pat, in your prepared remarks, you noted additional AWS availability zones going live. I'm wondering, though, could you step back and kind of -- sort of shed light on kind of the overall public cloud partners? Obviously, you guys just extended GCP this last quarter, but maybe more of a holistic view of where we sit there and maybe how Pivotal feeds into that as well?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [22]

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Yes. And at the broadest brush, we now feel like we've completed the portfolio of our multi-cloud partnerships and offerings. And obviously, VMware Cloud on AWS has been our preferred offering and now 16 regions globally. This is a broad footprint that we're now able to satisfy customers' global requirements. Nice customer wins this quarter. Lots of repeat sales now, which is a key aspect of a cloud business where you're seeing people start to use it and then build more use cases and expansion. So that's going very well.

Obviously, the Azure update was very positive. First customers on the platform just launching the GCP alternative. So now VMware can clearly say we're uniquely positioned as the multi-cloud, hybrid cloud of choice. And customers are beginning to understand that, and we're going to describe that much more broadly in several major announcements in that area as part of VMworld next week. So this idea of being able to tell customers that we enable you to take advantage of these enormous, rapidly evolving, globally available public cloud resources is a very powerful thing. And the AWS partnership, our preferred hybrid cloud partnership, has clearly, I'll say, led the way as we're building more and more of that market presence. And we see that customers really have resonated with this idea of being able to look at us and saying we really do give them cloud choice into the future.

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Operator [23]

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We'll take our next question from Mr. Michael Turits from Raymond James.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [24]

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Congrats on the deals. Pat, can I continue along the security line and ask you somewhat about your strategy again? You said security is broken. So is your -- you bought an end point company here, next gen but in a clearly defined category. Is your thought that you buy in each of these major traditional categories? Or are you thinking about redefining security in some way? And what kind of an M&A acquisition strategy does that require?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [25]

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Yes. Let me -- let's make sure we define end point in a broader sense because we are already integrating the Carbon Black technology into vSphere, right? This is a capability we announced as part of AppDefense. So we have already taken that core technology, and we're applying it to analyze application workloads in the server side, a unique position for VMware.

Clearly, on the Workspace ONE side, we have this ability to bring together, and we describe this unified agent, where customers, today, they have bloatware that sets -- they have this breadth of fat -- different products that sit on the client and their anxious to fix that. It's slowing down and needs to be patched and upgraded. We're going to resolve that by making it all part of the Workspace ONE agent.

We've also been organically building the NSX security capabilities with our micro-segmentation for several years. And we're going to be -- embedded Carbon Black technology into that. So we see we have it on the workload. We have it on the client. We have it in the network. But all of these produce telemetry, right? We're going to have more access, more data that allows us to combined with the security cloud that Carbon Black is already operating now with a torrent of higher data that allows them to analyze at scale as nobody else in the industry. And this end-to-end characteristic, we think, is something uniquely of combining Carbon Black's technology with VMware's footprint and some of our early technology to give us this end-to-end opportunity. And thus, we really see this complementariness of their technology positioned in the industry. But as I already commented, the distribution capacity that this brings us is unrivaled. And combining that with Dell's reach, we really see this as a very unique opportunity. And there really is nothing like it in the industry of what we think is possible by bringing these 2 entities together. And we're out to change security for the industry. It is broken. We're out to fix it in a fundamental way.

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Operator [26]

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We'll next take Mr. Mark Moerdler from Bernstein Research.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [27]

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VMware already had a tight relationship with Pivotal given the prior ownership structure of Pivotal. Could you not have accomplished the same results via technology partnerships in resales? What's the secret sauce here? Is there more of a better go-to-market? Is it cleaning up structures? Is this some key technology that you can leverage, you can gain full access to? Can you give me a help a little more on understanding what the key drivers of that is going to be?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [28]

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Yes. There's a couple of aspects to that, that I'd like to just reemphasize a bit. One is this analogy that says this is a complete stack, and there's going to be a build, run, manage, stack associated with Kubernetes. And VMware with what we have in the one area -- we're already uniquely positioned with what we acquired in Heptio. We are well positioned in the managed, but we really did not have build assets. And that's where Pivotal and their capabilities was uniquely positioned in the industry to finish that stack. So we can now go to customers and say we can help you build it. We've done all the integration, validation, testing and scale to be able to run it. And we're able to manage across multiple clouds. So this build, run, manage is the core of our strategic thesis.

We've been derisking that with our PKS relationship that we've been working with Pivotal over the last couple of years. Heptio has given us deep insights into the evolution and the influence of how that community will evolve. So we're now in a position that we feel very confident making this next step of bringing all of these assets together.

We also clearly heard from customers, "We want one place to come together for this technology pool." And we believe that VMware can respond to that by owning and controlling a complete Kubernetes platform. We also believe that customers are looking for -- in this very significant and massive transition, they want somebody who has enterprise credibility, enterprise scale, enterprise reach, and that's something VMware can really accelerate dramatically for Pivotal. And while we can help when they're in the family, as we've been doing, now we are responsible. And we're going to bring this together in a very aggressive way to bring that reach, scale and credibility.

And we believe it's timely. We understand it well with Heptio. We've heard from customers clearly. And Pivotal is making their transition to Kubernetes already, and they're now well underway on that transition. And now we believe is the time to bring this together, accelerate the growth, leverage the VMware position. And you're going to hear more from us at VMworld next week where we'll be making several very specific announcements about our vSphere extensions for Kubernetes, the first offerings from our Heptio acquisition. The story that you'll hear next week will be a complete, robust and exciting one for the industry.

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Operator [29]

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We're taking our next question from Mr. Keith Bachman from the Bank of Montreal.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [30]

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I wanted to come back to the M&A for a second. Pat, you had mentioned that the security market is broken, and Carbon Black, I think, is a very small part. But just to finish the thought, is this the start of your venture into security? In other words, over the next 5 years, would you intend to be a larger participant in the security market? Because, candidly, Carbon Black is a very small piece of it. And then if I could just sneak in a clarification. Zane, could you give us the RPO year-over-year?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [31]

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Let me -- let's try to draw the curtain back a little bit more broadly on the security market as a whole. And VMware with our NSX offering, we would claim that we are already an active participant in the security market at scale. And we've indicated that maybe 1/3 or 40% of NSX's revenue is associated with security use cases, so this is already very substantive. We've already launched our AppDefense and the integration of that into vSphere. So we're now -- some of our vSphere revenue is associated with security. Workspace ONE is sold, in many cases, based on the security benefits. So we believe that a narrow definition of the security market around specific and bespoke products actually misunderstands the buying behaviors associated with it and how people are spending budget to accomplish security.

We also believe that there needs to be a dramatic shift that today Gartner would estimate that 80% of security spend is on detect, respond, and that protect investments are 4 to 5x more effective than detect, respond investments. This is about flipping that over and moving the investment profile into a much more efficient model of preventing the accident from ever occurring.

At my RSA keynote this year, I described the security industry like bad attorneys, right? They chase around, find the accident and get more security spend justified after the accident. What a terrible business model. Prevent the accident from occurring. So this, to us, is a very fundamental disruptive change that's underway. We do believe that we're going to build a security business unit, and that's exactly what we're announcing. And Carbon Black and the team and people will be central to that. We'll also combine it with a number of resources from the VMware teams that we already have underway. This will become a much larger revenue area for us in the future. But our objectives are not to build a new business, it's to change the industry because the industry we know today is not working. And as more and more humanity puts their lives, their financials, their health on the tech platform, they're expecting a much higher return and a much better protection of their data and lives than the tech industry is giving. So to us, there's a much bigger cause than just building a business unit or starting a new revenue line. We're out to change the security industry.

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [32]

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Keith, maybe not quite as enthusiastic as Pat in my response to your part B, but the RPO on a year-over-year basis was 25% up. There are different ways we'll be talking about it. One of the ways is thinking about revenue plus the sequential change. If you were to look at it that way, it would be close to 13%. There's some normalization that would drive it higher, but the answer to your question on my side is 25%.

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Operator [33]

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We'll take our next question from Mr. Brad Zelnick from Crédit Suisse.

We'll take our next question from Mr. Alex Kurtz from KeyBanc.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [34]

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Pat, I think earlier in your prepared remarks, you talked about bringing Kubernetes deeper into vSphere, which would be a very unique and differentiated approach relative to other offerings in the market. So I know next week is going to be a lot more about that, but could you maybe offer up some high-level thoughts around what that might look like and how that could help VMware in the Kubernetes marketplace?

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

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Yes. And obviously, my first answer is come to VMworld, we'll fill you in, in great detail. But the second answer is if you think about Kubernetes, we see this dramatic shift in how people build and run their applications. And this abstraction, this API set is a new technology space that we believe is significantly changing how people are able to access and run infrastructure, but also how they deploy and operate and accelerate their software development. And that's why we say it's build, run and manage. When we talk about run, we will be integrating Kubernetes constructs directly into vSphere.

And you can also think about it that we're going to rebuild vCenter and vSphere on to Kubernetes. So it's a very fundamental view of how we integrate Kubernetes into the core vSphere, much more API-driven, service-driven as clouds are -- and making that part of core vSphere. These -- I'll say, this is the most aggressive step we could take to embrace vSphere into -- or Kubernetes into the core of VMware. And we'll give you a lot more details on that next week, but we see this as a major move of our organic core vSphere engine into the space.

And obviously, in doing that, we're going to have the most powerful community of operations and infrastructure, people are going to become Kubernetes-capable. And that's where we're going to be able to scale this across the industry in a fundamental way as it goes into the core product line that hundreds of thousands of companies build and operate their applications and infrastructure services around today. This is a big move.

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Operator [36]

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We'll take our next question from Heather Bellini from Goldman Sachs.

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Xiaocon Liu, Goldman Sachs Group Inc., Research Division - Research Analyst [37]

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This is Caroline on for Heather. So I wanted to go back to VMC on AWS and what you're seeing in terms of the pace of deployments. And does this impact the ELA renewal cycle as customers are migrating over? And in the future, as the mix shift progresses, are you planning to disclose current RPO?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [38]

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So I'll just say a few more words on the first part of that and then turn it over to Zane for the second part. Overall, as we mentioned, we're seeing nice customer traction. Customers are coming on for their second, third purchase. Often, those purchases in the second, third cycle are actually part of ELAs, right, where they're now looking at that as this broader portfolio of capabilities, products and services that they're acquiring from VMware. So it's part of our normal business cycle in many of those second or third purchases as they're looking for how do I structure my infrastructure investments over time. And VMC is now becoming one of the staple ingredients as part of that menu of offerings. Zane?

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Zane C. Rowe, VMware, Inc. - CFO & Executive VP [39]

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Yes, Caroline, I'll just add to Pat's point on the EAs. I mean you saw this quarter, our EA mix actually moved up from 44% to 47%, so nice strength in the EAs and the strategy throughout the portfolio. So we're very pleased there.

On the RPO, we don't currently plan on getting into detail on the current portion. Over the next number of calls, we'll get more and more into RPO and the importance of RPO as we think about our bookings trends and give you a sense of the unearned capability of the business, so not at this point in time.

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Operator [40]

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We'll take our next question from Mr. Nehal Chokshi from the Maxim Group.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [41]

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You guys noted that the compute license bookings grew mid-single digits, which I think is pretty strong considering data points out there that service spending had a material further weakness in the July quarter. So just talk about what was the driver of this, what I would call, a relatively robust compute license bookings?

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Patrick P. Gelsinger, VMware, Inc. - CEO & Director [42]

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Yes. Let me start on that. And overall, we're just continuing to see strength in VMware's infrastructure purchase decisions. And people look at that, the continued momentum there. As we've noted in the past, we continue to see strength in that from our VMware Cloud partner program, our VCPP program as well. That's a major contributor and continues to be a major contributor to it.

Another aspect of this is that we are increasingly selling the VMware Cloud Foundation, right? And that is a composite of compute, network storage and management, and it's the full solution. And increasingly we're seeing major customers say, "I'm going to build my full data center on the VMware offering." And that's the cloud foundation.

So in summary, we see it in top 10 of our largest deals in the quarter. We're pleased with the breadth and strength of the offering, and no end in sight to this being foundational to the VMware portfolio even as we saw more and more of the complete solutions on both the cloud and on-premise.

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Paul Ziots, VMware, Inc. - VP of IR [43]

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Thank you. Before we wrap up, Pat will have a final statement to make.

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

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Yes. Thank you, Paul. And as we said, Q2 was another strong quarter for VMware. I'm very proud of our team for these results. And with a meaningful expansion of the VMware portfolio with the acquisitions of Pivotal and Carbon Black, I'm even more excited than ever as we look into the future. And we look forward to sharing exciting new announcements and technology innovations that we're going to be unveiling as part of VMworld next week. And I hope to see you all there. Thank you very much.

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Operator [45]

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This concludes today's call. Thank you for your participation. You may now disconnect.