VMware Inc

XETRA:BZF1

Earnings Call Transcript 2018-Q4

[Operator]

Good day, everyone, and welcome to the VMware Fourth Quarter Fiscal Year 2018 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Paul Ziots, Vice President, Investor Relations. Please go ahead.

[Paul Ziots, VMware, Inc.]

Thank you. Good afternoon, everyone, and welcome to VMware's Fourth Quarter Fiscal 2018 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 can also be 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. Actual results may differ materially as a result of various risk factors, including those described in the 10-Ks, 10-Qs and 8-Ks VMware files with the SEC. We assume no obligation to and do not currently intend to update any such forward-looking statements. In addition, during today's call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures which are used as measures of VMware's performance, should be considered in addition to not as a substitute for or in isolation from GAAP measures.

Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation, amortization of acquired intangible assets, employer payroll tax on employee stock transactions, acquisitions, divestitures and other related items, non-GAAP tax rate adjustments, as well as the estimated net tax expense recognized in conjunction with the Tax Cuts and Jobs Act. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in the press release and on our Investor Relations website.

The webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link. Our first quarter fiscal 2019 quiet period begins at the close of business Thursday, April 19, 2018. Year-over-year comparisons of quarterly financial results included on this call compare results for VMware's fiscal 2018 fourth quarter, November 4, 2017, through February 2, 2018, to VMware's fiscal 2016 fourth quarter, October 1 through December 31, 2016. In addition, beginning in Q1, fiscal 2019, VMware will adopt ASC 606 using the full retrospective method. Guidance for Q1 in fiscal 2019 will be provided under ASC 606.

Growth rates associated with our guidance are calculated under ASC 606 using preliminary adjusted historical data for Q1 2018 and fiscal 2018 in order to provide comparisons on an apples-to-apples basis. Accordingly, we have included tables that present a preliminary view of selected financial information for Q1 2018 and fiscal year 2018 as adjusted under ASC 606 in the Q4 earnings press release, as well as in the appendix of the slide deck accompanying this call.

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

[Patrick P. Gelsinger, VMware, Inc.]

Thank you, Paul. Before we cover our Q4 and full year results, I want to recognize that many of you have been following the recent news cycle about the Schedule 13D public filing by Dell on February 2. Our press release in response to this filing, which outlines our sound governance practices, including that the VMware board is committed to taking actions that are in the best interest of all stockholders, can be found on our website. We will not comment further on Dell's 13D in these prepared remarks, or in the Q&A.

Moving now to provide you with an update on our business; our Q4 fiscal year 2018 results demonstrate the power of our broad-based portfolio. We're pleased with performance around the world, and in particular with the EMEA where we saw very positive momentum with large deals. Q4 total revenue grew 14% with a non-GAAP earnings per share growth of 18% year-over-year to $1.68 per share. Key factors contributing to our strong Q4 and terrific fiscal year 2018 results include our private, hybrid, public cloud and mobile strategy continues to resonate with customers, strong and consistent go-to-market execution globally, and a positive market environment for well-positioned enterprise companies.

During the quarter, we saw the power of our broad-based portfolio drive positive momentum culminating in a very good fiscal year 2018 for VMware. It's been an incredible year for our networking portfolio. Our NSX Everywhere strategy provides seamless connectivity from data center to cloud to edge, while enabling developers with the tools that help them innovate and providing administrators with visibility, automated controls and security.

We recently completed the acquisition of VeloCloud Networks. This industry-leading, cloud-delivered, SD-WAN solution extends our value in the enterprise and increases our relevance with service providers by offering end-to-end automation, application continuity and security from data center to cloud edge. With the recent expansion into SD-WAN cloud and container workloads, NSX is uniquely positioned to be a ubiquitous platform for the future of networking.

A recent example of embedding NSX with almost every VMware solution is with Pivotal Container Service, or PKS. VMware and Pivotal announced the general availability of PKS. This offering is a Kubernetes-based container service designed to meet the needs of operators and developers, and one of the unique and differentiating components of PKS is NSX. While just launched, several customers' first NSX use case is being driven by container networking and security benefits provided by Pivotal Container Service and Pivotal Cloud Foundry.

We're very pleased with customer enthusiasm for our cloud strategy. We believe we have the world's most complete and capable hybrid cloud architecture, uniquely offering customers freedom and control in their infrastructure decisions. We continue to see customer interest and engagement with VMware Cloud on AWS. The service designed to bring VMware software-defined data center to the AWS Cloud, allows customers to run applications across operationally-consistent VMware vSphere-based private, public and hybrid cloud environments, with optimized access to AWS services.

Customers across many industries are rapidly embracing VMware Cloud on AWS to enable modern, efficient and hybrid scalable infrastructure for a variety of use cases, including disaster recovery and data center extension. We are also pleased with the traction the VMware Cloud Provider Program continues to gain. The VMware Cloud Provider Program achieved an annual revenue growth rate of over 30% in fiscal year 2018. We are also experiencing great global customer momentum with our VMware Cloud for IBM with customers such as Amdocs, Ricoh and Vodafone.

As we continue our journey towards the hybrid cloud, providing the best solutions to span the private and public clouds, I wanted to share an update on two acquisitions recently completed. We acquired CloudCoreo, which will help us extend our support of consistent operations across any cloud, as their technology proactively identifies public cloud risk at the time of deployment, and prevents compliance violations before they occur. We also acquired CloudVelox, a pioneer in developing software to enable workload mobility from existing data centers to modern, private and public clouds. We expect the acquisition to become part of our Hybrid Cloud Extension service, and accelerate our road map to deliver cloud migration, mobility and delivery services in a hybrid, multi-cloud world.

On the software-defined storage area, I am also excited to report that VMware has been positioned in the leader's quadrant of Gartner Incorporation's February 2018 Magic Quadrant for Hyperconverged Infrastructure. We believe this Magic Quadrant for Hyperconverged Infrastructure reflects the strong momentum behind long-term strategic HCI platforms from software-focused vendors like VMware. We further believe that VMware's placement in the Leaders quadrant validates the impact our comprehensive vision, strategy, and VMware vSAN offerings are having in today's IT environments. While we are experiencing broad momentum from our Dell partnership, our HCI VxRail offering showed particular strength as we finished a very strong year in this area.

We were very pleased with the continued strength in our end user computing offerings. This growth is driven from our digital workspace platform, Workspace ONE. Workspace ONE securely delivers any application to any device. Customers are replacing the silos of end user solutions consolidating their mobile identity and desktop solutions into a single platform. Workspace ONE customer momentum is growing rapidly and will soon be the largest element of our end user computing portfolio as we continue to expand our market leadership in this space.

We were also pleased with the performance in Compute and Management. We're seeing increasing momentum for our integrated cloud platform. The latest release of VMware Cloud Foundation introduces integrated cloud management platform capabilities that provides customers with a simplified path to building a hybrid cloud based on consistent infrastructure and operations. With Cloud Foundation and other offerings, we continue to help our customers navigate a multi-cloud automated future.

Building on our strength in Compute in the data center, we continue to extend into additional growth areas, including security, network function virtualization and IoT. Globally, carriers are continuing their transformation of core networks with VMware NFV to increase their agility, reduce costs and prepare for the imminent arrival of 5G. At Mobile World Congress 2018 earlier this week, we demonstrated several new and exciting capabilities for carriers, including the ability for CSPs to connect their virtualized core networks on VMware NFV by extending them to hyperscale public clouds, such as VMware Cloud on AWS.

We are also pleased to mention some recent company awards, including ranking number seven on Fast Company's Most Innovative Company in Enterprise, and placing number six in the Leaders category among the top 50 companies Best Positioned for Growth in the Fortune Future 50 ranking. I am also very proud of ranking in Fortune Magazine's 100 Best Companies to Work For list in the U.S. For the fourth time in a row, VMware has ranked in the list, landing in the 39th spot this year.

In closing, we believe the cloud, mobile, networking and security technologies we offer are central to the digital transformation happening across every industry. We continue to apply virtualization and software innovation to connect, secure, manage and automate the world's increasingly complex digital infrastructure. I want to thank all of our VMware customers, partners, and of course, team VMware employees for a great quarter and terrific fiscal year 2018.

I'll now turn it over to Zane to talk more about our business performance.

[Zane C. Rowe, VMware, Inc.]

Thank you, Pat. And thanks to all of you for joining us today. Q4 closed out a very strong year for us, with broad-based growth across our diverse portfolio. As you'll see from our guidance for fiscal 2019, we expect this momentum to continue. VMware achieved record results across a number of key metrics for the year, including license and total revenue, non-GAAP net income and operating cash flow. Total revenue for Q4 grew 14%, and license revenue increased 20% year-over-year. Hybrid Cloud and SaaS represented over 8% of total Q4 revenue, with our VMware Cloud Provider Program or VCPP growing over 30% year-over-year.

Non-GAAP operating margin for the quarter was 37.3%, and non-GAAP EPS was $1.68 per share, up 18% year-over-year on a share count of 410 million diluted shares. Cash and short-term investments totaled $11.7 billion, of which 26% was held domestically. Unearned revenue at quarter-end was $6.2 billion, with $2.5 billion of this amount long-term. Total revenue plus the sequential change in total unearned revenue grew 14%, and licensed revenue plus the sequential change in unearned license revenue grew 13% year-over-year in Q4. We continue to see high levels of customer satisfaction and renewal rates, which resulted in strong SnS bookings growth in Q4.

We're also pleased with the collective business we've built with Dell Technologies, and ended the year with approximately $400 million in synergies. NSX license bookings grew 24% year-over-year in Q4 and over 50% for the full year. NSX use cases continue to expand beyond micro-segmentation, automation and application continuity to cloud and container networking, as well as brand's transformation and security. NSX reached a $1.4 billion run rate based on Q4's annualized total bookings. vSAN continued its strong growth trajectory in Q4 with licensed bookings increasing 100% year-over-year, and up over 130% for the full year. vSAN reached a $600 million run rate based on annualized Q4 total bookings.

EUC license bookings were up over 30% for both the quarter and for the full year. Throughout the year, Workspace ONE, our platform for securely delivering any application to any device, continued to be our primary growth driver in EUC. Q4 Compute license bookings declined 4% year-over-year. As a reminder, our growth rate in Q4 of last year was a particularly strong 11%. For the full year, Compute license bookings increased in the low single-digits. For the quarter, Compute license bookings represented approximately 35% of total license bookings. Total Compute bookings for Q4 increased in the low single-digits year-over-year and increased in the mid single-digits for the full year.

We had a strong quarter for Management software. Management license bookings increased over 10% year-over-year, and for the full year Management license bookings increased in the low single-digits. Total Management bookings also increased over 10% year-over-year for both the quarter and for the full year. Turning to stock repurchases, we bought $169 million of stock in the open market during Q4. We have approximately $900 million outstanding on our existing repurchase authorization. While we have suspended our buyback program for the time being, we continue to see share repurchases as a key component of our well-balanced capital allocation program.

With the enactment of the Tax Cuts and Jobs Act, we are required to pay U.S. taxes on the international portion of our earnings. We expect to repatriate a substantial portion of our international cash over time. The estimated net cost on the international portion of our earnings is $800 million, which we expect to pay over 8 years. This is included in our tax expense recognized during Q4. We also remeasured our deferred taxes at the end of the year using the lower U.S. tax rates, which resulted in an additional estimated tax expense of $167 million, recognized in the fourth quarter.

Turning to guidance; as we have previously stated, beginning in Q1, we will adopt ASC 606 using the full retrospective method. Guidance for Q1 and for fiscal 2019 will be provided under ASC 606. Growth rates associated with our guidance are calculated under ASC 606 using adjusted historical data in order to provide comparisons on an apples-to-apples basis. In aggregate, the 606 revenue impacts are not significant. An adjusted historical P&L statement for Q1 2018, and fiscal 2018 is included in the Q4 earnings press release, as well as in the appendix of the slide deck accompanying this call.

On our last earnings call, under ASC 605, we guided to revenue growth of approximately 10% and non-GAAP operating margin of 32.5% for fiscal 2019. Excluding the impact of ASC 606, our 10% revenue guidance for FY 2019 remains unchanged. After adjusting for the impact of ASC 606, we now expect a total revenue growth rate for 2019 to be up 10.8% to approximately $8.725 billion. Turning to operating margin, we have increased our non-GAAP operating margin guidance for fiscal 2019 to 33.3%, primarily due to a reduction in sales commission expense under ASC 606.

For the full year, we expect total license revenue to be approximately $3.565 billion, an increase of 11.3% year-over-year. For Q1, we expect total revenue to be approximately $1.955 billion, an increase of 10.1% year-over-year, and license revenue to be approximately $730 million, an increase of 13.5% year-over-year. We exited Q4 2018 with nearly $100 million of license backlog, which is approximately $10 million higher than the Q3-ending level. License backlog is the license portion of any unfulfilled orders at quarter-end. For fiscal 2019, we expect non-GAAP earnings per share of $6.02 on a diluted share count of 409 million shares. Our non-GAAP tax rate for fiscal 2019 and Q1 2019 is expected to be 16% due to lower U.S. tax rates with the enactment of the Tax Cuts and Jobs Act. The lower U.S. tax rate on domestic earnings is expected to more than offset the increase in U.S. taxes on international earnings.

For Q1, we expect non-GAAP operating margin to be 28.5% and non-GAAP earnings per share to be $1.14 on a diluted share count of 412 million shares. The benefit to margin from the transition to ASC 606 will be more prevalent in Q2 and Q4 due to commission expense seasonality. Following stronger than expected cash flow from operations of $3.2 billion in fiscal 2018, we expect fiscal 2019 cash flow from operations to grow approximately 11% to $3.55 billion. Capital expenditures for fiscal 2019 will be approximately at $280 million, and we expect free cash flow of approximately $3.27 billion.

Before wrapping up, I'll highlight a couple of key ASC 606 impacts on the balance sheet. There is substantially less deferral of license revenue in connection with the treatment of on premises license sales under ASC 606. Therefore, license revenue and license bookings will have a tighter correlation for on-premises software sales, and deferred license revenue will substantially decline upon adoption of ASC 606 in Q1 2019. Also, the treatment of commissions will change under ASC 606, and we will be deferring more commissions and amortizing the costs over a longer duration. As such, deferred commissions included on our balance sheet will increase significantly.

Select balance sheet items for fiscal 2018 under ASC 606 are provided as a supplemental chart in our financial statements this quarter, as well as in the appendix of the slide deck accompanying this call. Additional metrics for Q2, Q3 and Q4 of fiscal 2018, as well as fiscal 2016 will be provided on our next earnings call. In summary, we delivered a strong Q4 and fiscal 2018 with record performance in numerous financial metrics, while also earning broad-based recognition for our products, our innovation, our growth opportunities, and as a great place to work. This has been a terrific year for all stakeholders in VMware, and we're excited about continuing this momentum in fiscal 2019.

With that, I'll turn it back to Paul.

[Paul Ziots, VMware, Inc.]

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. In addition, I'll remind you we will not be commenting on Dell's 13D filing during Q&A.

Operator, let's get started.

[Operator]

Thank you. We'll take our first question from John DiFucci with Jefferies.

[John DiFucci, Jefferies LLC]

Thank you. Thanks. Zane, we appreciate the ASC 606 details. But if I could, I'd really like to focus on the business fundamentals here. You guys set a real high bar for license this quarter, and then you come out and you beat it, growing 20%. I know there's some FX in there, but it's against a really hard comp, the toughest comp of the year. And I don't know, even on the billings, license billings, the growth wasn't quite like it was last quarter, just a little bit lower, but still, again, a tough, tough comp. I know you went through a lot of your businesses and what's happening in them, and it all sounds good and that's great.

But can you talk, and maybe a little bit more like, this acceleration, it looks almost like a step function up, when you kind of look at license, whatever metric you want to look at license over the last three quarters. And again, there's a lot in there, but is it – like are we seeing, like right now is like the biggest impact here the relative maturation, and not to say that it's mature, but like the step-up in sort of the network virtualization market, because we're hearing a lot about that in the field, or is it just as simple as everything's hitting right now? Maybe you can give us a little bit just so how we can think about this going forward too.

[Zane C. Rowe, VMware, Inc.]

Sure, John. Yes. Thanks for the question, and obviously, as I highlighted earlier, it was a great quarter, not only across the geographies but also across the products, which, as you point out, we see in the licensed revenue as well as the bookings that we saw in the fourth quarter, which puts us on a great trajectory for FY 2019 and beyond, quite frankly. There are a number of things going on in the fourth quarter as you look at our growth products. I mean, not only is the strategy working, but the growth products continue to grow nicely, and you see the benefits of that in the fourth quarter on what's already our strongest quarter.

And then, of course, we continue to develop the products. So we continue to invest in the business as well. But as you look at that revenue, there's a little bit of timing between the third quarter and the fourth quarter. So some of the bookings from the third quarter did show up in revenue in the fourth quarter. One of the examples is DXC that we gave in the last quarter. But again, we couldn't be more pleased with the trajectory of the business and with the strength we're seeing across all the product sets. Pat, I'll have you touch on the core.

[Patrick P. Gelsinger, VMware, Inc.]

Sure. And maybe to add a little bit, as Zane said, we see the power of the portfolio, and that's really working now. These numbers are getting bigger and they continue to show great growth rates, so we see those adding up across the portfolio. Overall, as I've said before, John, that we think this is just a good time for well-positioned technology companies. The market is good for technology, as I've described that tech is breaking out of tech. So every business is becoming a tech business, and more areas of businesses are becoming influenced by tech, and our strategy is resonating with that. We're executing well inside of that framework. And the overall strategy really resonates with our customers. And the shifts that we've made have really aligned ourself very uniquely with our cloud strategies. A tremendous quarter in mobility and end-user computing. And overall, customers see us as a more critical role of their strategic future. So it's just been a terrific year.

[Paul Ziots, VMware, Inc.]

Thank you, John. Next question, please.

[Operator]

We'll go next to Kash Rangan from Bank of America Merrill Lynch.

[Kash Rangan, Bank of America Merrill Lynch]

Hey, gentlemen. Congratulations on a wonderful finish to the fiscal year. I just wanted to hone in on the comment that Pat you made with regards to the increasing traction you're finding for the VMware-AWS partnership. Can you talk about the business implications of this partnership, in the sense that if more and more VMware customers are really increasingly looking to engage with AWS and want to expand the data center footprint with AWS, what are the implications for VMware's products and the business model implications? If you could chime in on that, that will be great. Thank you so much.

[Patrick P. Gelsinger, VMware, Inc.]

Sure. Thanks, Kash, and always great to hear from you. And overall, the VMware Cloud on AWS continues to get great resonance from our customers, and customers really see this idea of the best of public and the best of private coming together as a very powerful force. In many cases it's this, I'll say, unique way for them to accelerate their move to the cloud without disrupting their applications, being able to do this in a seamless hybrid way to move into the public and back to the private cloud. We're getting great customer responses to that, expanding number of use cases, data center extension, DR, et cetera. We continue to expand.

Next week, we'll be launching in Europe the service. So that's going to open up new markets for us, and many U.S. customers are also looking for that as a U.S. present. Feature function is on track, as we do quarterly updates. Ecosystem build is occurring. And overall, as I've said before, Kash, customers look at that. And even though it's still small and not material this year, they see it as this, I can now bet more strategically on VMware, because it is this unique pathway. From the business, as we said, it's not material this year, and it's starting to build up. And obviously, as we go through the year, you'll see that become a larger element of the business, but not material this year.

We also see that, given it's a subscription business, that will also delay the direct fiscal impact. As we said before, it's a net business for us. So we're not carrying the cost of hosting through our P&Ls. So that gives it a pure subscription license business to us. And as we've said before, this is also – we see it as a step up, because in many cases this will be the fastest way for customers to experience the full Software-Defined Data Center, because it includes the full set of network, compute, storage, management, life cycle management. So we really see it as a great business and uniquely positioning us in the marketplace.

[Paul Ziots, VMware, Inc.]

Thank you, Kash. Next question, please.

[Operator]

We'll go next to Raimo Lenschow with Barclays.

[Raimo Lenschow, Barclays Capital, Inc.]

Hey. Congrats from me as well. I wanted to hone in on your comments around Compute and Management. Zane and Pat, you said you were happy on the results there. Can you kind of talk a little bit about drivers here? Management up 10%, obviously, it's like kind of was the best results for this year. Compute down 4%, like some people will ask me is there an end of an ELA cycle, or how I have to think about it. Just honing in on that segment. Thank you.

[Patrick P. Gelsinger, VMware, Inc.]

Yes. I'll start and ask Zane to chime in. On the Management side, if we start there, yes, we had a very strong quarter. As we've indicated in the past, Management has a high affinity to EA attach. So we had very good EAs as you see, and our enterprise agreements had a very robust Q4 and a good composite of Management as part of that. As we've indicated in the past, we are coming into a better cycle as we've done recent upgrades to vRA and vROps. So the products are stronger as well. And we really are seeing that this cloud management portfolio, the ability to manage on premise and public cloud workloads is gaining resonance with customers.

And then some of the new products that we've put into that are vRealize Network Insights, Wavefront. Some of those new acquisitions are really starting to be seen by customers as their ability to bet more on the VMware Management suite. So overall, it's been a good cycle on Management, and we're feeling that momentum as we go into the next year. With respect to Compute, clearly, as we've indicated in our guidance, we see this long-term view of flattish in terms of license bookings and low single-digits for overall, and we are in line with that over the year as we've seen. Some quarters will be better or stronger, respectively, but overall, nicely in line.

We're also seeing more element of the Compute license bookings coming from our strength in VCPP, as we've indicated, and another very strong quarter there. But we are in the VCPP program also starting to see more of our products being represented there. So Compute is a springboard as we've called it for the whole portfolio of our products, and that benefit is clearly being seen in this power of the portfolio this quarter. And as we've indicated, we've also started to see more presence in areas like NFV. So it also is part of how we're reaching into these new segments, and even though small, starting to become a new market opportunity for us there. Zane?

[Zane C. Rowe, VMware, Inc.]

Sure, Pat. Yes. I would just add, as I pointed out in my prepared remarks, Compute is now 35% of license bookings, and it faced a tough compare of 11% growth a quarter a year ago.

[Patrick P. Gelsinger, VMware, Inc.]

A year ago.

[Zane C. Rowe, VMware, Inc.]

So we still feel really strong about Compute. And EA renewals are a great opportunity for us. Not only did we see the strength in FY 2018, but continue to see continued strength at a slightly higher growth rate for FY 2019. So we're very pleased with the renewals part of the business as well.

[Raimo Lenschow, Barclays Capital, Inc.]

Perfect. Well done. Thank you.

[Paul Ziots, VMware, Inc.]

Thank you, Raimo. Next question, please.

[Operator]

We'll go next to Keith Weiss with Morgan Stanley.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Excellent. Thank you guys for taking the question, and very nice quarter. Pat, I know you were out at Mobile World Congress. I was hoping you could give us kind of your view on the timing for sort of NFV, and how you see that ramping along with sort of the 5G rollouts which was supposed to be a really big catalyst for that?

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. And we had a great Mobile World Congress. We did quite a number of demonstrations, new announcements, new partnerships. So we're feeling very good about our strategy in that area. As I've indicated before, it's like the national anthem is playing before the sports event gets underway because people are doing their trials, their first deployments of NFV, et cetera. And we really see it as becoming mainstream as they do their 5G build-outs, which we expect to really start occurring at the end of this decade. So I think we still have another year or two until it really starts to ramp, as you start seeing spectrum allocations, new micro cell deployments, et cetera. But we are starting to see very nice quarter-by-quarter increase of the number of new customers, number of trials, et cetera.

We did have several major new telcos that are starting to build on VMware NFV. One of the demos I really loved that we did at Mobile World Congress was showing the power of having a VMware-based NFV, combining with a VMware-based cloud using our VMware Cloud on AWS, and being able to show the two connecting and being able to run services from Amazon connecting over Vodafone's network. And this is really showing the power of those two worlds coming together, which I think really startled the number of people at Mobile World Congress as they saw the real benefits of a common infrastructure across their cloud architecture and their telco network architecture, and this is really where I think VMware is quite uniquely positioned.

And also some of the new – and this was very, very prevalent at Mobile World Congress that people were getting quite excited about the IoT opportunity as a new service area for them to reach from their 5G network build-out. So overall, it's going to be more and more of the conversation over the next year or two years, and I think right around 2020 is when it's going to really start hitting a big cadence of large capital investments.

[Keith Eric Weiss, Morgan Stanley & Co. LLC]

Thanks.

[Paul Ziots, VMware, Inc.]

Thank you, Keith. Next question, please.

[Operator]

We'll go next to Mark Murphy with JPMorgan.

[Mark R. Murphy, JPMorgan Securities LLC]

Yes. Thank you. And I will add my congratulations. Zane, I believe you mentioned $400 million of synergies from Dell for the year, if I heard that correctly. Could you just comment on that? And is that a recognized revenue number for the year, or is that more of a, what I would call, a forward-looking bookings run rate exiting the year?

[Zane C. Rowe, VMware, Inc.]

Sure, Mark. Yes, obviously, as I mentioned, we've been very pleased with the business we've been doing with Dell Technologies. The $400 million was an increase from the prior guide that we gave you of $250 million which was the annual synergy capture, annual bookings synergy capture for FY 2018. Now, it puts us on a great trajectory. We've talked about the success we've had on multiple fronts with our synergy capture, and believe we're very well-positioned for FY 2019. I'll let Pat talk a bit more about the categories and what we're thinking about for FY 2019.

[Patrick P. Gelsinger, VMware, Inc.]

Yes. And we're very happy with the performance from Dell as we see vSAN, VxRail. VxRail had a really tremendous Q4, and that's central to the Dell partnership with us. EUC, Compute attach starting to see some momentum in networking and emerging geos as well. Just to again emphasize, the $400 million is a run rate. So we had some initial synergies last year, so $100 million or so the prior year, $400 million as we complete this year. And we believe that we'll achieve $700 million in annualized synergies in this fiscal year that's just getting under way. So overall, the momentum is good, and as I've indicated before, we're ahead of schedule toward our synergy capture objectives.

[Paul Ziots, VMware, Inc.]

Thank you, Mark. Next question, please.

[Operator]

We'll go next to Heather Bellini with Goldman Sachs.

[Heather Bellini, Goldman Sachs & Co. LLC]

Great. Thank you. And Pat, I should say congratulations because I think you were the first one this time last year to kind of call such a great IT spending environment. So we'd love to get your thoughts on and if you're thinking this year is going to be even better. But my question was also related to the market growth, the growth that you guys are seeing in EUC. I think you said that business grew about 30%. And I'm just wondering if you could share with us, kind of, what's driving the growth in that market overall, and how much of this is new deployments versus competitive switches. Thank you.

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. Thanks. And I do feel good about the IT spend. As you said, I was a little bit earlier than most others, and analysts raise their forecasts pretty consistently, the IT analysts through the year. They're projecting a more aggressive growth rate this year. I still think they may be under-calling it a bit, not as dramatic a gap as last year, but still I think it's a very optimistic outlook for tech overall. With regard to EUC, really, and I just am hats off to my EUC team and the sales team. 30% year-on-year license growth in categories that people didn't think had that kind of growth potential in them, so really great execution.

And I do think we really attribute it to two things; one is, our products are delivering great value, and Workspace ONE, this idea of a complete suite of mobility, desktop, identity, security and management, that suite coming together, it is taking costs out and being able to capture benefit in other areas beyond what's traditionally been viewed as MDM or VDI. So we are able to capture more dollar share in these because of this integration of value that we have in that Workspace ONE suite. Also unquestionably we're pulling away from the industry. We're gaining share from all the competitors here. So unquestionably, we're picking up share from others. We do see competitive switch-outs on both the mobile and the desktop side. And if anything, that's accelerating.

[Paul Ziots, VMware, Inc.]

Thank you, Heather. Next question, please.

[Heather Bellini, Goldman Sachs & Co. LLC]

Great. Thank you.

[Operator]

We'll go next to Matt Hedberg with RBC Capital Markets.

[Matthew George Hedberg, RBC Capital Markets LLC]

Hey, guys. Thanks for taking my question. VMC for AWS gets a lot of the attention, and rightly so. But I wanted to ask about VCPP, which I think you said grew 30% this quarter. Pat, I'm wondering, can you help us size that business, maybe who's adopting it, and how it really supports Act 3 of your strategy, of really being a Cross-Cloud provider?

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. Happy to, and again, 30% year-over-year for the quarter and for the year, so a very consistent growth rate for that. And for us, it's a meaningful business now as we've been able to post that growth rate now for a number of years. Also, it portends that the customers of that product, they're getting much higher revenue from that as well. We're just a piece of what they're selling into the marketplace. So this view of all of the rest of the infrastructure providers and hosting providers, this is a large business. It's companies like Rackspace, OVH, CenturyLink, Fujitsu, NTT and 4,000 other partners, many of those system integrators, outsourcers, et cetera.

As we said in the formal remarks, the IBM partnership in particular is progressing extremely well, with very big name brands that are making major bets on the IBM-VMware Cloud offering, Vodafone, Amdocs, Ricoh was the three that we talked about on the call. We'd also say that one of the things that I've been pushing our team most aggressively on is making this not just a vSphere but the entire portfolio. And more and more of those cloud providers now are NSX, taking advantage of new hybrid services as we've launched in particular. IBM has been a huge partner of bringing our Hybrid Cloud Extension to the customers for unique migration services, as well as hybrid cloud offerings. And we see no end to the growth of this business in sight. If anything, we're picking up speed. So I'm very, very happy with our VMware Cloud Provider Program broadly, IBM partnership in particular. And we continue to sign new partners as well into the program.

[Paul Ziots, VMware, Inc.]

Thank you, Matt. Next question, please.

[Operator]

We'll go next to Walter Pritchard with Citi.

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Hi. Thanks. I'm wondering, Pat, on NSX, that business has been really strong, and you gave a run-rate update. Can you talk about how the drivers are evolving? You mentioned NFV is pretty early still. I know security has been a strong driver. And anything else that it's a driver in bundling, and just curious kind of the drivers there.

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. And clearly, the number one use case continues to be security, but increasingly our NSX Everywhere strategy is broadening the use cases. And as we're now, it's an integrated part of VMware Cloud Foundation, so it's our private cloud. It's an integrated part of the VMware Cloud and AWS, so it's our public cloud. Our hybrid cloud services based on NSX, so the hybrid cloud capabilities. And the two new ones that we announced this quarter were VeloCloud, extension to the WAN, and we see that as a very powerful use case, Walter, because everybody is looking for branch transformation, how do they take costs from the WAN, how do they connect to SaaS services, how do they deliver new security models to the branch, how do they be able to enable that transformation of their all of the remote offices, et cetera. So I'm very, very excited about that, and a lot of the enthusiasm from our sellers that they're seeing from our customers in that area.

And the other area that we announced is the Pivotal Container Service. Sorry to be stumbling over that, but now it's extending into container networking as a natural way to do container-to-container networking, security, policy management as well. So overall, we see NSX Everywhere being very strong. We're now $1.4 billion run rate as we said, compared to the $1 billion run rate a year ago, over 3,500 paying customers as we end Q4. We had extraordinary Q3, robust pipeline for Q1, very strong compare year-on-year. And overall, we're very happy about NSX and how strategic it is to our business for the long term.

[Paul Ziots, VMware, Inc.]

Thank you, Walter. Next question, please.

[Walter H. Pritchard, Citigroup Global Markets, Inc.]

Great. Thanks.

[Operator]

We'll go next to Philip Winslow with Wells Fargo.

[Philip Winslow, Wells Fargo Securities LLC]

Thanks for taking my question. Most of your new products and services have been touched on, but I really want to focus in on vSAN, because that's, obviously been a smaller contributor than NSX, but doubled in run rate year-over-year. When you think about sort of where the product is, and I guess, from the sales maturity, its life cycle, you talked about moving up marketing spend, its capability. Is this sort of the inflexion point where it's ready for prime time, and sort of this market is also ready for prime time from just an adoption perspective of sort of this hypervisor-converged storage?

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. I believe that we hit prime time a few quarters ago, Phil, and we're now seeing very large customers that are essentially betting on software-defined storage and HCI in very large ways. And now, we've reached a $600 million run rate. I mean, that's a very real business, high hardware drag associated with that, so it's very large. The VxRail element for that was very strong, 130% bookings growth rate year-on-year. So overall, this is a very substantial business for us.

And while the growth rates will temper a bit just based on the size of the business, this is still a very rapidly growing business, and we have a very robust ecosystem, 15 different hardware vendors with us. Obviously, the VxRail appliance with Dell is growing extremely rapidly. The Gartner Magic Quadrant on HCI putting us in the Leaders quadrant. So we really feel like this has a tremendous a tailwind into the future, and we're making very unique market opportunity for VMware with this hypervisor-attached store simplification into a very big market for us and our partners.

[Philip Winslow, Wells Fargo Securities LLC]

Great. Thanks, guys.

[Paul Ziots, VMware, Inc.]

Thank you, Phil.

[Patrick P. Gelsinger, VMware, Inc.]

Thank you.

[Paul Ziots, VMware, Inc.]

Next question, please.

[Operator]

We'll go next to Mark Moerdler with Bernstein Research.

[Mark L. Moerdler, Sanford C. Bernstein & Co. LLC]

Thank you very much for taking questions and congrats on the quarter. So we've seen with a couple other companies FX has had a large impact on revenue growth, a couple hundred basis points. Can you give us some more color on the FX impact on the key metrics, as well as what you're including within your guidance for next year? Thanks.

[Zane C. Rowe, VMware, Inc.]

Sure, Mark, happy to. As you look at the quarter, we did see a benefit in FX. I would say, it's more predominant in license just when you think about the dynamic between how we defer revenue on the SnS side. So for the quarter, it was roughly 2% on license, and about a point in total. And then, as we look at the year, it's included in our guidance, and I would say, as you look more broadly year-over-year, it's actually about the same trend. I mean, obviously the curves have been moving around a little bit on us, but generally speaking, I'd say it's probably giving us roughly a point of tailwind as we head into FY 2019.

[Mark L. Moerdler, Sanford C. Bernstein & Co. LLC]

Excellent. Thank you. I appreciate it.

[Paul Ziots, VMware, Inc.]

Thank you, Mark. Next question, please.

[Operator]

We'll go next to Kirk Materne with Evercore ISI.

[Kirk Materne, Evercore ISI]

Hi. Thanks very much. Pat, I actually want to follow up on your comment just around your partnership with Pivotal and the container service they have. There's obviously a lot of discussion and dollars being, I think, pivoted towards DevOps and containers in general. I was just kind of curious about your broader feel on VMware's positioning heading into 2018, and your ability to be able to tap into what seemed to be some nice growing budgets in that area. Thanks.

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. Thank you. And overall, the container trend, if I could just call it that, is clearly gaining momentum inside of enterprise customers. And sometimes they're taking containers, and I'll say, wrapping their existing applications in a container as a way to accelerate its migration. In other cases, it really is embracing the new containerized micro services scale-outs type of architectural model for new apps. So overall, we're definitely feeling that interest on the part of the market overall.

Obviously, the two key technologies that we've partnered with are Pivotal Cloud Foundry with our Pivotal partners and Kubernetes with Google, and combining that with NSX and a number of other VMware technologies have brought forward this PKS offering into the marketplace, and we're already getting customers who are in deployments on this. Pivotal is now selling it. We're selling it. So we feel extremely good about that offering. And obviously, Pivotal as a company has been working hard over several years now to build their position in the marketplace.

This is a very natural extension of a lot of the hard work that they've done. And we sort of describe it as this developer-ready infrastructure, making it easy to embrace the new stuff, but still having a robust infrastructure that customers know well, and uniquely connects to their existing application world. So bringing those two together is getting great resonance from the customer base. And since we just went GA a couple of weeks ago, it's real early to give any other indications, but as I also indicated, we have several of the initial NSX deployments for customers are results of the PKS offering. So it's going to be a nice complement to many other areas of our portfolio as well.

[Paul Ziots, VMware, Inc.]

Thank you, Kirk.

[Kirk Materne, Evercore ISI]

Thank you.

[Paul Ziots, VMware, Inc.]

Next question, please.

[Operator]

We'll go next to Gregg Moskowitz with Cowen & Company.

[Gregg Moskowitz, Cowen & Co. LLC]

Okay. Thank you very much, and good afternoon, guys. Most of my questions have been asked. But Pat, curious if you see any impact from Meltdown and Spectre on Compute demand over the near to medium term. In other words, are there increased server utilization and capacity requirements that might help your business, or is it a non-event in that respect?

[Patrick P. Gelsinger, VMware, Inc.]

I'd say at this point, no impact yet. I think everybody is still a little bit, I'll say, in triage mode on Spectre and Meltdown, because they're largely trying to figure out rollout patches, make sure we've dealt with the implications, et cetera. I do think that there is some potential here over time that people will say, hey, I have to expand my capacity a bit in the footprint. There will be, I think, need for people looking hard at some of their security architectures, and I think we're able to feed into that very nicely over time. Many of the things that we've done like AppDefense, I think, are going to become more and more interesting to customers in this regard, because they're going to say, it's burger and fries.

If I'm running a VM, of course I'm turning on the natural native security mechanisms associated with it. So I think that's going to just reinforce many of the messages that we're delivering as we talk about infrastructure-based security; the infrastructure itself must secure itself. And that aspect we think will be a strong element for us long term. But I think everybody at this point is still too early to really tell the direct implications of Spectre, Meltdown, and we're all working very closely with each other, as well as with Intel to make sure we've made any of the security implications immediately resolved, and then understanding the longer-term implications.

[Gregg Moskowitz, Cowen & Co. LLC]

Thanks.

[Paul Ziots, VMware, Inc.]

Thank you, Gregg. Next question, please.

[Operator]

We'll go next to Michael Turits with Raymond James.

[Michael Turits, Raymond James & Associates, Inc.]

Hey, guys. Question on margins and investment. I figure maybe this has been covered already, but (52:30) and arguably down slightly with ASC 606. Can you just review some of the places you're making incremental investments in fiscal 2019?

[Zane C. Rowe, VMware, Inc.]

Sure, Michael. Yes, I'll start and then happy to let Pat add to it. As we mentioned on the last call, we've seen great opportunity for further investments in a lot of the products we're talking about right now that have tremendous growth rates. So whether it's on the R&D front or otherwise, the go-to-market side, we see tremendous opportunity, and investing a little bit more in vSAN, NFV, as Pat's mentioned, including NSX with some of the ancillary products that are associated with that. So a lot of investments being made in the products that we're selling today.

We're also spending more dollars on R&D than we've ever spent for products in the future. So a lot of the products like VMC on AWS and a lot of the products that we're still developing are taking a significant amount of our spend. But we're very excited, as you see, with our growth rates. We think of margins in light of a balance between the revenue opportunity as you would expect, with the returns and expense that are driving those opportunities. So we're very pleased with that balance right now.

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. And I would just add, if you think about the growth vectors that we've been building up, vSAN, and NSX, and EUC, mobile, I mean, these are still in high growth cycles. So we're still feeding those investment cycles at an aggressive rate. But we've also planted the next flags, what we've done with AppDefense and PKS as we've already talked about on the call, NFV and IoT. Those are new investments that we're starting to pour into. So we really see ourself in a wonderful position, where we're feeding growth engines that are showing great success. We're planting the next flags.

And then some areas like VMC, boy, how big can we make the VMC business over time. And we're learning new cloud muscles, new cloud sales motions for that, rapidly expanding the geographic footprint. So we have many deserving mouths to feed inside the company these days. We're trying to be very thoughtful with regard to the operating margin leverage that we see over the longer term, as well as maximizing our growth rate, and really continuing to invest in those opportunities.

[Zane C. Rowe, VMware, Inc.]

And I'll just add one last point. We're coming off a quarter where we had 37.3% operating margin, the strongest operating margin I think we've had in the history of the company. So very pleased with that balance.

[Michael Turits, Raymond James & Associates, Inc.]

Okay. (55:05).

[Paul Ziots, VMware, Inc.]

Thank you, Michael. I think we have time for one more question. So we'll take the last question, please.

[Operator]

And that question will come from Brad Zelnick with Credit Suisse.

[Brad Alan Zelnick, Credit Suisse]

Fantastic. And thanks so much for fitting me in, and congrats on a great finish to a great year. Most of the questions have been asked. But I'm going to follow up and ask another question perhaps a little bit differently. If we look at NSX license bookings, decelerating a bit in Q4, and obviously, the numbers we're talking about now are quite large. But just wondering if, as the mix shifts to more multi-cloud environments with NSX, are there perhaps any duration effects that we should be mindful of? And as well, can you just remind us and perhaps give some context for how we should think about the size and scope of the overall opportunity, especially as you go more multi-cloud? Thank you.

[Patrick P. Gelsinger, VMware, Inc.]

Yeah. And overall, as we said, we're short of – if you think about Q4 in context, an extraordinary Q3, a very big compare from last year, and as we've indicated, we feel very robust about the growth into the next year. So overall, in terms of growth rate, a bit smaller, but in terms of growth and size of the business now, very robust and very healthy. As I've indicated before, Brad, we think that the networking opportunity is as large or larger than the vSphere opportunity for VMware. Why is that? Well, networking is a very large business. You start seeing these new areas like SD-WAN opening up, entire new available markets that we've yet to touch on.

Multi-cloud capabilities where we see that those are going to be quite large opportunities, and nobody's better positioned than us to go monetize those capabilities, the launch of container networking reaching into this next generation space. And also, if you think about our number one use case with NSX, it's been around security. And to some degree we're reaching into the security budget, as well as the networking budget as we deliver NSX and we see that continuing as well into the future. So overall, a very large market, our NSX Everywhere strategy resonating, uniquely positioned in the marketplace, and you'll see us expanding more just like we've done with VeloCloud and then PKS into more use cases as well in the longer term.

[Paul Ziots, VMware, Inc.]

Thank you, Brad. Before we conclude the call, Pat will have a few final remarks.

[Patrick P. Gelsinger, VMware, Inc.]

Yes. And thank you all for joining us today, and we're always pleased to have you join us in the call and our opportunity to share with you our terrific fiscal year 2018 results, and look forward to continuing this momentum into fiscal year 2019. Thank you all very much.

[Operator]

And this does conclude today's conference. We thank you for your participation. You may now disconnect.