VMware, Inc.

Paul Ziots - Vice President-Investor Relations Patrick P. Gelsinger - Chief Executive Officer & Director Carl M.

Eschenbach - President & Chief Operating Officer Jonathan C. Chadwick - Chief Financial Officer, Chief Operating Officer and Executive Vice President

Matthew Hedberg - RBC Capital Markets LLC Philip A. Winslow - Credit Suisse Securities (USA) LLC (Broker) John Stephen DiFucci - Jefferies LLC Brent John Thill - UBS Securities LLC Heather Anne Bellini - Goldman Sachs & Co.

Keith Eric Weiss - Morgan Stanley & Co. LLC Michael Turits - Raymond James & Associates, Inc.

Abhey R. Lamba - Mizuho Securities USA, Inc.

Mark R. Murphy - JPMorgan Securities LLC Karl E.

Keirstead - Deutsche Bank Securities, Inc. Gregg S.

Moskowitz - Cowen & Co. LLC

Thank you. Good afternoon, everyone, and welcome to VMware's third quarter 2015 earnings conference call.

On the call we have Pat Gelsinger, Chief Executive Officer; Carl Eschenbach, President and Chief Operating Officer; and Jonathan Chadwick, Chief Financial Officer and Chief Operating Officer. Following their prepared remarks, we will take questions.

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

We have also included in our earnings release and posted on our website a reconciliation of GAAP to non-GAAP data for constant currency growth in revenues plus sequential change in unearned revenues for Q3 2015 and Q3 2014. On this call today, we will make forward-looking statements that are subject to risks and uncertainties.

Actual results may differ materially as a result of various risk factors, including those described in the Form 10-Ks, Form 10-Qs and Form 8-Ks VMware files with the SEC. In addition, during today's call, we will discuss certain non-GAAP financial measures.

These non-GAAP financial measures, which are used as measures of VMware's performance, should be considered in addition to, not as a substitute for or in isolation from GAAP measures. Our non-GAAP measures exclude the effect of our GAAP results of stock-based compensation, amortization of acquired intangible assets, Employer Payroll Tax on Employee Stock Transactions, the net effect of amortization and capitalization of software, certain litigation and other related items, acquisition-related items and realignment-related net gains and charges.

You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures in the press release and on our Investor Relations website. Webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link.

Our fourth quarter 2015 quiet period begins at the close of business December 15, 2015. Unless otherwise stated, all financial comparisons in this call will be in reference to our results for the comparable period of 2014.

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

Thank you, Paul, and good afternoon, everyone. It's certainly been an exciting couple of weeks.

Last week we announced preliminary results for Q3 2015 in conjunction with the announcement by Dell and EMC that Dell is intending to acquire EMC while maintaining VMware as an independent, publicly traded company. Overall, we are pleased with our Q3 results, although bookings were a little softer than anticipated.

Total revenue exceeded the high end of our guidance at $1.7 billion, a year-over-year increase of 14% in constant currency or 10% as reported. Non-GAAP net income per diluted share increased 18% year-over-year at $1.02 per share, also exceeding the top end of our guidance.

I spoke last week about the upside we expect from the merger of Dell and EMC. We see significant opportunities for revenue synergies, which could exceed $1 billion over the next few years.

Dell's incredibly strong go-to-market engine will provide us greatly expanded reach to attach and upsell our full portfolio of products and services. Today, we made another major announcement that will drive significant growth for VMware.

EMC and VMware announced the intent to form a new Cloud Services Business, jointly owned 50/50 by EMC and VMware, and offering customers the industry's most comprehensive hybrid cloud portfolio. This new Federation business will bring together the vCloud Air, Virtustream, object storage and managed cloud services from VMware and EMC into one company using the Virtustream brand.

We expect to complete this transaction in early 2016, and we expect to consolidate Virtustream's results into VMware's financial statements. Virtustream will be led by Chief Executive Officer Rodney Rogers, reporting to a board comprised of leaders from both companies.

I will be a member of the board, and VMware Chairman Joe Tucci will chair the board. We expect the company to grow fast and generate multiple hundreds of millions of dollars of revenue for VMware in 2016.

Virtustream will be a leader in the largest market for IT infrastructure spending, and we expect Virtustream to become one of the top five cloud service providers globally. In Q3, we saw continued momentum for VMware vCloud Air as part of our unified hybrid cloud portfolio.

VMware's new Virtustream business combines the breadth of public cloud services available from vCloud Air with Virtustream's leading capabilities to run mission-critical applications in the cloud. Other assets from EMC will further extend the on- and off-premise and storage capabilities of this new company.

We are looking forward to talking to our customers about what we believe will be the industry's broadest portfolio of hybrid cloud offerings, enabling them to move all of their applications to cloud-based IT environments and seamlessly manage their on-premises and off-premises environments. We expect that the Dell and EMC merger along with today's Virtustream announcement will accelerate VMware's growth across all our businesses and that together, these two announcements will generate significant revenue for VMware over the next few years.

At our core, we create disruptive innovations that deliver huge economic value to our customers. Every year we showcase a number of these innovations as we host our VMware conferences in San Francisco and Barcelona, and our AirWatch Connect event in Atlanta and London.

This year, we welcomed over 33,000 attendees across these industry-leading events, and we made a number of new product announcements. These included a major refresh to our Cloud Management Platform, vRealize Automation 7.0 and vRealize Business, new vCloud Air services including vCloud Air Object Storage and vCloud Air SQL, and two new technology previews: VMware vSphere Integrated Containers and VMware Photon Platform, enabling our customers to run cloud-native applications while addressing their enterprise requirements.

As we think about our roadmap of innovation, I'm delighted that we named Ray O'Farrell, a 12-year VMware R&D veteran as VMware's Chief Technology Officer and Chief Development Officer. Ray is working in close partnership with our business unit leaders and world-class R&D teams to drive industry-leading innovation.

In summary, we are very optimistic about the long-term value to VMware of the Dell and the EMC merger and of our new Virtustream business. VMware's mission and strategy remain unchanged.

We expect to accelerate our growth through the revenue synergies of being part of one of the three largest IT companies in the world, and we expect to benefit from the decision-making agility that comes from our majority shareholder being privately controlled. We will also continue to enjoy the benefits of being an independent company with a strong partner ecosystem and expanded set of solutions.

For our customers, we believe this is the best of both worlds. For our employees, they continue to be part of one of the most successful disruptive technology companies in Silicon Valley.

I appreciate that this has been a volatile time for our investors. There are lots of questions about the implications for VMware of Dell's merger with EMC, and we look forward to answering your questions over the coming weeks.

I'll now turn it over to Carl to talk more about our business performance in Q3.

Thank you, Pat. We delivered a solid quarter, delivering results either in line or above our guidance.

We remain pleased with the increasing breadth in year-over-year growth of our newer product offerings across all three of our business priorities: hybrid cloud, software defined data center, and end user computing. However, we did see mixed booking results in certain areas.

I'll provide more color in just a minute. Taking a look at our Q3 regional bookings performance on a constant currency basis in relative terms, Asia Pacific performed best, followed by the Americas and EMEA.

In APJ, we had solid performance in India and Southeast Asia. We continue to see weakness in China, as experienced by many of our peers.

After a strong first half in Japan, we saw slower growth in Q3. In the Americas, we were pleased with our healthcare and U.S.

federal businesses, which both grew total bookings greater than 20% year-over-year in Q3. However, we did see softness in our SLED business and mixed results in our Enterprise segment.

In EMEA, we were pleased with our business in Germany and Italy powered by some larger deals. Meanwhile, our UK business did not grow as robustly as it had earlier in the year, and Russia continued to be challenging due to the economic environment.

Overall, our geo bookings performance was slightly softer than we planned. We attribute this to three primary factors: customer uncertainty due to secular shifts that we are seeing in the industry, speculation about VMware's future, and continued economic weakness in China, Russia and Brazil.

We saw solid execution in our large deals. Enterprise agreements were approximately 33% of total third quarter bookings.

This is up from approximately 29% last Q3. This strong performance demonstrates customers' commitment to investing in VMware's expanded solution offerings.

We closed five deals at or over $10 million in the quarter and had a healthy mix of new enterprise agreements as well as Enterprise Agreement renewals. New EAs continue to be over 50% of total EAs.

Our end quarter renewal rates were once again quite strong. Our large deals increasingly include components across our business.

For example, all of the top 10 deals contained end user computing, and six of the top 10 deals contained NSX. This reflects the strategic value our customers rely on from VMware.

End user computing continued their market momentum with a strong performance in Q3. End user computing, including AirWatch, grew license bookings over 20% year-over-year in Q3 on a constant currency basis.

I'm pleased to say that we now have over 60,000 end user computing customers across our desktop, mobile, identity and content collaboration solutions. The desktop license business grew nearly 20% year-over-year on a constant currency basis, and we believe we once again gained share from the competition during the quarter.

AirWatch grew license and subscription bookings over 20% year-over-year in Q3 on a constant currency basis on top of an exceptional growth rate of over 60% year-over-year in Q2. Since our acquisition of the AirWatch, we've continued to extend our leadership position in the enterprise mobile management.

Cloud management saw solid license bookings growth in Q3, helped by strong double-digit year-over-year growth from vSphere with operations management. We continue to be pleased with our vSOM growth, driven by our continued ability to execute on our no naked vSphere strategy.

Our cloud management penetration is now over 16% of our installed base, leaving plenty of headroom for growth. We saw continued momentum in Q3 for our network virtualization solution, VMware NSX.

In Q3, we introduced NSX 6.2 and saw license bookings grow over 100% year-over-year on a constant currency basis and the number of paying customers increase to over 900, including a significant number of repeat customers. At VMworld, NSX saw significant momentum in both customer interest and testimonials, evidenced by NSX being number one in terms of meeting requests and hands-on lab participation.

In fact, we had over two dozen public reference NSX customers telling their stories at VMworld. Customers are clearly embracing the strategic value of NSX.

We're seeing a wide variety of use cases in the three broad categories of IT automation, micro-segmentation and application continuity. We continue to see increasing production use of NSX.

We remain confident regarding our future opportunities in the networking space and see a solid pipeline heading into Q4. Summarizing a few other product areas.

In Q3 our virtual SAN business saw success across a wide variety of industries, market segments, and geos. At VMworld, we announced our third release of Virtual SAN, vSAN 6.1.

This newest release continues to make the software defined storage capabilities more robust through the addition of new features such as Stretched Clusters, enhanced vSphere Replication, and Remote Branch Office Support. And in relation to the hybrid cloud, we are adding three new service locations in Q4.

They are Texas, New Jersey and Virginia, all of which go live in October. These locations reflect the need for additional capacity to keep up with the client demand and also provide even greater levels of in-region resiliency, which reflects the increasing shift of deployments of production workloads into vCloud Air.

We also recently announced the general availability of strategic new hybrid networking capabilities, VMware Hybrid Cloud manager, and Advanced Networking Services that allow VMware to truly deliver on the promise of a unified hybrid cloud platform. We are excited that we will have Virtustream as part of the VMware family.

We will have the ability to not only offer our customers an industry-leading hybrid cloud solution, but also have the ability to support their mission critical applications, like SAP as a managed service. This combination of VMware's vCloud Air and Virtustream will help provide our customers a safe passage journey to the cloud, leveraging their existing infrastructure and remaining consistent with their current operating models.

With regard to the intended merger between Dell and EMC, I'm excited about the many opportunities for revenue synergies for VMware. VMware remains committed to our strong ecosystem, and we have commitment from both EMC and Dell that they will continue to support VMware's independent partnering strategy.

VMware has a decade-plus track record of strong execution in a complex operating environment, and I am confident our success will continue in the future under this new ownership structure. At our VMworld event in San Francisco and Barcelona, it was clear our ecosystem is more engaged than ever in finding new ways to integrate in, through and with VMware solutions.

We announced a strong set of offerings around network function virtualization and a new release of vRealize Automation. We also announced the AirWatch support of Windows 10 and the acquisition of Boxer, a secure e-mail or inbox solution.

It was very apparent our customers walked away recognizing the innovation engine at VMware is alive and well. In conclusion, we are excited about the future of VMware.

Our mission remains the same: to deliver extraordinary value to our customers through the power of disruptive innovation. When we combine VMware's innovation engine with Dell and EMC to form the most transformative IT company in the world, we believe we can accelerate VMware's growth in the future.

With that let me turn it over to Jonathan.

Thank you, Carl. There have been many questions around the transaction, which our parent company, EMC announced last week with Dell and Silver Lake.

We will attempt to answer many of your questions in the Q&A portion of our call, but I wanted to describe some key principles, which should increase our shareholders' understanding of the transaction. Moreover, there is greater detail in the set of questions and answers posted on the EMC website as well as in the proxy to EMC shareholders which will be filed in a few weeks.

I am sure there also will be further elaboration on EMC's earnings call tomorrow morning. First, VMware will have the same public company governance post-EMC's going private as there is today, with independent directors who will represent our common shareholders together with a majority of Dell and Silver Lake appointed directors.

Next, VMware will continue to have control over its cash flows and earnings. We look forward to synergies with a more powerful Dell/EMC entity and being able to utilize Dell's channel and strength in SMB and the public sector.

As Pat mentioned, having a parent company, which is private, will create one less set of financial constraints on VMware, and we will continue to have flexibility to pursue acquisitions. Dell and Silver Lake will own roughly $8 billion, or 28% of the economic interests of VMware.

So their stated goal to grow VMware is financially and strategically motivated. Finally I would like to reiterate that in an IT industry that is accelerating in its evolution and the commoditization of legacy products, we expect that being part of a larger, stronger private parent company will be highly advantageous to VMware.

Now turning to our Q3 financial results. We are pleased with our Q3 total revenue and non-GAAP EPS both exceeding the top end of guidance.

License bookings beyond stand-alone vSphere were greater than 60% of total license bookings, up from greater than 50% in Q3 2014, and up from more than 40% two years ago. Q3 total revenues were $1.7 billion, up 14% year-over-year on a constant currency basis, or up 10% as reported.

Q3 license revenues were $681 million, up 11% year-over-year on a constant currency basis, or up 7% as reported. Revenues from our hybrid cloud and SaaS offerings were greater than 6% of our total Q3 revenues with a growth rate of over 50% year-over-year.

Diluted non-GAAP EPS for Q3 was $1.02 per share on approximately 424 million shares. During the quarter we repurchased approximately 2.4 million shares of stock for a total of $200 million.

Over the first three quarters of 2015, we have bought back over 12.5 million shares for a total of approximately $1.05 billion. I'll talk more about our future buyback plans in a moment.

Our balance sheet remained strong with cash and short-term investments at quarter end of $7.2 billion. Total unearned revenues ended the quarter at $4.7 billion, up 7% from Q3 2014 with $1.7 billion in long-term unearned revenues, up 3% year-over-year.

The growth rate for total revenues plus change in unearned revenues was approximately 8% year-over-year. The growth rate for license revenues plus change in unearned license revenues was approximately 7% year-over-year.

These growth rates adjust for the impact of currency on revenues and unearned revenues. Turning to guidance for 2015, we are reiterating the midpoint of our outlook for non-GAAP total revenues for the year.

We expect non-GAAP total revenues for 2015 to be between $6.605 billion and $6.655 billion, or up 9% to 10% year-over-year. On a constant currency basis, this will be up 12% to 13% year-over-year.

We now expect license revenues for the full year to be between $2.695 billion and $2.725 billion, or up 4% to 5% year-over-year. On a constant currency basis, this will be up 8% to 9% year-over-year.

For 2015, we are increasing our expectation for non-GAAP operating margin to be approximately 31.8%, which balances some margin expansion against continued investment in our growth businesses. We are maintaining our cash flow from operations expectation for 2015 of approximately $1.875 billion, and we continue to expect capital expenditures to be approximately $350 million for the year.

We are modeling a share count of approximately 426 million shares for the year, and we are raising our non-GAAP EPS guidance for the year by approximately $0.06 a share to be between $4.04 and $4.08 per share. Shifting to Q4 2015, we expect total reported revenue to be between $1.825 billion and $1.875 billion, or up 7% to 10% year-over-year.

On a constant currency basis, this will be up 10% to 13% year-over-year. License revenues for Q4 are expected to be between $800 million to $830 million, or up 3% to 7% year-over-year.

On a constant currency basis, this would be up 6% to 10% year-over-year. For Q4, we expect non-GAAP operating margin to be approximately 35% and non-GAAP EPS of between $1.23 and $1.27 per share.

As a reminder, Q4 is typically our strongest quarter, both in terms of revenue and profit contribution. This year is no exception.

By contrast, we have been seeing our first quarter of each year as our seasonally weakest, especially with respect to operating margin performance. We expect this trend to continue moving forward.

Remaining guidance for Q4 and 2015 is included in the slide deck posted on our Investor Relations website. Now for a few comments on the financial aspects associated with the creation of our jointly owned Cloud Services Business with EMC under the name Virtustream.

Together this new entity will enable VMware and EMC to jointly address the largest market potential for cloud offerings across hybrid cloud, mission critical workloads and managed cloud environments. Over time, we see more customers wanting to move their on-premises workloads to the hybrid cloud or to run them in secure infrastructure as a service offerings.

Of the estimated over 145 million workloads that exist today, 130 million workloads run on-premises. This is a huge opportunity for VMware and EMC.

Together we will have an expanded capability to capture these workloads if they move to the cloud, as well as those generated organically in the cloud. As Pat described, today we are announcing the intent to form a new company, jointly owned 50/50 by VMware and EMC under the Virtustream brand.

VMware expects to consolidate the results of Virtustream into its financial statements. We expect to complete this transaction in early January 2016 and to begin incorporating results of Virtustream beginning in Q1 2016.

We expect Virtustream to grow fast and to become a multi-billion dollar profitable business over the next several years. It's important to note that much of the revenue is derived from subscription or consumption-based customer contracts and also largely recurring in nature.

We're also anticipating that Virtustream will be investing heavily in its global operations over the next few years, both in terms of operating and capital expenditures. We estimate that Virtustream will generate multiple hundreds of millions of dollars of revenue in 2016 with a strong double-digit growth rate.

In terms of operating results, we estimate Virtustream will have an operating loss of approximately $200 million to $300 million in 2016. It's important to note that net earnings or losses relating to the 50% minority interest owned by EMC will be reported below operating income on our income statement.

In the initial loss-making reporting periods, this will be a benefit to net income and earnings per share. We currently expect that approximately $100 million after-tax will be reflected as a benefit in minority interest and have a positive impact on earnings per share in 2016.

Now for a few more comments about 2016. Clearly, Virtustream will have an impact on our 2016 results.

In addition, as Carl mentioned, we experienced softer bookings than we planned for in Q3. We believe this is partly due to some disruptive impact resulting from speculation associated with VMware's future.

Although we expect the Dell acquisition of EMC will give rise to significant revenue synergies for VMware over time, we believe it is realistic to anticipate various disruptions in the near term. As a result, while sooner than we'd normally discuss, I want to give you an early indication on how we view 2016 at this point in time.

Taking all the comments I just made into account for the full year 2016, we are currently expecting total non-GAAP revenue to grow between high single-digits and low double-digits year-over-year in percentage terms. I'll also remind you that at the start of this year we quantified the effect of the shift to hybrid cloud and SaaS was expected to have on our business in 2015.

In addition, at our Analyst Day in August, we discussed the VMware hybrid purchase program, which will drive increasing levels of recurring revenue, but has a negative impact on total revenue and license revenue in the near term. We anticipate the continuing shift to hybrid cloud and SaaS, including the effect of the new hybrid purchasing program, will negatively impact total revenue growth by at least 3 percentage points in 2016.

Taking this into account, our current expectation for total non-GAAP revenue growth of VMware in 2016 would have been in the double digits. For 2016, especially given the impact of the Virtustream business, we're expecting that non-GAAP operating margin will be approximately 28%.

We're anticipating operating cash flow will grow 15% to 20% next year and that CapEx will be approximately $625 million. Of course, actual results can differ, but that's our view on 2016 at this time.

We'll provide formal guidance when discussing Q4 and 2015 results in January. Before I close, I'll also emphasize we continue to view the long-term opportunities for VMware to be significant, and subject to market and other customary conditions, plan to continue our goal of buying back $1.25 billion in stock in 2015 recommencing shortly.

In summary, we're excited about the long-term potential for the Dell and EMC combination and the strategic alignment of Virtustream underneath VMware's oversight. And with that I'll turn it back to Paul.

Thanks, Jonathan. Before we begin the Q&A, I'll ask you to limit yourselves to one question consisting of one part so we can get to as many people as possible.

Operator, let's get started.

Thanks, guys, for taking my question. Carl, I'm curious, in your prepared remarks you talked about several things impacting results.

I think you mentioned some customer uncertainty along with some geographic comments. I'm curious if you could dig into a little bit more granularity into – absent the Dell acquisition, what other customer uncertainty are you seeing out there?

Yeah, sure, Matt. So thanks for the question.

So first let me just reiterate, we were pretty pleased with our results. We beat our guidance for both top-line revenue and operating margin.

So once again, we've delivered on strong results overall. If you really think back over the last couple years, both in 2013 and 2014, the one thing we expected in those years was to accelerate our bookings in the second half of the year, Matt.

And actually, that did occur. Coming into 2015 we expected that to occur once again.

But when we looked at our Q3 bookings, they were actually not as strong as we had planned internally, and therefore gave us a bit of softer bookings than we would have liked to see. And as I've said in my prepared remarks, there's probably three primary reasons behind that.

The first is we are clearly – I think not just VMware, but the entire industry as a whole is seeing a massive secular shift right now in the market. And with this, our customers are a little bit more cautious before they enter into any type of strategic engagement or a technology spend as a whole.

Also leading up until just, I guess, a week-and-a-half ago, there was a lot of speculation about VMware's future. In fact, there was a lot of ambiguity about what would happen with us in the future.

The good news is the ambiguity is now gone, because we know we'll remain an independent company under the current operating model that was announced with the Dell acquisition or intended acquisition of EMC. But it doesn't mean we're not going to see customers still have questions about what the future of VMware looks like going forward.

And then the last area that we're seeing is just the overall macro issues we're seeing with the economy specifically in China, in Russia, and Brazil. I don't think we're any different than anyone else experiencing some challenges in those markets, and we saw that, once again, happen this quarter, specifically in China and Russia.

So when I think about the bookings as a whole, I think they're the three primary reasons and, again, coming into Q3, we did expect to accelerate bookings. It didn't turn out exactly as we had anticipated, and I think they're the three primary reasons behind the softness in bookings.

Thank you, Matt. Next question, please.

Hi. Thanks, guys.

I wonder if you could touch on NSX. Obviously, you gave the customer count there of 900, I believe, exiting this quarter.

Just what trends are you seeing there? The sales cycles, deal size, any kind of win rates, any sort of details on NSX would be great.

Yeah, thanks, Phil. So, first, as I said in my prepared remarks, we had another really solid quarter around NSX.

We saw our license growth year-over-year up over 100%. We now have over 900 paying customers in the quarter, and the one thing we were really excited about was seeing the number of repeat customers actually coming back and buying additional license, which is driving further deployment of the platform into their environments.

And we see a number of emerging use cases over the last quarter as well. And I'll tell you, again, if you went to VMworld – I know you were there, Phil, at VMworld, but you just saw time and time again, customers standing up and talking about how they're deploying this technology and using it, and we just are really excited about what we're seeing in the market from the adoption of this technology.

The deal size, I don't think it's changed as we exited Q3. As we go into Q4, I will tell you I'm pretty excited about the pipeline we have around NSX, and we do expect to see a solid quarter here in Q4, and probably very similar to what we saw last year in Q4 with the deal size increasing as you would expect in the final quarter of the year.

And I just couldn't tell you how excited we are about the momentum we see in the market and the fact that customers are continuously coming to us and saying, hey, we need to change our network infrastructure and NSX is the way of the future. So I'll also ask Pat to comment.

I think he has some good observations specifically around NSX and the momentum we see in the market.

Yeah. Thanks, Phil.

Just a couple points to add to Carl's comments. If you were at VMworld, what you would have seen was NSX being core to the SDDC.

It was also core to our cloud with the hybrid networking. It was also, in some of the security use cases, core to our end user computing.

It really has become a platform in and of itself now fully being integrated and embraced across the full spectrum of VMware opportunities. And it also is becoming a part of every ecosystem player in the industry as well, as we continue to see broader and broader ecosystem embrace for security solutions, for Layer 4-7 services associated with it, integrated top of rack switching – it really is now just being embraced as a key capability to transform the entirety of the network operations.

So as Carl said, the pipeline for Q4 is enormous, and we're quite excited about this opportunity going forward.

Thank you, Phil. Next question, please.

Thank you. My question still goes back to sort of Matt's first question a little bit, and why you're lowering the license guidance for the year because you – at least on the revenue side, and I understand the bookings, but I'm going to get to that.

You hit the numbers on the revenue side. And when I look at there – now that we have the detailed results, and I guess this question is for both Jonathan and then Carl, how this might be happening in the field, I see long-term deferred revenue declining by more than is typically seasonal, more than it usually does in the fourth quarter.

It was down 5% or the third quarter down 5% sequentially, down 2% last year. And it was growing in prior years.

And I know there's a little bit of foreign exchange in there, but not a lot, I don't think. And then current deferred was really – it was more in line with the seasonal norm, so flattish.

It was down 1% versus zero last year, but it's sort of in line. And I'm just wondering to me when I look at that I wonder if this is an indication that you're signing ELAs, but they're shorter duration.

And this would sort of explain the third quarter, the relatively strong revenue versus the more modest billings growth. But it doesn't explain you lowering your guidance for license revenue for next quarter, which is essentially what you did with the year.

So if you can explain that a little bit more is – well, first of all, are ELAs being signed but at a shorter duration than they normally have been in the past? And if that's the case there must be, I guess, some of the things that Carl talked about, I mean, if you can just sort of revisit a little bit more, Carl, about what's happening in the field to slow things down, in the fourth quarter for the license.

Because it seems like you'd still – if you're signing one-year to two-year ELAs versus three years, you're still going to recognize that license next quarter for the ones that are recognizing license over time. Sorry for the long question, but go ahead.

Great. Thanks, John.

Carl is going to start, I believe...

Actually, Jonathan is going to start, and then I'll follow up.

Yeah, let me just kick off, and then I'll let Carl talk about ELA lens in general. But as Carl articulated, John, we did see softer bookings than we would have liked typically at this time of the year, and as we planned both in 2013 and 2014, we've seen acceleration.

It's been largely planned, especially with newer product cycles, ELA renewals, et cetera, which Carl touched on a little bit. We didn't see quite that performances we were expecting coming into Q3 or coming out of Q3, and that obviously has an impact on the bookings, which in turn, has an impact on, then, deferred revenue build and obviously on the calculation that you're making with respect to implied bookings overall.

So when we look at that and we look at the overall yearly guidance, obviously, we are reiterating the midpoint of our guidance for the full year on the total level, but it does require us to take a look at the mix of our business as we think about where it's going to come from. And at this point the revenue on the license side looks a little bit softer than we were thinking about at the start of the year.

Full year guide has been maintained, but we're seeing a little bit more strength on the services side. And that's really reflected in our overall outlook for 2015.

Again, maintaining the full year, but we're seeing a little bit of a shift based on Q3 performance.

Yeah, and...

But are you seeing a duration of those ELAs as that duration coming down?

Hey, John, it's Carl. Let me answer, I guess, two parts to this question.

So first on the Q4 guide that Jonathan provided. As you could imagine, we take a look at our pipeline going into every quarter.

Based on our pipeline going into Q4, we feel pretty confident in the guidance Jonathan provided to maintain our overall guide for the quarter and top-line. The mix is slightly changing, and that's based on what we saw in Q3 and how we converted against our pipeline in Q3.

As it relates to the length of EAs and whether or not the average length is coming down, actually, it hasn't. Our ELA length in Q3 was very consistent with what we saw in Q2 and very consistent with what we saw in Q3 of last year.

So we have not seen any change in duration of our Enterprise Agreements on a year-over-year basis or sequentially from Q2 to Q3.

So it's really a volume comment, John, as we think about the overall level of bookings.

So why did...?

I think that's a great way to put it, Jonathan.

Why the difference in, like, the departure from seasonal norms with the long-term deferred revenue this quarter versus in short term?

Okay. Thanks, John, we're going to have to take that one quickly and move on because everyone will ask two- and three-part questions.

So could we take that one and continue forward?

I'm sorry. It's the same question, though, guys.

Yeah, John, again, I think it's the same point that we just said. We expected to see stronger bookings in line with seasonal norms we've seen for the last two years or three years or even more.

We expected to build more license deferred, and we didn't see that this time. And as a result, as we think about what's coming off the balance sheet and what gets recognized, it didn't get replenished at the same pace as we were expecting.

So it's a flow question just on how bookings came in.

And, John, if you look at our ELA bookings within the quarter, we had pretty solid ELA bookings of 33% of total bookings, up from 29% last year. But even a good bookings quarter around ELAs at 33% – remember, that's a metric on total bookings for the quarter, and our total bookings for the quarter were softer than we anticipated.

So although we had a strong ELA quarter as described by total bookings, it still was softer overall, which is what's driving the change that you're asking about in deferred.

Thank you, John.

Thank you.

Next question, please.

Hey, Carl, just to follow up on the bookings commentary: the first mention you made on the customer uncertainty and the secular shift, I'm assuming that is the shift to cloud and there's been a lot of questions about the competitive win rates. Do you feel like the deals in Q3 just slipped and they're technically awarded to you and they just need further time to get inked, or do you feel like they're getting pushed to competitors?

And then just secondarily, the follow-up to Jonathan is, in terms of your Q4 close rate that was in that, you're seeing a much lower close rate going into Q4 and maybe perhaps you saw in last Q4, I'd just be interested to get your color on that. Thank you.

Hey, Brent. Thanks.

So I think there was kind of two questions you asked me there on the secular shifts and then the competitive environment. So first on the secular shifts, what we're seeing in the market – it's probably more around the fact that when you talk to customers, they're more cautious about how they're going to engage with technology partners going forward just because – for example, are they going to build a private cloud, they're going to build a public cloud, or are they going to leverage hybrid cloud services from someone like VMware or Virtustream?

So there's just a lot of uncertainty exactly how they're going to proceed forward. Same thing: are they going to continue to build out their private cloud environments with VMware, or are they going to leverage an OpenStack technology like VMware Integrated OpenStack?

So there's just a lot of uncertainty in our customers, and they're much more cautious when they think about engaging in a long-term contract with any technology vendor, I believe, not just VMware. As it relates to the competitive environment, as you know, in any given quarter we have the ability to pull deals in and renew ELAs early, or some of them go from Q3 to Q4.

When we look at Q3, our conversion rate overall of the pipeline was a little bit softer than we had anticipated, which is what led to softer bookings, but I can honestly say there's not a scenario where we lost a whole bunch of deals to a competitor, or it's really driving a major impact to our Q4 outlook based on what Jonathan described earlier. So I'm quite confident in our Q4 outlook.

I'm confident that we're still winning against the competition in there. I really do believe it's much more about the secular shifts we're seeing as a whole in the market more than anything else at this time.

Thank you, Brent. Next question, please.

Let's go on.

Great. Can you guys hear me okay?

We can. We can, Heather.

Okay, great.

Yeah, I can hear you.

I just was wondering – sorry about that. I was just wondering if you could comment a little bit about what you're seeing with your OpenStack initiatives.

I know it launched just earlier this year, but if you could give us a sense of customer adoption and how you see win rates maybe progressing versus the competition. Thank you.

Thanks, Heather. A few general comments and maybe Carl will add to it.

Overall, we're seeing a good response from the market. Now, people can download our OpenStack, they could take advantage of it, so we believe there are lots of trials, and I think overall the OpenStack market is clearly one where there's a lot of trials and not a lot of production.

We have seen that several customers have taken VMware Integrated OpenStack, and we referred to several of those on last earnings call, and are now at scale production with VMware Integrated OpenStack, finding it to be significantly more robust and a very natural extension of what they're already doing with VMware. So I think the market's early, lots of POCs, and I think we're having good success with our offering where it is.

We just announced the next release of our OpenStack offering, so staying current to the OpenStack distributions. So keeping that commitment to customers, and overall we're just adding more and more support to the robustness of the OpenStack product line, and I think we're seeing the customer base respond to that in contrast to some of the weakness of the other offerings.

Carl, would you add anything?

No, I think it was well said, Pat, and I think the customers are out there looking at OpenStack solutions, and they're looking at VMware because they're looking to integrate it into their existing VMware framework. I'd add one thing Pat.

I'd take it one step further to say VMware is open to open in the fact that VMworld – Pat and the team really pushed us to make sure we had a great strategy around specifically the container movement we're seeing in the industry. So not only are we focused on delivering strong OpenStack solutions, but our container platform and solutions is getting a lot of energy and our customers excited to talk about that with us to see how they can integrate that also, on top of their existing VMware environments.

Thank you, Heather. Next question, please.

Excellent. Thank you, guys, and thank you for taking the question.

I think this one is for Jonathan, and really looking at that initial outlook on FY 2016, it seems like there's a lot of moving parts in there in terms of positive and negative impacts. Positive impacts for Virtustream, the top line, it seems like that's definitely dragging down on operating margins, adding to CapEx.

The one number that you didn't give us much specificity on was how it's impacting the revenue guidance and again, they were all (46:52) going to try to back in and figure it out. I was hoping that maybe you could help us out and sort of avoid sort of the margin of error and get you (46:59) to try and to back into that number, could you give us a sense of what's the kind of inorganic contribution you're expecting from Virtustream just from consolidating existing revenues into that business unit.

Yeah, Keith, thank you for the question. So, again, at this point recognizing this isn't normally when we would give guidance specifically for the forthcoming year, we felt that because of the announcement around the Virtustream cloud business coming together, we felt it was really important to give you a sense of it, and we'll clearly give you more precise guidance in 90 days or so.

And when we think about 2016, we think about the integrated business that Rodney is going to be running. I'm not at this point breaking out the contributions of vCloud Air in 2016, because at this point it will become more of a combined sort of offerings as we go forward.

As Carl mentioned, in 2013 and 2014 we had seen a greater acceleration in Q3 and we didn't see that in Q3 at this time. So as we think about Q3, Q4 and we think about our performance next year, we're thinking about the early views we're looking at, and we're thinking about our business in that sort of high single-digit, low double-digit growth rate with Virtustream, where we continue to be really optimistic about the strategy we've been pursuing, and we continue to be really optimistic about the opportunity now, especially with the cloud business under Rodney's leadership, with Virtustream combined under VMware, and also the acquisition of EMC by Dell.

So as we think about that, we think we've got near-term issues, which we're navigating through as we see bookings performance and as we look at the medium and longer term, we're highly optimistic and that's what the sort of significant medium-term opportunity is that's presented by Virtustream and Dell. We'll come back in 90 days and give you a more formal guide, but we're reflecting something of what we're seeing from the Q3 performance and the rest of this year as we think about the early start to 2016 guidance.

Thank you, Keith. Next question, please.

Hey, guys. Can we at least get a sense for whether or not it's a net positive or a net negative revenue contribution?

Or are you really trying to focus more on the lower revenue guide for next year on organic matters? And also, regarding the $200 million to $300 million in EBIT loss, is that, again, all from the incremental addition of Virtustream?

Or – some of that, I would assume, was from what you would have done with vCloud Air anyway. So, again, just trying to figure out how much is really incremental in terms of that margin compression.

Yeah. This is Jonathan, again, obviously.

So as I think about the addition of the Virtustream businesses overall with some of it coming from EMC and some of it coming from VMware, EMC's contributing a number of different elements, including the Virtustream business, the IS business that Rodney has brought in with the Virtustream acquisition. There's also other areas coming in from EMC, obviously.

We are contributing the VCA vCloud Air Hybrid Cloud capability. So there's a net positive incremental addition inorganic, if you like, coming together as we think about that business going forward.

I think as I indicated at the Analyst Day before we added the Cloud Services Business, we expected about a half a point improvement in operating margin compared to where we were headed for 2015. So I think you can assume on a combined basis before this business we would have been in the 32% range there give or take.

This obviously is an investment cycle we're in, but we think it's really important we, A, get aligned strategically with Virtustream under the leadership of VMware jointly with EMC, and then from a financial perspective we can put together the investment capability from both EMC and VMware as we think about the next few years. And again, as Pat has indicated in his remarks, we expect this to be a multi-billion dollar profitable business over the course of the next several years.

Okay. Thanks.

Thank you, Michael. Next question, please.

Yeah, thanks. Pat, can you discuss how you expect revenue synergies with Dell to work, and how that's going to impact your relationship with other hardware providers, especially as you're also outlining plans to be an independent operator along with realizing synergies?

Just trying to figure out how you're going to be able to do both. Thank you.

Yeah. Thank you, Abhey, great question.

And as you might have heard from our pre-call last week when we announced it and we reaffirmed today, yeah, we do expect that there'll be $1 billion-plus of synergies over a few years from the Dell deal. And we particularly see that emerging from areas like the mid-market strength that Dell has and really across our businesses.

We expect compute attach rate for vSphere, for management attach rate, our VDI opportunity, Dell is huge in the client space, the opportunity for things like vSAN and our hyper-converged infrastructure. Really all of these are very nice incremental opportunities for us, and we see the model being one where Dell will be accelerating VMware's business as a result as they increase those opportunities right through their massive sales engine.

At the same time, Dell has simultaneously been very firm with respect to the independent ecosystem that VMware affords, and I think he posted a blog just yesterday, right, reaffirming that position in the industry. And given Michael was really born in the open systems era, he has a very deep sense of the importance of that open environment.

He's highly committed to it. And he will enable us to continue to be operating as that independent entity, independent ecosystem, which he is reaffirming, I'm reaffirming, Carl's reaffirming through our partners, our largest OEMs, and industry partners in the world.

And we're quite confident that this will be a net positive as we maintain the ecosystem, and we see acceleration from Dell over the mid- and long-term.

Thank you, Abhey. Next question, please.

Yes. Thank you very much for taking my question.

Carl, I wanted to touch again on your comment about customer uncertainty due to secular shift. And just specifically I'm wondering does that uncertainty feel like a temporary pause that refreshes at some point as customers make their architectural decisions and move on?

Or does it feel like a dynamic that you think will persist for a while? And, Jonathan, I did want to ask as well.

I think that 2016 CapEx guidance is a very material increase if I heard it correctly, and I was wondering is that also a reflection of a faster pace of data center buildouts to address the growing interest in public cloud or hybrid cloud architectures?

Yeah. So I'll start and then I'll turn it over to you, Jonathan.

So as it relates to the secular shifts, I think you'd agree, Mark, we're all seeing the same thing in the industry. And as I said earlier, one of the biggest things we see customers kind of pausing and thinking about more – with a lot more, I guess, due diligence is whether they're going to go public, whether they're going to go private or whether they're going to go hybrid.

And I don't see that changing in the near term. I think everyone's going to continue to look at this as an opportunity to decide how they're going to run and operate their IT environments going forward, specifically around the infrastructure.

I think we're very well positioned, if people want to continue to build out private clouds. And I think we're uniquely positioned for customers who want to actually extend into public cloud, because no one house (55:12) the hybrid capabilities that we have today.

And I think this is going to continue for a while. At the same time our customers are continuing to engage with us.

They're continuing to sign ELAs with us, they're continuing to engage in long-term contracts, because we, VMware, have taken them on a journey that's allowed them to be very successful, save significant money, and drive business value with our technology. And I think most of them are betting with us again.

So I think it's a short-term pause. Probably not.

It's probably a longer term that we're looking at here. And I'll let Pat add some commentary as well.

Yeah. Before Jonathan addresses the CapEx question, what we really see in the formation of the Virtustream business is a very differentiated set of capabilities.

Carl commented on the hybrid, right, the mission critical capabilities. So while we're beginning to see real significant customer uptake for that, we think there will be some period of time until that is broadly recognized as a fundamental offering that delivers on hybrid cloud capabilities as no other person in the industry can offer to the marketplace.

So we do see that as a very substantive mid-term opportunity, one that we see substantial acceleration as we indicated in our prepared remarks, a multi-billion dollar business over the next few years. And as that really materializes, I think we will get past this phase of uncertainty as we've described.

Jonathan, maybe a few comments in the CapEx.

Yeah, Mark, we'll give you that bonus question because I'm sure it's top of mind for everybody. But yeah, so first of all, we're really pleased with the momentum we're seeing across the VCA business, and also the Virtustream business.

As I've got closer to the momentum that Rodney and team are pulling off, on both sides, it's been very impressive. Clearly we need to invest as we think about the market ahead of us.

And so as we think about securing those mission critical workloads and as we continue to invest in the hybrid cloud here at VMware, we're now putting together a shared investment model with EMC in this Cloud Services Business we were combining under the brand of Virtustream. And as we bring together those two investment areas, you do see an increase in CapEx overall.

And don't forget this is jointly funded overall as we think about the combination and contributions coming from both EMC and VMware. But, yes, the CapEx increase you're seeing is directly tied to the investment we're making jointly in the cloud buildout.

Thank you.

Thank you, Mark. Next question, please.

Yeah, hi. Thanks.

Jonathan, this one for you and it's a follow-up to Mark's question on cash flow. Cash flow has been down year-over-year for six straight quarters, yet by reaffirming your 4Q guide, you're assuming that operating cash flow is up double digits in 4Q.

And, obviously, you guided next year's operating cash flow up 15%, 20%. So it sounds like you're seeing an inflection point where operating cash flow can, going forward, start turning positive.

And I'm wondering if you might help us understand what those factors are driving that improvement.

Yeah, Carl, thanks for the question. And I'm going to remind you that we talked about this somewhat at the Analyst Day back in August.

So we have a number of factors that have driven cash flow headwinds this year, and I won't repeat them because we have been through them. But as we think about some of those items, a number of them reversed going into 2016.

And so that's having an impact on us overall. In addition, as you know, over the course of the last couple years we have been in an investment cycle.

And we've been managing the P&L and costs, I think, quite carefully over the course of this year. So clearly as we think about 2016 guidance, we're taking a number of things into account: growth in the business, the removal of a number of those headwinds and a couple of them become tailwinds, as you know, and also the investment cycle we're going to be getting into with respect to Virtustream, and the combined business that we just talked about with respect to the CapEx investment.

And again, I just want to mention that or remind you, as we think about this combined business, although the operating cash flow on the cash flow statement reflects the numbers I just raised, 15% to 20% for next year, there is obviously a net effect of the cash injection that you see going into the entity that will be shared jointly with EMC. While that won't appear in operating cash flow, it will appear as though the contributions are made into the business.

So we're pleased with the business, we're pleased with that operating cash flow outlook, and we think it reflects fairly where we are today.

Thank you, Karl.

Got it. Thank you.

Thank you. Let's take one final question before we wrap up.

Okay, thank you very much. I appreciate it.

So I feel obliged to just point out that EMC bought Virtustream not very long ago for about $1.2 billion, which of course beginning in Q1 you will now be consolidating into VMware and yet, at least based on the after-hours or after-market price, it looks as though VMware's market cap has fallen by more than $1.2 billion and everyone knew that bookings, obviously, from the announcement last week, so the delta here really is – or the difference here really is the guidance. And so really my question here, Jonathan, is: I can understand you not wanting to get too granular on 2016 yet, but I think it's important for us to have a baseline for the Cloud Services Business.

So I'm wondering if you could tell us first, what the revenue run rate is on a combined basis today; second, how fast those assets are growing, and third, what percentage of that revenue is owned by VMware today. Any color would be appreciated.

Thank you.

You know, Gregg, when you talk about Virtustream getting acquired by EMC, let's not forget that EMC and the whole Federation, we're always thinking about our position in the cloud overall. They were able to move very quickly to acquire Virtustream, leveraging the capital strength of the Federation as a whole, and as we think about the shift to the hybrid cloud, that's highly strategic for both companies, and we've been very consistent with our messaging for a number of years with respect to our position to the hybrid cloud.

What this does is allow us to put a joint operation together that brings all the cloud assets across the Federation under one house and under one set of leadership. Clearly, we are going to be investing heavily as we see the opportunity to be pretty significant over the next several years.

Again, we're sharing this investment as we think about the opportunity ahead. At this point, when we think about 2016, this is going to be a combined operation.

And I'm not breaking out the individual components at this stage. We'll provide additional disclosure as we think about how the business performs.

But what we've got is a very strong alignment between mission critical applications and what EMC sales force is able to drive and the hybrid cloud story that we have, and we're bringing this together for a very, very powerful story going forward.

Okay. Thank you.

Thank you, Gregg. Before we wrap up, Pat has some final comments.

In closing, we're extremely optimistic about the long-term value to VMware of the Dell and EMC merger and of the new Virtustream business. This combined with our growth businesses that we've been talking about, leave VMware's mission and strategy unchanged and now substantially accelerated.

We're going to continue as a publicly traded company. We expect these transactions to accelerate our growth across all of our businesses.

At the same time, we appreciate that this has been a volatile time for our investors, and we look forward to answering more of your questions over the coming weeks. Thank you very much.