VMware Inc (NYSE: VMW) Q1 2021 Earnings Call Transcript

VMware Inc (VMW) Q1 2021 earnings call dated May 28, 2020

Corporate Participants:

Paul Ziots — Vice President, Investor Relations

Patrick Gelsinger — Chief Executive Officer

Zane Rowe — Chief Financial Officer and Executive Vice President

Analysts:

Kash Rangan — Bank of America Merrill Lynch — Analyst

Walter Pritchard — Citigroup — Analyst

Mark Moerdler — Sanford C. Bernstein — Analyst

Raimo Lenschow — Barclays — Analyst

Philip Winslow — Wells Fargo — Analyst

Matt Hedberg — RBC Capital Markets — Analyst

Keith Bachman — Bank of Montreal — Analyst

Heather Bellini — Goldman Sachs — Analyst

Brent Thill — Jefferies — Analyst

Raymond McDonough — Credit Suisse — Analyst

Jason Ader — William Blair — Analyst

Ittai Kidron — Oppenheimer — Analyst

James Fish — Piper Sandler — Analyst

Alex Kurtz — KeyBanc Capital Markets — Analyst

Sanjit Singh — Morgan Stanley — Analyst

Shannon Cross — Cross Research — Analyst

Brad Reback — Stifel — Analyst

Robert Majek — Raymond James — Analyst

Presentation:

Operator

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

Paul Ziots — Vice President, Investor Relations

Thank you. Good afternoon, everyone, and welcome to VMware’s First Quarter Fiscal Year 2021 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 simultaneously webcast. Slides which accompany this webcast can be viewed in conjunction with live remarks, and downloaded at the conclusion of the webcast from ir.vmware.com.

On this call today, we will make forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially as a result of various risk factors described in the 10-Ks, 10-Qs and 8-Ks VMware files with the SEC. We assume no obligation to and do not currently intend to update any such forward-looking statements. In addition, during today’s call, we will discuss certain non-GAAP financial measures. These non-GAAP financial measures, which are used as measures of VMware’s performance, should be considered in addition to, not as a substitute for or in isolation from GAAP measures. Our non-GAAP measures exclude the effect on our GAAP results of stock-based compensation, amortization of acquired intangible assets, employer payroll tax on employee stock transactions, acquisition, disposition, certain litigation matters and other items as well as discrete items impacting our GAAP tax rate. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP measures, in the press release and our Investor Relations website.

Unless otherwise indicated, all financial metrics provided on this call are for the consolidated VMware entity, including Pivotal. Growth rates compare our Q1 2021 results, with the recast of prior period financial information to include Pivotal due to the Pivotal acquisition, which was accounted for as a transaction by entities under common control in accordance with GAAP. The webcast replay of this call will be available for the next 60 days on our company website under the Investor Relations link. Our second quarter fiscal ’21 quiet period begins at the close of business, Thursday, July 16, 2020.

With that, I’ll turn it over to Pat.

Patrick Gelsinger — Chief Executive Officer

Thank you, Paul. Overall, I am proud of our solid performance and strong execution in Q1 fiscal ’21 during these unprecedented times. As we navigate through this global pandemic, alongside our customers, partners, community, the industry and the world, we continue to see our vision resonate with customers, as we help them build, run, manage, connect and protect any application on any cloud across any device. In Q1, while all geographies were impacted by the COVID-19 pandemic, we were pleased with sales execution, including improved linearity throughout the quarter and end-of-quarter execution.

Total revenue for Q1 was $2.734 billion and up 12% year-over-year and non-GAAP EPS was $1.52 per share, up 41% year-over-year. Our comprehensive strategy is increasingly being embraced by our customers to enable their digital foundation. Customers continue to look to VMware for solutions across app monetization, multi-cloud, digital workspace, intrinsic security and virtual cloud network, as they rely more heavily on fewer strategic partners. These extraordinary times with a global pandemic and an unsettled macroeconomic environment, ensuring the safety and well-being of our employees and addressing our customers’ rapidly changing needs have been our top priorities.

We serve as an essential digital service to those customers who provide essential services, helping them build business resiliency to scale efficiently and more securely. We have proven that we can work effectively in a distributed manner, essentially flipping to work-from-home over a weekend. Our IT investments enabled us to execute a good quarter, support our customers seamlessly, and ship a record number of major new product releases. We have remained in work-from-home mode in order to provide our employees flexibility and contribute to flattening the curve around the world.

Even as we gradually reopen our sites, we will have a more distributed workforce over time, enabling our employees to choose their work environment. At a time when business as usual is not an option, many of our customers and partners have asked us how we can help them maintain business continuity during these times. Whether it is a government-mandated closure, a preemptive remote work initiative or an unexpected hospital network expansion, we rapidly enabled customers to respond effectively. With Workspace ONE, we are uniquely positioned to help our customers enable their employees to productively work remotely, work more securely with Carbon Black Cloud, increase connectivity with VMware SD-WAN and scale their applications with VMware Cloud.

Customers are innovating with VMware in extraordinary ways to make a difference. Utilizing VMware, Vanderbilt University Medical Center recently transformed an empty parking garage into a much-needed COVID-19 screening area, and Nebraska Medicine transitioned their staff to work from home and their students to learn from home. We are also developing enterprise-grade application with customers in an accelerated fashion. We are working with the UK’s National Health Service to bring their contact-tracing application to their citizens to help save lives and restart the country as an example.

We have also seen that COVID-19 is not stopping customers from their cloud migration projects with customers like IHS Markit advancing their partnership with us this quarter and meaning on VMware Cloud on AWS to meet their needs. On the community front, in line with our company values and our commitment to making a positive global impact, we have made monetary donations to nonprofit organizations, doubled our VMware Foundation Matching Gift program and are seeing our employees take action in their communities across the globe through our citizen philanthropy approach.

In Q1, we delivered a comprehensive portfolio of products and services to help customers modernize their applications and infrastructure. The new offerings featured VMware Tanzu, a portfolio of products and services that transforms the way enterprises build, run, manage application software and earlier this month, we announced the acquisition of Octarine, which will bring intrinsic security to containerized applications running in Kubernetes and build security capabilities into the fabric of the existing IT and DevOps ecosystems.

We made major updates to the core portfolio across VMware Cloud Foundation, the largest evolution of vSphere in a decade, NSX-T, vSAN and vRealize Operations Cloud, continuing to bring innovation to our leading infrastructure stack that powers on-premises environments and public clouds across the world. More recently, we have provided updates across many of our cloud partnership offerings, including an extension and expansion of our preferred VMware Cloud partnership with AWS as well as new service offerings based on VMware Cloud technologies from Microsoft Azure, Google Cloud, Dell EMC and Alibaba Cloud.

We also introduced new security offerings this past quarter, including VMware Advanced Security for Cloud Foundation, which will enable customers to replace legacy security solutions and deliver unified protection across private and public clouds. We continue to see customers embrace our security offerings, including Bank of Montreal, a Canadian multinational financial services company, who recently chose VMware Carbon Black.

We continue to see extraordinary interest in a software-driven approach to the 5G network and VMware’s telco cloud. Carriers deploying our telco cloud solution have seen substantial improvements in CapEx and OpEx as well as agility in deploying new services. We now see the opportunity to extend these benefits to the radio access network using virtualized RAN deployed on telco cloud. We’re pleased to be expanding our partnership with Intel to address carrier needs in this area. We’ll provide additional details regarding our partnership at a future date.

As we look to the future, our thoughts are with those who have been most greatly impacted by COVID-19. We are committed to helping our customers navigate this pandemic while also continuing to help ensure our employees’ safety and well-being. We are taking the opportunity to drive the company faster toward our future. This week, we also made some organizational changes directly related to accelerating our strategy and adding key new talent to the company. As we look at a much higher level of volatility in the market, our strategy is more relevant to customers than ever.

Although there is a level of economic uncertainty now, we remain confident in our long-term prospects and how we are enabling our customers with their digital transformation. In many ways, the pandemic has driven a decade of digital transformation in a few short weeks. Our technologies and our team have responded in an extraordinary manner even as challenges abound for health care improvements, new educational platforms, remote work environments and global digital access. While we must focus on solving the immediate challenges of COVID-19, we are also accelerating to a new post-pandemic world of how we will work, learn and live.

Thank you, and over to Zane.

Zane Rowe — Chief Financial Officer and Executive Vice President

Thank you, Pat. We were pleased with our Q1 performance, and financial results were ahead of earlier expectations against the backdrop of a challenging COVID-19 environment. Our team adapted quickly to support our customers’ needs, in particular with the rapid deployment of work-from-home-related solutions. We continue to see strong demand for many of our products and services, including our expanding subscription and SaaS offerings, which had revenue growth of 39% year-over-year in the quarter. Q1 success also demonstrated our continued strength in helping drive a positive ROI and enhanced resilience for customers undergoing their digital transformations.

In Q1, total revenue grew 11.6% year-over-year to $2.734 billion. The combination of subscription and SaaS and license revenue grew 16.6% to $1.232 billion, with subscription and SaaS revenue of $572 million. Within the category, we had the strongest revenue performance from our EUC, Carbon Black and VeloCloud offerings as well as VMware Cloud on AWS, which had triple-digit revenue growth rate for the quarter. Our on-premises perpetual license revenue was $660 million, up over 2 percentage points year-over-year primarily driven by stronger-than-expected EUC license demand.

Non-GAAP operating income increased 25% year-over-year in Q1 to $818 million. Operating income benefited from lower spending directly tied to the impact of COVID-19. Non-GAAP operating margin for the quarter was 29.9%, up over 3 percentage points year-over-year, with non-GAAP earnings per share of $1.52 on a share count of 422 million diluted shares. We ended the quarter with over $9.2 billion in unearned revenue and $5.9 billion in cash, which includes the proceeds from a $2 billion bond offering completed in April.

Early in Q2, we redeemed $1.250 billion of notes, which were originally due to mature in August of this year. Cash flow from operations in the quarter was $1.374 billion, and free cash flow was $1.287 billion. RPO, which includes our committed and non-cancelable future revenue, was $10.1 billion, up 19% year-over-year, 54% of which is classified as current and in line with historical levels. Total backlog was $4 million, which consisted primarily of orders held due to our export control process. License backlog at quarter end was $2 million. For Q1, growth in subscription and SaaS and license revenue plus the sequential change in unearned subscription and SaaS and license revenue was 16% year-over-year. Growth in total revenue plus the sequential change in unearned revenue was 6% year-over-year.

Turning to product bookings for Q1. EUC had a good quarter. At the beginning of fiscal 2021, we shifted emphasis from total contract value to annual contract value for EUC SaaS product bookings. This impacted total EUC product bookings in Q1, which grew nearly 10% year-over-year. Our focus on annual SaaS contracts for EUC resulted in ACV bookings growth of over 20% year-over-year. We saw strong demand from customers for our VDI solutions, which helped grow on-premises perpetual license bookings approximately 40% year-over-year.

NSX and vSAN also had strong quarters, each with product bookings growth of over 20% year-over-year. We were pleased with Carbon Black’s performance in Q1 with an increase in customers to over 15,000 as well as strong product bookings growth, particularly in Carbon Black Cloud and our modern applications business, which includes Pivotal, Heptio and Wavefront, had product bookings performance ahead of expectations in Q1. Core SDDC product bookings declined mid-single digits, with total core SDDC bookings down 7% year-over-year. These results were negatively impacted by COVID-19 and followed a particularly strong Q1 last year when core SDDC product and total bookings grew in the low teens year-over-year. We repurchased 1.5 million shares in the open market in Q1 at an average price of $117.52. Through the end of Q1, we utilized $681 million from our current authorization of $1.5 billion.

Regarding our outlook for Q2 and the remainder of the year, we’re seeing greater economic volatility and a far less visibility globally, which makes any kind of forecast more challenging. That said, our view on Q2 performance, given the status of our pipeline and the current economic outlook, is for total revenue of approximately $2.8 billion, including $1.3 billion or 45% from combined subscription and SaaS and license revenue for the quarter.

We currently expect non-GAAP operating margin of approximately 28% for Q2, with non-GAAP earnings per share of $1.24 on a diluted share count of about 422 million shares. We’re not currently reinstating formal guidance for the full year. However, with the immediate global economic challenges resulting from COVID-19 and its anticipated impact on our customers, we believe it’s reasonable to expect revenue growth to be in the mid-single digits for full year FY 2021. As economies around the world recover, we would expect to get back to a more normalized double-digit growth rate in FY 2022.

In the short term, given this outlook, we expect operating margin to be approximately 28% for full year FY 2021. We remain focused on driving long-term value through margin accretion combined with strong revenue growth in the business. This quarter highlighted our strength and opportunities in a challenging economic environment. The VMware team demonstrated great execution in Q1, supporting customer needs with the challenges presented by COVID-19. While we don’t have good visibility into the underlying economic backdrop for the remainder of the year, we remain confident that we will continue to support our customers, develop and enhance our portfolio and focus on driving long-term value and growth.

With that, I’ll turn it back to Paul.

Paul Ziots — Vice President, Investor Relations

Thanks Zane. Before we begin the Q&A, I will 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.

Questions and Answers:

Paul Ziots — Vice President, Investor Relations

[Operator Instructions]. Up first is Kash Rangan, Bank of America.

Kash Rangan — Bank of America Merrill Lynch — Analyst

Hi. Congratulations, team, on very nice results here considering everything that we’re going through. I just had one big question related to cloud and digital transformation. It looks like you booked a triple-digit growth rate with the Amazon partnership. Congratulations. That’s fantastic. Also, EUC bookings look really good. I’m curious, Pat, as you talk to customers post this pandemic, how are you coming out of the other side? What does life look like for VMware as far as new imperatives for digital transformation? Maybe things are accelerating to the cloud because of what we’re going through, maybe not. What do you see out there with respect to customer buying behavior? Thank you so much.

Patrick Gelsinger — Chief Executive Officer

Yes and it was a good quarter for us with respect to the overall cloud and the transformational activities that we’re doing there. We would say overall that as customers are going through the phases of the pandemic, triage, new normal, new opportunity that, overall, we do expect that there will be a bit of an acceleration of cloud activities, but it isn’t fundamentally shifting their cloud focus, right? That transition was already underway, as you well know, Kash. Customers were already putting more importance on their subscription, their SaaS, their cloud offerings. We expect, if anything, this will accelerate those a bit.

But industries that were largely focused on-premise, they’ll continue to be that way, right, for different regulatory, costs and other reasons. But overall, this will be a bit of an accelerant into the cloud and subscription offerings. So we’re — our focus in accelerating those areas of our businesses will be reinforced and also, we’d say the hybrid strategy that we’ve laid out and been building really is extremely well positioned, right? We help people get to the cloud more cost effectively. Our solution’s now 50% faster than alternatives and getting to the cloud with lower TCO. This ability to be private, public, hybrid really is a powerful point and you saw the great results we had this quarter as we saw extensions of our AWS relationship, new offerings from Azure, new offerings from Google, new offerings from Alibaba, a new version of our Dell EMC solution. So overall, we’re really nicely positioned here in the multi-cloud, hybrid cloud future.

Paul Ziots — Vice President, Investor Relations

Thank you, Kash. Next question please.

Operator

We’ll hear from Walter Pritchard, Citi.

Walter Pritchard — Citigroup — Analyst

Hi. Pat, I’m wondering if you could talk about on the EUC side. Strong results there. How do you think about sustainability of that strength as we move into a post-COVID world and also your prioritization of product development in that area, given it’s a smaller part of your revenue, but an area you’re seeing quite a bit of success?

Patrick Gelsinger — Chief Executive Officer

Yes. Thank you, Walter. And overall, the COVID environment clearly was a tailwind for our EUC business, and we saw lots of compelling market opportunities. Very pleased with how that team did in Q1 of this year. We saw that across a range of verticals. We saw it in finance, health care, public sector in particular and we’re also seeing it as a critical enabler of many companies being able to address their work-from-home environments and literally tens of millions of people were able to work this quarter because of solutions like Workspace ONE.

We’ve had examples like Veterans Administration, Nebraska Medicine, Bridgebain Catholic Education, almost 100,000 students down under Cognizant. All of these are just great examples of it and we do believe it will be a continued tailwind. While our overall product strategy, we feel pretty good that we are well aligned on digital transformation and what we’re doing with our five pillars before it. But on the margin, we’ll put more emphasis on EUC as a result of this good environment.

Zane Rowe — Chief Financial Officer and Executive Vice President

Walter, I’d just add, I mentioned in my remarks, obviously, we’re very pleased with the surge in demand we saw, in particular, for VDI solutions, which helped grow our on-premises license bookings by 40% on a year-over-year basis. We’ve also been focused on the ACV subscription, which we believe adds some value and allows us to both land and expand with new customers, too, and we saw a nice increase of over 20% there as well. So very pleased with the whole category, and we think there’s a lot of room to run here.

Paul Ziots — Vice President, Investor Relations

Thank you, Walter. Next question please.

Operator

Next up is Mark Moerdler, Bernstein Research.

Mark Moerdler — Sanford C. Bernstein — Analyst

Thank you very much and congrats on the quarter. It looks really nice. So I’d like to look at the question about cash and cash flow on a — not Kash the person, but cash flow on the go-forward basis. Can you give us color on the conversations you’re having with clients relating to deferred payments, changes in payment terms? Cash needed to be strong this quarter, better than some others. Any color would be appreciated?

Zane Rowe — Chief Financial Officer and Executive Vice President

Sure, Mark. Yes and we can talk to cash or otherwise, the other Kash, whichever you prefer. In this case, as you pointed out, we’re very pleased with — the first quarter cash fundamentals were great. We’re very pleased with receipts and our ability to drive cash flow. We believe longer term, it goes in line with the business. So I’d characterize it as largely in line with the characterization I made for the remainder of the year and for the second half of the year. We are affording flexibility for those customers that need it, and we do think there’ll be some pressure there. But overall, we feel very good about our overall cash position. We feel good about the balance sheet, and we think it will grow in line with the business.

Patrick Gelsinger — Chief Executive Officer

I’d also emphasize the relationship with Dell and DFS helps us present flexible cash options through our Dell Financial Services partnerships, which gives them the flexibility they need that allows us to continue to execute our business as we have in the past.

Zane Rowe — Chief Financial Officer and Executive Vice President

Yes. As Pat pointed out, there are many ways that we’re helping both customers and partners in this area.

Paul Ziots — Vice President, Investor Relations

Thank you, Mark. Next question please.

Operator

Raimo Lenschow from Barclays is up next.

Raimo Lenschow — Barclays — Analyst

Congrats from me as well. You guys were the first to kind of react to the crisis and just take guidance down, kind of think about executive pay, etc and not only, I think, we’re like two months in from that action. Like how would you characterize what you’re seeing now versus your initial expectation? Thank you.

Patrick Gelsinger — Chief Executive Officer

Yes. As I’ve mentioned, the — we see this sort of in the three phases of the response and as customers went through triage, new normal, new opportunity, the economy was hit hard, right? And I think many of those implications aren’t fully realized through the economy yet and as a result, we expect the next couple of quarters to be tough quarters overall for the market. No market segment, no geo is immune to those effects. But we’re surprised how quickly customers were able to adapt into a work-from-home environment. It has been particularly startling and I think the IT systems, the infrastructure investments that people made were really just pretty fabulous and I think I’ve talked to probably a couple of hundred CEOs over the last two months, and it really has been spectacular how quickly they’ve been able to adjust. That said, we do see that this pandemic as it’s spurred rapid expansion of work from home.

As I’ve described it, we’ve seen decades of momentum in weeks, right, and just how rapidly people have been able to adjust and clearly, we’re starting to see some recovery in some areas of the market like Asia. They’re starting to come back. But we have a long way to go until that’s the case.

And maybe the last general comment here, Raimo, would be — and I’ve spoken that tech is stronger than GDP, and software and cloud is stronger than tech and that priority order, if you would, where everybody will get affected by a major GDP impact. But technology, digital transformation is more important. So it will be several points stronger than the GDP, and cloud and software will be several points stronger than tech overall and we believe that, that ordering will remain the case, and we expect that uniquely positioned technology companies as we see VMware are will emerge from the crisis even stronger than we entered it.

Zane Rowe — Chief Financial Officer and Executive Vice President

Yes, Raimo, I’d just add, as we mentioned, there’s not tremendous visibility as you think further through the year and into next year. But our general thesis aligns with that, that those large institutions are portraying for the rest of the year. We think it will be a challenging second quarter and third quarter and then see progression after that that, but we feel good about the business and feel good about the general guide.

Paul Ziots — Vice President, Investor Relations

Thank you, Raimo. Next question please.

Operator

Phil Winslow from Wells Fargo.

Philip Winslow — Wells Fargo — Analyst

Thanks a lot for taking my question. I’m glad to hear that you all are good and well. Pat, you mentioned, obviously, this was a huge launch into the products, NSX, vSphere itself, vSAN and so forth. But really want to focus in on vSphere with Kubernetes, embedding Kubernetes control plane into vSphere. The question is, what are customers now that have been out there? And obviously, it’s been several months since VMware. What are they telling you about your strategy? What are they telling you in terms of their path to cloud-native and Kubernetes? Any change in that given the current environment? Thanks.

Patrick Gelsinger — Chief Executive Officer

Yes. Thank you, Phil, and great to talk to you. The — overall, the response to the Tanzu launch, which we did in March, was very strong. We just shipped the new version of vSphere a few weeks ago. So I think it’s a little bit early to say how quickly and how rapidly that upticks, but the customer interest is truly tremendous and we are thrilled as we’re starting to see Kubernetes become popularized, available broadly and our Tanzu launch was the full set of capabilities. It was the Tanzu application services leveraging the Pivotal capabilities. It was Tanzu mission control leveraging the Heptio capabilities and then what we call Project Pacific or the Tanzu Kubernetes grid, which is now being shipped as part of vSphere.

And overall, we say we’re off to a good start in this area and we call this the business unit for me, as you call, the modern application of BU. In that business area, the whole Tanzu business area performed well in Q1, overall ahead of our expectations as we would have and we’ve seen it starting to come into our big deals as well. Five of our top 10 deals this quarter included Tanzu. So we’re starting to see some good early attach rate as well and obviously, we’re not finished. This is the area where Octarine is joining our family as well to do container security.

So we expect that we’re going to continue to build and launch new capabilities in this area because we see ourselves uniquely positioned to bring VMs and containers together in a way that nobody else in the industry is positioned to do, but also do that on-premise and in the cloud. So a true multi-cloud, hybrid cloud capability. So overall, good start to what I think is the most critical product area for us over the next couple of years.

Paul Ziots — Vice President, Investor Relations

Thank you, Phil. Next question please.

Operator

Matt Hedberg, RBC Capital Markets is next.

Matt Hedberg — RBC Capital Markets — Analyst

Thanks for taking my questions and congrats again on the quarter. Triple-digit growth in VM cloud on AWS is impressive. Pat, I’m wondering if you could provide a bit more detail there and I know you talked about companies moving faster to the future as a result of COVID. Wondering if you’re seeing that in AWS cloud usage. Sort of a little bit more detail there would be helpful. Thank you.

Patrick Gelsinger — Chief Executive Officer

Yes and I’ll say a couple of things about the AWS offering where you’ve heard me talk in the past, Matt, where it takes two years for a new product to become mature enough that customers really trust them and start to build on it and when we first launched the VMC service at AWS, we thought we could do better than that. Well, guess what? It took two years and starting late last year, the two-year anniversary, we saw really start to take off nicely in the market. Seeing the triple-digit growth this quarter was really exciting. Big customers like IHS, our eight-figure deal this past quarter. Consuming host count in Q1 was up, over 200% year-on-year.

So customers starting to consume and utilize it. We expanded and renewed and extended our relationship with Amazon. We opened up the AWS GovCloud region West Coast. So we’re seeing more and more fed ramp capabilities to reach that market and bringing new services for app migration, DR, data center migration. So overall, it was a very good period of time, and we’re seeing great momentum in that relationship with Amazon.

Overall, we think in this environment, as I said to or respond to Kash’s question earlier, we expect while customers that need to be on-premise will be on-premise. Customers that are looking to move to cloud will do so. We don’t see this as a fundamental shift but a bit of an acceleration, right, of those cloud services. So on the bubble, this will drive acceleration, and we’re seeing that in our overall cloud offerings and in particular with the VMC on AWS offering.

Paul Ziots — Vice President, Investor Relations

Thank you, Matt. Next question, please.

Operator

We’ll go to Keith Bachman, Bank of Montreal.

Keith Bachman — Bank of Montreal — Analyst

Thank you very much. Pat, nice win on Carbon Black for a large financial institution in North America. Wanted to ask about SDD — SDDC rather. Wanted to ask about SDDC in particular. I know you said it was down mid-single digits and the context of the question is, how do you see that faring for the balance of the year? I would assume given the backdrop of guidance that, that would continue to decline mid-single digits or nothing else declined, but I just wonder if you could offer some color and I wanted to add a little bit to what you just referred to because the question is cloud-native versus cloud-neutral and what I mean by that is as more workloads do go to the cloud, it would seem to me that the virtualization engine, AWS and Microsoft in particular with Hyper-V, you’re trying to get more organizations to use cloud-native tools such as Hyper-V. But I just wanted to see if you could speak a little bit to what your expectations for growth for the next few quarters but then also raise it up a little bit and talk about the dynamics between cloud-native tools versus cloud-neutral, which is really supporting your strategy.

Zane Rowe — Chief Financial Officer and Executive Vice President

This is going to have to be the short version, Keith, but let’s go ahead and start and Keith, I’ll start while Pat’s getting his notes together to your other part of the question. You’re right. The SDDC bookings being down were on a tough compare. If you recall, we had double-digit growth in core SDDC for the first quarter of last year driven by exceptionally strong EA quarter. So there’s definitely a tough compare. All that being said, SDDC was impacted by COVID.

There’s no doubt we had some headwind in the portion of our transactional business, in particular, that area that’s more exposed to the SMB segment. We also did see some softness there in APJ. Of course, this has countered to some extent by the strength we saw on VMC on AWS and some of the other areas, but we definitely saw softness there nd we do think that as we contemplate the remainder of the year and the impact for the remainder of the year, the on-premises and some of the core elements will be more impacted than other parts of the emerging parts of the business.

Patrick Gelsinger — Chief Executive Officer

Yes. And I’ll violate Paul’s rule of a one-part question and give a bit of perspective on the cloud-native versus cloud-neutral. We’re clearly — the idea of being able to run one stack, the VMware Cloud Foundation on-premise, on Google, Amazon, Azure, Alibaba, Oracle and then further with Tanzu being able to take advantage of container and Kubernetes services in a cloud-neutral way is compelling to customers. I’d also emphasize that if it was easy to move your apps to the cloud-native services, customers would have done it already, right? It’s hard to migrate applications in existing workloads and complex, high availability, resilient workloads and that’s the core of the VMware value proposition.

So we’ll say in those cases, we’re seeing good resonance to our message around multi-cloud and hybrid cloud and customers always want choice, right, the ability to have more flexibility to decide where and which workloads go along, on what availability zones in their own data centers, what countries. Maybe there’s local requirements as well where German workloads will run on German data centers and so on. So that flexibility is of increasing interest on the part of customers. Now clearly, when they look to build their next-generation applications, they’re making considerations of cloud native and where do and how do they containerize those.

But that’s very much where the Tanzu strategy comes to play in a very powerful way because now you can say, not only do you get the best of modern containerized Kubernetes development capabilities, but you also have cloud choice as part of that and that really is quite compelling to customers and while it’s early, but going back to the earlier question that I think Phil asked, right, we are seeing good resonance to that Tanzu strategy.

Paul Ziots — Vice President, Investor Relations

Thank you, Keith. Next question, please.

Operator

Next is Heather Bellini, Goldman Sachs.

Heather Bellini — Goldman Sachs — Analyst

Great. Thank you so much, guys, for taking the question, and I hope and wish that for you and your families during these changing times. Pat, I had a question for you, given you always have a much better crystal ball than many others. I was just wondering if you could share with us how your view of EUC penetration is changing post the pandemic and maybe if you can share with us what you thought was a realistic penetration of knowledge workers maybe six months ago versus now that you’re looking out and the conversations you’re having with CIOs and CEOS, what it might look like going forward. Thank you.

Patrick Gelsinger — Chief Executive Officer

Yes. Thanks, Heather, and always a pleasure. Overall, this has just radically increased the ability to have managed devices, also a meaningful acceleration of VDI, which VDI was sort of, hey, some customers needed it, but a lot of them hey, we’ll just use a subset of apps that are managed apps as opposed to a true, full VDI experience. So unquestionably, this has been an accelerant. This has meaningfully accelerated. More customers need it. People are viewing work from home, it’s not a spurious thing, but we’re going to be here a while. If a virus broadly or a vaccine is broadly deployed one year or 1.5 years from now, I got to make my workforce productive in this environment. So we see a meaningful uptick. We think that’s going to last for a number of quarters in this business. Every device needs to become managed. Every device needs to become secured, right? So we’re seeing acceleration of our Carbon Black offerings.

Every device needs to have good quality of service. So we’re seeing acceleration of our VeloCloud offering, and we sort of call that our business continuity suite of services. So I think we’re in a period of time where this has gone from being 10% to 20% of the workforce to maybe double or more of that over the next couple of years because so much of the workforce now will be working from home permanently or on a majority basis for quarters to come and as we’re in this, I’ll say, second phase right, moving from triage to new normal, people are saying, oh, if I’m going to be here for the next six or eight quarters, I now have to be efficient, secured and well-managed in this distributor workforce environment. So this will be a sustainable change in how customers use these kind of technologies for the long term.

Paul Ziots — Vice President, Investor Relations

Thank you, Heather. Next question, please.

Operator

Brent Thill from Jefferies is up next.

Brent Thill — Jefferies — Analyst

Thanks. Many software companies are kind of characterizing May over April. I’m curious if you had any color in terms of what you’re seeing in the month May and anything different than you’ve seen coming — exiting April? Thanks.

Zane Rowe — Chief Financial Officer and Executive Vice President

No, Brent, I mean I think it’s coming in as expected. Our guide, as I mentioned, beyond the second quarter, we lack that kind of visibility that we would traditionally have. We think these are unprecedented times, but I wouldn’t say there’s been a significant shift. I mean, obviously, in software, we push hard through the end of the quarter, and then things build gradually after that. But I’d say the teams are still engaged. We’re still confident that the sales teams, even in a virtual way, are doing a great job out there and of course, as Pat mentioned, the strategy is resonating, and I think he’s on as many customer calls, if not more than when he was traveling around. So there’s still tremendous interest to get through this.

Patrick Gelsinger — Chief Executive Officer

I think one thing that we’d point to that is different, right, is that we’ve shown that in Q1 that we can close business effectively. Now it’s really question, can we develop new business, new projects, new pipeline, POCs were often delayed. So now it’s really developing new sales muscles that it isn’t just about closing business that was already in the pipeline, but it’s also generating new business, creating new projects with customers, working with them to accelerate and deliver those into the future. So that’s definitely a change and as we finish Q1 and delve into Q2, it was really about building pipeline for not only Q2, but the rest of the year as well.

Paul Ziots — Vice President, Investor Relations

Thank you, Brent. Next question, please.

Operator

Up next is Brad Zelnick, Credit Suisse.

Raymond McDonough — Credit Suisse — Analyst

Hi, this is Ray McDonough on for Brad. Thanks for taking questions and congrats on a strong quarter. Maybe one for Pat. You mentioned that customers are looking to decrease the amount of strategic vendors that are leveraging and pairing that with the momentum you’re seeing with Carbon Black, I’m just interested to hear how conversations around Carbon Black have progressed throughout this period of disruption? And maybe where you see share gains coming from in that segment of the market?

Patrick Gelsinger — Chief Executive Officer

Yes. Thank you and let me first say, security business unit, the Carbon Black team and some of the other things you put into there, Q1 performance execution was great and we saw the cloud, Carbon Black cloud have triple-digit growth in the most comparable prior quarter, 15,000 customers now. We’ve also seen that this idea of fewer strategic customers is a powerful theme, where they trust VMware. They’re doing lots of things with us. They’re building on our EUC or our networking products and they say, oh, you’re going to build security directly into that. So I need one less vendor, one less set of management training, etc. This is a powerful motion.

Now we’ve got a lot of work to do. The Dell on the box offering is doing well. We’ve seen the integration projects that we have with Workspace ONE. VSphere and NSX are all in flight and well underway. We got a lot of work to do there. It was great to — in Q1, Bank of Montreal, a big win for us, so excited and that was very much a VMware relationship win, right, where it was definitely all of VMware coming to the table. But lots of other great wins as well this quarter. We’re also very dedicated to building a broad ecosystem.

In our security partnership ecosystem, we announced the expansion of our relationship with Octa, but also in areas such as Zoom, Teams, others as we’re doing deeper integrations to deliver more complete solutions for end-user computing and work-from-home environments where security becomes an essential piece of now having — instead of having a few campuses, now I have thousands or tens of thousands of campuses measured in every home of every worker. So all of a sudden, the security profile and your potential points of intrusion are so much larger that we see this becoming even more critical. So our idea of an intrinsic security platform from a credible trusted vendor like VMware, I think the strategy will be even further accelerated beyond the good success we had in Q1 as a result of this environment.

Paul Ziots — Vice President, Investor Relations

Thank you, Ray. Next question, please.

Operator

Jason Ader, William Blair is up next.

Jason Ader — William Blair — Analyst

Thank you. Pat, when you talked about visibility being weaker, is that just customers slowing down spending and just kind of not giving you their plans for the year? And that’s kind of across your different business — your verticals? Or is this driven more by the hard-hit verticals and the percentage of your business covered by those verticals that’s really just kind of started on the brakes?

Patrick Gelsinger — Chief Executive Officer

Well, I would say there is tumult period, and let me just characterize a little bit. Clearly, there’s travel and entertainment, the most impacted industries. But every industry is being impacted in some way. Geos, we’re starting to see China and some of the Asian economies just start to emerge, but we think we have a long way to go until we’re normal in geos. Different segments, SMB being more impacted than enterprise and as a result, we’ll just say a lot of uncertainty. Visibility limited and most CIOs have become more important to the business in this process. The criticality of technology, digital transformation has increased, not diminished per my earlier comments on the priority and where spending will occur.

But everybody is now looking at those budgets and saying, oh, which are the projects that are now most critical? I wasn’t planning on having tens of thousands of work from home people in my January priority setting. Now I do. So everybody is now saying which projects become more important, which ones get more funding, right, or shift around. We’d say, overall, we’re not seeing deals lost for us. We’re not seeing customers engaging with us differently, but we do see priority shifts, right, different views of their pipeline turning into deals at different points in time. So that’s where we’re going through, and we see this period of uncertainty lasting a couple of more quarters, and we’ve given our best view of the coming period as we can financially. Zane, anything to add?

Zane Rowe — Chief Financial Officer and Executive Vice President

No, I think you’ve covered. I mean, obviously, we were thrilled last year with a number of really, really large deals that we’re able to execute against and while we don’t think that’s necessarily changed, we think that will be a little tougher as customers are thinking about their financial plans and how deep they go with us at that point in time. So overall, we’re pleased with the strategy, and we’re pleased with the outlook. Granted, as I mentioned earlier, we just don’t have that same level of visibility that we have historically had.

Paul Ziots — Vice President, Investor Relations

Thank you, Jason. Next question, please.

Operator

We’ll now hear from Ittai Kidron, Oppenheimer.

Ittai Kidron — Oppenheimer — Analyst

Congrats, guys. Great numbers. A couple of questions from me. First, on EUC. Zane, can you kind of break it for us how much of that business is done, is licensed versus subscription software? And then more of a longer-term margin question. You’ve done clearly very well here, working from home. Is there a way to think about your long-term margin potential a little bit differently now that, I guess, we’ve all discovered we can actually do just fine working from home? How do we think about that from a long-term perspective?

Zane Rowe — Chief Financial Officer and Executive Vice President

Sure. Yes, I’ll start with the mix. This quarter, we highlighted the fact that we actually saw stronger growth in license than we have historically, which was unique, but still less than half of the total EUC basket is licensed bookings. So we’re still very pleased with the trajectory that the SaaS business has been on and obviously, as I mentioned, in particular with our ACV focus, we saw nice growth there on a year-over-year basis as well. So we feel very pleased with where the product is performing and how it’s proceeding. I’m not sure if Paul’s going to let us go to the second point.

Paul Ziots — Vice President, Investor Relations

I think the others will be upset with me. So we’ll save that for the next time, Ittai. Next question, please.

Operator

Next up is James Fish, Piper Sandler.

James Fish — Piper Sandler — Analyst

Congrats on the quarter and I’m glad you both during — hope you’re all doing well. One thing I hope to dive into is your color on what you’re seeing vertically, including with the troubled areas of retail, hospitality, travel and oil and gas as well as the opportunity around carriers with 5G, which historically isn’t a big area for you. Just wondering how this evolved for VMware over the next year, given what you’re showing with the various customers like Deutsche and Vodafone. Thanks.

Patrick Gelsinger — Chief Executive Officer

Yes and I’ll start on that. Generally, our biggest verticals, federal, the federal government, public sector, the financial sector and telco are the three biggest ones for us. Generally, financial has done well in this period of time even though I think there’s some general forecast that, that may get to be more troubled as SMB implications, etc, happen through the marketplace. So far, our business has gone well with them, and they’re well underway to digital transformation with us. Federal has remained quite strong and if anything, stimulus dollars will probably drive even some potential upside in those areas. Telco, we think, is a huge opportunity and the telco environment, if anything, has proven more important, more resilient to this period of time and the focus on 5G is one that VMware’s been driving and focused on for several years now. We’ve had good wins that we’ve been seeing.

The Deutsche Telekom example that we gave last quarter around O-RAN was a very powerful one as we’re seeing the O-RAN initiative being one where essentially Open RAN, right, open radio access network enables the U.S. strengths of silicon, software and cloud to come into the 5G network and we think this is industry shaping for years to come and part of the reason that we announced our expanded partnership with Intel in this area the last quarter. So overall, we feel like we’re well positioned in those verticals, and all of those received good business opportunity for over time.

Some of the other segments will be more challenged as you’d expect. Travel and entertainment, retail, we believe, to have greater impact in this period of time. We’d also say SMB will have a greater impact, but all of those are smaller business areas for VMware, even though we don’t think any segment, any geo, any country, all of them will be affected in such a turbulent environment.

Paul Ziots — Vice President, Investor Relations

Thank you, Jim. Next question, please.

Operator

We’ll go to Alex Kurtz, KeyBanc Capital Markets.

Alex Kurtz — KeyBanc Capital Markets — Analyst

Thanks for taking the question. Pat, I just wanted to go back to your earlier comment about five out of your top 10 deals, including Tanzu. I guess I know it’s early, but you know if they’re changing the scope of the projects, the number of VMs, the number of NSX licenses you might need, just the overall size? Or is it just too early to tell?

Patrick Gelsinger — Chief Executive Officer

Yes. I’ll just start. It’s too early to tell. We just launched the product. High — our objective is high attach rate to the VMware platform. We launched a version of our VMware Cloud Foundation, right? That includes Tanzu and now you’re saying the whole stack or the whole IS stack plus the PaaS capabilities of Tanzu. So we’re quite excited about being able to put top on bottom for that solution. We have our first offerings, the Tanzu mission control, the multi-cloud control plane and we’ve closed our first deals for TMC as well with some large banks around the world. We’re also seeing good engagements such as the NHS is leveraging our Tanzu development capabilities for some of their work recently in their fight against COVID. So overall, very positive response from the marketplace. Quite excited to see it in five of the 10 early deals. But we have a long way to go to declare success or what the financial implications of that could be for us over time.

Paul Ziots — Vice President, Investor Relations

Thank you, Alex. Next question, please.

Operator

Next is Keith Weiss, Morgan Stanley.

Sanjit Singh — Morgan Stanley — Analyst

This is Sanjit Singh for Keith Weiss, and congrats to the VMware team on a strong Q1. I had one question on sort of on Pat’s call out of the product cycle. It seems like we have a major product cycle going on at the company. I was wondering how you could sort of put this in context relative to some of the other major product cycles. How long do you think this product cycle will last compared to what we saw maybe with the NSX, vSAN and maybe vSphere 6, some of the past ones? And then for Zane, on the product cycle as the company gains traction, how is that going to express itself in the model maybe differently than some of the other ones when it comes to license versus SaaS and maybe metrics on how to track success with this current product cycle? Thank you.

Patrick Gelsinger — Chief Executive Officer

Yes. On the product cycle, the first reason I highlighted that as I had was the fact that we could operate so efficiently during a pandemic and we switched from work from home, and yet we were able to deliver on every product release essentially on schedule, and this was NSX. It was vSAN. It was vRealize. It was the biggest vSphere release in probably 10 years, major upgrade to VMC and our first Tanzu release. It’s like wow. It’s an incredible amount of software that we’ve delivered at production scale in the last — in April and with that, we’ll say this just begins a powerful cycle for us that we believe.

Like the Tanzu comments that I made earlier, we’re just getting started. This will be a one to two-year cycle building on those capabilities into the marketplace. The VMware Cloud Foundation offering is — vSphere is being replaced by VMware Cloud Foundation. We are moving all of our sales motions to, say, VCF, as we call it. The VMware Cloud Foundation is the new vSphere and that VMware Cloud Foundation is the same underpinnings for the VMC offering with Amazon. It’s also the same underpinnings for the Azure offering, the Google offering. It’s all standardizing on this common platform, which is now on-premise, in the cloud, to the edge. This strategy, we believe is one that we can be building on for a couple of years to the future. So we’ve really launched a powerful cycle of product innovation. We’ve delivered on the things that we promised last year at VMworld, and we’re well underway in this turbulent period with, I think, the greatest portfolio of software that VMware has ever had.

Zane Rowe — Chief Financial Officer and Executive Vice President

And I would just add, along with that solution focus, there are obviously efficiencies that you see in the business, which continue to drive our long-term growth as well as margin profile. Nothing in what we’ve discussed isn’t incorporated in our forecast. We continue to focus on subscription and SaaS as a big driver for the business, which is the way we guide and forecast.

Paul Ziots — Vice President, Investor Relations

Thank you, Sanjit. Next question, please.

Operator

Up next is Shannon Cross, Cross Research.

Shannon Cross — Cross Research — Analyst

Thank you very much. Just one question on your thoughts on acquisitions and use of capital. I’m just curious, given the current environment, if you’re seeing any opportunities for perhaps some technologies that are owned by private equity or how you’re thinking about the potential, given you’ve obviously closed Pivotal and Carbon Black at the end of last year. Thank you.

Patrick Gelsinger — Chief Executive Officer

Yes. Overall, our capital allocation policy hasn’t changed. As you saw, we continue to exercise buybacks and with the Octarine acquisition that we just announced, we continue to do M&As. As I described as we finished last year with Pivotal and Carbon Black, that not only were those large, right, but we had a lot of work to do to integrate those into the company. So I expected this year to be a more modest M&A year, one where we’re more focused on tuck-ins. That said, we’re going to continue to look for good opportunities, and we do expect that there will be more cost-effective uses of balance sheet investments for acquisitions as a result of the environment we’re in and we’re going to be looking for those opportunities, but it’s going to fit more into, I’ll say, a modest M&A tuck-in kind of focused year for us because we simply got to finish what we started with Carbon Black and Pivotal and even though those are going very well so far as I’ve already commented and both of those businesses performed above our expectations for Q1, we believe we have a lot of integration work to finish up with both of those.

Paul Ziots — Vice President, Investor Relations

Thank you, Shannon. Next question, please.

Operator

We’ll go to Brad Reback, Stifel.

Brad Reback — Stifel — Analyst

Great. Thanks very much. On EUC, were there any short-term transactions done there that might create a difficult comp down the road as customers sort of transitorily move to work from home?

Zane Rowe — Chief Financial Officer and Executive Vice President

No, I don’t believe there are any short-term impacts. I mean, obviously, we were pleased to see the VDI portion that I mentioned. We did see a strong license growth, which will expect to see continued SnS and attach beyond that and if anything, with the ACV focus, we’re focused on high retention rate and growing and landing and expanding as we talked about earlier. So we do see more normalized growth as the year progresses and as the years progress, but we’re still very encouraged by the category and what we’re doing in the category. So we couldn’t be more excited about our position and the overall growth of the portfolio there.

Patrick Gelsinger — Chief Executive Officer

Yes and I’ll just add that we — some of our business continuity offerings, we had special 30-day trials for certain segments and certain customers. So if anything, we think that we’ve gotten some new customers who are now considering us that might not have considered us before. So I think we see more upside there than headwinds in the future.

Paul Ziots — Vice President, Investor Relations

Thank you, Brad. We have time for one more question. So this will be the last question, please.

Operator

And that’ll come from Robert Majek, Raymond James.

Robert Majek — Raymond James — Analyst

Congrats on the good results. In the container space, I was just wondering if you can give us an update on what you’re seeing in the competitive landscape? Who do you view as your core competitors, if you’re seeing any changes in win rates? Thanks.

Patrick Gelsinger — Chief Executive Officer

Yes. Given the comments I made before on just getting Tanzu in the marketplace, just launching vSphere, which includes Kubernetes, I’d say it’s pretty hard to give us any real competitive win loss metrics at this early phase of the market. As I’ve described it before, I see that the market becomes five players. It players. It’s IBM Red Hat. It’s the three mega cloud players, Google, Amazon, Microsoft and their native services and VMware and when we think about those five, we’re uniquely positioned with a multi-cloud, hybrid-cloud strategy, deep partnerships with Amazon and partnerships with Azure and Google as well, a huge footprint that we can leverage in vSphere that really allows us to present this integration of containers and VMs, right? And we don’t think it’s an or. We think it’s an and that we can do both of those and make it just seamless for customers to begin embracing the new Kubernetes and container strategies. So we really like our strategy here. Customers resonate with it, and we’re pretty excited about the good results we saw in Q1.

Paul Ziots — Vice President, Investor Relations

Thank you, Robert. Before we conclude, Pat will have final comments to make.

Patrick Gelsinger — Chief Executive Officer

Yes. Thank you all for joining us today. I’m very proud of the team and our strong execution in Q1 and as we’re focusing on the immediate challenges of COVID-19, we are also accelerating to a new post-pandemic world of how we will work, how we learn and how we live being permanently changed in the result. Our strategy, we believe, is very relevant to customers and even more so in environment as we look into the future and we’re excited to update you in our progress next quarter. So thank you very much.

Operator

[Operator Closing Remarks].