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EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - VMWARE, INC.vmw-9302015x10qex312.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - VMWARE, INC.vmw-9302015x10qex321.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - VMWARE, INC.vmw-9302015x10qex322.htm
EX-10.5 - AMENDED AND RESTATED REAL ESTATE LICENSE AGREEMENT - VMWARE, INC.ex105amendedandrestatedrea.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - VMWARE, INC.vmw-9302015x10qex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period            from            to
Commission File Number 001-33622
_______________________________________________________
VMWARE, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________________
Delaware
94-3292913
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
3401 Hillview Avenue
Palo Alto, CA
94304
(Address of principal executive offices)
(Zip Code)
(650) 427-5000
(Registrant’s telephone number, including area code)
_____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 x
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
 o
(Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of October 31, 2015, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 421,019,601 of which 121,019,601 shares were Class A common stock and 300,000,000 were Class B common stock.



TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 
VMware, Immidio, vCloud, vCloud Air, vCloud Suite, vSphere, NSX, Airwatch, Horizon, Horizon Suite, vRealize, Virtual SAN and VMware Virtual Volumes are registered trademarks or trademarks of VMware or its subsidiaries in the United States and other jurisdictions. All other marks and names mentioned herein may be trademarks of their respective companies.


2


PART I
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
VMware, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(amounts in millions, except per share amounts, and shares in thousands)
(unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
License
$
681

 
$
639

 
$
1,896

 
$
1,814

Services
991

 
876

 
2,883

 
2,519

GSA settlement

 

 
(76
)
 

Total revenues
1,672

 
1,515

 
4,703

 
4,333

Operating expenses (1):
 
 
 
 
 
 
 
Cost of license revenues
46

 
46

 
142

 
143

Cost of services revenues
212

 
196

 
609

 
519

Research and development
331

 
327

 
958

 
936

Sales and marketing
556

 
529

 
1,656

 
1,550

General and administrative
201

 
169

 
568

 
498

Realignment charges

 
6

 
20

 
4

Operating income
326

 
242

 
750

 
683

Investment income
13

 
11

 
38

 
28

Interest expense with EMC
(7
)
 
(7
)
 
(20
)
 
(18
)
Other income (expense), net
(7
)
 
(2
)
 
(8
)
 
(2
)
Income before income taxes
325

 
244

 
760

 
691

Income tax provision
69

 
50

 
137

 
131

Net income
$
256

 
$
194

 
$
623

 
$
560

Net income per weighted-average share, basic for Class A and Class B
$
0.61

 
$
0.45

 
$
1.47

 
$
1.30

Net income per weighted-average share, diluted for Class A and Class B
$
0.60

 
$
0.45

 
$
1.46

 
$
1.29

Weighted-average shares, basic for Class A and Class B
422,329

 
430,463

 
424,799

 
430,408

Weighted-average shares, diluted for Class A and Class B
423,981

 
434,118

 
427,466

 
434,656

__________
 
 
 
 
 
 
 
(1)   Includes stock-based compensation as follows:
 
 
 
 
 
 
 
Cost of license revenues
$

 
$
1

 
$
1

 
$
2

Cost of services revenues
11

 
11

 
32

 
31

Research and development
56

 
61

 
164

 
187

Sales and marketing
43

 
43

 
124

 
128

General and administrative
16

 
17

 
47

 
51

The accompanying notes are an integral part of the condensed consolidated financial statements.


3


VMware, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
256

 
$
194

 
$
623

 
$
560

Other comprehensive income (loss):
 
 
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $1, $(2), $1 and $1
1

 
(3
)
 
2

 
2

Reclassification of (gains) losses realized during the period, net of taxes of $0, $(1), $0 and $(2) for all periods

 
(1
)
 

 
(2
)
Net change in market value of available-for-sale securities
1

 
(4
)
 
2

 

Changes in market value of effective foreign currency forward contracts:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $0 for all periods
1

 
(3
)
 
(4
)
 
(3
)
Reclassification of (gains) losses realized during the period, net of taxes of $0 for all periods
(2
)
 
(1
)
 

 

Net change in market value of effective foreign currency forward contracts
(1
)
 
(4
)
 
(4
)
 
(3
)
Total other comprehensive income (loss)

 
(8
)
 
(2
)
 
(3
)
Total comprehensive income, net of taxes
$
256

 
$
186

 
$
621

 
$
557

The accompanying notes are an integral part of the condensed consolidated financial statements.

4


VMware, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in millions, except per share amounts, and shares in thousands)
(unaudited)
 
September 30,
 
December 31,
 
2015
 
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,083

 
$
2,071

Short-term investments
5,139

 
5,004

Accounts receivable, net of allowance for doubtful accounts of $2 and $2
1,011

 
1,520

Due from related parties, net
25

 
49

Deferred tax assets
254

 
248

Other current assets
150

 
238

Total current assets
8,662

 
9,130

Property and equipment, net
1,124

 
1,035

Other assets
175

 
174

Deferred tax assets
204

 
165

Intangible assets, net
645

 
748

Goodwill
3,981

 
3,964

Total assets
$
14,791

 
$
15,216

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
139

 
$
203

Accrued expenses and other
622

 
811

Unearned revenues
2,989

 
2,982

Total current liabilities
3,750

 
3,996

Notes payable to EMC
1,500

 
1,500

Unearned revenues
1,697

 
1,851

Other liabilities
310

 
283

Total liabilities
7,257

 
7,630

Contingencies (refer to Note I)

 

Stockholders’ equity:
 
 
 
Class A common stock, par value $.01; authorized 2,500,000 shares; issued and outstanding 121,799 and 129,359 shares
1

 
1

Class B convertible common stock, par value $.01; authorized 1,000,000 shares; issued and outstanding 300,000 shares
3

 
3

Additional paid-in capital
2,707

 
3,380

Accumulated other comprehensive income (loss)
(3
)
 
(1
)
Retained earnings
4,821

 
4,198

Total VMware, Inc.’s stockholders’ equity
7,529

 
7,581

Non-controlling interests
5

 
5

Total stockholders’ equity
7,534

 
7,586

Total liabilities and stockholders’ equity
$
14,791

 
$
15,216

The accompanying notes are an integral part of the condensed consolidated financial statements.

5


VMware, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(unaudited)
 
Nine Months Ended
 
September 30,
 
2015
 
2014
Operating activities:
 
 
 
Net income
$
623

 
$
560

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
246

 
255

Stock-based compensation
368

 
399

Excess tax benefits from stock-based compensation
(27
)
 
(34
)
Deferred income taxes, net
(44
)
 
(115
)
Impairment of strategic investment
5

 

Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
508

 
293

Other assets
14

 
(70
)
Due to/from related parties, net
31

 
25

Accounts payable
(36
)
 
41

Accrued expenses
(153
)
 
(4
)
Income taxes payable
24

 
178

Unearned revenues
(148
)
 
237

Net cash provided by operating activities
1,411

 
1,765

Investing activities:
 
 
 
Additions to property and equipment
(274
)
 
(254
)
Purchases of available-for-sale securities
(2,675
)
 
(2,974
)
Sales of available-for-sale securities
1,700

 
1,551

Maturities of available-for-sale securities
840

 
483

Purchases of strategic investments
(11
)
 
(41
)
Business acquisitions, net of cash acquired
(21
)
 
(1,112
)
Decrease (increase) in restricted cash
77

 
(76
)
Other investing
2

 
(10
)
Net cash used in investing activities
(362
)
 
(2,433
)
Financing activities:
 
 
 
Proceeds from issuance of common stock
123

 
158

Proceeds from issuance of notes payable to EMC

 
1,050

Reduction in capital from EMC

 
(24
)
Proceeds from non-controlling interests
4

 
7

Repurchase of common stock
(1,050
)
 
(450
)
Excess tax benefits from stock-based compensation
27

 
34

Shares repurchased for tax withholdings on vesting of restricted stock
(141
)
 
(119
)
Net cash provided by (used in) financing activities
(1,037
)
 
656

Net increase (decrease) in cash and cash equivalents
12

 
(12
)
Cash and cash equivalents at beginning of the period
2,071

 
2,305

Cash and cash equivalents at end of the period
$
2,083

 
$
2,293

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
21

 
$
20

Cash paid for taxes, net
155

 
65

Non-cash items:
 
 
 
Changes in capital additions, accrued but not paid
$
(49
)
 
$
(3
)
Fair value of stock-based awards assumed in acquisitions

 
25

The accompanying notes are an integral part of the condensed consolidated financial statements.

6


VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Overview and Basis of Presentation
Company and Background
VMware, Inc. (“VMware” or the “Company”) is the leader in virtualization infrastructure solutions utilized by organizations to help them transform the way they build, deliver and consume information technology (“IT”) resources. VMware’s virtualization infrastructure solutions, which include a suite of products and services designed to deliver a software-defined data center, run on industry-standard desktop computers and servers and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
Accounting Principles
The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
Unaudited Interim Financial Information
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, for a fair statement of VMware’s condensed consolidated results of operations, financial position and cash flows for the periods presented. Results of operations are not necessarily indicative of the results that may be expected for the full year 2015. Certain information and footnote disclosures typically included in annual consolidated financial statements have been condensed or omitted. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in VMware’s 2014 Annual Report on Form 10-K.
As of September 30, 2015, EMC Corporation (“EMC”) held 81.3% of VMware’s outstanding common stock and 97.5% of the combined voting power of VMware’s outstanding common stock, including 43 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock. VMware is a majority-owned and controlled subsidiary of EMC, and its results of operations and financial position are consolidated with EMC’s financial statements. On October 12, 2015, Dell, Inc. (“Dell”), Denali Holding Inc. (“Denali”) and EMC entered into a definitive agreement under which Denali has agreed to acquire EMC. Refer to Note M for further information.
Management believes the assumptions underlying the condensed consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with EMC may not be considered arm’s length with an unrelated third party. Therefore, the financial statements included herein may not necessarily reflect the results of operations, financial position and cash flows had VMware engaged in such transactions with an unrelated third party during all periods presented. Accordingly, VMware’s historical financial information is not necessarily indicative of what the Company’s results of operations, financial position and cash flows will be in the future if and when VMware contracts at arm’s length with unrelated third parties for the services the Company receives from and provides to EMC.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of VMware and subsidiaries in which VMware has a controlling financial interest. Non-controlling interests are presented as a separate component within total stockholders’ equity and represent the equity and cumulative pro-rata share of the results of operations attributable to the non-controlling interests. Net earnings attributable to the non-controlling interests are included in other income (expense), net on the condensed consolidated statements of income and are not presented separately as the amounts were not material for the periods presented. All intercompany transactions and account balances between VMware and its subsidiaries have been eliminated in consolidation. Transactions with EMC and its subsidiaries are generally settled in cash and are classified on the condensed consolidated statements of cash flows based upon the nature of the underlying transaction.
Reclassification
Certain prior period amounts related to the notes payable to EMC have been reclassified within the financing activities section of the condensed consolidated statements of cash flows. The reclassifications had no effect on total cash flows used in or provided by operating, investing or financing activities as previously reported.

7

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Use of Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting periods, and the disclosure of contingent liabilities at the date of the financial statements. Estimates are used for, but not limited to, trade receivable valuation, marketing development funds and rebates, useful lives assigned to fixed assets and intangible assets, valuation of goodwill and definite-lived intangibles, income taxes, stock-based compensation, and contingencies. Actual results could differ from those estimates.
New Accounting Pronouncement
During May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The updated revenue standard establishes principles for recognizing revenue and develops a common revenue standard for all industries. Upon adoption, entities will be required to recognize the amount of revenue that they expect to be entitled to for the transfer of promised goods or services to their customers. The updated standard is effective for the Company in the first quarter of 2018 and permits the use of either the retrospective or cumulative effect transition method. Early adoption is permitted, but not earlier than the first quarter of 2017. The Company has not selected a transition method and is currently evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures.
B. Business Combination, Definite-Lived Intangible Assets, Net and Goodwill
Business Combination
On February 2, 2015, VMware acquired all of the outstanding shares of Immidio B.V. (“Immidio”) for approximately $21 million of cash, net of liabilities assumed. VMware acquired Immidio to expand VMware’s Workspace Environment Management solutions within the End-User Computing product group. The preliminary purchase price primarily included $8 million of identifiable intangible assets and approximately $17 million of goodwill that is expected to be non-deductible for tax purposes. The impact of the acquisition was not material to VMware’s condensed consolidated financial statements.
Definite-Lived Intangible Assets, Net
As of September 30, 2015 and December 31, 2014, definite-lived intangible assets consisted of the following (amounts in tables in millions):
 
September 30, 2015
 
Weighted-Average
Useful Lives
(in years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Purchased technology
6.6
 
$
651

 
$
(281
)
 
$
370

Leasehold interest
34.9
 
149

 
(19
)
 
130

Customer relationships and customer lists
8.3
 
151

 
(60
)
 
91

Trademarks and tradenames
8.6
 
61

 
(14
)
 
47

Other
2.9
 
20

 
(13
)
 
7

Total definite-lived intangible assets
 
 
$
1,032

 
$
(387
)
 
$
645

 
December 31, 2014
 
Weighted-Average
Useful Lives
(in years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Purchased technology
6.5
 
$
699

 
$
(252
)
 
$
447

Leasehold interest
34.9
 
149

 
(15
)
 
134

Customer relationships and customer lists
8.2
 
157

 
(53
)
 
104

Trademarks and tradenames
8.6
 
61

 
(9
)
 
52

Other
2.7
 
18

 
(7
)
 
11

Total definite-lived intangible assets
 
 
$
1,084

 
$
(336
)
 
$
748


8

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Amortization expense on definite-lived intangible assets was $36 million and $110 million during the three and nine months ended September 30, 2015, respectively, and $37 million and $104 million during the three and nine months ended September 30, 2014, respectively.
Based on intangible assets recorded as of September 30, 2015 and assuming no subsequent additions or impairment of underlying assets, the remaining estimated annual amortization expense is expected to be as follows (table in millions):
Remainder of 2015
$
35

2016
128

2017
121

2018
108

2019
87

Thereafter
166

Total
$
645

Goodwill
The following table summarizes the changes in the carrying amount of goodwill during the nine months ended September 30, 2015 (table in millions):
Balance, January 1, 2015
$
3,964

Increase in goodwill related to a business combination
17

Balance, September 30, 2015
$
3,981

C. Realignment Charges
During the first quarter of 2015, VMware eliminated approximately 350 positions across all major functional groups and geographies to streamline its operations. As a result of this action, $20 million of severance-related realignment charges were recognized during the nine months ended September 30, 2015. As of September 30, 2015, $1 million remained in accrued expenses and other on the condensed consolidated balance sheets and is expected to be paid during 2015.
The following table summarizes the activity for the accrued realignment charges for the nine months ended September 30, 2015 (table in millions):
 
Nine Months Ended September 30, 2015
 
Balance as of
January 1, 2015
 
Realignment
Charges
 
Utilization
 
Balance as of
September 30, 2015
Severance-related costs
$
8

 
$
20

 
$
(27
)
 
$
1

During the third quarter of 2014, VMware eliminated approximately 90 positions across all major functional groups and geographies to streamline its operations. As a result of these actions, $7 million of severance-related realignment charges was recognized during the three months ended September 30, 2014.
D. Net Income per Share
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares outstanding and potentially dilutive securities outstanding during the period, as calculated using the treasury stock method. Potentially dilutive securities primarily include unvested restricted stock units, performance stock units, stock options and purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate net income per share as both classes share the same rights in dividends, therefore basic and diluted earnings per share are the same for both classes.

9

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table sets forth the computations of basic and diluted net income per share during the three and nine months ended September 30, 2015 and 2014 (net income in millions, shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
256

 
$
194

 
$
623

 
$
560

Weighted-average shares, basic for Class A and Class B
422,329

 
430,463

 
424,799

 
430,408

Effect of dilutive securities
1,652

 
3,655

 
2,667

 
4,248

Weighted-average shares, diluted for Class A and Class B
423,981

 
434,118

 
427,466

 
434,656

Net income per weighted-average share, basic for Class A and Class B
$
0.61

 
$
0.45

 
$
1.47

 
$
1.30

Net income per weighted-average share, diluted for Class A and Class B
$
0.60

 
$
0.45

 
$
1.46

 
$
1.29

The following table sets forth the weighted-average common share equivalents of Class A common stock that were excluded from the diluted net income per share calculations during the three and nine months ended September 30, 2015 and 2014, because their effect would have been anti-dilutive (shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Anti-dilutive securities:
 
 
 
 
 
 
 
Employee stock options
2,129

 
1,180

 
2,173

 
1,244

Restricted stock units
365

 
107

 
58

 
37

Total
2,494

 
1,287

 
2,231

 
1,281


10

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

E. Cash, Cash Equivalents and Investments
Cash, cash equivalents and investments as of September 30, 2015 and December 31, 2014 consisted of the following (tables in millions):
 
September 30, 2015
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
Cash
$
770

 
$

 
$

 
$
770

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
1,312

 
$

 
$

 
$
1,312

Municipal obligations
1

 

 

 
1

Total cash equivalents
$
1,313

 
$

 
$

 
$
1,313

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
642

 
$
3

 
$

 
$
645

U.S. and foreign corporate debt securities
3,337

 
5

 
(8
)
 
3,334

Foreign governments and multi-national agency obligations
35

 

 

 
35

Municipal obligations
823

 
1

 

 
824

Asset-backed securities
30

 

 

 
30

Mortgage-backed securities
271

 

 

 
271

Total short-term investments
$
5,138

 
$
9

 
$
(8
)
 
$
5,139

Other assets:
 
 
 
 
 
 
 
Marketable available-for-sale equity securities
$
15

 
$
1

 
$

 
$
16

 
December 31, 2014
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
Cash
$
885

 
$

 
$

 
$
885

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
1,130

 
$

 
$

 
$
1,130

U.S. and foreign corporate debt securities
54

 

 

 
54

Foreign governments and multi-national agency obligations
2

 

 

 
2

Total cash equivalents
$
1,186

 
$

 
$

 
$
1,186

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
542

 
$

 
$

 
$
542

U.S. and foreign corporate debt securities
3,236

 
3

 
(5
)
 
3,234

Foreign governments and multi-national agency obligations
23

 

 

 
23

Municipal obligations
930

 
2

 

 
932

Asset-backed securities
53

 

 

 
53

Mortgage-backed securities
221

 

 
(1
)
 
220

Total short-term investments
$
5,005

 
$
5

 
$
(6
)
 
$
5,004

Refer to Note F for further information regarding the fair value of VMware’s cash equivalents and investments.
The realized gains and losses on investments during the three and nine months ended September 30, 2015 and 2014 were not material.

11

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Unrealized losses on cash equivalents and investments as of September 30, 2015 and December 31, 2014, which have been in a net loss position for less than twelve months, were classified by investment category as follows (table in millions):
 
September 30, 2015
 
December 31, 2014
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
U.S. and foreign corporate debt securities
$
1,545

 
$
(7
)
 
$
1,964

 
$
(5
)
Mortgage-backed securities
132

 
(1
)
 
107

 
(1
)
Total
$
1,677

 
$
(8
)
 
$
2,071

 
$
(6
)
Unrealized losses on cash equivalents and available-for-sale investments, which have been in a net loss position for twelve months or greater, were not material as of September 30, 2015 and December 31, 2014.
Contractual Maturities
The contractual maturities of short-term investments held at September 30, 2015 consisted of the following (table in millions):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
1,592

 
$
1,593

Due after 1 year through 5 years
3,243

 
3,243

Due after 5 years through 10 years
95

 
95

Due after 10 years
208

 
208

Total short-term investments
$
5,138

 
$
5,139

F. Fair Value Measurements
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
Certain financial assets and liabilities are measured at fair value on a recurring basis. VMware determines fair value using the following hierarchy:
Level 1 - Quoted prices in active markets for identical assets or liabilities
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are noted active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
VMware’s fixed income securities are primarily classified as Level 2, with the exception of some of the U.S. Government and agency obligations which are classified as Level 1. Additionally, VMware’s Level 2 classification includes foreign currency forward contracts and notes payable to EMC. At September 30, 2015 and December 31, 2014, VMware’s Level 2 securities were generally priced using non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques.
VMware did not have any material assets or liabilities that fall into Level 3 of the fair value hierarchy as of September 30, 2015 and December 31, 2014, and there have been no transfers between fair value measurement levels during the three and nine months ended September 30, 2015 and 2014.

12

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following tables set forth the fair value hierarchy of VMware’s money-market funds, available-for-sale securities, and foreign currency forward contracts, that were required to be measured at fair value as of September 30, 2015 and December 31, 2014 (tables in millions):
 
September 30, 2015
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 


Money-market funds
$
1,312

 
$

 
$
1,312

Municipal obligations

 
1

 
1

Total cash equivalents
$
1,312

 
$
1

 
$
1,313

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
472

 
$
173

 
$
645

U.S. and foreign corporate debt securities

 
3,334

 
3,334

Foreign governments and multi-national agency obligations

 
35

 
35

Municipal obligations

 
824

 
824

Asset-backed securities

 
30

 
30

Mortgage-backed securities

 
271

 
271

Total short-term investments
$
472

 
$
4,667

 
$
5,139

Other assets:
 
 
 
 
 
Marketable available-for-sale equity securities
$
16

 
$

 
$
16

Accrued expenses and other:
 
 
 
 
 
Foreign currency forward contracts
$

 
$
(3
)
 
$
(3
)
 
December 31, 2014
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money-market funds
$
1,130

 
$

 
$
1,130

U.S. and foreign corporate debt securities

 
54

 
54

Foreign governments and multi-national agency obligations

 
2

 
2

Total cash equivalents
$
1,130

 
$
56

 
$
1,186

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
353

 
$
189

 
$
542

U.S. and foreign corporate debt securities

 
3,234

 
3,234

Foreign governments and multi-national agency obligations

 
23

 
23

Municipal obligations

 
932

 
932

Asset-backed securities

 
53

 
53

Mortgage-backed securities

 
220

 
220

Total short-term investments
$
353

 
$
4,651

 
$
5,004

Other current assets:
 
 
 
 
 
Foreign currency forward contracts
$

 
$
1

 
$
1

Accrued expenses and other:
 
 
 
 
 
Foreign currency forward contracts
$

 
$
(1
)
 
$
(1
)
VMware has elected not to record its notes payable to EMC at fair value, but has measured the notes at fair value for disclosure purposes. As of September 30, 2015 and December 31, 2014, the fair value of the notes payable to EMC was $1,499 million and $1,503 million, respectively. Fair value was estimated based on observable market interest rates (Level 2 inputs).

13

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

VMware offers a deferred compensation plan for eligible employees that allows participants to defer payment for part or all of their compensation. VMware’s results of operations are not significantly affected by this plan since changes in the fair value of the assets substantially offset changes in the fair value of the liabilities. As such, assets and liabilities associated with this plan have not been included in the above tables. Assets and liabilities associated with this plan were both approximately $18 million and $8 million as of September 30, 2015 and December 31, 2014, respectively, and are included in other assets and other liabilities on the condensed consolidated balance sheets.
Assets Measured and Recorded at Fair Value on a Non-Recurring Basis
VMware evaluated the strategic investments in its portfolio accounted for under the cost method to assess whether any of its strategic investments were other-than-temporarily impaired. VMware uses Level 3 inputs as part of its impairment analysis, including, pre- and post-money valuations of recent financing events and the impact of those on its fully diluted ownership percentages, as well as other available information regarding the issuer’s historical and forecasted performance. The estimated fair value of these investments is considered in VMware’s impairment review if any events or changes in circumstances occur that might have a significant adverse effect on their value.
During the three and nine months ended September 30, 2015, VMware recognized a charge of approximately $5 million as a result of determining that a strategic investment was considered to be other-than-temporarily impaired. All other realized gains and losses on investments in the three and nine months ended September 30, 2015 and 2014 were not material. Strategic investments are included in other assets on the condensed consolidated balance sheets. The carrying value of VMware’s strategic investments accounted for under the cost method was $100 million and $110 million as of September 30, 2015 and December 31, 2014, respectively.
G. Derivatives and Hedging Activities
VMware conducts business on a global basis in multiple foreign currencies, subjecting the Company to foreign currency risk. To mitigate this risk, VMware utilizes hedging contracts as described below, which potentially expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. VMware manages counterparty risk by seeking counterparties of high credit quality, by monitoring credit ratings and credit spreads of, and other relevant public information about its counterparties. VMware does not, and does not intend to, use derivative instruments for trading or speculative purposes.
Cash Flow Hedges
To mitigate its exposure to foreign currency fluctuations resulting from operating expenses denominated in certain foreign currencies, VMware enters into foreign currency forward contracts. The Company designates these forward contracts as cash flow hedging instruments as the accounting criteria for such designation have been met. Therefore, the effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported in accumulated other comprehensive income (loss) on the condensed consolidated balance sheets and is subsequently reclassified to the related operating expense line item on the condensed consolidated statements of income in the same period that the underlying expenses are incurred. During the three and nine months ended September 30, 2015 and 2014 the effective portion of gains or losses reclassified to the condensed consolidated statements of income was not material to the individual functional line items. Interest charges or “forward points” on VMware’s forward contracts are excluded from the assessment of hedge effectiveness and are recorded in other income (expense), net on the condensed consolidated statements of income as incurred.
VMware enters into forward contracts annually, which have maturities of 12 months or less. As of September 30, 2015 and December 31, 2014, VMware had foreign currency forward contracts designated as cash flow hedges with a total notional value of $64 million and $240 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
During the three and nine months ended September 30, 2015 and 2014, all cash flow hedges were considered effective.
Foreign Currency Forward Contracts Not Designated as Hedges
VMware has established a program that utilizes foreign currency forward contracts to offset the foreign currency risk associated with net outstanding monetary asset and liability positions. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are reported in other income (expense), net on the condensed consolidated statements of income.
VMware enters into foreign currency forward contracts on a monthly basis, which typically have a contractual term of one month. As of September 30, 2015 and December 31, 2014, VMware had outstanding forward contracts with a total notional

14

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

value of $511 million and $697 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
During the three and nine months ended September 30, 2015, VMware recognized a gain of $12 million and $33 million, respectively, relating to the settlement of foreign currency forward contracts. During the three and nine months ended September 30, 2014, VMware recognized a gain of $29 million and $24 million, respectively. Gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
The combined gains and losses derived from the settlement of foreign currency forward contracts and the underlying foreign currency denominated assets and liabilities resulted in a net loss of $1 million and $10 million during the three and nine months ended September 30, 2015, respectively. The combined gains and losses derived from the settlement of foreign currency forward contracts and the underlying foreign currency denominated assets and liabilities resulted in a net loss of $3 million and $4 million during the three and nine months ended September 30, 2014, respectively. Net gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
H. Unearned Revenues
Unearned revenues as of September 30, 2015 and December 31, 2014 consisted of the following (table in millions):
 
September 30,
 
December 31,
 
2015
 
2014
Unearned license revenues
$
404

 
$
488

Unearned software maintenance revenues
3,850

 
3,905

Unearned professional services revenues
432

 
440

Total unearned revenues
$
4,686

 
$
4,833

Unearned license revenues are generally recognized upon delivery of existing or future products or services, or are otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Unearned revenues are impacted by timing of both product promotion offers and delivery of the future products offered as part of a product promotion.
In the event the arrangement does not include professional services, unearned license revenues may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist. Total unearned license revenues may vary over periods for a variety of factors, including the type and level of promotions offered, and the timing of when the products are delivered upon general availability.
Unearned software maintenance revenues are attributable to VMware’s maintenance contracts and are generally recognized ratably over the contract period. The weighted-average remaining term at September 30, 2015 was approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered.
I. Contingencies
Litigation
During the second quarter of 2015, VMware reached an agreement with the Department of Justice (“DOJ”) and the General Services Administration (“GSA”) to pay $76 million to resolve allegations that VMware's government sales practices between 2006 and 2013 had violated the federal False Claims Act. The settlement was paid and recorded as a reduction of VMware's total revenues during the nine months ended September 30, 2015.
On March 27, 2015, Phoenix Technologies (“Phoenix”) filed a complaint against VMware in the U.S. District Court for the Northern District of California asserting claims for copyright infringement and breach of contract relating to a version of Phoenix’s BIOS software that VMware licensed from Phoenix. In the lawsuit, Phoenix is seeking injunctive relief and monetary damages. Trial is currently scheduled for November 2016. VMware believes that it has meritorious defenses in connection with this lawsuit, and currently a reasonably possible loss or range of loss cannot be estimated.

15

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

On March 4, 2015, Christoph Hellwig, a software developer who alleges that software code he wrote is used in a component of the Company's vSphere product, filed a lawsuit against VMware in the Hamburg Regional Court in Germany alleging copyright infringement for failing to comply with the terms of an open source General Public License v.2 (“GPL v.2”) and seeking an order requiring VMware to comply with the GPL v.2 or cease distribution of any affected code within Germany. VMware believes that it has meritorious defenses in connection with this lawsuit, and currently a reasonably possible loss or range of loss cannot be estimated.
VMware accrues for a liability at the low end of the range of estimated losses when a determination has been made that a loss is both probable and the amount of the loss can be reasonably estimated. Significant judgment is required in both the determination that the occurrence of a loss is probable and is reasonably estimable. In making such judgments, VMware considers the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal costs are generally recognized as expense when incurred.
VMware believes that it has valid defenses against each of the ongoing legal matters disclosed. However, given the unpredictable nature of legal proceedings, an unfavorable resolution of one or more legal proceedings, claims, or investigations could have a material adverse effect on VMware’s condensed consolidated financial statements.
VMware is also subject to other legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business, including claims with respect to commercial, contracting and sales practices, product liability, intellectual property, employment, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from and has discussions with government entities on various matters. VMware does not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on its condensed consolidated financial statements.
J. Stockholders’ Equity
VMware Stock Repurchases
On January 27, 2015, VMware’s Board of Directors authorized the repurchase of up to an additional one billion dollars of VMware’s Class A common stock through the end of 2017. Stock will be purchased from time to time, in the open market or through private transactions, subject to market conditions. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. VMware is not obligated to purchase any shares under its stock repurchase programs. Purchases can be discontinued at any time VMware believes additional purchases are not warranted. All shares repurchased under VMware’s stock repurchase programs are retired.
The following table summarizes stock repurchase authorization that remains open as of September 30, 2015 (amount in table in millions):
Authorization Date
 
Amount Authorized
 
Expiration Date
 
Status
January 27, 2015
 
$1,000
 
December 31, 2017
 
Open
As of September 30, 2015, the cumulative authorized amount remaining for repurchase was $910 million.
The following table summarizes stock repurchase activity during the three and nine months ended September 30, 2015 and 2014 (aggregate purchase price in millions, shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Aggregate purchase price
$
200

 
$
43

 
$
1,050

 
$
450

Class A common shares repurchased
2,408

 
436

 
12,524

 
4,691

Weighted-average price per share
$
83.06

 
$
98.94

 
$
83.84

 
$
95.56

The aggregate purchase price of repurchased shares includes commissions and is classified as a reduction to additional paid-in capital.

16

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

VMware Stock Options
The following table summarizes stock option activity since January 1, 2015 (shares in thousands):
 
Number of
Shares
 
Weighted-
Average
Exercise Price
(per share)
Outstanding, January 1, 2015
5,869

 
$
50.54

Granted
13

 
84.68

Forfeited
(213
)
 
66.83

Exercised
(2,289
)
 
29.92

Outstanding, September 30, 2015
3,380

 
63.65

The stock options outstanding as of September 30, 2015 had an aggregate intrinsic value of $74 million based on VMware’s closing price as of September 30, 2015.
VMware Restricted Stock
VMware's restricted stock primarily consists of restricted stock unit (“RSU”) awards granted to employees. RSUs are valued based on VMware's stock price on the date of grant. The shares underlying the RSU awards are not issued until the RSUs vest. Upon vesting, each RSU converts into one share of VMware Class A common stock.
VMware's restricted stock also includes performance stock unit (“PSU”) awards, which have been granted to certain of VMware’s executives and employees. The PSU awards include performance conditions and, in certain cases, a time-based vesting component. Upon vesting, each PSU award will convert into VMware’s Class A common stock at various ratios ranging from 0.5 to 2.0 shares per PSU, depending upon the degree of achievement of the performance target designated by each individual award. If minimum performance thresholds are not achieved, then no shares will be issued. As of September 30, 2015, the number of PSUs outstanding includes certain PSUs for which performance conditions have concluded but that remain subject to certain service conditions.
The following table summarizes restricted stock activity since January 1, 2015 (units in thousands):
 
Number of Units
 
Weighted-
Average Grant
Date Fair
Value
(per unit)
Outstanding, January 1, 2015
12,585

 
$
88.88

Granted
5,823

 
86.98

Vested
(3,311
)
 
92.17

Forfeited
(1,382
)
 
88.16

Outstanding, September 30, 2015
13,715

 
87.38

The total fair value of VMware restricted stock that vested during the nine months ended September 30, 2015 was $281 million. As of September 30, 2015, restricted stock representing 13.7 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $1,081 million based on VMware’s closing price as of September 30, 2015.
As of September 30, 2015, the total unrecognized compensation cost for stock options and restricted stock was $909 million and will be recognized through 2019 with a weighted-average remaining period of 1.5 years.

17

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Accumulated Other Comprehensive Income (Loss)
The changes in components of accumulated other comprehensive income (loss) during the nine months ended September 30, 2015 and 2014 were as follows (tables in millions):
 
Unrealized Gain on
Available-for-Sale Securities
 
Unrealized Loss on
Cash Flow Hedges
 
Total
Balance, January 1, 2015
$

 
$
(1
)
 
$
(1
)
Unrealized gain (loss), net of taxes of $1, $0 and $1
2

 
(4
)
 
(2
)
Balance, September 30, 2015
$
2

 
$
(5
)
 
$
(3
)
 
Unrealized Gain on
Available-for-Sale Securities
 
Unrealized Loss on
Cash Flow Hedges
 
Total
Balance, January 1, 2014
$
4

 
$

 
$
4

Unrealized gain (loss), net of taxes of $1, $0 and $1
2

 
(3
)
 
(1
)
Amounts reclassified from accumulated other comprehensive income to the condensed consolidated statement of income, net of taxes of $(2), $0 and $(2)
(2
)
 

 
(2
)
Other comprehensive income (loss), net

 
(3
)
 
(3
)
Balance, September 30, 2014
$
4

 
$
(3
)
 
$
1

Unrealized gains on VMware’s available-for-sale securities are reclassified to investment income on the condensed consolidated statements of income in the period that such gains are realized.
The effective portion of gains (losses) resulting from changes in the fair value of forward contracts designated as cash flow hedging instruments are reclassified to its related operating expense line item on the condensed consolidated statements of income in the same period that the underlying expenses are incurred. The amounts recorded to their related operating expense functional line items on the condensed consolidated statements of income during the three and nine months ended September 30, 2015 and 2014 were not material to the individual functional line items.
K. Related Parties
The information provided below includes a summary of the transactions entered into with EMC and EMC’s consolidated subsidiaries (collectively “EMC”). EMC acquired VCE Company LLC (“VCE”) during the fourth quarter of 2014. Transactions with VCE from the date EMC acquired the controlling interest in VCE have been included in the tables below.
Transactions with EMC
VMware and EMC engaged in the following ongoing intercompany transactions, which resulted in revenues and receipts and unearned revenues for VMware:
Pursuant to an ongoing reseller arrangement with EMC, EMC bundles VMware’s products and services with EMC’s products and sells them to end users.
EMC purchases products and services from VMware for internal use.
VMware provides professional services to end users based upon contractual agreements with EMC.
From time to time, VMware and EMC enter into agreements to collaborate on technology projects, and EMC pays VMware for services that VMware provides to EMC in connection with such projects.
Pursuant to an ongoing distribution agreement, VMware acts as the selling agent for certain products and services of Pivotal Software, Inc. (“Pivotal”), a subsidiary of EMC, in exchange for an agency fee. Under this agreement, cash is collected from the end user by VMware and remitted to Pivotal, net of the contractual agency fee.
VMware provides various transition services to Pivotal. Support costs incurred by VMware are reimbursed to VMware and are recorded as a reduction to the costs incurred by VMware.

18

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Information about VMware’s revenues and receipts from such arrangements with EMC during the three and nine months ended September 30, 2015 and 2014 and unearned revenues as of September 30, 2015 and December 31, 2014 consisted of the following (table in millions):
 
Revenues and Receipts from
EMC
 
Unearned Revenues from
EMC
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
 
September 30,
 
September 30,
 
September 30,
 
December 31,
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Reseller revenues
$
68

 
$
47

 
$
199

 
$
136

 
$
256

 
$
290

Internal-use revenues
4

 
4

 
13

 
17

 
11

 
18

Professional services revenues
20

 
13

 
68

 
53

 
5

 
9

Agency fee revenues
1

 
1

 
4

 
4

 

 

Reimbursement for transition services
2

 

 
3

 
1

 
 n/a

 
 n/a

VMware and EMC engaged in the following ongoing intercompany transactions, which resulted in costs to VMware:
VMware purchases and leases products and purchases services from EMC.
From time to time, VMware and EMC enter into agreements to collaborate on technology projects, and VMware pays EMC for services provided to VMware by EMC related to such projects.
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with EMC subsidiaries for support services and EMC personnel who are managed by VMware. The costs incurred by EMC on VMware’s behalf related to these employees are charged to VMware with a mark-up intended to approximate costs that would have been incurred had VMware contracted for such services with an unrelated third party. These costs are included as expenses on VMware’s condensed consolidated statements of income and primarily include salaries, benefits, travel and rent expenses. EMC also incurs certain administrative costs on VMware’s behalf in the U.S. that are recorded as expenses on VMware’s condensed consolidated statements of income.
Information about VMware’s costs from such arrangements with EMC for the three and nine months ended September 30, 2015 and 2014 consisted of the following (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Purchases and leases of products and purchases of services
$
14

 
$
15

 
$
45

 
$
48

Collaborative technology project costs
1

 
3

 
4

 
10

EMC subsidiary support and administrative costs
24

 
31

 
79

 
107

VMware also purchases EMC products through EMC's channel partners. Purchases of EMC products through EMC's channel partners were $7 million and $33 million during the three and nine months ended September 30, 2015, respectively, and $7 million and $18 million during the three and nine months ended September 30, 2014, respectively.
Certain Stock-Based Compensation
Effective September 1, 2012, Pat Gelsinger was appointed Chief Executive Officer of VMware. Prior to joining VMware, Mr. Gelsinger was the President and Chief Operating Officer of EMC Information Infrastructure Products. Mr. Gelsinger retains certain of his EMC equity awards that were held as of September 1, 2012 and he continues to vest in such awards. Stock-based compensation related to Mr. Gelsinger’s EMC awards are being recognized on VMware’s condensed consolidated statements of income over the awards’ remaining requisite service periods.

19

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Tax Sharing Agreement with EMC
Pursuant to a tax sharing agreement between VMware and EMC, payments are made between VMware and EMC related to VMware's portion of federal income taxes on EMC's consolidated tax return as well as income taxes for states in which combined state income tax returns are filed. The following table summarizes these payments made between VMware and EMC during the three and nine months ended September 30, 2015 and 2014 (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Payments from VMware to EMC
$

 
$

 
$
92

 
$
20

Payments made by VMware to EMC result from VMware having a tax liability. The amount that VMware pays to EMC for its portion of federal income taxes on EMC’s consolidated tax return differs from the amount VMware would owe on a separate return basis, and the difference is presented as a component of stockholders’ equity. During the three and nine months ended September 30, 2015 and 2014, the difference between the amount of tax calculated on a stand-alone basis and the amount of tax calculated per the tax sharing agreement was not material.
Due To/From Related Parties, Net
As a result of the related party transactions with EMC described above, amounts due to and from related parties, net as of September 30, 2015 and December 31, 2014 consisted of the following (table in millions):
 
September 30,
 
December 31,
 
2015
 
2014
Due to related parties
$
(50
)
 
$
(76
)
Due from related parties
75

 
125

Due (to) from related parties, net
$
25

 
$
49

 
 
 
 
Income tax due (to) from related parties
$
(36
)
 
$
(40
)
Balances due to or from related parties, which are unrelated to tax obligations, are generally settled in cash within 60 days of each quarter-end. The timing of the tax payments due to and from related parties is governed by the tax sharing agreement with EMC.
Notes Payable to EMC
VMware and EMC entered into a note exchange agreement on January 21, 2014 providing for the issuance of three promissory notes in the aggregate principal amount of $1,500 million. The total debt of $1,500 million includes $450 million that was exchanged for the $450 million promissory note issued to EMC in April 2007, as amended and restated in June 2011.
The three notes issued may be prepaid without penalty or premium, and outstanding principal is due on the following dates: $680 million due May 1, 2018, $550 million due May 1, 2020 and $270 million due December 1, 2022. The notes bear interest, payable quarterly in arrears, at the annual rate of 1.75%. During the three and nine months ended September 30, 2015, $7 million and $20 million, respectively, of interest expense was recognized. During the three and nine months ended September 30, 2014, $7 million and $18 million, respectively, of interest expense was recognized.
L. Segment Information
VMware operates in one reportable operating segment, thus all required financial segment information can be found in the condensed consolidated financial statements. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.

20

VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Revenues by geographic area for the three and nine months ended September 30, 2015 and 2014 were as follows (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
United States
$
861

 
$
780

 
$
2,364

 
$
2,112

International
811

 
735

 
2,339

 
2,221

Total
$
1,672

 
$
1,515

 
$
4,703

 
$
4,333

Revenues by geographic area are based on the ship-to addresses of VMware’s customers. No individual country other than the United States accounted for 10% or more of revenues for the three and nine months ended September 30, 2015 and 2014.
Long-lived assets by geographic area, which primarily include property and equipment, net, as of September 30, 2015 and December 31, 2014 were as follows (table in millions):
 
September 30,
 
December 31,
 
2015
 
2014
United States
$
835

 
$
801

International
147

 
117

Total
$
982

 
$
918

No individual country other than the United States accounted for 10% or more of these assets as of September 30, 2015 and December 31, 2014, respectively.
M. Subsequent Events
Dell and EMC Merger
On October 12, 2015, EMC entered into a merger agreement among EMC, Denali and Dell. Upon closing of the transaction, a portion of the merger consideration that EMC shareholders will receive will include shares of Class V common stock that will be registered with the SEC and issued by Denali. It is expected that approximately 0.111 shares of Class V common stock will be issued for each EMC share and that the Class V common stock will be a publicly traded tracking stock that, upon issuance, will track the performance of an approximately 53% economic interest in the VMware business. The closing of the transactions contemplated by the merger agreement is subject to approval of the EMC shareholders as well as various regulatory approvals.
Virtustream
On October 20, 2015, VMware and EMC announced their intention to form a new cloud services business (“Virtustream”), jointly owned by VMware and EMC. The proposed new cloud business will bring together VMware vCloud Air, Virtustream's Infrastructure-as-a-Service and certain other EMC assets into one company. VMware's level of ownership in Virtustream, the accounting treatment for the transaction, and the effect the transaction will have on VMware's future financial results have not been determined.

21


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management's discussion and analysis (“MD&A”) is provided in addition to the accompanying condensed consolidated financial statements and notes to assist in understanding our results of operations and financial condition. Financial information as of September 30, 2015 should be read in conjunction with our consolidated financial statements for the year ended December 31, 2014 contained in our Form 10-K filed February 26, 2015.
All dollar amounts expressed as numbers in this MD&A (except share and per share amounts) are in millions. Period-over-period changes are calculated based upon the respective underlying, non-rounded data. Unless the context requires otherwise, we are referring to VMware, Inc. and its consolidated subsidiaries when we use the terms “VMware,” the “Company,” “we,” “our” or “us.”
Overview
The information technology (“IT”) industry is transforming, moving from a hardware-based traditional model to one of a software-defined infrastructure. We are the leader in virtualization infrastructure solutions utilized by organizations to help transform the way they build, deliver and consume IT resources. We develop and market our product and service offerings within three main product groups and we also leverage synergies across these three product and service areas:
SDDC or Software-Defined Data Center
Hybrid Cloud Computing
End-User Computing
We generally sell our solutions using enterprise agreements (“EAs”) or as part of our non-EA, or transactional, business. EAs are comprehensive volume license offerings, offered both directly by us and through certain channel partners, that also provide for multi-year maintenance and support.
SDDC or Software-Defined Data Center
Historically, the majority of our license sales have been from our standalone vSphere product, which is included in our compute product category within our SDDC architecture. However, over the last two years, standalone vSphere product license sales are continuing to decline. As the transformation of the IT industry continues, we expect that our growth of license sales will be increasingly derived from sales of our newer products, suites and services solutions across our SDDC portfolio. For example, we have experienced continued growth in sales volumes, production use and number of customers who have purchased VMware NSX, our network virtualization solution, during the nine months ended September 30, 2015. We also continue to see traction of our Virtual SAN product and other newer offerings.
Hybrid Cloud Computing
Hybrid cloud computing is comprised of VMware vCloud Air (“vCloud Air”) and VMware vCloud Air Network (“vCAN”) Service Providers Program offerings. Revenues derived from these offerings continued to grow during the three and nine months ended September 30, 2015.
On October 20, 2015, we, together with EMC, announced our intention to form a new cloud services business (“Virtustream”), jointly owned by us and EMC. The proposed new cloud business will bring together vCloud Air, Virtustream's Infrastructure-as-a-Service and certain other EMC assets into one company under the Virtustream brand.
In connection with the expected formation of Virtustream, we anticipate contributing certain assets relating to our vCloud Air business and possibly cash. The amount of cash to be contributed, if any, will be determined upon finalization of the definitive agreement. Our level of ownership in Virtustream, the accounting treatment for the transaction, and the effect the transaction will have on our future financial results have not been determined.
End-User Computing
Our end-user computing solutions continue to experience strong growth. These solutions include our Horizon workplace suites and enterprise mobile management offerings, led by our AirWatch mobile solutions. Currently, our AirWatch business models include an on-premise solution that we offer through the sale of perpetual licenses and an off-premise solution that we offer as software-as-a-service (“SaaS”). AirWatch products and services continued to contribute to the growth of our end-user computing products during the three and nine months ended September 30, 2015. Our investments in AirWatch resulted in increased operating expenses during the nine months ended September 30, 2015, primarily driven by employee-related costs, including expenses we recognized in connection with installment payments to certain key employees as part of the acquisition, as well as amortization of purchased intangible assets.

22


Dell and EMC Merger
We are a majority-owned and controlled subsidiary of EMC Corporation (“EMC”). As of September 30, 2015, EMC held 81.3% of our outstanding common stock and 97.5% of the combined voting power of our outstanding common stock, including 43 million shares of our Class A common stock and all of our Class B common stock.
On October 12, 2015, Dell, Inc. (“Dell”), Denali Holding Inc. (“Denali”) and EMC entered into a definitive agreement under which Denali has agreed to acquire EMC. Under the terms of the agreement, we will remain a separate, publicly traded company. Upon closing of the transaction, a portion of the merger consideration that EMC shareholders will receive will include shares of Class V common stock that will be registered with the Securities and Exchange Commission and issued by Denali. It is expected that approximately 0.111 shares of Class V common stock will be issued for each EMC share and that the Class V common stock will be a publicly traded tracking stock that, upon issuance, will track the performance of an approximately 53% economic interest in our business. The closing of the transactions contemplated by the merger agreement is subject to approval of the EMC shareholders as well as various regulatory approvals.
Results of Operations
Approximately 70% of our sales are denominated in the U.S. dollar, however, we also invoice and collect in the euro, the British pound, the Japanese yen, the Australian dollar and the Chinese renminbi in their respective regions. As a result, our financial statements, including our revenues, operating expenses, unearned revenues, and the resulting cash flows derived from the U.S. dollar equivalent of foreign currency transactions are impacted by foreign exchange fluctuations. Foreign currency fluctuations have had a negative impact on the growth rate of our revenues during 2015, the amount of unearned revenues recognized derived from sales denominated in foreign currencies, and the U.S. dollar equivalent of foreign currency cash collections. We have also benefited from operating expenses incurred and paid in currencies other than the U.S. dollar.
Revenues
Our revenues during the three and nine months ended September 30, 2015 and 2014 were as follows: 
 
Three Months Ended
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
 
 
September 30,
 
$ Change
 
% Change
 
September 30,
 
$ Change
 
% Change
 
2015
 
2014
 
Actual
 
Actual
 
Constant
Currency
 
2015
 
2014
 
Actual
 
Actual
 
Constant
Currency
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License
$
681

 
$
639

 
$
42

 
7
%
 
11
%
 
$
1,896

 
$
1,814

 
$
81

 
4
%
 
9
%
Services:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software maintenance
863

 
779

 
84

 
11

 
 
 
2,505

 
2,217

 
287

 
13

 
 
Professional services
128

 
97

 
30

 
31

 
 
 
378

 
302

 
78

 
26

 
 
Total services
991

 
876

 
114

 
13

 
 
 
2,883

 
2,519

 
365

 
14

 
 
GSA settlement

 

 

 
n/a

 
 
 
(76
)
 

 
(76
)
 
n/a

 
 
Total revenues
$
1,672

 
$
1,515

 
$
156

 
10

 
14

 
$
4,703

 
$
4,333

 
$
371

 
9

 
12

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
861

 
$
780

 
$
80

 
10
%
 
 
 
$
2,364

 
$
2,112

 
$
252

 
12
%
 
 
International
811

 
735

 
76

 
10

 
 
 
2,339

 
2,221

 
119

 
5

 
 
Total revenues
$
1,672

 
$
1,515

 
$
156

 
10

 
14

 
$
4,703

 
$
4,333

 
$
371

 
9

 
12

In order to provide a comparable framework for assessing how our business performed, adjusted for the impact of foreign currency fluctuations, management analyzes year-over-year license and total revenues growth on a constant currency basis. License and total revenues recognized during the current period derived from non-U.S. dollar based transactions were converted into U.S. dollars using the exchange rates that were effective in the comparable prior year period. The calculated current period license and total revenues, adjusted for foreign currency fluctuations, is compared to the license and total revenues of the comparable prior year period, as reported, in calculating license and total revenue growth in constant currency.
Hybrid cloud, including vCAN and vCloud Air, and our SaaS offerings, including our AirWatch mobile solutions, increased to greater than 6% of our total revenues during the three and nine months ended September 30, 2015. vCAN revenues

23


are generally included in license revenues and our SaaS revenues, including vCloud Air and our AirWatch mobile solutions, are included in both license and services revenues.
While license and total sales increased during the third quarter of 2015 compared to the same period in 2014, the growth rate of our license sales was at a lower rate than we had expected. We believe contributing factors included (i) increased caution expressed by our customers around longer term technology commitments; (ii) continued weakness in China and Russia; and (iii) the uncertainty during the third quarter as to whether we would continue to operate as a public company.
License Revenues
License revenues during the three and nine months ended September 30, 2015 were up 7% and 4%, respectively, compared to the same periods in the prior year. Our license revenues increased primarily as a result of increased sales of our emerging product offerings, including AirWatch mobile solutions and VMware NSX, as well as revenues from our hybrid cloud offerings. Sales of products beyond standalone vSphere, including vSphere with Operations Management, also contributed to license revenues growth, partially offset by a decline in our standalone vSphere product license sales. License revenues during the three and nine months ended September 30, 2015 also benefited as a result of declines in unearned license revenues.
Our license revenues growth rate during 2015 has been negatively impacted by certain factors including, lower sales of standalone vSphere, changes in the value of the U.S. dollar against the foreign currencies in which we invoice, and increased growth derived from our hybrid cloud and SaaS offerings. License revenues that are part of a multi-year perpetual license arrangement are generally recognized upon delivery of the underlying license, whereas revenues derived from our hybrid cloud and SaaS offerings are recognized over a period of time. Growth from our hybrid and SaaS offerings have resulted in less revenue being recognized up-front which has had an adverse impact on our growth rate during 2015.
Services Revenues
During the three and nine months ended September 30, 2015, software maintenance revenues benefited from renewals, multi-year software maintenance contracts sold in previous periods and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers bought, on a weighted-average basis, more than 24 months of support and maintenance with each new license purchased.
Professional services revenues increased during the three and nine months ended September 30, 2015 compared to the same periods in 2014, which is attributable to growth in our license sales and solution offerings. As we continue to invest in our partners and expand our ecosystem of third-party professionals with expertise in our solutions to independently provide professional services to our customers, our professional services revenues will vary based on the delivery channels used in any given period as well as the timing of engagements.
GSA settlement 
During the second quarter of 2015, we reached an agreement with the Department of Justice (“DOJ”) and the General Services Administration (“GSA”) to pay $76 to resolve allegations that our government sales practices between 2006 and 2013 had violated the federal False Claims Act. The settlement was paid and recorded as a reduction of our total revenues during the nine months ended September 30, 2015.
Unearned Revenues
Our unearned revenues as of September 30, 2015 and December 31, 2014 were as follows: 
 
September 30, 2015
 
December 31, 2014
Unearned license revenues
$
404

 
$
488

Unearned software maintenance revenues
3,850

 
3,905

Unearned professional services revenues
432

 
440

Total unearned revenues
$
4,686

 
$
4,833

Unearned license revenues are generally recognized upon delivery of existing or future products or services, or are otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Unearned license and software maintenance revenues will fluctuate based on sales volume, as well as timing of both product promotion offers and delivery of the future products offered. The amount of unearned license revenues has declined as a result of less license revenues being deferred in connection with our product promotions when comparing the balances as of September 30, 2015 to December 31, 2014.

24


In the event the arrangement does not include professional services, unearned license revenues may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist. Total unearned license revenues may vary over periods for a variety of factors, including the type and level of promotions offered, and the timing of when the products are delivered upon general availability.
Unearned software maintenance revenues are attributable to our maintenance contracts and are generally recognized ratably over the contract period. The weighted-average remaining term at September 30, 2015 was approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered. Our total unearned revenues are impacted by the amount and timing of sales as well as fluctuations in the foreign currencies in which we invoice.
Cost of License Revenues, Cost of Services Revenues and Operating Expenses
Our cost of services revenues and operating expenses were primarily impacted by increasing headcount, net of realignment activities discussed below. Headcount during the three and nine months ended September 30, 2015 continued to increase due to organic growth. The increased headcount has resulted in higher cash-based employee-related expenses across most of our income statement expense categories when compared to the same period in 2014, and we expect this trend to continue.
Cost of License Revenues
Our cost of license revenues principally consists of the cost of fulfillment of our software, royalty costs in connection with technology licensed from third-party providers and amortization of intangible assets. The cost of fulfillment of our software includes IT development efforts, personnel costs and related overhead associated with the physical and electronic delivery of our software products.
 
Three Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
September 30,
 
 
 
September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
 
2015
 
2014
 
$ Change
 
% Change
Cost of license revenues
$
46

 
$
45

 
$


(1
)%
 
$
141

 
$
141

 
$

 
 %
Stock-based compensation

 
1

 

 
(15
)
 
1

 
2

 

 
(16
)
Total expenses
$
46

 
$
46

 
$

 
(1
)
 
$
142

 
$
143

 
$

 

% of License revenues
7
%
 
7
%
 
 
 
 
 
8
%
 
8