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EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - VMWARE, INC.vmw-552017x10qex322.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - VMWARE, INC.vmw-552017x10qex321.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - VMWARE, INC.vmw-552017x10qex312.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - VMWARE, INC.vmw-552017x10qex311.htm
EX-10.12 - EXECUTIVE BONUS PROGRAM, AS AMENDED AND RESTATED FEBRUARY 10, 2017 - VMWARE, INC.vmw-552017x10qex1012.htm
EX-10.11 - 2007 EMPLOYEE STOCK PURCHASE PLAN, AS AMENDED AND RESTATED JUNE 8, 2017 - VMWARE, INC.vmw-552017x10qex1011.htm
EX-10.7 - FORM OF INDEMNIFICATION AGREEMENT - VMWARE, INC.vmw-552017x10qex107.htm
EX-10.6 - 2007 EQUITY AND INCENTIVE PLAN, AS AMENDED AND RESTATED JUNE 8, 2017 - VMWARE, INC.vmw-552017x10qex106.htm
EX-3.1 - AMENDED AND RESTATED CERTIFICATE OF INCORPORATION - VMWARE, INC.vmw-552017x10qex31.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 5, 2017
OR
o
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  þ    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  þ    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 þ
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
 o
(Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
 
 
Emerging growth company
 o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    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  þ
As of June 2, 2017, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 408,423,739, of which 108,423,739 shares were Class A common stock and 300,000,000 were Class B common stock.



TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 
VMware, vCloud, vCloud Air, vCloud Air Network, Cross-Cloud Services, vSphere, NSX, VMware vSAN, AirWatch, Workspace ONE, Horizon, Horizon Suite, Photon, Photon OS and vSphere Integrated Containers 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 (LOSS)
(amounts in millions, except per share amounts, and shares in thousands)
(unaudited)
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Revenue:
 
 
 
 
 
License
$
610

 
$
572

 
$
125

Services
1,126

 
1,017

 
371

Total revenue
1,736

 
1,589

 
496

Operating expenses(1):
 
 
 
 
 
Cost of license revenue
39

 
40

 
13

Cost of services revenue
250

 
211

 
80

Research and development
421

 
356

 
150

Sales and marketing
586

 
565

 
231

General and administrative
151

 
172

 
63

Realignment and loss on disposition
51

 
53

 

Operating income (loss)
238

 
192

 
(41
)
Investment income
23

 
16

 
8

Interest expense with Dell
(7
)
 
(7
)
 
(2
)
Other income (expense), net
4

 
(1
)
 
1

Income (loss) before income tax
258

 
200

 
(34
)
Income tax provision (benefit)
26

 
39

 
(26
)
Net income (loss)
$
232

 
$
161

 
$
(8
)
Net income (loss) per weighted-average share, basic for Class A and Class B
$
0.57

 
$
0.38

 
$
(0.02
)
Net income (loss) per weighted-average share, diluted for Class A and Class B
$
0.56

 
$
0.38

 
$
(0.02
)
Weighted-average shares, basic for Class A and Class B
408,431

 
423,230

 
408,625

Weighted-average shares, diluted for Class A and Class B
414,018

 
424,180

 
408,625

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

 
$
1

 
$

Cost of services revenue
14

 
12

 
5

Research and development
82

 
70

 
31

Sales and marketing
48

 
49

 
19

General and administrative
18

 
18

 
7

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


3


VMware, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(unaudited)
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Net income (loss)
$
232

 
$
161

 
$
(8
)
Other comprehensive income (loss):
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
Unrealized gains (losses), net of tax provision (benefit) of $5, $11 and $1
8

 
18

 
2

Reclassification of (gains) losses realized during the period, net of tax (provision) benefit of $— for all periods
1

 

 

Net change in market value of available-for-sale securities
9

 
18

 
2

Changes in market value of effective foreign currency forward contracts:
 
 
 
 
 
Unrealized gains (losses), net of tax provision (benefit) of $— for all periods
5

 
2

 
3

Reclassification of (gains) losses realized during the period, net of tax (provision) benefit of $— for all periods
1

 

 

Net change in market value of effective foreign currency forward contracts
6

 
2

 
3

Total other comprehensive income (loss)
15

 
20

 
5

Total comprehensive income (loss), net of taxes
$
247

 
$
181

 
$
(3
)
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)
 
 
 
 
 
Transition Period
 
May 5,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
3,864

 
$
2,790

 
$
3,220

Short-term investments
4,748

 
5,195

 
5,173

Accounts receivable, net of allowance for doubtful accounts of $2, $2 and $2
867

 
1,856

 
1,192

Due from related parties, net
127

 
132

 
93

Other current assets
172

 
362

 
173

Total current assets
9,778

 
10,335

 
9,851

Property and equipment, net
993

 
1,049

 
1,042

Other assets
240

 
248

 
249

Deferred tax assets
724

 
462

 
716

Intangible assets, net
474

 
517

 
507

Goodwill
4,032

 
4,032

 
4,032

Total assets
$
16,241

 
$
16,643

 
$
16,397

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable
$
116

 
$
125

 
$
53

Accrued expenses and other
897

 
898

 
887

Note payable to Dell
680

 

 

Unearned revenue
3,317

 
3,531

 
3,349

Total current liabilities
5,010

 
4,554

 
4,289

Notes payable to Dell
820

 
1,500

 
1,500

Unearned revenue
1,918

 
2,093

 
1,991

Other liabilities
425

 
399

 
401

Total liabilities
8,173

 
8,546

 
8,181

Contingencies (refer to Note I)

 

 

Stockholders’ equity:
 
 
 
 
 
Class A common stock, par value $.01; authorized 2,500,000 shares; issued and outstanding 108,409, 108,351 and 110,060 shares
1

 
1

 
1

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

 
3

 
3

Additional paid-in capital
1,448

 
1,721

 
1,843

Accumulated other comprehensive income (loss)
11

 
(9
)
 
(4
)
Retained earnings
6,605

 
6,381

 
6,373

Total stockholders’ equity
8,068

 
8,097

 
8,216

Total liabilities and stockholders’ equity
$
16,241

 
$
16,643

 
$
16,397

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)
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Operating activities:
 
 
 
 
 
Net income (loss)
$
232

 
$
161

 
$
(8
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
85

 
88

 
29

Stock-based compensation
163

 
150

 
62

Excess tax benefits from stock-based compensation

 

 
(5
)
Deferred income taxes, net
(8
)
 
(18
)
 
(254
)
Loss on disposition
49

 

 

(Gain) loss on Dell stock purchase
2

 

 
(1
)
Impairment of strategic investments
2

 
5

 

Other
1

 
1

 

Changes in assets and liabilities, net of acquisitions:
 
 
 
 
 
Accounts receivable
325

 
544

 
664

Other assets
(12
)
 
(5
)
 
190

Due to/from related parties, net
(34
)
 
63

 
39

Accounts payable
59

 
(28
)
 
(68
)
Accrued expenses
(34
)
 
(118
)
 
(41
)
Income taxes payable
15

 
(23
)
 
38

Unearned revenue
(70
)
 
(100
)
 
(284
)
Net cash provided by operating activities
775

 
720

 
361

Investing activities:
 
 
 
 
 
Additions to property and equipment
(49
)
 
(41
)
 
(18
)
Purchases of available-for-sale securities
(506
)
 
(1,124
)
 
(38
)
Sales of available-for-sale securities
548

 
420

 
43

Maturities of available-for-sale securities
418

 
286

 
20

Proceeds from disposal of assets

 
3

 

Purchases of strategic investments
(6
)
 
(2
)
 

Decrease in restricted cash
2

 
2

 

Net cash provided by (used in) investing activities
407

 
(456
)
 
7

Financing activities:
 
 
 
 
 
Proceeds from issuance of common stock
7

 
52

 
61

Repurchase of common stock
(425
)
 

 

Excess tax benefits from stock-based compensation

 

 
5

Shares repurchased for tax withholdings on vesting of restricted stock
(120
)
 
(24
)
 
(4
)
Net cash provided by (used in) financing activities
(538
)
 
28

 
62

Net increase in cash and cash equivalents
644

 
292

 
430

Cash and cash equivalents at beginning of the period
3,220

 
2,493

 
2,790

Cash and cash equivalents at end of the period
$
3,864

 
$
2,785

 
$
3,220

Supplemental disclosures of cash flow information:
 
 
 
 
 
Cash paid for interest
$
9

 
$
7

 
$

Cash paid for taxes, net
27

 
63

 
3

Non-cash items:
 
 
 
 
 
Changes in capital additions, accrued but not paid
$
5

 
$
(3
)
 
$
(6
)
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 a leader in virtualization and cloud infrastructure solutions that enable businesses to transform the way they build, deliver and consume information technology (“IT”) resources in a manner that is based on their specific needs. 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, servers and mobile devices and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
Change in Fiscal Year End
On October 25, 2016, the VMware Board of Directors approved a change to VMware’s fiscal year from a fiscal year ending on December 31 of each calendar year to a fiscal year consisting of a 52- or 53-week period ending on the Friday nearest to January 31 of each year. The change in VMware’s fiscal year was effective January 1, 2017. The period that began on January 1, 2017 and ended on February 3, 2017 is reflected as a transition period (the “Transition Period”). VMware’s first full fiscal year 2018 under the revised fiscal calendar is a 52-week year that began on February 4, 2017 and will end on February 2, 2018.
The Company has included its unaudited condensed consolidated financial statements for the Transition Period in this report on Form 10-Q. As permitted under SEC rules, prior-period financial statements have not been recast as management believes (i) the three months ended March 31, 2016 are comparable to the three months ended May 5, 2017; and (ii) recasting prior-period results was not practicable or cost justified.
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 fiscal year 2018. 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 2016 Annual Report on Form 10-K. 
Effective September 7, 2016, Dell Technologies Inc. (“Dell”) (formerly Denali Holding Inc.) acquired EMC Corporation (“EMC”), including EMC’s majority control of VMware (the “Dell Acquisition”). As a result of the Dell Acquisition, EMC became a wholly-owned subsidiary of Dell and VMware became an indirectly-held, majority-owned subsidiary of Dell. As of May 5, 2017, Dell controlled 81.8% of VMware’s outstanding common stock and 97.6% of the combined voting power of VMware’s outstanding common stock, including 34 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock.
As VMware is a majority-owned and controlled subsidiary of Dell, its results of operations and financial position are consolidated with Dell’s financial statements. Transactions prior to the effective date of the Dell Acquisition represent transactions only with EMC and its consolidated subsidiaries (“Parent”).
Management believes the assumptions underlying the condensed consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with Dell and its consolidated subsidiaries 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 products and services the Company receives from and provides to Dell.

7

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

Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of VMware and its subsidiaries. All intercompany transactions and account balances between VMware and its subsidiaries have been eliminated in consolidation. Transactions with Dell and its consolidated 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.
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 revenue 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 Pronouncements
Topic 606, Revenue from Contracts with Customers
During May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). In 2016, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12, which provide interpretive clarifications on the new guidance in Topic 606 (collectively, “Topic 606”). The updated revenue standard replaces all existing revenue recognition guidance under GAAP and establishes common principles for recognizing revenue for all industries. It also provides guidance on the accounting for costs to fulfill or obtain a customer contract. The core principle underlying the updated standard is the recognition of revenue based on consideration expected to be entitled from the transfer of goods or services to a customer. The updated standard is effective for interim and annual periods beginning after December 15, 2017 and permits the use of either the full retrospective or cumulative effect transition method.
VMware plans to adopt Topic 606 using the full retrospective transition method when it becomes effective for the Company in the first quarter of fiscal 2019. While the Company is continuing to assess the potential impacts of Topic 606, VMware currently expects unearned license revenue related to the sale of perpetual licenses will decline significantly upon adoption. Currently, VMware defers all license revenue related to the sale of its perpetual licenses in the event certain revenue recognition criteria are not met. However, under Topic 606, the Company would generally expect that substantially all license revenue related to the sale of its perpetual licenses will be recognized upon delivery. Topic 606 is also expected to impact the timing and recognition of costs to obtain contracts with customers, such as commissions. Under the new standard, incremental costs to obtain contracts with customers are deferred and recognized over the expected period of benefit. As a result, VMware expects deferred commission costs to increase. The Company is continuing to evaluate the effect that Topic 606 will have on its consolidated financial statements and related disclosures, and preliminary assessments are subject to change.
ASU No. 2016-02, Leases
During February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires a lessee to recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The updated standard also requires additional disclosure regarding leasing arrangements. It is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption, with early adoption permitted. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures, and expects that most of its lease commitments will be subject to the updated standard and recognized as lease liabilities and right-of-use assets upon adoption.
ASU No. 2016-16, Income Taxes
During October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which requires entities to recognize at the transaction date the income tax consequences of intra-entity asset transfers. Previous guidance required the tax effects from intra-entity asset transfers to be deferred until that asset is sold to a third party or recovered through use. The updated standard is effective for annual and interim periods beginning after December 15, 2017 and requires a modified retrospective transition method. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.
ASU No. 2016-09, Compensation
VMware adopted ASU No. 2016-09, Compensation-Stock Compensation (Topic 718), on a prospective basis, effective February 4, 2017. Prior periods have not been reclassified to conform to the fiscal 2018 presentation. Net excess tax benefits

8

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

recognized in connection with stock-based awards are now included in the income tax provision on the condensed consolidated statements of income. Net excess tax benefits recognized during the three months ended May 5, 2017 were $31 million. Prior to adopting the updated standard, such amounts were recognized in additional paid-in capital on the Company’s condensed consolidated balance sheets.
Additionally, all tax-related cash flows resulting from stock-based awards are reported as operating activities in the statement of cash flows. Prior to adopting the updated standard, excess tax benefits were reported as a cash inflow from financing activities in the statement of cash flows.
B. Related Parties
The information provided below includes a summary of the transactions entered into with Dell and Dell’s consolidated subsidiaries including EMC (collectively, “Dell”). Transactions prior to September 7, 2016 reflect transactions only with EMC and its consolidated subsidiaries.
Transactions with Dell
VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in revenue and receipts and unearned revenue for VMware:
Pursuant to ongoing reseller arrangements with Dell, Dell bundles VMware’s products and services with Dell’s products and sells them to end users. Reseller revenue is presented net of related marketing development funds and rebates paid to Dell.
Dell purchases products and services from VMware for internal use.
VMware provides professional services to end users based upon contractual agreements with Dell.
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 Dell, 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 services to Pivotal. Support costs incurred by VMware are reimbursed to VMware and are recorded as a reduction to the costs incurred by VMware.
Information about VMware’s revenue and receipts, and unearned revenue from such arrangements, for the periods presented consisted of the following (table in millions):
 
Revenue and Receipts
 
Unearned Revenue
 
 
 
Transition Period
 
As of
 
Three Months Ended
 
January 1 to
 
 
 
 
 
Transition Period
 
May 5,
 
March 31,
 
February 3,
 
May 5,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
 
2017
 
2016
 
2017
Reseller revenue
$
223

 
$
79

 
$
44

 
$
652

 
$
637

 
$
616

Internal-use revenue
5

 
5

 
7

 
11

 
15

 
18

Professional services revenue
29

 
25

 
3

 

 

 

Agency fee revenue

 
1

 

 

 

 

Reimbursement for services to Pivotal

 
1

 

 
 n/a

 
 n/a

 
 n/a

VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in costs to VMware:
VMware purchases and leases products and purchases services from Dell.
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with Dell subsidiaries for support services and Dell personnel who are managed by VMware. The costs incurred by Dell 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 occupancy expenses. Dell also incurs certain administrative costs on VMware’s behalf in the United States that are recorded as expenses on VMware’s condensed consolidated statements of income.

9

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

From time to time, VMware invoices end users on behalf of Dell for certain services rendered by Dell. Cash related to these services is collected from the end user by VMware and remitted to Dell.
Information about VMware’s costs from such arrangements during the periods presented consisted of the following (table in millions):
 
 
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Purchases and leases of products and purchases of services
$
36

 
$
17

 
$
14

Dell subsidiary support and administrative costs
29

 
23

 
13

VMware also purchases Dell products through Dell’s channel partners. Purchases of Dell products through Dell’s channel partners were not significant during the periods presented.
Dell Financial Services (“DFS”)
DFS provided financing to certain of VMware’s end customers based on the customer’s discretion. Upon acceptance of the financing arrangement by both VMware’s end customer and DFS, amounts classified as trade accounts receivable are reclassified to due from related parties, net on the condensed consolidated balance sheets. Financing fees recognized on these arrangements were not significant during the three months ended May 5, 2017 and the Transition Period.
Tax Sharing Agreement with Dell
VMware has made payments to Dell pursuant to a tax sharing agreement. The following table summarizes the payments made during the periods presented (table in millions):
 
 
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Payments from VMware to Dell
$

 
$
40

 
$

The timing of the tax payments due to and from related parties is governed by a tax sharing agreement. Payments from VMware to Dell under the tax sharing agreement relate to VMware’s portion of federal income taxes on Dell’s consolidated tax return as well as state tax payments for combined states. The amounts that VMware pays to Dell for its portion of federal income taxes on Dell’s consolidated tax return differ from the amounts VMware would owe on a separate tax return basis and the difference is presented as a component of stockholders’ equity. The difference between the amount of tax calculated on a separate return basis and the amount of tax calculated per the tax sharing agreement was not significant during the three months ended May 5, 2017 and March 31, 2016 and the Transition Period.
Due To/From Related Parties, Net
Amounts due to and from related parties, net as of the periods presented consisted of the following (table in millions):
 
 
 
 
 
Transition Period
 
May 5,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
Due (to) related parties
$
(73
)
 
$
(71
)
 
$
(85
)
Due from related parties
200

 
203

 
178

Due from related parties, net
$
127

 
$
132

 
$
93

 
 
 
 
 
 
Income tax related asset, net
$

 
$
181

 
$

Income tax due (to) related parties
(26
)
 

 
(21
)
Amounts included in due from related parties, net, which are unrelated to DFS and tax obligations, are generally settled in cash within 60 days of each quarter-end.

10

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

Stock Purchase Agreements with Dell
On March 29, 2017, VMware entered into a stock purchase agreement with Dell to purchase $300 million of VMware Class A common stock. During the three months ended May 5, 2017, VMware paid Dell $300 million in exchange for an initial delivery of shares of 2.7 million shares, or approximately 80% of the expected total shares to be received and retired under the arrangement. On May 10, 2017, the stock purchase agreement with Dell was completed and VMware received an additional 0.7 million shares. The aggregate number of shares of 3.4 million purchased was determined based upon the volume-weighted average price during a defined period, less an agreed upon discount.
On December 15, 2016, VMware entered into a stock purchase agreement with Dell to purchase $500 million of VMware Class A common stock. VMware purchased 4.8 million shares for $375 million through December 31, 2016. On February 15, 2017, the stock purchase agreement with Dell was completed. A total of $500 million was paid in exchange for 6.2 million shares. The aggregate number of shares purchased was determined based upon the volume-weighted average price during a defined period, less an agreed upon discount.
Notes Payable to Dell
VMware entered into a note exchange agreement with its Parent on January 21, 2014 providing for the issuance of three promissory notes in the aggregate principal amount of $1,500 million. 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. As of May 5, 2017, $680 million was classified as a current liability.
The notes bear interest, payable quarterly in arrears, at the annual rate of 1.75%. During the three months ended May 5, 2017 and March 31, 2016 and the Transition Period, $7 million, $7 million and $2 million, respectively, of interest expense was recognized.
C. Definite-Lived Intangible Assets, Net
Definite-Lived Intangible Assets, Net
As of the periods presented, definite-lived intangible assets consisted of the following (amounts in tables in millions):
 
May 5, 2017
 
Weighted-Average Useful Lives
(in years)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
Purchased technology
6.5
 
$
638

 
$
(390
)
 
$
248

Leasehold interest
34.9
 
149

 
(25
)
 
124

Customer relationships and customer lists
8.3
 
132

 
(67
)
 
65

Trademarks and tradenames
8.7
 
61

 
(25
)
 
36

Other
5.7
 
4

 
(3
)
 
1

Total definite-lived intangible assets
 
 
$
984

 
$
(510
)
 
$
474

 
December 31, 2016
 
Weighted-Average Useful Lives
(in years)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
Purchased technology
6.6
 
$
641

 
$
(358
)
 
$
283

Leasehold interest
34.9
 
149

 
(24
)
 
125

Customer relationships and customer lists
8.3
 
132

 
(62
)
 
70

Trademarks and tradenames
8.7
 
61

 
(23
)
 
38

Other
5.7
 
4

 
(3
)
 
1

Total definite-lived intangible assets
 
 
$
987

 
$
(470
)
 
$
517


11

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

 
Transition Period February 3, 2017
 
Weighted-Average Useful Lives
(in years)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
Purchased technology
6.5
 
$
641

 
$
(366
)
 
$
275

Leasehold interest
34.9
 
149

 
(24
)
 
125

Customer relationships and customer lists
8.3
 
132

 
(64
)
 
68

Trademarks and tradenames
8.7
 
61

 
(23
)
 
38

Other
5.7
 
4

 
(3
)
 
1

Total definite-lived intangible assets
 
 
$
987

 
$
(480
)
 
$
507

Amortization expense on definite-lived intangible assets was $32 million, $34 million and $10 million during the three months ended May 5, 2017 and March 31, 2016 and the Transition Period, respectively.
Based on intangible assets recorded as of May 5, 2017 and assuming no subsequent additions, dispositions or impairment of underlying assets, the remaining estimated annual amortization expense over the next five fiscal years and thereafter is expected to be as follows (table in millions):
Remainder of 2018
$
96

2019
117

2020
93

2021
39

2022
24

Thereafter
105

Total
$
474

D. Realignment and Loss on Disposition
Disposition of VMware vCloud Air Business
On April 4, 2017, VMware announced the sale of its VMware vCloud Air business (“vCloud Air”) to OVH US LLC (“OVH”). In connection with the transaction, the fair value of the fixed assets of $3 million identified as part of the sale was reclassified to assets held for sale in other current assets on the condensed consolidated balance sheets as of May 5, 2017. The initial loss recognized in connection with this transaction was $51 million and is included in realignment and loss on disposition on the condensed consolidated statements of income. In addition, the unearned revenue of $35 million associated with vCloud Air will be assumed by OVH and has been reclassified to accrued expenses and other on the condensed consolidated balance sheets as of May 5, 2017.
Realignment
On January 22, 2016, VMware approved a plan to streamline its operations, with plans to reinvest the associated savings in field, technical and support resources associated with growth products. As a result of these actions, approximately 800 positions were eliminated during the three months ended March 31, 2016. VMware recognized $50 million of severance-related realignment expenses during the three months ended March 31, 2016 on the condensed consolidated statements of income. Additionally, VMware consolidated certain facilities as part of this plan, which resulted in the recognition of $3 million of related expenses during the three months ended March 31, 2016.

12

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

The following table summarizes the activity for the accrued realignment expenses for the period presented (table in millions):
 
Three Months Ended March 31, 2016
 
Balance as of
January 1, 2016
 
Realignment
 
Utilization
 
Balance as of
March 31, 2016
Severance-related costs
$
3

 
$
50

 
$
(26
)
 
$
27

Costs to exit facilities

 
3

 

 
3

Total
$
3

 
$
53

 
$
(26
)
 
$
30

E. Net Income (Loss) per Share
Basic net income (loss) per share is computed by dividing net income (loss) 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, including performance stock units, and stock options, including purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income (loss) per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate net income (loss) per share as both classes share the same rights in dividends, therefore basic and diluted earnings per share are the same for both classes.
The following table sets forth the computations of basic and diluted net income (loss) per share during the periods presented (table in millions, shares in thousands):
 
 
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Net income (loss)
$
232

 
$
161

 
$
(8
)
Weighted-average shares, basic for Class A and Class B
408,431

 
423,230

 
408,625

Effect of other dilutive securities
5,587

 
950

 

Weighted-average shares, diluted for Class A and Class B
414,018

 
424,180

 
408,625

Net income (loss) per weighted-average share, basic for Class A and Class B
$
0.57

 
$
0.38

 
$
(0.02
)
Net income (loss) per weighted-average share, diluted for Class A and Class B(1)
$
0.56

 
$
0.38

 
$
(0.02
)
(1) During the Transition Period, VMware incurred a net loss. As a result, all potentially dilutive securities were anti-dilutive and excluded from the computation of diluted net loss per share.
The following table sets forth the weighted-average common share equivalents of Class A common stock that were excluded from the diluted net income (loss) per share calculations during the periods presented, because their effect would have been anti-dilutive (shares in thousands):
 
 
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
Anti-dilutive securities:
 
 
 
 
 
Employee stock options
895

 
2,352

 
2,353

Restricted stock units
44

 
15,491

 
3,259

Total
939

 
17,843

 
5,612


13

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

F. Cash, Cash Equivalents and Investments
Cash, cash equivalents and investments as of the periods presented consisted of the following (tables in millions):
 
May 5, 2017
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate Fair Value
Cash
$
427

 
$

 
$

 
$
427

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
3,422

 
$

 
$

 
$
3,422

Municipal obligations
15

 

 

 
15

Total cash equivalents
$
3,437

 
$

 
$

 
$
3,437

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
733

 
$

 
$
(3
)
 
$
730

U.S. and foreign corporate debt securities
3,607

 
5

 
(10
)
 
3,602

Foreign governments and multi-national agency obligations
24

 

 

 
24

Municipal obligations
207

 

 

 
207

Mortgage-backed securities
157

 

 
(1
)
 
156

Marketable available-for-sale equity securities
15

 
14

 

 
29

Total short-term investments
$
4,743

 
$
19

 
$
(14
)
 
$
4,748

 
December 31, 2016
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate Fair Value
Cash
$
512

 
$

 
$

 
$
512

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
2,235

 
$

 
$

 
$
2,235

Time deposits
26

 

 

 
26

Municipal obligations
17

 

 

 
17

Total cash equivalents
$
2,278

 
$

 
$

 
$
2,278

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
734

 
$

 
$
(3
)
 
$
731

U.S. and foreign corporate debt securities
3,885

 
2

 
(18
)
 
3,869

Foreign governments and multi-national agency obligations
32

 

 

 
32

Municipal obligations
365

 

 

 
365

Asset-backed securities
4

 

 

 
4

Mortgage-backed securities
196

 

 
(2
)
 
194

Total short-term investments
$
5,216

 
$
2

 
$
(23
)
 
$
5,195

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

 
$
7

 
$

 
$
22


14

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

 
Transition Period February 3, 2017
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate Fair Value
Cash
$
720

 
$

 
$

 
$
720

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
2,471

 
$

 
$

 
$
2,471

Time deposits
26

 

 

 
26

Municipal obligations
3

 

 

 
3

Total cash equivalents
$
2,500

 
$

 
$

 
$
2,500

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
733

 
$

 
$
(3
)
 
$
730

U.S. and foreign corporate debt securities
3,884

 
3

 
(16
)
 
3,871

Foreign governments and multi-national agency obligations
32

 

 

 
32

Municipal obligations
350

 

 

 
350

Asset-backed securities
4

 

 

 
4

Mortgage-backed securities
188

 

 
(2
)
 
186

Total short-term investments
$
5,191

 
$
3

 
$
(21
)
 
$
5,173

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

 
$
7

 
$

 
$
22

VMware evaluated its available-for-sale investments as of May 5, 2017, December 31, 2016 and February 3, 2017 for other-than-temporary declines in fair value and did not consider any to be other-than-temporarily impaired. The realized gains and losses on investments during the three months ended May 5, 2017 and March 31, 2016 and the Transition Period were not significant.
Unrealized losses on cash equivalents and available-for-sale investments as of the periods presented, which have been in a net loss position for less than twelve months, were classified by sector as follows (table in millions):
 
 
 
 
 
 
 
 
 
Transition Period
 
May 5, 2017
 
December 31, 2016
 
February 3, 2017
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
U.S. Government and agency obligations
$
681

 
$
(3
)
 
$
608

 
$
(3
)
 
$
527

 
$
(3
)
U.S. and foreign corporate debt securities
1,864

 
(10
)
 
2,595

 
(18
)
 
2,287

 
(16
)
Mortgage-backed securities
121

 
(1
)
 
164

 
(2
)
 
151

 
(2
)
Total
$
2,666

 
$
(14
)
 
$
3,367

 
$
(23
)
 
$
2,965

 
$
(21
)
As of May 5, 2017, December 31, 2016 and February 3, 2017, unrealized losses on cash equivalents and available-for-sale investments in the other investment categories, which have been in a net loss position for less than twelve months, were not significant. 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 significant for the periods presented.

15

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

Contractual Maturities
The contractual maturities of fixed income securities held as of May 5, 2017 consisted of the following (table in millions):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
1,445

 
$
1,445

Due after 1 year through 5 years
2,916

 
2,908

Due after 5 years through 10 years
116

 
116

Due after 10 years
251

 
250

Total fixed income securities
$
4,728

 
$
4,719

G. 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 that are classified as Level 1. Additionally, VMware’s Level 2 classification includes forward contracts, notes payable to Dell and the estimated fair value of assets held for sale in connection with the disposition of vCloud Air. As of May 5, 2017, December 31, 2016 and February 3, 2017, VMware’s Level 2 investment securities were generally priced using non-binding market consensus prices that were corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques. The fair value of assets held for sale in connection with the disposition of vCloud Air was based upon the terms of the sale between VMware and OVH and was immaterial as of May 5, 2017.
VMware did not have any significant assets or liabilities that fell into Level 3 of the fair value hierarchy for the periods presented, and there have been no transfers between fair value measurement levels during the periods presented.

16

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

The following tables set forth the fair value hierarchy of VMware’s cash equivalents, available-for-sale securities and derivatives that were required to be measured at fair value as of the periods presented (tables in millions):
 
May 5, 2017
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 


Money-market funds
$
3,422

 
$

 
$
3,422

Municipal obligations

 
15

 
15

Total cash equivalents
$
3,422

 
$
15

 
$
3,437

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
455

 
$
275

 
$
730

U.S. and foreign corporate debt securities

 
3,602

 
3,602

Foreign governments and multi-national agency obligations

 
24

 
24

Municipal obligations

 
207

 
207

Mortgage-backed securities

 
156

 
156

Marketable available-for-sale equity securities
29

 

 
29

Total short-term investments
$
484

 
$
4,264

 
$
4,748

Other current assets:
 
 
 
 
 
Forward contracts
$

 
$
10

 
$
10

 
December 31, 2016
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money-market funds
$
2,235

 
$

 
$
2,235

Time deposits

 
26

 
26

Municipal obligations

 
17

 
17

Total cash equivalents
$
2,235

 
$
43

 
$
2,278

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
441

 
$
290

 
$
731

U.S. and foreign corporate debt securities

 
3,869

 
3,869

Foreign governments and multi-national agency obligations

 
32

 
32

Municipal obligations

 
365

 
365

Asset-backed securities

 
4

 
4

Mortgage-backed securities

 
194

 
194

Total short-term investments
$
441

 
$
4,754

 
$
5,195

Other current assets:
 
 
 
 
 
Derivative due to stock purchase with Dell
$

 
$
8

 
$
8

Other assets:
 
 
 
 
 
Marketable available-for-sale equity securities
$
22

 
$

 
$
22


17

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

 
Transition Period February 3, 2017
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money-market funds
$
2,471

 
$

 
$
2,471

Time deposits

 
26

 
26

Municipal obligations

 
3

 
3

Total cash equivalents
$
2,471

 
$
29

 
$
2,500

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
445

 
$
285

 
$
730

U.S. and foreign corporate debt securities

 
3,871

 
3,871

Foreign governments and multi-national agency obligations

 
32

 
32

Municipal obligations

 
350

 
350

Asset-backed securities

 
4

 
4

Mortgage-backed securities

 
186

 
186

Total short-term investments
$
445

 
$
4,728

 
$
5,173

Other current assets:
 
 
 
 
 
Derivative due to stock purchase with Dell
$

 
$
9

 
$
9

Other assets:
 
 
 
 
 
Marketable available-for-sale equity securities
$
22

 
$

 
$
22

Marketable available-for-sale equity securities were classified as short-term investments as of May 5, 2017 as restrictions on the Company’s ability to sell the common stock lapse within twelve months of May 5, 2017. As of December 31, 2016 and February 3, 2017, these securities were classified as other assets.
Notes payable to Dell are not adjusted to fair value. The fair value of the notes payable to Dell was approximately $1,497 million, $1,489 million and $1,492 million as of May 5, 2017, December 31, 2016 and February 3, 2017, respectively. Fair value was estimated primarily based on observable market interest rates (Level 2 inputs).
VMware offers a deferred compensation plan for eligible employees, which allows participants to defer payment for part or all of their compensation. The net impact to the condensed consolidated statements of income is not significant 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 the same at approximately $45 million, $35 million and $36 million as of May 5, 2017, December 31, 2016 and February 3, 2017, 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 holds strategic investments in its portfolio accounted for using the cost method. These strategic investments are periodically assessed for other-than-temporary impairment. VMware uses Level 3 inputs as part of its impairment analysis, including pre- and post-money valuations of recent financing events, the impact of financing events on its ownership percentages, and other available information relevant to 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. If VMware determines that an other-than-temporary impairment has occurred, VMware writes down the investments to their fair value.
During the three months ended March 31, 2016, certain strategic investments were considered to be other-than-temporarily impaired and accordingly, an impairment charge of approximately $5 million was recognized. The impairment charge for the three months ended May 5, 2017 was not significant. Strategic investments are included in other assets on the condensed consolidated balance sheets. The carrying value of VMware’s strategic investments was $142 million, $139 million and $139 million as of May 5, 2017, December 31, 2016 and February 3, 2017, respectively.
H. Derivatives and Hedging Activities
VMware conducts business on a global basis in multiple foreign currencies, subjecting the Company to foreign currency risk. To mitigate a portion of this risk, VMware utilizes hedging contracts as described below, which potentially expose the

18

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

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 certain operating expenses denominated in certain foreign currencies, VMware enters into forward contracts that are designated 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 instruments 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 months ended May 5, 2017 and March 31, 2016 and the Transition Period, the effective portion of gains or losses reclassified to the condensed consolidated statements of income was not significant. 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.
These forward contracts have contractual maturities of twelve months or less, and as of May 5, 2017, December 31, 2016 and February 3, 2017, outstanding forward contracts had a total notional value of $193 million, $22 million and $250 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 months ended May 5, 2017 and March 31, 2016 and the Transition Period, all cash flow hedges were considered effective.
Forward Contracts Not Designated as Hedges
VMware has established a program that utilizes 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.
These forward contracts have a contractual maturity of one month, and as of May 5, 2017, December 31, 2016 and February 3, 2017, outstanding forward contracts had a total notional value of $687 million, $875 million and $834 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 months ended May 5, 2017, March 31, 2016 and the Transition Period, VMware recognized a loss of $8 million, $23 million and $18 million, respectively, relating to the settlement of forward contracts. Gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
The combined gains and losses related to forward contracts and the underlying foreign currency denominated assets and liabilities resulted in a net gain of $4 million during the three months ended May 5, 2017, and net losses of $2 million and $1 million during the three months ended March 31, 2016 and the Transition Period, respectively. Net gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
I. Contingencies
Litigation
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. On January 6, 2017, the court granted VMware’s motion for summary judgment on the contract statute of limitations issues, which removed Phoenix’s breach of contract claim from the lawsuit. No other claims were removed from the lawsuit on summary judgment and trial began on May 30, 2017, but has not yet concluded. VMware believes that it has meritorious defenses in connection with this lawsuit. A possible range of loss is between zero (if VMware is found not liable) and $110 million, with the high end of the range based on claims made by Phoenix during trial.
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 the open source General Public License v.2 (“GPL v.2”)

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

and seeking an order requiring VMware to comply with the GPL v.2 or cease distribution of any affected code within Germany. On July 8, 2016, the German court issued a written decision dismissing Mr. Hellwig’s lawsuit. Mr. Hellwig has appealed the Regional Court’s decision and has filed his opening appellate brief and VMware has filed its responsive appellate brief. No further briefing or hearing schedule has yet been set by the appellate court.
While VMware believes that it has valid defenses against each of the above legal matters, 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.
Former employee Dane Smith filed a lawsuit against the Company alleging (i) wrongful retaliation in violation of the False Claims Act and (ii) wrongful termination in violation of public policy. As of May 2, 2017, the parties had completed an arbitration hearing. The results of the arbitration hearing were immaterial to VMware’s consolidated financial statements.
On November 17, 2015, Francis M. Ford, a VMware Class A stockholder, filed an action in the Delaware Chancery Court against certain current and former VMware directors, among others (collectively, the “Defendants”), alleging that the Defendants breached their fiduciary duties in connection with the Dell Acquisition, and the proposed issuance of tracking stock that is intended to track the performance of VMware. The plaintiff did not assert claims directly against VMware, but purported to bring class claims on behalf of other VMware Class A stockholders and derivative claims on behalf of VMware. On May 2, 2017, the Delaware Chancery Court granted Defendants’ motion to dismiss without leave to amend, dismissing all claims against all Defendants. The time limitation for the plaintiff to file an appeal lapsed on June 1, 2017. While VMware does not believe that the Ford case represents material adverse exposures, no assurances can be given that the litigation will not have any adverse consequences for the company or the directors named in the suits.
VMware accrues for a liability when a determination has been made that a loss is both probable and the amount of the loss can be reasonably estimated. If only a range can be estimated and no amount within the range is a better estimate than any other amount, an accrual is recorded for the minimum amount in the range. 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 is also subject to other legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business or in connection with business mergers and acquisitions, including claims with respect to commercial, contracting and sales practices, product liability, intellectual property, employment, corporate and securities law, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from and has discussions with government entities and stockholders on various matters. As of May 5, 2017, amounts accrued relating to these other matters arising as part of the ordinary course of business were considered immaterial. 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. Unearned Revenue
Unearned revenue as of the periods presented consisted of the following (table in millions):
 
 
 
 
 
Transition Period
 
May 5,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
Unearned license revenue
$
472

 
$
503

 
$
484

Unearned software maintenance revenue
4,323

 
4,628

 
4,405

Unearned professional services revenue
440

 
493

 
451

Total unearned revenue
$
5,235

 
$
5,624

 
$
5,340

Unearned license revenue is generally recognized upon delivery of existing or future products or services, or is 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. In the event the arrangement does not include professional services, unearned license revenue 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. Unearned license revenue derived from commitments to

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

future products that have not been delivered represents a significant portion of total unearned license revenue as of May 5, 2017. VMware expects unearned license revenue to substantially decline upon the adoption of Topic 606.
Unearned software maintenance revenue is attributable to VMware’s maintenance contracts and is generally recognized ratably over the contract period. The weighted-average remaining term as of May 5, 2017 was approximately two years. Unearned professional services revenue results primarily from prepaid professional services, including training, and is generally recognized as the services are delivered.
Unearned license and software maintenance revenue will fluctuate based upon a variety of factors including sales volume, the timing of both product promotion offers and delivery of the future products offered, and the amount of arrangements sold with ratable revenue recognition. Additionally, the amount of unearned revenue derived from transactions denominated in a foreign currency is affected by fluctuations in the foreign currencies in which VMware invoices.
In connection with the sale of vCloud Air, approximately $18 million of unearned license revenue and $35 million of total unearned revenue were reclassified to accrued expenses and other on the condensed consolidated balance sheets as of May 5, 2017. Refer to Note D for further information.
K. Stockholders’ Equity
VMware Stock Repurchases
During January 2017, VMware’s board of directors authorized the repurchase of up to $1,200 million of VMware’s Class A common stock through the end of fiscal 2018. Stock will be purchased from time to time in open market 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, legal 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. From time to time, VMware also purchases stock in private transactions, such as with Dell. All shares repurchased under VMware’s stock repurchase programs are retired. As of May 5, 2017, the cumulative authorized amount remaining for stock repurchases under the January 2017 authorization was $900 million.
The following table summarizes stock repurchase activity, including shares purchased from Dell, during the period presented (aggregate purchase price in millions, shares in thousands):
 
Three Months Ended
 
May 5, 2017
Aggregate purchase price(1)(2)
$
357

Class A common shares repurchased
4,161

Weighted-average price per share
$
85.85

(1) The aggregate purchase price of repurchased shares is classified as a reduction to additional paid-in capital.
(2) The aggregate purchase price of $357 million includes the purchase price associated with the final delivery of 1.4 million shares under the December 15, 2016 agreement with Dell and the initial delivery of 2.7 million shares under the March 29, 2017 agreement with Dell.
During the three months ended March 31, 2016 and the Transition Period, VMware did not repurchase any shares of its Class A common stock.
VMware Restricted Stock
VMware’s restricted stock primarily consists of restricted stock unit (“RSU”) awards granted to employees. The value of an RSU grant is 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 VMware executives and employees. The PSU awards include performance conditions and, in certain cases, a time-based vesting component. Upon vesting, PSU awards 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.

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

The following table summarizes restricted stock activity since January 1, 2017 (units in thousands):
 
Number of Units
 
Weighted-Average Grant Date Fair Value
(per unit)
Outstanding, January 1, 2017
20,866

 
$
67.54

Vested
(256
)
 
77.07

Forfeited
(159
)
 
68.11

Outstanding, February 3, 2017
20,451

 
67.41

Granted
813

 
89.87

Vested
(3,750
)
 
66.05

Forfeited
(448
)
 
70.62

Outstanding, May 5, 2017
17,066

 
68.70

The total fair value of VMware restricted stock that vested during the three months ended May 5, 2017 and the Transition Period was $350 million and $21 million, respectively. As of May 5, 2017, restricted stock representing 17.1 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $1,604 million based on VMware’s closing stock price as of May 5, 2017.
Accumulated Other Comprehensive Income (Loss)
The changes in components of accumulated other comprehensive income (loss) during the periods presented were as follows (tables in millions):
 
Unrealized Gain (Loss) on
Available-for-Sale Securities
 
Unrealized Gain (Loss) on
Forward Contracts
 
Total
Balance, January 1, 2017
$
(8
)
 
$
(1
)
 
$
(9
)
Unrealized gains (losses), net of tax provision (benefit) of $1, $— and $1
2

 
3

 
5

Balance, February 3, 2017
$
(6
)
 
$
2

 
$
(4
)
Unrealized gains (losses), net of tax provision (benefit) of $5, $— and $5
8

 
5

 
13

Amounts reclassified from accumulated other comprehensive income to the consolidated statement of income, net of taxes of $—
1

 
1

 
2

Other comprehensive income (loss), net
9

 
6

 
15

Balance, May 5, 2017
$
3

 
$
8

 
$
11

 
Unrealized Gain (Loss) on
Available-for-Sale Securities
 
Unrealized Gain (Loss) on
Forward Contracts
 
Total
Balance, January 1, 2016
$
(7
)
 
$
(1
)
 
$
(8
)
Unrealized gain (loss), net of tax provision (benefit) of $11, $— and $11
18

 
2

 
20

Balance, March 31, 2016
$
11

 
$
1

 
$
12

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 is 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

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

functional line items on the condensed consolidated statements of income were not significant to the individual functional line items during the periods presented.
L. Segment Information
VMware operates in one reportable operating segment, thus all required financial segment information is included in the condensed consolidated financial statements. Operating segments are defined as components of an enterprise for 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.
Revenue by geographic area during the periods presented was as follows (table in millions):
 
 
 
 
 
Transition Period
 
Three Months Ended
 
January 1 to
 
May 5,
 
March 31,
 
February 3,
 
2017
 
2016
 
2017
United States
$
860

 
$
800

 
$
248

International
876

 
789

 
248

Total
$
1,736

 
$
1,589

 
$
496

Revenue by geographic area is based on the ship-to addresses of VMware’s customers. No individual country other than the United States accounted for 10% or more of revenue during the three months ended May 5, 2017 and March 31, 2016 and the Transition Period.
Long-lived assets by geographic area, which primarily include property and equipment, net, as of the periods presented were as follows (table in millions):
 
 
 
 
 
Transition Period
 
May 5,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
United States
$
728

 
$
784

 
$
777

International
121

 
132

 
131

Total
$
849

 
$
916

 
$
908

No individual country other than the United States accounted for 10% or more of these assets as of May 5, 2017, December 31, 2016 and February 3, 2017.

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

M. Transition Period
Comparable Financial Information
In conjunction with VMware’s change in fiscal year end, the Company had a Transition Period of 34 days that began on January 1, 2017 and ended on February 3, 2017. The most comparable prior-year period, the one month ended January 31, 2016, had a duration of 31 days.
The following table presents certain financial information during the periods presented (table in millions, shares in thousands):
 
Transition Period
 
Comparable Period
 
January 1 to
 
January 1 to
 
February 3,
 
January 31,
 
2017
 
2016
Total revenue
$
496

 
$
470

Operating income (loss)
(41
)
 
22

Income tax provision (benefit)
(26
)
 
4

Net income (loss)
(8
)
 
22

 
 
 
 
Net income (loss) per weighted-average share, basic for Class A and Class B
$
(0.02
)
 
$
0.05

Net income (loss) per weighted-average share, diluted for Class A and Class B
$
(0.02
)
 
$
0.05

 
 
 
 
Weighted-average shares, basic for Class A and Class B
408,625

 
422,067

Weighted-average shares, diluted for Class A and Class B(1)
408,625

 
423,092

(1) During the Transition Period, VMware incurred a net loss. As a result, all potentially dilutive securities were anti-dilutive and excluded from the computation of diluted net loss per share.