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EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - VMWARE, INC.vmw-842017x10qex322.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - VMWARE, INC.vmw-842017x10qex321.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - VMWARE, INC.vmw-842017x10qex312.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - VMWARE, INC.vmw-842017x10qex311.htm
EX-10.34 - FORM OF PERFORMANCE STOCK UNIT AGREEMENT FOR NON-U.S. PARTICIPANTS - VMWARE, INC.vmw-842017x10qex1034.htm
EX-10.30 - FORM OF RESTRICTED STOCK UNIT AGREEMENT FOR U.K. PARTICIPANTS, AS AMENDED - VMWARE, INC.vmw-842017x10qex1030.htm
EX-10.16 - FORM OF PERFORMANCE STOCK UNIT AGREEMENT, AS AMENDED - VMWARE, INC.vmw-842017x10qex1016.htm
EX-10.10 - FORM OF RESTRICTED STOCK UNIT AGREEMENT, AS AMENDED - VMWARE, INC.vmw-842017x10qex1010.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 August 4, 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 September 1, 2017, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 408,947,278, of which 108,947,278 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 6.
 
 
 
 
 
 
 
 
VMware, vCloud, vCloud Air, vCloud Air Network, NSX, VMware vSAN, VMware Cloud, Workspace ONE, AirWatch, Horizon, Horizon Suite, vSphere, 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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Revenue:
 
 
 
 
 
 
 
 
 
License
$
732

 
$
644

 
$
1,342

 
$
1,216

 
$
125

Services
1,168

 
1,049

 
2,294

 
2,066

 
371

Total revenue
1,900

 
1,693

 
3,636

 
3,282

 
496

Operating expenses(1):
 
 
 
 
 
 
 
 
 
Cost of license revenue
39

 
40

 
78

 
81

 
13

Cost of services revenue
231

 
221

 
481

 
432

 
80

Research and development
428

 
363

 
849

 
720

 
150

Sales and marketing
668

 
580

 
1,255

 
1,144

 
231

General and administrative
160

 
167

 
311

 
338

 
63

Realignment and loss on disposition
36

 
(1
)
 
86

 
52

 

Operating income (loss)
338

 
323

 
576

 
515

 
(41
)
Investment income
25

 
19

 
48

 
35

 
8

Interest expense with Dell
(7
)
 
(7
)
 
(13
)
 
(13
)
 
(2
)
Other income (expense), net
51

 
2

 
54

 

 
1

Income (loss) before income tax
407

 
337

 
665

 
537

 
(34
)
Income tax provision (benefit)
73

 
72

 
99

 
111

 
(26
)
Net income (loss)
$
334

 
$
265

 
$
566

 
$
426

 
$
(8
)
Net income (loss) per weighted-average share, basic for Class A and Class B
$
0.82

 
$
0.62

 
$
1.39

 
$
1.00

 
$
(0.02
)
Net income (loss) per weighted-average share, diluted for Class A and Class B
$
0.81

 
$
0.62

 
$
1.37

 
$
1.00

 
$
(0.02
)
Weighted-average shares, basic for Class A and Class B
408,399

 
425,107

 
408,415

 
424,169

 
408,625

Weighted-average shares, diluted for Class A and Class B
412,768

 
427,102

 
413,920

 
425,729

 
408,625

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

 
$

 
$
1

 
$
1

 
$

Cost of services revenue
12

 
13

 
25

 
25

 
5

Research and development
89

 
74

 
170

 
144

 
31

Sales and marketing
48

 
47

 
98

 
95

 
19

General and administrative
20

 
18

 
37

 
36

 
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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Net income (loss)
$
334

 
$
265

 
$
566

 
$
426

 
$
(8
)
Other comprehensive income:
 
 
 
 
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
 
 
 
 
Unrealized gains, net of tax provision of $5, $6, $9, $15 and $1
8

 
10

 
15

 
24

 
2

Reclassification of losses realized during the period, net of tax benefit of $—, $—, $1, $2, and $—

 

 
2

 
3

 

Net change in market value of available-for-sale securities
8

 
10

 
17

 
27

 
2

Changes in market value of effective foreign currency forward contracts:
 
 
 
 
 
 
 
 
 
Unrealized gains (losses), net of tax provision of $3, $—, $3, $—, and $—
(5
)
 
(3
)
 
1

 

 
3

Reclassification of losses realized during the period, net of tax benefit of $— for all periods
2

 
1

 
2

 
1

 

Net change in market value of effective foreign currency forward contracts
(3
)
 
(2
)
 
3

 
1

 
3

Total other comprehensive income
5

 
8

 
20

 
28

 
5

Total comprehensive income (loss), net of taxes
$
339

 
$
273

 
$
586

 
$
454

 
$
(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
 
August 4,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
3,552

 
$
2,790

 
$
3,220

Short-term investments
5,350

 
5,195

 
5,173

Accounts receivable, net of allowance for doubtful accounts of $2, $2 and $2
1,189

 
1,856

 
1,192

Due from related parties, net
207

 
132

 
93

Other current assets
173

 
362

 
173

Total current assets
10,471

 
10,335

 
9,851

Property and equipment, net
1,005

 
1,049

 
1,042

Other assets
262

 
248

 
249

Deferred tax assets
691

 
462

 
716

Intangible assets, net
476

 
517

 
507

Goodwill
4,270

 
4,032

 
4,032

Total assets
$
17,175

 
$
16,643

 
$
16,397

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

 
$
125

 
$
53

Accrued expenses and other
1,016

 
898

 
887

Note payable to Dell
680

 

 

Unearned revenue
3,464

 
3,531

 
3,349

Total current liabilities
5,276

 
4,554

 
4,289

Notes payable to Dell
820

 
1,500

 
1,500

Unearned revenue
2,040

 
2,093

 
1,991

Other liabilities
440

 
399

 
401

Total liabilities
8,576

 
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 109,651, 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
1,640

 
1,721

 
1,843

Accumulated other comprehensive income (loss)
16

 
(9
)
 
(4
)
Retained earnings
6,939

 
6,381

 
6,373

Total stockholders’ equity
8,599

 
8,097

 
8,216

Total liabilities and stockholders’ equity
$
17,175

 
$
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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
Operating activities:
 
 
 
 
 
Net income (loss)
$
566

 
$
426

 
$
(8
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
165

 
174

 
29

Stock-based compensation
331

 
301

 
62

Excess tax benefits from stock-based compensation

 
(1
)
 
(5
)
Deferred income taxes, net
35

 
(5
)
 
(254
)
Loss on disposition
79

 

 

(Gain) loss on Dell stock purchase
2

 

 
(1
)
Impairment of strategic investments
2

 
5

 

Gain on disposition of strategic investments
(38
)
 
(1
)
 

Other
1

 
5

 

Changes in assets and liabilities, net of acquisitions:
 
 
 
 
 
Accounts receivable
4

 
417

 
664

Other assets
(27
)
 
(23
)
 
190

Due to/from related parties, net
(114
)
 
(18
)
 
39

Accounts payable
60

 
(10
)
 
(68
)
Accrued expenses
122

 
18

 
(41
)
Income taxes payable
8

 
(36
)
 
38

Unearned revenue
199

 
45

 
(284
)
Net cash provided by operating activities
1,395

 
1,297

 
361

Investing activities:
 
 
 
 
 
Additions to property and equipment
(105
)
 
(79
)
 
(18
)
Purchases of available-for-sale securities
(2,152
)
 
(2,211
)
 
(38
)
Sales of available-for-sale securities
1,253

 
979

 
43

Maturities of available-for-sale securities
770

 
619

 
20

Proceeds from disposition of assets

 
3

 

Purchases of strategic investments
(32
)
 
(27
)
 

Proceeds from sales of strategic investments
6

 
1

 

Business combinations, net of cash acquired
(236
)
 
(59
)
 

Net cash paid on disposition of business
(41
)
 

 

Increase in restricted cash

 
(2
)
 

Net cash provided by (used in) investing activities
(537
)
 
(776
)
 
7

Financing activities:
 
 
 
 
 
Proceeds from issuance of common stock
76

 
52

 
61

Payment to acquire non-controlling interests

 
(4
)
 

Repurchase of common stock
(425
)
 

 

Excess tax benefits from stock-based compensation

 
1

 
5

Shares repurchased for tax withholdings on vesting of restricted stock
(177
)
 
(72
)
 
(4
)
Net cash provided by (used in) financing activities
(526
)
 
(23
)
 
62

Net increase in cash and cash equivalents
332

 
498

 
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
$
3,552

 
$
2,991

 
$
3,220

Supplemental disclosures of cash flow information:
 
 
 
 
 
Cash paid for interest
$
16

 
$
14

 
$

Cash paid for taxes, net
63

 
135

 
3

Non-cash items:
 
 
 
 
 
Changes in capital additions, accrued but not paid
$
6

 
$
(19
)
 
$
(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 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
Effective January 1, 2017, VMware’s fiscal year changed 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 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 and six months ended June 30, 2016 are comparable to the three and six months ended August 4, 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 August 4, 2017, Dell controlled 81.4% of VMware’s outstanding common stock and 97.5% of the combined voting power of VMware’s outstanding common stock, including 33 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 effects that Topic 606 will have on its consolidated financial statements and related disclosures, and its 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 and six months ended August 4, 2017 were $13 million and $44 million, respectively. Prior to adopting the updated standard, such amounts were recognized in additional paid-in capital on the Company’s consolidated balance sheets.
Additionally, all tax-related cash flows resulting from stock-based awards are reported as operating activities in the statements of cash flows. Prior to adopting the updated standard, excess tax benefits were reported as a cash inflow from financing activities in the statements 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. 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.
Dell purchases VMware products and services directly from VMware, as well as through VMware’s channel partners. 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
 
Six Months Ended
 
January 1 to
 
 
 
 
 
Transition Period
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
August 4,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
 
2017
 
2016
 
2017
Reseller revenue
$
282

 
$
85

 
$
505

 
$
163

 
$
44

 
$
806

 
$
637

 
$
616

Internal-use revenue
4

 
14

 
9

 
19

 
7

 
9

 
15

 
18

Professional services revenue
26

 
26

 
55

 
51

 
3

 

 

 

Agency fee revenue

 
1

 
1

 
2

 

 

 

 

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.

9

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

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.
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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Purchases and leases of products and purchases of services
$
32

 
$
17

 
$
68

 
$
34

 
$
14

Dell subsidiary support and administrative costs
33

 
21

 
62

 
44

 
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.
During the second quarter of fiscal 2018, VMware acquired Wavefront, Inc. (“Wavefront”). Upon closing of the acquisition, Dell was paid $20 million in cash for its ownership interest in Wavefront.
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. Revenue recognized on transactions financed through DFS was recorded net of financing fees, which were $7 million and $9 million during the three and six months ended August 4, 2017, respectively. Financing fees during the Transition Period were not significant.
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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Payments from VMware to Dell
$
12

 
$
54

 
$
12

 
$
95

 
$

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 pursuant to the tax sharing agreement was not significant during the three and six months ended August 4, 2017 and the Transition Period, and was $14 million and $15 million during the three and six months ended June 30, 2016, respectively.

10

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

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
 
August 4,
 
December 31,
 
February 3,
 
2017
 
2016
 
2017
Due (to) related parties
$
(67
)
 
$
(71
)
 
$
(85
)
Due from related parties
274

 
203

 
178

Due from related parties, net
$
207

 
$
132

 
$
93

 
 
 
 
 
 
Income tax related asset, net
$

 
$
181

 
$

Income tax due (to) related parties
(14
)
 

 
(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.
Stock Purchase Agreements with Dell
On March 29, 2017, VMware entered into a stock purchase agreement to purchase $300 million of VMware Class A common stock from Dell. During the first quarter of fiscal 2018, VMware paid Dell $300 million in exchange for an initial delivery 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 3.4 million shares 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 to purchase $500 million of VMware Class A common stock from Dell. 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.
On August 23, 2017, VMware entered into a stock purchase agreement to purchase $300 million of VMware Class A common stock from Dell. Purchases under this agreement are expected to occur during fiscal 2018. The aggregate number of shares purchased will be determined based upon a 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 August 4, 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 and six months ended August 4, 2017, $7 million and $13 million, respectively, of interest expense was recognized. During the three and six months ended June 30, 2016 and the Transition Period, $7 million, $13 million and $2 million, respectively, of interest expense was recognized.
On August 21, 2017, VMware repaid certain of the notes payable to Dell in the aggregate principal amount of $1,230 million. The aggregate principal amount included repayment of the note due May 1, 2018 at par value and repayment of the note due May 1, 2020 at a discount. Refer to Note N for further information regarding subsequent events.
C. Business Combinations, Definite-Lived Intangible Assets, Net and Goodwill
Business Combinations
During the second quarter of fiscal 2018, VMware completed the acquisitions of Wavefront and Apteligent, Inc., which were not material to the condensed consolidated financial statements. These acquisitions are part of a strategy to accelerate the development of VMware’s Cloud services and other technologies. The aggregate purchase price for the two acquisitions was $238 million, net of cash acquired of $35 million. The aggregate purchase price included $36 million of identifiable intangible

11

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

assets and $238 million of goodwill that is not expected to be deductible for tax purposes. The identifiable intangible assets primarily relate to purchased technology, with estimated useful lives of five years. The fair value of assumed unvested equity attributed to post-combination services was $37 million and will be expensed over the remaining requisite service periods on a straight-line basis. The estimated fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model.
Prior to the closing of the acquisition, VMware held an ownership interest in Wavefront. Upon completion of the step acquisition, VMware recognized a gain of $34 million in other income (expense), net for the remeasurement of its ownership interest to fair value, which was $49 million. The gain recognized on the step acquisition is not expected to be taxable and resulted in a discrete tax benefit of $13 million during the second quarter of fiscal 2018. Upon closing of the acquisition, Dell was paid $20 million in cash for its ownership interest in Wavefront.
The pro forma financial information assuming the acquisition had occurred as of the beginning of the fiscal year prior to the fiscal year of acquisition, as well as the revenue and earnings generated during the current fiscal year, were not material for disclosure purposes.
Definite-Lived Intangible Assets, Net
As of the periods presented, definite-lived intangible assets consisted of the following (amounts in tables in millions):
 
August 4, 2017
 
Weighted-Average Useful Lives
(in years)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
Purchased technology
6.5
 
$
663

 
$
(412
)
 
$
251

Leasehold interest
34.9
 
149

 
(26
)
 
123

Customer relationships and customer lists
8.2
 
135

 
(71
)
 
64

Trademarks and tradenames
8.5
 
63

 
(27
)
 
36

Other
5.7
 
5

 
(3
)
 
2

Total definite-lived intangible assets
 
 
$
1,015

 
$
(539
)
 
$
476

 
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


12

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 $34 million and $66 million during the three and six months ended August 4, 2017, respectively, and $32 million and $65 million during the three and six months ended June 30, 2016, respectively. Amortization expense on definite-lived intangible assets was $10 million during the Transition Period.
Based on intangible assets recorded as of August 4, 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
$
67

2019
124

2020
100

2021
46

2022
31

Thereafter
108

Total
$
476

Goodwill
The following table summarizes the changes in the carrying amount of goodwill during the six months ended August 4, 2017 (table in millions):
Balance, February 3, 2017
$
4,032

Increase in goodwill related to business combinations
238

Balance, August 4, 2017
$
4,270

D. Realignment and Loss on Disposition
Disposition of VMware vCloud Air Business
During the second quarter of fiscal 2018, VMware completed the sale of its VMware vCloud Air business (“vCloud Air”) to OVH US LLC (“OVH”). Losses recognized in connection with this transaction were $36 million and $86 million during the three and six months ended August 4, 2017, respectively, and were recorded in realignment and loss on disposition on the condensed consolidated statements of income. Losses recognized on the disposition of vCloud Air include the impairment of fixed assets identified as part of the sale, as well as the costs associated with certain transition services, which primarily include employee-related expenses and costs associated with data-center colocation services. Transition services are to be provided over a period of 18 months, starting from the date of the sale. The losses recognized on the disposition of vCloud Air are deductible for tax purposes and resulted in a discrete tax benefit of $12 million during the second quarter of fiscal 2018.
In connection with the disposition of vCloud Air, approximately $35 million of total unearned revenue, including $18 million of unearned license revenue, was transferred to OVH during the second quarter of fiscal 2018.

13

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

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 six months ended June 30, 2016. VMware recognized $49 million of severance-related realignment expenses during the six months ended June 30, 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 six months ended June 30, 2016. Actions associated with this plan were substantially completed by December 31, 2016.
The following table summarizes the activity for the accrued realignment expenses for the period presented (table in millions):
 
Six Months Ended June 30, 2016
 
Balance as of
January 1, 2016
 
Realignment
 
Utilization
 
Balance as of
June 30, 2016
Severance-related costs
$
3

 
$
49

 
$
(50
)
 
$
2

Costs to exit facilities

 
3

 

 
3

Total
$
3

 
$
52

 
$
(50
)
 
$
5

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, except per share amounts and shares in thousands):
 
 
 
 
 
 
 
 
 
Transition Period
 
Three Months Ended
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Net income (loss)
$
334

 
$
265

 
$
566

 
$
426

 
$
(8
)
Weighted-average shares, basic for Class A and Class B
408,399

 
425,107

 
408,415

 
424,169

 
408,625

Effect of other dilutive securities
4,369

 
1,995

 
5,505

 
1,560

 

Weighted-average shares, diluted for Class A and Class B
412,768

 
427,102

 
413,920

 
425,729

 
408,625

Net income (loss) per weighted-average share, basic for Class A and Class B
$
0.82

 
$
0.62

 
$
1.39

 
$
1.00

 
$
(0.02
)
Net income (loss) per weighted-average share, diluted for Class A and Class B(1)
$
0.81

 
$
0.62

 
$
1.37

 
$
1.00

 
$
(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.

14

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

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
 
Six Months Ended
 
January 1 to
 
August 4,
 
June 30,
 
August 4,
 
June 30,
 
February 3,
 
2017
 
2016
 
2017
 
2016
 
2017
Anti-dilutive securities:
 
 
 
 
 
 
 
 
 
Employee stock options
845

 
2,065

 
870

 
2,207

 
2,353

Restricted stock units
499

 
3,315

 
250

 
9,512

 
3,259

Total
1,344

 
5,380

 
1,120

 
11,719

 
5,612

F. Cash, Cash Equivalents and Investments
Cash, cash equivalents and investments as of the periods presented consisted of the following (tables in millions):
 
August 4, 2017
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate Fair Value
Cash
$
473

 
$

 
$

 
$
473

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
2,848

 
$

 
$

 
$
2,848

U.S. Government and agency obligations
45

 

 

 
45

U.S. and foreign corporate debt securities
183

 

 

 
183

Foreign governments and multi-national agency obligations
3

 

 

 
3

Total cash equivalents
$
3,079

 
$

 
$

 
$
3,079

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
940

 
$

 
$
(2
)
 
$
938

U.S. and foreign corporate debt securities
4,170

 
8

 
(5
)
 
4,173

Foreign governments and multi-national agency obligations
74

 

 

 
74

Mortgage-backed securities
134

 

 
(1
)
 
133

Marketable available-for-sale equity securities
15

 
17

 

 
32

Total short-term investments
$
5,333

 
$
25

 
$
(8
)
 
$
5,350


15

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

 
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

 
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 August 4, 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 and six months ended August 4, 2017 and June 30, 2016 and the Transition Period were not significant.

16

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

Unrealized losses on cash equivalents and available-for-sale investments, which have been in a net loss position for less than twelve months as of the periods presented, were classified by sector as follows (table in millions):
 
 
 
 
 
 
 
 
 
Transition Period
 
August 4, 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
$
720

 
$
(2
)
 
$
608

 
$
(3
)
 
$
527

 
$
(3
)
U.S. and foreign corporate debt securities
1,587

 
(5
)
 
2,595

 
(18
)
 
2,287

 
(16
)
Mortgage-backed securities
102

 
(1
)
 
164

 
(2
)
 
151

 
(2
)
Total
$
2,409

 
$
(8
)
 
$
3,367

 
$
(23
)
 
$
2,965

 
$
(21
)
As of the periods presented, 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.
Contractual Maturities
The contractual maturities of fixed income securities included in short-term investments on the condensed consolidated balance sheets and held as of August 4, 2017, consisted of the following (table in millions):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
1,990

 
$
1,989

Due after 1 year through 5 years
3,138

 
3,140

Due after 5 years through 10 years
95

 
95

Due after 10 years
95

 
94

Total fixed income securities
$
5,318

 
$
5,318

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 and notes payable to Dell. As of August 4, 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.
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.

17

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

The following tables set forth the fair value hierarchy of VMware’s cash equivalents, short-term investments and derivatives that were required to be measured at fair value as of the periods presented (tables in millions):
 
August 4, 2017
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 


Money-market funds
$
2,848

 
$

 
$
2,848

U.S. Government and agency obligations

 
45

 
45

U.S. and foreign corporate debt securities

 
183

 
183

     Foreign governments and multi-national agency obligations

 
3

 
3

Total cash equivalents
$
2,848

 
$
231

 
$
3,079

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
659

 
$
279

 
$
938

U.S. and foreign corporate debt securities

 
4,173

 
4,173

Foreign governments and multi-national agency obligations

 
74

 
74

Mortgage-backed securities

 
133

 
133

Marketable available-for-sale equity securities
32

 

 
32

Total short-term investments
$
691

 
$
4,659

 
$
5,350

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


18

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

During the first quarter of 2018, marketable available-for-sale equity securities were reclassified to short-term investments on the condensed consolidated balance sheets, as restrictions on the Company’s ability to sell the common stock lapse within twelve months of the balance sheet date. 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 $1,477 million, $1,489 million and $1,492 million as of August 4, 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 $48 million, $35 million and $36 million as of August 4, 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 investment to its fair value.
Strategic investments are included in other assets on the condensed consolidated balance sheets. The carrying value of VMware’s strategic investments was $151 million, $139 million and $139 million as of August 4, 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 Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreements. VMware

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

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 and six months ended August 4, 2017 and June 30, 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 August 4, 2017, December 31, 2016 and February 3, 2017, outstanding forward contracts had a total notional value of $134 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 and six months ended August 4, 2017 and June 30, 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 August 4, 2017, December 31, 2016 and February 3, 2017, outstanding forward contracts had a total notional value of $854 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 and six months ended August 4, 2017, VMware recognized losses of $27 million and $35 million, respectively, relating to the settlement of forward contracts. During the three and six months ended June 30, 2016 and the Transition Period, VMware recognized a gain of $11 million, and losses of $12 million and $18 million, respectively. 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 net gains of $10 million and $13 million during the three and six months ended August 4, 2017, respectively. Net losses during the three and six months ended June 30, 2016 and the Transition Period were not significant. 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. Following trial, the jury issued its verdict on June 12, 2017, finding that VMware did not infringe on any of the four bases asserted by Phoenix. The Court entered judgment in VMware’s favor, and the parties are in the post-trial briefing stage. The Company intends to continue vigorously defending itself against this lawsuit.
On March 4, 2015, Christoph Hellwig, a software developer who alleged 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”). 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. No hearing schedule has yet been set by the appellate court.

20

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

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.
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.
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 August 4, 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
 
August 4,
 
December 31,