VMW-6.30.2013-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period            from            to
Commission File Number 001-33622
_______________________________________________________
VMWARE, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________________
Delaware
94-3292913
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
3401 Hillview Avenue
Palo Alto, CA
94304
(Address of principal executive offices)
(Zip Code)
(650) 427-5000
(Registrant’s telephone number, including area code)
______________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 x
 
Accelerated filer
¨
 
 
 
 
 
Non-accelerated filer
 o
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of July 26, 2013, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 429,517,210 of which 129,517,210 shares were Class A common stock and 300,000,000 were Class B common stock.


TABLE OF CONTENTS
 
 
Page
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 

VMware, VMworld, vSphere, VMware vCloud, vCenter, VMware View, VMware vCloud Suite, VMware Horizon Suite, vCloud Hybrid Service, Dynamic Ops, Nicira, Wanova and Virsto are registered trademarks or trademarks of VMware, Inc. in the United States and other jurisdictions. All other marks and names mentioned herein may be trademarks of their respective companies.


2
Table of Contents

PART I
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
VMware, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share amounts)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
License
$
530.5

 
$
517.2

 
$
1,018.7

 
$
999.1

Services
712.6

 
605.8

 
1,415.9

 
1,179.1

Total revenues
1,243.1

 
1,123.0

 
2,434.6

 
2,178.2

Operating expenses (1):
 
 
 
 
 
 
 
Cost of license revenues
54.6

 
56.6

 
111.9

 
113.3

Cost of services revenues
118.5

 
122.7

 
243.1

 
236.8

Research and development
260.7

 
248.6

 
531.2

 
471.0

Sales and marketing
442.1

 
391.5

 
859.5

 
754.9

General and administrative
96.3

 
91.7

 
194.8

 
173.1

Realignment charges
0.6

 
—

 
63.5

 
—

Operating income
270.3

 
211.9

 
430.6

 
429.1

Investment income
7.0

 
6.9

 
14.8

 
12.7

Interest expense with EMC
(0.9
)
 
(1.2
)
 
(1.9
)
 
(2.4
)
Other income (expense), net
16.9

 
(3.5
)
 
13.9

 
(1.4
)
Income before income taxes
293.3

 
214.1

 
457.4

 
438.0

Income tax provision
49.2

 
22.4

 
39.7

 
54.8

Net income
$
244.1

 
$
191.7

 
$
417.7

 
$
383.2

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

 
$
0.45

 
$
0.98

 
$
0.90

Net income per weighted-average share, diluted for Class A and Class B
$
0.57

 
$
0.44

 
$
0.97

 
$
0.88

Weighted-average shares, basic for Class A and Class B
428.3

 
427.2

 
428.2

 
426.1

Weighted-average shares, diluted for Class A and Class B
432.0

 
434.6

 
432.4

 
434.0

__________
 
 
 
 
 
 
 
(1)   Includes stock-based compensation as follows:
 
 
 
 
 
 
 
Cost of license revenues
$
0.5

 
$
0.5

 
$
1.0

 
$
1.0

Cost of services revenues
6.7

 
7.1

 
14.0

 
12.9

Research and development
51.0

 
48.0

 
113.3

 
87.4

Sales and marketing
33.4

 
33.9

 
69.5

 
59.1

General and administrative
11.6

 
11.4

 
25.7

 
22.3

Realignment charges
0.3

 
—

 
5.7

 
—

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


3
Table of Contents

VMware, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
244.1

 
$
191.7

 
$
417.7

 
$
383.2

Other comprehensive income (loss):
 
 
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $(5.6), $(0.1), $(5.0) and $1.0
(9.2
)
 
(0.2
)
 
(8.2
)
 
1.7

Reclassification of (gains) losses realized during the period, net of taxes of $(0.3), $(0.3), $(0.7) and $0.1
(0.4
)
 
(0.4
)
 
(1.1
)
 
0.1

Net change in market value of available-for-sale securities
(9.6
)
 
(0.6
)
 
(9.3
)
 
1.8

Changes in market value of effective foreign currency forward exchange contracts:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $(0.1), $0.0, $(0.1) and $0.0
(1.1
)
 
0.2

 
(1.1
)
 
0.2

Reclassification of (gains) losses realized during the period, net of taxes of $0.0, $0.0, $0.0 and $0.0
0.5

 
(0.7
)
 
—

 
—

Net change in market value of effective foreign currency forward exchange contracts
(0.6
)
 
(0.5
)
 
(1.1
)
 
0.2

Total other comprehensive income (loss)
(10.2
)
 
(1.1
)
 
(10.4
)
 
2.0

Total comprehensive income, net of taxes
$
233.9

 
$
190.6

 
$
407.3

 
$
385.2

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

4
Table of Contents

VMware, Inc.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share amounts)
(unaudited)
 
June 30,
2013
 
December 31,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,839.7

 
$
1,609.3

Short-term investments
3,483.3

 
3,021.5

Accounts receivable, net of allowance for doubtful accounts of $2.1 and $4.3
940.9

 
1,150.9

Due from EMC, net
33.7

 
67.9

Deferred tax assets
158.5

 
179.4

Other current assets
127.8

 
91.0

Total current assets
6,583.9

 
6,120.0

Property and equipment, net
742.8

 
664.7

Other assets, net
107.3

 
128.7

Deferred tax assets
118.8

 
103.0

Intangible assets, net
627.3

 
731.9

Goodwill
2,966.4

 
2,848.1

Total assets
$
11,146.5

 
$
10,596.4

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
87.3

 
$
89.6

Accrued expenses and other
661.4

 
674.7

Unearned revenues
2,230.2

 
2,195.9

Total current liabilities
2,978.9

 
2,960.2

Note payable to EMC
450.0

 
450.0

Unearned revenues
1,366.2

 
1,264.6

Other liabilities
195.1

 
181.6

Total liabilities
4,990.2

 
4,856.4

Contingencies (see Note L)

 

Stockholders’ equity:
 
 
 
Class A common stock, par value $.01; authorized 2,500 shares; issued and outstanding 129.9 and 128.7 shares
1.3

 
1.3

Class B convertible common stock, par value $.01; authorized 1,000 shares; issued and outstanding 300 shares
3.0

 
3.0

Additional paid-in capital
3,440.7

 
3,431.7

Accumulated other comprehensive income (loss)
(4.7
)
 
5.7

Retained earnings
2,716.0

 
2,298.3

Total stockholders’ equity
6,156.3

 
5,740.0

Total liabilities and stockholders’ equity
$
11,146.5

 
$
10,596.4

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

5

VMware, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Operating activities:
 
 
 
 
 
 
 
Net income
$
244.1

 
$
191.7

 
$
417.7

 
$
383.2

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
87.0

 
89.4

 
178.3

 
175.2

Stock-based compensation
103.2

 
100.9

 
219.2

 
182.7

Excess tax benefits from stock-based compensation
(25.6
)
 
(32.7
)
 
(47.8
)
 
(86.4
)
Non-cash realignment charges
0.3

 
—

 
14.8

 
—

Gain on disposition of certain lines of business and other, net
(19.3
)
 
—

 
(19.3
)
 
—

Other
1.0

 
0.4

 
(1.2
)
 
(0.6
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
 
 
 
 
Accounts receivable
(172.6
)
 
(91.3
)
 
207.6

 
135.3

Other assets
(34.2
)
 
(69.6
)
 
(75.0
)
 
(117.1
)
Due to/from EMC, net
(25.2
)
 
(43.4
)
 
34.3

 
12.1

Accounts payable
26.6

 
4.9

 
18.3

 
17.4

Accrued expenses
94.1

 
95.8

 
(21.2
)
 
0.9

Income taxes receivable from EMC
15.5

 
—

 
15.5

 
—

Income taxes payable
(4.1
)
 
12.4

 
(2.3
)
 
67.7

Deferred income taxes, net
37.1

 
(1.4
)
 
8.9

 
(36.4
)
Unearned revenues
206.2

 
134.2

 
262.9

 
233.9

Net cash provided by operating activities
534.1

 
391.3

 
1,210.7

 
967.9

Investing activities:
 
 
 
 
 
 
 
Additions to property and equipment
(76.1
)
 
(44.3
)
 
(153.9
)
 
(78.0
)
Purchases of available-for-sale securities
(917.4
)
 
(1,253.6
)
 
(1,654.3
)
 
(1,955.1
)
Sales of available-for-sale securities
333.6

 
348.4

 
819.2

 
770.8

Maturities of available-for-sale securities
187.7

 
277.1

 
369.7

 
534.1

Proceeds from disposition of certain lines of business
30.0

 
—

 
30.9

 
—

Business acquisitions, net of cash acquired
—

 
(102.2
)
 
(184.5
)
 
(102.2
)
Other investing
(1.0
)
 
(2.6
)
 
(2.1
)
 
(4.2
)
Net cash used in investing activities
(443.2
)
 
(777.2
)
 
(775.0
)
 
(834.6
)
Financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of common stock
47.2

 
33.6

 
115.1

 
144.6

Repurchase of common stock
(120.0
)
 
(178.2
)
 
(302.0
)
 
(178.2
)
Excess tax benefits from stock-based compensation
25.6

 
32.7

 
47.8

 
86.4

Shares repurchased for tax withholdings on vesting of restricted stock
(44.1
)
 
(51.4
)
 
(66.2
)
 
(65.0
)
Net cash used in financing activities
(91.3
)
 
(163.3
)
 
(205.3
)
 
(12.2
)
Net increase (decrease) in cash and cash equivalents
(0.4
)
 
(549.2
)
 
230.4

 
121.1

Cash and cash equivalents at beginning of the period
1,840.1

 
2,626.1

 
1,609.3

 
1,955.8

Cash and cash equivalents at end of the period
$
1,839.7

 
$
2,076.9

 
$
1,839.7

 
$
2,076.9

Non-cash items:
 
 
 
 
 
 
 
Changes in capital additions, accrued but not paid
$
8.6

 
$
18.0

 
$
(4.3
)
 
$
15.3

Changes in tax withholdings on vesting of restricted stock, accrued but not paid
3.0

 
6.0

 
1.0

 
6.8

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

6
Table of Contents

VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Overview and Basis of Presentation
Company and Background
VMware, Inc. (“VMware” or the “Company”) is the leader in virtualization infrastructure solutions utilized by organizations to help them transform the way they build, deliver and consume information technology (“IT”) resources. VMware’s virtualization infrastructure solutions, which include a suite of products designed to deliver a software-defined data center, run on industry-standard desktop computers and servers and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
Accounting Principles
The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
Unaudited Interim Financial Information
These accompanying unaudited 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 consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, for a fair statement of VMware’s consolidated results of operations, financial position and cash flows for the periods presented. Results of operations are not necessarily indicative of the results that may be expected for the full year 2013. Certain information and footnote disclosures typically included in annual consolidated financial statements have been condensed or omitted. Accordingly, these unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in VMware’s 2012 Annual Report on Form 10-K.
As of June 30, 2013, EMC Corporation (“EMC”) holds approximately 79.8% of VMware’s outstanding common stock and 97.2% of the combined voting power of VMware’s outstanding common stock, including 43.0 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock. VMware is a majority-owned and controlled subsidiary of EMC, and its results of operations and financial position are consolidated with EMC’s financial statements. VMware and EMC engage in intercompany transactions, including agreements regarding the use of EMC’s and VMware’s intellectual property and real estate, agreements regarding the sale of goods and services to one another, and an agreement for EMC to resell VMware’s products and services to third party customers. In geographic areas where VMware has not established its own subsidiaries, VMware contracts with EMC subsidiaries for support services and for personnel who are managed by VMware. See Note N to the consolidated financial statements for further information regarding intercompany transactions between VMware and EMC.
Management believes the assumptions underlying the consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with EMC may not be considered arm’s length with an unrelated third party by nature of EMC’s majority ownership of VMware. Therefore, the financial statements included herein may not necessarily reflect the financial position, results of operations and cash flows had VMware engaged in such transactions with an unrelated third party during all periods presented. Accordingly, VMware’s historical financial information is not necessarily indicative of what the Company’s results of operations, financial position and cash flows will be in the future if and when VMware contracts at arm’s length with unrelated third parties for the services the Company receives from and provides to EMC.
Principles of Consolidation
The consolidated financial statements include the accounts of VMware and its subsidiaries. All intercompany transactions and balances between VMware and its subsidiaries have been eliminated. All intercompany transactions with EMC in the consolidated statements of cash flows will be settled in cash, and changes in the current intercompany balances are presented as a component of cash flows from operating activities.
Use of Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting periods, and the disclosure of contingent liabilities at the date of the financial statements. Estimates are used for, but not limited to trade receivable valuation, certain accrued liabilities, useful lives of fixed assets and intangible assets, valuation of acquired intangibles, revenue reserves, income taxes, stock-based compensation and contingencies. Actual results could differ from those estimates.

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

New Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). ASU 2013-02 requires companies to present information about reclassification adjustments from accumulated other comprehensive income in their financial statements or footnotes. ASU 2013-02 is effective for fiscal periods beginning after December 15, 2012. VMware adopted this accounting standard update on January 1, 2013, and presents accumulated other comprehensive income in accordance with the requirements of the standard in this Quarterly Report on Form 10-Q.
In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives, including bifurcated embedded derivatives, repurchase agreements, reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement or similar agreement. ASU 2013-01 is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. VMware adopted this accounting standard update, as amended, on January 1, 2013, and determined that there was no material impact to its consolidated financial statements.
B. Business Combinations and Goodwill
Business Combinations
On February 15, 2013, VMware acquired Virsto Software (“Virsto”), a provider of software that optimizes storage performance and utilization in virtual environments. The consideration paid for this acquisition was $184.5 million, net of cash acquired.
The following table summarizes the allocation of the consideration to the fair value of the tangible and intangible assets acquired and liabilities assumed as of the acquisition date (table in millions):
Intangible assets
$
32.4

Goodwill
162.3

Total intangible assets acquired
194.7

Deferred tax liabilities, net
(0.1
)
Other acquired liabilities, net of acquired assets
(10.1
)
Total net liabilities assumed
(10.2
)
Fair value of intangible assets acquired and net liabilities assumed
$
184.5

During the three months ended June 30, 2013, an adjustment to provisional amounts was recorded, which was not material to VMware’s consolidated financial statements and is not reflected in the table above. The accounting for the Virsto acquisition has not been finalized due to pending items related to open tax returns, which are to be filed in the first quarter of 2014.
The excess of the consideration for Virsto over the fair values assigned to the assets acquired and liabilities assumed, which represents the goodwill resulting from the acquisition, was allocated to VMware’s one operating segment. Management believes that the goodwill represents the synergies expected from combining the technologies of VMware with those of Virsto, including complementary products that will enhance the Company’s overall product portfolio.
The following table summarizes the fair value of the intangible assets acquired by VMware in conjunction with the acquisition of Virsto (amounts in table in millions):
 
Weighted-Average
Useful Lives
(in years)
 
Fair Value
Amount
Purchased technology
5.0
 
$
23.8

In-process research and development

 
8.6

Total intangible assets, net, excluding goodwill
 
 
$
32.4

The results of operations of Virsto described above have been included in VMware’s consolidated financial statements from the date of purchase. Pro forma results of operations have not been presented as the results of the acquired business were not material to VMware’s consolidated results of operations in the three and six months ended June 30, 2013.

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

In the third quarter of 2012, VMware acquired all of the outstanding capital stock of Nicira, Inc. (“Nicira”). The accounting for the Nicira acquisition has not been finalized due to pending items related to open tax returns, which are to be filed in the third quarter of 2013. Additionally, the accounting has not been finalized for certain other business combinations made within the last year. These business combinations were not material to VMware’s financial statements. For all business combinations where the accounting has not been finalized, VMware has recorded provisional amounts in its consolidated financial statements. During the measurement period, VMware may record adjustments to the provisional amounts recorded.
Goodwill
The following table summarizes the changes in the carrying amount of goodwill for the six months ended June 30, 2013 (table in millions):
Balance, January 1, 2013
$
2,848.1

Increase in goodwill related to business combination
162.3

Contribution to GoPivotal, Inc. (“Pivotal”; see Note N)
(28.4
)
Reduction related to business realignment plan
(4.2
)
Deferred tax adjustments to purchase price allocations on prior-year acquisitions
(10.8
)
Other adjustments to purchase price allocations on prior-year acquisitions
(0.6
)
Balance, June 30, 2013
$
2,966.4

C. Realignment Charges
Realignment Plan
In January 2013, VMware approved a business realignment plan to streamline its operations. As of June 30, 2013, the plan was substantially completed, and it is expected to be fully completed by the end of 2013. The total charge resulting from this plan is expected to be between $70.0 million and $85.0 million, with total cash expenditures associated with the plan expected to be in the range of $50.0 million to $60.0 million. The associated cash payments are expected to be paid out primarily through the end of 2013.
The plan includes the elimination of approximately 750 positions and personnel across all major functional groups and geographies, which is expected to result in a total charge in the range of $55.0 million to $60.0 million. As of June 30, 2013, approximately 710 of the employees had been terminated. Of the total expected charge for workforce reductions, $2.5 million and $56.4 million, respectively, were recorded on the consolidated statements of income for the three and six months ended June 30, 2013. The remainder of the workforce reduction charge primarily relates to employees in foreign jurisdictions and will be recognized in future periods as the expected severance amounts are finalized. Additionally, VMware exited certain lines of business and consolidated and is planning to consolidate facilities, which VMware expects to result in a total charge, including asset impairments recorded in the prior quarter, in the range of $15.0 million to $25.0 million, of which $1.8 million and $10.8 million, respectively, was recorded on the consolidated statements of income for the three and six months ended June 30, 2013.
The following tables summarize the activity for the accrued realignment charges for the three and six months ended June 30, 2013 (tables in millions):
 
For the Three Months Ended June 30, 2013
 
Balance as of
March 31, 2013
 
Realignment
Charges
 
Utilization
 
Adjustments and Reversals
 
Balance as of
June 30, 2013
 
Non-Cash Portion
of Utilization
Workforce reductions
$
25.8

 
$
2.5

 
$
(23.0
)
 
$
(3.7
)
 
$
1.6

 
$
(0.3
)
Asset impairments, exit of facilities and other exit costs
—

 
1.8

 
(1.3
)
 
—

 
0.5

 
—

Total
$
25.8

 
$
4.3

 
$
(24.3
)
 
$
(3.7
)
 
$
2.1

 
$
(0.3
)

9
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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

 
For the Six Months Ended June 30, 2013
 
Balance as of
January 1, 2013
 
Realignment
Charges
 
Utilization
 
Adjustments and Reversals
 
Balance as of
June 30, 2013
 
Non-Cash Portion
of Utilization
Workforce reductions
$
—

 
$
56.4

 
$
(51.1
)
 
$
(3.7
)
 
$
1.6

 
$
(5.7
)
Asset impairments, exit of facilities and other exit costs
—

 
10.8

 
(10.3
)
 
—

 
0.5

 
(9.0
)
Total
$
—

 
$
67.2

 
$
(61.4
)
 
$
(3.7
)
 
$
2.1

 
$
(14.7
)
Adjustments and reversals for the workforce reduction primarily relate to the reversal of severance amounts for employees who were hired by certain acquirers in conjunction with VMware’s exit of certain lines of business in the third quarter of 2013. The non-cash portion of utilization for the workforce reduction relates to equity compensation. The non-cash portion of asset impairments and exit of facilities primarily relates to the write-off of intangible assets due to disposition.
Other Related Activities
In connection with VMware's business realignment plan, in the three months ended June 30, 2013, VMware disposed of certain lines of business that were no longer aligned with VMware's core business priorities. VMware recognized a pre-tax gain of $31.9 million on the dispositions. The gain was recorded to other income (expense), net on the consolidated statements of income for the three and six months ended June 30, 2013.
As of June 30, 2013, VMware had reclassified assets of $18.7 million, primarily related to intangible assets for a line of business it exited in the third quarter of 2013, to assets held for sale. Additionally, $21.0 million in unearned revenues was reclassified to liabilities held for sale. Assets held for sale are reported in other current assets, while liabilities held for sale are reported in accrued expenses and other on the consolidated balance sheet as of June 30, 2013.
D. Earnings per Share
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares outstanding and potentially dilutive securities outstanding during the period, as calculated using the treasury stock method. Potentially dilutive securities primarily include unvested restricted stock units, stock options and purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate earnings 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 per share for the three and six months ended June 30, 2013 and 2012 (table in millions, except per share data):
 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
244.1

 
$
191.7

 
$
417.7

 
$
383.2

Weighted-average shares, basic for Class A and Class B
428.3

 
427.2

 
428.2

 
426.1

Effect of dilutive securities
3.7

 
7.4

 
4.2

 
7.9

Weighted-average shares, diluted for Class A and Class B
432.0

 
434.6

 
432.4

 
434.0

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

 
$
0.45

 
$
0.98

 
$
0.90

Net income per weighted-average share, diluted for Class A and Class B
$
0.57

 
$
0.44

 
$
0.97

 
$
0.88

For the three months ended June 30, 2013 and 2012, stock options to purchase 1.0 million and 0.4 million shares, respectively, of VMware Class A common stock, and for the six months ended June 30, 2013 and 2012, stock options to purchase 0.8 million and 0.4 million shares, respectively, of VMware Class A common stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive.

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

For the three months ended June 30, 2013 and 2012, 3.1 million and 2.7 million shares, respectively, of restricted stock, and for the six months ended June 30, 2013 and 2012, 2.2 million and 1.5 million shares, respectively, of restricted stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive.
E. Investments
Investments as of June 30, 2013 and December 31, 2012 consisted of the following (tables in millions):
 
June 30, 2013
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
U.S. Government and agency obligations
$
402.1

 
$
0.5

 
$
(0.5
)
 
$
402.1

U.S. and foreign corporate debt securities
1,986.1

 
3.2

 
(6.6
)
 
1,982.7

Foreign governments and multi-national agency obligations
37.3

 
—

 
(0.1
)
 
37.2

Municipal obligations
915.3

 
1.6

 
(2.2
)
 
914.7

Asset-backed securities
4.1

 
—

 
—

 
4.1

Mortgage-backed securities
144.3

 
0.2

 
(2.0
)
 
142.5

Total investments
$
3,489.2

 
$
5.5

 
$
(11.4
)
 
$
3,483.3

 
December 31, 2012
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
U.S. Government and agency obligations
$
373.9

 
$
1.1

 
$
—

 
$
375.0

U.S. and foreign corporate debt securities
1,545.4

 
6.1

 
(0.5
)
 
1,551.0

Foreign governments and multi-national agency obligations
40.6

 
—

 
—

 
40.6

Municipal obligations
972.9

 
2.7

 
(0.5
)
 
975.1

Asset-backed securities
1.0

 
—

 
—

 
1.0

Mortgage-backed securities
78.5

 
0.4

 
(0.1
)
 
78.8

Total investments
$
3,012.3

 
$
10.3

 
$
(1.1
)
 
$
3,021.5

In addition, VMware evaluated its investments as of June 30, 2013 and December 31, 2012 and determined that there were no unrealized losses that indicated an other-than-temporary impairment.
In the three and six months ended June 30, 2013, VMware recognized a $13.0 million charge for a non-recoverable strategic investment. All other realized gains and losses on investments in the three and six months ended June 30, 2013 and 2012 were not material.

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

As of June 30, 2013 and December 31, 2012, VMware did not have investments in a material continuous unrealized loss position for twelve months or greater. Unrealized losses on investments as of June 30, 2013 and December 31, 2012, which have been in a net loss position for less than twelve months, were classified by investment category as follows (table in millions):
 
June 30, 2013
 
December 31, 2012
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
U.S. Government and agency obligations
$
180.8

 
$
(0.5
)
 
$
34.9

 
$
—

U.S. and foreign corporate debt securities
1,053.4

 
(6.6
)
 
315.6

 
(0.5
)
Foreign governments and multi-national agency obligations
64.1

 
(0.1
)
 
5.5

 
—

Municipal obligations
333.4

 
(2.2
)
 
259.4

 
(0.5
)
Asset-backed securities
4.1

 
—

 
—

 
—

Mortgage-backed securities
118.2

 
(2.0
)
 
27.4

 
(0.1
)
Total
$
1,754.0

 
$
(11.4
)
 
$
642.8

 
$
(1.1
)
Contractual Maturities
The contractual maturities of investments held at June 30, 2013 consisted of the following (table in millions):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
872.1

 
$
873.4

Due after 1 year through 5 years
2,478.4

 
2,473.0

Due after 5 years
138.7

 
136.9

Total investments
$
3,489.2

 
$
3,483.3

F. Fair Value Measurements
GAAP provides that fair value is an exit price, representing the amount that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, GAAP established a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) inputs are quoted prices in active markets for identical assets or liabilities; (Level 2) inputs other than the quoted prices included within Level 1 that are observable for the assets or liabilities, either directly or indirectly; and (Level 3) unobservable inputs for the assets or liabilities in which there is little or no market data, which requires VMware to develop its own assumptions.
VMware’s Level 1 classification of the fair value hierarchy includes money market funds and certain available-for-sale fixed income securities because these securities are valued using quoted prices in active markets for identical assets.
VMware’s Level 2 classification includes the remainder of the available-for-sale fixed income securities because these securities are priced using quoted market prices for similar instruments and non-binding market prices that are corroborated by observable market data. VMware obtains the fair values of its Level 2 financial instruments based upon fair values obtained from its custody bank. In addition, VMware obtains fair values of its Level 2 financial instruments from the asset manager of each of its portfolios. VMware validates the fair value provided by its custody bank by comparing it against the independent pricing information obtained from the asset managers. Independently, the custody bank and the asset managers use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable instruments, or inputs other than quoted prices that are observable either directly or indirectly. VMware is ultimately responsible for the financial statements and underlying estimates.
Additionally, VMware’s Level 2 classification includes foreign currency forward contracts as the valuation inputs for these are based upon quoted prices and quoted pricing intervals from public data sources. The fair value of these contracts was not material for any period presented. VMware does not have any material assets or liabilities that fall into Level 3 of the fair value hierarchy as of June 30, 2013 and December 31, 2012.

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

The following tables set forth the fair value hierarchy of VMware’s money market funds and available-for-sale securities, including those securities classified within cash and cash equivalents on the consolidated balance sheets, that were required to be measured at fair value as of June 30, 2013 and December 31, 2012 (tables in millions):
 
June 30, 2013
 
Level 1
 
Level 2
 
Total
Money-market funds
$
1,344.2

 
$
—

 
$
1,344.2

U.S. Government and agency obligations
279.4

 
122.7

 
402.1

U.S. and foreign corporate debt securities
—

 
2,044.6

 
2,044.6

Foreign governments and multi-national agency obligations
—

 
37.2

 
37.2

Municipal obligations
—

 
914.7

 
914.7

Asset-backed securities
—

 
4.1

 
4.1

Mortgage-backed securities
—

 
142.5

 
142.5

Total
$
1,623.6

 
$
3,265.8

 
$
4,889.4

 
December 31, 2012
 
Level 1
 
Level 2
 
Total
Money-market funds
$
1,125.2

 
$
—

 
$
1,125.2

U.S. Government and agency obligations
249.8

 
155.2

 
405.0

U.S. and foreign corporate debt securities
—

 
1,568.6

 
1,568.6

Foreign governments and multi-national agency obligations
—

 
40.6

 
40.6

Municipal obligations
—

 
975.1

 
975.1

Asset-backed securities
—

 
1.0

 
1.0

Mortgage-backed securities
—

 
78.8

 
78.8

Total
$
1,375.0

 
$
2,819.3

 
$
4,194.3

G. Derivative Instruments
VMware conducts business in several foreign currencies and has international sales and expenses denominated in foreign currencies, subjecting the Company to foreign currency risk. To mitigate this risk, VMware enters into hedging activities as described below. The counterparties to VMware’s foreign currency forward contracts are multi-national commercial banks considered to be credit-worthy. VMware does not enter into speculative foreign exchange contracts for trading purposes.
Cash Flow Hedging Activities
To mitigate its exposure to foreign currency fluctuations resulting from operating expenses denominated in certain foreign currencies, VMware enters into foreign currency forward contracts. The Company designates these forward contracts as cash flow hedging instruments as the accounting criteria for such designation has been met. Therefore, the effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported in accumulated other comprehensive income (loss) on the consolidated balance sheet and is subsequently reclassified to the related operating expense line item in the consolidated statements of income in the same period that the underlying expenses are incurred. 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 in the consolidated statements of income as incurred.
VMware generally enters into cash flow hedges semi-annually with maturities of six months or less. As of June 30, 2013 and December 31, 2012, VMware had forward contracts to purchase foreign currency designated as cash flow hedges with a total notional value of $75.9 million and $9.3 million, respectively. The fair value of these forward contracts was immaterial as of June 30, 2013 and December 31, 2012, and therefore excluded from the fair value tables above. For the three and six months ended June 30, 2013, all cash flow hedges were considered effective.
Balance Sheet Hedging Activities
In order to manage exposure to foreign currency fluctuations, VMware enters into foreign currency forward contracts to hedge a portion of its net outstanding monetary assets and liabilities against movements in certain foreign exchange rates. 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 in the consolidated statements of income. The

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

gains and losses on VMware’s foreign currency forward contracts generally offset the majority of the gains and losses associated with the underlying foreign-currency denominated assets and liabilities that VMware hedges.
VMware’s foreign currency forward contracts are generally traded on a monthly basis with a typical contractual term of one month. As of June 30, 2013 and December 31, 2012, VMware had outstanding forward contracts with a total notional value of $322.9 million and $439.8 million, respectively. The fair value of these forward contracts was immaterial as of June 30, 2013 and December 31, 2012 and therefore excluded from the fair value tables above.
In the three months ended June 30, 2013 and 2012, VMware recognized gains of $4.8 million and $3.1 million, respectively, on its consolidated statements of income for its foreign currency forward contracts. In the six months ended June 30, 2013 and 2012, VMware recognized a gain of $15.7 million and a loss of $1.4 million, respectively, on its consolidated statements of income for its foreign currency forward contracts.
The net impact of the gains and losses on VMware’s foreign currency forward contracts and the gains and losses associated with the underlying foreign-currency denominated assets and liabilities resulted in net losses of $2.8 million and $2.6 million in the three months ended June 30, 2013 and 2012, respectively, and net losses of $5.3 million and $1.4 million in the six months ended June 30, 2013 and 2012, respectively,
H. Property and Equipment, Net
Property and equipment, net, as of June 30, 2013 and December 31, 2012 consisted of the following (table in millions):
 
June 30,
 
December 31,
 
2013
 
2012
Equipment and software
$
684.3

 
$
636.5

Buildings and improvements
483.5

 
438.3

Furniture and fixtures
69.3

 
67.2

Construction in progress
140.8

 
97.0

Total property and equipment
1,377.9

 
1,239.0

Accumulated depreciation
(635.1
)
 
(574.3
)
Total property and equipment, net
$
742.8

 
$
664.7

Depreciation expense was $33.7 million and $32.9 million in the three months ended June 30, 2013 and 2012, respectively. Depreciation expense was $69.0 million and $65.7 million in the six months ended June 30, 2013 and 2012, respectively.
As of June 30, 2013 and December 31, 2012, construction in progress primarily represented buildings and site improvements related to VMware’s Palo Alto campus expansion that had not yet been placed into service.
I. Accrued Expenses and Other
Accrued expenses and other as of June 30, 2013 and December 31, 2012 consisted of the following (table in millions):
 
June 30,
 
December 31,
 
2013
 
2012
Salaries, commissions, bonuses, and benefits
$
278.8

 
$
292.2

Accrued partner liabilities
121.0

 
128.9

Other
261.6

 
253.6

Total
$
661.4

 
$
674.7

Accrued partner liabilities relate to rebates and marketing development fund accruals for channel partners, system vendors and systems integrators, as well as accrued royalties.

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

J. Unearned Revenues
Unearned revenues as of June 30, 2013 and December 31, 2012 consisted of the following (table in millions):
 
June 30,
 
December 31,
 
2013
 
2012
Unearned license revenues
$
427.2

 
$
462.7

Unearned software maintenance revenues
2,903.3

 
2,755.0

Unearned professional services revenues
265.9

 
242.8

Total unearned revenues
$
3,596.4

 
$
3,460.5

Unearned license revenues are either recognized ratably, recognized upon delivery of existing or future products or services, or will be recognized ratably upon delivery of future products or services. 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 a promotional product at no additional charge. VMware regularly offers product promotions to improve awareness of its emerging products. To the extent promotional products have not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Unearned license revenue may also be recognized ratably, which is generally due to a right to receive unspecified future products or a lack of VSOE of fair value on the software maintenance element of the arrangement. At June 30, 2013, the ratable component represented over half of the total unearned license revenue balance. Unearned software maintenance revenues are attributable to VMware’s maintenance contracts and are recognized ratably, typically over terms of one to five years with a weighted-average remaining term at June 30, 2013 of approximately 2.0 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are recognized as the services are delivered.
K. Income Taxes
Although VMware files a consolidated federal tax return with EMC, the income tax provision is calculated under a hybrid method, primarily as though VMware were a separate taxpayer, however, where VMware and EMC are parties to transactions outside the normal course of business, the tax consequences of these transactions are determined in accordance with consolidated return rules. The Company’s effective tax rate in the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The rate at which the provision for income taxes is calculated differs from the U.S. federal statutory income tax rate primarily due to differential tax rates in foreign jurisdictions where income is earned and considered to be indefinitely reinvested.
VMware’s effective income tax rate was 16.8% and 10.5% for the three months ended June 30, 2013 and 2012, respectively. The effective income tax rate was 8.7% and 12.5% for the six months ended June 30, 2013 and 2012, respectively. The higher effective rate for the three months ended June 30, 2013 compared with the three months ended June 30, 2012 was primarily attributable to the unfavorable tax impact of VMware’s dispositions associated with VMware’s business realignment plan during the three months ended June 30, 2013, as well as to a jurisdictional shift of income from lower-tax non-U.S. jurisdictions to the United States. Additionally, the federal R&D credit applicable to 2013 favorably impacted the effective tax rate for the three months ended June 30, 2013. The lower effective rate for the six months ended June 30, 2013 compared with the six months ended June 30, 2012 was primarily attributable to the discrete tax benefits recognized in the six months ended June 30, 2013 due to the retroactive enactment of the federal R&D tax credit by the United States Congress in January 2013 and the net favorable tax impact of charges under VMware’s realignment plan, which occurred in the first quarter of 2013. This was partially offset by a jurisdictional shift of income from lower-tax non-U.S. jurisdictions to the United States. See Note C to the consolidated financial statements for further information on VMware’s realignment plan and related dispositions.
VMware’s rate of taxation in foreign jurisdictions is lower than the U.S. tax rate. VMware’s international income is primarily earned by VMware’s subsidiaries in Ireland, where the statutory tax rate is 12.5%. Management does not believe that any recent or currently expected developments in non-U.S. tax jurisdictions are reasonably likely to have a material impact on VMware’s effective tax rate. As of June 30, 2013, VMware’s total cash, cash equivalents, and short-term investments were $5,323.0 million, of which $3,736.8 million were held outside the U.S. VMware’s intent is to indefinitely reinvest its non-U.S. funds in its foreign operations, and VMware’s current plans do not demonstrate a need to repatriate them to fund its U.S. operations. VMware plans to meet its U.S. liquidity needs through cash flows from operations, external borrowings, or both. VMware utilizes a variety of tax planning strategies in an effort to ensure that its worldwide cash is available in the locations in which it is needed. If VMware determines these overseas funds are needed for its operations in the U.S., the Company would

15
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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

be required to accrue U.S. taxes on the related undistributed earnings in the period VMware determines the earnings will no longer be indefinitely invested outside the U.S. in order to repatriate these funds. At this time, it is not practicable to estimate the amount of tax that may be payable were VMware to repatriate these funds.
As of June 30, 2013, VMware had gross unrecognized tax benefits totaling $164.2 million, which excludes $7.2 million of offsetting tax benefits. Approximately $156.7 million of VMware’s net unrecognized tax benefits, not including interest and penalties, if recognized, would reduce income tax expense and lower VMware’s effective tax rate in the period or periods recognized. In total, there were $167.6 million of net unrecognized tax benefits, including interest and penalties, which were classified as a non-current liability on the consolidated balance sheet as of June 30, 2013. It is reasonably possible that within the next 12 months audit resolutions could potentially reduce total unrecognized tax benefits by approximately $7.5 million. Due to the closure of tax audits and statutes that lapsed, approximately $5.0 million of uncertain tax benefits were reversed during the six months ended June 30, 2013. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.
VMware recognizes interest expense and penalties related to income tax matters in the income tax provision. VMware recognized approximately $2.8 million in interest and penalties for the six months ended June 30, 2013. Interest and penalties for the three months ended June 30, 2013 were not material. As of June 30, 2013, there were $10.9 million of interest and penalties accrued for unrecognized tax benefits. These amounts are included as components of the $167.6 million of net unrecognized tax benefits as of June 30, 2013.
L. Contingencies
Litigation
From time to time, VMware is subject to legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business, including claims with respect to commercial, product liability, intellectual property, employment, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from government entities regarding the compliance of its contracting and sales practices with applicable regulations. VMware accrues for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. These accruals are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. As of June 30, 2013 and December 31, 2012, the amounts accrued were not material. To the extent there is a reasonable possibility that the losses could exceed the amounts already accrued, management believes that the amount of any such additional loss would also be immaterial to VMware’s consolidated financial position and results of operations.
M. Stockholders’ Equity
VMware Equity Plan and VMware Employee Stock Purchase Plan
In May 2013, VMware amended its 2007 Equity and Incentive Plan to increase the number of shares available for issuance by 13,300,000 shares. VMware also amended its 2007 Employee Stock Purchase Plan to increase the number of shares available for issuance by 7,900,000 shares.
VMware Stock Repurchase Programs
In November 2012, VMware’s Board of Directors authorized the repurchase of up to $250.0 million of VMware’s Class A common stock through the end of 2014. In February 2012, VMware’s Board of Directors authorized the repurchase of up to $600.0 million of VMware’s Class A common stock, which was completed in the second quarter of 2013. Previously, in February 2011, VMware’s Board of Directors authorized the repurchase of up to $550.0 million of VMware’s Class A common stock, which was completed in the second quarter of 2012.
From time to time, future stock repurchases may be made pursuant to the November 2012 authorization in open market transactions or privately negotiated transactions as permitted by securities laws and other legal requirements. VMware is not obligated to purchase any shares under its stock repurchase programs. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. Purchases can be discontinued at any time that VMware feels additional purchases are not warranted. All shares repurchased under VMware’s stock repurchase programs are retired.

16
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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table summarizes stock repurchase activity in the three and six months ended June 30, 2013 and 2012 (table in millions, except per share amounts):
 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2013
 
2012
 
2013
 
2012
Aggregate purchase price
$
120.0

 
$
178.2

 
$
302.0

 
$
178.2

Class A common shares repurchased
1.6

 
1.8

 
4.0

 
1.8

Weighted-average price per share
$
73.26

 
$
96.50

 
$
75.50

 
$
96.50

The amount of repurchased shares includes commissions and was classified as a reduction to additional paid-in capital. As of June 30, 2013, the authorized amount remaining for repurchase was $165.8 million.
VMware Restricted Stock
VMware restricted stock primarily consists of restricted stock unit (“RSU”) awards granted to employees. RSUs are valued based on the VMware stock price on the date of grant, and shares underlying RSU awards are not issued until the restricted stock units vest. Upon vesting, each RSU converts into one share of VMware Class A common stock.
VMware restricted stock also included performance stock unit (“PSU”) awards. Beginning in 2012, VMware granted PSU awards to certain of its executives and employees. The awards will vest through the first quarter of 2015 if certain employee-specific or VMware-designated performance targets are achieved. If minimum performance thresholds are achieved, each PSU award will convert into VMware’s Class A common stock at ratios ranging from 0.5 to 3.0 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 under that PSU award.
The following table summarizes restricted stock activity since January 1, 2013 (units in millions):
 
Number
of
Units
 
Weighted-
Average Grant
Date Fair
Value
(per unit)
Outstanding, January 1, 2013
12.2

 
$
91.93

Granted
4.6

 
72.66

Vested
(2.5
)
 
81.97

Forfeited
(1.4
)
 
92.01

Outstanding, June 30, 2013
12.9

 
87.08

As of June 30, 2013, the 12.9 million of units outstanding included 11.9 million of RSUs, 0.6 million of restricted stock and 0.4 million of PSUs. Such PSUs are convertible into a maximum aggregate of 1.1 million shares.
The total fair value of VMware restricted stock, including restricted stock and restricted stock units that vested in the six months ended June 30, 2013 was $187.1 million. As of June 30, 2013, restricted stock representing 12.9 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $866.5 million based on VMware’s closing price as of June 28, 2013. These awards are scheduled to vest through 2017.

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

Accumulated Other Comprehensive Income (Loss)
The changes in components of accumulated other comprehensive income (loss) in the six months ended June 30, 2013 were as follows (table in millions):
 
Unrealized Losses on
Available-for-Sale Securities
 
Losses on
Cash Flow Hedges
 
Total
Balance, January 1, 2013
$
5.7

 
$
—

 
$
5.7

Other comprehensive loss before reclassifications, net of taxes of $(5.0), $(0.1) and $(5.1)
(8.2
)
 
(1.1
)
 
(9.3
)
Amounts reclassified from accumulated other comprehensive income to the consolidated statement of income, net of taxes of $(0.7), $0.0 and $(0.7)
(1.1
)
 
—

 
(1.1
)
Other comprehensive loss, net
(9.3
)
 
(1.1
)
 
(10.4
)
Balance, June 30, 2013
$
(3.6
)
 
$
(1.1
)
 
$
(4.7
)
Gains (losses) on VMware’s available-for-sale securities are reclassified to investment income on the consolidated statement of income in the same period that they 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 consolidated statement of income in the same period that the underlying expenses are incurred. The amounts recorded to their related operating expense line items on the consolidated statements of income in the three and six months ended June 30, 2013 were not material.
N. Related Party Transactions
Pursuant to an ongoing reseller arrangement with EMC, EMC bundles VMware’s products and services with EMC’s products and sells them to end-users. In the three months ended June 30, 2013 and 2012, VMware recognized revenues of $35.5 million and $45.6 million, respectively, from such contractual arrangement with EMC. In the six months ended June 30, 2013 and 2012, VMware recognized revenues of $71.8 million and $80.6 million, respectively, from such contractual arrangement with EMC. As of June 30, 2013, $160.8 million of revenues from products and services sold under the reseller arrangement were included in unearned revenues.
In the three months ended June 30, 2013 and 2012, VMware recognized professional services revenues of $30.2 million and $23.6 million, respectively, from such contractual agreements with EMC. In the six months ended June 30, 2013 and 2012, VMware recognized revenues of $45.7 million and $42.3 million, respectively, from such contractual agreements with EMC. As of June 30, 2013, $6.0 million of revenues from professional services to EMC customers were included in unearned revenues.
In the three months ended June 30, 2013 and 2012, VMware recognized revenues of $3.3 million and $2.1 million, respectively, from products and services purchased by EMC for internal use pursuant to VMware’s contractual agreements with EMC. In the six months ended June 30, 2013 and 2012, VMware recognized revenues of $6.4 million and $3.8 million, respectively, from such contractual agreements with EMC. As of June 30, 2013, $31.6 million of revenues from products and services purchased by EMC for internal use were included in unearned revenues.
VMware purchased products and services for internal use from EMC for $14.8 million and $5.9 million in the three months ended June 30, 2013 and 2012, respectively, and for $25.0 million and $23.9 million in the six months ended June 30, 2013 and 2012, respectively. Additionally, VMware purchased products and services for internal use from Pivotal for $2.5 million and $5.5 million in the three and six months ended June 30, 2013, respectively.
Although VMware files a consolidated federal tax return with EMC, the income tax provision is calculated under a hybrid method, primarily as though VMware were a separate taxpayer, however, where VMware and EMC are parties to transactions outside the normal course of business, the tax consequences of these transactions are determined in accordance with consolidated return rules. Payments between VMware and EMC under the tax sharing agreement primarily relate to VMware’s portion of federal income taxes on EMC’s consolidated tax return. Payments from VMware to EMC primarily relate to periods for which VMware had federal taxable income, while payments from EMC to VMware relate to periods for which VMware had a federal taxable loss. In the three and six months ended June 30, 2013, EMC paid VMware $15.5 million under the tax sharing agreement and no payments were made by VMware to EMC. In the three and six months ended June 30, 2012, no payments were made by either VMware or EMC under the tax sharing agreement. The amounts that VMware either pays to or receives from EMC for its portion of federal income taxes on EMC’s consolidated tax return differ from the amounts VMware

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

would owe based on the hybrid-method and the difference is presented as a component of stockholders’ equity. For all periods presented, the difference was not material.
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with EMC subsidiaries for support services and EMC personnel who are managed by VMware. The costs incurred by EMC on VMware’s behalf related to these employees are passed on to VMware and VMware is charged a mark-up intended to approximate costs that would have been charged had VMware contracted for such services with an unrelated third party. These costs are included as expenses in VMware’s consolidated statements of income and primarily include salaries, benefits, travel and rent. Additionally, EMC incurs certain administrative costs on VMware’s behalf in the U.S. that are also recorded as expenses in VMware’s consolidated statements of income. The total cost of the services provided to VMware by EMC as described above was $27.2 million and $21.2 million in the three months ended June 30, 2013 and 2012, respectively, and $62.7 million and $49.0 million in the six months ended June 30, 2013 and 2012, respectively.
In the three months ended June 30, 2013 and 2012, $0.9 million and $1.2 million, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on VMware’s consolidated statements of income. In the six months ended June 30, 2013 and 2012, $1.9 million and $2.4 million, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on VMware’s consolidated statements of income. VMware’s interest expense as a separate, stand-alone company may be higher or lower than the amounts reflected in the consolidated financial statements.
In 2011, VMware acquired certain assets relating to EMC’s Mozy cloud-based data storage and data center services, including certain data center assets and a license to certain intellectual property. EMC retained ownership of the Mozy business and its remaining assets and continued to be responsible to Mozy customers for Mozy products and services and to recognize revenue from such products and services. VMware entered into an operational support agreement with EMC through the end of 2012, pursuant to which VMware took over responsibility to operate the Mozy service on behalf of EMC. Pursuant to the support agreement, costs incurred by VMware to support EMC’s Mozy services, plus a mark-up intended to approximate third-party costs and a management fee, were reimbursed to VMware by EMC. In the fourth quarter of 2012, the operational support agreement between VMware and EMC was amended such that VMware would no longer operate the Mozy service on behalf of EMC. Under the amendment, VMware transferred substantially all employees that support Mozy services to EMC and EMC purchased certain assets from VMware in relation to transferred employees. The termination of service and related transfer of employees and sale of assets was substantially completed during the first quarter of 2013. On the consolidated statements of income, such amounts reimbursed by EMC to VMware to operate Mozy were immaterial in the three and six months ended June 30, 2013, and $16.4 million and $30.9 million in the three and six months ended June 30, 2012, respectively. These amounts were recorded as a reduction to the costs VMware incurred.
From time to time, VMware and EMC enter into agreements to collaborate on technology projects. In both the three months ended June 30, 2013 and 2012, VMware received $1.7 million from EMC for EMC’s portion of expenses related to such projects, and in the six months ended June 30, 2013 and 2012, VMware received $3.8 million and $2.8 million, respectively, from such contractual agreements with EMC. In the three months ended June 30, 2013, VMware paid $1.5 million to EMC for services provided to VMware by EMC related to such projects, and in the six months ended June 30, 2013, VMware paid $2.1 million to EMC for such contractual agreements with EMC.
Effective September 1, 2012, Pat Gelsinger succeeded Paul Maritz as Chief Executive Officer of VMware. Prior to joining VMware, Pat Gelsinger was the President and Chief Operating Officer of EMC Information Infrastructure Products. Paul Maritz remains a board member of VMware and currently serves as Chief Executive Officer of Pivotal, a majority-owned subsidiary of EMC in which VMware has an ownership interest. With the exception of a long-term incentive performance award from EMC that Pat Gelsinger agreed to cancel in consideration of a new PSU award from VMware, both Paul Maritz and Pat Gelsinger retained and continue to vest in their respective equity awards that they held as of September 1, 2012. Stock-based compensation related to Pat Gelsinger’s EMC awards will be recognized on VMware’s consolidated statements of income over the awards’ remaining requisite service periods. Stock-based compensation related to Paul Maritz’s VMware awards will be recognized by EMC and Pivotal.
As of June 30, 2013, VMware had $33.7 million net due from EMC, which consisted of $84.5 million due from EMC and $7.9 million due from Pivotal, partially offset by $43.2 million due to EMC and $15.5 million due to Pivotal. These amounts resulted from the related-party transactions with EMC described above, as well as the related-party transactions with Pivotal described below. Additionally, VMware had a net income tax payable due to EMC of $2.3 million as of June 30, 2013, which was included in accrued expenses and other on VMware’s consolidated balance sheet. Balances due to or from EMC which are unrelated to tax obligations are generally settled in cash within 60 days of each quarter-end. The timing of the tax payments due to and from EMC is governed by the tax sharing agreement with EMC.

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

Joint Contribution of Assets with EMC into Pivotal
On April 1, 2013, VMware and EMC contributed certain assets to Pivotal and Pivotal assumed certain liabilities from VMware and EMC. VMware contributed substantially all assets, including intellectual property, to Pivotal, and Pivotal assumed substantially all liabilities, related to certain of its Cloud Application Platform products and services, including VMware’s Cloud Foundry, VMware vFabric (including Spring and GemFire) and Cetas organizations, except for certain tangible assets related to Cloud Foundry. During the three months ended June 30, 2013, VMware transferred approximately 400 VMware employees to Pivotal. EMC contributed substantially all assets, including intellectual property, to Pivotal, and Pivotal assumed substantially all liabilities, related to its Greenplum and Pivotal Labs businesses. Additionally, EMC made a capital contribution to Pivotal. Pivotal assumed substantially all of the rights and responsibilities for the respective support arrangements transferred by VMware and EMC.
In exchange for their contributions, VMware received preferred equity interests in Pivotal equal to approximately 31% of Pivotal’s outstanding shares, and EMC received equity interests in Pivotal equal to approximately 69% of Pivotal’s outstanding shares. Additionally, VMware and Pivotal entered into an agreement with Pivotal pursuant to which VMware will act as the selling agent of the products and services it contributed to Pivotal until at least December 31, 2013 in exchange for a customary agency fee. In the three months ended June 30, 2013, VMware recognized revenues of $1.6 million from such contractual arrangement with Pivotal. VMware also agreed to provide various transition services to Pivotal until at least December 31, 2013. Pursuant to the support agreement, costs incurred by VMware to support Pivotal services are reimbursed to VMware by Pivotal. During the three months ended June 30, 2013, VMware provided transition services of $7.7 million that are reimbursable by Pivotal and which were recorded as a reduction to the costs VMware incurred.
The book value of all contributed assets and the liabilities assumed by Pivotal, with the exception of intangible assets and goodwill, was based on the book values of those assets and liabilities specific to those particular products and services. For intangible assets and goodwill, the book value contributed was based on the relative fair value of the contributed assets applicable to Pivotal.
On April 1, 2013, VMware contributed a net liability of $15.7 million to Pivotal, which was included in VMware’s consolidated balance sheet as of March 31, 2013. During the three months ended June 30, 2013, adjustments to provisional amounts were recorded, which were not material to VMware’s consolidated financial statements. The following table summarizes the assets VMware contributed to Pivotal and the liabilities Pivotal assumed from VMware, adjusted for provisional amounts, which were not material to VMware’s consolidated financial statements (table in millions):
Accounts receivable
$
4.3

Property and equipment, net
1.4

Intangible assets
27.7

Goodwill
28.4

Total assets
61.8

Accounts payable, accrued liabilities and other, net
(6.3
)
Unearned revenues
(71.2
)
Total liabilities
(77.5
)
Total liabilities, net assumed by Pivotal
$
(15.7
)
Of the $71.2 million in unearned revenues assumed by Pivotal, $32.0 million related to unearned license revenues and $39.2 million related to unearned services revenues.
VMware accounts for its investment in Pivotal on a cost basis as VMware’s preferred equity interests have a distribution preference upon dissolution or liquidation of Pivotal. As Pivotal assumed a net liability from VMware, the investment carried by VMware has a cost basis of zero. Thus the net liability assumed by Pivotal of $15.7 million as of April 1, 2013 was classified to additional paid-in capital on VMware’s consolidated balance sheet.
In May 2013, a third-party strategic investor made an investment of approximately $105.0 million in Pivotal. Upon closing of the third-party investment, the interests of EMC, VMware and the third party investor represented approximately 62%, 28% and 10%, respectively, of Pivotal’s outstanding equity.
O. Segment Information
VMware operates in one operating segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources

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

and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level. Since VMware operates in one operating segment, all required financial segment information can be found in the consolidated financial statements.
Revenues by geographic area for the three and six months ended June 30, 2013 and 2012 were as follows (table in millions):
 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2013
 
2012
 
2013
 
2012
United States
$
590.3

 
$
550.7

 
$
1,158.8

 
$
1,035.6

International
652.8

 
572.3

 
1,275.8

 
1,142.6

Total
$
1,243.1

 
$
1,123.0

 
$
2,434.6

 
$
2,178.2

No individual country other than the United States had material revenues for the three and six months ended June 30, 2013 and 2012.
Long-lived assets by geographic area, which primarily include property and equipment, net, as of June 30, 2013 and December 31, 2012 were as follows (table in millions):
 
June 30,
2013
 
December 31,
2012
United States
$
646.2

 
$
562.9

International
51.4

 
51.2

Total
$
697.6

 
$
614.1

No individual country other than the United States accounted for 10% or more of these assets as of June 30, 2013 and December 31, 2012, respectively.

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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All dollar amounts expressed as numbers in this MD&A (except share and per share amounts) are in millions.
Overview
We are the leader in virtualization infrastructure solutions utilized by organizations to help transform the way they build, deliver and consume information technology (“IT”) resources. Our primary source of revenues is from the licensing and support of these solutions to organizations of all sizes and across numerous industries. The benefits of our solutions to our customers include substantially lower IT costs, cost-effective high availability across a wide range of applications and a more automated and resilient systems infrastructure capable of responding dynamically to variable business demands.
We pioneered the development and application of virtualization technologies with x86 server-based computing, separating application software from the underlying hardware. Since then, we have introduced a broad and proven suite of virtualization technologies that address a range of complex IT problems that include cost and operational inefficiencies, facilitating access to cloud computing capacity, business continuity, and corporate end-user computing device management. In 2012, we articulated a vision for the software-defined data center (“SDDC”), where increasingly infrastructure is virtualized and delivered as a service, and the control of this data center is entirely automated by software. To further this vision, in the third quarter of 2012, we released the VMware vCloud Suite, which is the first integrated solution designed to meet the requirements of the SDDC by pooling industry-standard hardware and running compute, networking, storage and management functions in the data center as software-defined services.
Our solutions are based upon our core virtualization technology and are organized into two main product groups: Cloud Infrastructure and Management and End-User Computing. The Cloud Infrastructure and Management product group is based upon our flagship virtualization platform, VMware vSphere. VMware vSphere not only decouples the entire software environment from its underlying hardware infrastructure but also enables the aggregation of multiple servers, storage infrastructures and networks into shared pools of resources that can be delivered dynamically, securely and reliably to applications as needed. The Cloud Infrastructure and Management group also encompasses the VMware vCloud Suite and various Cloud Management solutions that are optimized to work with vSphere environments and are designed to simplify and automate management of dynamic cloud infrastructures that enable enterprises to build, manage and automate their own private clouds. Our End-User Computing product group has solutions designed to enable a user-centric approach to personal computing, including, for example, the VMware Horizon Suite launched in the first quarter of 2013, that enable secure access to applications and data from a variety of devices and locations, and addresses the needs of IT departments by delivering existing end-user assets as a managed service.
We have developed a multi-channel distribution model to expand our presence and reach various segments of the market. We derive a significant majority of our sales from our indirect sales channel, which includes distributors, resellers, system vendors and systems integrators. Sales to our channel partners often involve three tiers of distribution: a distributor, a reseller and an end-user customer. Our sales force works collaboratively with our channel partners to introduce them to end-user customer accounts and new sales opportunities. As we expand geographically, we expect to continue to add additional channel partners.
We expect to grow our business by building long-term relationships with our customers through the adoption of enterprise license agreements (“ELAs”). ELAs are comprehensive volume license offerings offered both directly by us and through certain channel partners that provide for multi-year maintenance and support at discounted prices. Under a typical ELA, a portion of the revenues is attributed to the license revenues and the remainder is primarily attributed to software maintenance revenues. In addition, the initial maintenance period is typically longer for ELAs than for other types of license sales. ELAs enable us to build long-term relationships with our customers as they commit to our virtual infrastructure solutions in their data centers. ELAs also provide a base from which to sell additional products, such as our end-user computing products and our cloud infrastructure and management products. ELAs comprised 37% and 29% of our overall sales during the second quarters of 2013 and 2012, respectively, and 33% and 26% of our overall sales during the first halves of 2013 and 2012, respectively, with the balance represented by our non-ELA, or transactional business. In 2013, in addition to continuing to increase revenues through the adoption of ELAs, we are focused on driving additional transactional business.
In January 2013, we announced a realignment of our strategy to refocus our resources and investments in support of three growth priorities that focus on our core opportunities as a provider of virtualization technologies that simplify IT infrastructure: the software-defined data center, the hybrid cloud and end-user computing. For the SDDC, we plan to continue to invest in the development and delivery of innovations in networking, security, storage and management as we continue to roll out and enhance the features of our vCloud Suite. For the hybrid cloud, we are introducing a public cloud infrastructure as a service offering designed to be completely interoperable with our customers’ VMware virtualized infrastructure. For end-user

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computing, we plan to enhance our offerings to enable a virtual workspace for both existing PC environments and emerging mobile devices in a secure enterprise environment.
In January 2013, we also approved a business realignment plan to streamline our operations and to enhance focus on our three growth priorities. As of June 30, 2013, the plan was substantially completed, and it is expected to be fully completed by the end of 2013. The total charge resulting from this plan is expected to be between $70.0 and $85.0. The plan includes the elimination of approximately 750 positions and personnel across all major functional groups and geographies, which is expected to result in a charge in the range of $55.0 to $60.0, of which $56.4 was recorded in the first half of 2013. Additionally, we exited certain lines of business and consolidated and are planning to consolidate facilities, which are expected to result in a charge in the range of $15.0 to $25.0, of which $10.8 was recorded in the first half of 2013. Although we expect that streamlining our operations will have a favorable impact on our operating expenses in future quarters, we expect that operating expenses related to our headcount will increase as we expect our total headcount to increase by approximately 500 during 2013 as we continue to make key investments in support of our long-term growth objectives.
On April 1, 2013, we and EMC contributed certain assets to GoPivotal, Inc. (“Pivotal”) and Pivotal assumed certain liabilities from us and EMC. We contributed substantially all assets to Pivotal, including intellectual property, and Pivotal assumed substantially all liabilities, related to certain of our Cloud Application Platform products and services, including our Cloud Foundry, VMware vFabric (including Spring and GemFire) and Cetas organizations, except for certain tangible assets related to Cloud Foundry. The net liability assumed by Pivotal as of June 30, 2013, was $15.7. We transferred approximately 400 of our employees to Pivotal during the second quarter of 2013. EMC contributed substantially all assets, including intellectual property, to Pivotal, and Pivotal assumed substantially all liabilities, related to its Greenplum and Pivotal Labs businesses. Additionally, EMC made a capital contribution to Pivotal. Pivotal assumed substantially all of the rights and responsibilities for the respective support arrangements transferred by us and EMC.
In exchange for our and EMC’s contributions, we received preferred equity interests in Pivotal equal to approximately 31% of Pivotal’s outstanding shares, and EMC received equity interests in Pivotal equal to approximately 69% of Pivotal’s outstanding shares. Following the formation of Pivotal, a third party invested $105.0 in Pivotal reducing our ownership interest to 28%. We account for our investment in Pivotal on a cost basis. Additionally, we and Pivotal entered into an agreement pursuant to which we are acting as the selling agent of the products and services we contributed to Pivotal until at least December 31, 2013 in exchange for a customary agency fee. We have also agreed to provide various transition services to Pivotal until at least December 31, 2013, for which we are reimbursed for our costs.
Starting with the second quarter of 2013, substantially all revenues and costs associated with our contribution to Pivotal have been eliminated from our consolidated statements of income. While the contribution of these business lines to Pivotal has had a negative impact on our revenue growth rate compared to 2012, it had a positive impact on our 2013 operating margin due to the elimination of Pivotal related costs from our consolidated statements of income. In addition, the disposition of certain lines of business under our realignment plan had and is expected to have a negative impact on our revenue growth rate in 2013 compared to periods in the prior year.
Results of Operations
As we operate our business in one operating segment, our revenues and operating expenses are presented and discussed at the consolidated level.
Our current financial focus is on long-term revenue growth to enable us to fund our expansion of industry segment share and to evolve our virtualization-based products for data centers, end-user devices and cloud computing through a combination of internal development and acquisitions. In evaluating our results, we also focus on our free cash flows and operating margin excluding certain expenses which are included in our total operating expenses calculated in accordance with accounting principles generally accepted in the United States (“GAAP”). The expenses excluded are stock-based compensation, amortization of acquired intangible assets, realignment charges and certain other expenses consisting of the net effect of amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items. We believe these measures reflect our ongoing business in a manner that allows meaningful period-to-period comparisons. We are not currently focused on short-term operating margin expansion, but rather on investing at appropriate rates to support our growth and priorities in what may be a substantially more competitive environment. See “Non-GAAP Financial Measures” for further information.

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Revenues
Our revenues in the second quarter and first half of 2013 and 2012 were as follows: 
 
For the Three Months Ended
 
 
 
 
 
For the Six Months Ended
 
 
 
 
 
June 30,
 
 
 
June 30,
 
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
 
2013
 
2012
 
$ Change
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License
$
530.5

 
$
517.2

 
$
13.3

 
3
%
 
$
1,018.7

 
$
999.1

 
$
19.6

 
2
%
Services:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software maintenance
614.3

 
519.1

 
95.2

 
18

 
1,219.8

 
1,011.4

 
208.4

 
21

Professional services
98.3

 
86.7

 
11.6

 
13

 
196.1

 
167.7

 
28.4

 
17

Total services
712.6

 
605.8

 
106.8

 
18

 
1,415.9

 
1,179.1

 
236.8

 
20

Total revenues
$
1,243.1

 
$
1,123.0

 
$
120.1

 
11

 
$
2,434.6

 
$
2,178.2

 
$
256.4

 
12

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
590.3

 
$
550.7

 
$
39.6

 
7
%
 
$
1,158.8

 
$
1,035.6

 
$
123.2

 
12
%
International
652.8

 
572.3

 
80.5

 
14

 
1,275.8

 
1,142.6

 
133.2

 
12

Total revenues
$
1,243.1

 
$
1,123.0

 
$
120.1

 
11

 
$
2,434.6

 
$
2,178.2

 
$
256.4

 
12

In the second quarter and first half of 2013, we achieved growth in license and services revenues, and growth in the United States and internationally, as compared with the second quarter and first half of 2012.
License Revenues
License revenues in the second quarter and first half of 2013 were up 3% and 2%, respectively, compared to the second quarter and first half of 2012. Our revenue growth rate was negatively impacted by the contribution of certain business lines to Pivotal and the disposition of certain business lines under our realignment plan, negatively impacting license revenue growth rates by 2% and 1% in the second quarter and first half of 2013, respectively. Excluding from both the 2013 and the 2012 periods the revenues related to Pivotal and all dispositions under our realignment plan, including the business line we exited in the third quarter of 2013, license revenues grew 5% and 3% in both the second quarter and first half of 2013, respectively. See “Non-GAAP Financial Measures” for further information on license revenues excluding Pivotal and our 2013 dispositions.
Services Revenues
In the second quarter and first half of 2013, software maintenance revenues benefited from strong renewals, multi-year software maintenance contracts sold in previous periods, and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers bought, on average, more than 24 months of support and maintenance with each new license purchased, which we believe illustrates our customers’ commitment to VMware as a core element of their data center architecture and hybrid cloud strategy.
In the second quarter and first half of 2013, professional services revenues increased as growth in our license sales and installed-base led to additional demand for our professional services.
Our revenue growth rate was negatively impacted by the contribution of certain business lines to Pivotal and the disposition of certain business lines under our realignment plan, negatively impacting services revenues growth rates by 6% and 3% in the second quarter and first half of 2013, respectively. Excluding from both the 2013 and the 2012 periods the revenues related to Pivotal and all dispositions under our realignment plan, including the business line we exited in the third quarter of 2013, services revenues grew 24% in both the second quarter and first half of 2013. See “Non-GAAP Financial Measures” for further information on services revenues excluding Pivotal and our 2013 dispositions.
Revenue Growth in Constant Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen and the Australian Dollar in their respective regions. As a result, our total revenues are affected by changes in the value of the U.S. Dollar against these currencies. In order to provide a comparable framework for assessing how our business performed excluding the effect of foreign currency fluctuations, management analyzes year-over-year revenue growth on a constant currency basis. Since we operate with the U.S. Dollar as our functional currency, unearned revenues for orders booked in currencies other than the U.S. Dollar are converted into U.S. Dollars at the exchange rate in effect for the month in which each order is booked and remain at their

24
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historical rate when recognized into revenue. We calculate constant currency on license revenues recognized during the current period that were originally booked in currencies other than U.S. Dollars by comparing the exchange rates used to recognize revenue in the current period against the exchange rates used to recognize revenue in the comparable period. For the second quarter of 2013, the year-over-year growth in license revenues measured on a constant currency basis was 4% compared with 3% as reported, and was 3% compared with 2% as reported year-over-year for the first half of 2013. We do not calculate constant currency on services revenues, which include software maintenance revenues and professional services revenues.
Unearned Revenues
Our unearned revenues as of June 30, 2013 and December 31, 2012 were as follows: 
 
June 30,
 
December 31,
 
2013
 
2012
Unearned license revenues
$
427.2

 
$
462.7

Unearned software maintenance revenues
2,903.3

 
2,755.0

Unearned professional services revenues
265.9

 
242.8

Total unearned revenues
$
3,596.5

 
$
3,460.6

The complexity of our unearned revenues has increased over time as a result of acquisitions, an expanded product portfolio and a broader range of pricing and packaging alternatives. Unearned license revenues are either recognized ratably, recognized upon delivery of existing or future products or services, or will be recognized ratably upon delivery of future products or services. 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 a promotional product at no additional charge. We regularly offer product promotions to improve awareness of our emerging products. To the extent promotional products have 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. Increasingly, unearned license revenue may also be recognized ratably, which is generally due to a right to receive unspecified future products or a lack of VSOE of fair value on the software maintenance element of the arrangement. At June 30, 2013, the ratable component represented over half of the total unearned license revenue balance. The amount of total unearned license revenues may vary over periods due to the type and level of promotions offered, the portion of license contracts sold with a ratable recognition element, and when promotional products are delivered upon general availability. Unearned software maintenance revenues are attributable to our maintenance contracts and are recognized ratably, typically over terms from one to five years with a weighted-average remaining term at June 30, 2013 of approximately 2.0 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are recognized as the services are delivered. We believe that our overall unearned revenue balance improves predictability of future revenues and that it is a key indicator of the health and growth of our business. As of June 30, 2013, 88% of our total unearned revenues are expected to be recognized ratably, after the delivery of any specified deliverables, if applicable.
As of June 30, 2013, we reclassified $21.0 of unearned revenues to liabilities held for sale that are related to a line of business that we exited in the third quarter of 2013. Liabilities held for sale are reported in accrued expenses and other on the consolidated balance sheet.
In the second quarter of 2013, approximately $101.4 previously included in our unearned revenues was removed from our total unearned revenue balance. Of this amount, $71.2 was attributable to the transfer of unearned revenues to Pivotal and the balance of approximately $30.2 was attributable to the remaining disposals of businesses under our realignment plan.

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Table of Contents

Operating Expenses
Information about our operating expenses for the second quarter and first half of 2013 and 2012 is as follows:
 
For the Three Months Ended June 30, 2013
 
Core
Operating
Expenses (1)
 
Stock-Based
Compensation
 
Intangible Amortization
 
Realignment Charges
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenues
$
18.7

 
$
0.5

 
$
22.2

 
$
—

 
$
13.2

 
$
54.6

Cost of services revenues
110.8

 
6.7

 
0.8

 
—

 
0.2

 
118.5

Research and development
207.4

 
51.0

 
0.8

 
—

 
1.5

 
260.7

Sales and marketing
405.7

 
33.4

 
1.6

 
—

 
1.4

 
442.1

General and administrative
83.6

 
11.6

 
—

 
—

 
1.1

 
96.3

Realignment charges
—

 
—

 
—

 
0.6

 
—

 
0.6

Total operating expenses
$
826.2

 
$
103.2

 
$
25.4

 
$
0.6

 
$
17.4

 
$
972.8

Operating income
 
 
 
 
 
 
 
 

 
$
270.3

Operating margin
 
 
 
 
 
 
 
 
 
 
21.7
%
 
For the Three Months Ended June 30, 2012
 
Core
Operating
Expenses(1)
 
Stock-Based
Compensation
 
Intangible Amortization
 
Realignment Charges
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenues
$
21.5

 
$
0.5

 
$
13.7

 
$
—

 
$
20.9

 
$
56.6

Cost of services revenues
114.1

 
7.1

 
1.1

 
—

 
0.4

 
122.7

Research and development
197.7

 
48.0

 
0.8

 
—

 
2.1

 
248.6

Sales and marketing
353.3

 
33.9

 
2.9

 
—

 
1.4

 
391.5

General and administrative
78.2

 
11.4

 
—

 
—

 
2.1

 
91.7

Total operating expenses
$
764.8

 
$
100.9

 
$
18.5

 
$
—

 
$
26.9

 
$
911.1

Operating income
 
 
 
 
 
 
 
 


 
$
211.9

Operating margin
 
 
 
 
 
 
 
 
 
 
18.9
%
 
For the Six Months Ended June 30, 2013
 
Core
Operating
Expenses(1)
 
Stock-Based
Compensation
 
Intangible Amortization
 
Realignment Charges
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenues
$
39.1

 
$
1.0

 
$
45.5

 
$
—

 
$
26.3

 
$
111.9

Cost of services revenues
226.9

 
14.0

 
1.8

 
—

 
0.4

 
243.1

Research and development
413.6

 
113.3

 
1.8

 
—

 
2.5

 
531.2

Sales and marketing
783.7

 
69.5

 
4.2

 
—

 
2.1

 
859.5

General and administrative
166.8

 
25.7

 
—

 
—

 
2.3

 
194.8

Realignment charges
—

 
—

 
—

 
63.5

 
—

 
63.5

Total operating expenses
$
1,630.1

 
$
223.5

 
$
53.3

 
$
63.5

 
$
33.6

 
$
2,004.0

Operating income
 
 
 
 
 
 
 
 
 
 
$
430.6

Operating margin
 
 
 
 
 
 
 
 
 
 
17.7
%

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Table of Contents

 
For the Six Months Ended June 30, 2012
 
Core
Operating
Expenses(1)
 
Stock-Based
Compensation
 
Intangible Amortization
 
Realignment Charges
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenues
$
42.7

 
$
1.0

 
$
27.0

 
$
—

 
$
42.6

 
$
113.3

Cost of services revenues
220.9

 
12.9

 
2.2

 
—

 
0.8

 
236.8

Research and development
378.0

 
87.4

 
1.5

 
—

 
4.1

 
471.0

Sales and marketing
686.5

 
59.1

 
5.9

 
—

 
3.4

 
754.9