Edgar Filing: VMWARE, INC.

VMW-9.30.2013-10Q

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 September 30, 2013



¨	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 October 24, 2013, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 430,366,009 of which 130,366,009 shares were Class A common stock and 300,000,000 were Class B common stock.

TABLE OF CONTENTS



		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2013 and 2012	3
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012	4
	Consolidated Balance Sheets at September 30, 2013 and December 31, 2012	5
	Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2013 and 2012	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34
Part II - OTHER INFORMATION		35
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 3.	Defaults Upon Senior Securities	59
Item 4.	Mine Safety Disclosures	59
Item 5.	Other Information	59
Item 6.	Exhibits	59
	SIGNATURES	60
	EXHIBIT INDEX	61

VMware, VMworld, vSphere, VMware vCloud, vCenter, VMware View, vCloud Suite, Horizon Suite, vCloud Hybrid Service, vShield, 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.

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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 Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Revenues:
License	$	564		$	491		$	1,583		$	1,490
Services	725			643			2,141			1,822
Total revenues	1,289			1,134			3,724			3,312
Operating expenses (1):
Cost of license revenues	51			60			163			174
Cost of services revenues	132			119			375			356
Research and development	266			260			797			731
Sales and marketing	449			412			1,308			1,166
General and administrative	103			93			298			266
Realignment charges	1			—			64			—
Operating income	287			190			719			619
Investment income	7			8			21			20
Interest expense with EMC	(1		)	(1		)	(3		)	(4		)
Other income (expense), net	15			(2		)	29			(2		)
Income before income taxes	308			195			766			633
Income tax provision	47			38			87			93
Net income	$	261		$	157		$	679		$	540
Net income per weighted-average share, basic for Class A and Class B	$	0.61		$	0.37		$	1.58		$	1.26
Net income per weighted-average share, diluted for Class A and Class B	$	0.60		$	0.36		$	1.57		$	1.24
Weighted-average shares, basic for Class A and Class B	430			427			429			427
Weighted-average shares, diluted for Class A and Class B	433			433			433			434
__________
(1) Includes stock-based compensation as follows:
Cost of license revenues	$	1		$	—		$	2		$	1
Cost of services revenues	7			8			21			21
Research and development	52			60			165			148
Sales and marketing	37			52			106			111
General and administrative	16			12			42			34
Realignment charges	—			—			6			—

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

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VMware, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions)

(unaudited)



	For the Three Months Ended					For the Nine Months Ended
	September 30,					September 30,
	2013			2012		2013			2012
Net income	$	261		$	157	$	679		$	540
Other comprehensive income (loss):
Changes in market value of available-for-sale securities:
Unrealized gains (losses), net of taxes of $3, $3, $(2) and $4	5			4		(3		)	7
Reclassification of (gains) realized during the period, net of taxes of $0, $0, $(1) and $0	—			—		(1		)	(1		)
Net change in market value of available-for-sale securities	5			4		(4		)	6
Changes in market value of effective foreign currency forward exchange contracts:
Unrealized gains (losses), net of $0 taxes for all periods	(1		)	1		(1		)	1
Reclassification of losses realized during the period, net of $0 taxes for all periods	1			—		—			—
Net change in market value of effective foreign currency forward exchange contracts	—			1		(1		)	1
Total other comprehensive income (loss)	5			5		(5		)	7
Total comprehensive income, net of taxes	$	266		$	162	$	674		$	547

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

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VMware, Inc.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)



	September 30, 2013		December 31, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	2,263	$	1,609
Short-term investments	3,574		3,022
Accounts receivable, net of allowance for doubtful accounts of $2 and $4	789		1,151
Due from related parties, net	—		68
Deferred tax assets	183		179
Other current assets	116		91
Total current assets	6,925		6,120
Property and equipment, net	793		665
Other assets, net	113		128
Deferred tax assets	63		103
Intangible assets, net	602		732
Goodwill	2,958		2,848
Total assets	$	11,454	$	10,596
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	84	$	90
Accrued expenses and other	546		674
Due to related parties, net	16		—
Unearned revenues	2,225		2,196
Total current liabilities	2,871		2,960
Note payable to EMC	450		450
Unearned revenues	1,411		1,265
Other liabilities	195		181
Total liabilities	4,927		4,856
Contingencies (see Note L)
Stockholders’ equity:
Class A common stock, par value $.01; authorized 2,500 shares; issued and outstanding 131 and 129 shares	1		1
Class B convertible common stock, par value $.01; authorized 1,000 shares; issued and outstanding 300 shares	3		3
Additional paid-in capital	3,545		3,432
Accumulated other comprehensive income	1		6
Retained earnings	2,977		2,298
Total stockholders’ equity	6,527		5,740
Total liabilities and stockholders’ equity	$	11,454	$	10,596

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

VMware, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(unaudited)



	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Operating activities:
Net income	$	261		$	157		$	679		$	540
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	82			86			261			262
Stock-based compensation	113			119			332			302
Excess tax benefits from stock-based compensation	(12		)	(25		)	(60		)	(111		)
Non-cash realignment charges	—			—			15			—
Gain on disposition of certain lines of business and other, net	(12		)	—			(31		)	—
Other	4			(1		)	3			(1		)
Changes in assets and liabilities, net of acquisitions:
Accounts receivable	152			67			360			202
Other assets	4			(5		)	(72		)	(122		)
Due to/from related parties, net	49			15			84			28
Accounts payable	(2		)	10			16			26
Accrued expenses	(69		)	(64		)	(91		)	(63		)
Income taxes receivable from EMC	—			—			15			—
Income taxes payable	(2		)	60			(4		)	128
Deferred income taxes, net	32			(34		)	41			(70		)
Unearned revenues	37			51			300			283
Net cash provided by operating activities	637			436			1,848			1,404
Investing activities:
Additions to property and equipment	(94		)	(75		)	(247		)	(153		)
Purchases of available-for-sale securities	(573		)	(765		)	(2,227		)	(2,720		)
Sales of available-for-sale securities	253			882			1,072			1,653
Maturities of available-for-sale securities	227			234			597			768
Proceeds from disposition of certain lines of business	6			—			37			—
Business acquisitions, net of cash acquired	—			(1,242		)	(184		)	(1,344		)
Other investing	(8		)	(8		)	(11		)	(12		)
Net cash used in investing activities	(189		)	(974		)	(963		)	(1,808		)
Financing activities:
Proceeds from issuance of common stock	70			70			185			214
Repurchase of common stock	(90		)	(129		)	(392		)	(307		)
Excess tax benefits from stock-based compensation	12			25			60			111
Shares repurchased for tax withholdings on vesting of restricted stock	(17		)	(25		)	(84		)	(90		)
Net cash used in financing activities	(25		)	(59		)	(231		)	(72		)
Net increase (decrease) in cash and cash equivalents	423			(597		)	654			(476		)
Cash and cash equivalents at beginning of the period	1,840			2,077			1,609			1,956
Cash and cash equivalents at end of the period	$	2,263		$	1,480		$	2,263		$	1,480
Non-cash items:
Changes in capital additions, accrued but not paid	$	(3	)	$	(17	)	$	(8	)	$	(2	)
Changes in tax withholdings on vesting of restricted stock, accrued but not paid	(2		)	(4		)	(1		)	3
Fair value of stock options assumed in acquisition	—			17			—			17

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

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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 September 30, 2013, EMC Corporation (“EMC”) holds approximately 79.7% of VMware’s outstanding common stock and 97.2% of the combined voting power of VMware’s outstanding common stock, including 43 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock. VMware is a majority-owned and controlled subsidiary of EMC, and its results of operations and financial position are consolidated with EMC’s financial statements. 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 K and N to the consolidated financial statements for further information.

The amounts recorded for VMware’s intercompany transactions with EMC and GoPivotal, Inc. (“Pivotal”) may not be considered arm’s length with an unrelated third party. 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 and Pivotal.

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 and Pivotal 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)

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 million, net of cash acquired.

The following table summarizes the initial 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
Goodwill	162
Total intangible assets acquired	194
Deferred tax liabilities, net	—
Other acquired liabilities, net of acquired assets	(10		)
Total net liabilities assumed	(10		)
Fair value of intangible assets acquired and net liabilities assumed	$	184

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	$	32
Total intangible assets, net, excluding goodwill		$	32

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 nine months ended September 30, 2013.

Goodwill

The following table summarizes the changes in the carrying amount of goodwill for the nine months ended September 30, 2013 (table in millions):



Balance, January 1, 2013	$	2,848
Increase in goodwill related to business combination	162
Contribution to Pivotal (see Note N)	(28		)
Reduction related to business realignment plan	(4		)
Deferred tax adjustments to purchase price allocations on acquisitions	(19		)
Other adjustments to purchase price allocations on acquisitions	(1		)
Balance, September 30, 2013	$	2,958

C. Realignment Charges

Realignment Plan

During January 2013, VMware approved and initiated a business realignment plan to streamline its operations. As of the second quarter of 2013, the plan was substantially completed. The associated cash payments are expected to be fully paid out by the end of 2013.

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The realignment plan included the elimination of approximately 725 positions and personnel across all major functional groups and geographies. The total cash and non-cash charge for workforce reductions of $54 million was recorded on the consolidated statements of income for the nine months ended September 30, 2013. In connection with the realignment plan, VMware also recognized other cash and non-cash costs primarily associated with asset impairments of $10 million during the nine months ended September 30, 2013. Substantially all of the cash-related expenses incurred in connection with the business realignment plan have been paid as of September 30, 2013.

Other Related Activities

In connection with VMware's business realignment plan, in the three months ended September 30, 2013, VMware sold certain of its assets relating to a previous acquisition, Zimbra, in exchange for cash and equity resulting in a pre-tax gain of $12 million. During the nine months ended September 30, 2013, VMware recognized cumulative pre-tax gains of $44 million relating to the disposition of certain lines of business that were no longer aligned with VMware's core business priorities, including Zimbra. The gains recognized in connection with these dispositions were recorded to other income (expense), net on the consolidated statements of income for the three and nine months ended September 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 nine months ended September 30, 2013 and 2012 (table in millions, except per share data):



	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2013		2012		2013		2012
Net income	$	261	$	157	$	679	$	540
Weighted-average shares, basic for Class A and Class B	430		427		429		427
Effect of dilutive securities	3		6		4		7
Weighted-average shares, diluted for Class A and Class B	433		433		433		434
Net income per weighted-average share, basic for Class A and Class B	$	0.61	$	0.37	$	1.58	$	1.26
Net income per weighted-average share, diluted for Class A and Class B	$	0.60	$	0.36	$	1.57	$	1.24

For both the three and nine months ended September 30, 2013, stock options to purchase 1 million shares of VMware Class A common stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive. For the three and nine months ended September 30, 2012, the number of stock options to purchase shares of VMware Class A common stock that were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive was not material.

For the three months ended September 30, 2013 and 2012, 2 million and 3 million shares, respectively, of restricted stock, and for the nine months ended September 30, 2013 and 2012, 1 million and 2 million shares, respectively, of restricted 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)

E. Investments

Investments as of September 30, 2013 and December 31, 2012 consisted of the following (tables in millions):



	September 30, 2013
	Cost or Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
U.S. Government and agency obligations	$	448	$	1	$	—		$	449
U.S. and foreign corporate debt securities	2,082		4		(3		)	2,083
Foreign governments and multi-national agency obligations	25		—		—			25
Municipal obligations	880		3		(1		)	882
Asset-backed securities	4		—		—			4
Mortgage-backed securities	133		—		(2		)	131
Total investments	$	3,572	$	8	$	(6	)	$	3,574



	December 31, 2012
	Cost or Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
U.S. Government and agency obligations	$	374	$	1	$	—		$	375
U.S. and foreign corporate debt securities	1,545		6		(1		)	1,550
Foreign governments and multi-national agency obligations	41		—		—			41
Municipal obligations	973		3		—			976
Asset-backed securities	1		—		—			1
Mortgage-backed securities	79		—		—			79
Total investments	$	3,013	$	10	$	(1	)	$	3,022

In addition, VMware evaluated its investments as of September 30, 2013 and December 31, 2012 to determine whether or not any security has experienced an other-than-temporary decline in fair value. During the three months ended September 30, 2013, VMware did not consider any of its investments to be other-than-temporarily impaired. During the nine months ended September 30, 2013, VMware recognized a charge of approximately $13 million as a result of determining that a strategic investment was considered to be other-than-temporarily impaired. All other realized gains and losses on investments in the three and nine months ended September 30, 2013 and 2012 were not material.

As of September 30, 2013 and December 31, 2012, investments in a continuous unrealized loss position for twelve months or greater were not considered significant. Unrealized losses on investments as of September 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):



	September 30, 2013					December 31, 2012
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Government and agency obligations	$	64	$	—		$	35	$	—
U.S. and foreign corporate debt securities	888		(3		)	316		(1		)
Foreign governments and multi-national agency obligations	16		—			5		—
Municipal obligations	132		(1		)	259		—
Asset-backed securities	2		—			—		—
Mortgage-backed securities	110		(2		)	28		—
Total	$	1,212	$	(6	)	$	643	$	(1	)

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Contractual Maturities

The contractual maturities of investments held at September 30, 2013 consisted of the following (table in millions):



	Amortized Cost Basis		Aggregate Fair Value
Due within one year	$	839	$	840
Due after 1 year through 5 years	2,610		2,612
Due after 5 years	123		122
Total investments	$	3,572	$	3,574

F. Fair Value Measurements

Certain financial assets and liabilities are measured at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the nine months ended September 30, 2013.

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 September 30, 2013 and December 31, 2012 (tables in millions):



	September 30, 2013
	Level 1		Level 2		Total
Money-market funds	$	1,817	$	—	$	1,817
U.S. Government and agency obligations	331		118		449
U.S. and foreign corporate debt securities	—		2,108		2,108
Foreign governments and multi-national agency obligations	—		25		25
Municipal obligations	—		882		882
Asset-backed securities	—		4		4
Mortgage-backed securities	—		131		131
Total	$	2,148	$	3,268	$	5,416



	December 31, 2012
	Level 1		Level 2		Total
Money-market funds	$	1,125	$	—	$	1,125
U.S. Government and agency obligations	250		155		405
U.S. and foreign corporate debt securities	—		1,567		1,567
Foreign governments and multi-national agency obligations	—		41		41
Municipal obligations	—		976		976
Asset-backed securities	—		1		1
Mortgage-backed securities	—		79		79
Total	$	1,375	$	2,819	$	4,194

Fixed income available-for-sale securities consist of high quality, investment-grade securities from diverse issuers. Fair value of fixed income securities are determined based on pricing from pricing vendors who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs). The valuation techniques used to measure the fair value of financial instruments having Level 2 inputs were derived from non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques. VMware’s procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources.

G. Derivatives and Hedging Activity

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

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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 September 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 $39 million and $9 million, respectively. The fair value of these forward contracts was immaterial as of September 30, 2013 and December 31, 2012, and therefore excluded from the fair value tables above. For the three and nine months ended September 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.

VMware’s foreign currency forward contracts are generally traded on a monthly basis with a typical contractual term of one month. As of September 30, 2013 and December 31, 2012, VMware had outstanding forward contracts with a total notional value of $314 million and $440 million, respectively. The fair value of these forward contracts was immaterial as of September 30, 2013 and December 31, 2012 and therefore excluded from the fair value tables above.

In the three months ended September 30, 2013 and 2012, VMware recognized losses of $16 million and $6 million, respectively, on its consolidated statements of income for its foreign currency forward contracts. In the nine months ended September 30, 2013, the impact on its consolidated statements of income for its foreign currency forward contracts was not material. In the nine months ended September 30, 2012, VMware recognized a loss of $7 million 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 a net gain of $1 million and a net loss of $1 million in the three months ended September 30, 2013 and 2012, respectively, and net losses of $5 million and $3 million in the nine months ended September 30, 2013 and 2012, respectively.

H. Property and Equipment, Net

Property and equipment, net, as of September 30, 2013 and December 31, 2012 consisted of the following (table in millions):



	September 30, 2013			December 31, 2012
Equipment and software	$	708		$	636
Buildings and improvements	495			438
Furniture and fixtures	72			67
Construction in progress	180			98
Total property and equipment	1,455			1,239
Accumulated depreciation	(662		)	(574		)
Total property and equipment, net	$	793		$	665

Depreciation expense was $36 million and $31 million in the three months ended September 30, 2013 and 2012, respectively. Depreciation expense was $105 million and $97 million in the nine months ended September 30, 2013 and 2012, respectively.

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

As of September 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 September 30, 2013 and December 31, 2012 consisted of the following (table in millions):



	September 30, 2013		December 31, 2012
Salaries, commissions, bonuses, and benefits	$	202	$	292
Accrued partner liabilities	114		129
Other	230		253
Total	$	546	$	674

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

J. Unearned Revenues

Unearned revenues as of September 30, 2013 and December 31, 2012 consisted of the following (table in millions):



	September 30, 2013		December 31, 2012
Unearned license revenues	$	415	$	463
Unearned software maintenance revenues	2,937		2,755
Unearned professional services revenues	284		243
Total unearned revenues	$	3,636	$	3,461

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 is not established, 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.

Unearned software maintenance revenues are attributable to VMware’s maintenance contracts and are recognized ratably, typically over terms of one to five 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 certain discrete 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 nine months ended September 30, 2013, EMC paid VMware $16 million under the tax sharing agreement. No other payments were made either by EMC or VMware under the tax sharing agreement during the three months ended September 30, 2013 and 2012, or during the nine months ended September 30, 2012. 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 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.

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.

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

VMware’s effective income tax rate was 15.3% and 19.7% for the three months ended September 30, 2013 and 2012, respectively. The effective income tax rate was 11.4% and 14.7% for the nine months ended September 30, 2013 and 2012, respectively. The lower effective rate for the three months ended September 30, 2013 compared with the three months ended September 30, 2012 was primarily attributable to the finalization of the 2012 federal return related to the change in estimate of the U.S. federal research tax credit calculation. The lower effective rate for the nine months ended September 30, 2013 compared with the nine months ended September 30, 2012 was primarily attributable to the discrete tax benefits recognized in the nine months ended September 30, 2013 due to the retroactive enactment of the U.S. federal research tax credit by the U.S. Congress in January 2013.

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. 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.

As of September 30, 2013, VMware had gross unrecognized tax benefits totaling $162 million, which excludes $7 million of offsetting tax benefits. Approximately $155 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 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 September 30, 2013. It is reasonably possible that within the next 12 months, audit resolutions could potentially reduce total unrecognized tax benefits by approximately $4 million. Due to the closure of tax audits and statutes that lapsed, approximately $6 million of uncertain tax benefits were reversed during the nine months ended September 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 $4 million in interest and penalties for the nine months ended September 30, 2013. Interest and penalties for the three months ended September 30, 2013 were not material. As of September 30, 2013, there were $12 million of interest and penalties accrued for unrecognized tax benefits. These amounts are included as components of the $167 million of net unrecognized tax benefits as of September 30, 2013.

L. Contingencies

Litigation

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. VMware evaluates its claims on a quarterly basis and considers the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. As of September 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 Repurchases

In August 2013, VMware’s Board of Directors authorized the repurchase of up to $700 million of VMware’s Class A common stock through the end of 2015. In November 2012, VMware’s Board of Directors authorized the repurchase of up to $250 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 million of VMware’s Class A common stock, which was completed in the second quarter of 2013. From time to time, future stock repurchases may be made pursuant to the August 2013 and November 2012

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

authorizations 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.

The following table summarizes stock repurchase activity in the three and nine months ended September 30, 2013 and 2012 (table in millions, except per share amounts):



	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2013		2012		2013		2012
Aggregate purchase price	$	90	$	129	$	392	$	307
Class A common shares repurchased	1		1		5		3
Weighted-average price per share	$	73.63	$	88.35	$	75.06	$	92.91

The amount of repurchased shares includes commissions and was classified as a reduction to additional paid-in capital. As of September 30, 2013, the cumulative authorized amount remaining for repurchase was $775 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 includes performance stock unit (“PSU”) awards, which have been granted to certain of VMware's executives and employees. The PSU awards include performance conditions, as well as time-based vesting. Upon vesting, each PSU award will convert into VMware’s Class A common stock at various 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.

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		$	91.93
Granted	6		74.90
Vested	(3	)	80.36
Forfeited	(2	)	91.01
Outstanding, September 30, 2013	13		87.23

As of September 30, 2013, the 13 million of units outstanding included 12 million of RSUs and 1 million of PSUs.

As of September 30, 2013, restricted stock representing 13 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $1,023 million based on VMware’s closing price as of September 30, 2013.

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Accumulated Other Comprehensive Income

The changes in components of accumulated other comprehensive income in the nine months ended September 30, 2013 were as follows (table in millions):



	Unrealized Gains on Available-for-Sale Securities			Losses on Cash Flow Hedges			Total
Balance, January 1, 2013	$	6		$	—		$	6
Other comprehensive loss before reclassifications, net of taxes of $(2), $0 and $(2)	(3		)	(1		)	(4		)
Amounts reclassified from accumulated other comprehensive income to the consolidated statement of income, net of taxes of $(1), $0 and $(1)	(1		)	—			(1		)
Other comprehensive loss, net	(4		)	(1		)	(5		)
Balance, September 30, 2013	$	2		$	(1	)	$	1

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 are 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 nine months ended September 30, 2013 were not material.

N. Related Parties

EMC Reseller Arrangement, Other Services and Note Payable

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 September 30, 2013 and 2012, VMware recognized revenues of $37 million and $27 million, respectively, from such contractual arrangement with EMC. In the nine months ended September 30, 2013 and 2012, VMware recognized revenues of $108 million and $88 million, respectively, from such contractual arrangement with EMC. As of September 30, 2013, $162 million of revenues from products and services sold under the reseller arrangement were included in unearned revenues.

In the three months ended September 30, 2013 and 2012, VMware recognized professional services revenues of $14 million and $21 million, respectively, from such contractual agreements with EMC. In the nine months ended September 30, 2013 and 2012, VMware recognized revenues of $60 million and $63 million, respectively, from such contractual agreements with EMC. As of September 30, 2013, $9 million of revenues from professional services to EMC customers were included in unearned revenues.

In both the three months ended September 30, 2013 and 2012, VMware recognized revenues of $3 million from products and services purchased by EMC for internal use pursuant to VMware’s contractual agreements with EMC. In the nine months ended September 30, 2013 and 2012, VMware recognized revenues of $9 million and $7 million, respectively, from such contractual agreements with EMC. As of September 30, 2013, $30 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 $20 million and $4 million in the three months ended September 30, 2013 and 2012, respectively, and for $45 million and $28 million in the nine months ended September 30, 2013 and 2012, respectively.

From time to time, VMware and EMC enter into agreements to collaborate on technology projects. In both the three months ended September 30, 2013 and 2012, VMware received $2 million from EMC for EMC’s portion of expenses related to such projects, and in the nine months ended September 30, 2013 and 2012, VMware received $6 million and $5 million, respectively, from such contractual agreements with EMC. In the three months ended September 30, 2013, VMware paid $5 million to EMC for services provided to VMware by EMC related to such projects, and in the nine months ended September 30, 2013, VMware paid $7 million to EMC for such contractual agreements with EMC.

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

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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 $29 million and $26 million in the three months ended September 30, 2013 and 2012, respectively, and $94 million and $75 million in the nine months ended September 30, 2013 and 2012, respectively.

In both the three months ended September 30, 2013 and 2012, $1 million 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 nine months ended September 30, 2013 and 2012, $3 million and $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.

Certain Stock-Based Compensation

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. Both Paul Maritz and Pat Gelsinger retain and continue to vest in certain of 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. Effective September 1, 2012, stock-based compensation related to Paul Maritz’s VMware awards will not be recognized by VMware.

Mozy

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 nine months ended September 30, 2013, and $17 million and $48 million in the three and nine months ended September 30, 2012, respectively. These amounts were recorded as a reduction to the costs VMware incurred.

Joint Contribution of Assets with EMC to Pivotal

On April 1, 2013, VMware transferred certain assets and liabilities to Pivotal. VMware contributed certain 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 nine months ended September 30, 2013, VMware transferred approximately 415 VMware employees to Pivotal.

VMware received preferred equity interests in Pivotal equal to approximately 31% of Pivotal’s outstanding shares in exchange for its contributions. Additionally, VMware and Pivotal entered into an agreement pursuant to which VMware will act as the selling agent for the products and services it contributed to Pivotal until at least December 31, 2013 in exchange for a customary agency fee. In the three and nine months ended September 30, 2013, VMware recognized revenues of $2 million and $3 million, respectively, from such contractual arrangement with Pivotal. As of September 30, 2013, $1 million of revenues from such contractual arrangement with Pivotal were included in unearned revenues. 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 and nine months ended September 30, 2013, VMware provided transition services of $2 million and $10 million, respectively, that are reimbursable by Pivotal and which were recorded as a reduction to the costs VMware incurred. Additionally, VMware purchased products and services for internal use from Pivotal for $1 million and $6 million in the three and nine months ended September 30, 2013, respectively.

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VMware, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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's initial contribution was a net liability of $16 million to Pivotal, which was included in VMware’s consolidated balance sheet as of March 31, 2013. The following table summarizes the assets VMware contributed to Pivotal and the liabilities Pivotal assumed from VMware, including certain adjustments made subsequent to April 1, 2013, which were not material to VMware’s consolidated financial statements (table in millions):



Accounts receivable	$	4
Property and equipment, net	1
Intangible assets	28
Goodwill	28
Total assets	61
Accounts payable, accrued liabilities and other, net	(3		)
Unearned revenues	(71		)
Total liabilities	(74		)
Total liabilities, net assumed by Pivotal	$	(13	)

Of the $71 million in unearned revenues assumed by Pivotal on April 1, 2013, $32 million related to unearned license revenues and $39 million related to unearned services revenues.

VMware's ownership interest in Pivotal is 28% as of September 30, 2013 as a result of investments made by a third-party strategic investor. 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 $13 million as of September 30, 2013 was classified to additional paid-in capital on VMware’s consolidated balance sheet.

Due To/Due From Related Parties

As of September 30, 2013, VMware had $16 million net due to related parties, which consisted of $59 million due to EMC and $15 million due to Pivotal, partially offset by $55 million due from EMC and $3 million due from Pivotal. These amounts resulted from the related-party transactions with EMC and Pivotal described above. Additionally, as of September 30, 2013, VMware had a net income tax receivable from EMC of $6 million, which consisted of $9 million due from EMC, partially offset by $3 million due to EMC. 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. See Note K to the consolidated financial statements for information regarding tax payments with EMC.

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 and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.

Revenues by geographic area for the three and nine months ended September 30, 2013 and 2012 were as follows (table in millions):



	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2013		2012		2013		2012
United States	$	614	$	554	$	1,773	$	1,589
International	675		580		1,951		1,723
Total	$	1,289	$	1,134	$	3,724	$	3,312

No individual country other than the United States had material revenues for the three and nine months ended September 30, 2013 and 2012.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Long-lived assets by geographic area, which primarily include property and equipment, net, as of September 30, 2013 and December 31, 2012 were as follows (table in millions):



	September 30, 2013		December 31, 2012
United States	$	697	$	563
International	53		51
Total	$	750	$	614

No individual country other than the United States accounted for 10% or more of these assets as of September 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 product solutions are based upon three growth priorities, which include SDDC, hybrid cloud and End-User Computing. SDDC includes 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. VMware vCloud Suite and various Cloud Management solutions that are optimized to work with vSphere environments are designed to simplify and automate management of dynamic cloud infrastructures that enable enterprises to build, manage and automate their own private clouds. For the hybrid cloud, we have introduced a public cloud infrastructure as a service offering designed to be completely interoperable with our customers’ VMware virtualized infrastructures. Currently, revenues for our hybrid cloud solution during the third quarter and first nine months of 2013 have not been significant. 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, which includes selling our solutions through 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. 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 and support 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 comprised 33% and 24% of our overall sales during the third quarters of 2013 and 2012, respectively, and 33% and 25% of our overall sales during the first nine months of 2013 and 2012, respectively, with the balance primarily 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.

Realignment

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. The business realignment plan was substantially completed at the end of the second quarter of 2013. The realignment plan also included the disposition of certain business activities, which have also been substantially completed.

GoPivotal, Inc. (“Pivotal”)

During the year, we transferred certain assets and liabilities to Pivotal in exchange for an ownership interest in Pivotal of approximately 28% as of September 30, 2013. In connection with this transaction, we transferred approximately 415 of our

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employees to Pivotal during the first nine months of 2013. Additionally, we also entered into an agreement with Pivotal 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.

Results of Operations

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.

Revenues

Our revenues in the third quarter and first nine months of 2013 and 2012 were as follows:



	For the Three Months Ended									For the Nine Months Ended
	September 30,									September 30,
	2013		2012		$ Change			% Change		2013		2012		$ Change		% Change
Revenues:
License	$	564	$	491	$	73		15	%	$	1,583	$	1,490	$	93	6	%
Services:
Software maintenance	644		551		93			17		1,864		1,562		302		19
Professional services	81		92		(11		)	(12	)	277		260		17		7
Total services	725		643		82			13		2,141		1,822		319		18
Total revenues	$	1,289	$	1,134	$	155		14		$	3,724	$	3,312	$	412	12

Revenues:
United States	$	614	$	554	$	60		11	%	$	1,773	$	1,589	$	184	12	%
International	675		580		95			16		1,951		1,723		228		13
Total revenues	$	1,289	$	1,134	$	155		14		$	3,724	$	3,312	$	412	12

In the third quarter and first nine months of 2013, we achieved growth in license and services revenues, and growth in the United States and internationally, as compared with the third quarter and first nine months of 2012.

License Revenues

License revenues in the third quarter and first nine months of 2013 were up 15% and 6%, respectively, compared to the third quarter and first nine months of 2012. Our revenue growth rate for both periods was due to overall increased sales volumes, slightly offset by the disposition of certain business lines under our realignment plan and the contribution of certain business lines to Pivotal.

Excluding from both the 2013 and the 2012 periods the revenues related to Pivotal and all dispositions under our realignment plan, license revenues grew 17% and 8% in the third quarter and first nine months of 2013, respectively. See “Non-GAAP Financial Measures” for further information on license revenues excluding Pivotal and our 2013 dispositions.

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Services Revenues

In the third quarter and first nine months 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 third quarter of 2013, professional services revenues decreased primarily due to the contribution of certain business lines to Pivotal and the disposition of certain business lines under our realignment plan. In the first nine months of 2013, professional services revenues increased primarily as a result of 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. 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 20% and 22% in the third quarter and first nine months of 2013, respectively. See “Non-GAAP Financial Measures” for further information on services revenues excluding Pivotal and our 2013 dispositions.

Foreign 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. Foreign currencies did not have a material impact when comparing revenues during the third quarter and first nine months of 2013 to the same periods in the prior year.

Unearned Revenues

Our unearned revenues as of September 30, 2013 and December 31, 2012 were as follows:



	September 30, 2013		December 31, 2012
Unearned license revenues	$	415	$	463
Unearned software maintenance revenues	2,937		2,755
Unearned professional services revenues	284		243
Total unearned revenues	$	3,636	$	3,461

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. 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 generally recognized ratably, typically over terms from one to five years with a weighted-average remaining term at September 30, 2013 of approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are recognized as the services are delivered.

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Operating Expenses

Information about our operating expenses for the third quarter and first nine months of 2013 and 2012 is as follows:



	For the Three Months Ended September 30, 2013
	Core Operating Expenses (1)		Stock-Based Compensation		Intangible Amortization		Realignment Charges		Other Operating Expenses		Total Operating Expenses
Cost of license revenues	$	20	$	1	$	22	$	—	$	8	$	51
Cost of services revenues	125		7		—		—		—		132
Research and development	212		52		1		—		1		266
Sales and marketing	410		37		1		—		1		449
General and administrative	86		16		—		—		1		103
Realignment charges	—		—		—		1		—		1
Total operating expenses	$	853	$	113	$	24	$	1	$	11	$	1,002
Operating income											$	287
Operating margin											22.4		%



	For the Three Months Ended September 30, 2012
	Core Operating Expenses(1)		Stock-Based Compensation		Intangible Amortization		Realignment Charges		Other Operating Expenses		Total Operating Expenses
Cost of license revenues	$	26	$	—	$	19	$	—	$	15	$	60
Cost of services revenues	110		8		1		—		—		119
Research and development	198		60		1		—		1		260
Sales and marketing	356		52		4		—		—		412
General and administrative	79		12		—		—		2		93
Total operating expenses	$	769	$	132	$	25	$	—	$	18	$	944
Operating income											$	190
Operating margin											16.8		%



	For the Nine Months Ended September 30, 2013
	Core Operating Expenses(1)		Stock-Based Compensation		Intangible Amortization		Realignment Charges		Other Operating Expenses		Total Operating Expenses
Cost of license revenues	$	60	$	2	$	67	$	—	$	34	$	163
Cost of services revenues	350		21		2		—		2		375
Research and development	627		165		2		—		3		797
Sales and marketing	1,193		106		6		—		3		1,308
General and administrative	251		42		—		—		5		298
Realignment charges	—		—		—		64		—		64
Total operating expenses	$	2,481	$	336	$	77	$	64	$	47	$	3,005
Operating income											$	719
Operating margin											19.3		%

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	For the Nine Months Ended September 30, 2012
	Core Operating Expenses(1)		Stock-Based Compensation		Intangible Amortization		Realignment Charges		Other Operating Expenses		Total Operating Expenses
Cost of license revenues	$	69	$	1	$	46	$	—	$	58	$	174
Cost of services revenues	331		21		3		—		1		356
Research and development	575		148		3		—		5		731
Sales and marketing	1,042		111		9		—		4		1,166
General and administrative	228		34		—		—		4		266
Total operating expenses	$	2,245	$	315	$	61	$	—	$	72	$	2,693
Operating income											$	619
Operating margin											18.7		%

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(1)	Core operating expenses is a non-GAAP financial measure. See additional discussion in the “Core Operating Expenses” section.

Core Operating Expenses

Core operating expenses is a non-GAAP financial measure that excludes stock-based compensation, amortization of acquired intangible assets, realignment charges, and certain other expenses from our total operating expenses calculated in accordance with GAAP. The other operating expenses excluded are the net effect of the amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items. Our core operating expenses reflect our business in a manner that allows meaningful period-to-period comparisons. Our core operating expenses are reconciled to the most comparable GAAP measure, “total operating expenses,” in the table above. See “Non-GAAP Financial Measures” for further information.

Core operating expenses increased by $84 or 11% in the third quarter of 2013 compared with the third quarter of 2012. Core operating expenses increased by $236 or 11% in the first nine months of 2013 compared with the first nine months of 2012. As quantified below, these increases were primarily due to increases in employee-related expenses, which include salaries and benefits, bonuses, commissions, and recruiting and training as well as an increase in marketing programs and contractor costs. The increase in core operating expenses in the third quarter and first nine months of 2013 compared with the same periods during 2012 was partially offset by a decrease in operating expenses related to Pivotal.

Cost of License Revenues

Our core operating expenses for cost of license revenues principally consist of the cost of fulfillment of our software and royalty costs in connection with technology licensed from third-party providers. The cost of fulfillment of our software includes IT development efforts, personnel costs, product packaging and related overhead associated with the physical and electronic delivery of our software products.

Core operating expenses for cost of license revenues decreased by $6 or 23% in the third quarter of 2013 compared with the third quarter of 2012, and by $9 or 13% in the first nine months of 2013 compared with the first nine months of 2012. The decreases were primarily due to a decrease of IT development costs of $3 and $7, respectively, as well as a decrease in royalty and licensing costs for technology licensed from third-party providers that is used in our products.

Cost of Services Revenues

Our core operating expenses for cost of services revenues primarily include the costs of personnel and related overhead to deliver technical support for our products and to provide our professional services.

Core operating expenses for cost of services revenues increased by $15 or 14% in the third quarter of 2013 compared with the third quarter of 2012, and by $19 or 6% in the first nine months of 2013 compared with the first nine months of 2012. The increase was primarily due to $10 and $27, respectively, of employee-related expenses as well as an increase of $13 and $16, respectively, in costs we incur to provide technical support, IT development and professional services. These increases were generally proportional to the increases in services revenues for the same comparable periods. The increase was partially offset by a decrease of $10 and $22, respectively, of operating expenses related to Pivotal.

Research and Development Expenses

Our core operating expenses for research and development (“R&D”) expenses include the personnel and related overhead associated with the R&D of new product offerings and the enhancement of our existing software offerings.

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Core operating expenses for R&D increased by $14 or 7% in the third quarter of 2013 compared with the third quarter of 2012, and by $52 or 9% in the first nine months of 2013 compared with the first nine months of 2012. The increase in the third quarter and first nine months of 2013 compared with the third quarter and first nine months of 2012 was primarily due to growth in employee-related expenses of $16 and $60, respectively, which was primarily driven by incremental growth in headcount from strategic hiring. Additionally, contractor costs, IT development costs, and equipment and depreciation expenses also increased by $15 and $28 during the third quarter and first nine months of 2013, respectively, compared to the same periods in the prior year. The increases in expenses in the third quarter and first nine months of 2013 were partially offset by a decrease of $19 and $40, respectively, of research and development expenses related to Pivotal.

Sales and Marketing Expenses

Our core operating expenses for sales and marketing expenses include personnel costs, sales commissions and related overhead associated with the sale and marketing of our license and services offerings, as well as the cost of product launches. Sales commissions are generally earned and expensed when a firm order is received from the customer and may be expensed in a period other than the period in which the related revenue is recognized. Sales and marketing expenses also include the net impact from the expenses incurred and fees generated by certain marketing initiatives, including our annual VMworld and VMworld Europe conferences.

Core operating expenses for sales and marketing increased by $54 or 15% in the third quarter of 2013 compared with the third quarter of 2012, and by $151 or 14% in the first nine months of 2013 compared with the first nine months of 2012. The increase in the third quarter and first nine months of 2013 was primarily due to growth in employee-related expenses of $44 and $139, respectively, driven by incremental growth in headcount and by higher commission expense due to increased sales volumes. To a lesser extent, costs incurred for marketing programs, contractor costs and IT development costs of $23 and $32 also contributed to the increase of expense during the third quarter and first nine months of 2013, respectively, compared to the same periods in the prior year. The increases in expenses in the third quarter and first nine months of 2013 were partially offset by a decrease of $14 and $29, respectively, of sales and marketing expenses related to Pivotal.

General and Administrative Expenses

Our core operating expenses for general and administrative expenses include personnel and related overhead costs to support the overall business. These expenses include the costs associated with our finance, human resources, IT infrastructure and legal, as well as expenses related to corporate costs and initiatives and facilities costs.

Core operating expenses for general and administrative increased by $7 or 9% in the third quarter of 2013 compared with the third quarter of 2012, and by $23 or 10% in the first nine months of 2013 compared with the first nine months of 2012. The most significant driver of the increase in the third quarter and first nine months of 2013 was due to incremental growth in headcount resulting in an increase of $4 and $11, respectively. The increase in the first nine months of 2013 compared to the same period in the prior year was also due to an increase in charitable donations and contractor expenses.

Stock-Based Compensation

Stock-based compensation was $113 and $132 in the third quarter of 2013 and 2012, respectively, a decrease of $19 or 14%. Stock-based compensation was $336 and $315 in the first nine months of 2013 and 2012, respectively, an increase of $21 or 7%.

The decrease in total stock-based compensation expense in the third quarter of 2013 compared with the third quarter of 2012 was primarily due to certain acquisition costs recognized during the third quarter of 2012 that were not recognized during the same period in 2013. Our recent realignment plan that included divesting of certain business activities, and our investment in Pivotal resulting in the transfer of certain of our employees also contributed to a decline in stock-based compensation during the third quarter of 2013 compared to the same period in the prior year.

Although stock-based compensation expense declined during the third quarter 2013 compared to 2012, the decrease only partially offset the increase of approximately $41 in stock-based compensation expense during the first six months of fiscal year 2013 compared to the same period in the prior year, resulting in an increase of stock-based compensation during the nine months ended 2013 compared to same period in the prior year.

Stock-based compensation is recorded to each operating expense category based upon the function of the employee to whom the stock-based compensation relates and fluctuates based upon the value and number of awards granted. Compensation philosophy varies by function, resulting in different weightings of cash incentives versus equity incentives. As a result, functions with larger cash-based components, such as sales commissions, will have comparatively lower stock-based compensation than other functions.

As of September 30, 2013, the total unamortized fair value of our outstanding equity-based awards held by our employees was $834, and is expected to be recognized over a weighted-average period of approximately 1.5 years.

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Intangible Amortization

Intangible amortization increased $16 or 26% in the first nine months of 2013 compared with the first nine months of 2012 as a result of new acquisitions, primarily the acquisition of Nicira in the third quarter of 2012. The increase was partially offset by the transfer of certain intangible assets to Pivotal, as well as a result of exiting certain lines of business under our realignment plan. Additionally, intangible amortization decreased as certain intangible assets became fully amortized. Intangible amortization decreased by an immaterial amount in the third quarter of 2013 compared with the third quarter of 2012. Intangible amortization is predominantly recorded to cost of license revenues on our accompanying consolidated statements of income.

Realignment Charges

During January 2013, we approved and initiated a business realignment plan to streamline our operations resulting in realignment charges incurred during the first nine months of 2013. As of the second quarter of 2013, the plan was substantially complete.

The plan included the elimination of approximately 725 positions and personnel across all major functional groups and geographies. The total cash and non-cash charge for workforce reductions of $54 was recorded on the consolidated statements of income during the first nine months of 2013.

Although we expect that streamlining our operations will have a favorable impact on our operating expenses in future quarters, we expect that core operating expenses related to our headcount will increase as our total headcount is expected to have a net increase of approximately 500 during 2013 as we continue to make key investments in support of our long-term growth objectives. This expected net increase takes into account the reduction of employees that have or will transfer to Pivotal, as well as the impact of our realignment activities.

Other Operating Expenses

Other operating expenses consist of the net effect of the amortization and capitalization of software development costs and employer payroll tax on employee stock transactions, which are recorded to each individual line of operating expense on our accompanying consolidated statements of income. Additionally, other operating expenses include acquisition and other-related items, which are recorded in general and administrative expense on our income statement.

Other operating expenses decreased $7 and $25 in the third quarter and first nine months of 2013, respectively, from the third quarter and first nine months of 2012. The decrease in the third quarter and first nine months of 2013 was primarily due to a decrease of $7 and $24, respectively, in the amortization of capitalized software development costs resulting from the completion of amortization for previous product releases. Amortization expense from capitalized software development costs is included in cost of license revenues on our accompanying consolidated statements of income. In future periods, we expect our amortization expense from capitalized software development costs to continue to decline as these costs are expected to be recorded as R&D expense as incurred.

Other Income (Expense), Net

Other income, net of $15 and $29 in the third quarter and first nine months of 2013, respectively, changed by $17 and $31, respectively, compared with other expense, net of $2 and $2 in the third quarter and first nine months of 2012, respectively, primarily due to pre-tax gains of $12 and $44 recognized in the third quarter and first nine months of 2013, respectively, as a result of divesting of certain business activities under our business realignment plan. Partially offsetting this gain was the recognition of an other-than-temporary impairment charge for a strategic investment in the first nine months of 2013.

Income Tax Provision

Our 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.

We have been included in the EMC consolidated group for U.S. federal income tax purposes, and expect to continue to be included in such consolidated group for periods in which EMC owns at least 80% of the total voting power and value of our outstanding stock as calculated for U.S. federal income tax purposes. The percentage of voting power and value calculated for U.S. federal income tax purposes may differ from the percentage of outstanding shares beneficially owned by EMC due to the greater voting power of our Class B common stock as compared to our Class A common stock and other factors. Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Should EMC's ownership fall below 80% of the total voting power or value of our outstanding stock in any period, then we would no longer be included in the EMC consolidated group for U.S. federal income tax purposes, and thus no longer be liable in the event that any income tax liability

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was incurred, but not discharged, by any other member of the EMC consolidated group. Additionally, our U.S. federal income tax would be reported separately from that of the EMC consolidated group.

Our effective income tax rate was 15.3% and 19.7% for the third quarter of 2013 and 2012, respectively. The effective income tax rate was 11.4% and 14.7% for the first nine months of 2013 and 2012, respectively. The lower effective rate for the third quarter of 2013 compared to the same period in 2012 was primarily attributable to the finalization of the 2012 federal return related to the change in estimate of the U.S. federal research tax credit calculation. The lower effective rate for the first nine months of 2013 compared to the same period in 2012 was primarily attributable to the discrete tax benefits recognized in the first nine months of 2013 due to the retroactive enactment of the U.S. federal research tax credit by the U.S. Congress in January 2013.

Our rate of taxation in foreign jurisdictions is lower than our U.S. tax rate. Our international income is primarily earned by our subsidiaries in Ireland, where the statutory tax rate is 12.5%. We do not believe that any recent or currently expected developments in non-U.S. tax jurisdictions are reasonably likely to have a material impact on our effective tax rate. Our intent is to indefinitely reinvest our non-U.S. funds in our foreign operations, and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

Our effective tax rate for the remainder of 2013 may be affected by such factors as changes in tax laws, regulations or rates, changing interpretation of existing laws or regulations, the impact of accounting for stock-based compensation, the impact of accounting for business combinations, dispositions, changes in our international organization, shifts in the amount of income before tax earned in the U.S. as compared with other regions in the world, and changes in overall levels of income before tax.

Our Relationship with EMC

As of September 30, 2013, EMC owned 43,025,000 shares of Class A common stock and all 300,000,000 shares of Class B common stock, representing 79.7% of our total outstanding shares of common stock and 97.2% of the combined voting power of our outstanding common stock.

EMC Reseller Arrangement, Other Services and Note Payable

Pursuant to an ongoing reseller arrangement with EMC, EMC bundles our products and services with EMC’s products and sells them to end-users. In the three months ended September 30, 2013 and 2012, we recognized revenues of $37 and $27, respectively, from such contractual arrangement with EMC. In the nine months ended September 30, 2013 and 2012, we recognized revenues of $108 and $88, respectively, from such contractual arrangement with EMC. As of September 30, 2013, $162 of revenues from products and services sold under the reseller arrangement were included in unearned revenues.

In the three months ended September 30, 2013 and 2012, we recognized professional services revenues of $14 and $21, respectively, from such contractual agreements with EMC. In the nine months ended September 30, 2013 and 2012, we recognized revenues of $60 and $63, respectively, from such contractual agreements with EMC. As of September 30, 2013, $9 of revenues from professional services to EMC customers were included in unearned revenues.

In both the three months ended September 30, 2013 and 2012, we recognized revenues of $3 from products and services purchased by EMC for internal use pursuant to our contractual agreements with EMC. In the nine months ended September 30, 2013 and 2012, we recognized revenues of $9 and $7, respectively, from such contractual agreements with EMC. As of September 30, 2013, $30 of revenues from products and services purchased by EMC for internal use were included in unearned revenues.

We purchased products and services for internal use from EMC for $20 and $4 in the three months ended September 30, 2013 and 2012, respectively, and for $45 and $28 in the nine months ended September 30, 2013 and 2012, respectively.

From time to time, we and EMC enter into agreements to collaborate on technology projects. In both the three months ended September 30, 2013 and 2012, we received $2 from EMC for EMC’s portion of expenses related to such projects, and in the nine months ended September 30, 2013 and 2012, we received $6 and