Edgar Filing: VMWARE, INC.

VMW-3.31.2015 10-Q

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 March 31, 2015



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 001-33622

_______________________________________________________

VMWARE, INC.

(Exact name of registrant as specified in its charter)

_______________________________________________________



Delaware	94-3292913
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

3401 Hillview Avenue Palo Alto, CA	94304
(Address of principal executive offices)	(Zip Code)

(650) 427-5000

(Registrant’s telephone number, including area code)

_____________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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 April 28, 2015, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 423,862,844 of which 123,862,844 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

	Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2015 and 2014	3

	Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2015 and 2014	4

	Condensed Consolidated Balance Sheets at March 31, 2015 and December 31, 2014	5

	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2015 and 2014	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33

Item 4.	Controls and Procedures	34

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	35

Item 1A.	Risk Factors	35

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59

Item 3.	Defaults Upon Senior Securities	59

Item 4.	Mine Safety Disclosures	59

Item 5.	Other Information	60

Item 6.	Exhibits	61

	SIGNATURES	62

	EXHIBIT INDEX	63

VMware, vSphere, vCloud, vCloud Suite, Horizon Suite, VMware NSX, Virtual SAN, vCloud Air, Horizon, vRealize, Immidio, Workspace Environment Management, AirWatch, and Desktone are registered trademarks or trademarks of VMware or its subsidiaries in the United States and other jurisdictions. All other marks and names mentioned herein may be trademarks of their respective companies.

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PART I

FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS

VMware, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in millions, except per share amounts, and shares in thousands)

(unaudited)



	Three Months Ended
	March 31,
	2015			2014
Revenues:
License	$	576		$	561
Services	935			799
Total revenues	1,511			1,360
Operating expenses (1):
Cost of license revenues	50			50
Cost of services revenues	193			151
Research and development	305			293
Sales and marketing	536			474
General and administrative	187			151
Realignment charges	22			—
Operating income	218			241
Investment income	12			9
Interest expense with EMC	(6		)	(5		)
Other expense	(2		)	—
Income before income taxes	222			245
Income tax provision	26			46
Net income	$	196		$	199
Net income per weighted-average share, basic for Class A and Class B	$	0.46		$	0.46
Net income per weighted-average share, diluted for Class A and Class B	$	0.45		$	0.46
Weighted-average shares, basic for Class A and Class B	427,962			430,546
Weighted-average shares, diluted for Class A and Class B	430,496			434,729
__________
(1) Includes stock-based compensation as follows:
Cost of license revenues	$	1		$	1
Cost of services revenues	11			9
Research and development	54			60
Sales and marketing	39			41
General and administrative	14			17

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

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VMware, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions)

(unaudited)



	Three Months Ended
	March 31,
	2015			2014
Net income	$	196		$	199
Other comprehensive income:
Changes in market value of available-for-sale securities:
Unrealized gains, net of taxes of $4 and $1	6			1
Changes in market value of effective foreign currency forward exchange contracts:
Unrealized losses, net of $0 taxes for all periods	(5		)	—
Total other comprehensive income	1			1
Total comprehensive income, net of taxes	$	197		$	200

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

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VMware, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in millions, except per share amounts, and shares in thousands)

(unaudited)



	March 31,		December 31,
	2015		2014
ASSETS
Current assets:
Cash and cash equivalents	$	1,941	$	2,071
Short-term investments	5,285		5,004
Accounts receivable, net of allowance for doubtful accounts of $2 and $2	988		1,520
Due from related parties, net	2		49
Deferred tax assets	250		248
Other current assets	239		238
Total current assets	8,705		9,130
Property and equipment, net	1,059		1,035
Other assets	168		174
Deferred tax assets	175		165
Intangible assets, net	719		748
Goodwill	3,981		3,964
Total assets	$	14,807	$	15,216
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	124	$	203
Accrued expenses and other	680		811
Unearned revenues	2,970		2,982
Total current liabilities	3,774		3,996
Notes payable to EMC	1,500		1,500
Unearned revenues	1,774		1,851
Other liabilities	275		283
Total liabilities	7,323		7,630
Contingencies (refer to Note I)
Stockholders’ equity:
Class A common stock, par value $.01; authorized 2,500,000 shares; issued and outstanding 125,556 and 129,359 shares	1		1
Class B convertible common stock, par value $.01; authorized 1,000,000 shares; issued and outstanding 300,000 shares	3		3
Additional paid-in capital	3,082		3,380
Accumulated other comprehensive loss	—		(1		)
Retained earnings	4,394		4,198
Total VMware, Inc.’s stockholders’ equity	7,480		7,581
Non-controlling interests	4		5
Total stockholders’ equity	7,484		7,586
Total liabilities and stockholders’ equity	$	14,807	$	15,216

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

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VMware, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(unaudited)



	Three Months Ended
	March 31,
	2015			2014
Operating activities:
Net income	$	196		$	199
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	76			83
Stock-based compensation	119			128
Excess tax benefits from stock-based compensation	(2		)	(15		)
Deferred income taxes, net	(15		)	(29		)
Other	—			1
Changes in assets and liabilities, net of acquisitions:
Accounts receivable	531			418
Other assets	—			(29		)
Due to/from related parties, net	52			33
Accounts payable	(49		)	(11		)
Accrued expenses	(102		)	(104		)
Income taxes payable	(32		)	41
Unearned revenues	(91		)	35
Net cash provided by operating activities	683			750
Investing activities:
Additions to property and equipment	(106		)	(77		)
Purchases of available-for-sale securities	(1,027		)	(531		)
Sales of available-for-sale securities	501			411
Maturities of available-for-sale securities	255			153
Business acquisitions, net of cash acquired	(21		)	(1,068		)
Decrease (increase) in restricted cash	1			(76		)
Other investing	—			(10		)
Net cash used in investing activities	(397		)	(1,198		)
Financing activities:
Proceeds from issuance of common stock	54			88
Proceeds from issuance of notes payable to EMC	—			1,050
Reduction in capital from EMC	—			(24		)
Repurchase of common stock	(438		)	(169		)
Excess tax benefits from stock-based compensation	2			15
Shares repurchased for tax withholdings on vesting of restricted stock	(34		)	(29		)
Net cash provided by (used in) financing activities	(416		)	931
Net increase (decrease) in cash and cash equivalents	(130		)	483
Cash and cash equivalents at beginning of the period	2,071			2,305
Cash and cash equivalents at end of the period	$	1,941		$	2,788
Supplemental disclosures of cash flow information:
Cash paid for interest	$	7		$	6
Cash paid for taxes, net	74			33
Non-cash items:
Changes in capital additions, accrued but not paid	$	(42	)	$	(7	)
Fair value of stock-based awards assumed in acquisition	—			24

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

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

A. Overview and Basis of Presentation

Company and Background

VMware, Inc. (“VMware” or the “Company”) is the leader in virtualization infrastructure solutions utilized by organizations to help them transform the way they build, deliver and consume information technology (“IT”) resources. VMware’s virtualization infrastructure solutions, which include a suite of products and services designed to deliver a software-defined data center, run on industry-standard desktop computers and servers and support a wide range of operating system and application environments, as well as networking and storage infrastructures.

Accounting Principles

The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Unaudited Interim Financial Information

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, for a fair statement of VMware’s condensed consolidated results of operations, financial position and cash flows for the periods presented. Results of operations are not necessarily indicative of the results that may be expected for the full year 2015. Certain information and footnote disclosures typically included in annual consolidated financial statements have been condensed or omitted. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in VMware’s 2014 Annual Report on Form 10-K.

As of March 31, 2015, EMC Corporation (“EMC”) held approximately 80.6% of VMware’s outstanding common stock and 97.4% 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.

Management believes the assumptions underlying the condensed consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with EMC may not be considered arm’s length with an unrelated third party. Therefore, the financial statements included herein may not necessarily reflect the 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 financial position, results of operations and cash flows will be in the future if and when VMware contracts at arm’s length with unrelated third parties for the services the Company receives from and provides to EMC.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of VMware and subsidiaries in which VMware has a controlling financial interest. Non-controlling interests are presented as a separate component within total stockholders’ equity and represent the equity and cumulative pro-rata share of the results of operations attributable to the non-controlling interests. Net earnings attributable to the non-controlling interests are eliminated within other expense on the condensed consolidated statements of income and are not presented separately as the amounts were not material for the periods presented. All intercompany transactions and account balances between VMware and its subsidiaries have been eliminated in consolidation. Transactions with EMC and its subsidiaries are generally settled in cash and are classified on the condensed consolidated statements of cash flows based upon the nature of the underlying transaction.

Reclassification

Certain prior period amounts related to the notes payable to EMC have been reclassified within the financing activities section of the condensed consolidated statements of cash flows. The reclassifications had no effect on total cash flows used in or provided by operating, investing or financing activities as previously reported.

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

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

not limited to trade receivable valuation, marketing development funds and rebates, useful lives assigned to fixed assets and intangible assets, valuation of goodwill and definite-lived intangibles, income taxes, stock-based compensation, and contingencies. Actual results could differ from those estimates.

New Accounting Pronouncement

During May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The updated revenue standard establishes principles for recognizing revenue and develops a common revenue standard for all industries. Upon adoption, entities will be required to recognize the amount of revenue that they expect to be entitled to for the transfer of promised goods or services to their customers. The updated standard is effective for the Company in the first quarter of 2017 and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. In April 2015, the FASB proposed a one-year delay in the effective date of the new standard to 2018. Under this proposal, early adoption will be allowed, but not earlier than the original effective date.

The Company has not selected a transition method and is currently evaluating the effect that the updated standard will have on its condensed consolidated financial statements and related disclosures.

B. Business Combination, Definite-Lived Intangible Assets, Net and Goodwill

Business Combination

On February 2, 2015, VMware acquired all of the outstanding shares of Immidio B.V. (“Immidio”) for approximately $21 million of cash, net of liabilities assumed. VMware acquired Immidio to expand VMware's Workspace Environment Management solutions within the End-User Computing product group. The preliminary purchase price primarily included $8 million of identifiable intangible assets and approximately $17 million of goodwill that is expected to be non-deductible for tax purposes. The impact of the acquisition was not material to VMware's condensed consolidated financial statements.

Definite-Lived Intangible Assets, Net

As of March 31, 2015 and December 31, 2014, definite-lived intangible assets consisted of the following (amounts in table in millions):



	March 31, 2015
	Weighted-Average Useful Lives (in years)	Gross Carrying Amount		Accumulated Amortization			Net Book Value
Purchased technology	6.5	$	705	$	(279	)	$	426
Leasehold interest	34.9	149		(16		)	133
Customer relationships and customer lists	8.2	157		(58		)	99
Trademarks and tradenames	8.6	61		(11		)	50
Other	2.1	20		(9		)	11
Total definite-lived intangible assets		$	1,092	$	(373	)	$	719



	December 31, 2014
	Weighted-Average Useful Lives (in years)	Gross Carrying Amount		Accumulated Amortization			Net Book Value
Purchased technology	6.5	$	699	$	(252	)	$	447
Leasehold interest	34.9	149		(15		)	134
Customer relationships and customer lists	8.2	157		(53		)	104
Trademarks and tradenames	8.6	61		(9		)	52
Other	2.7	18		(7		)	11
Total definite-lived intangible assets		$	1,084	$	(336	)	$	748

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

During the three months ended March 31, 2015 and 2014, amortization expense on definite-lived intangible assets was $37 million and $30 million, respectively.

Based on intangible assets recorded as of March 31, 2015 and assuming no subsequent additions or impairment of underlying assets, the remaining estimated annual amortization expense is expected to be as follows (table in millions):



Remainder of 2015	$	109
2016	128
2017	121
2018	108
2019	87
Thereafter	166
Total	$	719

Goodwill

The following table summarizes the changes in the carrying amount of goodwill during the three months ended March 31, 2015 (table in millions):



Balance, January 1, 2015	$	3,964
Increase in goodwill related to business combination	17
Balance, March 31, 2015	$	3,981

C. Realignment Charges

During the three months ended March 31, 2015, VMware eliminated approximately 350 positions across all major functional groups and geographies to streamline its operations. As a result of this action, $22 million of realignment charges were recognized during the three months ended March 31, 2015, which consisted of severance-related costs. As of March 31, 2015, $16 million remained in accrued expenses and other on the condensed consolidated balance sheets and is expected to be paid during 2015.

The following table summarizes the activity for the accrued realignment charges for the three months ended March 31, 2015 (table in millions):



	For the Three Months Ended March 31, 2015
	Balance as of January 1, 2015		Realignment Charges		Utilization			Balance as of March 31, 2015
Severance-related costs	$	8	$	22	$	(14	)	$	16

No realignment charges were recognized during the three months ended March 31, 2014.

D. Net Income per Share

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares outstanding and potentially dilutive securities outstanding during the period, as calculated using the treasury stock method. Potentially dilutive securities primarily include unvested restricted stock units, performance stock units, stock options and purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate net income per share as both classes share the same rights in dividends, therefore basic and diluted earnings per share are the same for both classes.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The following table sets forth the computations of basic and diluted net income per share during the three months ended March 31, 2015 and 2014 (net income in millions, shares in thousands):



	Three Months Ended
	March 31,
	2015		2014
Net income	$	196	$	199
Weighted-average shares, basic for Class A and Class B	427,962		430,546
Effect of dilutive securities	2,534		4,183
Weighted-average shares, diluted for Class A and Class B	430,496		434,729
Net income per weighted-average share, basic for Class A and Class B	$	0.46	$	0.46
Net income per weighted-average share, diluted for Class A and Class B	$	0.45	$	0.46

The following table sets forth the weighted-average common share equivalents of Class A common stock that were excluded from the diluted net income per share calculations during the three months ended March 31, 2015 and 2014, because their effect would have been anti-dilutive (shares in thousands):



	Three Months Ended
	March 31,
	2015	2014
Anti-dilutive securities:
Employee stock options	2,503	930
Restricted stock units	223	35
Total	2,726	965

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

E. Cash, Cash Equivalents and Investments

Cash, cash equivalents and investments as of March 31, 2015 and December 31, 2014 consisted of the following (tables in millions):



	March 31, 2015
	Cost or Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
Cash	$	827	$	—	$	—		$	827
Cash equivalents:
Money-market funds	$	1,082	$	—	$	—		$	1,082
U.S. and foreign corporate debt securities	32		—		—			32
Total cash equivalents	$	1,114	$	—	$	—		$	1,114
Short-term investments:
U.S. Government and agency obligations	$	665	$	2	$	—		$	667
U.S. and foreign corporate debt securities	3,322		8		(2		)	3,328
Foreign governments and multi-national agency obligations	28		—		—			28
Municipal obligations	908		2		—			910
Asset-backed securities	87		—		—			87
Mortgage-backed securities	265		—		—			265
Total short-term investments	$	5,275	$	12	$	(2	)	$	5,285
Other assets:
Marketable available-for-sale equity securities	$	15	$	—	$	(1	)	$	14



	December 31, 2014
	Cost or Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
Cash	$	885	$	—	$	—		$	885
Cash equivalents:
Money-market funds	$	1,130	$	—	$	—		$	1,130
U.S. and foreign corporate debt securities	54		—		—			54
Foreign governments and multi-national agency obligations	2		—		—			2
Total cash equivalents	$	1,186	$	—	$	—		$	1,186
Short-term investments:
U.S. Government and agency obligations	$	542	$	—	$	—		$	542
U.S. and foreign corporate debt securities	3,236		3		(5		)	3,234
Foreign governments and multi-national agency obligations	23		—		—			23
Municipal obligations	930		2		—			932
Asset-backed securities	53		—		—			53
Mortgage-backed securities	221		—		(1		)	220
Total short-term investments	$	5,005	$	5	$	(6	)	$	5,004

Refer to Note F for further information regarding the fair value of VMware’s cash equivalents and investments.

The realized gains and losses on investments during the three months ended March 31, 2015 and 2014 were not material.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Unrealized losses on cash equivalents and investments as of March 31, 2015 and December 31, 2014, which have been in a net loss position for less than twelve months, were classified by investment category as follows (table in millions):



	March 31, 2015					December 31, 2014
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. and foreign corporate debt securities	$	1,041	$	(2	)	$	1,964	$	(5	)
Mortgage-backed securities	93		—			107		(1		)
Marketable available-for-sale equity securities	14		(1		)	—		—
Total	$	1,148	$	(3	)	$	2,071	$	(6	)

As of March 31, 2015 and December 31, 2014, unrealized losses on cash equivalents and investments in other investment categories, which have been in a net loss position for less than twelve months, were not material. Unrealized losses on cash equivalents and available-for-sale investments, which have been in a net loss position for twelve months or greater, were not material as of March 31, 2015 and December 31, 2014.

Contractual Maturities

The contractual maturities of cash equivalents and short-term investments held at March 31, 2015 consisted of the following (table in millions):



	Amortized Cost Basis		Aggregate Fair Value
Due within one year	$	2,632	$	2,633
Due after 1 year through 5 years	3,470		3,479
Due after 5 years	287		287
Total cash equivalents and short-term investments	$	6,389	$	6,399

F. Fair Value Measurements

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

Certain financial assets and liabilities are measured at fair value on a recurring basis. VMware determines fair value using the following hierarchy:


•	Level 1 - Quoted prices in active markets for identical assets or liabilities


•	Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are noted active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities


•	Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

VMware’s fixed income securities are primarily classified as Level 2, with the exception of some of the U.S. Government and agency obligations which are classified as Level 1. Additionally, VMware’s Level 2 classification includes foreign currency forward contracts and notes payable to EMC. At March 31, 2015 and December 31, 2014, VMware’s Level 2 securities were generally priced using non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques.

VMware does not have any material assets or liabilities that fall into Level 3 of the fair value hierarchy as of March 31, 2015 and December 31, 2014, and there have been no transfers between fair value measurement levels during the three months ended March 31, 2015 and 2014.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

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



	March 31, 2015
	Level 1		Level 2			Total
Cash equivalents:
Money-market funds	$	1,082	$	—		$	1,082
U.S. and foreign corporate debt securities	—		32			32
Total cash equivalents	$	1,082	$	32		$	1,114
Short-term investments:
U.S. Government and agency obligations	$	436	$	231		$	667
U.S. and foreign corporate debt securities	—		3,328			3,328
Foreign governments and multi-national agency obligations	—		28			28
Municipal obligations	—		910			910
Asset-backed securities	—		87			87
Mortgage-backed securities	—		265			265
Total short-term investments	$	436	$	4,849		$	5,285
Other current assets:
Foreign currency forward contracts	$	—	$	1		$	1
Other assets:
Marketable available-for-sale equity securities	$	14	$	—		$	14
Accrued expenses and other:
Foreign currency forward contracts	$	—	$	(7	)	$	(7	)



	December 31, 2014
	Level 1		Level 2			Total
Cash equivalents:
Money-market funds	$	1,130	$	—		$	1,130
U.S. and foreign corporate debt securities	—		54			54
Foreign governments and multi-national agency obligations	—		2			2
Total cash equivalents	$	1,130	$	56		$	1,186
Short-term investments:
U.S. Government and agency obligations	$	353	$	189		$	542
U.S. and foreign corporate debt securities	—		3,234			3,234
Foreign governments and multi-national agency obligations	—		23			23
Municipal obligations	—		932			932
Asset-backed securities	—		53			53
Mortgage-backed securities	—		220			220
Total short-term investments	$	353	$	4,651		$	5,004
Other current assets:
Foreign currency forward contracts	$	—	$	1		$	1
Accrued expenses and other:
Foreign currency forward contracts	$	—	$	(1	)	$	(1	)

VMware has elected not to record its notes payable to EMC at fair value, but has measured the notes at fair value for disclosure purposes. As of March 31, 2015 and December 31, 2014, the fair value of the notes payable to EMC was $1,519 million and $1,503 million, respectively. Fair value was estimated based on observable market data (Level 2 inputs).

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

VMware offers a deferred compensation plan for eligible employees that allows participants to defer payment for part or all of their compensation. VMware’s results of operations are not significantly affected by this plan since changes in the fair value of the assets substantially offset changes in the fair value of the liabilities. As such, assets and liabilities associated with this plan have not been included in the above tables. Assets and liabilities associated with this plan were both approximately $13 million and $8 million as of March 31, 2015 and December 31, 2014, respectively, and are included in other assets and other liabilities on the condensed consolidated balance sheets.

Assets Measured and Recorded at Fair Value on a Non-Recurring Basis

VMware evaluated the strategic investments in its portfolio accounted for under the cost method to assess whether any of its strategic investments were other-than-temporarily impaired. VMware uses Level 3 inputs as part of its impairment analysis, including, pre- and post-money valuations of recent financing events and the impact of those on its fully diluted ownership percentages, as well as other available information regarding the issuer’s historical and forecasted performance. The estimated fair value of these investments is considered in VMware’s impairment review if any events or changes in circumstances occur that might have a significant adverse effect on their value. During the three months ended March 31, 2015 and 2014, VMware did not recognize an other-than-temporary impairment charge for a non-recoverable strategic investment.

During the three months ended March 31, 2015 and 2014, VMware did not have material realized gains or realized losses on strategic investments. Strategic investments are included in other assets on the condensed consolidated balance sheets. The carrying value of VMware’s strategic investments was $94 million and $110 million as of March 31, 2015 and December 31, 2014, respectively.

G. Derivatives and Hedging Activities

VMware conducts business on a global basis in multiple foreign currencies, subjecting the Company to foreign currency risk. To mitigate this risk, VMware utilizes hedging contracts as described below, which potentially expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. VMware manages counterparty risk by seeking counterparties of high credit quality, by monitoring credit ratings and credit spreads of, and other relevant public information about its counterparties. VMware does not, and does not intend to, use derivative instruments for speculative purposes.

Cash Flow Hedges

To mitigate its exposure to foreign currency fluctuations resulting from operating expenses denominated in certain foreign currencies, VMware enters into foreign currency forward contracts. The Company designates these forward contracts as cash flow hedging instruments as the accounting criteria for such designation have been met. Therefore, the effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported in accumulated other comprehensive loss on the condensed consolidated balance sheets and is subsequently reclassified to the related operating expense line item on the condensed consolidated statements of income in the same period that the underlying expenses are incurred. During the three months ended March 31, 2015 and 2014, the effective portion of gains or losses reclassified to the condensed consolidated statements of income was not material. Interest charges or “forward points” on VMware’s forward contracts are excluded from the assessment of hedge effectiveness and are recorded in other expense on the condensed consolidated statements of income as incurred.

VMware enters into forward contracts annually, which have maturities of 12 months or less. As of March 31, 2015 and December 31, 2014, VMware had foreign currency forward contracts designated as cash flow hedges with a total notional value of $178 million and $240 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.

During the three months ended March 31, 2015 and 2014, all cash flow hedges were considered effective.

Foreign Currency Forward Contracts Not Designated as Hedges

VMware has established a program that utilizes foreign currency forward contracts to offset the foreign currency risk associated with net outstanding monetary asset and liability positions. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are reported in other expense on the condensed consolidated statements of income.

VMware enters into foreign currency forward contracts on a monthly basis, which typically have a contractual term of one month. As of March 31, 2015 and December 31, 2014, VMware had outstanding forward contracts with a total notional value of $489 million and $697 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

During the three months ended March 31, 2015, VMware recognized a gain of $40 million relating to the settlement of foreign currency forward contracts. Losses derived from the settlement of foreign currency forward contracts during the three months ended March 31, 2014 were immaterial.

The combined gains and losses derived from the settlement of foreign currency forward contracts and the underlying foreign-currency denominated assets and liabilities resulted in a net loss of $6 million during the three months ended March 31, 2015. The combined gains and losses derived from the settlement of foreign currency forward contracts and the underlying foreign-currency denominated assets and liabilities were immaterial during the three months ended March 31, 2014. Net gains and losses are recorded in other expense on the condensed consolidated statements of income.

H. Unearned Revenues

Unearned revenues as of March 31, 2015 and December 31, 2014 consisted of the following (table in millions):



	March 31,		December 31,
	2015		2014
Unearned license revenues	$	466	$	488
Unearned software maintenance revenues	3,847		3,905
Unearned professional services revenues	431		440
Total unearned revenues	$	4,744	$	4,833

Unearned license revenues are generally recognized upon delivery of existing or future products or services, or are otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. In the event the arrangement does not include professional services, unearned license revenues may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist. Total unearned license revenues may vary over periods for a variety of factors, including the type and level of promotions offered, and the timing of when the products are delivered upon general availability.

Unearned software maintenance revenues are attributable to VMware’s maintenance contracts and are generally recognized ratably over the contract period. The weighted-average remaining term at March 31, 2015 was approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered.

I. Contingencies

Litigation

VMware and the U.S. General Services Administration (“GSA”) and the Department of Justice (“DOJ”) are in ongoing discussions regarding VMware’s government sales practices covering the period between 2007 and 2013. The Company believes that its government sales practice disclosures were both accurate and complete. Notwithstanding this belief, possible resolution of this matter has been part of the ongoing discussions with the government. Based on these discussions, the Company currently believes that a reasonably possible range to resolve this matter is $11 million to $78 million. A total of $11 million has been accrued for this matter and reflects the low end of the range of estimated losses that are considered both probable and reasonably estimable. Final resolution of this matter could be materially different from the amount accrued. The amount accrued for this matter is included in accrued expenses and other on the condensed consolidated balance sheets.

On March 4, 2015, Christoph Hellwig, a software developer who alleges that software code he wrote is used in a component of our vSphere product, filed a lawsuit against us in Germany alleging copyright infringement for failing to comply with the terms of an open source General Public License v.2 (“GPL v.2”), and seeking an order requiring us to comply with the GPL v.2 or cease distribution of any affected code within Germany. VMware believes that it has meritorious defenses in connection with this lawsuit, and currently a reasonably possible loss or range of loss cannot be estimated.

On March 27, 2015, Phoenix Technologies (“Phoenix”) filed a complaint against VMware in the U.S. District Court for the Northern District of California asserting claims for copyright infringement and breach of contract relating to a version of Phoenix’s BIOS software that VMware licensed from Phoenix. In the lawsuit, Phoenix is seeking injunctive relief and

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

monetary damages. VMware believes that it has meritorious defenses in connection with this lawsuit, and currently a reasonably possible loss or range of loss cannot be estimated.

VMware accrues for a liability at the low end of the range of estimated losses when a determination has been made that a loss is both probable and the amount of the loss can be reasonably estimated. Significant judgment is required in both the determination that the occurrence of a loss is probable and is reasonably estimable. In making such judgments, VMware considers the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal costs are generally recognized as expense when incurred.

VMware believes that it has valid defenses against each of the legal matters disclosed. However, given the unpredictable nature of legal proceedings, an unfavorable resolution of one or more legal proceedings, claims, or investigations could have a material adverse effect on VMware’s condensed consolidated financial statements.

VMware is also subject to other legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business, including claims with respect to commercial, product liability, intellectual property, employment, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from and has discussions with government entities on various matters. VMware does not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on its condensed consolidated financial statements.

J. Stockholders’ Equity

VMware Stock Repurchases

On January 27, 2015, VMware’s Board of Directors authorized the repurchase of up to an additional one billion dollars of VMware’s Class A common stock through the end of 2017. Stock will be purchased from time to time, in the open market or through private transactions, subject to market conditions. The new stock repurchase authorization is in addition to VMware’s ongoing one-billion-dollar stock repurchase program, originally announced on August 6, 2014. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. VMware is not obligated to purchase any shares under its stock repurchase programs. Purchases can be discontinued at any time VMware believes additional purchases are not warranted. All shares repurchased under VMware’s stock repurchase programs are retired.

The following table summarizes stock repurchase authorizations that remain open as of March 31, 2015 (amounts in table in millions):



Authorization Date	Amount Authorized	Expiration Date	Status
January 27, 2015	$1,000	December 31, 2017	Open
August 6, 2014	$1,000	December 31, 2016	Open

As of March 31, 2015, the cumulative authorized amount remaining for repurchase was $1,521 million.

The following table summarizes stock repurchase activity during the three months ended March 31, 2015 and 2014 (aggregate purchase price in millions, shares in thousands):



	Three Months Ended
	March 31,
	2015		2014
Aggregate purchase price	$	438	$	169
Class A common shares repurchased	5,366		1,767
Weighted-average price per share	$	81.65	$	95.56

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

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

VMware Stock Options

The following table summarizes stock option activity since January 1, 2015 (shares in thousands):



	Number of Shares		Weighted- Average Exercise Price (per share)
Outstanding, January 1, 2015	5,869		$	50.54
Granted	13		84.68
Forfeited	(82	)	75.58
Exercised	(273	)	23.12
Outstanding, March 31, 2015	5,527		51.63

The stock options outstanding as of March 31, 2015 had an aggregate intrinsic value of $185 million based on VMware’s closing price as of March 31, 2015.

VMware Restricted Stock

VMware's restricted stock primarily consists of restricted stock unit (“RSU”) awards granted to employees. RSUs are valued based on VMware's stock price on the date of grant. The shares underlying the RSU awards are not issued until the RSUs vest. Upon vesting, each RSU converts into one share of VMware Class A common stock.

VMware's restricted stock also includes performance stock unit (“PSU”) awards, which have been granted to certain of VMware’s executives and employees. The PSU awards include performance conditions and, in certain cases, a time-based vesting component. Upon vesting, each PSU award will convert into VMware’s Class A common stock at various ratios ranging from 0.5 to 2.0 shares per PSU, depending upon the degree of achievement of the performance target designated by each individual award. If minimum performance thresholds are not achieved, then no shares will be issued. As of March 31, 2015, the number of PSUs outstanding includes certain PSUs for which performance conditions have concluded but that remain subject to certain service conditions.

The following table summarizes restricted stock activity since January 1, 2015 (units in thousands):



	Number of Units		Weighted- Average Grant Date Fair Value (per unit)
Outstanding, January 1, 2015	12,585		$	88.88
Granted	1,132		82.54
Vested	(939	)	81.85
Forfeited	(539	)	88.06
Outstanding, March 31, 2015	12,239		87.87

As of March 31, 2015, the 12.2 million units outstanding included 11.7 million of RSUs and restricted stock, and 0.5 million of PSUs. The above table includes RSUs issued for outstanding unvested RSUs in connection with business combinations.

The total fair value of VMware RSUs, restricted stock, and PSUs that vested during the three months ended March 31, 2015 was $77 million. As of March 31, 2015, restricted stock representing 12.2 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $1,004 million based on VMware’s closing price as of March 31, 2015.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Accumulated Other Comprehensive Income (Loss)

The changes in components of accumulated other comprehensive income (loss) during the three months ended March 31, 2015 and 2014 were as follows (tables in millions):



	Unrealized Gain on Available-for-Sale Securities		Unrealized Loss on Cash Flow Hedges			Total
Balance, January 1, 2015	$	—	$	(1	)	$	(1	)
Unrealized gain (loss), net of taxes of $4, $0, and $4	6		(5		)	1
Balance, March 31, 2015	$	6	$	(6	)	$	—



	Unrealized Gain on Available-for-Sale Securities		Total
Balance, January 1, 2014	$	4	$	4
Unrealized gain, net of taxes of $1 and $1	1		1
Balance, March 31, 2014	$	5	$	5

Gains on VMware’s available-for-sale securities are reclassified to investment income on the condensed consolidated statements of income in the period that such gains are realized.

The effective portion of gains (losses) resulting from changes in the fair value of forward contracts designated as cash flow hedging instruments are reclassified to its related operating expense line item on the condensed consolidated statements of income in the same period that the underlying expenses are incurred. The amounts recorded to their related operating expense line items on the condensed consolidated statements of income during the three months ended March 31, 2015 and 2014, were not material.

K. Related Parties

The information provided below includes a summary of the transactions entered into with EMC and EMC’s consolidated subsidiaries (collectively “EMC”). EMC acquired VCE Company LLC (“VCE”) during the fourth quarter of 2014. Transactions with VCE from the date EMC acquired the controlling interest in VCE have been included in the tables below.

Transactions with EMC

VMware and EMC engaged in the following ongoing intercompany transactions, which resulted in revenues and receipts and unearned revenues for VMware:


•	Pursuant to an ongoing reseller arrangement with EMC, EMC bundles VMware’s products and services with EMC’s products and sells them to end users.


•	EMC purchases products and services from VMware for internal use.


•	VMware provides professional services to end users based upon contractual agreements with EMC.


•	From time to time, VMware and EMC enter into agreements to collaborate on technology projects, and EMC pays VMware for services that VMware provides to EMC in connection with such projects.


•	Pursuant to an ongoing distribution agreement, VMware acts as the selling agent for certain products and services in exchange for an agency fee.


•	VMware provides various transition services to Pivotal Software, Inc. (“Pivotal”), a subsidiary of EMC. Support costs incurred by VMware are reimbursed to VMware and are recorded as a reduction to the costs incurred by VMware.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Information about VMware’s revenues and receipts from such arrangements with EMC during the three months ended March 31, 2015 and 2014 and unearned revenues as of March 31, 2015 and December 31, 2014 consisted of the following (table in millions):



	Revenues and Receipts from EMC				Unearned Revenues from EMC
	Three Months Ended March 31,				As of March 31,		As of December 31,
	2015		2014		2015		2014
Reseller revenues	$	61	$	46	$	272	$	290
Internal-use revenues	3		7		16		18
Professional services revenues	23		23		3		9
Collaborative technology project receipts	—		—		n/a		n/a
Agency fee revenues	1		2		—		—
Reimbursement for transition services	1		2		n/a		n/a

VMware and EMC engaged in the following ongoing intercompany transactions, which resulted in costs to VMware:


•	VMware purchases and leases products and purchases services for internal use from EMC.


•	From time to time, VMware and EMC enter into agreements to collaborate on technology projects, and VMware pays EMC for services provided to VMware by EMC related to such projects.

•

In certain geographic regions where VMware does not have an established legal entity, VMware contracts with EMC subsidiaries for support services and EMC personnel who are managed by VMware. The costs incurred by EMC on VMware’s behalf related to these employees are charged to VMware with a mark-up intended to approximate costs that would have been incurred had VMware contracted for such services with an unrelated third party. These costs are included as expenses on VMware’s condensed consolidated statements of income and primarily include salaries, benefits, travel and rent expenses. EMC also incurs certain administrative costs on VMware’s behalf in the U.S. that are recorded as expenses on VMware’s condensed consolidated statements of income.

Information about VMware’s costs from such arrangements with EMC for the three months ended March 31, 2015 and 2014 consisted of the following (table in millions):



	Three Months Ended
	March 31,
	2015		2014
Purchases and leases of products and purchases of services	$	19	$	21
Collaborative technology project costs	1		3
EMC subsidiary support and administrative costs	28		41

Certain Stock-Based Compensation

Effective September 1, 2012, Pat Gelsinger was appointed Chief Executive Officer of VMware. Prior to joining VMware, Mr. Gelsinger was the President and Chief Operating Officer of EMC Information Infrastructure Products. Mr. Gelsinger retains certain of his EMC equity awards that were held as of September 1, 2012 and he continues to vest in such awards. Stock-based compensation related to Mr. Gelsinger’s EMC awards are being recognized on VMware’s condensed consolidated statements of income over the awards’ remaining requisite service periods.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Tax Sharing Agreement with EMC

Pursuant to a tax sharing agreement between VMware and EMC, payments are made between VMware and EMC related to VMware's portion of federal income taxes on EMC's consolidated tax return as well as income taxes for states in which combined state income tax returns are filed. The following table summarizes these payments made between VMware and EMC during the three months ended March 31, 2015 and 2014 (table in millions):



	Three Months Ended
	March 31,
	2015		2014
Payments from VMware to EMC	$	49	$	20

Payments made by VMware to EMC result from VMware having a tax liability. The amount that VMware pays to EMC for its portion of federal income taxes on EMC’s consolidated tax return differs from the amount VMware would owe on a separate return basis, and the difference is presented as a component of stockholders’ equity. During the three months ended March 31, 2015 and 2014, the difference between the amount of tax calculated on a stand-alone basis and the amount of tax calculated per the tax sharing agreement was not material.

Due To/From Related Parties, Net

As a result of the related-party transactions with EMC described above, amounts due to and from related parties, net as of March 31, 2015 and December 31, 2014 consisted of the following (table in millions):



	March 31,			December 31,
	2015			2014
Due to EMC	$	(55	)	$	(76	)
Due from EMC	57			125
Due from related parties, net	$	2		$	49

Income tax payable due to EMC	$	(37	)	$	(40	)

Balances due to or from related parties, which are unrelated to tax obligations, are generally settled in cash within 60 days of each quarter-end. The timing of the tax payments due to and from EMC is governed by the tax sharing agreement with EMC.

Notes Payable to EMC

VMware and EMC entered into a note exchange agreement on January 21, 2014 providing for the issuance of three promissory notes in the aggregate principal amount of $1,500 million. The total debt of $1,500 million includes $450 million that was exchanged for the $450 million promissory note issued to EMC in April 2007, as amended and restated in June 2011.

The three notes issued may be prepaid without penalty or premium, and outstanding principal is due on the following dates: $680 million due May 1, 2018, $550 million due May 1, 2020 and $270 million due December 1, 2022. The notes bear interest, payable quarterly in arrears, at the annual rate of 1.75%. During the three months ended March 31, 2015 and 2014, $6 million and $5 million, respectively, of interest expense was recognized.

L. Segment Information

VMware operates in one reportable operating segment, thus all required financial segment information can be found in the condensed consolidated financial statements. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.

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VMware, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Revenues by geographic area for the three months ended March 31, 2015 and 2014 were as follows (table in millions):



	Three Months Ended
	March 31,
	2015		2014
United States	$	762	$	649
International	749		711
Total	$	1,511	$	1,360

Revenues by geographic area are based on the ship-to-addresses of VMware’s customers. No individual country other than the United States accounted for 10% or more of revenues for the three months ended March 31, 2015 and 2014.

Long-lived assets by geographic area, which primarily include property and equipment, net, as of March 31, 2015 and December 31, 2014 were as follows (table in millions):



	March 31,		December 31,
	2015		2014
United States	$	804	$	801
International	128		117
Total	$	932	$	918

No individual country other than the United States accounted for 10% or more of these assets as of March 31, 2015 and December 31, 2014, respectively.

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ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management's discussion and analysis (“MD&A”) is provided in addition to the accompanying condensed consolidated financial statements and notes to assist in understanding our results of operations and financial condition. Financial information as of March 31, 2015 should be read in conjunction with our consolidated financial statements for the year ended December 31, 2014 contained in our Form 10-K filed February 26, 2015.

All dollar amounts expressed as numbers in this MD&A (except share and per share amounts) are in millions. Period-over-period changes are calculated based upon the respective underlying, non-rounded data. Unless the context requires otherwise, we are referring to VMware, Inc. and its consolidated subsidiaries when we use the terms “VMware,” the “Company,” “we,” “our” or “us.”

Overview

The information technology (“IT”) industry is transforming, moving from a hardware-based traditional model to one of a software-defined infrastructure. We are the leader in virtualization infrastructure solutions utilized by organizations to help transform the way they build, deliver and consume IT resources. We develop and market our product and service offerings within three main product groups and we also leverage synergies across these three product and service areas:


•	SDDC or Software-Defined Data Center


•	Hybrid Cloud Computing


•	End-User Computing

Historically, the majority of our license sales have been from our standalone vSphere product, which is included in our compute product category within our SDDC architecture. However, over the last two years, the growth rate of our standalone vSphere product license sales has declined as certain large markets for server virtualization have matured. The growth rate of license sales beyond our standalone vSphere product has increased over this period as we transition to offering a wider range of products and services to enable the entire SDDC. As the transformation of the IT industry continues, we expect that our growth rates will be increasingly derived from sales of our newer products, suites and services solutions across our SDDC portfolio, beyond standalone vSphere. For example, we have experienced continued growth in sales volumes, production use and number of customers who have purchased VMware NSX, our network virtualization solution, throughout 2014 and into the first quarter of 2015. We also continue to see traction of our Virtual SAN product and other newer offerings.

Hybrid cloud computing, comprised of VMware vCloud Air and VMware vCloud Air Network Service Providers Program offerings, continued to experience growth during the first quarter of 2015. We plan to continue to expand our hybrid cloud global footprint as well as our service offerings. Due to the nature of these offerings, revenues are recognized over a period of time.

Our end-user computing solutions include our Horizon workplace suites and enterprise mobile management offerings, led by our AirWatch mobile solutions. We acquired AirWatch during the first quarter of 2014. AirWatch expands our portfolio of mobile solutions within the enterprise mobile and security space and we are in the early stages of growing this business by leveraging the reach of our global presence, robust channel and access to enterprise accounts via our sales force. Currently, our AirWatch business models include an on-premise solution that we offer through the sale of perpetual licenses and an off-premise solution that we offer as software-as-a-service (“SaaS”). AirWatch products and services continue to contribute to the growth of our end-user computing products during the first quarter of 2015. Our investments in AirWatch resulted in increased operating expenses during the first quarter of 2015, primarily driven by employee-related costs, including expenses we recognized in connection with installment payments to certain key employees as part of the acquisition, as well as amortization of purchased intangible assets.

Approximately 70% of our sales are denominated in the U.S. dollar, however, we also invoice and collect in the euro, the British pound, the Japanese yen, the Australian dollar and the Chinese renminbi in their respective regions. As a result, our financial statements, including our revenues, operating expenses, unearned revenues, and the resulting cash flows derived from the U.S. dollar equivalent of foreign currency transactions are impacted by foreign exchange fluctuations. Foreign currency fluctuations have had a negative impact on the growth rate of our revenues, the amount of unearned revenues recognized derived from sales denominated in foreign currencies, and the U.S. dollar equivalent of foreign currency cash collections. We have also benefited from operating expenses incurred and paid in currencies other than the U.S. dollar.

We generally sell our solutions using enterprise license agreements (“ELAs”) or as part of our non-ELA, or transactional, business. ELAs are comprehensive volume license offerings, offered both directly by us and through certain channel partners that also provide for multi-year maintenance and support.

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Results of Operations

Revenues

Our revenues during the three months ended March 31, 2015 and 2014 were as follows:



	Three Months Ended
	March 31,				$ Change		% Change
	2015		2014		Actual		Actual		Constant Currency
Revenues:

License	$	576	$	561	$	15	3	%	6	%
Services:
Software maintenance	813		701		111		16
Professional services	122		98		24		25
Total services	935		799		135		17
Total revenues	$	1,511	$	1,360	$	151	11		13

Revenues:
United States	$	762	$	649	$	113	17	%
International	749		711		38		5
Total revenues	$	1,511	$	1,360	$	151	11		13

In order to provide a comparable framework for assessing how our business performed, adjusted for the impact of foreign currency fluctuations, management analyzes year-over-year license and total revenues growth on a constant currency basis. License and total revenues recognized during the current period derived from non-U.S. dollar based transactions were converted into U.S. dollars using the exchange rates that were effective in the comparable prior year period. The calculated current period license and total revenues, adjusted for foreign currency fluctuations, is compared to the license and total revenues of the comparable prior year period, as reported, in calculating license and total revenue growth in constant currency.

Hybrid cloud and our SaaS offerings, including our AirWatch mobile solutions, increased to greater than 6% of our total revenues during the first quarter of 2015. We expect our hybrid cloud and our SaaS offerings will continue to grow and represent an increasing percentage of total revenues in future periods. VMware vCloud Air Network Service revenues are generally included in license revenues and our SaaS revenues, including VMware Cloud Air and our AirWatch mobile solutions, are included in both license and services revenues.

License Revenues

License revenues during the first quarter of 2015 were up 3%, compared to the same period in the prior year. Our license revenues increased as a result of increased revenues from our hybrid cloud offerings as well as our end-user computing products, including AirWatch mobile solutions. However, our license revenues growth rate was negatively impacted by changes in the value of the U.S. dollar against foreign currencies in which we invoice. Additionally, our license revenues growth rate was adversely impacted during the first quarter of 2015 as compared to the same period in the prior year by the decline in the growth rate of our standalone vSphere product license sales as certain markets for server virtualization have matured.

The anticipated continued revenue growth of our hybrid cloud and SaaS offerings are expected to adversely impact the growth rate of our license revenues during the remainder of 2015 as we will recognize less revenue up-front than we would otherwise recognize as part of a multi-year license arrangement. Additionally, we expect changes in foreign currency to continue to have an impact on our license revenues growth rate.

Services Revenues

During the first quarter of 2015, software maintenance revenues benefited from renewals, multi-year software maintenance contracts sold in previous periods and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers bought, on average, more than 24 months of support and maintenance with each new license purchased, which we believe demonstrates our customers’ commitment to our SDDC strategy.

Professional services revenues increased during the first quarter of 2015 compared to the same period in 2014, as growth in our license sales and increased complexity of our product suite led to additional demand for our professional services. As we continue to invest in our partners and expand our ecosystem of third-party professionals with expertise in our solutions to

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independently provide professional services to our customers, our professional services revenue will vary based on the delivery channels used in any given period as well as the timing of engagements.

Unearned Revenues

Our unearned revenues as of March 31, 2015 and December 31, 2014 were as follows:



	March 31, 2015		December 31, 2014
Unearned license revenues	$	466	$	488
Unearned software maintenance revenues	3,847		3,905
Unearned professional services revenues	431		440
Total unearned revenues	$	4,744	$	4,833

Unearned license revenues are generally recognized upon delivery of existing or future products or services, or they are otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. In the event the arrangement does not include professional services, unearned license revenues may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist. Total unearned license revenues may vary over periods for a variety of factors, including the type and level of promotions offered, and the timing of when the products are delivered upon general availability.

Unearned software maintenance revenues are primarily attributable to our maintenance contracts and are generally recognized ratably over the contract period. The weighted-average remaining term at March 31, 2015 was approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered.

Cost of License and Services Revenues, and Operating Expenses

Our cost of services revenues and operating expenses were primarily impacted by increasing headcount, net of realignment activities discussed below. Headcount during the three months ended March 31, 2015 continued to increase due primarily to organic growth. The increased headcount has resulted in higher cash and stock-based employee-related expenses across most of our income statement expense categories when compared to the same period in 2014, and we expect this trend to continue.

Cost of License Revenues

Our cost of license revenues principally consists of the cost of fulfillment of our software, royalty costs in connection with technology licensed from third-party providers and amortization of intangible assets. The cost of fulfillment of our software includes IT development efforts, personnel costs and related overhead associated with the physical and electronic delivery of our software products.



	Three Months Ended
	March 31,
	2015			2014			$ Change		% Change
Cost of license revenues	$	49		$	49		$	—	1	%
Stock-based compensation	1			1			—		(14	)
Total expenses	$	50		$	50		$	—	—
% of License revenues	9		%	9		%

Cost of license revenues was flat when comparing the first quarter of 2015 to the first quarter of 2014.

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Cost of Services Revenues

Our cost of services revenues primarily includes the costs of personnel and related overhead to deliver technical support for our products and to provide our professional services. Additionally, our costs of services revenues include costs related to our IT development efforts and depreciation on equipment supporting our service offerings. As we continue to invest in and grow business from our hybrid cloud, SaaS and professional services offerings, we expect our total costs of services revenues to continue to increase.



	Three Months Ended
	March 31,
	2015			2014			$ Change		% Change
Cost of services revenues	$	182		$	142		$	40	28	%
Stock-based compensation	11			9			2		20
Total expenses	$	193		$	151		$	42	28
% of Services revenues	21		%	19		%

Cost of services revenues increased in the first quarter of 2015 compared to the first quarter of 2014 primarily driven by the growth in cash-based employee-related expenses of $30 due to incremental growth in headcount, both organic and through the AirWatch acquisition, and the investment and growth in our hybrid cloud, SaaS and professional services offerings. Additionally, increases in equipment and depreciation costs also contributed to the increase in cost of services. These increases were partially offset by the positive impact of $10 from fluctuations in the exchange rate between the U.S. dollar and foreign currencies.

Research and Development Expenses

Our research and development expenses include the personnel and related overhead associated with the development of our product software and service offerings.



	Three Months Ended
	March 31,
	2015			2014			$ Change			% Change
Research and development	$	251		$	233		$	19		8	%
Stock-based compensation	54			60			(7		)	(11	)
Total expenses	$	305		$	293		$	12		4
% of Total revenues	20		%	22		%

Research and development expenses increased in the first quarter of 2015 compared to the first quarter of 2014. The increase was primarily due to growth in cash-based employee-related expenses of $23 driven by incremental growth in headcount, both organic and through the AirWatch acquisition. The increase in research and development expenses during the first quarter of 2015 was partially offset by a decrease in stock-based compensation, primarily as a result of certain awards becoming fully vested in fiscal year 2014.

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Sales and Marketing Expenses

Our 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. Sales and marketing expenses also include the net impact from the expenses incurred and fees generated by certain marketing initiatives.



	Three Months Ended
	March 31,
	2015			2014			$ Change			% Change
Sales and marketing	$	497		$	433		$	61		14	%
Stock-based compensation	39			41			(1		)	(2	)
Total expenses	$	536		$	474		$	61		13
% of Total revenues	35		%	35		%

Sales and marketing expenses increased in the first quarter of 2015 compared to the first quarter of 2014 primarily driven by growth in cash-based employee-related expenses of $62 due to incremental growth in headcount, both organic and through the AirWatch acquisition, and higher commission expense due to increased sales volumes. Costs incurred for marketing programs also increased during the first quarter of 2015 compared to the same period in prior year. These increases in expenses during the first quarter of 2015 were partially offset by the positive impact of $23 from fluctuations in the exchange rate between the U.S. dollar and foreign currencies.

General and Administrative Expenses

Our 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.



	Three Months Ended
	March 31,
	2015			2014			$ Change			% Change
General and administrative	$	173		$	134		$	39		29	%
Stock-based compensation	14			17			(3		)	(17	)
Total expenses	$	187		$	151		$	36		24
% of Total revenues	12		%	11		%

General and administrative expenses increased in the first quarter of 2015 compared to the first quarter of 2014. We have made and will continue to make installment payments to certain key employees of AirWatch subject to the achievement of specified future employment conditions. We recognized compensation expense of $41 during the first quarter of 2015 relating to these installment payments compared to $19 during the first quarter of 2014. Other cash-based employee-related expenses increased by $14 during the first quarter of 2015 due to incremental growth in headcount, both organic and through the AirWatch acquisition. Costs of $11 related to certain litigation further contributed to the increase in expenses during the first quarter of 2015 compared to the same period in prior year.

Realignment Charges



	Three Months Ended
	March 31,
	2015			2014			$ Change		% Change
Realignment charges	$	22		$	—		$	22	100	%
% of Total revenues	1		%	—		%

During the first quarter of 2015, we eliminated approximately 350 positions across all major functional groups and geographies to streamline our operations. As a result of these actions, $22 of realignment charges were recognized during the first quarter of 2015, which consisted of severance-related costs. As of March 31, 2015, $16 remained in accrued expenses and other on the condensed consolidated balance sheets and is expected to be paid during 2015.

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Income Tax Provision

Our quarterly effective tax rate, which includes adjustments for discrete items within the quarter, was 11.9% and 18.6% during the first quarter of 2015 and 2014, respectively. The lower effective tax rate year-over-year was primarily the result of certain discrete items being recognized in the first quarter of 2015.

Our rate of taxation in foreign jurisdictions is lower than our U.S. tax rate. Our foreign earnings are primarily earned by our subsidiaries organized in Ireland, and as such, our annual effective tax rate can be significantly impacted by the mix of our earnings in the U.S. and foreign jurisdictions.

We are 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 combined outstanding Class A and Class B common 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 our U.S. federal income tax would be reported separately from that of the EMC consolidated group.

Although we file a consolidated federal tax return with EMC, the income tax provision is calculated primarily as though we were a separate taxpayer. However, certain transactions that we and EMC are parties to are assessed using consolidated tax return rules. 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 different tax rates in foreign jurisdictions where income is earned.

The EMC consolidated group is routinely under audit by the Internal Revenue Service (the “IRS”). All U.S. federal income tax matters have been concluded for years through 2008. The IRS commenced a federal income tax audit for the tax years 2009 and 2010 in the third quarter of 2012, and they commenced an audit of tax year 2011 during the first quarter of 2015. The federal income tax audit for the tax years 2009 and 2010 is ongoing, and it is expected to be completed during 2015.

Our future effective tax rate may be affected by such factors as changes in tax laws, changes in our business, 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 and shifts in the amount of earnings in the U.S. compared with other regions in the world as well as the expiration of statute of limitations and settlements of audits.

Our Relationship with EMC

As of March 31, 2015, EMC owned 43,025,000 shares of Class A common stock and all 300,000,000 shares of Class B common stock, representing 80.6% of our total outstanding shares of common stock and 97.4% of the combined voting power of our outstanding common stock.

Transactions with EMC

We and EMC engaged in the following ongoing intercompany transactions, which resulted in revenues and receipts and unearned revenues for us:


•	Pursuant to an ongoing reseller arrangement with EMC, EMC bundles our products and services with EMC’s products and sells them to end users.


•	EMC purchases products and services from us for internal use.


•	We provide professional services to end users based upon contractual agreements with EMC.


•	From time to time, we and EMC enter into agreements to collaborate on technology projects, and EMC pays us for services that we provide to EMC in connection with such projects.


•	Pursuant to an ongoing distribution agreement, we act as the selling agent for certain products and services in exchange for an agency fee.


•	We provide various transition services to Pivotal Software, Inc. (“Pivotal”), a subsidiary of EMC. Support costs incurred by us are reimbursed to us and are recorded as a reduction to the costs incurred by us.

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Information about our revenues and receipts from such arrangements with EMC during the three months ended March 31, 2015 and 2014 and unearned revenues as of March 31, 2015 and December 31, 2014 consisted of the following:



	Revenues and Receipts from EMC				Unearned Revenues from EMC
	Three Months Ended March 31,				As of March 31,		As of December 31,
	2015		2014		2015		2014
Reseller revenues	$	61	$	46	$	272	$	290
Internal-use revenues	3		7		16		18
Professional services revenues	23		23		3		9
Collaborative technology project receipts	—		—		n/a		n/a
Agency fee revenues	1		2		—		—
Reimbursement for transition services	1		2		n/a		n/a

We and EMC engaged in the following ongoing intercompany transactions, which resulted in costs to us:


•	We purchase and lease products and purchase services for internal use from EMC.


•	From time to time, we and EMC enter into agreements to collaborate on technology projects, and we pay EMC for services provided to us by EMC related to such projects.

•

In certain geographic regions where we do not have an established legal entity, we contract with EMC subsidiaries for support services and EMC personnel who are managed by us. The costs incurred by EMC on our behalf related to these employees are charged to us with a mark-up intended to approximate costs that would have been incurred had we contracted for such services with an unrelated third party. These costs are included as expenses on our condensed consolidated statements of income and primarily include salaries, benefits, travel and rent expenses. EMC also incurs certain administrative costs on our behalf in the U.S. that are recorded as expenses on our condensed consolidated statements of income.

Information about our costs from such arrangements with EMC for the three months ended March 31, 2015 and 2014 consisted of the following:



	Three Months Ended
	March 31,
	2015		2014
Purchases and leases of products and purchases of services	$	19	$	21
Collaborative technology project costs	1		3
EMC subsidiary support and administrative costs	28		41

Certain Stock-Based Compensation

Effective September 1, 2012, Pat Gelsinger was appointed Chief Executive Officer of VMware. Prior to joining VMware, Mr. Gelsinger was the President and Chief Operating Officer of EMC Information Infrastructure Products. Mr. Gelsinger retains certain of his EMC equity awards that were held as of September 1, 2012 and he continues to vest in such awards. Stock-based compensation related to Mr. Gelsinger’s EMC awards are being recognized on our condensed consolidated statements of income over the awards’ remaining requisite service periods.

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Tax Sharing Agreement with EMC

Pursuant to a tax sharing agreement between us and EMC, payments are made between us and EMC related to our portion of federal income taxes on EMC's consolidated tax return as well as income taxes for states in which combined state income tax returns are filed. The following table summarizes these payments made between us and EMC during the three months ended March 31, 2015 and 2014:



	Three Months Ended March 31,
	2015		2014
Payments from us to EMC	$	49	$	20

Payments made by us to EMC result from us having a tax liability. The amount that we pay to EMC for our portion of federal income taxes on EMC’s consolidated tax return differs from the amount we would owe on a separate return basis, and the difference is presented as a component of stockholders’ equity. During the three months ended March 31, 2015 and 2014, the difference between the amount of tax calculated on a stand-alone basis and the amount of tax calculated per the tax sharing agreement was not material.

Due To/From Related Parties, Net

As a result of the related-party transactions with EMC described above, amounts due to and from related parties, net as of March 31, 2015 and December 31, 2014 consisted of the following:



	As of March 31,			As of December 31,
	2015			2014
Due to EMC	$	(55	)	$	(76	)
Due from EMC	57			125
Due from related parties, net	$	2		$	49

Income tax payable due to EMC	$	(37	)	$	(40	)

Notes Payable to EMC

We and EMC entered into a note exchange agreement on January 21, 2014 providing for the issuance of three promissory notes in the aggregate principal amount of $1,500. The total debt of $1,500 includes $450 that was exchanged for the $450 promissory note issued to EMC in April 2007, as amended and restated in June 2011.

The three notes issued may be prepaid without penalty or premium, and outstanding principal is due on the following dates: $680 due May 1, 2018, $550 due May 1, 2020 and $270 due December 1, 2022. The notes bear interest, payable quarterly in arrears, at the annual rate of 1.75%. During the three months ended March 31, 2015 and 2014, $6 and $5, respectively, of interest expense was recognized.

Liquidity and Capital Resources

At March 31, 2015 and 2014, we held cash, cash equivalents and short-term investments as follows:



	March 31,
	2015		2014
Cash and cash equivalents	$	1,941	$	2,788
Short-term investments	5,285		3,828
Total cash, cash equivalents and short-term investments	$	7,226	$	6,616

As of March 31, 2015, we held a diversified portfolio of money market funds and fixed income securities totaling $5,285. Our fixed income securities are denominated in U.S. dollars and consisted of highly liquid debt instruments of the U.S. Government and its agencies, municipal obligations, and U.S. and foreign corporate debt securities. We limit the amount of our domestic and international investments with any single issuer and any single financial institution, and also monitor the diversity of the portfolio, thereby diversifying the credit risk. As of March 31, 2015, our total cash, cash equivalents and short-term investments were $7,226, of which $5,341 was held outside the U.S. If these overseas funds were needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes on the related undistributed earnings to repatriate these funds.

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However, our intent is to indefinitely reinvest our non-U.S. earnings in our foreign operations and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

We expect that cash generated by operations will be our primary source of liquidity. We also believe that existing cash and cash equivalents, together with any cash generated from operations will be sufficient to meet normal operating requirements for at least the next twelve months. While we believe our existing cash and cash equivalents and cash to be generated by operations will be sufficient to meet our normal operating requirements, our overall level of cash needs may be impacted by the number and size of acquisitions, investments and stock repurchases. Should we require additional liquidity, we may seek to arrange debt financing or enter into credit facilities.

Our cash flows summarized for the three months ended March 31, 2015 and March 31, 2014 were as follows:



	Three Months Ended
	March 31,
	2015			2014
Net cash provided by (used in):
Operating activities	$	683		$	750
Investing activities	(397		)	(1,198		)
Financing activities	(416		)	931
Net (decrease) increase in cash and cash equivalents	$	(130	)	$	483

Operating Activities

Cash provided by operating activities decreased by $67 during the first quarter of 2015 compared to the first quarter of 2014, mainly due to the change in income taxes payable as a result of tax payments made to EMC under the tax sharing agreement. Under the tax sharing agreement, we are obligated to pay EMC an amount equal to the tax expense generated by us that EMC may recognize in a given year on its consolidated tax return. During the first quarter of 2015, we paid $49 to EMC under the tax sharing agreement compared to $20 during the first quarter of 2014. Additionally, cash provided by operating activities decreased as a result of higher operating expenses due to an increase in headcount-related expenses driven by the AirWatch acquisition, including installment payments made to certain key employees of AirWatch. These decreases were partially offset by a change in accounts receivable as a result of an increase in cash collections.

While we expect sales and related cash collections to continue increasing during the remainder of 2015, we expect further installment payments of approximately $159 to certain key employees of AirWatch during 2015 as well as higher tax payments to offset the benefit of increased sales. Additionally, even if currency exchange rates stabilize, our cash flows from operations are still expected to be negatively impacted, primarily due to an unfavorable foreign exchange impact on our U.S. dollar equivalent of foreign currency cash collections.

Investing Activities

Cash used in investing activities is generally attributable to the purchase of fixed income securities, business acquisitions, and capital expenditures. Cash provided by investing activities is also impacted by the timing of purchases, sales and maturities of our available-for-sale securities.

Cash used in investing activities decreased during the first quarter of 2015 compared to the first quarter of 2014. The most significant factor driving this decrease related to business combinations. During the first quarter of 2015, we paid $21 for a business acquisition, which was significantly lower than the first quarter of 2014 as a result of our acquisition of AirWatch for $1,068. Additionally, although we used more cash during the first quarter of 2015 to purchase available-for-sale securities, this use of cash was partially offset by cash received from an increase in sales and maturities of available-for-sale securities as compared to the first quarter of 2014.

Financing Activities

Net cash used in financing activities during the first quarter of 2015 changed compared to net cash provided by financing activities during the first quarter of 2014 primarily as a result of our notes payable exchange agreement with EMC and our repurchase of common stock. Refer to sections below for further information.

Notes Payable to EMC

As of March 31, 2015, $1,500 remained outstanding on notes payable to EMC, with interest payable quarterly in arrears.

In connection with our acquisition of AirWatch, we entered into a note exchange agreement with EMC on January 21, 2014 providing for the issuance of three promissory notes in the aggregate principal amount of $1,500. The total debt of $1,500

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includes $450 that was exchanged for the $450 promissory note issued to EMC in April 2007, as amended and restated in June 2011.

The three notes issued have the following principal amounts and maturity dates: $680 due May 1, 2018, $550 due May 1, 2020 and $270 due December 1, 2022.

The notes bear interest at the annual rate of 1.75%. Interest is payable quarterly in arrears. The notes may be prepaid without penalty or premium. We drew down on all three notes in late January 2014.

Stock Repurchase Program

From time to time, we repurchase stock pursuant to authorized stock repurchase programs in open market transactions or privately negotiated transactions as permitted by securities laws and other legal requirements. We are not obligated to purchase any shares under our stock repurchase programs. The timing of any repurchases and the actual number of shares repurchased depends on a variety of factors, including our 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 we believe additional purchases are not warranted. All shares repurchased under our stock repurchase programs are retired. On January 27, 2015, our Board of Directors authorized the repurchase of up to an additional one billion dollars of our Class A common stock through the end of 2017. During the three months ended March 31, 2015, we repurchased 5.4 million shares for an aggregate purchase price of $438. As of March 31, 2015, the cumulative authorized amount remaining for repurchase under an authorized program was $1,521. Refer to Note J to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion.

We are increasing our share buyback goal compared to recent years, and as a result, we expect to repurchase over one billion dollars of our Class A common stock in 2015.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are based upon the selection and application of accounting principles generally accepted in the United States of America (“GAAP”) that require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial statements. We believe that the critical accounting policies set forth within Item 7 of our 2014 Annual Report on Form 10-K may involve a higher degree of judgment and complexity in their application than our other significant accounting policies and represent the critical accounting policies used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements, including, without limitation, statements regarding expectations of, or our plans for: newer products and services driving strong growth; maintaining our industry leadership position; benefits of our products and services to customers and partners; sales of licenses that include products beyond VMware vSphere hypervisor continuing to grow; sales and related cash collections to continue increasing during the remainder of 2015, but installment payments to certain key employees of AirWatch as well as higher tax payments to offset the benefit of increased sales; SaaS revenues and revenues from our hybrid cloud offerings comprising an increasing percentage of our revenues in future periods; continued growth of hybrid cloud and SaaS revenues in 2015 and the associated negative impact on revenues and license revenues growth; synergies across product areas; increased total costs of services revenues; the impact and timing of our realignment plan on our financial results; the recognition of unearned revenues; the impact of our relationship with EMC Corporation on taxes; repurchasing over one billion dollars of Class A common stock in 2015; customer and partner demand for our products and services; the sufficiency of our liquidity and capital reserves to fund our operations and business strategy; our ability to generate positive cash flows from operations; our effective tax rate and the effects of potential developments in U.S. and non-U.S. tax jurisdictions; the timing and outcome of the IRS tax audit of the EMC consolidated group; acquisition accounting and the deductibility of goodwill and identifiable intangible assets for U.S. income tax purposes; indefinitely reinvesting our overseas earnings outside of the U.S. and not repatriating them to the U.S.; the effect on us due to the resolution of pending claims, legal proceedings and investigations, including the General Services Administration and Department of Justice inquiries and other matters described in Note I of the notes to the condensed consolidated financial statements; impact of foreign currency exchange rates on future revenues, unearned revenues and cash flows from operations; and increasing employee headcount and impact on operating expenses.

These forward-looking statements involve risks and uncertainties and the cautionary statements set forth above and those contained in the section of this report entitled “Risk Factors” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. All forward-looking statements in this document are

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made as of the date hereof, based on information available to us as of the date hereof. We assume no obligation to, and do not currently intend to, update these forward-looking statements.

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Available Information

Our website is located at www.vmware.com, and our investor relations website is located at http://ir.vmware.com. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, all of which is made available free of charge, including:


•	our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (“SEC”);


•	announcements of investor conferences, speeches and events at which our executives talk about our products, services and competitive strategies;


•	webcasts of our quarterly earnings calls and links to webcasts of investor conferences at which our executives appear (archives of these events are also available for a limited time);


•	additional information on financial metrics, including reconciliations of non-GAAP financial measures discussed in our presentations to the nearest comparable GAAP measure;


•	press releases on quarterly earnings, product and service announcements, legal developments and international news;


•	corporate governance information including our certificate of incorporation, bylaws, corporate governance guidelines, board committee charters, business conduct guidelines (which constitutes our code of business conduct and ethics) and other governance-related policies;


•	other news, blogs and announcements that we may post from time to time that investors might find useful or interesting; and


•	opportunities to sign up for email alerts and RSS feeds to have information pushed in real time.

The information found on our website is not part of, and is not incorporated by reference into, this or any other report we file with, or furnish to, the SEC.


ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There were no material changes to our market risk exposures in the three months ended March 31, 2015. See Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of our 2014 Annual Report on Form 10-K for a detailed discussion of our market risk exposures.

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ITEM 4.	CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation required by the Exchange Act, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal Controls Over Financial Reporting

There were no changes in our internal control over financial reporting during the most recent fiscal quarter ended March 31, 2015 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Controls

Our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II

OTHER INFORMATION


ITEM 1.	LEGAL PROCEEDINGS

Refer to Note I to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of legal proceedings. See also the risk factor entitled “We are involved in litigation and regulatory inquiries and proceedings that could negatively affect us” in Part II, Item 1A of this Quarterly Report on Form 10-Q for a discussion of potential risks to our results of operations and financial condition that may arise from legal proceedings.


ITEM 1A.	RISK FACTORS

The risk factors that appear below could materially affect our business, financial condition and results of operations. The risks and uncertainties described below are not the only risks and uncertainties facing us. Our business is also subject to general risks and uncertainties that affect many other companies. Specific risk factors related to our relationship with EMC are also included below.

Risks Related to Our Business

As the markets for our server and desktop virtualization products have matured we have been increasingly developing and marketing products and services targeted toward the delivery, management and automation of information technology (“IT”) infrastructure, platforms and services through cloud-based solutions. If businesses do not find our cloud computing solutions compelling, our revenue growth and operating margins will decline.

Our products and services are based on server virtualization and related technologies that have primarily been used for virtualizing on-premise data center servers and form the foundation for private cloud computing. As the market for data center server virtualization has matured, we have increasingly directed our product development and marketing toward products and services that enable businesses to utilize virtualization as the foundation for public, private and hybrid cloud-based computing, including our VMware vCloud Suite, VMware vSphere with Operations Management and VMware vRealize suite offerings, our Horizon client virtualization offerings and our AirWatch mobile device management offerings. We have been increasing our focus on our hybrid cloud offerings, which include our vCloud Air service offerings, and we have been increasingly offering software as a service (“SaaS”) versions of our on-premises products, including our vRealize and Horizon suites, and certain AirWatch offerings. These initiatives present new and difficult technological and compliance challenges, and significant investments will be required to develop or acquire solutions to address those challenges. Our success depends on our current and future customers perceiving technological and operational benefits and cost savings associated with the increasing adoption of our private and hybrid cloud solutions as well as our client virtualization and mobile device management solutions. As the market for our server virtualization products matures and the scale of our business increases, our rate of revenue growth will depend largely upon the success of our newer product and service offerings. In addition, to the extent that our newer private and hybrid cloud solutions, as well as our client virtualization and mobile device management solutions are adopted more slowly or less comprehensively than we expect, our revenue growth rates may slow materially or our revenue may decline substantially.

The large majority of our revenues have come from our server virtualization products including our flagship VMware vSphere product line. Decreases in demand for our server virtualization products could adversely affect our results of operations and financial condition.

The large majority of our revenues have come from our server virtualization products. Although we continue to develop other applications for our virtualization technology such as our network virtualization solution, VMware NSX, end-user computing products and hybrid cloud services and expand our offerings into related areas such as our vRealize SDDC management products and vCloud product suites, we expect that our server virtualization products and related enhancements and upgrades will constitute a majority of our revenues for the foreseeable future. Declines and variability in demand for our server virtualization products could occur as a result of:


•	improved products or product versions being offered by competitors in our markets;


•	competitive pricing pressures;


•	failure to timely execute and implement our product strategy, which could lead to quality issues, integration issues with ecosystem partners, and difficulties in creating and marketing suites of interoperable solutions;


•	failure to release new or enhanced versions of our server virtualization products on a timely basis, or at all;


•	technological change that we are unable to address with our server virtualization and private cloud products or that changes the way enterprises utilize our products; and


•	general economic conditions.

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Also, as more and more businesses achieve high levels of virtualization in their data centers, certain markets for our VMware vSphere product line have matured. Our sales of standalone VMware vSphere have declined as a portion of our overall business as we seek to transition our customers to product suites, our newer products and infrastructure-as-a-service offerings. If we fail to introduce compelling new features in future upgrades to our VMware vSphere product line, manage the transition to hybrid cloud platforms, develop new applications for our virtualization technology or provide product suites based on the VMware vSphere platform that address customer requirements for integration, automation and management of their IT systems, overall demand for products and services based on VMware vSphere may decline.

Due to our product concentration, our business, financial condition, results of operations, and cash flows would therefore be adversely affected by a decline in demand for our server virtualization products.

We face intense competition that could adversely affect our operating results.

The virtualization, cloud computing, end-user computing and software-defined data center industries are inter-related and rapidly evolving, and we face intense competition across all the markets for our products and services. Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do.

We face competition from, among others:

Large, diversified enterprise software and hardware companies. These competitors supply a wide variety of products and services to, and have well-established relationships with, our current and prospective end users. For example, small to medium sized businesses and companies in emerging markets that are evaluating the adoption of virtualization-based technologies and solutions may be inclined to consider Microsoft solutions because of their existing use of Windows and Office products. Some of these competitors have in the past and may in the future take advantage of their existing relationships to engage in business practices that make our products and services less attractive to our end users. Other competitors have limited or denied support for their applications running in VMware virtualization environments. In addition, these competitors could integrate competitive capabilities into their existing products and services and make them available without additional charge. For example, Oracle provides free server virtualization software intended to support Oracle and non-Oracle applications, and Microsoft offers its own server virtualization software packaged with its Windows Server product and offers built-in virtualization in the client version of Windows. As a result, existing and prospective VMware customers may elect to use products that are perceived to be “free” or “very low cost” instead of purchasing VMware products and services for certain applications where they do not believe that more advanced and robust capabilities are required.

Companies offering competing platforms based on open source technologies. Open source technologies for virtualization, containerization and cloud platforms such as Xen, KVM, Docker, Rocket and OpenStack provide significant pricing competition and enable competing vendors to leverage these open source technologies to compete directly with our SDDC initiative. Enterprises and service providers have shown significant interest in building their own clouds based on open source projects such as OpenStack, and other companies have indicated their intention to expand offerings of virtual management and cloud computing solutions as well.

Other industry alliances. Many of our competitors have entered into or extended partnerships or other strategic relationships to offer more comprehensive virtualization and cloud computing solutions than they individually had offered. We expect these trends to continue as companies attempt to strengthen or maintain their positions in the evolving virtualization infrastructure and enterprise IT solutions industry. These alliances may result in more compelling product and service offerings than we offer.

Providers of public cloud infrastructure offerings. We compete with infrastructure-as-a service offerings from various public cloud providers such as Amazon, Microsoft, IBM and Google both directly through our vCloud Air offerings and indirectly, as these cloud providers present alternatives to VMware’s on-premises server virtualization products.

Our partners and members of our developer and technology partner ecosystem. We face competition from our partners. For example, third parties currently selling our products and services could build and market their own competing products and services or market competing products and services of other vendors. Additionally, as formerly distinct sectors of enterprise IT such as software-based virtualization and hardware-based server, networking and storage solutions converge, we also increasingly compete with companies who are members of our developer and technology partner ecosystem. Consequently, we may find it more difficult to continue to work together productively on other projects, and the advantages we derive from our ecosystem could diminish.

This competition could result in increased pricing pressure and sales and marketing expenses, thereby materially reducing our operating margins, and could also prevent our new products and services from gaining market acceptance, thereby harming our ability to increase, or causing us to lose, market share.

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Our new product and technology initiatives subject us to additional business, legal and competitive risks.

Over the last several years, we have introduced new product and technology initiatives that aim to leverage our virtualization infrastructure software products into the emerging areas of cloud computing and end-user computing as alternatives to the provisioning of physical computing resources. The expansion of our offerings to deliver the SDDC, address IT management and automation, add network and storage virtualization, and enhance our end-user computing capabilities and our hybrid cloud offerings subjects us to additional risks, such as the following:


•	These initiatives may present new and difficult technological challenges. Significant investments will be required to acquire and develop solutions to those challenges. Customers may choose not to adopt our new product or service offerings and we may be unable to recoup or realize a reasonable return on our investments.

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Some of our new initiatives are hosted by third parties whom we do not control but whose failure to prevent service disruptions, or other failures or breaches may require us to issue credits or refunds or indemnify or otherwise be liable to customers or third parties for damages that may occur. Any transition of our services from a third party hosting service to our own data centers would also entail a risk of service disruption during a transition. We may be subject to claims if customers of these service offerings experience service disruptions or failures, security breaches, data losses or other quality issues.


•	The success of these new offerings depends upon the cooperation of hardware, software and cloud hosting vendors to ensure interoperability with our products and offer compatible products and services to end users. If we are unable to obtain such cooperation, it may be difficult and more costly for us to achieve functionality and service levels that would make our services attractive to end users.


•	We will need to develop and implement appropriate go-to-market strategies and train our sales force in order to effectively market offerings in product categories in which we may have less experience than our competitors. Accordingly, end users could choose competing products and services over ours, even if such offerings are less advanced than ours.

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Our increasing focus on developing and marketing IT management and automation and infrastructure-as-a-service (including software-defined networking and vCloud Air) offerings that enable customers to transform their IT systems requires a greater focus on marketing and selling product suites and more holistic solutions, rather than selling on a product-by-product basis. Consequently, we have developed, and must continue to develop, new strategies for marketing and selling our offerings, and the duration of sales cycles for our offerings has increased as our customers’ purchasing decisions become more complex and require additional levels of approval.