Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period            from            to
Commission File Number 001-33622
_______________________________________________________
VMWARE, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________________
Delaware
94-3292913
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
3401 Hillview Avenue
Palo Alto, CA
94304
(Address of principal executive offices)
(Zip Code)
(650) 427-5000
(Registrant’s telephone number, including area code)
_____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  þ    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
 þ
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
 o
(Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  þ
As of October 31, 2016, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 411,565,890 of which 111,565,890 shares were Class A common stock and 300,000,000 were Class B common stock.


TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 
 
 
 
 
VMware, vSphere, NSX, vCloud, vCloud Air, vCloud Air Network, Workspace ONE, AirWatch, vSAN, VMworld, and Horizon are registered trademarks or trademarks of VMware or its subsidiaries in the United States and other jurisdictions. All other marks and names mentioned herein may be trademarks of their respective companies.


2
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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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Revenue:
 
 
 
 
 
 
 
License
$
691

 
$
681

 
$
1,907

 
$
1,896

Services
1,087

 
991

 
3,153

 
2,883

GSA settlement
—

 
—

 
—

 
(76
)
Total revenue
1,778

 
1,672

 
5,060

 
4,703

Operating expenses(1):
 
 
 
 
 
 
 
Cost of license revenue
40

 
46

 
121

 
142

Cost of services revenue
226

 
212

 
658

 
609

Research and development
389

 
331

 
1,109

 
958

Sales and marketing
564

 
556

 
1,708

 
1,656

General and administrative
178

 
201

 
516

 
568

Realignment
—

 
—

 
52

 
20

Operating income
381

 
326

 
896

 
750

Investment income
21

 
13

 
56

 
38

Interest expense with Dell
(7
)
 
(7
)
 
(20
)
 
(20
)
Other income (expense), net
(8
)
 
(7
)
 
(8
)
 
(8
)
Income before income taxes
387

 
325

 
924

 
760

Income tax provision
68

 
69

 
179

 
137

Net income
$
319

 
$
256

 
$
745

 
$
623

Net income per weighted-average share, basic for Class A and Class B
$
0.76

 
$
0.61

 
$
1.76

 
$
1.47

Net income per weighted-average share, diluted for Class A and Class B
$
0.75

 
$
0.60

 
$
1.75

 
$
1.46

Weighted-average shares, basic for Class A and Class B
421,704

 
422,329

 
423,341

 
424,799

Weighted-average shares, diluted for Class A and Class B
425,008

 
423,981

 
425,851

 
427,466

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

 
$
—

 
$
2

 
$
1

Cost of services revenue
13

 
11

 
38

 
32

Research and development
80

 
56

 
224

 
164

Sales and marketing
51

 
43

 
146

 
124

General and administrative
26

 
16

 
62

 
47

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
319

 
$
256

 
$
745

 
$
623

Other comprehensive income (loss):
 
 
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $(2), $1, $12 and $1
(4
)
 
1

 
19

 
2

Reclassification of (gains) losses realized during the period, net of taxes of $0, $0, $3 and $0
—

 
—

 
4

 
—

Net change in market value of available-for-sale securities
(4
)
 
1

 
23

 
2

Changes in market value of effective foreign currency forward contracts:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $0 for all periods
—

 
1

 
—

 
(4
)
Reclassification of (gains) losses realized during the period, net of taxes of $0 for all periods
—

 
(2
)
 
1

 
—

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

 
(1
)
 
1

 
(4
)
Total other comprehensive income (loss)
(4
)
 
—

 
24

 
(2
)
Total comprehensive income (loss), net of taxes
$
315

 
$
256

 
$
769

 
$
621

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

4
Table of Contents

VMware, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in millions, except per share amounts, and shares in thousands)
(unaudited)
 
September 30,
 
December 31,
 
2016
 
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,654

 
$
2,493

Short-term investments
5,600

 
5,016

Accounts receivable, net of allowance for doubtful accounts of $2 and $2
1,119

 
1,633

Due from related parties, net
23

 
74

Other current assets
159

 
144

Total current assets
9,555

 
9,360

Property and equipment, net
1,050

 
1,128

Other assets
232

 
193

Deferred tax assets
462

 
456

Intangible assets, net
538

 
616

Goodwill
4,032

 
3,993

Total assets
$
15,869

 
$
15,746

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
104

 
$
138

Accrued expenses and other
649

 
746

Unearned revenue
3,279

 
3,245

Total current liabilities
4,032

 
4,129

Notes payable to Dell
1,500

 
1,500

Unearned revenue
1,815

 
1,831

Other liabilities
388

 
363

Total liabilities
7,735

 
7,823

Contingencies (refer to Note I)

 

Stockholders’ equity:
 
 
 
Class A common stock, par value $.01; authorized 2,500,000 shares; issued and
outstanding 113,870 and 121,947 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
2,174

 
2,728

Accumulated other comprehensive income (loss)
16

 
(8
)
Retained earnings
5,940

 
5,195

Total VMware, Inc.’s stockholders’ equity
8,134

 
7,919

Non-controlling interests
—

 
4

Total stockholders’ equity
8,134

 
7,923

Total liabilities and stockholders’ equity
$
15,869

 
$
15,746

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)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Operating activities:
 
 
 
Net income
$
745

 
$
623

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
261

 
246

Stock-based compensation
472

 
368

Excess tax benefits from stock-based compensation
(7
)
 
(27
)
Deferred income taxes, net
(24
)
 
(44
)
Impairment of strategic investments
12

 
5

Gain on sales of strategic investments
(1
)
 
—

Loss on disposal of assets
12

 
—

Other
(1
)
 
—

Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
513

 
508

Other assets
(22
)
 
14

Due to/from related parties, net
55

 
31

Accounts payable
(26
)
 
(36
)
Accrued expenses
(64
)
 
(153
)
Income taxes payable
(26
)
 
24

Unearned revenue
18

 
(148
)
Net cash provided by operating activities
1,917

 
1,411

Investing activities:
 
 
 
Additions to property and equipment
(109
)
 
(274
)
Purchases of available-for-sale securities
(3,337
)
 
(2,675
)
Sales of available-for-sale securities
1,769

 
1,700

Maturities of available-for-sale securities
1,015

 
840

Proceeds from disposal of assets
3

 
—

Purchases of strategic investments
(33
)
 
(11
)
Sales of strategic investments
1

 
2

Business acquisitions, net of cash acquired
(59
)
 
(21
)
Decrease (increase) in restricted cash
(2
)
 
77

Net cash used in investing activities
(752
)
 
(362
)
Financing activities:
 
 
 
Proceeds from issuance of common stock
106

 
123

Proceeds from non-controlling interests
—

 
4

Payment to acquire non-controlling interests
(4
)
 
—

Repurchase of common stock
(1,016
)
 
(1,050
)
Excess tax benefits from stock-based compensation
7

 
27

Shares repurchased for tax withholdings on vesting of restricted stock
(97
)
 
(141
)
Net cash used in financing activities
(1,004
)
 
(1,037
)
Net increase in cash and cash equivalents
161

 
12

Cash and cash equivalents at beginning of the period
2,493

 
2,071

Cash and cash equivalents at end of the period
$
2,654

 
$
2,083

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
21

 
$
21

Cash paid for taxes, net
212

 
155

Non-cash items:
 
 
 
Changes in capital additions, accrued but not paid
$
(15
)
 
$
(49
)
The accompanying notes are an integral part of the condensed consolidated financial statements.

6
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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 a leader in virtualization and cloud infrastructure solutions that enable businesses to transform the way they build, deliver and consume information technology (“IT”) resources in a manner that is based on their specific needs. VMware’s virtualization infrastructure solutions, which include a suite of products and services designed to deliver a software-defined data center, run on industry-standard desktop computers, servers and mobile devices and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
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 2016. 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 2015 Annual Report on Form 10-K.
Effective September 7, 2016, Dell Technologies Inc. (“Dell”) (formerly Denali Holding Inc.) acquired EMC Corporation (“EMC”) which resulted in a change in control of VMware (the “Dell Acquisition”). As a result of the Dell Acquisition, EMC became a wholly-owned subsidiary of Dell and VMware became an indirectly-held, majority-owned subsidiary of Dell. As of September 30, 2016, Dell controlled 82.9% of VMware’s outstanding common stock and 97.7% of the combined voting power of VMware’s outstanding common stock held by EMC, including 43 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock.
In connection with the Dell Acquisition, Michael S. Dell was elected to the VMware Board of Directors as Chairman and Egon Durban was elected to the VMware Board. Additionally, both Joseph M. Tucci, VMware’s Chairman of the Board, and John R. Egan resigned from the VMware Board.
As VMware is a majority-owned and controlled subsidiary of Dell, its results of operations and financial position are consolidated with Dell’s financial statements. Pushdown accounting was not applied as a result of the Dell Acquisition and consequently no change in basis was reflected in VMware’s condensed consolidated financial statements. References to transactions with Dell within the financial statements and accompanying notes include transactions with EMC prior to September 7, 2016.
Management believes the assumptions underlying the condensed consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with Dell and its consolidated subsidiaries may not be considered arm’s length with an unrelated third party. Therefore, the financial statements included herein may not necessarily reflect the results of operations, financial position and cash flows had VMware engaged in such transactions with an unrelated third party during all periods presented. Accordingly, VMware’s historical financial information is not necessarily indicative of what the Company’s results of operations, financial position and cash flows will be in the future if and when VMware contracts at arm’s length with unrelated third parties for the services the Company receives from and provides to Dell.
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. The portion of results of operations attributable to the non-controlling interests is eliminated in other income (expense), net on the condensed consolidated statements of income and is not presented separately as the amount was not material for the periods presented. During the second quarter of 2016, VMware acquired all of the non-controlling interests previously presented as a separate component within total stockholders’ equity. Refer to Note B for further discussion. All intercompany transactions and

7
Table of Contents
VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

account balances between VMware and its subsidiaries have been eliminated in consolidation. Transactions with Dell and its consolidated subsidiaries are generally settled in cash and are classified on the condensed consolidated statements of cash flows based upon the nature of the underlying transaction.
Use of Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenue and expenses during the reporting periods, and the disclosure of contingent liabilities at the date of the financial statements. Estimates are used for, but not limited to, trade receivable valuation, marketing development funds and rebates, useful lives assigned to fixed assets and intangible assets, valuation of goodwill and definite-lived intangibles, income taxes, stock-based compensation, and contingencies. Actual results could differ from those estimates.
New Accounting Pronouncements
During October 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which requires entities to recognize at the transaction date the income tax consequences of intra-entity asset transfers. Previous guidance requires the tax effects from intra-entity asset transfers to be deferred until that asset is sold to a third party or recovered through use. The updated standard is effective in annual and interim periods in fiscal years beginning after December 15, 2017, with early adoption permitted during the first interim period of a fiscal year, and requires a modified retrospective transition method. The Company is currently evaluating the effect that ASU 2016-16 will have on its consolidated financial statements and related disclosures.
During March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718), which impacts the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The updated standard is effective for interim and annual periods beginning after December 15, 2016 and permits early adoption in any interim or annual period. The Company is currently evaluating the effect that ASU 2016-09 will have on its consolidated financial statements and related disclosures.
During February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires a lessee to recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. This ASU also requires additional disclosure regarding leasing arrangements. The updated lease standard is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption, with early adoption permitted. The Company is currently evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures, and expects that most of its lease commitments will be subject to the updated standard and recognized as lease liabilities and right-of-use assets upon adoption of ASU 2016-02.
During May 2014, the FASB issued 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. In 2016, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12, which provide interpretive clarifications on the new guidance in Topic 606. The updates are effective for the Company for interim and annual periods beginning after December 15, 2017 and permits the use of either the retrospective or cumulative effect transition method. Early adoption is permitted for annual periods beginning after December 15, 2016. The Company has not selected a transition method and is currently evaluating the effect that the updates will have on its consolidated financial statements and related disclosures.
B. Business Combination, Definite-Lived Intangible Assets, Net, Goodwill and Joint Venture
Business Combination
On June 21, 2016, VMware acquired all of the outstanding shares of Arkin Net, Inc. (“Arkin”) for approximately $67 million of cash, net of liabilities assumed. VMware acquired Arkin, a provider of software-defined data center security and operations, as part of a strategy to accelerate customers’ adoption of VMware NSX and software-defined data centers. The pro forma financial information assuming the acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition, as well as the revenue and earnings generated during the current year, were not material for disclosure purposes.

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

The following table summarizes the preliminary allocation of the consideration to the fair value of the assets acquired and liabilities assumed (table in millions):
Cash
$
7

Intangible assets
26

Goodwill
38

Deferred tax assets
5

Other acquired assets
1

Total assets acquired
77

Deferred tax liabilities
(10
)
Total liabilities assumed
(10
)
Fair value of assets acquired and liabilities assumed
$
67

The identifiable intangible assets acquired were primarily related to purchased technology with estimated useful lives of four to five years. Goodwill is not expected to be deductible for U.S. income tax purposes.
Prior to the closing of the acquisition on June 21, 2016, EMC owned approximately 16% of the outstanding shares of Arkin. As a result of the acquisition, cash paid to EMC was approximately $13 million.
Definite-Lived Intangible Assets, Net
As of September 30, 2016 and December 31, 2015, definite-lived intangible assets consisted of the following (amounts in tables in millions):
 
September 30, 2016
 
Weighted-Average
Useful Lives
(in years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Purchased technology
6.6
 
$
632

 
$
(337
)
 
$
295

Leasehold interest
34.9
 
149

 
(23
)
 
126

Customer relationships and customer lists
8.2
 
135

 
(60
)
 
75

Trademarks and tradenames
8.6
 
61

 
(22
)
 
39

Other
5.4
 
5

 
(2
)
 
3

Total definite-lived intangible assets
 
 
$
982

 
$
(444
)
 
$
538

 
December 31, 2015
 
Weighted-Average
Useful Lives
(in years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Purchased technology
6.6
 
$
648

 
$
(298
)
 
$
350

Leasehold interest
34.9
 
149

 
(20
)
 
129

Customer relationships and customer lists
8.4
 
148

 
(62
)
 
86

Trademarks and tradenames
8.6
 
61

 
(16
)
 
45

Other
2.9
 
20

 
(14
)
 
6

Total definite-lived intangible assets
 
 
$
1,026

 
$
(410
)
 
$
616

Amortization expense on definite-lived intangible assets was $33 million and $99 million during the three and nine months ended September 30, 2016, respectively, and $36 million and $110 million during the three and nine months ended September 30, 2015, respectively.

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

Based on intangible assets recorded as of September 30, 2016 and assuming no subsequent additions, dispositions or impairment of underlying assets, the remaining estimated annual amortization expense is expected to be as follows (table in millions):
Remainder of 2016
$
32

2017
125

2018
115

2019
92

2020
42

Thereafter
132

Total
$
538

Goodwill
The following table summarizes the changes in the carrying amount of goodwill during the nine months ended September 30, 2016 (table in millions):
Balance, January 1, 2016
3,993

Increase in goodwill related to a business combination
39

Balance, September 30, 2016
$
4,032

Joint Venture
During the year ended December 31, 2014, VMware established a joint venture intended to expand VMware vCloud Air services in Japan. At December 31, 2015, VMware had a controlling interest in the joint venture and approximately 51% of the ownership. Accordingly, VMware consolidated the financial results of the joint venture. During the second quarter of 2016, VMware acquired all of the remaining non-controlling interests in the joint venture for $4 million.
C. Realignment
On January 22, 2016, VMware approved a plan to streamline its operations, with plans to reinvest the associated savings in field, technical and support resources associated with growth products. As a result of these actions, approximately 800 positions were eliminated during the nine months ended September 30, 2016. VMware recognized $49 million of severance-related realignment expenses during the nine months ended September 30, 2016 on the condensed consolidated statements of income. Additionally, VMware consolidated certain facilities as part of this plan, which resulted in the recognition of $3 million of related expenses during the nine months ended September 30, 2016 on the condensed consolidated statements of income. Actions associated with this plan were substantially completed by June 30, 2016.
During fiscal 2015, VMware eliminated approximately 350 positions across all major functional groups and geographies to streamline its operations. As a result of these actions, $20 million of realignment expenses were recognized during the nine months ended September 30, 2015, which consisted of severance-related costs.

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

The following table summarizes the activity for the accrued realignment expenses for the nine months ended September 30, 2016 and September 30, 2015 (tables in millions):
 
For the Nine Months Ended September 30, 2016
 
Balance as of
January 1, 2016
 
Realignment
 
Utilization
 
Balance as of
September 30, 2016
Severance-related costs
$
3

 
$
49

 
$
(51
)
 
$
1

Costs to exit facilities
—

 
3

 
(1
)
 
2

Total
$
3

 
$
52

 
$
(52
)
 
$
3

 
For the Nine Months Ended September 30, 2015
 
Balance as of
January 1, 2015
 
Realignment
 
Utilization
 
Balance as of
September 30, 2015
Severance-related costs
$
8

 
20

 
(27
)
 
$
1

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, including performance stock units, and stock options, including purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income 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.
The following table sets forth the computations of basic and diluted net income per share during the three and nine months ended September 30, 2016 and 2015 (net income in millions, shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
319

 
$
256

 
$
745

 
$
623

Weighted-average shares, basic for Class A and Class B
421,704

 
422,329

 
423,341

 
424,799

Effect of dilutive securities
3,304

 
1,652

 
2,510

 
2,667

Weighted-average shares, diluted for Class A and Class B
425,008

 
423,981

 
425,851

 
427,466

Net income per weighted-average share, basic for Class A and Class B
$
0.76

 
$
0.61

 
$
1.76

 
$
1.47

Net income per weighted-average share, diluted for Class A and Class B
$
0.75

 
$
0.60

 
$
1.75

 
$
1.46

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 and nine months ended September 30, 2016 and 2015, because their effect would have been anti-dilutive (shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Anti-dilutive securities:
 
 
 
 
 
 
 
Employee stock options
1,655

 
2,129

 
2,027

 
2,173

Restricted stock units
3,632

 
365

 
2,416

 
58

Total
5,287

 
2,494

 
4,443

 
2,231


11
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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 September 30, 2016 and December 31, 2015 consisted of the following (tables in millions):
 
September 30, 2016
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
Cash
$
565

 
$
—

 
$
—

 
$
565

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
2,015

 
$
—

 
$
—

 
$
2,015

Time deposits
35

 
—

 
—

 
35

Municipal obligations
39

 
—

 
—

 
39

Total cash equivalents
$
2,089

 
$
—

 
$
—

 
$
2,089

Short-term investments:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
818

 
$
2

 
$
—

 
$
820

U.S. and foreign corporate debt securities
4,109

 
19

 
(2
)
 
4,126

Foreign governments and multi-national agency obligations
35

 
—

 
—

 
35

Municipal obligations
401

 
—

 
—

 
401

Asset-backed securities
5

 
—

 
—

 
5

Mortgage-backed securities
213

 
1

 
(1
)
 
213

Total short-term investments
$
5,581

 
$
22

 
$
(3
)
 
$
5,600

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

 
$
7

 
$
—

 
$
22

 
December 31, 2015
 
Cost or Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Aggregate
Fair Value
Cash
$
725

 
$
—

 
$
—

 
$
725

Cash equivalents:
 
 
 
 
 
 
 
Money-market funds
$
1,763

 
$
—

 
$
—

 
$
1,763

Time deposits
5

 
—

 
—

 
5

Total cash equivalents
$
1,768

 
$
—

 
$
—

 
$
1,768

Short-term investments:
 
 
 
 
 
 
 
Time deposits
$
12

 
$
—

 
$
—

 
$
12

U.S. Government and agency obligations
753

 
—

 
(3
)
 
750

U.S. and foreign corporate debt securities
3,263

 
1

 
(12
)
 
3,252

Foreign governments and multi-national agency obligations
35

 
—

 
—

 
35

Municipal obligations
705

 
1

 
—

 
706

Asset-backed securities
20

 
—

 
—

 
20

Mortgage-backed securities
243

 
—

 
(2
)
 
241

Total short-term investments
$
5,031

 
$
2

 
$
(17
)
 
$
5,016

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

 
$
3

 
$
—

 
$
18

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

12
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VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

VMware evaluated its available-for-sale investments as of September 30, 2016 and December 31, 2015 to determine whether or not any security had experienced an other-than-temporary decline in fair value. As of September 30, 2016 and December 31, 2015, VMware did not consider any of its available-for-sale investments to be other-than-temporarily impaired. The realized gains and losses on investments during the three and nine months ended September 30, 2016 and 2015 were not significant.
Unrealized losses on cash equivalents and available-for-sale investments as of September 30, 2016 and December 31, 2015, which have been in a net loss position for less than twelve months, were classified by asset class as follows (table in millions):
 
September 30, 2016
 
December 31, 2015
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
U.S. Government and agency obligations
$
170

 
$
—

 
$
657

 
$
(3
)
U.S. and foreign corporate debt securities
915

 
(2
)
 
2,564

 
(11
)
Mortgage-backed securities
88

 
(1
)
 
171

 
(1
)
Total
$
1,173

 
$
(3
)
 
$
3,392

 
$
(15
)
As of September 30, 2016 and December 31, 2015, unrealized losses on cash equivalents and available-for-sale investments in the other investment categories, which have been in a net loss position for less than twelve months, were not significant. Unrealized losses on cash equivalents and available-for-sale investments, which have been in a net loss position for twelve months or greater, were not significant as of September 30, 2016 and December 31, 2015.
Contractual Maturities
The contractual maturities of short-term investments held at September 30, 2016 consisted of the following (table in millions):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
1,693

 
$
1,694

Due after 1 year through 5 years
3,545

 
3,562

Due after 5 years through 10 years
111

 
112

Due after 10 years
232

 
232

Total short-term investments
$
5,581

 
$
5,600

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 forward contracts and notes payable to Dell. At September 30, 2016 and December 31, 2015, 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.

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

VMware did not have any significant assets or liabilities that fell into Level 3 of the fair value hierarchy as of September 30, 2016 and December 31, 2015, and there have been no transfers between fair value measurement levels during the three and nine months ended September 30, 2016 and 2015.
The following tables set forth the fair value hierarchy of VMware’s cash equivalents, available-for-sale securities, and forward contracts that were required to be measured at fair value as of September 30, 2016 and December 31, 2015 (tables in millions):
 
September 30, 2016
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 


Money-market funds
$
2,015

 
$
—

 
$
2,015

Time deposits
—

 
35

 
35

Municipal obligations
—

 
39

 
39

Total cash equivalents
$
2,015

 
$
74

 
$
2,089

Short-term investments:
 
 
 
 
 
U.S. Government and agency obligations
$
485

 
$
335

 
$
820

U.S. and foreign corporate debt securities
—

 
4,126

 
4,126

Foreign governments and multi-national agency obligations
—

 
35

 
35

Municipal obligations
—

 
401

 
401

Asset-backed securities
—

 
5

 
5

Mortgage-backed securities
—

 
213

 
213

Total short-term investments
$
485

 
$
5,115

 
$
5,600

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

 
$
—

 
$
22

 
December 31, 2015
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money-market funds
$
1,763

 
$
—

 
$
1,763

Time deposits
—

 
5

 
5

Total cash equivalents
$
1,763

 
$
5

 
$
1,768

Short-term investments:
 
 
 
 
 
Time deposits
$
—

 
$
12

 
$
12

U.S. Government and agency obligations
543

 
207

 
750

U.S. and foreign corporate debt securities
—

 
3,252

 
3,252

Foreign governments and multi-national agency obligations
—

 
35

 
35

Municipal obligations
—

 
706

 
706

Asset-backed securities
—

 
20

 
20

Mortgage-backed securities
—

 
241

 
241

Total short-term investments
$
543

 
$
4,473

 
$
5,016

Other assets:
 
 
 
 
 
Marketable available-for-sale equity securities
$
18

 
$
—

 
$
18

Accrued expenses and other:
 
 
 
 
 
Forward contracts
$
—

 
$
(1
)
 
$
(1
)
VMware has elected not to record its notes payable to Dell at fair value, but has measured the notes at fair value for disclosure purposes. As of September 30, 2016, the fair value of the notes payable to Dell approximated its carrying value due to the minimal difference between the fair market interest rate as of September 30, 2016 and the fixed interest rate for the notes

14
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VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

payable to Dell. As of December 31, 2015, the fair value of the notes payable to Dell was approximately $1,474 million. Fair value was estimated primarily based on observable market interest rates (Level 2 inputs).
VMware offers a deferred compensation plan for eligible employees that allows participants to defer payment for part or all of their compensation. The net impact to the condensed consolidated statements of income is not significant since changes in the fair value of the assets substantially offset changes in the fair value of the liabilities. As such, assets and liabilities associated with this plan have not been included in the above tables. Assets and liabilities associated with this plan were both approximately $33 million and $20 million as of September 30, 2016 and December 31, 2015, 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 has strategic investments in its portfolio accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. VMware evaluates these investments 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. If VMware determines that an other-than-temporary impairment has occurred, VMware writes down the investments to their fair value.
During the three and nine months ended September 30, 2016, VMware determined that certain strategic investments were considered to be other-than-temporarily impaired and accordingly, approximately $7 million and $12 million, respectively, was recognized as an impairment charge. During the three and nine months ended September 30, 2015, approximately $5 million was recognized as an impairment charge. All other realized gains and losses on investments during the three and nine months ended September 30, 2016 and 2015 were not significant. Strategic investments are included in other assets on the condensed consolidated balance sheets. The carrying value of VMware’s strategic investments was $124 million and $103 million as of September 30, 2016 and December 31, 2015, 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 trading or 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 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 income (loss) on the condensed consolidated balance sheets and is subsequently reclassified to the related operating expense line item on the condensed consolidated statements of income in the same period that the underlying expenses are incurred. During the three and nine months ended September 30, 2016 and 2015, the effective portion of gains or losses reclassified to the condensed consolidated statements of income was not significant. Interest charges or “forward points” on VMware’s forward contracts are excluded from the assessment of hedge effectiveness and are recorded in other income (expense), net on the condensed consolidated statements of income as incurred.
VMware enters into forward contracts annually, which have maturities of twelve months or less. As of September 30, 2016 and December 31, 2015, VMware had forward contracts designated as cash flow hedges with a total notional value of $54 million and $213 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
During the three and nine months ended September 30, 2016 and 2015, all cash flow hedges were considered effective.
Forward Contracts Not Designated as Hedges
VMware has established a program that utilizes forward contracts to offset the foreign currency risk associated with net outstanding monetary asset and liability positions. These forward contracts are not designated as hedging instruments under

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

applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are reported in other income (expense), net on the condensed consolidated statements of income.
VMware enters into forward contracts on a monthly basis, which typically have a contractual term of one month. As of September 30, 2016 and December 31, 2015, VMware had outstanding forward contracts with a total notional value of $539 million and $721 million, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
VMware recognized a loss of $12 million during the nine months ended September 30, 2016 relating to the settlement of forward contracts. During the three and nine months ended September 30, 2015, VMware recognized gains of $12 million and $33 million, respectively. Gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
The combined gains and losses derived from the settlement of forward contracts and the underlying foreign currency denominated assets and liabilities resulted in a net loss of $10 million during the nine months ended September 30, 2015, respectively, and were not significant for all other periods presented. Net gains and losses are recorded in other income (expense), net on the condensed consolidated statements of income.
H. Unearned Revenue
Unearned revenue as of September 30, 2016 and December 31, 2015 consisted of the following (table in millions):
 
September 30, 2016
 
December 31, 2015
Unearned license revenue
$
425

 
$
428

Unearned software maintenance revenue
4,201

 
4,174

Unearned professional services revenue
468

 
474

Total unearned revenue
$
5,094

 
$
5,076

Unearned license revenue is 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 revenue may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist.
Unearned software maintenance revenue is attributable to VMware’s maintenance contracts and are generally recognized ratably over the contract period. The weighted-average remaining term at September 30, 2016 was approximately two years. Unearned professional services revenue results primarily from prepaid professional services, including training, and are generally recognized as the services are delivered.
Unearned license and software maintenance revenue will fluctuate based upon a variety of factors including sales volume, the timing of both product promotion offers and delivery of the future products offered, and the amount of arrangements sold with ratable revenue recognition. Additionally, the amount of unearned revenue derived from transactions denominated in a foreign currency is impacted by fluctuations in the foreign currencies in which VMware invoices.
I. Contingencies
Litigation
On March 27, 2015, Phoenix Technologies (“Phoenix”) filed a complaint against VMware in the U.S. District Court for the Northern District of California asserting claims for copyright infringement and breach of contract relating to a version of Phoenix’s BIOS software that VMware licensed from Phoenix. In the lawsuit, Phoenix is seeking injunctive relief and monetary damages. Trial is in process of being rescheduled to 2017. 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 4, 2015, Christoph Hellwig, a software developer who alleges that software code he wrote is used in a component of the Company’s vSphere product, filed a lawsuit against VMware in the Hamburg Regional Court in Germany alleging copyright infringement for failing to comply with the terms of an open source General Public License v.2 (“GPL v.2”) and seeking an order requiring VMware to comply with the GPL v.2 or cease distribution of any affected code within Germany.

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

On July 8, 2016, the German court issued a written decision dismissing Mr. Hellwig’s lawsuit because he failed to show that his protectable software code had been used in VMware’s product. On August 9, 2016, a Notice of Appeal was filed.
While VMware believes that it has valid defenses against each of the above legal matters, given the unpredictable nature of legal proceedings, an unfavorable resolution of one or more legal proceedings, claims, or investigations could have a material adverse effect on VMware’s condensed consolidated financial statements.
On November 17, 2015, Francis M. Ford, a VMware Class A stockholder, filed an action in the Delaware Chancery Court against certain current and former VMware directors, among others, alleging that the directors breached their fiduciary duties in connection with the Dell Acquisition, and the proposed issuance of tracking stock that is intended to track the performance of VMware. The plaintiff does not assert claims directly against VMware, but purports to bring class claims on behalf of other VMware Class A stockholders and derivative claims on behalf of VMware. In addition, on November 10, 2015, David Jacobs, also a VMware stockholder, filed an action in Massachusetts Superior Court against, among others, EMC and four directors who serve on both the EMC board and the VMware board, setting forth similar allegations to those in the Ford matter. While VMware does not believe that the cases represent material adverse exposures, no assurances can be given that the litigation will not have any adverse consequences for the company or the directors named in the suits.
VMware accrues for a liability when a determination has been made that a loss is both probable and the amount of the loss can be reasonably estimated. If only a range can be estimated and no amount within the range is a better estimate than any other amount, an accrual is recorded for the minimum amount in the range. Significant judgment is required in both the determination that the occurrence of a loss is probable and is reasonably estimable. In making such judgments, VMware considers the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal costs are generally recognized as expense when incurred.
VMware is also subject to other legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business or in connection with business mergers and acquisitions, including claims with respect to commercial, contracting and sales practices, product liability, intellectual property, employment, corporate and securities law, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from and has discussions with government entities and stockholders on various matters. As of September 30, 2016, amounts accrued relating to these other matters arising as part of the ordinary course of business were not considered material. 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
During April 2016, VMware’s board of directors authorized the repurchase of up to an aggregate of $1,200 million of VMware’s Class A common stock through the end of 2016. The aggregate authorized stock repurchase amount of $1,200 million included the amount remaining from VMware’s previous stock repurchase authorization announced on January 27, 2015 of $835 million. All shares repurchased under VMware’s stock repurchase programs are retired. The cumulative authorized amount remaining for stock repurchases as of September 30, 2016 was utilized during the fourth quarter of fiscal 2016.
The following table summarizes stock repurchase activity during the three and nine months ended September 30, 2016 and 2015 (aggregate purchase price in millions, shares in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Aggregate purchase price
$
1,016

 
$
200

 
$
1,016

 
$
1,050

Class A common shares repurchased
13,999

 
2,408

 
13,999

 
12,524

Weighted-average price per share
$
72.57

 
$
83.06

 
$
72.57

 
$
83.84

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

17
Table of Contents
VMware, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

VMware Stock Options
Stock option activity was not significant during the nine months ended September 30, 2016. As of September 30, 2016, there were 2.2 million stock options outstanding. The stock options outstanding as of September 30, 2016 had an aggregate intrinsic value of $43 million based on VMware’s closing stock price as of September 30, 2016.
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.
The following table summarizes restricted stock activity during the nine months ended September 30, 2016 (units in thousands):
 
Number of Units
 
Weighted-
Average Grant
Date Fair
Value
(per unit)
Outstanding, January 1, 2016
18,693

 
$
77.29

Granted
11,008

 
57.73

Vested
(4,660
)
 
79.72

Forfeited
(2,916
)
 
77.01

Outstanding, September 30, 2016
22,125

 
67.08

The total fair value of VMware restricted stock that vested during the nine months ended September 30, 2016 was $272 million. As of September 30, 2016, restricted stock representing 22.1 million shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of $1,623 million based on VMware’s closing stock price as of September 30, 2016.
As of September 30, 2016, the total unrecognized compensation cost for stock options and restricted stock was $1,080 million and will be recognized through 2020 with a weighted-average remaining period of 1.4 years.

18
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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 nine months ended September 30, 2016 and 2015 were as follows (tables in millions):
 
Unrealized Gain (Loss) on
Available-for-Sale Securities
 
Unrealized Gain (Loss) on
Forward Contracts
 
Total
Balance, January 1, 2016
$
(7
)
 
$
(1
)
 
$
(8
)
Unrealized gains (losses), net of taxes of $12, $0 and $12
19

 
—

 
19

Amounts reclassified from accumulated other comprehensive income (loss) to the consolidated statement of income, net of taxes of $3, $0 and $3
4

 
1

 
5

Balance, September 30, 2016
$
16

 
$
—

 
$
16

 
Unrealized Gain (Loss) on
Available-for-Sale Securities
 
Unrealized Gain (Loss) on
Forward Contracts
 
Total
Balance, January 1, 2015
$
—

 
$
(1
)
 
$
(1
)
Unrealized gains (losses), net of taxes of $1, $0 and $1
2

 
(4
)
 
(2
)
Balance, September 30, 2015
$
2

 
$
(5
)
 
$
(3
)
Unrealized gains on VMware’s available-for-sale securities are reclassified to investment income on the condensed consolidated statements of income in the period that such gains are realized.
The effective portion of gains (losses) resulting from changes in the fair value of forward contracts designated as cash flow hedging instruments 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 functional line items on the condensed consolidated statements of income during the three and nine months ended September 30, 2016 and 2015 were not significant to the individual functional line items.
K. Related Parties
The information provided below includes a summary of the transactions entered into with Dell and Dell’s consolidated subsidiaries including EMC (collectively “Dell”) from the effective date of the Dell Acquisition through September 30, 2016. References to transactions with Dell include transactions with EMC prior to September 7, 2016.
Transactions with Dell
VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in revenue and receipts and unearned revenue for VMware:
•
Pursuant to ongoing reseller arrangements with Dell, Dell bundles VMware’s products and services with Dell’s products and sells them to end users.
•
Dell purchases products and services from VMware for internal use.
•
VMware provides professional services to end users based upon contractual agreements with Dell.
•
Pursuant to an ongoing distribution agreement, VMware acts as the selling agent for certain products and services of Pivotal Software, Inc. (“Pivotal”), a subsidiary of Dell, in exchange for an agency fee. Under this agreement, cash is collected from the end user by VMware and remitted to Pivotal, net of the contractual agency fee.
•
VMware provides various services to Pivotal. Support costs incurred by VMware are reimbursed to VMware and are recorded as a reduction to the costs incurred by VMware.

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

Information about VMware’s revenue and receipts from such arrangements during the three and nine months ended September 30, 2016 and 2015 and unearned revenue from such arrangements as of September 30, 2016 and December 31, 2015 consisted of the following (table in millions):
 
Revenue and Receipts
 
Unearned Revenue
 
Three Months Ended
 
Nine Months Ended
 
As of
 
As of
 
September 30,
 
September 30,
 
September 30,
 
December 31,
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Reseller revenue
$
98

 
$
68

 
$
261

 
$
199

 
$
553

 
$
292

Internal-use revenue
5

 
4

 
24

 
13

 
17

 
11

Professional services revenue
28

 
20

 
79

 
68

 
—

 
3

Agency fee revenue
1

 
1

 
3

 
4

 
—

 
—

Reimbursement for services to Pivotal
—

 
2

 
1

 
3

 
 n/a

 
 n/a

VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in costs to VMware:
•
VMware purchases and leases products and purchases services from Dell.
•
From time to time, VMware and Dell enter into agreements to collaborate on technology projects, and VMware pays Dell for services provided to VMware by Dell related to such projects.
•
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with Dell subsidiaries for support services and Dell personnel who are managed by VMware. The costs incurred by Dell on VMware’s behalf related to these employees are charged to VMware with a mark-up intended to approximate costs that would have been incurred had VMware contracted for such services with an unrelated third party. These costs are included as expenses on VMware’s condensed consolidated statements of income and primarily include salaries, benefits, travel and rent expenses. Dell 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.
•
From time to time, VMware invoices end users on behalf of Dell for certain services rendered by Dell. Cash related to these services is collected from the end user by VMware and remitted to Dell.
Information about VMware’s costs from such arrangements for the three and nine months ended September 30, 2016 and 2015 consisted of the following (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Purchases and leases of products and purchases of services
$
24

 
$
14

 
$
58

 
$
45

Collaborative technology project costs
—

 
1

 
—

 
4

Dell subsidiary support and administrative costs
30

 
24

 
74

 
79

VMware also purchases Dell products through Dell’s channel partners. Purchases of Dell products through Dell’s channel partners were not significant during the three and nine months ended September 30, 2016. Purchases of Dell products through Dell’s channel partners were $7 million and $33 million during the three and nine months ended September 30, 2015, respectively.
Dell Financial Services (“DFS”)
DFS provides financing to certain of VMware’s end customers based on the customer’s discretion. Upon acceptance of the financing arrangement by both VMware’s end customer and DFS, amounts classified as trade accounts receivable are reclassified to due from related parties on the condensed consolidated balance sheets. Amounts due from DFS as of September 30, 2016 were not significant.

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

Tax Sharing Agreement with Dell
On September 6, 2016, VMware entered into an amended tax sharing agreement with Dell, in connection with, and effective as of, the Dell Acquisition. The amended tax sharing agreement amends and restates the tax sharing agreement dated August 13, 2007 between VMware and EMC. Key contractual terms of the amended tax sharing agreement are substantially unchanged from the original agreement with EMC.
VMware has made payments to Dell pursuant to the tax sharing agreement. The following table summarizes the payments made during the three and nine months ended September 30, 2016 and 2015 (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Payments from VMware to Dell
$
54

 
$
—

 
$
148

 
$
92

Payments from VMware to Dell under the tax sharing agreement relate to VMware’s portion of federal income taxes on Dell’s consolidated tax return as well as the state payments for combined states. The timing of the tax payments due to and from related parties is governed by the tax sharing agreement. The amounts that VMware pays to Dell for its portion of federal income taxes on Dell’s consolidated tax return differ from the amounts VMware would owe on a separate return basis and the difference is presented as a component of stockholders’ equity. The difference between the amount of tax calculated on a separate return basis and the amount of tax calculated per the tax sharing agreement was not significant during the three months ended September 30, 2016 and was $13 million during the nine months ended September 30, 2016. During the three and nine months ended September 30, 2015, the difference was not significant.
EMC Equity Awards Held by VMware Employees
In connection with the Dell Acquisition, vesting was accelerated for all outstanding EMC stock options and restricted stock units and stock options were automatically exercised on the last trading day prior to the effective date of the merger. VMware’s portion of the expense associated with accelerated EMC equity awards held by VMware employees was $7 million and was included within stock-based compensation expense on the condensed consolidated statement of income during the three and nine months ended September 30, 2016.
Due To/From Related Parties, Net
As a result of the related party transactions with Dell described above, amounts due to and from related parties, net as of September 30, 2016 and December 31, 2015 consisted of the following (table in millions):
 
September 30,
 
December 31,
 
2016
 
2015
Due (to) related parties
$
(54
)
 
$
(68
)
Due from related parties
77

 
142

Due (to) from related parties, net
$
23

 
$
74

 
 
 
 
Income tax due (to) from related parties
$
—

 
$
(18
)
Balances due to and from related parties, which are unrelated to DFS and tax obligations, are generally settled in cash within 60 days of each quarter-end.
Notes Payable to Dell
VMware and Dell 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 Dell 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 and nine months ended September 30, 2016, $7 million and $20 million, respectively, of interest expense was recognized. During the three and nine months ended September 30, 2015, $7 million and $20 million, respectively, of interest expense was recognized.

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

Pivotal
During 2013, VMware transferred certain assets and liabilities to Pivotal in exchange for preferred equity interests in Pivotal’s outstanding shares. As of December 31, 2015, VMware’s ownership interest in Pivotal was 28%.
In April 2016, VMware contributed $20 million in cash to Pivotal in exchange for additional preferred equity interests in Pivotal. After VMware’s contribution, VMware’s ownership interest in Pivotal was 17% and the cost method is being applied to this strategic investment. The decrease in VMware’s ownership interest was a result of investments made by other investors.
L. Segment Information
VMware operates in one reportable operating segment, thus all required financial segment information can be found on the condensed consolidated financial statements. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.
Revenue by geographic area for the three and nine months ended September 30, 2016 and 2015 were as follows (table in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
United States
$
916

 
$
861

 
$
2,587

 
$
2,364

International
862

 
811

 
2,473

 
2,339

Total
$
1,778

 
$
1,672

 
$
5,060

 
$
4,703

Revenue 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 revenue for the three and nine months ended September 30, 2016 and 2015. 
Long-lived assets by geographic area, which primarily include property and equipment, net, as of September 30, 2016 and December 31, 2015 were as follows (table in millions):
 
September 30, 2016
 
December 31, 2015
United States
$
793

 
$
831

International
128

 
148

Total
$
921

 
$
979

No individual country other than the United States accounted for 10% or more of these assets as of September 30, 2016 and December 31, 2015, respectively.
M. Subsequent Events
On October 25, 2016, the VMware Board of Directors approved a change to VMware’s fiscal year (which currently ends on December 31 of each calendar year) whereby each fiscal year will consist of a 52- or 53-week period ending on the Friday nearest to January 31 of each year. The change in VMware’s fiscal year will be effective January 1, 2017 with the period ending on February 3, 2017, which will be reported as a transition period. Accordingly, VMware’s first full fiscal year under the revised fiscal calendar will begin on February 4, 2017 and end on February 2, 2018.

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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 September 30, 2016 should be read in conjunction with our consolidated financial statements for the year ended December 31, 2015 contained in our Form 10-K filed on February 25, 2016.
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 a leader in virtualization and cloud 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, which are discussed in more detail below and allow organizations to leverage synergies and manage IT resources across complex multi-cloud, multi-device environments. Our three main product groups are:
•
SDDC or Software-Defined Data Center
•
Hybrid Cloud Computing
•
End-User Computing
We sell our solutions using enterprise agreements (“EAs”) or as part of our non-EA, or transactional, business. EAs are comprehensive volume license offerings, offered both directly by us and through certain channel partners that also provide for multi-year maintenance and support. We continue to experience strong renewals, including our EAs, resulting in additional license sales of both our existing and newer products and solutions.
SDDC or Software-Defined Data Center
Our SDDC technologies are the basis for the private cloud environment and provide the capabilities for our customers to extend their private cloud to the public cloud and to help them run, manage, secure and connect all their applications across all clouds and devices. Historically, the majority of our license sales have been from VMware vSphere, which is included in our compute product category within our SDDC product group. However, the market for our compute products is reaching maturity, and VMware vSphere license sales have been declining. As the transformation of the IT industry continues, we expect that our growth of license sales within the SDDC product group will be increasingly derived from sales of our newer products and services solutions across our SDDC portfolio. We have experienced continued growth in sales volume of VMware NSX (“NSX”), our network virtualization solution. We also continue to see growth in sales volume of our VMware vSAN (“vSAN”) products as well as other newer offerings.
Hybrid Cloud Computing
Our cloud strategy has three components: (i) continue to expand beyond compute virtualization in the private cloud, (ii) extend the private cloud into the public cloud, and (iii) connect and secure endpoints across a range of public clouds.
Hybrid cloud computing is comprised of VMware vCloud Air Network (“vCAN”) Service Providers Program and VMware vCloud Air (“vCloud Air”) offerings. We continue to see growth in revenue derived from vCAN. We have narrowed the focus of vCloud Air to provide specialized cloud software and services unique to VMware that are distinct from those offered by other cloud providers.
End-User Computing
End-user computing includes VMware Workspace ONE, which consists primarily of VMware AirWatch (“AirWatch”) and Horizon desktop and application virtualization (“Horizon”). Our AirWatch business model includes 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 continued to contribute to the growth of our end-user computing product group during the three and nine months ended September 30, 2016.
Dell and EMC Merger
In October 2015, EMC Corporation (“EMC”) and Dell Technologies Inc. (“Dell”) (formerly Denali Holdings Inc.) entered into a definitive merger agreement, pursuant to which Dell acquired EMC in a transaction that closed on September 7, 2016 (the “Dell Acquisition”).

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As a result of the Dell Acquisition, VMware became a majority-owned subsidiary of Dell. As of September 30, 2016, Dell controlled 82.9% of our outstanding common stock and 97.7% of the combined voting power of our outstanding common stock, including 43 million shares of our Class A common stock and all of our Class B common stock. We will continue to operate as a publicly traded company.
On October 25, 2016, our Board of Directors approved a change to our fiscal year (which currently ends on December 31 of each calendar year) whereby each fiscal year will consist of a 52- or 53-week period ending on the Friday nearest to January 31 of each year. The change in our fiscal year will be effective January 1, 2017 with the period ending on February 3, 2017, which will be reported as a transition period. Accordingly, our first full fiscal year under our revised fiscal calendar will begin on February 4, 2017 and end on February 2, 2018.
Results of Operations
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. In addition, we incur and pay operating expenses in currencies other than the U.S. dollar. As a result, our financial statements, including our revenue, operating expenses, unearned revenue, and the resulting cash flows derived from the U.S. dollar equivalent of foreign currency transactions are impacted by foreign exchange fluctuations.
Revenue
Our revenue during the three and nine months ended September 30, 2016 and 2015 were as follows (dollars in millions): 
 
Three Months Ended
 
 
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
 
 
September 30,
 
$ Change
 
% Change
 
September 30,
 
$ Change
 
% Change
 
2016
 
2015
 
Actual
 
Actual
 
Constant
Currency
 
2016
 
2015
 
Actual
 
Actual
 
Constant
Currency
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License
$
691

 
$
681

 
$
10

 
1
%
 
1
%
 
$
1,907

 
$
1,896

 
$
12

 
1
 %
 
1
%
Services:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software maintenance
947

 
863

 
84

 
10

 
 
 
2,753

 
2,505

 
249

 
10

 
 
Professional services
140

 
128

 
14

 
11

 
 
 
400

 
378

 
21

 
6

 
 
Total services
1,087

 
991

 
97

 
10

 
 
 
3,153

 
2,883

 
270

 
9

 
 
GSA settlement
—

 
—

 
—

 
n/a

 
 
 
—

 
(76
)
 
76

 
(100
)
 
 
Total revenue
$
1,778

 
$
1,672

 
$
107

 
6

 
7

 
$
5,060

 
$
4,703

 
$
357

 
8

 
8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
916

 
$
861

 
$
56

 
6
%
 
 
 
$
2,587

 
$
2,364

 
$
223

 
9
 %
 
 
International
862

 
811

 
51

 
6

 
 
 
2,473

 
2,339

 
135

 
6

 
 
Total revenue
$
1,778

 
$
1,672

 
$
107

 
6

 
7

 
$
5,060

 
$
4,703

 
$
357

 
8

 
8

In order to provide a comparable framework for assessing how our business performed, adjusted for the impact of foreign currency fluctuations, management analyzed year-over-year license and total revenue growth on a constant currency basis. License and total revenue growth in constant currency are non-GAAP financial measures that are calculated by converting license and total revenue recognized during the current period derived from non-U.S. dollar based transactions into U.S. dollars using the exchange rates that were effective in the comparable prior year period. The calculated current period license and total revenue, adjusted for foreign currency fluctuations, is compared to the license and total revenue of the comparable prior year period, as reported, in calculating license and total revenue growth in constant currency. We believe this information is useful to investors to facilitate comparisons of operating results and better identify trends in our business. These constant currency performance measures should be viewed in addition to, and not in lieu of or superior to, our operating performance measures calculated in accordance with GAAP.
Hybrid cloud, including vCAN and vCloud Air, and our SaaS offerings, including our AirWatch mobile solutions, increased to approximately 8% of our total revenue during the three and nine months ended September 30, 2016. vCAN revenue is generally included in license revenue and our SaaS revenue, including vCloud Air and our AirWatch mobile solutions, is included in both license and services revenue.

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While we are seeing strong growth across our portfolio of emerging products, our compute products are reaching maturity and the sales of these products are expected to represent a decreasing percentage of our total business going forward. Our total revenue growth has slowed in 2016 as sales continue to transition to our emerging products.
License Revenue
License revenue increased slightly during the three months ended September 30, 2016 when compared with the same period in 2015. While we experienced stronger than expected sales of our compute products during the three months ended September 30, 2016, we continue to expect a decline in compute license sales over the longer-term as the market is reaching maturity. Strong sales of our compute and management offerings as well as our install base continue to enable sales of our newer offerings, including NSX and vSAN. Additionally, we continue to experience growth in our vCAN offering while sales of our end-user computing desktop products declined.
While license revenue increased slightly during the nine months ended September 30, 2016, we experienced a decline both in sales of our compute products and end-user computing desktop products as compared to the same period in 2015. Offsetting this decline was increased sales in our emerging products and increased growth derived from our hybrid cloud and SaaS offerings.
Services Revenue
During the three and nine months ended September 30, 2016, software maintenance revenue benefited from renewals of our software enterprise agreements, maintenance contracts sold in previous periods and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers purchased, on a weighted-average basis, more than 24 months of support and maintenance with each new license purchased.
Professional services revenue increased during the three and nine months ended September 30, 2016 when compared to the same period in 2015. As we continue to invest in our partners and expand our ecosystem of third-party professionals with expertise in our offerings to 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 service engagements.
GSA Settlement 
During June 2015, we reached an agreement with the Department of Justice (“DOJ”) and the General Services Administration (“GSA”) to pay $76 million to resolve allegations that our government sales practices between 2006 and 2013 had violated the federal False Claims Act. The settlement was paid and recorded as a reduction of our total revenue during the nine months ended September 30, 2015.
Unearned Revenue
Our unearned revenue as of September 30, 2016 and December 31, 2015 were as follows (table in millions): 
 
September 30, 2016
 
December 31, 2015
Unearned license revenue
$
425

 
$
428

Unearned software maintenance revenue
4,201

 
4,174

Unearned professional services revenue
468

 
474

Total unearned revenue
$
5,094

 
$
5,076

Unearned license revenue is generally recognized upon delivery of existing or future products or services, or is otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and vendor-specific objective evidence (“VSOE”) of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. In the event the arrangement does not include professional services, unearned license revenue may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist.
Unearned software maintenance revenue is attributable to our maintenance contracts and is generally recognized ratably over the contract period. The weighted-average remaining term at September 30, 2016 was approximately two years. Unearned professional services revenue results primarily from prepaid professional services, including training, and is generally recognized as the services are delivered.
Unearned license and software maintenance revenue will fluctuate based upon a variety of factors including sales volume, the timing of both product promotion offers and delivery of the future products offered, and the amount of arrangements sold

25
Table of Contents

with ratable revenue recognition. Additionally, the amount of unearned revenue derived from transactions denominated in a foreign currency is impacted by fluctuations in the foreign currencies in which we invoice.
Cost of License Revenue, Cost of Services Revenue and Operating Expenses
Our cost of services revenue and operating expenses were primarily impacted by increasing employee-related expenses including salaries, bonuses, commissions and stock-based compensation across most of our income statement expense categories, net of realignment activities, when compared to the same period in 2015. We expect this trend to continue. As part of the realignment plan approved in January 2016, we have been reinvesting the associated savings primarily in research and development as well as sales and marketing.
In calculating the impact of foreign currency fluctuations on cost of license revenue, cost of services revenue and operating expenses, we converted expenses recognized during the current period derived from non-U.S. dollar based transactions into U.S. dollars using the exchange rates that were effective in the comparable prior year period and compared the calculated amount to the amount, as reported, in the comparable prior year period.
Cost of License Revenue
Our cost of license revenue 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 personnel costs and related overhead associated with the physical and electronic delivery of our software products.
Our cost of license revenue during the three and nine months ended September 30, 2016 and 2015 was as follows (dollars in millions):
 
Three Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
September 30,
 
 
 
 
 
September 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
$ Change
 
% Change
Cost of license revenue
$
40

 
$
46

 
$
(6
)

(13
)%
 
$
119

 
$
141

 
$
(22
)
 
(15
)%
Stock-based compensation
—

 
—

 
—

 
4

 
2

 
1

 
—

 
5

Total expenses
$
40

 
$
46

 
$
(6
)
 
(13
)
 
$
121

 
$
142

 
$
(22
)
 
(15
)
% of License revenue
6
%
 
7
%
 
 
 
 
 
6
%
 
8
%
 
 
 
 
Cost of license revenue decreased during the three and nine months ended September 30, 2016 compared to the same periods in 2015 primarily due to a decrease in royalty costs of $4 million and $13 million, respectively. In addition, amortization of intangible assets decreased by $6 million during the nine months ended September 30, 2016 due to certain intangible assets becoming fully amortized.
Cost of Services Revenue
Our cost of services revenue primarily includes the costs of personnel and related overhead to physically and electronically deliver technical support for our products and to provide professional services. Additionally, our cost of services revenue includes depreciation on equipment supporting our service offerings.
Our cost of services revenue during the three and nine months ended September 30, 2016 and 2015 was as follows (dollars in millions):
 
Three Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
September 30,
 
 
 
 
 
September 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
 
2016