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| VMW > SEC Filings for VMW > Form 10-Q on 1-Nov-2012 | All Recent SEC Filings |
1-Nov-2012
Quarterly Report
All dollar amounts expressed as numbers in this MD&A (except share and per share
amounts) are in millions.
Overview
Our primary source of revenues is the licensing of virtualization and
virtualization-based cloud infrastructure solutions and related support and
services for use by businesses and organizations of all sizes and across
numerous industries in their information technology ("IT") infrastructure.
We have developed a multi-channel distribution model to expand our global
presence and to reach various segments of our industry. In the third quarter and
first nine months of 2012, we derived over 85% of our sales from our channel
partners, which include distributors, resellers, system vendors and systems
integrators. Sales to our channel partners often involve three tiers of
distribution: a distributor, a reseller and an end-user customer. Our sales
force works collaboratively with our channel partners to introduce them to
customers and new sales opportunities. As we expand geographically, we expect to
continue to add additional channel partners.
Although we believe we are currently the leading provider of virtualization
infrastructure software solutions, we face competitive threats to our leadership
position from a number of companies, some of which have significantly greater
resources than we do, which could result in increased pressure to reduce prices
on our offerings. As a result, we believe it is important to continue to invest
in strategic initiatives related to product research and development, market
expansion and associated support functions to expand our industry leadership. We
believe that we will be able to continue to meet our product development
objectives through continued investment in our existing infrastructure,
supplemented with strategic hires and acquisitions, funded through the operating
cash flows generated from the sale of our products and services. We believe this
is the appropriate priority for the long-term health and growth of our business.
We expect to grow our business by broadening our virtualization infrastructure
software solutions technology and product portfolio, increasing product
awareness, promoting the adoption of virtualization and building long-term
relationships with our customers through the adoption of enterprise license
agreements ("ELAs"). Since the introduction of VMware vSphere in 2009, we have
introduced more products that build on the vSphere foundation, including VMware
vSphere 5 and a comprehensive suite of cloud infrastructure technologies, as
well as VMware View 5. Additionally, in the third quarter of 2012, we released
VMware vCloud Suite 5.1, which integrates our virtualization, cloud
infrastructure and management portfolio into a comprehensive solution consisting
of cloud infrastructure and management products, expertise and ecosystem
support. VMware vCloud Suite 5.1 is our first solution to deliver a software
defined data center ("SDDC"). The SDDC architecture abstracts all hardware
resources and pools them into aggregate capacity, enabling automation to safely
and efficiently parcel it out as needed for applications. The SDDC delivers IT
services for cloud computing by extending and simplifying the benefits of
virtualization to every domain in the data center: compute, storage, networking,
and management functionality. We plan to continue to introduce additional
products in the future that expand and promote the use of the vSphere foundation
and the SDDC. In addition, we have made acquisitions that strengthen our product
offerings or extend our strategy to deliver broader virtualization solutions.
For example, in August 2012 we acquired Nicira, Inc. ("Nicira"), a developer of
software defined networking solutions, which expands our product portfolio to
provide a suite of software defined networking capabilities. Business
acquisitions are an important element of our strategy and we expect to continue
to consider additional strategic business acquisitions in the future.
Our current financial focus is on long-term revenue growth to generate free cash
flows to fund our expansion of industry segment share and to evolve our
virtualization-based products for data centers, end-user devices and cloud
computing through a combination of internal development and acquisitions. See
"Non-GAAP Financial Measures" for further information on free cash flows. In
evaluating our results, we also focus on operating margin excluding certain
expenses which are included in our total operating expenses calculated in
accordance with GAAP. The expenses excluded are stock-based compensation, the
net effect of the amortization and capitalization of software development costs
and certain other expenses consisting of employer payroll taxes on employee
stock transactions, amortization of intangible assets and acquisition-related
items. We believe this measure reflects our ongoing business in a manner that
allows meaningful period-to-period comparisons. We are not currently focused on
short-term operating margin expansion, but rather on investing at appropriate
rates to support our growth and future product offerings in what may be a
substantially more competitive environment.
Although our customers continue to adopt our product platform as a strategic
investment that improves efficiency and flexibility for their business and
enables substantial cost savings, we remain cautious about the macroeconomic
environment. The volatility we are observing in both the world economy and
individual sovereign nations may impact IT spending and demand for our products
and services for the remainder of 2012. We expect to continue to manage our
resources prudently, while making key investments in support of our long-term
growth objectives.
Income Statement Presentation
As we operate our business in one operating segment, our revenues and operating
expenses are presented and discussed at the consolidated level.
As a consequence of the timing differences in the recognition of license
revenues and software maintenance revenues, variability in operating margin can
result from differences between when we quote and contract for our services and
when the cost is incurred. Variability in operating margin can also result when
we recognize previously unearned foreign denominated software maintenance and
license revenues in future periods. Due to our use of the U.S. Dollar as our
functional currency, unearned revenue remains at its historical rate when
recognized into revenue while our operating expenses in future periods are based
upon the foreign exchange rates at that time.
Sources of Revenues
License revenues
Our license revenues consist of revenues earned from the licensing of our
software products. These products are generally licensed on a perpetual basis.
License revenues are recognized when the elements of revenue recognition for the
licensed software are complete, generally upon electronic shipment of the
software. The revenues allocated to the software license included in
multiple-element contracts represent the residual amount of the contract after
the fair value of the other elements has been determined. While some of our
products are licensed on a subscription basis, subscription license revenues are
not a material part of our business.
Pricing models have generally been based upon the physical infrastructure, such
as the number of physical desktop computers or server processors, on which our
software runs. We base pricing for some of our products on virtual, rather than
purely physical, entitlements, while continuing to license such products on a
perpetual basis. In 2011, we revised the pricing model for VMware vSphere 5 so
that while it continued to be licensed perpetually on a per-processor basis, the
two physical constraints, number of cores and physical RAM, had been eliminated.
These physical constraints were replaced with a single virtualization-based
entitlement of virtual memory, or vRAM, which could be shared across a large
pool of servers. In the third quarter of 2012, we revised the pricing model
again for VMware vSphere when sold on a perpetual basis, continuing to license
on a per-processor basis but with no core, vRAM or number of virtual machine
limits. The revised pricing model did not impact our revenue recognition
policies.
Software maintenance revenues
Software maintenance revenues are recognized ratably over the contract period.
Our contract periods typically range from one to five years and include renewals
of software maintenance sold after the initial software maintenance period
expires. Vendor-specific objective evidence ("VSOE") of fair value for software
maintenance services is established by the rates charged in stand-alone sales of
software maintenance contracts. Customers receive various types of technical
support based on the level of support purchased. Customers who are party to
software maintenance agreements with us are entitled to receive product updates
and upgrades on a when-and-if-available basis.
Professional services revenues
Professional services include solution design, implementation and training.
Professional services are not considered essential to the functionality of our
products, as these services do not alter the product capabilities and may be
performed by our customers or by other vendors. Professional services
engagements performed for a fixed fee, for which we are able to make reasonably
dependable estimates of progress toward completion, are recognized on a
proportional performance basis based on hours incurred and estimated hours of
completion. Professional services engagements that are on a time and materials
basis are recognized based on hours incurred. Revenues on all other professional
services engagements are recognized upon completion. Our professional services
may be sold with software products or on a stand-alone basis. VSOE of fair value
for professional services is based upon the standard rates we charge for such
services when sold separately.
Operating Expenses
Cost of license revenues
Our cost of license revenues principally consist of the amortization of
capitalized software development costs and of intangibles, as well as royalty
costs in connection with technology licensed from third-party providers and the
cost of fulfillment of our software. The cost of fulfillment of our software
includes product packaging, personnel costs and related overhead associated with
the physical and electronic delivery of our software products.
Cost of services revenues
Our cost of services revenues include the costs of personnel and related
overhead to deliver technical support for our products and to provide our
professional services.
Research and development expenses
Our research and development ("R&D") expenses include the personnel and related
overhead associated with the R&D of new product offerings and the enhancement of
our existing software offerings, net of any amounts capitalized.
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 and may be expensed in a period other than the period in which the
related revenue is recognized. Sales and marketing expenses also include the net
impact from the expenses incurred and fees generated by certain marketing
initiatives, including our annual VMworld conferences in the U.S. and Europe.
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 facilities, finance, human resources, IT infrastructure and
legal departments, as well as expenses related to corporate costs and
initiatives.
Results of Operations
Revenues
Our revenues in the third quarter and first nine months of 2012 and 2011 were as
follows:
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2012 2011 % Change 2012 2011 % Change
Revenues:
License $ 491.1 $ 443.6 11 % $ 1,490.3 $ 1,327.4 12 %
Services:
Software maintenance 550.6 426.8 29 1,562.0 1,176.9 33
Professional services 92.0 71.5 29 259.6 202.5 28
Total services 642.6 498.3 29 1,821.6 1,379.4 32
Total revenues $ 1,133.7 $ 941.9 20 $ 3,311.9 $ 2,706.8 22
Revenues:
United States $ 553.6 $ 443.4 25 % $ 1,589.2 $ 1,293.3 23 %
International 580.1 498.5 16 1,722.7 1,413.5 22
Total revenues $ 1,133.7 $ 941.9 20 $ 3,311.9 $ 2,706.8 22
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Total revenues increased by $191.8 or 20% to $1,133.7 in the third quarter of
2012 from $941.9 in the third quarter of 2011. Total revenues increased by
$605.1 or 22% to $3,311.9 in the first nine months of 2012 from $2,706.8 in the
first nine months of 2011.
In the third quarter and first nine months of 2012 we saw growth in license and
services revenues, and growth in the United States and internationally, as
compared with the third quarter and first nine months of 2011.
License Revenues
Software license revenues increased by $47.5 or 11% to $491.1 in the third
quarter of 2012 from $443.6 in the third quarter of 2011. Software license
revenues increased by $162.9 or 12% to $1,490.3 in the first nine months of 2012
from $1,327.4 in the first nine months of 2011. License revenues in the third
quarter and first nine months of 2012 increased as compared to the third quarter
and first nine months of 2011 due to continued demand for our product offerings.
In the third quarter of 2012, ELAs comprised 24% of total sales compared with
22% in the third quarter of 2011, and 25% in the first nine months of 2012
compared with 24% in the first nine months of 2011. We have promoted the
adoption of virtualization and built long-term relationships with our customers
through the adoption of ELAs. ELAs continue to be an important component of our
revenue growth and are offered both directly by us and through certain channel
partners. ELAs are a core element to our strategy to build long-term
relationships with customers as they commit to our virtualization infrastructure
software solutions in their data centers. ELAs provide a base from which to sell
additional products, such as our application platform products, our end-user
computing products and our cloud infrastructure and management products. Under
a typical ELA, a portion of the revenues is attributed to the license and
recognized immediately and the remainder is deferred and primarily recognized as
software maintenance revenues in future periods. In addition, the initial
maintenance period is typically longer for ELAs than for other types of license
sales.
Services Revenues
Services revenues increased by $144.3 or 29% to $642.6 in the third quarter of
2012 from $498.3 in the third quarter of 2011. Services revenues increased by
$442.2 or 32% to $1,821.6 in the first nine months of 2012 from $1,379.4 in the
first nine months of 2011. The increase in services revenues during the third
quarter and first nine months of 2012 was primarily attributable to growth in
our software maintenance revenues.
Software maintenance revenues increased by $123.9 or 29% to $550.6 in the third
quarter of 2012 from $426.8 in the third quarter of 2011. Software maintenance
revenues increased by $385.1 or 33% to $1,562.0 in the first nine months of 2012
from $1,176.9 in the first nine months of 2011. In the third quarter and first
nine months of 2012, software maintenance revenues benefited from strong
renewals, multi-year software maintenance contracts sold in previous periods,
and additional maintenance contracts sold in conjunction with new software
license sales. In the third quarter and first nine months of 2012, customers
bought, on average, more than 24 months of support and maintenance with each new
license purchased, which we believe illustrates our customers' commitment to
VMware as a core element of their data center architecture and hybrid cloud
strategy.
Professional services revenues increased by $20.4 or 29% to $92.0 in the third
quarter of 2012 from $71.5 in the third quarter of 2011. Professional services
revenues increased by $57.1 or 28% to $259.6 in the first nine months of 2012
from $202.5 in the first nine months of 2011. Professional services revenues
increased as growth in our license sales and installed-base 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 independently provide professional services to our customers, we do
not expect our professional services revenues to constitute an increasing
component of our revenue mix. As a result of this strategy, our professional
services revenue can vary based on the delivery channels used in any given
period as well as the timing of engagements.
Revenue Growth in Constant Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen and the
Australian Dollar in their respective regions. As a result, our total revenues
are affected by changes in the value of the U.S. Dollar against these
currencies. In order to provide a comparable framework for assessing how our
business performed excluding the effect of foreign currency fluctuations,
management analyzes year-over-year revenue growth on a constant currency basis.
Since we operate with the U.S. Dollar as our functional currency, unearned
revenues for orders booked in currencies other than the U.S. Dollar are
converted into U.S. Dollars at the exchange rate in effect for the month in
which each order is booked. We calculate constant currency on license revenues
recognized during the current period that were originally booked in currencies
other than U.S. Dollars by comparing the exchange rates used to recognize
revenue in the current period against the exchange rates used to recognize
revenue in the comparable period. For the third quarter of 2012, the
year-over-year growth in license revenues measured on a constant currency basis
was 14% compared with 11% as reported, and was 14% compared with 12% as reported
year-over-year for the first nine months of 2012. We do not calculate constant
currency on services revenues, which include software maintenance revenues and
professional services revenues.
Unearned Revenues
Our unearned revenues as of September 30, 2012, and December 31, 2011 were as
follows:
September 30, 2012 December 31, 2011
Unearned license revenues $ 366.1 $ 389.2
Unearned software maintenance revenues 2,415.3 2,133.5
Unearned professional services revenues 211.9 185.7
Total unearned revenues $ 2,993.3 $ 2,708.4
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The complexity of our unearned revenues has increased over time as a result of
acquisitions, an expanded product portfolio and a broader range of pricing and
packaging alternatives. As of September 30, 2012, total unearned revenues
increased by $284.9 or 11% to $2,993.3 from $2,708.4 at December 31, 2011. This
increase was primarily due to growth in unearned software maintenance revenues,
attributable to our growing base of maintenance contracts.
Unearned license revenues are recognized either ratably or upon the delivery of
existing products, future products or services. Future products include, in some
cases, emerging products that are offered as part of product promotions where
the
purchaser of an existing product is entitled to receive a promotional product at
no additional charge. We regularly offer product promotions as a strategy to
improve awareness of our emerging products. To the extent promotional products
have not been delivered and VSOE of fair value cannot be established, the
revenue for the entire order is deferred until such time as all product delivery
obligations have been fulfilled. Increasingly, unearned license revenue may also
be recognized ratably, which is generally due to a right to receive unspecified
future products or a lack of VSOE of fair value on the software maintenance
element of the arrangement. At September 30, 2012, the ratable component
represented over half of the total unearned license revenue balance. The amount
of total unearned license revenues may vary over periods due to the type and
level of promotions offered, as well as due to the portion of license contracts
sold with a ratable recognition element. Unearned software maintenance revenues
are attributable to our maintenance contracts and are recognized ratably over
terms from one to five years with a weighted-average remaining term at
September 30, 2012 of 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. We believe
our overall unearned revenue balance improves predictability of future revenues
and that it is a key indicator of the health and growth of our business.
Operating Expenses
Information about our operating expenses for the third quarter and first nine
months of 2012 and 2011 is as follows:
For the Three Months Ended September 30, 2012
Capitalized
Core Software Other Total
Operating Stock-Based Development Operating Operating
Expenses (1) Compensation Costs, net Expenses Expenses
Cost of license revenue $ 25.6 $ 0.6 $ 14.9 $ 19.2 $ 60.3
Cost of services revenue 110.1 7.8 - 1.1 119.0
Research and development 197.8 60.2 - 1.9 259.9
Sales and marketing 356.3 51.7 - 3.5 411.5
General and administrative 78.7 11.8 - 2.1 92.6
Total operating expenses $ 768.5 $ 132.1 $ 14.9 $ 27.8 $ 943.3
Operating income $ 190.3
Operating margin 16.8 %
For the Three Months Ended September 30, 2011
Capitalized
Core Software Other Total
Operating Stock-Based Development Operating Operating
Expenses (1) Compensation Costs, net Expenses Expenses
Cost of license revenue $ 18.5 $ 0.4 $ 14.4 $ 12.8 $ 46.1
Cost of services revenue 99.0 6.1 - 1.6 106.7
Research and development 170.9 46.7 (21.1 ) 3.2 199.7
Sales and marketing 302.6 24.8 - 4.2 331.6
General and administrative 65.4 10.4 - 1.2 77.0
Total operating expenses $ 656.4 $ 88.4 $ (6.7 ) $ 23.0 $ 761.1
Operating income $ 180.7
Operating margin 19.2 %
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For the Nine Months Ended September 30, 2012
Capitalized
Core Software Other Total
Operating Stock-Based Development Operating Operating
Expenses (1) Compensation Costs, net Expenses Expenses
Cost of license revenue $ 68.3 $ 1.5 $ 57.5 $ 46.3 $ 173.6
Cost of services revenue 331.0 20.7 - 4.2 355.9
Research and development 575.8 147.6 - 7.5 730.9
Sales and marketing 1,042.8 110.8 - 12.8 1,166.4
General and administrative 226.9 34.3 - 4.5 265.7
Total operating expenses $ 2,244.8 $ 314.9 $ 57.5 $ 75.3 $ 2,692.5
Operating income $ 619.4
Operating margin 18.7 %
For the Nine Months Ended September 30, 2011
Capitalized
Core Software Other Total
Operating Stock-Based Development Operating Operating
Expenses (1) Compensation Costs, net Expenses Expenses
Cost of license revenue $ 54.1 $ 1.2 $ 62.7 $ 33.0 $ 151.0
Cost of services revenue 281.8 17.4 - 4.9 304.1
Research and development 486.8 134.6 (74.0 ) 10.7 558.1
Sales and marketing 866.5 70.6 - 12.0 949.1
General and administrative 189.3 30.6 - 3.5 223.4
Total operating expenses $ 1,878.5 $ 254.4 $ (11.3 ) $ 64.1 $ 2,185.7
Operating income $ 521.1
Operating margin 19.3 %
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