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VMW > SEC Filings for VMW > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for VMWARE, INC.


3-May-2013

Quarterly Report


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

All dollar amounts expressed as numbers in this MD&A (except share and per share amounts) are in millions.
Overview
We are the leader in virtualization infrastructure solutions utilized by organizations to help transform the way they build, deliver and consume information technology ("IT") resources. Our primary source of revenues is from the licensing and support of these solutions to organizations of all sizes and across numerous industries. The benefits of our solutions to our customers include substantially lower IT costs, cost-effective high availability across a wide range of applications and a more automated and resilient systems infrastructure capable of responding dynamically to variable business demands. We pioneered the development and application of virtualization technologies with x86 server-based computing, separating application software from the underlying hardware. Since then, we have introduced a broad and proven suite of virtualization technologies that address a range of complex IT problems that include cost and operational inefficiencies, facilitating access to cloud computing capacity, business continuity, and corporate end-user computing device management. In 2012, we articulated a vision for the software-defined data center ("SDDC"), where increasingly infrastructure is virtualized and delivered as a service, and the control of this data center is entirely automated by software. To further this vision, in the third quarter of 2012, we released the VMware vCloud Suite, which is the first integrated solution designed to meet the requirements of the SDDC by pooling industry-standard hardware and running compute, networking, storage and management functions in the data center as software-defined services.
Our solutions are based upon our core virtualization technology and are organized into two main product groups: Cloud Infrastructure and Management and End-User Computing. The Cloud Infrastructure and Management product group is based upon our flagship virtualization platform, VMware vSphere. VMware vSphere not only decouples the entire software environment from its underlying hardware infrastructure but also enables the aggregation of multiple servers, storage infrastructures and networks into shared pools of resources that can be delivered dynamically, securely and reliably to applications as needed. The Cloud Infrastructure and Management group also encompasses the VMware vCloud Suite and various Cloud Management solutions that are optimized to work with vSphere environments and are designed to simplify and automate management of dynamic cloud infrastructures that enable enterprises to build, manage and automate their own private clouds. Our End-User Computing product group has solutions designed to enable a user-centric approach to personal computing, including, for example, the VMware Horizon Suite launched in the first quarter of 2013, that enable secure access to applications and data from a variety of devices and locations, and addresses the needs of IT departments by delivering existing end-user assets as a managed service.
We have developed a multi-channel distribution model to expand our presence and reach various segments of the market. We derive a significant majority of our sales from our indirect sales channel, which includes distributors, resellers, system vendors and systems integrators. Sales to our channel partners often involve three tiers of distribution: a distributor, a reseller and an end-user customer. Our sales force works collaboratively with our channel partners to introduce them to end-user customer accounts and new sales opportunities. As we expand geographically, we expect to continue to add additional channel partners. We expect to grow our business by building long-term relationships with our customers through the adoption of enterprise license agreements ("ELAs"). ELAs are comprehensive volume license offerings offered both directly by us and through certain channel partners that provide for multi-year maintenance and support at discounted prices. Under a typical ELA, a portion of the revenues is attributed to the license revenues and the remainder is primarily attributed to software maintenance revenues. In addition, the initial maintenance period is typically longer for ELAs than for other types of license sales. ELAs enable us to build long-term relationships with our customers as they commit to our virtual infrastructure solutions in their data centers. ELAs also provide a base from which to sell additional products, such as our end-user computing products and our cloud infrastructure and management products. ELAs comprised 29% and 22% of our overall sales during the first quarters of 2013 and 2012, respectively, with the balance represented by our non-ELA, or transactional business. In 2013, in addition to continuing to increase revenues through the adoption of ELAs, we are focused on driving additional transactional business.
In January 2013, we announced a realignment of our strategy to refocus our resources and investments in support of three growth priorities that focus on our core opportunities as a provider of virtualization technologies that simplify IT infrastructure: the software-defined data center, the hybrid cloud and end-user computing. For the SDDC, we plan to continue to invest in the development and delivery of innovations in networking, security, storage and management as we continue to roll out and enhance the features of our vCloud Suite. For the hybrid cloud we plan to focus on expanding our capabilities with our partners to deliver enterprise-class cloud services that are complementary to private clouds in order to enhance our customers' flexibility to run applications on and off premise, as they choose on a compatible, high-quality, secure and resilient hybrid cloud platform.


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For end-user computing, we plan to enhance our offerings to enable a virtual workspace for both existing PC environments and emerging mobile devices in a secure enterprise environment.
In January 2013, we also approved a business realignment plan to streamline our operations and to enhance focus on our three growth priorities. The plan is expected to be completed by the end of 2013. The total charge resulting from this plan is expected to be between $75.0 and $90.0. The plan includes the elimination of approximately 800 positions and personnel across all major functional groups and geographies, which is expected to result in a charge in the range of $60.0 to $65.0, of which $53.9 was recorded in the first quarter of 2013. Additionally, we exited and are planning to exit certain lines of business and consolidate facilities, which are expected to result in a charge in the range of $15.0 to $25.0, of which $9.0 was recorded in the first quarter of 2013. Although we expect that streamlining our operations will have a favorable impact on our operating expenses in future quarters, we expect that operating expenses related to our headcount will increase as we expect our total headcount to increase by approximately 500 during 2013 as we continue to make key investments in support of our long-term growth objectives.
On April 1, 2013, we and EMC contributed certain assets to GoPivotal, Inc. ("Pivotal") and Pivotal assumed certain liabilities from us and EMC. We contributed substantially all assets to Pivotal, including intellectual property, and Pivotal assumed substantially all liabilities, related to certain of our Cloud Application Platform products and services, including our Cloud Foundry, VMware vFabric (including Spring and GemFire), and Cetas organizations. The net liability assumed by Pivotal was $15.0. We expect that approximately 500 of our employees will transfer to Pivotal during the second quarter of 2013. EMC contributed substantially all assets, including intellectual property, and Pivotal assumed substantially all liabilities, related to its Greenplum and Pivotal Labs businesses. Additionally, EMC made a capital contribution to Pivotal. Pivotal assumed substantially all of the rights and responsibilities for the respective support arrangements transferred by us and EMC. In exchange for our and EMC's contributions, we received preferred equity interests in Pivotal equal to approximately 31% of Pivotal's outstanding shares, and EMC received equity interests in Pivotal equal to approximately 69% of Pivotal's outstanding shares. We will account for our investment in Pivotal on a cost basis. Additionally, we and Pivotal entered into an agreement with Pivotal pursuant to which we will act as the selling agent of the products and services we contributed to Pivotal until at least December 31, 2013 in exchange for a customary agency fee. We have also agreed to provide various transition services to Pivotal until at least December 31, 2013, for which we will be reimbursed for our costs.
Starting with the second quarter of 2013, substantially all revenues and costs associated with our contribution to Pivotal will be eliminated from our consolidated statements of income. As a result, we expect this will have a negative impact on our 2013 revenue growth rate as we recognized approximately $125 of revenues during 2012 related to products and services we contributed to Pivotal, compared to only one quarter of revenues for these products and services in 2013. Although we expect that our revenue growth will be negatively impacted, we expect a positive impact on our 2013 operating margin due to the elimination of Pivotal related costs from our consolidated statements of income. On April 24, 2013, EMC and Pivotal announced that a third party strategic investor is expected to make an investment of approximately $105 in Pivotal. Upon closing of the third party investment, the interests of EMC, us and the third party will represent approximately 62%, 28% and 10%, respectively, of Pivotal's outstanding equity.
Results of Operations
As we operate our business in one operating segment, our revenues and operating expenses are presented and discussed at the consolidated level.
We classify our revenues into two categories, i.e. license revenues and services revenues.
Our current financial focus is on long-term revenue growth to enable us to fund our expansion of industry segment share and to evolve our virtualization-based products for data centers, end-user devices and cloud computing through a combination of internal development and acquisitions. In evaluating our results, we also focus on our free cash flows and operating margin excluding certain expenses which are included in our total operating expenses calculated in accordance with GAAP. The expenses excluded are stock-based compensation, amortization of acquired intangible assets, realignment charges and certain other expenses consisting of the net effect of amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items. We believe these measures reflect our ongoing business in a manner that allows meaningful period-to-period comparisons. We are not currently focused on short-term operating margin expansion, but rather on investing at appropriate rates to support our growth and priorities in what may be a substantially more competitive environment. See "Non-GAAP Financial Measures" for further information.


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Revenues
Our revenues in the first quarter of 2013 and 2012 were as follows:
                           For the Three Months Ended
                                    March 31,
                                2013                2012       $ Change      % Change
Revenues:
License               $        488.2             $   481.9    $      6.3         1 %
Services:
Software maintenance           605.4                 492.3         113.1        23
Professional services           97.9                  81.0          16.9        21
Total services                 703.3                 573.3         130.0        23
Total revenues        $      1,191.5             $ 1,055.2    $    136.3        13

Revenues:
United States         $        568.5             $   485.0    $     83.5        17 %
International                  623.0                 570.2          52.8         9
Total revenues        $      1,191.5             $ 1,055.2    $    136.3        13

In the first quarter of 2013, we achieved growth in license and services revenues, and growth in the United States and internationally, as compared with the first quarter of 2012.
License Revenues
License revenues in the first quarter of 2013 were up 1% compared to the first quarter of 2012. Our growth rate was lower than our historical growth rate due to a variety of factors, including challenges in the macroeconomic environment, both across the U.S. and internationally in Europe. Services Revenues
In the first quarter of 2013, software maintenance revenues benefited from strong renewals, multi-year software maintenance contracts sold in previous periods, and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers bought, on average, more than 24 months of support and maintenance with each new license purchased, which we believe illustrates our customers' commitment to VMware as a core element of their data center architecture and hybrid cloud strategy. In the first quarter of 2013, professional services revenues increased as growth in our license sales and installed-base led to additional demand for our professional services.
Revenue Growth in Constant Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen and the Australian Dollar in their respective regions. As a result, our total revenues are affected by changes in the value of the U.S. Dollar against these currencies. In order to provide a comparable framework for assessing how our business performed excluding the effect of foreign currency fluctuations, management analyzes year-over-year revenue growth on a constant currency basis. Since we operate with the U.S. Dollar as our functional currency, unearned revenues for orders booked in currencies other than the U.S. Dollar are converted into U.S. Dollars at the exchange rate in effect for the month in which each order is booked and remain at their historical rate when recognized into revenue. We calculate constant currency on license revenues recognized during the current period that were originally booked in currencies other than U.S. Dollars by comparing the exchange rates used to recognize revenue in the current period against the exchange rates used to recognize revenue in the comparable period. For the first quarter of 2013, the year-over-year growth in license revenues measured on a constant currency basis was 2% compared with 1% as reported. We do not calculate constant currency on services revenues, which include software maintenance revenues and professional services revenues.


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Unearned Revenues
Our unearned revenues as of March 31, 2013 and December 31, 2012 were as
follows:
                                         March 31,     December 31,
                                           2013            2012
Unearned license revenues               $    446.2    $        462.7
Unearned software maintenance revenues     2,796.5           2,755.0
Unearned professional services revenues      247.5             242.9
Total unearned revenues                 $  3,490.2    $      3,460.6

The complexity of our unearned revenues has increased over time as a result of acquisitions, an expanded product portfolio and a broader range of pricing and packaging alternatives. Unearned license revenues are either recognized ratably, recognized upon delivery of existing or future products or services, or will be recognized ratably upon delivery of future products or services. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive a promotional product at no additional charge. We regularly offer product promotions to improve awareness of our emerging products. To the extent promotional products have not been delivered and vendor-specific objective evidence ("VSOE") of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Increasingly, unearned license revenue may also be recognized ratably, which is generally due to a right to receive unspecified future products or a lack of VSOE of fair value on the software maintenance element of the arrangement. At March 31, 2013, the ratable component represented over half of the total unearned license revenue balance. The amount of total unearned license revenues may vary over periods due to the type and level of promotions offered, the portion of license contracts sold with a ratable recognition element, and when promotional products are delivered upon general availability. Unearned software maintenance revenues are attributable to our maintenance contracts and are recognized ratably, typically over terms from one to five years with a weighted-average remaining term at March 31, 2013 of approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are recognized as the services are delivered. We believe that our overall unearned revenue balance improves predictability of future revenues and that it is a key indicator of the health and growth of our business. As of March 31, 2013, 88% of our total unearned revenues are expected to be recognized ratably.
As of March 31, 2013, we reclassified $27.2 of unearned revenues to liabilities held for sale that are related to a line of business that we plan to exit. Liabilities held for sale are reported in accrued expenses and other on the consolidated balance sheet.
In the second quarter of 2013, we expect that approximately $100.0 included in our unearned revenues as of March 31, 2013 will be removed from our total unearned revenue balance. Of this amount, $71.2 will be attributable to the transfer of unearned revenues to Pivotal and the balance of approximately $30.0 will be attributable to the anticipated remaining disposals of businesses under our realignment plan.
Operating Expenses
Information about our operating expenses for the first quarter of 2013 and 2012 is as follows:

                                                          For the Three Months Ended March 31, 2013
                                Core                                                                       Other          Total
                              Operating        Stock-Based         Intangible         Realignment        Operating      Operating
                            Expenses (1)      Compensation        Amortization          Charges          Expenses       Expenses
Cost of license revenues   $        20.3     $         0.5     $           23.3     $            -     $      13.2     $    57.3
Cost of services revenues          116.2               7.3                  1.0                  -             0.1         124.6
Research and development           206.3              62.3                  1.0                  -             0.9         270.5
Sales and marketing                378.1              36.1                  2.6                  -             0.7         417.5
General and administrative          83.0              14.0                    -                  -             1.5          98.5
Realignment charges                    -                 -                    -               62.9               -          62.9
Total operating expenses   $       803.9     $       120.2     $           27.9     $         62.9     $      16.4     $ 1,031.3
Operating income                                                                                                       $   160.2
Operating margin                                                                                                            13.4 %


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                                                                 For the Three Months Ended March 31, 2012
                                   Core                                                                                 Other          Total
                                Operating           Stock-Based          Intangible                                   Operating      Operating
                               Expenses(1)          Compensation        Amortization        Realignment Charges       Expenses        Expenses
Cost of license revenues   $        21.2          $          0.4     $           13.3     $                   -     $      21.8     $     56.7
Cost of services revenues          106.8                     5.8                  1.1                         -             0.5          114.2
Research and development           180.3                    39.4                  0.8                         -             1.9          222.4
Sales and marketing                333.2                    25.2                  2.9                         -             2.1          363.4
General and administrative          70.0                    11.0                    -                         -             0.3           81.3
Total operating expenses   $       711.5          $         81.8     $           18.1     $                   -     $      26.6     $    838.0
Operating income                                                                                                                    $    217.2
Operating margin                                                                                                                          20.6 %


____________________________


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

Our operating margin on total operating expenses decreased to 13.4% in the first quarter of 2013 from 20.6% in the first quarter of 2012. The decrease in our operating margin in the first quarter of 2013 compared with the first quarter of 2012 primarily related to the year-over-year increase in realignment charges and stock-based compensation.
Core Operating Expenses
The following discussion of our core operating expenses and the components comprising our core operating expenses highlights the factors that we focus on when evaluating our operating margin and operating expenses. The increases or decreases in operating expenses discussed in this section do not include changes relating to stock-based compensation, amortization of acquired intangible assets, realignment charges, and certain other expenses, which consist of the net effect of the amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items.
Core operating expenses increased by $92.4 or 13% in the first quarter of 2013 compared with the first quarter of 2012. As quantified below, these increases were primarily due to increases in employee-related expenses, which include salaries and benefits, bonuses, commissions, and recruiting and training, which increased largely as a result of increases in headcount. Our headcount as of March 31, 2013 was approximately 13,000, compared with approximately 11,800 as of March 31, 2012. This increase in headcount was driven by strategic hiring, business growth and business acquisitions, but also includes the reduction of approximately 700 personnel in the first quarter of 2013 as the result of our realignment efforts. A portion of our core operating expenses, primarily the cost of personnel to deliver technical support on our products and professional services, marketing, and research and development, are denominated in foreign currencies and are thus exposed to foreign exchange rate fluctuations. Core operating expenses benefited by $2.1 in the first quarter of 2013 as compared with the first quarter of 2012 due to the effect of fluctuations in the exchange rates between the U.S. Dollar and other currencies. Cost of License Revenues
Our core operating expenses for cost of license revenues principally consist of the cost of fulfillment of our software and royalty costs in connection with technology licensed from third-party providers. The cost of fulfillment of our software includes IT development efforts, personnel costs, product packaging and related overhead associated with the physical and electronic delivery of our software products.
Core operating expenses for cost of license revenues decreased by $0.8 or 4% in the first quarter of 2013 compared with the first quarter of 2012. Cost of Services Revenues
Our core operating expenses for cost of services revenues primarily include the costs of personnel and related overhead to deliver technical support for our products and to provide our professional services.


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Core operating expenses for cost of services revenues increased by $9.4 or 9% in the first quarter of 2013 compared with the first quarter of 2012. The increase in the first quarter of 2013 was primarily due to growth in employee-related expenses of $9.5, which was largely driven by incremental growth in headcount to support increased revenues.
Research and Development Expenses
Our core operating expenses for research and development ("R&D") expenses include the personnel and related overhead associated with the R&D of new product offerings and the enhancement of our existing software offerings. Core operating expenses for R&D increased by $26.0 or 14% in the first quarter of 2013 compared with the first quarter of 2012. The increase was primarily due to growth in employee-related expenses of $19.5 in the first quarter of 2013, which was primarily driven by incremental growth in headcount from strategic hiring and business acquisitions. In the first quarter of 2013, contractor costs of $4.3 related to product development and security efforts further contributed to the year-over-year increase.
Sales and Marketing Expenses
Our core operating expenses for sales and marketing expenses include personnel costs, sales commissions and related overhead associated with the sale and marketing of our license and services offerings, as well as the cost of product launches. Sales commissions are generally earned and expensed when a firm order is received from the customer and may be expensed in a period other than the period in which the related revenue is recognized. Sales and marketing expenses also include the net impact from the expenses incurred and fees generated by certain marketing initiatives, including our annual VMworld conferences in the U.S. and Europe.
Core operating expenses for sales and marketing increased by $44.8 or 13% in the first quarter of 2013 compared with the first quarter of 2012. The increase in the first quarter of 2013 was primarily due to growth in employee-related . . .

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