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VMW > SEC Filings for VMW > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for VMWARE, INC.


7-Nov-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 product solutions are based upon three growth priorities, which include SDDC, hybrid cloud and End-User Computing. SDDC includes development and delivery of innovations in networking, security, storage and management as we continue to roll out and enhance the features of our vCloud Suite. VMware vCloud Suite and various Cloud Management solutions that are optimized to work with vSphere environments are designed to simplify and automate management of dynamic cloud infrastructures that enable enterprises to build, manage and automate their own private clouds. For the hybrid cloud, we have introduced a public cloud infrastructure as a service offering designed to be completely interoperable with our customers' VMware virtualized infrastructures. Currently, revenues for our hybrid cloud solution during the third quarter and first nine months of 2013 have not been significant. Our End-User Computing product group has solutions designed to enable a user-centric approach to personal computing, including, for example, the VMware Horizon Suite launched in the first quarter of 2013, that enable secure access to applications and data from a variety of devices and locations, and addresses the needs of IT departments by delivering existing end-user assets as a managed service. We have developed a multi-channel distribution model to expand our presence and reach various segments of the market. We derive a significant majority of our sales from our indirect sales channel, which includes distributors, resellers, system vendors and systems integrators. Sales to our channel partners often involve three tiers of distribution: a distributor, a reseller and an end-user customer. Our sales force works collaboratively with our channel partners to introduce them to end-user customer accounts and new sales opportunities. As we expand geographically, we expect to continue to add additional channel partners. We expect to grow our business by building long-term relationships with our customers, which includes selling our solutions through enterprise license agreements ("ELAs"). ELAs are comprehensive volume license offerings offered both directly by us and through certain channel partners that provide for multi-year maintenance and support. Under a typical ELA, a portion of the revenues is attributed to the license revenues and the remainder is primarily attributed to software maintenance revenues. In addition, the initial maintenance and support period is typically longer for ELAs than for other types of license sales. ELAs enable us to build long-term relationships with our customers as they commit to our virtual infrastructure solutions in their data centers. ELAs comprised 33% and 24% of our overall sales during the third quarters of 2013 and 2012, respectively, and 33% and 25% of our overall sales during the first nine months of 2013 and 2012, respectively, with the balance primarily represented by our non-ELA, or transactional business. In 2013, in addition to continuing to increase revenues through the adoption of ELAs, we are focused on driving additional transactional business. Realignment
In January 2013, we announced a realignment of our strategy to refocus our resources and investments in support of three growth priorities that focus on our core opportunities as a provider of virtualization technologies that simplify IT infrastructure: the software-defined data center, the hybrid cloud and end-user computing. The business realignment plan was substantially completed at the end of the second quarter of 2013. The realignment plan also included the disposition of certain business activities, which have also been substantially completed.
GoPivotal, Inc. ("Pivotal")
During the year, we transferred certain assets and liabilities to Pivotal in exchange for an ownership interest in Pivotal of approximately 28% as of September 30, 2013. In connection with this transaction, we transferred approximately 415 of our


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employees to Pivotal during the first nine months of 2013. Additionally, we also entered into an agreement with Pivotal pursuant to which we are acting as the selling agent of the products and services we contributed to Pivotal until at least December 31, 2013 in exchange for a customary agency fee. We have also agreed to provide various transition services to Pivotal until at least December 31, 2013, for which we are reimbursed for our costs.
Starting with the second quarter of 2013, substantially all revenues and costs associated with our contribution to Pivotal have been eliminated from our consolidated statements of income. While the contribution of these business lines to Pivotal has had a negative impact on our revenue growth rate compared to 2012, it had a positive impact on our 2013 operating margin due to the elimination of Pivotal related costs from our consolidated statements of income. Results of Operations
Our current financial focus is on long-term revenue growth to enable us to fund our expansion of industry segment share and to evolve our virtualization-based products for data centers, end-user devices and cloud computing through a combination of internal development and acquisitions. In evaluating our results, we also focus on our free cash flows and operating margin excluding certain expenses which are included in our total operating expenses calculated in accordance with accounting principles generally accepted in the United States ("GAAP"). The expenses excluded are stock-based compensation, amortization of acquired intangible assets, realignment charges and certain other expenses consisting of the net effect of amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items. We believe these measures reflect our ongoing business in a manner that allows meaningful period-to-period comparisons. We are not currently focused on short-term operating margin expansion, but rather on investing at appropriate rates to support our growth and priorities in what may be a substantially more competitive environment. See "Non-GAAP Financial Measures" for further information. Revenues
Our revenues in the third quarter and first nine months of 2013 and 2012 were as follows:

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

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

In the third quarter and first nine months of 2013, we achieved growth in license and services revenues, and growth in the United States and internationally, as compared with the third quarter and first nine months of 2012.
License Revenues
License revenues in the third quarter and first nine months of 2013 were up 15% and 6%, respectively, compared to the third quarter and first nine months of 2012. Our revenue growth rate for both periods was due to overall increased sales volumes, slightly offset by the disposition of certain business lines under our realignment plan and the contribution of certain business lines to Pivotal.
Excluding from both the 2013 and the 2012 periods the revenues related to Pivotal and all dispositions under our realignment plan, license revenues grew 17% and 8% in the third quarter and first nine months of 2013, respectively. See "Non-GAAP Financial Measures" for further information on license revenues excluding Pivotal and our 2013 dispositions.


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Services Revenues
In the third quarter and first nine months of 2013, software maintenance revenues benefited from strong renewals, multi-year software maintenance contracts sold in previous periods, and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers bought, on average, more than 24 months of support and maintenance with each new license purchased, which we believe illustrates our customers' commitment to VMware as a core element of their data center architecture and hybrid cloud strategy.
In the third quarter of 2013, professional services revenues decreased primarily due to the contribution of certain business lines to Pivotal and the disposition of certain business lines under our realignment plan. In the first nine months of 2013, professional services revenues increased primarily as a result of growth in our license sales and installed-base led to additional demand for our professional services.
Our revenue growth rate was negatively impacted by the contribution of certain business lines to Pivotal and the disposition of certain business lines under our realignment plan. Excluding from both the 2013 and the 2012 periods the revenues related to Pivotal and all dispositions under our realignment plan, including the business line we exited in the third quarter of 2013, services revenues grew 20% and 22% in the third quarter and first nine months of 2013, respectively. See "Non-GAAP Financial Measures" for further information on services revenues excluding Pivotal and our 2013 dispositions. Foreign Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen and the Australian Dollar in their respective regions. As a result, our total revenues are affected by changes in the value of the U.S. Dollar against these currencies. Foreign currencies did not have a material impact when comparing revenues during the third quarter and first nine months of 2013 to the same periods in the prior year.
Unearned Revenues
Our unearned revenues as of September 30, 2013 and December 31, 2012 were as follows:

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

Unearned license revenues are either recognized ratably, recognized upon delivery of existing or future products or services, or will be recognized ratably upon delivery of future products or services. The amount of total unearned license revenues may vary over periods due to the type and level of promotions offered, the portion of license contracts sold with a ratable recognition element, and when promotional products are delivered upon general availability.
Unearned software maintenance revenues are attributable to our maintenance contracts and are generally recognized ratably, typically over terms from one to five years with a weighted-average remaining term at September 30, 2013 of approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are recognized as the services are delivered.


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Operating Expenses
Information about our operating expenses for the third quarter and first nine
months of 2013 and 2012 is as follows:
                                                           For the Three Months Ended September 30, 2013
                               Core                                                                              Other          Total
                             Operating       Stock-Based          Intangible                                   Operating      Operating
                           Expenses (1)      Compensation        Amortization         Realignment Charges       Expenses       Expenses
Cost of license revenues   $        20     $            1     $              22     $                   -     $        8     $       51
Cost of services revenues          125                  7                     -                         -              -            132
Research and development           212                 52                     1                         -              1            266
Sales and marketing                410                 37                     1                         -              1            449
General and administrative          86                 16                     -                         -              1            103
Realignment charges                  -                  -                     -                         1              -              1
Total operating expenses   $       853     $          113     $              24     $                   1     $       11     $    1,002
Operating income                                                                                                             $      287
Operating margin                                                                                                                   22.4 %


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


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


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


____________________________


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

Core Operating Expenses
Core operating expenses is a non-GAAP financial measure that excludes stock-based compensation, amortization of acquired intangible assets, realignment charges, and certain other expenses from our total operating expenses calculated in accordance with GAAP. The other operating expenses excluded are the net effect of the amortization and capitalization of software development costs, employer payroll taxes on employee stock transactions and acquisition and other-related items. Our core operating expenses reflect our business in a manner that allows meaningful period-to-period comparisons. Our core operating expenses are reconciled to the most comparable GAAP measure, "total operating expenses," in the table above. See "Non-GAAP Financial Measures" for further information.
Core operating expenses increased by $84 or 11% in the third quarter of 2013 compared with the third quarter of 2012. Core operating expenses increased by $236 or 11% in the first nine months of 2013 compared with the first nine months of 2012. As quantified below, these increases were primarily due to increases in employee-related expenses, which include salaries and benefits, bonuses, commissions, and recruiting and training as well as an increase in marketing programs and contractor costs. The increase in core operating expenses in the third quarter and first nine months of 2013 compared with the same periods during 2012 was partially offset by a decrease in operating expenses related to Pivotal.
Cost of License Revenues
Our core operating expenses for cost of license revenues principally consist of the cost of fulfillment of our software and royalty costs in connection with technology licensed from third-party providers. The cost of fulfillment of our software includes IT development efforts, personnel costs, product packaging and related overhead associated with the physical and electronic delivery of our software products.
Core operating expenses for cost of license revenues decreased by $6 or 23% in the third quarter of 2013 compared with the third quarter of 2012, and by $9 or 13% in the first nine months of 2013 compared with the first nine months of 2012. The decreases were primarily due to a decrease of IT development costs of $3 and $7, respectively, as well as a decrease in royalty and licensing costs for technology licensed from third-party providers that is used in our products. Cost of Services Revenues
Our core operating expenses for cost of services revenues primarily include the costs of personnel and related overhead to deliver technical support for our products and to provide our professional services.
Core operating expenses for cost of services revenues increased by $15 or 14% in the third quarter of 2013 compared with the third quarter of 2012, and by $19 or 6% in the first nine months of 2013 compared with the first nine months of 2012. The increase was primarily due to $10 and $27, respectively, of employee-related expenses as well as an increase of $13 and $16, respectively, in costs we incur to provide technical support, IT development and professional services. These increases were generally proportional to the increases in services revenues for the same comparable periods. The increase was partially offset by a decrease of $10 and $22, respectively, of operating expenses related to Pivotal. Research and Development Expenses
Our core operating expenses for research and development ("R&D") expenses include the personnel and related overhead associated with the R&D of new product offerings and the enhancement of our existing software offerings.


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Core operating expenses for R&D increased by $14 or 7% in the third quarter of 2013 compared with the third quarter of 2012, and by $52 or 9% in the first nine months of 2013 compared with the first nine months of 2012. The increase in the third quarter and first nine months of 2013 compared with the third quarter and first nine months of 2012 was primarily due to growth in employee-related expenses of $16 and $60, respectively, which was primarily driven by incremental growth in headcount from strategic hiring. Additionally, contractor costs, IT development costs, and equipment and depreciation expenses also increased by $15 and $28 during the third quarter and first nine months of 2013, respectively, compared to the same periods in the prior year. The increases in expenses in the third quarter and first nine months of 2013 were partially offset by a decrease of $19 and $40, respectively, of research and development expenses related to Pivotal.
Sales and Marketing Expenses
Our core operating expenses for sales and marketing expenses include personnel costs, sales commissions and related overhead associated with the sale and marketing of our license and services offerings, as well as the cost of product launches. Sales commissions are generally earned and expensed when a firm order is received from the customer and may be expensed in a period other than the period in which the related revenue is recognized. Sales and marketing expenses also include the net impact from the expenses incurred and fees generated by certain marketing initiatives, including our annual VMworld and VMworld Europe conferences.
Core operating expenses for sales and marketing increased by $54 or 15% in the third quarter of 2013 compared with the third quarter of 2012, and by $151 or 14% in the first nine months of 2013 compared with the first nine months of 2012. The increase in the third quarter and first nine months of 2013 was primarily due to growth in employee-related expenses of $44 and $139, respectively, driven by incremental growth in headcount and by higher commission expense due to increased sales volumes. To a lesser extent, costs incurred for marketing programs, contractor costs and IT development costs of $23 and $32 also contributed to the increase of expense during the third quarter and first nine months of 2013, respectively, compared to the same periods in the prior year. The increases in expenses in the third quarter and first nine months of 2013 were partially offset by a decrease of $14 and $29, respectively, of sales and marketing expenses related to Pivotal. General and Administrative Expenses
Our core operating expenses for general and administrative expenses include personnel and related overhead costs to support the overall business. These expenses include the costs associated with our finance, human resources, IT infrastructure and legal, as well as expenses related to corporate costs and initiatives and facilities costs.
Core operating expenses for general and administrative increased by $7 or 9% in the third quarter of 2013 compared with the third quarter of 2012, and by $23 or 10% in the first nine months of 2013 compared with the first nine months of . . .

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