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VMW > SEC Filings for VMW > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for VMWARE, INC.

Form 10-K for VMWARE, INC.


25-Feb-2014

Annual Report


ITEM 7. 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. Period-over-period changes are calculated based upon the respective underlying, non-rounded data. 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. We develop and market our product and service offerings within three main product groups, and we also seek to leverage synergies across these three product areas.
SDDC or Software-Defined Data Center

End-User Computing

Hybrid Cloud Computing

We pioneered the development and application of virtualization technologies with x86 server-based computing, separating application software from the underlying hardware. The benefits to our customers include lower IT costs and a more automated and resilient systems infrastructure capable of responding dynamically to variable business demands. Our broad and proven suite of virtualization technologies are designed to establish secure and, reliable IT environments and address a range of complex IT challenges that include cost reduction, operational inefficiencies, access to cloud computing capacity, business continuity and corporate end-user computing device management. Our solutions enable organizations to aggregate multiple servers, storage infrastructure and networks together into shared pools of capacity that can be allocated dynamically, securely and reliably to applications as needed. Once created, these internal computing infrastructures, or "clouds," can be dynamically extended by our customers to the public cloud environment. When linked, this results in a "hybrid" computing cloud of highly available internal and external computing resources that organizations can access on demand. Our customers' deployments range in size from a single virtualized server for small businesses to thousands of virtual machines for our Fortune 1000 enterprise customers. We have articulated a vision for the software-defined data center ("SDDC"), where increasingly infrastructure is virtualized and delivered as a service, enabling control of the data center to be entirely automated by software. The SDDC is designed to transform the data center into an on-demand service that addresses application requirements by abstracting, pooling, and automating the services that are required from the underlying hardware. SDDC promises to dramatically simplify data center operations and lower costs. The VMware vCloud Suite, which is our first integrated solution toward realizing the SDDC vision and is based upon our VMware vSphere virtualization platform, was initially introduced in late 2012. The VMware vCloud Suite addresses virtualization of not only CPU and memory, but also networks and associated security services. In addition, the vCloud Suite delivers a new approach to management, leveraging policy-based automation. VMware vCloud Suite is engineered for hybrid cloud computing so that it federates with other pools of infrastructure. We believe that our solutions enable organizations to realize significant operational and cost efficiencies as they transition their underlying legacy IT infrastructure. We work closely with more than 1,200 technology partners, including leading server, microprocessor, storage, networking, software and security vendors. We have shared the economic opportunities surrounding virtualization with our partners by facilitating solution development through open application programming interface ("APIs") formats and protocols and providing access to our source code and technology. The endorsement and support of our partners further enhances the awareness, reputation and adoption of our virtualization solutions.
We expect to grow our business by building long-term relationships with our customers, which includes continuing to sell 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 compared to our transactional business. We believe that ELAs facilitate our objective of building long-term relationships with our customers as they commit to our virtual infrastructure solutions in their data centers. ELAs comprised 35%, 27% and 26% of our overall sales in 2013, 2012 and 2011, respectively, with the balance primarily represented by our non-ELA, or transactional business. Pivotal Software, Inc. ("Pivotal", previously known as "GoPivotal, Inc.") During the year, we transferred certain assets and liabilities to Pivotal in exchange for an ownership interest in Pivotal of approximately 28% as of December 31, 2013. In connection with this transaction, we transferred approximately 415 of our employees to Pivotal during 2013. 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 in exchange for a customary agency fee. We have also agreed to provide various transition services to Pivotal, for which we are reimbursed for our costs.


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Beginning 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 to Pivotal has had a negative impact on our revenue growth rate compared to 2012, our 2013 operating margin has been positively impacted due to the elimination of Pivotal related costs from our consolidated statements of income. Results of Operations
Revenues
Our revenues in the years ended 2013, 2012 and 2011 were as follows:

                          For the Year Ended December 31,               2013 vs. 2012                   2012 vs. 2011
                          2013           2012         2011         $ Change        % Change        $ Change        % Change
Revenues:
License               $     2,270     $  2,087     $  1,841     $     183               9 %     $     246              13 %
Services:
Software maintenance        2,563        2,153        1,640           410              19             513              31
Professional services         374          365          286             9               2              80              28
Total services              2,937        2,518        1,926           419              17             592              31
Total revenues        $     5,207     $  4,605     $  3,767     $     602              13       $     838              22

Revenues:
United States         $     2,485     $  2,229     $  1,824     $     256              11 %     $     404              22 %
International               2,722        2,376        1,943           345              15             434              22
Total revenues        $     5,207     $  4,605     $  3,767     $     602              13       $     838              22

License Revenues
License revenues in 2013 and 2012 were up 9% and 13%, respectively. Our revenue growth rate for both periods was due to overall increased global sales volumes in all major geographies, slightly offset by the disposition of certain business lines under our realignment plan and the contribution to Pivotal.
During 2013, we expanded the sales of product suites, such as our vCloud suite, that integrate advanced management and automation features with our vSphere cloud infrastructure platform and which are primarily sold through ELAs. Our growth in ELA volume across all geographies contributed to our overall increase in license revenues during 2013 compared to 2012. The growth in our ELA business is also attributing, in part, to lower growth rates of our non-ELA or transactional business.
Our revenue growth rate was negatively impacted by the contribution to Pivotal and the disposition of other net assets under our realignment plan. License revenues related to Pivotal and all dispositions under our realignment plan were $18 in 2013 and $56 in 2012.
Services Revenues
In 2013 and 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 each year 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 2013 and 2012, professional services revenues increased as 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 to Pivotal and the disposition of other net assets under our realignment plan. Service revenues related to Pivotal and all dispositions under our realignment plan were $37 in 2013 and $143 in 2012.
Foreign Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen, the Australian Dollar and Chinese Renminbi 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 license revenues in 2013 and 2012 to their respective prior years.


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Unearned Revenues
Our unearned revenues as of December 31, 2013 and December 31, 2012 were as
follows:
                                           December 31,
                                          2013       2012
Unearned license revenues               $   465    $   463
Unearned software maintenance revenues    3,304      2,755
Unearned professional services revenues     323        243
Total unearned revenues                 $ 4,092    $ 3,461

Unearned license revenues are generally recognized upon delivery of existing or future products or services, or will be 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 a promotional product at no additional charge and 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. 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 December 31, 2013 of approximately 2.0 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered. Cost of License and Services Revenues, and Operating Expenses Cost of License Revenues
Our cost of license revenues principally consist of the cost of fulfillment of our software, royalty costs in connection with technology licensed from third-party providers and amortization of intangible assets and capitalized software. The cost of fulfillment of our software includes IT development efforts, personnel costs and related overhead associated with the physical and electronic delivery of our software products.

                               For the Year Ended December 31,                2013 vs. 2012                  2012 vs. 2011
                             2013            2012           2011         $ Change       % Change         $ Change        % Change
Cost of license revenues $     208       $     235       $     205     $      (27 )       (11 )%     $      29               14 %
Stock-based compensation         2               2               2              -           -                -                -
Total expenses           $     210       $     237       $     207     $      (27 )       (11 )      $      30               14
% of Total revenues              4 %             5 %             6 %

Cost of license revenues decreased in 2013 compared to 2012 primarily due to a decrease of $37 in amortization of capitalized software and a decrease of $11 in IT development costs. These decreases were partially offset by an increase of $18 in intangible amortization expense.
Cost of license revenues increased in 2012 compared to 2011 primarily due to an increase of $26 in intangible amortization expense. Additionally, cost of license revenues increased due to increases in IT development costs and royalty and licensing costs for technology licensed from third-party providers that is used in our products. The increases were partially offset by a decrease of $14 in amortization of capitalized software.


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Cost of Services Revenues
Our 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.
                                For the Year Ended December 31,                2013 vs. 2012                  2012 vs. 2011
                              2013            2012           2011         $ Change       % Change         $ Change        % Change
Cost of services revenues $     491       $     456       $     392     $       35           8 %      $      65               17 %
Stock-based compensation         29              28              23              1           4                5               21
Total expenses            $     520       $     484       $     415     $       36           7        $      70               17
% of Total revenues              10 %            11 %            11 %

Cost of services revenues increased in 2013 compared to 2012 primarily due to an increase of $39 in employee-related expenses and an increase of $27 in costs we incur to provide technical support. These increases were generally proportional to the increases in services revenues for the same comparable period. Equipment and depreciation costs also contributed to the increase in cost of services revenues. The increases were partially offset by a decrease of $32 of operating expenses related to Pivotal.
Cost of services revenues increased in 2012 compared to 2011 primarily due to an increase of $61 in employee-related expenses and travel and entertainment expenses as well as an increase of $17 in costs we incur to provide technical support. Stock-based compensation expense also contributed to the increase in cost of services revenues. These increases were partially offset by a decrease in IT development costs and the positive impact of foreign exchange rate fluctuations.
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.

                                For the Year Ended December 31,                 2013 vs. 2012                  2012 vs. 2011
                              2013              2012           2011        $ Change       % Change        $ Change        % Change
Research and development $        855       $     789       $    601     $       66           8 %      $     188              31 %
Stock-based compensation          227             210            174             17           8               36              21
Total expenses           $      1,082       $     999       $    775     $       82           8        $     224              29
% of Total revenues                21 %            22 %           21 %

R&D expenses increased in 2013 compared to 2012 primarily due to growth in employee-related expenses of $85, which was primarily driven by planned incremental growth in headcount. Additionally, contractor costs, stock-based compensation expense and equipment and depreciation expenses also increased by $48 during 2013 compared to the prior year. The increases in expenses were partially offset by a decrease of $59 of research and development expenses related to Pivotal.
R&D expenses increased in 2012 compared to 2011 primarily due to growth in employee-related expenses of $105, which were primarily driven by planned incremental growth in headcount from hiring and business acquisitions. A decrease of $74 in capitalization of software expenses and an increase of $36 in stock-based compensation expense further contributed to the increase in R&D. Additionally, the positive impact of foreign rate fluctuations partially offset the increases in 2012.


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Sales and Marketing Expenses
Our sales and marketing expenses include personnel costs, sales commissions and
related overhead associated with the sale and marketing of our license and
services offerings, as well as the cost of product launches. Sales commissions
are generally earned and expensed when a firm order is received from the
customer 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.
                              For the Year Ended December 31,                2013 vs. 2012                  2012 vs. 2011
                             2013             2012          2011        $ Change       % Change        $ Change        % Change
Sales and marketing      $    1,671       $    1,495     $  1,238     $     177           12  %     $     256              21 %
Stock-based compensation        144              150           96            (7 )         (5 )             54              57
Total expenses           $    1,815       $    1,645     $  1,334     $     170           10        $     311              23
% of Total revenues              35 %             36 %         35 %

Sales and marketing expenses increased in 2013 compared to 2012 primarily due to growth in employee-related expenses of $174, including, incremental growth in headcount and by higher commission expense due to increased sales volumes. To a lesser extent, costs incurred for marketing programs also contributed to the increase of expense in 2013, compared to prior year. The increases in expenses in 2013 were partially offset by a decrease of $44 of sales and marketing expenses related to Pivotal.
Sales and marketing expenses increased in 2012 compared to 2011 primarily due to growth in employee-related expenses of $214, including. incremental growth in headcount and by higher commission expense due to increased sales volumes, as well as an increase of $104 in stock-based compensation expense and costs of marketing programs. The increases in 2012 were partially offset by the positive impact of $29 from fluctuations in foreign exchange rates. General and Administrative Expenses
Our general and administrative expenses include personnel and related overhead costs to support the overall business. These expenses include the costs associated with our finance, human resources, IT infrastructure and legal, as well as expenses related to corporate costs and initiatives and facilities costs.

                           For the Year Ended December 31,                 2013 vs. 2012                    2012 vs. 2011
                         2013            2012           2011           $ Change        % Change         $ Change        % Change
General and
administrative       $     363       $     320       $     261     $      43               14 %     $      59               23 %
Stock-based
compensation                56              48              40             9               18               8               20
Total expenses       $     419       $     368       $     301     $      52               14       $      67               22
% of Total revenues          8 %             8 %             8 %

General and administrative expenses increased in 2013 compared to 2012 due to incremental growth in headcount resulting in an increase of $19. The increase in 2013 compared to the prior year was also due to an increase in charitable donations, stock-based compensation expense and contractor expenses. General and administrative expenses increased in 2012 compared to 2011 due to incremental growth in headcount resulting in an increase of $24. The increase in 2012 compared to the prior year was also due to an increase in charitable donations, equipment and depreciation expenses and contractor expenses. Realignment Charges
During January 2013, we approved and initiated a business realignment plan to streamline our operations resulting in realignment charges incurred in 2013. As of the second quarter of 2013, the plan was substantially complete. The plan included the elimination of approximately 710 positions and personnel across all major functional groups and geographies. The total cash and non-cash charges for workforce reductions of $54 and costs primarily associated with asset impairments of $14 were recorded on the consolidated statements of income in 2013.
Although we expect that streamlining our operations will have a favorable impact on our business, our operating expenses are expected to continue to increase as a result of the investments we are making to support our key strategic initiatives. These investments include our continued effort to add resources. Total headcount had a net increase of approximately 500 during 2013, which is net of the reduction of employees that have or will transfer to Pivotal, as well as the impact of our realignment activities.


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Other Income (Expense), Net
Other income, net of $28 in 2013 changed by $29 compared with other expense, net of $1 in 2012. Other expense, net of $1 in 2012 changed by $48 compared with other income, net of $47. The changes in 2013 compared with 2012 were primarily due to pre-tax gains of $44 recognized in 2013, as a result of disposing of certain business activities under our business realignment plan. Partially offsetting this gain was the recognition of an other-than-temporary impairment charge for a strategic investment in 2013. The changes in 2012 compared with 2011 were primarily due to a $56 gain recognized on the sale of our investment in Terremark Worldwide, Inc. in 2011.
Income Tax Provision
Our effective income tax rate was 11.6%, 16.5% and 8.9% for 2013, 2012 and 2011, respectively. The effective rate in 2013 was lower than 2012 primarily due to the retroactively enacted extension of the federal research credit through December 31, 2013 which was passed by the United States Congress during January 2013, which decreased our effective rate for 2013 by 7%. The effective tax rate in 2012 was higher than 2011 primarily due to the federal research credit, which expired at the end of 2011 and was unavailable in 2012. The rate was also negatively impacted by a greater proportion of earnings in the U.S., which are taxed at a higher rate than our earnings in foreign jurisdictions. Our rate of taxation in foreign jurisdictions is lower than the U.S. tax rate. Our international income is primarily earned by our subsidiaries in Ireland, where the statutory tax rate is 12.5%. Recent developments in non-US tax jurisdictions and unfavorable changes in non-US tax laws and regulations could have an adverse effect on our effective tax rate if earnings are lower than anticipated in countries where the statutory tax rates are lower than the US federal tax rate. All income earned abroad, except for previously taxed income for U.S. tax purposes, is considered indefinitely reinvested in our foreign operations and no provision for U.S. taxes has been provided with respect to such income.
We have been included in the EMC consolidated group for U.S. federal income tax purposes, and expect to continue to be included in such consolidated group for periods in which EMC owns at least 80% of the total voting power and value of our outstanding stock as calculated for U.S. federal income tax purposes. The percentage of voting power and value calculated for U.S. federal income tax purposes may differ from the percentage of outstanding shares beneficially owned by EMC due to the greater voting power of our Class B common stock as compared to our Class A common stock and other factors. Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Should EMC's ownership fall below 80% of the total voting power or value of our outstanding stock in any period, then we would no longer be included in the EMC consolidated group for U.S. federal income tax purposes, and thus we would no longer be liable in the event that any income tax liability was incurred, but not discharged, by any other member of the EMC consolidated group. Additionally, our U.S. federal income tax would be reported separately from that of the EMC consolidated group.
Although we file a consolidated federal tax return with EMC, the income tax provision is calculated primarily as though we were a separate taxpayer. However, certain transactions that we and EMC are parties to, are assessed using consolidated tax return rules. Our effective tax rate in the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The rate at which the provision for income taxes is calculated differs from the U.S. federal statutory income tax rate primarily due to different tax rates in foreign jurisdictions where income is earned and considered to be indefinitely reinvested.
Our future effective tax rate may be affected by such factors as changes in tax laws, changes in our business, regulations, or rates, changing interpretation of existing laws or regulations, the impact of accounting for stock-based compensation, the impact of accounting for business combinations, changes in our international organization, shifts in the amount of income before tax earned in the U.S. as compared with other regions in the world, and changes in overall levels of income before tax.
Our Relationship with EMC
As of December 31, 2013, EMC owned 43,025,000 shares of Class A common stock and all 300,000,000 shares of Class B common stock, representing 79.7% of our total outstanding shares of common stock and 97.2% of the combined voting power of our outstanding common stock. . . .

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