NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Overview and Basis of Presentation
Company and Background
VMware, Inc. (“VMware” or the “Company”) is a leader in virtualization and cloud infrastructure solutions that enable businesses to transform the way they build, deliver and consume information technology (“IT”) resources in a manner that is based on their specific needs. VMware’s virtualization infrastructure solutions, which include a suite of products and services designed to deliver a software-defined data center, run on industry-standard desktop computers, servers and mobile devices and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
Basis of Presentation
The consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for annual financial reporting.
VMware was incorporated as a Delaware corporation in 1998, was acquired by EMC Corporation (“EMC”) in 2004 and conducted its initial public offering of VMware’s Class A common stock in August 2007. Effective September
7, 2016, Dell Technologies Inc. (“Dell”) (formerly Denali Holding Inc.) acquired EMC, and majority control of VMware (the “Dell Acquisition”). As a result of the Dell Acquisition, EMC became a wholly-owned subsidiary of Dell and VMware became an indirectly-held, majority-owned subsidiary of Dell. As of
December 31, 2016
, Dell controlled
82.8%
of VMware’s outstanding common stock and
97.7%
of the combined voting power of VMware’s outstanding common stock, including
38 million
shares of VMware’s Class A common stock and all of VMware’s Class
B common stock.
Michael S. Dell was elected to the VMware Board of Directors as Chairman and Egon Durban was elected to the VMware Board. As VMware is a majority-owned and controlled subsidiary of Dell, its results of operations and financial position are consolidated with Dell’s financial statements. Pushdown accounting was not applied as a result of the Dell Acquisition and consequently no change in basis was reflected in VMware’s consolidated financial statements. Transactions prior to the effective date of the Dell Acquisition represent transactions only with EMC and its consolidated subsidiaries (“Parent”).
On October 25, 2016, the VMware Board of Directors approved a change to VMware’s fiscal year from a fiscal year ending on December 31 of each calendar year to a fiscal year consisting of a 52- or 53-week period ending on the Friday nearest to January 31 of each year. The change in VMware’s fiscal year was effective January 1, 2017. As a result of the change, the Company had a transition period that began on January 1, 2017 and ended on February 3, 2017, and VMware’s first full fiscal year under the revised fiscal calendar began on February 4, 2017 and will end on February 2, 2018. The Company plans to include its financial statements for the approximately one-month transition period in its Quarterly Report on Form
10‑Q filed for the fiscal quarter ended May
5, 2017.
Management believes the assumptions underlying the consolidated financial statements are reasonable. However, the amounts recorded for VMware’s intercompany transactions with Dell and its consolidated subsidiaries may not be considered arm’s length with an unrelated third party. Therefore, the financial statements included herein may not necessarily reflect the results of operations, financial position and cash flows had VMware engaged in such transactions with an unrelated third party during all periods presented. Accordingly, VMware’s historical financial information is not necessarily indicative of what the Company’s results of operations, financial position and cash flows will be in the future if and when VMware contracts at arm’s length with unrelated third parties for products and services the Company receives from and provides to Dell.
Principles of Consolidation
The consolidated financial statements include the accounts of VMware and subsidiaries in which VMware has a controlling financial interest. Non-controlling interests are presented as a separate component within total stockholders’ equity and represent the equity and cumulative pro-rata share of the results of operations attributable to the non-controlling interests. The portion of results of operations attributable to the non-controlling interests is eliminated in other income (expense), net on the consolidated statements of income and is not presented separately as the amount was not material for the periods presented. During 2016, VMware acquired all of the non-controlling interests previously presented as a separate component within total stockholders’ equity.
All intercompany transactions and account balances between VMware and its subsidiaries have been eliminated in consolidation. Transactions with Dell and its consolidated subsidiaries are generally settled in cash and are classified on the consolidated statements of cash flows based upon the nature of the underlying transaction.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Use of Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenue and expenses during the reporting periods, and the disclosure of contingent liabilities at the date of the financial statements. Estimates are used for, but not limited to, trade receivable valuation, marketing development funds and rebates, useful lives assigned to fixed assets and intangible assets, valuation of goodwill and definite-lived intangibles, income taxes, stock-based compensation, and contingencies. Actual results could differ from those estimates.
Revenue Recognition
VMware derives revenue primarily from licensing software under perpetual licenses, related software maintenance and support, training, consulting services and hosted services. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or service has been provided, the sales price is fixed or determinable and collectibility is probable.
License Revenue
VMware sells most of its license software through distributors, resellers, system vendors, systems integrators and through its direct sales force. VMware recognizes revenue from the sale of its software licenses upon shipment, provided all other revenue recognition criteria have been met. VMware also rents its software to customers using a pay-as-you-go consumption model. Revenue from this selling model is generally recognized based upon the customer's reported usage. When software license arrangements are offered with new products that become available on a when-and-if-available basis, revenue associated with these arrangements is recognized ratably over the subscription period.
For software sold by system vendors that is bundled with their hardware, unless VMware has a separate license agreement which governs the transaction, revenue is recognized in arrears upon the receipt of royalty reports.
Services Revenue
VMware’s services revenue generally consist of software maintenance and support, training, consulting services and hosted services. Software maintenance and support offerings entitle customers to receive major and minor product upgrades on a when-and-if-available basis and technical support. Revenue from software maintenance and support offerings is generally recognized ratably over the contract period.
Professional services include design, implementation and training. Professional services are not considered essential to the functionality of VMware’s products as these services do not alter the intended product capabilities and may be performed by customers or other vendors. Revenue from professional services engagements performed for a fixed fee, for which VMware is able to make reasonably dependable estimates of progress toward completion, is recognized on a proportional performance basis assuming all other revenue recognition criteria are met. Revenue from professional services engagements invoiced on a time and materials basis is recognized as the hours are incurred.
VMware’s hosted services consist of certain software offerings sold as a service without the customer’s ability to take possession of the software over the subscription term. These arrangements are offered to VMware’s customers over a specified period of time and revenue is recognized in both license and services revenue ratably over the subscription term commencing upon delivery of the service. Hosted services are also provided on a consumption basis with revenue recognized commensurate with customer’s usage of the related services.
Rebate Reserves and Marketing Development Funds
Rebates are offered to certain channel partners, which are recognized as a reduction to revenue or unearned revenue. Rebates based on actual partner sales are recognized as a reduction of revenue as the underlying revenue is recognized. Rebates earned based upon partner achievement of cumulative level of sales are recognized as a reduction of revenue proportionally for eligible sales required to achieve the target.
VMware participates in marketing development programs with certain channel partners wherein VMware reimburses its partners for certain direct costs incurred by the partners for marketing-related expenses or other services under the terms of the programs. Reimbursed costs to channel partners are recognized as a reduction of revenue based upon the maximum potential liability. The difference between the maximum potential liability recognized and the actual amount paid out has not been material to date.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Returns Reserves
With limited exceptions, VMware’s return policy does not allow product returns for a refund. VMware estimates and records reserves for product returns at the time of sale based on historical return rates. Amounts are recorded as a reduction of revenue or unearned revenue. Returns reserves were not material for all periods presented.
Multiple-Element Arrangements
VMware enters into multiple-element revenue arrangements in which a customer may purchase a combination of software, maintenance and support, training, consulting services and hosted services. For multiple-element arrangements with software elements, VMware allocates and defers revenue for the undelivered elements based on fair value using vendor-specific objective evidence (“VSOE”) and applies the residual method to allocate the remaining fee to the delivered products and services. If a product or service included in a software-related multiple-element arrangement has not been delivered, and is not considered essential to the functionality of the delivered products or services, VMware must determine the fair value of each undelivered product or service using VSOE. Absent VSOE, revenue is deferred until VSOE of fair value exists for each of the undelivered products or services, or until all elements of the arrangement have been delivered. However, if the only undelivered element without VSOE is maintenance and support, the entire arrangement fee is recognized ratably over the performance period.
VSOE of fair value for an undelivered element is generally based on historical stand-alone sales to third parties. In limited instances, for an offering that is not yet sold, VSOE is the price established by management if it is probable that the price will not change when introduced to the marketplace, including through the use of a contractually stated renewal rate. In determining VSOE of fair value, VMware requires that the selling prices for a product or service fall within a reasonable pricing range. VMware has established VSOE for its software maintenance and technical support services, consulting services and training.
For multiple-element arrangements that contain software and non-software elements, VMware allocates revenue to software or software-related elements as a group and any non-software elements separately based on relative selling prices using the selling price hierarchy. The relative selling price for each deliverable is determined using VSOE, if it exists, or third-party evidence (“TPE”) of selling price. TPE of selling price is based on evaluation of prices charged for competitor products or services sold to similarly situated customers. As VMware’s offerings contain significant proprietary technology and provide different features and functionality, comparable prices of similar products typically cannot be obtained and relied upon.
If neither VSOE nor TPE of selling price exists for a deliverable, VMware uses its best estimate of selling price (“BESP”) for that deliverable. The objective of BESP is to determine the price at which VMware would transact a sale if the product or service were sold on a stand-alone basis. VMware determines BESP by considering its overall pricing objectives and practices across different sales channels and geographies, market conditions, and historical sales. VMware uses BESP in the allocation of arrangement consideration for non-software elements. Once value is allocated to software or software-related elements as a group, revenue is then recognized when the relevant revenue recognition criteria are met.
A specified upgrade obligation is created in the event VMware publicly announces new specific features, functionalities or entitlements to software upgrades or license products that have not been made available. VMware generally does not have VSOE of fair value for specified upgrades or license products. Accordingly, revenue recognition is deferred for multiple-element arrangements that entitle a customer to specified upgrades or new license products until the product obligations have been fulfilled.
Unearned revenue substantially consists of payments received in advance of revenue recognition for products and services described above.
Foreign Currency Remeasurement
The U.S. dollar is the functional currency of VMware’s foreign subsidiaries. VMware records net gains and losses resulting from foreign exchange transactions as a component of foreign currency exchange gains and losses in other income (expense), net on the consolidated statements of income. These gains and losses are net of those recognized on foreign currency forward contracts (“forward contracts”) not designated as hedges that VMware enters into to partially mitigate its exposure to foreign currency fluctuations. Net losses were
$8 million
,
$11 million
and
$8 million
during the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Cash and Cash Equivalents, Short-Term Investments, and Restricted Cash
VMware invests primarily in money market funds, highly liquid debt instruments of the United States (“U.S.”) government and its agencies, municipal obligations, and U.S. and foreign corporate debt securities. All highly liquid investments with maturities of 90 days or less from date of purchase are classified as cash equivalents and all highly liquid investments with maturities of greater than 90 days from date of purchase as short-term investments. Short-term investments are classified as
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
available-for-sale securities. VMware may sell these securities at any time for use in current operations or for other purposes, such as consideration for acquisitions and strategic investments.
Fixed income investments are reported at fair value and unrealized gains and losses on these investments, net of taxes, are included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Realized gains or losses are included on the consolidated statements of income. Gains and losses on the sale of fixed income securities issued by the same issuer and of the same type are determined using the first-in first-out (“FIFO”) method. When a determination has been made that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is realized and is included on the consolidated statements of income.
Cash balances that are restricted pursuant to the terms of various agreements are classified as restricted cash and included in other current assets and other assets in the accompanying consolidated balance sheets. As of
December 31, 2016
and
2015
the total amount of VMware’s restricted cash was
$20 million
and
$19 million
, respectively.
As of
December 31, 2016
, VMware’s total cash, cash equivalents and short-term investments were
$7,985 million
, of which
$6,921 million
was held outside the United States.
Allowance for Doubtful Accounts
VMware maintains an allowance for doubtful accounts for estimated losses on uncollectible accounts receivable. The allowance for doubtful accounts considers such factors as creditworthiness of VMware’s customers, historical experience, the age of the receivable, and current economic conditions. The allowance for doubtful accounts was insignificant for all periods presented.
Property and Equipment, Net
Property and equipment, net is recorded at cost. Depreciation commences upon placing the asset in service and is recognized on a straight-line basis over the estimated useful life of the assets, as follows:
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|
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|
Buildings
|
|
Term of underlying land lease
|
Land improvements
|
|
15 years
|
Furniture and fixtures
|
|
7 years
|
Equipment
|
|
3 to 6 years
|
Software
|
|
3 to 8 years
|
Leasehold improvements
|
|
20 years, not to exceed the shorter of the estimated useful life or remaining lease term
|
Upon retirement or disposition, the asset cost and related accumulated depreciation are removed with any gain or loss recognized on the consolidated statements of income. Repair and maintenance costs that do not extend the economic life of the underlying assets are expensed as incurred.
Capitalized Software Development Costs
Costs associated with internal-use software systems, including those used to provide hosted services, during the application development stage are capitalized. Capitalization of costs begins when the preliminary project stage is completed, management has committed to funding the project, and it is probable that the project will be completed and the software will be used to perform the function intended. Capitalization ceases at the point when the project is substantially complete and is ready for its intended purpose. The capitalized amounts are included in property and equipment, net on the consolidated balance sheets.
Development costs of software to be sold, leased, or otherwise marketed are subject to capitalization beginning when technological feasibility for the product has been established and ending when the product is available for general release. During the years presented, software development costs incurred for products during the time period between reaching technological feasibility and general release were not material and accordingly were expensed as incurred.
Business Combinations
For business combinations, VMware recognizes the identifiable assets acquired, the liabilities assumed, and any non-controlling interests in an acquiree, which are measured based on the acquisition date fair value. Goodwill is measured as the excess of consideration transferred over the net amounts of the identifiable tangible and intangible assets acquired and the liabilities assumed at the acquisition date.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
VMware uses significant estimates and assumptions, including fair value estimates, to determine the fair value of assets acquired and liabilities assumed and the related useful lives of the acquired assets, when applicable, as of the acquisition date. When those estimates are provisional, VMware refines them as necessary during the measurement period. The measurement period is the period after the acquisition date, not to exceed one year, in which VMware may gather and analyze the necessary information about facts and circumstances that existed as of the acquisition date to adjust the provisional amounts recognized. Measurement period adjustments are recorded during the period in which the adjustment amount is determined. All other adjustments are recorded to the consolidated statements of income.
Businesses acquired from Dell are accounted for as a business combination between entities under common control. VMware includes the results of operations of the acquired businesses under common control, if significant, in the period of acquisition as if it had occurred at the beginning of the period and also retrospectively adjusts the financial statement information presented for prior years to reflect the business as if it had been acquired at the beginning of the financial period presented. VMware recognizes the net assets under common control at Dell’s carrying values as of the date of the transfer and records the difference between the carrying value and the cash consideration as an equity transaction.
Costs to effect an acquisition are recorded in general and administrative expenses on the consolidated statements of income as the expenses are incurred.
Purchased Intangible Assets and Goodwill
Goodwill is evaluated for impairment during the fourth quarter of each year or more frequently if events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. VMware elected to perform a quantitative assessment of goodwill with respect to its
one
reporting unit. In doing so, VMware compared the enterprise fair value to the carrying amount of the reporting unit, including goodwill. VMware concluded that, to date, there have been
no
impairments of goodwill.
Purchased intangible assets with finite lives are generally amortized over their estimated useful lives using the straight-line method. VMware reviews intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate.
Derivative Instruments and Hedging Activities
Derivative instruments are measured at fair value and reported as current assets and current liabilities on the consolidated balance sheets, as applicable.
In order to manage VMware’s exposure to foreign currency fluctuations, VMware enters into forward contracts to hedge a portion of VMware’s net outstanding monetary asset and liability positions. These forward contracts are generally entered into on a monthly basis, with a typical contractual term of
one
month. These forward contracts are not designated as hedging instruments under applicable accounting guidance and therefore are adjusted to fair value through other income (expense), net on the consolidated statements of income.
Additionally, VMware enters into forward contracts which it designates as cash flow hedges to manage the volatility of cash flows that relate to operating expenses denominated in certain foreign currencies. These forward contracts are entered into annually, have maturities of
twelve months
or less, and are adjusted to fair value through accumulated other comprehensive income (loss), net of tax, on the consolidated balance sheets. When the underlying expense transaction occurs, the gains or losses on the forward contract are subsequently reclassified from accumulated other comprehensive income to the related operating expense line item on the consolidated statements of income.
The Company does not, and does not intend to, use derivative financial instruments for trading or speculative purposes.
Advertising
Advertising costs are expensed as incurred. Advertising expense was
$21 million
,
$22 million
and
$29 million
in the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Income Taxes
Income taxes as presented herein are calculated on a separate tax return basis, although VMware is included in the consolidated tax return of Dell. However, certain transactions that VMware and Dell are parties to are assessed using consolidated tax return rules. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year in which the differences are expected to reverse. Tax credits are generally recognized as reductions of income tax
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
provisions in the year in which the credits arise. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
VMware does not provide for a U.S. income tax liability on undistributed earnings of VMware’s non-U.S. subsidiaries. The earnings of non-U.S. subsidiaries, which reflect full provision for non-U.S. income taxes, are currently indefinitely reinvested in foreign operations or will be remitted substantially free of additional tax. If these overseas funds are needed for its operations in the United States, VMware would be required to accrue and pay U.S. taxes on substantially all undistributed earnings to repatriate these funds. However, VMware’s intent is to indefinitely reinvest its non-U.S. earnings in its foreign operations and VMware’s current plans do not demonstrate a need to repatriate them to fund its U.S. operations. At this time, it is not practicable to estimate the amount of tax that may be payable if VMware were to repatriate these funds.
The difference between the income taxes payable or receivable that is calculated on a separate return basis and the amount actually paid to or received from Dell pursuant to VMware’s tax sharing agreement is presented as a component of additional paid-in capital. Refer to Note M for further information.
Net Income Per Share
Basic net income per share is calculated using the weighted-average number of shares of VMware’s common stock outstanding during the period. Diluted net income per share is calculated using the weighted-average number of common shares, including the dilutive effect of equity awards as determined under the treasury stock method. VMware has two classes of common stock, Class A and Class B common stock. For purposes of calculating net income per share, VMware uses the two-class method. As both classes share the same rights in dividends, basic and diluted net income per share are the same for both classes.
Concentrations of Risks
Financial instruments, which potentially subject VMware to concentrations of credit risk, consist principally of cash and cash equivalents, short-term investments and accounts receivable. Cash on deposit with banks may exceed the amount of insurance provided on such deposits. These deposits may be redeemed upon demand. VMware places cash and cash equivalents and short-term investments primarily in money market funds and fixed income securities and limits the amount of investment with any single issuer and any single financial institution. VMware holds a diversified portfolio of money market funds and fixed income securities, which primarily consist of various highly liquid debt instruments of the U.S. government and its agencies, municipal obligations, and U.S. and foreign corporate debt securities. VMware’s fixed income investment portfolio is denominated in U.S. dollars and consists of securities with various maturities.
VMware manages counterparty risk through adequate diversification of the investment portfolio among various financial institutions and by entering into derivative contracts with financial institutions that are of high credit quality.
VMware provides credit to its customers, including distributors, original equipment manufacturers (“OEMs”), resellers, and end-user customers, in the normal course of business. To reduce credit risk, the Company performs periodic credit evaluations, which consider the customer’s payment history and financial stability.
As of
December 31, 2016
and
2015
, one distributor accounted for
19%
and
18%
, respectively, of VMware's accounts receivable balance, and another distributor accounted for
13%
and
15%
, respectively, of VMware's accounts receivable balance. A third distributor accounted for
13%
and
11%
of VMware's accounts receivable balance as of
December 31, 2016
and
2015
.
One distributor accounted for
15%
of revenue in each of the years ended
December 31, 2016
,
2015
and
2014
, and another distributor accounted for
12%
,
12%
and
13%
of revenue in the years ended
December 31, 2016
,
2015
and
2014
, respectively. A third distributor accounted for
10%
,
11%
and
11%
of revenue in the years ended
December 31, 2016
,
2015
and
2014
.
Accounting for Stock-Based Compensation
VMware restricted stock, including performance stock unit (“PSU”) awards, are valued based on the Company’s stock price on the date of grant. For those awards expected to vest which only contain a service vesting feature, compensation cost is recognized on a straight-line basis over the awards’ requisite service periods.
PSU awards will vest if certain VMware-designated performance targets are achieved. If minimum performance thresholds are achieved, each PSU award will convert into VMware’s Class A common stock at a defined ratio depending on the degree of achievement of the performance target designated by each individual award. If minimum performance thresholds are not achieved, then no shares will be issued. Based upon the expected levels of achievement, stock-based compensation is recognized on a straight-line basis over the PSUs’ requisite service periods. The expected levels of achievement are reassessed over the requisite service periods and, to the extent that the expected levels of achievement change, stock-based compensation
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
is adjusted and recorded on the statements of income and the remaining unrecognized stock-based compensation is recognized over the remaining requisite service period.
The Black-Scholes option-pricing model is used to determine the fair value of VMware’s stock option awards and Employee Stock Purchase Plan (the “ESPP”) shares. The Black-Scholes model includes assumptions regarding dividend yields, expected volatility, expected term and risk-free interest rates. These assumptions reflect the Company’s best estimates, but these items involve uncertainties based on market and other conditions outside of the Company’s control.
New Accounting Pronouncements
Topic 606, Revenue from Contracts with Customers
During May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). In 2016, the FASB issued ASU 2016-08, ASU 2016-10 and ASU 2016-12, which provide interpretive clarifications on the new guidance in Topic 606 (collectively, “Topic 606”). The updated revenue standard replaces all existing revenue recognition guidance under GAAP and establishes common principles for recognizing revenue for all industries. It also provides guidance on the accounting for costs to fulfill or obtain a customer contract. The core principle underlying the updated standard is the recognition of revenue based on consideration expected to be entitled from the transfer of goods or services to a customer. The updated standard is effective for interim and annual periods beginning after December 15, 2017 and permits the use of either the full retrospective or cumulative effect transition method. Early adoption is permitted for annual periods beginning after December 15, 2016.
VMware plans to adopt Topic 606 using the full retrospective transition method when it becomes effective for the Company in the first fiscal quarter of 2019, under the Company’s new fiscal calendar. While the Company is continuing to assess the potential impacts of Topic 606, VMware currently expects unearned license revenue related to the sale of perpetual licenses will decline significantly upon adoption. Currently, VMware defers all license revenue related to the sale of its perpetual licenses in the event certain revenue recognition criteria are not met. However, under Topic 606 the Company would generally expect that substantially all license revenue related to sale of its perpetual licenses will be recognized upon delivery. The Company is continuing to evaluate the effect that Topic 606 will have on its financial statements and related disclosures, and preliminary assessments are subject to change.
ASU No. 2016-02, Leases
During February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires a lessee to recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The updated standard also requires additional disclosure regarding leasing arrangements. It is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption, with early adoption permitted. The Company is currently evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures, and expects that most of its lease commitments will be subject to the updated standard and recognized as lease liabilities and right-of-use assets upon adoption.
ASU No. 2016-09, Compensation
During March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718), which impacts the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statements of cash flows. The updated standard is effective for interim and annual periods beginning after December 15, 2016 and permits early adoption in any interim or annual period. VMware adopted the updated standard effective February 4, 2017. The updated standard is expected to cause volatility in VMware’s effective tax rates and net income per share due to the treatment of the tax effects on exercised or vested stock-based awards recorded to the consolidated statements of income. The volatility in future periods will depend on VMware’s stock price at the awards’ vest dates or exercise dates and the number of awards that vest or exercise in each period. In addition, all tax-related cash flows resulting from share-based payments are required to be reported as operating activities in the consolidated statement of cash flows. As permitted under the updated standard, VMware will continue to estimate forfeitures at each period and did not elect an accounting policy change to record forfeitures as they occur.
ASU No. 2016-16, Income Taxes
During October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which requires entities to recognize at the transaction date the income tax consequences of intra-entity asset transfers. Previous guidance requires the tax effects from intra-entity asset transfers to be deferred until that asset is sold to a third party or recovered through use. The updated standard is effective in annual and interim periods beginning after December 15, 2017, with early adoption permitted during the first interim period of a fiscal year, and requires a modified
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
retrospective transition method. The Company is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.
B. Related Parties
The information provided below includes a summary of the transactions entered into with Dell and Dell’s consolidated subsidiaries including EMC (collectively, “Dell”) from the effective date of the Dell Acquisition through December 31, 2016. Transactions prior to the effective date of the Dell Acquisition represent transactions only with EMC and its consolidated subsidiaries.
During the fourth quarter of 2014, Dell acquired the controlling interest in VCE Company LLC (“VCE”). Transactions with VCE from the acquisition date have been included in the tables below.
Transactions with Dell
VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in revenue and receipts and unearned revenue for VMware:
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•
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Pursuant to ongoing reseller arrangements with Dell, Dell bundles VMware’s products and services with Dell’s products and sells them to end users. Reseller revenue is presented net of related marketing development funds and rebates paid to Dell.
|
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|
•
|
Dell purchases products and services from VMware for internal use.
|
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|
•
|
VMware provides professional services to end users based upon contractual agreements with Dell.
|
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|
•
|
Pursuant to an ongoing distribution agreement, VMware acts as the selling agent for certain products and services of Pivotal Software, Inc. (“Pivotal”), a subsidiary of Dell, in exchange for an agency fee. Under this agreement, cash is collected from the end user by VMware and remitted to Pivotal, net of the contractual agency fee.
|
|
|
•
|
VMware provides various services to Pivotal. Support costs incurred by VMware are reimbursed to VMware and are recorded as a reduction to the costs incurred by VMware.
|
Information about VMware’s revenue and receipts from such arrangements during the
years ended
December 31, 2016
,
2015
and
2014
and unearned revenue from such arrangements at
December 31, 2016
and
2015
consisted of the following (table in millions):
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|
|
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|
|
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Revenue and Receipts
|
|
Unearned Revenue
|
|
For the Year Ended December 31,
|
|
As of December 31,
|
|
2016
|
|
2015
|
|
2014
|
|
2016
|
|
2015
|
Reseller revenue
|
$
|
508
|
|
|
$
|
301
|
|
|
$
|
205
|
|
|
$
|
637
|
|
|
$
|
292
|
|
Internal-use revenue
|
35
|
|
|
17
|
|
|
21
|
|
|
15
|
|
|
11
|
|
Professional services revenue
|
115
|
|
|
100
|
|
|
85
|
|
|
—
|
|
|
3
|
|
Agency fee revenue
|
4
|
|
|
6
|
|
|
5
|
|
|
—
|
|
|
—
|
|
Reimbursement for services to Pivotal
|
1
|
|
|
4
|
|
|
2
|
|
|
n/a
|
|
|
n/a
|
|
VMware and Dell engaged in the following ongoing intercompany transactions, which resulted in costs to VMware:
|
|
•
|
VMware purchases and leases products and purchases services from Dell.
|
|
|
•
|
From time to time, VMware and Dell enter into agreements to collaborate on technology projects, and VMware pays Dell for services provided to VMware by Dell related to such projects.
|
|
|
•
|
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with Dell subsidiaries for support services and Dell personnel who are managed by VMware. The costs incurred by Dell on VMware’s behalf related to these employees are charged to VMware with a mark-up intended to approximate costs that would have been incurred had VMware contracted for such services with an unrelated third party. These costs are included as expenses on VMware’s consolidated statements of income and primarily include salaries, benefits, travel and rent expenses. Dell also incurs certain administrative costs on VMware’s behalf in the United States that are recorded as expenses on VMware’s consolidated statements of income.
|
|
|
•
|
From time to time, VMware invoices end users on behalf of Dell for certain services rendered by Dell. Cash related to these services is collected from the end user by VMware and remitted to Dell.
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Information about VMware’s costs from such arrangements for the
years ended
December 31, 2016
,
2015
and
2014
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Purchases and leases of products and purchases of services
|
$
|
97
|
|
|
$
|
63
|
|
|
$
|
71
|
|
Collaborative technology project costs
|
—
|
|
|
5
|
|
|
12
|
|
Dell subsidiary support and administrative costs
|
105
|
|
|
100
|
|
|
137
|
|
VMware also purchases Dell products through Dell’s channel partners. Purchases of Dell products through Dell’s channel partners were not significant during the year ended
December 31, 2016
. During the
years ended
December 31, 2015
and
2014
, purchases of Dell products through Dell’s channel partners were
$36 million
and
$25 million
, respectively.
Dell Financial Services (“DFS”)
During 2016, DFS provided financing to certain of VMware’s end customers based on the customer’s discretion. Upon acceptance of the financing arrangement by both VMware’s end customer and DFS, amounts classified as trade accounts receivable are reclassified to due from related parties, net on the consolidated balance sheets. Financing fees recognized on these arrangements were not significant during the year-ended
December 31, 2016
.
EMC Equity Awards Held by VMware Employees
In connection with the Dell Acquisition, vesting was accelerated for all outstanding EMC stock options and restricted stock units and stock options were automatically exercised on the last trading day prior to the effective date of the merger. VMware’s portion of the expense associated with accelerated EMC equity awards held by VMware employees was
$7 million
and was included within stock-based compensation expense on the consolidated statements of income during the year ended
December 31, 2016
.
Due To/From Related Parties, Net
Amounts due to and from related parties, net as of
December 31, 2016
and
2015
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Due (to) related parties
|
$
|
(71
|
)
|
|
$
|
(68
|
)
|
Due from related parties
|
203
|
|
|
142
|
|
Due (to) from related parties, net
|
$
|
132
|
|
|
$
|
74
|
|
Amounts included in due from related parties, net, which are unrelated to DFS and tax obligations, are generally settled in cash within
60 days
of each quarter-end.
Stock Purchase Agreement with Dell
On December 15, 2016, VMware entered into a stock purchase agreement with Dell to purchase
$500 million
of VMware Class A common stock. Through December 31, 2016, VMware had purchased
4.8 million
shares for
$375 million
. A derivative asset was recognized related to VMware’s obligation to purchase additional shares for
$125 million
and is measured at fair value on a recurring basis. The fair value adjustment measured as of December 31, 2016 resulted in the recognition of an
$8 million
gain that was included in other income (expense), net on the consolidated statements of income.
On February 15, 2017, the stock purchase agreement with Dell was completed. A total of
$500 million
was paid in exchange for
6.2 million
shares. The aggregate number of shares purchased was determined based upon the volume-weighted average price during a defined period, less an agreed upon discount.
Notes Payable to Dell
VMware entered into a note exchange agreement with its Parent on January 21, 2014 providing for the issuance of
three
promissory notes in the aggregate principal amount of
$1,500 million
. The total debt of
$1,500 million
includes
$450 million
that was exchanged for the
$450 million
promissory note issued to VMware’s Parent in April 2007, as amended and restated in June 2011.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The three notes issued may be prepaid without penalty or premium, and outstanding principal is due on the following dates:
$680 million
due
May 1, 2018
,
$550 million
due
May 1, 2020
and
$270 million
due
December 1, 2022
. The notes bear interest, payable quarterly in arrears, at the annual rate of
1.75%
. During the
years ended
December 31, 2016
,
2015
and
2014
,
$26 million
,
$26 million
and
$24 million
, respectively, of interest expense was recognized.
Pivotal
In April 2016, VMware contributed
$20 million
in cash to Pivotal in exchange for additional preferred equity interests in Pivotal. As of December 31, 2016, VMware’s ownership interest in Pivotal was
21%
. As of December 31, 2015, VMware’s ownership interest in Pivotal was
28%
. This strategic investment is accounted for using the cost method.
C. Business Combinations, Definite-Lived Intangible Assets, Net and Goodwill
Business Combination
2016
Acquisition of Arkin Net, Inc.
On June 21, 2016, VMware acquired all of the outstanding shares of Arkin Net, Inc. (“Arkin”) for approximately
$67 million
of cash, net of liabilities assumed. VMware acquired Arkin, a provider of software-defined data center security and operations, as part of a strategy to accelerate customers’ adoption of VMware NSX and software-defined data centers. The pro forma financial information assuming the acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition, as well as the revenue and earnings generated during the current year, were not significant for disclosure purposes.
The following table summarizes the preliminary allocation of the consideration to the fair value of the assets acquired and liabilities assumed (table in millions):
|
|
|
|
|
Intangible assets
|
$
|
25
|
|
Goodwill
|
39
|
|
Other acquired assets
|
12
|
|
Total assets acquired
|
76
|
|
Deferred tax liabilities
|
(9
|
)
|
Fair value of assets acquired and liabilities assumed
|
$
|
67
|
|
The identifiable intangible assets acquired were primarily related to purchased technology with estimated useful lives of
four to five years
. Goodwill is
not
expected to be deductible for U.S. income tax purposes.
Prior to the closing of the acquisition on June 21, 2016, EMC owned approximately
16%
of the outstanding shares of Arkin. As a result of the acquisition, cash paid to EMC was approximately
$13 million
.
Other 2016 Business Combination
In December 2016, VMware completed
one
asset acquisition in addition to Arkin, in which VMware acquired certain intangible assets classified as completed technology for
$15 million
.
2015
During the year ended December 31, 2015, VMware completed
two
business combinations, which were not significant to VMware's consolidated financial statements, either individually or in the aggregate. On October 15, 2015, VMware acquired all of the outstanding shares of Boxer, Inc. (“Boxer”) to enhance the enterprise mobile management and security solutions. On February 2, 2015, VMware acquired all of the outstanding shares of Immidio B.V. (“Immidio”) to expand VMware’s workspace environment management solutions within the End-User Computing product group. The aggregate purchase price for these
two
acquisitions was
$39 million
of cash, net of liabilities assumed. The purchase price primarily included
$13 million
of identifiable intangible assets and
$29 million
of goodwill that is non-deductible for tax purposes.
2014
Acquisition of AirWatch LLC
On February 24, 2014, VMware acquired for cash all of the outstanding membership units of A.W.S. Holding, LLC (“AirWatch Holding”), the sole member and equity holder of AirWatch LLC (“AirWatch”). AirWatch is a leader in enterprise mobile management and security solutions. VMware acquired AirWatch to expand VMware’s solutions within the enterprise
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
mobile management and security space. The total purchase price of
$1,128 million
included cash of
$1,104 million
and the fair value of assumed unvested equity attributed to pre-combination services totaling
$24 million
. The purchase price included
$868 million
of goodwill and
$250 million
of identified intangible assets, with useful lives ranging from
two
to
eight
years. The majority of the goodwill and intangible assets is deductible for U.S. income tax purposes.
Merger consideration totaling
$300 million
, including
$75 million
that was held in escrow, was payable to certain employees of AirWatch subject to specified future employment conditions and was recognized as expense over the requisite service period on a straight-line basis. Compensation expense of
$14 million
,
$145 million
and
$141 million
was recognized during the
years ended
December 31, 2016
,
2015
and
2014
respectively.
VMware assumed all of AirWatch’s unvested stock options and restricted stock outstanding at the completion of the acquisition with an estimated fair value of
$134 million
. Of the total fair value,
$24 million
was allocated to the purchase price and
$110 million
was allocated to future services and is being expensed over the remaining requisite service periods on a straight-line basis.
The following pro forma financial information summarizes the combined net income for VMware and AirWatch, which was significant for purposes of the unaudited pro forma financial information disclosure, as though the companies were combined at the beginning of 2013. The amount of revenue from AirWatch was not considered significant, and as such, has not been separately presented in the unaudited pro forma financial information disclosure below.
Supplemental information on an unaudited pro forma basis as if AirWatch had been acquired on January 1, 2013 is presented as follows (table in millions):
|
|
|
|
|
|
For the Year Ended
December 31, 2014
|
Pro forma adjusted net income
|
$
|
849
|
|
Pro forma adjustments primarily include compensation expense for certain key employees subject to specified future employment conditions, intangible amortization, stock-based compensation and related tax effects.
Definite-Lived Intangible Assets, Net
The following table summarizes the changes in the carrying amount of definite-lived intangible assets for the years ended
December 31, 2016
and
2015
(table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Balance, beginning of the year
|
$
|
616
|
|
|
$
|
748
|
|
Additions to intangible assets related to business combinations
|
40
|
|
|
13
|
|
Amortization expense
|
(129
|
)
|
|
(145
|
)
|
Reduction related to sale of assets
|
(10
|
)
|
|
—
|
|
Balance, end of the year
|
$
|
517
|
|
|
$
|
616
|
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
As of
December 31, 2016
and
2015
, definite-lived intangible assets consisted of the following (amounts in tables in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Weighted-Average Useful Lives
(in years)
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Net Book Value
|
Purchased technology
|
6.6
|
|
$
|
641
|
|
|
$
|
(358
|
)
|
|
$
|
283
|
|
Leasehold interest
|
34.9
|
|
149
|
|
|
(24
|
)
|
|
125
|
|
Customer relationships and customer lists
|
8.3
|
|
132
|
|
|
(62
|
)
|
|
70
|
|
Trademarks and tradenames
|
8.7
|
|
61
|
|
|
(23
|
)
|
|
38
|
|
Other
|
5.7
|
|
4
|
|
|
(3
|
)
|
|
1
|
|
Total definite-lived intangible assets
|
|
|
$
|
987
|
|
|
$
|
(470
|
)
|
|
$
|
517
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Weighted-Average Useful Lives
(in years)
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Net Book Value
|
Purchased technology
|
6.6
|
|
$
|
648
|
|
|
$
|
(298
|
)
|
|
$
|
350
|
|
Leasehold interest
|
34.9
|
|
149
|
|
|
(20
|
)
|
|
129
|
|
Customer relationships and customer lists
|
8.4
|
|
148
|
|
|
(62
|
)
|
|
86
|
|
Trademarks and tradenames
|
8.6
|
|
61
|
|
|
(16
|
)
|
|
45
|
|
Other
|
2.9
|
|
20
|
|
|
(14
|
)
|
|
6
|
|
Total definite-lived intangible assets
|
|
|
$
|
1,026
|
|
|
$
|
(410
|
)
|
|
$
|
616
|
|
Amortization expense of definite-lived intangible assets was
$129 million
,
$145 million
and
$141 million
during the
years ended
December 31, 2016
,
2015
and
2014
, respectively.
Based on intangible assets recorded as of
December 31, 2016
and assuming no subsequent additions, dispositions or impairment of underlying assets, the remaining estimated annual amortization expense is expected to be as follows (table in millions):
|
|
|
|
|
2017
|
$
|
126
|
|
2018
|
116
|
|
2019
|
95
|
|
2020
|
45
|
|
2021
|
27
|
|
Thereafter
|
108
|
|
Total
|
$
|
517
|
|
Goodwill
The following table summarizes the changes in the carrying amount of goodwill during the
year ended
December 31, 2016
and
2015
(table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Balance, beginning of the year
|
$
|
3,993
|
|
|
$
|
3,964
|
|
Increase in goodwill related to business combinations
|
39
|
|
|
29
|
|
Balance, end of the year
|
$
|
4,032
|
|
|
$
|
3,993
|
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
D. Realignment
On January 22, 2016, VMware approved a plan to streamline its operations, with plans to reinvest the associated savings in field, technical and support resources associated with growth products. As a result of these actions, approximately
800
positions were eliminated during the
year ended
December 31, 2016
. VMware recognized
$50 million
of severance-related realignment expenses during the
year ended
December 31, 2016
on the consolidated statements of income. Additionally, VMware consolidated certain facilities as part of this plan, which resulted in the recognition of
$2 million
of related expenses during the
year ended
December 31, 2016
on the consolidated statements of income. Actions associated with this plan were substantially completed by December 31, 2016.
During the
year ended
December 31, 2015
, VMware eliminated approximately
380
positions across all major functional groups and geographies to streamline its operations. As a result of these actions,
$23 million
of realignment expenses were recognized during the year ended December 31, 2015 on the consolidated statements of income.
During the
year ended
December 31, 2014
, VMware eliminated approximately
180
positions across all major functional groups and geographies to streamline its operations. As a result of these actions,
$16 million
of severance-related realignment expenses were recognized during the year ended December 31, 2014 on the consolidated statements of income.
The following table summarizes the activity for the accrued realignment expenses for the
years ended
December 31, 2016
,
2015
and
2014
(tables in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2016
|
|
Balance as of
January 1, 2016
|
|
Realignment
|
|
Utilization
|
|
Balance as of
December 31, 2016
|
Severance-related costs
|
$
|
3
|
|
|
$
|
50
|
|
|
$
|
(52
|
)
|
|
$
|
1
|
|
Costs to exit facilities
|
—
|
|
|
2
|
|
|
(1
|
)
|
|
1
|
|
Total
|
$
|
3
|
|
|
$
|
52
|
|
|
$
|
(53
|
)
|
|
$
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2015
|
|
Balance as of
January 1, 2015
|
|
Realignment
|
|
Utilization
|
|
Balance as of
December 31, 2015
|
Severance-related costs
|
$
|
8
|
|
|
23
|
|
|
(28
|
)
|
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2014
|
|
Balance as of
January 1, 2014
|
|
Realignment
|
|
Utilization
|
|
Balance as of
December 31, 2014
|
Workforce reductions
|
$
|
—
|
|
|
$
|
18
|
|
|
$
|
(10
|
)
|
|
$
|
8
|
|
Asset impairments, exit of facilities and other exit costs
|
3
|
|
|
(2
|
)
|
|
(1
|
)
|
|
—
|
|
Total
|
$
|
3
|
|
|
$
|
16
|
|
|
$
|
(11
|
)
|
|
$
|
8
|
|
E. Net Income per Share
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares outstanding and potentially dilutive securities outstanding during the period, as calculated using the treasury stock method. Potentially dilutive securities primarily include unvested restricted stock units, including performance stock units, stock options, including purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate net income per share as both classes share the same rights in dividends, therefore basic and diluted earnings per share are the same for both classes.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table sets forth the computations of basic and diluted net income per share during the
years ended
December 31, 2016
,
2015
and
2014
(table in millions, shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Net income
|
$
|
1,186
|
|
|
$
|
997
|
|
|
$
|
886
|
|
Gain on stock purchase with Dell, net of tax
|
(8
|
)
|
|
—
|
|
|
—
|
|
Net income, as adjusted
|
$
|
1,178
|
|
|
$
|
997
|
|
|
$
|
886
|
|
Weighted-average shares, basic for Class A and Class B
|
420,520
|
|
|
424,003
|
|
|
430,355
|
|
Effect of stock purchase with Dell
|
7
|
|
|
—
|
|
|
—
|
|
Effect of other dilutive securities
|
3,467
|
|
|
2,544
|
|
|
4,158
|
|
Weighted-average shares, diluted for Class A and Class B
|
423,994
|
|
|
426,547
|
|
|
434,513
|
|
Net income per weighted-average share, basic for Class A and Class B
|
$
|
2.82
|
|
|
$
|
2.35
|
|
|
$
|
2.06
|
|
Net income per weighted-average share, diluted for Class A and Class B
|
$
|
2.78
|
|
|
$
|
2.34
|
|
|
$
|
2.04
|
|
The following table sets forth the weighted-average common share equivalents of Class A common stock that were excluded from the diluted net income per share calculations during the
years ended
December 31, 2016
,
2015
and
2014
, because their effect would have been anti-dilutive (shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Anti-dilutive securities:
|
|
|
|
|
|
Employee stock options
|
1,817
|
|
|
2,219
|
|
|
1,440
|
|
Restricted stock units
|
652
|
|
|
249
|
|
|
16
|
|
Total
|
2,469
|
|
|
2,468
|
|
|
1,456
|
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
F. Cash, Cash Equivalents and Investments
Cash, cash equivalents and investments as of
December 31, 2016
and
2015
consisted of the following (tables in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Cost or Amortized Cost
|
|
Unrealized Gains
|
|
Unrealized Losses
|
|
Aggregate Fair Value
|
Cash
|
$
|
512
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
512
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
Money-market funds
|
$
|
2,235
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,235
|
|
Time deposits
|
26
|
|
|
—
|
|
|
—
|
|
|
26
|
|
Municipal obligations
|
17
|
|
|
—
|
|
|
—
|
|
|
17
|
|
Total cash equivalents
|
$
|
2,278
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,278
|
|
Short-term investments:
|
|
|
|
|
|
|
|
U.S. Government and agency obligations
|
$
|
734
|
|
|
$
|
—
|
|
|
$
|
(3
|
)
|
|
$
|
731
|
|
U.S. and foreign corporate debt securities
|
3,885
|
|
|
2
|
|
|
(18
|
)
|
|
3,869
|
|
Foreign governments and multi-national agency obligations
|
32
|
|
|
—
|
|
|
—
|
|
|
32
|
|
Municipal obligations
|
365
|
|
|
—
|
|
|
—
|
|
|
365
|
|
Asset-backed securities
|
4
|
|
|
—
|
|
|
—
|
|
|
4
|
|
Mortgage-backed securities
|
196
|
|
|
—
|
|
|
(2
|
)
|
|
194
|
|
Total short-term investments
|
$
|
5,216
|
|
|
$
|
2
|
|
|
$
|
(23
|
)
|
|
$
|
5,195
|
|
Other assets:
|
|
|
|
|
|
|
|
Marketable available-for-sale equity securities
|
$
|
15
|
|
|
$
|
7
|
|
|
$
|
—
|
|
|
$
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Cost or Amortized Cost
|
|
Unrealized Gains
|
|
Unrealized Losses
|
|
Aggregate Fair Value
|
Cash
|
$
|
725
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
725
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
Money-market funds
|
$
|
1,763
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,763
|
|
Time deposits
|
5
|
|
|
—
|
|
|
—
|
|
|
5
|
|
Total cash equivalents
|
$
|
1,768
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,768
|
|
Short-term investments:
|
|
|
|
|
|
|
|
Time deposits
|
$
|
12
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
12
|
|
U.S. Government and agency obligations
|
753
|
|
|
—
|
|
|
(3
|
)
|
|
750
|
|
U.S. and foreign corporate debt securities
|
3,263
|
|
|
1
|
|
|
(12
|
)
|
|
3,252
|
|
Foreign governments and multi-national agency obligations
|
35
|
|
|
—
|
|
|
—
|
|
|
35
|
|
Municipal obligations
|
705
|
|
|
1
|
|
|
—
|
|
|
706
|
|
Asset-backed securities
|
20
|
|
|
—
|
|
|
—
|
|
|
20
|
|
Mortgage-backed securities
|
243
|
|
|
—
|
|
|
(2
|
)
|
|
241
|
|
Total short-term investments
|
$
|
5,031
|
|
|
$
|
2
|
|
|
$
|
(17
|
)
|
|
$
|
5,016
|
|
Other assets:
|
|
|
|
|
|
|
|
Marketable available-for-sale equity securities
|
$
|
15
|
|
|
$
|
3
|
|
|
$
|
—
|
|
|
$
|
18
|
|
VMware evaluated its available-for-sale investments as of
December 31, 2016
and
2015
for other-than-temporary declines in fair value. As of
December 31, 2016
and
2015
, VMware did not consider any of its available-for-sale investments to be
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
other-than-temporarily impaired. The realized gains and losses on investments during the
years ended
December 31, 2016
,
2015
and
2014
were not significant.
Unrealized losses on cash equivalents and available-for-sale investments as of
December 31, 2016
and
2015
, which have been in a net loss position for less than twelve months, were classified by sector as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
Fair Value
|
|
Unrealized Losses
|
|
Fair Value
|
|
Unrealized Losses
|
U.S. Government and agency obligations
|
$
|
608
|
|
|
$
|
(3
|
)
|
|
$
|
657
|
|
|
$
|
(3
|
)
|
U.S. and foreign corporate debt securities
|
2,595
|
|
|
(18
|
)
|
|
2,564
|
|
|
(11
|
)
|
Mortgage-backed securities
|
164
|
|
|
(2
|
)
|
|
171
|
|
|
(1
|
)
|
Total
|
$
|
3,367
|
|
|
$
|
(23
|
)
|
|
$
|
3,392
|
|
|
$
|
(15
|
)
|
As of
December 31, 2016
and
2015
, unrealized losses on cash equivalents and available-for-sale investments in the other investment categories, which have been in a net loss position for less than twelve months, were not significant. Unrealized losses on cash equivalents and available-for-sale investments, which have been in a net loss position for twelve months or greater, were not significant as of
December 31, 2016
and
2015
.
Contractual Maturities
The contractual maturities of short-term investments held at
December 31, 2016
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
Amortized
Cost Basis
|
|
Aggregate
Fair Value
|
Due within one year
|
$
|
1,570
|
|
|
$
|
1,570
|
|
Due after 1 year through 5 years
|
3,171
|
|
|
3,153
|
|
Due after 5 years through 10 years
|
113
|
|
|
112
|
|
Due after 10 years
|
362
|
|
|
360
|
|
Total short-term investments
|
$
|
5,216
|
|
|
$
|
5,195
|
|
G. Fair Value Measurements
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
Certain financial assets and liabilities are measured at fair value on a recurring basis. VMware determines fair value using the following hierarchy:
|
|
•
|
Level 1 - Quoted prices in active markets for identical assets or liabilities
|
|
|
•
|
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are noted active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
|
|
|
•
|
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities
|
VMware’s fixed income securities are primarily classified as Level 2, with the exception of some of the U.S. Government and agency obligations which are classified as Level 1. Additionally, VMware’s Level 2 classification includes forward contracts and notes payable to Dell. At
December 31, 2016
and
2015
, VMware’s Level 2 securities were generally priced using non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques.
VMware did not have any significant assets or liabilities that fell into Level 3 of the fair value hierarchy as of
December 31, 2016
and
2015
, and there have been no transfers between fair value measurement levels during the
years ended
December 31, 2016
and
2015
.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following tables set forth the fair value hierarchy of VMware’s cash equivalents, available-for-sale securities and derivatives that were required to be measured at fair value as of
December 31, 2016
and
2015
(tables in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Level 1
|
|
Level 2
|
|
Total
|
Cash equivalents:
|
|
|
|
|
|
|
Money-market funds
|
$
|
2,235
|
|
|
$
|
—
|
|
|
$
|
2,235
|
|
Time deposits
|
—
|
|
|
26
|
|
|
26
|
|
Municipal obligations
|
—
|
|
|
17
|
|
|
17
|
|
Total cash equivalents
|
$
|
2,235
|
|
|
$
|
43
|
|
|
$
|
2,278
|
|
Short-term investments:
|
|
|
|
|
|
U.S. Government and agency obligations
|
$
|
441
|
|
|
$
|
290
|
|
|
$
|
731
|
|
U.S. and foreign corporate debt securities
|
—
|
|
|
3,869
|
|
|
3,869
|
|
Foreign governments and multi-national agency obligations
|
—
|
|
|
32
|
|
|
32
|
|
Municipal obligations
|
—
|
|
|
365
|
|
|
365
|
|
Asset-backed securities
|
—
|
|
|
4
|
|
|
4
|
|
Mortgage-backed securities
|
—
|
|
|
194
|
|
|
194
|
|
Total short-term investments
|
$
|
441
|
|
|
$
|
4,754
|
|
|
$
|
5,195
|
|
Other current assets:
|
|
|
|
|
|
Derivative on stock purchase with Dell (refer to Note B)
|
$
|
—
|
|
|
$
|
8
|
|
|
$
|
8
|
|
Other assets:
|
|
|
|
|
|
Marketable available-for-sale equity securities
|
$
|
22
|
|
|
$
|
—
|
|
|
$
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Level 1
|
|
Level 2
|
|
Total
|
Cash equivalents:
|
|
|
|
|
|
Money-market funds
|
$
|
1,763
|
|
|
$
|
—
|
|
|
$
|
1,763
|
|
Time deposits
|
—
|
|
|
5
|
|
|
5
|
|
Total cash equivalents
|
$
|
1,763
|
|
|
$
|
5
|
|
|
$
|
1,768
|
|
Short-term investments:
|
|
|
|
|
|
Time deposits
|
$
|
—
|
|
|
$
|
12
|
|
|
$
|
12
|
|
U.S. Government and agency obligations
|
543
|
|
|
207
|
|
|
750
|
|
U.S. and foreign corporate debt securities
|
—
|
|
|
3,252
|
|
|
3,252
|
|
Foreign governments and multi-national agency obligations
|
—
|
|
|
35
|
|
|
35
|
|
Municipal obligations
|
—
|
|
|
706
|
|
|
706
|
|
Asset-backed securities
|
—
|
|
|
20
|
|
|
20
|
|
Mortgage-backed securities
|
—
|
|
|
241
|
|
|
241
|
|
Total short-term investments
|
$
|
543
|
|
|
$
|
4,473
|
|
|
$
|
5,016
|
|
Other assets:
|
|
|
|
|
|
Marketable available-for-sale equity securities
|
$
|
18
|
|
|
$
|
—
|
|
|
$
|
18
|
|
Notes payable to Dell are not adjusted to fair value. The fair value of the notes payable to Dell was approximately
$1,489 million
and
$1,474 million
, respectively. Fair value was estimated primarily based on observable market interest rates (Level 2 inputs).
VMware offers a deferred compensation plan for eligible employees, which allows participants to defer payment for part or all of their compensation. The net impact to the consolidated statements of income is not significant since changes in the fair value of the assets substantially offset changes in the fair value of the liabilities. As such, assets and liabilities associated with this plan have not been included in the above tables. Assets and liabilities associated with this plan were both approximately
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
$35 million
and
$20 million
as of
December 31, 2016
and
2015
, respectively, and are included in other assets and other liabilities on the consolidated balance sheets.
Assets Measured and Recorded at Fair Value on a Non-Recurring Basis
VMware holds strategic investments in its portfolio accounted for using the cost method. These strategic investments are periodically assessed for other-than-temporary impairment. VMware uses Level 3 inputs as part of its impairment analysis, including, pre- and post-money valuations of recent financing events, the impact of financing events on its ownership percentages, and other available information relevant to the issuer’s historical and forecasted performance. The estimated fair value of these investments is considered in VMware’s impairment review if any events or changes in circumstances occur that might have a significant adverse effect on their value. If VMware determines that an other-than-temporary impairment has occurred, VMware writes down the investments to their fair value.
During the
years ended
December 31, 2016
and
2015
, VMware determined that certain strategic investments were considered to be other-than-temporarily impaired and accordingly, approximately
$14 million
and
$5 million
, respectively, were recognized as impairment charges. There was
no
impairment charge during the year ended December 31, 2014. Strategic investments are included in other assets on the consolidated balance sheets. The carrying value of VMware’s strategic investments was
$139 million
and
$103 million
as of
December 31, 2016
and
December 31, 2015
, respectively.
H. Derivatives and Hedging Activities
VMware conducts business on a global basis in multiple foreign currencies, subjecting the Company to foreign currency risk. To mitigate a portion of this risk, VMware utilizes hedging contracts as described below, which potentially expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. VMware manages counterparty risk by seeking counterparties of high credit quality, by monitoring credit ratings and credit spreads of, and other relevant public information about its counterparties. VMware does not, and does not intend to, use derivative instruments for trading or speculative purposes.
Cash Flow Hedges
To mitigate its exposure to foreign currency fluctuations resulting from certain operating expenses denominated in certain foreign currencies, VMware enters into forward contracts that are designated as cash flow hedging instruments as the accounting criteria for such designation have been met. Therefore, the effective portion of gains or losses resulting from changes in the fair value of these instruments is initially reported in accumulated other comprehensive income (loss) on the consolidated balance sheets and is subsequently reclassified to the related operating expense line item on the consolidated statements of income in the same period that the underlying expenses are incurred. During the
years ended
December 31, 2016
,
2015
and
2014
, the effective portion of gains or losses reclassified to the consolidated statements of income was not significant. Interest charges or “forward points” on VMware’s forward contracts are excluded from the assessment of hedge effectiveness and are recorded in other income (expense), net on the consolidated statements of income as incurred.
These forward contracts have contractual maturities of
twelve months
or less, and as of
December 31, 2016
and
2015
, outstanding forward contracts had a total notional value of
$22 million
and
$213 million
, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
During the
years ended
December 31, 2016
and
2015
, all cash flow hedges were considered effective.
Forward Contracts Not Designated as Hedges
VMware has established a program that utilizes forward contracts to offset the foreign currency risk associated with net outstanding monetary asset and liability positions. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are reported in other income (expense), net on the consolidated statements of income.
These forward contracts have a contractual maturity of
one
month, and as of
December 31, 2016
and
2015
, outstanding forward contracts had a total notional value of
$875 million
and
$721 million
, respectively. The notional value represents the gross amount of foreign currency that will be bought or sold upon maturity of the forward contract.
During the
years ended
December 31, 2016
,
2015
and
2014
, VMware recognized a gain of
$23 million
,
$36 million
and
$48 million
, respectively, relating to the settlement of forward contracts. Gains and losses are recorded in other income (expense), net on the consolidated statements of income.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The combined gains and losses related to forward contracts and the underlying foreign currency denominated assets and liabilities resulted in a net loss of
$3 million
,
$14 million
and
$9 million
during the
years ended
December 31, 2016
,
2015
and
2014
, respectively. Net gains and losses are recorded in other income (expense), net on the consolidated statements of income.
I. Property and Equipment, Net
Property and equipment, net, as of
December 31, 2016
and
2015
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Equipment and software
|
$
|
1,269
|
|
|
$
|
1,180
|
|
Buildings and improvements
|
814
|
|
|
792
|
|
Furniture and fixtures
|
102
|
|
|
100
|
|
Construction in progress
|
30
|
|
|
30
|
|
Total property and equipment
|
2,215
|
|
|
2,102
|
|
Accumulated depreciation
|
(1,166
|
)
|
|
(974
|
)
|
Total property and equipment, net
|
$
|
1,049
|
|
|
$
|
1,128
|
|
Depreciation expense was
$215 million
,
$190 million
and
$190 million
during the
years ended
December 31, 2016
,
2015
and
2014
, respectively.
J. Commitments and Contingencies
Litigation
Former employee Dane Smith filed a lawsuit against the Company alleging (i) wrongful retaliation in violation of the False Claims Act and (ii) wrongful termination in violation of public policy. The parties completed an arbitration hearing on January 23, 2017, but no decision has yet been issued by the arbitrator. VMware believes that it has meritorious defenses relating to these claims, and currently a reasonably possible loss or range of loss cannot be estimated.
On March 27, 2015, Phoenix Technologies (“Phoenix”) filed a complaint against VMware in the U.S. District Court for the Northern District of California asserting claims for copyright infringement and breach of contract relating to a version of Phoenix’s BIOS software that VMware licensed from Phoenix. In the lawsuit, Phoenix is seeking injunctive relief and monetary damages. On January 6, 2017, the court granted VMware’s motion for summary judgment on the contract statute of limitations issues, which removed Phoenix’s breach of contract claim from the lawsuit. No other claims were removed from the lawsuit on summary judgment and trial is currently scheduled to start on May 30, 2017. VMware believes that it has meritorious defenses in connection with this lawsuit, and currently a reasonably possible loss or range of loss cannot be estimated.
On March 4, 2015, Christoph Hellwig, a software developer who alleges that software code he wrote is used in a component of the Company’s vSphere product, filed a lawsuit against VMware in the Hamburg Regional Court in Germany alleging copyright infringement for failing to comply with the terms of an open source General Public License v.2 (“GPL v.2”) and seeking an order requiring VMware to comply with the GPL v.2 or cease distribution of any affected code within Germany. On July 8, 2016, the German court issued a written decision dismissing Mr. Hellwig’s lawsuit because he failed to show that his protectable software code had been used in VMware’s product. Mr. Hellwig has appealed the Regional Court’s decision and has filed his opening appellate brief and VMware has filed its responsive appellate brief. No further briefing or hearing schedule has yet been set by the appellate court.
While VMware believes that it has valid defenses against each of the above legal matters, given the unpredictable nature of legal proceedings, an unfavorable resolution of one or more legal proceedings, claims, or investigations could have a material adverse effect on VMware’s consolidated financial statements.
On November 17, 2015, Francis M. Ford, a VMware Class A stockholder, filed an action in the Delaware Chancery Court against certain current and former VMware directors, among others, alleging that the directors breached their fiduciary duties in connection with the Dell Acquisition, and the proposed issuance of tracking stock that is intended to track the performance of VMware. The plaintiff does not assert claims directly against VMware, but purports to bring class claims on behalf of other VMware Class A stockholders and derivative claims on behalf of VMware. The
Ford
matter is currently in the motion to dismiss stage; the hearing on these motions took place on February 3, 2017, but the court has not yet issued an order. In addition, on November 10, 2015, David Jacobs, also a VMware stockholder, filed an action in Massachusetts Superior Court
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
against, among others, EMC and four directors who serve on both the EMC board and the VMware board, setting forth similar allegations to those in the
Ford
matter. The
Jacobs
matter settled in December 2016 for an immaterial amount. While VMware does not believe that the
Ford
case represents material adverse exposures, no assurances can be given that the litigation will not have any adverse consequences for the company or the directors named in the suits.
During 2015, VMware reached an agreement with the Department of Justice (“DOJ”) and the General Services Administration (“GSA”) to pay
$76 million
to resolve allegations that VMware's government sales practices between 2006 and 2013 had violated the federal False Claims Act. The settlement was paid and recorded as a reduction of VMware's total revenue during the year ended December 31, 2015.
VMware accrues for a liability when a determination has been made that a loss is both probable and the amount of the loss can be reasonably estimated. If only a range can be estimated and no amount within the range is a better estimate than any other amount, an accrual is recorded for the minimum amount in the range. Significant judgment is required in both the determination that the occurrence of a loss is probable and is reasonably estimable. In making such judgments, VMware considers the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. Legal costs are generally recognized as expense when incurred.
VMware is also subject to other legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business or in connection with business mergers and acquisitions, including claims with respect to commercial, contracting and sales practices, product liability, intellectual property, employment, corporate and securities law, class action, whistleblower and other matters. From time to time, VMware also receives inquiries from and has discussions with government entities and stockholders on various matters. As of
December 31, 2016
, amounts accrued relating to these other matters arising as part of the ordinary course of business were considered immaterial. VMware does not believe that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would have a material adverse effect on its consolidated financial statements.
Operating Leases and Other Contractual Commitments
VMware leases office facilities and equipment under various operating arrangements. Rent expense for the years ended
December 31, 2016
,
2015
and
2014
was
$112 million
,
$105 million
and
$85 million
, respectively. VMware’s minimum future lease commitments and other contractual commitments at
December 31, 2016
were as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future Lease Commitments
(1)
|
|
Purchase Obligations
|
|
Other Contractual Commitments
(2)
|
|
Total
|
2017
|
$
|
89
|
|
|
$
|
39
|
|
|
$
|
3
|
|
|
$
|
131
|
|
2018
|
73
|
|
|
29
|
|
|
5
|
|
|
107
|
|
2019
|
59
|
|
|
4
|
|
|
5
|
|
|
68
|
|
2020
|
44
|
|
|
—
|
|
|
3
|
|
|
47
|
|
2021
|
36
|
|
|
—
|
|
|
2
|
|
|
38
|
|
Thereafter
|
544
|
|
|
—
|
|
|
9
|
|
|
553
|
|
Total
|
$
|
845
|
|
|
$
|
72
|
|
|
$
|
27
|
|
|
$
|
944
|
|
|
|
(1)
|
Amounts in the table above exclude expected sublease income.
|
|
|
(2)
|
Consisting of various contractual agreements, which include commitments on the lease for VMware’s Washington data center facility and asset retirement obligations.
|
The amount of the future lease commitments after 2021 is primarily for the ground leases on VMware’s Palo Alto, California headquarter facilities, which expire in
2046
. As several of VMware’s operating leases are payable in foreign currencies, the operating lease payments may fluctuate in response to changes in the exchange rate between the U.S. dollar and the foreign currencies in which the commitments are payable.
In addition to the amounts above,
$1,500 million
of notes payable to Dell was outstanding as of December 31, 2016 and reflected on the consolidated balance sheets. VMware also had an obligation as of December 31, 2016 to purchase
$125 million
of VMware Class A common stock under a stock purchase agreement with Dell, which was settled during February 2017. Refer to Note B for further information regarding the notes payable to Dell and the stock purchase agreement with Dell.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Guarantees and Indemnification Obligations
VMware enters into agreements in the ordinary course of business with, among others, customers, distributors, resellers, system vendors and systems integrators. Most of these agreements require VMware to indemnify the other party against third-party claims alleging that a VMware product infringes or misappropriates a patent, copyright, trademark, trade secret, and/or other intellectual property right. Certain of these agreements require VMware to indemnify the other party against certain claims relating to property damage, personal injury, or the acts or omissions of VMware, its employees, agents, or representatives.
VMware has agreements with certain vendors, financial institutions, lessors and service providers pursuant to which VMware has agreed to indemnify the other party for specified matters, such as acts and omissions of VMware, its employees, agents, or representatives.
VMware has procurement or license agreements with respect to technology that it has obtained the right to use in VMware’s products and agreements. Under some of these agreements, VMware has agreed to indemnify the supplier for certain claims that may be brought against such party with respect to VMware’s acts or omissions relating to the supplied products or technologies.
VMware has agreed to indemnify the directors and executive officers of VMware, to the extent legally permissible, against all liabilities reasonably incurred in connection with any action in which such individual may be involved by reason of such individual being or having been a director or executive officer. VMware’s by-laws and charter also provide for indemnification of directors and officers of VMware and VMware subsidiaries to the extent legally permissible, against all liabilities reasonably incurred in connection with any action in which such individual may be involved by reason of such individual being or having been a director or executive officer. VMware also indemnifies certain employees who provide service with respect to employee benefits plans, including the members of the Administrative Committee of the VMware 401(k) Plan, and employees who serve as directors or officers of VMware’s subsidiaries.
In connection with certain acquisitions, VMware has agreed to indemnify the former directors and officers of the acquired company in accordance with the acquired company’s by-laws and charter in effect immediately prior to the acquisition or in accordance with indemnification or similar agreements entered into by the acquired company and such persons. VMware typically purchases a “tail” directors and officers insurance policy, which should enable VMware to recover a portion of any future indemnification obligations related to the former officers and directors of an acquired company.
It is not possible to determine the maximum potential amount under these indemnification agreements due to the Company’s limited history with prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on the Company’s consolidated results of operations, financial position, or cash flows.
K. Accrued Expenses and Other
Accrued expenses and other as of
December 31, 2016
and
2015
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Salaries, commissions, bonuses, and benefits
|
$
|
503
|
|
|
$
|
388
|
|
Accrued partner liabilities
|
219
|
|
|
146
|
|
Other
|
176
|
|
|
212
|
|
Total
|
$
|
898
|
|
|
$
|
746
|
|
Accrued partner liabilities primarily relate to rebates and marketing development fund accruals for channel partners, system vendors and systems integrators. Additionally, from time to time, unearned revenue for professional services is reclassified to accrued partner liabilities as VMware intends to leverage channel partners to directly fulfill the obligation to its customers.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
L. Unearned Revenue
Unearned revenue as of
December 31, 2016
and
2015
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Unearned license revenue
|
$
|
503
|
|
|
$
|
428
|
|
Unearned software maintenance revenue
|
4,628
|
|
|
4,174
|
|
Unearned professional services revenue
|
493
|
|
|
474
|
|
Total unearned revenue
|
$
|
5,624
|
|
|
$
|
5,076
|
|
Unearned license revenue is generally recognized upon delivery of existing or future products or services, or is otherwise recognized ratably over the term of the arrangement. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive the future product at no additional charge. To the extent the future product has not been delivered and VSOE of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. In the event the arrangement does not include professional services, unearned license revenue may also be recognized ratably, if the customer is granted the right to receive unspecified future products or VSOE of fair value on the software maintenance element of the arrangement does not exist.
Unearned software maintenance revenue is attributable to VMware’s maintenance contracts and is generally recognized ratably over the contract period. The weighted-average remaining term at
December 31, 2016
was approximately
two years
. Unearned professional services revenue results primarily from prepaid professional services, including training, and is generally recognized as the services are delivered.
Unearned license and software maintenance revenue will fluctuate based upon a variety of factors including sales volume, the timing of both product promotion offers and delivery of the future products offered, and the amount of arrangements sold with ratable revenue recognition. Additionally, the amount of unearned revenue derived from transactions denominated in a foreign currency is impacted by fluctuations in the foreign currencies in which VMware invoices.
M. Income Taxes
The domestic and foreign components of income before provisions for income taxes were as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Domestic
|
$
|
478
|
|
|
$
|
257
|
|
|
$
|
174
|
|
Foreign
|
995
|
|
|
956
|
|
|
874
|
|
Total
|
$
|
1,473
|
|
|
$
|
1,213
|
|
|
$
|
1,048
|
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
VMware’s provision for income taxes consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Federal:
|
|
|
|
|
|
Current
|
$
|
153
|
|
|
$
|
142
|
|
|
$
|
188
|
|
Deferred
|
5
|
|
|
(33
|
)
|
|
(116
|
)
|
|
158
|
|
|
109
|
|
|
72
|
|
State:
|
|
|
|
|
|
Current
|
14
|
|
|
9
|
|
|
15
|
|
Deferred
|
(5
|
)
|
|
(1
|
)
|
|
(12
|
)
|
|
9
|
|
|
8
|
|
|
3
|
|
Foreign:
|
|
|
|
|
|
Current
|
128
|
|
|
96
|
|
|
87
|
|
Deferred
|
(8
|
)
|
|
3
|
|
|
—
|
|
|
120
|
|
|
99
|
|
|
87
|
|
Total provision for income taxes
|
$
|
287
|
|
|
$
|
216
|
|
|
$
|
162
|
|
A reconciliation of VMware’s income tax rate to the statutory federal tax rate is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Statutory federal tax rate
|
35
|
%
|
|
35
|
%
|
|
35
|
%
|
State taxes, net of federal benefit
|
1
|
%
|
|
1
|
%
|
|
1
|
%
|
Tax rate differential for non-U.S. jurisdictions
|
(16
|
)%
|
|
(20
|
)%
|
|
(21
|
)%
|
U.S. tax credits
|
(3
|
)%
|
|
(2
|
)%
|
|
(3
|
)%
|
Permanent items and other
|
2
|
%
|
|
4
|
%
|
|
4
|
%
|
Effective tax rate
|
19
|
%
|
|
18
|
%
|
|
16
|
%
|
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Deferred tax assets and liabilities are recognized for future tax consequences resulting from differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to be reversed. Significant deferred tax assets and liabilities consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
2016
|
|
2015
|
Deferred tax assets:
|
|
|
|
Unearned revenue
|
$
|
324
|
|
|
$
|
320
|
|
Accruals and other
|
66
|
|
|
60
|
|
Stock-based compensation
|
75
|
|
|
73
|
|
Tax credit and net operating loss carryforwards
|
175
|
|
|
162
|
|
Other assets, net
|
33
|
|
|
19
|
|
Intangible and other non-current assets
|
57
|
|
|
65
|
|
Basis difference on investment in business
|
20
|
|
|
20
|
|
Gross deferred tax assets
|
750
|
|
|
719
|
|
Valuation allowance
|
(166
|
)
|
|
(144
|
)
|
Total deferred tax assets
|
584
|
|
|
575
|
|
Deferred tax liabilities:
|
|
|
|
Property, plant and equipment, net
|
(122
|
)
|
|
(119
|
)
|
Net deferred tax assets
|
$
|
462
|
|
|
$
|
456
|
|
VMware has U.S. federal net operating loss carryforwards of
$91 million
from acquisitions made since
2007
. These operating loss carryforwards expire at different periods through
2035
. Portions of these carryforwards are subject to annual limitations. VMware expects to be able to fully utilize these net operating losses against future income. VMware also has state net operating loss carryforwards of
$131 million
, resulting from acquisitions since 2007, expiring at different periods through
2036
.
VMware has California research and development (“R&D”) credit carryforwards for income tax purposes of
$113 million
that can be carried over indefinitely. VMware also has R&D credit carryforwards for Massachusetts and Georgia of approximately
$7 million
and
$9 million
, respectively, which expire at different periods through
2031
. VMware has non-U.S. net operating losses of
$16 million
resulting from certain foreign operations and non-U.S. acquisitions in
2014
. These net operating losses have various carryforward periods, including certain portions that can be carried over indefinitely.
VMware determined that the realization of deferred tax assets relating to portions of the state net operating loss carryforwards, state R&D tax credits, capital losses, and certain non-U.S. net operating losses did not meet the more-likely-than-not threshold, and accordingly, a valuation allowance of
$139 million
was recorded. If, in the future, new evidence supports the realization of the deferred tax assets related to these items, the valuation allowance will be reversed and a tax benefit will be recorded accordingly.
VMware believes it is more-likely-than-not that the net deferred tax assets as of December 31, 2016 and 2015, will be realized in the foreseeable future as VMware believes that it will generate sufficient taxable income in future years. VMware's ability to generate sufficient taxable income in future years in appropriate tax jurisdictions will determine the amount of net deferred tax asset balances to be realized in future periods. During the years ended
December 31, 2016
and December 31, 2015, the total change in the valuation allowance was
$22 million
and
$38 million
, respectively. The increases in the valuation allowance were primarily due to the California R&D credits and capital losses generated in each respective year.
U.S. income taxes have not been provided on certain undistributed earnings of non-U.S. subsidiaries of approximately
$5,354 million
and
$4,473 million
at
December 31, 2016
and
2015
, respectively, because such earnings are considered to be reinvested indefinitely outside of the United States, or will be remitted substantially free of additional U.S. tax. VMware’s rate of taxation in non-U.S. jurisdictions is lower than the U.S. tax rate. VMware’s non-U.S. income is primarily earned by VMware’s subsidiaries in Ireland, where the statutory tax rate is
12.5%
. Recent developments in non-U.S. tax jurisdictions and unfavorable changes in non-U.S. tax laws and regulations could have an adverse effect on VMware’s annual effective tax rate in the future. All income earned abroad, except for previously taxed income for U.S. tax purposes, is considered indefinitely
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
reinvested in VMware’s foreign operations and no provision for U.S. taxes has been provided with respect to such income. At this time, it is not practicable to estimate the amount of tax that may be payable if VMware were to repatriate these earnings.
Tax Sharing Agreement with Dell
On September 6, 2016, VMware entered into an amended tax sharing agreement with Dell, in connection with, and effective as of, the Dell Acquisition. The amended tax sharing agreement amends and restates the tax sharing agreement dated August 13, 2007 between VMware and EMC. Key contractual terms of the amended tax sharing agreement are substantially unchanged from the original agreement with EMC.
Although VMware’s results are included in the Dell consolidated return for U.S. federal income tax purposes, VMware’s income tax provision is calculated primarily as though VMware were a separate taxpayer. However, certain transactions that VMware and Dell are parties to are assessed using consolidated tax return rules.
VMware has made payments to Dell pursuant to the tax sharing agreement. The following table summarizes the payments made during the
years ended
December 31, 2016
,
2015
, and
2014
(table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Payments from VMware to Dell
|
$
|
373
|
|
|
$
|
144
|
|
|
$
|
150
|
|
Payments from VMware to Dell under the tax sharing agreement relate to VMware’s estimated portion of federal income taxes on Dell’s consolidated tax return as well as the state payments for combined states. The timing of the tax payments due to and from Dell is governed by the tax sharing agreement. The amounts that VMware owes to Dell for the estimated portion of federal income taxes on Dell’s consolidated tax return differ from the amounts VMware would owe on a separate return basis and the difference is presented as a component of stockholders’ equity. In the years ended
December 31, 2016
,
2015
and
2014
, the difference between the amount of tax calculated on a separate return basis and the amount of tax calculated per the tax sharing agreement was recorded in stockholders’ equity as an
increase
of
$15 million
and
$13 million
, and a
decrease
of
$12 million
, respectively.
As a result of the activity under the tax sharing agreement with Dell, amounts due to and from Dell, net as of
December 31, 2016
and
2015
consisted of the following (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
Income tax-related asset, net
|
$
|
181
|
|
|
$
|
—
|
|
Income tax due to Dell
|
—
|
|
|
(18
|
)
|
VMware’s expected tax obligation includes two U.S. tax return periods in 2016 as a result of the Dell acquisition. Cash payments to Dell for taxes reflect expected tax obligations for the tax return period prior to the Dell acquisition and the period from the date of the Dell acquisition through the end of Dell’s fiscal year end. The
$181 million
asset shown in the table above was included in other current assets on VMware’s consolidated balance sheets as of December 31, 2016.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits, excluding interest and penalties associated with unrecognized tax benefits, is as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Balance, beginning of the year
|
$
|
245
|
|
|
$
|
190
|
|
|
$
|
167
|
|
Tax positions related to current year:
|
|
|
|
|
|
Additions
|
45
|
|
|
41
|
|
|
32
|
|
Tax positions related to prior years:
|
|
|
|
|
|
Additions
|
9
|
|
|
54
|
|
|
1
|
|
Reductions
|
(8
|
)
|
|
(14
|
)
|
|
(3
|
)
|
Settlements
|
(16
|
)
|
|
(12
|
)
|
|
(1
|
)
|
Reductions resulting from a lapse of the statute of limitations
|
(14
|
)
|
|
(11
|
)
|
|
(2
|
)
|
Foreign currency effects
|
(1
|
)
|
|
(3
|
)
|
|
(4
|
)
|
Balance, end of the year
|
$
|
260
|
|
|
$
|
245
|
|
|
$
|
190
|
|
Of the net unrecognized tax benefits, including interest and penalties, of
$277 million
as of
December 31, 2016
, approximately
$259 million
would, if recognized, benefit VMware's annual effective income tax rate. The
$277 million
of net unrecognized tax benefits are included in other liabilities on the consolidated balance sheets. VMware includes interest expense and penalties related to income tax matters in the income tax provision. VMware had accrued
$44 million
and
$34 million
of interest and penalties associated with unrecognized tax benefits as of
December 31, 2016
and
2015
, respectively. Income tax expense for the years ended
December 31, 2016
,
2015
and
2014
included interest and penalties of
$10 million
,
$13 million
and
$8 million
, respectively, associated with uncertain tax positions.
The Dell-owned EMC consolidated group is routinely under audit by the Internal Revenue Service (“IRS”). All U.S. federal income tax matters have been concluded for years through
2010
, except for any matters under appeal. The
2011
federal tax returns of the Dell-owned EMC consolidated group are currently under audit by the IRS. In addition, we are under corporate income tax audits in various states and non-U.S. jurisdictions. Consistent with our historical practices under the tax sharing agreement with EMC, when we become subject to federal tax audits as a member of Dell’s consolidated group, the tax sharing agreement provides that Dell has authority to control the audit and represent Dell’s and VMware’s interests to the IRS.
Open tax years subject to examinations for larger non-U.S. jurisdictions vary beginning
2008
. Open tax years for Ireland, the largest non-U.S. jurisdiction, begin
2010
. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. When considering the outcomes and the timing of tax examinations, the expiration of statutes of limitations for specific jurisdictions, or the timing and result of ruling requests from taxing authorities, it is reasonably possible that total unrecognized tax benefits could be potentially reduced by approximately
$8 million
within the next 12 months.
N. Stockholders’ Equity
VMware Class B Common Stock Conversion Rights
Each share of Class B common stock is convertible into one share of Class A common stock. If VMware’s Class B common stock is distributed to security holders of Dell in a qualified distribution, the Class B shares will no longer be convertible into shares of Class A common stock unless a stockholder vote is obtained after certain conditions are satisfied. Prior to any such distribution, all Class B shares automatically convert into shares of Class A common stock if Dell transfers such shares to a third party that is not a successor or a Dell subsidiary or at such time as the number of shares of common stock owned by Dell or its successor falls below
20%
of the outstanding shares of VMware’s common stock. As of
December 31, 2016
and
2015
,
300.0 million
shares of Class A common stock were reserved for conversion.
VMware Equity Plan
In June 2007, VMware adopted its 2007 Equity and Incentive Plan (the “2007 Plan”). As of
December 31, 2016
, the number of authorized shares under the 2007 Plan was
121.6 million
. The number of shares underlying outstanding equity awards that VMware assumes in the course of business acquisitions are also added to the 2007 Plan reserve on an as-converted basis. VMware has assumed
4.4 million
shares, which accordingly have been added to authorized shares under the 2007 Plan reserve.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Awards under the 2007 Plan may be in the form of stock-based awards, such as restricted stock units, or stock options. VMware’s Compensation and Corporate Governance Committee determines the vesting schedule for all equity awards. Generally, restricted stock grants made under the 2007 Plan have a
three
-year to
four
-year period over which they vest and vest
25%
the first year and semi-annually thereafter. The exercise price for a stock option awarded under the 2007 Plan shall not be less than
100%
of the fair market value of VMware Class A common stock on the date of grant. Most options granted under the 2007 Plan vest
25%
after the first year and monthly thereafter over the following
three
years and expire between
six
and
seven
years from the date of grant. VMware utilizes both authorized and unissued shares to satisfy all shares issued under the 2007 Plan. At
December 31, 2016
, there were an aggregate of
12.8 million
shares of common stock available for issuance pursuant to future grants under the 2007 Plan.
VMware Stock Repurchases
During January 2017, VMware’s board of directors authorized the repurchase of up to
$1,200 million
of VMware’s Class A common stock through the end of fiscal 2018. Stock will be purchased from time to time, in the open market or through private transactions, subject to market conditions. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate, legal and regulatory requirements and other market and economic conditions. VMware is not obligated to purchase any shares under its stock repurchase programs. Purchases can be discontinued at any time VMware believes additional purchases are not warranted. All shares repurchased under VMware’s stock repurchase programs are retired.
On December 15, 2016, VMware entered into a stock purchase agreement with Dell to purchase
$500 million
of VMware Class A common stock. Through December 31, 2016, VMware had purchased
4.8 million
shares for
$375 million
. On February 15, 2017, the stock purchase agreement with Dell was completed. A total of
$500 million
was paid in exchange for
6.2 million
shares. The aggregate number of shares purchased was determined based upon the volume-weighted average priced during a defined period, less an agreed upon discount. Refer to Note B for further information.
During April 2016, VMware’s board of directors authorized the repurchase of up to an aggregate of
$1,200 million
of VMware’s Class A common stock through the end of 2016. The aggregate authorized stock repurchase amount of
$1,200 million
included the amount remaining from VMware’s previous stock repurchase authorization announced on January 27, 2015 of
$835 million
. All shares repurchased under VMware’s stock repurchase programs were retired. The cumulative authorized amount for stock repurchases was fully utilized during the fourth quarter of 2016.
Excluding the stock purchase agreement with Dell as described above, the following table summarizes stock repurchase authorizations, which were open or completed during the
years ended
December 31, 2016
,
2015
, and
2014
(amount in table in millions):
|
|
|
|
|
|
|
|
Authorization Date
|
|
Amount Authorized
|
|
Expiration Date
|
|
Status
|
April 18, 2016
|
|
$1,200
|
|
December 31, 2016
|
|
Completed in 2016
|
January 27, 2015
|
|
1,000
|
|
December 31, 2017
|
|
Completed in 2016
|
August 6, 2014
|
|
1,000
|
|
December 31, 2016
|
|
Completed in 2015
|
August 7, 2013
|
|
700
|
|
December 31, 2015
|
|
Completed in 2014
|
The following table summarizes stock repurchase activity, including shares purchased from Dell, during the
years ended
December 31, 2016
,
2015
, and
2014
(aggregate purchase price in millions, shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Aggregate purchase price
|
$
|
1,575
|
|
|
$
|
1,125
|
|
|
$
|
700
|
|
Class A common shares repurchased
|
21,281
|
|
|
13,495
|
|
|
7,642
|
|
Weighted-average price per share
|
$
|
73.99
|
|
|
$
|
83.36
|
|
|
$
|
91.61
|
|
The aggregate purchase price of repurchased shares includes commissions and is classified as a reduction to additional paid-in capital.
VMware Restricted Stock
VMware’s restricted stock primarily consists of restricted stock unit (“RSU”) awards granted to employees. The value of RSU grants is based on VMware’s stock price on the date of grant. The shares underlying the RSU awards are not issued until the RSUs vest. Upon vesting, each RSU converts into one share of VMware Class A common stock.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
VMware’s restricted stock also includes performance stock unit (“PSU”) awards, which have been granted to certain VMware executives and employees. The PSU awards include performance conditions and, in certain cases, a time-based vesting component. Upon vesting, each PSU award will convert into VMware’s Class A common stock at various ratios ranging from
0.5
to
2.0
shares per PSU, depending upon the degree of achievement of the performance target designated by each individual award. If minimum performance thresholds are not achieved, then no shares will be issued. As of
December 31, 2016
, the number of PSUs outstanding includes certain PSUs for which performance conditions have concluded but time-based vesting is still required.
The following table summarizes restricted stock activity since
January 1, 2014
(units in thousands):
|
|
|
|
|
|
|
|
|
Number of Units
|
|
Weighted-Average Grant Date Fair Value
(per unit)
|
Outstanding, January 1, 2014
|
12,856
|
|
|
$
|
85.85
|
|
Granted
|
6,189
|
|
|
92.82
|
|
Vested
|
(5,166
|
)
|
|
86.27
|
|
Forfeited
|
(1,294
|
)
|
|
88.03
|
|
Outstanding, December 31, 2014
|
12,585
|
|
|
88.88
|
|
Granted
|
12,787
|
|
|
72.42
|
|
Vested
|
(4,855
|
)
|
|
90.72
|
|
Forfeited
|
(1,824
|
)
|
|
87.39
|
|
Outstanding, December 31, 2015
|
18,693
|
|
|
77.29
|
|
Granted
|
12,742
|
|
|
60.90
|
|
Vested
|
(7,188
|
)
|
|
77.18
|
|
Forfeited
|
(3,381
|
)
|
|
75.93
|
|
Outstanding, December 31, 2016
|
20,866
|
|
|
67.54
|
|
As of
December 31, 2016
, the
20.9 million
units outstanding included
20.4 million
of RSUs and
0.5 million
of PSUs. The above table includes RSUs issued for outstanding unvested RSUs in connection with business combinations.
As of
December 31, 2016
, restricted stock that is expected to vest was as follows:
|
|
|
|
|
|
|
|
|
|
|
Number of Units
(in thousands)
|
|
Weighted Average Remaining Term
(in years)
|
|
Aggregate Intrinsic Value
(1)
(in millions)
|
Expected to vest, December 31, 2016
|
17,835
|
|
|
2.65
|
|
$
|
1,404
|
|
|
|
(1)
|
The aggregate intrinsic values represent the total pre-tax intrinsic values based on VMware's closing stock price of
$78.73
as of
December 31, 2016
, which would have been received by the RSU holders had the RSUs been issued as of
December 31, 2016
.
|
The total fair value of VMware restricted stock that vested during the
years ended
December 31, 2016
,
2015
and
2014
was
$468 million
,
$379 million
and
$480 million
, respectively. As of
December 31, 2016
, restricted stock representing
20.9 million
shares of VMware’s Class A common stock were outstanding, with an aggregate intrinsic value of
$1,643 million
based on VMware’s closing stock price as of
December 31, 2016
.
VMware Employee Stock Purchase Plan
In June 2007, VMware adopted its 2007 Employee Stock Purchase Plan (the “ESPP”), which is intended to be qualified under Section 423 of the Internal Revenue Code. As of
December 31, 2016
, the number of authorized shares under the ESPP was a total of
14.3 million
shares. Under the ESPP, eligible VMware employees are granted options to purchase shares at the lower of
85%
of the fair market value of the stock at the time of grant or
85%
of the fair market value at the time of exercise. The option period is generally twelve months and includes two embedded six-month option periods. Options are exercised at the end of each embedded option period. If the fair market value of the stock is lower on the first day of the second embedded option period than it was at the time of grant, then the twelve-month option period expires and each enrolled participant is granted a new twelve-month option. As of
December 31, 2016
,
2.1 million
shares of VMware Class A common stock were available for issuance under the ESPP.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes ESPP activity during the
years ended
December 31, 2016
,
2015
, and
2014
(cash proceeds in millions, shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Cash proceeds
|
$
|
103
|
|
|
$
|
98
|
|
|
$
|
80
|
|
Class A common shares purchased
|
2,657
|
|
|
1,495
|
|
|
1,099
|
|
Weighted-average price per share
|
$
|
38.78
|
|
|
$
|
65.54
|
|
|
$
|
73.21
|
|
As of
December 31, 2016
,
$56 million
of ESPP withholdings were recorded as a liability in accrued expenses and other on the consolidated balance sheets for the purchase that occurred during
January 2017
.
VMware Stock Options
The following table summarizes stock option activity since
January 1, 2014
(shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VMware Stock Options
|
|
EMC Stock Options
|
|
Number of Shares
|
|
Weighted-Average Exercise Price
(per share)
|
|
Number of Shares
|
|
Weighted-Average Exercise Price
(per share)
|
Outstanding, January 1, 2014
|
5,755
|
|
|
$
|
44.12
|
|
|
1,696
|
|
|
$
|
15.53
|
|
Options relating to employees transferred (to) from EMC
|
—
|
|
|
—
|
|
|
149
|
|
|
15.87
|
|
Granted
|
2,695
|
|
|
50.91
|
|
|
—
|
|
|
—
|
|
Forfeited
|
(220
|
)
|
|
47.89
|
|
|
(2
|
)
|
|
19.10
|
|
Expired
|
—
|
|
|
—
|
|
|
(9
|
)
|
|
14.14
|
|
Exercised
|
(2,361
|
)
|
|
35.58
|
|
|
(563
|
)
|
|
14.37
|
|
Outstanding, December 31, 2014
|
5,869
|
|
|
50.54
|
|
|
1,271
|
|
|
16.08
|
|
Options relating to employees transferred (to) from EMC
|
—
|
|
|
—
|
|
|
8
|
|
|
20.23
|
|
Granted
|
21
|
|
|
54.23
|
|
|
—
|
|
|
—
|
|
Forfeited
|
(322
|
)
|
|
70.42
|
|
|
(1
|
)
|
|
19.37
|
|
Expired
|
—
|
|
|
—
|
|
|
(14
|
)
|
|
14.21
|
|
Exercised
|
(2,404
|
)
|
|
29.44
|
|
|
(201
|
)
|
|
13.96
|
|
Outstanding, December 31, 2015
|
3,164
|
|
|
64.56
|
|
|
1,063
|
|
|
16.54
|
|
Options relating to employees transferred (to) from EMC
|
—
|
|
|
—
|
|
|
19
|
|
|
15.90
|
|
Granted
|
66
|
|
|
6.53
|
|
|
—
|
|
|
—
|
|
Forfeited
|
(259
|
)
|
|
77.42
|
|
|
—
|
|
|
—
|
|
Expired
|
(476
|
)
|
|
80.52
|
|
|
(17
|
)
|
|
14.44
|
|
Exercised
|
(418
|
)
|
|
13.41
|
|
|
(1,065
|
)
|
|
16.56
|
|
Outstanding, December 31, 2016
|
2,077
|
|
|
67.75
|
|
|
—
|
|
|
—
|
|
The above table includes stock options granted in conjunction with unvested stock options assumed in business combinations. As a result, the weighted-average exercise price per share may vary from the VMware stock price at time of grant.
The stock options outstanding as of
December 31, 2016
had an aggregate intrinsic value of
$39 million
based on VMware’s closing stock price as of
December 31, 2016
.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Options outstanding that are exercisable and that have vested and are expected to vest as of
December 31, 2016
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VMware Stock Options
|
|
Outstanding Options
(in thousands)
|
|
Weighted Average Exercise Price
|
|
Weighted Average Remaining Term
(in years)
|
|
Aggregate Intrinsic Value
(1)
(in millions)
|
Exercisable, December 31, 2016
|
1,436
|
|
|
$
|
66.56
|
|
|
4.41
|
|
$
|
28
|
|
Vested and expected to vest, December 31, 2016
|
2,050
|
|
|
67.47
|
|
|
4.48
|
|
39
|
|
|
|
(1)
|
The aggregate intrinsic values represent the total pre-tax intrinsic values based on VMware's closing stock price of
$78.73
as of
December 31, 2016
, which would have been received by the option holders had all in-the-money options been exercised as of that date.
|
The total fair value of VMware stock options that vested during the
years ended
December 31, 2016
,
2015
, and
2014
was
$29 million
,
$60 million
and
$64 million
, respectively.
The options exercised during the
years ended
December 31, 2016
,
2015
, and
2014
had a pre-tax intrinsic value of
$22 million
,
$136 million
and
$147 million
, respectively.
The pre-tax intrinsic value of EMC stock options held by VMware employees that were exercised during the
years ended
December 31, 2016
,
2015
, and
2014
was
$13 million
,
$3 million
and
$7 million
, respectively.
VMware Shares Repurchased for Tax Withholdings
During the
years ended
December 31, 2016
,
2015
and
2014
, VMware repurchased and retired or withheld
2.6 million
,
2.6 million
and
1.8 million
shares, respectively, of Class A common stock, for
$167 million
,
$173 million
and
$162 million
, respectively, to cover tax withholding obligations. These amounts may differ from the amounts of cash remitted for tax withholding obligations on the consolidated statements of cash flows due to the timing of payments. Pursuant to the respective award agreements, these shares were withheld in conjunction with the net share settlement upon the vesting of restricted stock and restricted stock units during the period. The value of the withheld shares, including restricted stock units, was classified as a reduction to additional paid-in capital.
Stock-Based Compensation
The following table summarizes the components of total stock-based compensation included in VMware’s consolidated statements of income for the
years ended
December 31, 2016
,
2015
and
2014
(table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
Cost of license revenue
|
$
|
2
|
|
|
$
|
2
|
|
|
$
|
2
|
|
Cost of services revenue
|
52
|
|
|
44
|
|
|
42
|
|
Research and development
|
305
|
|
|
226
|
|
|
244
|
|
Sales and marketing
|
195
|
|
|
168
|
|
|
172
|
|
General and administrative
|
82
|
|
|
64
|
|
|
69
|
|
Stock-based compensation
|
636
|
|
|
504
|
|
|
529
|
|
Income tax benefit
|
(183
|
)
|
|
(144
|
)
|
|
(157
|
)
|
Total stock-based compensation, net of tax
|
$
|
453
|
|
|
$
|
360
|
|
|
$
|
372
|
|
From time to time, VMware issues equity awards that have a guaranteed amount of value and are classified as liability awards on VMware’s consolidated balance sheets. Upon vesting, these grants will be settled in shares based upon the stock price or a trailing average stock price on a date determined by the terms of each individual award. As of
December 31, 2016
and
2015
, there were
no
outstanding liability-classified awards. During the year ended
December 31, 2014
,
$21 million
of liability-classified awards was reclassified to additional paid-in capital upon vesting.
As of
December 31, 2016
, the total unrecognized compensation cost for stock options and restricted stock was
$1,044 million
and will be recognized through
2020
with a weighted-average remaining period of
1.5 years
. Stock-based
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
compensation related to VMware equity awards held by VMware employees is recognized on VMware’s consolidated statements of income over the awards’ requisite service periods.
Fair Value of VMware Options
The fair value of each option to acquire VMware Class A common stock granted during the
years ended
December 31, 2016
,
2015
and
2014
was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
VMware Stock Options
|
2016
|
|
2015
|
|
2014
|
Dividend yield
|
None
|
|
|
None
|
|
|
None
|
|
Expected volatility
|
31.9
|
%
|
|
32.0
|
%
|
|
36.2
|
%
|
Risk-free interest rate
|
0.9
|
%
|
|
1.1
|
%
|
|
0.9
|
%
|
Expected term (in years)
|
3.1
|
|
|
3.3
|
|
|
3.2
|
|
Weighted-average fair value at grant date
|
$
|
49.64
|
|
|
$
|
27.16
|
|
|
$
|
48.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
VMware Employee Stock Purchase Plan
|
2016
|
|
2015
|
|
2014
|
Dividend yield
|
None
|
|
|
None
|
|
|
None
|
|
Expected volatility
|
38.3
|
%
|
|
30.1
|
%
|
|
32.3
|
%
|
Risk-free interest rate
|
0.5
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
Expected term (in years)
|
0.7
|
|
|
0.5
|
|
|
0.5
|
|
Weighted-average fair value at grant date
|
$
|
13.57
|
|
|
$
|
20.59
|
|
|
$
|
20.71
|
|
The weighted-average grant date fair value of VMware stock options can fluctuate from period to period primarily due to higher valued options assumed through business combinations with exercise prices lower than the fair market value of VMware’s stock on the date of grant.
For equity awards granted during the
years ended
December 31, 2016
,
2015
and
2014
, volatility was based on an analysis of historical stock prices and implied volatilities of VMware’s Class A common stock. The expected term is based on historical exercise patterns and post-vesting termination behavior, the term of the option period for grants made under the ESPP, or the weighted-average remaining term for options assumed in acquisitions. VMware’s expected dividend yield input was
zero
as it has not historically paid, nor expects in the future to pay, cash dividends on its common stock. The risk-free interest rate was based on a U.S. Treasury instrument whose term is consistent with the expected term of the stock options.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Accumulated Other Comprehensive Income (Loss)
The changes in components of accumulated other comprehensive income (loss) during the
years ended
December 31, 2016
and
2015
were as follows (tables in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Gain (Loss) on
Available-for-Sale Securities
|
|
Unrealized Gain (Loss) on
Forward Contracts
|
|
Total
|
Balance, January 1, 2015
|
$
|
—
|
|
|
$
|
(1
|
)
|
|
$
|
(1
|
)
|
Unrealized gains (losses), net of tax provision (benefit) of $(4), $— and $(4)
|
(7
|
)
|
|
—
|
|
|
(7
|
)
|
Other comprehensive income (loss), net
|
(7
|
)
|
|
—
|
|
|
(7
|
)
|
Balance, December 31, 2015
|
(7
|
)
|
|
(1
|
)
|
|
(8
|
)
|
Unrealized gains (losses), net of tax provision (benefit) of $(4), $— and $(3)
|
(6
|
)
|
|
1
|
|
|
(5
|
)
|
Amounts reclassified from accumulated other comprehensive income (loss) to the consolidated statement of income, net of tax (provision) benefit of $3, $— and $3
|
5
|
|
|
(1
|
)
|
|
4
|
|
Other comprehensive income (loss), net
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
Balance, December 31, 2016
|
$
|
(8
|
)
|
|
$
|
(1
|
)
|
|
$
|
(9
|
)
|
Unrealized gains on VMware’s available-for-sale securities are reclassified to investment income on the consolidated statements of income in the period that such gains are realized.
The effective portion of gains (losses) resulting from changes in the fair value of forward contracts designated as cash flow hedging instruments is reclassified to its related operating expense line item on the consolidated statements of income in the same period that the underlying expenses are incurred. The amounts recorded to their related operating expense functional line items on the consolidated statements of income during the
years ended
December 31, 2016
and
2015
were not significant to the individual functional line items.
O. Segment Information
VMware operates in
one
reportable operating segment, thus all required financial segment information can be found on the consolidated financial statements. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level.
Revenue by geographic area for the
years ended
December 31, 2016
,
2015
and
2014
was as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
United States
|
$
|
3,588
|
|
|
$
|
3,311
|
|
|
$
|
2,912
|
|
International
|
3,505
|
|
|
3,260
|
|
|
3,123
|
|
Total
|
$
|
7,093
|
|
|
$
|
6,571
|
|
|
$
|
6,035
|
|
Revenue by geographic area is based on the ship-to addresses of VMware’s customers. No individual country other than the United States accounted for 10% or more of revenue for the
years ended
December 31, 2016
,
2015
and
2014
.
One
customer accounted for
15%
of revenue during each of the
years ended
December 31, 2016
,
2015
and
2014
, respectively, and
another
customer accounted for
12%
,
12%
and
13%
of revenue during the
years ended
December 31, 2016
,
2015
and
2014
, respectively. A
third
customer accounted for
10%
,
11%
and
11%
of revenue during the
years ended
December 31, 2016
,
2015
and
2014
, respectively.
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Long-lived assets by geographic area, which primarily include property and equipment, net, as of
December 31, 2016
and
2015
were as follows (table in millions):
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
2015
|
United States
|
$
|
784
|
|
|
$
|
831
|
|
International
|
132
|
|
|
148
|
|
Total
|
$
|
916
|
|
|
$
|
979
|
|
No
individual country other than the United States accounted for 10% or more of these assets as of
December 31, 2016
and
2015
, respectively.
VMware’s product and service solutions are organized into
three
main product groups:
|
|
•
|
SDDC or Software-Defined Data Center
|
VMware develops and markets product and service offerings within each of these three product groups. Additionally, synergies are leveraged across these three product areas. VMware’s products and service solutions from each of its product groups may also be bundled as part of an enterprise agreement arrangement or packaged together and sold as a suite. Accordingly, it is not practicable to determine revenue by each of the three product groups described above.
P. Selected Quarterly Financial Data (unaudited)
Quarterly financial data for
2016
and
2015
were as follows (tables in millions, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
Q1 2016
|
|
Q2 2016
|
|
Q3 2016
|
|
Q4 2016
|
Revenue
|
$
|
1,589
|
|
|
$
|
1,693
|
|
|
$
|
1,778
|
|
|
$
|
2,032
|
|
Net income
|
161
|
|
|
265
|
|
|
319
|
|
|
441
|
|
Net income per share, basic
|
$
|
0.38
|
|
|
$
|
0.62
|
|
|
$
|
0.76
|
|
|
$
|
1.07
|
|
Net income per share, diluted
|
$
|
0.38
|
|
|
$
|
0.62
|
|
|
$
|
0.75
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2015
|
Q1 2015
|
|
Q2 2015
|
|
Q3 2015
|
|
Q4 2015
|
Revenue
|
$
|
1,511
|
|
|
$
|
1,521
|
|
|
$
|
1,672
|
|
|
$
|
1,868
|
|
Net income
|
196
|
|
|
172
|
|
|
256
|
|
|
373
|
|
Net income per share, basic
|
$
|
0.46
|
|
|
$
|
0.41
|
|
|
$
|
0.61
|
|
|
$
|
0.89
|
|
Net income per share, diluted
|
$
|
0.45
|
|
|
$
|
0.40
|
|
|
$
|
0.60
|
|
|
$
|
0.88
|
|