VMWARE, INC. The following management's discussion and analysis is provided in addition to the accompanying condensed consolidated financial statements and notes to assist in understanding our results of operations and financial condition. Financial information as ofNovember 1, 2019 should be read in conjunction with our consolidated financial statements for the year endedFebruary 1, 2019 contained in our Form 10-K filed onMarch 29, 2019 . Period-over-period changes are calculated based upon the respective underlying, non-rounded data. We refer to our fiscal years endedJanuary 29, 2021 ,January 31, 2020 andFebruary 1, 2019 as "fiscal 2021," "fiscal 2020" and "fiscal 2019," respectively. Unless the context requires otherwise, we are referring toVMware, Inc. and its consolidated subsidiaries when we use the terms "VMware ," the "Company," "we," "our" or "us." Overview We originally pioneered the development and application of virtualization technologies with x86 server-based computing, separating application software from the underlying hardware. Information technology ("IT") driven innovation continues to disrupt markets and industries. Technologies emerge faster than organizations can absorb, creating increasingly complex environments. IT is working at an accelerated pace to harness new technologies, platforms and cloud models, ultimately guiding their business through a digital transformation. To take on these challenges, we are working with customers in the areas of hybrid cloud, multi-cloud, modern applications, networking and security, and digital workspaces. Our software provides a flexible digital foundation to help enable customers in their digital transformations. We help customers manage their IT resources across private clouds and complex multi-cloud, multi-device environments by offering solutions across three categories:Software-Defined Data Center ("SDDC"), Hybrid Cloud Computing and End-User Computing ("EUC"). This portfolio supports and addresses the key IT priorities of our customers: accelerating their cloud journey, empowering digital workspaces and transforming networking and security. TheseVMware solutions enable the digital transformation our customers need as they ready their applications, infrastructure and devices for their future business needs. We sell our solutions using enterprise agreements ("EAs") or as part of our non-EA, or transactional, business. EAs are comprehensive volume license offerings, offered both directly by us and through certain channel partners that also provide for multi-year maintenance and support. We continue to experience strong renewals, including renewals of our EAs, resulting in additional license sales of both our existing and newer products and solutions. SDDC orSoftware-Defined Data Center Our SDDC technologies form the foundation of our customers' private cloud environments and provide the capabilities for our customers to extend their private cloud to the public cloud and to help them run, manage, secure and connect all their applications across all clouds and devices. During the nine months endedNovember 1, 2019 , we continued to see growth in sales of our SDDC solutions. Future sales growth rates may fluctuate period to period, depending largely upon the extent to which SDDC technologies are included in our larger EAs. For example, sales from our management products were positively impacted during the nine months endedNovember 1, 2019 as a result of being included in some of the larger strategic deals. Hybrid Cloud Computing Our overarching cloud strategy contains three key components: (i) continue to expand beyond compute virtualization in the private cloud; (ii) extend the private cloud into the public cloud; and (iii) connect and secure endpoints across a range of public clouds. Hybrid cloud subscription offerings were primarily comprised of VMware Cloud Provider Program ("VCPP") and included VMware Cloud Services, which enable customers to run, manage, connect and secure their applications across private and public clouds. During the nine months endedNovember 1, 2019 , revenue growth in our hybrid cloud subscription offerings was primarily driven by our VCPP offerings. We expectCloudHealth byVMware and VMware Cloud on AWS to contribute to revenue growth in fiscal 2020. During the third quarter of fiscal 2020, we acquiredCarbon Black, Inc. ("Carbon Black") to grow our intrinsic security portfolio across network, workload, endpoint, identity and analytics. Also, during the third quarter of fiscal 2020, we entered into a definitive agreement to acquirePivotal Software, Inc. ("Pivotal"), which is expected to deliver enterprise-grade, Kubernetes-based portfolio for modern applications. The transaction is expected to close during the fourth quarter of fiscal 2020. We expect both the completedCarbon Black acquisition and proposed Pivotal acquisition to contribute to the growth of our revenue derived from our hybrid cloud subscription and software-as-a-service ("SaaS") offerings. In addition, we expect operating margin will be impacted in fiscal 2021 as a result of our incremental investment in our hybrid cloud subscription and SaaS portfolio, including consideration of the recentCarbon Black acquisition. 32
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EUC or End-User Computing
Our complete EUC solution, VMware Workspace ONE ("Workspace ONE"), is a digital
workspace platform powered by Unified Endpoint Management and VMware Horizon.
Our Unified Endpoint Management business model includes an on-premises solution
that we offer through the sale of perpetual licenses, subscription and SaaS
solutions. EUC sales continued to increase during the nine months ended
November 1, 2019 , driven by the adoption of our subscription offerings such as
Workspace ONE.
Dell Synergies
We continue joint marketing, sales, branding and product development efforts
with Dell Technologies Inc. ("Dell") and other Dell companies to enhance the
collective value we deliver to our mutual customers. Our collective business
built with Dell continued to create synergies that benefited our sales during
the nine months ended November 1, 2019 .
Results of Operations
Approximately 70% of our sales are denominated in the United States ("U.S.")
dollar, however, in certain countries we also invoice and collect in the
following currencies: euro; British pound; Japanese yen; Australian dollar; and
Chinese renminbi. In addition, we incur and pay operating expenses in currencies
other than the U.S. dollar. As a result, our financial statements, including our
revenue, operating expenses, unearned revenue and the resulting cash flows
derived from the U.S. dollar equivalent of foreign currency transactions, are
affected by foreign exchange fluctuations.
Revenue
Our revenue during the periods presented was as follows (dollars in millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % ChangeRevenue: License $ 974 $ 884$ 90 10 %$ 2,853 $ 2,558 $ 296 12 % Services: Software maintenance 1,280 1,138 143 13 3,720 3,324 397 12 Professional services 202 178 23 13 588 501 86 17 Total services 1,482 1,316 166 13 4,308 3,825 483 13 Total revenue$ 2,456 $ 2,200 $ 256 12$ 7,161 $ 6,383 $ 778 12 Revenue: United States$ 1,172 $ 1,052 $ 120 11 %$ 3,395 $ 3,053 $ 342 11 % International 1,284 1,148 137 12 3,766 3,330 436 13 Total revenue$ 2,456 $ 2,200 $ 256 12$ 7,161 $ 6,383 $ 778 12 Revenue from our hybrid cloud subscription offerings consisted primarily of VCPP, and revenue from our SaaS offerings consisted primarily of our Unified Endpoint Management mobile solution within Workspace ONE and newer SaaS offerings, such asCloudHealth byVMware , VMware SD-WAN byVeloCloud andVMware Cloud on AWS. VCPP revenue is included in license revenue and SaaS revenue is included in both license and services revenue. Hybrid cloud subscription offerings, together with our SaaS offerings, increased to greater than 12% of our total revenue during the three and nine months endedNovember 1, 2019 from greater than 10% of our total revenue during the three and nine months endedNovember 2, 2018 . License revenue relating to the sale of perpetual licenses that are part of a multi-year contract is generally recognized upon delivery of the underlying license, whereas revenue derived from our hybrid cloud subscription and SaaS offerings is recognized on a consumption basis or over a period of time. License Revenue License revenue during the three and nine months endedNovember 1, 2019 compared to the three and nine months endedNovember 2, 2018 , continued to benefit from broad-based growth across our diverse product portfolio and across ourU.S. and international geographies. Revenue growth from our VCPP offerings continued to contribute to license revenue growth during the three and nine months endedNovember 1, 2019 . Strength in our large EAs also contributed to license revenue growth during the three and nine months endedNovember 1, 2019 compared to the three and nine months endedNovember 2, 2018 . 33
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Services Revenue During the three and nine months endedNovember 1, 2019 , software maintenance revenue continued to benefit from strong renewals of our EAs, maintenance contracts sold in previous periods and additional maintenance contracts sold in conjunction with new software license sales. In each period presented, customers purchased, on a weighted-average basis, approximately three years of support and maintenance with each new license purchased. Professional services revenue increased 13% and 17% during the three and nine months endedNovember 1, 2019 , respectively, as compared to the three and nine months endedNovember 2, 2018 . Services we provide through our technical account managers and our continued focus on solution deployments, including ourVMware NSX ("NSX") products, management solutions as well as other emerging technology products, contributed to the increase in professional services revenue. We continue to also focus on enabling our partners to deliver professional services for our solutions and as such, our professional services revenue may vary as we continue to leverage our partners. Timing of service engagements will also impact the amount of professional services revenue we recognize during a period. Unearned Revenue Unearned revenue as of the periods presented consisted of the following (table in millions): November 1, February 1, 2019 2019 Unearned license revenue $ 458 $ 255 Unearned software maintenance revenue 6,545 5,972 Unearned professional services revenue 882 751 Total unearned revenue$ 7,885 $ 6,978 Unearned license revenue is primarily related to the allocated portion of our SaaS offerings and is generally recognized over time as customers consume the services or ratably over the term of the subscription, commencing upon provisioning of the service. Unearned software maintenance revenue is attributable to our maintenance contracts and is generally recognized over time on a ratable basis over the contract duration. The weighted-average remaining contractual term as ofNovember 1, 2019 was approximately two years. In addition, unearned software maintenance revenue also includes the allocated portion of our SaaS offerings. Unearned professional services revenue results primarily from prepaid professional services and is generally recognized as the services are performed. Remaining Performance Obligations and Backlog Remaining Performance Obligations Remaining performance obligations represent the aggregate amount of the transaction price in contracts allocated to performance obligations not delivered, or partially undelivered, as of the end of the reporting period. Remaining performance obligations include unearned revenue, multi-year contracts with future installment payments and certain unfulfilled orders against accepted customer contracts at the end of any given period. As ofNovember 1, 2019 , the aggregate transaction price allocated to remaining performance obligations was$8.5 billion , of which approximately 55% is expected to be recognized as revenue over the next twelve months and the remainder thereafter. As ofFebruary 1, 2019 , the aggregate transaction price allocated to remaining performance obligations was$7.7 billion , of which approximately 56% was expected to be recognized as revenue during fiscal 2020, and the remainder thereafter. Backlog Backlog is comprised of unfulfilled purchase orders or unfulfilled executed agreements at the end of a given period and is net of related estimated rebates and marketing development funds. As ofNovember 1, 2019 , our total backlog was$71 million . Backlog primarily consists of licenses, maintenance and services. Our backlog related to licenses was$33 million , which we generally expect to deliver and recognize as revenue during the following quarter. Backlog totaling$10 million as ofNovember 1, 2019 was excluded from the remaining performance obligations because such contracts are subject to cancellation until fulfillment of the performance obligation occurs. As ofFebruary 1, 2019 , our total backlog was approximately$449 million and our backlog related to licenses was approximately$147 million . Backlog totaling$34 million as ofFebruary 1, 2019 was excluded from the remaining performance obligations because such contracts are subject to cancellation until fulfillment of the performance obligation occurs. The amount and composition of backlog will fluctuate period to period, and backlog is managed based upon multiple considerations, including product and geography. We do not believe the amount of backlog is indicative of future sales or 34
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revenue or that the mix of backlog at the end of any given period correlates with actual sales performance of a particular geography or particular products and services. Cost of License Revenue, Cost of Services Revenue and Operating Expenses Our cost of services revenue and operating expenses primarily reflected increasing cash-based employee-related expenses, driven by incremental growth in salaries and headcount, both organic and through acquisitions, across most of our income statement expense categories for the three and nine months endedNovember 1, 2019 . We expect increases in cash-based employee-related expenses to continue. Cost of License Revenue Cost of license revenue primarily consists of the cost of fulfillment of our software and SD-WAN offerings, royalty costs in connection with technology licensed from third-party providers and amortization of intangible assets. The cost of fulfillment of our software and SD-WAN offerings includes personnel costs and related overhead associated with the physical and electronic delivery of our products. Cost of license revenue during the periods presented was as follows (dollars in millions): Three Months Ended Nine Months Ended November 1, November 2, November 1, November 2, 2019 2018 $ Change % Change 2019 2018 $ Change % Change Cost of license revenue $ 59 $ 49$ 10 21 %$ 159 $ 138$ 20 15 % Stock-based compensation - - - 98 1 1 - 81 Total expenses $ 59 $ 49$ 10 22$ 160 $ 139$ 21 15 % of License revenue 6 % 5 % 6 % 5 % Cost of license revenue increased during the three and nine months endedNovember 1, 2019 compared to the three and nine months endedNovember 2, 2018 , but remained relatively consistent as a percentage of license revenue. The increase during the nine months endedNovember 1, 2019 was primarily due to increased amortization of intangible assets of$12 million . Cost of Services Revenue Cost of services revenue primarily includes the costs of personnel and related overhead to physically and electronically deliver technical support for our products, all hosted services supporting our SaaS offerings, and costs to deliver professional services. Additionally, cost of services revenue includes depreciation of equipment supporting our service offerings. Cost of services revenue during the periods presented was as follows (dollars in millions): Three Months Ended
Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
Cost of
services
revenue $ 301 $ 253 $ 49 19 % $ 886 $ 740 $ 146 20 %
Stock-based
compensation 18 13 4 34 50 37 14 38
Total
expenses $ 319 $ 266 $ 53 20 $ 936 $ 777 $ 160 21
% of
Services
revenue 22 % 20 % 22 % 20 %
Cost of services revenue increased during the three and nine months ended
November 1, 2019 compared to the three and nine months ended November 2, 2018 .
The increase was primarily due to growth in cash-based employee-related expenses
of $29 million and $71 million , respectively, during the three and nine months
ended November 1, 2019 , driven by incremental growth in headcount and salaries.
The increase during the nine months ended November 1, 2019 was also due to an
increase in costs associated with third-party hosting services to support our
SaaS offerings of $29 million and third-party professional services costs of $20
million , resulting from an increase in demand for technical support and
services. Equipment and depreciation of $18 million and amortization of
intangible assets of $14 million also contributed to the increase during the
nine months ended November 1, 2019 .
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Research and Development Expenses Research and development expenses include the personnel and related overhead associated with the development of our product software and service offerings. We continue to invest in our key growth areas, including NSX andVMware vSAN, while also investing in areas that we expect to be significant growth drivers in future periods, such as VMware Cloud on AWS. Research and development expenses during the periods presented were as follows (dollars in millions): Three Months Ended
Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
Research and
development $ 472 $ 401 $ 71 18 % $ 1,363 $ 1,161 $ 201 17 %
Stock-based
compensation 110 98 12 12 306 272 34 13
Total
expenses $ 582 $ 499 $ 83 17 $ 1,669 $ 1,433 $ 236 16
% of Total
revenue 24 % 23 % 23 % 22 %
Research and development expenses increased during the three and nine months
ended November 1, 2019 compared to the three and nine months ended November 2,
2018 . The increase was primarily due to growth in cash-based employee-related
expenses of $65 million and $162 million , respectively, during the three and
nine months ended November 1, 2019 driven by incremental growth in salaries and
headcount, both organic and through acquisitions. The increase was also driven
by an increase of stock-based compensation of $12 million and $34 million ,
respectively, during the three and nine months ended November 1, 2019 primarily
driven by an increase in restricted stock unit awards granted after the first
quarter of fiscal 2019. Equipment, depreciation and facilities related costs of
$37 million also contributed to the increase during the nine months ended
November 1, 2019 .
Sales and Marketing Expenses
Sales and marketing expenses include personnel costs, sales commissions and
related overhead associated with the sale and marketing of our license and
services offerings, as well as the cost of product launches and marketing
initiatives. A significant portion of our sales commissions are deferred and
recognized over the expected period of benefit.
Sales and marketing expenses during the periods presented were as follows
(dollars in millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
Sales and
marketing $ 760 $ 654 $ 106 16 % $ 2,219 $ 1,963 $ 258 13 %
Stock-based
compensation 67 53 13 25 183 147 34 23
Total
expenses $ 827 $ 707 $ 119 17 $ 2,402 $ 2,110 $ 292 14
% of Total
revenue 34 % 32 % 34 % 33 %
Sales and marketing expenses increased during the three and nine months ended
November 1, 2019 compared to the three and nine months ended November 2, 2018 .
The increase was primarily due to growth in cash-based employee-related expenses
of $80 million and $198 million , respectively, during the three and nine months
ended November 1, 2019 . The growth in cash-based employee-related expenses was
driven by incremental growth in salaries and headcount, both organic and through
acquisitions, as well as higher commission costs resulting from increased sales
volume. The increase was also driven by an increase in stock-based compensation
of $13 million and $34 million , respectively, during the three and nine months
ended November 1, 2019 primarily driven by an increase in restricted stock unit
awards granted after the first quarter of fiscal 2019. The increase during the
nine months ended November 1, 2019 was also driven by increased equipment and
depreciation of $19 million and increased amortization of intangible assets of
$11 million .
General and Administrative Expenses
General and administrative expenses include personnel and related overhead costs
to support the business. These expenses include the costs associated with
finance, human resources, IT infrastructure and legal, as well as expenses
related to corporate costs and initiatives, including certain charitable
donations to the VMware Foundation .
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General and administrative expenses during the periods presented were as follows (dollars in millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
General and
administrative $ 203 $ 150 $ 53 35 % $ 533 $ 455 $ 78 17 %
Stock-based
compensation 35 28 7 27 92 74 18 24
Total expenses $ 238 $ 178 $ 60 34 $ 625 $ 529 $ 96 18
% of Total
revenue 10 % 8 % 9 % 8 %
General and administrative expenses increased during the three and nine months
ended November 1, 2019 compared to the three and nine months ended November 2,
2018 primarily due to growth in cash-based employee-related expenses of
$25 million and $51 million , driven by incremental growth in headcount and
salaries, as well as an increase in compensation expense of $14 million and $30
million , respectively, relating to installment payments due to certain key
employees of our previous acquisitions that are subject to future employment
requirements. Acquisition-related costs also increased by $26 million and $27
million for the three and nine months ended November 1, 2019 , respectively,
primarily relating to the Carbon Black acquisition. Stock-based compensation of
$18 million also contributed to the increase during the nine months ended
November 1, 2019 , primarily driven by an increase in restricted stock unit
awards granted after the first quarter of fiscal 2019. The increase for the nine
months ended November 1, 2019 was also affected by the variability in timing and
amount of charitable donations.
Investment Income
Investment income during the periods presented was as follows (dollars in
millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
Investment
income $ 12 $ 63 $ (51 ) (81 )% $ 40 $ 168 $ (128 ) (76 )%
% of Total
revenue - % 3 % 1 % 3 %
Investment income decreased during the three and nine months ended November 1,
2019 compared to the three and nine months ended November 2, 2018 . The decrease
was primarily due to a decrease in interest income driven by the decline in our
cash equivalents and short-term investments as a result of the liquidation of
our fixed income investments that were used primarily to fund the $11.0 billion
special cash dividend paid during the fourth quarter of fiscal 2019. We expect
investment income during fiscal 2020 to decrease as compared to fiscal 2019,
primarily due to lower cash equivalent and short-term investment balances in
fiscal 2020.
Other Income (Expense), net
Other income (expense), net during the periods presented was as follows (dollars
in millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 $ Change % Change 2019 2018 $ Change % Change
Other
income
(expense),
net $ 263 $ (180 ) $ 442 246 % $ (97 ) $ 839 $ (934 ) (111 )%
% of Total
revenue 11 % 8 % 1 % 13 %
The change in other income (expense), net was primarily related to our
investment in Pivotal. To adjust our investment in Pivotal to its fair value, we
recognized an unrealized gain of $249 million and an unrealized loss of
$157 million during the three and nine months ended November 1, 2019 ,
respectively. Additionally, unrealized gains of $12 million and $35 million
related to our other strategic investments in privately held companies were
recognized for the three and nine months ended November 1, 2019 , respectively.
During the three and nine months ended November 2, 2018 , an unrealized loss of
$161 million and an unrealized gain of $851 million , including an unrealized
gain of $668 million recognized as a result of Pivotal's initial public
offering, respectively, were recognized to adjust our investment in Pivotal to
its fair value.
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The fair value of our investment is determined primarily using the quoted market
price of Pivotal's Class A common stock. As a result, any volatility in
Pivotal's publicly traded Class A common stock introduces variability to our
condensed consolidated statements of income.
Upon the closing of the proposed acquisition of Pivotal, our investment in
Pivotal, including any unrealized gain or loss previously recognized, will be
derecognized. The proposed acquisition will be accounted for as a transaction by
entities under common control, in which assets and liabilities transferred will
be recorded at their historical carrying amounts on the date of the transfer.
Refer to Note N to the condensed consolidated financial statements in Part I,
Item 1 of this Quarterly Report on Form 10-Q for disclosure regarding our
proposed acquisition of Pivotal.
Income Tax Provision
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
(Dollars in millions) 2019 2018 2019 2018
Income tax provision (benefit)
6.7 % 3.2 % N/M 16.2 %
N/M - Effective tax rate is not considered meaningful.
Our quarterly effective income tax rate is based on our estimated annual income tax rate forecast and discrete tax items recognized in the period. During the second quarter of fiscal 2020, we completed an intra-group transfer of certain of our intellectual property rights (the "IP") to our Irish subsidiary, where our international business is headquartered (the "IP Transfer"). The transaction will change our mix of international income from a lower non-U.S. tax jurisdiction toIreland , which is subject to a statutory tax rate of 12.5%. However, we do not expect our effective income tax rate to increase significantly in fiscal 2020, as we expect the income earned inIreland will largely be offset by certain tax deductions. A discrete tax benefit of$4.9 billion was recognized as a deferred tax asset during the nine months endedNovember 1, 2019 . This deferred tax asset was recognized as a result of the book and tax basis difference on the IP transferred toIreland . The tax amortization related to the IP transferred will be recognized in future periods and any amortization that is unused in a particular year can be carried forward indefinitely under Irish tax laws. The deferred tax asset and the tax benefit were measured based on the Irish tax rate expected to apply in the years the asset will be recovered. We expect to realize the deferred tax asset resulting from the IP Transfer and will assess the realizability of the deferred tax asset periodically. The impact of the transaction to net cash provided by or used in operating, investing and financing activities on our condensed consolidated statements of cash flows during the nine months endedNovember 1, 2019 was not material. The change in our effective income tax rate for the three and nine months endedNovember 1, 2019 as compared to the three and nine months endedNovember 2, 2018 was primarily driven by a discrete tax expense of$61 million and a discrete tax benefit of$39 million related to our book and tax basis difference on our investment in Pivotal for the three and nine months endedNovember 1, 2019 , respectively, as compared to a discrete tax benefit of$40 million and a discrete tax expense of$196 million , net of the reversal of the previously recorded valuation allowance, for the three and nine months endedNovember 2, 2018 , respectively. The change was also driven by a reduction in our unrecognized tax benefits of$53 million due to the expiration of statutes of limitations. We are included inDell's consolidated tax group forU.S. federal income tax purposes and will continue to be included inDell's consolidated tax group for periods in whichDell beneficially owns at least 80% of the total voting power and value of our combined outstanding Class A and Class B common stock as calculated forU.S. federal income tax purposes. The percentage of voting power and value calculated forU.S. federal income tax purposes may differ from the percentage of outstanding shares beneficially owned byDell due to the greater voting power of our Class B common stock as compared to our Class A common stock and other factors. Each member of a consolidated tax group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. ShouldDell's ownership fall below 80% of the total voting power or value of our outstanding stock in any period, then we would no longer be included in theDell consolidated tax group forU.S. federal income tax purposes, and ourU.S. federal income tax would be reported separately from that of theDell consolidated tax group. Although our results are included in theDell consolidated return forU.S. federal income tax purposes, our income tax provision is calculated primarily as though we were a separate taxpayer. However, under certain circumstances, transactions between us andDell are assessed using consolidated tax return rules. Our future effective tax rate will depend upon the proportion of our income before provision for income taxes earned in theU.S. and in jurisdictions with a tax rate lower than theU.S. statutory rate. Our non-U.S. earnings are primarily earned by our subsidiaries organized inIreland where the rate of taxation is lower than ourU.S. tax rate, and as such, our annual effective tax rate can be significantly affected by the composition of our earnings in theU.S. and non-U.S. jurisdictions. Our future effective 38
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tax rate is subject to variance arising from changes in international tax laws and may also be significantly affected by such factors, as changes in our business or statutory rates, changing interpretation of existing laws or regulations, the impact of accounting for stock-based compensation and the recognition of excess tax benefits and tax deficiencies within the income tax provision in the period in which they occur, the impact of accounting for business combinations, changes in the composition of earnings in theU.S. compared with other regions in the world and overall levels of income before tax, changes in our international organization, as well as the expiration of statute of limitations and settlements of audits. Our Relationship withDell As ofNovember 1, 2019 ,Dell controlled 31 million shares of Class A common stock and all 300 million shares of Class B common stock, representing 80.7% of our total outstanding shares of common stock and 97.5% of the combined voting power of our outstanding common stock. For a description of related risks, refer to "Risks Related to Our Relationship withDell " in Part II, Item 1A of this Quarterly Report on Form 10-Q. The information provided below includes a summary of the transactions entered into withDell andDell's consolidated subsidiaries, includingEMC Corporation (collectively, "Dell"). Transactions withDell We engaged withDell in the following ongoing related party transactions, which resulted in revenue and receipts, and unearned revenue for us: • Pursuant to original equipment manufacturer and reseller arrangements,
and sells them to end users.
our standalone products and services for resale to end-user customers
through
presented net of related marketing development funds and rebates paid to
Dell . In addition, we provide professional services to end users based upon contractual agreements withDell .
•
• Pursuant to an ongoing distribution agreement, we act as the selling agent
for certain products and services of Pivotal, a subsidiary of Dell , in
exchange for an agency fee. Under this agreement, cash is collected fromthe end user by us and remitted to Pivotal, net of the contractual agency
fee.
• From time to time, we and
technology projects, and Dell pays us for services or reimburses us for
costs incurred by us, in connection with such projects.
our channel partners. Information about our revenue and receipts, and unearned
revenue from such arrangements, for the periods presented consisted of the
following (table in millions):
Revenue and Receipts Unearned Revenue
Three Months Ended Nine Months Ended As of
November 1, November 2, November 1, November 2, November 1, February 1,
2019 2018 2019 2018 2019 2019
Reseller
revenue $ 730 $ 544 $ 2,076 $ 1,435 $ 3,031 $ 2,375
Internal-use
revenue 32 5 43 17 49 13
Agency fee
revenue - - 1 4 - -
Collaborative
technology
project
receipts 2 1 7 3 n/a n/a
Sales through Dell as a distributor, which is included in reseller revenue,
continues to grow rapidly.
Customer deposits resulting from transactions with Dell were $151 million and
$85 million as of November 1, 2019 and February 1, 2019 , respectively.
We engaged with Dell in the following ongoing related party transactions, which
resulted in costs to us:
• We purchase and lease products and purchase services from Dell .
• From time to time, we and
technology projects, and we pay Dell for services provided to us by Dell
related to such projects.
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• In certain geographic regions where we do not have an established legal
entity, we contract with
support from
mark-up intended to approximate costs that would have been incurred had we
contracted for such services with an unrelated third party. These costs
are included as expenses on our condensed consolidated statements of
income and primarily include salaries, benefits, travel and occupancy
expenses.
the U.S. that are recorded as expenses on our condensed consolidated
statements of income.
• In certain geographic regions, Dell files a consolidated indirect tax
return, which includes value added taxes and other indirect taxes
collected by us from our customers. We remit the indirect taxes to Dell
and Dell remits the tax payment to the foreign governments on our behalf.
• From time to time, we invoice end users on behalf of Dell for certain
services rendered by
from the end user by us and remitted to
Information about our payments for such arrangements during the periods presented consisted of the following (table in millions):
Three Months Ended Nine Months Ended
November 1, November 2, November 1, November 2,
2019 2018 2019 2018
Purchases and leases of products
and purchases of services(1) $ 60 $ 38 $ 196 $ 129
Dell subsidiary support and
administrative costs 14 25 60 79
(1) Amount includes indirect taxes that were remitted to Dell during the periods
presented.
We also purchase Dell products through Dell's channel partners. Purchases of
Dell products through Dell's channel partners were not significant during the
periods presented.
From time to time, we and Dell also enter into joint marketing, sales, branding
and product development arrangements, for which both parties may incur costs.
During the fourth quarter of fiscal 2020, we entered into an arrangement with
Dell to transfer approximately 250 employees from the Dell Technologies
Consulting group to us. These employees are experienced in providing
professional services delivering our technology and this transfer centralizes
these resources within the Company in order to serve our customers more
efficiently and effectively. The transfer is expected to be substantially
completed during the fourth quarter of fiscal 2020 and we also expect that Dell
will resell our consulting solutions to our customers.
Dell Financial Services ("DFS")
DFS provided financing to certain of our end users at our end users' discretion.
Upon acceptance of the financing arrangement by both our end users and DFS,
amounts classified as trade accounts receivable are reclassified to due from
related parties, net on the condensed consolidated balance sheets. Revenue
recognized on transactions financed through DFS was recorded net of financing
fees of $34 million and $29 million during the nine months ended November 1,
2019 and November 2, 2018 , respectively. Financing fees during the three months
ended November 1, 2019 and November 2, 2018 were not significant.
Tax Sharing Agreement with Dell
The following table summarizes the payments made to Dell pursuant to a tax
sharing agreement during the periods presented (table in millions):
Three Months Ended Nine Months Ended
November 1 ,November 2 ,
2019 2018 2019 2018
Payments from
132 $ 103
Payments from us toDell under the tax sharing agreement relate to our portion of federal income taxes onDell's consolidated tax return as well as state tax payments for combined states. The timing of the tax payments due to and from related parties is governed by the tax sharing agreement. Our portion of the mandatory one-time transition tax on accumulated earnings of foreign subsidiaries (the "Transition Tax") is governed by a letter agreement betweenDell ,EMC Corporation and 40
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us executed during the first quarter of fiscal 2020 (the "Letter Agreement"). The amounts that we pay toDell for our portion of federal income taxes onDell's consolidated tax return differ from the amounts we would owe on a separate tax return basis and the difference is recognized as a component of additional paid-in capital, generally in the period in which the consolidated tax return is filed. The difference between the amount of tax calculated on a separate tax return basis and the amount of tax calculated pursuant to the tax sharing agreement recorded in additional paid-in capital during the nine months endedNovember 1, 2019 was$85 million , primarily due to a reduction in Transition Tax liability based on the terms of the Letter Agreement and certain tax attribute determination made byDell . The amount recognized in additional paid-in capital during the three months endedNovember 1, 2019 and the three and nine months endedNovember 2, 2018 was not significant. During the third quarter of fiscal 2020, we andDell entered into a support agreement in connection with our entry into a definitive agreement to acquire Pivotal, which provides that, prior to the close of the proposed acquisition of Pivotal, we andDell will execute an amended tax sharing agreement that will, subject to certain exceptions, generally limit our maximum annual tax liability toDell to the amount we would owe on a separate tax return basis. Due To/From Related Parties, Net Amounts due to and from related parties, net as of the periods presented consisted of the following (table in millions):November 1 , February
1,
2019 2019
Due from related parties, current $ 906 $ 1,079
Due to related parties, current(1) 153
142
Due from related parties, net, current(2) $ 753 $ 937
Income tax due to related parties, current $ 60 $ - Income tax due to related parties, non-current
492 646
(1) Includes an immaterial amount related to our current operating lease liabilities due to related parties as ofNovember 1, 2019 . (2) We also recognized an immaterial amount related to non-current operating lease liabilities due to related parties. This amount has been included in operating lease liabilities on the condensed consolidated balance sheets as ofNovember 1, 2019 . Amounts included in due from related parties, net, excluding DFS and tax obligations, includes the current portion of amounts due to and due from related parties. Amounts included in due from related parties, net are generally settled in cash within 60 days of each quarter-end. Notes Payable toDell OnJanuary 21, 2014 , we entered into a note exchange agreement with our parent company providing for the issuance of three promissory notes in the aggregate principal amount of$1.5 billion , which consisted of outstanding principal due on the following dates:$680 million dueMay 1, 2018 ,$550 million dueMay 1, 2020 and$270 million dueDecember 1, 2022 . OnAugust 21, 2017 , we repaid two of the notes payable toDell in the aggregate principal amount of$1.2 billion , representing repayment of the note dueMay 1, 2018 at par value and repayment of the note dueMay 1, 2020 at a discount. The remaining note payable of$270 million dueDecember 1, 2022 may be prepaid without penalty or premium. Interest is payable quarterly in arrears at the annual rate of 1.75%. During the three and nine months endedNovember 1, 2019 andNovember 2, 2018 , interest expense on the notes payable toDell was not significant. Pivotal Prior to Pivotal's initial public offering onApril 20, 2018 , our previously held preferred shares were converted to shares of non-trading Class B common stock, resulting in us having a financial interest of 17% and a voting interest of 24% in Pivotal as ofFebruary 1, 2019 . As ofNovember 1, 2019 , we had a financial interest of 16% and a voting interest of 24% in Pivotal. During the three and nine months endedNovember 1, 2019 , we recognized an unrealized gain of$249 million and an unrealized loss of$157 million , respectively, to adjust our investment in Pivotal to its fair value. During the three and nine months endedNovember 2, 2018 , we recognized an unrealized loss of$161 million and an unrealized gain of$851 million , respectively, to adjust our investment in Pivotal to its fair value, including an unrealized gain of$668 million recognized as a result of Pivotal's initial public offering. Refer to Note I and Note N to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for disclosure regarding our current investment in Pivotal and our proposed acquisition of Pivotal. 41
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Liquidity and Capital Resources As of the periods presented, we held cash, cash equivalents and short-term investments as follows (table in millions):
November 1, February 1,
2019 2019
Cash and cash equivalents $ 2,025 $ 2,830
Short-term investments - 19
Total cash, cash equivalents and short-term investments
Cash equivalents primarily consisted of amounts invested in money market funds. We limit the amount of our investments with any single issuer and monitor the diversity of the portfolio and the amount of investments held at any single financial institution, thereby diversifying our credit risk. We continue to expect that cash generated by operations will be our primary source of liquidity. Upon the closing of the proposed acquisition of Pivotal, we will pay$15.00 per share in cash to the stockholders of Pivotal's Class A common shares, and our Class B common shares will be exchanged for Pivotal's Class B common shares held byDell , resulting in an expected net cash payout of$0.8 billion and issuance of approximately 7.2 million shares of our Class B common stock toDell . Notwithstanding the impact from the proposed acquisition, we continue to believe that existing cash, cash equivalents and investments, and our borrowing capacity, together with any cash generated from operations, will be sufficient to fund our operations for at least the next twelve months. As a result of the enactment of the 2017 Tax Cuts and Jobs Act ("2017 Tax Act"), we have greater flexibility to repatriate foreign earnings in future periods without significantU.S. tax impact. While we believe these cash sources will be sufficient to fund our operations, our overall level of cash needs may be affected by capital allocation decisions that may include the number and size of acquisitions and stock repurchases, among other things. We remain committed to a balanced capital allocation policy through investing in our product and solution offerings, acquisitions and returning capital to stockholders through share repurchases. Additionally, given the unpredictable nature of our outstanding legal proceedings, an unfavorable resolution of one or more legal proceedings, claims, or investigations could have a negative impact on our overall liquidity. The 2017 Tax Act imposed a Transition Tax and eliminatesU.S. Federal taxes on foreign subsidiary distributions. The Transition Tax was calculated on a separate tax return basis. Our unpaid liabilities related to the Transition Tax as ofNovember 1, 2019 was$557 million , which we expect to pay over the next six years pursuant to the Letter Agreement. Actual tax payments made toDell pursuant to the tax sharing agreement may differ materially from our total estimated tax liability calculated on a separate tax return basis. The difference between our estimated liability and the amount paid toDell is recognized as a component of additional paid-in capital, generally in the period in which the consolidated tax return is filed. During the nine months endedNovember 1, 2019 ,$84 million was recognized, primarily due to a reduction in Transition Tax liability based on the terms of the Letter Agreement and certain tax attribute determination made byDell , and the amount was recognized as a component of additional paid-in capital. Our cash flows summarized for the periods presented were as follows (table in millions): Nine Months Ended November 1, November 2, 2019 2018 Net cash provided by (used in): Operating activities $ 2,782$ 2,651 Investing activities (2,646 ) 634 Financing activities (880 ) (55 ) Net increase (decrease) in cash, cash equivalents and restricted cash $ (744 )$ 3,230 Operating Activities Cash provided by operating activities increased by$131 million during the nine months endedNovember 1, 2019 compared to the nine months endedNovember 2, 2018 . Cash provided by operating activities benefited from an increase in cash collections due to increased sales. The increase was partially offset by increased cash payments for operating expenses and employee-related expenses, including salaries, bonuses and commissions, resulting primarily from growth in headcount, as well as decreased investment income from our available-for-sale securities as a result of the liquidation of our fixed income investments used to fund the payment of the$11.0 billion special cash dividend during the fourth quarter of fiscal 2019. 42
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Investing Activities Cash used in investing activities is generally attributable to the purchase of available-for-sale securities, business acquisitions and capital expenditures. Cash provided by investing activities is affected by the sales and maturities of our available-for-sale securities. Cash used in investing activities increased by$3.3 billion during the nine months endedNovember 1, 2019 compared to the nine months endedNovember 2, 2018 , driven primarily by higher business combinations activities during the nine months endedNovember 1, 2019 primarily due to$2.0 billion paid to acquireCarbon Black . Additionally, cash used in investing activities was also driven by decreased net proceeds from our available-for-sale securities as a result of the liquidation of our fixed income investments used to fund the payment of the$11.0 billion special cash dividend during the fourth quarter of fiscal 2019. Financing Activities Cash used in financing activities increased by$825 million during the nine months endedNovember 1, 2019 compared to the nine months endedNovember 2, 2018 . The increase was primarily a result of an increase in the repurchase of our common stock activity of$1.3 billion , partially offset by borrowing and repayment of our senior unsecured term loan facility (the "Term Loan"), which resulted in net cash inflow of$593 million . Unsecured Senior Notes OnAugust 21, 2017 , we issued three series of unsecured notes ("Senior Notes") pursuant to a public debt offering in the aggregate principal amount of$4.0 billion . The carrying value of the Senior Notes as ofNovember 1, 2019 was as follows (amounts in millions): Senior Notes: 2.30% Senior Note DueAugust 21, 2020 $ 1,250 2.95% Senior Note DueAugust 21, 2022 1,500 3.90% Senior Note DueAugust 21, 2027 1,250 Total principal amount$ 4,000 Interest is payable semiannually in arrears, onFebruary 21 andAugust 21 of each year. During each of the nine months endedNovember 1, 2019 andNovember 2, 2018 ,$122 million was paid for interest related to the Senior Notes. The Senior Notes also include restrictive covenants that, in certain circumstances, limit our ability to create certain liens, to enter into certain sale and leaseback transactions and to consolidate, merge, sell or otherwise dispose of all or substantially all of our assets. Revolving Credit Facility OnSeptember 12, 2017 , we entered into a Credit Facility with a syndicate of lenders that provides us with a borrowing capacity of up to$1.0 billion , for general corporate purposes. The credit agreement contains certain representations, warranties and covenants. Commitments under the Credit Facility are available for a period of five years, which may be extended, subject to the satisfaction of certain conditions, by up to two one-year periods. As ofNovember 1, 2019 , there were no outstanding borrowings under the Credit Facility. Senior Unsecured Term Loan Facility OnSeptember 26, 2019 , we entered into the Term Loan with a syndicate of lenders that provides us with a borrowing capacity of up to$2.0 billion , for general corporate purposes. We may borrow against the Term Loan two times up to its borrowing capacity of$2.0 billion untilFebruary 7, 2020 . The Term Loan matures on the 364th day following the initial funding under the Term Loan. The Term Loan bears interest at theLondon interbank offered rate plus 0.75% to 1.25%, or an alternate base rate plus 0.00% to 0.25%, depending on our external credit ratings. As ofNovember 1, 2019 , the weighted-average interest rate on the outstanding Term Loan was 2.67%. We drew down$2.0 billion and repaid$1.4 billion during the third quarter of fiscal 2020. As ofNovember 1, 2019 , the outstanding balance of$599 million , net of unamortized debt issuance costs, on the Term Loan was included in current portion of long-term debt and other borrowings on the condensed consolidated balance sheets, and$1.4 billion remained available for future borrowing purposes. The Term Loan contains certain representations, warranties and covenants. Commitment fees paid and interest expense, including amortization of issuance costs, for the Term Loan were not significant during the three and nine months endedNovember 1, 2019 . 43
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Note Payable toDell As ofNovember 1, 2019 , the carrying value of the outstanding note payable toDell dueDecember 1, 2022 was$270 million . Interest is payable quarterly in arrears at the annual rate of 1.75%. The amount paid for interest related to the Note was not significant during the nine months endedNovember 1, 2019 andNovember 2, 2018 . Stock Repurchase Program From time to time, we repurchase stock pursuant to authorized stock repurchase programs in open market transactions as permitted by securities laws and other legal requirements. We are not obligated to purchase any shares under our stock repurchase programs. The timing of any repurchases and the actual number of shares repurchased depends on a variety of factors, including our stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. Purchases can be discontinued at any time we believe additional purchases are not warranted. From time to time, we also purchase stock in private transactions, such as withDell . All shares repurchased under our stock repurchase programs are retired. OnMay 29, 2019 , our board of directors authorized the repurchase of up to an additional$1.5 billion of Class A common stock through the end of fiscal 2021. The$1.5 billion authorization is in addition to our ongoing stock repurchase program authorized inAugust 2017 . As ofNovember 1, 2019 , the cumulative authorized amount remaining for stock repurchases was$1.1 billion . Refer to Note L to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion. Critical Accounting Policies and Estimates In preparing our condensed consolidated financial statements in accordance with accounting principles generally accepted inthe United States of America ("GAAP"), we are required to make estimates, assumptions and judgments that affect the amounts reported on our financial statements and the accompanying disclosures. Estimates and assumptions about future events and their effects cannot be determined with certainty and therefore require the exercise of judgment. We base our estimates, assumptions and judgments on historical experience and various other factors that we believe to be reasonable under the circumstances. These estimates may change, as new events occur and additional information is obtained, and are recognized in the condensed consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to our financial statements. We believe that the critical accounting policies and estimates set forth within Part II, Item 7, "Critical Accounting Policies and Estimates" of our Form 10-K filed onMarch 29, 2019 involve a higher degree of judgment and complexity in their application than our other significant accounting policies. Our senior management has reviewed our critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. During the three months endedNovember 1, 2019 , except for the change in critical accounting policies and estimates related to the business combinations described below, there were no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Form 10-K. Business Combinations We allocate the purchase price of acquirees to the identifiable assets acquired, the liabilities assumed, and any noncontrolling 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. The allocation of the purchase price requires us to make 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. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates used in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: • future expected cash flows from sales, maintenance agreements and acquired
developed technologies;
• the acquired company's trade name and customer relationships as well as
assumptions about the period of time the acquired trade name and customer
relationships will continue to be used in the combined company's product
portfolio;
• discount rates used to determine the present value of estimated future
cash flows.
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These estimates are inherently uncertain and unpredictable, and if different estimates were used the purchase price for the acquisition could be allocated to the acquired assets and liabilities differently from the allocation that we have made. Additionally, unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical fact could be deemed forward-looking statements, and words such as "expect," "anticipate," "target," "goal," "project," "intent," "plan," "believe," "momentum," "seek," "estimate," "continue," "potential," "future," "endeavor," "will," "may," "should," "could," "depend," "predict," and variations or the negative expression of such words and similar expressions are intended to identify forward-looking statements. Forward-looking statements in this report include statements relating to expected industry trends and conditions; future financial performance, trends or plans; anticipated impacts of developments in accounting rules and tax laws and rates;VMware's expectations regarding the timing of tax payments and the impact of a recent change inVMware's corporate structure; plans for and anticipated benefits ofVMware products, services and solutions and partner and alliance relationships; plans for, timing of and anticipated benefits of corporate transactions, acquisitions, stock repurchases and investment activities; the outcome or impact of pending litigation, claims or disputes; and any statements of assumptions underlying any of the foregoing. These statements are based on current expectations about the industries in whichVMware operates and the beliefs and assumptions of management. These forward-looking statements involve risks and uncertainties and the cautionary statements set forth above and those contained in the section of this report entitled "Risk Factors" identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof. We assume no obligation to, and do not currently intend to, update these forward-looking statements. Available Information Our website is located at www.vmware.com, and our investor relations website is located at http://ir.vmware.com. Our goal is to maintain the investor relations website as a portal through which investors can easily find or navigate to pertinent information about us, all of which is made available free of charge, including: • our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and any amendments to those reports, as soon as
reasonably practicable after we electronically file that material with or
furnish it to the
• announcements of investor conferences, speeches and events at which our
executives discuss our products, services and competitive strategies;
• webcasts of our quarterly earnings calls and links to webcasts of investor
conferences at which our executives appear (archives of these events are
also available for a limited time);
• additional information on financial metrics, including reconciliations of
non-GAAP financial measures discussed in our presentations to the nearest
comparable GAAP measure;
• press releases on quarterly earnings, product and service announcements,
legal developments and international news;
• corporate governance information including our certificate ofincorporation, bylaws, corporate governance guidelines, board committee
charters, business conduct guidelines (which constitutes our code of
business conduct and ethics) and other governance-related policies;
• other news, blogs and announcements that we may post from time to time
that investors might find useful or interesting; and
• opportunities to sign up for email alerts and RSS feeds to have
information pushed in real time.
The information found on our website is not part of, and is not incorporated by
reference into, this or any other report we file with, or furnish to, the SEC .
The SEC also maintains a website at www.sec.gov that contains reports, proxy and
information statements, and other information regarding issuers that file
electronically with the SEC .
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