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 ofOctober 28, 2022 should be read in conjunction with our consolidated financial statements for the year endedJanuary 28, 2022 contained in our Annual Report on Form 10-K filed onMarch 24, 2022 . Our fiscal year is the 52 or 53 weeks ending on the Friday nearest toJanuary 31 of each year. We refer to our fiscal years endingFebruary 2, 2024 andFebruary 3, 2023 , and fiscal year endedJanuary 28, 2022 as "fiscal 2024," "fiscal 2023" and "fiscal 2022," respectively. Fiscal 2023 is a 53-week fiscal year, in which the first three quarters each has 13 weeks while the fourth quarter has 14 weeks. Fiscal 2024 and fiscal 2022 are each 52-week fiscal years. Period-over-period changes are calculated based upon the respective underlying non-rounded data. 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, and then evolved to become the private cloud and
mobility management leader. Building upon that leadership, we are focused on
becoming the multi-cloud leader. Information technology ("IT") driven innovation
continues to disrupt markets and industries. Technologies emerge faster than
organizations can absorb, creating increasingly complex environments.
Organizations' IT departments and corporate divisions are working at an
accelerated pace to harness new technologies, platforms and cloud models,
ultimately guiding businesses and their product teams through a digital
transformation. To take on these challenges, we are helping customers drive
their multi-cloud strategy by providing the multi-cloud platform for all
applications, enabling digital innovation and enterprise control.
Our portfolio supports and addresses our customers' key priorities, including
modernizing their applications, managing multi-cloud environments, accelerating
their cloud journey, modernizing the network using commodity hardware, embracing
zero-trust security and empowering anywhere workspaces. We enable digital
transformations of customers' applications, infrastructure and operations for
their constantly evolving business and employee needs.
End users can purchase the full breadth of our subscription,
software-as-a-service ("SaaS"), license and services portfolio through discrete
purchases or through enterprise agreements ("EAs"). EAs are sold to our direct
customers and through channel partners and can include our license, multi-year
maintenance and support, subscription and SaaS offerings.
During the nine months ended October 28, 2022 , we continued to see an increase
in the portion of our sales occurring through our subscription and SaaS
offerings compared to the portion of our on-premises solutions sold as perpetual
licenses. We expect this trend to continue, and as a result, a greater portion
of our revenue will be recognized over time as subscription and SaaS revenue
rather than license revenue, which is typically recognized in the fiscal period
in which sales occur. As this trend continues, the rate of growth in our license
revenue, which has historically been viewed as a leading indicator of our
business performance, has and will likely continue to be less relevant on a
standalone basis, and we believe that the overall growth rate of our combined
license and subscription and SaaS revenue and annual recurring revenue for
subscription and SaaS, as well as the growth in the current portion of our
remaining performance obligations, will become better indicators of our future
growth prospects. In addition, we expect our operating margin to be negatively
impacted in fiscal 2023 as a result of our incremental investment in our
subscription and SaaS portfolio.
Broadcom Merger Agreement
OnMay 26, 2022 , we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Broadcom Inc. ("Broadcom"). Under the terms of the Merger Agreement, each share of our Class A common stock ("Common Stock"), par value$0.01 per share, issued and outstanding immediately prior to the effective time of the transaction will be indirectly converted into the right to receive, at the election of the holder of such share of Common Stock, and subject to proration in accordance with the Merger Agreement as described below: (i)$142.50 per share in cash, without interest (the "Cash Consideration"), or (ii) 0.25200 (the "Exchange Ratio") shares of common stock, par value$0.001 per share, of Broadcom ("Broadcom Common Stock", and such consideration, the "Stock Consideration"). The stockholder election will be subject to a proration mechanism, such that the total number of shares of Common Stock entitled to receive the Cash Consideration, and the total number of shares of Common Stock entitled to receive the Stock Consideration, will, in each case, be equal to 50% of the aggregate number of shares of Common Stock issued and outstanding immediately prior to the consummation of the transaction. Holders of Common Stock that do not make an election will be treated as having elected to receive the Cash Consideration or the Stock Consideration in accordance with the proration methodology in the Merger Agreement. 27
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The transaction, which is expected to be consummated in Broadcom's fiscal year 2023, was approved byVMware shareholders at a special meeting held onNovember 4, 2022 but remains subject to the receipt of regulatory approvals and other customary closing conditions. If the transaction is consummated, the Common Stock will be delisted from theNew York Stock Exchange and deregistered under the Securities Exchange Act of 1934, as amended.
Business Operations in
In response to Russian military actions inUkraine , we suspended sales and services inRussia andBelarus , including support on existing contracts and professional services in the first quarter of fiscal 2023. Furthermore,the United States ("U.S.") and other countries have imposed sanctions onRussia that have impacted our future revenue streams from affected customers. During the second quarter of fiscal 2023, we ceased our business operations inRussia entirely. The impact of these events on our condensed consolidated financial statements during the nine months endedOctober 28, 2022 was not material as a percentage of total consolidated revenue, and we do not expect the impact to be material in future periods. We do not expect the cessation of business operations will have an impact on our existing contracts with customers inRussia andBelarus ifU.S. and international restrictions and sanctions are lifted. We continue to closely monitor the ongoing situation inRussia andBelarus .
Results of Operations
Approximately 70% of our sales are denominated in theU.S. dollar. In certain countries, however, we also invoice and collect in various foreign currencies, principally euro, British pound, Japanese yen, Australian dollar and Chinese renminbi. In addition, we incur and pay operating expenses in currencies other than theU.S. dollar. As a result, our financial statements, including our revenue, operating expenses, unearned revenue and the resulting cash flows derived from theU.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
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Revenue:
License $ 621 $ 710 $ (89) (13) % $ 1,990 $ 2,093 $ (104) (5) %
Subscription and SaaS 988 820 168 20 2,830 2,336 493 21
Total license and
subscription and SaaS 1,609 1,530 79 5 4,820 4,429 390 9
Services:
Software maintenance 1,298 1,354 (56) (4) 3,907 4,011 (104) (3)
Professional services 304 304 - - 908 880 30 3
Total services 1,602 1,658 (56) (3) 4,815 4,891 (74) (2)
Total revenue $ 3,211 $ 3,188 $ 23 1 $ 9,635 $ 9,320 $ 316 3
Revenue:
United States $ 1,614 $ 1,582 $ 33 2 % $ 4,780 $ 4,587 $ 194 4 %
International 1,597 1,606 (9) (1) 4,855 4,733 122 3
Total revenue $ 3,211 $ 3,188 $ 23 1 $ 9,635 $ 9,320 $ 316 3
Revenue from our subscription offerings consisted primarily of our VMware Cloud
Provider Program cloud-based offerings that are billed to customers on a
consumption basis and revenue from VMware Tanzu and other offerings that are
billed on a subscription basis. Revenue from our SaaS offerings consisted
primarily of our Workspace ONE Unified Endpoint Management, VMware Carbon Black
Cloud, VMware Cloud on AWS, VMware SD-WAN by VeloCloud and CloudHealth by
VMware .
License revenue relating to the sale of on-premises licenses that are part of a
multi-year contract is generally recognized upon delivery of the underlying
license, whereas revenue derived from our subscription and SaaS offerings is
generally
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recognized over time as customers consume the services or ratably over the term of the subscription, commencing upon provisioning of the service.
As customers adopt our subscription and SaaS offerings, license and software maintenance revenue has been, and may continue to be, lower and subject to greater fluctuation in the future, driven by a higher proportion of our sales occurring through our subscription and SaaS offerings as well as the variability of large deals between fiscal quarters, which deals historically have had a large license revenue impact. Furthermore, during the three months endedOctober 28, 2022 , we introduced termination for convenience ("TFC") clauses with respect to term license offerings in certain EAs. Revenue on such term license offerings subject to TFC clauses is recognized ratably as subscription and SaaS revenue, rather than as license revenue, due to the requirement to refund any unused, pre-paid fees upon termination. Although the impact of sales of term license offerings subject to TFC clauses was not significant to license revenue recognized on our condensed consolidated financial statements during the three months endedOctober 28, 2022 , any concentration of such sales in any given future period could have a material negative impact on our license revenue in such future periods.
License Revenue
License revenue decreased during the three and nine months endedOctober 28, 2022 compared to the three and nine months endedOctober 29, 2021 , largely due to increased sales occurring through our subscription and SaaS offerings compared to the portion of our on-premises solutions sold as perpetual licenses, as we continue to transition our portfolio from a perpetual license model to subscription and SaaS offerings.
Subscription and SaaS Revenue
Subscription and SaaS revenue increased during the three and nine months endedOctober 28, 2022 compared to the three and nine months endedOctober 29, 2021 , primarily due to increased sales of our Workspace ONE, vRealize Cloud Management, VMware Cloud on AWS and other major hyperscalers, and VMware Tanzu offerings. Annual recurring revenue ("ARR") represents the annualized value of our committed customer subscription and SaaS contracts as of the end of the reporting period, assuming any contract that expires during the next 12 months is renewed on its existing terms and any applicable TFC clauses are not exercised, except that, for consumption-based subscription and SaaS offerings, ARR represents the annualized quarterly revenue based on revenue recognized for the current reporting period. ARR is an operating measure we use to assess the strength of our subscription and SaaS offerings. ARR is a performance metric and should be viewed independently of, and not as a substitute for or combined with, revenue and unearned revenue. ARR was$4.1 billion as ofOctober 28, 2022 and$3.3 billion as ofOctober 29, 2021 .
Services Revenue
Software maintenance revenue decreased during the three and nine months endedOctober 28, 2022 compared to the three and nine months endedOctober 29, 2021 , largely due to the continued shift in demand from our on-premises licenses sold with the associated software maintenance to cloud-based solutions. In each period presented, customers purchased, on a weighted-average basis, greater than three years of support and maintenance with each new license purchased. Professional services remained flat during the three months endedOctober 28, 2022 compared to the three months endedOctober 29, 2021 . Professional services revenue increased during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 . Services we provide through our consultants and technical account managers, and our continued focus on solution deployments, including our networking, security, cloud management and digital workspace offerings, contributed to the increase in professional services revenue. Our professional services revenue may vary, as we continue to enable our partners to deliver professional services for our solutions. Further, the timing of services rendered 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):
October 28, January 28,
2022 2022
Unearned license revenue $ 28 $ 19
Unearned subscription and SaaS revenue 3,197 2,669
Unearned software maintenance revenue 6,636 7,208
Unearned professional services revenue 1,356 1,326
Total unearned revenue $ 11,217 $ 11,222
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Unearned subscription and SaaS revenue 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 ratably over the contract duration. The weighted-average remaining contractual term as ofOctober 28, 2022 was approximately two years. 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, non-cancellable customer contracts at the end of any given period.
As ofOctober 28, 2022 , the aggregate transaction price allocated to remaining performance obligations was$11.9 billion , of which approximately 56% is expected to be recognized as revenue over the next twelve months and the remainder thereafter. As ofJanuary 28, 2022 , the aggregate transaction price allocated to remaining performance obligations was$12.0 billion , of which approximately 57% was expected to be recognized as revenue during fiscal 2023 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. Backlog consists of licenses, subscription and SaaS and services. As ofOctober 28, 2022 , our total backlog was$85 million , substantially all of which consisted of orders received on the last day of the quarter that were not shipped or provisioned to customers, and orders held due to our export control process. Backlog related to license was not material as ofOctober 28, 2022 . For our backlog related to licenses, we generally expect to deliver and recognize revenue during the following quarter. Backlog totaling$35 million as ofOctober 28, 2022 was excluded from the remaining performance obligations because such contracts are subject to cancellation until the performance obligation is fulfilled. As ofJanuary 28, 2022 , our total backlog was$88 million and our backlog related to licenses was$14 million . Backlog totaling$36 million as ofJanuary 28, 2022 was excluded from the remaining performance obligations because such contracts are subject to cancellation until the performance obligation is fulfilled. The amount and composition of backlog will fluctuate period to period. We do not believe the amount of backlog is indicative of future sales or 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 Subscription and SaaS Revenue, Cost of Services Revenue and Operating Expenses
Collectively, our cost of license revenue, cost of subscription and SaaS revenue, cost of services revenue and operating expenses primarily reflected increasing cash-based employee-related expenses, driven by an increase in headcount and salaries across most of our income statement expense categories during the three and nine months endedOctober 28, 2022 .
Cost of License Revenue
Cost of license revenue primarily consists of the cost of fulfillment of our
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 hardware SD-WAN offerings includes personnel
costs and related overhead associated with delivery of our products.
Cost of license revenue during the periods presented was as follows (dollars in
millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % ChangeCost of license revenue$ 39 $ 37 $ 2 5 %$ 112 $ 110 $ 1 1 % Stock-based compensation - - - 41 1 1 - - Total expenses$ 39 $ 37 $ 2 6$ 113 $ 111 $ 1 1 % of License revenue 6 % 5 % 6 % 5 % 30
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Cost of license revenue remained relatively flat during the three and nine
months ended
Cost of Subscription and SaaS Revenue
Cost of subscription and SaaS revenue primarily includes personnel costs and related overhead associated with hosted services supporting our SaaS offerings. Additionally, cost of subscription and SaaS revenue also includes depreciation of equipment supporting our subscription and SaaS offerings.
Cost of subscription and SaaS revenue during the periods presented was as follows (dollars in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Cost of subscription
and SaaS revenue $ 189 $ 170 $ 19 11 % $ 565 $ 486 $ 79 16 %
Stock-based
compensation 7 5 2 45 18 16 2 14
Total expenses $ 196 $ 175 $ 21 12 $ 583 $ 502 $ 81 16
% of Subscription and
SaaS revenue 20 % 21 % 21 % 21 %
Cost of subscription and SaaS revenue increased during the three months ended
October 28, 2022 compared to the three months ended October 29, 2021 , primarily
driven by an increase in costs associated with hosted services that support our
SaaS offerings.
Cost of subscription and SaaS revenue increased during the nine months ended
October 28, 2022 compared to the nine months ended October 29, 2021 . The
increase was primarily driven by growth in costs associated with hosted services
to support our SaaS offerings of $53 million and growth in cash-based
employee-related cost of $23 million , which was primarily driven by incremental
growth in headcount. In addition, the increase was driven by increased equipment
and depreciation of $16 million .
Cost of Services Revenue
Cost of services revenue primarily includes the costs of personnel and related overhead to deliver technical support for our products 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
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Cost of services revenue $ 353 $ 341 $ 12 4 % $ 1,049 $ 981 $ 68 7 %
Stock-based compensation 31 21 9 43 79 70 9 12
Total expenses $ 384 $ 362 $ 22 6 $ 1,128 $ 1,051 $ 77 7
% of Services revenue 24 % 22 % 23 % 21 %
Cost of services revenue increased during the three months ended
Cost of services revenue increased during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 . The increase was primarily due to growth in cash-based employee-related expenses of$44 million , primarily driven by incremental growth in headcount and salaries, as well as increased travel-related expenses, primarily resulting from lifted travel restrictions previously imposed in response to the COVID-19 pandemic. 31
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Research and Development Expenses
Research and development expenses include personnel and related overhead costs associated with the development of our products and services offerings. We continue to invest in and focus on expanding our subscription and SaaS offerings.
Research and development expenses during the periods presented were as follows
(dollars in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Research and development $ 669 $ 643 $ 25 4 % $ 1,968 $ 1,849 $ 119 6 %
Stock-based compensation 163 125 38 31 441 402 39 10
Total expenses $ 832 $ 768 $ 63 8 $ 2,409 $ 2,251 $ 158 7
% of Total revenue 26 % 24 % 25 % 24 %
Research and development expenses increased during the three months ended
October 28, 2022 compared to the three months ended October 29, 2021 . The
increase was primarily due to increased stock-based compensation expense of $38
million , primarily driven by increased restricted stock unit ("RSU") awards
granted to our employees, and increased cash-based employee-related expenses of
$32 million , primarily driven by an increase in headcount and salaries. The
increases was partially offset by increased capitalized internal-use software
development costs.
Research and development expenses increased during the nine months ended
October 28, 2022 compared to the nine months ended October 29, 2021 . The
increase was primarily due to growth in cash-based employee-related expenses of
$113 million , primarily driven by incremental growth in headcount and salaries.
The increase was also driven by increased stock-based compensation expense of
$39 million , primarily driven by increased RSU awards granted to our employees,
and increased equipment, depreciation and facilities-related costs of $32
million . These increases were partially offset by increased capitalized
internal-use software development costs of $50 million .
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, subscription and SaaS 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
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Sales and marketing
5 % $ 2,938 $ 2,766 $ 175 6 %
Stock-based compensation 104 74 30 40 278 227 51 22
Total expenses $ 1,081 $ 1,011 $ 72 7 $ 3,216 $ 2,993 $ 225 8
% of Total revenue 34 % 32 % 33 % 32 %
Sales and marketing expenses increased during the three months ended October 28,
2022 compared to the three months ended October 29, 2021 . The increase was
primarily driven by increased stock-based compensation of $30 million , primarily
driven by increased RSU awards granted to our employees, and higher commission
costs of $23 million resulting from increased sales volume. The increase was
also driven by increased travel-related expenses of $15 million , primarily
resulting from lifted travel restrictions previously imposed in response to the
COVID-19 pandemic.
Sales and marketing expenses increased during the nine months ended October 28,
2022 compared to the nine months ended October 29, 2021 . The increase was
primarily due to higher commission costs of $60 million , resulting from
increased sales volume, and increased stock-based compensation of $51 million ,
primarily driven by increased RSU awards granted to our employees. The increase
was also driven by increased travel-related expenses of $50 million , primarily
resulting from lifted travel restrictions previously imposed in response to the
COVID-19 pandemic, as well as an increase in cash-based employee-related
expenses of $38 million , primarily driven by incremental growth in headcount and
salaries, and increased equipment, depreciation and facilities-related costs of
$22 million .
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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.
General and administrative expenses during the periods presented were as follows
(dollars in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
General and administrative $ 246 $ 283 $ (38) (13) % $ 691 $ 711 $ (20) (3) %
Stock-based compensation 43 33 10 31 124 97 27 28
Total expenses $ 289 $ 316 $ (28) (9) $ 815 $ 808 $ 7 1
% of Total revenue 9 % 10 % 8 % 9 %
General and administrative expenses decreased during the three months ended
October 28, 2022 compared to the three months ended October 29, 2021 . The
decrease was primarily driven by the absence of certain costs incurred related
to the Spin-Off, such as legal and advisory fees of $66 million recognized
during the three months ended October 29, 2021 . The decrease was offset in part
by certain merger-related costs, such as legal and advisory fees, recognized
during the three months ended October 29, 2022 related to our pending
acquisition by Broadcom.
General and administrative expenses increased slightly during the nine months
ended October 28, 2022 compared to the nine months ended October 29, 2021 . The
increase was primarily driven by increased stock-based compensation of $27
million , primarily driven by increased RSU awards granted to our employees as
well as increased cash-based employee-related expenses of $20 million , largely
driven by an increase in headcount and salaries. The increase was also driven by
third-party professional services costs of $15 million and certain
merger-related costs, such as legal and advisory fees, recognized during the
nine months ended October 28, 2022 related to our pending acquisition by
Broadcom. These increases were partially offset by the absence of certain costs
incurred related to the Spin-Off, such as legal and advisory fees, of $72
million recognized during the nine months ended October 29, 2021 .
Interest Expense
Interest expense during the periods presented was as follows (dollars in
millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % ChangeInterest expense$ 77 $ 74 $ 4 5 %$ 222 $ 173 $ 49 28 % % of Total revenue 2 % 2 % 2 % 2 % Interest expense remained relatively flat during the three months endedOctober 28, 2022 compared to the three months endedOctober 29, 2021 . Interest expense increased during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 , primarily driven by the five series of unsecured senior notes issued during the third quarter of fiscal 2022 (the "2021 Senior Notes") in the aggregate principal amount of$6.0 billion . We expect the annual interest expense associated with the 2021 Senior Notes to be approximately$100 million . The increase in interest expense during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 was also driven by the senior unsecured term loan facility on which we drew down onNovember 1, 2021 . Interest expense on the term loan facility was$39 million during the nine months endedOctober 28, 2022 . Refer to Note I to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding the Company's outstanding indebtedness. 33
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Other Income (Expense), net
Other income (expense), net during the periods presented was as follows (dollars
in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
Other income (expense), net
(221) % $ (44) $ (7) $ (35) (406) %
% of Total revenue - % - % - % - %
The change in other income (expense), net during the three and nine months ended
October 28, 2022 compared to the three and nine months ended October 29, 2021
was primarily driven by net losses, whether realized or unrealized, on our
investments in equity securities, as well as net gains on foreign currency
exchange.
Pursuant to a tax matters agreement entered into with Dell effective April 14,
2021 (the "Tax Matters Agreement"), we have agreed to indemnify one another for
certain tax liabilities or tax benefits relating to periods prior to VMware's
spin-off from Dell on November 1, 2021 (the "Spin-Off") and certain adjustments
to these amounts that will be recognized in future periods will be recorded in
other income (expense), net on the consolidated statements of income. We cannot
reasonably predict the amount that we may receive or pay in future periods,
which could introduce significant risk of variability to our consolidated
statements of income.
Income Tax Provision
The following table summarizes our income tax provision during the periods presented (dollars in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 2022 2021
Income tax provision $ 88 $ 59 $ 306 $ 190
Effective income tax rate 27.6 % 12.9 % 27.2 % 13.3 %
Our quarterly effective income tax rate is based on our estimated annual income
tax rate forecast and discrete tax items recognized in the period. The change in
our effective income tax rate for the three and nine months ended October 28,
2022 compared to the three and nine months ended October 29, 2021 was primarily
driven by a higher estimated annual income tax rate for fiscal 2023 due to the
increase in global intangible low-taxed income ("GILTI") from the impacts of
Internal Revenue Code Section 174 research and development expense
capitalization, which was part of the U.S. Tax Cuts and Jobs Act enacted on
December 22, 2017 (the "2017 Tax Act") and became effective beginning in fiscal
2023. As we record impacts of GILTI as a period cost, the capitalization of
foreign research and experimental costs in GILTI increases our provision for
income taxes. In addition, the increase in our effective income tax rate during
the nine months ended October 28, 2022 was also driven by the discrete tax
impact related to our book and tax basis difference on our investment in equity
securities, which provided a discrete tax expense that was not significant
during the nine months ended October 28, 2022 , as compared to a discrete tax
benefit of $28 million recognized during the nine months ended October 29, 2021 .
The increase in our effective income tax rate was also driven by net tax
deficiencies recognized in connection with stock-based awards, which were not
significant during the nine months ended October 28, 2022 , compared to net
excess tax benefits of $19 million recognized during the nine months ended
October 29, 2021 .
Prior to the Spin-Off, our financial results were included in the Dell
consolidated tax return for U.S. federal income tax purposes, but our income tax
provision or benefit was calculated primarily as though we were a separate
taxpayer, with certain transactions between us and Dell being assessed using
consolidated tax return rules. As a result of the Spin-Off, we are no longer a
member of the Dell consolidated tax group, and our U.S. federal income tax will
be reported separately from that of the Dell consolidated tax group.
Our effective tax rate in the future will depend upon the proportion of our
income before provision for income taxes earned in the U.S. and in jurisdictions
with a tax rate lower than the U.S. statutory rate. Our non-U.S. earnings are
primarily earned by our subsidiary organized in Ireland , where the rate of
taxation is lower than our U.S. tax rate and, as such, our annual effective tax
rate can be significantly affected by the composition of our earnings in U.S.
and non-U.S. jurisdictions. Our future effective tax rate may be affected by
such factors as: changes in our business; changes in tax laws or statutory
rates; changing interpretation of existing laws or regulations; the impact of
accounting for stock-based compensation; the recognition of excess tax benefits
or tax deficiencies within the income tax provision or benefit in the period in
which they occur; the impact of accounting for business combinations; shifts in
the amount of earnings in the U.S. compared with other regions in the world;
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overall levels of income before tax; changes in our international organization; the expiration of statute of limitations; and settlements of audits.
The Inflation Reduction Act (the "IRA") was enacted inAugust 2022 , and it will be effective for us commencing with our fiscal 2024. The key tax provisions of the IRA relate to a new 15% corporate alternative minimum tax on adjusted financial statement income for companies with profits greater than$1.0 billion and a 1% excise tax on stock repurchases by publicly traded companies. We will continue to evaluate the impact to us as further guidance becomes available.
Our Relationship with Dell
Transactions with Dell continue to be considered related party transactions following the Spin-Off due to the MSD Stockholders' and SLP Stockholders' direct ownership in bothVMware and Dell, as well asMr. Dell's executive position with Dell. OnNovember 1, 2021 , in connection with the Spin-Off, we entered into the Commercial Framework Agreement with Dell to provide a framework under which our strategic commercial relationship will continue, particularly with respect to projects mutually agreed as having the potential to accelerate the growth of an industry, product, service or platform that may provide the parties with a strategic opportunity. The Commercial Framework Agreement has an initial term of five years, with automatic one-year renewals occurring annually thereafter, subject to certain terms and conditions.
The information provided below includes a summary of transactions with Dell.
Transactions with Dell
We engaged with Dell in the following ongoing related party transactions, which resulted in revenue and receipts, and unearned revenue for us:
•Pursuant to original equipment manufacturer ("OEM") and reseller arrangements,
Dell integrates or bundles our products and services with Dell's products and
sells them to end users. Dell also acts as a distributor, purchasing our
standalone products and services for resale to end-user customers through
VMware -authorized resellers. Revenue under these arrangements is 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
with Dell.
•Dell purchases products and services from us for its internal use.
•From time to time, we and Dell enter into agreements to collaborate on technology projects, in connection with which Dell pays us for services or reimburses us for costs.
During the three and nine months endedOctober 28, 2022 , revenue from Dell accounted for 37% and 38% of our consolidated revenue, respectively. During the three and nine months endedOctober 28, 2022 , revenue recognized on transactions where Dell acted as an OEM accounted for 15% and 14% of total revenue from Dell, and 6% and 5%of our consolidated revenue. During the three and nine months endedOctober 29, 2021 , revenue from Dell accounted for 38% and 37% of our consolidated revenue, respectively. During each of the three and nine months endedOctober 29, 2021 , revenue recognized on transactions where Dell acted as an OEM accounted for 13% of total revenue from Dell, respectively, and 5% of our consolidated revenue. Dell purchases our products and services directly from us, as well as through 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 October 28, October 29, October 28, October 29, October 28, January 28, 2022 2021 2022 2021 2022 2022 Reseller revenue$ 1,184 $ 1,183 $ 3,634 $ 3,380 $ 5,448 $ 5,550 Internal-use revenue 13 17 41 43 24 39
Sales through Dell as a distributor, which is included in reseller revenue, comprise the largest route-to-market for our sales.
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Customer deposits resulting from transactions with Dell were
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 Dell enter into agreements to collaborate on technology projects, in connection with which we pay Dell for services it provides to us.
•In certain geographic regions where we do not have an established legal entity, we contract with Dell subsidiaries for support services and support from Dell personnel who are managed by us. The costs incurred by Dell on our behalf related to these employees are charged to us with a 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. •Prior to the Spin-Off, in certain geographic regions, Dell filed a consolidated indirect tax return, which included value added taxes and other indirect taxes collected by us from our customers. We remitted the indirect taxes to Dell, and Dell remitted the tax payment to the foreign governments on our behalf.
•From time to time, we enter into agency arrangements with Dell that enable us to sell our subscriptions and services, leveraging the Dell enterprise relationships and end customer contracts.
Information about our payments for such arrangements during the periods presented consisted of the following (table in millions):
Three Months Ended Nine Months Ended
October 28, October 29, October 28, October 29,
2022 2021 2022 2021
Purchases and leases of products and purchases
of services(1) $ 52 $
57
Dell subsidiary support and administrative costs 1 8 6 32
(1) Amount includes indirect taxes that were remitted to Dell during the periods presented.
We also purchase Dell products through Dell's channel partners, however such amounts were not material 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.
DFS provides 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 the current portion of due from related parties on the condensed consolidated balance sheets. Revenue recognized on transactions financed through DFS was recorded net of financing fees. Financing fees on arrangements accepted by both parties were$25 million and$20 million during the nine months endedOctober 28, 2022 andOctober 29, 2021 , respectively, and were not material during each of the three months endedOctober 28, 2022 andOctober 29, 2021 .
Liquidity and Capital Resources
As of the periods presented, we held cash, cash equivalents and short-term investments as follows (table in millions):
October 28, January 28,
2022 2022
Cash and cash equivalents $ 3,972 $ 3,614
Short-term investments - 19
Total cash, cash equivalents and short-term investments
Cash equivalents primarily consisted of amounts invested in money market funds.
We continue to expect that cash generated by operations will be our primary source of liquidity. We also continue to believe that existing cash, cash equivalents 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. While we believe these cash sources will be sufficient to
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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 expect to use free cash flow primarily to repay our outstanding indebtedness through the end of fiscal 2023. In addition, we plan to continue with our balanced capital allocation policy through investing in our product and solution offerings, and acquisitions. 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. OnMay 26, 2022 , we entered into the Merger Agreement with Broadcom. The Merger Agreement contains customary representations, warranties and covenants. The Merger Agreement also contains termination rights for either or each of Broadcom and us. If the consummation of the transaction does not occur on or beforeFebruary 26, 2023 by either party, subject to three extensions of three months each (at either Broadcom's or our election) if on such date all of the closing conditions except those relating to regulatory approvals have been satisfied or waived, Broadcom would be required to pay us a termination fee of$1.5 billion . Upon termination of the Merger Agreement under certain specified circumstances, including by us to enter into a definitive agreement with respect to a superior proposal in accordance with the terms of the Merger Agreement, we would be required to pay Broadcom a termination fee in the amount of$1.5 billion . The 2017 Tax Act imposed a one-time transition tax on accumulated earnings of foreign subsidiaries ("Transition Tax") and eliminatedU.S. Federal taxes on foreign subsidiary distributions. The Transition Tax was calculated on a separate tax return basis. Our liability related to the Transition Tax as ofOctober 28, 2022 was$445 million , which we expect to pay over the next three years pursuant to a letter agreement between Dell,EMC and us executed during the first quarter of fiscal 2020. Actual tax payments made to Dell pursuant to the Tax Agreements, as defined in Note C to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, may differ materially from our total estimated tax liability calculated on a separate tax return basis. Pursuant to the Tax Matters Agreement with Dell, we have agreed to indemnify one another for certain tax liabilities or tax benefits relating to periods prior to the Spin-Off and certain adjustments to these amounts that will be recognized in future periods will be recorded in other income (expense), net on the consolidated statements of income. Our cash flows summarized for the periods presented were as follows (table in millions): Nine Months Ended October 28, October 29, 2022 2021 Net cash provided by (used in): Operating activities$ 2,667 $ 3,220 Investing activities (231) (212) Financing activities (2,098) 4,775
Net increase in cash, cash equivalents and restricted cash $ 338
Operating Activities Cash provided by operating activities decreased by$553 million during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 , primarily due to increased cash payments for employee-related expenses, including salaries, bonuses and commissions, resulting primarily from growth in headcount and salaries, as well as higher cash outflows related to operating expenses, and interest on our unsecured senior notes and term loan facility. These increases were offset in part by increased cash collections during the nine months endedOctober 28, 2022 .
Investing Activities
Cash used in investing activities increased by$19 million during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 , primarily driven by an increase in additions to property and equipment and a decrease in sales of investments in equity securities. This was offset in part by an increase in proceeds from the disposition of assets.
Financing Activities
Cash used in financing activities increased by$6,873 million during the nine months endedOctober 28, 2022 compared to the nine months endedOctober 29, 2021 , primarily driven by the absence of net cash proceeds received from the issuance of senior notes of$6.0 billion during the nine months endedOctober 29, 2021 and the repayment of$2.0 billion towards our senior unsecured term loan facility during the nine months endedOctober 28, 2022 . This increase was offset in part by a decrease of$783 million in cash used for repurchases of shares of our common stock during the nine months endedOctober 28, 2022 , which resulted from the suspension of our stock repurchase program in connection with our entry into the Merger 37
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Agreement during the second quarter of fiscal 2023. In addition, we repaid our outstanding notes payable to Dell of$270 million during the nine months endedOctober 29, 2021 . Debt Unsecured Senior Notes We have unsecured senior notes ("Senior Notes") outstanding with an aggregated carrying value of$9.2 billion as ofOctober 28, 2022 . The Senior Notes mature betweenAugust 2023 andAugust 2031 and contain 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. During the nine months endedOctober 28, 2022 andOctober 29, 2021 , interest paid for the Senior Notes was$184 million and$139 million , respectively.
Senior Unsecured Term Loan Facility
During the third quarter of 2023, we repaid$500 million of our five-year senior unsecured term loan facility. As ofOctober 28, 2022 , the outstanding balance was$1.5 billion . During the nine months endedOctober 28, 2022 , interest paid for the term loan facilities was$37 million . Refer to Note I to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding the Company's outstanding indebtedness.
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 may be discontinued at any time we believe additional purchases are not warranted. All shares repurchased under our stock repurchase programs are retired. In connection with our entry into the Merger Agreement, we suspended our stock repurchase program, and we did not repurchase Common Stock during the second and third quarter of fiscal 2023. Refer to Note M to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for stock repurchase authorizations approved by our board of directors during the periods presented.
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 in future periods and will be recognized in the condensed consolidated financial statements as new events occur and additional information becomes 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 Annual Report on Form 10-K filed onMarch 24, 2022 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.
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, but are not limited to, statements relating to expected industry trends and conditions; the expected timing and completion of the proposed transaction with Broadcom; future financial performance, trends or plans; anticipated impacts of developments in accounting rules and tax laws and rates; our expectations regarding the timing of tax payments and the impacts of changes in our corporate structure and alignment; plans for and anticipated benefits ofVMware products, services and solutions and partner and alliance relationships; plans for, timing of and anticipated impacts and benefits of corporate transactions, capital-raising activities, acquisitions, stock 38
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repurchases and investment activities; the outcome or impact of pending litigation, claims or disputes; our ESG-related programs including the objectives of our 2030 Agenda and our programs to further diversity, equity and inclusion; the continuing impact of the COVID-19 pandemic on the global economy as well as any related effects on our business operations, financial performance, results of operations and stock price; our commercial relationship with Dell following completion of the Spin-Off; our plans to repay our outstanding indebtedness; our commitment and ability to maintain an investment-grade credit rating; the sufficiency of our cash sources to fund our operations; 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 vmware.com and our investor relations website is located at 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 theSecurities and Exchange Commission ("SEC");
•announcements of investor conferences, speeches and events at which our executives discuss our products, services and competitive strategies;
•webcasts of our 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 of incorporation, bylaws, corporate governance guidelines, board committee charters, business conduct guidelines (which constitutes our code of business conduct and ethics) and other governance-related policies;
•ESG (environmental, social and governance) information;
•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, theSEC . TheSEC also maintains a website at sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with theSEC .
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