VMW-6.30.2012-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period             from            to
Commission File Number 001-33622
________________________________________________ 
VMWARE, INC.
(Exact name of registrant as specified in its charter)
________________________________________________  
Delaware
 
94-3292913
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
3401 Hillview Avenue
Palo Alto, CA
 
94304
(Address of principal executive offices)
 
(Zip Code)
(650) 427-5000
(Registrant’s telephone number, including area code) 
________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 x
 
Accelerated filer
¨
 
 
 
 
 
Non-accelerated filer
 o
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of July 26, 2012, the number of shares of common stock, par value $0.01 per share, of the registrant outstanding was 426,466,973 of which 126,466,973 shares were Class A common stock and 300,000,000 were Class B common stock.



TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 

VMware, VMworld, VMware vSphere, VMware vCloud, Zimbra, SpringSource, VMware vCenter, VMware vShield, Cloud Foundry, VMware View, VMware Horizon, Rabbit MQ, GemFire, Socialcast, SlideRocket, Digital Fuel, NeoAccel, PacketMotion, Shavlik and WaveMaker are registered trademarks or trademarks of VMware, Inc. in the United States and other jurisdictions. All other marks and names mentioned herein may be trademarks of their respective companies.


2

Table of Contents

PART I
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
VMware, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Operating activities:
 
 
 
 
 
 
 
Net income
$
191,729

 
$
220,158

 
$
383,165

 
$
345,970

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
89,392

 
74,709

 
175,158

 
155,658

Stock-based compensation, excluding amounts capitalized
100,900

 
85,442

 
182,706

 
166,015

Excess tax benefits from stock-based compensation
(32,701
)
 
(101,256
)
 
(86,383
)
 
(151,264
)
Gain on sale of Terremark investment

 
(56,000
)
 

 
(56,000
)
Other
373

 
2,864

 
(555
)
 
3,826

Changes in assets and liabilities, net of acquisitions:
 
 
 
 
 
 
 
Accounts receivable
(91,296
)
 
(54,757
)
 
135,254

 
26,583

Other assets
(69,444
)
 
(16,133
)
 
(117,150
)
 
(34,053
)
Due to/from EMC, net
(43,403
)
 
(35,265
)
 
12,145

 
25,435

Accounts payable
4,894

 
(11,105
)
 
17,419

 
(1,707
)
Accrued expenses
95,753

 
102,780

 
936

 
34,211

Income taxes receivable from EMC

 
141,000

 

 
176,444

Income taxes payable
12,367

 
4,674

 
67,733

 
37,601

Deferred income taxes, net
(1,416
)
 
11,119

 
(36,371
)
 
(958
)
Unearned revenue
134,177

 
94,566

 
233,872

 
212,952

Net cash provided by operating activities
391,325

 
462,796

 
967,929

 
940,713

Investing activities:
 
 
 
 
 
 
 
Additions to property and equipment
(44,336
)
 
(95,186
)
 
(78,007
)
 
(122,232
)
Purchase of leasehold interest (see Note H)

 
(173,126
)
 

 
(173,126
)
Capitalized software development costs

 
(25,437
)
 

 
(52,859
)
Purchases of available-for-sale securities
(1,253,605
)
 
(529,038
)
 
(1,955,068
)
 
(1,127,805
)
Sales of available-for-sale securities
348,437

 
223,491

 
770,754

 
376,588

Maturities of available-for-sale securities
277,099

 
277,390

 
534,076

 
492,969

Sale of strategic investments

 
76,000

 

 
78,513

Business acquisitions, net of cash acquired
(102,166
)
 
(189,138
)
 
(102,166
)
 
(204,088
)
Transfer of net assets under common control

 
(7,973
)
 

 
(20,463
)
Other investing
(2,677
)
 
31,858

 
(4,174
)
 
(27,142
)
Net cash used in investing activities
(777,248
)
 
(411,159
)
 
(834,585
)
 
(779,645
)
Financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of common stock
33,554

 
110,543

 
144,595

 
200,714

Repurchase of common stock
(178,195
)
 
(132,660
)
 
(178,195
)
 
(280,389
)
Excess tax benefits from stock-based compensation
32,701

 
101,256

 
86,383

 
151,264

Shares repurchased for tax withholdings on vesting of restricted stock
(51,346
)
 
(48,666
)
 
(64,983
)
 
(70,578
)
Net cash provided by (used in) financing activities
(163,286
)
 
30,473

 
(12,200
)
 
1,011

Net increase (decrease) in cash and cash equivalents
(549,209
)
 
82,110

 
121,144

 
162,079

Cash and cash equivalents at beginning of the period
2,626,109

 
1,708,934

 
1,955,756

 
1,628,965

Cash and cash equivalents at end of the period
$
2,076,900

 
$
1,791,044

 
$
2,076,900

 
$
1,791,044

Non-cash items:
 
 
 
 
 
 
 
Changes in capital additions, accrued but not paid
$
17,980

 
$
(985
)
 
$
15,330

 
$
6,221

Changes in tax withholdings on vesting of restricted stock, accrued but not paid
6,029

 
3,656

 
6,837

 
2,938

The accompanying notes are an integral part of the consolidated financial statements.

3

Table of Contents

VMware, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
License
$
517,222

 
$
464,806

 
$
999,149

 
$
883,805

Services
605,804

 
456,404

 
1,179,059

 
881,126

Total revenues
1,123,026

 
921,210

 
2,178,208

 
1,764,931

Operating expenses (1):
 
 
 
 
 
 
 
Cost of license revenues
56,553

 
48,928

 
113,296

 
104,946

Cost of services revenues
122,669

 
103,547

 
236,841

 
197,426

Research and development
248,594

 
189,241

 
470,984

 
358,404

Sales and marketing
391,501

 
314,560

 
754,913

 
617,484

General and administrative
91,799

 
78,042

 
173,099

 
146,277

Operating income
211,910

 
186,892

 
429,075

 
340,394

Investment income
6,945

 
3,715

 
12,688

 
7,121

Interest expense with EMC
(1,158
)
 
(972
)
 
(2,445
)
 
(1,931
)
Other income (expense), net
(3,560
)
 
56,639

 
(1,275
)
 
56,804

Income before income taxes
214,137

 
246,274

 
438,043

 
402,388

Income tax provision
22,408

 
26,116

 
54,878

 
56,418

Net income
$
191,729

 
$
220,158

 
$
383,165

 
$
345,970

Net income per weighted-average share, basic for Class A and Class B
$
0.45

 
$
0.52

 
$
0.90

 
$
0.83

Net income per weighted-average share, diluted for Class A and Class B
$
0.44

 
$
0.51

 
$
0.88

 
$
0.80

Weighted-average shares, basic for Class A and Class B
427,223

 
419,657

 
426,106

 
418,557

Weighted-average shares, diluted for Class A and Class B
434,647

 
430,473

 
434,014

 
429,984

_______________________
 
 
 
 
 
 
 
(1)   Includes stock-based compensation as follows:
 
 
 
 
 
 
 
Cost of license revenues
$
524

 
$
438

 
$
964

 
$
904

Cost of services revenues
7,103

 
5,740

 
12,922

 
11,328

Research and development
48,027

 
46,074

 
87,404

 
87,958

Sales and marketing
33,883

 
23,264

 
59,117

 
45,787

General and administrative
11,363

 
9,926

 
22,299

 
20,038


The accompanying notes are an integral part of the consolidated financial statements.


4

Table of Contents

VMware, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
191,729

 
$
220,158

 
$
383,165

 
$
345,970

Other comprehensive income:
 
 
 
 
 
 
 
Changes in market value of available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $(96), $1,352, $1,028 and $1,196
(157
)
 
2,029

 
1,677

 
1,794

Reclassification of (gains) losses recognized during the period, net of taxes of $(283), $(22,494), $53 and $(12,788)
(461
)
 
(33,742
)
 
86

 
(19,181
)
Net change in market value of available-for-sale securities
(618
)
 
(31,713
)
 
1,763

 
(17,387
)
Changes in market value of effective foreign currency forward exchange contracts:
 
 
 
 
 
 
 
Unrealized gains (losses), net of taxes of $10, $0, $10 and $0
194

 

 
194

 

Reclassification of (gains) losses recognized during the period, net of taxes of $(40), $0, $10 and $0
(728
)
 

 
50

 

Net change in market value of effective foreign currency forward exchange contracts
(534
)
 

 
244

 

Total other comprehensive income
(1,152
)
 
(31,713
)
 
2,007

 
(17,387
)
Total comprehensive income, net of taxes
$
190,577

 
$
188,445

 
$
385,172

 
$
328,583


The accompanying notes are an integral part of the consolidated financial statements.

5

Table of Contents

VMware, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)
 
June 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,076,900

 
$
1,955,756

Short-term investments
3,269,969

 
2,556,450

Accounts receivable, net of allowance for doubtful accounts of $2,492 and $3,794
748,698

 
882,857

Due from EMC, net
61,654

 
73,799

Deferred tax asset
151,704

 
128,471

Other current assets
127,528

 
80,439

Total current assets
6,436,453

 
5,677,772

Property and equipment, net
553,124

 
525,490

Capitalized software development costs, net and other
109,532

 
154,236

Deferred tax asset
172,190

 
156,855

Intangible assets, net
402,425

 
407,375

Goodwill
1,827,068

 
1,759,080

Total assets
$
9,500,792

 
$
8,680,808

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
77,026

 
$
49,747

Accrued expenses and other
590,268

 
587,650

Unearned revenues
1,850,681

 
1,764,109

Total current liabilities
2,517,975

 
2,401,506

Note payable to EMC
450,000

 
450,000

Unearned revenues
1,091,709

 
944,309

Other liabilities
120,415

 
114,711

Total liabilities
4,180,099

 
3,910,526

Commitments and contingencies (see Note M)

 

Stockholders’ equity:
 
 
 
Class A common stock, par value $.01; authorized 2,500,000 shares; issued and outstanding 127,264 and 123,610 shares
1,273

 
1,236

Class B convertible common stock, par value $.01; authorized 1,000,000 shares; issued and outstanding 300,000 shares
3,000

 
3,000

Additional paid-in capital
3,377,466

 
3,212,264

Accumulated other comprehensive income
3,183

 
1,176

Retained earnings
1,935,771

 
1,552,606

Total stockholders’ equity
5,320,693

 
4,770,282

Total liabilities and stockholders’ equity
$
9,500,792

 
$
8,680,808


The accompanying notes are an integral part of the consolidated financial statements.


6

Table of Contents

VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A. Overview and Basis of Presentation
Company and Background
VMware, Inc. (“VMware” or the “Company”) is the leader in virtualization and virtualization-based cloud infrastructure solutions utilized by businesses to help them transform the way they build, deliver and consume information technology (“IT”) resources in a manner that is evolutionary and based on their specific needs. VMware’s virtualization infrastructure software solutions run on industry-standard desktop computers and servers and support a wide range of operating system and application environments, as well as networking and storage infrastructures.
Accounting Principles
The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America.
Unaudited Interim Financial Information
These accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. In the opinion of management, these unaudited consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, for a fair statement of VMware’s consolidated cash flows, results of operations and financial condition for the periods presented. Results of operations are not necessarily indicative of the results that may be expected for the full year 2012. Certain information and footnote disclosures typically included in annual consolidated financial statements have been condensed or omitted. Accordingly, these unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in VMware’s 2011 Annual Report on Form 10-K.
VMware was incorporated as a Delaware corporation in 1998, was acquired by EMC Corporation (“EMC”) in 2004 and conducted its initial public offering of VMware’s Class A common stock in August 2007. As of June 30, 2012, EMC holds approximately 79.3% of VMware’s outstanding common stock, including 38.7 million shares of VMware’s Class A common stock and all of VMware’s Class B common stock. VMware is a majority-owned and controlled subsidiary of EMC, and its results of operations and financial position are consolidated with EMC’s financial statements. VMware and EMC engage in intercompany transactions, including agreements regarding the use of EMC’s and VMware’s intellectual property and real estate, agreements regarding the sale of goods and services to one another, and an agreement for EMC to resell VMware's products and services to third party customers. In geographic areas where VMware has not established its own subsidiaries, VMware contracts with EMC subsidiaries for support services and for personnel who are managed by VMware. Additionally, beginning in the second quarter of 2011, VMware incurs costs to operate the Mozy service on behalf of EMC. These costs, plus a mark-up to approximate third-party costs and a management fee, are reimbursed to VMware by EMC and recorded as an offset to the costs VMware incurred on the consolidated statements of income. See Note O to the consolidated financial statements for further information regarding intercompany transactions between VMware and EMC.
Management believes the assumptions underlying the consolidated financial statements are reasonable. However, the amounts recorded for VMware's intercompany transactions with EMC may not be considered arm’s length with an unrelated third party by nature of EMC’s majority ownership of VMware. Therefore, the financial statements included herein may not necessarily reflect the cash flows, results of operations and financial condition had VMware engaged in such transactions with an unrelated third party during all periods presented. Accordingly, VMware’s historical financial information is not necessarily indicative of what the Company’s cash flows, results of operations and financial condition will be in the future if and when VMware contracts at arm’s length with unrelated third parties for the services the Company receives from and provides to EMC.
Prior period financial statements have been reclassified to conform to current period presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of VMware and its subsidiaries. All intercompany transactions and balances between VMware and its subsidiaries have been eliminated. All intercompany transactions with EMC in the consolidated statements of cash flows will be settled in cash, and changes in the current intercompany balances are presented as a component of cash flows from operating activities.
Use of Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management

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Table of Contents
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting periods, and the disclosure of contingent liabilities at the date of the financial statements. Estimates are used for, but not limited to, capitalized software development costs, trade receivable valuation, certain accrued liabilities, useful lives of fixed assets and intangible assets, valuation of acquired intangibles, revenue reserves, income taxes, stock-based compensation and contingencies. Actual results could differ from those estimates.
New Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 eliminated the option to report other comprehensive income and its components in the statement of changes in equity. Comprehensive income must be presented in one continuous statement of comprehensive income or two separate consecutive statements. In December 2011, the FASB issued an amendment to ASU 2011-05 that defers the requirement to present reclassification adjustments out of accumulated other comprehensive income on the face of the consolidated statement of income. VMware adopted this accounting standard update, as amended, on January 1, 2012, and presents comprehensive income in accordance with the requirements of the standard in this Quarterly Report on Form 10-Q.
B. Research and Development and Capitalized Software Development Costs
Development costs of software to be sold, leased, or otherwise marketed are subject to capitalization beginning when the product’s technological feasibility has been established and ending when the product is available for general release. Judgment is required in determining when technological feasibility is established, and as the Company’s business, products and go-to-market strategy have evolved, management has continued to evaluate when technological feasibility is established. Following the release of vSphere 5 and the comprehensive suite of cloud infrastructure technologies in the third quarter of 2011, management determined that VMware’s go-to-market strategy had changed from single solutions to product suite solutions. As a result of this change in strategy, and the related increased importance of interoperability between VMware’s products, the length of time between achieving technological feasibility and general release to customers significantly decreased. For future releases, management expects VMware’s products to be available for general release soon after technological feasibility has been established.
VMware’s expensed and capitalized research and development (“R&D”) costs may not be comparable to VMware’s peer companies due to differences in judgment as to when technological feasibility has been reached or differences in judgment regarding when the product is available for general release. Additionally, future changes in management’s judgment as to when technological feasibility is established, or additional changes in VMware’s business, including its go-to-market strategy, could materially impact the amount of costs capitalized. For example, if the length of time between technological feasibility and general availability were to increase again in the future, the amount of capitalized costs would likely increase.
Generally accepted accounting principles require annual amortization expense of capitalized software development costs to be the greater of the amounts computed using the ratio of current gross revenue to a product’s total current and anticipated revenues, or the straight-line method over the product’s remaining estimated economic life. To date, VMware has amortized these costs using the straight-line method as it is the greater of the two amounts. The costs are amortized over periods ranging from 18 to 24 months, which represent the product’s estimated economic life. The ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors such as anticipated future revenue, estimated economic life, and changes in software and hardware technologies. Material differences in amortization amounts could occur as a result of changes in the periods over which VMware actually generates revenues or the amounts of revenues generated.
Unamortized software development costs were $62.3 million and $104.9 million as of June 30, 2012 and December 31, 2011, respectively, and are included in capitalized software development costs, net and other on the consolidated balance sheets.
In the three and six months ended June 30, 2012, all software development costs were expensed as incurred and were included in R&D expenses on the accompanying consolidated statement of income. In the three months ended June 30, 2011, VMware capitalized $29.6 million (including $4.2 million of stock-based compensation) of costs incurred for the development of software products. In the six months ended June 30, 2011, VMware capitalized $61.9 million (including $9.0 million of stock-based compensation) of costs incurred for the development of software products. These amounts have been excluded from R&D expenses on the accompanying consolidated statements of income. Amortization expense from capitalized amounts was $20.8 million and $19.8 million for the three months ended June 30, 2012 and 2011, respectively. Amortization expense from capitalized amounts was $42.6 million and $48.3 million for the six months ended June 30, 2012 and 2011, respectively. Amortization expense is included in cost of license revenues on the consolidated statements of income.


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Table of Contents
VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

C. Earnings per Share
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares outstanding and potentially dilutive securities outstanding during the period, as calculated using the treasury stock method. Potentially dilutive securities primarily include stock options, unvested restricted stock units, and purchase options under VMware’s employee stock purchase plan. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive. VMware uses the two-class method to calculate earnings per share as both classes share the same rights in dividends, therefore basic and diluted earnings per share are the same for both classes.
The following table sets forth the computations of basic and diluted net income per share for the three and six months ended June 30, 2012 and 2011 (table in thousands, except per share data):
 
For the Three Months
Ended June 30,
 
For the Six Months
Ended June 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
191,729

 
$
220,158

 
$
383,165

 
$
345,970

Weighted-average shares, basic for Class A and Class B
427,223

 
419,657

 
426,106

 
418,557

Effect of dilutive securities
7,424

 
10,816

 
7,908

 
11,427

Weighted-average shares, diluted for Class A and Class B
434,647

 
430,473

 
434,014

 
429,984

Net income per weighted-average share, basic for Class A and Class B
$
0.45

 
$
0.52

 
$
0.90

 
$
0.83

Net income per weighted-average share, diluted for Class A and Class B
$
0.44

 
$
0.51

 
$
0.88

 
$
0.80

For the three months ended June 30, 2012 and 2011, stock options to purchase 0.4 million and 0.9 million shares, respectively, of VMware Class A common stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive. For the three months ended June 30, 2012, 2.7 million shares of restricted stock were excluded from the diluted earnings per share calculations. For the three months ended June 30, 2011, no shares of restricted stock were excluded from the diluted earnings per share calculations.
For the six months ended June 30, 2012 and 2011, stock options to purchase 0.4 million and 1.2 million shares, respectively, of VMware Class A common stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive. For the six months ended June 30, 2012 and 2011, 1.5 million and 0.4 million shares of restricted stock were excluded from the diluted earnings per share calculations because their effect would have been anti-dilutive.
D. Investments
Investments as of June 30, 2012 and December 31, 2011 consisted of the following (tables in thousands):
 
June 30, 2012
 
Cost or Amortized Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. Government and agency obligations
$
475,556

 
$
1,220

 
$
(73
)
 
$
476,703

U.S. and foreign corporate debt securities
1,488,144

 
2,800

 
(821
)
 
1,490,123

Foreign governments and multi-national agency obligations
39,138

 
14

 
(29
)
 
39,123

Municipal obligations
1,160,540

 
2,442

 
(756
)
 
1,162,226

Asset-backed securities
36,648

 
53

 
(10
)
 
36,691

Mortgage-backed securities
65,122

 
129

 
(148
)
 
65,103

Total investments
$
3,265,148

 
$
6,658

 
$
(1,837
)
 
$
3,269,969


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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

 
December 31, 2011
 
Cost or Amortized Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. Government and agency obligations
$
516,795

 
$
1,842

 
$
(23
)
 
$
518,614

U.S. and foreign corporate debt securities
1,134,009

 
1,404

 
(2,036
)
 
1,133,377

Foreign governments and multi-national agency obligations
58,455

 
30

 
(87
)
 
58,398

Municipal obligations
768,282

 
1,396

 
(437
)
 
769,241

Asset-backed securities
27,107

 
2

 
(23
)
 
27,086

Mortgage-backed securities
49,778

 
128

 
(172
)
 
49,734

Total investments
$
2,554,426

 
$
4,802

 
$
(2,778
)
 
$
2,556,450

Both the realized gains and realized losses on investments were not material for the three and six months ended June 30, 2012. During the three months ended June 30, 2011, a realized gain of $56.0 million was recorded in other income (expense), net on the consolidated income statement for the sale of VMware’s investment in Terremark Worldwide, Inc. All other realized gains and losses on investments were not material for the three and six months ended June 30, 2011. In addition, VMware evaluated its investments as of June 30, 2012 and December 31, 2011 and determined that there were no unrealized losses that indicated an other-than-temporary impairment.
As of June 30, 2012 and December 31, 2011, VMware did not have investments in a material continuous unrealized loss position for twelve months or greater. Unrealized losses on investments as of June 30, 2012, and December 31, 2011, which have been in a net loss position for less than twelve months, were classified by investment category as follows (table in thousands):
 
June 30, 2012
 
December 31, 2011
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
U.S. Government and agency obligations
$
214,612

 
$
(73
)
 
$
50,604

 
$
(23
)
U.S. and foreign corporate debt securities
500,126

 
(819
)
 
539,228

 
(2,036
)
Foreign governments and multi-national agency obligations
31,175

 
(29
)
 
43,026

 
(87
)
Municipal obligations
407,195

 
(756
)
 
298,187

 
(406
)
Asset-backed securities
9,399

 
(10
)
 
20,025

 
(23
)
Mortgage-backed securities
38,309

 
(148
)
 
32,817

 
(172
)
Total
$
1,200,816

 
$
(1,835
)
 
$
983,887

 
$
(2,747
)
Contractual Maturities
The contractual maturities of investments held at June 30, 2012 consisted of the following (table in thousands):
 
Amortized
Cost Basis
 
Aggregate
Fair Value
Due within one year
$
1,275,888

 
$
1,276,571

Due after 1 year through 5 years
1,929,232

 
1,933,370

Due after 5 years
60,028

 
60,028

Total investments
$
3,265,148

 
$
3,269,969

E. Fair Value Measurements
Generally accepted accounting principles provide that fair value is an exit price, representing the amount that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, generally accepted accounting principles established a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) inputs are quoted prices in

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

active markets for identical assets or liabilities; (Level 2) inputs other than the quoted prices included within Level 1 that are observable for the assets or liabilities, either directly or indirectly; and (Level 3) unobservable inputs for the assets or liabilities in which there is little or no market data, which requires VMware to develop its own assumptions.
VMware’s Level 1 classification of the fair value hierarchy includes money market funds and certain available-for-sale fixed income securities because these securities are valued using quoted prices in active markets for identical assets.
VMware’s Level 2 classification includes the remainder of the available-for-sale fixed income securities because these securities are priced using quoted market prices for similar instruments and non-binding market prices that are corroborated by observable market data. VMware obtains the fair values of its Level 2 financial instruments based upon fair values obtained from its custody bank. In addition, VMware obtains fair values of its Level 2 financial instruments from the asset manager of each of its portfolios. VMware validates the fair value provided by its custody bank by comparing it against the independent pricing information obtained from the asset managers. Independently, the custody bank and the asset managers use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable instruments, or inputs other than quoted prices that are observable either directly or indirectly. VMware is ultimately responsible for the financial statements and underlying estimates.
Additionally, VMware’s Level 2 classification includes foreign currency forward contracts as the valuation inputs for these are based upon quoted prices and quoted pricing intervals from public data sources. These contracts were not material for any period presented. VMware does not have any material assets or liabilities that fall into Level 3 of the fair value hierarchy.
The following tables set forth the fair value hierarchy of VMware’s money market funds and available-for-sale securities, including those securities classified within cash and cash equivalents on the consolidated balance sheets, that were required to be measured at fair value as of June 30, 2012 and December 31, 2011 (tables in thousands):
 
June 30, 2012
 
Level 1
 
Level 2
 
Total
Money-market funds
$
1,644,790

 
$

 
$
1,644,790

U.S. Government and agency obligations
283,364

 
193,339

 
476,703

U.S. and foreign corporate debt securities

 
1,554,617

 
1,554,617

Foreign governments and multi-national agency obligations

 
39,123

 
39,123

Municipal obligations

 
1,168,226

 
1,168,226

Asset-backed securities

 
36,691

 
36,691

Mortgage-backed securities

 
65,103

 
65,103

Total cash equivalents and investments
$
1,928,154

 
$
3,057,099

 
$
4,985,253

 
 
 
 
 
 
 
December 31, 2011
 
Level 1
 
Level 2
 
Total
Money-market funds
$
1,345,904

 
$

 
$
1,345,904

U.S. Government and agency obligations
170,744

 
347,870

 
518,614

U.S. and foreign corporate debt securities

 
1,143,378

 
1,143,378

Foreign governments and multi-national agency obligations

 
58,397

 
58,397

Municipal obligations

 
769,241

 
769,241

Asset-backed securities

 
27,086

 
27,086

Mortgage-backed securities

 
49,734

 
49,734

Total cash equivalents and investments
$
1,516,648

 
$
2,395,706

 
$
3,912,354

F. Derivative Instruments
VMware conducts business in several foreign currencies and has international sales and expenses denominated in foreign currencies, subjecting the Company to foreign currency risk. To mitigate this risk, VMware enters into hedging activities as described below. The counterparties to VMware’s foreign currency forward contracts are multi-national commercial banks considered to be credit-worthy. VMware does not enter into speculative foreign exchange contracts for trading purposes.


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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Cash Flow Hedging Activities
To mitigate its exposure to foreign currency fluctuations resulting from operating expenses denominated in certain foreign currencies, VMware entered into foreign currency forward contracts starting in the fourth quarter of 2011. The Company designates these forward contracts as cash flow hedging instruments as the accounting criteria for such designation has been met. Therefore, the effective portion of gains or losses resulting from changes in the fair value of these hedges is initially reported in accumulated other comprehensive income on the consolidated balance sheet, and is subsequently reclassified to the related operating expense line item in the consolidated statements of income in the same period that the underlying expenses are incurred. Interest charges or “forward points” on VMware’s forward contracts are excluded from the assessment of hedge effectiveness and are recorded in other income (expense), net in the consolidated statements of income as incurred. For the three and six months ended June 30, 2012, all amounts recognized on the consolidated statements of income related to VMware’s cash flow hedging program were immaterial.
VMware generally enters into cash flow hedges semi-annually with maturities of six months or less. As of June 30, 2012 and December 31, 2011, VMware had forward contracts to purchase currency designated as cash flow hedges with a total notional value of $11.0 million and $47.1 million, respectively. The fair value of these forward contracts was immaterial as of June 30, 2012 and therefore excluded from the fair value tables above. For the three and six months ended June 30, 2012, all cash flow hedges were considered effective.
Balance Sheet Hedging Activities
In order to manage exposure to foreign currency fluctuations, VMware enters into foreign currency forward contracts to hedge a portion of its net outstanding monetary assets and liabilities against movements in certain foreign exchange rates. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are reported in other income (expense), net in the consolidated statements of income. The gains and losses on VMware’s foreign currency forward contracts generally offset the majority of the gains and losses associated with the underlying foreign-currency denominated assets and liabilities that VMware hedges.
VMware’s foreign currency forward contracts are generally traded on a monthly basis with a typical contractual term of one month. As of June 30, 2012 and December 31, 2011, VMware had outstanding forward contracts with a total notional value of $261.5 million and $324.1 million, respectively. The fair value of these forward contracts was immaterial as of June 30, 2012 and December 31, 2011 and therefore excluded from the fair value tables above.
G. Business Combinations, Goodwill and Intangible Assets, Net
Business Combinations
The results of operations of the acquired businesses mentioned below have been included in VMware’s consolidated financial statements from the date of purchase. Pro forma results of operations have not been presented as the results of the acquired businesses were not material to VMware’s consolidated results of operations in the three and six months ended June 30, 2012 and 2011.
In the six months ended June 30, 2012, VMware acquired three businesses. The aggregate consideration for these acquisitions was $102.2 million, net of cash acquired. The following table summarizes the allocation of the consideration to the fair value of the tangible and intangible assets acquired in the six months ended June 30, 2012 (table in thousands):
Other current assets
$
531

Intangible assets
33,800

Goodwill
70,798

Other assets
106

Total tangible and intangible assets acquired
105,235

Unearned revenues
(100
)
Deferred tax liabilities, net
(1,460
)
Accrued liabilities and other
(1,509
)
Total liabilities assumed
(3,069
)
Fair value of tangible and intangible assets acquired and liabilities assumed
$
102,166



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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Intangible Assets, Net
Changes in the carrying amount of intangible assets, net, excluding goodwill for the six months ended June 30, 2012 consisted of the following (table in thousands):
Balance, January 1, 2012
$
407,375

Additions to intangible assets related to business combinations
33,800

Change in accumulated amortization
(38,750
)
Balance, June 30, 2012
$
402,425

The following table summarizes the fair value of the intangible assets acquired by VMware through business combinations in the six months ended June 30, 2012 (table in thousands):
 
Weighted-Average
Useful Lives
(in years)
 
Fair Value
Amount
Purchased technology
5.9
 
$
33,800

Total intangible assets acquired, net, excluding goodwill
 
 
$
33,800

Goodwill
Changes in the carrying amount of goodwill for the six months ended June 30, 2012 consisted of the following (table in thousands):
Balance, January 1, 2012
$
1,759,080

Increase in goodwill related to business combinations
70,798

Deferred tax adjustments to purchase price allocations on previous acquisitions
(2,814
)
Other adjustments to purchase price allocations on previous acquisitions
4

Balance, June 30, 2012
$
1,827,068

H. Property and Equipment, Net
Property and equipment, net, as of June 30, 2012 and December 31, 2011 consisted of the following (table in thousands):
 
June 30, 2012
 
December 31, 2011
Equipment and software
$
563,494

 
$
512,754

Buildings and improvements
371,985

 
340,596

Furniture and fixtures
63,802

 
61,023

Construction in progress
75,670

 
68,707

Total property and equipment
1,074,951

 
983,080

Accumulated depreciation
(521,827
)
 
(457,590
)
Total property and equipment, net
$
553,124

 
$
525,490

Depreciation expense was $32.9 million and $31.3 million in the three months ended June 30, 2012 and 2011, respectively, and $65.7 million and $62.0 million in the six months ended June 30, 2012 and 2011, respectively.
In the three months ended June 30, 2011, VMware closed an agreement to purchase the right, title and interest in a ground lease covering the property and improvements located adjacent to VMware’s existing Palo Alto, California campus for a total cost of $225.0 million. VMware paid the seller $45.0 million in the three months ended March 31, 2011 as a good faith deposit and in the three months ended June 30, 2011, VMware paid the remaining $180.0 million. Based upon the preliminary respective fair values, $51.9 million of the purchase price was recorded to property and equipment, net on the consolidated balance sheet for the estimated fair value of the buildings and site improvements. The remaining $173.1 million of the purchase price was attributed to the fair value of the ground lease and was recorded to intangible assets, net on the consolidated balance

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

sheet. These amounts are reflected on the consolidated statements of cash flows for the three and six months ended June 30, 2011.
In the three months ended September 30, 2011, the gross amount classified to property and equipment, net was increased by $22.0 million to $73.9 million to reflect the final assumptions regarding VMware’s intended use of the existing structures. As a result of this adjustment, the gross amount of the value recorded to intangible assets, net on the consolidated balance sheet was decreased by the same amount.
As of June 30, 2012 and December 31, 2011, construction in progress primarily represented buildings and site improvements related to VMware’s Palo Alto campus expansion that had not yet been placed into service.
I. Accrued Expenses and Other
Accrued expenses and other as of June 30, 2012 and December 31, 2011 consisted of the following (table in thousands):
 
June 30, 2012
 
December 31, 2011
Salaries, commissions, bonuses, and benefits
$
279,223

 
$
287,248

Accrued partner liabilities
110,274

 
124,359

Other
200,771

 
176,043

Total
$
590,268

 
$
587,650

Accrued partner liabilities relate to rebates and marketing development fund accruals for channel partners, system vendors and systems integrators, as well as accrued royalties.
J. Unearned Revenues
Unearned revenues as of June 30, 2012 and December 31, 2011 consisted of the following (table in thousands):
 
June 30, 2012
 
December 31, 2011
Unearned license revenues
$
375,644

 
$
389,225

Unearned software maintenance revenues
2,356,977

 
2,133,512

Unearned professional services revenues
209,769

 
185,681

Total unearned revenues
$
2,942,390

 
$
2,708,418

Unearned license revenues are recognized either ratably or upon the delivery of existing products, future products or services. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive a promotional product at no additional charge. VMware regularly offers product promotions as a strategy to improve awareness of its emerging products. To the extent promotional products have not been delivered and VSOE of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Increasingly, unearned license revenue may also be recognized ratably, which is generally due to a right to receive unspecified future products or a lack of VSOE of fair value on the software maintenance element of the arrangement. At June 30, 2012, the ratable component represented over half of the total unearned license revenue balance. Unearned software maintenance revenues are attributable to VMware’s maintenance contracts and are recognized ratably over terms of one to five years with a weighted-average remaining term at June 30, 2012 of approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered.
K. Note Payable to EMC
In April 2007, VMware declared an $800.0 million dividend to EMC paid in the form of a note payable, with interest payable quarterly in arrears and original maturity date of April 2012. In August 2007, VMware repaid $350.0 million of the note payable, and as of June 30, 2012, $450.0 million remained outstanding. In June 2011, VMware and EMC amended and restated the note to extend the maturity date of the note to April 16, 2015 and to modify the principal amount of the note to reflect the outstanding balance of $450.0 million. The interest rate of the 90-day LIBOR plus 55 basis points continues to reset quarterly. For the three months ended June 30, 2012 and 2011, $1.2 million and $1.0 million, respectively, of interest expense were recorded related to the note payable. For the six months ended June 30, 2012 and 2011, $2.4 million and $1.9 million, respectively, of interest expense were recorded related to the note payable. The note may be repaid prior to the maturity date

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

without penalty. No repayments of principal were made during the three and six months ended June 30, 2012 and 2011.
L. Income Taxes
Although VMware files a consolidated federal tax return with EMC, VMware calculates its income tax provision on a stand-alone basis. The Company’s effective tax rate in the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The rate at which the provision for income taxes is calculated differs from the U.S. federal statutory income tax rate primarily due to different tax rates in foreign jurisdictions where income is earned and considered to be indefinitely reinvested.
VMware’s effective income tax rate was 10.5% and 10.6% for the three months ended June 30, 2012 and 2011, respectively. The effective income tax rate was 12.5% and 14.0%, respectively, for the six months ended June 30, 2012 and 2011. The lower effective rate for the three and six months ended June 30, 2012, compared with the three and six months ended June 30, 2011, was primarily attributable to a jurisdictional shift of income from the U.S. to lower-tax non-U.S. jurisdictions, partially offset by a decrease in the release of unrecognized tax benefits from uncertain tax positions as a percentage of income before tax, as well as by the expiration of the federal research tax credit.
VMware’s rate of taxation in foreign jurisdictions is lower than the U.S. tax rate. VMware’s international income is primarily earned by VMware’s subsidiaries in Ireland, where the statutory tax rate is 12.5%. Management does not believe that any recent or currently expected developments in non-U.S. tax jurisdictions are reasonably likely to have a material impact on VMware’s effective tax rate. As of June 30, 2012, VMware’s total cash, cash equivalents, and short-term investments were $5,346.9 million, of which $2,694.0 million were held outside the U.S. If these overseas funds are needed for its operations in the U.S., VMware would be required to accrue and pay U.S. taxes on related undistributed earnings to repatriate these funds. However, all income earned abroad, except for previously taxed income for U.S. tax purposes, is considered indefinitely reinvested in VMware’s foreign operations and no provision for U.S. taxes has been provided with respect thereto. At this time, it is not practicable to estimate the amount of tax that may be payable were VMware to repatriate these funds, and VMware’s current plans do not demonstrate a need to repatriate them to fund its U.S. operations. VMware will meet its U.S. liquidity needs through cash flows from operations, external borrowings, or both. VMware utilizes a variety of tax planning and financing strategies in an effort to ensure that its worldwide cash is available in the locations in which it is needed.
As of June 30, 2012, VMware had gross unrecognized tax benefits totaling $87.3 million, which excludes $10.6 million of offsetting tax benefits. Approximately $82.6 million of VMware’s net unrecognized tax benefits, not including interest, if recognized, would reduce income tax expense and lower VMware’s effective tax rate in the period or periods recognized. The $90.1 million of net unrecognized tax benefits, including interest, were classified as a non-current liability on the consolidated balance sheet. It is reasonably possible that within the next 12 months audit resolutions could potentially reduce total unrecognized tax benefits by between approximately $7.0 million and $9.0 million. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.
VMware recognizes interest expense and penalties related to income tax matters in the income tax provision. VMware recognized approximately $0.4 million and $1.6 million in interest and penalties for the three and six months ended June 30, 2012 and had accrued $7.5 million of interest and penalties as of June 30, 2012, associated with the net unrecognized tax benefits. These amounts are included as components of the $90.1 million of net unrecognized tax benefits as of June 30, 2012.
M. Commitments and Contingencies
Litigation
From time to time, VMware is subject to legal, administrative and regulatory proceedings, claims, demands and investigations in the ordinary course of business, including claims with respect to intellectual property, contracts, employment and other matters. VMware accrues for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. These accruals are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. As of June 30, 2012 and December 31, 2011, the amounts accrued were not material. To the extent there is a reasonable possibility that the losses could exceed the amounts already accrued, management believes that the amount of any such additional loss would also be immaterial to VMware’s consolidated financial position and results of operations.

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Operating Lease Commitments
VMware leases office facilities and equipment under various operating leases. Facility leases generally include renewal options. VMware’s future lease commitments at June 30, 2012 were as follows (table in thousands):
2012
$
26,395

2013
51,171

2014
43,814

2015
34,425

2016
29,044

Thereafter
562,814

Total minimum lease payments
$
747,663

The amount of the future lease commitments after 2016 is primarily for the ground leases on VMware’s Palo Alto, California headquarter facilities, which expire in 2046. As several of VMware’s operating leases are payable in foreign currencies, the operating lease payments may fluctuate in response to changes in the exchange rate between the U.S. Dollar and the foreign currencies in which the commitments are payable.
N. Stockholders’ Equity
VMware Stock Repurchase Programs
In February 2012, VMware’s Board of Directors authorized the repurchase of up to $600.0 million of VMware’s Class A common stock through the end of 2013. In February 2011, a committee of VMware’s Board of Directors authorized the repurchase of up to $550.0 million of VMware’s Class A common stock, which was completed in the second quarter of 2012.
From time to time, stock repurchases may be made pursuant to the February 2012 authorization in open market transactions or privately negotiated transactions as permitted by securities laws and other legal requirements. VMware is not obligated to purchase any shares under its stock repurchase programs. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. Purchases can be discontinued at any time that VMware feels additional purchases are not warranted.
In both the three and six months ended June 30, 2012, VMware repurchased and retired 1.8 million shares of its Class A common stock at a weighted-average price of $96.50 per share for an aggregate purchase price of $178.2 million, including commissions. In the three and six months ended June 30, 2011, VMware repurchased and retired 1.4 million shares and 3.2 million shares, respectively, of its Class A common stock at a weighted-average price of $91.60 per share and $88.50 per share, respectively, for an aggregate purchase price of $132.7 million and $280.4 million, respectively, including commissions. The amount of repurchased shares was classified as a reduction to additional paid-in capital. As of June 30, 2012, the authorized amount remaining for repurchase was $507.1 million.
VMware Employee Stock Purchase Plan
The following table summarizes Employee Stock Purchase Plan (the “ESPP”) activity in the three and six months ended June 30, 2012 and 2011 (table in thousands, except per share amounts):
 
Purchase Period Ended
 
January 31,
 
2012
 
2011
Cash proceeds
$
32,861

 
$
26,813

Class A common shares purchased
424

 
407

Weighted-average price per share
$
77.58

 
$
65.90

As of June 30, 2012, $34.6 million of ESPP withholdings were recorded as a liability on the consolidated balance sheet for the next purchase in July 2012.
VMware Restricted Stock
VMware restricted stock units primarily consist of restricted stock unit (“RSU”) awards granted to employees. RSUs are valued based on the VMware stock price on the date of grant, and shares underlying RSU awards are not issued until the

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

restricted stock units vest. Upon vesting, each RSU converts into one share of VMware Class A common stock.
In the first half of 2012, VMware granted performance stock unit (“PSU”) awards to certain of its executives and employees. The awards will vest through the first quarter of 2015 if certain employee specific or VMware designated performance targets are achieved. If minimum performance thresholds are achieved, each PSU award will convert into VMware’s Class A common stock at a ratio ranging from 0.5 to 3.0 shares for each PSU, depending upon the degree of achievement of the performance target designated by each individual award. If minimum performance thresholds are not achieved, then no shares will be issued under that PSU award. As of June 30, 2012, 0.4 million PSUs were outstanding and are included in the table below.
The following table summarizes restricted stock activity since January 1, 2012 (stock units in thousands):
 
Number
of
Stock Units
 
Weighted-
Average Grant
Date Fair
Value
(per stock unit)
Outstanding, January 1, 2012
9,540

 
$
72.74

Granted
5,052

 
106.17

Vested
(2,148
)
 
66.85

Forfeited
(748
)
 
74.39

Outstanding, June 30, 2012
11,696

 
88.61

The total fair value of VMware stock units that vested in the six months ended June 30, 2012 was $199.9 million. As of June 30, 2012, stock units representing 11.7 million shares of VMware were outstanding, with an aggregate intrinsic value of $1,064.8 million based on VMware’s closing price as of June 30, 2012. These stock units are scheduled to vest through 2016.
VMware Shares Repurchased for Tax Withholdings
In both the three months ended June 30, 2012 and 2011, VMware repurchased or withheld and retired 0.6 million shares of Class A common stock, for $57.5 million and $52.3 million, respectively, to cover tax withholding obligations. In both the six months ended June 30, 2012 and 2011, VMware repurchased or withheld and retired 0.8 million shares of Class A common stock, for $72.0 million and $73.5 million, respectively, to cover tax withholding obligations. These amounts differ from the amounts of cash remitted for tax withholding obligations on the consolidated statement of cash flows due to the timing of payments. Pursuant to the respective award agreements, these shares were repurchased or withheld in conjunction with the net share settlement upon the vesting of restricted stock and restricted stock units during the period. The value of the repurchased or withheld shares, including restricted stock units, was classified as a reduction to additional paid-in capital.
O. Related Party Transactions
In the second quarter of 2011, VMware acquired certain assets relating to EMC’s Mozy cloud-based data storage and data center services, including certain data center assets and a license to certain intellectual property. EMC retained ownership of the Mozy business and its remaining assets. EMC continues to be responsible to Mozy customers for Mozy products and services and continues to recognize revenue from such products and services. VMware entered into an operational support agreement with EMC through the end of 2012, pursuant to which VMware took over responsibility to operate the Mozy service on behalf of EMC. Pursuant to the support agreement, costs incurred by VMware to support EMC’s Mozy services, plus a mark-up intended to approximate third-party costs and a management fee, are reimbursed to VMware by EMC. On the consolidated statements of income, in the three months ended June 30, 2012 and 2011, such amounts as described above were approximately $16.4 million and $12.2 million, respectively. In the six months ended June 30, 2012 and 2011, such amounts were $30.9 million and $12.2 million, respectively. These amounts were recorded as a reduction to the costs VMware incurred.
In the second quarter of 2010, VMware acquired certain software product technology and expertise from EMC’s Ionix IT management business for cash consideration of $175.0 million. EMC retained the Ionix brand and will continue to offer customers the products acquired by VMware, pursuant to the ongoing reseller agreement between EMC and VMware. During the six months ended June 30, 2011, a $12.5 million contingent payment was made to EMC. This payment was recorded as an equity transaction and was an offset to the initial capital contribution from EMC. As of December 31, 2011all contingent payments under the agreement had been made.
Pursuant to an ongoing reseller arrangement with EMC, EMC bundles VMware’s products and services with EMC’s hardware and sells them to end-users. In the three months ended June 30, 2012 and 2011, VMware recognized revenues of

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

$45.6 million and $14.2 million, respectively, from products and services sold pursuant to VMware’s reseller arrangement with EMC. In the six months ended June 30, 2012 and 2011, VMware recognized revenues of $80.6 million and $34.2 million, respectively, from such contractual arrangement with EMC. As of June 30, 2012, $107.6 million of revenues from products and services sold under the reseller arrangement were included in unearned revenues.
In the three months ended June 30, 2012 and 2011, VMware recognized professional services revenues of $23.6 million and $16.4 million, respectively, for services provided to EMC’s customers pursuant to VMware’s contractual agreements with EMC. In the six months ended June 30, 2012 and 2011, VMware recognized professional services revenues of $42.3 million and $30.8 million, respectively, from such contractual agreements with EMC. As of June 30, 2012, $6.7 million of revenues from professional services to EMC customers were included in unearned revenues.
In the three months ended June 30, 2012 and 2011, VMware recognized revenues of $2.1 million and $0.5 million, respectively, from server and desktop products and services purchased by EMC for internal use pursuant to VMware’s contractual agreements with EMC. In the six months ended June 30, 2012 and 2011, VMware recognized revenues of $3.8 million and $1.0 million, respectively, from such contractual agreements with EMC. As of June 30, 2012, $22.7 million of revenues from server and desktop products and services purchased by EMC for internal use were included in unearned revenues.
VMware purchased storage systems and software, as well as consulting services, from EMC for $5.9 million and $7.5 million in the three months ended June 30, 2012 and 2011, respectively, and for $23.9 million and $13.3 million in the six months ended June 30, 2012 and 2011, respectively.
In certain geographic regions where VMware does not have an established legal entity, VMware contracts with EMC subsidiaries for support services and EMC personnel who are managed by VMware. The costs incurred by EMC on VMware’s behalf related to these employees are passed on to VMware and VMware is charged a mark-up intended to approximate costs that would have been charged had VMware contracted for such services with an unrelated third party. These costs are included as expenses in VMware’s consolidated statements of income and primarily include salaries, benefits, travel and rent. Additionally, EMC incurs certain administrative costs on VMware’s behalf in the U.S. that are also recorded as expenses. The total cost of the services provided to VMware by EMC as described above was $21.2 million and $18.0 million in the three months ended June 30, 2012 and 2011, respectively, and $49.0 million and $42.7 million in the six months ended June 30, 2012 and 2011, respectively.
In the three and six months ended June 30, 2012, no payments were made by either VMware or EMC under the tax sharing agreement. In the three and the six months ended June 30, 2011, EMC paid VMware $141.0 million and $176.4 million, respectively, under the tax sharing agreement and no payments were made by VMware to EMC. Payments between VMware and EMC under the tax sharing agreement primarily relate to VMware’s portion of federal income taxes on EMC’s consolidated tax return. Payments from VMware to EMC primarily relate to periods for which VMware had stand-alone federal taxable income, while payments from EMC to VMware relate to periods for which VMware had a stand-alone federal taxable loss. The amounts that VMware either pays to or receives from EMC for its portion of federal income taxes on EMC’s consolidated tax return differ from the amounts VMware would owe on a stand-alone basis and the difference is presented as a component of stockholders’ equity. For all periods presented, the difference was not material.
In the three months ended June 30, 2012 and 2011, $1.2 million and $1.0 million, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on VMware’s consolidated statements of income. In the six months ended June 30, 2012 and 2011, $2.4 million and $1.9 million, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on VMware’s consolidated statements of income. VMware’s interest expense as a separate, stand-alone company may be higher or lower than the amounts reflected in the consolidated financial statements.
As of June 30, 2012, VMware had $61.7 million net due from EMC, which consisted of $88.6 million due from EMC, partially offset by $26.9 million due to EMC. These amounts resulted from the related party transactions described above. In addition to the $61.7 million net due from EMC as of June 30, 2012, VMware had an immaterial amount of net income taxes payable to EMC, which is included in accrued expenses and other on VMware’s consolidated balance sheets. Balances due to or from EMC which are unrelated to tax obligations are generally settled in cash within 60 days of each quarter-end. The timing of the tax payments due to and from EMC is governed by the tax sharing agreement with EMC.
P. Segment Information
VMware operates in one operating segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. VMware’s chief operating decision maker allocates resources and assesses performance

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VMware, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

based upon discrete financial information at the consolidated level. Since VMware operates in one operating segment, all required financial segment information can be found in the consolidated financial statements.
Revenues by geographic area for the three months ended June 30, 2012 and 2011 were as follows (table in thousands):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
United States
$
550,659

 
$
450,327

 
$
1,035,633

 
$
849,877

International
572,367

 
470,883

 
1,142,575

 
915,054

Total
$
1,123,026

 
$
921,210

 
$
2,178,208

 
$
1,764,931

No country other than the United States had material revenues for the three and six months ended June 30, 2012 or 2011.
Long-lived assets by geographic area, which primarily include property and equipment, net, as of June 30, 2012 and December 31, 2011 were as follows (table in thousands):
 
June 30, 2012
 
December 31, 2011
United States
$
466,115

 
$
429,678

International
45,331

 
46,477

Total
$
511,446

 
$
476,155

No country other than the United States accounted for 10% or more of these assets at June 30, 2012 or December 31, 2011, respectively.
Q. Subsequent Events
In July 2012, VMware, Inc. entered into a definitive agreement to acquire Nicira, Inc. (“Nicira”), a developer of software-defined networking solutions, for approximately $1,050.0 million in cash plus approximately $210.0 million of assumed unvested equity awards. The acquisition is subject to regulatory approvals and other customary closing conditions. The parties expect the acquisition to close during the second half of 2012. The acquisition has been approved by the boards of directors of both VMware and Nicira and the stockholders of Nicira.


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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All dollar amounts expressed as numbers in this MD&A (except share and per share amounts) are in millions.
Overview
Our primary source of revenues is the licensing of virtualization and virtualization-based cloud infrastructure solutions and related support and services for use by businesses and organizations of all sizes and across numerous industries in their information technology (“IT”) infrastructure.
We have developed a multi-channel distribution model to expand our global presence and to reach various segments of the industry. In the second quarter and first half of 2012, we derived over 85% of our sales from our channel partners, which include distributors, resellers, system vendors and systems integrators. Sales to our channel partners often involve three tiers of distribution: a distributor, a reseller and an end-user customer. Our sales force works collaboratively with our channel partners to introduce them to customers and new sales opportunities. As we expand geographically, we expect to continue to add additional channel partners.
Although we believe we are currently the leading provider of virtualization infrastructure software solutions, we face competitive threats to our leadership position from a number of companies, some of which have significantly greater resources than we do, which could result in increased pressure to reduce prices on our offerings. As a result, we believe it is important to continue to invest in strategic initiatives related to product research and development, market expansion and associated support functions to expand our industry leadership. We believe that we will be able to continue to meet our product development objectives through continued investment in our existing infrastructure, supplemented with strategic hires and acquisitions, funded through the operating cash flows generated from the sale of our products and services. We believe this is the appropriate priority for the long-term health and growth of our business.
We expect to grow our business by broadening our virtualization infrastructure software solutions technology and product portfolio, increasing product awareness, promoting the adoption of virtualization and building long-term relationships with our customers through the adoption of enterprise license agreements (“ELAs”). Since the introduction of VMware vSphere in 2009, we have introduced more products that build on the vSphere foundation, including VMware vSphere 5 and a comprehensive suite of cloud infrastructure technologies, as well as VMware View 5. We plan to continue to introduce additional products in the future. We have made, and expect to continue to make, acquisitions designed to strengthen our product offerings or extend our strategy to deliver solutions that can be hosted at customer data centers or at service providers.
Our current financial focus is on long-term revenue growth to generate free cash flows to fund our expansion of industry segment share and to evolve our virtualization-based products for data centers, end-user devices and cloud computing through a combination of internal development and acquisitions. See “Non-GAAP Financial Measures” for further information on free cash flows. In evaluating our results, we also focus on operating margin excluding certain expenses which are included in our total operating expenses calculated in accordance with GAAP. The expenses excluded are stock-based compensation, the net effect of the amortization and capitalization of software development costs and certain other expenses consisting of employer payroll taxes on employee stock transactions, amortization of intangible assets and acquisition-related items. We believe this measure reflects our ongoing business in a manner that allows meaningful period-to-period comparisons. We are not currently focused on short-term operating margin expansion, but rather on investing at appropriate rates to support our growth and future product offerings in what may be a substantially more competitive environment.
Although our customers continue to adopt our product platform as a strategic investment that improves efficiency and flexibility for their business and enables substantial cost savings, we remain cautious about the macroeconomic environment. The volatility we are observing in both the world economy and individual sovereign nations may impact IT spending and demand for our products and services for the remainder of 2012. We expect to continue to manage our resources prudently, while making key investments in support of our long-term growth objectives.
Income Statement Presentation
As we operate our business in one operating segment, our revenues and operating expenses are presented and discussed at the consolidated level.
As a consequence of the timing differences in the recognition of license revenues and software maintenance revenues, variability in operating margin can result from differences between when we quote and contract for our services and when the cost is incurred. Variability in operating margin can also result when we recognize previously unearned foreign denominated software maintenance and license revenues in future periods. Due to our use of the U.S. Dollar as our functional currency, unearned revenue remains at its historical rate when recognized into revenue while our operating expenses in future periods are based upon the foreign exchange rates at that time.

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Sources of Revenues
License revenues
Our license revenues consist of revenues earned from the licensing of our software products. These products are generally licensed on a perpetual basis. License revenues are recognized when the elements of revenue recognition for the licensed software are complete, generally upon electronic shipment of the software. The revenues allocated to the software license included in multiple-element contracts represent the residual amount of the contract after the fair value of the other elements has been determined. While some of our products are licensed on a subscription basis, subscription license revenues are not a material part of our business.
Pricing models have generally been based upon the physical infrastructure, such as the number of physical desktop computers or server processors, on which our software runs. We base pricing for some of our products on virtual, rather than purely physical, entitlements, while continuing to license such products on a perpetual basis. In the third quarter of 2011, we revised the pricing model for VMware vSphere 5 effective with its general availability. VMware vSphere 5 will continue to be licensed perpetually on a per-processor basis. The two physical constraints, number of cores and physical RAM, have been eliminated, however, and replaced with a single virtualization-based entitlement of virtual memory, or vRAM, which can be shared across a large pool of servers.
Software maintenance revenues
Software maintenance revenues are recognized ratably over the contract period. Our contract periods typically range from one to five years and include renewals of software maintenance sold after the initial software maintenance period expires. Vendor-specific objective evidence (“VSOE”) of fair value for software maintenance services is established by the rates charged in stand-alone sales of software maintenance contracts. Customers receive various types of technical support based on the level of support purchased. Customers who are party to software maintenance agreements with us are entitled to receive product updates and upgrades on a when-and-if-available basis.
Professional services revenues
Professional services include solution design, implementation and training. Professional services are not considered essential to the functionality of our products, as these services do not alter the product capabilities and may be performed by our customers or by other vendors. Professional services engagements performed for a fixed fee, for which we are able to make reasonably dependable estimates of progress toward completion, are recognized on a proportional performance basis based on hours incurred and estimated hours of completion. Professional services engagements that are on a time and materials basis are recognized based on hours incurred. Revenues on all other professional services engagements are recognized upon completion. Our professional services may be sold with software products or on a stand-alone basis. VSOE of fair value for professional services is based upon the standard rates we charge for such services when sold separately.
Operating Expenses
Cost of license revenues
Our cost of license revenues principally consist of the amortization of capitalized software development costs and of intangibles, as well as royalty costs in connection with technology licensed from third-party providers and the cost of fulfillment of our software. The cost of fulfillment of our software includes product packaging, personnel costs and related overhead associated with the physical and electronic delivery of our software products.
Cost of services revenues
Our cost of services revenues include the costs of personnel and related overhead to deliver technical support for our products and to provide our professional services.
Research and development expenses
Our research and development (“R&D”) expenses include the personnel and related overhead associated with the R&D of new product offerings and the enhancement of our existing software offerings, net of amounts capitalized.
Sales and marketing expenses
Our sales and marketing expenses include personnel costs, sales commissions and related overhead associated with the sale and marketing of our license and services offerings, as well as the cost of product launches and certain marketing initiatives, including our annual VMworld conferences in the U.S. and Europe. Sales commissions are generally earned and expensed when a firm order is received from the customer and may be expensed in a period other than the period in which the related revenue is recognized.

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General and administrative expenses
Our general and administrative expenses include personnel and related overhead costs to support the overall business. These expenses include the costs associated with our facilities, finance, human resources, IT infrastructure and legal departments, as well as expenses related to corporate costs and initiatives.
Results of Operations
Revenues
Our revenues in the second quarter and first half of 2012 and 2011 were as follows: 
 
For the Three Months Ended
 
 
 
For the Six Months Ended
 
 
 
June 30,
 
 
 
June 30,
 
 
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
 
 
License
$
517.2

 
$
464.8

 
11
%
 
$
999.1

 
$
883.8

 
13
%
Services:
 
 
 
 
 
 
 
 
 
 
 
Software maintenance
519.1

 
386.3

 
34

 
1,011.4

 
750.1

 
35

Professional services
86.7

 
70.1

 
24

 
167.7

 
131.0

 
28

Total services
605.8

 
456.4

 
33

 
1,179.1

 
881.1

 
34

Total revenues
$
1,123.0

 
$
921.2

 
22

 
$
2,178.2

 
$
1,764.9

 
23

 
 
 
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
United States
$
550.7

 
$
450.3

 
22
%
 
$
1,035.6

 
$
849.9

 
22
%
International
572.3

 
470.9

 
22

 
1,142.6

 
915.0

 
25

Total revenues
$
1,123.0

 
$
921.2

 
22

 
$
2,178.2

 
$
1,764.9

 
23

Total revenues increased by $201.8 or 22% to $1,123.0 in the second quarter of 2012 from $921.2 in the second quarter of 2011. Total revenues increased by $413.3 or 23% to $2,178.2 in the first half of 2012 from $1,764.9 in the first half of 2011.
In the second quarter and first half of 2012 we saw growth in license and services revenues, and growth in the United States and internationally, as compared with the second quarter and first half of 2011.
License Revenues
Software license revenues increased by $52.4 or 11% to $517.2 in the second quarter of 2012 from $464.8 in the second quarter of 2011. Software license revenues increased by $115.3 or 13% to $999.1 in the first half of 2012 from $883.8 in the first half of 2011. License revenues in the second quarter and first half of 2012 benefited from demand across our product offerings, as compared to the second quarter and first half of 2011.
In the second quarter of 2012, ELAs comprised 29% of total sales compared with 26% in the second quarter of 2011, and 26% in the first half of 2012 compared with 24% in the first half of 2011. We have promoted the adoption of virtualization and built long-term relationships with our customers through the adoption of ELAs. ELAs continue to be an important component of our revenue growth and are offered both directly by us and through certain channel partners. ELAs are a core element to our strategy to build long-term relationships with customers as they commit to our virtualization infrastructure software solutions in their data centers. ELAs provide a base from which to sell additional products, such as our application platform products, our end-user computing products and our cloud infrastructure and management products. Under a typical ELA, a portion of the revenues is attributed to the license and recognized immediately and the remainder is deferred and primarily recognized as software maintenance revenues in future periods. In addition, the initial maintenance period is typically longer for ELAs than for other types of license sales.
Services Revenues
Services revenues increased by $149.4 or 33% to $605.8 in the second quarter of 2012 from $456.4 in the second quarter of 2011. Services revenues increased by $297.9 or 34% to $1,179.1 in the first half of 2012 from $881.1 in the first half of 2011. The increase in services revenues during the second quarter and first half of 2012 was primarily attributable to growth in our software maintenance revenues.
Software maintenance revenues increased by $132.8 or 34% to $519.1 in the second quarter of 2012 from $386.3 in the second quarter of 2011. Software maintenance revenues increased by $261.3 or 35% to $1,011.4 in the first half of 2012 from

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$750.1 in the first half of 2011. In the second quarter and first half of 2012, software maintenance revenues benefited from strong renewals, multi-year software maintenance contracts sold in previous periods, and additional maintenance contracts sold in conjunction with new software license sales. In the second quarter and first half of 2012, customers bought, on average, more than 24 months of support and maintenance with each new license purchased, which we believe illustrates our customers’ commitment to VMware as a core element of their data center architecture and hybrid cloud strategy.
Professional services revenues increased by $16.6 or 24% to $86.7 in the second quarter of 2012 from $70.1 in the second quarter of 2011. Professional services revenues increased by $36.7 or 28% to $167.7 in the first half of 2012 from $131.0 in the first half of 2011. Professional services revenues increased as growth in our license sales and installed-base led to additional demand for our professional services. As we continue to invest in our partners and expand our ecosystem of third-party professionals with expertise in our solutions to independently provide professional services to our customers, we do not expect our professional services revenues to constitute an increasing component of our revenue mix. As a result of this strategy, our professional services revenue can vary based on the delivery channels used in any given period as well as the timing of engagements.
Revenue Growth in Constant Currency
We invoice and collect in the Euro, the British Pound, the Japanese Yen and the Australian Dollar in their respective regions. As a result, our total revenues are affected by changes in the value of the U.S. Dollar against these currencies. In order to provide a comparable framework for assessing how our business performed excluding the effect of foreign currency fluctuations, management analyzes year-over-year revenue growth on a constant currency basis. Since we operate with the U.S. Dollar as our functional currency, unearned revenues for orders booked in currencies other than the U.S. Dollar are converted into U.S. Dollars at the exchange rate in effect for the month in which each order is booked. We calculate constant currency on license revenues recognized during the current period that were originally booked in currencies other than U.S. Dollars by comparing the exchange rates used to recognize revenue in the current period against the exchange rates used to recognize revenue in the comparable period. We do not calculate constant currency on services revenues, which include software maintenance revenues and professional services revenues.
For the second quarter of 2012, the year-over-year growth in license revenues measured on a constant currency basis was 13% compared with 11% as reported, and was 14% compared with 13% as reported year-over-year for the first half of 2012. The year-over-year growth in total revenues in the second quarter of 2012 measured on a constant currency basis was 23% compared with 22% as reported and was 24% compared with 23% as reported year-over-year in the first half of 2012.
Unearned Revenues
Our unearned revenues as of June 30, 2012, and December 31, 2011 were as follows: 
 
June 30, 2012
 
December 31, 2011
Unearned license revenues
$
375.6

 
$
389.2

Unearned software maintenance revenues
2,357.0

 
2,133.5

Unearned professional services revenues
209.8

 
185.7

Total unearned revenues
$
2,942.4

 
$
2,708.4


The complexity of our unearned revenues has increased over time as a result of acquisitions, an expanded product portfolio and a broader range of pricing and packaging alternatives. As of June 30, 2012, total unearned revenues increased by $234.0 or 9% to $2,942.4 from $2,708.4 at December 31, 2011. This increase was primarily due to growth in unearned software maintenance revenues, attributable to our growing base of maintenance contracts.
Unearned license revenues are recognized either ratably or upon the delivery of existing products, future products or services. Future products include, in some cases, emerging products that are offered as part of product promotions where the purchaser of an existing product is entitled to receive a promotional product at no additional charge. We regularly offer product promotions as a strategy to improve awareness of our emerging products. To the extent promotional products have not been delivered and VSOE of fair value cannot be established, the revenue for the entire order is deferred until such time as all product delivery obligations have been fulfilled. Increasingly, unearned license revenue may also be recognized ratably, which is generally due to a right to receive unspecified future products or a lack of VSOE of fair value on the software maintenance element of the arrangement. At June 30, 2012, the ratable component represented over half of the total unearned license revenue balance. Unearned software maintenance revenues are attributable to our maintenance contracts and are recognized ratably over terms from one to five years with a weighted-average remaining term at June 30, 2012 of approximately 1.9 years. Unearned professional services revenues result primarily from prepaid professional services, including training, and are generally recognized as the services are delivered. We believe our overall unearned revenue balance improves predictability of

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future revenues and that it is a key indicator of the health and growth of our business.
Operating Expenses
Information about our operating expenses for the second quarter and first half of 2012 and 2011 is as follows:
 
For the Three Months Ended June 30, 2012
 
Core
Operating
Expenses (1)
 
Stock-Based
Compensation
 
Capitalized
Software
Development
Costs, net
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenue
$
21.5

 
$
0.5

 
$
20.8

 
$
13.8

 
$
56.6

Cost of services revenue
114.1

 
7.1

 

 
1.5

 
122.7

Research and development
197.7

 
48.0

 

 
2.9

 
248.6

Sales and marketing
353.2

 
33.9

 

 
4.4

 
391.5

General and administrative
78.3

 
11.4

 

 
2.0

 
91.7

Total operating expenses
$
764.8

 
$
100.9

 
$
20.8

 
$
24.6

 
$
911.1

Operating income
 
 
 
 
 
 
 
 
$
211.9

Operating margin
 
 
 
 
 
 
 
 
18.9
%
 
 
For the Three Months Ended June 30, 2011
 
Core
Operating
Expenses (1)
 
Stock-Based
Compensation
 
Capitalized
Software
Development
Costs, net
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenue
$
17.5

 
$
0.4

 
$
19.8

 
$
11.2

 
$
48.9

Cost of services revenue
96.1

 
5.7

 

 
1.7

 
103.5

Research and development
164.0

 
46.1

 
(25.4
)
 
4.5

 
189.2

Sales and marketing
286.6

 
23.3

 

 
4.7

 
314.6

General and administrative
66.3

 
9.9

 

 
1.9

 
78.1

Total operating expenses
$
630.5

 
$
85.4

 
$
(5.6
)
 
$
24.0

 
$
734.3

Operating income
 
 
 
 
 
 
 
 
$
186.9

Operating margin
 
 
 
 
 
 
 
 
20.3
%
 
For the Six Months Ended June 30, 2012
 
Core
Operating
Expenses (1)
 
Stock-Based
Compensation
 
Capitalized
Software
Development
Costs, net
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenue
$
42.7

 
$
1.0

 
$
42.6

 
$
27.0

 
$
113.3

Cost of services revenue
220.9

 
12.9

 

 
3.0

 
236.8

Research and development
378.0

 
87.4

 

 
5.6

 
471.0

Sales and marketing
686.5

 
59.1

 

 
9.3

 
754.9

General and administrative
148.2

 
22.3

 

 
2.6

 
173.1

Total operating expenses
$
1,476.3

 
$
182.7

 
$
42.6

 
$
47.5

 
$
1,749.1

Operating income
 
 
 
 
 
 
 
 
$
429.1

Operating margin
 
 
 
 
 
 
 
 
19.7
%
 

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For the Six Months Ended June 30, 2011
 
Core
Operating
Expenses (1)
 
Stock-Based
Compensation
 
Capitalized
Software
Development
Costs, net
 
Other
Operating
Expenses
 
Total
Operating
Expenses
Cost of license revenue
$
35.6

 
$
0.9

 
$
48.3

 
$
20.1

 
$
104.9

Cost of services revenue
182.7

 
11.3

 

 
3.4

 
197.4

Research and development
315.9

 
88.0

 
(52.9
)
 
7.4

 
358.4

Sales and marketing
563.9

 
45.8

 

 
7.8

 
617.5

General and administrative
123.9

 
20.0

 

 
2.4

 
146.3

Total operating expenses
$
1,222.0

 
$
166.0

 
$
(4.6
)
 
$
41.1

 
$
1,424.5

Operating income
 
 
 
 
 
 
 
 
$
340.4

Operating margin
 
 
 
 
 
 
 
 
19.3
%
____________________________
(1)
Core operating expenses is a non-GAAP financial measure that excludes stock-based compensation, the net effect of the amortization and capitalization of software development costs and certain other expenses from our total operating expenses calculated in accordance with GAAP. The other expenses excluded are employer payroll taxes on employee stock transactions, amortization of intangible assets and acquisition-related items. See “Non-GAAP Financial Measures” for further information.
Operating margins decreased to 18.9% in the second quarter of 2012 from 20.3% in the second quarter of 2011. The decrease in our operating margin in the second quarter of 2012 compared with the second quarter of 2011 primarily relates to the year-over-year decrease in capitalized software development costs due to the change in our go-to-market strategy. Our operating margin in the first half of 2012 was flat compared with the first half of 2011 at 19.7% and 19.3%, respectively. Although the change was not significant, our operating margin in the first half of 2012 compared with the first half of 2011 was negatively impacted by the year-over-year decrease in capitalized software development costs. This negative impact was offset by increases in our revenues, which outpaced the increases in our core operating expenses and stock-based compensation.
Our core operating expenses reflect our business in a manner that allows meaningful period-to-period comparisons. Our core operating expenses are reconciled to the most comparable GAAP measure, “total operating expenses,” in the table above.
Core Operating Expenses
The following discussion of our core operating expenses and the components comprising our core operating expenses highlights the factors that we focus on when evaluating our operating margin and operating expenses. The increases or decreases in operating expenses discussed in this section do not include changes relating to stock-based compensation, the net effect of the amortization and capitalization of software development costs and certain other expenses, which consist of employer payroll taxes on employee stock transactions, amortization of acquired intangible assets and acquisition-related items.
Core operating expenses increased by $134.3 or 21% in the second quarter of 2012 compared with the second quarter of 2011. Core operating expenses increased by $254.3 or 21% in the first half of 2012 compared with the first half of 2011. As quantified below, these increases were primarily due to an increase in employee-related expenses, which include salaries and benefits, bonuses, commissions, and recruiting and training. The increase in employee-related expenses was largely a result of an increase in headcount of over 2,000 employees in the second quarter of 2012 compared with the second quarter of 2011, driven by strategic hiring, business growth and business acquisitions. A portion of our core operating expenses, primarily the cost of personnel to deliver technical support on our products and professional services, marketing, and research and development, are denominated in foreign currencies, and are thus exposed to foreign exchange rate fluctuations. Core operating expenses benefited by $19.1 and $23.0 in the second quarter and first half of 2012, as compared with the second quarter and first half of 2011, due to the effect of fluctuations in the exchange rates between the U.S. Dollar and other currencies.
Cost of License Revenues
Core operating expenses in cost of license revenues increased by $4.0 or 23% in the second quarter of 2012 compared with the second quarter of 2011, and by $7.1 or 20% in the first half of 2012 compared with the first half of 2011. The increases were primarily due to an increase of $2.2 and $3.8 in the second quarter and first half of 2012, respectively, for IT development costs.
Cost of Services Revenues
Core operating expenses in cost of services revenues increased by $18.0 or 19% in the second quarter of 2012 compared with the second quarter of 2011, and by $38.2 or 21% in the first half of 2012 compared with the first half of 2011. The increases were primarily due to growth in employee-related expenses of $14.4 and $27.5 in the second quarter and first half of

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2012, respectively, which were largely driven by incremental growth in headcount. Additionally, our third-party professional services costs increased by $4.6 and $8.8 in the second quarter and first half of 2012, respectively, to provide technical support and professional services primarily in connection with increased demand for services.
Research and Development Expenses
Core operating expenses for R&D increased by $33.7 or 21% in the second quarter of 2012 compared with the second quarter of 2011, and by $62.1 or 20% in the first half of 2012 compared with the first half of 2011. The increases were primarily due to growth in employee-related expenses of $28.2 and $52.9 in the second quarter and first half of 2012, respectively, which was primarily driven by incremental growth in headcount from strategic hiring and business acquisitions.
Sales and Marketing Expenses
Core operating expenses for sales and marketing increased by $66.6 or 23% in the second quarter of 2012 compared with the second quarter of 2011, and by $122.6 or 22% in the first half of 2012 compared with the first half of 2011. The increases were primarily due to growth in employee-related expenses of $54.5 and $99.9 in the second quarter and first half of 2012, respectively, driven by incremental growth in headcount. Additionally, the costs of marketing programs increased by $13.2 and $21.6 in the second quarter and first half of 2012, respectively. These increases were partially offset by the positive impact of $10.5 and $12.1, respectively, from fluctuations in the exchange rate between the U.S. Dollar and foreign currencies.
General and Administrative Expenses
Core operating expenses for general and administrative increased by $12.0 or 18% in the second quarter of 2012 compared with the second quarter of 2011, and by $24.3 or 20% in the first half of 2012 compared with the first half of 2011. The increases were primarily due to an increase of $4.3 and $10.2 in the second quarter and first half of 2012, respectively, related to employee-related expenses mostly due to incremental growth in headcount. General and administrative expenses also increased in the second quarter and first half of 2012 due to equipment and depreciation expenses of $3.3 and $4.6, respectively, to support increased headcount and IT security initiatives. Additionally, contractor costs primarily related to IT security initiatives contributed to the overall year-over-year change in expenses with an increase of $1.9 and $3.9 in the second quarter and first half of 2012, respectively.
Stock-Based Compensation Expense
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
2012
 
2011
 
2012
 
2011
Stock-based compensation, excluding amounts capitalized
$
100.9

 
$
85.4

 
$
182.7

 
$
166.0

Stock-based compensation capitalized

 
4.2

 

 
9.0

Stock-based compensation, including amounts capitalized
$
100.9

 
$
89.6

 
$
182.7

 
$
175.0

Stock-based compensation expense increased by $11.3 and $7.7 in the second quarter and first half of 2012 compared to the second quarter and first half of 2011 primarily due to an increase of $35.9 and $54.9, respectively, for new awards issued to our existing employees, as well as an increase of $9.2 and $17.8, respectively, for awards made to new employees over the last year. Partially offsetting these increases was a decrease of $31.4 and $65.7, respectively, related to grants which became fully vested over the past year.
Stock-based compensation is recorded to each operating expense category based upon the function of the employee to whom the stock-based compensation relates and fluctuates based upon the value and number of awards granted. Compensation philosophy varies by function, resulting in different weightings of cash incentives versus equity incentives. As a result, functions with larger cash-based components, such as sales commissions, will have comparatively lower stock-based compensation expense than other functions.
As of June 30, 2012, the total unamortized fair value of our outstanding equity-based awards held by our employees was approximately $884.7 and is expected to be recognized over a weighted-average period of approximately 1.7 years.
Capitalized Software Development Costs, Net
Development costs of software to be sold, leased, or otherwise marketed are subject to capitalization beginning when the product’s technological feasibility has been established and ending when the product is available for general release. Judgment is required in determining when technological feasibility is established, and as our business, products and go-to-market strategy have evolved, we have continued to evaluate when technological feasibility is established. Following the release of vSphere 5 and the comprehensive suite of cloud infrastructure technologies in the third quarter of 2011, we determined that VMware’s go-

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to-market strategy had changed from single solutions to product suite solutions. As a result of this change in strategy, and the related increased importance of interoperability between our products, the length of time between achieving technological feasibility and general release to customers significantly decreased. We expect our products to be available for general release soon after technological feasibility has been established. Given that we expect the majority of our product offerings to be suites or to have key components that interoperate with our other product offerings, the costs incurred subsequent to achievement of technological feasibility are expected to be immaterial in future periods. In the second quarter and first half of 2012, all software development costs were expensed as incurred and were included in R&D expenses on the accompanying consolidated statement of income. In the second quarter and first half of 2011, we capitalized $29.6 (including $4.2 of stock-based compensation) and $61.9 (including $9.0 of stock-based compensation), respectively, of costs for the development of software products. The amounts capitalized in the second quarter and first half of 2011 primarily related to the development of VMware vSphere 5.
Our expensed and capitalized R&D costs may not be comparable to our peer companies due to differences in judgment as to when technological feasibility has been reached or differences in judgment regarding when the product is available for general release. Additionally, future changes in our judgment as to when technological feasibility is established, or additional changes in our business, including our go-to-market strategy, could materially impact the amount of costs capitalized. For example, if the length of time between technological feasibility and general availability was to increase again in the future, the amount of capitalized costs would likely increase.
In the second quarter of 2012, amortization expense from capitalized software development costs increased $1.0 to $20.8 from $19.8 in the second quarter of 2011. This increase was primarily due to the general release of VMware vSphere 5.0 in the second half of 2011. In the first half of 2012, amortization expense from capitalized software development costs decreased $5.7 to $42.6 from $48.3 in the first half of 2011. This decrease was primarily due to a decrease of $24.6 related to the amortization of prior versions of vSphere, as well as a decrease of $7.4 related to certain capitalized projects that were fully amortized prior to the end of the second quarter of 2012. These decreases were partially offset by an increase of $22.6 related to the general release of VMware vSphere 5.0 in the second half of 2011. Amortization expense from capitalized software development costs is included in cost of license revenues on our accompanying consolidated statements of income. In future periods, we expect our amortization expense from capitalized software development costs to decline as these costs are expected to be recorded as R&D expense as incurred given our current go-to-market strategy.
Other Operating Expenses
Other operating expenses consist of employer payroll tax on employee stock transactions and intangible amortization, which are recorded to each individual line of operating expense on our accompanying consolidated statements of income. Additionally, other operating expenses include acquisition-related items, which are recorded to general and administrative expense on our income statement.
Other operating expenses increased by $0.6 to $24.6 in the second quarter of 2012 from $24.0 in the second quarter of 2011. The increase in the second quarter of 2012 was primarily due to an increase in intangible amortization of $2.9 resulting from new acquisitions, which was primarily recorded to costs of license revenues on our income statement. The increase was partially offset by a decrease of $2.7 in employer payroll taxes on employee stock transactions, which was primarily attributable to a decrease in the number of awards exercised, sold or vested. Other operating expenses increased by $6.3 to $47.5 in the first half of 2012 from $41.1 in the first half of 2011. The increase in the first half of 2012 was primarily due to an increase in intangible amortization of $7.8 resulting from new business acquisitions, which was primarily recorded to costs of license revenues on our income statement. The increase was partially offset by a decrease of $1.7 in employer payroll taxes on employee stock transactions, which was primarily attributable to a decrease in the number of awards exercised, sold or vested.
Investment Income
Investment income increased by $3.2 to $6.9 in the second quarter of 2012 from $3.7 in the second quarter of 2011. Investment income increased by $5.6 to $12.7 in the first half of 2012 from $7.1 in the first half of 2011. Investment income primarily consists of interest earned on cash, cash equivalents and short-term investment balances partially offset by the amortization of premiums paid on fixed income securities. Investment income increased in the second quarter and first half of 2012 as compared with the second quarter and first half of 2011 due to an increase in the average rate of interest earned, resulting from a reallocation of funds from cash equivalents to fixed income securities, and increased cash equivalent and short-term investment balances available for investment.
Other Income (Expense), Net
Other expense, net of $3.6 in second quarter of 2012 changed by $60.2 as compared with other income, net of $56.6 in second quarter of 2011. Other expense, net of $1.3 in first half of 2012 changed by $58.1 from other income, net of $56.8 in first half of 2011. The change in second quarter and first half of 2012 as compared with the second quarter and first half of 2011 was primarily due to a $56.0 gain recognized on the sale of our investment in Terremark Worldwide, Inc. in 2011.


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Income Tax Provision
Our effective income tax rate was 10.5% and 10.6%, respectively, for the second quarter of 2012 and 2011. The effective income tax rate was 12.5% and 14.0%, respectively, for the first half of 2012 and 2011. The lower effective rate for the second quarter and first half of 2012, as compared with the second quarter and first half of 2011, was primarily attributable to a jurisdictional shift of income from the United States to lower-tax non-U.S. jurisdictions, partially offset by a decrease in the release of unrecognized tax benefits from uncertain tax positions as a percentage of income before tax, as well as by the expiration of the federal research tax credit.
Our rate of taxation in foreign jurisdictions is lower than our U.S. tax rate. Our international income is primarily earned by our subsidiaries in Ireland, where the statutory tax rate is 12.5%. We do not believe that any recent or currently expected developments in non-U.S. tax jurisdictions are reasonably likely to have a material impact on our effective tax rate. As of June 30, 2012, our total cash, cash equivalents, and short-term investments were $5,346.9, of which $2,694.0 were held outside the U.S. If these overseas funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes on related undistributed earnings to repatriate these funds. However, all income earned abroad, except for previously taxed income for U.S. tax purposes, is considered indefinitely reinvested in our foreign operations and no provision for U.S. taxes has been provided with respect thereto. At this time, it is not practicable to estimate the amount of tax that may be payable were we to repatriate these funds and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. We will meet our U.S. liquidity needs through ongoing cash flows generated from our U.S. operations, external borrowings, or both. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.
Although we file a federal consolidated tax return with EMC, we calculate our income tax provision on a stand-alone basis. Our effective tax rate in the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The rate at which the provision for income taxes is calculated differs from the U.S. federal statutory income tax rate primarily due to different tax rates in foreign jurisdictions where income is earned and considered to be indefinitely reinvested.
We have been included in the EMC consolidated group for U.S. federal income tax purposes, and expect to continue to be included in such consolidated group for periods in which EMC owns at least 80% of the total voting power and value of our outstanding stock as calculated for U.S. federal income tax purposes. The percentage of voting power and value calculated for U.S. federal income tax purposes may differ from the percentage of outstanding shares beneficially owned by EMC due to the greater voting power of our Class B common stock as compared to our Class A common stock and other factors. Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Should EMC’s ownership fall below 80% of the total voting power or value of our outstanding stock in any period, then we would no longer be included in the EMC consolidated group for U.S. federal income tax purposes, and thus no longer be liable in the event that any income tax liability was incurred, but not discharged, by any other member of the EMC consolidated group. Additionally, our U.S. federal income tax would be reported separately from that of the EMC consolidated group.
Our effective tax rate for the remainder of 2012 may be affected by such factors as changes in tax laws, regulations or rates, changing interpretation of existing laws or regulations, the impact of accounting for stock-based compensation, the impact of accounting for business combinations, changes in our international organization, shifts in the amount of income before tax earned in the U.S. as compared with other regions in the world, and changes in overall levels of income before tax.
Our Relationship with EMC
As of June 30, 2012, EMC owned 38,664,000 shares of Class A common stock and all 300,000,000 shares of Class B common stock, representing 79.3% of our total outstanding shares of common stock and 97.2% of the combined voting power of our outstanding common stock.
In the second quarter of 2011, we acquired certain assets relating to EMC’s Mozy cloud-based data storage and data center services, including certain data center assets and a license to certain intellectual property. EMC retained ownership of the Mozy business and its remaining assets. EMC continues to be responsible to Mozy customers for Mozy products and services and continues to recognize revenue from such products and services. We entered into an operational support agreement with EMC through the end of 2012, pursuant to which we took over responsibility to operate the Mozy service on behalf of EMC. Pursuant to the support agreement, costs incurred by us to support EMC’s Mozy services, plus a mark-up intended to approximate third-party costs and a management fee, are reimbursed to us by EMC. On the consolidated statements of income, in the three months ended June 30, 2012 and 2011, such amounts as described above were approximately $16.4 and $12.2, respectively. In the six months ended June 30, 2012 and 2011, such amounts were $30.9 and $12.2, respectively. These amounts were recorded as a reduction to the costs we incurred.

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In the second quarter of 2010, we acquired certain software product technology and expertise from EMC’s Ionix IT management business for cash consideration of $175.0. EMC retained the Ionix brand and will continue to offer customers the products acquired by us, pursuant to the ongoing reseller agreement between EMC and us. During the six months ended June 30, 2011, a $12.5 contingent payment was made to EMC. This payment was recorded as an equity transaction and was an offset to the initial capital contribution from EMC. As of December 31, 2011all contingent payments under the agreement had been made.
Pursuant to an ongoing reseller arrangement with EMC, EMC bundles our products and services with EMC’s hardware and sells them to end-users. In the three months ended June 30, 2012 and 2011, we recognized revenues of $45.6 and $14.2, respectively, from products and services sold pursuant to our reseller arrangement with EMC. In the six months ended June 30, 2012 and 2011, we recognized revenues of $80.6 and $34.2, respectively, from such contractual arrangement with EMC. As of June 30, 2012, $107.6 of revenues from products and services sold under the reseller arrangement were included in unearned revenues.
In the three months ended June 30, 2012 and 2011, we recognized professional services revenues of $23.6 and $16.4, respectively, for services provided to EMC’s customers pursuant to our contractual agreements with EMC. In the six months ended June 30, 2012 and 2011, we recognized professional services revenues of $42.3 and $30.8, respectively, from such contractual agreements with EMC. As of June 30, 2012, $6.7 of revenues from professional services to EMC customers were included in unearned revenues.
In the three months ended June 30, 2012 and 2011, we recognized revenues of $2.1 and $0.5, respectively, from server and desktop products and services purchased by EMC for internal use pursuant to our contractual agreements with EMC. In the six months ended June 30, 2012 and 2011, we recognized revenues of $3.8 and $1.0, respectively, from such contractual agreements with EMC. As of June 30, 2012, $22.7 of revenues from server and desktop products and services purchased by EMC for internal use were included in unearned revenues.
We purchased storage systems and software, as well as consulting services, from EMC for $5.9 and $7.5 in the three months ended June 30, 2012 and 2011, respectively, and for $23.9 and $13.3 in the six months ended June 30, 2012 and 2011, respectively.
In certain geographic regions where we do not have an established legal entity, we contract with EMC subsidiaries for support services and EMC personnel who are managed by us. The costs incurred by EMC on our behalf related to these employees are passed on to us and we are charged a mark-up intended to approximate costs that would have been charged had we contracted for such services with an unrelated third party. These costs are included as expenses in our consolidated statements of income and primarily include salaries, benefits, travel and rent. Additionally, EMC incurs certain administrative costs on our behalf in the U.S. that are also recorded as expenses. The total cost of the services provided to us by EMC as described above was $21.2 and $18.0 in the three months ended June 30, 2012 and 2011, respectively, and $49.0 and $42.7 in the six months ended June 30, 2012 and 2011, respectively.
In the three and six months ended June 30, 2012, no payments were made by either us or EMC under the tax sharing agreement. In the three and the six months ended June 30, 2011, EMC paid us $141.0 and $176.4, respectively, under the tax sharing agreement and no payments were made by us to EMC. Payments between us and EMC under the tax sharing agreement primarily relate to our portion of federal income taxes on EMC’s consolidated tax return. Payments from us to EMC primarily relate to periods for which we had stand-alone federal taxable income, while payments from EMC to us relate to periods for which we had a stand-alone federal taxable loss. The amounts that we either pay to or receive from EMC for our portion of federal income taxes on EMC’s consolidated tax return differ from the amounts we would owe on a stand-alone basis and the difference is presented as a component of stockholders’ equity. For all periods presented, the difference was not material.
In the three months ended June 30, 2012 and 2011, $1.2 and $1.0, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on our consolidated statements of income. In the six months ended June 30, 2012 and 2011, $2.4 and $1.9, respectively, of interest expense was recorded related to the note payable to EMC and included in interest expense with EMC on our consolidated statements of income. Our interest expense as a separate, stand-alone company may be higher or lower than the amounts reflected in the consolidated financial statements.
As of June 30, 2012, we had $61.7 net due from EMC, which consisted of $88.6 due from EMC, partially offset by $26.9 due to EMC. These amounts resulted from the related party transactions described above. In addition to the $61.7 net due from EMC as of June 30, 2012, we had an immaterial amount of net income taxes payable to EMC, which is included in accrued expenses and other on our consolidated balance sheets. Balances due to or from EMC which are unrelated to tax obligations are generally settled in cash within 60 days of each quarter-end. The timing of the tax payments due to and from EMC is governed by the tax sharing agreement with EMC.
By nature of EMC’s majority ownership of us, the amounts we recorded for our intercompany transactions with EMC may not be considered arm’s length with an unrelated third party. Therefore the financial statements included herein may not

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necessarily reflect our financial condition, results of operations and cash flows had we engaged in such transactions with an unrelated third party during all periods presented. Accordingly, our historical results should not be relied upon as an indicator of our future performance as a stand-alone company.
Liquidity and Capital Resources
At June 30, 2012 and 2011, we held cash, cash equivalents, and short-term investments as follows:
 
June 30,
2012
 
2011
Cash and cash equivalents
$
2,076.9

 
$
1,791.0

Short-term investments
3,270.0

 
1,912.1

Total cash, cash equivalents and short-term investments
$
5,346.9

 
$
3,703.1

Our operating activities in the second quarter and first half of 2012 and 2011, respectively, generated sufficient cash to meet our operating needs. Our cash flows for the second quarter and first half of 2012 and 2011 were as follows:
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net cash provided by (used in):
 
 
 
 
 
 
 
Operating activities
$
391.3

 
$
462.8

 
$
967.9

 
$
940.7

Investing activities
(777.2
)
 
(411.2
)
 
(834.6
)
 
(779.6
)
Financing activities
(163.3
)
 
30.5

 
(12.2
)
 
1.0

Net increase (decrease) in cash and cash equivalents
$
(549.2
)
 
$
82.1

 
$
121.1

 
$
162.1

In evaluating our liquidity internally, we focus on long-term, sustainable growth in free cash flows and in non-GAAP cash flows from operating activities (“non-GAAP operating cash flows”) over trailing twelve months periods, which we consider to be a relevant measure of our long-term progress. We define non-GAAP operating cash flows as net cash provided by operating activities less capitalized software development costs plus the excess tax benefits from stock-based compensation. We define free cash flows, also a non-GAAP financial measure, as non-GAAP operating cash flows less capital expenditures. See “Non-GAAP Financial Measures” for additional information.
Our non-GAAP operating cash flows and free cash flows for the three months and trailing twelve months ended June 30, 2012 and 2011 were as follows:
 
For the Three Months Ended
 
For the Trailing Twelve Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net cash provided by operating activities
$
391.3

 
$
462.8

 
$
2,052.8

 
$
1,544.0

Capitalized software development costs

 
(25.4
)
 
(21.1
)
 
(75.8
)
Excess tax benefits from stock-based compensation
32.7

 
101.3

 
159.7

 
286.2

Non-GAAP operating cash flows
424.0

 
538.7

 
2,191.4

 
1,754.4

Capital expenditures
(44.3
)
 
(95.2
)
 
(185.9
)
 
(193.8
)
Free cash flows
$
379.7

 
$
443.5

 
$
2,005.5

 
$
1,560.6

Free cash flows increased by $444.9 or 29% to $2,005.5 for the trailing twelve months ended June 30, 2012 from $1,560.6 for the trailing twelve months ended June 30, 2011. The increase was primarily due to increased sales and related cash collections, partially offset by higher operating expenses which were primarily driven by headcount growth.
As of June 30, 2012, we held a diversified portfolio of money market funds and fixed income securities. Our fixed income securities were denominated in U.S. Dollars and consisted of highly liquid debt instruments of the U.S. government and its agencies, U.S. municipal obligations, and U.S. and foreign corporate debt securities. We limit the amount of our domestic and international investments with any single issuer and any single financial institution, and also monitor the diversity of the portfolio, thereby diversifying the credit risk. Within our portfolio, we held $39.1 of foreign government and agencies securities, $15.1 of which was deemed sovereign debt, at June 30, 2012. These sovereign debt securities had an average credit

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rating of AAA and were predominantly from Canada and France. None of the securities deemed sovereign debt were from Greece, Ireland, Italy, Portugal or Spain.
As of June 30, 2012, our total cash, cash equivalents and short-term investments were $5,346.9, of which $2,694.0 was held outside the U.S. If these overseas funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes on related undistributed earnings to repatriate these funds. However, our intent is to indefinitely reinvest our non-U.S. earnings in our foreign operations and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.
We expect to continue to generate positive cash flows from operations in 2012 and to use cash generated by operations as our primary source of liquidity. We believe that existing cash and cash equivalents, together with any cash generated from operations will be sufficient to meet normal operating requirements including strategic acquisitions and capital expenditures for at least the next twelve months.
Operating Activities
Cash provided by operating activities is driven by our net income, adjusted for non-cash items and changes in assets and liabilities. Non-cash adjustments include depreciation, amortization of intangible assets, amortization of premiums paid upon purchase of investments in our fixed income portfolio, stock-based compensation expense, excess tax benefits from stock-based compensation and other adjustments. Net changes in assets and liabilities were impacted by increases in unearned revenues in the periods presented, and we expect this trend to continue in the future.
Cash provided by operating activities decreased by $71.5 to $391.3 in the second quarter of 2012 from $462.8 in the second quarter of 2011. The decrease year-over-year was primarily driven by the timing of tax payments we received from EMC under the tax sharing agreement. Under the tax sharing agreement, EMC is obligated to pay us an amount equal to the tax benefit generated by us that EMC will recognize on its consolidated tax return. In the second quarter of 2012, we did not receive any amounts from EMC under the tax sharing agreement, but in the second quarter of 2011, we benefited from the collection of $141.0, which included amounts for both the 2011 and 2010 tax years. For 2012, we expect to pay U.S. federal state income taxes to EMC, therefore we do not expect to benefit from the collection of income tax receivables under the tax sharing agreement in 2012. Additionally, the overall change in our cash provided by operating activities year-over-year was impacted by increases in cash collections driven by growth in our sales to customers, which were partially offset by increases in our core operating expenses, primarily driven by headcount growth.
Cash provided by operating activities did not change significantly in the first half of 2012 compared to the first half of 2011. While cash collections from our customers increased in the first half of 2012 as a result of strong sales volume, they were partially offset by increases in our core operating expenses, primarily driven by headcount growth. Additionally, in the first half of 2011, we benefited from the collection of $176.4 from EMC under the tax sharing agreement. In the first half of 2012, there were no cash payments or receipts under the tax sharing agreement.
Investing Activities
Cash used in investing activities is generally attributable to the purchase of fixed income securities, business acquisitions, and capital expenditures. Cash provided by investing activities is primarily attributable to the sales or maturities of fixed income securities.
Total fixed income securities of $1,253.6 and $529.0 were purchased in the second quarter of 2012 and 2011, respectively. In the first half of 2012 and 2011, we purchased $1,955.1 and $1,127.8, respectively, of fixed income securities. All purchases of fixed income securities were classified as cash outflows from investing activities. We classified these investments as short-term investments on our consolidated balance sheets based upon the nature of the security and their availability for use in current operations or for other purposes, such as business acquisitions and strategic investments. These cash outflows were partially offset by cash inflows of $625.5 and $500.9 in the second quarter of 2012 and 2011, respectively, and $1,304.8 and $869.6 in the first half of 2012 and 2011, respectively, as a result of the sales and maturities of fixed income securities. Activity in our fixed income portfolio increased primarily from increased cash equivalent and short-term investment balances available for investment, including a reallocation of funds from cash equivalents to fixed income securities.
We did not capitalize any development costs for software to be sold, leased, or otherwise marketed in the second quarter and first half of 2012 as compared to $25.4 and $52.9 of costs capitalized in the second quarter and first half of 2011. Following the release of vSphere 5 and the comprehensive suite of cloud infrastructure technologies in the third quarter of 2011, we determined that VMware’s go-to-market strategy had changed from single solutions to product suite solutions. As a result of this change in strategy, and the related increased importance of interoperability between our products, the length of time between achieving technological feasibility and general release to customers significantly decreased. As the vast majority of our products are now available for general release soon after technological feasibility has been established, we expect the costs incurred subsequent to the achievement of technological feasibility to continue to be immaterial in future periods and all software development costs will be expensed as incurred.

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In the second quarter of 2012 and 2011, we paid $102.2 and $189.1, respectively, and in the first half of 2012 and 2011, we paid $102.2 and $204.1, respectively, for business acquisitions. Business acquisitions are an important element of our strategy and we expect to continue to consider additional strategic business acquisitions in the future. Refer to Note G to the consolidated financial statements for further information.
In the second quarter of 2011, we closed an agreement to purchase all of the right, title and interest in a ground lease covering the property and improvements located adjacent to our existing Palo Alto, California campus for $225.0. We paid the seller $45.0 in the first quarter of 2011 as a good faith deposit, and in the second quarter of 2011, we paid the remaining $180.0. Based upon the respective preliminary fair values, $51.9 of the purchase price was recorded to property and equipment and the remaining $173.1 was recorded to intangible assets on the consolidated balance sheet. Refer to Note H to the consolidated financial statements for further information. On the consolidated statement of cash flows for the second quarter and first half of 2011, the $51.9 paid for the property is included within additions to property and equipment and the $173.1 paid for the intangible assets is separately disclosed within cash used in investing activities. Our renovation of the new property will be a multi-year project with capital investment extending into future periods. Our total capital expenditures for 2012 are expected to be approximately $320 to $340, which includes the continued renovation of our expanded campus.
In the second quarter of 2011, we sold our investment in Terremark Worldwide, Inc. for $76.0.
In July 2012, we entered into a definitive agreement to acquire Nicira, Inc., a developer of software-defined networking solutions, for approximately $1,050.0 in cash plus approximately $210.0 of assumed unvested equity awards. The acquisition is subject to regulatory approvals and other customary closing conditions and is expected to close during the second half of 2012. 
Financing Activities
Proceeds from the issuance of our Class A common stock from the exercise of stock options and the purchase of shares under the VMware Employee Stock Purchase Plan (“ESPP”) were $33.6 and $110.5 in the second quarter of 2012 and 2011, respectively. Proceeds from the issuance of our Class A common stock from the exercise of stock options and the purchase of shares under the VMware Employee Stock Purchase Plan (“ESPP”) were $144.6 and $200.7 in the first half of 2012 and 2011, respectively.
In the second quarter of 2012 and 2011, we paid $178.2 and $132.7, including commissions, to repurchase and retire 1.8 million and 1.4 million shares, respectively, of our Class A common stock at a weighted-average price of $96.50 and $91.60 per share, respectively, as part of our stock repurchase programs. In the first half of 2012 and 2011, we paid $178.2 and $280.4, including commissions, to repurchase and retire 1.8 million and 3.2 million shares, respectively, of our Class A common stock at a weighted-average price of $96.50 and $88.50 per share, respectively, as part of our stock repurchase programs. From time-to-time, stock repurchases may be made pursuant to the stock repurchase authorizations in open market transactions or privately negotiated 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 will depend 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 that we feel that additional purchases are not warranted. As of June 30, 2012, the amount remaining for repurchase was $507.1. This amount is authorized for repurchases through the end of 2013.
There were additional cash outflows of $51.3 and $48.7 in the second quarter of 2012 and 2011, respectively, and $65.0 and $70.6 in the first half of 2012 and 2011, respectively, to cover tax withholding obligations in conjunction with the net share settlement upon the vesting of restricted stock units and restricted stock. Additionally, the excess tax benefit from stock-based compensation was $32.7 and $101.3 in the second quarter of 2012 and 2011, respectively, and $86.4 and $151.3 in the first half of 2012 and 2011, respectively, and is shown as a reduction to cash flows from operating activities and an increase to cash flows from financing activities. The year-over-year changes in the repurchase of shares to cover tax withholding obligations and the excess tax benefit from stock-based compensation in the second quarter and first half of 2012 were primarily due to changes in the market value of our stock and the number of awards exercised, sold or vested.
Future cash proceeds from issuances of common stock and the excess tax benefit from stock-based compensation and future cash outflows to repurchase our shares to cover tax withholding obligations will depend upon, and could fluctuate significantly from period-to-period based on, the market value of our stock, the number of awards exercised, sold or vested, the tax benefit realized and the tax-affected compensation recognized.
Note Payable to EMC
As of June 30, 2012, $450.0 remained outstanding on a note payable to EMC, with interest payable quarterly in arrears. In June 2011, we and EMC amended and restated the note to extend the maturity date of the note to April 16, 2015 and to modify the principal amount of the note to reflect the outstanding balance of $450.0. The interest rate of the 90-day LIBOR plus 55 basis points continues to reset quarterly.

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To date, inflation has not had a material impact on our financial results.
Non-GAAP Financial Measures
Regulation S-K Item 10(e), “Use of Non-GAAP Financial Measures in Commission Filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of core operating expenses, non-GAAP operating cash flows and free cash flows each meet the definition of a non-GAAP financial measure.
Core Operating Expenses
Management uses the non-GAAP measure of core operating expenses to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, to calculate bonus payments and to evaluate our financial performance, the performance of our individual functional groups and the ability of operations to generate cash. Management believes that by excluding certain expenses that are not reflective of our ongoing operating results, core operating expenses reflect our business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business.
We define core operating expenses as our total operating expenses excluding the following components, which we believe are not reflective of our ongoing operational expenses. In each case, for the reasons set forth below, management believes that excluding the component provides useful information to investors and others in understanding and evaluating our operating results and future prospects in the same manner as management, in comparing financial results across accounting periods and to those of peer companies and to better understand the long-term performance of our core business.
Stock-based compensation. Stock-based compensation expense is generally fixed at the time the stock-based instrument is granted and amortized over a period of several years. Although stock-based compensation is an important aspect of the compensation of our employees and executives, determining the fair value of some of the stock-based instruments we utilize involves a high degree of judgment and estimation and the expense recorded may bear little resemblance to the actual value realized upon the vesting or future exercise of the related stock-based awards. Furthermore, unlike cash compensation, the value of stock options, which is an element of our ongoing stock-based compensation expense, is determined using a complex formula that incorporates factors, such as market volatility, that are beyond our control. Additionally, in order to establish the fair value of performance-based stock awards, which are also an element of our ongoing stock-based compensation expense, we are required to apply judgment to estimate the probability of the extent to which performance objectives will be achieved.
Amortization and capitalization of software development costs. Capitalized software development costs encompasses capitalization of development costs and the subsequent amortization of the capitalized costs over the useful life of the product. Amortization and capitalization of software development costs can vary significantly depending upon the timing of products reaching technological feasibility and being made generally available. In future periods, we expect our amortization expense from capitalized software development costs to decline as software development costs are expected to be recorded as R&D expense as incurred given our current go-to-market strategy, which has changed from single product solutions to product suite solutions. As a result of this change in strategy, and the related increased importance of interoperability between our products, the length of time between achieving technological feasibility and general release to customers has significantly decreased. Given that we expect the majority of our product offerings to be suites or to have key components that interoperate with our other product offerings, the costs incurred subsequent to achievement of technological feasibility are expected to be immaterial in future periods. For additional information, see “Results of Operations - Capitalized Software Development Costs, Net” above.
Other expenses. Other expenses excluded are employer payroll taxes on employee stock transactions, amortization of intangible assets and acquisition-related items. The amount of employer payroll taxes on stock-based compensation is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of the business. Regarding the amortization of intangible assets, a portion of the purchase price of our acquisitions is generally allocated to intangible assets, such as intellectual property, and is subject to amortization. Additionally, the amount of an acquisition’s purchase price allocated to intangible assets and the term of its related amortization can vary significantly and are unique to each acquisition. Acquisition-related items include direct costs of acquisitions, such as transaction fees, which vary significantly and are unique to each acquisition. We also do not acquire businesses on a predictable cycle.
Non-GAAP operating cash flows and free cash flows
We define non-GAAP operating cash flows as net cash provided by operating activities less capitalized software development costs plus the excess tax benefits from stock-based compensation. We define free cash flows as non-GAAP operating cash flows less capital expenditures. As discussed above, when viewing operating results for evaluating our past performance and for planning purposes, management excludes certain items, including the effect of capitalizing and amortizing

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software development costs and items related to stock-based compensation, which are also excluded in the non-GAAP operating cash flows measure. Management also uses non-GAAP operating cash flows and free cash flows as measures of financial progress in our business, as they balance operating results, cash management and capital efficiency. In addition to quarterly free cash flows, management also focuses on trailing twelve month free cash flows, as free cash flows can be volatile in the short-term.
We believe that our measures of non-GAAP operating cash flows and free cash flows provide useful information to investors and others, as they allow for meaningful period-to-period comparisons of our operating cash flows for analysis of trends in our business. Additionally, we believe that information regarding non-GAAP operating cash flows and free cash flows provides investors and others with an important perspective on cash that we may choose to make available for strategic acquisitions and investments, the repurchase of shares, operations and other capital expenditures.
We deduct capitalization of software development costs from both measures because software development costs are considered to be a necessary component of our operations and the amount capitalized under GAAP can vary significantly from period-to-period depending upon the timing of products reaching technological feasibility and being made generally available. Consequently, software development costs paid out during a period that are capitalized under GAAP and do not impact GAAP operating cash flows for that period do result in a decrease to our measures of non-GAAP operating cash flows and non-GAAP free cash flows, thereby providing management with useful measures of cash flows generated from operations during the period. We add back the excess income tax benefits from stock-based compensation to our measures of non-GAAP operating cash flows and free cash flows as management internally views cash flows arising from income taxes as similar to operating cash flows rather than as financing cash flows as required under GAAP. Furthermore, we exclude capital expenditures on property and equipment from free cash flows because these expenditures are also considered to be a necessary component of our operations.
Limitations on the use of Non-GAAP financial measures
A limitation of our non-GAAP financial measures of core operating expenses, non-GAAP operating cash flows and free cash flows is that they do not have uniform definitions. Our definitions will likely differ from the definitions used by other companies, including peer companies, and therefore comparability may be limited. Thus, our non-GAAP measures of core operating expenses, non-GAAP operating cash flows and free cash flows should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP. Additionally, in the case of stock-based compensation, if we did not pay out a portion of compensation in the form of stock-based compensation and related employer payroll taxes, the cash salary expense included in costs of revenues and operating expenses would be higher which would affect our cash position. Further, the non-GAAP measure of core operating expenses has certain limitations because it does not reflect all items of income and expense that affect our operations and are reflected in the GAAP measure of total operating expenses.
We compensate for these limitations by reconciling core operating expenses to the most comparable GAAP financial measure. Management encourages investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view our non-GAAP financial measures in conjunction with the most comparable GAAP financial measures.
See “Results of Operations—Operating Expenses” for a reconciliation of the non-GAAP financial measure of core operating expenses to the most comparable GAAP measure, “total operating expenses,” for the three and six months ended June 30, 2012 and 2011.
See “Liquidity and Capital Resources” for a reconciliation of non-GAAP operating cash flows and free cash flows to the most comparable GAAP measure, “net cash provided by operating activities,” for the three and six months ended June 30, 2012 and 2011.
Critical Accounting Policies
Our consolidated financial statements are based on the selection and application of accounting principles generally accepted in the United States of America that require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. 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 set forth within Item 7 of our 2011 Annual Report on Form 10-K may involve a higher degree of judgment and complexity in their application than our other significant accounting policies and represent the critical accounting policies used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.



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Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements, including, without limitation, statements regarding: the potential role of our products in cloud computing and other shifts in computing infrastructures; expectations of, and our plans for, achieving future business growth; macroeconomic conditions; future product offerings; plans for future acquisitions; our view of the competitive landscape and our plans for maintaining our leadership position through continuing investments; our expectation that we will be able to fund strategic investments through operating cash flows generated by sales of our products and services; our plans for funding expansion of our industry segment share and developing long term relationships with our customers; our expectations to manage our resources prudently while making key investment in support of long term growth objectives; our plans for geographic expansion and adding additional channel partners; our relationship with EMC; our plans for meeting product development objectives and introducing new products; our plans for growing our business by broadening our product portfolio; our revenue outlook and mix; customer demand for our products; trends in enterprise license agreement (“ELA”) size and renewals and information technology (“IT”) spending in general; macroeconomic trends; the delivery of professional services to our customers; the sufficiency of our liquidity and capital reserves to fund our operations and business strategy; continuation of our stock repurchase program; factors affecting our tax position; the effects on us of potential developments in non-U.S. tax jurisdictions; our intention to indefinitely reinvest our overseas earnings in our foreign operations and our plans not to repatriate them to fund our U.S. operations; expected expenditures to improve the real estate parcel adjacent to our headquarters that we recently purchased; our anticipated capital spending for 2012; expectations that software development costs incurred subsequent to achievement of technological feasibility will be immaterial and software development costs will generally be expensed as incurred and that the subsequent amortization of such capitalized costs will decline for 2012; plans regarding interoperability among our future product offerings and for the increasing development of product suites; our expectation that stock-based compensation will increase in future periods; our plans regarding cash, cash equivalents and short-term investments held in non-U.S. accounts; our expectations with respect to costs associated with foreign currency fluctuation and internal development; and our belief that the resolution of pending claims, legal proceedings and investigations will not have a material adverse effect on us.
These forward-looking statements involve risks and uncertainties and the cautionary statements set forth above and those contained in the section of this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 entitled “Risk Factors” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. 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 Securities and Exchange Commission (“SEC”);
announcements of investor conferences, speeches and events at which our executives talk about our product, service and competitive strategies. 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;
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.
Unless the context requires otherwise, we are referring to VMware, Inc. when we use the terms “VMware,” the “Company,” “we,” “our” or “us.”

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
We operate in foreign countries, which expose us to market risk associated with foreign currency exchange rate fluctuations between the U.S. Dollar and various foreign currencies, the most significant of which is the Euro.
International revenues as a percentage of total revenues were 51.0% and 51.1% in the second quarter of 2012 and 2011, respectively, and 52.5% and 51.8% in the first half of 2012 and 2011, respectively. We invoice and collect in the Euro, the British Pound, the Japanese Yen and the Australian Dollar in their respective regions. Additionally, a portion of our operating expenses, primarily the cost of personnel to deliver technical support on our products and professional services, sales and sales support and research and development, are denominated in foreign currencies, primarily those currencies in which we also invoice and collect. Revenues resulting from selling in local currencies and costs incurred in local currencies are exposed to foreign exchange rate fluctuations which can affect our operating income. As exchange rates vary, operating margins may differ materially from expectations.
Core operating expenses benefited by $19.1 million and $23.0 million in the second quarter and first half of 2012 due to fluctuations in the exchange rates between the U.S. Dollar and foreign currencies as compared with the same period in the prior year. We calculate the foreign currency impact on our operating expenses as the difference between operating expenses translated at current exchange rates and the same expenses translated at prior-period exchange rates.
To manage the risk associated with fluctuations in foreign currency exchange rates, we utilize derivative financial instruments, principally foreign currency forward contracts, as described below.
Cash Flow Hedging Activities. To mitigate our exposure to foreign currency fluctuations resulting from operating expenses denominated in certain foreign currencies, we entered into foreign currency forward contracts starting in the fourth quarter of 2011. We expect to enter into cash flow hedges semi-annually with maturities of six months or less. As of June 30, 2012, we had foreign currency forward contracts to purchase approximately $11.0 million in foreign currency. The fair value of these forward contracts was immaterial as of June 30, 2012.
Balance Sheet Hedging Activities. We enter into foreign currency forward contracts to hedge a portion of our net outstanding monetary assets and liabilities against movements in certain foreign exchange rates. Our foreign currency forward contracts are generally traded on a monthly basis with a typical contractual term of one month. As of June 30, 2012, we had outstanding forward contracts with a total notional value of $261.5 million. The fair value of these forward contracts was immaterial as of June 30, 2012.
Sensitivity Analysis. There can be no assurance that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. A hypothetical adverse foreign currency exchange rate movement of 10% would have resulted in a potential loss in fair value of our foreign currency forward contracts used in both the cash flow hedging and balance sheet hedging activities of $24.8 million as of June 30, 2012. This sensitivity analysis disregards any potentially offsetting gain that may be associated with the underlying foreign-currency denominated assets and liabilities that we hedge.
This analysis also assumes a parallel adverse shift of all foreign currency exchange rates against the U.S. Dollar; however, foreign currency exchange rates do not always move in such a manner and actual results may differ materially. We do not enter into speculative foreign exchange contracts for trading purposes. See Note F to the consolidated financial statements for further information.
Interest Rate Risk
Fixed Income Securities
Our fixed income investment portfolio is denominated in U.S. Dollars and consists of various holdings, types, and maturities.
Our primary objective for holding fixed income securities is to achieve an appropriate investment return consistent with preserving principal and managing risk. At any time, a sharp rise in interest rates or credit spreads could have a material adverse impact on the fair value of our fixed income investment portfolio. Hypothetical changes in interest rates of 50 basis points and 100 basis points would have changed the fair value of our fixed income investment portfolio as of June 30, 2012 by $20.8 million and $41.6 million, respectively. This sensitivity analysis assumes a parallel shift of all interest rates, however, interest rates do not always move in such a manner and actual results may differ materially. We monitor our interest rate and credit risk, including our credit exposures to specific rating categories and to individual issuers. There were no impairment charges on our cash equivalents and fixed income securities during the second quarter of 2012. These instruments are not leveraged and we do not enter into speculative securities for trading purposes. See Notes D and E to the consolidated financial statements for further information.

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Note Payable to EMC
As of June 30, 2012, $450.0 million was outstanding on our consolidated balance sheet for the note payable to EMC. The interest rate on the note payable was 1.02% as of June 30, 2012 and 0.85% as of June 30, 2011. In the second quarter of 2012 and 2011, $1.2 million and $1.0 million, respectively, of interest expense was recorded in each period related to the note payable. In the first half of 2012 and 2011, $2.4 million and $1.9 million, respectively of interest expense was recorded in each period related to the note payable.
The note may be repaid, without penalty, at any time. In June 2011, we and EMC amended and restated the note to extend the maturity date of the note to April 16, 2015 and to modify the principal amount of the note to reflect the outstanding balance of $450.0 million. The amended agreement continues to bear an interest rate of the 90-day LIBOR plus 55 basis points, with interest payable quarterly in arrears. The interest rate on the note resets quarterly and is determined on the two business days prior to the first day of each fiscal quarter. If the interest rate on the note payable were to change 100 basis points from the June 30, 2012 rate, and assuming no additional repayments on the principal were made, our annual interest expense would change by $4.5 million.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation required by the Exchange Act, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Controls Over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal quarter ended June 30, 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
Our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
See Note M to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of legal proceedings. See also the risk factor entitled “We may become involved in litigation that may adversely affect us” in Part II, Item 1A of this Quarterly Report on Form 10-Q for a discussion of potential risks to our results of operations and financial condition that may arise from legal proceedings.
ITEM 1A.
RISK FACTORS
The risk factors that appear below could materially affect our business, financial condition and results of operations. The risks and uncertainties described below are not the only risks and uncertainties facing us. Our business is also subject to general risks and uncertainties that affect many other companies.
Risks Related to Our Business
As the market for our computer virtualization products has matured, we have been increasingly developing and marketing products and services targeted toward the delivery, management and automation of information technology (“IT”) infrastructure, platforms and services through cloud-based solutions. If businesses do not find our cloud computing solutions compelling, our revenue growth and operating margins may decline.
Our products and services are based on computer virtualization and related technologies that have primarily been used for virtualizing on-premises data centers. As the market for data center virtualization has matured, we have increasingly directed our product development and marketing toward products and services that enable businesses to utilize virtualization as the foundation for cloud-based computing, management and automation of the delivery of IT resources and end-user computing. We are also investing in the development of products and services for the emerging platform as a service, or “PaaS,” and software as a service, or “SaaS,” markets. Our success depends on organizations and customers perceiving technological and operational benefits and cost savings associated with the increasing adoption of virtualization-based infrastructure and management solutions for cloud computing, application development and end-user computing. as the market for our data center virtualization products mature and the scale of our business increases, the rate of growth in our product sales will likely be lower than those we have experienced in earlier periods and we expect our annual revenue growth rate in 2012 to decline from the growth rate of 32% experienced in 2011. In addition, to the extent that our newer cloud computing infrastructure management and automation, end-user computing, PaaS and SaaS solutions are adopted more slowly or less comprehensively than we expect, our revenue growth rates may slow materially or our revenue may decline substantially.
We expect to face increasing competition that could result in a loss of customers, reduced revenues or decreased operating margins.
The virtualization, cloud computing, and end-user computing markets are inter-related and rapidly evolving. We experienced increased competition during the first half of 2012 and expect it to remain intense through the rest of 2012 and into 2013. For example, Microsoft continues to make incremental improvements to its virtual infrastructure and virtual management products. Microsoft has announced that it will ship an upcoming major release of Windows Server, including a more advanced version of its Hyper-V virtualization product, that will continue its push into the virtualization market, and upcoming release of System Center, Microsoft’s bundle of management products targeted at legacy and virtual environments. Microsoft also has cloud-based computing offerings and recently announced infrastructure as a service (“IaaS”)-like capabilities for Windows Azure. We also face competition from other companies that have announced a number of new product initiatives, alliances and consolidation efforts. For example, Citrix Systems continues to enhance its end-user and server virtualization offerings and now has a client hypervisor in the market. IBM, Google and Amazon have existing cloud computing offerings and announced new cloud computing initiatives. Red Hat has also released commercial versions of Linux that have virtualization capabilities as part of the Linux kernel (“KVM”) and has also announced plans for cloud computing products. Other companies have also indicated their intention to expand offerings of virtual management and cloud computing solutions. Additionally, our vision for hybrid cloud computing in which enterprises pool internal and external IT resources running on a common VMware vSphere infrastructure competes with low-cost public cloud infrastructure offerings such as Amazon EC2. Google also announced its plans to enter the low-cost public cloud infrastructure market. Enterprises and service providers have also shown an interest in building their own clouds based on open source projects such as OpenStack.
We believe that the key competitive factors in the virtualization and cloud computing markets include:
the level of reliability, security and new functionality of product offerings;
the ability to provide comprehensive solutions, including management capabilities;

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the ability to offer products that support multiple hardware platforms, operating systems, applications and application development frameworks;
the ability to deliver an intuitive end-user experience for accessing data, applications and services from a wide variety of end-user devices;
the proven track record of formulating and delivering a roadmap of virtualization and cloud computing capabilities;
pricing of products, individually and in bundles;
the ability to attract and preserve a large installed base of customers;
the ability to attract and preserve a large number of application developers to develop to a given cloud ecosystem;
the ability to create and maintain partnering opportunities with hardware vendors, infrastructure software vendors and cloud service providers;
the ability to develop robust indirect sales channels; and
the ability to attract and retain cloud, virtualization and systems experts as key employees.
Existing and future competitors may introduce products in the same markets we serve or intend to serve, and competing products may have better performance, lower prices, better functionality and broader acceptance than our products. Our competitors may also add features to their virtualization, end-user and cloud computing products similar to features that presently differentiate our product offerings from theirs. Many of our current or potential competitors also have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. This competition could result in increased pricing pressure and sales and marketing expenses, thereby materially reducing our operating margins, and could harm our ability to increase, or cause us to lose, market share. Increased competition also may prevent us from entering into or renewing service contracts on terms similar to those that we currently offer and may cause the length of our sales cycle to increase. Some of our competitors and potential competitors supply a wide variety of products to, and have well-established relationships with, our current and prospective end users. For example, small to medium sized businesses and companies in emerging markets that are evaluating the adoption of virtualization-based technologies and solutions may be inclined to consider Microsoft solutions because of their existing use of Windows and Office products. Some of these competitors have in the past and may in the future take advantage of their existing relationships to engage in business practices that make our products less attractive to our end users. Other competitors have limited or denied support for their applications running in VMware virtualization environments. These distribution, licensing and support restrictions, as well as other business practices that may be adopted in the future by our competitors, could materially impact our prospects regardless of the merits of our products. In addition, competitors with existing relationships with our current or prospective end users could in the future integrate competitive capabilities into their existing products and make them available without additional charge. For example, Oracle provides free server virtualization software intended to support Oracle and non-Oracle applications, and Microsoft offers its own server virtualization software packaged with its Windows Server product and has announced plans to offer built-in virtualization for future releases of the client version of Windows. As a result, existing VMware customers may elect to use products that are perceived to be “free” or “very low cost” instead of purchasing VMware products and services for certain applications where they do not believe that more advanced and robust capabilities are required. Competitors may also leverage open source technologies to offer zero or low cost products capable of putting pricing pressure on our own product offerings. By engaging in such business practices, our competitors can diminish competitive advantages we may possess by incentivizing end users to choose products that lack some of the technical advantages of our own offerings. Even if customers find our products to be technically superior, they may choose to employ a 'multiple-vendor' strategy, regardless of the technical merits of VMware’s products, where they purposely deploy multiple vendors in their environment in order to prevent any one vendor from gaining too much control over their IT operations.
We also face potential competition from our partners. For example, third parties currently selling our products could build and market their own competing products and services or market competing products and services of third parties. If we are unable to compete effectively, our growth and our ability to sell products at profitable margins could be materially and adversely affected.
The large majority of our revenues have come from our data center virtualization products including our flagship VMware vSphere product line. Decreases in demand for our data center virtualization products could adversely affect our results of operations and financial condition.
In fiscal year 2011, approximately 90% of our license revenues were from our cloud infrastructure and management solutions with the balance from our other solutions. Although we are continuing to develop other applications for our virtualization technology such as our cloud computing and end-user computing products, we expect that our data center

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virtualization products and related enhancements and upgrades will constitute a majority of our revenue for the foreseeable future. Declines and variability in demand for our data center virtualization products could occur as a result of:
improved products or product versions being offered by competitors in our markets;
competitive pricing pressures;
failure to release new or enhanced versions of our data center virtualization products on a timely basis, or at all;
technological change that we are unable to address with our data center virtualization products or that changes the way enterprises utilize our products; and
general economic conditions.
Also, as more and more businesses achieve the virtualization of their data centers and other IT functions, the market for our VMware vSphere product line may become saturated. If we fail to introduce compelling new features in future upgrades to our VMware vSphere product line, develop new applications for our virtualization technology or provide product suites based on the VMware vSphere platform that address customer requirements for integration, automation and management of their IT systems, demand for VMware vSphere may decline.
Additionally, in connection with the announcement in July 2011 of our latest update to VMware vSphere, we announced a change to its pricing structure. We expect that the new pricing model, which we began to implement with the general availability of VMware vSphere 5 in the third quarter of 2011, better aligns with a cloud computing approach, whereby customers can align cost with actual use and value derived, rather than purely with hardware configurations and capacity. VMware vSphere 5 will continue to be licensed perpetually on a per processor basis. However, two physical constraints, core and physical RAM, were eliminated and replaced with a single virtualization-based entitlement of virtual memory, or vRAM, which can be shared across a large pool of servers. Although we believe that our new pricing structure is better suited to changing trends in enterprise utilization of IT resources as the industry shifts to a cloud computing model, if our customers react adversely to this pricing structure change, they may consider adopting the products of our competitors or we may need to further adjust our pricing model, resulting in reduced demand for or revenue from our data center virtualization products. Moreover, if our modeling of the impact of this change in pricing structure on payment streams from our customers proves to be inaccurate, our revenue and operating margins could be negatively affected.
Due to our product concentration, our business, results of operations, financial condition, and cash flows would therefore be adversely affected by a decline in demand for our data center virtualization products.
Our new product and technology initiatives subject us to additional business, legal and competitive risks.
Over the last several years, we have introduced new product and technology initiatives that aim to leverage our virtualization infrastructure software products into the emerging areas of cloud computing and end-user computing as alternatives to the provisioning of physical computing resources. In 2010, we introduced the first of our vCenter and vCloud products, which we combined in 2011 with our vShield security product to create our new Cloud Infrastructure and Management (“CIM”) Suite offering. Our CIM technologies are designed to facilitate the creation of secure private clouds. They also enable workload mobility with vSphere-compatible public cloud resources offered by our vCloud partners who are IaaS providers.
In connection with our 2009 acquisition of SpringSource, we announced our intention to use SpringSource solutions to extend VMware’s strategy to deliver solutions in the emerging PaaS market and have since also acquired GemFire and RabbitMQ as part of our overall PaaS strategy. Additionally, SpringSource’s current offerings and their underlying open source technology position us in the enterprise and web application development markets. In 2011, we announced CloudFoundry, a VMware-operated developer cloud service and a new open source PaaS project for the development of applications designed to utilize cloud computing.
Our 2010 acquisition of Zimbra extended our footprint to cloud-based email and collaboration services - a part of VMware’s strategy to extend into the emerging SaaS market. In 2011, we expanded our SaaS offerings, as we acquired Socialcast and SlideRocket, which provide applications directed toward the collaborative development and sharing of user-generated content within the enterprise. In 2011, we also acquired Digital Fuel, which provides IT financial and business management solutions and we acquired certain assets related to our parent company’s Mozy cloud-based data storage and data services and entered into an agreement with EMC to operate the services on EMC’s behalf. We have also continued to expand and enhance our end-user computing offerings, such as VMware View, and in 2011 announced that our first Horizon offerings, which include a mobile phone application, are expected to become available in 2012. In 2012, we also acquired Wanova, a leading provider of intelligent desktop solutions that centralize and simplify the management of physical desktop images while enabling users to take advantage of the native performance of a PC.

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The expansion of our offerings to include IT management and automation, IaaS, PaaS and SaaS offerings subjects us to additional risks, such as the following:
These initiatives may present new and difficult technological challenges. Significant investments will be required to acquire and develop solutions to those challenges. End users may choose not to adopt our new product or service offerings and we may be unable to recoup or realize a reasonable return on our investments. In addition, some of our new initiatives are hosted by third parties whom we do not control but whose failure to prevent such disruptions, failures or breaches may require us to issue credits or refunds or indemnify or otherwise be liable to customers or third parties for damages that may occur. Any transition of our services from a third party hosting service to our own data centers would also entail a risk of service disruption during a transition.
We may be subject to claims if customers of these service offerings experience service disruptions or failures, security breaches, data losses or other quality issues.
The success of these new offerings depends upon the cooperation of hardware, software and cloud hosting vendors to ensure interoperability with our products and offer compatible products and services to end users. If we are unable to obtain such cooperation, it may be difficult and more costly for us to achieve functionality and service levels that would make our new products and services attractive to end users.
We will need to develop and implement appropriate go-to-market strategies and train our sales force in order to effectively market offerings in product categories in which we may have less experience than our competitors. Accordingly, end users could choose competing products over ours, even if such offerings are less advanced than ours.
Our increasing focus on developing and marketing IT management and automation, IaaS, PaaS and SaaS offerings that enable customers to transform their IT systems will require a greater focus on marketing and selling product suites and more holistic solutions, rather than selling on a product-by-product basis. Consequently, we will need to develop new strategies for marketing and selling our offerings, our customers’ purchasing decisions may become more complex and require additional levels of approval and the duration of sales cycles for our offerings may increase.
We will need to develop appropriate pricing strategies for our new product initiatives. For example, it has frequently been challenging for software companies to derive significant revenue streams from open source projects, such as certain of our PaaS offerings. Additionally, in some cases our new product initiatives are predicated on converting free and trial users to paying customers of the premium tiers of these services and therefore we must maintain a sufficient conversion ratio for such services to be profitable. Also, certain of our new product initiatives have a subscription model. We may not be able to accurately predict subscription renewal rates or their impact on results and because revenue is recognized for our services over the term of the subscription, downturns or upturns in sales may not be immediately reflected in our results.
Our new products and services may compete with offerings from companies who are members of our developer and technology partner ecosystem. Consequently, we may find it more difficult to continue to work together productively on other projects and the advantages we derive from our ecosystem could diminish.
The cloud computing and virtualized end-user computing markets are in early stages of development. Other companies seeking to enter and develop competing standards for the cloud computing market, such as Microsoft, IBM, Oracle, Google and Amazon, and the end-user computing market, such as Citrix and Microsoft, have introduced or are likely to introduce their own initiatives that may compete with or not be compatible with our cloud and end-user computing initiatives which could limit the degree to which other vendors develop products and services around our offerings and end users adopt our platforms.
Additionally, our operating margins in our newer initiatives may be lower than those we have achieved in the markets we currently serve, and we may not be successful enough in these newer activities to recoup our investments in them. If any of these risks were to occur, it could damage our reputation, limit our growth and negatively affect our operating results.
Ongoing uncertainty regarding global economic conditions and the stability of regional financial markets may reduce information technology spending below current expectations and therefore adversely impact our revenues, impede end-user adoption of new products and product upgrades and adversely impact our competitive position.
Our business depends on the overall demand for information technology and on the economic health of our current and prospective customers. The purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. Weak economic conditions or significant uncertainty regarding the stability of financial markets could adversely impact our business, financial condition and results of operations in a number of ways, including by lengthening sales cycles, affecting the size of enterprise license agreements (“ELAs”) that customers will commit to, lowering prices for our products and services, reducing unit sales and reducing the rate of adoption of our products by new customers and the willingness of current customers to purchase upgrades to our existing products. The ongoing sovereign debt crisis in Europe

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threatens to suppress demand and our customers’ access to credit in that region, which is an important market for our products and services. Additionally, in response to sustained economic uncertainty, many national and local governments that are current or prospective customers for our products and services have also made, or announced plans to make, spending cutbacks which could reduce the amount of government spending on IT and the potential demand for our products and services from the government sector.
Ongoing economic uncertainty has also resulted in general and ongoing tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy and significant volatility in the credit, equity and fixed income markets. As a result, current or potential customers may be unable to fund software purchases, which could cause them to delay, decrease or cancel purchases of our products and services. Even if customers are willing to purchase our products and services, if they do not meet our credit requirements, we may not be able to record accounts receivable or unearned revenue or recognize revenues from these customers until we receive payment, which could adversely affect the amount of revenues we are able to recognize in a particular period.
In addition, although we plan to continue making strategic investments in our business, many of our competitors have significantly greater financial, technical and other resources than we do, and if the economic recovery is anemic or not sustained, they may be better positioned to continue investment in competitive technologies.
Industry alliances or consolidation may result in increased competition.
Some of our competitors have made acquisitions, entered into or extended partnerships or other strategic relationships to offer more comprehensive virtualization and cloud computing solutions than they individually had offered. In 2011, Citrix Systems continued to invest in desktop virtualization marketing by continuing its close collaboration with Microsoft and acquired smaller players like Kaviza and Ringcube. Moreover, information technology companies are increasingly seeking to deliver top-to-bottom IT solutions to end users that combine enterprise-level hardware and software solutions to provide an alternative to our virtualization platform. For example, in 2011, Oracle brought to market integrated hardware and software solutions that utilized technologies from its 2010 acquisition of Sun Microsystems, and Microsoft and Hewlett-Packard continued their collaboration based on Microsoft’s cloud computing and virtualization platforms. Hewlett-Packard and Cisco also joined the OpenStack effort, an effort to develop an open source solution for cloud computing. In 2011, Citrix announced its acquisition of Cloud.com, which offers an IaaS cloud services solution, and Red Hat continued to invest in the Open Virtualization Alliance (“OVA”) to bolster KVM as a direct competitor to VMware vSphere. In 2012, Dell acquired Wyse Technologies to bolster its ability to serve the “cloud client” market. On the PaaS front, Salesforce.com acquired Heroku in late 2010. We expect these trends to continue as companies attempt to strengthen or maintain their market positions in the evolving virtualization infrastructure and enterprise IT solutions industry. Many of the companies driving this trend have significantly greater financial, technical and other resources than we do and may be better positioned to acquire and offer complementary products and technologies. The companies and alliances resulting from these possible combinations may create more compelling product offerings and be able to offer greater pricing flexibility than we can or may engage in business practices that make it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs (such as providing greater incentives to our channel partners to sell a competitor’s product), technology or product functionality. This competition could result in a substantial loss of customers or a reduction in our revenues.
Our operating results may fluctuate significantly, which makes our future results difficult to predict and may result in our operating results falling below expectations or our guidance, which could cause the price of our Class A common stock to decline.
Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Our past results should not be relied upon as an indication of our future performance. In addition, a significant portion of our quarterly sales typically occurs during the last month of the quarter, which we believe generally reflects customer buying patterns for enterprise technology. As a result, our quarterly operating results are difficult to predict even in the near term. If our revenues or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, the price of our Class A common stock would likely decline substantially.
In addition, factors that may affect our operating results include, among others:
general economic conditions in our domestic and international markets and the effect that these conditions have on our customers’ capital budgets and the availability of funding for software purchases;
fluctuations in demand, adoption rates, sales cycles and pricing levels for our products and services;
fluctuations in foreign currency exchange rates;
changes in customers’ budgets for information technology purchases and in the timing of their purchasing decisions;

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the timing of recognizing revenues in any given quarter, which, as a result of software revenue recognition policies, can be affected by a number of factors, including product announcements, beta programs and product promotions that can cause revenue recognition of certain orders to be deferred until future products to which customers are entitled become available;
the sale of our products in the time frames we anticipate, including the number and size of orders in each quarter;
our ability to develop, introduce and ship in a timely manner new products and product enhancements that meet customer demand, certification requirements and technical requirements;
the introduction of new pricing and packaging models for our product offerings;
the timing of the announcement or release of upgrades or new products by us or by our competitors;
our ability to maintain scalable internal systems for reporting, order processing, license fulfillment, product delivery, purchasing, billing and general accounting, among other functions;
our ability to control costs, including our operating expenses;
changes to our effective tax rate;
the increasing scale of our business and its effect on our ability to maintain historical rates of growth;
our ability to attract and retain highly skilled employees, particularly those with relevant experience in software development and sales;
our ability to conform to emerging industry standards and to technological developments by our competitors and customers;
renewal rates for ELAs as original ELA terms expire;
the timing and amount of software development costs that are capitalized beginning when technological feasibility has been established and ending when the product is available for general release;
unplanned events that could affect market perception of the quality or cost-effectiveness of our products and solutions; and
the recoverability of benefits from goodwill and intangible assets and the potential impairment of these assets.
We are dependent on our management and our key development personnel, and the loss of key personnel may prevent us from implementing our business plan in a timely manner.
Our success depends largely upon the continued services of our existing management. We are also substantially dependent on the continued service of our key development personnel for product innovation and timely development and delivery of upgrades and enhancements to our existing products. The market for expert software developers upon whom we rely has become increasingly competitive. We generally do not have employment or non-compete agreements with our existing management or development personnel and, therefore, they could terminate their employment with us at any time without penalty and could pursue employment opportunities with any of our competitors. Changes to management and key employees can also lead to additional unplanned losses of key employees. The loss of key employees could seriously harm our ability to release new products on a timely basis and could significantly help our competitors.
Our current research and development efforts may not produce significant revenues for several years, if at all.
Developing our products is expensive. Our investment in research and development may not result in marketable products or may result in products that take longer to generate revenues, or generate less revenues, than we anticipate. Our research and development expenses were over 20% of our total revenues in the first six months of 2012 and in the fiscal year 2011, respectively. Our future plans include significant investments in software research and development and related product opportunities. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we may not receive significant revenues from these investments for several years, if at all.
Because competition for our target employees is intense, we may not be able to attract and retain the highly skilled employees we need to support our planned growth, and our compensation expenses may increase.
To execute on our strategy, we must continue to attract and retain highly qualified personnel. Competition for these personnel is intense, especially for senior sales executives and engineers with high levels of experience in designing and developing software. We may not be successful in attracting and retaining qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled

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employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. In addition, in making employment decisions, particularly in the high-technology industry, job candidates often consider the value of the stock options, restricted stock grants or other stock-based compensation they are to receive in connection with their employment. Declines in the value of our stock could adversely affect our ability to attract or retain key employees and result in increased employee compensation expenses. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be severely harmed.
We may not be able to respond to rapid technological changes with new solutions and services offerings, which could have a material adverse effect on our sales and profitability.
The markets for our software solutions are characterized by rapid technological changes, changing customer needs, frequent new software product introductions and evolving industry standards. The introduction of third-party solutions embodying new technologies and the emergence of new industry standards could make our existing and future software solutions obsolete and unmarketable. Cloud computing promises to be a disruptive technology that will alter the way that businesses consume, manage and provide physical IT resources, applications, data and IT services. We may not be able to develop updated products that keep pace with technological developments and emerging industry standards and that address the increasingly sophisticated needs of our customers or that interoperate with new or updated operating systems and hardware devices or certify our products to work with these systems and devices. As a result, we may not be able to accurately predict the lifecycle of our software solutions, and they may become obsolete before we receive the amount of revenues that we anticipate from them. There is no assurance that any of our new offerings would be accepted in the marketplace. Significant reductions in server-related costs or the rise of more efficient infrastructure management software could also affect demand for our software solutions. As hardware and processors become more powerful, we will have to adapt our product and service offerings to take advantage of the increased capabilities. For example, while the introduction of more powerful servers presents an opportunity for us to provide better products for our customers, the migration of servers to quad-core and greater multi-core microprocessor technology also allows an end user with a given number of licensed copies of our software to more than double the number of virtualization machines run per server socket without having to purchase additional licenses from us. If any of the foregoing events were to occur, our ability to retain or increase market share and revenues in the virtualization software market could be materially adversely affected.
Our success depends upon our ability to develop new products and services, integrate acquired products and services and enhance our existing products and services and develop appropriate business and pricing models.
If we are unable to develop new products and services, integrate acquired products and services, enhance and improve our products and support services in a timely manner, or position and/or price our products and services to meet market demand, customers may not buy new software licenses from us, update to new versions of our software or renew product support. In addition, information technology standards from both consortia and formal standards-setting forums as well as de facto marketplace standards are rapidly evolving. We cannot provide any assurance that the standards on which we choose to develop new products will allow us to compete effectively for business opportunities in emerging areas such as cloud computing.
New product development and introduction involves a significant commitment of time and resources and is subject to a number of risks and challenges including:
managing the length of the development cycle for new products and product enhancements, which has frequently been longer than we originally expected;
managing customers’ transitions to new products, which can result in delays in their purchasing decisions;
adapting to emerging and evolving industry standards and to technological developments by our competitors and customers;
entering into new or unproven markets with which we have limited experience;
tailoring our business and pricing models appropriately as we enter new markets and respond to competitive pressures and technological changes;
incorporating and integrating acquired products and technologies; and
developing or expanding efficient sales channels.
In addition, if we cannot adapt our business models to keep pace with industry trends, our revenues could be negatively impacted. For example, if we increase our adoption of subscription-based pricing models for our products, we may fail to set pricing at levels appropriate to maintain our revenue streams or our customers may choose to deploy products from our competitors that they believe are priced more favorably. Additionally, we may fail to accurately predict subscription renewal rates or their impact on results, and because revenue from subscriptions is recognized for our services over the term of the subscription, downturns or upturns in sales may not be immediately reflected in our results. As we offer more products that

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depend on converting users of free services to users of premium services and as such services grow in size, our ability to maintain or improve and to predict conversion rates will become more important.
Breaches of our cybersecurity systems could degrade our ability to conduct our business operations and deliver products and services to our customers, delay our ability to recognize revenue, compromise the integrity of our software products, result in significant data losses and the theft of our intellectual property, damage our reputation, expose us to liability to third parties and require us to incur significant additional costs to maintain the security of our networks and data.
We increasingly depend upon our IT systems to conduct virtually all of our business operations, ranging from our internal operations and product development activities to our marketing and sales efforts and communications with our customers and business partners. Computer programmers may attempt to penetrate our network security, or that of our website, and misappropriate our proprietary information or cause interruptions of our service. Because the techniques used by such computer programmers to access or sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system. We have also outsourced a number of our business functions to third party contractors, and our business operations also depend, in part, on the success of our contractors’ own cybersecurity measures. Similarly, we rely upon distributors, resellers, system vendors and systems integrators to sell our products and our sales operations depend, in part, on the reliability of their cybersecurity measures. Additionally, we depend upon our employees to appropriately handle confidential data and deploy our IT resources in safe and secure fashion that does not expose our network systems to security breaches and the loss of data. Accordingly, if our cybersecurity systems and those of our contractors fail to protect against unauthorized access, sophisticated cyberattacks and the mishandling of data by our employees and contractors, our ability to conduct our business effectively could be damaged in a number of ways, including:
sensitive data regarding our business, including intellectual property and other proprietary data, could be stolen;
our electronic communications systems, including email and other methods, could be disrupted, and our ability to conduct our business operations could be seriously damaged until such systems can be restored;
our ability to process customer orders and electronically deliver products and services could be degraded, and our distribution channels could be disrupted, resulting in delays in revenue recognition;
defects and security vulnerabilities could be introduced into our software products, thereby damaging the reputation and perceived reliability and security of our products and potentially making the data systems of our customers vulnerable to further data loss and cyberincidents; and
personally identifiable data of our customers, employees and business partners could be lost.
Should any of the above events occur, we could be subject to significant claims for liability from our customers, regulatory actions from governmental agencies, our ability to protect our intellectual property rights could be compromised and our reputation and competitive position could be significantly harmed. Also, the regulatory and contractual actions, litigations, investigations, fines, penalties and liabilities relating to data breaches that result in losses of personally identifiable or credit card information of users of our services can be significant in terms of fines and reputational impact and necessitate changes to our business operations that may be disruptive to us. Additionally, we could incur significant costs in order to upgrade our cybersecurity systems and remediate damages. Consequently, our financial performance and results of operations could be adversely affected.
Our products are highly technical and may contain errors, defects or security vulnerabilities which could cause harm to our reputation and adversely affect our business.
Our products are highly technical and complex and, when deployed, have contained and may contain errors, defects or security vulnerabilities. Some errors in our products may only be discovered after a product has been installed and used by customers. Any errors, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenues or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, financial condition and results of operations. Undiscovered vulnerabilities in our products could expose them to hackers or other unscrupulous third parties who develop and deploy viruses, worms, and other malicious software programs that could attack our products. On April 23, 2012, VMware became aware of the public posting by a hacker of a single file from the VMware ESX source code. The hacker has publicly indicated that additional portions of the source code will be posted in the future. The posted code and associated commentary is from the 2004 timeframe. It is possible that the released source code could expose unknown security vulnerabilities in our products that could be exploited by hackers or others. Actual or perceived security vulnerabilities in our products could harm our reputation and lead some customers to return products, to reduce or delay future purchases or use competitive products. End users, who rely on our products and services for the interoperability of enterprise servers and applications that are critical to their information systems, may have a greater

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sensitivity to product errors and security vulnerabilities than customers for software products generally. Any security breaches could lead to interruptions, delays and data loss and protection concerns. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld and customers and channel partners may seek indemnification from us for their losses and those of their customers. Defending a lawsuit, regardless of its merit, is costly and time-consuming and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all; our business, financial condition and results of operations could be adversely impacted.
Operating in foreign countries subjects us to additional risks that may harm our ability to increase or maintain our international sales operations and investments.
Revenues from customers outside the United States comprised approximately 52% of our total revenues in the first six months ended 2012 and 2011, respectively. We have sales, administrative, research and development and technical support personnel in numerous countries worldwide. We expect to continue to add personnel in additional countries. Additionally, our investment portfolio includes investments in non-U.S. financial instruments and holdings in non-U.S. financial institutions, including European institutions. Our international operations subject us to a variety of risks, including:
the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;
increased exposure to foreign currency exchange rate risk;
difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;
difficulties in delivering support, training and documentation in certain foreign markets;
tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;
economic or political instability and security concerns in countries that are important to our international sales and operations;
macroeconomic disruptions, such as monetary and credit crises, that can threaten the stability of local and regional financial institutions and decrease the value of our international investments;
the overlap of different tax structures or changes in international tax laws;
reduced protection for intellectual property rights, including reduced protection from software piracy in some countries;
difficulties in transferring funds from certain countries; and
difficulties in maintaining appropriate controls relating to revenue recognition practices.
Additionally, as we continue to expand our business globally, we will need to maintain compliance with legal and regulatory requirements covering the foreign activities of U.S. corporations, such as export control requirements and the Foreign Corrupt Practices Act, as well as with local regulatory requirements in non-U.S. jurisdictions. Our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. We expect a significant portion of our growth to occur in foreign countries, which can add to the difficulties in maintaining adequate management and compliance systems and internal controls over financial reporting and increase challenges in managing an organization operating in various countries.
Our failure to manage any of these risks successfully could negatively affect our reputation, harm our operations and reduce our international sales.
If operating system and hardware vendors do not cooperate with us or we are unable to obtain early access to their new products, or access to certain information about their new products to ensure that our solutions interoperate with those products, our product development efforts may be delayed or foreclosed.
Our products interoperate with Windows, Linux and other operating systems and the hardware devices of numerous manufacturers. Developing products that interoperate properly requires substantial partnering, capital investment and employee resources, as well as the cooperation of the vendors or developers of the operating systems and hardware. Operating system and hardware vendors may not provide us with early access to their technology and products, assist us in these development efforts or share with or sell to us any application programming interfaces, or APIs, formats, or protocols we may need. If they do not

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provide us with the necessary early access, assistance or proprietary technology on a timely basis, we may experience product development delays or be unable to expand our products into other areas. To the extent that software or hardware vendors develop products that compete with ours or those of our controlling stockholder, EMC, they may have an incentive to withhold their cooperation, decline to share access or sell to us their proprietary APIs, protocols or formats or engage in practices to actively limit the functionality, or compatibility, and certification of our products. To the extent that we enter into collaborations or joint development and marketing arrangements with certain hardware and software vendors, vendors who compete with our collaborative partners may similarly choose to limit their cooperation with us. In addition, hardware or operating system vendors may fail to certify or support or continue to certify or support our products for their systems. If any of the foregoing occurs, our product development efforts may be delayed or foreclosed and our business and results of operations may be adversely affected.
We rely on distributors, resellers, system vendors and systems integrators to sell our products, and our failure to effectively develop, manage or prevent disruptions to our distribution channels and the processes and procedures that support them could cause a reduction in the number of end users of our products.
Our future success is highly dependent upon maintaining and increasing the number of our relationships with distributors, resellers, system vendors and systems integrators. Because we rely on distributors, resellers, system vendors and systems integrators, we may have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements, estimate end-user demand and respond to evolving customer needs.
Recruiting and retaining qualified channel partners and training them in the use of our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to expand and improve our processes and procedures that support our channel, including our investment in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. The time and expense required for sales and marketing organizations of our channel partners to become familiar with our product offerings, including our new product developments, may make it more difficult to introduce those products to end users and delay end-user adoption of our product offerings.
We generally do not have long-term contracts or minimum purchase commitments with our distributors, resellers, system vendors and systems integrators, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours. Our competitors may be effective in providing incentives to existing and potential channel partners to favor products of our competitors or to prevent or reduce sales of our products. Certain system vendors now offer competing virtualization products preinstalled on their server products. Additionally, our competitors could attempt to require key distributors to enter into exclusivity arrangements with them or otherwise apply their pricing or marketing leverage to discourage distributors from offering our products. Accordingly, our channel partners may choose not to offer our products exclusively or at all. Our failure to maintain and increase the number of relationships with channel partners would likely lead to a loss of end users of our products which would result in us receiving lower revenues from our channel partners. Three of our distributors each accounted for more than 10% of revenues during the first six months of 2012, and three of our distributors each accounted for more than 10% of revenues during the first six months of 2011. Our agreements with distributors are typically terminable by either party upon 30 to 90 days’ prior written notice to the other party, and neither party has any obligation to purchase or sell any products under the agreements. While we believe that we have in place, or would have in place by the date of any such termination, agreements with replacement distributors sufficient to maintain our revenues from distribution, if we were to lose the distribution services of a significant distributor, such loss could have a negative impact on our results of operations until such time as we arrange to replace these distribution services with the services of existing or new distributors.
The concentration of our product sales among a limited number of distributors and the weakness in credit markets increases our potential credit risk. Additionally, weakness in credit markets could affect the ability of our distributors, resellers and customers to comply with the terms of credit we provide in the ordinary course of business. Accordingly, if our distributors, resellers and customers find it difficult to obtain credit or comply with the terms of their credit obligations, it could cause significant fluctuations or declines in our product revenues.
Three of our distributors each accounted for more than 10% of revenues during the first six months of 2012, and three of our distributors each accounted for more than 10% of revenues during the first six months of 2011. We anticipate that sales of our products to a limited number of distributors will continue to account for a significant portion of our total product revenues for the foreseeable future. The concentration of product sales among certain distributors increases our potential credit risks. For example, approximately 47% of our total accounts receivable as of June 30, 2012 was from three distributors. Some of our distributors may experience financial difficulties, which could adversely impact our collection of accounts receivable. One or more of these distributors could delay payments or default on credit extended to them. Our exposure to credit risks of our distributors may increase if our distributors and their customers are adversely affected by global or regional economic

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conditions. Additionally, we provide credit to distributors, resellers, and certain end-user customers in the normal course of business. Credit is generally extended to new customers based upon a credit evaluation. Credit is extended to existing customers based on ongoing credit evaluations, prior payment history, and demonstrated financial stability. We often allow distributors and customers to purchase and receive shipments of products in excess of their established credit limit. We are unable to recognize revenue from such shipments until the collection of those amounts becomes reasonably assured. Any significant delay or default in the collection of significant accounts receivable could result in an increased need for us to obtain working capital from other sources, possibly on worse terms than we could have negotiated if we had established such working capital resources prior to such delays or defaults. Any significant default could result in a negative impact on our results of operations and delay our ability to recognize revenue.
Our revenues, collection of accounts receivable and financial results may be adversely impacted by fluctuation of foreign currency exchange rates. Although foreign currency hedges can offset some of the risk related to foreign currency fluctuations, we will continue to experience foreign currency gains and losses in certain instances where it is not possible or cost effective to hedge our foreign currency exposures.
Our revenues and our collection of accounts receivable may be adversely impacted as a result of fluctuations in the exchange rates between the U.S. Dollar and foreign currencies. For example, we have distributors in foreign countries that may incur higher costs in periods when the value of the U.S. Dollar strengthens against foreign currencies. One or more of these distributors could delay payments or default on credit extended to them as a result. Any significant delay or default in the collection of significant accounts receivable could result in an increased need for us to obtain working capital from other sources. If we determine that the amount of accounts receivable to be uncollectible is greater than our estimates, we would recognize an increase in bad debt expense, which would have a negative impact on our results of operations. In addition, in periods when the value of the U.S. Dollar strengthens, we may need to offer additional discounts, reduce prices or offer other incentives to mitigate the negative effect on demand.
We invoice and collect in certain non-U.S. Dollar denominated currencies, thereby conducting a portion of our revenue transactions in currencies other than the U.S. Dollar. Although this program may alleviate credit risk from our distributors during periods when the U.S. Dollar strengthens, it shifts the risk of currency fluctuations to us and may negatively impact our revenues, anticipated cash flows and financial results due to fluctuations in foreign currency exchange rates, particularly the Euro, the British Pound, the Japanese Yen and the Australian Dollar relative to the U.S. Dollar. While variability in operating margin may be reduced due to invoicing in certain of the local currencies in which we also recognize expenses, increased exposure to foreign currency fluctuations will introduce additional risk for variability in revenue-related components of our consolidated financial statements.
We enter into foreign currency forward contracts to hedge a portion of our net outstanding monetary assets and liabilities against movements in certain foreign exchange rates. Although we expect the gains and losses on our foreign currency forward contracts to generally offset the majority of the gains and losses associated with the underlying foreign-currency denominated assets and liabilities that we hedge, our hedging transactions may not yield the results we expect. Additionally, we expect to continue to experience foreign currency gains and losses in certain instances where it is not possible or cost effective to hedge our foreign currency exposures.
We may become involved in litigation and regulatory inquiries and proceedings that could negatively affect us.
From time to time, we are involved in various legal, administrative and regulatory proceedings, claims, demands and investigations relating to our business, which may include claims with respect to patent, commercial, product liability, employment, class action, whistleblower and other matters. From time to time, we receive inquiries from government entities regarding the compliance of our contracting and sales practices with applicable regulations. Such matters can be time-consuming, divert management’s attention and resources and cause us to incur significant expenses. While no formal legal proceedings that could have a material impact on our results of operations or financial condition have been taken, there can be no assurance that actions will not be taken in the future. Furthermore, because litigation and the outcome of regulatory proceedings are inherently unpredictable, it is possible that our business, results of operations or financial condition could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims, demands or investigations.
Our business is subject to a variety of U.S. and international laws and regulations regarding data protection.
Our business is subject to federal, state and international laws and regulations regarding privacy and protection of personal data. We collect contact and other personal or identifying information from our customers. Additionally, in connection with some of our new product initiatives, our customers may use our services to store and process personal information and other user data. We post, on our website, our privacy policies and practices concerning our treatment of personal data. Any failure by us to comply with our posted privacy policies or other federal, state or international privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others which could have a material adverse effect on our business, results of operations and financial condition. In addition, the increased attention focused upon liability issues

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as a result of lawsuits and legislative proposals could harm our reputation or otherwise impact the growth of our business.
It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices. If so, in addition to the possibility of fines and penalties, a governmental order requiring that we change our data practices could result, which in turn could have a material adverse effect on our business. Compliance with such an order may involve significant costs or require changes in business practices that result in reduced revenue. Noncompliance could result in penalties being imposed on us or we could be ordered to cease conducting the noncompliant activity.
In addition to government regulation, privacy advocacy and industry groups or other third parties may propose new and different self-regulatory standards that either legally or contractually apply to us or our customers. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy or data protection laws, regulations and policies, could result in additional cost and liability to us, damage our reputation, inhibit sales and harm our business.
Additionally, our virtualization technology is used by cloud computing vendors, and we have expanded our involvement in the delivery and provision of cloud computing through business alliances with various providers of cloud computing services and software and expect to continue to do so in the future. For example, in April 2011, we entered into an agreement with EMC to acquire certain assets relating to EMC’s Mozy cloud-based data storage and data services, including certain data center assets and a license to certain intellectual property. We also entered into an operational support agreement with EMC pursuant to which we will take over responsibility for operating the Mozy service on behalf of EMC. The application of U.S. and international data privacy laws to cloud computing vendors is uncertain, and our existing contractual provisions may prove to be inadequate to protect us from claims for data loss or regulatory noncompliance made against cloud computing providers who we may partner with. Accordingly, the failure to comply with data protection laws and regulations by our customers and business partners who provide cloud computing services could have a material adverse effect on our business.
If we fail to comply with our customer contracts or government contracting regulations, our business could be adversely affected.
Our contracts with our customers may include unique and specialized performance requirements. In particular, our contracts with federal, state, and local and non-U.S. governmental customers and our arrangements with distributors and resellers who may sell directly to governmental customers are subject to various procurements regulations, contract provisions and other requirements relating to their formation, administration and performance. Any failure by us to comply with provisions in our customer contracts or any violation of government contracting regulations could result in the imposition of various civil and criminal penalties, which may include termination of contracts, forfeiture of profits, suspension of payments and, in the case of our government contracts, fines and suspension from future government contracting. Further, any negative publicity related to our customer contracts or any proceedings surrounding them, regardless of its accuracy, may damage our business and affect our ability to compete for new contracts. From time to time, we receive inquiries from government entities regarding the compliance of our contracting and sales practices with applicable regulations. While no formal legal proceedings that could have a material impact on our results of operations or financial condition have been taken, there can be no assurance that actions will not be taken in the future. If our customer contracts are terminated, if we are suspended from government work or fines or other government sanctions are imposed, or if our ability to compete for new contracts is adversely affected, we could suffer an adverse effect on our business, operating results or financial condition.
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
We depend on our ability to protect our proprietary technology. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. As such, despite our efforts, the steps we have taken to protect our proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation or infringement is uncertain, particularly in countries outside of the United States. Further, with respect to patent rights, we do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. To the extent that additional patents are issued from our patent applications, which are not certain, they may be contested, circumvented or invalidated in the future. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superior technologies to our own now or in the future. In addition, we rely on confidentiality or license agreements with third parties in connection with their use of our products and technology. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights, in part because we rely on “click-wrap” and “shrink-wrap” licenses in some instances.
Detecting and protecting against the unauthorized use of our products, technology and proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could

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result in substantial costs and diversion of management resources, either of which could harm our business, financial condition and results of operations, and there is no guarantee that we would be successful. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to protecting their technology or intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property, which could result in a substantial loss of our market share.
We provide access to our hypervisor and other selected source code to partners, which creates additional risk that our competitors could develop products that are similar or better than ours.
Our success and ability to compete depend substantially upon our internally developed technology, which is incorporated in the source code for our products. We seek to protect the source code, design code, documentation and other information relating to our software, under trade secret and copyright laws. However, we have chosen to provide access to our hypervisor and other selected source code to more than 50 of our partners for co-development, as well as for open APIs, formats and protocols. Though we generally control access to our source code and other intellectual property, and enter into confidentiality or license agreements with such partners, as well as with our employees and consultants, this combination of procedural and contractual safeguards may be insufficient to protect our trade secrets and other rights to our technology. Our protective measures may be inadequate, especially because we may not be able to prevent our partners, employees or consultants from violating any agreements or licenses we may have in place or abusing their access granted to our source code. Improper disclosure or use of our source code could help competitors develop products similar to or better than ours.
We are, and may in the future be, subject to claims by others that we infringe their proprietary technology which could force us to pay damages or prevent us from using certain technology in our products.
Companies in the software and technology industries own large numbers of patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. This risk may increase as the number of products and competitors in our market increases and overlaps occur. In addition, as a well-known information technology company, we face a higher risk of being the subject of intellectual property infringement claims. Any claim of infringement by a third party, even one without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from offering our products. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially reasonable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any of these events could seriously harm our business, operating results and financial condition. Third parties may also assert infringement claims against our customers and channel partners. Any of these claims could require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and channel partners from claims of infringement of proprietary rights of third parties in connection with the use of our products. If any of these claims succeed, we may be forced to pay damages on behalf of our customers or channel partners, which could negatively affect our results of operations.
Our use of “open source” software in our products could negatively affect our ability to sell our products and subject us to possible litigation.
A significant portion of the products, technologies or services acquired, licensed, developed or offered by us may incorporate so-called “open source” software, and we may incorporate open source software into other products in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses, including, for example, the GNU General Public License, the GNU Lesser General Public License, “Apache-style” licenses, “BSD-style” licenses and other open source licenses. We monitor our use of open source software in an effort to avoid subjecting our products to conditions we do not intend. Although we believe that we have complied with our obligations under the various applicable licenses for open source software that we use, there is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses, and therefore the potential impact of these terms on our business is somewhat unknown and may result in unanticipated obligations regarding our products and technologies. For example, we may be subjected to certain conditions, including requirements that we offer our products that use the open source software for no cost, that we make available source code for modifications or derivative works we create based upon incorporating, using or distributing the open source software and/or that we license such modifications or derivative works under the terms of the particular open source license. Any of these obligations could have an adverse impact on our intellectual property rights and our ability to derive revenue from products incorporating the open source software.
If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations. Although we have received inquiries regarding open source license compliance for software used in our products,

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no formal proceedings that would have a material impact on our results of operations or financial condition have been taken. However, there can be no assurance that actions will not be taken in the future. If our defenses were not successful, we could be subject to significant damages, enjoined from the distribution of our products that contained the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of some of our products. In addition, if we combine our proprietary software with open source software in a certain manner, under some open source licenses we could be required to release the source code of our proprietary software, which could substantially help our competitors develop products that are similar to or better than ours.
In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or assurance of title or controls on origin of the software. In addition, many of the risks associated with usage of open source such as the lack of warranties or assurances of title, cannot be eliminated, and could, if not properly addressed, negatively affect our business. We have established processes to help alleviate these risks, including a review process for screening requests from our development organizations for the use of open source and conducting appropriate due diligence of the use of open source in the products developed by companies we acquire, but we cannot be sure that all open source software is submitted for approval prior to use in our products or is discovered during due diligence.
We offer a number of products, including our SpringSource, Zimbra and Cloud Foundry products under open source licenses that subject us to additional risks and challenges, which could result in increased development expenses, delays or disruptions to the release or distribution of those software solutions, and increased competition.
In September 2009, we completed our acquisition of SpringSource and, in February 2010, we completed our acquisition of Zimbra. In April 2011, we launched our Cloud Foundry PaaS offering. We offer each of the product offerings under open source licenses. Software solutions that are substantially or mostly based on open source software subject us to a number of risks and challenges:
If open source software programmers, most of whom we do not employ, do not continue to develop and enhance open source technologies, our development expenses could be increased and our product release and upgrade schedules could be delayed.
One of the characteristics of open source software is that anyone can modify the existing software or develop new software that competes with existing open source software. As a result, competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. It is also possible for new competitors with greater resources than ours to develop their own open source solutions, potentially reducing the demand for, and putting price pressure on, our solutions.
It is possible that a court could hold that the licenses under which our open source products and services are developed and licensed are not enforceable or that someone could assert a claim for proprietary rights in a program developed and distributed under them. Any ruling by a court that these licenses are not enforceable, or that open source components of our product or services offerings may not be liberally copied, modified or distributed, may have the effect of preventing us from distributing or developing all or a portion of our products or services. In addition, licensors of open source software employed in our offerings may, from time to time, modify the terms of their license agreements in such a manner that those license terms may no longer be compatible with other open source licenses in our offerings or our end-user license agreement or terms of service, and thus could, among other consequences, prevent us from continuing to distribute the software code subject to the modified license or terms of service.
Actions to protect and maintain ownership and control over our intellectual property could adversely affect our standing in the open source community, which in turn could limit our ability to continue to rely on this community, upon which we are dependent, as a resource to help develop and improve our open source products and services.
If we are unable to successfully address the challenges of integrating offerings based upon open source technology into our business, our ability to realize revenues from such offerings will be negatively affected and our development costs may increase.
Our sales cycles can be long and unpredictable, our sales efforts require considerable time and expense and timing of sales is subject to changing purchasing behaviors of our customers. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.
The timing of our revenues is difficult to predict. Our sales efforts involve educating our customers about the use and benefit of our products, including their technical capabilities, potential cost savings to an organization and advantages compared to lower-cost products offered by our competitors. Customers typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle which typically lasts several months, and may last a year or longer. We spend substantial time, effort and money on our sales efforts without any assurance that our efforts will produce any sales. In

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addition, product purchases are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. Moreover, the greater number of competitive alternatives, as well as announcements by our competitors that they intend to introduce competitive alternatives at some point in the future, can lengthen customer procurement cycles, cause us to spend additional time and resources to educate end users on the advantages of our product offerings and delay product sales. Economic downturns and uncertainty can also cause customers to add layers to their internal purchase approval processes, adding further time to a sales cycle. These factors can have a particular impact on the timing and length of our ELA sales cycles.
Additionally, our quarterly sales have historically reflected an uneven pattern in which a disproportionate percentage of a quarter’s total sales occur in the last month, weeks and days of each quarter. Similarly, our yearly sales have historically reflected a disproportionate percentage of the year’s sales in the fourth fiscal quarter. These patterns make prediction of revenues, earnings and working capital for each financial period especially difficult and uncertain and increase the risk of unanticipated variations in financial condition and results of operations. We believe this uneven sales pattern is a result of many factors including the following:
the tendency of customers to wait until late in a quarter to commit to a purchase in the hope of obtaining more favorable pricing;
the fourth quarter influence of customers spending their remaining capital budget authorization prior to new budget constraints in the first nine months of the following year; and
seasonal influences, such as holiday or vacation periods.
If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, our results could fall short of public expectations and our business, financial condition and results of operations could be materially adversely affected.
Acquisitions could disrupt our business, cause dilution to our stockholders and harm our business, financial condition and results of operations.
We have acquired in the past and plan to acquire in the future other businesses, products or technologies. For example, in 2011 we completed a number of acquisitions, including acquisitions of Digital Fuel, NeoAccel, Packet Motion, Shavlik, SlideRocket, Socialcast and WaveMaker. We also acquired certain assets from EMC’s Mozy cloud-based data storage and data services and entered into an agreement with EMC to operate the services on EMC’s behalf. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, or they may be viewed negatively by customers, financial markets or investors.
Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expenses and adversely impact our business, financial condition and results of operations. An acquired business may not deliver the expected results. For example, an acquisition may not further our strategies or results in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, cost savings, operating efficiencies and other synergies. Acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable intangible assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt.
Additionally, we have limited historical experience with the integration of acquired companies. There can be no assurance that we will be able to manage the integration of acquired businesses effectively or be able to retain and motivate key personnel from these businesses. Any difficulties we encounter in the integration process could divert management from day-to-day responsibilities, increase our expenses and have a material adverse effect on our business, financial condition and results of operations. We may also face difficulties due to the lack of experience in new markets, products or technologies or the initial dependence on unfamiliar supply or distribution partners. Other risks related to acquisitions include the assumption of the liabilities of the acquired business, including litigation-related liabilities.
In addition, we review our amortizable intangible assets annually for impairment, or more frequently, when events or changes in circumstances indicate the carrying value may not be recoverable, and we are required to test goodwill for impairment at least annually. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets resulting from an acquisition or otherwise is determined, resulting in an adverse impact on our results of operations. In addition to the risks commonly encountered in the acquisition of a business as described above, we may also experience risks relating to the challenges and costs of closing a transaction. Further, the risks described above may be exacerbated as a result of managing multiple acquisitions at the same time. We also seek to invest in businesses that offer complementary products, services or technologies. These investments are accompanied by risks similar to those encountered in an acquisition of a business.

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If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, our stockholders could lose confidence in our financial reporting, which could harm our business and the trading price of our Class A common stock.
We have complied with Section 404 of the Sarbanes-Oxley Act of 2002 by assessing and testing our system of internal controls. Even though we concluded our system of internal controls was effective as of December 31, 2011, we need to continue to maintain our processes and systems and adapt them to changes as our business changes and we rearrange management responsibilities and reorganize our business accordingly. We may seek to automate certain processes to improve efficiencies and better ensure ongoing compliance but such automation may itself disrupt existing internal controls and introduce unintended vulnerability to error or fraud. This continuous process of maintaining and adapting our internal controls and complying with Section 404 is expensive and time-consuming, and requires significant management attention. We cannot be certain that our internal control measures will continue to provide adequate control over our financial processes and reporting and ensure compliance with Section 404. Furthermore, as our business changes and as we expand through acquisitions of other companies, our internal controls may become more complex and we will require significantly more resources to ensure our internal controls overall remain effective. Failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our independent registered public accounting firm identify material weaknesses, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price. In addition, if we are unable to continue to comply with Section 404, our non-compliance could subject us to a variety of administrative sanctions, including the suspension or delisting of our Class A common stock from the New York Stock Exchange and the inability of registered broker-dealers to make a market in our Class A common stock, which could reduce our stock price.
Problems with our information systems could interfere with our business that could adversely impact our operations.
We rely on our information systems and those of third parties for processing customer orders, delivery of products, providing services and support to our customers, billing and tracking our customers, fulfilling contractual obligations, and otherwise running our business. Any disruption in our information systems and those of the third parties upon whom we rely could have a significant impact on our business. In addition, we continuously work to enhance our information systems. The implementation of these types of enhancements is frequently disruptive to the underlying business of an enterprise, which may especially be the case for us due to the size and complexity of our business. Any disruptions relating to our systems enhancements, particularly any disruptions impacting our operations during the implementation period, could adversely affect our business in a number of respects. Even if we do not encounter these adverse effects, the implementation of these enhancements may be much more costly than we anticipated. If we are unable to successfully implement the information systems enhancements as planned, our financial position, results of operations, and cash flows could be negatively impacted.
Our financial results may be adversely impacted by higher than expected tax rates, and we may have exposure to additional tax liabilities.
As a multinational corporation, we are subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. Our domestic and international tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses. Additionally, the amount of income taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we file and changes to tax laws. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. From time to time, we are subject to income tax audits. While we believe we have complied with all applicable income tax laws, there can be no assurance that a governing tax authority will not have a different interpretation of the law and assess us with additional taxes. Should we be assessed with additional taxes, there could be a material adverse effect on our financial condition or results of operations.
Our future effective tax rate may be affected by such factors as changes in tax laws, regulations or rates, changing interpretation of existing laws or regulations, the impact of accounting for stock-based compensation, the impact of accounting for business combinations, changes in our international organization, and changes in overall levels of income before tax. For example, the U.S. federal research tax credit, which provided a significant reduction in our effective tax rate, expired on December 31, 2011. Reinstatement of the U.S. federal research tax credit would have a favorable effect on our effective tax rate.
In addition, in the ordinary course of our global business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain. Although we believe that our tax estimates are reasonable, we cannot ensure that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals.

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We are also subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the United States and various foreign jurisdictions. We are under audit from time to time by tax authorities with respect to these non-income taxes and may have exposure to additional non-income tax liabilities.
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events such as pandemics, and to interruption by man-made problems, such as computer viruses, unanticipated disruptions in local infrastructure or terrorism, which could result in delays or cancellations of customer orders or the deployment of our products.
Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire, flood or other act of God, could have a material adverse impact on our business, financial condition and results of operations. As we continue to grow internationally, increasing amounts of our business will be located in foreign countries that may be more subject to political or social instability that could disrupt operations. Furthermore, some of our new product initiatives and business functions are hosted and carried out by third parties that may be vulnerable to disruptions of these sorts, many of which may be beyond our control. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Unanticipated disruptions in services provided through localized physical infrastructure, such as utility or telecommunication outages, can curtail the functioning of local offices as well as critical components of our information systems and adversely affect our ability to process orders, provide services, respond to customer requests and maintain local and global business continuity. Natural disasters that affect the manufacture of IT products, such as the 2011 flooding in Thailand, can also delay customer spending on our software, which is often coupled with customer purchases of new servers and IT systems. Furthermore, acts of terrorism or war could cause disruptions in our or our customers’ business or the economy as a whole and disease pandemics could temporarily sideline a substantial part of our or our customers’ workforce at any particular time. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment or availability of our products and services, our revenues would be adversely affected.
Changes in accounting principles and guidance, or their interpretation, could result in unfavorable accounting charges or effects, including changes to our previously-filed financial statements, which could cause our stock price to decline.
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting principles and guidance. A change in these principles or guidance, or in their interpretations, may have a significant effect on our reported results and retroactively affect previously reported results.
Risks Related to Our Relationship with EMC
As long as EMC controls us, other holders of our Class A common stock will have limited ability to influence matters requiring stockholder approval.
As of June 30, 2012, EMC owned 38,664,000 shares of our Class A common stock and all 300,000,000 shares of our Class B common stock, representing 79.3% of the total outstanding shares of common stock or 97.2% of the voting power of outstanding common stock. The holders of our Class A common stock and our Class B common stock have identical rights, preferences and privileges except with respect to voting and conversion rights, the election of directors, certain actions that require the consent of holders of Class B common stock and other protective provisions as set forth in our certificate of incorporation. Holders of our Class B common stock are entitled to 10 votes per share of Class B common stock on all matters except for the election of our Group II directors, in which case they are entitled to one vote per share, and the holders of our Class A common stock are entitled to one vote per share of Class A common stock. The holders of Class B common stock, voting separately as a class, are entitled to elect 80% of the total number of directors on our board of directors that we would have if there were no vacancies on our board of directors at the time. These are our Group I directors. Subject to any rights of any series of preferred stock to elect directors, the holders of Class A common stock and the holders of Class B common stock, voting together as a single class, are entitled to elect our remaining directors, which at no time will be less than one director-our Group II director(s). Accordingly, the holders of our Class B common stock currently are entitled to elect 7 of our 8 directors.
If EMC transfers shares of our Class B common stock to any party other than a successor-in-interest or a subsidiary of EMC prior to a distribution to its stockholders under Section 355 of the Internal Revenue Code of 1986, as amended (a “355 distribution”), those shares will automatically convert into Class A common stock. Additionally, if, prior to a 355 distribution, EMC’s ownership falls below 20% of the outstanding shares of our common stock, all outstanding shares of Class B common stock will automatically convert to Class A common stock. Following a 355 distribution, shares of Class B common stock may convert to Class A common stock if such conversion is approved by VMware stockholders after the 355 distribution. For so long as EMC or its successor-in-interest beneficially owns shares of our common stock representing at least a majority of the votes entitled to be cast by the holders of outstanding voting stock, EMC will be able to elect all of the members of our board of directors.

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In addition, until such time as EMC or its successor-in-interest beneficially owns shares of our common stock representing less than a majority of the votes entitled to be cast by the holders of outstanding voting stock, EMC will have the ability to take stockholder action without the vote of any other stockholder and without having to call a stockholder meeting, and holders of our Class A common stock will not be able to affect the outcome of any stockholder vote during this period. As a result, EMC will have the ability to control all matters affecting us, including:
the composition of our board of directors and, through our board of directors, any determination with respect to our business plans and policies;
any determinations with respect to mergers, acquisitions and other business combinations;
our acquisition or disposition of assets;
our financing activities;
certain changes to our certificate of incorporation;
changes to the agreements we entered into in connection with our transition to becoming a public company;
corporate opportunities that may be suitable for us and EMC;
determinations with respect to enforcement of rights we may have against third parties, including with respect to intellectual property rights;
the payment of dividends on our common stock; and
the number of shares available for issuance under our stock plans for our prospective and existing employees.
Our certificate of incorporation and the master transaction agreement entered into between us and EMC in connection with our initial public offering (“IPO”) also contain provisions that require that as long as EMC beneficially owns at least 20% or more of the outstanding shares of our common stock, the prior affirmative vote or written consent of EMC (or its successor-in-interest) as the holder of the Class B common stock is required (subject in each case to certain exceptions) in order to authorize us to:
consolidate or merge with any other entity;
acquire the stock or assets of another entity in excess of $100 million;
issue any stock or securities except to our subsidiaries or pursuant to our employee benefit plans;
establish the aggregate annual amount of shares we may issue in equity awards;
dissolve, liquidate or wind us up;
declare dividends on our stock;
enter into any exclusive or exclusionary arrangement with a third party involving, in whole or in part, products or services that are similar to EMC’s; and
amend, terminate or adopt any provision inconsistent with certain provisions of our certificate of incorporation or bylaws.
If EMC does not provide any requisite consent allowing us to conduct such activities when requested, we will not be able to conduct such activities and, as a result, our business and our operating results may be harmed. EMC’s voting control and its additional rights described above may discourage transactions involving a change of control of us, including transactions in which holders of our Class A common stock might otherwise receive a premium for their shares over the then-current market price. EMC is not prohibited from selling a controlling interest in us to a third party and may do so without the approval of the holders of our Class A common stock and without providing for a purchase of any shares of Class A common stock held by persons other than EMC. Accordingly, shares of Class A common stock may be worth less than they would be if EMC did not maintain voting control over us nor have the additional rights described above.
In the event EMC is acquired or otherwise undergoes a change of control, any acquirer or successor will be entitled to exercise the voting control and contractual rights of EMC, and may do so in a manner that could vary significantly from EMC’s historic practice.
By becoming a stockholder in our company, holders of our Class A common stock are deemed to have notice of and have consented to the provisions of our certificate of incorporation and the master transaction agreement with respect to the limitations that are described above.

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Our business and that of EMC overlap, and EMC may compete with us, which could reduce our market share.
EMC and we are both IT infrastructure companies providing products related to storage management, back-up, disaster recovery, security, system management and automation, provisioning and resource management. There can be no assurance that EMC will not engage in increased competition with us in the future. In addition, the intellectual property agreement that we have entered into with EMC provides EMC the ability to use our source code and intellectual property, which, subject to limitations, it may use to produce certain products that compete with ours. EMC’s rights in this regard extend to its majority-owned subsidiaries, which could include joint ventures where EMC holds a majority position and one or more of our competitors hold minority positions.
EMC could assert control over us in a manner which could impede our growth or our ability to enter new markets or otherwise adversely affect our business. Further, EMC could utilize its control over us to cause us to take or refrain from taking certain actions, including entering into relationships with channel, technology and other marketing partners, enforcing our intellectual property rights or pursuing business combinations, other corporate opportunities or product development initiatives that could adversely affect our competitive position, including our competitive position relative to that of EMC in markets where we compete with them. In addition, EMC maintains significant partnerships with certain of our competitors, including Microsoft.
EMC’s competition in certain markets may affect our ability to build and maintain partnerships.
Our existing and potential partner relationships may be affected by our relationship with EMC. We partner with a number of companies that compete with EMC in certain markets in which EMC participates. EMC’s majority ownership in us might affect our ability to effectively partner with these companies. These companies may favor our competitors because of our relationship with EMC.
EMC competes with certain of our significant channel, technology and other marketing partners, including IBM and Hewlett-Packard. Pursuant to our certificate of incorporation and other agreements that we have with EMC, EMC may have the ability to impact our relationship with those of our partners that compete with EMC, which could have a material adverse effect on our results of operations or our ability to pursue opportunities which may otherwise be available to us.
In order to preserve the ability for EMC to distribute its shares of our Class B common stock on a tax-free basis, we may be prevented from pursuing opportunities to raise capital, to effectuate acquisitions or to provide equity incentives to our employees, which could hurt our ability to grow.
Beneficial ownership of at least 80% of the total voting power is required in order for EMC to affect a tax-free spin-off of VMware or certain other tax-free transactions. We have agreed that for so long as EMC or its successor-in-interest continues to own greater than 50% of the voting control of our outstanding common stock, we will not knowingly take or fail to take any action that could reasonably be expected to preclude EMC’s or its successor-in-interest’s ability to undertake a tax-free spin-off. Additionally, under our certificate of incorporation and the master transaction agreement we entered into with EMC, we must obtain the consent of EMC or its successor-in-interest, as the holder of our Class B common stock, to issue stock or other VMware securities, excluding pursuant to employee benefit plans (provided that we obtain Class B common stockholder approval of the aggregate annual number of shares to be granted under such plans), which could cause us to forgo capital raising or acquisition opportunities that would otherwise be available to us. As a result, we may be precluded from pursuing certain growth initiatives.
Third parties may seek to hold us responsible for liabilities of EMC, which could result in a decrease in our income.
Third parties may seek to hold us responsible for EMC’s liabilities. Under our master transaction agreement with EMC, EMC will indemnify us for claims and losses’ relating to liabilities related to EMC’s business and not related to our business. However, if those liabilities are significant and we are ultimately held liable for them, we cannot be certain that we will be able to recover the full amount of our losses from EMC.
Although we have entered into a tax sharing agreement with EMC under which our tax liabilities effectively will be determined as if we were not part of any consolidated, combined or unitary tax group of EMC Corporation and/or its subsidiaries, we nonetheless could be held liable for the tax liabilities of other members of these groups.
We have historically been included in EMC’s consolidated group for U.S. federal income tax purposes, as well as in certain consolidated, combined or unitary groups that include EMC Corporation and/or certain of its subsidiaries for state and local income tax purposes. Pursuant to our tax sharing agreement with EMC, we and EMC generally will make payments to each other such that, with respect to tax returns for any taxable period in which we or any of our subsidiaries are included in EMC’s consolidated group for U.S. federal income tax purposes or any other consolidated, combined or unitary group of EMC Corporation and/or its subsidiaries, the amount of taxes to be paid by us will be determined, subject to certain adjustments, as if we and each of our subsidiaries included in such consolidated, combined or unitary group filed our own consolidated,

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combined or unitary tax return.
We have been included in the EMC consolidated group for U.S. federal income tax purposes since our acquisition by EMC, and expect to continue to be included in such consolidated group for periods in which EMC owns at least 80% of the total voting power and value of our outstanding stock. Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Similarly, in some jurisdictions, each member of a consolidated, combined or unitary group for state, local or foreign income tax purposes is jointly and severally liable for the state, local or foreign income tax liability of each other member of the consolidated, combined or unitary group. Accordingly, for any period in which we are included in the EMC consolidated group for U.S. federal income tax purposes or any other consolidated, combined or unitary group of EMC Corporation and/or its subsidiaries, we could be liable in the event that any income tax liability was incurred, but not discharged, by any other member of any such group.
Any inability to resolve favorably any disputes that arise between us and EMC with respect to our past and ongoing relationships may result in a significant reduction of our revenues and earnings.
Disputes may arise between EMC and us in a number of areas relating to our ongoing relationships, including:
labor, tax, employee benefit, indemnification and other matters arising from our separation from EMC;
employee retention and recruiting;
business combinations involving us;
our ability to engage in activities with certain channel, technology or other marketing partners;
sales or dispositions by EMC of all or any portion of its ownership interest in us;
the nature, quality and pricing of services EMC has agreed to provide us;
arrangements with third parties that are exclusionary to EMC;
business opportunities that may be attractive to both EMC and us; and
product or technology development or marketing activities or customer agreements which may require the consent of EMC.
We may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable than if we were dealing with an unaffiliated party.
The agreements we enter into with EMC may be amended upon agreement between the parties. While we are controlled by EMC, we may not have the leverage to negotiate amendments to these agreements if required on terms as favorable to us as those we would negotiate with an unaffiliated third party.
Some of our directors own EMC common stock, restricted shares of EMC common stock or equity awards to acquire EMC common stock and hold management positions with EMC, which could cause conflicts of interests that result in our not acting on opportunities we otherwise may have.
Some of our directors own EMC common stock or equity awards to purchase EMC common stock. In addition, some of our directors are executive officers or directors of EMC, and EMC, as the sole holder of our Class B common stock, is entitled to elect 7 of our 8 directors. Ownership of EMC common stock, restricted shares of EMC common stock and equity awards to purchase EMC common stock by our directors and the presence of executive officers or directors of EMC on our board of directors could create, or appear to create, conflicts of interest with respect to matters involving both us and EMC that could have different implications for EMC than they do for us. Provisions of our certificate of incorporation and the master transaction agreement between EMC and us address corporate opportunities that are presented to our directors or officers that are also directors or officers of EMC. There can be no assurance that the provisions in our certificate of incorporation or the master transaction agreement will adequately address potential conflicts of interest or that potential conflicts of interest will be resolved in our favor or that we will be able to take advantage of corporate opportunities presented to individuals who are officers or directors of both us and EMC. As a result, we may be precluded from pursuing certain growth initiatives.
EMC’s ability to control our board of directors may make it difficult for us to recruit independent directors.
So long as EMC beneficially owns shares of our common stock representing at least a majority of the votes entitled to be cast by the holders of outstanding voting stock, EMC can effectively control and direct our board of directors. Further, the interests of EMC and our other stockholders may diverge. Under these circumstances, persons who might otherwise accept our invitation to join our board of directors may decline.

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We are a “controlled company” within the meaning of the New York Stock Exchange rules and, as a result, are relying on exemptions from certain corporate governance requirements that provide protection to stockholders of companies that are not “controlled companies.”
EMC owns more than 50% of the total voting power of our common shares and, as a result, we are a “controlled company” under the New York Stock Exchange corporate governance standards. As a controlled company, we are exempt under the New York Stock Exchange standards from the obligation to comply with certain New York Stock Exchange corporate governance requirements, including the requirements:
that a majority of our board of directors consists of independent directors;
that we have a corporate governance and nominating committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;
that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and
for an annual performance evaluation of the nominating and governance committee and compensation committee.
While we have voluntarily caused our Compensation and Corporate Governance Committee to currently be composed entirely of independent directors in compliance with the requirements of the New York Stock Exchange, we are not required to maintain the independent composition of the committee. As a result of our use of the “controlled company” exemptions, holders of our Class A common stock will not have the same protection afforded to stockholders of companies that are subject to all of the New York Stock Exchange corporate governance requirements.
Our historical financial information as a business segment of EMC may not be representative of our results as an independent public company.
The historical financial information covering the periods prior to our IPO in August 2007 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 does not necessarily reflect what our financial position, results of operations or cash flows would have been had we been an independent entity during those historical periods. The historical costs and expenses reflected in our consolidated financial statements prior to 2008 include an allocation for certain corporate functions historically provided by EMC, including tax, accounting, treasury, legal and human resources services. Although we have transitioned most of these corporate functions to VMware personnel, in certain geographic regions where we do not have an established legal entity, we contract with EMC subsidiaries for support services and EMC employees who are managed by VMware personnel. The costs incurred by EMC on VMware’s behalf related to these employees include a mark-up intended to approximate costs that would have been charged had we contracted for such services with an unrelated third party. These costs have been charged by EMC and are included as expenses in our consolidated statements of income. Our historical financial information is not necessarily indicative of what our financial position, results of operations or cash flows will be in the future if and when we contract at arm’s length with independent third parties for the services we have received and currently receive from EMC. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical consolidated financial statements and notes thereto.
Risks Related to Owning Our Class A Common Stock
The price of our Class A common stock has fluctuated substantially in recent years and may fluctuate substantially in the future.
The trading price of our Class A common stock has fluctuated significantly since our IPO in August 2007. For example, between January 1, 2011 and June 30, 2012, the closing trading price of our Class A common stock was very volatile, ranging between $74.81 and $114.62 per share. Our trading price could fluctuate substantially in the future due to the factors discussed in this Risk Factors section and elsewhere in this Annual Report on Form 10-K.
Substantial amounts of Class A common stock are held by our employees, EMC and Cisco, and all of the shares of our Class B common stock, which may be converted to Class A common stock upon request of the holder, are held by EMC. Shares of Class A common stock held by EMC (including shares of Class A common stock that might be issued upon the conversion of Class B common stock) are eligible for sale subject to the volume, manner of sale and other restrictions of Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”), which allows the holder to sell up to the greater of 1% of our outstanding Class A common stock or our four-week average weekly trading volume during any three-month period and following the expiration of their contractual restrictions. Additionally, EMC possesses registration rights with respect to the shares of our common stock that it holds. If EMC chooses to exercise such rights, its sale of the shares that are registered would not be subject to the Rule 144 limitations. If a significant amount of the shares that become eligible for resale enter the public trading markets in a short period of time, the market price of our Class A common stock may decline.

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Additionally, broad market and industry factors may decrease the market price of our Class A common stock, regardless of our actual operating performance. The stock market in general and technology companies in particular, also have often experienced extreme price and volume fluctuations. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted, including against us, and, if not resolved swiftly, can result in substantial costs and a diversion of management’s attention and resources.
If securities or industry analysts change their recommendations regarding our stock adversely, our stock price and trading volume could decline.
The trading market for our Class A common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts who may cover us change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, our stock price would likely decline.
Delaware law and our certificate of incorporation and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
Provisions in our certificate of incorporation and bylaws will have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:
the division of our board of directors into three classes, with each class serving for a staggered three-year term, which would prevent stockholders from electing an entirely new board of directors at any annual meeting;
the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;
following a 355 distribution of Class B common stock by EMC to its stockholders, the restriction that a beneficial owner of 10% or more of our Class B common stock may not vote in any election of directors unless such person or group also owns at least an equivalent percentage of Class A common stock or obtains approval of our board of directors prior to acquiring beneficial ownership of at least 5% of Class B common stock;
the prohibition of cumulative voting in the election of directors or any other matters, which would otherwise allow less than a majority of stockholders to elect director candidates;
the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;
the ability of the board of directors to issue, without stockholder approval, up to 100,000,000 shares of preferred stock with terms set by the board of directors, which rights could be senior to those of common stock; and
in the event that EMC or its successor-in-interest no longer owns shares of our common stock representing at least a majority of the votes entitled to be cast in the election of directors, stockholders may not act by written consent and may not call special meetings of the stockholders.
Until such time as EMC or its successor-in-interest ceases to beneficially own 20% or more of the outstanding shares of our common stock, the affirmative vote or written consent of the holders of a majority of the outstanding shares of the Class B common stock will be required to:
amend certain provisions of our bylaws or certificate of incorporation;
make certain acquisitions or dispositions;
declare dividends, or undertake a recapitalization or liquidation;
adopt any stockholder rights plan, “poison pill” or other similar arrangement;
approve any transactions that would involve a merger, consolidation, restructuring, sale of substantially all of our assets or any of our subsidiaries or otherwise result in any person or entity obtaining control of us or any of our subsidiaries; or
undertake certain other actions.
In addition, we have elected to apply the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our certificate of incorporation and bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock.

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ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Sales of Unregistered Securities
None.
(b) Use of Proceeds from Public Offering of Common Stock
None.
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Purchases of equity securities during the three months ended June 30, 2012:
 
Total Number of Shares Purchased (1)(2)
 
Average Price Paid Per Share (1)(2)
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
(2)(5)
 
Approximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or Programs
(3)(4)(5)
April 1 – April 30, 2012
122,471

 
$
108.05

 
121,200

 
$
672,281,691

May 1 – May 31, 2012
973,900

 
100.53

 
709,400

 
599,341,009

June 1 – June 30, 2012
1,349,473

 
90.47

 
1,015,945

 
507,215,985

 
2,445,844

 
95.36

 
1,846,545

 
 
____________________________
(1)
Includes 1,271 shares repurchased and retired to satisfy tax withholding obligations that arose on the vesting of shares of restricted stock.
(2)
Includes 598,028 shares repurchased by EMC in open market transactions. In the three months ended March 31, 2010, EMC announced a stock purchase program of VMware’s Class A common stock to maintain its approximate level of ownership in VMware over the long term. Inclusion of EMC’s purchases in the above table does not indicate that EMC is deemed to be an “affiliated purchaser” with respect to the VMware stock repurchase program discussed in the following footnote. Shares purchased by EMC remain issued and outstanding.
(3)
In February 2011, a committee of VMware’s Board of Directors authorized the repurchase of up to $550.0 million of VMware’s Class A common stock through the end of 2012. In February 2012, VMware’s Board of Directors authorized the repurchase of up to an additional $600.0 million of VMware’s Class A common stock through the end of 2013. Purchases under the February 2011 repurchase authorization were completed in the second quarter of 2012. Stock has, and may in the future be, purchased pursuant to our stock repurchase authorizations, from time to time, in the open market or through private transactions, subject to market conditions. We are not obligated to purchase any shares under our stock repurchase program. Subject to applicable laws, repurchases under our stock repurchase program may be made at such times and in such amounts as we deem appropriate. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including VMware’s stock price, cash requirements for operations and business combinations, corporate and regulatory requirements and other market and economic conditions. Purchases under our stock repurchase program can be discontinued at any time that we feel additional purchases are not warranted.
(4)
Represents the amounts remaining in the VMware stock repurchase authorizations.
(5)
Amounts do not include potential purchases by EMC.
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.
MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5.
OTHER INFORMATION
None.

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ITEM 6.
EXHIBITS 
 
  
 
  
Incorporated by Reference
Exhibit
Number
  
Exhibit Description
  
Filed
Herewith
  
Form/
File No.
  
Date
 
 
 
 
 
3.1
  
Amended and Restated Certificate of Incorporation
  
 
  
S-1/A-2
  
7/9/2007
 
 
 
 
 
3.2
  
Amended and Restated Bylaws
  
 
  
8-K
  
3/8/2011
 
 
 
 
 
10.27+
  
Form of Restricted Stock Unit Agreement with certain termination provisions, approved April 9, 2012.
  
X
  
 
  
 
 
 
 
 
 
31.1
  
Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
31.2
  
Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
32.1
  
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
32.2
  
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
101.INS
  
XBRL Instance Document
  
X
  
 
  
 
 
 
 
 
 
101.SCH
  
XBRL Taxonomy Extension Schema
  
X
  
 
  
 
 
 
 
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.DEF
  
XBRL Taxonomy Extension Definition Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase
  
X
  
 
  
 
+ Management contract or compensatory plan or arrangement

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
VMWARE, INC.
 
 
 
 
Dated:
August 2, 2012
By:
 
/S/    ROBYNNE D. SISCO
 
 
 
 
Robynne D. Sisco
 
 
 
 
Chief Accounting Officer and Corporate Controller
(Principal Accounting Officer and Controller)


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EXHIBIT INDEX
 
 
  
 
  
Incorporated by Reference
Exhibit
Number
  
Exhibit Description
  
Filed
Herewith
  
Form/
File No.
  
Date
 
 
 
 
 
3.1
  
Amended and Restated Certificate of Incorporation
  
 
  
S-1/A-2
  
7/9/2007
 
 
 
 
 
3.2
  
Amended and Restated Bylaws
  
 
  
8-K
  
3/8/2011
 
 
 
 
 
10.27+
  
Form of Restricted Stock Unit Agreement with certain termination provisions, approved April 9, 2012.
  
X
 
 
 
 
 
 
 
 
 
 
 
 
 
31.1
  
Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
31.2
  
Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
32.1
  
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
32.2
  
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  
X
  
 
  
 
 
 
 
 
 
101.INS
  
XBRL Instance Document
  
X
  
 
  
 
 
 
 
 
 
101.SCH
  
XBRL Taxonomy Extension Schema
  
X
  
 
  
 
 
 
 
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.DEF
  
XBRL Taxonomy Extension Definition Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase
  
X
  
 
  
 
 
 
 
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase
  
X
  
 
  
 
+ Management contract or compensatory plan or arrangement


63