VMware 2013 Annual Report Download - page 56

Table of Contents
permanently reinvested outside the U.S. While we do not anticipate changing our intention regarding permanently reinvested earnings, if certain foreign
earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these
earnings.
The value of our deferred tax assets reflect our estimates of the amount and category of future taxable income, such as income from operations, capital
gains income and also consider other key factors that might restrict our ability to realize the deferred tax assets. Actual operating results and the underlying
amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate.
We calculate our current and deferred tax provision based on estimates and assumptions that could differ significantly from the actual results reflected in
income tax returns filed during the subsequent year. Adjustments based on filed returns are generally recorded in the period when the tax returns are filed.
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 52.3% , 51.6% and 51.6% in 2013 , 2012 and 2011 , respectively. We invoice and
collect in the Euro, the British Pound, the Japanese Yen, the Australian Dollar and the Chinese Renminbi 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. We calculate the foreign currency impact on our revenues and operating
expenses as the difference between amounts translated at current exchange rates and the same amounts 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 typically enter into cash flow hedges semi-
annually with maturities of six months or less. As of December 31, 2013 and 2012 , we had foreign currency forward contracts to purchase approximately
$82 million and $9 million , respectively, in foreign currency. The fair value of these forward contracts was immaterial as of December 31, 2013 and
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 traded on a monthly basis with a typical
contractual term of one month. As of December 31, 2013 and 2012 , we had outstanding forward contracts with a total notional value of $498 million and
$440 million , respectively. The fair value of these forward contracts was immaterial as of December 31, 2013 and 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 of $53 million in fair value of
our foreign currency forward contracts used in both the cash flow hedging and balance sheet hedging activities as of December 31, 2013 . 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 G to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K 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
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ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK