EMC Corporation Q2 2006 Earnings Conference Call Transcript (EMC)

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EMC Corporation (EMC)

Q2 2006 Earnings Conference Call

July 14, 2006 8:30 am ET


Joe Tucci - Chairman, President, CEO

Bill Teuber - Vice Chairman, CFO

Tony Takazawa - Vice President of Global Investor Relations


Laura Conigliaro - Goldman Sachs

Dan Renouard - Robert Baird

Rebecca Runkle - Morgan Stanley

Harry Blount - Lehman Brothers

Paul Mansky – Citigroup

Glenn Hanus – Needham

Aaron Rakers - A.G. Edwards

Keith Bachman - Banc of America


Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions) I would now like to turn the meeting over to Mr. Tony Takazawa, Vice President of Global Investor Relations. Sir, you may begin.

Tony Takazawa

Thank you, Laurie. Good morning. Welcome to EMC's call to discuss our 2Q 2006 financial results. We are going to shake up the batting order a bit today and kick things off with Joe Tucci, EMC's Chairman, President, and CEO. Joe will spend some time walking you through what happened in the quarter. He will also talk about what he sees in terms of customer budgets, the competitive environment, and the outlook for the rest of the year. We will then be joined by Bill Teuber, Vice Chairman and CFO. Bill will lead you through some of the details of our results.

After their prepared remarks, we will then open up the lines to take your questions. We will be making references to our slides today, so we encourage you to view them on EMC's website at EMC.com. An archive of the audio and slide presentation will also be available following the call.

Finally, I do want to note that the call this morning will contain forward-looking statements and information concerning factors that could cause actual results to differ from those forward-looking statements can be found in EMC's filings with the U.S. Securities and Exchange Commission. With that, it is now my pleasure to introduce Joe Tucci.

Joe Tucci

Thank you, Tony and thank you all for joining us today. Let me start out by stating that while we had some real bright spots in Q2, I am deeply disappointed with our performance this past quarter. Our overall execution was clearly not up to EMC's standards. The senior executive team -- especially me -- takes full responsibility; and I give you my personal commitment that we can and will do better.

I would now like to take you on a fairly deep analysis of our business. Let's start with a bit of good news. We firmly believe that our ILM and information infrastructure strategies are being very well received by our customers and the IT market in general. We see a healthy demand for our hardware and software products that underpins our strategy, as well as for our service offerings that help customers maximize value from our solutions.

For sure, the leading economic indicator for the health of almost any business is new bookings growth and the underlying margin trends. Both these trends were solid for EMC in Q2. Bookings grew 14% year-over-year and margins on that book of business were healthy.

To give you yet another layer of visibility, within our overall bookings growth of 14%, our storage products bookings grew 11% and gross margins on these bookings were also healthy. Our storage products are primarily comprised of our Symmetrix, CLARiiON, Centera, Celerra, Invista, and Rainfinity hardware and software products, our Connectrix switches and directors, our backup recovery, Power Path and resource management software.

Our service bookings grew 12% year-on-year. This represents an impressive rebound from Q1. This was the result of the action plans we put in place to assure our focus on profitably growing our services business.

Now, I will bring down our Q2 analysis even another layer and share our storage booking trends with you. As we have already stated, the quarter was very back-end loaded. In fact, as we entered the last week of the quarter, we needed about $500 million of bookings to meet our plan. I am proud to say our sales organizations really stepped up and actually booked almost 10% more than that in the final week, a terrific performance. To repeat myself, the margins on these late bookings were solid.

By the way, I want to point out that we did have numerous incentives in place for our sales force to bring in orders earlier. Yet as I said, approximately $550 million of orders came in during the last week of June. By the way, we were confident of our ability to achieve this end of quarter goal, as we had ample bid coverage and firm field commitments to make our plan.

To answer a question that I know is on a lot of your minds, namely, when we announced our intention to acquire RSA on Thursday afternoon, June 29, did we expect to achieve our revenue and GAAP EPS guidance for the quarter? The answer is yes. Again, the quality of customer names along with strong field commitments gave us confidence.

So what happened? The primary answer lies in the wrong mix and factory inventories, specifically with Symmetrix DMX. Now let me state that I absolutely believe this issue was a self-induced execution failure on our part. There is no excuse.

As we were progressing through the quarter, bookings on both DMX 2 and DMX 3 were tracking well relative to their respective plans. During the final week of the quarter, DMX 3 orders literally exploded, while DMX 2 stalled. A significant piece of this phenomenon happened in the last two days of the quarter. These bookings came from a deal pipeline that was larger in size than what we booked and included both potential DMX 2 and DMX 3 deals.

What surprised us was that a very high percentage of deals that ultimately came in were for DMX 3, causing a severe shortage. While we did have contingency capacity to ship more than 100% of our DMX 3 plan, we did not have sufficient systems built to meet all of the demand. So in essence, we had too many DMX 2s in inventory and too few DMX 3s.

Remember, in most cases, these DMX 3 orders had other EMC hardware and software products on the same PO or purchase order; products like Centera, products like CLARiiON, products like Connectrix switches, which in many cases -- indeed, most cases -- we could not ship because of customer contractual requirements to only ship complete orders. Due to lateness of the quarter, we did not have the ability to go back to customers and secure their permission or consent to ship these partial orders.

So what did we learn from this experience? Well, we learned a lot. Number one is we need to make new product transitions faster, even major product transitions. We need to trust our ability to quickly prove to customers that we have done very extensive compatibility and regression testing, and trust our sales organizations to get the transition job done faster.

Secondly, we know we played it too tight with our supply chain. We need to make sure we have ample new product parts and components to build out extra systems.

Third, we kept DMX 2 in production too long. Obviously, making a single product line, or a single DMX product line in this case, is more efficient and far easier.

The good news is we are now through this transition. All new SIM builds will be DMX 3. The best news is that customers love the performance, the scalability, the functionality, and the availability of the DMX 3. DMX 3 clearly is the benchmark by which all other storage systems are judged.

Speaking of transitions, I would like to take you through another transition, which was our CLARiiON CX to CX 3 transition. First, let me state that mid-tier storage transitions are always faster than high-end transitions.

Second, let me remind you that in general, there are two types of new product introductions which we categorize in two distinct buckets. The first category I would categorize as a major transition. This is when a new product has substantially changed its underlying base technology. This isn't just gimmicky marketing names; this is really new underlying technology.

The second type of new product introduction is substantially what we call a mid-life kicker. This is where you put in faster chips; you put in faster connectivity; more memory; more cache; more drives; more features and an OS. Symmetrix 5 to DMX 1, and DMX 2 to DMX 3 were examples of major transitions. DMX 1 to DMX 2 was an example of a mid-life kicker.

Customers are very sophisticated these days, and they always know -- in fact, we tell them -- which is which. When we introduce a major new product like DMX 3 or CX 3, enterprise customers will always insist on more testing within their own specific environment before ordering the product and buying for production. Thus a longer transition period takes place.

So back to our CX to CX 3 transition. The CX 3 is truly all-new. It is the only -- and it's still the only -- full 4-gigabyte storage system shipping in the market today. It is absolutely a major transition type. The new CX 3 family was announced on May 8th, so obviously we sold zero units before then, as you can see in the chart that is before you on the webcast.

So orders began hitting our factories in week 7, which is the following week to introduction. By the end of the quarter, as you can see, the CX 3 had really started to gain customer acceptance. In fact, in this last week over 70% of the new CLARiiON system orders were for CX 3. Thus the two points I talked about played out. Since the CX 3 was a major product introduction, customers needed time to get comfortable with its compatibility and its reliability.

Second , mid-tier storage transactions do happen faster than high-end ones. But we did need more time to ramp up our sales and bookings than just the seven weeks we allowed ourselves in Q2. Thus CLARiiON revenues year-on-year grew only 4%. Bookings, however, did grow in the double-digits.

The great news is that customers' interest and reception of the new CX 3 is excellent. The CX 3 absolutely offers the highest performance, the highest quality, the best availability, the best cost performance of any -- and I mean any – mid-tier storage system, period.

Even better news is that the transition to the CX 3 is now substantially complete. I would now like to make a few comments on trends that we're seeing in the IT marketplace and on competition. We are seeing the exact same competitors in the market we have seen for years. For sure, several of these competitors have refreshed their product lines. Also for sure, customers are forcing a more formal bidding process, which is one factor affecting the timing of orders.

The good news is that customers' demand for storage and information infrastructure products and services is still strong. The better news is that with our new DMX 3 and CX 3 family of products, we are well positioned and our win rates are strong.

I mentioned earlier that EMC had a significant number of real bright spots in Q2, and I would like to take you through several of them right now. Let's start with VMware. VMware had revenues up 73%, to $157 million. The third generation of ESX is a huge hit with customers. Customers understand that Virtual Infrastructure 3 benefits go way beyond the Hypervisor, and the reception and the proliferation of this technology is nothing short of fantastic.

Content management, another huge success, up 79% year-on-year. Now to be fair, we did acquire Captiva some months ago, which was not in the previous year's count. But even if you took Captiva out, the license revenue growth in content management was up over 30%. Again, a very important market where we are doing exceedingly well.

SMARTS. The market is really understanding what model-based resource management can do. Revenues in SMARTS nearly doubled year-on-year. We also had strength in our Centera and Celerra NAS products. Centera is object storage, as you know, fixed content; and Celerra is NAS. Both grew over 20%. SIM revenues were flat because of the backlog issues I talked to you about. Bookings were up over 9%.

We also had nice rebounds in our services business. As you recall, last quarter services business was only up 6%. It rebounded to 9% on a bookings rebound of over 12%.

Our back-up and recovery business had a nice rebound. Revenues were up year on year over 13%. In mid-June I spent eight days in APJ. I traveled to India, China, and Japan. I can tell you we have new leadership in place and we are regaining momentum.

CLARiiON, I went through that in pretty good detail. The ramp and the customer acceptance on CX 3 is great, and I know this is going to be a big winner going forward.

So, let's turn to guidance. Based on the lateness of customer orders, order flow over the last several quarters and the attendant necessity for EMC to run with larger backlogs, I believe it is prudent for us to reduce our targets for the year. As part of this action, I assure you we will focus on cost control and integration synergies.

Our guidance for Q3 is for revenue to be at or exceed $2.66 billion and for GAAP EPS to be at $0.12. For the year 2006, we believe revenues should exceed $10.8 billion -- that would be up 12% -- and GAAP EPS should be approximately $0.51.

Before I go to my closing remarks, I would like to review our major acquisition track record with you. Those of you that are on the website can see this on your screens.

VMware. We acquired VMware in January of '04. The annual revenues, as we acquired it, were $75 million. If I take the Q2 accomplishment of $157.5 million and multiplied it by four, this would be an annualized run rate of $630 million. Of course this is still on a trajectory, but if we do this -- that revenue exactly for 2006 -- that would represent a compounded annual growth rate, since we acquired VMware, of 103%. Pretty fantastic.

Documentum. We acquired Documentum in December of '03, very late December of '03. Its pre-acquisition annual revenues was $289 million. You'll see the exact same number there, ironically, as VMware; that also did $157.5 million and that also is a $630 million annualized run rate business.

To be fair, again, we acquired Captiva several months ago for $74 million. Let's back that out of the $630 million. So $289 million to that $556 million or so number would be about a 24% compounded annual growth rate. Again, fantastic growing multiples. Growing more than twice as fast as what this industry is growing.

SMARTS. We acquired SMARTS in February of 2005. It had annualized revenues at that time of $67 million. If you take SMARTS' Q2 times four, that is $128 million. Again, this is on a trajectory, and we would expect this number also to be bigger than $128 million on an annual basis. But just taking $128 million, that would be a CAGR of 38%.

All of these companies were what I would call best-of-breed in their industry and had fantastic leadership, which is one of the reasons why we have been so successful as they continue to help us drive this inside of EMC.

Turning to Legato, we acquired Legato -- again mostly back-up recovery and archive software -- in December of '03. It had annualized revenues of $316 million. If I look at Q2 times four, that would be $433 million for a CAGR of 11%. While not as fast as the other three companies, I would remind you that if you look at this industry and the growth rates in back-up recovery, which are low single digits, we are also growing several times as fast as this market.

So how is this being done? How are we accomplishing this, what I think is a pretty phenomenal success with our acquisitions? The answer is two things: leadership and leverage. By buying, in most cases, best-of-breed companies and making sure that the leadership that was driving that company becomes a real part of the senior leadership of EMC has worked incredibly well.

And by leverage. Leveraging our large EMC sales organization, and the phenomenal reach we have to help shorten sales cycles for these new members of our family. By leveraging our reputation for high-quality products and global support. By leveraging the trust factor we have built up with customers. EMC is a company customers trust in their data centers with their most mission-critical tasks. By leveraging our G&A and back office functions to reduce costs.

But most importantly, customers understand how collectively EMC's information infrastructure and portfolio of products, services and solutions is growing in both relevance and importance to them.

Let's turn to RSA for a second. RSA is another best-of-breed company. RSA Security will operate under the RSA Security brand as EMC's information security division. It will be led by RSA's CEO, Art Coviello. RSA will retain its own specialized sales, marketing and development functions and obviously will leverage all those things from EMC that I talked about. It is our goal with RSA to serve both companies' customers two ways: creating synergies across all of EMC's products and businesses as we laid out for you, while continuing to develop an independent security franchise.

So in closing, I believe, EMC is one of the best technology businesses out there. We are focused on both short-term performance as well as long-term opportunity and success. While we did have some missteps, we're stepping up in ownership; we are offering no excuses. Again, I commit we can and will do better.

With that, let me turn it over to Bill Teuber to drill down a little bit further into the financial aspects of the quarter.

Bill Teuber

Thanks, Joe. First let me say this is the earliest analyst call we have ever had here at EMC. While Joe has highlighted a number of areas of interest this quarter, I'm going to take you through our overall business results from top to bottom.

Results were $2.575 billion, up 10%. EPS on a GAAP basis was $0.12. Non-GAAP EPS was $0.15, which excludes stock option expense, restricted stock expense, intangible amortization, as well as a $0.01 benefit from taxes partially offset by an in-process R&D charge.

This quarter, our systems revenues were up 8%. Software revenues were up 14%. Service revenues were up 9%, a nice bounce-back from last quarter. In fact, that growth was pretty balanced across the revenue lines as a positive result. In addition, Joe mentioned these results are not truly indicative of the actual demand, as orders were much stronger than reported revenues.

Turning to our geographic results, obviously the issues around product availability and the timing of customer orders were factors in the global results. North American revenues were up 10% year-over-year. Demand here continues to be good, especially in the high-end systems. This market was 59% of our total revenues.

EMEA revenues were up 12%. We saw good results in Eastern Europe and in a number of the more established markets in the region. APJ revenues were up 2% from last year. We said last quarter that this would not be a one-quarter fix. We made progress in the quarter, and we hope to see better financial results in the second half of the year.

Finally, Latin American revenues were up 21%. We continue to see good opportunity in this area of the world, and Mexico was the best performer in the region.

Now, let's move from this geographic discussion to one that is more business line focused. We continue to provide you with the traditional supplemental revenue line, and I will talk about many of these today. However, as I have mentioned several times in the past, we will be moving away from this format towards a more business segment view of our results, while continuing to provide color around the more discrete product lines. This type of analysis makes the most sense, since it reflects the way we go to market and the way our customers acquire our solutions.

Let's take a look at some of the traditional storage-related businesses. Symmetrix was essentially flat for the quarter, and CLARiiON was up 4%. Bill covered a lot of what transpired here during the quarter, so I won't belabor the point.

In our traditional platform software, license and maintenance revenues were down 2%. Looking at some of the other software highlights, our content management business had an outstanding quarter. Software licenses were up 79%, and the overall business was up 56%. Excluding Captiva, license revenues were up more than 30%.

As Joe mentioned, we had very nice rebound in our backup and archive software licenses which were up 13%, and SMARTS nearly doubled. VMware continues to shine; both license revenue and overall growth were up in excess of 70%. Dell was 14% of our total revenues again this quarter.

Turning now to the rest of the income statement, all of my comments will be centered around our results on a non-GAAP basis, which includes the impact of the equity compensation expense, intangible amortization, and restructuring and other special charges.

Our gross margin for the quarter was 54.2%, up 30 basis points from Q1 of '06. Mix was the driver here. Total operating costs for Q2 were up 13.7% or $119 million from last year. The high levels of investment here are due to our anticipation of hitting higher revenue targets and the fact that Q2 and Q4 are quarters where we traditionally make larger investments.

The increase in operating expense is focused on growing our revenue opportunities. Let me take a minute and break out where the investment is going. We're investing heavily in VMware. In fact, we are actually growing expenses here faster than revenues to ensure we capture the full market opportunity of this game-changing technology. As you can see from the chart, the investment in VMware represents the largest component of the increase in operating expenses this quarter.

Our content management business, excluding acquisitions from the past year, was about 10% of the total operating expense increase and up 16% from last year. Considering that our license revenue, excluding Captiva, grew 30%, you can see we are gaining significant leverage from our investment here. This is close to the model which we target.

Operating expenses for the traditional EMC storage-related business were a little less than one-third of the total operating expense increase, and up 5% from Q2 of last year. Had revenues grown as fast as our storage bookings, leverage here would have been in the right range.

Finally, approximately 25% of the total operating expense increase was related to acquisitions which we have done in the last year and are in the early stages of integration. Thus, we have not optimize the revenue expense ratio yet.

So you can see that the increase in expenses came from important areas of growth for the Company. As we move forward, we're focused on gaining additional synergies from each of these areas, especially as we leverage the entire EMC footprint.

From a corporate perspective, we will continue to focus on gaining efficiencies. We intend to go to the next level of integration with our G&A processes and create additional leverage between the sales forces we have in place.

Turning now to taxes, we benefited from a lower tax rate due to the closure of a few audits this quarter. This benefited us by $0.01 in the quarter. The tax rate we expect for the rest of the year is approximately 26% on a GAAP basis.

CapEx for the quarter was $156 million, and depreciation and amortization was $183 million in the quarter.

Turning to the balance sheet, cash and investments came in at $6.3 billion, down from the $7.4 billion in Q1. During the quarter, we accelerated our buyback, using $1 billion for 78 million shares; redeemed $125 million of outstanding convertible debt; and spent $283 million on acquisitions and investments.

DSOs came in at 45 days, right in the middle of our targeted range. Inventory was $764 million, up almost $ 70 million from Q1. We believe we have ample demand for the DMX 2s that remain in inventory at the end of the quarter. We have an installed base of well over 12,000 DMX 1s and DMX 2s, and we have many customers who want to expand their storage environment with these systems.

Deferred revenue continued to increase this quarter, up about $29 million from Q1. I want to spend a few minutes on our use of cash. There's been a lot of discussion around the various potential uses of cash, so I want to discuss how we look at it. We have historically done three things with our cash: invest it; repurchase our shares; and make acquisitions that add shareholder value over time. For our invested cash in Q2 our rate of return was slightly north of 4.25%. As you can see, we get a modest benefit from interest income; but this is obviously not a long-term, strategic benefit for the Company.

Four our buyback program, as I previously mentioned, we bought 78 million shares, spending $1 billion in Q2. It's important to remember that you forego the benefit of investment income when you engage in this activity.

Lastly, on the acquisition and investment front, we spent $283 million this quarter. Spending in this area expands our market opportunity and strengthens our competitive advantage.

Turning now to guidance, our outlook for Q3 and the rest of the year currently excludes the impact of the RSA acquisition. As Joe said, our guidance for Q3 is for revenues to be at or above $2.66 billion and GAAP EPS to be $0.12. Excluding stock option expense of $0.02 and combined amortization, intangible amortization and restricted stock expense of $0.02, we expect non-GAAP EPS to be $0.16.

For the year, we believe revenue should exceed $10.8 billion and GAAP EPS should be approximately $0.51. Excluding stock option expense of $0.09 and combined intangible amortization and restricted stock expense of $0.08, we expect non-GAAP EPS to be approximately $0.68. The amortization, which was previously rounded down to $0.07, now rounds to $0.08 for the year due to our recent acquisitions and a few fewer shares in the base.

With that, I will now turn the call over to Tony.

Tony Takazawa

Thanks, Bill. Before we open up the lines for your questions, as usual we ask you to try and limit yourself to one question, including clarifications. This will enable us to take as many questions as possible in the time we have allotted. We thank you all for your cooperation in this matter. Laurie, can we open up the lines for questions, please?

Question-and-Answer Session


(Operator Instructions) Our first question comes from Laura Conigliaro - Goldman Sachs.

Laura Conigliaro - Goldman Sachs

Thank you. I understand that you are in a mode where you are really trying to build more backlog; and therefore you appear to be holding back more on revenue expense, go-forward actual results. But you really did have a substantial additional backlog. Maybe you can go into a little more detail about why? What is it in the environment or anything else that is causing you to hold back on what you're characterizing as go-forward targets?

As part of that, maybe you can give some more detail on the kind of backlog build targets that you have for the end of this year, and how we will be able to metric that as the year goes on? Will you be giving us more information on this?

Joe Tucci

What is causing customers to order so late, I can't put my finger on it 100%. Obviously, I have said that I do believe that the environment is more competitive. I do believe there are more bid processes. I do believe there are more kinds of checks in the system. You have chief security officers getting involved now in decisions in storage, which we had not seen before, for instance. Purchasing departments are continuing to flex their muscles. And again, more formal processes. So the demand is still good. It is just taking longer to get through a pipeline.

Obviously, we have been complicating the issues with going through this transition cycle. As you got from our remarks, we did not execute the DMX 2 to 3 transition even close to adequate; and that is our fault. I think the CX 3 transition is going great. Just timing. So it's a little bit of all of that.

I do see, as I said, sufficient budgets. I mean, your own survey, Laura, as well as others I have read, storage is still right up there. As a matter-of-fact, storage and security still dominates the list; and other things we do, like VMware and content management, are hot. So I think our portfolio of products is good. Our sales force is phenomenal.

I would use a baseball analogy here. I just find three quarters in a row now we are doing a tremendous number of diving catches in the outfield here. Twice, even though we caught the ball, you haven't got enough time to throw it to get the runner out. So I just think it's more prudent to say, okay, we just have to go with bigger backlogs and a little more conservatism.

To the same point, I have indicated that Bill and I are going to go after more of the synergies around the acquisitions we have done; not in terms of the go-to-market or development, but in terms of everything else we do; and really work the cost the side hard; and just run the business a little more conservatively. And hopefully -- Laura, to your favorite word -- be able to be in a better position to gain our footing and to create some upside.

So it is prudent, and I think over time we will try to give you -- Bill and I have to talk about it -- but we will try to give you better metrics on what is happening with this backlog. But we're talking of backlogs here that are more than double, closing in on triple what we would have run, say, a year or two years ago. So they are growing substantially.

We need it because you never know what customers are going to order. We are chasing thousands of orders at the end of a quarter, and hundreds of those orders come in. If the mix is wrong -- we don't want to be sloppy and just carry huge inventories. One of the reasons EMC did great transitions in the past was we carried bigger inventories, and we had turns of four; and we certainly don't want to go back there. We need to make sure that we run efficiently.

So we just think this is more prudent. As we regain our footing I absolutely believe the market will like the answer. Bill, you want to add anything?

Bill Teuber

We certainly have talked about it the last few quarters, and we will give you the information you need to assess what is happening, both at the revenue line and at this line. That would be the only fair thing to do.


Our next question comes from Dan Renouard - Robert Baird.

Dan Renouard - Robert Baird

My question is on the expense line. As you stumbled little bit, growth rates have come in meaningfully over the last year or two, so now you are growing slower than you thought. Obviously, you hope to better. Some of the faster-growing areas seem to be expensive to grow. Maybe you could just give us some comfort and a little more detail into how you plan to manage your expenses, maybe as a percent of revenue, down over the next several quarters. Thanks.

Joe Tucci

Again, I will let Bill comment specifically. But I think the chart that Bill did, that pie chart, on how we are thinking: we're hyper investing in VMware because of that phenomenal, phenomenal potential.

I think what we're doing, led by Dave DeWalt, in the content management area is perfect. We are growing revenues there; expenses there half the rate of revenues, if we hit the revenue targets we wanted in our core business; I think we're doing a good job there.

Of course, in the last few months here, we have acquired five companies. So there is obviously a lot we need to do and really step up on just the basket of acquisitions we have had. We need to really step up there.

We have showed you, I think without a shadow of a doubt, that if you look at what we did in 2002 -- which you gave us like AAs for, and A+s for in the scorecard -- we know how to go after costs. I am telling you that is part of this get a little more conservative, get our feet underneath us plan.

Bill Teuber

It's Bill. As Joe said, there's a variety of things. But on some of the specifics, we put in some new systems this year. We have some new systems coming online at the second half of the year, which everyone within the EMC family is going to be able to leverage. Previously, some of the acquisitions were using their own systems, obviously creating some redundancy. So that is an example. You see evidence of that just in the CapEx line, some of the systems we have invested in over a period of time, to be able to get that.

That also drives leverage at the tax line, because some of the ways we are organized internationally reflect how we are able to report the numbers. So there is going to be potentially some benefit up and down the income statement. So both from an operational standpoint and from a structure standpoint, we want to see continued efficiencies.


Our next question comes from Rebecca Runkle - Morgan Stanley.

Rebecca Runkle - Morgan Stanley

Thanks a lot, good morning. Joe, in your commentary you don't really seem to highlight increased competition per se as being a factor. Just on that point, some would obviously look at the extended sales cycle, the more formal sales review process and interpret that as being increased competition.

So just to give us some confidence in the fact that you are not seeing increased competition, can you talk about how win rates have changed both on the Symmetrix platform and CLARiiON platform over the last 12 months, and then in this latest quarter?

Joe Tucci

Sure, Rebecca. I did acknowledge -- maybe I didn't do it well; I will do it again. What I tried to say was that I don't see new competitors. You see a lot of kind of flashy advertising for a lot of -- I'm talking primarily with our storage business now -- for new companies getting in the storage business. I think if you added them all up, it is two bits of nothing. That is definitely not a factor.

So the competitors that we see out there are the ones that have been out there for a long time. It is IBM, it is HP, it is NetApps, right? For sure, I said that these competitors have refreshed their product families, and to that extent as they refresh, they are get stronger.

I think what they have done in the enterprise, as we look at our end win rates in the enterprise, they just have not changed much. Now you can slash that any way you want, but that is the facts, and I am not making it up. We have got good win rates.

Of course with win rates, we look at bookings, right? So some of the bookings didn't turn; so obviously when the share count, when share goes on revenues, like in mid-tier and in high-end -- I don't know what will happen in high-end, but mid-tier for sure -- as sure as I'm sitting here we will lose some share this quarter because we didn't turn it. But the bookings are there, and that is just timing.

So in the enterprise we are holding our own. One of the factors I said that is forcing these competitive bids, there are new product lines and there are more emphasis on this. But as we get into the bids our win rates are excellent.

I think when you get into the lower end of the market, where I think some of our competitors are having great success, we really have a single product now on the low end of the market, which is the AX150. That is not sufficient.

So while the AX150 is doing fantastic to really get the potential of what this SMB market can do, and I do think that is the fastest-growing part of the market, we need a product family. That is coming. That is a lower-end product than the AX150 and that is a higher-end product to AX150.

You have seen so many announcements we have done with Intel, so many announcements we have done with NEC, that kind of hints at what we are doing on the lower end. I guarantee there is a bigger brother coming to the AX150 too. I think that is one of the things we need, and we're not executing there on all cylinders because of that.

So that is how I would break up competition. They are stronger, they are forcing more competitive bids, they're forcing a lateness. Our win rates are great. In the CX 3 and the DMX 3 we are holding our own. When you go into the SMB and lower end of the market, we're not sufficient from a product point of view.

Hang in here; six months or so and I think we're going to rock the world there too. It is our goal to be the leader in the low-end storage also, not only high-end and mid-tier.


Our next question comes from Harry Blount - Lehman Brothers.

Harry Blount - Lehman Brothers

I just want to circle back to probably a lot of what is on slide 4 in terms of the bookings strength that you guys indicated. I'm just trying to get a sense on how much of that bookings strength is really through the organic means, excluding the acquisition contribution over the last 12 months?

Also trying to get a sense of overall channel mix. In the past you guys have kind of said CLARiiON was a third, a third, a third. But trying to get a broader sense of what your direct to indirect business mix is.

Joe Tucci

Let me put it this way. The backlog is 100% -- basically this change in backlog is 99% -- it is the Ivory soap, 0.9944% EMC core storage that is causing that. It is not the acquisitions causing that effect, Harry.

You asked about CLARiiON. You know, it is still as Bill said: a third, a third, a third. I know Tony hates it when you do this, but give me a clarification question if you want; I am not sure what you're asking there.

Harry Blount - Lehman Brothers

Joe, basically what I am driving at is you guys have, over the past several years, really grown your indirect channel business through Dell, through some of the other channel partners -- Intel, etc. I'm just trying to get a sense of the growth rate, if you will, in the direct business versus the indirect business; or how that mix has changed, say, over the last 12 months.

Joe Tucci

We always break it up into three buckets: direct, indirect, and Dell, which is also a channel. As Bill told you it was about a third, a third, a third.

Bill Teuber

That is sort of in the past, but we are trying to grow Dell and the other indirect channel. That is beneficial to us. So whether it is going to be a third, a third, a third as we go out, the two channels are growing a little bit better than the direct because we're trying to feed the other channel.

Joe Tucci

That is because of that SMB effect that I talked to you about. As I told you, we have had and are having great success with the AX150. We understand when we go down there, this is a clear 100% indirect sell. So as that becomes a bigger part of our portfolio, that is our extent.

Of the three, Dell grew faster than the 4%. I think it bodes great, because as Dell goes into their last month of their quarter, as you saw by the chart that we showed you; for the first time we actually showed you the ramp. You can see the CX 3 is up the ramp as Dell goes into the third quarter. So I think that bodes well for Dell, too.

Harry Blount - Lehman Brothers

Joe, what I was trying to get at is one of the theories of making all the acquisitions and growing out your service business over the last several years is that you have got this awesome enterprise class sales force that does have a lot of trust in the enterprise, based on every survey. But it doesn't feel like that is necessarily translating.

That broader product set addressing the bigger customer wallet doesn't necessarily feel like it is translating or really getting the leverage and the synergies from being able to use that particular channel with a broader product offering. That is the piece I'm really trying to get at.

Joe Tucci

I would disagree, I think. I took you through the success of our acquisitions and the integration and why I think they're working as well as they are. Certainly that leverage is happening. Certainly, again, since I love baseball, if this was a baseball game, Harry, I would say we are still in maybe the bottom of the third.

There is a lot more we can do in terms of leverage both on the go to market side and on the cost side, and we're going to go after that with a vengeance right now.

Harry Blount - Lehman Brothers

Thank you.


Our next question comes from Paul Mansky - Citigroup.

Paul Mansky – Citigroup

Joe, I guess this is probably for you. On the product side, exactly a year ago on the call you mentioned that EMC had widened its offer pricing bands. About a quarter or so later you launched the new systems with the high-capacity drives. Since that time, we have seen platform software attach rates on SIM drop from about 33% to about 27% per my model.

As we anniversary that adjustment and head into the back half of this year, directionally how should we be thinking about the platform? Specifically, platform software attach rates?

Joe Tucci

Let me give you the real answer. The real answer is what we are going to try to focus on -- and obviously we give a lot of data – but what we really want to focus on is the storage business. Because what we're really bidding is we are bidding these things to get -- I mean, customers don't care. Part of it is software, part of it hardware. But a customer is buying this set. So they are buying a Symmetrix; and then they are going to buy PowerPath; and then they are going to buy SRDF; and then they are going to buy a Connectrix switch. Then they might buy something for backup; and they might buy like a Centera for fixed content. What they want is, what's the price for that stack? They say, go ahead, EMC; break it up some ways and we'll obviously have hardware/software.

So what we really need to focus on and what we're trying to do here, Paul, is say hey, how fast is this storage stack? I just defined the storage stack, rather than focus on the pieces. If I incent the sales forces, they will force more into software. If I say hey, hardware too. That is just not the way customers are buying. It's not the way the competitors are competing with us. It is a stack, and what we really need to do is you really need to focus much more on that complete solution for storage.

Again, you can look at where we're heading. We are heading to business units -- not heading, we are there. There is a business unit for content management and archive. There is going to be a business unit for VMware, obviously, which we run very independently. There is a business unit which will be our EMC Security, RSA. Then we're going to have our storage business.

We are going to focus you more and more on really good trends around those businesses, which is the way we go to market. Then of course, across that, in the back office we've got to get synergies. We can get synergies in services, and we can get synergies in go to market. That is the real way we need to think of this business, because this other stuff is -- it is all in the pie, right?


Our next question comes from Glenn Hanus - Needham.

Glenn Hanus – Needham

Back on Analysts Day, you talked about budgets being committed for '06, but people under-spending them. You were sort of wondering whether that meant there was going to be a pickup in the second half or that indicated a trend. Could you comment on the broad environment, perhaps by geography, and how you might update that comment?

Joe Tucci

Yes. Obviously, I wish I didn't make that comment. Because I think it got very misunderstood. Two things I was trying to get across is, a very positive thing I was trying to get across which was totally missed, which was when I talk to customers and ask them, what percentage of budget increases, it is healthy. So the CIOs have budgets out there.

Clearly, what I did not get across is they spend more in the second half every year than they do in the first half. You know, if you look at most companies in this industry, there is a big spike in Q4 with a bit of a budget flush.

I think everything is teed up again, that you're going to see the exact same thing this year. There will be. So if you look at, you run three quarters. You have Q4; you go down a little bit in Q1; you kind of come back to that level of Q4 for Q2 and Q3; and then you spike in Q4. I think it is going to be the same, and that is all I was trying to indicate. I think the budgets were good since they are not spending half of their budget in the first half of the year for sure, and they never do. They never do. I do believe in everything I see that you will see a better second half than a first half.

Glenn Hanus – Needham

So there is nothing that has really changed in the environment?

Joe Tucci

No, I think what has changed is there is something that definitely -- by the way, when I talk to my peers out there, I know in the one-on-ones and behind closed doors in meetings that we happen to be in together, there is a lot of talk about they're seeing also elongated cycles and more back end.

So there is something causing that, but I think a lot of that is just more process now. Companies are following more and more bid process as part of their Sarbanes-Oxley. Their chief security officers are getting involved in what we do, and they never did before, as security is very important in the IT environment. Purchasing departments are continuing to get more involved; and all of this forms more of a process.

We still have a big dependence here on enterprise accounts. I do see a little bit of movement to the right. There's more reviews, and I think that is part of the processes under Sarbanes-Oxley that companies have that we do it here internally. There is more checks to make sure that processes are being followed, and I think that is just causing a little bit of back end, and that causes a different flow to your business.

If you figure, if we were going to do $2.66 billion plus in revenue, forgetting even about backlog; and I just told you we did $550 million in the last week, that is 20% the last week; and a big piece of that was the last two or three days. So that is no way to run a business. So that is why I'm saying we have got to be more prudent here. We've got to carry bigger backlogs if we're going to pull off this kind of trending. That is what I see, so that is where we have to go.


Our next question comes from Aaron Rakers - A.G. Edwards.

Aaron Rakers - A.G. Edwards

One clarification. I apologize if I missed it, but you have mentioned order growth in the Symmetrix business being about 9% year-over-year. Can you provide the order growth in the CLARiiON business, what that looked like?

Also, how should we think about the gross margin structure looking into the back half of the year, as you now have noted that you fully transitioned to the new products? Is it fair to assume that as you rationalize your inventory levels and those products carry a more favorable component cost dynamic that we should see a decent spike in gross margin going forward?

Joe Tucci

Well, you're seeing decent price in gross margins now. I think we have done a great job in both our design, our service ability, to really try to pick up some margins in a competitive market.

To answer your CLARiiON question, it is low single digit bookings growth. Absolutely.

What did I say? I'm sorry, low double-digits. I'm sorry, low double-digit booking growth in CLARiiON. It's 4% on the revenue side, low double-digits on the revenue side.

Bill Teuber

On the gross margin question, you know the factors that impact you there. It is volume, it is mix, and it is the price costs, other. Volume obviously helped in the second half of the year. As we do more software that should help us.

The other factors typically are planned to be a wash. They never are in any particular quarter; but you have seen our gross margins grow in the second half of the year traditionally.


Our next question comes from Keith Bachman - Banc of America.

Keith Bachman - Banc of America

Joe, this is for you. I want to jump back to CLARiiON for a second. I think in the last comment you said low double-digit backlog, or bookings growth, rather. What I am really trying to understand is CLARiiON to me was a big surprise this quarter, even given the product transition. I just want to try to understand how we should be thinking about the revenue growth profile. Is that back to double-digits?

A different way to ask the question is, that double-digit bookings growth, how was that impacted by the product introductions since the CX 3 was introduced in week 7?

Joe Tucci

What happens to us now, because of some of our key partners is instead of giving ourselves an entire quarter to transition, which you can do in the mid-tier, so typically we love to announce a product like this, say on April 1 or as near to that as we can, and then you've got more time to ramp. But obviously, we don't want to announce in the last month of some of our major partner's quarters.

So basically, we launched this product, as I said, on May 8. That means you are into the seventh week of the quarter before these orders are hitting the factory. Because this is a very, very different product, customers do need to kick the tires and really test it in their environments. We had a very normal ramp.

So we knew going in that seven weeks was not going to be enough. So we certainly internally were not planning for say post north of 20% growth. We knew that we had to get a lot of both ourselves and partners through this transition. What I am saying is, as we exited the quarter, we were very comfortable.

So we did get a lot of bookings late, and that bookings growth was north of 10%, as I said. Double digits; we are not giving you an exact number, but it was north of that. Again, our goal is to get it north of 20, and I see no reason why that won't happen with the reception of this product.

This thing is screamingly fast, and the reliability figures that we have accumulated on this are nothing short of phenomenal. This is the most stable mid-tier product out there, and basically has almost high-end performance. The big system goes up to close to 500 drives.

So we have announced actually another new category in the high end. I said we need to flesh out the low end more. I think when this whole line is in place, we will get growth rates north of 20.

Keith Bachman - Banc of America

Won't the ramp of the CX-3 improve the software attach rates?

Bill Teuber

Yes, it will.

Joe Tucci

As I said, in Symmetrix we are in a phenomenon where it is very hard -- I think, actually impossible unless we want to -- It is virtually impossible to grow software and Symmetrix now faster than the core hardware grows.

In CLARiiON that is not the case; we can grow software faster, because these are new systems. You install Navisphere and Snaps and Clones and all of that with this all the time. So, yes. This is going to be good news for software.

Keith Bachman - Banc of America

Okay, thank you.

Joe Tucci

Well, thank you for joining us. I think we have taken a pretty deep dive, given you a lot of data.

I just want to close with two thoughts. Number one, it is hard for me to express how bad we feel and how deeply disappointed that we have let our investor base down.

The good news is that we have not let our customers down. If you look at the people inside of EMC, because the sales force finished so well and we are paying the sales force based on what they booked, there is nobody down inside.

So our customers love what we're doing. EMC is not down, and we will not miss like this again. We think lowering these targets, getting our feet back under us, as I said, is going to bode well for us in the future and better days will be ahead. So thank you very much for being with us.

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