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EMC Corporation (NYSE:EMC)

Q4 2009 Earnings Call

January 26, 2010 8:30 am ET

Executives

Joseph M. Tucci - Chairman, Chief Executive Officer

David I. Goulden - Chief Financial Officer and Executive Vice President

Tony Takazawa - Vice President of Investor Relations

Analysts

Jason Ader - William Blair

Mark Kelleher - Brigantine Advisors

William Shope - Credit Suisse

Benjamin Reitzes - Barclays Capital

Daniel Ives - FBR Capital Markets

Brian Marshall - Broadpoint AmTech

Ittai Kidron - Oppenheimer & Co.

Brian Freed - Morgan, Keegan & Co.

Maynard Um - UBS

Toni Sacconaghi - Sanford Bernstein

William Fearnley - FTN Equity Capital Markets

Kaushik Roy - Wedbush Morgan Securities Inc.

Mark Moskowitz - J.P. Morgan

David Bailey - Goldman Sachs

Operator

Welcome and thank you for standing by. (Operator Instructions). Now, I will turn the meeting over to Mr. Tony Takazawa.

Tony Takazawa

Good morning. Welcome to EMC’s call to discuss our financial results for the fourth quarter and year 2009. Today we are joined by Joe Tucci, EMC’s Chairman and CEO and David Goulden, EMC Executive Vice President and CFO. David will provide a few comments about the results that we released this morning. He will highlight some of the activities that was had this quarter and discuss our outlook for 2010. Joe will then spend some time discussing his view of what is happening in the market, EMC’s execution of the strategy and how EMC is positioned.

After the prepared remarks, we will then open up the lines to take your questions. I would like to point out that we will be referring to non-GAAP numbers in today’s presentation unless otherwise indicated. The reconciliation of our non-GAAP comments to our GAAP results can be found in the disclosure today in our press release, supplemental schedules, and the slides that accompany our presentation. All these are available for download within the investor relations section of EMC.com.

As always we have provided detailed financial tables in our news release and on our corporate website. These include a lot of financial details; so, we do encourage you to take a look at them. And with regard to details of VMware’s results, we refer you to their financial release from last night.

The call this morning will contain forward-looking statements and information concerning factors that could cause actual results to differ, can be found in EMC’s filings with the U.S. Securities and Exchange Commission.

Lastly, I will note that an archive of today’s presentation will be available following the call.

With that, it is now my pleasure to introduce David Goulden.

David I. Goulden

Good morning and thank you for joining us today. EMC showed good progress through 2009 and end of the year with very solid growth in Q4 with revenues of $4.1 billion up 17% from Q3 2009. Non-GAAP EPS of $0.33, up 43% and free cash flow of $793 million, up 6%. These quarterly results provide a good example of the resilience in our model with revenues up 2% over Q4 2008 demonstrating good profit leverage with non-GAAP EPS of 6% and solid free cash flow generation of 2%.

Within these results, our are EMC infrastructure business had a good quarter with $3.5 billion in revenue, up 15% sequentially and $0.28 of non-GAAP EPS, up 40% from Q3. On a year-over-year basis, non-GAAP EPS was up 12% on flat revenue, a result that clearly shows the success of our cost translation efforts.

As previously announced, VMware also had a strong fourth quarter contributing $607 million of revenue and was $0.05 of non-GAAP EPS of EMC and showed very good growth from Q3. Given the tough global economic conditions and an IT spending environment down across the board, EMC performed well as we moved through 2009. Our vision, strategy, and most importantly the hard work and sacrifice of EMC team as enabled our company to come out of the year with business momentum and very well positioned to grow and gain share in 2010 and beyond. It is especially worthy to note that even in this economic climate, the consolidated Q4 revenues, Q4 non-GAAP operating margin, Q4 non-GAAP EPS, and Q4 free cash flow results were all records for EMC. In other words, EMC is coming out of the worst global recession we have seen in our best financial shape ever. We think this is truly impressive.

Beyond the financial metrics, we’ve accomplished a lot in 2009. We maintained good focus on our goals and opportunities despite numerous economic and market distractions. We stay close to customers and help them through the tough time while other vendors cut back. We rolled out new market leading products with the best quality in our history. We successfully implemented our biggest cost translation program ever and strengthened the operational and financial position. We used our financial strength wisely to continue to invest in R&D and to make strategic acquisitions, both of which will contribute to our ongoing success, and we improved our customer satisfaction at an important time when customers are looking to solidify their true business partners.

While 2009 was a tough year, EMC achieved a lot of good things and exited the year in a very strong position.

So, moving to the agenda for today’s call, I will start off by making some comments about the Q4 spending environments, our business outlook for 2010, and then discuss some more specific details from our Q4 results.

Overall, the environment in 2009 was pretty much as we anticipated with reasonable stability at the end of the year. While there is still uncertainty as customers evaluate their own business prospects and plans, we do expect 2010 to be better than 2009. Joe will spend some time discussing the 2010 environments in his comments, but the next is that we currently see IT spending growing between 3% and 5% in 2010.

Given the compelling dynamics we see in our target markets, we continue to expect EMC’s total addressable market to grow faster than IT overall, probably something near 6% to 8%. And lastly, given EMC’s strategic focus on the shift of private cloud and a good position in the most important opportunities such as storage tiering, virtualization security, next generation backup, etc., we believe that EMC is poised to grow even faster and gain share.

As a result, we currently anticipate 2010 consolidated revenues of approximately $16 billion, up 14%, and we expect significant leverage with non-GAAP operating margins of 20% and non-GAAP EPS of approximately $1.12, up over 24% from last year. This projected growth demonstrates the strength of our unique strategic positioning, ability to gain share, and the earnings leverage inherent in a leaner financial model.

Given what we see in the market and our understanding of customer spend plans, we currently expect our quarterly revenue contribution in 2010 to follow reasonably normal seasonal patterns.

Now, let’s take a closer look at some of the financial highlights from the fourth quarter. EMC information infrastructure revenues were $3.5 billion, up 15% sequentially and flat year-over-year. Non-GAAP earnings per share were $0.28, up 40% quarter-on-quarter and up 12% from last year, very good leverage in a very tough year.

Within these overall numbers, information/infrastructure product revenues were almost $2.4 billion, up 20% quarter-to-quarter, and information infrastructure storage revenues were a bit over $1.1 billion, up 7% sequentially. Free cash flow was $554 million. Looking at the geographic results from our information infrastructure business, our revenues from North America represented about 56% of total and were up a solid 13% sequentially and down 1% from Q4 2008. EMEA and Latin America both had strong sequential growth, up 23% and 17% respectively from Q3 and both up around 1% year-over-year. APJ also improved from Q3 and was up 6%. The Brick Plus 13 countries continue to show strength, up 14% quarter-on-quarter and 5% year-over-year. A very positive data point is that these markets were also up 1% year-over-year on a constant currency basis, and this is encouraging to see.

Looking at the results from the businesses within information infrastructure, Q4 information storage revenues were $3.1 billion, up 16% sequentially. Overall, we’re seeing an increase in net new implementations as customers are looking to put in place infrastructure to support their virtual environments. As part of these investments, we continue to see very strong growth in the adoption of shared storage utilizing solid state and SATA drives. In addition, the recent introduction of our fully-automated storage tiering software known as FAST is a compelling and unique capability that is enabling customers to improve efficiency via storage tiering across their environments.

Overall, we believe the demand will continue to strengthen for our broad and deep storage portfolio as customers look to deploy more efficient, flexible, and cost effective technology.

In the high-end Symmetrix revenues were up 13% sequentially; a very good result as the V-Max continues its positive ramp. The introduction of FAST is also driving more rapid adoption of both SSD and SATA drives in Symmetrix as customers look to take advantage of the unique value of V-Max based storage tiering. The ramp of these new products is proceeding very well and is very well positioned as customers invest in their cloud infrastructures.

Not only is the V-Max is very successful in the more traditional high-end markets where the Symmetrix has always done well, but its scalable architecture and unique capabilities are receiving a very good response in new use cases such as internet hosting. For example, in Q4 we won a V-Max deal to completely replace a competitor, a major TELCO based hosting provider.

Now, let’s take a look at the mid tier business including our CLARiiON and Celerra product families. Within this, CLARiiON revenues were up 15% sequentially, a nice acceleration over Q3 growth. Directing channel business continued to be about 75% of total CLARiiON revenue. Within the CLARiiON results, the DELL EMC co-branded CLARiiON OEM revenues were up 27% sequentially and represented about 16% of total the CLARiiON revenues.

Celerra NAS business continues to be a great performer posting the 11th consecutive quarter of double-digit year-over-year revenue growth in Q4 with revenues up over 50%. Our unified products combine our best of breed, sound enough capabilities without sacrificing performance in either environment and our success here continues to set pace in the industry. In Q3, we were number one in the market with 46% share according to IDC, and given our outstanding performance, it is pretty clear we gained share again in Q4.

As an example of our success here, we recently beat that up and others for a large deal including 1.4 petabytes of unified storage at a major New York based stock exchange. This market shift towards unified storage is a very important trend in the mid tier, and I’ll talk a little bit more about it later on.

Our newly formed back-end recovery system division which we call BRS has fantastic results again this quarter with each up over 50% year-over-year in Q4. Within BRS, I’m happy to say that data domain was ahead of plan in its first few quarters as part of the EMC family. The excellent focus and execution by the teams has led to the continued growth and success of these businesses. As an example, the growth potential within this business, we added 600 new customers in the quarter with 300 of these being net new to EMC. Given the growth, this business is clearly very strategic to customers and EMC is also the acknowledged leader in this important area.

As an indicator of our strength in market leadership, in the forthcoming IDC survey, respondents chose either an EMC or data domain primary branded deduplication solution at nearly double the rates of the next nearest vendor. This means that we have almost twice as much mindshare as anyone else in this great market and we show the ability to capture it.

Taking a look at a few other storage related businesses, our Mozy cloud based backup business is now managing over 25 petabytes of customer data this quarter in conjunction with partners Cox, McAfee, and Vodafone. This year, Mozy will also expand beyond online backup to a broad set of personal cloud services.

In addition, Iomega, our customer in small business focus operation is seeing an increasing customer demand for backup and protection, and Q4, shifted over one exabyte of storage, more than double the capacity shift last Q4. Iomega continues to roll out new and compelling products that are highlighted by winning an Editor’s Choice Award with the v.Clone products and by the fact that the Iomega brand is one of the most popular storage solutions at Apple Stores.

In total, the EMC storage business finished 2009 with very good momentum due to great products, compelling solutions, and focused execution by the team. Importantly, we believe that we are poised to really extend our league this year for three additional reasons; to move to virtualized data centers, the implementation of next generation backup and recovery, and the evolution of unified storage.

Let me spend a few moments highlighting each of these trends with you.

First of all, the virtualization of the data centers are beginning in earnest as customers are looking to move towards the private cloud, and EMC is absolutely best positioned to benefit from this. Some recent survey results from Goldman Sachs really highlights these facts. As you can see in the first chart, customers are looking to put incremental spending towards next generation technology this year, and this survey shows that over two-thirds of these customers will move at least 20% of that data centers in this direction by the end of 2010.

Obviously, a major factor of this next generation technology is virtualization, and not only is VMware the lead in this space, but EMC is the clear storage vent of choice in virtualized service environments. As you can see on the next chart, EMC is preferred by 38% of the survey participants and will be more than twice the mind share of the next closest competitor, and I might add, over three times as much mind share as a smaller vendor who has been making a lot of noise about this topic lately.

And finally, as virtualized storage becomes more prevalent with customer environments, EMC is once again in the forefront with 34% of customer surveys saying that would choose EMC when they implement storage virtualization technology. As you can see, not only does EMC already have 50% more mind share than the next vendor, you can also expect us to make several announcements throughout 2010 that will extend or lead in this important area.

The second major trend is the rapid implementation of next generation backup and recovery capabilities. The benefit of these solutions are becoming well known including simplicity, efficiency, flexibility, manageability and cost savings. So, customer demand is very high. This is also a vastly under-penetrated opportunity. In the same IDC survey I mentioned earlier, the survey also indicates that only 22% of respondents implemented deduplication for backup data. Obviously, we are already seeing great success here, and with the leading products in both forms of data deduplication, with data demand in Avamar with tremendous mindshare in the markets and the clearly under-penetrated opportunity, we should be able to drive a lot of growth here.

The third trend is that the market is moving towards a more of a unified storage approach in the mid tier this year and into the future. In other words, customer requirement for flexibility and best of breed performance are propelling to desire for products that truly unify the best capabilities in file and object information. As I previously mentioned, our current unified products based upon a leading SAN and NAS technologies continue to set the pace of this market, growing faster than the other companies. Unified storage is becoming one of the hottest product areas in the mid tier market, EMC is in the lead here, and you can expect several more important announcements from this year and beyond that will extend our capabilities in this area.

So, EMC’s information storage saw the most important trend in IT. As customers begin their journey towards the private cloud, we are focused on helping them make the transition at their own pace. With our product portfolio, solutions, and partnership, EMC is uniquely able to help solve their problems today while at the same time helping customers position themselves to meet their needs of tomorrow. And as you can see from our Q4 results and some of the recent success stories, we are certainly delivering what customers are looking for. We are confident we will gain share because EMC has the best, the broadest, and the most integrated storage portfolio to meet customers’ needs both now and in the future.

Our RSA security revenues in Q4 were $164 million, up $0.07 sequentially. This business is executing well this year even in a tough environment, growth was positive in 2009 and paced the year up 4% overall as information centric security continues to be a top customer priority. RSA strategy to offer built-in information centric security were often bolted on perimeter based security and served as well as the industry is clearly moving in our directly. Not only have we utilized this expertise to augment the security capability of products throughout EMC, this focus has also led to numerous new alliances with partners seeking to seamlessly improve the security of their offerings. A good point is the qualification by VMware of secure ID for virtual desktops.

We also continue to extend the lead in our information security products. For example, we have integrated the VLP, an adaptive authentication into enVision. In addition, we have extended this capability across both physical and virtual IT infrastructures and this is a true unique capability that we built into a highly differentiated VCE Vblock offering.

Finally, the recent acquisition of Archer, a leading company in the enterprise government risk and compliance markets, further extends our strategies to offer complete security solutions.

Revenues for our content management and archive division in Q4 was $208 million, up a strong 17% from Q3. This division was recognized as a leader in enterprise content management by several firms recently. In Q4, EMC CMA division was positioned by Gartner in its ECM market leader quadrants which recognizes companies demonstrating broad platform support and presence in multiple regions, strong channel partners, and good customer support; and earlier this month, we recognized EMC’s content management division’s market leadership for its broad range of capabilities and strengths in document management, document imaging, and capture and records management. The assets in CMA’s portfolio should service well as customers review spending on applications that will streamline processing and enable efficient access to contents.

In Q4, EMC’s global services business continued its solid performance and revenues grew 7% sequentially. Overall, we saw a recovery in our consulting business which tends to be somewhat of a leading indicator of customers’ IT plans. It’s good news that we’re seeing interest in investments to growth, new opportunities in integrations as opposed to what used to be mostly a focus on cost cutting. Our professional and technical consultants are well positioned and have been effective in helping customers to manage their various investments including virtual data center investments.

Now, turning to some highlights from the income statements. Q4 information infrastructure non-GAAP gross margins were 55.3% and operating margins were 21.9%. Both metrics improved sequentially and showed especially strong year-over-year improvement from Q4 2008 non-GAAP gross margin of 52.5% and operating margin of 18.1% for the year. Non-GAAP gross margins were 52.3% and operating margins were 16.3%. This compares quite well with 2008 non-GAAP gross margin of 52.7% and operating margin of 16.6% that was achieved of a much higher revenue base.

This highlights our successful cost reduction efforts and is a great example of the new leverage inherent in our financial model. In fact, these 2009 full year operating margins are even more impressive given that they include around $55 billion of transition investments and about $30 million of incremental investments in our cloud infrastructure and services business. Without these investments, non-GAAP operating margins actually would have been up versus 2008.

Clearly, our cost transformation efforts this year are paying off, and we’re certainly exceeded our target of $450 million in savings. We’re truly moving our model to a new level of efficiency, and I’d like to thank everyone at EMC for the hard work and dedication in achieving these results.

Now, turning to a few highlights from our consolidated results. Total Q4 consolidated revenues were approximately $4.1 billion, up about 17% sequentially and up 2% year-over-year. On a constant currency basis, revenues were almost flat with last year. Non-GAAP earnings per share was $0.33 and free cash flow was $793 million. Free cash flow this quarter is almost $100 million higher than Q4 non-GAAP net income. This year, we generated a record $2.6 billion in free cash flow, this is about $760 million greater than cumulative 2009 non-GAAP net income and over $40 million higher than the free cash flow in 2008. We are very pleased with the strong free cash flow generation we’ve achieved this year, and we continue to focus on driving free cash flow higher than non-GAAP net income.

In 2009, the non-GAAP combination of interest income, interest expense, and other income was a net $66 billion expense. For 2010, we expect this non-operating expense to be approximately $90 million due to lower interest rates and higher non-cash interest expense.

The non-GAAP tax rate was 19% for Q4 and for the full year 2009. We currently expect the non-GAAP tax rate in 2010 to be around 20%. Q4 consolidated operating cash flow was $1 billion. A few balance sheet items impacted Q4 operating cash flows include deferred revenues which were $3.6 billion, inventory turns which were $7.7 billion and DSO’s which were 47 days, all very good given the current economic climate.

We ended Q4 with $9.4 billion in cash and investments. As you may recall, last quarter we announced our plan to reorganize our international operations. While this plan was laid out in our announcement in November, a byproduct of this reorganization was the transfer of approximately $1.3 billion from our international businesses to our domestic operations. At quarter end, approximately $4.1 billion of our cash in investments were held domestically, $2.8 billion overseas, and additional $2.5 billion was at VMware.

Financial flexibility is a critical strength and competitive edge for EMC, particularly in this unpredictable economy. Our financial strength allows us to continue to invest in our business during all types of economic cycles and you can expect us to continue this practice in 2010. In addition, we’re able to return capital to our shareholders via buybacks. I am pleased to announce that we have EMC board approval for a $1 billion EMC share buyback.

It is a great accomplishment for EMC to have successfully weathered the worst recession in decades and to be exiting the year in our best operational and financial position ever. The combination of EMC’s vision, strategy, leading products and solutions, strong partnerships, increasingly efficient business model, great people, and solid execution has made EMC stronger, more agile, and more profitable.

As we all know, companies are continuing to face the trade-offs among trying to gain share, investing for the future, and showing improving profitability, and one of the relative focus among these three tends to change with time depending upon the environment, the ultimate goal, and its progress along all three metrics.

At EMC in particular, we’re continually trying to optimize the trade-offs among these three objectives, and in 2009, we were successfully putting in place an operational foundation that will enable us to efficiently manage the business along these three important goals. As a result, looking to 2010, we are very pleased that we will be delivering meaningful progress towards all three objectives. To be specific, 14% topline growth in 2010 will certainly result in significant share gains across all business. In 2010, we will invest $50 million in the future of our business as we continue our successful cost transformation program.

We will also accelerate the investments in our product development by increasing R&D investments by approximately 20% and we’ll continue to show profit margin improvements as we reap the benefit of our ongoing cost transformation efforts, disciplined spending and increasing the efficient operating model. As a result, we expect non-GAAP operating margins to be 20% in 2010, a 260 basis point increase over 2009, and we expect non-GAAP EPS to grow over 24% versus 2009. I think you’ll agree with this leverage.

To sum it all up, we’re excited about our opportunities and we’re confident in our ability to deliver a solid year including the triple play of market share gains, investment in the future, and income leverage.

With that, I’ll turn the call over to Joe.

Joseph M. Tucci

I’d like to begin by welcoming everyone to today’s call. Thank you for joining us and thank you for your interest in EMC.

Looking back to Q4, I was very pleased with our overall results. Certainly, demand for storage was strong, especially in the areas of next generation backup with integrated deduplication technologies with storage systems that support virtualized and cloud environments, where unified storage effectively features fiber channel SAN, IT SAN, and NAS architectures, where storage supports mass consolidation and business continuity, and for storage that is custom built for the SOHO market; in other words, storage opportunities in which EMC leads with innovative products, technology solutions and services.

Also, you heard from VMware yesterday, the demand for virtualization was very strong. As our customers continue to make solid progress in recovering from the effects of the great recession, they are demanding faster and better returns on their IT investment while striving to be more environmentally conscious. They are turning to VMware and virtualization technologies in record numbers, and Q4 demand for technologies and solutions that help customers ensure they are implementing and adhering to good governance principles and policies while minimizing risk was strong. This helped drive our RSA security in our information management businesses. In fact, our RSA business produced year-over-year growth in each and every quarter throughout 2009.

Additionally, I was very pleased with the very warm market reception our private cloud Vision strategy and product roadmap and partner ecosystem has received. This holds well for our future and gives confidence in our ability to grow and take market share going forward.

I would like to take this opportunity to thank the global workforce of EMC and VMware. Our team was selfless accepting and even volunteering for 5% pay reduction to help us minimize layoffs, keeping us strong not only in 2009 but for the future. They focused on and stayed closer than ever to our customers. They were and are innovative and they executed our strategy in business planning exceedingly well. Again, thank you all very much.

Looking forward into 2010, we expect the economic recovery to continue and GDP growth to be in the low single digits worldwide. Despite this prediction for continued economic recovery, there is still some caution and potential for choppiness as job recovery lags. As David says, on the back of this recovery, we expect whole world IT spending to return to growth; our best estimate is between 3% and 5%. We expect the storage market to grow in the 6% to 7% range and the market for security and virtualization to be in the mid teens to low 20s.

And as our 2010 outlook demonstrates, we expect to grow faster than the markets we serve, take share, and produce leverage. To make it clear, the 2010 forecast David gave you for consolidated EMC revenue of $16 billion and non-GAAP EPS of $1.12 is in fact our management plan as approved by our Board of Directors. At our upcoming February meeting, the Board will add a free cash flow metric to our 2010 plan.

So, a question that must be on your minds is what gives us confidence we can achieve our 2010 goals. First and foremost, we have a very strong product lineup and product cycle that has grown for us throughout 2010. Also, analyst survey after analyst survey points out that the number one hardware infrastructure spending priority for CIOs in 2010 is storage. And when these CIOs were asked what areas in storage that are most important, back up the disk with data de-duplication, storage consolidation, unified storage, tiering of storage, and business continuity show to be consistently high priorities; again, areas where EMC is the leader. And very importantly, these surveys had EMC gaining share.

Likewise, software surveys had virtualization as a top IT spending priority for 2010 and CIO surveys picked VMware as a number one share gainer here. Also, security and governance, risk, and compliance or GRC were mentioned as top 10 priorities, and again, EMC was on the share gainers list.

And lastly, what gives us optimism in 2010 is the deep belief EMC people have worldwide in our ability to help our customers succeed. What gives us optimism for the longer term, not only in 2010, but well beyond is our focus on several rapidly emerging multibillion dollar markets which we believe present double-digit market growth opportunities for EMC. Our first and largest billion-dollar plus opportunity is helping customers transform their current data centers into fully virtualized fully automated dynamic flexible data centers where applications workflows are truly policy and service level driven, while significantly lowering total costs, as much as 40% lower than today’s data center environments. We call this initiative helping our customers build their own internal or private cloud.

Our second mega opportunity is to work with our service provider and telecom partners and help them stand up and build up their public clouds using the same technology as our enterprise and commercial customers will use in building up their private clouds. This will allow enterprise customers to federate some of their workloads with these external service provider clouds resulting in even better infrastructure utilization. Additionally, we will team with our service provider partners to have greater access to the SMV markets. EMC will also run a set of applications as a service on top of our service provider partners’ public clouds. Applications like PC backup as a service, storage as a service, archive as a service, elements of content management and security as a service, desktop as a service, and the potential list goes on and on.

Our third multibillion dollar market opportunity is around virtualizing client devices. This V-client initiative benefits customers by allowing them to more efficiently provision uses once, not for each of their multiple continuously changing devices. This means not only better and simpler management, but better security and protection from viruses and provides a lower TCO.

Our fourth massive billion-dollar plus opportunity is for AMC to lead customers to the next generation of backup recovery and archive solutions. We size this market at approximately $10 billion in 2010. It is extremely fragmented with EMC being a market leader. The opportunity here stems from the continuing sea of data that customers need to better manage and protect, the attributes of automated tier storage coupled with the best of data de-duplication technologies are the keys to success here. We are absolutely accelerating the move to up backup and recovery from tapes to disk.

To compete in these four rapidly emerging multibillion dollar opportunities, innovative technologies around virtualization; technologies like a fully function data center OS that incorporates a new higher level of automation, management, and security; technology for federated information storage, and technology that provides much more efficient and effective backup in archiving the disk for de-duplication. In other words, key innovative technology that EMC and VMware have and leading today and are investing in heavily for the future. The further sure we capitalize on these four mega opportunities before us, we are rapidly building a repertoire with our top-tier partners. We have a need of technology partners, distribution partners, service, system integration, and outsourcing partners, and service providers. In short, our ecosystem will be second to none.

In closing, we believe we have a compelling vision and strategy, one that is right for 2010 and well beyond, leading technology, products, solutions and services, and support, world-class partners, and we have the leadership and a deep belief throughout our 43,000 people around the world that we can and will win.

I would now like to turn it back to Tony to moderate the Q&A portion of today’s call.

Tony Takazawa

Before we open up the line for your question, as usual, we ask you to try and limit yourself to one question including clarification. It will enable us to take as many questions as possible in the time that we have. We thank you all for your cooperation in this matter. Teresa, can we open up the line for questions, please?

Question-and-Answer Session

Operator

We will now begin the formal question and answer session. (Operator Instructions). Our first question comes from the line of Jason Ader - William Blair.

Jason Ader - William Blair

Two related questions; for Q1, what would normal seasonality be; I know we lost a couple of years, have not exactly been normal; and then secondly, could you give us some color on the backlog as you enter Q1?

David I. Goulden

I will answer both in the same way. We don’t comment on backlog, but I did point out to you that we expect the progression, the expense contribution to revenues from each quarter as a percentage of the total to follow a reasonably normal seasonal pattern. You can go back and look at your own data. We’re trying to avoid guiding all on the quarterly basis; we’re giving annual guidance, and we can’t tell you; the progression during the year will be seasonally normal as a percentage of revenue; so I encourage you to just go back and not have me guide you towards Q1.

Jason Ader - William Blair

And what year should we look at to see the most, to get a sense of what the normal contribution would be?

David I. Goulden

I wouldn’t look at 2009. the whole comment that we made about 2009 and if you look at the contribution in 2009, the first half versus second half, we saw a much higher percentage of revenue than normal in the second half of 2009 as we expected that to be the case because we saw a much weaker demand in the first half; so I would go back and look at the three or four years leading up to 2009.

Operator

Your next question comes from the line of Mark Kelleher - Brigantine Advisors.

Mark Kelleher - Brigantine Advisors

Some very good gross margin numbers there; maybe the highest in the couple of years; can you give us some puts and takes on that and whether you think that is sustainable?

David I. Goulden

We are very pleased with gross margin performance this quarter. A couple of things really; perhaps the best way to look at gross margins is probably look sequentially; so we saw a nice uptick from Q3. You have seen our margins improving during the year, that really being the results of some of the cost translation problem we would be doing and driving efficiencies through our supply chain, but also some good work in the field to make sure that while this is a very tough pricing environment, we are charging suitably for value. But if you look sequentially, what we saw was a nice improvement in both product margins and services margins, and in both cases, principally volume driven as we see additional leverage in the models volume starts to pick up again. So, that’s the biggest driver. A little bit of FX impact sequentially, but mainly both products and services margins pick up sequentially because of volume.

Operator

Your next question comes from the line of William Shope - Credit Suisse.

William Shope - Credit Suisse

Can you discuss your R&D plans for 2010 in a bit more detail, more specifically help us to understand where it is targeted; is this somewhat from a snapback from a compressed 2009 plan; and then touching on a more sensitive topic, can you address this target in light of the nagging historical concerns that you will reinvest upside and leverage back into the business?

David I. Goulden

As we have been talking throughout this tough cycle, we’ve really worked hard through our cost transformation to get ourselves in a situation where our cost structure is simply more lean and efficient; you saw the benefits of that happening in Q4 where on the EMCII we saw operating margins close to 22% which is much higher than we have seen for any recent period of time. So we really believe we have put that cost structure in place so we can generate much more leverage on incremental revenues, but also as we said earlier we can produce that leverage while continuing to top our investments. So, if you think about revenue growth next year of 14%, R&D growth is a 20-point growth, then obviously we’re showing a much higher investment back into R&D, and just before I hand over to Joe and talk about what we’re going to be investing in; this year you made a comment that R&D looks a little less robust. I think when you’re looking at the change on year-on-year growth or decline in R&D dollars versus SG&A dollars, that in turn is being impacted by a number of things including software capitalization, transition expense, and acquisitions, and if you pull those three out, the year-on-year decline in those lines are actually much closer than they look on the financial statement. So, just a few comments upon leverage and R&D mix, and I will hand it back to Joe to talk about the investment areas.

Joseph M. Tucci

Obviously, the two big investments are around storage and VMware on the virtualization building the next generation of data center OS. Within storage, what is hot is where the majority of the increase will go. So, a lot is going around the federation and virtualization, which David said, we have a number of big announcements there and initiatives coming out obviously around the next generation backup and recovery, obviously in unified storage, obviously in building in security to both our virtualized and physical products. So, those are areas off the top of my head that are getting some big increases or nice increases.

Operator

Your next question comes from the line of Benjamin Reitzes - Barclays Capital.

Benjamin Reitzes - Barclays Capital

Could you address whether there were any shortages in the quarter and whether they have been alleviated and I’ll sneak another one in there; of your 14% growth this year, could you talk about the Data Domain and Avamar segment, what is the growth expected of the Data Domain Avamar segment within the 14%?

Joseph M. Tucci

We’re not going to break out that segment but we will as we go through give you a lot of color around that, but let me put it this way; throughout the entire company the segment we expect to grow the fastest will be that BRS group that we talked about, the Data Domain and the Avamar technology by far. So we continue to believe that.

David I. Goulden

On the shortages, obviously you can see that we diluted $4.1 billion of revenue against our guidance of $4 billion; so we obviously had the supplies to feed our guidance during the quarter, but just to comment a little bit deeper, you will notice, I am sure as you start to pull through the financials that we did have a buildup in inventory of Q4; we built up about $100 million of inventory and that was designed to protect ourselves going into Q1 against what we knew would be a tight supply environment. So, we think, and we’re well positioned going into Q1, we did invest a little bit ahead of our Q4 needs, we have good relationships with all of our suppliers, and so we’re very confident and we do not see anything that will disrupt our Q1 numbers either, but we have invested a little bit to make sure we have that protection.

Operator

Your next question comes from the line of Daniel Ives - FBR Capital Markets.

Daniel Ives - FBR Capital Markets

Could you just, anecdotally; you guys are talking to customers, quarter to quarter; what really changed this quarter, and maybe could you compare it with a typical Q4, what you see when you’re visiting customers around the world in terms of spending?

David I. Goulden

Obviously, there was a lot more optimism in our customers, a lot more clarity, a lot more normality in the CIO’s ability to spend their budget without all kinds of checks and approvals they had to get in prior quarters, especially when it went up to and including board levels; so that was for sure. Obviously, we saw what I would consider to be a very normal budget rush, and I think we also saw even maybe a little extra in some of that spending the customers didn’t do in Q1 and Q2 as the companies got more confident in their next year 2010 business plans, they were doing a little bit of catch-up because I think they really starved their infrastructures in Q1 and Q2.

Operator

Your next question comes from the line of Brian Marshall - Broadpoint AmTech.

Brian Marshall - Broadpoint AmTech

I was wondering if you could comment on what’s baked into your EPS guidance for calendar year 2010 non-GAAP with regards to minority interests; it looks like based on my calculations, that might be doubling year-over-year to roughly $120 million, and then also, the 20% R&D growth; can you talk about if any M&A in organic growth is baked in as well?

David I. Goulden

We’ll take those in reverse order, Brian; no that is an organic growth in R&D spend; and in terms of minority interests, I think you’re talking about the minority interests in VMware, obviously you can run the math based upon the guidance of VMware I gave you last night about the revenue and their operating margins. As the programs roll out, we do expect the minority investments to increase slightly during the course of the year because it is more profitable or more contribution coming from VMware and the actual dollars will be greater than they were in 2009. So, you’re probably directionally generally okay.

Operator

Your next question comes from the line of Ittai Kidron - Oppenheimer & Co.

Ittai Kidron - Oppenheimer & Co.

Congratulations on the great numbers. Maybe if you could talk a little bit about your operating margins; great performance there and great targets for the year. I guess going forward, have we reached peak levels of your operating margins, where are the opportunities to keep on growing that level?

David I. Goulden

Thank you for the comments on the quarter and the question. We are really here to talk about 2010, I think we’ve given you a very compelling roadmap for 2010 that is going to give us, this combination is triple flavor; I spoke about market share growth, investment for the future, and significant operating margin leverage. Going forward, we’re obviously looking at all three of those metrics, but we’re here today to talk about 2010 and we’ll leave our comments there at this point in time.

Joseph M. Tucci

I think the longer-term to that Ittai is how well we execute on those four mega billion-dollar plus growth opportunities for us, and we intend to execute well. We’ll keep you posted as we go through.

Operator

Your next question comes from the line of Brian Freed - Morgan, Keegan & Co.

Brian Freed - Morgan, Keegan & Co.

When you look at the mix between your V-Max and DMX products in the fourth quarter, can you talk about that for direction there, and secondly, can you talk about merging related to V-Max versus DMX clearly higher given the component; do you think they would continue to leverage on the product gross margins on as that continues to gain share?

David I. Goulden

Brian, on the V-Max versus DMX question; that transition continues to be ahead of plan and it continues to be going faster than other major transitions. So, we’re up close to three-quarter of the total mix this quarter coming from V-Max versus DMX, and yes, because of the design of the V-Max, it does inherently, particularly now we’ve gotten up to higher volumes of product levels, it would cost us less on a per box or per capacity basis, and therefore, margins are better; and that’s one of the reasons why you saw a margin uptick as well in Q3 to Q4, the mix shifting from a little over 50% of total to close to 75% helped us a little bit as we moved through the progression between the two quarters.

Operator

Your next question comes from the line of Maynard Um - UBS.

Maynard Um - UBS

Related to the seasonality, I am just curious if you’re expecting that across all your geographies or if there are more specific geographies that will outperform others; and sorry if I missed this, but can you just give us the information; storage gross margins in the quarter?

Joseph M. Tucci

Seasonality by geographies, it does absolutely vary. For instance, not a geography, but our federal business for instance has a little bit different drumbeat than the directional seasonality, but as David said, we don’t break up that up and we’re not going to be guiding that way, but on the macro level, if you look with this regard in 2009 and look at the previous four years or so, I think you can come to proper conclusions.

David I. Goulden

All information on storage gross margins, we’re not giving those out today, but I can tell you that from both a parts and service basis, within information storage margins, we saw an increase both on a quarter on quarter and a year on year basis to margins within information; we’ll give you more information as we complete our filing for the quarter.

Operator

Your next question comes from the line of Toni Sacconaghi - Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

I wanted to just follow up on the very strong gross margin performance and try and better understand beyond volume what else may have helped in the quarter more permanently. When you think about $450 million or $500 million in cost savings that you generated year over year in 2009, how much of that is impacting the COGs line; should we be thinking about the six COGs portion being structurally reduced by a certain amount, and how do we think about that, and can you also comment on changes in depreciation, warranty expense, and other allowances, and whether those had an impact on gross margins in 2009 and expected for 2010?

Joseph M. Tucci

I think more than anything else the bet that this company has placed from top to bottom, this is consolidated EMC statement, on the x86 architecture has really served us well; (a) build up a lot of expertise, (b) build up a lot of commonality which helps both volume side and helps on the cost side as we get more commonality of physical parts. Obviously, we’re also seeing what V-Max helped on the performance side as Intel and others have done a phenomenal job moving the power curve and performance curve, and with better environmentals. That has proved to be a great bet for us and one that will continue to get benefit from.

David I. Goulden

Just on the other areas that you mentioned; in terms of our cross transformation program, we have basically about a third of those reductions impacting COGs and two-third in OpEx, and the areas that we’re impacting on the COGs side are along some of the areas that you spoke about, kind of reducing some of our structural fixed costs in the parts and services side of the business. I think the important thing to recognize is that quarter on quarter we had really nice progression in both parts and service margins; yes, volume is the biggest single factor, but we did get some benefit from ongoing cost transformation, but as you know, if you’re adding volume onto a fixed cost structure with variable margins, or the attractiveness what we saw during the quarter.

Operator

Your next question comes from the line of William Fearnley - FTN Equity Capital Markets.

William Fearnley - FTN Equity Capital Markets

A question for Joe here; when you look at pipelines, can you provide more color on pipeline by segment, geography, or product, and any additional color on the direct pipeline and what you’re seeing with the channel partners; where are the bright spots here when you look across the world for 2010?

Joseph M. Tucci

Certainly, David commented some of our emerging markets we called Brick Plus 13 here and we’re increasing that 13 number which is Brick countries plus 13 others we really put a strong focus and that 13 number will go up; that has performed very well. We continue to believe that will perform very well. I think there are a lot of opportunities on the back of our partnerships with Cisco and VCE, and revitalizing our DELL partnership; I think those two are massive opportunities for us if we do them right, and I believe we can do them both right. Of course, as we really get into this next generation of how we take the cloud computing and really bring it, internal or private cloud market is going to be a big, big, big opportunity for us and how we really execute on that is phenomenal. And then the reception of the combination of the Data Domain and Avamar products is nothing short of exceptional. So, I would say those are the things, the markets, and the opportunities for us that comes off the top of my mind.

Operator

Your next question comes from the line of Kaushik Roy - Wedbush Morgan Securities Inc.

Kaushik Roy - Wedbush Morgan Securities Inc.

Can you give us a little bit more color on the 20% operating margin for 2010; R&D is going up by 20%, where is the leverage coming from; can you quantify in any way your expectations for the SG&A or what are your gross margin assumptions for 2010?

David I. Goulden

Kaushik, I think we’ve given you a lot of pieces of the puzzle; we’re not going to give you the entire puzzle. Our real focus here is commitment for 2010 for the full year to deliver 20% operating margins. What you will see is that you will see our operating margins improving sequentially during the year with 20% being the average. I told you that R&D is going to go faster than revenues; so we’re going to see, by definition, a negative leverage there. So, on a year-over-year basis to deliver the increase, you’re going to need to see improvements as a percentage of revenue in both SG&A and gross margins. I am not going to give you the mix between those two pieces, but I think I have given you most of the puzzle.

Operator

Your next question comes from the line of Mark Moskowitz - J.P. Morgan.

Mark Moskowitz - J.P. Morgan

First, a clarification if I could on Dan’s question earlier; could you talk a little more about the inventory protection, is that more on the hard disk drive side, any comment there; and then Joe, can you talk a little more about the smarter pricing environment that was exhibited throughout most of 2009 with the downturn; heard a lot of folks and seemed like discounting was not as pervasive within the system environment; do you expect the discounting to change and get more competitive as we go through 2010 or are folks going to be structurally a little smarter?

Joseph M. Tucci

Being in the middle of the food fight here, so to speak, 2010 was a very competitive market with the storage industry in total being down. Obviously, because of our cost transformation projects, because of our move to x86 and more commonality in parts and service, etc., we were able to offset that. I think going into 2010, I think you’ll see more the same. I think it obviously will be a very competitive market, and we got to continue to make sure that we’re incredibly cost competitive and make sure that we get the best out of our cost transformation, and at the same time, just they can’t beat innovative products; so that’s why the increase in our R&D and that is what is going to make more of a difference than anything else.

Joseph M. Tucci

Just to pick up on the first part of your question on inventory, relative to a drive, yes, it’s mainly on the SSD side, but there are some other non-drive components as well that are not quite as obvious but we were concerned about supply chain, but on the drive side, yes, it’s SSD.

Tony Takazawa

We have enough time for one more question and then Joe will have a few closing comments.

Operator

Your next question is from David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

You announced resumption of your share buyback, can you talk a little bit about how you prioritize buyback versus acquisitions and internal spending to drive growth?

David I. Goulden

Clearly, those are the three priorities for any use of cash, and as you know, we’re in the fortunate position this year to have strong cash balances and feel sufficiently comfortable about the environment to commit to a buyback; so, the most important thing we can do with our cash is to put to work with the company and things like what we did last year with the acquisition of data domain was a great result for the company, will be very accretive on the long-term basis, but if we have excess capital beyond what we think we need for investments that’s what we put into buybacks; so, essentially, first two are investments and third is buybacks, and we’ve committed to spend a billion dollars.

Joseph M. Tucci

Thanks everybody for joining us. Hopefully we leave here believing that we have a great vision, a solid strategy and we’ve had pretty good execution; we’re focusing on, as David called, the triple play. We are focused on taking share and growing faster than the market, we are very focused in investing in the future, and we are very focused on creating leverage, and if we do that, it will be a good day for everyone here at EMC and a good day for our shareholders.

So, thank you very much for your interest in being with us today and we’ll be talking to you soon.

Operator

This concludes today’s conference call. Thank you for your participation.

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Source: EMC Corporation, Q4 2009 Earnings Call Transcript
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