EMC Corporation (EMC) Q4 2013 Earnings Call January 29, 2014 8:30 AM ET
Tony Takazawa - Vice President, Global Investor Relations.
Joe Tucci - Chairman of the Board, Chief Executive Officer
David Goulden - Chief Executive Officer - EMC Information Infrastructure
Amit Daryanani - RBC Capital Markets
Alex Kurtz - Sterne Agee
Keith Bachman - Bank of Montreal
Shebly Seyrafi - FBN Securities
Brian Marshall - ISI Group
Kulbinder Garcha - Credit Suisse
Ben Reitzes - Barclays
Scott Craig - Bank of America Merrill Lynch
Good morning and welcome to the EMC Q4 2013 Earnings Conference Call. All parties are in a listen-only mode until the question-and-answer portion of today's call. As a reminder, this conference is being recorded. If you have any objections, you may disconnect at this time.
I would like to introduce your host, Mr. Tony Takazawa, VP of Global Investor Relations of EMC. Thank you. You may begin.
Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the fourth quarter and year 2013. Today, we are joined by EMC Chairman and CEO, Joe Tucci and David Goulden, EMC's CFO and CEO of the EMC Information Infrastructure business.
Joe will begin our discussion with his view of the trends happening in IT, EMC's vision and strategy and how the EMC federation is managing the transition to the third platform.
David will then make a few comments on our results and provide a bit more color and detail around the factors contributing to our results. He will also discuss our outlook for the year 2014. After the prepared remarks, we will then open up the lines to take your questions.
We are providing you with our projected financial model for 2014. This model lays out the key assumptions and discrete financial expectations that are foundation of our outlook this year. We hope that you find this model helpful in understanding our assumptions in context and in ensuring that these expectations are correctly incorporated into your models. This model is available as background in today's slides available for download in the Investor Relations section of emc.com.
Please note 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 in today press release, supplemental schedules and the slides that accompany our presentation. In addition, all financial comparisons will be on a year-over-year basis unless otherwise indicated.
As always, 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.
With that, it's now my pleasure to introduce Joe Tucci. Joe?
Thank you, Tony. I would like to begin by welcoming everyone to today's call. Thank you all for joining us.
Overall, I am pleased with our Q4 results as our year-over-year revenue and non-GAAP EPS, both grew at 11%. This acceleration of our topline growth was broad based the majority of our businesses, a clear sign that our strategy, products and business model is resonating well with our customers and their confidence in us is resulting in strong market share gains against our large competitors.
Looking briefly at 2013 as a whole, we came in pretty much in line with what we told you at our last call in October. Revenue of $23.22 billion, up 7%, non-GAAP EPS of $1.80, up 6% and we produced slightly more than $5.5 billion in free cash flow.
As I said last quarter, we are disappointed we didn't hit our original goals of $23.5 billion in revenue and $1.85 per share. We are, however, proud that we did hit our $5.5 billion free cash flow goal, grew revenue considerably faster in the markets we serve and substantially faster in the overall IP market. And we did this by investing heavily in our future. A future that focuses is on higher growth markets.
I would like to thank the 63,000 plus people of EMC, VMware and Pivotal and our value-add partners all over the world for their hard work and dedication to the success of our customers.
I would like to give you our view of what is happening in the IT market right now. To be clear, the IT market is going through the biggest, most disruptive and yet most opportunistic transition in its 60 plus year history. At this particular time, the pace of this transition is accelerating. As we have said before, this IT transition is being driven by several key macro trends.
The first is mobile. Smart phones, tablets and new PC form factors are only the beginning. This trend will accelerate as sensors and telemetry get built into almost every imaginable product that will collectively spew out massive amounts of data. This massive amount of data will be stored and processed in a new hyperscale data center paradigm, which will encompass both private and public clouds.
This move to cloud computing is the second macro trend driving IT. There will be tens of thousands of private clouds along with thousands of public clouds which will be powered by a new software defined data center model, featuring new levels of virtualization, automation, efficiency and agility.
The third macro trend is called big data. The ability to reach in the multi-petabyte, even an exabyte scale of data, that is stored in these new clouds quickly and affordably, allowing businesses or any enterprise to make more and better customer intimate decisions faster.
And building on these first three macro trends mobile, cloud computing and big data is the coming of the Internet of things where billions of devices will be connected to the Internet dramatically increasing the amount of data that will need to be digested and the speed at which it will need to be processed. But it is not enough just to adjust and analyze this data, it needs to be acted upon. This means building a new generation of applications quickly and easily. The ability to analyze vast amounts of information and act in real-time will change every business model and process in virtually every enterprise in almost every industry.
The fourth important macro IT trend is social networking which is changing the way humans communicate and interact.
Collectively, these four macro trends are shaping what is being called the third platform IT. With that said, there is a fifth important element that is a critical success factor for this third IT platform and that fifth element is all about the establishment of security, privacy and trust.
So what is the EMC Squared family of companies doing to capitalize on this dramatic shift to the third IT platform and to make sure we ride the opportunistic side of this huge wave of change. In mobile, VMware has entered into a definitive to acquire AirWatch, the leader in enterprise mobile management and mobile security. With this acquisition, VMware is adding a fundamental element towards end-user computing portfolio that will celebrate their strategy, enable us to deliver a complete and proven enterprise class solution for empowering the mobile workforce.
In cloud computing, we are driving the software defined data center into private and public clouds, and I emphasize the word and. VMware is leading this charge and leveraging their position of over 40 million virtual machines in more than 500,000 enterprises with their industry-leading vSphere Hypervisor, their innovative NSX software defined networking and they are game-changing automation technologies.
EMC II is cooperating closely with VMware, and is leading with their software defined storage technology, ViPR. EMC II is also partnered VMware on its VSAN software. Give customers choice, vSphere, NSX and ViPR will work in either VMware or an OpenStack based cloud environment. Collectively, no other company is in a better position to drive the software defined data center than we are.
As I alluded to, EMC and VMware must play in both, the private and public side of this immense cloud computing opportunity. We call this our hybrid cloud initiative. Together, VMware and EMC, will offer a host of solutions via our own DCHS cloud and very importantly, also with and through our highly valued service provider partners.
These solutions include a broad range of production cloud services and a number of specialized services including, disaster recovery and business continuity, test and development, backup and archive, desktop as a service, Cloud Foundry as a service, global management security, Syncplicity, file, sync and share services, object and other storage related offerings, security and analytics services leveraging our RSA Pivotal offerings and we will add more services in the future that leverage the technologies we have throughout our family.
In Big Data, Pivotal along with a host of leading and full partners like IBM, SAP, Intel GE, NTT, Accenture, Verizon and more, will support and contribute Cloud Foundry, an open platform for developing and operating new cloud applications that can be run on multiple leading private and public clouds in addition to our own and not lock a customer into any one particular.
On top of this platform, Pivotal offer its own suite of big and fast data capabilities, featuring game changing innovations that use HDFS and scalar processing technologies. Pivotal Labs, the customer development arm of Pivotal, will help existing customers and digital era startups build industrial-strength applications with more agility, much faster, with better quality.
EMC II, with its ViPR HDFS and now storage products and services, will team with Pivotal and help our customers build out their new massive data links. These data links will be the foundation for the big data analytics platform and technologies which I just mentioned. Additionally, EMC II is investing heavily in other important third platform technologies in areas like flash, hybrid disc and flash arrays with unmatched functionality and services and next generation of disaster recovery and business continuity technologies and in converged infrastructures with VCE, VSPEX in the coming VSPEX next.
There is one additional implication that I would like to discuss and that is the incredibly important and tough job that CIOs have right now. CIOs not only have to help their companies form new, more software and services-oriented business models and revenue streams, they have to support the IT workloads that run their businesses or enterprises today. Today's application and workloads primarily on platform to client/server architectures and ironically demand here is also growing.
To fund their new platform 3 business transformation future, CIOs us have to find efficiencies in their current IT environment. In other words, CIOs today need to play in two IT worlds as they plan a journey to a new platform and execute flawlessly every step of the way. Again, a tough job, and here are our technologies and people can help. The technologies we usually have in mobile, in the software defined data center, in storage, in converged infrastructure, in analytics, in security and in the hybrid cloud, are technologies that are applicable to both, platform 2 to platform 3 needs and very much helps CIOs to drive the OpEx and CapEx cost efficiencies they need.
I would like to close with a few comments on our EMC's grid federation business model, a model built for this rapidly changing IT world. I have outlined the rich opportunity before us along the strong position we have with our innovative and leading technology and product portfolios. I have also commented on the disruption that many IT companies will feel. Make no mistake, there will be big winners and big losers. So, what is the power of the federation? Simply, it will help us win.
This year collectively, we will spend $3 billion on a cash basis on R&D. This affords us approximately 15,000 innovative engineers to power third platform and bridge technologies. We have almost 20,000 talented people in sales and marketing that will help guide our customers on their IT journey. We have another 20,000 very technical people in our services organization, therefore our customers get the best experience possible.
We have roughly $16 billion in cash, approximately $7.5 billion in the U.S. after repaying the convertible debt. This, along with our cash flow, will allow us to return cash to our shareholders through our dividend and buyback programs and gives us the ability to acquire technology that will help fuel our growth. We have more than 8,200 patents issued and pending to protect our intellectual property and rich technology suite.
Our model has yielded us terrific leaders like our CEOs, Paul Maritz, Pat Gelsinger and David Goulden and a deep bench under them and has enhanced our ability to recruit and retain top talent. It keeps us more focused on our missions and perhaps most importantly it provides customers with a deep and rich technology stack while giving them choice as each of our companies will continue to work with other players in the IT ecosystem, the best of both worlds. For sure, our model is contributing in a major way through our growing strategic relevance in the minds of our customers and prospective customers. It's a real differentiator.
With that, I would now like to thank you and hand it over to David for his comments. David?
Thanks, Joe. Good morning, everyone and thank you for joining us today. For the fourth quarter of 2013 EMC achieved revenue and non-GAAP EPS growth of 11% and in the year in which IT spending was less than expected and several of the largest tech peers declined we achieved relatively strong topline growth of 7%, non-GAAP EPS growth of 6% and free cash flow growth of 10%. This increase in revenue for the full year reflects growth across the federation, as Pivotal grew 15%, VMware grew 15% and EMC Information Infrastructure grew at 5%.
Together this outperformance relative to the industry demonstrates the strength of our strategy. We are making the right bets, investing in the best technology and building the most complete portfolio to transition customers from the second the mobile, social, cloud and big data driven third platform of IT. As a result, we feel very good about where we are right now and where we go from here. The second platform of IT continues to support the vast majority of enterprise workloads and customers contained at these environments. We are a market leader here and we will continue to gain share in the second platform.
At the same time, we have more plays in the third platform of IT than anyone else and establishing this beachhead helps ensure on market leadership will extend far into the future. And we are better equipped than anybody else to help customers bridge the gap as they transition from second to third platform with technologies that like converged infrastructure, where we are the market leader, ViPR where we are unique in our ability to provide such far-reaching and sophisticated software defined storage and the software defined data center capabilities of the vCloud Suite.
While much of what we have been preparing for is playing out, no one can predict exactly how fast this transition to the third platform will occur. In 2013, we saw faster than expected growth from the technologies aligned with the third platform and slightly slower growth than we expected in offerings that are more associated with the second platform. That said, we achieved growth in all the major lines of our EMC II business and VMware in Q4 and in every major geography, and for the year, all our major lines of business performed right in line with the growth ranges we laid out for you last March.
As we look at our results this morning, I will talk first about the progress made by each of the three businesses within the EMC federation, with the business I head up EMC II coming last. I will then close my comments today by talking about the financial results of the federation as a whole.
Turning first to Pivotal and its differentiated software and services portfolio. In the nine months since formation, Pivotal met all the objectives we set out for the company in 2013. Pivotal managed financial goals, put a strong executive leadership team in place and launched an integrated technology platform in the form of Pivotal One. The face of Pivotal One, Cloud Foundry, is gaining momentum to become the standard for platform as a service with industry leaders such as GE, IBM, SAP, NCC, Intel, Symantec, Orange, Verizon and Swisscom all having committed to the Cloud Foundry platform.
With customers' desires to build out their new applications on more open standards and avoid vendor lock-in, we expect to grow this list to several times this number over the course of 2014. In addition to establishing Cloud Foundry as the industry-standard path in 2014, we are also concentrating our efforts on providing the software and value added services supporting our Pivotal One platform and big data analytic solutions.
Pivotal has the modern data and application fabrics that enterprise are looking for to build their third platform applications and we expect demand for Pivotal's offerings to grow over 30% in 2014. We also expect for Pivotal to start building a strong subscription-oriented license revenue stream in 2014, which will lead to reporting revenue growth being less than this 30% bookings growth expectation while also developing a strong deferred revenue balance by the end of the year. What is most important here is, market adoption as our storage, security, and VMware customers build out third platform technologies to drive competitive advantage for their business Pivotal is already proving to be an invaluable asset.
VMware also achieved its goal for 2013, as the virtualization foundation laid by VMware years ago is proving to be a solid platform for continued growth. The management and automation relations features that fully leverage the benefits of virtualization are in high demand. Management and automation will once again be VMware's fastest growing product group with management license bookings up over 40% for the full year. With his progress, VMware is setting the stage for the build out of the software defined data centers that we believe will become standard in IT over the next few years.
VMware's advanced management capabilities and long history of rock solid technology have established a level of trust with customers that is hard for competitors or build old solutions to match. This positions VMware well for success on every level, in software defined data centers to hybrid cloud to end-user computing.
VMware's success in each of these areas contributes to the success of the federation whole. ViPR, for example, will provide the major software defined storage component in a VMware SDDC environments. VNX, the most prevalent storage array behind VMware environments sounds to benefit from the growth of VGHS. XtremIO's largest use case is VDI.
VMware just double down in end-user computing with the acquisition of AirWatch, the world's largest mobile security and enterprise mobility management provider. With this acquisition, VMware is adding foundational elements to the end-user computing portfolio that will accelerate our strategy, enable us to deliver a complete and proven enterprise class solution for empowering the mobile workforce.
Now turning to EMC's information infrastructure business, where I will drill down into little more detail. EMC I, continues to lead with our portfolio of best-of-breed storage for traditional workloads as well as the third platform applications and thus data-driven security on content management solutions are increasingly mobile-first and cloud-based.
Storage revenue growth accelerated as expected in Q4 to 10%, bringing full-year revenue growth in storage to 4%. Q4 growth was driven by a smaller, but much faster growing emerging storage offerings and complemented by accelerated growth and what we believe to be continued steady share gains by our VMAX, VNX and backup solutions.
Our Emerging Storage products achieved revenue of $1.5 billion in 2013. Revenue growth for the products in this group accelerated in Q4 to 73% year-on-year, propelled by the very successful launch of XtremIO as well as continued strong growth of Isilon, Atmos and VPLEX. After less than two months in general availability, XtremIO has catapulted the market-leading position. By any measure, bookings or revenue, we believe XtremIO has comfortably surpassed every other old flash array because it offers incredible value, a powerful scale architecture outperforms the competition, incredible capacity utilization and efficiency technology with data services that are always on, the most consistent and predictable performance in the industry and it's easy to use and manage. This momentum is meaningful in a market as expected by industry research firm IDC to reach $1.2 billion in 2015.
Our scale out solutions also support third platform applications gain traction in the industry, the strong demand from Isilon scale out file and our Atmos distributed object storage solution continues. Service providers are increasingly accommodating massive amount of content for their customers and object storage solution like Atmos offer an ideal scale out platform to do this. In fact Atmos revenue more than tripled in 2013, large due to service provider demand.
Isilon is also in demand for new use cases. As we saw last quarter, use of Isilon for Big Data analytics is by far the most rapidly expanding use case. Much of this is on Hadoop and in partnership with Pivotal. Isilon has always done well in CME and continue to drive exceptional growth here in Q4 with demand up almost 40% year-on-year. At the same time, verticals more traditional to EMC like healthcare continue to rapidly adopt Isilon as well, with demand from this vertical up over 40% in Q4.
Our Unified and Backup Recovery portfolio revenue grew 11% in Q4 with the recent product refreshes in both, VNX and Data Domain clearly helping some here. Our Backup Recovery business finished 2013 with record-setting revenues for quarter and the year, with Data Domain commanding lead in the market for purpose-built backup appliances and growth in backup software that continues to outpace the market, our backup recovery solution are cleaning meeting the needs that competitors cannot. We believe our success is due to our ability to accommodate trends like VM Sprawl, the increasing mobility of users and sheer data growth to levels that make backup or protection more challenging.
We saw solid growth in our unified offerings in the first full quarter of availability of the new VNX. VNX is benefiting from industry trends towards flash and converged infrastructure. The MCx software on the new VNX enhances the value of flash in the array, as evidenced by the fact that over 70% of next-gen VNX is shipped with flash in the quarter compared with about 50% on the previous generation.
Converged infrastructures are increasingly popular consumers for VNX. VSPEX Reference Architectures, the technologies that our partners built around VNX technology have rapidly outpaced the competition. With demand growth in Q4 more than doubling year-on-year VSPEX has rapidly become the market leader in converged infrastructure reference architectures accounting for 45% of the market for these reference architectures.
This is according to industry research firm Gartner, who also recently confirmed that our share of integrated converged infrastructure systems is even higher. Built around VMAX or VNX with VMware and Cisco, Vblock share of this market is over 50%. Demand growth of Vblock from VCE exceeded 50% once again in Q4 and the most common storage systems inside Vblocks is VNX. With growth of these new converged infrastructure systems greatly outstripping that of the market for the individual components, we are confident that all leadership in converged infrastructure will help VNX and VMAX continue to gain share.
Our high-end storage revenue returned to growth in Q4 and grew 2% for the full year. VMAX continue to add new customers in the quarter primarily with the VMAX 10K. When it comes to mission-critical transaction oriented workloads with zero or extremely short recovery points and recovery time objectives, nothing else comes close. VMAX is the gold standard for the highest level of data services and predictable performance for the most highly prized data. The trust we have earned from customers encourage them to look at this first as they seek to build out next-gen infrastructures. Looking ahead to Q1, I will remind you that VMAX makes a tough compare against the revenue growth achieved in Q1 a year ago.
EMC offers a broad range of storage platform because it's important to have the right tool for the job and our new ViPR software defined storage adds even more value to this portfolio. The ease with which device control enables customers to consistently manage heterogeneous storage environments is an incredibly important value proposition. ViPR got off to a very strong start in Q4 having amassed almost three times the number of customers already targeted for the quarter.
No other storage solution on the market today can help customers bridge from the second to third platform the way ViPR can, with a simple extensible and open architecture that substantially lowers the cost associated with existing environments while accommodating new ones. We are fostering adoption and collaboration on ViPR by making the ViPR controller free to academia and for nonproduction use and easily available via a simple download.
The ViPR data plane provides the object, HDFS and other software defined storage data services that customers can run on existing arrays or on dense commodity hardware. With the recent addition of ViPR's Hadoop Distributed File System data service we drive even more value as ViPR HDFS used in conjunction with Pivotal will enable customers to build next-generation data legs and we have a very exciting roadmap for ViPR and ViPR related products in 2014.
Before moving on from storage, I want to point out how strong our portfolio is going in to 2014. We have our new VNX and new Data Domain systems, new XtremIO and new SRM and ViPR suites. We also have a strong product roadmap you will hear more about as we go through the year. The breadth and strength of our portfolio helps drive share gains in '13, and we are confident it will again in '14.
IT decisions today cannot be made without paying close attention to information security and RSA continues to differentiate EMC solutions across the stack with advanced data driven security. RSA's revenues accelerated once again in Q4 to 17% bringing full-year Revenue growth of 11%. Over 70% of RSA's revenue now comes from offerings other than SecurID and these offerings grew up over 25% in Q4. Security analytics, powered by big data is the next big thing in security and our Security Analytics products benefited from this trend in Q4, with revenue growth almost doubling from Q4 year ago.
Going forward, we see opportunities across the federation to leverage our infrastructure, virtualization and Big Data analytics technology to further harden customers IT environments.
Our Information Intelligence group grew 3% in Q4, driving positive growth for the full year. Our new vertical content solutions plus xCP and Syncplicity accounted for about 40% of IIG's license bookings in Q4, and these bookings grew approximately 50% year-on-year. IIG continue to innovate to meet customers' demand for technologies that work seamlessly in mobile cloud environments and we feel good about this transition to these newer solution sets.
To more effectively bring the full value of our offerings to customers, we are adding new capabilities to our EMC II go-to-market team. By developing new solutions for areas including, private/hybrid clouds, service providers and Big Data storage, with proposition guys tight use cases and software-oriented selling skills around areas like ViPR, we expect to continue to drive growth, particularly in new areas of the business.
EMC II services organization, which provides expertise around I product sets is becoming increasing engaged across the federation. In fact, the three largest wins in Q4 for our consulting business, leverage the investments we will be making to build out the full EMC stack, including the migration of customers' applications off-premise to our key service provider partners, the development of advanced analytics capability with Pivotal and VMware's cloud management capabilities over converged infrastructure to enable hybrid cloud in new application frameworks. We are also supporting a major enterprise that's moving from a public cloud to a new EMC powered private cloud for cost and privacy reasons.
Revenue from our service provider partner program continues to grow at several times the rate of our other industry verticals. This growth is being helped in part by VCE. Vblocks enable service providers to quickly introduce new services and easy scale services up or down as needed, value products that are instrumental to service provider success. In fact, four of VCE's five largest customers in 2013, are service providers buying Vblocks to run cloud services for their customers.
Our focus on supporting service providers and their cloud initiatives have positioned us well going forward, a great example of potential here is the reward of telco service provider partner accommodating one of their customers a large company with explosive content growth. The environment for this one customer alone already consists of thousands of VMs running on more on than 4000 physical servers 10,000 OS instances and more than 200,000 disk drives, delivering almost 1 Exabyte overall storage on dense commodity drives and we expect this customer will continue to grow from here.
Trends like software defined capabilities, converged infrastructure and hybrid and off-prem cloud will continue to grow and we are making significant investments in each of these areas across the EMC Information Infrastructure business.
Before I conclude my remarks of EMC II, I would like to take this chance to acknowledge my deep appreciation for the support of our customers, the commitment of our partners and most of all the dedication shown by the entire EMC II team.
Turning now to our consolidated financial results for the EMC federation. Year-on-year revenue growth in the quarter was 11% to $6.7 billion, supported by growth in all four of our major geographies, with North America up 11%, EMEA growth continue to accelerate to 15%, APJ up 1%, up 7% ex-Japan and Latin America up 12% from last year's fourth quarter. Our BRIC plus 13 emerging markets continue to grow faster than our average at 17%.
Looking at line items that drive our earnings growth, gross margins in Q4 improved from last quarter by 70 basis points, compared with Q4 of 2012 gross margins were down by 160 basis points. This is primarily due to storage, where gross margins were down by 200 basis points.
Looking at storage, it's important to note that storage product bookings margins were essentially flat year-on-year. While the pricing environment is tough, a mixed shift towards higher margin business in the quarter offset this pressure. The margins on revenue we achieved this quarter were impacted by the fact the bookings we were able to ship will low margin than last year.
Storage services gross margins were impacted by higher field service costs compared with Q4 of last year. While this was a headwind to most of 2013 because we expect a similar level of activity this year, the year-on-year impact to storage services margins should be neutral in 2014.
We continue to make major investments in new business areas including NSX, DCHS Pivotal, ViPR, ScaleIO, XtremIO and Project Nile. In with the investments, we are making the transition our business as the platform, we were able to control operating expenses which was down 150 basis points for the quarter and 30 basis points for the year. These good cost controls enable us to keep non-GAAP operating margins essentially flat for the quarter versus last year and down slightly for the full year.
Our tax rate for the quarter was consistent with last year's Q4, but came in lower than expected due to mix of international versus domestic profits. Nonoperating expense was up from last year principally due to interest expense on the new debt and was lower than expected due to more investment income and FX gains.
Our buyback program added $0.02 in the quarter versus last year. The net growth of the quarter's non-GAAP earnings per share was 11% over last year's $0.60.
Free cash flow for the quarter was $1.8 billion, bringing the full year to $5.5 billion, up 10%. We ended the year with $17.6 billion in cash and investments approximately $7.1 of which was U.S. based ex- VMware. In early January, we used $1.7 billion of this to retire our remaining convertible debt.
In 2013, we introduced a capital allocation framework that's returning value to our shareholders with 50% of EMC II's free cash flow going towards buybacks and dividends over time, with an accelerated buyback program for 2013 through 2015. As part of this program in Q4, we purchased $1 billion of EMC stock. This brings our EMC buyback to $3 billion in 2013, about halfway to our $6 billion target. We expect to spend $2 billion on EMC share buybacks in 2014.
We have also generated very attractive ROI on our acquisitions. Examples include VMware, Data Domain and Isilon. We have recently acquired key earlier stage companies including XtremIO, Nicira and the companies that make up Pivotal and we announced the pending acquisition of AirWatch, each of which we expect to produce great ROIs in the future.
As we look ahead to 2014, we expect IT spend growth and storage growth to be broadly similar to what we were in 2013. So both 2013 and 2014 are expected to be slower spending environments than we anticipate at the start of last year. However the macro trends in IT that we discussed are playing out pretty much as we expected and EMC is extremely well positioned to help customers optimize and modernize their second platform environments, implement leading-edge third platform solutions and bridge from second to third.
The accelerating transition in IT means that our higher growth markets are poised to grow faster than we expect a year ago and the growth of our more mature markets will be lower than we expected a year ago. With this in mind we expect revenue of $24.5 billion, up 6%, year-on-year, operating margin roughly flat with last year, non-GAAP EPS of $1.95, up 8% year-on-year and free cash flow well in excess of the $5.5 billion we generated in 2013. As is our custom, the exact free cash flow target will be set at our upcoming board meeting. Note that these expectations do not include AirWatch which would add approximately $75 million in revenue and cost approximately $0.05 of non-GAAP EPS for 2014.
As you are aware, last year we shall extremely high volumes of orders coming in on the last few days of the quarter. Since this does seem to be the new normal in customer purchasing patterns, we are making permanent changes to our business practices to mitigate the impact of this hockey stick and reduce our dependency on late orders. These changes will reduce the extra inventory and factory costs incurred by trying to shift such a high value orders in such a short amount of time and also improve our revenue predictability in the quarter. While this will not affect revenue growth for the full-year, this will change the normal flow of our revenues within this year with Q1 being about a point lower than normal at 22% and Q4 a point higher. This will also affect EPS and we expect to earn about $0.35 per share in Q1 before AirWatch which would cost us about $0.01 in Q1.
With IT spend of the 3% we were modeling on a revenue growth an expected growth in 2013 and 2014, lower than we were expecting when we met with you last March, will be revising our 2016 revenue growth target and will update you on this on our next strategic forum.
Having said that, the strategy we discussed on the 2013 forum hasn't changed and we continue to make significant investments across our business in new and high-growth areas. We continue to expect to grow faster than our IT peers and faster than IT spending.
In closing, we are excited about all we can accomplish in 2014. Given our position and strength, we are working with a very large installed base of loyal customers with leading-edge technology for every layer of the IT stack, products and services for the infrastructure layer that include best-of-breed storage arrays, software defined storage, converged infrastructure and information security.
Solutions for virtualization layer that enable the software defined data center, hybrid cloud and end-user computing, with over 40 million virtual machines powering the world's large organizations, and a cloud agnostic platform as a service offering in less than a year has become the PaaS offering of choice for enterprises looking to build out next-gen apps to harness the power of Big Data. This combination gives a strong play in the second platform which will continue to support the [enterprise] workloads for several years to come, leading technologies and product as a service platform and a powerful capability to bridge the gap between the two.
With that I will turn it over to Tony to moderate the Q&A. Tony?
Thanks, David. Before we open up the lines for your questions, as usual we ask you to try and limit yourself to one question, including clarification. This will enable us to take as many questions as possible. We thank you all for your cooperation in this matter.
Sandy, can we take the first question please?
Thank you. Our first question is from Amit Daryanani of RBC Capital Markets.
Amit Daryanani - RBC Capital Markets
Thanks a lot. Good morning, guys. I have a question just around the March quarter guide. I want to understand if that actually includes the $100 million to $120 million of restructuring initiative that you guys have talked about today. If so, what sort of payback are you expecting out of this initiative? When do you expect those savings and it is naturally the driver of the changes you talked to proven the backend loaded nature of the quarterly you have experienced in 2013.
Amit, this is David. Let me take that. Good morning. Think of the restructure as more of rebalancing activity, very similar to what we did last year within EMC information infrastructure. As we continue to move more of our people into the third platform R&D part of the business, we have had to go - reduced resources, some areas build the resources in other areas.
Last year when we did this, we actually wound up with about 2,000 people more at the end of the year than we start off with. This year we expect to probably end the year flat or slightly up in EMC information infrastructure. Just think of it as rebalancing rather than a year restructuring. The impact of that is backed into the Q1 guide. That is not related to what I told about in terms of the quarter end business practices. The quarter end business practices, which has really impacted Q1 revenue guide is the fact that we are changing the way we want to run the factories at the quarter end, reduce our inventory levels, reduce the amount of overtime, expedite shipping costs et cetera, which will result as a byproduct in a higher volume of orders we cannot ship during the quarter will set a higher definitely backlog and that higher backlog is a results of the new business practices what is driving the Q1 revenue guide. To tie those two back together, there is probably a little bit of the year rebalancing charge that ties to that, but only a minor, minor part.
Amit Daryanani - RBC Capital Markets
Got it. Thank you.
Next question please?
Thank you. Your next question is from Alex Kurtz of Sterne Agee.
Alex Kurtz - Sterne Agee
Yes. Thanks for taking the question. David, just looking at the Q1 guide and thinking about the year here, you are trying to factor your new strategy on a month-three kind of practices versus the broader concept of a product refresh and VNX XtremIO and potentially a refresh of VMAX. I mean, historically those have been catalyst for product growth and I am trying to understand why Windows help the first half of the year balancing that against your guidance here?
Alex, that will help. What we have is this effect, so the new products are definitely going to help us from an order flow point of view going through the year. As I mentioned, we entered year this year with a really strong portfolio, I would say stronger than the same time last year. That's going to help in the absolute sense and also help with just taking share during the year, but again the factors that we are talking about are going to drive us with a higher percentage of orders that we cannot ship during the year.
Particularly in Q1, you will see the impact of that. but I will point out this will not impact the full year because the business practices that I am talking about are actually the way that we end our fourth-quarter anyway. So said differently we are applying some of the ways that we close our fourth quarter where we do not try and ship everything that comes out in the last few days over the quarter and we are taking that practice and applying it to the other three quarters of the year.
So that's why you see the seasonal impact occur in Q1 but not impacting the revenue guide for the full year. So back to Q1, the reason for difference in the revenue level from an average to the actual guiding numbers is related to with this change in business practices and you are right, we will see some benefit from order flow during the quarter that will be masked by business practices change in revenue.
Alex Kurtz - Sterne Agee
Thanks, Alex. Next question, please.
Thank you. Your next question is from Keith Bachman of Bank of Montreal.
Keith Bachman - Bank of Montreal
Hi, David. I wanted to see if you could revisit on the gross margins in Q4. I wasn't entirely clear about why gross margins were down and what we heard was it was a bit more aggressive than normal this quarter in terms of pricing. So if you could address the storage products. And within the context of answering it, again why gross margins are down, could you speak to against the backdrop of your operating margin target for calendar year '14 to being 25%? How should we think about gross margins in calendar year '14, both on a consolidated level and at the storage products level? Thank you.
Hi, Keith, always you have multiple thoughts there. But let me provide some type of aspect because I am sure that will come out at some point in time during the conversation this morning. So let me recap. The reason why gross margins were down in Q4 was related to the storage business. There were two factors that impacted the storage business.
The first is storage product margins. Very important to understand, that the booking margins, so the margin we got on the orders that we took it was essentially flat year-on-year in the fourth quarter. So we did see some pricing pressure but relatively offset of that out with positive mix towards our software and higher margin products. So our booking margins was flat. This is the most important point.
The reason why the revenue margin was down is, of those bookings the revenue that we took, of those booking that we had revenue this quarter, the mix of those was lower margin than the bookings we took to revenue last quarter. So you saw essentially flat bookings turning to lower revenue margin because of the mix. Ergo, we obviously had higher margins in backlog exiting this year, last year we did exiting 2012. That's what was the really major driver.
Now the other driver of margins is what's been happening all year in the services business. We mentioned to you on a few occasions that in our maintenance business, we had a high-level of field service activity due to components out there in our products which just brought margin down on services. So that's the storage issue. Now fast forward into next year, n what we expect at the EMC II and therefore at the storage level is approximately flat gross margins for a couple reason.
One is that year-on-year those service activities are expected to normalize out. And then, if you think of the things that impacted us this year on the product side, it's the higher quarter in closing costs and we have taken steps to impact those. Then of course, we got the issue that impact us in Q4 doesn't really drive a huge amount of change for the full year in 2014.
So were expecting going forward in 2014, at the II level, relatively flat gross margins, relatively flat operating margins and at the consolidated level, due to the mix shift towards VMware, expecting both gross margins and OpEx to be up slightly and giving us a slight boost in operating margins.
Keith Bachman - Bank of Montreal
Thank you, David.
Thanks, Keith. Next question, please.
Thank you. Your next question is Shebly Seyrafi of FBN Securities.
Shebly Seyrafi - FBN Securities
Yes, thank you. So your guidance for the year, $24.5 billion, I it is below the consensus of $25 billion. You seem to indicate that you are going to be below your prior plan because of these core inventory balances in Q1, but, make up for it in Q4. But it seems to be that if you look at or if you take VMware's guidance last night and make reasonable assumptions on II and Pivotal and security, it seems like the storage revenue growth which was about 5% per year in 2012 and 2013, is going to decelerate to like 2%. So it seems like fiscal Q4 won't make up for the below expected result in fiscal Q1. I am wondering if there are other factors explaining this. Are you seeing the storage market slowing down because of the movement to the cloud and other factors? Are you in fact saying or believe that your storage segment will decelerate to roughly 1% to 2% from 5%?
Let me talk about that. The historic numbers for the storage segment are correct was in 2012. It's actually 4% in 2013, and the guidance is based upon a 3% number in 2014, not the 2% number which you mentioned. You have to make some adjustments from VMware down low into VMware and EMC et cetera to get to the numbers together.\
Relative to what's happening, we are as I said, expecting IT spend growth and storage spend grow to be relatively similar to what they were this year, so market conditions relatively are the same. The reason for a slight deceleration in the storage business growth in 2014 is really here to rebalancing of the revenue growth rates between product and services.
The last couple years we have been really maximizing the potential of our installed base from a maintenance point of view. You have seen services revenue grow a lot faster than product revenue, so for example in 2012 you saw a wide discrepancy between those two. As we go forward into 2014, we have really capture the opportunity. We expect those rates to up to normalize, so the product revenue growth across those for years actually relatively consistent and that's really the biggest reason why you are seeing a slight deceleration in 2014 versus 2013 in the storage business.
Next question please?
Thank you. Your next question is from Brian Marshall of ISI Group.
Brian Marshall - ISI Group
Great. Thanks, guys. It seems like the last couple of quarters we have had a little bit difficulty kind of forecasting sort of intra-quarter metrics. I mean, in September, it was obviously mix related and some push outs into the December quarter. Then this quarter obviously the margins with respect to what was shipped and actually what was booked seem to be half by decent amount.
Can you talk about any action that's possible with respect to quarter end business practices at accompany that alleviate some of these anomalies that we have seen over the past six months? Thanks.
Brian, that really comes back to the first thing I talked about in terms of changing our quarter end practice, particularly relative to quarters one, two and three. Basically, having a more measured quarter end process, where we are not carrying as much inventory, we are not having as much factory overtime, we are not as dependent upon shipping its high percentage of orders coming into the last week as we used to be. That should help, cost should help with predictability. That really is the change that we are making.
Now as I mentioned and you said this being a factor in Q4, we are not changing our Q4 end of quarter, because we carry more meaningful backlog at Q4 end, but we do believe that as we implement these new processes, we are going to actually take a lot of stress out of the system and make the results in the quarter much more predictable.
Let me just add a little color. This is Joe. If you looked at this time of the year and going back to 2012, the analyst expectation for growth for macro IT was 3% to 4% and it ends up doing a tick below 3%. If you go back a year, the analyst expectation for 2013 was 3%, we did about 2%. Now this year, it's the analyst expectations of 3% to 4% and we are still staying at 2%. We are going to stay at 2% until we see the lights in the market. Why? Because, there's little bit off the last two years. That said, I personally see more upside to that 2% that we are calling than downside, which I probably would have said the last two years.
What David said is - and exactly to the point you are making, we just have to get - it's going to be very good for business with David's leading it to build bigger backlogs, so our bookings rate and our revenue rate will not be the same as it's been pretty much in the last few years. We are going to try to keep more bookings which basically let us have more efficiency and I think more predictability in the business and I think you as investors and people that watch us will be happier as we get into that trend. Obviously you are going to take some medicine and that's what we are telling you we are taking and I gave you my view on the market growth and forecast and we are viewing it the fact that I see more upside to that 2% than downside.
Brian Marshall - ISI Group
Thanks for the question, Brian. Next question please?
Thank you. The next question is from Kulbinder Garcha of Credit Suisse.
Kulbinder Garcha - Credit Suisse
Thanks. I want to just kind of go back to that previous point. This question is for Joe and David, I guess. Going back to the issue of just the product revenue growth being around 3% this year, David. I guess you said at various points that you are very confident about your product portfolio. If I think about 2014, VNX2 was slightly delayed. It sounded like it will have full year impact this year. You have got the impact of XtremIO which seems to be going quite well. On top of that you are going to probably have a refresh, I imagine, in the middle of the year, to several of your product lines. So why can't you gain more share than that revenue growth implies? Are you being very conservative? Or have you thought about he the capacity to gain shares? And I am thinking about that in the context of the comments you made about pricing environment. It sounds like it's a bit more challenging than it maybe have been for a few quarters. Many thanks.
Yes, Kulbinder. We are taking a conservative view of what we think the market growth will be and we expect to gain share against that market. Obviously there are a number of things in our favor. Our product cycle is very strong. We also recognize that CIOs right now are being very cautious in their spend. Joe talked about the real challenges that CIOs are facing in terms of trying to figure out how they are going to play in the third platform which is still in the early innings, how they really get cost out of the second platform while drive efficiency in the second platform infrastructure. So what we are seeing is a little bit of a pause in the market as people work through how this transition impacts a lot of their spending and more people are spending just enough and being a little bit cautious about rolling out quite as many big projects as they used to. So we really are factoring what we are seeing in the market and the dilemma that the CIOs are facing into our thoughts about how the year might in fact play out.
So we are taking a conservative view of IT spending. We are taking a conservative view of how rapidly people spend in both existing areas and new areas. Of course, we have a got a lot of things going for us. It's not by accident we gained a lot of share in 2013 in storage. We gained share because we built the strongest portfolio, the most complete portfolio with a market-leading converged infrastructure and those are the reasons why we gained share. The best go to market team out there is our services team. And those things are all factors for us in 2014. So we are confident. We are just being a little bit cautious about the spending environment.
I think you look at it, you know, that we are just cautious but prudent also. If you just look at Q4, we just grew topline and EPS at 11% and you look at our peers across the industry. There is just nobody doing that and then basically we told you in the revenue, we took a richer, there was a richer mix of margin that was taken into Q1 in 2014. You look at our new businesses, right. The stuff we do sell totally in, what we term as platform three, that has a $2 billion run rate that had 70% growth, right. Look at the value that those kind of companies are getting in the marketplace today. We are in a great position. It's basically, we are just going to get a more rational operating model which I think will pick up profit and make us more predictable going forward, which I think the investors are going to like. We just have to transition to that but I am very optimistic about 2014 and our opportunities. We are much more relevant. The conversation we are having with customers are much more relevant and strategically relevant than it has ever been in the past. So we are positioned very well.
Thanks, Kulbinder. Next question, please.
Thank you. The next question is Ben Reitzes of Barclays.
Ben Reitzes - Barclays
Yes, thanks. Joe, obviously you can't really talk about before you do it, but in terms of what you laid out in the beginning, what does that say about EMCs acquisition strategy? And as you balance the cash returned to shareholders versus the gaps in your portfolio. Sometimes in the past, you have actually been pretty forthright saying that you need some things in security or some other areas and I was just wondering if you could give us some color on what EMC's acquisition strategy might be as you attack those opportunities and try to revive growth, obviously outside of AirWatch with VMware which we already know about and how you think about that? Thanks.
Look, we are in a market where the vast majority, probably 90%, of the growth going forward is going to be VMware we term it platform three. And I went through all the assets, I won't do it again, I will spare you, that we have that's relevant to platform three inside EMC II, inside our security business, inside VMware, inside Pivotal and the way we are playing that together and the way we are giving customers choice. That's where we are gong to make investments. I am not a big believer in defensive investments
We are also making a really - make sure we return cash to shareholders and continue those programs and we got a good balance and that's where I am spending a lot of my time, you know, spending a lot of my time on strategy and strategic alignment across the businesses, on talent acquisition, on capital allocation, on M&A and obviously a lot of times I always do with customers and I really can't as you as you predicted answer your question directly, but I would kind of give you a feel for kind of the way I am thinking a little bit and which is the company is thinking.
Ben Reitzes - Barclays
Okay. Thanks a lot.
We have time for one more question and then a few concluding comments from Joe.
All right. Thank you. Our final question is from Scott Craig of Bank of America Merrill Lynch.
Scott Craig - Bank of America Merrill Lynch
Thanks. Good morning. Can you just talk about the restructuring and how you think about dropping the savings to the bottom line and maybe sort of quantify the savings as opposed to reinvesting in a business for growth and how that sort of plays out on a linearity basis as you look through the calendar year? Thanks.
Yes, Scott. Thank you. As I mentioned a little earlier, really think out rebalancing activity. We talked about the two transitions from second platform to the third platform and it's basically part of helping to fund the investments we are making in the third platform, so it is rebalancing all activities. It's not a of restructuring for just sake of getting cost out. We are going to reinvest those savings back in the business to support many of the third platform initiatives that we talked about. It's very similar to what we did last year, making clear for our EMC II, what we are doing this year is almost a mirror image of what we did last year in terms of the size of the rebalancing charge we are going to take in the first quarter, the amount of our rebalancing we expected to do during the year, so it really is a wait to fund.
The reinvestments we are making in the business in the new areas and as we talked about before, the areas are either growing exceptionally quickly or have great potential, so we think it's a very prudent thing to do again it's rebalancing and both restructuring.
Scott Craig - Bank of America Merrill Lynch
Okay. Thanks for the clarification.
Thank you all again for joining us. I truly believe across our family of companies, we had a really solid close to 2013. As I said, our strategic relevance with customers is very high and never been higher when customers take their kind of (Inaudible) what companies they want to look and we are on those lists consistently now. We have technologies and the people will help customers balance to help our CIOs the customers balance that basically make sure they optimize what they have today and build the bridge in a journey to the future in the third platform.
We have that all important momentum and we have a great team to execute on it, so I really appreciate you being with us today and thank you for your confidence in us and we will be talking to you. Thank you.
Thank you for your participation. That does conclude today's conference. You may disconnect at this time.
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