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EMC Corporation (NYSE:EMC)

Q1 2010 Earnings Call

April 21, 2010 8:30 am ET

Executives

Tony Takazawa

Joe Tucci - Chairman and CEO

David Goulden - Executive Vice President and CFO

Analysts

Aaron Rakers – Stifel Nicolaus

Ittai Kidron – Oppenheimer

Ryan Hutchinson – Lazard

Mark Kelleher – Brigantine Advisors

Ben Reitzes – Barclays Capital

Maynard Um – UBS

Brian Marshall – Broadpoint

David Bailey – Goldman Sachs

Kevin Hunt – Hapoalim Securities

Toni Sacconaghi – Sanford Bernstein

Daniel Ives – FBR

Brian Freed – Morgan Keegan

Kaushik Roy – Wedbush

Bill Shope – Credit Suisse

Katie Huberty – Morgan Stanley

Operator

(Operator Instructions) Now, I will turn the meeting over to Mr. Tony Takazawa.

Tony Takazawa

Welcome to EMC’s call to discuss our financial results for the first quarter 2010. 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 EMC’s activities this quarter and discuss our updated 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.

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 US 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 Goulden

I’m pleased to report that EMC started the year with very solid results in Q1 with revenues of $3.9 billion up 23% from Q1 ’09, non-GAAP EPS of $0.06 up 63% and free cash flow of $1.1 billion also up 63%. These results speak to the strength of our leadership position in some of the most important areas of IT and to the power of our operational model.

We clearly executed on our triple play. We gained market share, we invested for the future and we improved profitability. We’re confident that we will continue to execute in all three of these areas going forward.

Within these numbers, each of our two businesses had excellent results. Our EMC Information Infrastructure business had a great quarter with $3.3 billion in revenue up 22% year on year and $0.21 of non-GAAP EPS almost double our EPS from last Q1. VMware also had a great quarter contributing $632 million of revenue up 34% year on year and $0.05 of non-GAAP EPS to EMC. Customers are increasing recognizing that VMware is the strategic layer on which to build their next generation cloud data centers.

I’ll start off this morning by making some comments about the Q1 spending environment, why EMC is thriving and then I’ll discuss some details from our Q1 results. There are three major factors contributed to our excellent revenue performance this quarter. First of all, based upon what we saw in the marketplace, we think IT spending looks to be on track with what we’ve been expecting, up around 3% to 5% this year. In addition, customer activity and commentary is consistent with the view that our addressable market will be up around 6% to 8% this year.

A second factor this quarter was the continuation of some pent up demand that we saw in Q4. EMC Information Infrastructure business the strength is concentrated in the US storage business especially in financial services. While it’s difficult to quantify it was certainly a positive. As a result of these two factors, we think growth in IT spending and our target marketplace in 2010 will end up at the higher end of our projected ranges.

Third, and most important, we expect to gain a significant amount of share this year and it seems pretty clear we’re off to a good start in this regard. EMC grew faster than our target market for a number of reasons including our expanding role as a trusted partner with customers, our leading technology in several of the hottest areas of IT today, our proven support and service to back up the technology, and our compelling vision and ability to execute on this vision.

As a result, we’re increasingly the best guide for customer’s journeys to private cloud and we believe this competitive advantage is the major factor enabling us to show strong growth and gain share. And it positions us well to continue to gain share going forward.

Given this unique combination of strategic market and technology advantages we now anticipate 2010 consolidated revenues of $16.5 billion up 18%, non-GAAP operating margin of 20% to 21% and non-GAAP EPS of $1.18 up 31% from last year.

Now let’s take a closer look at some of the financial highlights from the first quarter. As I mentioned, EMC Information Infrastructure revenues were $3.3 billion up 22% year on year. Non-GAAP earnings per share for EMC II were $0.21 up 91% from last year. Free cash flow was a very strong $819 million up 66%.

Within these overall numbers, strong demand for our Information Infrastructure products generated revenues of $2.2 billion up 27% from last year while Information Infrastructure services were $1.1 billion up 13%. The fact that products were so much better than services is an encouraging sign that customers are moving forward with their infrastructure investments.

EMC Information Infrastructure operating performance for the quarter was also very strong. Non-GAAP gross margins were 53.4% and non-GAAP operating margins were 17.8% in Q1. These substantial year on year improvements stem from higher volumes, a better prospects and the measures we’ve taken to lower and streamline our cost structure.

Looking at the revenue results from each of the businesses within Information Infrastructure, Q1 Information Storage revenues were $2.9 billion up 24%. As always, information growth continued to be a key driver. We also saw customers beginning new projects in their existing traditional infrastructures. I looked at both of these was continued growth in the number of customers that are moving to virtual data center infrastructures. All three of these drivers benefited us in the quarter as EMC is a trusted partner not only for customer’s requirements today but also going forward as they embark on their own journeys to a private cloud.

In the high end, Symmetrix product revenues were up 28% year on year. Our V-Max transition is essentially complete. Customers are eager to benefit from its more efficient flexible and cost effective technology and we’re clearly gaining share. Today’s applications required architecture scales with their business needs.

In Q1 one of the largest software companies in the world chose V-Max for its ability to scale capacity and performance and to support critical online applications. The combination of proven reliability along with cost effective storage tiering utilizing fiber channel, solid state, and stated drives provided this customer with the best value.

Now turning to the Mid-tier, over the last few years we’ve seen a shift in the way customers utilize mid-tier storage. The rapidly changing business environment in this tier increasingly requires the adaptability of multi-protocol systems and growing virtualized serve environment intensify the need for these dynamic storage capabilities.

As a result, customers are increasingly looking for mid-tier storage that’s capable of supporting multiple information types and communication protocols. We have been lock set with customers throughout this transition. For years we’ve been the technology leader in the mid-tier for these capabilities and we began to combine some of them when we introduced our market leading unified products in 2006.

While we haven’t previously disclosed our overall mid-tier revenues today we’re expanding our reporting to help you track our progress here. In Q1 our mid-tier storage product revenues were $800 million and grew a very robust 32% year on year. This amounts to a $3.2 billion annualized run rate from our mid-tier product revenues alone. This annualized number is quite conservative as it does not include support, updates or other services revenue and is being annualized based on our seasonally smallest quarter.

We gained share in the mid-tier due to the breadth and depth of our portfolio and the world class service and support to back it up. Let me give you a couple of examples from Q1 of how we’re winning in this space. A large medical services company was looking for unified storage, replication, disaster recovery, backup and recovery, the duplication and path managements. We won this multi million dollar deal again NetApp on the strength of our mid-tier portfolio as well as our replication and recovery capabilites within the customers clustered VMware environments.

Another win was a global online content services provider who selected EMC over NetApp for a couple of reasons. EMC’s superior role to usable efficiency resulting in lower total cost ownership and compelling duplication and VMware integration.

Our relationship with Dell strengthened in the quarter and we were pleased to announce an expansion of our partnership to include additional mid-tier products. Channel partners including Dell are extremely important to our ongoing success in the mid-tier and we’re very focused on expanding these partnerships.

Our efforts here have really paid off as EMC was recently named 2010 CRN Channel Champion. Channels were a big contributor to our mid-tier business at approximately 75% of our mid-tier product revenues in Q1.

It should also be noted that our mid-tier revenues are more weighted towards the high end of the mid-tier markets. We’re excited about the opportunity to expand our footprint into the faster growing low end of the mid-tier and are mobilizing the people, investing in the products, and engaging the partners to make this happen.

Our success in the high end of the mid-tier is driven by our ability to satisfy customer’s needs today no matter where they are on their journey to the private cloud. EMC has been leading the charge on most of the important new technology and information infrastructure today. These include virtualization data centers, SSDs and automated storage tiering, and next generation backup and recovery.

As our biggest most immediate and most important growth opportunity, the evolution to fully virtualized data centers is where we’re focusing the majority of our efforts. Fundamental to the virtualized data centers is the creation and integration of virtual servers and virtual storage infrastructures. Clearly we are far and away the leader on the service side with VMware. In addition, our unique vision around the virtualization of the information storage infrastructure is resonating with the industry and you can expect to hear more from us soon on how we’re going to make this happen.

We also continue to lead the charge in virtualization infinity across our product set both directions. In other words, we are unique in being able to see and manage from storage to virtual machine and from virtual machine to storage and the connections continue to grow. These capabilities are key to new way of thinking about data center design and no company is as well positioned as EMC to help customers.

Our fully automated storage tiering software, known as FAST completed its first quarter availability in Q1 including double digit penetration rates in the high end. Customers clearly see the value proposition of having the right data in the right place at the right time. Turning this advanced capability into a feature across our fall solution set further extends our competitive advantage as customers prefer to buy from a partner with a comprehensive solution as opposed to buying point products.

Our backup recovery systems business performed ahead of our high expectations. In fact, Data domain and Avamar each accelerated over 100% growth in the quarter. The synergy between these two is key to the acceleration here and these businesses are certainly growing faster than any other duplication technology in the markets. It’s great to see this business systematically capitalize upon opportunities worldwide over EMC’s existing accounts and with net new customers as well.

In other storage areas, online backup solution Mozy continued its strategy in the quarter to build its customer base via service providers, adding Comcast to an already long list of partners. Iomega continued to thrive on the unrelenting demand from customers wanting plug and play storage for all their media types. In addition, we’re seeing increased demand from small and medium businesses that want easy to use network storage.

In sum, EMC storage business in the quarter outperformed our expectations due to our ability to provide leading edge technology in a comprehensive solution that is supported by our world class of services organization. There is no vendor with a broad and innovative technology solutions set, the depth of experience and a proven track record to provide information infrastructures that can safely and securely transition customers data centers at their own pace to private clouds.

Our RSA security revenues in Q1 were $161 million up 13% year on year as information centric security remains a key customer priority. There are several noteworthy events for RSA this quarter including RSA annual marquee security conference and the acquisition of Archer. Delegate’s attendance at the RSA conference was up 25% from last year attesting to the growing importance of IT security. The addition of Archer’s governance, risk and compliance technology complements our existing DLP and envision S-I-E-M tools to create one security management platform. The resulting level of visibility shines a welcome security and compliance spotlight into both physical and virtualized environments.

In addition, in Q1 RSA Archer, VMware, and Intel introduced a concept for compliance security and control down to the most fundamental layers of multi-tenant virtualized infrastructure. This is an important early step to help accelerate the growth of x-general clouds. With the addition of Archer, RSA is now the leader in every area in which it competes; authentication, IT GRC, DLP, S-I-E-M and web fraud detection.

Revenues from our concept management and archiving division in Q1 were $178 million up 2% from Q1 ’09. We saw increased customer activity with new license growth up 8%, a higher number of big deals done in Q4 and a strong pipeline exiting Q1. Our XEP composition platform for management which is unique in the industry, is garnering a lot of customer interest. In fact, a major European national health system has standardized upon XEP for its health records.

A sharper focus on partnerships is also expanding CMAs growth opportunities in 2010. These include our recently announced partnership with FatWire to improve web content management as well as a new relationship with SAP to provide a number of SAP focused ECM solutions, the first of which we plan to announce in the next few weeks.

EMC’s global services business once again showed strong results in the quarter with revenues up 13% over last year’s Q1. Our professional and technical services are doing well and our consulting business continues to outperform, benefiting from customers transitions to virtual data center architectures. In fact, EMC consulting expertise was key to winning the first phase of a long term collaboration with a 4100 defense contractor to accelerate transformation of their data centers to a service oriented private cloud model. Such an undertaking requires deep expertise in cloud strategy and architecture as well as the infrastructure products that are being purpose built for such environments. This is why they chose EMC.

Our partnership with Cisco continues to gain momentum. In Q1 our VCE coalition was up and running. Its focus on helping customers accelerate their move to cloud infrastructures has really struck a cord and interest has been outstanding. Customers are already in production with V-Blocks and will soon be rolling out a lower end version of the V-Block. Over the next few months you will see exciting announcements from both systems integrators and service providers leveraging the work of this coalition of best of breed technology companies.

Now turning to a few highlights from our consolidated results; including both our Information Infrastructure and Virtual Infrastructure businesses. As I mentioned, the EMC Information Infrastructure business has revenues of $3.3 billion, non-GAAP operating margins of 17.8%, and contributed non-GAAP EPS of $0.21 and free cash flow of $819 million. The VMware Virtual Infrastructure business had revenues of $632 million, non-GAAP operating margins of 28.1%, and contributed non-GAAP EPS of $0.05 and free cash flow of $291 million.

Together our two businesses had total Q1 consolidated revenues of approximately $3.9 billion, up 23% year on year, non-GAAP operating margins of 19.5% and non-GAAP earnings per share of $0.26. Free cash flow was $1.1 billion, $561 million higher than Q1 non-GAAP net income. These consolidated results represent the combined power of Virtual Infrastructure and Information Infrastructure. Together we’re moving forward on a shared vision and strategic direction. Additionally, through complementary efforts we’re increasing affinity between the Virtual and Information Infrastructures.

This strategic alignment positions us well to execute our triple play to gain market share, to invest in the future, and to improve profitability. As you can see, from our revised 2010 revenue growth guidance of 18% we intent to grow substantially faster than our target market in gained share.

Second, we’re investing for the future. We continue to plan to expand our R&D spend by 20% over last year and we’re further adding to our sales capability worldwide, particularly in emerging markets and the commercial and S&B markets. We now plan to implement a broad base annual compensation review to reward and retain our workforce which has been outstanding throughout what has been a very challenging period.

Third, these increased investments; notwithstanding, we expect to further improve profitability. We now expect consolidated non-GAAP operating margin for 2010 to reach between 20% and 21% representing a substantial increase over the levels seen from the past several years.

Now a few housekeeping items. Currency added 240 basis point to the year on year revenue growth on a consolidated basis. The Q1 non-GAAP tax rate was 22%, higher than expected as renewal of the US R&D tax credit has not yet been passed. We still expect our full year non-GAAP tax rate to be around 20% as we project the tax rate will occur later this year, possibly as lat as the fourth quarter. Q1 consolidated operating cash flow was $1.3 billion up 53%. The improvements generated these strong results include better revenues which were $4 billion, inventory turns which were eight times, and DSOs which were 40 days.

Due to the improvements in our stock price we now expect our fully diluted share count for the year to be around 2.15 billion, the difference from the 2.12 billion we disclosed in January is primarily due to the impact of our convertible debt.

We ended Q1 with $10.2 billion in cash and investments; of this a total of $6.2 billion was held in the US with the remainder overseas. In the quarter, we used $176 million of our cash to buy back 10 million shares of EMC stock and spent approximately $290 million on acquisitions.

The program we announced last month to maintain our position in VMware as an approximately 80% majority ownership underscore the important of VMware’s role in the EMC’s strategic direction. We believe maintaining EMC’s ownership in VMware at this level enables us to continue to achieve our original objectives for the publicly offering this stock and also maximized for EMC shareholders over the long term. To this goal, EMC purchased approximately $100 million of VMware stock in Q1.

Now looking at our best of breed technologies portfolio our long standing presence in data centers worldwide and a customer trust we have earned, we believe there is no company better positioned to guide customers along their journey to their private cloud and there is no doubt that’s exactly where customers are heading.

As this recent survey shows, almost every single CIO spending priority this year is either on technology imports customers on the path to the private cloud or is a benefit of having a private cloud. The first step to building a private cloud is server virtualization and capturing the full benefits of server virtualization requires advanced automation and management capabilities designed for these environments. This is where VMware stands alone.

Customers are embracing the new security paradigms that are necessary for private cloud infrastructures to proliferate. As you saw in the quarter, EMC, RSA and VMware are working hard together with partners like Intel on approaches to information centric security that will accelerate the adoption of private cloud infrastructures.

Customer interest in cloud computing is really picking up. At EMC our strategy to bridge internal private clouds and external public clouds is spot on.

The ability to virtualize storage infrastructure enables the necessary new remote computer models required for private clouds. EMC has introduced several innovative new offerings in this space and in the very near future will introduce virtual storage technology that will enable customers to use distance as an asset rather than see it as a constraint.

The need for desktop virtualization is gaining momentum. A virtualized foundation like V-Sphere on the back end enables the scalability and seamlessness of use that are critical to a successful enterprise roll out of VDI.

On priorities like labor optimization efficiency and green computing all of these are byproducts of operating a private cloud infrastructure.

All this indicates is that customers are quickly discovering that the key to a competitive edge they need to do things differently to transform the aging traditional infrastructures into the more cost effective agile new models for IT that are now possible. EMC and VMware together are leading the charge in making these new compute models a reality. No other company has the proven or market leading technology, services, and support that we do. No other company is as squarely aligned to these priorities and no other company has a vision and ability to execute on this vision.

I’ll now turn the call over to Joe.

Joe Tucci

Overall I was very pleased with our Q1 results. In fact, this Q1 was the best first quarter in EMC’s history. We had record Q1 revenues, record Q1 net income, and record Q1 free cash flow. I might add, these results mark the second consecutive quarter in which we announced record quarterly results, proof that our strategy, coupled with our focus and strength in storage, virtualization, security, and information and content management is resonating very well with our customers.

Clearly, at an apple to apples year on year growth rate of 20% this Q1 we are growing significantly faster than the markets we serve, in other words we are taking share. As always, what propels any company in any industry is excellence in execution. To that end I would like to thank the more than 43,500 people of EMC and VMware across the globe for their dedication to our customers, for their skill, hard work, and teamwork they exhibit every day. Congratulations to all of you on these strong results.

As David has indicated, in Q1 IT spending patters were so much stronger than normal as customers caught up with some pent up demand from last year’s cut backs. Other positives for their customers have firm IT budgets in place and they are investing in IT to gain productivity both to help contain costs and to enhance revenues.

As an example, we saw this global strength in our flagship Symmetrix line. In addition, we had good visibility and predictability throughout the quarter, and experienced a good flow or calendarization of orders, much better than the experience in first half 2009. While we remain cautious about the pace of recovery, we are optimistic and have confidence in our ability to exceed our goals for this year as is evidenced in our enhanced 2010 guidance David just shared with you.

What gives us this confidence in our ability to continue to grow and take share is our focus on four multi-billion dollar markets, all of which or currently are and will continue to exhibit extremely rapid double digit growth for many years to come. Each one has the potential to be a billion dollar plus revenue opportunity for EMC.

Our first and largest opportunity is help CIOs transform their data centers into private clouds. The attribute of a private clouds that this will give CIOs the ability to truly offer their internal and external customers IT as a service. IT as a service is an IT environment where application workloads are truly policy and service level driven. IT as a service is an IT environment that is far more automated, flexible, and dynamic than today’s data center environment. IT as a service is an IT environment that advanced security, availability, and control to a higher level. IT as a service is an IT environment that will deliver significantly lower costs.

Our second billion dollar plus opportunity is help service providers and telcos build out their public clouds using virtualization, storage, and security and information management technologies. We will bring the same private cloud attributes in technologies to our service providers and telco partners as they build out their public clouds.

This will allow them to attract application workloads from our enterprise and commercial customers and by adding a suite of applications they will be able to have full IT service offerings to attack markets such as SNB and public sector. Additionally, EMC will offer our service partners several application choices like PC backup and storage as a service.

Our third multi billion dollar opportunity is for EMC to the clear leader in next generation backup recovery and archive solutions. As a proof point of the opportunity here, the actual Q1 results from just the data domain and Avamar product and services already represents $1 billion in revenue on an annualized run rate basis. This is especially impressive when you consider that these products represent new growth areas for EMC. For the record, we do expect Q2, Q3, and Q4 results for data domain Avamar solutions to show sequential improvement.

To top things off in this category we have other offerings like network or for backup, those source one product family for compliant archiving and our family of FISK libraries.

Our fourth massive opportunity is around virtualizing client devices. We will bring to this market the benefits of virtualization and centralized management, the protection of centralized storage and enhanced information management. With a new and better way to secure information while lowering total costs. In short, we’ll help our customers embrace and get the maximum value from the rapid advancing choices that are now happening in client devices while lowering their total TCO.

This V client market, while quite small right now is extremely active as numerous customers are engaged in proof of concepts. Additionally, we see early adopters experiencing solid results. These are clear signs, to steal the phrase, that this is going to be big.

Collectively in these four mega growth opportunities we have division, the leading technologies and virtualization and security and storage for block, file and object data, and for the next generation of backup recovery and archive solutions. We have the people and the expertise to help customers and service providers make this transition. We have the partner ecosystem in place to succeed and very importantly we have the trust and permission of our customers to play in these markets.

We are convinced that continuing our focus on these four growth markets along with continued investments in innovative technology and exceptional people; we can maintain a long term double digit revenue growth rate.

Thanks again for joining us today. I’ll now turn it over to Tony to moderate the Q&A portion of today’s call.

Tony Takazawa

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Aaron Rakers – Stifel Nicolaus

Aaron Rakers – Stifel Nicolaus

Understanding that you guys are giving a new, what you call mid-tier breakdown of revenue, I’d like to dig into that a little bit deeper as you’re not disclosing CLARiiON growth. If I look at data domain within that and you sited 100% growth, $800 million of revenue, backing that out would imply organic growth of about 6% by my math. First of all, can you help me, am I thinking about that correctly or maybe even more importantly could you give us what the CLARiiON growth was in the quarter.

David Goulden

First of all I think the way to look at things would be on an apple to apples basis, I’ll give you that data point. If you took off mid-tier product revenues that are at $800 million, bear in mind this is per my clarification. The apple to apples growth rate is 20% so the reported growth rate was 32% but if you included data domain as if we’d owned it a year ago the apple to apples growth rate is 20% so that’s really the comparable data point you should be looking at.

Aaron Rakers – Stifel Nicolaus

Can you say what CLARiiON growth was?

David Goulden

We’re not going to break it out because really what’s happening is because of all the conversions in the mid-tier, individual prox is now less relevant and that’s why we want to focus upon the total business and show you how that is progressing over time. Also, as we pointed out, the channel partner is so important here as well hence we gave it the 75% data point in terms of channel partner contribution to mid-tier revenues.

Joe Tucci

Let me put a little color on that. First of all, we’re kind of following the classic gartner context for what makes up a mid-tier storage price range and size. What we’re doing now as we go to market we’re basically going to market with a more unified message. For instance, a lot of what would have been CLARiiON now has a CLARiiON in back of a Solera as a unified platform. What would have been sometimes a CLARiiON data library this library we might now throw over to data domain. You’ve really got to look at these things collectively and that’s why we’re giving you a fair number.

In other words, we have an exact same set of assets in first quarter 2009 as we have in 2010 and the apple to apples growth is 20%. It’s really the way we go to market to look at one product is just not a good way to look at the market. This is the way we’re going to go forward, a unified message and the fact that we have this unique ability to have this next generation backup and archiving included in our offerings is truly a mid-tier category and that’s how we’re going to report and that is the 20%.

Operator

Your next question comes from Ittai Kidron – Oppenheimer

Ittai Kidron – Oppenheimer

In your prepared remarks earlier on you mentioned that you still saw more pent up demand in this quarter, I believe US and financials were the specific verticals you highlighted you’re seeing a lot of that. Do you have any gauge or insight as to how long do you think that still can last before we move into “normal” purchasing patters, not catch up mode?

David Goulden

I’ll also refer you back to what you heard from VMware last night because they also conjured up on the fact they saw pent up demand in the quarter. As I mentioned, for the Information Infrastructure business we saw it mainly in the US storage sector, we saw it in financial services obviously where there was a weak compare with Q1 a year ago. We saw it in the form of more large deals than you would typically expect in Q1. We really are not anticipating a lot of that pent up demand running forward into the rest of the year.

If you look at how we guided, obviously our $16.5 billion guidance is a very strong revenue number, it’s an 18% revenue growth. If you pull it apart you’ll see that because the pent up demand we’re expecting Q1 to be higher than a usual percentage of the total. We’re expecting to move to a more seasonal pattern after Q1 which would mean essentially you wouldn’t see quite as big a jump, in fact Q2 might near flattish compared to Q1 and then expect a more seasonal progression from that point going forward.

Operator

Your next question comes from Ryan Hutchinson – Lazard

Ryan Hutchinson – Lazard

As part of the change related to the mid-tier storage number due to the CLARiiON refresh and the convergent share with project unity?

Joe Tucci

I’m not sure I understood your question.

Ryan Hutchinson – Lazard

I’m trying to understand the mid-tier storage number that you’re giving. Is this partly related to the CLARiiON refresh expected here and then the convergence of the CLARiiON and Solera platforms with project unity that is underway?

Joe Tucci

Certainly we are absolutely collapsing platforms, our big message is unified and we have a strong family there. You’ll see the second wave of emphasis beyond, I’m not going to use any code names, the second wave emphasis will be the mid-tier market is even growing faster where we’re not a major player today and that’s in the smaller systems. You’ll see a lot of work on that probably in very early next year. We’re very excited. This is the category; this is how we compete against others in the industry. They’re trying to pull together a suite of products that covers this landscape and of course we have an extraordinary position in the next generation backup recovery.

Operator

Your next question comes from Mark Kelleher – Brigantine Advisors

Mark Kelleher – Brigantine Advisors

I wanted to ask about the deferred revenue, you had a nice spike up there; can you give us some things that are driving that?

David Goulden

You see that coming from two side of the business. You saw a nice build up in deferred revenue on both the VMware side and the EMC Information Infrastructure side. In both cases, basically, mainly due to prepaid software maintenance contracts. Customer’s basically prepaying software maintenance with their software licenses which is always a good sign.

Operator

Your next question comes from Ben Reitzes – Barclays Capital

Ben Reitzes – Barclays Capital

Could you talk a little bit more about your cash usage and first of all how you’re going to balance acquisitions versus the various repurchase? It seems like there is a pretty good strategy of obviously keeping your VMware stake at 80%, how important is that and what does that mean for purchases of VMware versus purchases of EMC and how you balance acquisitions for the rest of the year.

Joe Tucci

Obviously we are going to continue, VMware is part of the EMC family. You can see the private cloud when you heard their conference call yesterday and the strategy for both companies is the journey to the private cloud strategy is making sure we get to the service provider, public cloud community strategy is to watch and participate and have the best technology and as this growing business for the virtual desktop and virtual client emerges those are all common strategies so its important that we work them together.

Obviously we continue to work VMware in a very open fashion that others can continue to play and that will continue to be the case. Of course EMC on the back of that which is good for today’s environment and good for tomorrows cloud environments, the next generation backup and recovery that we add. Keeping that stake is incredibly important and that’s exactly what we’re going to do.

Secondly, as we have those four, probably one of the first times in my life that I had four opportunities this big hitting me at once. Our best return on value for customers is to make sure we take the right moves and continue to invest in technology through our own R&D so it’s going to ramp up but we are going to increase our R&D this year to 20%. We are going to continue to buy companies both in VMware and in EMC and that’ll be the primary focus for the cash and I think a great return for the shareholders.

We continue to focus on what David calls the triple play, we want to hit short term, we want to make sure that we continue to grow and take share; we want to make sure that we continue to invest for the long term and capitalize the opportunities. We want to do all three.

Operator

Your next question comes from Maynard Um – UBS

Maynard Um – UBS

Can you talk about components in the quarter if there are any shortages and if so what components. I see inventory was down only modestly and I’m wondering if that’s a buffer and if that’s still a sign that things are still tight. If I could follow up on that, can you provide any color on whether you’re expecting component tightness to ease in the back half and if that’s reflected in your 20% to 21% margin guidance for the year?

Joe Tucci

This might surprise you but we were fine this quarter in terms of our supply chain, we did not see that tightness that you referred to, we didn’t see that hard and did not impact us at all, we don’t expect it to impact going forward. We think we’re fine.

Maynard Um – UBS

Do you expect the ease going into the back half of the year that might help you on the margins and is that reflected in the your guidance?

Joe Tucci

I think what obviously happens is when you get a tightness everybody is ramping up and these are the suppliers we use and as that happens there is some opportunity there. I expect with my statement we did not see this tightness that you referred to did not impact us this quarter. We had all the parts we needed and our suppliers were very responsive.

Operator

Your next question comes from Brian Marshall – Broadpoint

Brian Marshall – Broadpoint

It looks like your incremental gross margins on your information storage business have been trending nicely over the past several years and especially the four quarters. Going forward do you expect those trends to continue at these high levels and if not is there a reason why we shouldn’t expect so see six handle on overall corporate gross margins at some point down the road?

David Goulden

Obviously if you look at our information storage infrastructure business margins have progressed very nicely. You saw we did 53.4% in the last quarter. As I mentioned, there’s been a few drivers; obviously volume helps, mix shift helps, obviously our V-Max transition has been helpful for us and that is something that is basically, that piece of it is now complete. As we go through the rest of this year we expect to still be able to improve on the gross margins we delivered in Q1.

Operator

Your next question comes from David Bailey – Goldman Sachs

David Bailey – Goldman Sachs

You talked a lot about share gains and can you give a little bit more detail about what the competitive environment is like right now.

Joe Tucci

It’s very competitive out there, I don’t think much has changed; we’re still seeing the same competitors we’ve seen for the last couple of years. I do believe that, and you saw tremendous strength in Symmetrix, the move to the X 86 technologies and V-Max, the fact that we have the flash and the FAST technology out now is resonating very well with customers. We’re competing very well there. You saw our mid-tier results, Unified is absolutely the way to go and then of course I think we are uniquely positioned in this next generation archive. If you look at our security business the unique focuses we have there on IPV and on security and event management and on data loss prevention are hot areas.

I think as we go through this case XEP type of approach in our content management business that’s going to play extremely well. Again, competition is the same, competition is intense but the teams have done a really good job distinguishing our products and we have a good go to market organization and we’re now investing heavily in marketing. Jeremy Burton just joined us as CMO and we’re going to make sure that we do a better job on that front. It’s how we see the landscape.

Operator

Your next question comes from Kevin Hunt – Hapoalim Securities

Kevin Hunt – Hapoalim Securities

I wanted to call up a little bit on the Symmetrix business which you just mentioned. Specifically if I’m not mistaken I think that business is down about 10% last quarter year over year and accelerated pretty substantially so if you did correct that or maybe say what the sequential growth was. Then maybe give a little more color what’s driving that. Finally, IBM mentioned in their call their mainframe cycle ticking in the second half, any impact that might have on your guys on the Symmetrix?

Joe Tucci

Mainframe cycle is always good for us on Symmetrix we’re still a major player there. I think the big story is V-Max, the adoption and the opportunity to V-Max gives us. Of course the two big things with V-Max is the fact, the way we’ve planned this from the beginning to really optimize the use of flash drives and then our FAST technology which tiers storage automatically so whether it puts it on, it’s dramatically different cost structure whether it puts it on a flash drive a 15K, fiber channel drive, or a two terabyte SATA drive or two terabyte SATA drive duped, there are very different cost profiles for the customers.

Therefore a customer can set a policy and let us just move the data automatically. Of course as we have thousands of customers and now have over a petabyte of data this automation is what has to happen, that’s what one of the basic tenants would be of the private cloud its becoming, so that you’ve got to trust the automation to help you get the productivity and that trust is there in Symmetrix and I think that’s the big reason it did well. Also to be fair, Symmetrix did benefit from some of the pent up demand from last year’s hiatus so to speak.

David Goulden

Symmetrix was up sequentially 7% from Q4 which obviously reflects a very strong result. Typically you expect a sequential decline in Q4. As we explained on the last call, Q4 was also down 14% year on year which actually was the best year on year comparison we had in 2009 for Symmetrix.

Operator

Your next question comes from Toni Sacconaghi – Sanford Bernstein

Toni Sacconaghi – Sanford Bernstein

I was wondering if you could comment on gross margins in the quarter relative to your expectations, it looked like there were a lot of really positive forces; V-Max went up, you had exceptionally strong performance from both VMware and D-Dupe which are higher margin. I actually would have thought maybe gross margins on a sequential basis could have done a little bit better. Can you comment on whether gross margins, given those considerations were in line with your expectations and what you saw both in the pricing environment and any reinvestments that you would have made?

David Goulden

You’re right in terms of what some of the positives were better mix from some of the D-Dupe prox including Avamar and V-Max certainly helps. Obviously sequentially volumes are in total down so you’ve got to factor that in. The area that is a little different from what you may have expected is if you look at our services component of gross margin which you can get to either with the results or by pulling out VMware what you’ll see is a fairly large decline sequentially in the services gross margin for a few factors.

One is we are building up our consulting and professional services business that has a lower margin mix and that was a high percentage of the business. Also on the services side bear in mind we reinstated the 5% salary cuts. This quarter we had some fringe adjustments and a couple of other things happening to the services side. The services gross margin sequentially was a little bit down more than it would have been or more than it was, for example from the last Q4 to Q1, that’s perhaps the difference between what you’re expecting and your margin model.

Toni Sacconaghi – Sanford Bernstein

Pricing was in line with your expectations across the marketplace?

David Goulden

Yes, when we look at the pricing trends and we look at the sequential year on year declines we’d say saw a pretty normal pricing environment. Given the comments that Joe made, notwithstanding the comments that Joe made about it still being a tough out there but in terms of the impact of price it’s pretty much in line with our expectations.

Operator

Your next question comes from Daniel Ives – FBR

Daniel Ives – FBR

How did closure rates in general compare to historical trends? Anecdotally is there anything that you saw that surprised you in talking to customers across the board throughout the quarter in terms of change in behavior?

Joe Tucci

As David said, we saw a little bit better than normal calendarization so obviously that would say we booked more earlier than we had certainly for the last four or five quarters. Some of that is because of the recovery, some of that is because of the advances we had in the product family like V-Max hitting its stride now. The closure rates were a little better than they normally were so sales cycles were a little shorter.

Operator

Your next question comes from Brian Freed – Morgan Keegan

Brian Freed – Morgan Keegan

As you look at competitors and as they move toward integrated products you often see it take a long time to do software integration. You guys talk a lot about unified platforms, yet you have a lot of distinct personalities within your storage infrastructure. Does virtualization allow you to unify them without a big overhead of software integration?

Joe Tucci

The bigger is the Intel Multicore. It takes time to rework your products but it gives you the ability now with multicore and reworking some of your products into more tread like approach so to speak it helps a lot. You’re right, there are products that we are putting natively under VMware and that overhead now is drastically reduced and gives us opportunities. It’s a combination of multicore and virtualization. Mostly the native use of multicore that we’re doing.

Operator

Your next question comes from Kaushik Roy – Wedbush

Kaushik Roy – Wedbush

It’s well known that the new VCX will be out in Q2. Do you see customers stall in the mid range in anticipation of the refreshed product and if not then why not?

Joe Tucci

That’s not true. VCX will not be out. First of all, I’m not going to say that that’s the name of the product. We have not named it yet. Certainly the bloggosphere has named it. I kind of like the name by the way. It will not be out in Q2.

Kaushik Roy – Wedbush

You didn’t see customer stalls in the mid range?

Joe Tucci

No.

David Goulden

First of all we will continue to enhance the mid range products and very importantly as we go into the future we have a great history of preserving customer software investments on all our platforms. Whatever future products that we bring out let them take advantage of the applications that were written on existing platforms. We really have given them investment protection roadmap which gives them enhancements into the future which is why they’re comfortable continuing with our state of the art leading technologies that we have today.

Joe Tucci

There are a lot of newer, what we call the NS product family which are unified which we’ve released fairly recently. We shouldn’t get too hung up on whatever that code name is you used, VCX.

Operator

Your next question comes from Bill Shope – Credit Suisse

Bill Shope – Credit Suisse

For what its worth I do think the new mid-tier category you guys are using makes a lot more sense for analyzing the business. I want to dig into the high end versus the mid-tier a bit. I understand you’re enjoying a product refresh and cyclical recovery within Symmetrix so with that in mind can you help us understand how we should think about mid-tier versus high end growth over time, particularly over the long term.

Secondarily to that, does the increasing tendency to tier within the box eventually even make the distinction between mid-tier and high and somewhat irrelevant?

Joe Tucci

I do think there’ll always be a mid-tier and a high end. I do think you hit on a very important point. We for sure are seeing customers that would have bought a mid-tier product just saying okay now that Sym has this degree of scalability, this new Sym is unique in that it scales up like every other Sym but it also scales out. You could scale these things out fairly inexpensively and sometimes by taking that approach and adding a low tier of say SATA drives in it and using software like FAST it can compete very, very effectively with mid-tier. You are right, it does, and that is one of the reasons for Sym high growth this quarter.

There will be some blurring but that being said, I still think you’ll see the two distinct tiers for the long term. And I do expect that the mid-tier has the ability, especially as we get into the lower mid-tier which where the higher growth is today, that we’re not a strong player in yet but will be. I think you will see the mid-tier for the long haul grow faster than the high end.

Operator

Your last question comes from Katie Huberty – Morgan Stanley

Katie Huberty – Morgan Stanley

On linearity, do you think that is a theme for this year? Meaning more linear quarters, lower DSOs and free cash flow closer to the $1 billion range you reported for March. Is that sustainable for the rest of this year?

David Goulden

Linearity, Q1 I think a little bit better than expected because some more of the pent up demand we spoke about we saw earlier in the quarter and you’re absolutely right that’s reflected in our DSOs down 40 days. If we’re correct on our assumptions about pent up demand reaping a Q4, Q1 phenomenon then I think we’ll go back to our quarters that are slightly more normal from a linearity point of view. Obviously better than we saw last year but more comfortable with what we saw in 2008.

From a free cash flow point of view bear in mind that Q1 is always our strongest quarter. Q1 and Q4 are always our strongest quarters because you’re collecting off the biggest receivable base. Obviously we’re very pleased with what we’ve done but we’re not promising billion dollar cash flow quarter going forward at this point in time. We are very confident that we’ll continue to show significant positive difference between free cash flow and non-GAAP net income for the year.

Joe Tucci

In closing, thank you all for joining us. We are very confident and do believe we have a compelling vision and strategy, one that’s not only right for 2010 but well behind. I think we’re in great shape with our products and solutions and the support to underpin this vision and strategy. We have a world class partner, Ecosystem. Very importantly the leadership and a deep belief throughout our 43,500 people plus around the world that we can and will win.

As a side note, our premier customer events, we call EMC World happens to be in Boston, it starts on May 10th and we will use this opportunity to be giving our customers updates on our strategy and vision of how take them to the private cloud and all the great features and new products that the R&D teams have been working on. This is their time to share this with our customers and of course as we share with our customers we share it with all of you.

Thank you very much for being with us today we’ll be talking to you.

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Source: EMC Corporation Q1 2010 Earnings Call Transcript
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