David Goulden - Chief Financial Officer and Executive Vice President
Joseph Tucci - Chairman, Chief Executive Officer, President, Member of Mergers & Acquisitions Committee and Member of Finance Committee
Tony Takazawa - VP
Louis Miscioscia - Collins Stewart LLC
Brian Marshall - Gleacher & Company, Inc.
Benjamin Reitzes - Barclays Capital
Deepak Sitaraman - Crédit Suisse AG
Aaron Rakers - Stifel, Nicolaus & Co., Inc.
Amit Daryanani - RBC Capital Markets, LLC
Daniel Ives - FBR Capital Markets & Co.
Kaushik Roy - Wedbush Securities Inc.
Toni Sacconaghi - Sanford C. Bernstein & Co., Inc.
Ittai Kidron - Oppenheimer & Co. Inc.
EMC (EMC) Q1 2011 Earnings Call April 20, 2011 8:30 AM ET
Good morning, and welcome to the EMC First Quarter 2011 Earnings Conference Call. [Operator Instructions] 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, Vice President of Global Investor Relations for EMC.
Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the first quarter of 2011. Today, we are joined by EMC Chairman and CEO, Joe Tucci; 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 outlook for 2011. 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 to help customers on their journey to the cloud and in their efforts to handle the growth of Big Data. After their 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 of 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 detail, 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 U.S. Securities and Exchange Commission. And lastly, I will note that an archive of today's presentation will be available following the call.
With that, it's now my pleasure to introduce David Goulden. David?
Thanks Tony. Good morning, and thank you for joining us today. I'm pleased to report that EMC started off the year with solid results. We achieved record Q1 revenues of $4.6 billion, up 18% from last year's first quarter. And non-GAAP EPS of $0.31, up 19% over Q1 of last year.
We improved both non-GAAP gross margin and non-GAAP operating margin considerably from the first quarter last year. And we achieved free cash flow of almost $860 million, well in excess of record Q1 non-GAAP net income of $700 million.
We successfully executed our financial triple play once again, gaining market share, investing in the future and improving profitability. We fully expect to continue realizing this triple play over the long term for two reasons: one, we're in the early stages of the largest IT transformation in history which is creating enormous opportunities in cloud computing and Big Data; and two, we positioned ourselves to take full advantage of this opportunity by focusing on the transformation of IT infrastructure and applications.
Customers recognize that their ability to compete is increasingly tied to the efficiency and agility of the IT operations, and their transition into cloud architectures to make their businesses more efficient, more flexible and more agile. To get there, they're seeking partners who can meet their requirements from start to finish. From their first Phase 1 server virtualization deployments through the Phase 2 large-scale ramping up of virtualization to include mission-critical applications, through Phase 3 implementations where IT is automated and offered as a service and well into the future.
Successfully navigating these phases could be challenging, and doing so in the face of additional challenge created by the rise of Big Data makes it even more so. In addition to scalable yet manageable storage of petabytes of data, customers need knowledge to grow beyond pros and cons. They need to analyze and leverage the massive amounts of data generated from various sources, such as always-on networks, the Web, consumers, surveillance systems and sensors.
We are squarely focused on helping our customers take advantages of the rapid, reemerging opportunities offered by both cloud and Big Data. And it's this focus that drives us to continually identify and execute on opportunities that increase our value proposition to customers in this new world. As their IT needs grow larger and more complex, and as more and more of the company's success is linked to IT, we have innovated and invested to come out in front of these needs.
There is no other company in IT with the combination of market-leading virtualization and infrastructure assets that EMC has today: the getting to cloud and for unlocking the value contained within the Big Data that surrounds us.
Our virtualization and infrastructure assets are critically important for getting customers where they want to be. This is why EMC is a vendor of choice for organizations, just for every size and every vertical, and it's a key reason why our opportunity is so vast.
Not only do we have an excellent base of technology assets, but we're expanding our reach by getting to market in many different ways. We're working directly with our customers to move in to cloud infrastructures and address that Big Data needs on their terms and timelines. We're investing in and expanding our channel to equip them to become more invaluable partners to their customers, who are looking to gain great efficiencies from IT.
We're working with dozens of service providers who want to deliver the efficiencies of IT as a scale for their customers, and use best-of-breed technology to do so. And we're meeting the rapidly expanding demand to converge IT infrastructures to our VCE [Virtual Computing Environment] joint venture.
In short, we're developing solutions and expanding our go-to-market in ways that make it easy for customers to take part in cloud computing and unlock the value of Big Data. There is a vast growth potential in the areas of where we compete and we're aggressively pursuing these opportunities at multiple levels. Given the strong growth we saw in the first quarter and the opportunity we see for rest of the year, we are now more confident that we can meet and potentially exceed our 2011 goals of $19.6 billion of revenue, $1.46 non-GAAP EPS and $4 billion of free cash flow.
Now let's take a closer look at how these opportunities are driving the financial results across our various lines of business, starting with information storage. Q1 information storage revenues were $3.4 billion, up 18%. For years, storage has been a top priority as information growth continues unabated. This phenomenon is purely on a growth at a fundamental level and is not likely to change anytime soon. But perhaps more important is the fact that this unbridled information growth has forced customers to seek more efficient and intelligent ways to handle these massive volumes of data. The best solution for one customer may not be the best for another, which is why we continually strive to offer the very best-in-class technology, tailored for various business requirements.
High-end storage product revenues were up a robust 25% year-on-year, driven primarily by pent-up demand for the much-anticipated FAST VP [Fully Automated Storage Tiering with Virtual Pools] tiering software we announced in January. This, in turn, drove new VMAX [Virtual Matrix Architecture] system sales and upgrades. VMAX continues to be the smartest, most scalable and most efficient high-end storage system available in the market. And the ongoing introduction of unique capabilities such as Flash [Enterprise Flash Drives], FAST and VPLEX has led to tremendous growth since the introduction of VMAX in April 2009. The success and growth of this business has been great, and given our share in the high end, it has resulted in higher than expected growth in the market as well. While it's realistic to expect growth to moderate in this relatively mature market, we do expect to continue to grow faster than the market and gain share.
Our main reason we expect to continue to gain share is the ongoing introduction of unique and value-added capabilities such as FAST VP that I mentioned earlier. In Q1, we saw a steep increase in the sale of FAST licenses from Q4 and 3/4 of systems we shipped with FAST in Q1 used both Flash and data.
Clearly, customers has taken advantage of the value proposition offered by automated storage tiering, and for good reason, as they're able to achieve up to 40% more application performance, while significantly reducing the number of disks and power needed, compared with single-tier systems. This type of differentiation in value will is what will lead to our continued success in this market.
An excellent example in the quarter of how this differentiation is winning occurred with a rapidly growing IT service provider in Brazil. This company needs an infrastructure to support the VMware virtualized operating environment to host their customers platforms. A mission-critical implementation, their solution has to be proven, smart and ultra efficient, as well as perfectly suited for virtualized environments. With the ability to meet each of these requirements VMAX was head-and-shoulders above the competition in this deal.
Our mid-tier storage revenue grew 20% in Q1, as our market-leading portfolio solutions offers important competitive distinctions in each of the areas it addresses. Looking across our broad set of capabilities in the mid-tier, it is clear that our ability to meet the wide variety of mid-tier use cases is unique. We firmly believe that this strategic approach will continue to drive our success here. By keeping the value proposition of each offering very distinct, channel partners benefit from selling the entire portfolio. This is an important point and one of which we are very focused.
In our traditional mid-tier storage space, our newly launched VNX family is being very well received by the market. Our unified VNX products, which is also part of our January announcement, started shipping the last week in February and was off to a strong start in March.
VNX represented over 50% of the traditional mid-tier orders we have booked in the last two weeks in the quarter and we expect VNX revenue to continue to ramp over the course of the year. It has a long list of advantages against competitors, advantages that customers in this space really respond to.
First, it is simple. The market-leading capabilities of our file and block solutions are now combined into a single unified platform that is managed to a centralized and simple user interface.
Also, it is efficient. It is the only storage system that automates both file and block sub-LUN tiering with FAST VP. The combination of this, the compression and file duplication, enables customers to significantly improve capacity efficiency. It was great to see that almost 50% of VNX systems went out with flash capability, which indicates customers are taking advantage of tiering.
And finally, it is powerful. By leveraging x86-based multi-core processor technology to maximize solution throughput and bandwidth, the VNX, that it will record performance benchmark the network file performance and overall response times. VNX is 3x faster than our previous generation systems.
With the launch of VNX, we drastically simplified our storage software offerings by streamlining over 25 different software products into five suites. This bundling has been extremely popular with our customers as well as with channel partners, as it's now much simpler to buy. The result was a dramatic increase in software penetration with VNX and a deeper value proposition for our customers.
In short, the VNX features set resonates with customers and was instrumental in winning several competitive deals in the quarter, across a variety of verticals, including a telephone service provider, building out infrastructure of the service for its client base; a bank, eager to take advantage of information [ph] FAST and FAST Cache on VNX to increase usable capacity and improve performance at lowest costs; a restaurant chain, looking to move out to private cloud; and a national police force, where we were already a trusted provider, and with VNX we're able to displace the incumbent vendor of this tiered file storage.
We entered the SMB market in Q1 with the launch of VNXe which started shipping the 2nd week of March. The VNXe provides proven EMC quality into an affordable unified storage system. We designed the VNXe to be easy to manage, easy to sell and easy to support, with the features and functions you would expect from an EMC products at a price you may not.
The VNXe offers capabilities like advanced data reduction technology, automated technical support and efficient provisioning for mailboxes or VMware data stores, as an enterprise, it firmly establishes it as the best value in the markets. Remember, that this is a new product in a new space being sold to new customers through new channel partners, so it's going to take some time before we see a material benefit to our growth. However, we are pleased to report that VNXe is off to a strong start.
We are rapidly on-boarding hundreds of new partners to sell the VNXe at a crazy [indiscernible] with existing channels. In fact, with VNXe launch events in dozens of cities across the globe, we signed on more new partners in the first quarter this year than we signed on over the course of all of last year, and the progress continues.
The significant majority of our mid-tier portfolio is sold via our channel partners and we are proud of progress we're making here, particularly, as our client -- oh, we have an agreement with Dell, the client's less than $40 million of revenue in Q1.
In response to feedback we solicited from our growing partner community, just last week, we announced several enhancements to our channel partner program to accelerate partner profitability. We'll continue to deal with these relationships in ways that are mutually beneficial to both EMC and to our channel partners.
Moving now to our Backup Recovery Systems division, which spans a variety of customer sizes, verticals and environments. BRS' ability to add value to just about any backup environment helps explain this division's consistently strong performance, with our Data Domain products leading this growth.
We expect this growth to continue, especially given the ongoing enhancements we're making to our market-leading product lineup. On Monday, we announced the expansion of Avamar for use in much larger production environments, by integrating it with Data Domain technology. We also announced state-of-the-art VMWare backup enhancements, with VMware APIs for Data Protection and tight integration with vCenter, Avamar can now provide up to 3x the backup speed of its nearest competitor.
This is an excellent illustration of the EMC effect at its fullest, capturing the wealth of opportunities available within EMC's existing accounts, while leveraging the deep resource of EMC, not only to connect with new customers, but also to drive valuable innovation as well.
We intend to use the power of the EMC effect to capture the opportunity presented by Big Data, with scale on NAS [network-attached storage] and data analytics as well. In the scale of that space, our Isilon Storage Division exceeded expectations in its first quarter within EMC. This is due to the merits of its highly differentiated technology with the global namespace, a multi-petabyte scalability, Isilon Systems are designed to handle massive numbers of large files. In other words, Big Data.
We continue to differentiate the Isilon technology. Last week, we launched our next-generation hardware and software. The new systems incorporate greater tiering flexibility across SSD and FAST or SATA drives and combined this tier back-end with a large globally cogent cache and next-generation core processors. This technology improvements are leveraged by innovations on the software side, with significant enhancements to improve performance of mission-critical data center operations and with new recovery point objectives. The net effect is accelerated performance, throughput replication underscoring Isilon's market-leading position in scale at NAS.
Our technology advantage here is winning us new customers and getting us into environments where we're able to swap out competitors' products that cannot meet customers' scalability requirements. Isilon is also seeing early examples of the EMC effect and benefiting from the strength of EMC's brand and global reach.
A couple of large wins in China in Q1 illustrate why Isilon is a storage infrastructure of choice for some many Big Data applications, in these cases, the Genomics. These customers need to make petabyte scale data sets simultaneously available to numerous instruments, users and data service. With Isilon, these customers are able to achieve unprecedented levels of both concurrent of sequential higher performance, while saving significant time and capital costs.
Our Data Computing Division continues to thrive in the Big Data analytics space, both Forrester and Gartner have recently recognized the Greenplum for architecture leadership in this space, as our continued innovation, solid execution and strong cloud focus form the basis of our competitive advantage. With twice the data loading speed of its nearest competitor and the industry's best performance, the EMC Data Computing Appliance permits more data to be analyzed faster and at lower costs. Because of these advantages, FAST, the leader in business analytics software, recently announced the expansion of its high performance computing offerings on our Data Computing Appliance. The combination of FAST's unique analytic capabilities with Greenplum's massively parallel architecture in a complete purpose-built appliance, delivers a compelling value proposition to customers.
To sum up, our Storage business has never been better positioned. Looking forward, we expect to see a bounce back of growth in the mid-tier, driven by full-quarter contributions from the new VNX family and continued leadership in the high end. Again, our strength in storage comes from our ability to provide leading-edge technology to a broader range of customers in used cases. After this, our depth of experience and our proven track record, and EMC emerges as the storage vendor of choice as customers transition to the cloud and navigate the challenges and opportunity presented by Big Data.
Our RSA Security revenues in Q1 were $174 million, up 8% year-on-year. We saw a strong growth from our GRC [governance, risk and compliance], data loss prevention and IPv solutions. This was somewhat offset by a pause in shipments as we reviewed and hardened our systems in response to the sophisticated cyber attacks targeting RSAs that occurred in the quarter.
Customers are our first priority, and RSA's management and sales force are actively engaged in the customers and partners to address their questions and ensure they have the tools and support necessary to reinforce the security of their RSA SecureID environments. As we look ahead to the rest of the year, it is likely that we will give up some revenue growth within the RSA business in the short term, as we continue to work with customers and strengthen these relationships for the long term.
This year's record attendance at the RSA conference, which is the marquee security conference, underscores the fact that the security challenges faced by IT organizations around the world are not going away. As attacks grow more sophisticated, previously targeted, customers need defense mechanisms at multiple levels to defend against them.
We deepened our RSA's analytics and virtualization offerings early this month with the acquisition of NetWitness. This acquisition, adds network analysis and insight to better inform security managements. This is a highly complementary addition to our store of GRC, data loss prevention and security information and event management offerings, as customers seek multilayer security offerings, as threats become increasingly persistent and complex.
Revenues from our Information Intelligence Group in Q1 were $160 million, down 10% from Q1 of last year, when we saw a larger number of big orders, including one particularly large financial services transaction. While growth here has been disappointing, the technology is good. We're making some key changes to help this business perform to its potential.
Our new xCP offering is earning accolades. It was awarded a leadership position by both Forrester and Gartner, in the most recent assessment of the space, because it can be used to build intelligent case-based apps faster at much lower costs and with fewer resources. We are building lightweight applications on top of xCP, using modern virtualized frameworks. These are geared for specific industries, which will in turn allow for much faster solution deployments.
And we've reorganized the IIG [Information Intelligence Group] sales force into a more vertically aligned structure with fewer accounts for rep, enabling our sales teams to identify and execute on opportunities more rapidly. This is an initiative we expect to start bearing fruit in the second half of the year. Because of these efforts, we expect this year to be one of modest growth and significant transition for IIG, with results being a business as much better positioned for success.
VMware revenue grew 33% in the quarter to a record $843 million. The VMware saw strength across all geographies and benefited from high close rates on large enterprise license agreements in the quarter. This impressive growth of VMware stems from a few simple facts. Virtualization is now mainstream, with the majority of new applications being deployed in virtual environments, it is a standard feature in modern data centers.
Virtualization is a fundamental first step for cloud computing, without it, customers are limited by the inefficiencies of physical infrastructures. And virtualization is being led by VMware, which is head and shoulders above others in this space, particularly for full data center deployments.
In Q1, there continues to be countless examples of the affinity between VMware's robust virtualization platform and EMC's proven information infrastructure. As more customers entering Phase 2 in their journey to the cloud, we see more mission-critical applications being virtualized and deployed on high-end infrastructure or said differently, this can live up to the more demanding SLAs [Service Level Agreements] these workloads require. There are many such examples of these implementations in Q1, in retail, telecom, Internet, construction and insurance, to name but a few.
Let me take a moment here for a couple of housekeeping items on how you should model VMware's results within EMC. First, we've broken out for you the expected full-year minority interest of approximately $175 million. We've also provided you with an estimate of the additional dilution of $50 million for the non-GAAP EPS calculation.
These items are being implied within our consolidated expectations, but we noticed not everyone has modeled in correctly. These amounts have been relatively small historically, but as VMWare's success continues it is increasingly important how non-GAAP EPS is calculated. The take away here is you should include both of these when modeling consolidated non-GAAP EPS for the full year.
Across our business, we have a number of additional initiatives to facilitate customers’ transition to cloud. Our Consulting division continues to see good demand for assistance building out cloud architectures. But getting to hybrid cloud also means utilizing enterprise cloud searches offered by external providers. And we're directing a lot of energy to make sure service providers have the technology and expertise necessary to enable these offerings. We've made lots of progress in this front, and you can expect additional announcements from us next week.
Through our joint venture with Cisco and VMware, VCE, we're helping customers get to IT-as-a-Service much more quickly, with Vblock converged infrastructure products. The value proposition here is incredibly powerful as a Vblock enables the deployments of best-of-breed IT infrastructure in a matter of hours, rather than days or even months. With an expanding pipeline and a workforce approaching 1,000, VCE opened its headquarters in Dallas last month and will soon open offices in San Jose, Raleigh, Durham and London.
Given the market momentum, we're accelerating our investments in VCE. As it's important route to market, we'll service well in the race to create both private and public cloud infrastructures. We're increasing our projection for other expense in 2011 by approximately $70 million. The accelerated VCE investment is reflected here as our changes in the operating effects associated with VCE. However, we expect improvement to our operating margin from Vblock operating sales to effectively offset most of these increase in other expense during 2011.
We are focused on developing the broader IT ecosystem to support hybrid cloud implementations. The alternative to our broad-based strategy is the single-vendor approach, wherein customers are dependent upon one company for applications, infrastructure and services. Our open approach offers choice, as it engages an array of partners allowing customers to take advantage of developments and innovations, springing up across the broad ecosystem. While this strategy requires coordination of efforts across several players, we are committed, as we fairly believe it offers the best long-term value proposition to our customers.
Looking more closely at our financials. It is evident that the strategic combination of our technology assets, which we've been building over the last several years, has resulted in clear value for our customers and for our shareholders as well.
Total revenue grew 18% to $4.6 billion in Q1. Revenue from the U.S. was up double digits, while our strategy to invest in geographies outside the U.S. is paying off, as the rapid growth of these markets helped drive our overall results. Our BRIC + 13 markets grew over 40%, and EMEA and APJ [Asia Pacific/Japan] were up 21% and 43%, respectively. This helps drive our non-U.S. mix to record 49% of revenue.
We improved non-GAAP gross margin by 160 basis points over last year's first quarter. This improvement was driven in part by our ability to offer differentiated features that enable customers to maximize the value of their information infrastructures. We continued to show leverage and our non-GAAP operating margin grew 220 basis points year-on-year to 21.7%. Results of these improvements was non-GAAP earnings per share of $0.31, up 19% from $0.26 a year ago.
We recognized there's a lot of interest in Japan and how it might impact our supply chain. While the longer-term impacts of these tragic events are still unknown, we have very solid relationships with our suppliers and believe we've been able to develop a clearer picture of our near-term risks. After carefully assessing hundreds of our suppliers and their supplies that may have been impacted, we have determined that only a handful currently have some supply risk exposure. We've taken risk mitigation steps and continue to monitor the situation. At this time, we do not see any meaningful impact in Q2 and continue to work with our suppliers to secure the components we need for the second half.
We ended the quarter with $9.5 billion in cash and investments. We returned nearly $900 million in cash to shareholders in Q1, with the repurchase of more than 33 million EMC shares. Augmenting VMware's $148 million share repurchase in Q1, we also invested $38 million purchasing VMware shares in the quarter to keep our stake at around 80%. To reiterate the rationale for these purchases, we strongly believe in VMware's potential, given its strategic position as the cloud data center operating system of the future. As a result, we believe our relatively small purchase to maintain our ownership level on excellent long-term investment.
In closing, we're encouraged by our strong Q1 results and the opportunities as we look ahead for the rest of the year. Given the trends in the market, our strategic position and our focus to execution, we now have greater confidence in our ability to meet and potentially exceed our 2011 goals of $19.6 billion of revenue, non-GAAP EPS of $1.46 and free cash flow of $4 billion.
Note that the non-GAAP EPS goal we gave you in January contemplated a share count of 2.23 billion. We since increased our projected share count to 2.26 billion shares, which impacts our full-year non-GAAP EPS by approximately $0.02. This is a direct result of the increase in our share price in Q1, driving a higher average share price assumption for the full year. Offsetting this, we now expect that operating margin for the full year to be between 23% and 24% due to better operating margins in our Storage business and improved margins from VMware.
In summary, we executed well against our strategy in Q1, and we believe the outlook for the rest of 2011 and beyond is bright. The major trends in cloud and Big Data are large and growing, our strategy is in place and we will continue to execute very well. With that, I'll turn it over to Joe, who will give you more color on the outlook, the quarter and the vast opportunities that lie ahead. Joe?
Thanks, David. I would like to begin by welcoming everyone to today's Q1 earnings call. Thank you for your interest in EMC. Overall, I am pleased with our Q1 results and I'm even more pleased with the way our strategy and products are resonating with our customers. Clearly, customers are extremely interested in the massive benefits which private and public cloud computing can bring. And they see how our products, services and solutions can help them accelerate their journey to the cloud, while helping them meet the vast demands their business is placing on IT today.
Also, it is extremely clear that good financial results and winning strategies, products and services do not happen at any company or organization without talented, hard-working, dedicated people. And EMC and VMware are truly blessed with more than 50,000 people who exhibit these winning traits, as they focus day in and day out on the success of their customers. I would like to thank each and every one of them for their first class execution.
Let me now comment on IT spending and our expectations for the remainder of 2011. On balance, we still expect to see IT spending up this year in the 5% to 7% range, most probably in the higher end of that range. And we still firmly believe that the core areas where EMC and VMware have leading technology, namely in virtualization, the cloud OS [operating system] and information storage, information protection, information security and then, information management intelligence, are technology areas which will grow substantially faster than the 5% to 7% IT average.
However, while we are pretty confident that IT spending will be solid, I would like to note that there are some potential event risks, such as the impacts of the disasters in Japan, global public-sector deficits and rising commodity prices, especially oil that can cause a sense of uncertainty. We will continue to monitor these three resources of potential risks. And to be clear, we are still confident that we can meet and potentially beat our 2011 plan of $19.6 billion in revenue and $1.46 of non-GAAP EPS.
The source of this confidence is based on our strong belief that our cloud computing and Big Data strategies are well-placed, and are underpinned with winning products and fully committed and funded product roadmaps.
On the VMware side, vSphere, vShield, the vCloud Director, vCenter, the vFabric, Cloud Foundry and the claim are critical market-leading core elements for private, public and hybrid cloud computing, and cloud computing engenders information on a massive scale. We call this phenomena Big Data. Our VMAX, Isilon and Atmos product families, along with our virtual storage offering VPLEX, addresses Big Data storage opportunity head-on.
These products continue to be extremely well-received by our customers on both the private and public side. And our Greenplum and IIG suite of products help customers get big value from their Big Data assets.
Next is massive scale of information needs to be protected. In other words, information needs to be highly available and eventually archived at reasonable cost points, in concert with business process objectives. Here our Data Domain, Avamar and network technologies, featuring industry-leading performance, data compression and data de-duplication hit the mark head on.
Additionally, strong, effective and pervasive information security is quick becoming a top four mandate for all IT data center environments, especially for cloud computing environments. Here is where we see our safety on newer products were identity protection and verification for data loss prevention; for security and event management; for governance, risk and compliance; and now, with our acquisition of NetWitness, for network forensic, play a critical role. In short, we are the most complete suite of security technology products that meet the vigorous demands of massive scale clouds.
And finally, with demanding mid-tier environments and SMB implementations, our VNX and VNXe storage lines are generating a very strong reception from our customers.
All in all, we have an extremely well-placed and focused technology lineup, backed by our world-class services organization and our service provider partners to help accelerate our customers' journey to the hybrid cloud. And the best news of all, we have more innovation coming. Stay tuned to EMC World, which starts on May 9th, where we will launch many more exciting new products that will help extend our leading cloud technology stack.
Thank you for joining us today. I will now turn it back to Tony to moderate the Q&A portion of today's call.
Thanks, Joe. [Operator Instructions]. We thank you all for your cooperation in this matter. Sherri, can we open up the lines for questions, please?
[Operator Instructions] And our first question comes from Ittai Kidron of Oppenheimer [Oppenheimer & Co. Inc.].
Ittai Kidron - Oppenheimer & Co. Inc.
Thanks, and a couple of questions. David, first, with regards to your comments on the mid-tier, good results there, but could you give us a little bit more color on CLARiiON and Celerra, do you expect those products, just given your order momentum that you're seeing at VNX to have a significant sequential declines over the next couple of quarters? And so how do we think about the transition moving forward? And also, with regards to your annual guide commentary, you mentioned that you feel much more comfortable in your ability to achieve it, then why isn't that feeling good enough to actually raise the number?
Okay. Let me start, and I'm sure Joe have a couple of comments as well. So relative to the VNX, we're very excited about the way that is progressing. As I've mentioned, we even start shipping the products until the last week in February, so we really had a very short selling quarter for VNX. We announced it, of course, in the middle part of January, so we knew we created a little bit of a pause in the market until it became available, and that's what happened. Essentially, the VNX replaces both cloud and Celerra. And as I mentioned, in the last two weeks of the quarter, we sold more than 50% of the orders from those 3 products moving towards VNX. So we do expect the growth of VNX to accelerate. We expect it to quite quickly, certainly in the second quarter, it will be well over 50% of the what we call our traditional mid-tier, but we expect the combination of those 3 products to grow quite nicely. And with others we expect to bounce back in total growth in the mid-tier in the second quarter, because we'll have a full quarter where we will be shipping and selling VNX. That's the flavor on the mid-tier. Relative to the year, obviously, we're off to a great start, the numbers I think speak for themselves. We did 18% revenue growth. We did the 19% non-GAAP EPS growth. And of course, that combines with our annual guidance of 15% and 16%, respectively. So we obviously started off out the gates, ahead of the pace. And that's why I said, we are more confident now. We can meet and of course potentially beat our guidance, and we just want to see a little bit more the year develop before we change our numbers explicitly.
And our next question comes from Amit Daryanani of RBC Capital Markets.
Amit Daryanani - RBC Capital Markets, LLC
Thanks. I just have a question on Big Data market. Given that Isilon performed better than you expected, just remind us, do you still expect Atmos, plus Isilon to get to a $1 billion-plus run rate on the back half of the year? And secondly, I think there's some news about Apple ordering 12 petabytes of Isilon storage in 2 quarter, the previous volume [indiscernible] what's the feedback been from the enterprise side, where you've introduced Isilon products?
We absolutely expect that Isilon will be at $1 billion run rate in the second half of next year, not this year. So obviously, a lot of success. I don't want to comment on any specific wins without any customer agreements. So I'm not going to make any comment on any specific wins, other than what we already made with Isilon, but just that it's been well-received. Our pipeline is strong and I am more confident than I was when we bought it that we will hit that $1 billion run rate either in Q3 or Q4 in next year, probably in Q3.
And just to clarify, that run rate is for Isilon plus Atmos combined.
And our next question comes from Aaron Rakers of Stifel, Nicolaus.
Aaron Rakers - Stifel, Nicolaus & Co., Inc.
Yes. Thanks, guys. And congratulations on the quarter. Question on VMAX, obviously quite strong, I think you referenced the new FAST technology. Can you talk about your adoption rate of SSDs [Solid State Drive]? What kind of contribution SSDs represent as a percentage of capacity or drive shift in the typical Symmetrix platform? And just a point of clarification, when you say SSDs, is that just fiber channel interface SSDs or is it a VMAX-supporting SATA interface SSDs? Thank you.
We will support both right now, it's just the fiber channel for Q1, okay? Around 50% of the systems went out with Flash technology. So we're very pleased with the progression, and that's going to grow over time. I foresee the day when virtually every single system that we ship, from the bigger end VNXs to the bigger end -- to all VMAXs will have Flash technology in them.
Our next question comes Deepak Sitaraman from Crédit Suisse.
Deepak Sitaraman - Crédit Suisse AG
Thanks very much. Joe or David, on the midrange, is there a concern that the ramp of VNX could actually reduce the growth rates for VMAX, given that VMAX has moved slightly down market? Also, can you talk a little bit about how we should think about the pricing disparity between VNX and the older midrange products? And lastly, as we exit the year, what portion of the midrange do you think will be VNX? Thanks very much.
Well, we've really changed -- as David said, one of the real successes that we had in the quarter was the adoption of FAST VP, which is on both systems. And of course, when you start tiering like that, you remove the need for customer to buy separate, in a way, high-end, mid-tier and low-end systems because you can get all those benefits in one architecture. And of course, if you have a, say a Symmetrix, a big farm of Symmetrix or VMAXs, probably the least expensive alternative for you is to put – they’ve got a lot of horsepower and there's to put more drives with better big SATA drives and use the FAST technology to move data very quickly, very efficiently to that lower tier. So in a way, that's helping blur the line, so for sure, VMAX is now taking some loads that were in formerly mid-tier. As far as the VNX line is concerned, as the performance and capabilities of that system, I mean, it is -- we're seeing in real customer instances, 3x the performance as that technology gets more and more used, and FAST VP works there, we expect that. So basically, do the lines overlap a bit? Yes, they do, and that's intentional. Because when you leave gaps, that's where competitors drive. So we believe we're going to see a significant acceleration of VNX sales and VNXe sales, obviously, and we're very pleased with our position on both.
And Deepak, just to clarify on the mix question. Again, as we you look into VNX and CLARiiON and Celerra combined, as I mentioned, the second quarter, we expect that VNX to be over 50% of that mix and a growing percentage thereafter. So obviously, the significant majority by the time we get to the year end. And from a price performance point of view, as Joe mentioned, we have positioned VNX to be much more competitive from a price performance perspective. And also, as I've mentioned, we've made it easier for customers to buy, evaluate software and some of the value-added components. So we're even more competitive on the baseline pricing, we have many more sell-up opportunities with VNX than we did with the prior generation of products.
Your next question comes from Ben Reitzes of Barclays.
Benjamin Reitzes - Barclays Capital
Yes, thanks a lot. Could you comment on VCE? How things are going? And how things are recognized in terms of revenue throughout the P&L? I'm a little confused with the -- it sounds like there's an extra $75 million in costs below the line that you weren't forecasting, about a $0.03 hit, but it sounds like you'll make it up through the revenue and profits you get to the P&L. So first, just talk about that dynamic and then also talk about just how it's going in general. I appreciate it, thanks a lot.
We'll take it in your order. Why don't I let David start, and I'll talk about more about how it's going.
Yes, Ben. So let me talk about the P&L mechanics and dynamics. So first of all, and Joe will give you a little bit more color on how it's going. We are accelerating investment because the market opportunity is great. As I mentioned, we're up to close 1,000 people which is certainly ahead of our plan at this point in time by a few hundred. So there's 2 things that are impacting that $70 million increase in guidance we gave you in the other expense line. The first is the fact that we are accelerating our expenses a little bit more than we expected. And the second piece, is that because of how we're selling Vblocks and where we're selling Vblocks. More of the Vblock sales are being recorded directly up on the parent P&L. So differently, not much as the revenues is flowing through VCE as we expected. What's happening is that the margin that would have been captured by VCE, is now being captured directly by us in our operating margin. Over time, we do expect that to cap balance out a little bit, but for this year we expect that to be the case. What's happening is, you got a little bit of accelerated investment and you've also got margin that would've been flowing through VCE now flowing up through the parents. And that's why I said, we expect to cover both of those through the operating results of Vblocks as they flow through the parents over the course of the year. Obviously, there'll be a slight timing issue. We're going be accelerating our investments sooner when we're picking up all the revenue on the other side. But that's why we say net-net, it will be pretty neutral when you look at the full year guidance.
And obviously, we would not have increased the investment. And we are investing a little bit ahead, as David said. So you saw some of that kind of drag, if you will to EPS in Q1, and you'll see it as we progress through the year. But obviously, as revenues continue to ramp, we think, we wouldn't have done it if we didn't think it's a great investment. And we wouldn't invest there, if we didn't think the market wasn't hot. So as far as how do we see the future VCE, we see it very bright.
Thank you, Ben.
Our next question comes from Kaushik Roy of Wedbush.
Kaushik Roy - Wedbush Securities Inc.
Thank you. So you're doing everything right, growing nicely, your gross margin, the operating margins are expanding. But it seems like the headwind is the share count. So the question is, can you accelerate the buyback? And then the other question, I would say is, any thoughts on dividends? Thank you.
Okay. Let me talk about the share counts and how we're going on with buyback. So you're right, it started off the year, our guidance on share counts has gone from $2.23 billion to $2.26 billion, and that's directly a function of share price. If you remember from what we talked about last time, the increase in share price basically drives three things, that's account for the extra 30 million shares in our forecast. The first is, it impacts the dilution from the convertible. Remember roughly half of that is kind of what we call accounting dilution, it goes away when the convertible matures. About half of that is economic dilution, as agreed we have to pay those shares out. Then the second is, the smallest of the three, is with a higher share price we expect some increase in acceleration of option timing. Last but not least, the high share price impacts the number of shares we can buy with the buyback we have for the year. As you know, we're committed to spending $1.5 billion on buying back EMC shares this year. We spent a little less than $900 million in the first quarter, so we actually did move pretty quickly getting out the blocks after the earnings call just to start buying back. And when we look at the timing, the opportunity, but we're still on track do the $1.5 billion. But bear in mind, again, on the share count, a big piece of the impact goes away. And if you kind of look at our Q1 average, we have about 80 million shares in our share count, which are from the accounting impact of the convertible. So when that convertible matures, disappear completely, so you've got a little bit of artificial inflation in the share count as well as real inflation. Joe on dividends?
Our board continues to look at book and examine all uses of cash that generate shareholder value. And we'll continue to look at dividends. Right now, we think we're in a really sweet spot and have terrific ability to execute on our cloud strategy and Big Data strategy and invest in the future. So primarily, the two courses we're following now is buybacks and smart acquisitions. And we see a lot of opportunity on that smart acquisition side that are going to, I think, pay off really big for us in the future. So that's probably our bias right now. But there is nothing in our DNA against a dividend at all and at some point in time. I'm sure that will happen. But right now, I gave you our primary focus.
Our next question comes from Brian Marshall of Gleacher & Company.
Brian Marshall - Gleacher & Company, Inc.
Great, thanks. With respect to the advent of cloud computing and incremental services being offered, almost on a daily basis, and as that business continues to grow in the future, do you anticipate any changes and sort of buying power of the end customer, i.e., who's consuming the mainly enterprise storage? And if so, how will that impact kind of financial model over time from a pricing pressure perspective, et cetera? Thanks.
We think the answer to that is going to be what we're doing with FAST. And it kind of blurred out -- blur those lines of in a way of what's enterprise storage, what's Tier 2 storage, which as these systems work better together and get more homogenized, more networked, we think we have a really good future. And it's not a “one size fits all.” I mean, we have our Big Data assets, we have assets aimed more to mid-tier and assets aimed more to SMB. Over time, we think the Big Data side is going to be where a tremendous amount of the cloud action goes, but there's opportunities throughout the whole storage line, which is why we have such a broad line.
Brian, bear in mind that whilst we talk about cloud computing as a broad and very important term, it applies just as much to our enterprise customers as it does to service providers. So our primary focus is helping our enterprise move to their private clouds, which is basically turning that traditional data centers into more cloud-like environments. Working with service providers so they could stand up for enterprise-compatible clouds. And then the end goal here, is what we call the hybrid cloud, where those 2 environments were working seamlessly together. And enterprises can use service providers more key applications, flex demand capacity, archiving, et cetera, in a much more flexible environment. So enterprise is in its model, continues to consume a lot of computing in the same they do today, just for the different technology objective.
Brian Marshall - Gleacher & Company, Inc.
Thank you, Brian.
Our next question comes from Lou Miscioscia of Collins Stewart.
Louis Miscioscia - Collins Stewart LLC
Okay. Maybe you can give us some color on spending in the public sector? And if you can break that out, maybe by federal, state and local, education? And then maybe, throw also in there sales in Japan. I know you mentioned Japan, but we didn't know what kind of demand dynamics you're seeing out there?
Yes. Let me do it this way, because I'm not going to break down public sector totally. But if you looked at our kind of average, you'd have markets like retail, from a vertical perspective, retail manufacturing, others. If you look at what was kind of better than average, I would point to telco, financial services, services, companies. If you look to what was lower than average, I would point from our Q1, I would point to public sector. And I already talked about one of the headwinds that I think everyone will face is -- most governments, certainly in the U.S., certainly in most parts of Europe, are faced with deficits or other issues and I do think they're going to be very -- IT is the real seat of productivity for sure. I still think IT will not be immune from public sector as they really sharpen their pencil and try to cut back a bit, so -- and again, healthcare maybe a little bit outside, I think education and healthcare unfortunately, will probably get -- will probably also fall victim to the very, very, very pointed pencil. Healthcare might get a bit more investment, but that's kind of the way I see it.
Oh, Japan. Optioning Q1, our sales into Japan were okay and on plan. So you just worry about the future. It's not that we haven't been given any bad forecast or anything yet, but we just can't have help but have a worry with what's, it's a little bit of an unknown. Our supply chain people have really done a heck of a job looking at the first, second or third order effects, and we think in the main we'll be okay and have most of our -- almost everything we do virtually is multisource. So we feel okay. But you still have some eggs, it's a big supplier for the IT community, so you just still have some eggs as to anything if we miss our fourth or fifth order effect that could come down a line and bite you a little bit. We don't think so, but it just causes a little bit of kind of uncertainty and a little bit more focus, that's what I was pointing to.
Our next question comes from Toni Sacconaghi from Sanford and Bernstein (sic) [Sanford C. Bernstein & Co., Inc.].
Toni Sacconaghi - Sanford C. Bernstein & Co., Inc.
Yes, thank you. David, I have a question on operating margins. You commented on the very strong year-over-year margin improvement in the first quarter's 220 basis points on an operating margin basis. If we look at your full year guidance, it kind of implies year-over-year operating margin improvement for the remaining three quarters, that's about half that level, the midpoint in your guidance. I'm wondering if you could comment whether that's just kind of prudent conservatism, given some of the caveats you and Joe have mentioned? Or whether some mix dynamics, particularly with the new product offerings and VMAX that we need to be aware of as we model through the remainder of the year?
Tony, there aren't any adverse headwinds from a mix or margin point of view. And if any thing, as I mentioned with VNX replacing CLARiiON and the Celerra, we’re actually a bit more positive about the margin potential in the midrange. So we feel good about the mix. Obviously, what we've done is that we've basically given you a set of numbers that gets you back to our same guidance, midpoint is last time, so the $19.6 billion and the $1.46. And obviously, we have implied in that, that there's going to be some improvement in operating margin for the full year. And as I said, we're incrementally more confidant about being able to beat we were before and there are multiple aspects to how we can potentially beat that number and volume is clearly one, and additional profitability in the model is clear second.
And we are focusing, Tony, on what we think are prudent investments which are going to help us over a midterm and long-term grow faster. We're making a major investment with our programs for our channels. We're broadening out our channels significantly. And we're really pleased with our momentum in channels. And we had a record number of, as we pointed out, a record number of channel partners signed up. And they're very excited about some of our new offerings, our new programs. We're investing in VCE. And we're going to continue to acquire smartly. And follow our string of pearls approach.
Our last question comes from Daniel Ives of FBR.
Daniel Ives - FBR Capital Markets & Co.
Oh, yes. Just a last question, in terms of deal sizes. Was there any sort of change for a March quarter in terms of deals getting bigger? Anything that you're seeing either in the channel or on the south front that may be surprise you on deal sizes?
Daniel, I mean, I think it's difficult to generalize across those businesses with so many different aspects. Obviously, on the VMWare side, as we mentioned or they mentioned on the call last night, we saw some good sized deals on the VMware side. By definition, because the Symmetrix were so strong this quarter on the back of FAST VP we saw some larger deals. Nothing particularly unusual for a Q1. Good news is, that out of the gates, some of the VNX sales were making a little larger than the prior generation systems, but nothing particularly in terms of overall deal size. I think obviously, it was such a strong quarter, we did seal a number of large deals in the quarter, which is good, after clearly what was a good Q4. So that's nice to see the level of spending continue, nothing particularly remarkable in terms of overall transaction size.
So let me close, and thank you for joining us. In summary, we truly do believe our hybrid and Big Data strategies are right on the mark. Our vast stable of products is being extremely well received by our customers. Our customers believe they're hitting the mark of their IT needs today, and they believe they'll help them on their journey to the cloud. Our service organization, our branch of first class partners is also helping customers meet their needs today and on their cloud journey. And most importantly, the 50,000 talented people in EMC VMware believe in our vision, believe in our future and they are just plain charged up. Again, I invite you to join us at VM World either in person -- EMC World, VM World is later. EMC World in Vegas on May 9, and if you can make it in person, and if not, we're going to -- almost everything we do there will be also presented virtually. So hopefully, you can join us one way or the other. And we have some exciting announcements. So good seeing you, and thank you for joining us today.
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