EMC (EMC) Joseph M. Tucci on Q1 2016 Results - Earnings Call Transcript

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EMC Corp. (EMC) Q1 2016 Earnings Call April 20, 2016 8:30 AM ET

Executives

Anthony T. Takazawa - Vice President-Global Investor Relations

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Denis G. Cashman - Chief Financial & Accounting Officer

David I. Goulden - Chief Executive Officer-Information Infrastructure

Analysts

Ittai Kidron - Oppenheimer & Co., Inc. (Broker)

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Toni Sacconaghi - Sanford C. Bernstein & Co. LLC

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Andrew James Nowinski - Piper Jaffray & Co (Broker)

Rod B. Hall - JPMorgan Securities LLC

James Kisner - Jefferies LLC

Steven M. Milunovich - UBS Securities LLC

Operator

Good morning, and welcome to the EMC Q1 Earnings Conference Call. All parties are in a listen-only mode until the question-and-answer portion of the call. As a reminder, this conference is being recorded. If you have any objections, you may disconnect at this time.

I would like to introduce your host, Mr. Tony Takazawa, VP, Global Investor Relations of EMC. Sir, you may begin.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the first quarter of 2016. Today, we are joined by EMC Chairman and CEO, Joe Tucci; EMC's CFO, Denis Cashman; and David Goulden, EMC Information Infrastructure CEO. After the prepared remarks, we will then open up the lines to take your questions.

Due to the pending transaction with Dell, we have made some changes to our call format and content. In an effort to improve the efficiency of the call today, we are streamlining our presentation and voluntary disclosures. EMC will also not be providing expectations for company financial results.

Please note that we will be referring to non-GAAP numbers in today's presentation, unless otherwise indicated. A reconciliation of our non-GAAP comments to our GAAP results can be found in the disclosure in today's press release, supplemental schedules and the slides that accompany our presentation. In addition, all financial comparisons will be on a year-over-year basis, unless otherwise indicated.

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

Finally, this call does not constitute an offer to sell or a solicitation of any vote or approval. The proposed transaction will be submitted to the shareholders of EMC for their consideration. In connection with the proposed transaction, Denali Holding Inc. has filed with the SEC, a Registration Statement on Form S-4 that includes a preliminary proxy statement and prospectus regarding the proposed transaction. After the Registration Statement has been declared effective by the SEC, a definitive proxy statement and prospectus will be mailed to each EMC shareholder entitled to vote at the special meeting in connection with the proposed transaction.

Investors are urged to read the proxy statement and prospectus in its entirety, and other filings made by Dell and EMC as they contain important information about the proposed transaction. Investors may obtain copies of the proxy statement and prospectus and other documents filed with the SEC regarding the proposed transaction at the SEC's website or from EMC's website. Information regarding the persons who may, under the rules of the SEC, be deemed participants in such solicitation is set forth in the proxy statement and prospectus filed with the SEC.

With that, it's now my pleasure to introduce Joe Tucci. Joe?

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Thank you, Tony. I would like to begin by welcoming everyone to our Q1 earnings call. Thank you for joining us. This morning, I would like to give you some color around the quarter and provide a brief update on the progress of our pending merger with Dell. We had a solid quarter in Q1. We achieved non-GAAP EPS of $0.31 on revenues of $5.5 billion. These results were generally in line with our expectations when adjusted for an excess of unfulfilled orders due to their late receipt in the quarter. It is useful to put our performance in the context of macro industry trends.

As I have commented on previously, we saw several broad and secular IT trends reshaping our industry. Work forces are becoming increasingly mobile. There is an explosion of data from connected smart device as sensors and telemetry are being built into every imaginable product. Companies are embarking on digital transformations to exploit this ever increasing amount of data, get more connected with their customers, employees, and suppliers.

Enterprises are accelerating their deployments of hybrid cloud architectures across their private, managed and public clouds. And IT security and privacy has become board level issues and front page news. Clearly, we are seeing a new wave of cyber security carding and increasingly pervasive advanced threats. These secular trends are pretty much playing out as we expected. The good news is we recognized the trends early and have made significant investments in a series of growth platforms over the past several years. I am pleased to report that many of these growth platforms are increasingly gaining momentum in the market. Products like XtremIO, converged infrastructure, NSX, AirWatch, RSA Security Analytics and Pivotal Cloud Foundry are leaders in their categories and are experiencing rapid growth.

In short, we feel very good about the depth and breadth of our product portfolio. I would now like to say a few words about each of our businesses. Pivotal enjoyed a very strong quarter with continued customer momentum. Pivotal's modeling cloud platform and analytic solutions, combined with its agile, cloud-based software development capabilities are making a real difference to the digital transformation journey of some of the world's largest customers. Two that I can mention are Allstate Insurance and Volkswagen, where Pivotal had major wins in the quarter.

VMware continues to execute on its exciting multi-device, multi-cloud strategy. As Pat mentioned on their call yesterday, VMware's end user computing, NSX and DCM businesses are all growing nicely. VMware's strategy is at the center of where the future of IT is heading, and I am pleased with the progress they are making. EMC II had a strong quarter in a number of their product lines, including Data Protection and Isilon, which grew nicely on the back of recent product refreshes, with their converged infrastructure business, which continues to expand strong double-digit growth.

With XtremIO, which remains a clear leader in the all-flash market; with their software defined storage products including Elastic Cloud Storage for objects and ScaleIO for block storage; and with VxRail, which experienced very strong demand after it was introduced in February. VxRail is a great example of a strong partnership between EMC II and VMware.

Additionally, I am pleased to report that EMC II will be making major new product announcements at EMC World in two weeks. These announcements will cover a number of areas, but one important theme will be geared towards extending EMC II's lead in the all-flash primary storage market.

And finally, we saw outstanding market acceptance for Virtustream's mission-critical managed cloud solutions. Collectively, we are confident in our outlook for the U.S. for the year for both our growth products and our enhanced traditional products. Importantly, as Denis will describe later, our expense reduction programs are showing excellent results with more to come.

Let me now turn to an update on our merger with Dell. The combination of EMC and Dell creates a powerhouse in the IT industry with approximately $80 billion in revenues. And the best news is that customers and partners are overwhelmingly positive. They see that we will have the breadth of products and technologies critical to their key strategic needs around digital transformation, hybrid cloud, converged infrastructure, mobile and security.

Progress on integration planning has accelerated in the past 90 days. Our Value Creation and Integration Office led by Howard Elias from EMC and Rory Reid from Dell has developed detailed integration plans to assure we hit the ground running when the merger closes. Recently, Michael Dell announced his new leadership team with a number of our executives being tapped to have prominent roles in the new company. I am very proud of this.

We continue to make progress towards closing this transaction. We have received antitrust approvals from the U.S., the European Union, Canada, Japan, Australia and many other countries around the world. China is the remaining country where regulatory approval is required. We are working aggressively on finalizing the S-4 with the SEC so we can get to a shareholder vote ASAP. We expect this transaction will close under the original terms and in the originally announced timeframe. I am more convinced than ever that our combination with Dell is a great strategic option for our shareholders, customers, partners and people. I am very proud of the nearly 70,000 talented and dedicated people across the EMC family of companies. Despite all the distractions and a volatile economy, they worked diligently along with our valued partners, and focused intently on our customers and their needs. My deepest thanks to all of you.

With that, let me now turn the call over to Denis.

Denis G. Cashman - Chief Financial & Accounting Officer

Thanks, Joe. Good morning, everyone, and thank you for joining the call today. With over 27 years at EMC, I have been part of an exciting journey of growth and evolution as EMC has become an IT leader. During this time, the EMC finance organization has also become absolutely world-class. As the new CFO, I am honored to be leading such a great finance team.

Now turning to our consolidated results. I will discuss performance in the quarter and provide some additional detail on Pivotal, VMware and EMC Information Infrastructure. As Joe mentioned, the IT spending environment continues to be challenging that it's having a meaningful impact across enterprise tech. EMC continues to perform better relative to many of our peers due to our strategy and solid execution by the extended team across the organization. I want to take this opportunity, too, to commend and thank them for all their efforts.

Our quarter one consolidated revenue totaled $5.5 billion and EPS was $0.31. This quarter, our regional results were once again impacted by currency fluctuations. Consolidated revenue in North America was down 3% year-over-year. EMEA was down 1% as reported and up 2% on a constant currency basis. APJ rose 2% year-over-year, as reported, and up 4% in constant currency. Latin America was down 14%, as reported, and down 4% in constant currency. Overall, international revenues were down 1% versus last year and up 3% in constant currency.

Looking at the quarterly results for our three major businesses. Pivotal grew revenue 56% year-over-year. We are pleased to report over 200% in year-over-year growth in annualized recurring revenue, with total annualized recurring revenue of $116 million, up 11% sequentially. Pivotal had tremendous customer momentum followed by the signing of a long-term strategic collaboration with one of the world's largest financial institutions. Importantly, Pivotal Cloud Foundry, the world's most powerful continuous innovation cloud platform, recently expanded their technical and go-to-market partnerships with major cloud providers Google, Microsoft and Cisco to accompany existing partnerships with Amazon Web Services, VMware and OpenStack-based cloud.

VMware revenue was up 5% year-over-year and up 6% in constant currency. An important data point is that standalone vSphere license bookings were less than 35% of total license bookings as VMware successfully diversifies its product portfolio. There were a number of other VMware highlights this quarter, in particular within emerging parts of the business such as End-User Computing, network virtualization and Hyper-Converged Software. In quarter one, end-user computing license bookings grew in the mid-teens year-over-year, and total customer count increased to over 63,000. There was also continued strength with VMware's NSX network virtualization solution. NSX quarter one license bookings were up over 100% versus last year. NSX now has over 1,400 customers with nearly 350 of these in production.

EMC and Dell also announced new distribution options for VMware's Hyper-Converged Software offering, including the February launch of VxRail and the April announcement that Dell would also be reselling VxRail.

And finally, EMC II revenue was $3.8 billion, down 6% year-over-year and down 4% in constant currency. The Storage business within EMC II was also down 6% year-over-year and down 4% in constant currency. The spending environment continues to be challenging as customers focus more on transformative IT projects while also minimizing transactional spend. This customer behavior is impacting our traditional business in the near-term. However, the major trends in IT remain intact, and we are having positive discussions with customers regarding how EMC and eventually, the combination of Dell and EMC, can help them with their IT and digital transformation.

In addition, we expect that our exciting line-up of new and refreshed products will be very successful, and we are encouraged by the fast start in products like All Flash VMAX, VxRail and DSSD, and there is more coming at EMC World. David will provide more details on our Information Infrastructure business in a few minutes.

Looking at our consolidated income statement. In quarter one, we are pleased that consolidated gross margin was 61.4%, up 10 basis points versus quarter one last year. This was a very good result in a challenging environment. Consolidated operating expense was down 2% year-over-year. Within this, EMC II's operating expense was down 8% versus last year due to expense control efforts by the team.

While there were a few puts and takes on a year-over-year basis, the net is that EPS was flat at $0.31. We returned $227 million to shareholders via dividend in quarter one. Free cash flow was $588 million for the quarter. We ended the quarter on plan with $15 billion in total cash and investments, with $6.7 billion of this being EMC cash excluding VMware.

We are on track with the $850 million cost reduction and business transformation plans we announced last year. As we have mentioned previously, most of the aggregate cost reductions will be coming over time in several targeted areas, including direct materials and manufacturing, process simplification, and integration and third-party spend. These programs reduce our costs and will also result in improved working capital. For example, as part of our lab transformation initiative, we launched a centralized process to increase utilization of lab equipment. This program prioritizes virtualizing workloads onto our common engineering cloud, while also improving the utilization of lab equipment across the company.

As part of our IT transformation initiative, we have a program addressing telecom cost that is using technology differently to enable our ever-growing mobile workforce, while also generating cash savings today. We are making great progress across many initiatives such as these, and I want to thank the team for all their efforts in identifying and enabling these improvements.

In conclusion, our portfolio of Pivotal, VMware and EMC II plus Virtustream makes EMC an industry leader. Once we close the transaction and combine our portfolio and go-to-market strengths with Dell's offerings and distribution channel, we will be one of the most formidable companies in IT, which will bring significant value to our people, stakeholders and customers.

With that, I will now turn the call over to David to discuss the EMC Information Infrastructure business. David?

David I. Goulden - Chief Executive Officer-Information Infrastructure

Thank you, Denis. Good morning, everyone, and thank you for joining us today. We had an exciting start to the year with major product launches in the first quarter that will set the tone for us for the rest of the year. In Q1, we significantly expanded our all-flash portfolio with the launch of VMAX All Flash, our industry-leading, high-end enterprise storage platform re-architected to take full advantage of large capacity SSDs; and the launch of DSSD, an industry first, rack-scale flash platform with Quantum Leap performance for next-generation workloads. We also introduced our new, next-generation, hyper-converger appliance family, VxRail. VxRail represents a key partnership between EMC and VMware that's well positioned to disrupt the fast-growing hyper-converged markets. The initial customer response to all these launches has been tremendous. More on this later.

While our innovative market-leading portfolio bodes well for the future, today, we are still operating in an overall market environment that is pressured by cautious transactional spending. As we've discussed before, the overall market continues to show opposing behaviors. While businesses accelerate their adoption of newer storage technologies to drive their IT transformations, they remain cautious about their transactional spending, including traditional standalone storage. As a result, these counteracting spending behaviors pressure the overall growth of the markets.

Against this market backdrop, our overall storage was down 6% in Q1 and down 4% in constant currency. The continued customer caution in transactional spending resulted in a very late quarter and a higher than anticipated buildup of unfulfilled orders as compared to Q1 last year. Normalizing for the higher level of unfulfilled orders, overall storage was down 2% in constant currency, which was in line with our revenue expectations for Q1.

As our customers continue to prioritize between their transformational and their transactional spending, we believe that IT transformation initiatives will focus on building modern day defenses based on flash, scale-out, software-defined, cloud-enabled and trusted technologies. To enable this IT transformation for our customers, we've been actively transforming our storage portfolio well ahead of our peers to capitalize on this next wave of IT. Our newer storage technologies are growing very well, and we enjoy much higher market share in these areas than our overall share. These include all-flash, scale-out file and objects, converged infrastructure, purpose-built backup appliances, and software defined storage.

We believe that 2016 is the year of all-flash for primary storage as we reached a point where it can cost less to store data entirely on flash rather than performance hard drives. Our all-flash array, XtremIO, had a great 2015, gaining share, and according to IDC, in Q4 2015, XtremIO had over 40% market share and was almost three times the size of its closest competitor. This momentum continued in Q1 with demand for XtremIO plus the VMAX All Flash up more than 100%. DSSD, our rack-scale flash offering, delivers an order of magnitude improvement in performance, latency and bandwidth for next-generation workloads and started to ship in Q1. This is very exciting. And we'll continue to strengthen our all-flash portfolio with the launch of a new flash-optimized mid-tier storage family in the next few weeks.

In scale-out file and objects, the demand for Isilon, our scale-out file platform, plus ECS, our software defined object platform, was up more than 20% in Q1. Isilon continues to win against traditional file systems with unique scale-out file system and native Hadoop support. In fact, Isilon helped us win over, a top five global account from one of our largest traditional competitors where the customer completely replaced their entire traditional file infrastructure with 45 petabytes of Isilon. In the purpose-built backup appliances space, Data Domain continues to lead the market with a Q4 2015 market share of over 60%, up four points year-on-year based on the latest data from IDC. And demand for Data Domain was up 20% in Q1.

Now turning to our converged infrastructure portfolio of blocks, racks and appliances. In blocks, according to IDC's latest report, in Q4 2015, we had over 36% market share in the integrated infrastructure system space, up 9 points year-on-year, and our market share was almost two times our closest competitor.

In racks, our VxRack platform, powered by ScaleIO, was ahead of plan in Q1, while in the appliances space, the initial response to VxRail has been fantastic as the formidable EMC go-to-market engine and channel presence helped to sell VxRail appliances in 37 countries in less than 45 days after launch. Our industry-leading converged infrastructure portfolio addresses the increasing customer preference of buy versus build, and the combined demand for this portfolio grew more than 20% in Q1. Our momentum in converged infrastructure is poised to accelerate even further with the recently announced resell agreements with Dell that will enable us to significantly expand the market reach for our VxRack and VxRail platforms.

Converged infrastructure provide the building blocks for our engineered cloud solutions such as the Enterprise Hybrid Cloud and the Business Data Lake to help our customers drive their business transformation initiatives. For example, when one of Europe's leading financial institutions wanted to transform their legacy IT to a modern data center, they chose to partner with EMC. We positioned a phased approach to a fully orchestrated and automated cloud platform starting with converged infrastructure with Vblocks and by virtualizing most of their legacy infrastructure.

Some of the key technologies purchased were Vblocks based upon VMAX All Flash, VMware vCloud Suite and Data Domain for backup and recovery capabilities. The next phase of their IT transformation will target our full enterprise hybrid cloud solution. This customer also chose to deploy Pivotal Cloud Foundry to add an agile application development platform to support their business transformation initiatives. Stay tuned as we announce a brand-new engineered solution in a few weeks that leverages our Pivotal portfolio plus additional cloud-native technologies from EMC and VMware.

In our Cloud Services business, demand for the Virtustream Enterprise Cloud grew more than 50% in Q1 as we continue to gain traction with mission-critical workloads. For example, Virtustream won a major multimillion dollar cloud Infrastructure-as-a-Service project in Q1 with one of the world's largest agricultural conglomerates. We'll have more exciting announcements around Virtustream in the next few weeks.

In RSA, demand for its growth portfolio was up nicely, led by Security Analytics where product demand was up over 20%. Our Enterprise Content business continued to execute well and deliver profitable growth. License demand was up over 15%, and demand for the Documentum as a service managed cloud grew over 70% in Q1.

In closing, I'd like to thank the EMC team, our partners and our customers for their continued support. We are very encouraged by the increasing customer adoption of our modern data center technologies to underpin both their IT and digital business transformations. We're looking forward to a great EMC World, with many more exciting new announcements, some of which I've pointed to in my comments today. Looking forward, our proposed combination with Dell will enable us to become a larger, even more strategic partner for our customers and partners.

With that, I will turn the call back to Tony for Q&A. Tony?

Anthony T. Takazawa - Vice President-Global Investor Relations

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

Nicole, can we have the first question, please?

Question-and-Answer Session

Operator

Thank you. Our first question is coming from the line of Ittai Kidron of Oppenheimer. You may now ask your question.

Ittai Kidron - Oppenheimer & Co., Inc. (Broker)

Thanks. Hi, guys, and thanks for the question. A couple for me. One on the – David, with regards to the product revenue in storage, you're down 10% on a year-over-year basis. Do you see a bottom in this or do you think this is a year where double-digit decline in your product core is something we should expect? And also, just as a tweak to that, the VMAX All-Flash array, why did you feel you need something like this? Does it suggest that customers are not interested in XtremIO? Why is this product needed?

David I. Goulden - Chief Executive Officer-Information Infrastructure

Hi, Ittai. Joe, you want to start off with a couple comments about the overall environment for 2016? And maybe I can follow up specifically about this Q1 storage product revenue.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Yeah, maybe I'll start in a little bit different place. I think that if you look at the – one of the things that I think we should probably have gotten through maybe in our prepared remarks, so I'll do it now, is when we originally filed the S-4, we put some early views in of 2016. And as always, we looked at the environment and, of course, as always, the board has given us a plan that which – an approved plan for 2016, and I want to assure everybody this plan is a growth plan. It calls for year-on-year revenue growth over 2015, year-on-year non-GAAP EPS growth, and very importantly, year-on-year free cash flow growth.

The – in my opinion, out of all of the secular – there's secular things that happen and cyclical things that happen in any business, but the biggest – if you're in a product business, the biggest factor you face is product cycles. And obviously, the main engine of – one of the main engines of growth and profitability in all of EMC is what we do in primary storage.

And David will take this in a second, but that is subject to significant product cycles. So when the board gave us our plan for the year, we – that's why I said in my remarks that we basically, if you adjust for the lateness of the quarter and the build-up of unfulfilled orders, we basically hit exactly what our plan was. And in that plan, we assumed that we – as we knew that we had to face some major product launches and cycles. But it's really exciting and, of course, I wanted to make sure you knew that this was a growth year, and I think that answers, Ittai, the heart of your question. I'll let David give you the details.

David I. Goulden - Chief Executive Officer-Information Infrastructure

So, Ittai, let me pick up on that. So let's start with your first question, the storage product revenue down 10% for the quarter. Let me make a couple of comments about that. First of all, it was impacted by FX through a couple points. So that takes it down to 8%. The year-on-year backlog change actually made a four-point difference to the growth rate. The year-on-year backlog change is slightly more than the $75 million that Denis mentioned in his remarks, because I'm talking now year-on-year. That made a four-point difference in growth rate. So normalized for FX and normalized for the build-up in unfulfilled orders or backlog, it's actually down 4% year-on-year.

The first comment I'd make is that's actually an improvement from Q4 when you make the same adjusting factors. Part of that improvement is driven by the product cycle that Joe talked about. Now the product cycle, we're in a very early stage of the product cycle for the major products of VMAX and VNX. VMAX, we just announced the VMAX All Flash in the middle of Q1. That's a game changer. I'll come back at the end and explain why we needed that in (30:25) XtremIO. We have a major new mid-tier announcement at EMC World. I'll save the details, but that will be the start of a new cycle for where the traditional VNX plays. So you've got early product cycles that are going to be very exciting for both VMAX and VNX.

And then the other things that we've just announced recently that are gaining steam, VxRail, DSSD, VxRack, are small but starting to grow in Q1, and then as I mentioned in my prepared remarks, we've seen great growth in the quarter from some of the engines that are important, so XtremIO, Isilon, Data Domain, Vblocks, ECS, ScaleIO. So you pull all that together and we always knew that Q1 would be the lowest point of our growth cycle, and I think that answers your question quite directly.

And again, the minus 10%, you really need to think of it as a minus 4% when you normalize it for the FX and for the backlog change. So that's kind of the story around how we expect the year to progress, and as Joe said, our storage growth, our revenue growth was in line with our expectations for Q1 when you normalize it for the high level of backlog.

Now, to your last question, the VMAX All Flash, it's all about having a portfolio. XtremIO, as I mentioned, is doing exceptionally well. We gained market share last year. We're three times our closest competitor. But there are a range of workloads that VMAX – sorry, that XtremIO cannot directly address. So things like mainframe connectivity, things like mix file and block, very large port counts, multi-site replication with zero RPO, RTO. So it makes a lot of sense to have a portfolio, and VMAX All Flash is absolutely a game changer. We've made a big thing of it at the launch in London. The analysts who were out there understand the difference, and we and our customers are very excited about it. So just like we run a portfolio play traditionally, we'll run a portfolio play in the all flash space as well.

Anthony T. Takazawa - Vice President-Global Investor Relations

Okay. Thank you. Can we move on to the next question, please?

Operator

Thank you. Our next question is from Jayson Noland of Robert Baird and Company. You may now ask your question.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Okay. Thank you. David, the AFA market seems to have accelerated here recently. Love to hear you talk about AFA versus disk on-premise, Tier 1 data versus Tier 2 data going forward. Is there a place for disk? And then, Joe, is – do you have any role in the combined company? I'm sure Michael would love to have you on board.

David I. Goulden - Chief Executive Officer-Information Infrastructure

Well, I will certainly leave that second one to Joe, Jayson. I'll answer the first one. So we do believe – and we said that for primary storage, think of it for transactional applications – we believe this is the year where we're going to move the vast majority of all new system shifts to all-flash, and we're going to lead the industry in that trend. The real tipping point here is some of the technology advances, in particular, the advents of some of the 3D NAND Flash technology working at one write per day with very large capacity drives.

If you mirror that up with a high-performance platform like the VMAX, and obviously you can incorporate that technology in all the all-flash, that really is the tipping point where you can effectively get a customer into an all-flash system at the same or slightly lower dollar per gigabyte than the effective dollar per gigabyte for a hard disk drive system, but then they get all the additional benefits of easier management, lower footprint space, lower power and cooling, et cetera. So the TCO equation for a customer is very compelling.

Having said that, persistent data still has a very cost-effective equation being on these large capacity hard disk drives, and we see them being out there for many years to come in the persistent data category. So it will still be a question of and. But we believe that in primary storage, we're going to move industry rapidly to all-flash for the vast majority of new systems. We expect to do that throughout the course of this year.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Jayson, I'm going to punt a little bit, and this is – and then I'm going to tell you the absolute truth. To me, this is all about making sure it's a good deal for our customers, our shareholders and our people, and they're all priority number one to me. And it's not about me. I have a lot of energy left, I'm going to continue to work doing different things. Potential that I could help advise Michael, but I just don't want to go there yet, and Michael and I have not gone there yet. I could tell you, we're working incredibly well together and I have tremendous respect for Michael. (35:17) relationship more respectful, and I'm just going to – I'm just not going to – I'm just not making myself part of this process or a condition of any factor in this process. It's all about shareholders, customers, people. Our people.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Thanks, Joe.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thanks. Can we go to the next question, please?

Operator

Thank you. The next question is from Aaron Rakers of Stifel Nicolaus. Your line is now open.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Yeah, thanks for taking the question. I wanted to go through the product portfolio again on the storage side. And what I wanted – I was wondering if you could just help me understand kind of the continued decline that you've seen in your storage gross margin. As you make these migrations to these emerging product categories, is EMC either becoming more cost competitive in the market to drive those businesses or is there another reason that we continue to see kind of this storage gross margin decline? Thank you.

David I. Goulden - Chief Executive Officer-Information Infrastructure

Yeah, let me let Denis start on the margin comment, and then I'll just come back and talk a little bit more about the portfolio, Aaron.

Denis G. Cashman - Chief Financial & Accounting Officer

Yeah. So, just a little background on the gross margin for storage. We were – that's the biggest piece of our gross margin within EMC II. Now, it actually ticked off year-over-year if I back out the impact of software cap. So we are actually pleased with that, and that's as a result of some of the transformational work we're doing with our cost transformation program. So directionally, it was pretty good for quarter one, and we see that progressing for the year.

David I. Goulden - Chief Executive Officer-Information Infrastructure

Yeah. So, Aaron, as Denis said, certainly when you normalize the impact of software cap and you normalize the impact of volumes, because obviously volumes is very important for gross margin, we are actually quite pleased with the way the portfolio is shaping up. And if you think about it and you think about the product side from where we're actually going, we are very encouraged with the margins we're getting on the all-flash versions of our traditional products. And by that, I mean VMAX All Flash still in the early stages, but the ramp-up is going nicely and the gross margins are good. We expect to see that in the new mid-tier as well. And then if you think of the products that we've classically put in the emerging storage bucket, things like XtremIO, Isilon, ECS, ScaleIO, those are good margin products. So we actually see the profile, the mix shift of the storage portfolio actually being helpful to gross margins over time.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thanks. Next question, please?

Operator

Thank you. The next question is from Toni Sacconaghi of Sanford Bernstein. You may now ask your question.

Toni Sacconaghi - Sanford C. Bernstein & Co. LLC

Yes. Thank you. You've talked a lot about this migration from disk to flash. And I was wondering if you could sort of quantify or give some guideline on what you think that ultimate mix is. And also, specifically in the context of VMAX, you've often talked about new products taking three quarters to account for 50% of volume. And again, given that this is a radical change in terms of using flash in a primary array, how should we think about this product transition specifically on VMAX? And then just maybe for Joe, I was wondering if you could just comment on what you're seeing in the U.S. specifically. The growth rate in the U.S. was well below the company average. We've seen that from some other IT vendors as well. And I'm wondering if that's because the – you're seeing less transactional spending or whether the forces of change are more pronounced in the U.S., and so in the interim, there's more pressure on traditional vendors. Thank you.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Yeah, let me just start and do a little bit of front end, Toni, and I'll comment on your question you asked of me, and then David can take the meat of it. I would – when I think of the storage market, it's not just disk to flash for primary. It is that, for sure. I mean, I believe the process where you're doing your main transactions for ERP, CRM, HRM, things like billing, anything that you do in a proactive in which your business runs day-to-day is – that will move to flash. There is a persistent side to data, right, long live data, archive, back-up, which will have a role with disk systems for a long time. But think of it also this way. You have this flash moving for primary. You have this cloud storage becoming a factor. And then, of course, as customers buy, they're buying more and more appliances, racks and blocks.

So that's a – so you really got to think of all three of those shifts. The shift to flash, the shift to Cloud, the shift to appliances. And as you said, it's been the tradition and it's still happening as sure as I'm sitting here that these transitions are being led in the U.S. And this causes some confusion as we're going through this. I think the great news is, I'm sure as David gives you answer and as you listen to what we say at the end, we're a primary mover and influencer in the primary storage going to flash. We have great plans and activities in the cloud. And then, of course, we are leading in appliances, blocks and racks. So think it's even more broader, this shift, than you think. And that shift is being led in the U.S., and that does cause some confusion. But I – but this confusion is ultimately going to be very good for us. And if you think in a merged company, well actually, when your appliance is racks and blocks, it even makes us stronger. David?

David I. Goulden - Chief Executive Officer-Information Infrastructure

Sure. So thanks, Toni. So first of all, let me just go back and reinforce how important XtremIO is to us. That is from the ground up, our all-flash scale-out architecture designed for mixed transactional workloads. That's going to continue to be a very important part of the portfolio, a rapidly growing part of the portfolio. And as I said, it's – the market share in Q4 is three times its closest competitor. But, of course, we've learned a lot from that model. And we've really done some exciting things to the VMAX All Flash in terms of how we packaged it, in terms of the VBrick format. It's very easy to build up in modular format. We're actually including a lot of the software titles on an appliance model.

The Xtrem, they expect more. The lifetime maintenance guarantee, the lifetime insurance guarantee, et cetera, from XtremIO all apply into that model. So from a technology, a performance, a pricing, a packaging point of view, we've really changed the game with VMAX All Flash. Now, Toni, to your point, where we plan to drive that to, we're obviously early. We've had a few good weeks of experience in the market with the VMAX All Flash. I can tell you that from a goal point of view, by the time we get to year end, we're expecting over 50% of the new VMAX systems that we ship will be all-flash.

Anthony T. Takazawa - Vice President-Global Investor Relations

Okay. Thank you very much.

Toni Sacconaghi - Sanford C. Bernstein & Co. LLC

Thank you.

Anthony T. Takazawa - Vice President-Global Investor Relations

Next question, please?

Operator

Thank you. Our next question is from Katy Huberty of Morgan Stanley. You may now ask your question.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Yes. Thanks. Joe, you've mentioned that you're waiting on China for regulatory approval of the merger. Have you had any dialogue that gives you insight into their frame of mind or any concerns that they might have, and also on the timing of their decision and what might be delaying it relative to other countries? Thanks.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

I don't think it's delayed. China has a three-step process and they're – we are following and working with them on that process. Dell actually has a little bit more of a lead. So it's nothing that I'd say is concerning. But they do have a process and they are following their process.

Anthony T. Takazawa - Vice President-Global Investor Relations

Next question, please?

Operator

Thank you. Our next question is from Andrew Nowinski of Piper Jaffray. Your line is now open.

Andrew James Nowinski - Piper Jaffray & Co (Broker)

Okay. Thanks for taking the question. I'm wondering if you can give us any more color on VxRail and how it compares to Cisco's new HyperFlex solution, the Nutanix box, meaning, I guess, what do you see as the high level competitive advantages over HyperFlex and Nutanix? Thanks.

David I. Goulden - Chief Executive Officer-Information Infrastructure

Sure, Andrew. VxRail is firstly, a real joint collaboration, exclusive collaboration effort between EMC and VMware. So I would tell you that it takes better advantage of the VMware software capability than anybody else out there. Also, we've done some really neat packaging around the system itself in terms of the modular family range, the entry-level price points. We've basically integrated a lot of EMC storage technology. So, as customers look at it, it's very differentiated, particularly in the VMware environment where it excels.

But the inclusion of replication technology, of backup technology from VMware – sorry, from EMC makes it a really powerful combination, and nobody else can offer that kind of combined integrated offering with our set of feature functionality with a single support point. And that's why we think it's a barn buster. We're super excited about it. We've actually – I'm telling you, we've actually taken up our external expectations for it for the year. We had an aggressive set of goals coming out of the gate. We've actually increased those based upon what we're seeing for the first few weeks in the marketplace, and we think we can be in a market-leading position with this technology by the end of next year.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thank you. Next question, please?

Operator

Thank you. Our next question is from Rod Hall of JPMorgan. Your line is now open.

Rod B. Hall - JPMorgan Securities LLC

Yeah, thanks for giving me a question, guys. I just had a couple of, I guess, clarifications. One is with regards to this mission-critical switch to all-flash. I know this thing's been asked multiple times, but I think just to give a little bit of clarity to the question, what we've seen are specific data points this quarter that suggested that transition has accelerated. And so I wonder if you guys could very specifically comment on whether you've seen an acceleration this quarter in that transition and then how you think the rate of change moves through the next couple of quarters. I guess what we're all wondering is whether we do see an accelerated move these next couple of quarters toward all-flash and away from mission-critical high RPM drives.

And then the second thing I wanted ask is, Joe, just backing up to kind of your bigger picture comments and maybe, David, you, too. We're wondering what's happening with IT spending more broadly, not just storage but broad IT spending thinking amongst you guys' counterparts out there. Obviously, global macro situation still isn't particularly great, but the U.S. seems to be motoring along a little bit better than we thought it would. So I'm just wondering if you can give us any color on what you're hearing from your counterparts. Are they thinking about continuing to slow spending or are they feeling a little better about the overall macro environment? Thanks.

David I. Goulden - Chief Executive Officer-Information Infrastructure

Rod, yeah. Let me start out and talk about the move to all-flash. And again, let's just clarify, this is all-flash for primary storage. There are multiple classes of storage. If you hear us talk about our storage portfolio, we talk about performance optimized storage and capacity optimized storage, we're talking here about the performance optimized storage, that class of storage moving to all-flash. And we believe, again, for new systems shift that 2016 becomes the tipping point. And the tipping point is a combination of the developments of the flash media.

Again, I mentioned this 3D NAND technology which gives incredible performance and capacity at much better price points. That really has only become available in the first quarter of this year from some of the flash vendors, and that combined with some of the software enhancements that we and others have made around flash, really, I think changes the point such that the proposition to a customer now on a new system is, hey, for the same price as we could deliver to you, a hybrid system last year, we can give you at the same dollar per gigabyte or maybe slightly less, we can give you an all-flash system. And you don't have to bother about tearing, you don't have to bother about management, the performance is better.

The footprint is better. The power and cooling is better. So it really becomes relatively a no-brainer in the primary storage marketplace, and we've done that now for the high end with VMAX. We're going to do that for the mid-tier very, very soon and we'll be announcing that at EMC World.

And of course, we've got XtremIO for those applications where, really, all-flash and massive dedupe make a huge difference. So essentially, what's happening this year is in the primary storage marketplace, all-flash has gone from being a very important vector, which works for some applications, to where it can now really apply to all applications that are transactionally intensive, and that's the big shift. So that's going to play out during 2016. It's been a bit of a tidal wave that's coming and now we think that, that wave is going to break up on the shore very much this year.

And as I mentioned in answer to one of my prior questions, if you just take the VMAX by itself, by the end of the year, even in that category of systems, we expect over 50% of all new systems shifts. Again, new system shift by the end of the year will be VMAX All Flash as opposed to VMAX hybrid. So that's a pretty drastic shift in a short period of time. And then you look across the entire portfolio, you add together VMAX, you add together the new mid tiers, which will save details for a couple of weeks. And then you look at XtremIO, you put those together and you, clearly, by the end of the year, the significant majority of all systems, shifts, new system shifts, will be in the all-flash configuration. And that's a big shift in the course of 2016 versus 2015.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

On IT spending, you're seeing a shift now. I am convinced that if you really could accurately capture shadow IT and add that to classic IT spend, you'd see bigger increases than being reported. And in shadow IT, you're seeing marketing spend on IT. You're seeing even CEO-driven IT around Internet of Things and new business models. So this is causing a huge burden or kind of angst in this – in the world of the CIO, because basically, he's got to spend on mobile, he's got to spend on his – on their digital transfer, companies or enterprise digital transformation, you've got to spend more on security, you're moving applications to the cloud. And then, of course, you've got to deal with your – you've got to transform and cloudize your older applications. And when you – and so right now, I think you're seeing a bit of a pause in the CIO world as they figure this all out, but I absolutely believe when you – the opportunity for IT in the future is going to accelerate in terms of spending, absolutely believe that.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thanks. Next question, please?

Operator

Thank you. Our next question is from James Kisner of Jefferies. You may now ask your question.

James Kisner - Jefferies LLC

Yes. So, there's been a lot of talk on this call about the forces of change causing delays in customer purchases, but I just want to clarify, is it obvious to you from your customer conversations that this is not due to any kind of mounting concerns around the strength of the global economy at all? I mean, can that also be weighing on customer spending? Thanks.

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Well, absolutely, the economy is a factor. But I think this next wave of growth – and any company, any company is going to be more IT-driven than it was in the past. So it kind of – this is part of the digital transformation that every company and every enterprise, every government has got to go through. And how well they go through that transformation and become more digital, rediscover the art of writing software, become more software-enabled in their business processes and products, that's going to define how successful those companies are going to be. So we're – that's a huge change, but this is the biggest change that's the most disruptive, as I said before, and the most opportunity-rich that I've seen in my career in IT.

David I. Goulden - Chief Executive Officer-Information Infrastructure

And then just to pick up on that, James, I mean, what that translates to for CIOs is a degree of caution, and we see it. We talk about this transactional spending. If people are spending on their existing systems to kind of keep the lights on without driving change, then they're trying to basically minimize the spend on that piece of the budget, and we see it in terms of people buying just enough, just in time, more renewals versus buying new systems as characterization, and that happens late end of the quarter. That's all a function of this more cautious transactional spending whilst people figure out exactly what their transformational initiatives are going to be and where they are going to prioritize their budget spend towards the things that Joe talked about. Are they going to spend money, first of all, upon transforming their existing environment? Are they going to move into a new digital business agenda, et cetera? And these dual forces are what we see in the marketplace, and we see it very clearly within our business.

We see this heightened caution in the transactional spend, and we see it occurring in terms of late calls and things like that. But we also see these really exciting transformational projects as people are embarking upon these new journeys which is going to transform their business. And not surprisingly, in that environment, there's a counteracting force and it's a little harder to predict than when everything is flowing in the same direction.

James Kisner - Jefferies LLC

Thank you.

Anthony T. Takazawa - Vice President-Global Investor Relations

All right. Thanks. We have time for one more question and then we'll have a few concluding comments from Joe.

Operator

Thank you. Our last question is from Steven Milunovich of UBS. You may now ask your question.

Steven M. Milunovich - UBS Securities LLC

Thank you. I wonder if you could comment a bit about the competitive situation out there. Pure is obviously growing at a high rate, though I know you are much larger. But they talk about you having an older architecture in flash, so how do you think that plays out over time? And I was actually at NetApp, and like a lot of companies, they claim they're going to be picking up share as you go through the integration with Dell. They claim pretty strongly that they've – it's been pretty easier to pick up customers and employees much easier than in the past because of the deal. Would you comment on that?

David I. Goulden - Chief Executive Officer-Information Infrastructure

Steve, actually – well, obviously, people will try and take advantage of an opportunity, but let me make a couple of points. First of all, compared to Pure, we have a fundamentally different and more advantageous architecture. We have a system which is designed to scale out and have data services running always on and always on all the time. Pure basically has a dual control architecture. And that limits their ability to scale out and limits their ability to expand into broader workloads.

The traditional vendors like in NetApp, I talked about how the fact that we are, in fact, picking off their customers. I talked about 45 petabyte win sweeping the floor, we won their top five accounts during the quarter. So we are very confident that whilst people are obviously going to try to pick on us, we are the market leader, we're the biggest company in the industry, and we are obviously going through some change. We are very confident, our portfolio has never been stronger, and our competitive position had never been strong, which is great at this time.

Anthony T. Takazawa - Vice President-Global Investor Relations

Thanks, Steve. Joe?

Joseph M. Tucci - Chairman, President & Chief Executive Officer

Well, again, I want to thank everyone for joining us today. We really do appreciate it. And I want you to understand that we in the EMC family of companies are excited about our future. We are confident in our ability to meet our 2016 revenue, EPS and cash flow goals, which are again our growth goals. On the merger front, we are working diligently with the SEC to become effective as soon as possible, and we are aggressively planning the detailed reintegrations so we can get a fast start once everything is finalized and approved.

Importantly, as soon as our Registration Statement becomes effective, we will be out there with you, our valued shareholders, to make sure we answer your questions. So I thank you for – again, and we will see you real soon. Bye-bye.

Operator

That concludes today's conference. Thank you for participating. You may now disconnect.

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