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EMC Corporation (NYSE:EMC)

Q3 2007 Earnings Call

October 25, 2007 8:30 am ET

Executives

Tony Takazawa - Vice President, Global Investor Relations

Joe Tucci - EMC Chairman, President and Chief Executive Officer

David Goulden - Executive Vice President and Chief Financial Officer

Analysts

Aaron Rakers - Wachovia Capital Markets

Laura Conigliaro - Goldman Sachs

Shebly Seyrafi - Caris

Keith Bachman - Bank of Montreal

Toni Sacconaghi - Sanford Bernstein

Andrew Neff - Bear Stearns

Kevin Hunt - Thomas Weisel Partners

Katy Huberty - Morgan Stanley

Kaushik Roy - Pacific Growth Equities

Paul Mansky - Citigroup

Clay Sumner - FBR

Operator

Welcome to the EMC Conference Call and thank you for standing by. At this time, all participants are in a listen only mode (Operator Instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Now I will turn the meeting over to Mr. Tony Takazawa, Vice President, Global Investor Relations. Sir, you may begin.

Tony Takazawa

Good morning to everyone. Welcome to EMC's call to discuss our financial results for the third quarter of 2007. Today, we are joined by Joe Tucci, EMC Chairman, President and CEO and David Goulden, EMC Executive Vice President and CFO.

David will start things off by walking you through EMC's activities and financial results for the quarter. Joe will then spend some time discussing his market outlook, EMC's execution of the strategy and the progress we are making toward our annual goals. After the prepared remarks, we will then open up the lines to take your questions.

Today, we will be providing you with new financial schedules and disclosures. Our slides contain important information that is necessary to understand our results and this new disclosure. I highly recommend that you view these slides in conjunction with the audio portion of the call. The slides are also available for downloading on EMC's website at emc.com. An archive of the audio and slide presentation will also be available following the call.

As always, the call this morning will contain forward-looking statements. 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.

In addition, we will be discussing EMC's results on both a GAAP and non-GAAP basis. There are schedules in today's press release that reconcile our non-GAAP comments to our GAAP financials.

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

David Goulden

Tony, thank you. Good morning and thank you all for joining us today. We are very pleased with our Q3 operational and financial results. We demonstrated crisp execution, delivered strong performance in a number of areas and continue to make great progress towards our goals for the year.

On today's call, I will talk about EMC's consolidated performance and then spend some time discussing EMC's information infrastructure results. EMC information infrastructure is our storage, content management and security businesses or said another way, everything except VMware. I am sure you have all seen VMware's earnings report from last night. So, I'm not going to repeat anything that was covered, but I will make some comments about VMware's financial results within EMC.

As Tony mentioned, we have made some changes to our financial presentation and we've provided new supplementary schedules with today's press release.

Now turning to the numbers. Q3 consolidated revenues were $3.3 billion, up 17% from Q3 last year and included approximately 200 basis points from currency. GAAP earnings per share were $0.23. Excluding the gain we realized in the quarter, primarily from EMC's sale of VMware stock to Cisco, earnings per share were $0.17, up 31% over Q3 last year and free cash flow was $475 million, up 124% from Q3 last year.

I will now walk you through the consolidated revenue results in more detail, starting with our corporate revenue mix. Q3 systems revenues were up 9% year-on-year driven by strong growth in our midrange products.

Year-to-date, systems revenues were up 11%. Q3 storage revenues were up 25% year-on-year driven primarily by VMware, RSA Security and content management. Year-to-date software revenues were up 27%, and Q3 services revenues were up 25% year-on-year driven by strong performance in all of our business units. Year-to-date, services revenues were up 21%.

Now turning to revenue by geography, revenues from North America grew 15% over Q3 last year and we continue to experience strong growth in our commercial business. Year-to-date, North American revenues grew 17%. EMEA revenues were up 23% over Q3 last year and this region had another strong quarter in midrange systems. Year-to-date, EMEA revenues were up 20%.

APJ had another good quarter with Q3 revenues of 18% over last year driven largely by CLARiiON, which had very solid growth of approximately 40%. Year-to-date, APJ revenues up 26% over 2006 demonstrating great performance in this important region.

Finally, Latin America revenues were up 6% over Q3 last year and up 6% year-to-date. We are pleased with the revenue results of our major geographies and we remain focused on expanding our international footprint and increasing our worldwide market presence.

Next, I’d like to cover the revenue results from each of our four business segments, information storage, content management and archiving, RSA information security and VMware. These segments represent the major markets we focus on within IT and the solution sets we bring to customers. First, let's take a look at our information storage business.

Total revenues for Q3 were $2.6 billion, up 8% over a strong Q3 last year. Year-to-date, information storage revenues are up 9% over last year. In July, we had one of the most significant rollouts of new products in the history of our information storage business. These new systems and software capabilities span from the entry level to the high end and will help EMC further extend our lead in all of the storage markets we serve.

During the quarter, we introduced the DMX-4 and began shipping in August. This is the next generation Symmetrix with built-in information security along with significant performance gains and even better ease of management and energy efficiency.

The DMX-4 is the highest performing, most cost effective, secure, energy-efficient and easy to use high-end array on the market today. We met our internal goals for the DMX-4 transition this quarter and we are pleased with the positive response we are seeing from customers. For Q3, Symmetrix revenues were down 3% year-on-year against, as you will recall, a very tough compare. Year-to-date, Symmetrix revenues are approximately flat.

We had another good quarter in our midrange business with CLARiiON revenues up 18% over Q3 last year. Year-to-date, CLARiiON is up over 20% over last year. We are seeing good growth in the adoption of iSCSI. Over 50% of our CX3 units in the quarter were dual protocol, i.e. Fibre Channel and iSCSI systems.

We are also seeing very strong demand for our Celerra NS20 platform. This is our new, entry level, multiprotocol, mass Fibre Channel and iSCSI array, which is also a powerful, yet easy to deploy, tiered storage system. Smarts, Rainfinity and RecoverPoint all had strong double-digit growth this quarter and we also had double-digit growth in our backup and recovery software business led by our Avamar de-duplication technology.

Additionally, backup to disk library revenues were up over 40% year-over-year. We continue to drive deeper integration of our acquired technologies across our products to provide solutions that no one else offers.

And this quarter, we introduced important new products to our backup and recovery portfolio. In September, we launched EMC Avamar Virtual Edition, which enables customers to deploy Avamar's data de-duplication technology easily and effectively in VMware VSX environments.

And last week, we introduced our next-generation backup and recovery network of products. This release integrates our Avamar de-duplication and RecoverPoint continuous data protection technologies into the NetWorker platform providing customers with industry leading, next-generation capabilities for backup and recovery.

Information and storage services grew 13% over Q2 last year driven primarily by professional services. Our expanding professional services portfolio is enabling us to work in more ways with customers, and Dell represented 15.8% of EMC's total revenue this quarter. Within this total, Dell was around 35% of CLARiiON revenues and the balance came from a broad mix of EMC's information and storage, content management, security and VMware products.

In summary, Q3 was a very solid growth, very solid quarter in storage for EMC with revenues up 4% sequentially and 9% year-to-date. The demand for the differentiated products and services we offer gives us confidence we are well positioned for continued growth and share gains in storage this year.

Now turning to our content management and archive software business. Total revenues were $189 million, up 27% over last year. Year-to-date, total revenues for this business are up 11% over last year.

Q3 license revenues were up 34% over last year and are up 15% over Q2 of '07 reflecting a nice bounce back. Maintenance and professional services revenues were up 20% year-on-year.

Last quarter, I told you there were some key factors that gave us confidence in our CMA business heading into the second half of the year, including a strong pipeline of business, better market enhancements and strengthening of our partnerships with several of the leading global systems integrators and confidence in the competitiveness of our product portfolio and our technology leadership in CMA, particularly with the launch of our next-generation Documentum D6 platform in July, which we believe raises the bar for content management and archiving solutions. We’re pleased to see that these focused efforts paid off in our results in Q3.

And looking ahead, we see increasing demand for complete capture through archiving solutions and we remain confident that we are well positioned to post solid results in our CMA business this year.

Now, let me turn to the RSA information security business. Revenues in Q3 were $133 million, up 22% on a comparable basis over Q3 last year. Year-to-date, security revenues are up 23% on a comparable basis, validating the strategic focus of this business and demonstrating solid execution and share gains.

Trends in the marketplace continue to turn from perimeter-based security to information-centric security, driving demand for our RSA Security, access control and data protection products.

Compliance, particularly around the payment card industry's data security standards and security information management continue to be the major growth drivers and the acquisition of Tablus to our security portfolio adds important data leakage protection capabilities, which protects data at rest and complements our encryption and key management technology.

We believe there is no other company that offers as complete a suite of best-of-breed products focused on securing the information itself. Combined with our professional service offerings for risk assessment and security systems architecture, RSA solutions are covering the full spectrum of the security industry's most important growth areas.

In summary, we are pleased with the revenue results from our information infrastructure business units this quarter. We continue to believe we’re focused on the right markets and have the best solutions to help customers address their most critical information management priorities.

Now turning to VMware. Clearly, one of the highlights of the quarter was the very successful partial IPO of VMware, which achieved our goals of exposing VMware's value to the marketplace, improving VMware's ability to attract and retain employees and reinforcing our commitment to VMware's openness.

VMware had another quarter of record revenues with both Q3 and year-to-date revenues up approximately 90% over last year. This strong growth reflects the tremendous impact that VMware virtual infrastructure is having on the marketplace.

We’re also very encouraged that we continue to see VMware virtual infrastructure as a key-driver for network storage deployments.

Turning to VMware's reported results, let's talk about how they contribute to EMC's consolidated results. For Q3, last night, VMware reported revenues of $358 million and GAAP net income of $65 million. Within EMC's consolidated numbers, these results are adjusted for audit reconciliation’s and the minority interest of VMware not held by EMC.

On this basis, VMware's results within EMC were revenues of $354 million and net income of $58 million. This net income translates into a $2.06 contribution towards EMC's Q3 consolidated GAAP earnings per share.

Within this $2.06, it is important to notice that to note that $0.07 was from an atypically high level of software capitalization and a reduction in VMware's annual tax rate, which resulted in a beneficial catch-up in the tax rate in Q3.

Moving on from VMware and based upon our discussions with you, we know that there is a lot of interest in how EMC is doing, excluding VMware's results now these are reported separately.

In order to better help you with your analysis, we are adding a new financial presentation of EMC's information infrastructure business that includes our information storage, content management and RSA Security businesses, i.e. everything except VMware.

Today, we are providing you with an income statement view of the information infrastructure business for the last four quarters of 2006 and the first three quarters of 2007.

These schedules are included in today's press release. The financial presentation of the information infrastructure business will enable you to better understand the growth dynamics of the business and give you visibility into how we are doing operationally.

Based upon your feedback, we will be presenting these results on a non-GAAP basis, excluding stock-based compensation and intangible amortization. This detail will enable you to see how we are managing the business model and give you a view into how we are improving operating leverage and generating cash.

I’ll begin by taking you through the components of how we reconcile EMC consolidated GAAP results through to our EMC information infrastructure business on a non-GAAP basis. This may take a few minutes, but it will help you understand the basic mathematics of how we get to the numbers.

More importantly, I’ll then discuss the relevant operating metrics of the EMC information infrastructure business and talk to you about the improvements we are seeing there.

Now let's start with the basic math for Q3. We start with EMC consolidated GAAP revenues of $3.3 billion and earnings per share of $0.23. Next, we adjust to earnings per share for the Q3 investment gains, primarily on EMC's sale of VMware stock to Cisco. Within these adjusted consolidated EMC results, we then have the VMware GAAP standalone contributions as they reported last night.

Now, as I just explained to you, we then adjust for audit reconciliation’s between VMware standalone results and those results reported in our consolidated numbers and the minority interest of VMware not held by EMC. This gets you to VMware's contribution within EMC.

EMC's adjusted consolidated results less this VMware contribution gives you the results for the rest of the Company, representing the EMC information infrastructure business. We then adjust for the non-cash items so you can better see our progress in terms of operating efficiencies and cash generation.

These items are stock-based compensation of $0.02 and intangible amortization of $0.01. This gets to our EMC information infrastructure earnings per share on a non-GAAP basis of $0.18 for Q3.

Okay. So, there you have the math and as you can see, it is pretty straightforward. We think it is the right way to look at the information infrastructure business and gives you a great view of how we are doing.

So next, let's talk about what these numbers tell you. Q3 revenues for the EMC information infrastructure business were $2.9 billion, up 12% over last year. Year-to-date, revenues for the EMC information infrastructure business are up 14%.

Gross margins improved 40 basis points sequentially driven by higher profit margins in our information storage business. Year-to-date, gross margins are up 40 basis points due to the higher mix from RSA Security and CMA.

Operating expenses were down 50 basis points sequentially, reflecting good cost control. Year-to-date, operating expenses were up 20 basis points reflecting the growing contribution from the RSA Security and CMA businesses. As I have mentioned before, these businesses have higher gross margins and they also have higher operating expenses compared to the storage business.

Now let's take a look at the operating margin trends. The operating margin of our EMC information infrastructure business is up 80 basis points sequentially and up 20 basis points year-to-date. This shows the solid progress we’ve made towards improving the leverage in our operating model over the course of this year.

In Q3, we continued to make progress on our one EMC initiative. We are now about two-thirds of the way towards completing the Q4 '06 restructuring plan and we anticipate completing the majority of the remaining actions by year-end.

We’re pleased with our operating margin improvement this quarter and continue to be focused on our cost base, expense management and driving operating leverage. Q3, EMC information infrastructure non-GAAP earnings per share were $0.18. Year-to-date, on the same basis, EMC information infrastructure earnings per share were $0.53 up 18%.

So while I have gone through a lot of new numbers today, I think you will find it very helpful in your analysis of EMC. As you have requested, we are breaking out the EMC information infrastructure business. We are giving you a full income statement view of seven quarters of historical comparisons so you can see our progress.

And we are providing a view of the business, excluding non-cash expenses, so you can track our success in terms of driving operating leverage. We believe presenting the EMC information infrastructure business on a non-GAAP basis allows for the most transparent and clean view of our operational performance.

Now moving to the balance sheet and looking at a few consolidated balance sheet and cash flow items. EMC consolidated cash flow from operating activities in Q3 was $718 million, up 57% from Q3 last year. This improvement came primarily from our increased net income and improvements in working capital, including growth in deferred revenues and better inventory managements.

Looking at the other balance sheet items that impact operating cash flow, inventory turns were 6.6, up from 5.9 in Q3 last year and DSOs were 54 days, up five days from Q2 due to a number of factors, including VMware and some acquisitions that closed towards the end of the quarter. This is a little higher than we would like and we will work to bring DSOs closer to 50 days.

Excluding VMware, Q3 cash flow from operating activities was $529 million, up 51% from Q3 last year. And year-to-date, excluding VMware, cash flow from operating activities was $1.6 billion, up 35% from last year. EMC consolidated Q3 free cash flow was $475 million, up 124% from Q3 last year. CapEx was $177 million and software capitalization costs for the quarter was $65 million.

Excluding VMware, Q3 free cash flow was $357 million, up 123% from Q3 last year. Year-to-date, excluding VMware free cash flow was $1.1 billion, up 80% from last year. We are very pleased with the improvement we’ve made in this area.

Now, turning to cash use on a consolidated basis. In Q3, we spent $352 million on acquisitions for our information storage, content management and VMware businesses. And we spent $224 million to buy approximately 12 million shares in Q3. We were restricted from buying shares for most of the quarter due to the partial IPO VMware.

We ended the quarter with cash and investments of approximately $7.5 billion. $3.7 billion of this is held in our overseas operations and in VMware. We believe our capital structure initiatives over the last year, including our share repurchases, convertible debt transaction and partial IPO VMware, have been very beneficial for shareholders.

So far this year, we have bought back 73 million EMC shares returning $1.1 billion to our shareholders. As always, we are committed to delivering shareholder value, so I am pleased to announce we are now increasing our January 2007 share re-purchase commitment from $1 billion to $2 billion.

This increase includes a return of a portion of the proceeds from the VMware IPO and we expect to complete this repurchase by the end of Q1 2008. The average diluted share count for the quarter was 2.177 billion, up over 2.5% from Q2.

The largest driver of this sequential increase is the accounting treatment for the additional shares from our convertible debt that we issued last November. Accounting rules for this convertible debt caused our fully diluted shares to increase as the quarterly average share price increases above the convertible exchange price of $16.08.

And while we have structures in place to eliminate the net dilution to shareholders when the convertible bonds mature in 2011 and 2013, our reported diluted shares outstanding will continue to reflect the full accounting impact.

This accounting impact is meaningful and for those of you who are unfamiliar with the share calculation used in accounting treatments, there is a slide at the end of the presentation illustrating the math and including a numeric example.

While I am not going to walk through the calculation with you this morning, the example provides, the example provided illustrates the magnitude of these accounting treatments. Assuming EMC's stock price averages $22 for a given quarter, the calculation would lead to an accounting increase of approximately 60 million shares or a 3% increase in our current diluted share counts.

This will reduce our earnings per share by approximately $0.01 a quarter. I point this out because you'll probably want to keep this math in mind as you work through your future models.

Looking forward and based upon our results year-to-date and our expectations for a solid fourth quarter, we are now very clearly on track to exceed the annual targets we set in January of $12.7 billion of revenue and $0.64 of earnings per share.

With that, I will now turn the call over to Joe.

Joe Tucci

Thanks, David. I would also like to welcome everyone to today's conference call. Thank you very much for joining us. I was quite pleased with EMC's performance in Q3. Our execution and results were strong and very well balanced across our four businesses, across hardware, software and services and across our three major geographies. And besides posting solid results, we gained share in each of the major markets we serve.

Looking a little more closely at EMC without VMware, clearly, our information infrastructure strategy powered by our one EMC business model served us well this quarter. We grew revenues, we grew gross margins and we increased leverage. Which resulted in improved operating margins. Also, this past quarter, I was very pleased with our cash flow results.

Storage continues to be the bedrock of our information infrastructure business as customers around the world look to EMC for industry-leading products and services. In Q3, we were pleased with the launch and customer reception of our new Symmetrix DMX-4 product family.

Also, this past quarter, our CLARiiON CX3 line continued to post strong results. The market acceptance of our new entry and mid level multi-protocol systems, the NS20 and NS40, was nothing short of phenomenal.

Performance, reliability, ease-of-use, functionality and versatility of these new multi-protocol systems sets a new bar for the storage industry. And there is more to come. In the not too distant future, we will announce a system specifically designed for Web 2.0 data centers and new lower end, SMB oriented products.

Turning to our content management and archiving business, as you will remember in Q2, we said we were disappointed with the results of our content management and archiving business. We told you we are in the midst of both organizational and management changes and that we told you we expected and would do better in the second half of the year.

As you can see by our 27% year-on-year growth in content management in Q3, we are off to a good start. Unstructured information continues to grow at a rapid pace. The value of that information can only be realized by, proper storage and management of this content. Thus, we see a good, long-term opportunity in the content management and archiving business and the leverage it generates with our storage and security business is impressive and growing.

Our RSA Security business for the fifth quarter in a row posted a year-on-year growth rate of over 20% as the demand for securing the information itself through encryption and robust centralized key management continues to grow and the need for strong authentication and assured compliance is now a must have across virtually all industries.

And again, you can see the synergy and leverage between our security business and our storage business and content management businesses increasing. Examples are products like enVision for storage, RSA's Strong Authentication, which is built into Symmetrix, secure content management, the integration of information rights and management into our content management offerings and coming soon, you will see PowerPath encryption.

And lastly, our strategy calls for EMC to provide integrated information infrastructure solutions to assure one of the key ingredients for success on this or any other solutions front is having a strong and experienced service organization.

Today, our service organization has over 11,000 people around the globe and we expand this presence significantly through our value-added service partners. Proof of our success here is a 25% year-on-year growth we achieved this last quarter.

Now, I would like to briefly comment on the economic environment and the IT spending trends. As I said, in Q3, we actually saw a strong demand for our information infrastructure products and services in storage, content management and security.

I know there’s a lot of concern out there about a slowdown in the financial services arena, particularly in the U.S. But I must say, I would not categorize our Q3 performance in this sector as high-growth; we did see a little year-on-year growth in the financial services market this past quarter.

Trends that led to this growth were business continuity, consolidations, risk mitigation and compliance, intelligent archiving and backup to disk solutions. We continue to see good growth opportunities in the SMB and commercial market segments across the globe.

We continue to see robust growth opportunities in Asia Pacific, Middle East, Eastern Europe and Latin America and to complete the picture, in Europe, we see IT spending continuing at a pretty good pace.

So, despite the air of caution in the financial services industry, we currently see enough opportunity to achieve our growth objectives going forward. As David already said, without a doubt, the highlight of the quarter was the tremendously successful IPO of Vmware.

It was coupled with their equally impressive Q3 year-on-year revenue growth rate of almost 90%. And for me it’s virtual infrastructure is clearly being embraced by a wide set of customers across the globe.

The goal of this partial IPO was to unleash value and this goal was definitely met. Undoubtedly shareholder value was unleashed and undoubtedly VMware's unparalleled value proposition was exposed to a broader audience of current and future customers.

Going forward, I assure you we will continue to focus on creating shareholder value for both groups of shareholders. We are very pleased with the performance of our asset mixed and we have no current plans to further distribute VMware shares.

This is consistent with what we said at the time of the IPO. With that, let me turn it back to Tony to moderate the Q&A portion of today's call. Tony?

Tony Takazawa

Thanks, Joe. We open up the lines for your questions, as usual, we ask you to try to limit yourself to one question, including clarifications. It will enable us to take as many questions as possible. Thank you all for your corporation in this matter. Draney, can we open up the lines for questions, please?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Aaron Rakers, Wachovia Capital Markets.

Aaron Rakers - Wachovia Capital Markets

Thanks, guys and congratulations and also thanks for the clarity on the organic business. I guess my question is around the operating margin story, very strong story with 80 basis point improvements here over the last few quarters.

And I guess when you look out going forward, can you give us any type of target around where you would like to manage this business from an operating margin perspective? And then also on top of that, how much of this recent expansion is due to headcount versus just the changing mix of your overall business? Thank you.

David Goulden

Hi, Good morning. Let me take that for you. First of all, we are not going to give you a target for where we want to try and get the margins to, but I would point out that our goal is to continue to drive leverage.

Actually, in some ways, leverage is a little stronger year-on-year than it might have looked from the numbers because if you just looked at Q2 and Q3 versus Q2 and Q3 last year, the leverage would be up 60 basis points on the core business on a non-GAAP basis.

Because, if you remember in Q1 this year, we had a slightly unfavorable mix of hardware products so, normalizing that out, the improvement is quite good. You are going to see continued impact of the move towards the software businesses.

So, as I said in my comments, as you model going forward we expect the margins will continue to increase with mix as we move towards content and security, but also expect that to drive a higher SG&A yield as well because those businesses have higher SG&A profiles. So we are driving for leverage, but we are not going to give you a target.

Operator

Your next question comes from Laura Conigliaro, Goldman Sachs. You may ask your question.

Laura Conigliaro - Goldman Sachs

Well, I know you are not going to give targets, but given the fact that you really are driving for leverage and you have already provided evidence on a number of different fronts about where those cost savings and other kinds of leverage are coming from?

Why doesn't that imply that you should be exiting 2006 with operating margins pretty close to 20%?

David Goulden

Laura, we have made nice progress during the year. Q4 is always our strongest quarter from an operating margin point of view, so you should expect improvement from Q3 to Q4, but we do want to try to get away from being stuck to specific targets here. Just expect us to drive leverage and we will give you more a view into what we might see in 2008 as we get into 2008.

Operator

Your next question comes from Shebly Seyrafi, of Caris. You may ask your question.

Shebly Seyrafi - Caris

Yes, thank you very much. So you mentioned earlier that you have no plans, current plans to distribute more VMware shares, but I am wondering how firm you are with that statement.

Effectively, the stub or you call the EMC information infrastructure segment is selling at like single-digit P/E ratios, which I think is not appropriate. If this kind of disconnect continues might you change your mind over the next year?

And if you can frame this in the context of early 2009 when you can do this tax-free, I’d appreciate it. Thanks.

Joe Tucci

The IPO is barely two months old. We have generated, I believe, something close to in that year period, looking back here, about 70% growth in the shareholder value. We are focused. I understand all the moving parts.

I would submit that we’ve done a pretty darn good job and we will continue to work in the best interest of the shareholders and beyond that, I am not going to say anything at this structure.

Tony Takazawa

Thanks. Next question, please.

Operator

Your next question comes from Keith Bachman, Bank of Montreal.

Keith Bachman - Bank of Montreal

Hi, thank you. Joe, I think this is for you. In terms of IT storage, IT managers obviously taking a leg from what is going on in the several world there is a lot of discussions, increased focused.

I think on storage virtualization and the specific agenda that we’ve heard from customers is reducing array spending or storage spending. How should investors think about the role of storage virtualization on your business as you look out over the next 12 to 18 months?

Joe Tucci

When I think of storage virtualization, I think of three areas. One, and I think the most important is what is happening on the file side of the business. If you look at both growth rates and utilization rates, you look at almost any factor of control.

Companies across the globe have done a much better job inside the data centers on SANs of bringing up high levels of utilization and high levels of management and the sharing of that data.

Still if you ask -- I have yet to ask a CIO anywhere how much data they have around their file systems or how many file systems they have around a company that knows the answer.

I do think this file virtualization, global namespace technology is going to be is a very important space and one we are focusing on. I also think that we call virtual provisioning, some companies call thin provisioning.

We call it virtual provisioning because what we are doing in provisioning, which we will have that out on all systems first part of next year, it is out on our NS product line today, has tremendously broad capabilities where we can expand and contract loans and provision only when its necessary.

So I think virtual provisioning is going to be important. And I think there is a lot of hype around SAN provisioning. SAN utilization especially when you apply thin provisioning or virtual provisioning, are going to get very high.

And you are going to see most of that virtualization obviously used for dynamic movement of data between tiers and we have a great answer there with our Invista, which is networked-based virtualization.

So, we have all three covered and I actually mentioned what I think is just about the order of importance so if customers out there want to save the most money, just focus on what you're doing in your file systems around the world in storage.

If you want to look at a second thing, I would look at what virtual provisioning can bring to you. Then I would look at SAN provisioning for easier and more effective use of data mobility. It's probably not going to affect your utilization rates at all.

So yes, it is an important set of categories, but it is that set of categories that are going to make up this broader storage virtualization that you talked about.

Tony Takazawa

Thanks. Next question, please.

Operator

Your next question comes from Toni Sacconaghi, Sanford Bernstein. You may ask your question.

Toni Sacconaghi - Sanford Bernstein

Yes, thank you. I wanted to follow-up on your comments, Joe, about the relative weakness in U.S. financial institutions. My estimate is that U.S. financial institutions perhaps comprises about 10% of EMC's revenues. Can you confirm that?

And then more importantly, it looked as though you had weakness in storage software licenses. Those were down year-over-year. You also had some weakness albeit against a tough compare in the Symmetrix productline. Weakness in high-end systems and in software licenses is consistent with what IBM saw.

Was that particularly concentrated in U.S. financial institutions or was that more broad-based and there is a broader explanation for particularly the software license decline?

Joe Tucci

Well, first of all, Tony, we don't comment on what any particular vertical sector makes up as a percentage of our business, so I will pass on that broad topic. But the answer to your question is really a little bit of both.

Obviously, when you look at conditions around driving licensing, financial services in the U.S. is important to us, but it’s more broad. We have got just tremendous coverage of our software and we use a schema as you know where you pay for the license and then you get future upgrades for free as part of your maintenance, so our maintenance revenues on software are growing.

We don't have as much growth on a Symmetrix especially because of the way we licensed over the past years. But it is still Symmetrix; we think that the high-end industry over the last three years has just had single-digit growth, lower single-digit growth.

So this year, we are essentially flat. Last year, we were up a few percent, so I expect that to continue. I mean that business, I’ve said to others, will look a lot to us as the IBM mainframe business looks to IBM. They’re not going away. Customers' most mission critical data is on that.

We really have to have robust business continuity. Those systems are chosen. Or we’ve given options now where you can actually tier in that box and we are just about to release the one terabyte drives to be put into a different tier of the Symmetrix.

So, those things should help or preserve and have slight growth in that business. So, it is a great business and one we’re proud to have. And that does reflect some of our licensing.

David, you wanted to add some?

David

Yes, Tony, I just walked out

Tony Takazawa

Joe, one comment. When you are looking at Q3 year-on-year, which you were doing in those statements, don't forget that Q2 and Q3 last year, we had this abnormal distribution due to the backlog we carried out of Q2 into Q3.

So what you saw is a proportionally higher SIM revenue number in Q3 than you would have done in Q2 last year. So you are comparing a little bit of apples-and-oranges when you are just looking Q3 versus Q3, which is why I think the year-to-date comparisons I mentioned during my script are perhaps the more meaningful ones.

They don't change what Joe said, but it just basically normalizes that Q3 phenomenon.

Joe Tucci

That is why I used the flat, Tony, because if you look at it, we had pretty good Symmetrix growth last quarter, down 3% this quarter. But the way to look at it is over the nine months and the nine months was flat. So the statements that I made to you still hold in that context.

Tony Takazawa

Next question, please?

Operator

Your next question comes from Andrew Neff, Bear Stearns. You may ask your question?

Andrew Neff - Bear Stearns

Sure, if I could, Joe, just going back to what you were saying a moment ago about the weakness was primarily in that any weakness you saw was primarily in U.S. financial. What are other customers telling you? I mean they can all read the same newspapers we all do.

What makes them -- why aren't they being more cautious? And just, David, going back to your question before, comment before in terms of cash, can you give us a sense about how much cash could be available for share repurchases?

Joe Tucci

I did use in my comments the words air of caution. You asked a question on U.S. financial services. When I talked -- and maybe construction would be the industry or industries affected by construction might be in that same camp, but other than that, when I talk to CIOs across the U.S., not too many or any for that matter told me that, okay, my boss just significantly cut my budget for this year and going into next year. But everybody is always asking -- everybody is a little bit worried worried.

There is an air of caution out there, what is going to happen, are interest rates going to be lower? How is the economy going to have soft and long and how are we going to get through this credit crunch? And so there is an air of caution and there is a lot of unknown and I think we have all got to stay tuned.

But as I said, right now, set of products and solutions that we have that our customers, even in financial services. As I said, we had slight growth. Nothing to write home about, but we did have growth year-on-year in financial services. So, if you have the right solutions, customers are going to pay, are going to invest in those kinds of opportunities and so consolidations helped them save money for the future.

So, data center consolidation, server consolidation, storage consolidation are hot, virtualization is hot in a lot of areas. Customers need to make sure their businesses continue, so to back up the tape paradigm is just not a good way to recover information. So backup to disk is hot, de-duplication technologies are hot.

So, as long as we have two bits of nothing in the SMB space, two bits of nothing in the Web 2.0 space where big money is being spent in both of those. So, we have got to focus on opportunities and the opportunities are out there broadly and that is what we do as a company.

Andrew Neff - Bear Stearns

Thank you.

Joe Tucci

David, you wanted to focus on Andy's part two, which was cash.

David Goulden

Cash, yes. Obviously, I gave you the math to quickly figure out. We have $3.8 billion of cash in our U.S. business, excluding VMware.

So, the way to think about that consistent with what we said before, we need $1billion of that to run the business, we need $1 billion of that as a cushion because you wouldn't want to run the business without any cushion, so in theory, you have got $1.8 billion extra, which we could invest in projects or other programs. And we basically committed this morning to return close to $1 billion of that to shareholders over the next few months.

So that is the way to think about the cash position.

Tony Takazawa

Thank you,

Joe Tucci

Andy. Next question.

Operator

Your next question comes from Kevin Hunt, Thomas Weisel Partners. You may ask your question.

Kevin Hunt - Thomas Weisel Partners

Hi, thank you. I had a mechanical question. Maybe David can answer it. In terms of the minority interest, what’s the -- I was trying to figure out how that is calculated here. But can you help us out there a little bit?

David Goulden

Yes, sure, Kevin. Its, first of all, this quarter, it is a partial quarter because we only had a minority interest in VMware for basically a little less than half a quarter. The minority interest this quarter was approximately 7%.

If you look on a basic share count basis and what it would be next year, next quarter rather, it would be 14% next quarter. So, basically what you are doing is you are just taking the VMware GAAP net income and then you are deducting the minority that we don't own before we consolidate into our numbers.

Kevin Hunt - Thomas Weisel Partners

Okay. Thanks, David. The half-quarter is what threw me off. Thanks.

Operator

Your next question comes from Katie Huberty, Morgan Stanley. You may ask your question.

Katy Huberty - Morgan Stanley

Yes, did we see the full impact of the new midrange and entry-level systems this quarter or should we see more of a ramp in December?

Joe Tucci

Katie, from the new systems, the only one that would kind of categorize as low-end would-be the NS20, so we actually expect that to continue to ramp and do well and I categorize that kind of market acceptance as pretty close to phenomenal.

I mean it is a tremendously hot product. We do have other products coming out that will be more towards the first of the year. So I think you will see some better news in Q4 and some better, better news in Q1.

Katy Huberty - Morgan Stanley

And in terms of the new midrange products that were launched in July, how much of an impact did those have this quarter and do they ramp into December as well?

Joe Tucci

Oh yes, they should continue to ramp. The CX3 is doing very well. The new multi-critical NS40 is what I would categorize as midrange and that is doing very well. So between the CX3 and the NS40 products, we could -- still lots of runway for ramp.

Tony Takazawa

Thanks, next question, please.

Operator

Your next question comes from Kaushik Roy, Pacific Growth. You may ask your question.

Kaushik Roy - Pacific Growth Equities

Thank you. Overall, Q3 demand was pretty good for EMC, so why aren't you raising your full-year guidance? You will only have to generate flat revenues to get to your target.

Joe Tucci

You, got to basically take a position and the position we took was that we are going to give annual guidance and we did that and we did that, we said we hoped to, I think meet or exceed or more than I think we said or at least okay, thank you, David.

We said at least $0.64 and we said at least $12.7 billion. As you know, those were the goals. The goals actually as you saw that the Board gave us was $12.75 billion and $0.64.We then got into the midyear and said we changed, we were very bold and said more than we changed at least to more than and now we said we would definitely exceed.

So I grant you that’s not much, but you have got to take the position that you're going to do quarterly guidance or you're going to do annual guidance. We took the position for annual guidance. We are doing pretty well, so I will stay with the definitely exceed. I strongly believe it will definitely exceed $0.64 and $12.7 billion.

Kaushik Roy - Pacific Growth Equities

Can you comment on the competitive environment at the high end and mid range and some of these startups are coming out going public, four or five of them. Are you seeing them in the market?

Joe Tucci

Yes, sure. I mean, of course we see them. It’s really interesting. When I look at those startups, most of those startups, and to give them credit, have come up with a fairly innovative and good technology in a particular area

So one startup is basically hypes the heck out of thin provisioning. Another one says, hey, I invented for iSCSI, another one says I built it for Web 2.0, another one says I do spin down, etcetera.

And what I am telling you is that every single one of those technologies, every single one of those technologies with the exception of Web 2.0, we will build into all of our products. So we will be able to outperform anyone in terms of the port for say thin provisioning.

We are calling it virtual provisioning because we think we do it better. David, talked to you about the tremendous successes. We have done iSCSI and iSCSI replication both into our NS product line and our low-end CLARiiON product line or all the CLARiiON product line.

We will come out early next year with spin down for on our disk libraries. I told you, we’ve built a specific system, which will be out very, very shortly, for Web 2.0. So again customers love all the functionality, the 11,000 people we have in support and every one of those technologies we are building in and when we build it in, we know, okay, we compete very well and as we come out with these technologies, as we compete with those customers, our win rates go way up by these new companies.

So I think, give them credit, they have done some innovative things, but we have been noticing those too and of course we have got to build them in a more robust way because we are EMC and we are the leader and when we do that, our win rates are terrific.

Kaushik Roy - Pacific Growth Equities

Thank you. That's helpful.

Tony Takazawa

Next question, please.

Operator

Your next question comes from Paul Mansky, Citigroup. You may ask your question.

Paul Mansky - Citigroup

I had one question, but the prior question was a little interesting. I actually wanted to follow up on that. As we kind of look back pre-bubble, I mean we have had, I think about, four or five hardware related IPOs come out in the last year or set to come out and that is exactly four or five more since pre-bubble.

What do you think it is that has changed from a buying dynamic that has allowed these companies to emerge? I know you mentioned the technology, but technology differentiation has always been there. There has always been the opportunity to differentiate.

So what is it from a purchasing or a decision making process or a fundamental system requirement process that you think has enabled these companies to kind of mushroom out of nowhere?

Joe Tucci

I think, what has happened, Paul, is by focusing and doing kind of one thing well and just one thing that customers have been asking for. That’s why we have been building these into our systems. But obviously when you have all the other feature functions and benefits that we have to build these things in a very robust way.

Because one of the things I could tell you after acquiring a heck of a lot of companies, it just strikes me as before you bought company X, you call around to a bunch of my non public company obviously, a bunch of my friends that were CIOs and said, what do you think of this technology? And everyone said, it's great, it's great, it's great. We'd love to see you have it.

All of a sudden, you buy it and then two weeks later, they are calling you and saying, hey, this technology is not up to EMC standards in terms of quality, in terms of service, etcetera. And I said what do you expect me to do in the two weeks I have owned it?

But on the other side, there is an expectation that when we come out with a product, it is what I call is EMC standard and rock solid. So what happens is these companies get cut a little bit of break and then secondly, they are doing some really good innovative things and they are bringing it to market quickly and customers are saying, hey, let's bring it in and try it and then of course we will go put pressure on the EMCs of the world to go build these things into their current products so that we don't have to pay extra for them.

Because if you did go out there and say, okay, let me buy this product because I like spin down, let me buy this product because I like thin provisioning, let me buy this product because I like iSCSI, you are going to cost yourself a fortune in your data center supporting all those disparate products.

So what they really want is us to bring it, to have these functions in there, meet those price points and have the quality and that’s exactly what we are doing. Obviously to do that, I can't snap my fingers and do it quickly, so what they are beating us with is time to market.

They are getting there quickly. They are showing that this type of little technology or technology point works and it has value. And then of course we are parallel building it in and as I said, with every one of these, by the end of Q1 we will have it built into all our systems.

Paul Mansky - Citigroup

Thank you for that color. I appreciate it.

Tony Takazawa

Thanks, Paul. We have time for one more question and then Joe will have some comments.

Operator

Your last question comes from the Clay Sumner, FBR. You may ask your question.

Clay Sumner - FBR

Thanks very much. David, you talked a lot, you gave a lot of different ways to look at the numbers, but can you just tell us what revenue growth, what the growth rate would have been if we had assumed you had owned all of your acquisitions throughout the third quarter of '06, or quasi organic rate?

David Goulden

We’ve not broken that out though. I think, what we have done is we've given you how big the storage how fast the storage business grew. We showed you CMA. I think we have given you enough views of the business to break it all out. So hopefully you can work that through and, if not, we will talk later on.

Clay Sumner - FBR

Okay. Thanks.

Joe Tucci

Thanks, everybody, for joining us today. We really do appreciate it. I look forward to following up with you. Clearly, there is more we can do around what we call the one EMC initiative, which creates leverage across our products. There is more we can do with the one EMC initiative where we can hopefully take as we have acquired over 30 little companies now of some size over the past three to four years.

There is obviously some management layers we can reduce and some efficiencies we can create on the people side and we will continue to drive that.

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Source: EMC Corporation Q3 2007 Earnings Call Transcript
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