EMC Q4 2005 Earnings Conference Call Transcript (EMC)

EMC Corporation (EMC)
Q4 2005 Earnings Conference Call
January 24th 2006, 8:30 AM.

Executives:

Tony Takazawa, Vice President of Investor Relations
Joseph Tucci, Chairman, President and CEO
William Teuber, Executive Vice-President and CFO
Howard Elias, Executive Vice-President, Corporate Marketing & Technology

Analysts:

Kevin Hunt, Thomas Weisel Partners
Tom Curlin, RBC capital
Harry Blount, Lehman Brothers
Bill Shope, J P Morgan
Laura Conigliaro, Goldman Sachs
Ben Reitzes, UBS
Brian Freed, Morgan Keegan & Company
Shebly Seyrafi, Kaufman Brothers
Joel Wagonfeld, First Albany Corp
Toni Sacconaghi, Sanford Bernstein
Aaron Rakers, A.G. Edwards & Sons, Inc
Clay Sumner, Friedman, Billings, Ramsey & Co

Presentation

Operator

Welcome and thanking for standing by. Operator Instructions Now I would like to turn the meeting over to Tony Takazawa, Vice President of Investor Relations.

Tony Takazawa, Vice President of Investor Relations

Thank you Sherry. Good morning, welcome to EMC’s call to discuss our financial results for the fourth quarter for full year 2005. We will be making references to our slides today so we encourage you to view them on EMC’s website at www.emc.com. And archive of the audio and slide presentation will also be available following the call. William J. Teuber, EMC’s Executive Vice-President and CFO will start things off and walk you through our Q4 financial performance and highlights. They will also discuss our outlooks for Q1 and the full year of 2006, who then will be joined by Mr.Joseph Tucci, EMC’s Chairman, President and CEO. Jo will comment on our strategy, some of our business results and his view of the economic climate in the IT marketplace. After the formal remarks, we will open up the line to take your questions; we will be joined at that time by Mr. Howard Elias, Executive Vice-President of Corporate Marketing and the Office of Technology.

The call this morning will contain forward-looking statements and information’s concerning factors that could cause results to differ from those in our forward-looking statements can be found in EMC’s filings with the US Securities and Exchange Commission. In addition, our financial results contain a number of special items that were previously announced. For Q4 2005, these items include an IPRD charge of $14 million related to our acquisition of Captiva and $80 million charge associated with our announced workforce rebalancing and a tax expense impact of $180 million related to the repatriation of cash. For 3Q 2005, these items include a $105 million tax benefits.

To help you with your analysis we’ve included financial details and commentary relating to non-GAAP measures in today’s press release reconciling our GAAP results to our results excluding these items. With that, it’s my now pleasure to introduce EMC’s CFO, Mr. William Tauber.

William Tauber, CFO

Thanks Tony. We ended 2005 on a high note, as we achieved our annual goals for revenue growth in operating margin. Our solid performance and very positive momentum in 2005 make me confident about our position in the marketplace and our opportunities in 2006. We saw strong performance in a number of areas this quarter. We are pleased with the performance of the Symmetrix line, which was up 19% from Q3 driven by strong customer demand for our recently introduced DMX3. In fact, more than a third of our Symmetrix Systems revenues were from the DMX3 and we completely sold out of the product. Given customer reactions so far, I think we are set up nicely for 2006 in this part of the business.

In addition, our midrange business reaccelerated this quarter based upon our new Switch backends for the Clarion, which we introduced in the second half of the year. We also achieved an exciting milestone in Q4 with our first billion-dollar quarter in software revenues. We had strong performance across all of our products and in particular Content Management finished the year with a bang. I’ll go through each of these areas in more details in a few minutes. As usual, I’ll spend sometime today discussing the following items: the performance of our revenue lines, operating margin improvement, highlights from the balance sheet and some thoughts on expensing the stock options and I will close as usual with our expectations for Q1 in 2006.

Turning to the numbers, Q4 revenues are $2 billion and $710 million, up 15% versus a year ago. For the full year, our revenues were $9 billion and $664 million, up 17.4% in 2004. In Q4, we achieved our goal of getting operating margins in the high teens that came in at 19% and net income for the quarter was $409 million, up 27% over Q4 a year ago. Both of these items exclude the special items previously discussed by Tony. GAAP EPS including those items were $0.06 in Q4 and $0.47 for the full year of 2005. Adjusting for the special items, EPS per diluted share was $0.17 in Q4 and $0.53 for 2005.

In order for you to have a clear understanding of our operating results, we’ve also broken up the non-cash expenses of our acquisition and amortization and the cost associated with deferred compensation, which continues to be a little more than a penny per share for the quarter. Excluding these items, non-GAAP EPS for fully diluted share would be $0.18 for Q4 and $0.59 for the full year. We believe that this is an important way of assessing our performance on an ongoing basis.

Beyond the topline revenue numbers, the next important revenue breakdown is the results from our Systems Software and Services. Our Systems revenue grew 19% from Q4 of last year was 48% of our business. Software revenues grew 16% and were 37% of our business and Services revenue grew 4% and were 15% of our business. Now, I will turn to our Product categories within these revenue lines. We continue to provide the supplementary information to give you a better understanding of what happened in our business, given the solutions-based approach we bring to the market, the individual category results will vary from quarter-to-quarter.

First, turning to the components of our systems related product revenue, Symmetrix product revenue was $754 million. As expected, we saw a strong acceleration here between Q3 and Q4 as the new DMX3 had started the ramp. The market is voted on our new products and it’s a hit. And as I mentioned, we sold out of DMX3 and have a nice backlog there going into Q1. We expect that this product will continue to generate excitement and momentum for us in the high end on the storage market.

CLARiiON product revenues of $519 million were up a robust 32% this quarter, which is also its growth rate for the full year. As expected, this business saw a strong ramp as the enhanced products kicked in during Q4. In addition, we also saw a particular strength at the lower strength of the market with the CX300, and Europe led the overall geographic revenue growth.

Our connectivity revenue, which includes our Switching product’s sold as Connectrix and our Celera product’s excluding any disc storage grew 27%. Our mid tier product offerings which includes our CLARiiON, Celera and Centerra products collectively grew 32% in the quarter and 31% for the full year. We believe these results compared favorably to anyone in the industry. Additionally revenues for these products in 2005 were approximately $2.2 billion demonstrated the magnitude of our presence in this part of the market.

Our NASs business including the associated CLARiiON Disk Storage had a great quarter and was up nearly 50% over last year. We believe we’ve gained a significant amount of market share and mind share in 2005 and we will continue this momentum as we move forward into 2006.

Our customers are looking for EMC for much more than they had in the past, the types of conversations we are having and the value proposition we bring to the table had been dramatically enhanced by our ILM strategy in the Products and Services which we have developed in the quarter over the past few years.

Turning now to our Software business, total platform software revenues for Q4 were $450 million, up 9% year-over-year. And Multi-Platform software revenues for Q4 were $441 million, up 15% year-over-year. Now, taking a closer look at the components of Multi-Platform software License revenue, Resource Management software license revenues were $167 million, up 7% from last year. The growth driver here continues to be SMARTS which had a record quarter and year as demand for it’s unique model based technology continues to be very strong.

The largest product in this segment is Control Center, which is roughly correlated to Symmetric sales and saw a very nice sequential improvement. Back-up recovery and archive Software License revenues were $16 million, up 13% from last year. Within this, our network of license revenues were up nearly 20%, as we continue to gain share with this product. That work out very well last year setting new records for both the quarter and the year.

In addition, our EmailXtender product showed double-digit growth in the quarter. Content Management Software license revenues were $64 million up 25% for the quarter. This business ended the year on a high note with total license revenues of $200 million for the full year, up 16%. Looking at this business in it’s entirety including maintenance and services, total revenues were up 21% for 2005 driven by a record quarter year and year in the Documentum prior product shift. We believe that we continue to take share in this market. VMware had another sizzling quarter, license revenues were $87 million, up 55% and Services including maintenance and consulting revenues were $28 million, up 91% over the last year. For the full year VMware had revenues of $387 million, up 78% from 2004. VMware continues to be one of the best performing software companies ever at this stage in its history.

Turning to our Services category, which includes our professional services, system maintenance and other services, total revenues were $403 million in Q4, up 4% from last year. The growth rate in this line was affected by tough comparison last year, however our Professional Services bookings were very strong, our associated differed revenues were up and we see excellent opportunity in this space.

Turning now to the GS, North America continues to be very strong in a broad based market force, revenues here were $1.534 billion, up 14% over last year. We performed particularly well in the international arena this quarter. International revenues were 43% of total revenues reflecting the benefits of our investments in this space. We continue to invest in the international market to drive our revenue growth in those areas where we are underrepresented from either our market share or direct presence.

Looking at the results in EMEA, revenues were $801 million, up 15%. A number of countries had outstanding results here including our Eastern European business as well as Switzerland, France and the Nordics. Additionally it looks like a German economy is firming up, which pose well for 2006. EPJ-A had revenues of $290 million, up 16% from the last year. We are very excited by the opportunities we see seen in a number of countries in this region and we continue to invest in high growth areas like China and India. Latin America had revenues of $85 million, up 28% from last year. Brazil had an excellent quarter, as did some of the smaller countries in this region. Dell continues its strong performance, and when combined with the symmetric revenues they participated in was approximately 13% of total revenues for the quarter.

Turning now for the rest of the income statement and I am very pleased that we were able to reach our operating margin target of high teens this quarter with an operating margin of 19% ex the impact of the special items. While this is a good result, we are not standing still and continue to be focused on this metric as we move forward. As we have been targeting, we continue to strive for an operating margin exceeding 20% in Q4 of ‘06, of course this excludes stock option expense.

Looking at the elements that make up the operating margins, lets start with gross margins, which was 54.8% for the quarter, up 80 basis point from last quarter. The elements of the changes are as follows. Volume was up 140 basis points. In the mix and the price cost other lines had an offsetting impact of 25 basis points and 35 basis points respectively.

Turning now to operating expense, SG&A was $706 million or 21.6% of revenues, down 100 basis point from Q3. R&D was $262 million in Q4, or 9.7% of total revenues. For the full year we spend over billion dollars in R&D. We believe this investment to be an important part of our strategy as we move forward. We intend to continue the aggressive product development cycle we have been on over the last few years. This quarter, we also recorded an IPR&D charge of $14 million for Captiva and an $80 million charge for workforce rebalancing, which Joe will take you through in his comments. Finally the tax line this quarter contains $180 million charge for the repatriation of cash, excluding this our cash rate nudged up a bit this quarter.

Turning now to the balance sheet a few other items, we ended the quarter with $7.355 billion in cash. When you look at how we deployed cash this quarter we spent $334 million on acquisitions and used $400 million to buyback EMC stock. This year we broke the billion-dollar mark in our stock buyback and acquired approximately 74 million shares during the year.

Looking at our cash positions over the last eight quarters, we’ve generated approximately $3.3 billion before acquisitions and buybacks. More than 85% of our cash has been put to use for buybacks and acquisitions during that time.

For Q4, DSOs came in at 48 days, up a few days in Q3, inventory was $725 million and insurance calculated and the total tax basis were 6.7. We continue to be focus on getting this metric back to seven, as we get further through this transition of DMX3. CapEx was $182 million and depreciation and amortization was $190 million.

Now I want to talk a little about our stock options expensing since I know it’s a topic of great interest. Let me start off by saying unequivocally that we will strive to bring this expense down overtime. While we believe that broad based equity ownership by EMC employees has a tremendously beneficial impact on the company. We also recognize that it is prudent to reduce the associated expense.

For your modeling purposes we are currently expecting accounting for stock options to impact our 2006 results by approximately $0.09 per share, at down about 30% from $0.13 in 2005.

Now moving to our expectations for 2006 in Q1. We are very excited about the opportunities we would see in 2006. As we start off this year, there are number of factors that are driving my confidence and optimism for this coming year. First of all we expect to see continuing momentum from our 2005 performance. The solutions focus that we offer is resonating with our customers and the value proposition that we provide them will only get stronger in 2006. Secondly, in the later half of the year we rolled out new versions of high end Symmetrix and enhance our existing mid tier strength with CLARiiON, Celerra and Centerra. We saw a solid ramp of these products in Q4 and expect to continue our momentum as we introduce additional products this year starting with a major announcement later this week.

Thirdly, the breadth and depth of our entire staff software portfolio continues to develop and grow both organically and through acquisitions. The strength of our software strategy is becoming increasingly apparent in both the interest we are receiving from customers and the results we are delivering. We continue to see excellent opportunity for all of our software solutions with more products announcements also coming this year.

Finally Joe and I are just back from our sales kickoff, the excitement there was palpable and we both believe there was no finer sales team anywhere in fact, anywhere in the world. These factors indicate that our overall business model is striving, our competitive differentiation and strength is increasingly apparent and we expect we will continue to gain share this year as the result. So given these factors we believe that our 2006 revenues will continue to significantly outgrow the market, we see a revenue range of a $11.1 billion to $11.3 billion with earnings in the range of $0.63 to $0.66 per diluted share before options expense.

For Q1 we expect revenues to be between $2.57 billion and $2.59 billion and earnings of $0.14 per share before options expense of approximately $0.03. Before I turn the call over to Joe I want to mention that you have probably heard someone coughing and sneezing in the background, Joe is slightly under the weather and so you will hear a few more coughs and sneezes. I can assure you we have our best people on it and with Joe back to full capacity within a few days. So now here is Joe.

Joseph Tucci, Chairman, CEO

Thanks Bill. And welcome and thanks to all of you who have joined us for today’s conference call. Looking back on 2005, I believe EMC had a great year both operationally and strategically. Our information life-cycle management strategy, products and solutions sets hit directly on the areas of IT spend, they were of the highest priority, these areas include compliance, disaster recovery, storage software and SANs to name a few.

Looking to 2006, you can see in the Morgan Stanley’s CIO survey of top IT priorities that our ILM strategy is positioned very well and it is on 7 of the Top 20 for this coming year. I will comment more on 2006 later but right now let us examine the various elements of the EMC’s ILM technology stack and our success in 2005. I’ll start with our storage platforms.

In 2005 the anticipated Symmetrix DMX3 was incredibly well received and as you know we have only the largest number, we’ve only announced the largest members of the family up to now. That will change, I am pleased to preannounce that we will be in London this Thursday to launch both new lower end members of the DMX family as well as high end expansion. Our particular success in the Symmetrix DMX family was our replication technology, concurrent SRDF, SRDF/A and STAR all had banner year. The high-end DMX products with their massive consolidation capabilities really hit the mark.

The average DMX 3 sold in 2005 shipped with over 60 terabytes of raw storage, far and away the largest as any high-end array. Clearly customers trust EMC, in our DMX 3 technology for the most demanding information needs. And as we continue to rollout new models and functionality, included a new high capacity, low cost fiber channel drives, we expect to grow this business in 2006.

We believe that the total mid tier storage market grew around 15% in 2005 and an EMC’s mid tier offerings: CLARiiON, Celerra and Centerra, we call them “The Three Cs