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Executives

Tony Takazawa

David I. Goulden - President and Chief Operating Officer

Joseph M. Tucci - Chairman, Chief Executive Officer, Member of Mergers & Acquisitions Committee and Member of Finance Committee

Analysts

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

Brian Marshall - ISI Group Inc., Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Kulbinder Garcha - Crédit Suisse AG, Research Division

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Benjamin A. Reitzes - Barclays Capital, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Maynard Joseph Um - Wells Fargo Securities, LLC, Research Division

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Steven Milunovich - UBS Investment Bank, Research Division

EMC (EMC) Q2 2012 Earnings Call July 24, 2012 8:30 AM ET

Operator

Good morning, and welcome to the EMC Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce your host, Mr. Tony Takazawa, Vice President, Global Investor Relations of EMC.

Tony Takazawa

Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the second quarter of 2012. Today, we are joined by EMC Chairman and CEO, Joe Tucci; and David Goulden, EMC President and COO. To kick things off, David will comment on our results and how these tie with the execution of our strategy. He will also discuss our outlook for the rest of 2012. Joe will then spend some time discussing his view of what is happening in the economy and IT, EMC's vision and strategy and how EMC is helping customers navigate the massive transformation happening in IT regarding cloud, Big Data and trust. After their prepared remarks, we will then open up the lines to take your questions.

Please note that we will be referring to non-GAAP numbers in today's presentation unless otherwise indicated. The reconciliation of our non-GAAP comments to our GAAP results can be found in the disclosure today in our press release, supplemental schedules and the slides that accompany our presentation. All of these are available for download within the investor relations section of emc.com.

As always, 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.

We are also providing you with an update to our projected financial model for 2012. This model lays out all of the key assumptions and discrete financial expectations that are the foundation of our 2012 outlook. We hope that you find this model helpful in understanding our assumptions in context and in ensuring that these expectations are correctly incorporated into your models. This model is available as background in today's slides available for download in the investor relations section of emc.com.

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

David I. Goulden

Thanks, Tony. Good morning, everyone, and thank you for joining us today.

I'm pleased to report that we achieved our 10th consecutive quarter of double-digit revenue and EPS growth in Q2, with revenue up 10%, non-GAAP EPS up 11% and free cash flow up 36%. Our ability to deliver these strong results is linked in large part to our strategy, which is to help companies use cloud technologies and Big Data assets in their trust environments.

In spite of what is clearly an unsettled macro-environment, our solid results this quarter are a testament to the soundness of our strategy, the flexibility of our business model and the ability of our team to execute. As usual, Joe will comment more on the environment and what we're hearing from our customers, but it's pretty clear that things have gotten a bit weaker over the last few months. We all read the same headlines about Europe, concerns about slowing in China and the U.S., tight government spending, et cetera, and these are having an effect.

While not immune to economic pressures, we do believe that important customer priorities such as virtualization, storage and security will continue to grow faster than IT overall. Customers need to continue to drive their businesses forward, improve competitiveness and reduce costs, and these are the areas where they will continue to invest.

This is evidenced in our Information Storage business where we grew 7%. Within this number, our reported storage product revenue growth was 3%. However, this product number includes other storage product revenue, some of which is outside of our strategic storage offerings. The biggest line in this other storage product bucket is third-party products that we resell, and another meaningful element is our consumer products business. In fact, the consumer products business was the biggest drag on this other storage bucket during the quarter due to the planned decline in revenues as we refocused the consumer business on lowering NAS and away from single-drive hardware.

To make things clearer for you, this quarter we're adding a new metric, networked storage platforms, which includes our high-end and mid-tier, to measure progress across our full family of complementary storage products, including scale block, scale file, unified and backup. In today's rapidly changing environment, customers increasingly take advantage of our entire line-up of offerings to accommodate their storage requirements. And as a result, it's helpful to monitor how this product portfolio as a whole performs, and this quarter we continue to perform well. Our networked storage platforms grew 7% year-on-year compared with 9% growth in Q1.

Within networked storage platforms, our mid-tier storage product revenue grew 10% in Q2, the result of year-on-year growth across all of our major mid-tier product lines. One of the hottest areas in storage right now is scale-out NAS. Companies seek solutions that can accommodate the explosive growth of unstructured data and do so simply and at scale. As a result, our scale-out file offering from Isilon continues to thrive as this is an excellent option for customers who are looking for a truly linear scale-out solution especially given the lack of compelling alternatives. Isilon remains well suited for extremely large-scale Big Data needs and, with continued technical innovation and the help of EMC's core sales force, is being deployed in mainstream data centers at some very large customers.

Jaguar Land Rover has standardized upon Isilon to drive their most demanding HPC environments for modeling, simulation and design testing. Hyundai Heavy Industries selected Isilon to support a significant virtualization initiative. And a large Japanese mobile phone service provider recently chose Isilon as the foundation of a mission-critical service for business smartphone users. And while Isilon is already very relevant to the enterprise data center, our OneFS Mavericks operating system, expected to launch later this year, will make it even more so. Mavericks will open new opportunities for large-scale home directory, and that's archiving workloads, and will tightly integrate with VMware, making it an outstanding choice for virtual environments.

Our Backup Recovery Systems business also continued to be a growth engine for EMC in Q2. Demand for our newly launched Data Domain 990 exceeded our high expectations. As customers re-architect their IT infrastructures, they're looking across the entire backup landscape and thinking differently about how backup can be done most effectively, and this is where EMC comes in. Not only do our offerings cover the full range of backup requirements, they integrate it with other technologies in the data center in ways that make a difference to the user. Avamar is a good example of this. Its most recent addition, Avamar 6.1, expanded support for Hyper-V environments and now delivers 3x the backup performance and 30x the recovery performance of its nearest competitor in VMware environments.

Our unified storage offerings, VNX and VNXe, also contributed to our growth in networked storage in Q2. The unified architecture of the VNX Family puts it at the top of the list for customers seeking a storage solution that is simple and efficient as our VNX Family boasts some of the broadest integration among EMC products as well as other vendors' technologies.

The VNX5300 has been certified for Microsoft's FastTrack as well as SAP's HANA platform. VNX has points of integration with Avamar, RecoverPoint and VPLEX. Such integration made a big difference for Mecklenburg County, North Carolina, who use a combination of VNX, Avamar and our Cloud Tiering Appliance to reclaim terabytes of primary storage while avoiding the need for more capacity for file shares and decreasing backup times by 90%.

We continue to enhance the features and functionality of VNX, as evidenced by a number of recent innovations. These include deeper integration with VMware's management suites to provide the most comprehensive performance analysis for VMware environments, as well as an upgrade to the VNX operating environment known as Inyo. Available today for download to existing systems and shipping on new systems soon, Inyo features more efficient storage utilization, automatic rebalancing of data when new drivers are added and added snapshot functionality, enhancing VNX for use cases such as test and dev, point-in-time backups and reporting or the re-purposing of data.

Growth of our high-end storage products rebounded in Q2, with revenue up 3% year-on-year. Undoubtedly, some of this growth was a direct result of the VMAX refresh we announced in May which refreshed our VMAXe and VMAX with the VMAX 10K and VMAX 20K, respectively, and introduced a new ultra-high performance VMAX 40K. By making available several options for our scale-out block offering, customers can more closely match high-end features and functionalities with their specific requirements and resources.

Common across all 3 additions is the new VMAX operating system which is available across all generations of the EMC VMAX family, including all VMAX and VMAXe arrays sold since 2009.

We are pleased with how this transition is progressing. Approximately 1/3 of our new VMAX systems revenue in the quarter was from the 10K, 20K, 40K family. This new release illustrates the increasing importance of software to the storage infrastructure. While the underlying hardware offers different processing and capacity across the 10K, 20K and 40K, depending upon need, a lot of the value to the customer comes from the software.

The new VMAX line utilizes Unisphere, the same user interface as VNX; integrates recover points across the entire VMAX family; offers the ability to extend fast capabilities to other vendors' arrays; and could now apply FAST VP to mainframe and IBM iSeries environments. To ensure customers can extract maximum value from their storage solutions, the VMAX family incorporates options for MLC Flash, as well as 2.5-inch SaaS drives.

All in, we've assembled a best-of-breed portfolio of storage offerings that covers a wide range of customer needs with technology that truly requires no compromise on behalf of our customers. Some of these technologies were recently acquired, some were developed in our labs. Either way, a key value proposition we've developed over the past several years is bringing a wide array of offerings together via common hardware, leveraging generally available and industry standard components. The benefits of this strategy are many: faster time to market, lower cost of goods sold, better quality, lower support costs, great efficiencies from engineering, better leverage of our supply chain and more efficient inventory managements.

On the software side of things, getting to a more holistic view makes customers growing and heterogeneous environments simpler. In addition to VMware integration that is unmatched by any other storage provider, we continue to enhance integration across our products elsewhere to generate more value for our customers. In March, we integrated ProSphere with FAST VP to automatically track the consumption of virtual pools and identify when new capacity will be required. In May, we announced our new DataBridge software. DataBridge mashes up IT operations data, turning silos of disparate compute, storage and network management information into used-case specific views for better visibility across the infrastructure as part of an IT-As-A-Service deployment. Recently, we acquired Watch4net, a leader in IT performance management. Watch4net solution consolidates and analyzes performance in one unified platform across multi-vendor, multi-technology environments and is already tightly integrated with our IT Operations Intelligence Suite.

As you can see through these many examples, our best-of-breed storage products, which are built on common hardware and united by common management interfaces with an ability to integrate with many environments, are central to our strategy. This approach drives our complexity and empowers customers looking for efficiency, control and choice with agility.

The way we've leveraged Flash technology is a great example of how we integrate industry standard components and then build software around it. Once the Flash hardware is strategically placed, the next step is leveraging its functionality with intelligent automated software that operates across the stack. This is the key to delivering value. Not only does this two-part approach results in an optimal cost-benefit outcome for the customer, it also enables us to address a wide variety of use cases in the contemporary data center.

For mixed workloads, customers use a hybrid array, with a small amount of Flash for the hottest data and the rest cost-effectively tiered to high-capacity drives. For situations where 100% of the data is hot, such as VDI or database test and development, customers can use an all-Flash array. Our acquisition of Extreme I/O gives us excellent technology here, as we've seen from the customer access programs that are currently underway.

For market segments that require a persistent data store for performance-intensive workloads such as high-frequency trading and online gaming, we're developing Project Thunder, a server network-attached appliance built entirely of high-speed PCIe Flash. Our early customer access program is underway here as well. And for applications that benefit from Flash in the server, customers use VFCache. VFCache has been embraced by more than 100 customers across industries for the dramatic performance improvements it enables. One of the largest retailers in the U.S. bought VFCache to accelerate the performance of their SQL production environments. The retailer had already doubled performance with FAST VP and can now triple that again by adding VFCache. In total, that's 6x the performance compared to environments before FAST VP and VFCache. We will be significantly expanding the use case potential for VFCache in the second half with the addition of in-line dedupe, support for larger PCIe cards, MLC Flash and support for UCS blade servers.

The value of Flash is resonating with our customers, and in Q2, we shipped a record amount of Flash capacity. Importantly, our Flash solutions work in conjunction with customers' network storage environments, bringing all the performance benefits of Flash without sacrificing the benefits of network storage like data protection and availability. In sum, EMC is developing the most comprehensive Flash portfolio across the industry and will be the only company capable of providing the right Flash solution across a variety of use cases.

The benefits of offering a full portfolio are not limited to storage. We've also been able to gain wallet share and add value to customer relationships with offerings in analytics, security, content management and virtualization.

Greenplum continues to reap the benefits of being in the thick of one of the hottest areas of IT right now. With its very rich Big Data tool sets spanning data science, social collaboration, SQL processing and Hadoop for the enterprise, Greenplum is a truly differentiated player in the space. As a result, we're winning new customers and gaining repeat business as customers add on to their existing analytics implementations. Wins from Q2 came from across verticals and for a variety of reasons. Some are looking to become truly predictive enterprises, some are looking for line-of-business implementation that can get up and running quickly, while others simply want the ability to do ad hoc queries to find the best answer to a specific question about the business. A notable win in the quarter came from the utility customer looking to create insight from the analysis of their customer usage patterns. We're very excited about seizing these fast-growing opportunities.

Like Big Data, security is also enjoying a position near the top of customer priority lists. And RSA is delivering, growing 13% in Q2. Customers understand that with IT security there's no longer a question of whether there will be an attack. Rather, the question in today's advanced threat environment is how quickly and effectively attacks can be thwarted. Because the threat landscape changes rapidly, customer defenses need the, agile, risk-based and contextual solutions that RSA offers. While our products do very well individually, customers are increasingly embracing the value of the integration across them. For example, NetWitness, Archer, enVision and DLP work together to provide controls and visibility functions that are based upon agile, predictive analytics and continuous monitoring of massive and growing amounts of data.

Additionally, there are integrations between RSA's Data Loss Prevention technology and VMWare's vShield, as well as between Archer and EMC's network and storage configuration managers and the vSphere, all enhancements to accelerate customers' journey to the cloud without sacrificing trust.

Revenue from our Information Intelligence Group was down 4% year-on-year. It is encouraging to see license revenue growing at 3% this quarter. We see value here and we're making investments we believe are needed to return IIG to the growth business we know it can be. To that end, we acquired Syncplicity, a cloud-based sync-and-share provider for businesses, and continue to roll out vertical specific offerings such as the Documentum for life science solution suite that was announced in early May.

VMware revenues grew 22% over last year's second quarter as companies continue to expand their virtual infrastructures both in the data center and on the desktop and add management capabilities to virtual infrastructures they've built on VMware. Having become the standard way of running server applications in the cloud era, VMware is very well positioned for its move to the next phase of cloud computing, the software-defined data center. Customers of a software-defined data center can have their own virtual data center with isolated collections of all the compute, storage, networking and security resources they need. VMware's acquisition of Nicira upon closing will expand VMware's software-defined networking portfolio across multiple hypervisors and cloud environments. VMware will continue to work with networking, compute, storage and security ecosystem partners to complement and support their continued innovations.

Given VMware's strong foundation for future growth, EMC is focusing more resources than ever on VMware integration across our portfolio. This integration plays a major role in many of our wins, and we won a number of multimillion dollar orders in Q2 for virtualized environments, including a school system deploying a Vblock, VDI and Avamar; a large public-sector health organization deploying a Vblock, Data Domain; and a global energy company consolidating 15 arrays on the 2 VMAXes.

To take advantage of the fundamental trends of cloud and Big Data, we've not only made transformational changes to our product portfolio but we've also expanded our customers' options for how they buy IT as well. As a result, our go-to-market model has evolved considerably over the past several years. We've strengthened and expanded our lines of partnerships, invested heavily in our channel relationships, expanded our reseller base and sharpened our services capabilities to help our customers successfully transition to cloud architectures.

One of the greatest differences today compared with just a few years ago is the advent of IT service providers, and this is a trend that we've not only followed but fostered. We teamed up early with several key cloud service providers including CSC, Verizon Terremark, AT&T, Telefonica, Rackspace, Cable & Wireless, Colt, Telstra and many, many others. This early entry allowed us to pioneer this new space together and it's given us a head start on creating the technology solutions necessary to support enterprise cloud services. Some of the essentials we have found included giving our partners tools to support things like policy-based service levels and flexible disaster recovery service modules. The recently announced VMAX SP is an excellent example. As a result, many of these SPs are standardized on EMC's technology for their business class as a service offerings. We continue to see rapid growth from the service provider vertical.

The alliance we announced with Atos in February is an excellent example of how we work with our service provider partners to ensure customers have control, flexibility and choice. Atos' new cloud services company Canopy will provide a one-stop shop for cloud services, offering customers platform-as-a-service as well as a variety of applications available for a Software-as-a-Service model. Both of these are powered by best-of-breed technology from EMC and VMware. And in June, we announced a partnership with Verizon Terremark where they will standardize upon EMC technology for their private and hybrid cloud offerings as well as for public cloud offerings.

These joint collaborations enable EMC and our service partners to deliver dramatic customer value. The number of Software-as-a-Service offerings provided by our 50-plus primary partners increased over 100% from Q1. This rapid ramp reflects the strength of demand for enterprise-class public cloud offerings. As the technology provider to those looking to build their public cloud platforms on proven and trusted architectures, we expect to benefit as the world transitions to hybrid cloud over the next several years.

Our channel program has evolved considerably over the past 1.5 years as we set out to create a partner experience with EMC that's profitable, predictable and simple. The result has been incremental revenue to EMC and our partners alike. In fact, since we began the transformation of our channel program early last year, we've captured over $0.5 billion of revenue from these new partners, many of whom are small bars that used to be beyond our reach.

Vblock has continued to gain traction in enterprise data centers as well as in cloud service providers as demand continues to show very strong growth in Q2. Existing customers continue to expand their Vblock footprint, and VCE is winning new customers at a strong rate. VCE was recently selected to provide the infrastructure for Europe's first education cloud in Northern Ireland, which is a central repository of education materials accessible to 350,000 students and teachers in 1,200 schools. We remain on track to reach the $1 billion run rate for Vblocks.

Finally, we'd like to welcome Praveen Akkiraju, VCE's new CEO who previously was the GM of Cisco's routing technology group.

Our services organization continues to be instrumental in transitioning customers to cloud architectures, transforming IT and virtualizing their mission-critical applications. A greater focus on solution-selling in cooperation with VMware, VCE, RSA and Greenplum has also been beneficial to EMC as well as to our customers. And our focus on customer service has not gone unnoticed as we were honored with 3 TSIA Star Awards for service in excellence in Q2.

When customers think through how they want to build their cloud data centers, some choose to buy best-of-breed products sold separately, typically when the customer has specific requirements and prefers to configure a solution on their own. Some customers seek the ease and efficiency of our reference architecture with some flexibility on the server or networking side, which they can get with VSPEX, and over 400 partners have certified their VSPEX solutions.

Finally, there are situations where the customer know if they want to truly converge infrastructure with best-of-breed products and they want to deploy solutions rapidly as possible. These customers buy Vblocks. Our ability to provide these options gets us into more opportunities and is important to the customer. We're the only company that offers this degree of flexibility and choice.

In sum, our go-to-market model differentiates us from the competition as our approach makes the right tool for the job available to many types of customer in the way that makes the most sense for them. Our focus on the customer, which has guided our strategy for so many years, continues to serve us well, as we saw in our Q2 financial results. While macro headwinds, including the economies in Europe and the euro, increased during the quarter, we still grew the overall business by 10% year-over-year or 12% in constant currency. Within this, North America was up 14%; EMEA was down 1%, though up 5% in constant currency; APJ grew 14%; Latin America was up 2% and up 12% in constant currency; and BRIC plus 13 grew 20% or 24% in constant currency.

Now let's turn to the income statements. A useful way to understand how we achieve our EPS growth is to look at the various puts and takes driving the change in EPS year-on-year. To that end, we're providing a waterfall analysis to show how various income statement items have contributed to the non-GAAP EPS growth we achieved in Q2.

As has been the case for the last several quarters, gross margin improvement was an important factor. This quarter, non-GAAP gross margins were 64.4%, up 210 basis points from last year's Q2. The improvement here was driven primarily by an increase in volume and mix benefit of higher-margin products. As you can see in the waterfall charts, increase in gross margin dollars was the biggest contributor to our EPS growth. Non-GAAP operating margins were a solid 24%, up 90 basis points from Q2 of last year.

Within the operating expense line, SG&A grew a little slower than revenue and R&D grew faster than revenue as we continue to invest in our leading-edge product portfolio. As a result, growth in OpEx partially offset the robust gains from gross profits. Overall, our operating and financial model delivered solid EPS leverage this quarter.

Taking a look at a couple of other items that have a meaningful impact on EPS growth. Our tax rate was 25% compared to 22% in Q2 of 2011. We now expect our tax rate for the full year to be 22%, reflecting a higher mix of revenue and profits in the U.S. This assumes the U.S. R&D tax credit is passed in Q4.

The other important fact this quarter was share counts. In Q2, shares outstanding were about 58 million shares lower than in Q2 '11, a result of settling the first tranche of our converts, as well as share repurchases.

Other expense was $35 million non-GAAP. We've updated our full year guidance for other expense to reflect some gains from strategic investments in Q2. Non-GAAP EPS was $0.39, up 11% from last year.

These results are a great example of the resiliency of our model and the discipline of our execution.

Q2 free cash flow was $958 million, up 36% and $91 million higher than non-GAAP net income for the period. Contributing to this was continued strong growth in deferred revenues, up 30% year-on-year to $7.1 billion. We closed Q2 with $10.9 billion in cash and investments, and of this, $3.7 billion was U.S. cash, excluding VMware. We spent approximately $520 million on acquisitions in the quarter. We returned $260 million of our cash to shareholders via the repurchase of EMC stock in Q2 and we expect to buy $700 million worth of EMC shares in 2012.

Looking forward, we do not expect the economy to get better this year, but we do like how we've positioned the company near term and long term. We believe we have the right strategy in place to leverage the 3 major waves of change in IT: cloud, Big Data and trust. We have leadership positions in many of the key areas enabling these waves. We have a best-of-breed product portfolio with breadth and depth that is unique in the industry. We have a great track record of helping customers and very high customer loyalty and satisfaction. We have a solid operational and financial model that has demonstrated success across cycles. And we're fortunate to have a global EMC team that is second to none.

As a result of these and given our results so far in 2012, we expect to achieve $22 billion of revenues, $1.70 in non-GAAP EPS and $4.9 billion in free cash flow this year.

With that, I'll turn it over to Joe, who will give you more color on the quarter and the great opportunities that lie ahead of us. Joe?

Joseph M. Tucci

Thanks, David, and a warm welcome to all of you who have joined us for today's call. Thank you very much.

I would like to take a moment to publicly congratulate David on his promotion to President and Chief Operating Officer of EMC. The board and I are extremely confident in David's abilities and the people of EMC are solidly behind him. We know he will do a great job. David, as always, it's a pleasure working with you.

I would also like to sincerely and deeply thank Paul Maritz and Pat Gelsinger for the many, many contributions they have made towards the success of VMware and EMC, respectively, over the past several years and congratulate them as they take on their new roles. I look forward to continue to work closely with both of you also.

Focusing back on our Q2 results and accomplishments, I am pleased with our performance and our execution. We maintained double-digit top line growth, produced leverage on the bottom line and focused on our customer's success and satisfaction. Given the choppy global economic environment, these accomplishments were quite noteworthy. I'd like to congratulate and thank the more than 55,000 people of EMC and VMware around the world who produced these financial results while remaining dedicated to our customers. Well done.

I would now like to comment on what we are seeing in the global economy and its impact on IT spending. On the macro front, pretty much everywhere in the world we are seeing more caution and more scrutiny before any decisions to procure any IT product or service is made. There is an air of uncertainty that permeates the world stage right now. Customers want to ensure that they will get a good return on their investment in a shorter time frame. Despite this macro trend, customers do understand that they need to continue to better drive better productivity through the use of information technology. This helps to assure them a differentiation, a competitive advantage, and helps drive down their overall cost.

Translating all of this into IT spending metrics, we now expect global IT spending growth to be around 3% this year, possibly a tick less. Previously, we believed that 2012 IT spending growth would be in the higher end of the 3% to 4% range. Net-net against this backdrop in Q2, we grew our revenues in the Americas and APJ by 14% year-over-year while our business in EMEA declined 1%. But to give you a little more color, we showed several points of growth in Northern Europe and several points of decline in Southern Europe. And again, we saw our highest growth rates in the rapid-growth economies. Across our BRIC plus 13 countries, we grew approximately 20% in Q2 versus the same period last year.

Looking at our year-over-year growth from a vertical industry perspective. Our business with service providers, media, government and in financial services grew faster than our overall Q2 10% growth rate average while our growth in local government, education and to the service sector was considerably slower. Clearly, we at EMC and VMware are well positioned in markets such as virtualization, storage and security that are growing faster than the IT average and it is equally clear that we are gaining share. Undoubtedly, a key reason for our success is the well-placed strategy and focus we have in cloud computing, Big Data and trust.

But a company cannot rest on its past successes in this extremely fast-paced IT world we live in. And the best strategies, winning strategies: live, breathe, morph and grow. A winning strategy allows one's total addressable market or TAM to expand considerably and, when coupled with crisp execution, leads to profitable growth. In our case, EMC and VMware have enhanced and extended our strategies and have honed our focus on 3 core missions. Strategy one, which is VMware's primary mission, will focus on transforming data center infrastructures into truly automated software-defined data centers with cloud scale and style. Additionally, VMware will continue to have a strategic focus on supporting corporate end users in a multi-device post-PC world.

Strategy two will focus on the development community with technology, services and platform support to build out a new generation of cloud and Big Data applications. And strategy three, which is EMC's primary mission, will focus on transforming the storage market with industry-leading products and services that feature game-changing technologies like FAST part, FAST software and Flash hardware.

And we at EMC will focus on extending our RSA security assets to assure trust in this new cloud and Big Data era. Doing this properly with visionary leadership and solid execution will drive a new wave of opportunity our way. So to that end, we have assigned 3 world-class IT leaders: Pat, Paul and David, respectively. They each lead 1 of these 3 major strategic vectors and each of them has a dedicated, talented team to help assure crisp execution. Getting this right will be critical to our future success, and I can assure you, we are maniacally focused on getting it right.

With that, I will now turn it back to Tony to moderate the Q&A portion of today's call.

Tony Takazawa

Thanks, Joe. [Operator Instructions] We thank you all for your cooperation in this matter. Operator, can we open up the lines for the first question, please?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Ittai Kidron with from Oppenheimer.

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

Joe, maybe you can talk a little bit more about Europe. You mentioned north being a little bit better than the south, but could you talk about the evolution through the quarter, what have you seen? And in your assessment when you're looking at your customers in Southern Europe, how long do you think they can kind of hold out on spending before things kind of catch up to them and they have to, whether they like it or not, spend on storage, data still grows downturn or not?

Joseph M. Tucci

Well, Ittai, first of all, the customers in Europe are spending, they're just not spending as much. If you -- and a lot of the difference in -- several points of the difference was currency, I think. It 6 points of difference, I think. At -- with -- at constant currency, we grew 5% in Europe, and of course in reported it was minus 1%. So a lot of it -- a lot of the headwinds in Europe is currency, and from the news today it looks like that's continuing. So there is a drive in Europe for sure, just like there is here, for productivity. And if we can help customers with their productivity, as I said, gain competitive advantage, help control costs, get more intimate with their customers, they are investing. What they're doing is they're taking longer to invest, that they're being like the good carpenter, they're measuring twice, cutting once. And obviously, they're being -- they're buying just exactly what they need and not buying in excess. So it's not that we're down on Europe by any means, but it is we are feeling the effect. And I think this will be with us for a while. I don't think this is a short-term phenomena. And that causes you to have things that are more back-end loaded because it just takes longer to get through all of the approval cycles. So I think all of those things kick in. But Europe is not just laying flat doing nothing, they are spending.

Tony Takazawa

Thanks, Ittai.

Operator

Our next question comes from Brian Marshall with ISI Group.

Brian Marshall - ISI Group Inc., Research Division

Specifically with respect to cloud storage, public cloud storage business, small as that is, and as, well, there's more open APIs out there, obviously these -- a lot of these infrastructures are home-grown IT kind of taking an NFS, some in JBOD. Can you talk a little bit about, as this growth kind of ramps up pretty quickly here, what the impacts to EMC will be and other traditional enterprise storage vendors over time and how you might offset any migration of Tier 2 workloads that you might see there over time?

Joseph M. Tucci

Well, as you saw, Brian, the first market I mentioned in terms of high growth for us was to service providers, so there's a concept out there that we're not selling -- they're all home growing their own, and that's simply not true. If you look across our line of -- we have a VMAX specifically for service providers. There's a lot of interest in Isilon, scale-out; tremendous interest in Atmos and in -- and also VNX. So we are -- and so it is a big market for us, and if you look at that market collectively, we're doing actually quite well in it. So we believe that our strategy of having a play both inside building cloud, inside customers' data centers, the private cloud, and working that in conjunction and building out a big ecosystem of public cloud providers is a winning strategy. And so far, that's working quite well. And we're going to keep pushing. And you see, the growth of some of these products, like Atmos, is pretty impressive.

Tony Takazawa

Thanks, Brian.

Operator

Our next question comes from Aaron Rakers with Stifel, Nicolaus.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

I want to dive into the gross margin a little bit. David, you had mentioned several different times about the mix towards the VMAX, to the new high-end platforms, and referencing the software richness of that platform, Unisphere, as well as extending FAST functionality out to heterogeneous environments. Just curious, as that ramps, should -- does that new platform bring with it a richer mix from a gross margin relative to the prior platform? Any help on that would be greatly appreciated.

David I. Goulden

Sure. And as I pointed out on my -- in my comments, the biggest driver both year-on-year and quarter-on-quarter in the improvement in gross margin is the mix shift towards higher-gross-margin products. And in that, obviously with us having a decent rebound in the Symmetrix product line, that helps a little bit in the gross margin particularly on the quarter-on-quarter basis. And yes, I mean, our approach is to -- as more of the value in the storage stack moves into software, obviously wraps into appliances in our storage platforms, we'll try and increase the overall software content. And on the newer products, the software attach rate is typically higher, and that's part of our strategies. So that is a part of our ongoing program to maintain forward movement in margins.

Tony Takazawa

Thanks, Aaron.

Operator

Our next question comes from Kulbinder Garcha with Credit Suisse.

Kulbinder Garcha - Crédit Suisse AG, Research Division

And just on the mid-end business, I think we saw a deceleration in revenue growth after several quarters of above 20% growth. Could you -- was that just all macro, how we come up against more difficult comparisons? And then a question for Joe, just on the Nicira acquisition, how does that strain the VC relationship, do you think, if at all?

David I. Goulden

All right, thank you. Let me start off with the mid-tier. So there are -- a few factors are going on in mid-tier growth this quarter. First of all, as we said last quarter, we did expect from Q1 to Q2 the growth in mid-tier to come down because of the stronger compare. If you recall, last year it was -- in Q2 was the first full quarter of VNX and there was a fair amount of pent-up demand for that, so that caused a little bit of a reduction in growth rates. Also, a couple of other factors. Europe is actually overweight from a mix point of view towards mid-tier. So a higher percentage of total revenues are in Europe for mid-tier given the nature of that market. And of course with euro -- with Europe being down because of the economy, of course, with the euro effect, that has a slightly bigger impacts on mid-tier than it did on the overall business. A couple of other comments: The channel in mid-tier remains strong, which is important for us. All the key major parts of mid-tier family, the VNX Family, BRS, Isilon, all grew. And then if you look quarter-on-quarter, mid-tier actually grew 3%, which is quite respectable. So when you kind of put all that together, that's really the story on mid-tier. And finally, I think, when the dust settles and you look at our 10% and you look at how others are going to wind up reporting this quarter for that segment of the marketplace, I think we're going to look pretty good.

Joseph M. Tucci

Yes, on the Nicira front. And obviously, I should say Nicira and the VX land front, which together are VMware's initiatives in the SDN arena. Paul Maritz made it very clear yesterday, and I'll second what he said, that our strategy with Cisco is very important and continue to play very much with Cisco. There's a tremendous amount of opportunity where Cisco can add their hardware layer, their software layer, their firmware layer and their ASIC layer, and we think this is not a one's -- a one versus the other. I think it -- we're -- doing these well both together can give the new experience that the software-defined data center in total demands. And as such, both John Chambers and I and our teams remain extremely committed to the VCE initiative and joint venture.

Tony Takazawa

Thanks, Kulbinder.

Operator

Our next question comes from Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Joe, could you just take us through the dynamics with Symmetrix and V-Max over the next couple of years? I know you've always talked about that being a sort of a mid- to high-single-digit growth business. As VNX is growing capacity, has that kind seen a kind of cannibalization on VMAX? So sort of a refresh on your views on that growth rate for that business.

Joseph M. Tucci

Well, I still remain -- and I'll let David comment too. I still remain convinced that this is -- this will be a growth business for us, albeit in the single digits, mid to lower, mid-6 single-digit range. It is -- I think it's the functionality, the performance, the way auto tier storage are just critical to today's environment, cloud environments, as well as yesterday's environments. So I think we're well positioned. We're going to keep investing in it. I know there was a lot of worry last quarter when we had a decline. We said that, that was the effect of a very tough compare. We said that was the result of being 3 years since we announced the new VMAX. And we said point blank that, as much candor as I could, that we were going to have a significant VMAX relaunch at EMC World, which we did. And we said on the back of that, we believe that we would return to the growth rates that we predicted. So here we are.

Tony Takazawa

Thanks, Alex.

Operator

Next in queue is Ben Reitzes with Barclays.

Benjamin A. Reitzes - Barclays Capital, Research Division

Could you talk a little more specifically about Isilon? What was that particular growth rate in the quarter? How's the momentum there? And what do you think will happen with demand once Mavericks is out?

David I. Goulden

All right, Ben, thank you. Let me take that. Isilon was the fastest-growing of our major mid-tier families. I'm not going to break out the exact number, but it was a strong growth rate. As I mentioned in the call, we are seeing the traditional use case being strong. We're also seeing Isilon playing more in the data center and in more of the traditional file -- large file applications. I think that Mavericks is going to basically just expand the opportunity. The Isilon value proposition is really absolutely true scale-outs. And as we add more of those enterprise services, the TAM for Isilon is going to continue. So I think we're just going to kind of continue to keep that product moving forward. I think the growth rates are not going to slow down in the foreseeable future. It's doing very well.

Tony Takazawa

Okay, thanks, Ben.

Operator

Next in queue is Bill Shope with Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

There's been a growing amount of confusion over storage market share trends, with some calling into question the third-party data firms. And I think investors are really struggling to parse that organic and inorganic share shifts amongst the players. Can you help us understand what your data is telling us in terms of your market share trends? And in particular, how do you benchmark your performance versus NetApp over the past several quarters?

David I. Goulden

Bill, thanks. Ultimately, when it comes down to market share, it's all about math. I mean, you just need to get the math right. And I think there's been a little bit of confusion because of -- comparisons have included organic and inorganic growth, et cetera. The way to look -- the way we look at it is really very simple: We think the right way of looking at growth is, first of all, to kind of not break out individual products but look at the broad market performance of the different businesses. The other thing is to make sure you include a true what we would call apples-to-apples growth rates, so you include all the revenues from acquired companies as if you acquired them in prior periods. And then once you do that, here's how the math works out, it's really quite simple. If we look at NetApps and we look at the last 4 quarters of growth rate, including the guidance for their current quarter, their 4-quarter growth rate average is 4%. If you look at our business -- and by the way, that 4% includes services that have been growing faster than their products. If you look at our business and you just look at the mid-tier product category alone, that same 4-quarter apples-to-apples growth rate is 19%, and if you want to really stretch the case and include Symmetrix and include all of our storage products, it's 12%. So it's either 12% or 19% against 4%. I think that's the math.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Okay, it's very helpful. Quick follow-up, if I could. It looks like the new VMAX cycle's pretty much on track with historical cycles. But how should we think about that over the next few quarters, the ramp's impact on margins and revenues relative to prior SIM cycles? And how do you think the macro-environment may influence that adoption curve?

David I. Goulden

Well, Bill, obviously, as I mentioned, we're actually very pleased with the adoption rate of the new family, which as you know is the 10K, the 20K and the 40K, with about 1/3 of the new systems revenue this quarter coming in from that new family. So we're getting out of the gate a little bit faster. I think that next quarter we'll probably get closer to 50%. So we've always said it takes between 2 and 3 quarters to get to a 50% transition on a new family. It looks like, in this case, we'll be there a little sooner. And relative to the macro, nothing really to add. As Joe said, it's impacting everybody, but we've been executing well against that so I don't think that particularly is a dynamic against the VMAX transition rate.

Operator

Next in queue is Keith Bachman with Bank of Montreal.

Keith F. Bachman - BMO Capital Markets U.S.

I had a question on September. And David, specifically for you, if you could talk about within the context of the overall guidance for the year of $22 billion, is it your anticipation that September relative to June, any comments there on the sequential patterns? And then as part of that, for the overall operating margin guidance within -- the guidance was 24%. It would appear that you're anticipating that operating margins will be down sequentially in the September quarter, assuming a normal December bump. Is there anything that you want to call out? I would think that margins would actually increase with the VMAX ramping, but anything that you would want to call out for the operating margins in the September quarter or otherwise?

David I. Goulden

Keith, we're really going to try and not get into talking around individual quarters, obviously with we've done for the first half and what we guide to for the second half. The math for the second half is relatively clear. Europe is in an environment that is typically, as you know, being more impacted. September is typically the weakest quarter for Europe, so that's one of the factors to bear in mind. But beyond that, we're not really going to get into the dynamics between Q3 and Q4. We are clearly expecting a stronger Q4. And we're expecting a degree of budget flush in Q4 consistent with prior years to get to the overall number.

Keith F. Bachman - BMO Capital Markets U.S.

Okay. Well, then, perhaps I'll just get a follow-up in there on the -- Joe, for you, on the server side, if you could talk a little bit about the impact of specifically when you anticipate getting some revenues on VCache (sic) [VFCache] and/or the V Thunder side. In the corollary, if you could also talk about your views on the impact to storage spending as a consequence of more Flash on the server side.

Joseph M. Tucci

First of all, we are getting revenue from VFCache. You've got to remember, what is important? There's 4 things that are important when you consider storage. One is, what performance do you need for that information? And again, that's going to change over time, so the performance you need for an -- for that particular piece of information today might be less than the future usually is: the persistency of that information, the longevity of that information and how much you want to share that information. The answer to those questions tells you where to place your storage and what type of storage to use. We have software that seamlessly and agilely moves and fits that information across these storage types and medias that I just mentioned. And again, this is the key to when you talk about a software-defined data center. That's what you want to have happened. So it's not a "one size fits all" world, that's kind of yesterday's paradigm. The cloud paradigm is basically saying, what does the application need? What does it need to meet my SLAs? What does it need to meet my policies? And then, what type of device am I going to select, okay, what type of media? And then, where am I going to place that media? So I could take the storage and I could put it on a PCI card and put it right into the server. I can put it on the server side of the network, in a project like we have, like Thunder. We can put it, of course, in arrays and we can put both Flash -- memory Flash and storage -- spinning storage devices, media devices, in those arrays. And that's where we're playing. And we're all automating it through our FAST technology, and that's basically going to be root. I talked about one of the roots of the software-defined data center: How do you do that automatically? That's where we're spending our money. So it's -- that's the way we're playing the game, and a lot of the other stuff is just the bunk.

Tony Takazawa

Thank you, Keith.

Operator

Next in queue is Amit Daryanani with RBC Capital Markets.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

I just have a question. If I look at the reiteration of the 2012 revenue guide, this implies you've got about 53% of the total revenues in the back half of the year, which is about what you've done for the last few years. And so I'm just trying to connect the dots between an essential reiteration of the guidance seasonality in the back half versus your commentary that demanded that you down-ticked on a macro basis in the last few months. Is there a delta? Is there a market share shift that you expect to be extremely in your favor? What's driving seasonal expectations still for the back half?

David I. Goulden

Actually, one of the key things we talked about is that we really saw these increased economic pressures in Q2 and we looked at the growth rate we achieved in Q2 and we kind of look at what customers are telling us about the rest of the year in light of these current economic headwinds, and that's how we get to $22 billion. If you do the math against the seasonal average, you'd actually get to slightly above $22 billion. The way we looked at it, if you just apply the seasonal math, you might get nearer to $22.3 billion. But to your point, Amit, things are a little tougher than they were in Q1 so that's why we feel the number, $22 billion, is kind of where the -- our expectations come out.

Tony Takazawa

Thanks, Amit.

Operator

Next in queue is Maynard Um with Wells Fargo.

Maynard Joseph Um - Wells Fargo Securities, LLC, Research Division

I wonder if you can talk a little bit more about the competitive environment. You talked about Isilon presumably taking share from NetApp. But any other detail where and from whom you're taking share, or is it primarily NetApp? And just related to that, how to -- how do you think about pricing environment going forward, particularly if you continue to take share from your competitors?

David I. Goulden

Maynard, let me take that. When we look at market share, there are really a couple of major buckets. There are the server vendors that collectively still have, depending upon how you want to count the math, between 30% and 40% of the network storage market. And then there are the more specialized people like NetApps, Hitachi, et cetera. And we kind of look at share in total, as opposed to focus upon one or the other of those. We mentioned how we do against NetApp because that question has come in recent times. We still think the right opportunity is to continue to take share collectively from the server vendors, and that's one of our biggest areas of focus for them. While storage is important, it's just not as important as it is for us. And as you know, this is again where technology and investment and dedication is important and that's where we tend to win and focus. So that's the bigger pool. And then from a pricing environment, it's tough out there, it has been all year. But as you see, because of the innovation, the quality, the differentiation of our products, we've been able to maintain our gross margin despite what continues to be a tough marketplace. So we feel good about our position there as well.

Tony Takazawa

Thanks, Maynard.

Operator

The next question comes from Toni Sacconaghi with Stanford (sic) [Sanford] Bernstein.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Perhaps this is for Joe. But I was wondering again if you could comment on the macro. If I look at VMware's results, they did equally well outside of the U.S., as they did inside the U.S. If I look at EMC, I think your growth rate in the U.S. was 14%. Outside the U.S., you were about 6% or 7%, so very wide differential. Perhaps you can comment on why that might be. And then related to that, at what level of IT spend or at what level of the euro do you begin to get uncomfortable with your current forecast? And how should we be thinking about that?

Joseph M. Tucci

Want to take the euro part?

David I. Goulden

Yes. Toni, let me take the second part of that. As Joe said, we now expect IT spend about 3 or a tick less. And we're comfortable with that level. At the euro, when we put our numbers together -- first of all, let's just talk about the euro for a second and the impact that's having upon our business. If we look at Q2 quarter, Q2 year-end growth rates, it's about $250 million headwind year-on-year. And about $0.03 is the impact of the euro this year versus last year. Current spot rates, that includes -- then it goes up to like $280 million, $290 million on year-on-year impact and still about $0.03. And euro, at the level of where it was at quarter end and where it is now in that range, is consistent with our thinking about guidance. So those are the 2 parameters: 3 or a little less IT spending, and euro between where it is now and where it was at quarter end and again understand, relative to our growth rate, where it is now year-on-year, the euro is having about 150 basis points of year-on-year headwind growth on us. So when you kind of compare this year versus last year, you're going to take that into account. So those are the assumptions that go into the guidance that we've given. And then relative to EMC versus VMware outside U.S., I'll let Joe take that one.

Joseph M. Tucci

Yes. I mean, Toni, if you look at our results and if you look at the Americas and you look at APJ, we grew 14%. If you looked at the BRIC plus-plus countries that we focused on, we grew 20%. So obviously, we're pointing to the problem in Europe. While we don't break out Europe per se, EMEA itself, Europe, Africa, Middle East, was down 1%. And if you look at the constant currency, it was up 5%. And we also said, Toni, that we did much better in the north than we did in the south. So where is it? So if you'll bring that down, where is the real problem? The real problem's in Southern Europe. And why is that a little bit different than VMware? I'd say you can always, on something like storage, push it off a bit. And there was a good question: So how long do you think customers can push it off? It's not forever because, eventually, information is going to grow, you need a place to put it. You need a place for it to live. You need it to be managed. So you can only put that off so long. But I think, on the shorter jam down the -- you can say, "Look, I'm just going to get a little -- I'm just going to push it a little harder, get a little higher, raise the -- always cause -- get productivity tools and make sure you raise your utilization rates. And that's what we're seeing. So it really is that one spot in the world that's causing our problem.

Tony Takazawa

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

Operator

Final question comes from Steve Milunovich with UBS.

Steven Milunovich - UBS Investment Bank, Research Division

Regarding the cost and expenses, could you talk a bit about what you expect in second half component cost and particularly what's going on with disk drives? And do you expect R&D to continue to grow at about a 25% year-over-year rate?

David I. Goulden

Steve, on drives, good news is that the supply shortages are completely behind us at this point in time. We do start to expect price reductions in drives to start appearing in the second half, but it'll be a while before they get back to what I'll call pre-flood levels. But the good news is that we're beyond the availability shortages certainly when we look at our TAM and our needs. Relative to OpEx, we do expect that the R&D growth will continue to outpace revenue growth, but probably a little lower rate than we saw in the second quarter. But investment there is still critical for us. And as we said, this is a technology game, so that's what we're focusing our investment dollars this year versus the SG&A.

Tony Takazawa

Thanks, Steve. Joe?

Joseph M. Tucci

Well, thanks, everybody, for attending. We really do appreciate it.

In summary, we've been very open. We said the economic headwinds in Europe are going to remain choppy at best and we expect this to continue for a while. But globally and on the IT front, we think we're strategically very well positioned and we have momentum. The customers are -- all importantly, are giving us permission to play in our extended strategic areas that we've talked about today.

We are really blessed to have a great and dedicated leadership team with us with a really solid depth. And the people of EMC and VMware very much believe in the opportunity and in our future.

So I thank you very much for being with us again, and I'll be -- we'll be talking to you soon.

Operator

This concludes today's conference. You may disconnect at this time.

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