EMC Corporation Q2 2008 Earnings Call Transcript

Jul.23.08 | About: EMC Corporation (EMC)

EMC Corporation (NYSE:EMC)

Q2 2008 Earnings Call

July 23, 2008 8:30 am ET

Executives

Tony Takazawa – Vice President, Global Investor Relations

David I. Goulden – Executive Vice President, Chief Financial Officer

Joseph M. Tucci – Chairman, President, Chief Executive Officer

Analysts

Aaron Rakers – Wachovia Capital Markets

Toni Sacconaghii – Sanford C. Bernstein & Co.

Louis Miscioscia - Cowen and Company

Mark Moskowitz - JP Morgan

Kaushik Roy - Pacific Growth Equities

David Bailey - Goldman Sachs

William Fearnley – FTN Midwest Securities

Ben Reitzes - Lehman Brothers

Thomas Curlin - RBC Capital Markets

Brent Bracelin – Pacific Crest Securities

Keith Bachmann – BMO Capital Markets

Katie Huberty - Morgan Stanley

Wamsi Mohan - Merrill Lynch

Brian Freed - Morgan, Keegan & Company, Inc.

Operator

Good morning and welcome to the EMC Second Quarter 2008 Earnings Conference Call. (Operator Instructions) Now I will turn the meeting over to Mr. Tony Takazawa, Vice President of Global Investor Relations.

Tony Takazawa

Good morning, welcome to EMC's call to discuss our financial results for the second quarter of 2008. Today we are joined by Joe Tucci, EMC Chairman, President and CEO, and David Goulden, EMC Executive Vice President and CFO.

David will provide a few comments about the results that we released this morning, and he will highlight some of EMC's activities this quarter. Joe will then spend some time discussing his market outlook, EMC's execution of its strategy, and how EMC is positioned in the marketplace. After the prepared remarks we will then open up the lines to take your questions.

I would like to point out that we will be highlighting various non-GAAP numbers in today's presentation. 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.

And lastly, I will note that an archive of today's presentation will be available following the call.

With that, it's now my pleasure to introduce David Goulden.

David I. Goulden

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

I am pleased to report that against the backdrop of a challenging economic environment EMC executed on our business plan and demonstrated strong performance.

In the second quarter we had revenue growth of 18%, a non-GAAP EPS growth of 20%. Q2 was solid across the board with double-digit growth in all our business segments, double-digit growth in our major geographies, share gains, improving profitability and good execution by the EMC team. This marks the 20th quarter in a row of double-digit growth for EMC. Our strategy and hard work are certainly paying off.

EMC’s ability to post solid results the last few years, and especially so far in 2008, is directly related to our strategic positioning and operational execution. As we said before, IT spending will continue to grow, driven primarily by the need to manage the ever-growing volume of information. The challenge of dealing with this information overload is leading to a set of needs that EMC is uniquely able to address.

The challenge is universal in that the growth of information is outpacing the ability to store it efficiently. IT is getting increasingly complex and is outpacing the ability to manage all of it effectively. The volume of information and its ubiquity is outpacing the ability to secure it. The power needs of all this technology is outpacing the ability to supply the necessary power costs effectively and without new approaches and new technology, the growth and complexity of information will certainly outpace customers’ budget growth.

EMC helps customers meet these challenges in a way no other vendor does. In terms if they need to store information, EMC is a clear leader with the broadest and deepest portfolio. In terms of helping IT complexity, EMC is the leader in virtualization as a key enabling technology to simplify the management of service and storage. EMC has technology uniquely able to manage the IT environment from applications through to storage while seeing through virtual layers, and EMC’s content management products can help to automate the management of information via policies. This is a truly differentiating set of management capabilities.

With RSA, EMC is the leader in informationcentric security, to ensure that only the authorized can have access to particular information no matter where that information goes. EMC is a leader in helping reduce data-sensitive power needs via our power-efficient products and various solutions for reducing power consumption.

Finally, the combination of all these capabilities makes EMC uniquely positioned to improve the overall efficiency of IT environments and help keep costs in check. I believe that it is EMC’s ability to address all of these customer needs that makes us successful. While some make think of our four major segments as discrete businesses, it’s really the combination of these and how we help customers deal with the information challenge that makes EMC unique and successful over time.

Now let’s turn to the financial results. Since VMware’s results were announced last night, I am going to start out by discussing our Information Infrastructure business, as a whole, and then highlight our Information Infrastructure business units: Information Storage, Content Management, and Security. I will then make some comments about our consolidated results, including VMware.

In Q2 EMC Information Infrastructure revenues were $3.2 billion, up 14% with approximately 300 basis points coming from currency. We had 7% growth in North America, which is a little slower than the 9% growth we saw in Q1, mainly due to the enterprise segments. Given the environments, 7% growth is a good number.

We were very strong in EMEA, up 24%, Asia-Pacific up 23%, and Latin America up 19%. Growth in our brick, plus 13 other high-growth countries was again robust, up almost 40% year-on-year. We are pleased with the success we are seeing in these important geographies and I would like to congratulate our teams in these areas for driving such great numbers.

Our solid revenue growth continues to reflect the combined strength of our sales force and the increasing contributions from our growing network of channel, alliance, and service partners.

Now looking at profitability, non-GAAP earnings per share were $0.21, up 17%. Q2 operating cash flow was $457 million and free cash flow was $270 million. Year-to-date, operating cash flow is 8% and free cash flow is up 6%. We are pleased with these first half cash flow results and you will note the free cash flow was more than $80 million higher than our first half non-GAAP net income.

Now moving on to our Information Storage business, in Q2 Information Storage revenues were up a very solid 14% over Q2 last year and within this storage product revenue was up nicely at 9%. We saw a good demand for our storage product portfolio across our major geographies, with particular strength in commercial and overseas.

In the high end, Symmetrix revenues in Q2 were again strong, up 10% over Q2 of last year. The DMX-4 is the highest performing, most cost-effective, secure, energy-efficient, and easy to use high end array on the market today. The results show the demand for Symmetrix continues to be strong, with 10% growth on average in each quarter since we introduced the DMX-4.

We are gaining a lot of traction with some of the new technologies and features we announced earlier this year. EMC is the only company offering enterprise Flash drive technology. Customers are very excited about this capability and demand is growing nicely.

Our virtual provisioning is also getting a lot of interest from customers. We are especially pleased with the accelerated growth in our de-duplication offerings. The Avamar store de-duplication products were up triple digits and we sold out of the most recently introduced product this quarter. We are also getting excellent feedback on the target-based de-duplication products we introduced at EMC World in May.

Customers seem to appreciate the fact that they can get all these new technologies as part of EMC’s broad portfolio solutions, which provide better total value and integration than buying everything in piece parts from multiple vendors.

Let’s now turn to our mid-range business that includes both our client family and Celerra NAS products. CLARiiON revenues were up 8% over Q2 of last year and while we experienced somewhat lower growth this quarter, we do expect growth to bounce back in the second half with some exciting new announcements.

Our NAS business had another excellent quarter with revenues, again, up over 50%. Our NS20 and NS40 products are doing very well and clearly gaining share.

We also closed the acquisition of Iomega in the quarter. I am pleased to note that we have already seen a lot of renewed interest in this brand from the channel and retail now that Iomega has become part of the EMC family. In addition, we recently the integration of Iomega storage products with our Retrospect Backup Software and our MozyHome Backup Service to create a new easy-to-use integrated storage solution for consumers. Stay tuned for more announcements.

In Q2 Dell represented approximately 12.3% of EMC’s total revenues. Within this, Dell continued to be about 1/3 of CLARiiON revenues and the balance came from a mix of EMC’s Information Storage content management, security, VMware products.

Today, EMC has the best storage product offerings in the company’s history and also the broadest and most integrated portfolio. The new technologies and features we’ve added, like data de-duplication, virtual provisioning, spin down, and Flash drives, have made our portfolio even more compelling in the market. As information continues to grow at nearly 60%, customers are struggling to keep up with growth and EMC’s unique ability to help customers with their many needs is an important competitive edge.

Turning to Content Management Archive business, in Content Management and Archive revenues were up 18% over Q2 of last year. I am pleased to report that our execution in this business is improving. In addition, the pipeline is healthy. This continued customer need for scaleable solutions to effectively manage the huge volumes of content whilst at the same time improving business efficiencies, increasing productivity, and meeting compliance and risk mitigation requirements.

Toward this end, customers are particularly interested in the just announced Documentum 6.5 release, which extends the reach into more customer requirements and its new capabilities and is very easy to use. A key aspect of this release is the many innovations enabling richer Web 2.0 experiences for our customers, and in turn their customers.

We believe we have the right team in place and operational execution is improving. With the introduction of Documentum 6.5 and its many new capabilities, we are well positioned to continue to gain share in this market.

Now let me turn to our RSA Information Security business. Revenues in Q2 were up 15% over Q2 of last year. We are benefiting from strength in areas such as data-loss protection, identity protection and verification, and in security, information, and event managements. In the second quarter we continued to innovate by making securities stronger and easier to use through improvements to our Blackberry-based Two-Factor Authentication, the introduction of Flexible Card Authenticators, and the enhance of our Knowledge-based authentication offerings.

While Secure ID growth did improve over last quarter, the business is still facing some negative headwinds, particularly in the financial services sector. Security overall continues to be a high priority for customers as they strive to better protect themselves and their customers from new threats. Informationcentric security requires layers of protection at every point of vulnerability and RSA is uniquely able to provide solutions from consumer-facing areas such as anti-fraud, anti-phishing, to Enterprise Brocade’s DLP and encryption, an important competitive differentiator in our services organization, which spans across our Information Storage, Content Management, and RSA Security businesses.

In Q2 our Professional Services revenues again grew over 30%. Even in these uncertain economic times, EMC is gaining share in the Services businesses because of our unique services and underlying offerings of focus. There are three major factors underlying our Services success. First, customers are working to improve the efficiency of their IT environments. Secondly, customers are looking for help in managing their IT and consolidation and virtualization initiatives across their businesses. And third, customers are looking for help in implementing broader solutions that encompass multiple aspects of EMC’s best-of-breed portfolio.

In addition, continued operational improvements and the development of excellent relationships with our Services and Solutions alliance partners are also key to making EMC a much valuable business partner worldwide.

The bottom line here is that the broader information challenge is something that all customers are facing and the solutions require capabilities that span across areas like storage, virtualization, and security. EMC is well positioned strategically and a result EMC’s Services business is successful and gaining share.

Now turning to margins, Q2 Information Infrastructure non-GAAP operating margin improved again and was 16.5%, up almost 30 basis points year-on-year. Non-GAAP gross margins were up 30 basis points, driven by continued improvement in product margins. Non-GAAP operating expenses were flat as a percentage of revenue. Within this SG&A did grow a bit faster than revenues. The year-on-year growth in SG&A is principally due to our targeted investments in the faster growing markets, such as the commercial market place and the Brick Plus 13 countries.

I would like to take a moment to clarify that the incremental sales events that we first mentioned on the Q1 call are going into these high-growth markets and not into our more mature markets. We believe that these investments will have longer-term benefits in these high-growth markets in 2009 and beyond.

We continue to identify places where we can improve EMC’s operating efficiencies by carefully managing head count growths, driving proximity, and finding new ways to optimize our non-people spend across the business.

I will turn to a few highlights of EMC’s consolidated results. Total Q2 revenues were approximately $3.7 billion, up 18% from last year and we had good double-digit growth in each of our geographies. Revenue outside of the U.S. was up 27% and non-U.S. revenue was a record 48% of EMC’s overall revenue.

Q2 non-GAAP earnings per share were $0.24, up 20%. Our Q2 GAAP earnings include $0.04 from stock-based compensation and $0.02 from intangible amortization. As a result, Q2 GAAP earnings per share were $0.18, up from $0.16 in Q2 of 2007.

So you can get some sense of VMware’s contribution, I have broken out the VMware results as recognized within EMC on the slide, as well. As you can see, VMware had another strong quarter and contributed $0.035 to our consolidated, non-GAAP earnings results.

EMC consolidated cash flow from operating activities in Q2 was $619 million. A few balance-sheet metrics that impacted Q2 operating cash flow include deferred revenues, which were a record high at $3.1 billion and up 30% over Q2 of last year, inventory turns which were 6.8 up from 6.6 in Q1, and DSOs which were 54 days. The four-day increase from Q1 is made up of two days from normal seasonality and two days from the Iomega acquisition that closed toward the very end of the quarter.

Consolidated Q2 free cash flow was $374 million. On a year-to-date basis consolidated operating cash flow is up 7% year-on-year and free cash flow is up 8%. In addition, year-to-date free cash flow exceeded non-GAAP net income over the same period by about $100 million.

Going to our cash position and cash use, we ended Q2 with a record cash and investment position of approximately $8.1 billion. About $4.6 billion of this is held in our overseas operations and in VMware. Financial flexibility is an important strength and competitive advantage and we believe our investment portfolio is in good shape and managed conservatively.

An important way we continue to return value to shareholders is through our use of cash with share repurchase and for acquisitions. In Q2 we spent approximately $130 million to purchase around 9 million shares. In conjunction with our Q1 repurchase, we bought back about $700 million worth of stock in the first six months. So far in Q3 we have bought another $150 million worth of EMC stock, bringing our year-to-date repurchase to about $850 million. In Q2 we spent approximately $270 million on acquisitions in both Storage and Professional Services. We will continue to use our strong cash position to invest in [inaudible] acquisitions that expand our technology sources portfolio and take us into new markets.

Finally, I will make a few comments about our outlook for 2008. We now expect the EMC 2008 consolidate revenues to exceed $15 billion. Within this consolidated number expected revenues are helped by the solid performance in EMC Information Infrastructure plus the new Iomega revenues, and in turn, partially offset by the slightly expected revenue growth at VMware.

Turning to EPS, we continue to be comfortable with the consolidated non-GAAP guidance we gave you in January. We continue to expect 2008 non-GAAP consolidated EPS to be approximately $1.04. This EPS excludes the Q1 IPR&D charge of about $0.04, stock-based compensation of about $0.18, and intangible asset amortization or about $0.08.

To help you better understand our reasoning behind the consolidated EPS expectations, I would point out that even though we expect consolidated revenues to be a little stronger, we are not expecting a change in our consolidated non-GAAP EPS for three reasons. One, while Iomega adds to revenues, it is not expected to accretive to non-GAAP EPS this year. Two, as VMware announced last night, their results are expected to be a little below what was included in our original 2008 guidance. And three, we expect the EMC Information Infrastructure business to be a little ahead of our original expectations. All of which nets out to no change in non-GAAP EPS on a consolidated basis.

In closing, EMC’s results, over both the short term and long term, have been very solid. As one of the most trusted partners in IT, we believe EMC is well positioned strategically and operationally for continued success.

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

Joseph M. Tucci

Thanks, David.

I would also like to add my welcome and thanks to everyone joining us today for our Q2 conference call.

It is my pleasure to report that our overall performance in Q2 was strong, especially when you consider the tough economic climate in which we operated. This is evidenced by the fact that we achieved double-digit growth rates in all three geographies: the Americas; Europe, Middle East and Africa; and APJ. We did double-digit growth rates in all four of our businesses: Storage; Content Management; Security; and of course, in the VMware company. And across hardware, software, and services.

I am extremely pleased to announce that Q2 2008 marked our 20th consecutive quarter, that’s five years in a row, of double-digit revenue growth, a notable achievement of for a company of our size and scope. I am very proud of EMC and VMware teams around the world that produced these results. I would like to thank them for their innovation, dedication, and just plain hard work. Well done.

I will begin my formal comments with our take on the economic landscape and its impact on IT spending for the second half of 2008. As I said earlier, the economic environment is tough and I believe it will remain touch for at least the next several quarters. Really, IT spending is being more scrutinized now that it has been at any point in the 2003-2007 time frame and for sure, customers are showing more caution.

Please don’t confuse caution with not spending. Customers are continuing to spend in areas that give them cost advantage and customers are also spending to give themselves increased market advantage. In other words, they will invest to take share now and even more importantly, in the future.

This caution is manifesting itself in two related ways. First, we are seeing customers funding IT projects that have faster ROIs. And second, we are seeing greater scrutiny on almost every deal. In other words, the customer approval cycle is going through more senior-management layers and it is taking longer to get the final purchase order than we have seen in quite some time. The spending caution is most notable in U.S. enterprise accounts.

However, EMC is well positioned in this tight-spending environment. CIO survey after CIO survey points to the fact that EMC’s portfolio of products and services are squarely in areas where CIOs point to as their top 2008 spending priorities. Take for example the latest Goldman Sachs CIO report issued July 7, 2008. Virtualization, storage, security, along with data center, server, and storage consolidation were all pointed out to be top spending priorities. These are areas that EMC leads and excels in. In fact, in virtually all of these types of surveys, EMC is consistently mentioned as the company that company CIOs plan to do more business with this year.

As our guidance pointed out today, we still firmly believe there is enough market opportunity and activity for us to make our 2008 goals. Furthermore, this uncertain global economy gives us the opportunity and imperative to work on garnering further operating and capital efficiencies for you, our shareholders. I believe there are excellent opportunities for us in both of these areas. Ultimately, though, it will be the quality and determination of our people that enables us to continue to gain share in this tough global economy.

Let me know make a couple of comments on VMware before turning the call back to you for your questions.

When you examine the hallmark of a truly great technology company, one first looks at the market opportunity on which the company is focused. Is it large? Is it growing rapidly? Is it really, really strategic to customers? Now put VMware through that same lens. The virtualization market over the next several years will reach double-digit billions annually, therefore it is a very rapidly growing market. It is absolutely strategic in game-changing to customers.

The second thing you would look at as a hallmark of a truly great technology company, does it have innovative, distinct leading technology and products. Again, looking at VMware through that lens, we have the third generation of a hypervisor in place, a truly stable hallmark platform. We have 20 value-added virtual integration software, services, and products to sit on top of that hypervisor to make up our suite. Very distinctive. And of course we have plans to double and triple the number of value-added software, products, and services that we put on top.

A truly distinct hallmark of a great company is does it have the people and the talent pool. VMware has been the place, and is the place, where the best and brightest are and want to be in the future. When you think of VMware, it’s at the nexus of three of the macro trends and technology for the future, the virtual data center of the future; Cloud computing and virtual desk top integration. It’s a great place to be and we’re going to make sure it’s a rewarding place to be and we will retain and recruit great talent to this company.

And of course, does the company have great leadership in place? I have known Paul Maritz for years and I have worked with him now for the last six months and I can tell you he is a world-class technologist, he is a true technology visionary, he is a very, very good businessman, and he is an excellent leader. We have the right person in place and the right time for VMware.

The last thing you might look at is has this company built a great ecosystem around them. VMware has a great cadre of partners, over 700. I have reached out to some of the largest partners and assured them that VMware will remain an independent company that will work openly, evenly, and seamlessly with all the interested players in the IT landscape. As we have said before, EMC has no plan to spin out it’s remaining 85% ownership in VMware.

We believe EMC has an incredible set of assets and businesses and are squarely focused on high growth segments of IT. We are in great position for the future and we have a very strong strategic hand. As always, I promise you we will strive to obtain maximum benefit for both sets of shareholders over the long term.

We will give you more insight into our plans for VMware, as well as for our Storage, Content Management, Security, and Cloud technology and businesses at a full-blown investor/analyst conference which we will hold in New York City this fall right after the Q3 earnings call.

I will now turn it back to Tony to moderate the Q&A portion of today’s call.

Tony Takazawa

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Aaron Rakers with Wachovia Capital Markets.

Aaron Rakers – Wachovia Capital Markets

Congratulations on a great quarter. I guess the one stand out in my mind maybe we can dig into a little bit is the cash-flow generation story of the company. It looks like relative to last quarter the free cash flow generation was a bit below the EPS, or the non-GAAP EPS, generation for the core company. I’m just trying to understand how we should think about that. It looks like it’s more about accounts receivable and bringing Iomega into the equation. How should we think about free cash flow relative to your target of $1.15 for the full year, given this quarter’s results?

David I. Goulden

Aaron, great question. And really you hit the nail on the head. The difference in cash flow between Q1-Q2 is due to the timing of collections of receivables between Q1 and Q2. We just had a phenomenal collection quarter in Q1 and a less money collected in Q2. That’s why I focused on the year-to-date performance. Year-to-date free cash flow for the whole business is $1.1 billion, $100 million than the non-GAAP net income. Year-to-date free cash flow for EMC Information Infrastructure is $926 million, $84 million higher than non-GAAP net income.

So I think when you look over the six-month period, that gives you a much better picture of what’s actually going on.

Aaron Rakers – Wachovia Capital Markets

And can you say that you’re still on target? Do you still believe you’ll hit that $1.15 of free cash flow generation for the year? Per share?

David I. Goulden

Yes. As Joe said, we are on target to make our goals.

Operator

Your next question comes from Toni Sacconaghii with Sanford Bernstein.

Toni Sacconaghii – Sanford C. Bernstein & Co.

I was wondering if you could comment on why you’ve actually decided not to repurchase more shares given the pretty strong pullback in your stock price last quarter. Your share repurchases actually were significantly lower than they had been in the first quarter. Now, clearly by pointing out that you have been in the market early in the third quarter, you may be telling us something. But can you comment on existing authorization, how you think about share repurchases, and why we shouldn’t expect EMC, at these price levels, to get more aggressive in repurchasing its shares?

David I. Goulden

Sure, Toni. Let me start that and I think Joe will add a couple of comments.

First of all, as you know from the last call, we have a large authorization which was given to us by the Board a while ago so it’s not an authorization issue. Previously we had told you that this year we would spend $1 billion-$1.5 billion on buybacks. We think it’s very attractive to buy the stock at current prices and at these prices will very likely exceed the $1.5 billion number we gave you for the year.

Joseph M. Tucci

Just a little color. We don’t like the stock at this price, we love the stock at this price.

Operator

Your next question comes from Louis Miscioscia with Cowen and Company.

Louis Miscioscia - Cowen and Company

Maybe we could get another comment from you about the macro economy. Obviously, you’ve already said a few things here, but as we get to the back half of the year and we look maybe into even 2009, are you getting any kind of feel that the spending environment will change drastically as the macro conditions stay tough, that maybe conditions will get even more difficult than they are right now?

Joseph M. Tucci

Louis, I currently look at this. My take is, when I look at our pipelines and our front logs, there is sufficient business out there for us to do what we need to do. So we’re not opportunity-starved. I just think it’s going to kind of stay at this kind of level for maybe longer than any of us would like. I don’t see it getting a lot worse but I do see it maybe going a little bit longer than we would like. If that happens, I think we are well positioned because we’re in the right markets.

Louis Miscioscia - Cowen and Company

A quick follow-up on just hiring. Obviously VMware said that they are going to hire selectively. Some of your competitors are hiring rather aggressively. What’s EMC’s hiring plans for the rest of the year, mostly in sales?

Joseph M. Tucci

As David kind of hinted at, where we are hiring, and we are definitely hiring in sales, it’s pretty much in two areas. We created a new term called Brick Plus 13, which is the brick countries which everyone knows about and 13 other countries. It’s actually a little bit more than that but it’s sort of rapidly growing economies and we’re really investing there and that’s paying big dividends. David said our growth there, again, this quarter was over 40%.

And then another place we’re having great growth around the world is as we go down in the commercial SMB markets, and obviously we’re hiring there.

So those are the two areas where we are adding sales people.

Operator

Your next question comes from Mark Moskowitz with JP Morgan.

Mark Moskowitz - JP Morgan

I have a question in terms of the contribution from international as it relates to growth. You talked a little about how balance versus hardware relative to software, vice versa, in terms are, are you seeing a greater pull from the hardware first or software, as you try to relate and drive this to main creation?

Joseph M. Tucci

It’s pretty interesting, Mark. As we look around the world, it’s pretty even, you know, the hardware and software products. Obviously we’re growing faster but if you look at the percentages within that growth, they remain pretty constant. So it’s pretty interesting. We’ve look at that a number of times and I don’t know if it’s surprising or not surprising but that’s the facts.

Operator

Your next question comes from Kaushik Roy with Pacific Growth Equities.

Kaushik Roy - Pacific Growth Equities

Congratulations despite such a bad macro environment. Seems EMC share depends on the value of VMware and some investors are expecting a spin off of VMware in 2009 as you had earlier mentioned, you will do what is best for investors. Now it seems it’s very clear that you will not spin off VMware. And it seems the core EMC is being valued at less than 10x earnings, so can you comment what changed or why or how it is good for EMC shareholders?

Joseph M. Tucci

I think that is a great question and I think what you want me to do is talk a little bit about the analyst meeting now, which I am going to resist doing. So, we will give you the full breadth of our thinking but again, I want to emphasis, we are in the long term going to do what’s best for shareholders. Period.

Operator

Your next question comes from David Bailey with Goldman Sachs.

David Bailey - Goldman Sachs

Could you talk a little bit about linearity in the quarter and following up on commentary from VMware last night, did you see deals pushed out and decrease in size in the quarter.

David I. Goulden

David, let me start with that. So the linearity during the quarter was very typical of what we saw in Q1, typical of what we saw in Q2 a year ago.

Joseph M. Tucci

One of the things we’re doing, David, is we’ve recognized this trend and we picked it up staring a few months back. And we’re working really hard to get our sales people to say these big deals, and even smaller deals, are going to take longer than you think to get out of our customers’ processes and the sales cycles will elongate, therefore we have got to start moving up activity earlier in the quarter. And we did a pretty good job of that and is how we had posted the numbers we posted. And we will continue to do that and we do that through activity generation and in the way we work our comp plan, to really kind of force, a lot of force to try to work earlier in the quarter to give customers proper time to work it.

Because you’re not going to rush customers, they’re going to take their time, but if you get the deal and their order, the deal makes sense and it helps them save money, it gives a good ROI, it helps them get good benefit, you’ll get the deal done. There is sufficient pipeline out there.

Operator

Your next question comes from Bill Fearnley with FTN Midwest.

William Fearnley – FTN Midwest Securities

You guys mentioned share gains in your opening comments. Can you give some more color here on the competitive environment in terms of where you see your share gains? Because you had mentioned that before. And then also if you could add some additional color on the growth economies. How do you see the decision cycles and competitive dynamics there? Did that help your share gains?

Joseph M. Tucci

I’ll start with the growth economies. It certainly did. As you take us against like an HP and an IBM for instance, you know, both of those companies, one I think is a point or two over and one is a point or two under, they have 70% of their business coming out of international.

You noted that EMC set an all-time record at 48% of its revenues coming out of international. So again, tremendous progress. It used to be 60/40, 60% U.S., 40% international so we’ve made great progress over the last year or so. But still, we’ve got a long way to go. So international expansion is an important growth metric for us and we’re doing it well.

As you also noted, we’re doing reasonably good growth in the U.S. in these quarters and especially when you consider that U.S. enterprise has probably taken the brunt of the hit right now.

So, it is definitely part of our plan to get this broad base and of course, within the international theaters, the parts of this Brick Plus 13 as we call it, is the fastest growing piece so we’re putting extra focus there. So, yeah, it’s all part of our growth plan and it’s working exactly as we had it plotted out, thank God.

Operator

Your next question comes from Ben Reitzes with Lehman Brothers

Ben Reitzes - Lehman Brothers

I just want to hit on the VMware thing again, Joe. And I respect that you have to have an analyst day and perhaps you’re waiting for a new CEO to make his plan and you don’t want to front-run it. But obviously when you bought VMware I believe the market value of your company might even have been higher. You know, all you guys are doing is putting up good quarters and your CFO is providing great information. And I just wanted to get a feel for your sense of urgency for turning this around. It seems to be the main issue with the stock. And what you’re looking for Paul to do and I know you don’t want to front-run the analyst day, but this is what clients are asking about. This is why it feels like your stock’s underperformed. I mean, a good quarter today you would only be up a few nickels. I mean, can you give us a little more insight? I mean, this the, you know, maybe the single point of frustration near term and I’m just wondering how we make an investment decision if we wait for the analyst day, when this is the biggest thing that might be holding you guys back right now.

Joseph M. Tucci

Well, part of what you said doesn’t make a lot of sense, right, Ben? If the core EMC is increasing in value and we’re hitting the numbers we’re hitting, VMware has got to be worth quite a bit, right, incrementally. How could what’s happening happen, but that’s a point of frustration.

All I’m going to say for now is you’re absolutely right. Paul is world-class and the right guy at the right time. Trust me on this. And we are going to do the right things for the shareholders and I’m telling you that we just really need the time and we’re going to take that time and we will talk to you in the fall.

Operator

Your next question comes from Tom Curlin with RBC.

Thomas Curlin - RBC Capital Markets

VMware spin issue, you guys have talked about doing what’s right for shareholders, so now you’re explicitly saying you won’t spin it. There’s been some rumor to that effect for some time. But how do you reconcile those two comments, right? If shareholders decide that’s what’s right, are you saying you’re going to decide against what shareholders want and if so, what are you going to do to block that?

Joseph M. Tucci

We’re going to do what is in the best interest for the shareholders. They’re not in conflict. I think right now you would think for sure, we have to focus back on the business, get VMware back on track. It’s got phenomenal opportunities. You look through the EMC access, we have phenomenal opportunities. There’s a lot of things we can do together. They’re working great with their partners, their partners are comfortable with our ownership and working with an even hand.

And again, I’m just going to come back to the answer. We’ll give you some of the answers you want and we will give them to you in that time frame I just told you. Right now we’re going to focus on getting VMware business back on the right track, it’s still on a great track, but we’ve got to get it back in its almost perfect track, and we can and will.

Thomas Curlin - RBC Capital Markets

Is it logically coherent, though, to say that you will do what’s right for investors but you absolutely will not spin out VMware?

Joseph M. Tucci

There’s a timing for everything, okay? And I kind of know a lot more of what’s going on than anybody else and we will do the right thing for the shareholder when and if the time is right. And always, we will do the right thing for the shareholder over the longer term.

Operator

Your next question comes from Brent Bracelin with Pacific Crest.

Brent Bracelin – Pacific Crest Securities

I really wanted to spend some time of the kind of high end business. You’ve been very strong here now for three quarters, averaging 10% growth. How much of that is driven kind of by DMX-4 upgrades versus capacity. And, Joe, do you think there’s any sort of difference at the high end that gives you confidence that potentially that business could remain strong in the second half of the year and not slow down?

Joseph M. Tucci

I think the biggest difference is what we’ve done with the DMX which the customers have noticed. I’m not sure if maybe the investor community has noticed as well. Over the last several releases, now of course it takes customers time to get these releases into production so you’re seeing the effect now, we’ve added two really major capabilities.

One is the capability to use [sodded] drive so you can now put big terabyte drives into DMX. And of course, as you have extra space in DMX, and you insert those terabyte drives, and because of the vast power and capacity in that frame, it’s a very inexpensive way of adding tier-three storage.

The second thing we did is we added quality of service, similar to what an IBM mainframe would have. In other words, now as you put a tier-three storage layer in a DMX you can give that the proper quality of service. So therefore if you’re running a highly important online transaction processing system you’re not going to let’s say a decision support system that’s kicked off in tier-three interfere with the IO rate and timing of that important application. So that’s what quality of service gives you.

So as customers see that, they are using that capability and it’s just another way to tier your storage and it’s kind of tiering up your storage in the same frame with adding quality of service. And that’s been a phenomenal feature and I think that’s going to continue to help us drive growth as customers’ number one way. If you’re a customer and you want to save money on storage, tier your storage.

Brent Bracelin – Pacific Crest Securities

Are those two incents enough to kind of extend the life of the DMX-4 kind of upgrade cycle that took you through the last two to four quarters.

Joseph M. Tucci

We’ve also added what we call virtual provisioning which is a very good implementation of thin provisioning. It has a lot of ease of use, it’s got the world’s best replication, I could go on and on and on. I mean, this is the frame everybody compares themselves with. DMX is the standard. And of course, as we add more and more capabilities and features to that, de-duplication and all that is coming. So the more we add to this frame the more customers say it’s easy for them to manage, they need [inaudible] and it’s just a good way to go and that extends the life and it is what is helping funnel our growth.

Operator

Your next question comes from Keith Bachmann with Bank of Montreal.

Keith Bachmann – BMO Capital Markets

David, I was hoping you could talk margins a little bit. On the gross margin side give us some perspective on how you see products versus services unfolding in terms of the margin performance and then going against the OpEx side, how we should be thinking about SG&A in particular, which you mentioned has been moving up higher than sales and how we should be thinking about the aggregate margins when you roll all that up.

David I. Goulden

First point to note is that while there have been some movers, which I will come back and talk about, we’ve been moving things around in an environment where we’ve been expanding operating margins. So in the first half of the year operating margins have expanded about 30 basis points which in this kind of economy I think bodes well for all the businesses.

Relative to the different elements, you see gross margins have been going up and that’s being driven by increasing product margins and [inaudible] combined. And that’ true in the Storage business, that’s true in Information Infrastructure. Slight offset against that would be a high mix of Professional Services which always have lower margins when totaled, the margin lines would be moved up nicely.

And then as you pointed out, Keith, and as I pointed out, really OpEx has been flat with the exception of the investments in SG&A and those are paying dividends and we are making the investments while still expanding our operating margins. So we think the model is kind of working quite well. We’ll continue to make those investments in SG&A and we should continue to see margins move in the right direction.

Keith Bachmann – BMO Capital Markets

So, David, just to be clear, will gross margins, then, you think continue to track up, and I’m referring on a year-over-year basis because obviously you’re going to get some seasonality benefits, so those will continue to track up, you think, while you’re making those investments in SG&A to offset it?

David I. Goulden

Basically, yes. And we will balance the entire picture within an environment where we give you some slight expansion to operating margins this year, which is consistent with our original guidance.

Operator

Your next question comes from Katie Huberty with Morgan Stanley.

Katie Huberty - Morgan Stanley

David, you mentioned that Iomega will not be accretive in the back half of the year. Is it actually dilutive and if so, by what amount? And can you also touch on what you’re assuming for revenue, synergy or dis-synergy versus Iomega stand alone over the next year?

David I. Goulden

Katie, basically it’s a [diminimous] impact to our non-GAAP EPS this year from Iomega so no real impact or negative.

I’m sorry, I missed the second part of your question.

Katie Huberty - Morgan Stanley

What are you assuming in terms of the revenue opportunity over the next year versus Iomega stand alone?

David I. Goulden

We believe we can grow Iomega faster as part of EMC than it grew stand alone. Obviously you can look online and see what their stand alone performance has been but we certainly think we can drive incremental growth.

Operator

Your next question comes from Wamsi Mohan with Merrill Lynch.

Wamsi Mohan - Merrill Lynch

Could you comment on revenue funds vertically, where trends were better or worse than expected?

Joseph M. Tucci

It’s pretty interesting. You expect me now to say financial services, but we actually did okay in financial services. It’s not as lumpy as you would think across verticals. We are seeing it a little bit more by geography. And again, it wasn’t terrible in the U.S., the enterprise slowed down a little bit from what it was last year. But there is no one particular vertical that was horrible or no one particular vertical was outstanding.

Wamsi Mohan - Merrill Lynch

And as a follow-up, how much more elongated are sales cycles now relative to a year ago? I mean, you had mentioned that the incremental sales adds are sort of in the Brick Plus 13 and commercial SMB markets. Arguably, those folks are not going to be productive here in the near term. So for 2008, what gives you the confidence that you can close the same level of business with sort of no incremental resources and elongated sales cycles?

Joseph M. Tucci

Let me tell you how it’s manifesting itself. It used to be a customer said okay, you had been selected, you were going to get the order, that would have normally been a week to two week process. Now we’re seeing that take a week to ten days longer than that in some cases because it’s just got to go through more levels of scrutiny and what we need to do now is get that, knowing at the end of the quarter is a fixed date, in this case it happens to be September 30. We’ve got to make sure that we back up from that and get these things in the pipe in the first two weeks so we can get them out.

Operator

Your last question comes from Brian Freed with Morgan Keegan.

Brian Freed - Morgan, Keegan & Company, Inc.

You commented on Symmetrix and Celerra. You haven’t talked much about CLARiiON. Can you talk a little about CLARiiON trends in the quarter? I know you did have some product enhancements forthcoming so that might have hampered it. And secondly, how the Dell relationship is faring a couple of quarters into the EqualLogics purchase.

Joseph M. Tucci

I think you hit on the two events that caused us a little bit of a slowdown. Let me pick up on the Dell comments. Obviously when Dell did EqualLogics we created some confusion in the sales forces probably on both sides. If you were to talk to Michael Dell I am convinced he would give you the same answer I am going to give you. We have this thing back on track, we have a positioning. They do believe there is a good future. Obviously they are still high on what they can accomplish with EqualLogics but they do believe there is a very good future and growth opportunity with them with the CLARiiON line. And we have really actions between the two of us back with our field to make sure that happens and I absolutely believe it will happen. Those actions caused a little bit of stalling, a little bit of constipation in the field and we’re now through that. And course, we have some additional products coming and that will help, also.

Well, thank you all for joining us and again, I will just say it one more time, the environment is tough and we think it will stay tough for a while. We absolute believe it is manageable. We have the attention of our field forces and they are doing very well and we’ve just got to work more diligently with customers earlier in the quarter to make sure we can get the amount of business through the pipes that we want to and that’s what we’re focused on. And we’re focused on not letting you down and we look very much forward to the fall conference together where we can give you more insight into our future plans. Thank you very much.

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