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EMC Corporation (NYSE:EMC)

Q1 2006 Earnings Conference Call

April 20th 2006, 08.30 AM

Executives:

Tony Takazawa, Vice President, Investor Relations

William Teuber, Chief Financial Officer, Executive Vice President

Joseph Tucci, Chairman of the Board, President, Chief Executive Officer

Howard Elias, Executive Vice President, Global Marketing and Corporate Development

Analysts:

Tony Sacconaghi, Sanford Bernstein

Aaron Rakers, AG Edwards

Daniel Renouard, Robert W. Baird & Co.

Keith Bachman, Bank of America

Harry Blount, Lehman Brothers

Paul Mansky, Citigroup

Laura Conigliaro, Goldman Sachs

Brian Freed, Morgan, Keegan & Company

Rebecca Runkle, Morgan Stanley

Bill Shope, JP Morgan

Kevin Hunt, Thomas Weisel Partners

Thomas Curlin, RBC Capital Markets

Ben Reitzes, UBS Warburg

Presentation

Operator

Welcome and thank you for standing by. Operator comments. Now I would like to turn the meeting over to Mr. Tony Takazawa, Vice President of Global Investor Relations.

Tony Takazawa, Vice President, Investor Relations

Thank you, Sherry. Good morning, welcome to EMC’s call to discuss our financial results for Q1 2006. In our press release issued earlier this morning, EMC reported quarterly revenues of $2.551 billion, with net income of $272 million and GAAP EPS of $0.11. Today we’ll be discussing our results on both a GAAP and non-GAAP basis. To help you with your analysis, we have included in today’s presentation and press release, financial details and commentary to reconcile our non-GAAP analysis with our GAAP results.

On today’s call, Bill Teuber, EMC’s Executive Vice President and CFO, will start things off and walk you through our Q1 financial performance and highlights. We will then be joined by Joe Tucci, EMC’s Chairman, President and CEO. Joe will provide commentary on our strategy and our results. After the prepared remarks we will open up the lines and take your questions. We’ll be joined at that time by Howard Elias, Executive Vice President of Global Marketing and Corporate Development. We will be making references to our slides today, so we encourage you to view them on EMC’s website at EMC.com. An archive of the audio and slide presentation will also be available following the call.

Finally, I do want to note that the call this morning will contain forward-looking statements and information concerning factors that could cause results to differ from those in our forward-looking statements, can be found in EMC’s filings with the US Securities and Exchange Commission. With that, it is now my pleasure to introduce EMC’s CFO, Bill Teuber. Bill?

William Teuber, Chief Financial Officer, Executive Vice President

Thanks, Tony. This quarter’s financials reflect a number of changes which I’ll walk you through as we go along, so please bear with me. Thank you also for joining us this morning. Q1 was a quarter which demonstrated the continued strength of EMC’s business model, which relies increasingly on a more solutions-orientated approach to delivering customer value. We had some elements of our business perform better than expected and also a few areas that didn’t quite meet our expectations. While this caused us to come in a bit less than 1% below our expected revenue range, EPS was right on target and the overall business continues to perform well.

Today I’m going to discuss with you how we look at the business from a geographic standpoint, and from the perspective of our solutions-based approach. I’ll walk you through a bit of detail on the areas where performance didn’t meet our expectations, and I’ll spend some time on areas where things went well, such as Symmetrix, Content Management and VMware, in the success of our overall model. As always, I’ll touch on some of the income statements and balance sheet items and give you our thoughts as we look ahead.

As you know, the basis of reporting for every company has changed because of FAS123R. Considering this rule change, as well as the non-cash charges that acquisitive companies have, we believe that our non-GAAP results give better insight into the health of our business. Correspondingly, we have changed the basis of our presentation to reflect this non-GAAP approach and we have provided you with the data for the appropriate historical comparisons. Many other companies are providing results in this manner, and we agree that it’s a valuable way to analyze EMC. Beginning this quarter, I’m going to focus on our earnings, excluding a number of non-cash items we have been talking with you about for the last year, namely: equity compensations including restrictive stock expense and stock option expense, and acquisition-related amortization. Each of these is a significant non-cash item which can make it difficult for you to analyze comparable operating results on a going-forward basis. We will provide you with a non-GAAP EPS number excluding all of these components in addition to GAAP numbers. Of course there is a reconciliation of these numbers and appropriate historical comparisons included in today’s press release.

Now to walk you through the EPS results, we start with GAAP EPS of $0.11, as Tony mentioned. Adjusted for stock option expense of $0.03, EPS was $0.14 as we previously discussed with you and expected. Additionally, with the cost of restricted stock and acquisition-related amortization each accounting for about $0.01 this quarter, you get to a non-GAAP EPS measure of $0.16, which is up 33% over the comparable quarter a year ago, on the same basis.

As Tony mentioned earlier, Q1 revenues were $2.551 billion, up 14% versus a year ago. At the macro level, currency hit us for a couple of percentage points this quarter, as the dollar strengthened considerably from Q1 of last year to this year. Turning to the details of our revenues results, I would like to start today’s discussion with an overview of our global revenues. An important element to achieving EMC’s long-term growth potential is expanding our worldwide footprint, and realizing the benefits of our investments in new markets. We have maintained our leadership in North America for some time and we continue to invest in the international market, to drive growth in those areas where we are under-represented from either a market share or a direct presence. Starting with North America, revenues were up 14% over last year. This continues to be a major area of strength for EMC, as we continue to take share and believe that opportunities for us in this market are robust.

EMEA was the biggest contributor to growth this quarter, where revenues were up 17% YoverY. On a local currency basis, this region was up well over 20%. This is an excellent growth rate, led by our results in Eastern Europe. I visited a number of countries in Eastern Europe this quarter and was very impressed, not only by our opportunity there, but also in the growth that we’ve been able to achieve in the relatively short amount of time we’ve been investing there. We’re also seeing the benefits of increasing our presence in the commercial space in some of the larger companies within Europe. This opens up additional opportunity for us in this region.

In addition, Germany had a very solid quarter. APJ revenues were up 1% from last year, which is obviously a disappointment. We have already made some changes which we believe will get this region back on track. Specifically, effective April 1, we put a new leader for the region in place. We also expanded our strategic alliance with NEC and announced a new distribution relationship with Intel. We believe these actions and further focus on this region will produce results we are proud of by the end of the year. Latin America continues to do well with revenues up 16% from last year. We had an excellent quarter in Venezuela and Argentina, as well as some of the smaller countries in the region.

Next to our global revenues, another way we evaluate our business is from a solutions point of view, since that’s the way that many customers are doing business with us. These solutions are made up of a varying combination of systems, software and services that we provide. While the mix of these three items may ebb and flow due to the nature of the solutions provided, the long-term success of the solutions focus is clear. We are now able to help more customers in more ways more often, and I know from my own experience of dealing with customers, we are having very different and more strategic conversations with them than ever before.

Looking at our product revenues, our systems revenues grew 20% from Q1 2005 and were 48% of our business. This business line contains our storage hardware products, and our success here is a testament to our leadership position and the performance of these products in the market, including the strong performance of the DMX-3. Software revenues grew 11% and were 36% of our business. While we saw some very good growth in important areas such as Content Management, VMware and Smarts, this growth was offset by the results in a few of our other areas, which I will touch on in a bit. Services revenues grew 6% and were 16% of our business. There were a couple of factors that impacted our professional service business results. The first factor was timing. Q1 was back-end loaded, which made it harder to sign, fulfill and recognize services deals during the quarter. Secondly, much of our professional service business correlates with our platform software, and the results there impacted our services revenues. Now I’ll turn to some highlights within our product lines. We remain focused on leveraging our entire product portfolio to best serve our customers’ overall IT needs and we achieved a lot of success towards this goal in Q1.

Given our solutions-based approach and the vast scope of the marketplace we address, the individual category results have and will vary QtoQ. As our business evolves, we are continually looking for better ways to more clearly present our results based on how we go to market and customer buying patterns, and we’ll talk more about this with you at analyst day.

First, let’s turn to the storage-solutions-related highlights. The metric product revenue was up 10% over the last year. (Contrary to some loud competitor flood?), customer response to the new DMX-3 has been extremely positive, as we expected. This quarter, well over 50% of our Symmetrix systems revenues were from the new DMX-3. The DMX-3 is far and away the most scaleable, highest-performance system in the marketplace and has been very well accepted by our customer base in a very short amount of time. Overall, we achieved excellent results in a high end this quarter, and expect to see continued growth in this new market-leading product in the future. CLARiiON product revenues were up 13% for the quarter. In isolation, that’s a pretty good growth rate, but it’s not up to recent CLARiiON standards. However, the worst-kept secret in storage is that there’s a product refresh coming here. This knowledge froze the high end of the CLARiiON line a bit, while the low end with its channel partner focus did just fine.

With exciting new products coming soon, we believe that we are well-positioned for continued market share gain in this segment. Software that is associated with these successful platforms did not show similar results, however, and for very different reasons. On the Symmetrix side, the DMX-3 was utilized for consolidation efforts in many existing EMC environments, and these customers could upgrade their software licenses for the incremental capacities as opposed to buying new licenses. On the CLARiiON side, slowdown in the high end also impacted software growth, as these systems tend to drag more software. As I mentioned, we believe the slowdown in the high end is a short-term phenomenon and the reacceleration here should lead to stronger software sales.

These same factors also impacted the resource management line, which was down 7% for the quarter. The primary products here are the storage management suites that closely correlate with our high-end system sales. On the other hand, a continued bright spot in resource management was Smarts, and these products had a great quarter. Customers are increasingly moving to model-based approaches to management and we believe that the capabilities of the growing line of Smarts products will position us well to really help customers make this shift. Bill will have some additional comments on these product groups later in the call.

Looking at some additional software highlights, our Content Management business was one of the bright stars of the quarter, with license revenues up 62%. Of course, these results include the first quarter of revenues from our acquisition of Captiva late last year. Even without the acquisition impact, license revenues grew about 30%. While this business tends to be more of a year-end type of software purchase, demand is strong and we see improved traction between the classic EMC sales force and our EMC software sales force.

Our backup and archive software business was a bit of a victim of our focus on the content management space this quarter. We made some adjustments to the software sales force, combining our Content Management and backup and archive sales resources, which resulted on less focus on the backup and archive product. Given the relatively small size of this business, any swings here have a big percentage impact, and license revenues here were down 21%. We need to keep this in context, as the decrease amounted to only about 11 million, or less than a 0.005% of total revenues this quarter. Going forward, we are ensuring that we have the appropriate focus on this category.

Vmware had an excellent quarter and achieved record revenues, up 64% over last year. This accomplishment was fueled by a license revenue growth of 47% and maintenance and service revenue growth of 120% YoverY. Virtualization continues to be one of the hottest trends in IT. VMware’s virtual infrastructure software, already the gold standard in test and development, is now increasing being deployed in production environments, as customers optimize the use of their x86 technology. Finally, Dell continued strong performance, and when we include the Symmetrix revenue they participate in, it was approximately 14% of total revenues for the quarter.

Turning now to the rest of the income statement, my comments here once again will exclude the impact of equity compensation and acquisition-related amortization and I referred to as non-GAAP. Non-GAAP gross margin was 53.9% for the quarter, down 160bp from Q4. If you look at margin change on the same basis as we’ve looked at it traditionally, the components affecting gross margins were split pretty evenly between volume, mix and the price cost other line. Non-GAAP operating income came in at 17.3% for the quarter, up from a comparable 16.3% in Q1 2005. Of the 100bp improvement, 70 points came from gross margin and the remaining 30 points split fairly evenly between SG&A and R&D.

Finally, our Q1 tax rate, exclusive of just stock option expense, was 23.5%. We had a small tax benefit roll into the rate this quarter, and without that one-time item, the tax rate would have been slightly north of 26%. From an EPS perspective, even without this tax benefit, we still would have reported $0.14 per diluted share, just excluding stock options. The tax rate on our non-GAAP income, again excluding all equity comp and acquisition amortization, was around 27%, exclusive of the one-time benefit. Turning now to the balance sheet and a few other items, the end of the quarter was $7.4 billion of cash. As we had committed to you, we’ve stepped up the deployment of our cash balance, greatly increasing our stock buyback activity. This quarter we bought back $376 million worth of stock in the open market. We also called our outstanding convertible bonds for $125 million, and the cash impact hit on the first business day of April.

In the first 93 days of the year, we’ve already effectively deployed over $0.5 billion in cash toward share reduction. We intend to continue with this aggressive share repurchase program, and I want to announce that the board has approved a new share repurchase program for an additional 250 million shares. We currently still have 84 million shares authorized under the existing repurchase program. Because we believe that one of the best uses of our cash is for EMC stock, I also want to announce that we plan to purchase an additional $2.5 billion worth of stock through the rest of 2006. EMC will be spending approximately $3 billion this year, three times what we spent last year.

For Q1, DSOs came in at 42 days, down a few days from Q4. Inventory was $693 million, turns calculated on total cost basis were 7.1. We’ve been focused on getting this metric back to seven and we met this objective this quarter. Our deferred revenue continued to grow nicely this quarter. As of the end of the quarter, the balance was more than $1.9 billion, up $125 million from year end. Moving to our business outlook, we remain very excited about the opportunities we see in 2006. As we started off the year, there were a number of factors driving my confidence and optimism, that remain true today. Our business model continues to thrive as customers increasingly look to us for solutions for their infrastructure needs. We expect to see continued strength in our systems business on the back of our new product introductions, and we believe there continues to be a significant opportunity for us in the international geographies.

We also continue to remain focused on our original goal of achieving an operating margin greater than 20% exiting 2006, excluding the impact of stock option expense. For comparison purposes on a non-GAAP basis, restricted stock expanse and acquisition amortization, we add about another 200bps to this. While this is not a lay-up, expanding our margins is something we’re very focused on and we’ll keep you updated on this throughout the year. Looking at Q2, we expect revenues will be at least $2.66 billion, GAAP earnings are expected to be $0.13 per diluted share, non-GAAP EPS is expected to be $0.17 excluding $0.02 in stock option expense and another $0.02 in restricted stock and acquisition-related amortization expenses. For the full year, we believe 2006 revenues will be $11.1-11.3 billion, although right now we look to be closer to the lower end of the range, which would have us up 15% over 2005. GAAP earnings are expected to be $0.54-0.57 per diluted share.

Non-GAAP EPS will be in the range of $0.70-0.73, excluding the previously expected $0.09 impact from stock option expense and $0.07 in restricted stock and acquisition related amortization expenses.

With that I’ll now turn the call over to Joe.

Joseph Tucci, Chairman of the Board, President, Chief Executive Officer

Thanks, Bill. I would like to start by also welcoming everyone to today’s conference call and as always, thanks for dialing in. Q1 is always our toughest quarter. The major reason for this is that our primary focus for the first two months of any Q1 is on installing the vast amount of hardware and software products we sold in the previous quarter, Q4. As you know, Q4 is always a barn-burner(?) of a quarter for us. Our revenues tend to spike 14-16% above our next-largest quarter. We’re sure Q1 of 2006 is no exception. In fact, it really didn’t start to kick in until early March. The good news is that we handled it all quite well, as was demonstrated by the fact that our inventory balances declined to $693 million, turns were up to over 7, DSO came in at 42 days and our deferred revenue rose to almost $2 billion. In Q1 we generated over $635 million in cash from operations. Though revenue was a bit lighter than we would have liked, I assure you that we left more than its shortfall in excess unplanned backlog. Again, due to the fact that too many orders came in on the last few days of the quarter and we were not able to turn them around and shift these hardware products which obviously also include associated software components.

Right now, I’m sure you’re thinking something like this: with the fact that EMC has built this additional backlog, why isn’t it built into Q2’s outlook? The reason for this is that we want and need to change the rhythm and timing of our business a bit. It is extremely costly to be as back-end loaded as we have been the last few quarters. It is our intention to build and carry a little more backlog than has been customary for us. This could slightly affect Q2, hence our revenue outlook for at least – and I say at least - $2.66 billion. All in all, I believe this is healthy for our business on both the margin and cost front. As I said before, because of our strong product cycle and solution focus, the second half of 2006 has potential for upside.

Despite our slight revenue shortfall, I am pleased with our non-GAAP income growth of 28% year on year. This is the 14th consecutive quarter in which our net income and EPS have both grown in excess of 20% year on year. It was a quarter where the bounce and power of our business mix and model really shone through. Let’s spend a few minutes and explore what I mean when I talk about EMC’s powerful business model.

Let’s start by taking a look at our storage business and its solution focus which our sales force applies as they approach a customer opportunity. EMC’s storage offering consists of tiered storage, which is a combination of Symmetrix, CLARiiON, Celerra appliances and Centera. On these arrays, we offer a wide variety of disk types, from 73Gb drives that spin at 15000 revolutions per minute to 500Gb drives that spin at 7200 revolutions per minute, thus offering our customers a significant choice of different price and performance points for storing their information assets. Today, virtually all of our large customers deploy at least two of our array product lines or tiers, and many deploy three. Alternatively, we offer tiering in a single rate. For instance, in our new Symmetrix or new CLARiiON you can mix and match various drive types that have different cost performance characteristics as I just mentioned. Next, we offer the widest range of connectivity options in the industry, SAN, NAS, CAS, FibreChannel, IP etc. across these platforms to network the storage. Then we add protection and mobility software which runs on the array itself or in an appliance, to protect, replicate and move information. Examples here would be SRDF, Timefinder, MirrorView, SnapView, CelerraSnap, Open Replicator, SanCopy etc.

Finally we offer management software to tie it all together. Our leading offer here is ControlCenter. It is important to note that customers think holistically about storage and they usually buy complete solutions. The line items and mix may change, but most of our storage order contains elements from each of the line items I just reviewed. This past quarter, the tiered storage hardware layer actually grew faster than the software layers in our storage solutions stack, and Bill has reiterated some of the reasons. What I want to do is remind you that if you look at this total storage stack that our sales force brings to market, that I just described to you, it grew 13% YoverY in Q1, which I believe is solid performance. I also believe our storage business is healthy and as the new DMX-3 continues to hit its stride and the all-new CLARiiON products are announced, along with the associated all-new NAS lineup, EMC is well positioned for continued future storage growth.

In addition, we remain convinced that storage virtualization is an important new enabling technology, and that the network is the absolute right place to virtualize storage resources. Our two offerings in this space, Invista and Rainfinity, are gaining traction and clearly winning customer mind share, not to mention numerous awards and accolades from industry luminaries. These innovative products have the potentia to enhance our growth prospects in storage. (Inaudible) our storage business, EMC has enhanced our information lifecycle management solution stack with Enterprise Content Management and we’ve added capabilities to help customers better manage and optimize their IT infrastructures with VMware’s virtual infrastructure and our resource management software. I might add that all three of these segments happen to be very, very hot.

Let’s quickly review these three EMC product segments. Formally, the highest level of intelligence in our ILM strategy is our Content Management Business, which grew 30% year on year (on an apples to apples?) basis with D5(?) taking what we believe to be the lion’s share of growth in the Enterprise Content Management market. On top of this, the acquisitions we have done in this space, such as Captiva, Ocardis(?) and Authentica continue to expand our leadership in helping customers better capture and manage the explosive growth of information, including compliance, retention and archiving needs. With the benefits of x86 virtualization now becoming well accepted, VMwares virtual infrastructure continues its rapid rate of growth as more customers adapt this technology over any other and by a wide margin. While others are just getting started, VMware has DMX-3 version 3 in final beta, and is receiving rave reviews.

Together with Invista and Rainfinity, EMC is well placed to benefit from the continued rapid adoption of virtualization technologies. I am convinced that the majority of IT infrastructures will be virtualized over the next three years. This quarter represented the first anniversary of our acquisition of Smarts. While we don’t disclose the specific numbers for percentage of growth in this business, I can tell you that the new license growth rate this past quarter for Smarts was in the VMware-like territory, albeit off a smaller base. Customers appreciate the tremendous benefits of model-based management applied to every-increasing, complex IT-based networks. We are expanding this approach to storage with the addition of our (storage insight?) product this quarter, as well as the application discovery management shipping this quarter as well. This leads us into wwo new opportunities which we are well positioned to exploit.

The first opportunity is in resource management. Resource management that is model based and cross domain, meaning that there should be a more consistent way to manage all IT resource: storage resources, server resources, network resources, applications and information together. Smarts is an ideal base technology for this, and one we believe is industry-leading. The second new opportunity for us is security. It is no longer enough to protect the perimeter of the infrastructure. Rather, the information itself must be secured as it moves through its lifecycle. Positively, information security is an information management problem, and one which we are well-suited to help our customers with. We have already begun to roll out our offerings in this space, such as Documentum Trusted Content Services, encryption built into our protection software, secure remote support, information security assessment services and Authentica Visual Rights management. We see great opportunity in expanding our information management, protection and storage offerings to help our customers secure their information throughout its life cycle and are aggressively pursuing this as our next major focus area.

Before my closing remarks, I would like to address a subject on which we have received numerous questions, namely executive compensation here at EMC. Specifically the performance shares granted to our senior management team this past December. The number of performance shares granted seems rather large, but it’s important to understand four underlying conditions of the grant. First, nothing vests for a full three years and the executive needs to be here. Thus, objective number one is retention. The aim here is to keep a first-rate senior management team together. The war for talent is fierce out here. Second a three-year cumulative performance objective needs to be met. If it’s not, no pay out. This objective, if met, should make our shareholders happy, or at least happier. The third point; myself for sure and most other members of the executive team, will receive no additional form of compensation beyond base salary and bonus for the next two years, so it is more or less make or break, i.e. true pay for performance. The fourth point, as a reminder, neither I nor almost all members of the executive team have employment contracts, so there is no provision in this performance share grant for a goodbye kiss if an executive resigns or is terminated.

I would like to close my formal remarks with two comments. First, this is the first quarter in a long time in which we’ve pointed out that our execution was less than crisp on two fronts. Mainly in our backup and archive business and in our APJ region. I want to make it clear that we are and will address these areas. Secondly, I want to reiterate that we firmly believe that the global markets for the EMC portfolio of products and solutions is robust and offers us ample opportunity to meet and exceed the outlook we presented today. Yes competition is tough, but with our strong product cycle, our ILM solution sets and VMware’s virtual infrastructure, coupled with solid execution, we can and will succeed. Now I’d like to turn it back to Tony for the Q&A portion of today’s call.

Tony Takazawa

Thanks a lot, Joe. For some time now, we’ve been asking you to try and limit yourselves to one question, including clarification. I wanted to take this opportunity to thank you all for your cooperation in this matter. We’ve gotten a lot of positive feedback on this approach to the Q&A as we’re able to get through many different questioners within our allotted time and I’m sure we’ll have plenty today. Thank you again for your help in making this process run smoothly and fairly. Sherry, can we open up the line for Q&A?

Questions and Answers

Operator

Thank you. Operator Instructions. Our first question comes from Tony Sacconaghi of Sanford Bernstein.

Q – Tony Sacconaghi, Sanford Bernstein

Yes, thank you. You announced a sizeable share repurchase which, by my calculations, all else being equal, should have about a $0.05 boost to EPS through the remainder of the year by effectively lowering your share count. That associated boost was not reflected in the change in guidance for EPS. The question is why? What, all else being equal, has effectively gotten worse that didn’t give you the confidence to raise EPS guidance commensurate with the share repurchases. My suspicion is potential pressure on gross margins, but if you could address it, I would appreciate it.

A – William Teuber

Tony, it’s Bill. Your assumptions must be a little different than mine, I did not say we were going to go out and spend the additional $2.5 billion tomorrow, we’re going to do it throughout the year. In my analysis, I don’t get the $0.05 that you see. It could be helpful in Q4 depending on the timing and what we pay for the stock, but I certainly don’t see the $0.05 that you see.

Q – Tony Sacconaghi, Sanford Bernstein

I mean, it’s just $2.5 billion divided by a $15 stock price, which is 166 million shares, even with options issuance. You’re probably looking at about 120 million shares on a base of $2.4 billion, that’s 5%.

A – William Teuber

Right, but you know, it’s not going to be there for the whole year. You’ve got to weight the average and you’ve got to obviously think about what else is coming into the pool of shares. There’s a whole host of other ins and outs on our options, depending on where the price goes. It’s not quite that clear.

A - Joseph Tucci

Tony, this is Joe, did you include the interest income in that? Loss, because on incremental, in this day and age you can make over 4%…

Q – Tony Sacconaghi, Sanford Bernstein

Nonetheless, there should be some impact in terms of a lower share count and you’re…

A - Joseph Tucci

The potential is, but it’s much lower than you have. You know, if you didn’t take out the interest income, Tony. If you look at the incremental money, you can get over 4% now, Tony, so if you knock that out and then you look at it for the year and say even if we do it fairly aggressively or say evenly over the next three quarters – let’s just do that for an assumption – it’s probably closer to a penny than $0.05. We felt the penny was kind of in the range that we gave you. We’re not forecasting anything draconian in margins or expense or anything else that you mentioned, OK? It really is around interest income and we just assumed a third, a third, a third in the math that we did, and it’s much closer to a penny. I look forward to your renewed math and your response.

Q – Tony Sacconaghi, Sanford Bernstein

Thanks for the clarification

Tony Takazawa

Next question please?

Operator

Aaron Rakers, of AG Edwards, you may ask your question.

Q – Aaron Rakers, AG Edwards

Yes, thanks a lot for taking the question. I guess a question on the backlog. One, you entered the quarter, I noted last quarter that you entered into the March quarter with a nice backlog on the Symmetrix product. How much of an impact was the realization or recognition of that backlog for your Symmetrix growth this quarter? Then also, if you could even be a little bit more qualitative or quantitative in terms of how much backlog you believe is appropriate for yourself, looking out over the next few quarters – thanks.

A - Joseph Tucci

I’ll start and then I’ll turn it to Bill, Aaron. Obviously in Q4 we always build an immense backlog and then Q1 always eats some backlog, OK? But we do always put a plan together for what we think we want to exit Q1 with. We always try to exit every quarter with some backlog, obviously, A because it’s just the way business falls and B because it’s good form. All I’ve said is that if you look at our range we gave you in the midst, it was well covered within the backlog that we actually ended up with, which was over and above what we projected. Basically, what’s happening is we get these quarters more back-end loaded, it’s just costing us too much money to put that many people in factories, there’s too much cost that we’re putting into the entire system. So we just think we need to keep a little more backlog in the system going forward than we would have modeled at the beginning of the year. Obviously, once you do that it kind of flows through, so it’s not a hit every quarter. But it was factored into the fact that we gave you the guidance of $2.66 billion for Q2. As far as the absolute number, we’re probably not going to give that to you. But I’ll turn it to Bill. Maybe he’s more kind.

A – William Teuber

The way I look at it Aaron, we had a flat Q4 in terms of Sym but we had some backlog for the DMX-3. In Q1 we were up 10%, neither one of those is the right amount of growth between the quarters, so it helped us a little bit, but I’m not going to say how much.

Aaron Rakers, AG Edwards

Thank you.

A – William Teuber

We did run out of DMX-3s again, so the DMX-3 is doing very well. Again it’s factored in to all the guidance we’ve given you.

Tony Takazawa

Thanks, Aaron. Next question please?

Operator

Daniel Renouard of Robert Baird, you may ask your question.

Q – Daniel Renouard, Robert W. Baird & Co.

Sure, thanks. Just getting to the backup area, maybe you could give us a little more detail. Do you think it’s a product issue, do you need to invest more in R&D or is it purely a sales and execution issue?

A - Joseph Tucci

Dan, let me do it this way. If you looked at last year, we grew the backup and archive business 27%. I think one year ago this quarter, we actually grew it 36% if memory serves me right. My accounting team are shaking their heads to say I was right. If all of a sudden, after every quarter growing it well over 40, all four quarters last year, then we changed the sales force, we combined the sales force, what you have is incredibly hot. So now the sales force can sell backup and archive and/or content management, and then you have content management as hot as it is. We had too much migration there and we lost focus. As we changed management, reduced some levels, I think we lost a little bit of focus there, too. This is correct for why I absolutely, positively believe we did it to ourselves. Not that it was a bad move, we just didn’t execute it properly and we can get that fixed.

Tony Takazawa

Thanks, Dan. Next question please?

Operator

Keith Bachman, of Bank of America.

Q – Keith Bachman, Bank of America

Hi guys, I wanted to follow up on the software side. In the mix between DMX and CLARiiON, with DMX actually showing pretty good strength here, even with your comments previously that there’s a little bit of backlog carry over, I would have thought the EMC software pool would have been more positive given the mix. Can you help us understand?

A - Joseph Tucci

More positive to what, the DMX?

Q – Keith Bachman, Bank of America

Yes, if DMX was strengthened, DMX, I would have though EMC’s platform software would have been stronger because DMX was a higher percent of sales with CLARiiON being relatively weak and DMX being fairly strong?

A - Joseph Tucci

The two things that happen in software, Bill mentioned them – let me start with the CLARiiON line. If you look at the CLARiiON line, the lower end of the CLARiiON line continued to rock and roll, if you will, and did extremely well. Where we stalled is was in the bigger and the higher end of the CLARiiON line and that’s where the base is much more attuned to what you might do in terms of new products. As Bill said, we did not do our normal good job of kind of keeping it pretty quite when new product announcements would come. Obviously, we have always said that the high end of CLARiiON has software content very similar to Sym and the low end of CLARiiON is substantially less. That’s kind of one thing that did it to us. The second thing is on Symmetrix, with these big, big, big DMX-3s that we shipped this quarter. Most of them were the big DMX-3s. We did a lot of consolidations, and of course we run a perpetual model with software, where you buy the license and then you pay a percentage of that in maintenance and maintenance was up very nicely. Of course, what happens is when we consolidate a lot of these frames, customers had most of the licenses in place and they only had to pay for the incremental capacity. Rather than get a whole new license, what we ended up doing on most of these deals was incremental capacity. What happens with incremental capacity is maybe, well – I can think of several deals where we actually replaced some of the remaining Sym 4s that were there, all of the Sym 5s, even one or two Sym 6s, the first DMXs, plus a couple of competitors and the only basic increase we got was the increase in terabytes we shipped and for the competitor equipment we replaced. That’s a whole lot different. That’s what’s happening with the big Syms. In other words, terabytes were up, revenue was up, actually units were down because of shipping less bigger units, and the way we had our bands and our pricing set up it actually hurts us. That’s why we tried to bring you to the point where you’ve got to look at our whole storage business together, and why hardware grew 20% and software grew so much slower to bring the average to 13%. Customers are really buying these collections together, we’re competitive in the market out there at these kinds of prices, so it’s not that we’re leaving money on the table so this isn’t something we can go out and fix. As the lower Syms kick in - we just announced them in I think February – as these lower Syms kick in, then hopefully volume will kick up and that could get us more license growth.

Q – Keith Bachman, Bank of America

OK. Thanks.

Tony Takazawa

Thanks. Next question please?

Operator

Harry Blount, of Lehman Brothers.

Q – Harry Blount, Lehman Brothers

It’s a question on sales force growth and productivity. Dell continues to grow the percentage of overall revenue in the last few quarters and also I know you guys have fully integrated the software team now in terms of assigning accounts and channels. Looking for some broad commentary on how you’ve used the sales force productivity over the last several quarters, how that’s trending and within that context, you did not mention this quarter that Dell accounted for a third of CLARiiON. They are growing the percentage of Symmetrix. I’m trying to understand, as you look at the broad scope of go to market, internal and external, how has that changed and where do you see that going?

A - Joseph Tucci

It’s actually changed quite a bit, Harry. That’s a good question and a complex question. In our commercial end of our business, where we’re having a big sales force build up, we’re working there, you know, in kind of a mode that a company like Microsoft and Cisco has been very accustomed to working in, where our sales forces doesn’t end up taking less and less orders. What they’re doing is leveraging partners, whether it be Dell or Fujitsu Siemens on the large side, or whether it be a cadre of hundred and hundreds of smaller partners we have. Our sales force now is helping generate deals, helping generate bigger deals, and are working with partners. It’s really a leverage model and our sales force gets quota on that basis. If you look at productivity for sales reps it is absolutely increasing, and increasing nicely. On the Symmetrix side, we basically do most of the lifting there. What we’ll do is we’ll partner where it makes sense, or Dell has a frame contract in place or we can work better together or we’re competing against say an HP which is combining storage and servers, and if it does that it usually ends up on Dell paper, but I assure you we’re 100% involved in all of those sales. Our partnership with Dell is fantastic and I think getting better every day. But our productivity is going up.

Q – Harry Blount, Lehman Brothers

OK. Thank you.

Tony Takazawa

Thanks. Next question please?

Operator

Paul Mansky, of Citigroup.

Q – Paul Mansky, Citigroup

Great, thank you. Joe, just going back quickly to the new incentivization structure if I may, which I assume considers GAAP earnings, what is the compound annual earnings growth rate required to achieve 100% of the board’s three year accumulative target?

A - Joseph Tucci

We don’t devolve the metrics used in this plan. (inaudible) looked at a number of factors, including the outlooks that many of you out there have had out there for us. I can assure you it requires significant performance over the period. It does have all of the components I mentioned and it does look at competitive benchmarks and believes its fair and reasonable and in the best interests of our shareholders.

Q – Paul Mansky, Citigroup

Is GAAP EPS the primary metric?

A - Joseph Tucci

EPS is definitely a metric.

Q – Paul Mansky, Citigroup

A key metric? And that’s GAAP, right?

A - Joseph Tucci

It starts with GAAP. Just internally, it’s an important thing. Bill and I obviously, and everybody, we’re very much aware of GAAP as the rules change. Internally, we don’t run the business to GAAP and we don’t push down GAAP to any of our business units. We don’t push down amortization, we don’t push down restricted stock, we keep that up at corporate. The businesses are running on a kind of a cash EPS basis. Obviously, because we’ve been acquisitive, and because we didn’t restate the previous year’s periods – I think it’s really interesting. If we expensed last year, our stock options, the change year on year would have been 50% because we had $0.04 per share stock option expense last quarter. So it’s $0.50 if you do it that way. If you took them out of both periods it’s $0.25, you know, we think the fairest way to look at it is $0.28. So we’ve give you all of it, so pick and match. But it’s fairest because we used different – the GAAP last year and the GAAP this year is not the same GAAP. But that’s a ridiculous comparison, so you’ve got to use $0.50, $0.28 or $0.25, they all make sense. You pick. We happen to think that $0.28 is fairest, that’s kind of the way we drive the business internally.

Paul Mansky, Citigroup

OK. Thank you.

A - Joseph Tucci

But what isn’t a measurement is the restricted stock, OK? I assure you, in the measurement that the board gave us is the restricted stock, so we’ve got to pay for this plan.

Paul Mansky, Citigroup

OK. Thank you.

Tony Takazawa

Thanks, Paul, next question please?

Operator

Laura Conigliaro, from Goldman Sachs, you may ask your question.

Laura Conigliaro, Goldman Sachs

Yes, thanks. So you went into this year with the idea that you could have actually even more upside than normal, and already of course after just the first quarter you’re going to the lower end of the target. What is that telling us in general, since you’ve already commented at the end of this call about the robust environment and the fact that you felt very confident in new products, etc. Is it a comment on that, or is it a comment on the competitive environment, or what?

A - Joseph Tucci

Well Laura, I mean, even at your conference Laura, I’ve said it many times probably, I know I said it on stage with you at your conference, that because of the way our product cycles are flowing, I felt that there was potential for upside, but I said a bunch of times that the potential for upside is in the second half of the year. If you look at this quarter, we gave you a range of 2570 – 2590, we came in 0.0075% light. I said that more than that – and I mean more than that – we left in unplanned excess backlog. We did the $0.14 and I’ve been pretty consistent in saying that I do think there’s potential for upside, I don’t see anything happening in the market that we didn’t plan for, but I have been consistent and I’m going to be consistent again I think. We had the potential, the potential because of the product cycle is going to be the second half of the year.

Tony Takazawa

Thank you. Next question please.

Operator

Brian Freed, of Morgan Keegan, you may ask your question.

Q – Brian Freed, Morgan, Keegan & Company

Thanks for taking my call. Could you update us on the progress you’ve made with respect to the restructuring you announced last quarter? And also if you continue to plan to re-hire all the heads that you’re going to let go?

A - Joseph Tucci

Brian, we’re about half way through the restructure that we talked about. As you know, I’m sure, the international side of this always takes longer and so we’re continuing to work on it. What was the second half of your question?

Q – Brian Freed, Morgan, Keegan & Company

Do you still continue to plan to rehire the thousand heads and redeploy them?

A - Joseph Tucci

Yes. Our headcount is up a little bit from the end of last year and it’s all in the sales and service areas. We’re very focused on the opportunity that we see out there, and as we said, this was not about a headcount reduction, it was not about cost reduction, it was all about getting at the opportunity that was out there. We’re trying to go aggressively for it.

Q – Brian Freed, Morgan, Keegan & Company

OK, thanks.

Tony Takazawa

Thanks, Brian. Next question please.

Operator

Rebecca Runkle, of Morgan Stanley, you may ask your question.

Q – Rebecca Runkle, Morgan Stanley

Hi, good morning, thank you. I’m curious, did some of the high-end CLARiiON, maybe your high-end CLARiiON customers, opt for the low-end DMX at the end of the quarter? Or was this strictly a push out from the second quarter launch? And then, as it relates to the launch, I’m hearing that CLARiiON will be introduced sooner rather than later. Can you just confirm that it will ship for the majority of Q2?

A - Joseph Tucci

I do not believe – if you look at the size of the Syms that we sold, the DMX-3s that we’ve sold, these were big, really big. I find it hard to believe that they sold a lot of high-end CLARiiON, so I do think that it DSOs(?). Customers are figuring out now that this is not just a refresh, this is a new product cycle starting on CLARiiON. By new product cycle, what I mean is what you do is every couple of years or so you bring out a whole new design, then you do midlife kickers on that design, so to speak. This is one of those periods, where this is substantially in the design, customers do know this and I think that’s why I said the real performance and the higher ends are what stalled. If you look at the middle, the lower middle and the lower end of CLARiiON, they’re just fine. That would tell me that a lot of this is around the new product launch. You want to know if it would be the first half?

Q – Rebecca Runkle, Morgan Stanley

First half or second quarter or not?

A - Joseph Tucci

I really, for a number of reasons, can’t give you a date. But you’re not going to be disappointed.

Rebecca Runkle, Morgan Stanley

Great. Thank you very much.

Tony Takazawa

Thanks Rebecca. Next question please.

Operator

Bill Shope, at JP Morgan, you may ask your question

Q – Bill Shope, JP Morgan

Great, thanks. Looking at your goals to maintain higher levels of backlog and potentially reduce the back-end loaded nature of the quarters, first of all I certainly think it makes sense, but can you help us understand how you’re going to implement this? I’d imagine sales and customer behavior won’t change that quickly, it’s fairly entrenched and it’s been part of your model for quite some time now. Are you making any immediate changes to comp or discounting policies? Could you just give us some color here?

A - Joseph Tucci

We try a lot of those, and you’re right, Bill, I haven’t found a secret formula and I’ve been facing this problem for a lot of years. Obviously, we do try to pay even a higher commission if you bring in the order, we try to do hard cut-offs, and say look, if you’re international and you don’t bring the order in by XX week in the third month of the quarter – it’s just around reinforcing that and just not having the capability. If you don’t build the inventory levels or you don’t build the capabilities in the factory, then the sales force and the customers have got to understand that this is not a good practice. In truth, even though customers think they get much better discounts in the end, it’s really not true. We’ve just got to get that message out there, because it’s really costing us a tremendous amount of money and in my estimation it’s for nothing. There really is no benefit, it’s just a dis-benefit. As you know, Bill, a lot of companies face this issue and there’s no magic once-over bullet, it’s just keep going at it. Once of the things we’re going to do is build into our plan that we’re going to carry each quarter with probably the exception of Q4, higher inventory levels than were in our original plan.

Q – Bill Shope, JP Morgan

But there’s no changes to sales force comp, though, at this time?

A - Joseph Tucci

Well, we put those things, they just haven’t worked. One quarter doesn’t make a year, but it obviously didn’t work. All those things I talked to you about are in the plan. You do make more money if you bring it in earlier. We do have part cut-offs. We’ve got most of the things that you would think about, but if you have some good ideas I’d love to hear them.

Q – Bill Shope, JP Morgan

OK, great. Thanks.

Tony Takazawa

Thanks, Bill, Our next question, please.

Operator

Kevin Hunt, of Thomas Weisel Partners, you may ask your question.

Q – Kevin Hunt, Thomas Weisel Partners

Thank you. I just wanted to get some clarification on the go to market strategy and on the mid-range, and on a couple of aspects. It seems like the softness in the quarter was in mid-range and was in Asia. Given Dell was your major partner on the mid-range, are they not as good a partner in Asia? Maybe if you could clarify how you go to market in Asia on the mid-range. Then also, with this Intel relationship you announced, how does that then impact your other existing relationships on the mid-range?

A - Joseph Tucci

There’s a number of questions in there, Kevin. Let me say Dell did fine in Asia. This was us. Dell also drives a disproportionate number of the smaller end of the CLARiiON line. They do very, very well down there. This is really EMC and some of its other channels, which is where the mist is. None of this mists on Dell. Dell did great. You mentioned about the deals we’ve done with NEC and Intel and how would that potentially disrupt Dell, I think that’s what you’re asking me. First, I don’t think it will. We are tremendously, tremendously – I’ll add another one – tremendously under-penetrated with these product lines in Asia. So there’s ample opportunity out there. If we were anywhere near adequately penetrated, maybe there’d be an issue, but there’s not. I think it’s fine. Dell knows what we’re doing. Dell uniquely has the manufacturing rights and we do a lot of product planning together. I don’t believe this will impact Dell, the fault is squarely us. Again, it’s partly go to market and partly where we’ve just dropped the ball. And partly, you know, we need this refresh. It’s overdue and it’s going to be a good on. It’s going to be a good one.

Tony Takazawa

Thanks, next question please?

Operator

Tom Curlin, of RBC Capital Markets, you may ask your question.

Q – Thomas Curlin, RBC Capital Markets

Hi, good morning. Just sticking with the Intel topic, can you walk us through how that Intel relationship is going to be structured in terms of who builds the AX line related to the Intel effort? Also, of course, the distribution strategy, but especially the after-sales support. Is that primarily EMC, or third party? How does this work?

A - Joseph Tucci

Our operating system on CLARiiON is Flare. You can actually run Flare, if you wanted to, on a PC. We’ve got it to work at that level. Basically, we’ll cooperate in the designs and then basically we’re licensing our software, is a way you could look at it.

Q – Thomas Curlin, RBC Capital Markets

So there’s no after-sales support from EMC? Or how is that structured?

A - Howard Elias, Executive Vice President, Global Marketing and Corporate

It’s Howard, this is all Intel distribution through their model.

Q – Thomas Curlin, RBC Capital Markets

Thank you.

Tony Takazawa

Thanks. We have time for one more question.

Operator

Our last question comes from Ben Reitzes from UBS.

Q – Ben Reitzes, UBS Warburg

Well thanks for fitting me in. I guess with a lot of the questions asked, what does it say – the increased buybacks – what does it say about your acquisition strategy, Joe, I mean we constantly get asked about EMC doing some kind of big deal that’s going to either rock the boat or what. Or are you just going to do small, targeted acquisitions? Thank you.

A - Joseph Tucci

My statement for a long time, and I continue to believe that, is I’m against big deals. Now you can get into it on what’s the definition of a big deal. The biggest software company we bought from a revenue point of view was actually Legato, which was I think $315 million in revenues. At an $11 billion+ dollar company, we can certainly do something north of $300 million, but I’m not going to do anything that’s even close to shattering – we’re significantly bigger and we understand how to do it, it’s in our wheelhouse. I continue to prefer what I call ‘string of pearls’, you can look forward to that. I don’t think you’ll see anything bigger. You could see significantly – not significantly, but bigger than $300 million, OK? But certainly nothing that comes near to approach something that would disrupt our company in terms of making the integration so tough that you lose track of what you need to do on a daily basis. That’s still our thing. Will we do some of those? Yes we will. You can bet that besides this $3 billion, we will spend – we still have a rich balance sheet. We will use some of that to help our software assets and look for assets that have good growth and can support our ILM model and support our trust and security resource management and things around VMware. Think of areas, those are the areas where we’re active and I think we have to make good shareholder value. Cash will be lower than what Bill would forecast, just using up the $3 billion from where we’ll be.

Ben Reitzes, UBS Warburg

Thanks.

Joseph Tucci

Just in closing, we think these new product cycles are going to help us. We have a lot of interest, the enthusiasm of our people and our customers is fantastic, so nobody’s got their head hung a little bit low. We are obviously disappointed that we didn’t do that extra $20-40 million of revenue so that we could have said hey, it’s the first time we missed even a piece of our guidance in a long time. So we’re obviously not pleased about that, but the business was there and we will get it. I do believe that as we get up these products and crisp up our execution, there is ample opportunity for upside in the second half of the year. Thank you again for your attention and joining us today. I do appreciate it. Bye bye.

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Source: EMC Corporation Q1 2006 Earnings Conference Call Transcript (EMC)
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