EMC Corporation (EMC) Q2 2013 Results Earnings Call July 24, 2013 8:30 AM ET
Tony Takazawa - Vice President, IR
David I. Goulden - President and COO
Joseph M. Tucci - Chairman and CEO
Maynard Um - Wells Fargo
Lou Miscioscia - CLSA
Alex Kurtz - Sterne Agee
Amit Daryanani - RBC Capital Markets
Ittai Kidron - Oppenheimer
Brian Marshall - ISI Group
Shebly Seyrafi - FBN Securities
Aaron Rakers - Stifel Nicolaus
Kulbinder Garcha - Credit Suisse
Andrew Nowinski - Piper Jaffray
Good morning and welcome to the EMC Second Quarter 2013 Earnings Conference Call. All parties are in a listen only mode till the question-and-answer portion of the call. As a reminder, this conference is being recorded. If you have any objection, you may disconnect at this time. I would now like to introduce your host, Mr. Tony Takazawa, Vice President, Global Investor Relations at EMC.
Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the second quarter of 2013. Today, we are joined by EMC's Chairman and CEO, Joe Tucci and David Goulden, EMC President and COO.
David will begin with a few comments on our results and provide a bit more detail and color around the factors contributing to those results. He will also discuss our outlook for the year 2013. Joe will then spend some time discussing his view of what is happening in the economy and IT and the progress EMC is making with its vision and strategy.
After the prepared remarks, we will then open up the lines to take your questions. Today, we are providing you with important new schedules that will help you understand the operations and results of the EMC Information Infrastructure business, VMware and Pivotal individually and in the context of the consolidated results. Within these schedules, you will find six quarters of results for each of these three businesses including revenues, gross margin and operating margin. This information is key to better understanding the dynamics of our business and reflects how we will be discussing our results this quarter and moving forward. The full schedules are available for download on the EMC IR website and the summary data is included within our slides today.
We are providing you with our updated projected financial model for 2013. This model lays out all the key assumptions and discrete financial expectations that are the foundation of our outlook this year. We hope that you find this model helpful in understanding our assumptions in context and in ensuring that these expectations are correctly incorporated into your model. This model is available as background in today’s slides available for download in the IR sections of emc.com.
Please note that we will be referring to non-GAAP numbers in today’s presentation unless otherwise indicated. The reconciliation of our non-GAAP comments to our GAAP results can be found in the disclosure in today’s press release, supplemental schedules, and the slides that accompany our presentation. 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.
With that it's now my pleasure to introduce David Goulden. David?
David I. Goulden
Thanks Tony. Good morning everyone and thank you for joining us today. We’re making some improvements to the format of our conference call. We’re reordering our prepared remarks to include our overall results and financial position first. We’ll then discuss the progress of the three businesses that comprise the EMC Federation and end up with an update of our go-to-market model and our outlook. As you know, we have comprehensive disclosures with extensive detail on the many aspects of our business available with our release in the slide presented and on the web.
We already cover all these in our prepared remarks, we’ll spend more time on the primary results of our business and various puts and takes within the results, while still leaving ample time for your question. We think this approach will give you a better understanding of the major drivers of our business today, as well as those expect will be big drivers overtime.
Overall, our solid top and bottom line performance in Q2 continue to demonstrate the soundness of our strategy, importance of our federated business model, and the focus and dedication of an EMC team globally.
In addition to delivering a solid quarter, during the last three months, we formed Pivotal, including investors from GE, we announced a new capital allocation strategy which includes dividend and we completed a $5.5 billion debt offering, so very busy quarter. I want to extent my thanks to the entire EMC, VMware and Pivotal teams.
We achieved year-on-year revenue growth in the quarter of 6% to $5.6 billion, results of continued steady growth from our Information Infrastructure business, double-digit growth from Pivotal and accelerating growth from VMware.
All four of our major geographies grew as well, with North America up 4%, EMEA up 6%, APJ up 12% and Latin America up 12% from last years second quarter. Our BRIC+13 markets grew 18%, the result of our focus and investments within these faster growing markets.
With the increase volume from Q1, consolidated gross margins improved nicely by 120 basis points sequentially to 64.3% and were down 10 basis points year-on-year. If we exclude the one-time positive $9 million impact from the RSA charge reversal in Q2 last year, consolidated gross margins were up slightly year-on-year.
I think you’ll find the informative to look at the year-on-year gross margin performance of different parts of the business. Within EMC II storage products gross margin came back to last year’s levels, helped by ongoing mix shift but pressured by another backend loaded quarter. Storage gross margin were down 30 basis points year-on-year due to higher service costs.
EMC II gross margin were also impacted by the RSA charge reversal in Q2 2012 I just mentioned. Consolidated gross margin benefited from improved margins and increase mix from VMware.
Going forward we continue to expect consolidated gross margins to improve quarter-on-quarter for the rest of the year, so better in the second half than in the first half, and we continue to expect consolidated operating leverage for the full year will come from both gross margin and operating efficiency improvements.
Good cost controls and spending discipline held operating expenses in check and non-GAAP operating margin improved by 20 basis points from Q2 ’12. The increase investment supporting the build out of VMware’s capabilities around software defined data center, DCHS and end-user computing were balanced by major spending in the Information Infrastructure business.
We invested resource in several growth initiatives in the EMC II business such as XtremIO and ViPR, and also in Pivotal as lay the foundation for rapid expansion over the next few years. These investments notwithstanding we were able to expand operating margins in the second quarter last year and grow non-GAAP earnings per share 8% to $0.42.
First half free cash flow was $2.3 billion, approximately $500 million higher than non-GAAP net income. We remain on track to deliver $5.5 billion of free cash flow for the year.
We finished Q2 with $17.6 billion in cash and investments. This balance reflects the $5.5 billion debt offering we completed in Q2. We purchased $700 million worth of EMC stock in Q2 bringing by our buyback to $1 billion for the first half of the year. This leaves $2.5 billion of buyback to go by June 30, 2014 to meet our 18-month goal.
The EMC [ex-VMware] U.S. cash balance at quarter end was a little over $9 billion, over the next 12 month we committed about $5 billion of this to debt repayment, dividends and buybacks.
This is part of the larger capital allocation strategy we announced quarter, which includes repurchase of $6 billion of EMC shares over the three years ending December 2015, as well as the initiation of $0.10 per share quarterly dividend. We’re pleased to have paid our very first dividend just yesterday. Over time we expect to direct about 25% to 30% of our free cash flow ex-VMware to buybacks and about 20% to 25% to dividends. This framework allows the expansion of our cash returns to shareholders in sync with the growth of our ex-VMware free cash flow.
In summary, the net effect of gross and operating margin changes on EPS was positive. Various non-operating items such as tax rate and minority interest in the quarter were where we expect them to be. Noted increase to non-operating expense, including incremental interest expense related to our debt offering was roughly offset by the reduced share counts primarily stemming from our expanded share buyback.
In Q3, the interest expense fees associated with our debt offering will be about $35 million pre-tax in non-operating expense. The net results of always moving parts in the quarter was an incremental $0.03 per share on a non-GAAP EPS. David will demonstrate our ability to make required investments for our success tomorrow while still delivering returns today.
Our ability to deliver on the triple play to gain market share, reinvest for the future and deliver leverage has been strengthened by our federated structure. By dividing the strategy and executional focus between EMC II, VMware and Pivotal, we’re better able to focus each entity on their respective missions and set them up to succeed. Very importantly, this approach offers our customers horizontal solutions and more choice than they get from others.
It’s a unique business model that leaves each of the businesses free to build the products, go-to-market capabilities and ecosystems necessary to win and because the three share the same ultimate goal for customers, leveraging cloud, big data and trusted IT to maximize control efficiency and choice, their missions are clearly aligned. This is a powerful combination for customers. The federation also represents a portfolio of growth businesses that is well equipped for the industry transition to IT as a service. This approach captures the solid opportunities and growth of EMC’s Information Infrastructure business, the faster growing revenues of VMware as it executes on its focused strategy and the opportunity for hyper growth through Pivotal and its play in big and faster data.
Looking at each of these in turn, starting with our Information Infrastructure business, we continue to delight our customers and win new ones with our market leading storage portfolio. Storage revenue growth accelerates to 4% in Q2 driven by faster product revenue growth. Our high-end storage continued to show good growth and share gains. VMAX features are clearly relevance to a broader set of customers than we have traditionally served. Over three quarter of VMAX systems revenue in the quarter came from the 10K and the 40K and VMAX continues to add net new customers at EMC.
Growth in our Unified and Backup and Recovery portfolio improved from Q1. As expected, performance of our unified storage business was similar to last quarter. Our unified business was affected by the broad customer anticipation of the next generation VNX which is on track for major launch this quarter. We are confident customers and partners will be very pleased with capabilities, so stay tuned here. The improvement in growth was driven by our Backup and Recovery Systems business which grew considerably faster in Q2 than Q1.
As the largest data protection company in the world, EMC is creating new standards in this space and transforming backup so customers can better respond to the demand of their rapidly growing application and data environments. We laid the foundation for this with our protection storage architecture announcement two weeks ago and our brand new line of Data Domain products and new capabilities for our data protection suites, including better integration with applications, primary storage and optimization for VMware environments, means even greater scale for performance and integration than ever and represents a significant step toward delivering a full protection storage architecture.
Our emerging storage business grew a very healthy 39% in Q2 due to strong customer demand for our differentiated solutions, including Isilon, VPLEX, [IOPS] and our Xtrem flash products. These new technologies meet customers’ emerging needs as we build out their cloud embedded environments. VPLEX for instance is winning us new customers with capability that it alone is able to deliver, continuous operations for mission critical workloads over distance, in other words, full infrastructure utilization with zero downtime.
Isilon scale-out NAS architecture delivers an unmatched combination of performance and efficiency that make increasingly thoughtful for web-scale applications. In fact, iPhone has delivered almost 85 petabyte of capacity for single web-scale customer this year demonstrating the value its scale architecture can deliver.
iPhones stability verticals outside its traditional customer base is also gaining recognition. Revenue from FAST servers is doubling year-on-year in Q2. iPhones growth over the past year has been truly remarkable. In the first six months of this year, iPhones ships over half an exabyte.
Growth of Atmos also contributed meaningfully to emerging storage groups, strong growth in the quarter. More customers are seeking the globally distributed object based file storage that Atmos delivers and we’re seeing good adoption.
With the need for high performance in phase of massive data sets, more customers are implementing XtremSF Flash technology in the server environments. Improving the availability of server based storage, it is important to optimize this underlying infrastructure which is why we acquired ScaleIO early this month.
ScaleIO software which pool server storage across virtualize in physical environments will enable customers to build protected shared storage pools from whatever form factor exist in the server with SSDs, PCIe flash or hard disk drives. ScaleIO will become a key part of our Xtrem software suites.
The direct availability program of our all-Flash array XtremIO is exceeding our expectations and dozens of customers are now participating. Several customers have moved beyond the testing phase and have deployed XtremIO for their production environments.
We’re encouraged by this positive customer reaction. Our rigorous test in QA program is progressing and XtremIO is on track to GA before the end of the year. The growth in Q2 of each of our major storage portfolios underscores our conviction, the different storage technology required to meet the need of different workloads. Some like transaction processing require high levels of performance under advanced data management services.
Some like social media apps require minimum service levels that may need high performance levels while others on my archiving for instance may require capacity more than they do service or performance. At EMC, we have laid the folks while having the best-in-class solution across the spectrum and we are marketing technology across the board, we continue to gain share.
Our software defined storage platform, ViPR, which we announced in May adds further value to customer’s existing storage investments from EMC and from others. The ViPR controller allowed our diverse set of storage arrays to be managed in a standard and automated way. And the automation device controls provides, drives down IT cost and improves reliability.
We also recognized that the way next generation applications will be developed is different from the way the most traditional apps have been architected. And ViPR provides a set of data services including object and HDFS to allow for developments of the next generation, Big and FAST data applications including applications build using pivotal technologies.
The beauty of the ViPR architecture is that the control and data services will work with existing EMC arrays, third-party arrays and commodity storage, providing investment protection, flexibility and choice for our customers. The Early Adopter program that is underway for ViPR is in its final round and we’re on track to GA later this year.
Customers in the Early Adopter program are very happy that ViPR is delivering points to simplify managements. They are telling us they like how easy it is to deploy and how easy it is to use. They like that it works in heterogeneous environment. In fact, the advantage is all investments they’ve made in storage infrastructure and they like the vision.
ViPR solved the problems they have today and provide them a path to the future. Just as ViPR is an enabling technology for next generation in Cloud-based architectures so to is security. The agile intelligence security technology offered by RSA helps give organization the confidence from growing strengths towards mobile, social and cloud.
Overall, RSA revenue grew 3% in Q2 year-on-year. Our security analytic suites and compliance offerings show good growth. But the overall growth was impacted by two factors in identity and data protection. The first was our focus on customer migration, more than custom acquisition for our new highly claimed authentication manager 8.0 release. The second was due to timing of some large deals.
We expect stronger performance from our identity and data protection offerings in the second half. The growth of web-based applications, cloud architectures and mobile computing driving a transformation of authentication and identity management. RSA has recognized this trend and is investing in next generation authentication and identity access managements. The acquisition of Aveksa, a leader in identity and access governance, is a major step in that direction. And with the addition of Aveksa technology to our existing strong authentication portfolio, RSA can develop access governance for risk and activity based authentication and authorization. The result for customers is a more effective way to manage access to the business as the line of business owning the data rather than IT is given the power to make access decisions within the controls, processes and policies defined by information security.
Our Information Intelligence business continues to make progress and it’s transitioned to more cloud friendly offerings and vertical based solutions. While total future revenue was in line with comparable period last year, we saw a good growth for our new initiatives. Syncplicity was once again ahead of plan and earlier this month was positioned as the leader in the most recent Forrester report on file sink and share platforms.
The strong results VMware achieved this quarter speak the strategic position it holds in customers and partners data centers. The broad success we’re achieving across the three strategic pillars of software defined data center, hybrid cloud and end user computing is due in part to customer designs to undertake these initiatives with an existing trusted virtualization partner. VMWare consistently garnered the highest marks in customer satisfaction and net promoter scores and with over 500,000 customers using VMWare to run almost 40 million virtual machines this ability to delight customers is meaningful.
With an ever growing portion of license bookings coming from (inaudible) on standalone vSphere such as vCloud Suite, vSphere with operations management, the management and automation and end user computing is clear that VMWare’s expansion beyond several virtualization has gaining traction. VMWare’s recent launch of vCloud Hybrid Services furthers the opportunity for growth. The ability to see seamlessly extent private cloud to public cloud with vSphere as a foundation is very encouraging to customers and as a result we’ve seen strong interest in the early access program. While early and still maturing, OpenStack is the framework for customers to construct their own clouds, VMWare is expanding its market opportunity and so a good growth from these customers with its best in class components integrating into this framework. In particular, VMWare’s network virtualization platform is the leading software solution for OpenStack networking. All this has of for fantastic opportunity has for VMWare and its customers and with a line share of early renewal opportunity in the second half and with an exciting set of announcement planned for VMWorld, VMWare is highly energized and well positioned for the acceleration revenue growth we expect to achieve in the second half.
Pivotal made very good progress since its formal launch with a new company within the EMC family and with a significant investment from GE. The Pivotal team is building a new platform comprising next generation data fabrics, application fabrics and a cloud independent path layer. Pivotal announced during the quarter to the version of this platform for next generation big and fast data applications called Pivotal 1 will be launched before year end. Customer interest in Pivotal remains intense and we’re also actively engaging ours in the industry, in fact this morning Pivotal IBM for our press release on the work that they’ve been doing with Cloud family and the intention to work together to expand the ecosystem. Pivotal’s existing prox such as the Greenplum Database and the GemFire in memory data grid continues to score significant design wins particularly in the telecommunications, rental services, eCommerce and healthcare spaces. These factors all board well for Pivotal’s future growth. As we explained in our strategic forum 2013 will be a year of transition for Pivotal and we continue to expect revenues of about $300 million this year as we position Pivotal for rapid growth in 2014 and beyond.
As we’ve been building the federation and adding assets to strengthen the offerings across our businesses, we’ve also been developing our go-to-market model to enable customers to get the full value from these offerings in their preferred way. The work we’ve done with would converge infrastructures and recons architecture is clearly paying off. As IT headcount is growing at a fraction of the pace of data and as we demand from the data center, customers are looking for simple and scalable ways to build our IT-as-a-service and both Vblock and VSPEX meet these needs. Customers wanting a complete plug-and-play Cloud in a box leveraging best of breed technology from VMware, Cisco and EMC favor a Vblock from VCE. VCE has an excellent quarter as demand for Vblocks grew more than 50% year-on-year with roughly half the orders coming from repeat customers and the balance from brand new accounts just getting started with Vblocks.
We are seeing initial Vblock purchases by new customers growing in size and in a number of systems as converged infrastructure becomes a more accepted paradigm because of this. There is a good mix of service providers and Enterprise Data Center implementations as a value proposition of the Vblock converged architecture is strong for both.
Customers seeking more flexibility with referenced architecture look to VSPEX and more and more are doing just that. VSPEX is a resounding success with over 3,600 VSPEX systems sold since just last April. In other words, in less than half the time we have more systems been sold than another less flexible referenced architectures been on the market for several years. The programs makes it easy for partners to sell EMC and with over a further of total VSPEX systems sold coming in Q2 alone which is clearly gaining momentum.
The EMC Cloud Search provides a partner program continue to expand in Q2 with more partners added in the period and dozens more approved in being onboard. Revenue growth once again exceeded 40% over Q2 of last year with strength across all our major GAs. Our service provider partner program is a great example of the value EMC brings to table when it comes to IT as a service and service providers continues to be our fastest growing vertical market segments.
With these different choices to customers, the backing of world class services, tight integration with VMware and link to brand new possibilities through pivotal, EMC helps organizations transform confidently towards IT as a service. When you look across our company, the technologies that we offer is powerful when connected together.
It’s also powerful because it is horizontal and it is build to provide the choice that is one of our fundamental value propositions. We are confident that as customers continue to modernize their IT by leveraging their application infrastructures they have in place today and building out new platforms for future, EMC will be a key partner.
Looking towards the second half with the recent launch of our new Data Domain line, major launch is ahead of us for VNX, ViPR and XtremIO, an increasing momentum from VMware, we are reaffirming our expectations for 2013, namely that we expect EMC revenues to grow 8% to $23.5 billion. Non-GAAP EPS to grow 9% to $1.85 per share and free cash flow to grow by 10% to $5.5 billion.
Our robust product roadmaps, the success we are seeing across our go-to-market initiatives and the positive response from customers for our market leading technology have us very energized and highly focused on seeing the opportunities that lie ahead.
With that I will turn it over to Joe. Joe?
Thank you, David. I would like to welcome everyone to today's conference call. Thank you for joining us. Overall, I am very pleased with our Q3 results and our execution. Especially so, given the uncertainties that still exist in the global economy and the resultant continued tightness that exists in macro IT spending. This IT spending time has exhibited itself once again in a very back-end loaded quarter.
As in the past several quarters, customers are being very cautious with their IT spend and are subjecting potential IT purchase orders to more scrutiny, tougher ROI hurdles and in many cases requiring a higher level of executive examination resulting in elongated approval processes. The good news for EMC is that we expect this phenomena and as such, we have been in higher inventory levels put additional resources in our factories and in our order support and we had the feel preconfigured hardware. Thus we’re able to manage through a quite late Q2.
The bad news is that these processes are less sufficient, more costly and thus hurt our gross and operating margins. That said, and again I repeat, I believe we performed very well especially when one compares our organic growth profiles to that of our peers. I am very proud that approximately 60,000 talented people for EMC VMware and Pivotal. I would like to probably thank them for their hard work and dedication they exhibit everyday.
I would now like to give you a little more color on the quarter. On a geographic basis, we experienced 4% growth in North America, 6% growth in EMEA, 12% growth in both Latin American and APJ with growth in Asia Pacific excluding Japan at 18%. Japan grew at 6% on a constant currency basis and they exhibited 18% growth in your BRIC+13 countries.
Looking at our year-on-year Q2 results from a vertical market perspective, we saw a straight and high growth with our service providers and in healthcare. We had good growth in a public sector markets including our U.S. Federal business. Our business with financial service in Pivotal was flattish within that banking was weaker.
As we look into the balance of 2013 and we still believe IT spending growth for the full year to be in a 3% range. Against this 3% we continue to expect our topline to grow 8% this year, while producing some leverage target on non-GAAP EPS to grow by 9% and grow free cash flow by 10%.
Our confidence of 2013 stems from our belief in our ability to accelerate growth in the second half of this year. Our confidence/ability is underpin by our winning cloud, Big Data and trusted IT strategy, by our unique innovative federation model under which we assure our cloud Big Data and trusted IT strategies are fully aligned among EMCII, VMware and Pivotal, but that each entity is laser focused on a set of clear defined missions given each of them the charter to build the products, go-to-market capabilities, and ecosystem necessary to win.
To refresh your memory, Pivotal is focused on building a platform for new cloud, Big Data and fast data applications. VMware is focused on building a software defined data center that will cover private, public and hybrid clouds and on solving the demands for end-user device management, automation and security in the PC era.
And EMCII is focused on providing information storage of protection, information security and information intelligence for existing and new cloud and Big Data infrastructures. EMCII’s new and existing initiatives are out Flash, scale-out NAS, Atmos, WIPER, and HDFS position as well to capture these new opportunities.
And the best news is that come from interest in and receptivity off these strategies on our federation model is very high. Additionally, and very importantly, it will give us confidence on our ability to accelerate our growth in the second half of 2013 and achieve our goals as a strong product portfolio of exiting products which we will launch over the next few months.
Again, thank you very much for being with us today. And I would now like to turn it back to Tony, to moderate the Q&A portion of today’s call. Tony?
Thanks, Joe. Before we open the lines for your questions, as usual, we ask you to try and limit yourself to one question including clarification. Thank you all for your cooperation in this matter. Kevin, can we open up the line for the first question please.
Earnings Call Part 2: