EMC Reports Mixed 2Q

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EMC Corp. (EMC) reported a mixed second quarter 2012 results. Earnings on a non-GAAP basis increased 11.4% year over year to 39 cents per share in the quarter.

However, including stock based compensation expense of 7 cents but excluding net one-time items of 3 cents, earnings were up 10.3% year over year to 32 cents per share, which was a penny short of the Zacks Consensus Estimate.

Quarter Details

Revenue increased 9.6% year over year to $5.31 billion in the reported quarter, slightly ahead of the Zacks Consensus Estimate of $5.29 billion. The upside in revenue was primarily attributed to strong product sales (up 4.4% year over year to $3.18 billion) and services revenue (up 18.4% year over year to $2.13 billion).

Segment-wise, EMC’s Information Storage business revenues jumped 7.0% year over year to $3.82 billion, thanks to strong demand for networked storage platforms portfolio, which grew 7.0% year over year in the quarter. High-end Symmetrix storage product portfolio was up 3.0% annually.

The company’s mid-tier storage product portfolio witnessed a solid 10.0% growth in the quarter. Strong customer demand for Isilon scale-out NAS, VNX unified storage family, Backup Recovery Systems portfolio (BRS) and Greenplum products drove significant revenue growth in the quarter.

RSA information security business climbed 12.6% year over year to $220.8 million in the reported quarter. EMC information infrastructure revenue increased 6.8% year over year to $4.19 billion in the quarter. The significant growth from these segments fully compensated for a 4.4% year over year decline in Information Intelligence segment, which reported revenues of $152.8 million in the quarter.

EMC’s majority owned VMware Inc. (VMW) continued to impress with revenue growth of 21.7% on a year-over-year basis to reach $1.12 billion in the reported quarter.

On a geographical basis, domestic revenues climbed 14.0% year over year to $2.9 billion and contributed 54.0% to the quarter’s revenue. Revenue from international operations increased 5.0% year over year to $2.5 billion and accounted for the remaining 46.0% of revenues.

EMC’s bottom-line growth was primarily driven by strong margin expansion in the quarter. Gross profit (including stock-based compensation but excluding one time items) increased 13.4% year over year to $3.39 billion. Gross margin expanded 220 basis points (bps) to 63.8%, primarily due to strong revenue growth.

Research & development expense were up 21.7% year over year to $655.9 million in the second quarter. Selling, general & administrative expense increased 8.9% year over year to $1.72 billion in the reported quarter.

Operating profit (including stock-based compensation but excluding one-time items) surged 15.0% year over year to $1.06 billion. Operating margin expanded 90 bps year over year to 19.9%, based on strong revenue growth and higher gross margin base.

Net income (including stock-based compensation but excluding one-time items) increased 9.5% year over year to $712.4 million in the second quarter.

Balance Sheet

As of June 30, 2012, cash and cash equivalents including short-term investments were $5.65 billion compared with $6.34 billion at the end of March 31, 2011. EMC generated $1.24 billion in cash flow from operations in the second quarter compared with $1.69 billion in the prior quarter. Free cash flow declined to $957.6 million in the reported quarter from $1.43 million in the prior-year quarter.

2012 Guidance

EMC reiterated its full-year revenue guidance. The company forecasts revenues of approximately $22.0 billion for fiscal 2012. Non-GAAP operating income is expected to grow 24.0% for fiscal 2012. Non-GAAP net income is expected to be approximately $3.75 billion for the full year. EMC expects earnings to be $1.70 per share for fiscal 2012.

Cash flow from operating activities is expected to be $6.2 billion for fiscal 2012. Free cash flow is expected to be $4.9 billion for the full year. EMC also expects to repurchase shares worth $700.0 million in fiscal 2012.

Our Recommendation

We believe that EMC is well positioned to benefit from incremental Data center hardware spending going forward. Higher spending on high-end products (average selling price $250,000 and above) will also boost EMC’s market share going forward. We believe that EMC’s vast product portfolio, which has products suitable for any kind of budget, will boost its market share going forward.

We also believe that the increasing adoption of cloud computing technology will significantly drive the demand for EMC’s virtual infrastructure products, which in turn will drive top-line growth going forward.

Further, EMC’s leading position in the emerging economies of the Asia-Pacific and Africa will boost its profitability, as higher revenues from these markets will offset a sluggish growth in the Americas and Western Europe going forward.

However, increasing competition from the likes of IBM Corp. (IBM), Hewlett Packard Co. (HPQ), NetApp Inc. (NTAP), Hitachi Data Systems, Dell Inc. (DELL) and a sluggish IT spending outlook for the next two years will keep the stock range bound, in our view.

Thus, we remain Neutral over the long term (6-12 months). Currently, EMC has a Zacks #3 Rank, which implies a Hold rating in the near term.

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