Dell Technologies Inc.
Q2 2008 Earnings Call Transcript

Published: 23 Jul 2008

[Operator:]

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

[Tony Takazawa:]

Good morning, welcome to EMC's call to discuss our financial results for the second quarter of 2008. Today we are joined by Joe Tucci, EMC Chairman, President and CEO, and David Goulden, EMC Executive Vice President and CFO. David will provide a few comments about the results that we released this morning, and he will highlight some of EMC's activities this quarter. Joe will then spend some time discussing his market outlook, EMC's execution of its strategy, and how EMC is positioned in the marketplace. After the prepared remarks we will then open up the lines to take your questions. I would like to point out that we will be highlighting various non-GAAP numbers in today's presentation. The reconciliation of our non-GAAP comments to our GAAP results can be found in the disclosure today in our press release, supplemental schedules, and the slides that accompany our presentation. All of these are available for download within the Investor Relations section of EMC.com. As always, the call this morning will contain forward-looking statements, and information concerning factors that could cause actual results to differ can be found in EMC's filings with the U.S. Securities and Exchange Commission. And lastly, I will note that an archive of today's presentation will be available following the call. With that, it's now my pleasure to introduce David Goulden.

[David I. Goulden:]

Thanks, Tony. Good morning and thank you for joining us today. I am pleased to report that against the backdrop of a challenging economic environment EMC executed on our business plan and demonstrated strong performance. In the second quarter we had revenue growth of 18%, a non-GAAP EPS growth of 20%. Q2 was solid across the board with double-digit growth in all our business segments, double-digit growth in our major geographies, share gains, improving profitability and good execution by the EMC team. This marks the 20th quarter in a row of double-digit growth for EMC. Our strategy and hard work are certainly paying off. EMC’s ability to post solid results the last few years, and especially so far in 2008, is directly related to our strategic positioning and operational execution. As we said before, IT spending will continue to grow, driven primarily by the need to manage the ever-growing volume of information. The challenge of dealing with this information overload is leading to a set of needs that EMC is uniquely able to address. The challenge is universal in that the growth of information is outpacing the ability to store it efficiently. IT is getting increasingly complex and is outpacing the ability to manage all of it effectively. The volume of information and its ubiquity is outpacing the ability to secure it. The power needs of all this technology is outpacing the ability to supply the necessary power costs effectively and without new approaches and new technology, the growth and complexity of information will certainly outpace customers’ budget growth. EMC helps customers meet these challenges in a way no other vendor does. In terms if they need to store information, EMC is a clear leader with the broadest and deepest portfolio. In terms of helping IT complexity, EMC is the leader in virtualization as a key enabling technology to simplify the management of service and storage. EMC has technology uniquely able to manage the IT environment from applications through to storage while seeing through virtual layers, and EMC’s content management products can help to automate the management of information via policies. This is a truly differentiating set of management capabilities. With RSA, EMC is the leader in informationcentric security, to ensure that only the authorized can have access to particular information no matter where that information goes. EMC is a leader in helping reduce data-sensitive power needs via our power-efficient products and various solutions for reducing power consumption. Finally, the combination of all these capabilities makes EMC uniquely positioned to improve the overall efficiency of IT environments and help keep costs in check. I believe that it is EMC’s ability to address all of these customer needs that makes us successful. While some make think of our four major segments as discrete businesses, it’s really the combination of these and how we help customers deal with the information challenge that makes EMC unique and successful over time. Now let’s turn to the financial results. Since VMware’s results were announced last night, I am going to start out by discussing our Information Infrastructure business, as a whole, and then highlight our Information Infrastructure business units

[Joseph M. Tucci:]

Thanks, David. I would also like to add my welcome and thanks to everyone joining us today for our Q2 conference call. It is my pleasure to report that our overall performance in Q2 was strong, especially when you consider the tough economic climate in which we operated. This is evidenced by the fact that we achieved double-digit growth rates in all three geographies

[Tony Takazawa:]

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

[Operator:]

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

[Aaron Rakers:]

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

[David I. Goulden:]

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

[Aaron Rakers:]

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

[David I. Goulden:]

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

[Operator:]

Your next question comes from Toni Sacconaghii with Sanford Bernstein.

[Toni Sacconaghii:]

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

[David I. Goulden:]

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

[Joseph M. Tucci:]

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

[Operator:]

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

[Louis Miscioscia:]

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

[Joseph M. Tucci:]

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

[Louis Miscioscia:]

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

[Joseph M. Tucci:]

As David kind of hinted at, where we are hiring, and we are definitely hiring in sales, it’s pretty much in two areas. We created a new term called Brick Plus 13, which is the brick countries which everyone knows about and 13 other countries. It’s actually a little bit more than that but it’s sort of rapidly growing economies and we’re really investing there and that’s paying big dividends. David said our growth there, again, this quarter was over 40%. And then another place we’re having great growth around the world is as we go down in the commercial SMB markets, and obviously we’re hiring there. So those are the two areas where we are adding sales people.

[Operator:]

Your next question comes from Mark Moskowitz with JP Morgan.

[Mark Moskowitz:]

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

[Joseph M. Tucci:]

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

[Operator:]

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

[Kaushik Roy:]

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

[Joseph M. Tucci:]

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

[Operator:]

Your next question comes from David Bailey with Goldman Sachs.

[David Bailey:]

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

[David I. Goulden:]

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

[Joseph M. Tucci:]

One of the things we’re doing, David, is we’ve recognized this trend and we picked it up staring a few months back. And we’re working really hard to get our sales people to say these big deals, and even smaller deals, are going to take longer than you think to get out of our customers’ processes and the sales cycles will elongate, therefore we have got to start moving up activity earlier in the quarter. And we did a pretty good job of that and is how we had posted the numbers we posted. And we will continue to do that and we do that through activity generation and in the way we work our comp plan, to really kind of force, a lot of force to try to work earlier in the quarter to give customers proper time to work it. Because you’re not going to rush customers, they’re going to take their time, but if you get the deal and their order, the deal makes sense and it helps them save money, it gives a good ROI, it helps them get good benefit, you’ll get the deal done. There is sufficient pipeline out there.

[Operator:]

Your next question comes from Bill Fearnley with FTN Midwest.

[William Fearnley:]

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

[Joseph M. Tucci:]

I’ll start with the growth economies. It certainly did. As you take us against like an HP and an IBM for instance, you know, both of those companies, one I think is a point or two over and one is a point or two under, they have 70% of their business coming out of international. You noted that EMC set an all-time record at 48% of its revenues coming out of international. So again, tremendous progress. It used to be 60/40, 60% U.S., 40% international so we’ve made great progress over the last year or so. But still, we’ve got a long way to go. So international expansion is an important growth metric for us and we’re doing it well. As you also noted, we’re doing reasonably good growth in the U.S. in these quarters and especially when you consider that U.S. enterprise has probably taken the brunt of the hit right now. So, it is definitely part of our plan to get this broad base and of course, within the international theaters, the parts of this Brick Plus 13 as we call it, is the fastest growing piece so we’re putting extra focus there. So, yeah, it’s all part of our growth plan and it’s working exactly as we had it plotted out, thank God.

[Operator:]

Your next question comes from Ben Reitzes with Lehman Brothers

[Ben Reitzes:]

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

[Joseph M. Tucci:]

Well, part of what you said doesn’t make a lot of sense, right, Ben? If the core EMC is increasing in value and we’re hitting the numbers we’re hitting, VMware has got to be worth quite a bit, right, incrementally. How could what’s happening happen, but that’s a point of frustration. All I’m going to say for now is you’re absolutely right. Paul is world-class and the right guy at the right time. Trust me on this. And we are going to do the right things for the shareholders and I’m telling you that we just really need the time and we’re going to take that time and we will talk to you in the fall.

[Operator:]

Your next question comes from Tom Curlin with RBC.

[Thomas Curlin:]

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

[Joseph M. Tucci:]

We’re going to do what is in the best interest for the shareholders. They’re not in conflict. I think right now you would think for sure, we have to focus back on the business, get VMware back on track. It’s got phenomenal opportunities. You look through the EMC access, we have phenomenal opportunities. There’s a lot of things we can do together. They’re working great with their partners, their partners are comfortable with our ownership and working with an even hand. And again, I’m just going to come back to the answer. We’ll give you some of the answers you want and we will give them to you in that time frame I just told you. Right now we’re going to focus on getting VMware business back on the right track, it’s still on a great track, but we’ve got to get it back in its almost perfect track, and we can and will.

[Thomas Curlin:]

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

[Joseph M. Tucci:]

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

[Operator:]

Your next question comes from Brent Bracelin with Pacific Crest.

[Brent Bracelin:]

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

[Joseph M. Tucci:]

I think the biggest difference is what we’ve done with the DMX which the customers have noticed. I’m not sure if maybe the investor community has noticed as well. Over the last several releases, now of course it takes customers time to get these releases into production so you’re seeing the effect now, we’ve added two really major capabilities. One is the capability to use [sodded] drive so you can now put big terabyte drives into DMX. And of course, as you have extra space in DMX, and you insert those terabyte drives, and because of the vast power and capacity in that frame, it’s a very inexpensive way of adding tier-three storage. The second thing we did is we added quality of service, similar to what an IBM mainframe would have. In other words, now as you put a tier-three storage layer in a DMX you can give that the proper quality of service. So therefore if you’re running a highly important online transaction processing system you’re not going to let’s say a decision support system that’s kicked off in tier-three interfere with the IO rate and timing of that important application. So that’s what quality of service gives you. So as customers see that, they are using that capability and it’s just another way to tier your storage and it’s kind of tiering up your storage in the same frame with adding quality of service. And that’s been a phenomenal feature and I think that’s going to continue to help us drive growth as customers’ number one way. If you’re a customer and you want to save money on storage, tier your storage.

[Brent Bracelin:]

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

[Joseph M. Tucci:]

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

[Operator:]

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

[Keith Bachmann:]

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

[David I. Goulden:]

First point to note is that while there have been some movers, which I will come back and talk about, we’ve been moving things around in an environment where we’ve been expanding operating margins. So in the first half of the year operating margins have expanded about 30 basis points which in this kind of economy I think bodes well for all the businesses. Relative to the different elements, you see gross margins have been going up and that’s being driven by increasing product margins and [inaudible] combined. And that’ true in the Storage business, that’s true in Information Infrastructure. Slight offset against that would be a high mix of Professional Services which always have lower margins when totaled, the margin lines would be moved up nicely. And then as you pointed out, Keith, and as I pointed out, really OpEx has been flat with the exception of the investments in SG&A and those are paying dividends and we are making the investments while still expanding our operating margins. So we think the model is kind of working quite well. We’ll continue to make those investments in SG&A and we should continue to see margins move in the right direction.

[Keith Bachmann:]

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

[David I. Goulden:]

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

[Operator:]

Your next question comes from Katie Huberty with Morgan Stanley.

[Katie Huberty:]

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

[David I. Goulden:]

Katie, basically it’s a [diminimous] impact to our non-GAAP EPS this year from Iomega so no real impact or negative. I’m sorry, I missed the second part of your question.

[Katie Huberty:]

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

[David I. Goulden:]

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

[Operator:]

Your next question comes from Wamsi Mohan with Merrill Lynch.

[Wamsi Mohan:]

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

[Joseph M. Tucci:]

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

[Wamsi Mohan:]

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

[Joseph M. Tucci:]

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

[Operator:]

Your last question comes from Brian Freed with Morgan Keegan.

[Brian Freed:]

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

[Joseph M. Tucci:]

I think you hit on the two events that caused us a little bit of a slowdown. Let me pick up on the Dell comments. Obviously when Dell did EqualLogics we created some confusion in the sales forces probably on both sides. If you were to talk to Michael Dell I am convinced he would give you the same answer I am going to give you. We have this thing back on track, we have a positioning. They do believe there is a good future. Obviously they are still high on what they can accomplish with EqualLogics but they do believe there is a very good future and growth opportunity with them with the CLARiiON line. And we have really actions between the two of us back with our field to make sure that happens and I absolutely believe it will happen. Those actions caused a little bit of stalling, a little bit of constipation in the field and we’re now through that. And course, we have some additional products coming and that will help, also. Well, thank you all for joining us and again, I will just say it one more time, the environment is tough and we think it will stay tough for a while. We absolute believe it is manageable. We have the attention of our field forces and they are doing very well and we’ve just got to work more diligently with customers earlier in the quarter to make sure we can get the amount of business through the pipes that we want to and that’s what we’re focused on. And we’re focused on not letting you down and we look very much forward to the fall conference together where we can give you more insight into our future plans. Thank you very much.