Dell Technologies Inc.
Q1 2011 Earnings Call Transcript

Published: 20 Apr 2011

[Operator:]

Good morning, and welcome to the EMC First Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, if you have any objections you may disconnect at this time. I would like to introduce your host, Mr. Tony Takazawa, Vice President of Global Investor Relations for EMC.

[Tony Takazawa:]

Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the first quarter of 2011. Today, we are joined by EMC Chairman and CEO, Joe Tucci; and David Goulden, EMC Executive Vice President and CFO. David will provide a few comments about the results that we released this morning. He will highlight some of EMC's activities this quarter and discuss our outlook for 2011. Joe will then spend some time discussing his view of what is happening in the market, EMC's execution of the strategy and how EMC is positioned to help customers on their journey to the cloud and in their efforts to handle the growth of Big Data. After their prepared remarks, we will then open up the lines to take your questions. I would like to point out 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 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, we have provided detailed financial tables in our news release and on our corporate website. These include a lot of financial detail, so we do encourage you to take a look at them. 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?

[David Goulden:]

Thanks Tony. Good morning, and thank you for joining us today. I'm pleased to report that EMC started off the year with solid results. We achieved record Q1 revenues of $4.6 billion, up 18% from last year's first quarter. And non-GAAP EPS of $0.31, up 19% over Q1 of last year. We improved both non-GAAP gross margin and non-GAAP operating margin considerably from the first quarter last year. And we achieved free cash flow of almost $860 million, well in excess of record Q1 non-GAAP net income of $700 million. We successfully executed our financial triple play once again, gaining market share, investing in the future and improving profitability. We fully expect to continue realizing this triple play over the long term for two reasons

[Joseph Tucci:]

Thanks, David. I would like to begin by welcoming everyone to today's Q1 earnings call. Thank you for your interest in EMC. Overall, I am pleased with our Q1 results and I'm even more pleased with the way our strategy and products are resonating with our customers. Clearly, customers are extremely interested in the massive benefits which private and public cloud computing can bring. And they see how our products, services and solutions can help them accelerate their journey to the cloud, while helping them meet the vast demands their business is placing on IT today. Also, it is extremely clear that good financial results and winning strategies, products and services do not happen at any company or organization without talented, hard-working, dedicated people. And EMC and VMware are truly blessed with more than 50,000 people who exhibit these winning traits, as they focus day in and day out on the success of their customers. I would like to thank each and every one of them for their first class execution. Let me now comment on IT spending and our expectations for the remainder of 2011. On balance, we still expect to see IT spending up this year in the 5% to 7% range, most probably in the higher end of that range. And we still firmly believe that the core areas where EMC and VMware have leading technology, namely in virtualization, the cloud OS [operating system] and information storage, information protection, information security and then, information management intelligence, are technology areas which will grow substantially faster than the 5% to 7% IT average. However, while we are pretty confident that IT spending will be solid, I would like to note that there are some potential event risks, such as the impacts of the disasters in Japan, global public-sector deficits and rising commodity prices, especially oil that can cause a sense of uncertainty. We will continue to monitor these three resources of potential risks. And to be clear, we are still confident that we can meet and potentially beat our 2011 plan of $19.6 billion in revenue and $1.46 of non-GAAP EPS. The source of this confidence is based on our strong belief that our cloud computing and Big Data strategies are well-placed, and are underpinned with winning products and fully committed and funded product roadmaps. On the VMware side, vSphere, vShield, the vCloud Director, vCenter, the vFabric, Cloud Foundry and the claim are critical market-leading core elements for private, public and hybrid cloud computing, and cloud computing engenders information on a massive scale. We call this phenomena Big Data. Our VMAX, Isilon and Atmos product families, along with our virtual storage offering VPLEX, addresses Big Data storage opportunity head-on. These products continue to be extremely well-received by our customers on both the private and public side. And our Greenplum and IIG suite of products help customers get big value from their Big Data assets. Next is massive scale of information needs to be protected. In other words, information needs to be highly available and eventually archived at reasonable cost points, in concert with business process objectives. Here our Data Domain, Avamar and network technologies, featuring industry-leading performance, data compression and data de-duplication hit the mark head on. Additionally, strong, effective and pervasive information security is quick becoming a top four mandate for all IT data center environments, especially for cloud computing environments. Here is where we see our safety on newer products were identity protection and verification for data loss prevention; for security and event management; for governance, risk and compliance; and now, with our acquisition of NetWitness, for network forensic, play a critical role. In short, we are the most complete suite of security technology products that meet the vigorous demands of massive scale clouds. And finally, with demanding mid-tier environments and SMB implementations, our VNX and VNXe storage lines are generating a very strong reception from our customers. All in all, we have an extremely well-placed and focused technology lineup, backed by our world-class services organization and our service provider partners to help accelerate our customers' journey to the hybrid cloud. And the best news of all, we have more innovation coming. Stay tuned to EMC World, which starts on May 9th, where we will launch many more exciting new products that will help extend our leading cloud technology stack. Thank you for joining us today. I will now turn it back to Tony to moderate the Q&A portion of today's call.

[Tony Takazawa:]

Thanks, Joe. [Operator Instructions]. We thank you all for your cooperation in this matter. Sherri, can we open up the lines for questions, please?

[Operator:]

[Operator Instructions] And our first question comes from Ittai Kidron of Oppenheimer [Oppenheimer & Co. Inc.].

[Ittai Kidron:]

Thanks, and a couple of questions. David, first, with regards to your comments on the mid-tier, good results there, but could you give us a little bit more color on CLARiiON and Celerra, do you expect those products, just given your order momentum that you're seeing at VNX to have a significant sequential declines over the next couple of quarters? And so how do we think about the transition moving forward? And also, with regards to your annual guide commentary, you mentioned that you feel much more comfortable in your ability to achieve it, then why isn't that feeling good enough to actually raise the number?

[David Goulden:]

Okay. Let me start, and I'm sure Joe have a couple of comments as well. So relative to the VNX, we're very excited about the way that is progressing. As I've mentioned, we even start shipping the products until the last week in February, so we really had a very short selling quarter for VNX. We announced it, of course, in the middle part of January, so we knew we created a little bit of a pause in the market until it became available, and that's what happened. Essentially, the VNX replaces both cloud and Celerra. And as I mentioned, in the last two weeks of the quarter, we sold more than 50% of the orders from those 3 products moving towards VNX. So we do expect the growth of VNX to accelerate. We expect it to quite quickly, certainly in the second quarter, it will be well over 50% of the what we call our traditional mid-tier, but we expect the combination of those 3 products to grow quite nicely. And with others we expect to bounce back in total growth in the mid-tier in the second quarter, because we'll have a full quarter where we will be shipping and selling VNX. That's the flavor on the mid-tier. Relative to the year, obviously, we're off to a great start, the numbers I think speak for themselves. We did 18% revenue growth. We did the 19% non-GAAP EPS growth. And of course, that combines with our annual guidance of 15% and 16%, respectively. So we obviously started off out the gates, ahead of the pace. And that's why I said, we are more confident now. We can meet and of course potentially beat our guidance, and we just want to see a little bit more the year develop before we change our numbers explicitly.

[Tony Takazawa:]

Thank you.

[Operator:]

And our next question comes from Amit Daryanani of RBC Capital Markets.

[Amit Daryanani:]

Thanks. I just have a question on Big Data market. Given that Isilon performed better than you expected, just remind us, do you still expect Atmos, plus Isilon to get to a $1 billion-plus run rate on the back half of the year? And secondly, I think there's some news about Apple ordering 12 petabytes of Isilon storage in 2 quarter, the previous volume [indiscernible] what's the feedback been from the enterprise side, where you've introduced Isilon products?

[Joseph Tucci:]

We absolutely expect that Isilon will be at $1 billion run rate in the second half of next year, not this year. So obviously, a lot of success. I don't want to comment on any specific wins without any customer agreements. So I'm not going to make any comment on any specific wins, other than what we already made with Isilon, but just that it's been well-received. Our pipeline is strong and I am more confident than I was when we bought it that we will hit that $1 billion run rate either in Q3 or Q4 in next year, probably in Q3.

[David Goulden:]

And just to clarify, that run rate is for Isilon plus Atmos combined.

[Tony Takazawa:]

Thanks, Amit.

[Operator:]

And our next question comes from Aaron Rakers of Stifel, Nicolaus.

[Aaron Rakers:]

Yes. Thanks, guys. And congratulations on the quarter. Question on VMAX, obviously quite strong, I think you referenced the new FAST technology. Can you talk about your adoption rate of SSDs [Solid State Drive]? What kind of contribution SSDs represent as a percentage of capacity or drive shift in the typical Symmetrix platform? And just a point of clarification, when you say SSDs, is that just fiber channel interface SSDs or is it a VMAX-supporting SATA interface SSDs? Thank you.

[Joseph Tucci:]

We will support both right now, it's just the fiber channel for Q1, okay? Around 50% of the systems went out with Flash technology. So we're very pleased with the progression, and that's going to grow over time. I foresee the day when virtually every single system that we ship, from the bigger end VNXs to the bigger end -- to all VMAXs will have Flash technology in them.

[Tony Takazawa:]

Thanks, Aaron.

[Operator:]

Our next question comes Deepak Sitaraman from Crédit Suisse.

[Deepak Sitaraman:]

Thanks very much. Joe or David, on the midrange, is there a concern that the ramp of VNX could actually reduce the growth rates for VMAX, given that VMAX has moved slightly down market? Also, can you talk a little bit about how we should think about the pricing disparity between VNX and the older midrange products? And lastly, as we exit the year, what portion of the midrange do you think will be VNX? Thanks very much.

[Joseph Tucci:]

Well, we've really changed -- as David said, one of the real successes that we had in the quarter was the adoption of FAST VP, which is on both systems. And of course, when you start tiering like that, you remove the need for customer to buy separate, in a way, high-end, mid-tier and low-end systems because you can get all those benefits in one architecture. And of course, if you have a, say a Symmetrix, a big farm of Symmetrix or VMAXs, probably the least expensive alternative for you is to put – they’ve got a lot of horsepower and there's to put more drives with better big SATA drives and use the FAST technology to move data very quickly, very efficiently to that lower tier. So in a way, that's helping blur the line, so for sure, VMAX is now taking some loads that were in formerly mid-tier. As far as the VNX line is concerned, as the performance and capabilities of that system, I mean, it is -- we're seeing in real customer instances, 3x the performance as that technology gets more and more used, and FAST VP works there, we expect that. So basically, do the lines overlap a bit? Yes, they do, and that's intentional. Because when you leave gaps, that's where competitors drive. So we believe we're going to see a significant acceleration of VNX sales and VNXe sales, obviously, and we're very pleased with our position on both.

[David Goulden:]

And Deepak, just to clarify on the mix question. Again, as we you look into VNX and CLARiiON and Celerra combined, as I mentioned, the second quarter, we expect that VNX to be over 50% of that mix and a growing percentage thereafter. So obviously, the significant majority by the time we get to the year end. And from a price performance point of view, as Joe mentioned, we have positioned VNX to be much more competitive from a price performance perspective. And also, as I've mentioned, we've made it easier for customers to buy, evaluate software and some of the value-added components. So we're even more competitive on the baseline pricing, we have many more sell-up opportunities with VNX than we did with the prior generation of products.

[Tony Takazawa:]

Thanks, Deepak.

[Operator:]

Your next question comes from Ben Reitzes of Barclays.

[Benjamin Reitzes:]

Yes, thanks a lot. Could you comment on VCE? How things are going? And how things are recognized in terms of revenue throughout the P&L? I'm a little confused with the -- it sounds like there's an extra $75 million in costs below the line that you weren't forecasting, about a $0.03 hit, but it sounds like you'll make it up through the revenue and profits you get to the P&L. So first, just talk about that dynamic and then also talk about just how it's going in general. I appreciate it, thanks a lot.

[Joseph Tucci:]

We'll take it in your order. Why don't I let David start, and I'll talk about more about how it's going.

[David Goulden:]

Yes, Ben. So let me talk about the P&L mechanics and dynamics. So first of all, and Joe will give you a little bit more color on how it's going. We are accelerating investment because the market opportunity is great. As I mentioned, we're up to close 1,000 people which is certainly ahead of our plan at this point in time by a few hundred. So there's 2 things that are impacting that $70 million increase in guidance we gave you in the other expense line. The first is the fact that we are accelerating our expenses a little bit more than we expected. And the second piece, is that because of how we're selling Vblocks and where we're selling Vblocks. More of the Vblock sales are being recorded directly up on the parent P&L. So differently, not much as the revenues is flowing through VCE as we expected. What's happening is that the margin that would have been captured by VCE, is now being captured directly by us in our operating margin. Over time, we do expect that to cap balance out a little bit, but for this year we expect that to be the case. What's happening is, you got a little bit of accelerated investment and you've also got margin that would've been flowing through VCE now flowing up through the parents. And that's why I said, we expect to cover both of those through the operating results of Vblocks as they flow through the parents over the course of the year. Obviously, there'll be a slight timing issue. We're going be accelerating our investments sooner when we're picking up all the revenue on the other side. But that's why we say net-net, it will be pretty neutral when you look at the full year guidance.

[Joseph Tucci:]

And obviously, we would not have increased the investment. And we are investing a little bit ahead, as David said. So you saw some of that kind of drag, if you will to EPS in Q1, and you'll see it as we progress through the year. But obviously, as revenues continue to ramp, we think, we wouldn't have done it if we didn't think it's a great investment. And we wouldn't invest there, if we didn't think the market wasn't hot. So as far as how do we see the future VCE, we see it very bright.

[Tony Takazawa:]

Thank you, Ben.

[Operator:]

Our next question comes from Kaushik Roy of Wedbush.

[Kaushik Roy:]

Thank you. So you're doing everything right, growing nicely, your gross margin, the operating margins are expanding. But it seems like the headwind is the share count. So the question is, can you accelerate the buyback? And then the other question, I would say is, any thoughts on dividends? Thank you.

[David Goulden:]

Okay. Let me talk about the share counts and how we're going on with buyback. So you're right, it started off the year, our guidance on share counts has gone from $2.23 billion to $2.26 billion, and that's directly a function of share price. If you remember from what we talked about last time, the increase in share price basically drives three things, that's account for the extra 30 million shares in our forecast. The first is, it impacts the dilution from the convertible. Remember roughly half of that is kind of what we call accounting dilution, it goes away when the convertible matures. About half of that is economic dilution, as agreed we have to pay those shares out. Then the second is, the smallest of the three, is with a higher share price we expect some increase in acceleration of option timing. Last but not least, the high share price impacts the number of shares we can buy with the buyback we have for the year. As you know, we're committed to spending $1.5 billion on buying back EMC shares this year. We spent a little less than $900 million in the first quarter, so we actually did move pretty quickly getting out the blocks after the earnings call just to start buying back. And when we look at the timing, the opportunity, but we're still on track do the $1.5 billion. But bear in mind, again, on the share count, a big piece of the impact goes away. And if you kind of look at our Q1 average, we have about 80 million shares in our share count, which are from the accounting impact of the convertible. So when that convertible matures, disappear completely, so you've got a little bit of artificial inflation in the share count as well as real inflation. Joe on dividends?

[Joseph Tucci:]

Our board continues to look at book and examine all uses of cash that generate shareholder value. And we'll continue to look at dividends. Right now, we think we're in a really sweet spot and have terrific ability to execute on our cloud strategy and Big Data strategy and invest in the future. So primarily, the two courses we're following now is buybacks and smart acquisitions. And we see a lot of opportunity on that smart acquisition side that are going to, I think, pay off really big for us in the future. So that's probably our bias right now. But there is nothing in our DNA against a dividend at all and at some point in time. I'm sure that will happen. But right now, I gave you our primary focus.

[Tony Takazawa:]

Thanks, Kaushik.

[Operator:]

Our next question comes from Brian Marshall of Gleacher & Company.

[Brian Marshall:]

Great, thanks. With respect to the advent of cloud computing and incremental services being offered, almost on a daily basis, and as that business continues to grow in the future, do you anticipate any changes and sort of buying power of the end customer, i.e., who's consuming the mainly enterprise storage? And if so, how will that impact kind of financial model over time from a pricing pressure perspective, et cetera? Thanks.

[Joseph Tucci:]

We think the answer to that is going to be what we're doing with FAST. And it kind of blurred out -- blur those lines of in a way of what's enterprise storage, what's Tier 2 storage, which as these systems work better together and get more homogenized, more networked, we think we have a really good future. And it's not a “one size fits all.” I mean, we have our Big Data assets, we have assets aimed more to mid-tier and assets aimed more to SMB. Over time, we think the Big Data side is going to be where a tremendous amount of the cloud action goes, but there's opportunities throughout the whole storage line, which is why we have such a broad line.

[David Goulden:]

Brian, bear in mind that whilst we talk about cloud computing as a broad and very important term, it applies just as much to our enterprise customers as it does to service providers. So our primary focus is helping our enterprise move to their private clouds, which is basically turning that traditional data centers into more cloud-like environments. Working with service providers so they could stand up for enterprise-compatible clouds. And then the end goal here, is what we call the hybrid cloud, where those 2 environments were working seamlessly together. And enterprises can use service providers more key applications, flex demand capacity, archiving, et cetera, in a much more flexible environment. So enterprise is in its model, continues to consume a lot of computing in the same they do today, just for the different technology objective.

[Brian Marshall:]

Thank you.

[Tony Takazawa:]

Thank you, Brian.

[Operator:]

Our next question comes from Lou Miscioscia of Collins Stewart.

[Louis Miscioscia:]

Okay. Maybe you can give us some color on spending in the public sector? And if you can break that out, maybe by federal, state and local, education? And then maybe, throw also in there sales in Japan. I know you mentioned Japan, but we didn't know what kind of demand dynamics you're seeing out there?

[Joseph Tucci:]

Yes. Let me do it this way, because I'm not going to break down public sector totally. But if you looked at our kind of average, you'd have markets like retail, from a vertical perspective, retail manufacturing, others. If you look at what was kind of better than average, I would point to telco, financial services, services, companies. If you look to what was lower than average, I would point from our Q1, I would point to public sector. And I already talked about one of the headwinds that I think everyone will face is -- most governments, certainly in the U.S., certainly in most parts of Europe, are faced with deficits or other issues and I do think they're going to be very -- IT is the real seat of productivity for sure. I still think IT will not be immune from public sector as they really sharpen their pencil and try to cut back a bit, so -- and again, healthcare maybe a little bit outside, I think education and healthcare unfortunately, will probably get -- will probably also fall victim to the very, very, very pointed pencil. Healthcare might get a bit more investment, but that's kind of the way I see it.

[Tony Takazawa:]

Japan?

[Joseph Tucci:]

Oh, Japan. Optioning Q1, our sales into Japan were okay and on plan. So you just worry about the future. It's not that we haven't been given any bad forecast or anything yet, but we just can't have help but have a worry with what's, it's a little bit of an unknown. Our supply chain people have really done a heck of a job looking at the first, second or third order effects, and we think in the main we'll be okay and have most of our -- almost everything we do virtually is multisource. So we feel okay. But you still have some eggs, it's a big supplier for the IT community, so you just still have some eggs as to anything if we miss our fourth or fifth order effect that could come down a line and bite you a little bit. We don't think so, but it just causes a little bit of kind of uncertainty and a little bit more focus, that's what I was pointing to.

[Tony Takazawa:]

Thanks, Lou.

[Operator:]

Our next question comes from Toni Sacconaghi from Sanford and Bernstein (sic) [Sanford C. Bernstein & Co., Inc.].

[Toni Sacconaghi:]

Yes, thank you. David, I have a question on operating margins. You commented on the very strong year-over-year margin improvement in the first quarter's 220 basis points on an operating margin basis. If we look at your full year guidance, it kind of implies year-over-year operating margin improvement for the remaining three quarters, that's about half that level, the midpoint in your guidance. I'm wondering if you could comment whether that's just kind of prudent conservatism, given some of the caveats you and Joe have mentioned? Or whether some mix dynamics, particularly with the new product offerings and VMAX that we need to be aware of as we model through the remainder of the year?

[David Goulden:]

Tony, there aren't any adverse headwinds from a mix or margin point of view. And if any thing, as I mentioned with VNX replacing CLARiiON and the Celerra, we’re actually a bit more positive about the margin potential in the midrange. So we feel good about the mix. Obviously, what we've done is that we've basically given you a set of numbers that gets you back to our same guidance, midpoint is last time, so the $19.6 billion and the $1.46. And obviously, we have implied in that, that there's going to be some improvement in operating margin for the full year. And as I said, we're incrementally more confidant about being able to beat we were before and there are multiple aspects to how we can potentially beat that number and volume is clearly one, and additional profitability in the model is clear second.

[Joseph Tucci:]

And we are focusing, Tony, on what we think are prudent investments which are going to help us over a midterm and long-term grow faster. We're making a major investment with our programs for our channels. We're broadening out our channels significantly. And we're really pleased with our momentum in channels. And we had a record number of, as we pointed out, a record number of channel partners signed up. And they're very excited about some of our new offerings, our new programs. We're investing in VCE. And we're going to continue to acquire smartly. And follow our string of pearls approach.

[Operator:]

Our last question comes from Daniel Ives of FBR.

[Daniel Ives:]

Oh, yes. Just a last question, in terms of deal sizes. Was there any sort of change for a March quarter in terms of deals getting bigger? Anything that you're seeing either in the channel or on the south front that may be surprise you on deal sizes?

[David Goulden:]

Daniel, I mean, I think it's difficult to generalize across those businesses with so many different aspects. Obviously, on the VMWare side, as we mentioned or they mentioned on the call last night, we saw some good sized deals on the VMware side. By definition, because the Symmetrix were so strong this quarter on the back of FAST VP we saw some larger deals. Nothing particularly unusual for a Q1. Good news is, that out of the gates, some of the VNX sales were making a little larger than the prior generation systems, but nothing particularly in terms of overall deal size. I think obviously, it was such a strong quarter, we did seal a number of large deals in the quarter, which is good, after clearly what was a good Q4. So that's nice to see the level of spending continue, nothing particularly remarkable in terms of overall transaction size.

[Joseph Tucci:]

So let me close, and thank you for joining us. In summary, we truly do believe our hybrid and Big Data strategies are right on the mark. Our vast stable of products is being extremely well received by our customers. Our customers believe they're hitting the mark of their IT needs today, and they believe they'll help them on their journey to the cloud. Our service organization, our branch of first class partners is also helping customers meet their needs today and on their cloud journey. And most importantly, the 50,000 talented people in EMC VMware believe in our vision, believe in our future and they are just plain charged up. Again, I invite you to join us at VM World either in person -- EMC World, VM World is later. EMC World in Vegas on May 9, and if you can make it in person, and if not, we're going to -- almost everything we do there will be also presented virtually. So hopefully, you can join us one way or the other. And we have some exciting announcements. So good seeing you, and thank you for joining us today.

[Operator:]

Thank you for participating in today's conference. You may now disconnect.