Dell Technologies Inc.
Q4 2010 Earnings Call Transcript

Published: 25 Jan 2011

[Operator:]

Welcome, everyone, and thank you for standing by. [Operator Instructions] I would now like to turn the conference call over to our first speaker, Mr. Tony Takazawa. Thank you. Sir, you may begin.

[Tony Takazawa:]

Thank you. Good morning. Welcome to EMC's call to discuss our financial results for the fourth quarter of 2010. Today, we are joined by EMC Chairman and CEO, Joe Tucci; and David Goulden, EMC's 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 a journey to the cloud. After their prepared remarks, we will then open up the lines to take your questions. We 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 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, everyone, and thank you for joining us today. I'm very pleased to report that EMC had another great quarter to finish off a year of excellent operational and financial results. Q4 revenue, non-GAAP net income, non-GAAP EPS, and free cash flow are all new quarterly records for EMC. We also achieved a record-breaking year in 2010, with revenue of $17 billion, an increase of 21%. Non-GAAP operating margin for the full year of 22%, up 460 basis points; non-GAAP earnings per share of $1.26, up 40% from 2009; and free cash flow of $3.4 billion, up 31% and 27% higher than non-GAAP net income. 2010 revenue, non-GAAP net income, non-GAAP EPS, and free cash flow are also new annual records for EMC as well. Clearly, our vision and strategy are on target. The market is primed and ready, and we have the right assets to help our customers on their journey to the cloud. As a result, in 2010, we executed on our triple play to simultaneously invest meaningfully in our business, take market share and improve profitability. First, looking at the investments we made in our business. We stepped up investing in research and development by 16% to approximately $2 billion, including software development costs that were capitalized. We invested $3.2 billion on key acquisitions, targeted at high growth areas and invested substantially in our go-to-market capabilities, including our international sales infrastructure and expanding our channel network. Secondly, the market share gains we achieved were impressive, with faster market growth in areas like virtualization, security and storage, with especially strong share gains in back-up and archiving and in the high-end. For the full year 2010, we grew 21%, almost twice what we estimate was the growth for our total available market. Finally, even while investing in our business for growth and achieving sizable market share gains, we were still able to deliver a substantial leverage for our business in 2010. Products designed to deliver greater value, services driven more efficiently and faster growth in our higher-margin businesses all contributed to a 340 basis point gain in non-GAAP gross margin over last year. The improvement in non-GAAP operating margin was even greater, up 460 basis points to 22% for the full year due to the operating expense efficiencies we also achieved. Let me point out that these are also very strong gains over 2008. As we head into 2011, we're even better prepared to see the potential in front of us than we were in 2010 as we have expanded our market opportunity with the acquisitions of Greenplum and Isilon. We've extended our reach down market with the addition of a VNXe family of storage systems. And we've put an even greater distance between ourselves and our competitors across our storage portfolio with a newly refreshed and unified mid-tier storage family, new and enhanced products in our backup and archiving offering and valuable new software offerings for our flagship VMAX, to name just a few. By building out the strongest product portfolio in our history, we've positioned ourselves in the intersection of two of the most sweeping trends in IT

[Joseph Tucci:]

Thanks, David. I would like to begin by adding my welcome to everyone who has joined us for today's conference call. Thank you for your interest in EMC. Overall, I was very pleased with our performance in Q4, and I am proud to report that Q4 capped a truly strong year for EMC in 2010. A year marked by rapid growth, market share gains, financial leverage and significant investment in technology innovation. Even more important is the fact that in 2010, we positioned ourselves very well, not only for 2011 but well beyond. I would like to publicly congratulate the 49,000 people of EMC and VMware on their many accomplishments and thank them for their leadership, their laser focus on our customers and for their dedication. And on their behalf, I would like you to know that they are charged-up and excited about our future prospects. For sure, EMC and VMware are clear front leaders with compelling technology that would help our customers on their journey to private, public and hybrid cloud computing, which will enable the massive benefits that IT-As-A-Service has to offer, mainly, increased agility and significantly lower costs. Today, I will not talk much about our cloud strategies or our innovative products, services or partners, as in exactly two weeks from today, we are hosting a strategic forum for investors and analysts. Paul, Rich [ph] and I like would like to invite you to join us for this event in person in Boston or via the web. I would now like to make a few comments on the 2011 macro environment and contrast this outlook with what we saw one year ago as we began 2010. Last year at this time, we said we expected IT spending to grow 3% to 5% in 2010, and we've said EMC's TAM or total addressable market, would grow considerably faster in the 6% to 8% range. We also said on that call that EMC's plan for 2010 was to gain share and we set our goal to grow faster than our TAM. Our 2010 target was $16 billion, which represented a 14% growth. We now believe IT spending grew in the 7% to 8% range in 2010. EMC's consolidated TAM grew 10% to 12%, and EMC grew 21% or to be totally fair, a little over 19% on an apples-to-apples acquisition-adjusted basis. For 2011, our forecast is for EMC global IT spending to increase 5% to 7% and EMC's TAM to grow in the 8% to 10% range. And as David has said, our plan is for a 15% growth to $19.6 billion, while growing non-GAAP EPS to $1.46 per share, an increase of 16%. As is our custom, the outlook we provided you today of $19.6 billion in revenue and $1.46 per share is exactly the same numbers our Board of Directors has approved for management's plan. Additionally, EMC's Board will also approve a free cash flow goal for management at our upcoming board meeting, which we will share with you in our proxy. In 2011, we will focus on growing faster than the markets we serve, thus taking share, provide financial leverage and continue our investments in innovative products and solutions, and as always, we will strive to meet and beat our plan. So what gives us confidence in our future? First is our belief in our cloud/IT-As-A-Service vision, which is tightly coupled with a very developed strategy for private, public, and hybrid cloud computing. Second is the incredibly rich, and I do mean, incredibly rich product lineup and roadmap we had going for us in 2011. Third, the timing of that product roadmap. For starters, the fact that one week ago today, we launched a record breaking 41 new and enhanced storage products. This gives our sales force and channel partners virtually entire year to sell these high value products. And by the way, we’re far from done. There are many more exciting products, which we will launch throughout 2011. Fourth, is our preparedness to take those products to market and delight our customers via our well trained and motivated people, via our technology and service partners, via our channel and distribution partners, via our programs, and via our VCE coalition with Cisco which is now 700 people strong. Our best-of-breed convert infrastructure products and message is resonating very well with customers as VCE continues to outperform its plan by a considerable margin. Fifth, and very importantly, is our momentum and our will to win. With that, I’ll now turn it back to Tony to moderate the Q&A portion of today’s call. Tony.

[Tony Takazawa:]

Thanks, Joe. Before we open up the lines for questions, we ask your cooperation in limiting yourself to one question. This will enable us to take as many questions as possible from as many different people as possible. Bridget, can we open up the lines for questions please.

[Operator:]

[Operator Instructions] We do have our first response from Amit Daruanani from RBC Capital Markets.

[Amit Daryanani:]

Just a question around the March quarter. Historically, the quarter seems to be down about 9%, 10% for you guys. Do you think it shakes out any differently this time given the fact you have a lot of product refreshes that I believe will generally be available later in the quarter? And how do you think margins will shake out in the March quarter as well?

[David Goulden:]

Well, let me comment on the seasonality of the year. We don’t give quarterly guidance, but what I'll tell you is we expect the contribution of each quarter for a revenue percentage basis to the full year to be relatively consistent with the historical averages. And if you look over the last six years and you kind of draw an average of that, we're expecting roughly similar contributions to total revenue from each quarter.

[Operator:]

Our next question will be from Ittai Kidron of Oppenheimer.

[Ittai Kidron:]

David, could you give us a little bit more color on the impact of Isilon on the top line and how accretive was it to your annual earnings guide?

[David Goulden:]

We're obviously expecting Isilon to continue to grow nicely from what was a very strong 2010. I pointed out to you in my remarks that in the fourth quarter, they did better than the guidance they gave on the standalone company. So that's a good sign going into it. I'm not going to give a specific number for the overall 2011, but I'll tell you it will be nice growth from 2010. As we mentioned to you when we announced the acquisition, it’s going to be marginally accretive to non-GAAP EPS in 2011. It’s a big investment year for us in 2011. And we also said by the time we get to the back half of 2012, we get to $1 billion annualized run rate between Isilon and Atmos, at that point in time, it will be contributing at a level more commensurate with our overall operating margins.

[Operator:]

Our next question is from Aaron Rakers of Stifel Nicolaus.

[Aaron Rakers:]

My question is on free cash flow generation. I know that you guys don't give a target in your proxy, but over the last couple of years, you’ve been running 19%, 20% roughly of revenue from free cash flow or about a rate that’s about 30% higher than non-GAAP earnings. So with that as we look forward, given what you’ve talked about in guidance, is there anything that changes that trend or how should we think about free cash flow generation?

[David Goulden:]

Aaron, you’re right. We’ve done a very good job. We continue to expect to do a good job of driving our free cash flow higher than our non-GAAP net income. At the moment, we're still kind of finalizing all, fine tuning all those details. We have a conversation coming up with our board. So at this point in time, I will tell you that we're confident that we'll continue to show healthy growth in 2011, and we should be well above our non-GAAP net income, but beyond that, we just need a bit more time to give you a more specific number.

[Operator:]

Our next question is from Mark Moskowitz of JPMorgan.

[Mark Moskowitz:]

I wanted to get a greater color if I could though, David, around the operating leverage. You’ve made some significant investments in R&D in 2010, and you are taking up your 2011 operating margin target above what the consensus is expecting. But I want to get a sense in terms of R&D, how much of wiggle room do you have there, could that drive another point or so of operating margin improvements?

[David Goulden:]

No, Mark. When we look into 2011, and we’ve given you, you're roughly 100 basis points of non-GAAP operating margin leverage, the biggest piece of that, over half of that is going to come from continued improvements to our gross margins, and the gross margin improvements come from a couple of areas. Obviously, volume health, but also we pointed out this year, the mix shift, particularly within storage towards a higher margin products is a good thing. We expect that to continue into 2011 as well. So we expect a little bit more than half of the operating margin leverage in '11 to come from our gross margin. Then within OpEx, expects probably a little bit more from SG&A than you'd expect from R&D.

[Operator:]

Your next question is from Katy Huberty of Morgan Stanley.

[Kathryn Huberty:]

As we know, everyone in tech is dealing with tough compares going into 2011, but in light of the 41 new products you announced last week, do you think you can maintain close to the 17% growth you saw in the storage business, particularly in 2011?

[David Goulden:]

Well, Katy, you are right. I mean, we are facing tougher compares, and we've given you an overall growth number of 15%. So if you think about that and you obviously think about what VMware’s growth numbers are, then we're expecting a little less than 15% for the overall ex-VMware business, so not at the 17% range, but I still think that will be -- we've given you a growth rate for the year that’s going to maintain a significant share gains and we're very confident about the competitive position we have. We expect to gain shares in all the major segments in the storage marketplace this year.

[Joseph Tucci:]

Katy, we'll talk to you more about this in two weeks, but we really think that we're on to the future of storage when we -- kind of the vision for both enterprise data and what we call big data, and we think that's definitely going to help us propel our growth.

[Operator:]

Our next question is from Rajesh Ghai of ThinkEquity.

[Rajesh Ghai:]

I just wanted to follow-up on those last questions. So if I strip out VMware's guide and strip out about $500 million for Isilon, the implied growth for the rest of the business is about 10%, which is in line with what you said the market growth would be around 8% to 10%. So, considering the product refresh that you guys had, is that conservatism or is that an expectation of market growing slower?

[David Goulden:]

Well, Rajesh, first of all, we gave you a TAM, which is for the overall business. So the TAM, the total adjustable market growth we gave you, 8% to 10%, is what we believe the weighted average growth rate will be of all the markets which we’re serving, including the scale at NAS marketplace, including the VMware markets. So you can't really take our overall growth and then strip out those two pieces and compare it to our overall TAM because now you’re comparing apples and oranges. Obviously, the adjustable TAM, if you took out Isilon and VMware would also come down from a growth basis as well, and you’ve picked a number four for Isilon. We’re not commenting on the specifics, but that would be exceptionally high growth for Isilon in 2011.

[Operator:]

Our next question is from Richard Gardner of Citi.

[Richard Gardner:]

I was just hoping you could spend a little bit of time talking about the impact of the VNX and VNXe transitions on mid-range gross margins in 2011?

[David Goulden:]

Well, in terms of gross margins, we’re expecting the combination of the two to be relatively gross margin neutral. We are expecting to get little bit higher margins on VNX. I mentioned to you before that if you looked at our traditional mid-tier business, our NAS margins for the Celerra line were a little stronger than our SAN margins on the CLARiiON line and the converged infrastructure has a stronger software stack, and we expect to get slightly higher margins there. We expect VNXe on average to be slightly lower margins. Obviously, we’re into a more competitive price point down there. But in total, we expect the two to be relatively neutral to our overall gross margin profile compared to 2010 in the mid-tier for those two segments.

[Joseph Tucci:]

Just to add a bit of color, our margins in the mid-tier, even on the older products, are pretty good. Our focus is not as much on getting more margin percentage in the mid-tier, it's getting a lot more growth and a lot more margin dollars in the mid-tier, and that's going to be the real brunt of our focus.

[Operator:]

Our next question is from Daniel Ives of FBR Capital Markets.

[Daniel Ives:]

Yes, Joe, I'm just interested in terms of talking to customers throughout Q4. Is there anything surprising you in terms of specific vertical strength, product strength, bigger deal flow, just given your vast experience?

[Joseph Tucci:]

It sounds a little tripe. It's pretty much what we expected. I mean, for sure, the recovery is broad based. Big financials and the financial sector is certainly strong. Telcos are showing good signs of life. The manufacturing base we have, retail, it was pretty broad based. So we're very pleased in the -- the growth in storage is significant, and obviously, we got to give our customers tremendous value and if we do that right, we can maintain margins and grow margin dollars like I said.

[Operator:]

Our next question is from Shebly Seyrafi of Capstone Investments.

[Shebly Seyrafi:]

Can you give us an update on the Backup Recovery Solution segment? I think a few quarters ago, you said it's about $1 billion run rate. Is it about $1.5 million to $2 billion now? What's the growth rate you stated? Is that still near 100%? Or are we coming down to let's say 50%?

[David Goulden:]

Again, we'll give you a little more color on that in two weeks, but it's well, well -- two wells, over $1 billion.

[Operator:]

Next question is from Ananda Baruah of Brean Murray.

[Ananda Baruah:]

Just comment on the call about, I believe, cloud-related conversations, or engagement, growing 40% in the quarter. Can you give us a sense of what that type of activity has been in recent quarters, so I guess are those types of conversations, the growth rate actually accelerating as we enter the year here?

[David Goulden:]

Ananda, I gave you kind of a couple of data points relative to that. One, I think the one that you’re referring to as we talked about the number of professional consulting engagements we’re getting in terms of helping customers define their cloud architectures or their journey to the cloud, up 46 compared to Q4 of last year, and this is kind of an all-time record level for us. Quite honestly, if we had more people with our consulting skill set, we could be doing more, even more than we’re doing right now. There is certainly a huge opportunity and a great appetite amongst our customers to help them layout those road maps. So we think it’s a very good leading indicator for how quickly people are going to move their technology forward as well.

[Joseph Tucci:]

David said it right. The interest is incredibly high, probably as many people as we could possibly free up to consult and talk with our customers on this cloud subject, whether it be the private side or public side, for sure, we could absorb. So, the interest is high. The customers are planning and, we expect 2011 to be the year that this really starts picking up and continuing on to 2012 still on a pretty good upward trajectory.

[Operator:]

Next question is Jayson Noland, Robert W. Baird.

[Jayson Noland:]

Joe, I wanted to ask about VCE, it seems like field commentary has improved recently. There are some changes made to the structure last week, but any additional metrics you can offer up and how big of a deal is VCE long-term?

[Joseph Tucci:]

The biggest thing we changed is -- part of what we did with VCE was funded by the four founders of VCE, a company called Acadia, and that caused a lot of confusion because the initial concept there was that we would build these converged infrastructures, cloud, private clouds and public clouds out for our customers. Help our customers run them and then eventually turn them over. And what we turned more Acadia in is a real kind of systems house, which basically is helping customers spec out their needs and doing old fashioned selling, and that’s been well received. And of course, Michael Capellas is Chairman and CEO of that. I said it's 700 strong on its way to 1,000 this year. So we don't, either Cisco or us, have given any specific data points, but we did set out what I thought was a fairly aggressive plan, and again, I said we were considerably ahead of that plan. So, all points to good things ahead.

[Operator:]

Next question is from Kaushik Roy of Wedbush.

[Kaushik Roy:]

Can you give us some color if you’re assuming any Dell OEM contribution in 2011 and if Dell is likely to OEM the mid-range VNX?

[Joseph Tucci:]

Let me do it this way. For sure, our relationship with Dell has moved from strategic to tactical. For sure, it’s now mainly competitive. To give you some evidence of that fact, the Dell OEM business with CLARiiON, our CLARiiON business to Dell that they OEM was down to approximately $55 million in Q4. As a reminder, Q4 has been historically our largest quarter of the year with Dell. So the Dell-driven revenue now, which is their OEM business, the one they drive by themselves, is actually getting quite small now. And I might add that our other channel, mid-tier channels grew over 44% in Q4. So, obviously, you can see where our major focus. Now that being said, we have thousands and thousands of joint customers with Dell that we sold together, and Dell sold using our products, and we will -- and a lot many of those customers expect us to work together. And for our part, we’re most willing to work together, and there are discussions underway. So while it's highly, highly unlikely, almost impossible that they'lll sell the VNXe. There are some considerations that they will resell VNX, and those discussions are undergoing, but I want to kind of end it where I started. It's a tactical partnership. But again, when we partner in front of customers, we'll partner strong, and if we give our word that we’ll go together with a customer, we’ll go together and help our customer. So that’s kind of where it is.

[Operator:]

Next question is from Louis Miscioscia of Collins Stewart.

[Louis Miscioscia:]

Last quarter, you talked about the three different phases of virtualization, the first one being IT-owned apps and business-critical apps, and finally, IT-As-A-Service. Could you just give us some thoughts as to where it is? Has it changed much quarter-to-quarter? And maybe as you look out to 2011, we get to year end, where do you think the customer mix might be for that?

[David Goulden:]

The first phase is mostly virtualized, everything you can, IT took the lead, CIO took the lead, and the applications that they were in control of in Tier 3, Tier 2 apps, are the ones that moved first and the results were nothing short of fantastic, with the advent of vSphere. Customer started then getting enough confidence, and most customers now are in Phase 2 where they're now getting those same kind of benefits by moving their mission critical apps. And that’s going quite well. And that’s the phase we’re in now, and probably we'll stay in most of the year, all year in my opinion. A few leading-edge customers, and getting into next year, customers will want to move to more [indiscernible] IT-As-A-Service self portals, giving users more agility, giving users more control, making the applications run under a set of metrics that are policy and service level based. Then that kind of that's where this journey is headed. So, I would say we're just in the beginnings of step two. Two interesting data points, right now there are more -- as server shipments go more, applications are running on -- not as server shipments, as applications go, more applications now are running on virtualized servers than they are on physical servers. So that kind of chasm was crossed in actually in 2009 and that trend is continuing to grow. That being said, the potential that customers could virtualize, they are about 30% there on that journey. So again, pretty healthy data points. The ROIs are fantastic, and the quality of the virtualized infrastructure from VMware is fantastic and customers are going to continue to invest there. And also as you know, that has a tremendous impact on security and storage and protection, which we take care of from the EMC side of the family. So, all signs are good.

[David Goulden:]

We have time for one more question, and then we'll have few concluding comments from Joe.

[Operator:]

Our final question will be from Maynard Um of UBS.

[Maynard Um:]

If you look back at 2010, clearly, two of you have seen much faster growth when you look at the product revenue indicating share gains and presumably from the more traditional larger IT vendors. As we look into 2011, can you just talk about your 15% growth target and understanding that product is only a portion of that, but is there more share to gain or to be had from the traditionals or is this now a zero sum gain with share battle between kind of the pure plays or maybe we're underestimating kind of the overall market again given some of the key secular trends. Can you just give us some color on the balance of that?

[Joseph Tucci:]

I'll go back to an IDC study which came out last year where they said, and they predicted that information that’s stored on disc arrays will grow 44 times from the end of 2011 through 2020, 44 times, so information is still growing, and like always, that information needs to be protected. That information needs to be secured, it needs to be managed, and it needs to have intelligence added to it. Those are all things that EMC is focused on, and so we see great potential and so it's not a zero-sum game. Obviously, our plan is to take advantage of the expansion and new features that customer wants, we want to take share and, of course, expand it to new markets, an example of a big, big new market is this video based, big data based side of the storage equation which is going to be huge. So, we are very optimistic, and again, we'll chatter a lot more about that in two weeks. So, again, I want to just thank everybody for joining us. It means a lot to us that you have this great interest in EMC, and we thank you for that. Hopefully, you got out of today, we have a good plan, and we are very excited about our prospects not only for 2011 but beyond. And once again, I'd like to close by inviting you all to join us for our strategic forum on February 8. Have a wonder day, everyone.

[Operator:]

Thank you all for your participation in today’s conference. That does conclude today’s call. You may now disconnect. Thank you.