EMC Earnings Preview: Information Infrastructure Revenues Could Remain Subdued

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EMC (NYSE:EMC) is scheduled to announce its first quarter earnings on Wednesday, April 22. The company reported a 5% year-on-year increase in net revenues in Q4 2014 to just over $7 billion, while full year revenues were also up by about 5% y-o-y to $24.4 billion. EMC witnessed revenue growth in both combined services, which grew by almost 9% y-o-y to $10.4 billion, and consolidated product revenues, which rose by 3% y-o-y to $14 billion for the full year. EMC’s fast-growing businesses such as VMware (NYSE:VMW) and Pivotal were largely responsible for driving top line growth, with its core information infrastructure business (including storage, data security and content management) growing by only about 2% y-o-y to $18.2 billion. Comparatively, VMware’s revenues were up by over 16% y-o-y to $6 billion while Pivotal’s revenues grew by 27% y-o-y to $227 million.

Despite a slow year for information storage and EMC’s core businesses, the company has a positive outlook for the coming quarters. Management expects net revenues to rise by 7% y-o-y to over $26 billion in 2015 despite a possible negative impact of foreign exchange. According to management, FX could impact net revenues by as much as $550 million through 2015. We have a $30 price estimate for EMC, which is about 10% higher than the current market price.

See our full analysis for EMC’s stock

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Information Infrastructure Stagnant Through 2014

EMC’s information storage product and services revenues combined for 2014 were $16.5 billion, up from $16.2 billion in the previous year. Within information storage, services revenues grew by 4.2% to $5.7 billion while product revenues (hardware and software combined) stayed flat over the previous year at $10.8 billion. The company has been a clear leader in the external storage systems market over the last few years, with its share growing from under 23% in 2009 to over 31% in 2014. However, EMC lost market share in the external storage systems market through 2014, with its share declining by 30 basis points from 2013 levels of 31.3%. This was the first time since 2008 that EMC’s share in this market segment declined on a y-o-y basis. More worrying for EMC was the fact that its decline in revenues (about 1.5%) was higher than the industry-wide decline (0.4%) in storage hardware sales. This was evidenced across major storage systems providers including NetApp, IBM and Hitachi Data Systems. Some of the smaller storage vendors such as Pure Storage, Violin Memory, Nimbus Data and Solidfire gained share at the expense of these large companies. [1]

EMC’s Emerging Storage products – such as the all-flash array XtremIO, software-defined storage platform ViPR, scale-out network attached storage platform Isilon and converged storage infrastructure ScaleIO – were largely responsible for the growth in hardware sales during the year, with core storage offerings witnessing low sale volumes. Net revenues generated by the Emerging Storage sub-segment stood at $2.3 billion in 2014, up by 52% on a year-over-year basis. The company attributed the robust growth rate to a strong customer response for its new products. The company expects the growth in emerging storage to continue through 2015 and resulting revenues to rise by over 30% to $3 billion for the full year. [2] This would translate to about 12-13% of the company’s expected net revenues of about $25 billion. Comparatively, emerging storage contributed only about 6-7% of net revenues in 2013.

VMware, Pivotal To Sustain Growth

While the core business remains stagnant, strong growth is expected from software and services-intensive businesses particularly VMware. VMware’s revenues are expected to grow by over 11% year-on-year in Q1, with its services division driving much of the growth (see: Hybrid Clouds, End-User Computing, SDN To Boost VMware’s Q1 Earnings). VMware’s full year revenues could be 10-12% higher than 2014 at about $6.7 billion. VMware’s management expects robust growth in software-defined networking, hybrid cloud and end-user computing. Although VMware generates only a quarter of EMC’s consolidated revenues, the highly profitable business contributes about 50% to EMC’s net value, according to our estimates.

Pivotal was the fastest-growing division for EMC last year, with a 27% growth in net revenues to $227 million. Although product sales remained flat over the previous year at $65 million, services revenues were up by 43% over the prior year period to $162 million. The company attributed this rise to a higher number of subscription-based services as compared to standalone licenses increasingly becoming key to cross-EMC solutions. The company expects the growth to continue through the coming quarters, further boosting revenues of Pivotal Labs and Pivotal Cloud Foundry.

Impact On Margins

EMC’s consolidated gross margin (GAAP) stood at 62.8% in Q1 2014, which sequentially rose to 63.8% in Q2, mainly driven by an increasing proportion of revenues from sales of high-margin VMware licenses and services. However, margins declined in Q3 to 62% (10 basis points lower than the prior year period), primarily as VMware’s gross margin declined by 2 percentage points y-o-y during the quarter to 86.5%. [3] The consolidated gross margin (GAAP) was up by 70 basis points annually to 63.9% in Q4, mainly due to a favorable product mix and an increasing contribution of high-margin VMware revenues. Consequently, EMC’s margins for the full year were flat over the previous year due to weakness in preceding quarters. The company expects margins to improve through 2015, on the back of higher revenues generated by VMware and EMC’s emerging storage division. Margins could rise by as much as 70-80 basis points through 2015 due to a healthy growth in revenues generated by EMC’s consolidated information infrastructure, emerging storage and VMware.

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Notes:
  1. All-Flash Arrays Offer Strong Opportunity For NetApp Despite Competition, Forbes, June 2014 []
  2. EMC Earnings Call Transcript Q4 2014, Seeking Alpha, January 2015 []
  3. EMC Q3 2014 Earnings Call Transcript, Seeking Alpha, October 2014 []