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EMC pulls back on profit estimates for the year

Industry experts say they're concerned by a 5% drop in EMC's profits, as well as its second lowering of yearly earnings expectations in the last two months.

EMC Corp. adjusted its earnings targets down for the rest of the year, after reporting it missed its goal of $2.66 billion for the second quarter of 2006 by around $100 million. In a call with Wall Street analysts on Friday morning, the company said the discrepancy was due to a late-quarter scramble to fulfill orders for the new DMX-3 high-end storage system.

The company brought its revenue goals for the third quarter of this year down to $2.66 billion. It had not previously given a revenue goal for the third quarter, but the new estimate represents a 12% year-over-year growth, down from a previous growth estimate of between 15% and 17%. Earnings targets for the year were lowered to $10.8 billion from an $11.1 billion estimate in June, which itself was a tempering of earlier earnings forecasts. The company warned investors of the shortfall on Monday and moved its earnings call up a week to address analysts' concerns.

In his presentation on the earnings call, EMC chairman, president and CEO, Joe Tucci said that though EMC's business is typically heavy at the end of quarters, this quarter was worse than it's ever been. According to Tucci, the sales department at EMC had a $500 million gap left between its bookings for the quarter, which are customer agreements to order, and its targets. By the close of the quarter, Tucci said, the sales team had actually booked $550 million in new business, but inventory wasn't available fast enough in those final days to have orders turned into revenue for the company before the quarter ended.

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"It's something we weren't really expecting," said Brian Babineau, analyst with the Enterprise Strategy Group. "There were certainly rumors circulating on the Street that EMC wouldn't make its second-quarter targets, but I don't think anyone expected them to miss targets with a storage system backlog that could get them there -- they are used to having back-loaded quarters and usually prepare for that very well."

According to Babineau, the DMX-3 rationale seems fishy. "Unless there's been a significant shift in customer demand for the high-end or sales-force behavior toward the high end, I'd say the conspicuous missing ingredient in this announcement here is the Clariion -- that's the one that should be going through a product and inventory transition, and yet we're talking about Symmetrix?"

According to Tucci, Clariion CX-3 systems now account for 70% of new customer orders, which was not unexpected. "In general, midrange systems have a shorter adoption cycle than high-end systems," he said.

No inventory delays were reported by EMC for Clariion systems.

Two major EMC shops contacted by for this story, including a large telecom company and a large media company, both indicated that they saw no disruption in ordering DMX-3 systems.

The media company, located in the New York area with several petabytes of EMC storage, said it ordered a DMX-3 a month ago and experienced no delays in delivery. And, it was in the process of ordering another with no delays expected.

"So far, we have not suffered at all with regard to an EMC DMX-3 inventory problem," said a systems administrator for the company. With regard to EMC's troubles on Wall Street, he said, "EMC publicity in the press does not concern us too much, as we know what EMC can or cannot deliver."

Future remains uncertain

Generally, concerns remain on Wall Street about whether or not sales and profit growth are slowing for the company, and EMC shares have underperformed those of Hewlett-Packard Co. (HP), Dell Inc. and Network Appliance Inc. (NetApp), falling 32% in the 12-month period that ended on Thursday, while NetApp's shares fell 3%, and HP gained 27%. EMC's net profit for the year has fallen 5%. EMC shares fell 21 cents, or 2%, to trade at $9.77 following the call; it's the first time EMC shares have fallen below $10 since August 2004.

John Webster, analyst with the Data Mobility Group, said the dip in earnings was not much of a surprise to him -- nor did he think the long-term consequences for users looked worrying. "Long-term, I don't think the market will really punish EMC as much over that as they did over the RSA acquisition," Webster said. EMC announced its intention to acquire security cardmaker, RSA for $2.1 billion on June 29. "If anything, they would have anticipated this kind of issue -- EMC has been taking it on the chin in the stock market lately."

As far as customers were concerned, Webster said, the impact of delivery delays would be minimal. "The days of extreme inventory shortages that have a real negative impact on customers, as used to happen with mainframe systems where customers would have delays of three to five months and no alternatives to turn to -- those days are long gone," he said.

The analysts also had differing suggestions on damage control, but they generally remained cautiously optimistic that EMC would have a good second half of the year.

"Very rarely do you see this management team make the same mistake twice -- this is more the aberration than the norm," said Babineau. "But clearly, there needs to be a refocus on the salesforce and inventory management -- they need to make this right with customers and solve this problem immediately, before customers go to one of their competitors."

Babineau said he felt that if EMC can right the ship with regard to the inventory problems, it can change perceptions on Wall Street as well. "But they need to provide a rationale and specific methodology to fix this problems with customers first," he said. "For the customers, what matters most is that they've given them business at the end of the quarter, and EMC hasn't delivered them product."

Meanwhile, EMC also said that it had "showed exceptionally strong results" in its software business. License revenue from EMC's subsidiary, VMware Inc., grew year over year by 73%. EMC's content management license revenue increased year over year by approximately 30%, excluding the impact of the Captiva Software Corp. acquisition. License revenues from EMC Smarts-related software offerings reportedly almost doubled in the quarter, and backup and recovery software licenses showed year-over-year revenue growth of approximately 10%.

But Webster said it wasn't the growth of separate software units, but their integration that would be the key to EMC's future. "EMC could and should be doing further integration among the acquisitions they have already made and delivering on some of the very promising technologies it's acquired in a more integrated fashion," Webster said. "EMC could be going after more services offerings, helping customers integrate and architect the products it offers."

EMC, with a shift in strategy from information lifecycle management (ILM) to intelligent information management (IIM) this year, has been promising to do just that. "But it's been a difficult thing for them to do," said Webster. "They need to get beyond the 'intention stage.' "

Tucci promised that EMC would be redoubling efforts toward integration and overhauling the inventory process.

"We don't want to be sloppy and just stock a ton of inventory," he said. "We want to run efficiently. But clearly this past quarter was not up to EMC standards. The executive team, including me, takes full responsibility for this. We will not miss like this again."

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