EMC Sinks Despite Hiking Profits

Crediting growing demand for new product lines, storage giant EMC Corp. (NYSE: EMC) today posted a higher than expected second-quarter profit today, but disappointing gross margins and a weak outlook for the current quarter sent its stock price spiraling down more than 9 percent in early afternoon trading (see EMC Posts Q2 Profit).

EMC posted a profit of $82 million, or 4 cents a share, for the quarter ended on June 30, holding its ground in the black for the second quarter running (see EMC's Back in Black). The company also saw its revenues for the quarter jump 7 percent, to $1.48 billion, compared with $1.39 billion for the year-ago quarter.

"When I look at our Q2 results, two words come to mind: solid and balanced," EMC president and CEO Joe Tucci said on a conference call this morning. "It would be really hard to demonstrate better balance than this." He pointed out that during the quarter the company's storage system and storage services revenues were up 7 percent quarter-over-quarter, while its storage software revenues jumped 8 percent sequentially.

EMC also noted that sales of its new Symmetrix DMX accelerated, accounting for about 80 percent of total Symm revenues in the second quarter, up from last quarter's 56 percent (see EMC Soups Up Symm).

Wall Street apparently doesn't agree that everything is looking up for EMC: The fact that its results grazed the high end of both analysts' and the company's own forecasts for the quarter didn't stop EMC's shares from slipping 9.1 percent in afternoon trading today, to $10.06 a share."EMC's results are likely to cause at least some investors to re-evaluate just how optimistic they are willing to be both for EMC shares and tech stocks in general," writes Goldman Sachs & Co. analyst Laura Conigliaro in a note to investors, adding that the company's valuation has consistently been a major issue.

Analysts polled by First Call expected EMC to bring in between 3 and 4 cents a share, with the mean falling on 3 cents. EMC, meanwhile, announced last week that it probably beat its previous forecast of earnings of 3 cents a share (see EMC Upbeat on Q2).

While the company's second-quarter earnings were impressive compared with its depressed year-ago quarter's measly $1 million profit, or zero cents per share, lower-than-expected margins and a disappointing third-quarter forecast appear to have left the market cold, analysts say.

"If there's anything to be disappointed about, it's that the things the company has done to improve gross margins didn't have as big an effect this quarter as last quarter," says Punk Ziegel & Co. analyst Steve Berg. After the company saw its gross margins soar from 39.4 percent to 43.2 percent between its fourth quarter of 2002 to its first quarter of 2003, he says, the market probably expected more than a baby-step up to 43.5 percent during its second quarter. "That's not a very big jump," he notes.

Other observers say EMC's forecasts for the current quarter left a bit to be desired. While the company said it expects earnings of 4 cents a share for the current quarter, in line with analyst expectations, it forecast revenues of $1.45 billion to $1.5 billion, cautioning that seasonal conditions tend to make for a weak third quarter. The company says it expects margins to remain relatively flat."Their stock was priced for perfection," says Brion Tanous, an analyst with Merriman Curhan Ford & Co. "Modest disappointment on the guidance probably sent their stock down."

EMC's sinking stock today could also be part of the aftermath of its announcement last week that it intends to purchase Legato Systems Inc. (Nasdaq: LGTO) for $1.3 billion in stock (see EMC Gobbles Legato).

Despite the general impression that the acquisition will be a good deal for both EMC and Legato, EMC has seen its shares lose about 13 percent of their value since the announcement (see Behind EMC's New Software Splash). Tanous, however, doesn't think the Legato deal is to blame for EMC's slipping shares today. "Certainly that affected the stock last week, but I don't think it was putting pressure on the stock today," he says.

On today's call, Tucci was upbeat on the Legato deal, saying that it was a big step toward realizing EMC's goal of having software sales account for 30 percent of its revenues by the first quarter of 2005. While acknowledging that the company is planning to make other storage software acquisitions to reach that goal, he said EMC is not in a rush and will concentrate on integrating Legato first. Today, nearly 60 percent of the company's sales come from lower-margin hardware sales.

EMC anticipates taking between $30 million and $60 million in charges related to the acquisition during its fourth quarter of 2003, but the company says it still expects to post a profit for the quarter. EMC expects the addition of Legato to add some value to its stock in 2004. "We expect to continue being profitable for every quarter this year," EMC CFO Bill Teuber said on this morning's call.Eugénie Larson, Senior Editor, Byte and Switch