Analysts Surprised by EMC Forecast Adjustment

Analysts were surprised by the news July 10 that EMC had readjusted its outlook for the second quarter and blamed its misread on an "unfavorable inventory mix" due to a high number of late orders for two of its storage systems.

Shares of EMC, based in Hopkinton, Mass., fell nearly 7 percent to close at $10.41 after the company said it now expects to earn 12 cents a share on $2.58 billion in revenue, down from previous quarterly estimates of 13 cents a share on revenue of at least $2.66 billion.

The revised forecast includes 2 cents a share in stock-option expensing, a charge of 2 cents from amortization of intangible assets, and a gain of 1 cent from an income-tax benefit. The average estimate of analysts polled by Thomson First Call had been for a profit of 13 cents a share in the quarter on revenue of $2.66 billion.

EMC said it couldnt satisfy demand for its Symmetrix DMX-3 and DMX-2 systems due to the volume and mix of orders. While EMC said it had strong new orders for its DMX-3 systems, the sales came late in the quarter and couldnt balance fewer-than-expected orders placed for its DMX-2 systems.

Nonetheless, EMC, which is now the sixth-largest producer of software in the world, said product sales were up 14 percent from the second quarter of 2005.

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"I was surprised by their announcement," said analyst Carl Greiner, senior vice president for infrastructure at Boston-based Ovum.

"I was seeing no weakness in demand and had no reports of product being unavailable. The only thing I can figure is that they had a [demand] ramp-up—or most likely product problems that deferred shipments."

High-end disk array systems are made to order, so there may have been production issues, said David G. Hill, principal with the Mesabi Group, in Westwood, Mass.

"Buying a disk array is like buying a car that is shipped from the factory. You order the components—what color, what kind of sound system, whether or not you want leather seats, etc. —but the basic car is the same," Hill told eWEEK via e-mail. "Storage disk arrays are [also] assembled from standard components."

However, the "engine" in the DMX-3 is not the same as in the DMX-2, Hill said.

"That is like an automobile manufacturer making a model line change. Ramping up production on components that are unique to the DMX-3 may take longer than planned. Also, the products have to move through the supply chain to the factory, and there can be unforeseen delays."

In addition, forecasting and planning for that process during a product transition is not easy; the computer and storage industries have long suffered through the so-called "hockey stick effect," Hill said.

"Customers have become accustomed to better deals in the last few weeks of a quarter. That means that an inordinate amount of shipments go out the door the last week of the quarter. That means that if the demand for a new product is unexpectedly high late, there is no way to get the unique parts manufactured and through the supply chain in time," Hill said.

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Brian Babineau, a Palo Alto, Calif.-based analyst with Enterprise Strategy Group, said what he thought was "flabbergasting" is that the "miss is related to hardware inventory mismanagement due to end of the quarter customer orders."

"EMCs business is always back-end loaded, and traditionally, their manufacturing processes and inventory has been able to handle the end of quarter demand," Babineau said in an e-mail.

"For this to happen, EMC must have been caught off guard and sales forecasts did not align with inventory planning. Strikingly more odd was the increase in demand for DMX-3, which has been available for a year. We would have thought that EMCs mid-range product, Clariion CX-3, would have been the one that garnered customers attention and could have resulted in a sell-out issue as it was announced in March/April 2006."

With EMCs revenue backlog, there was not a demand issue, Babineau said.

"There was an EMC operational issue that needs to be worked out with customers," he said. "EMCs management team rarely lets business process mistakes repeat, as evident with the refocus on Legato revenue (up 10 percent y/y) after a tough Q1 for that product line, and we do not expect this one to happen again. Their key metric from a financial standpoint is the Clariion revenue, [because] there may have been a demand shift from mid-range to enterprise storage systems."

EMC, which announced June 29 that it will acquire RSA Security for $2.1 billion, said it would report its second-quarter results on July 14.

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