EMC Doesn't Equate

I've been reading through financial statements and notes for the better part of an hour now, trying to figure out why investors are down on EMC (NYSE: EMC  ) . Now my head hurts, and I still don't have an answer. (I know you were expecting something catchy. Sorry.)

Maybe it's just a perception problem. Though the storage maker grew revenues by 19% and net income by 52% year over year, EMC's Q3 outlook falls short of the Street's expectations. Third-quarter revenue was expected to come in at $2.39 billion, a $50 million sequential improvement. Management, however, expects sales to be even with this quarter, due primarily to the impact of currency; that could strip the top line by $25 million to $40 million. Earnings per share also lagged projections. Analysts hoped for $0.13; EMC says $0.12 per stub is closer to reality.

The company discussed all sorts of other potential issues during the conference call. Storage management software, for example, was down 4% after excluding the impact of the SMARTS acquisition made in December. In the content management business, licensing growth was a measly 1% due to deals being pushed into Q3. That said, I honestly think these are red herrings.

In my opinion, it makes more sense to focus on what matters: cash flow. EMC has loads of it. Indeed, take the company's cash from operations for the first six months of 2005, subtract capital expenditures, and you're left with more than $775 million. That's 9% higher than the same period a year ago. I might argue that EMC's organic cash-generating ability is actually a bit lower after stripping out stock option benefits and the like, but the growth rate still wouldn't change much. And EMC would still be on track to record well more than $1 billion in extra moola this year.

If you really want something to get worked up over, take a look at inventory. It's up more than 28% year over year and 17% sequentially, largely because EMC has a major product launch coming Monday. So what's the problem? As one enterprising questioner pointed out, you'd expect to see accounts payable increase in step with inventory, to account for parts bought to create the finished goods about to be sold. That's not the case here; EMC's payables are down nearly 9% from last quarter, and up 10% year over year. I'll concede this is worth watching, but it's also probably a minor issue -- like worrying whether spilled water will stain your shirt.

Yes, EMC's business is likely to grow more slowly from this point. Yes, there is a ton of competition in the storage market. And, yes, there is a risk that EMC will make a product that will flop. But margins continue to improve. Cash flow remains strong. The top line is growing at double the rate of the overall market. And the balance sheet is as sturdy as ever. Add it all up and there's really only one conclusion: EMC is a steady, boring, and altogether wonderful company leading a reasonably solid industry. What's the problem here, again?

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Fool contributor Tim Beyers wishes his three kids would learn a thing or two about storage. He and his wife would trip and fall a lot less often. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile, which is here.


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