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EMC Corp. (EMC) reported first quarter earnings of 32 cents per share that beat the Zacks Consensus Estimate by a penny. Earnings (including stock-based compensation but excluding other non-recurring items) increased 3.3% year over year but decreased 31.5% sequentially in the quarter.

Revenues

Revenues increased 5.8% year over year but decreased 10.7% sequentially to $5.39 billion, well short of the Zacks Consensus Estimate of $5.45 billion. Product sales climbed 1.4% year over year but plunged 16.5% sequentially to $3.11 billion. Services surged 12.3% from the year-ago quarter but decreased 1.1% from the previous quarter to $2.28 billion.

Information Infrastructure segment (80% of revenues) revenues increased 3.9% year over year but declined 11.4% sequentially to $4.20 billion. The year-over-year growth was primarily driven by strong performance from RSA (up 12.5% year over year), Information Intelligence (up 7.1% year over year) and Information Storage (up 3.3% year over year). All three segments posted significant sequential decline in the quarter.

EMC’s majority owned VMware Inc. (VMW) continued to impress with revenue growth of 12.8% on a year-over-year basis to reach $1.19 billion. Sequentially, VMware revenues decreased 8.0% in the reported quarter.

On a geographical basis, domestic revenues climbed 8.0% year over year to $2.8 billion and contributed 53.0% to revenues. Revenues from international operations increased 4.0% year over year to $2.6 billion and accounted for the remaining 47.0% of revenues.

Margins

Gross margin expanded 20 basis points (“bps”) from the year-ago quarter due to higher services margin. However, on a sequential basis, gross margin contracted 320 bps due to unfavorable product mix.

Research & development expenses were up 14.9% year over year and 1.9% sequentially to $675.6 million in the first quarter. Selling, general & administrative expense increased 3.9% year over year but decreased 11.1% sequentially to $1.71 billion in the reported quarter.

Operating margin contracted 30 bps on a year-over-year basis and 450 bps from the previous quarter to 18.9% due to modest revenue growth and lower gross margin base. Net income as a percentage of revenues was 12.8% compared with 13.2% in the year-ago quarter and 17.1% in the previous quarter.

Earnings (excluding stock-based compensation and other non-recurring items) increased 4.6% year over year but decreased 28.3% sequentially to 39 cents in the quarter.

Balance Sheet & Cash Flow

As of Mar 31, 2013, cash and cash equivalents including short-term investments were $6.53 billion compared with $6.17 billion at the end of Dec 31, 2012. EMC generated $1.71 billion in cash flow from operations in the first quarter compared with $1.90 billion in the prior quarter. Free cash flow slightly declined to $1.44 billion in the reported quarter from $1.50 billion in the prior-year quarter.

Pivotal Initiative

EMC and VMware recently formed a new company called GoPivotal Inc (Apr 1, 2013), which combines Greenplum, Cloud Foundry, Spring, Cetas, Pivotal Labs, GemFire and other products from the VMware vFabrix Suite. Reportedly, General Electric (GE) plans to make a strategic investment of approximately $105.0 million in Pivotal, representing a 10% equity stake.

Guidance

EMC forecasts revenues of $23.5 billion for 2013. Non-GAAP operating margin is expected to grow to 25.5% for 2013. Non-GAAP operating expense is expected to be $280.0 million for 2013. Non-GAAP net income is expected to be approximately $4.1 billion for the full year. EMC expects earnings of $1.85 per share for 2013.

Cash flow from operating activities is expected to be $6.8 billion, while free cash flow is expected to be $5.5 billion for 2013. EMC also expects to repurchase shares worth $1.0 billion in 2013.

Our Recommendation

We believe that EMC is well positioned to benefit from incremental data center hardware spending going forward. We believe that EMC’s vast product portfolio, which has products suitable for any kind of budget, will boost its market share going forward.

However, increasing competition from the likes of International Business Machines Corp. (IBM) and Hewlett Packard Co. and a sluggish IT spending outlook for the next two years will continue to keep margins under pressure in the near term.

Currently, EMC has a Zacks Rank #4 (Sell).