Dell Technologies Inc. (NYSE:DELL) Q2 2024 Earnings Call Transcript

Dell Technologies Inc. (NYSE:DELL) Q2 2024 Earnings Call Transcript August 31, 2023

Dell Technologies Inc. beats earnings expectations. Reported EPS is $1.74, expectations were $1.13.

Operator: Good afternoon, and welcome to the Fiscal Year 2024 Second Quarter Financial Results Conference Call for Dell Technologies Inc. I’d like to inform all participants this call is being recorded at the request of Dell Technologies. This broadcast is a copyrighted property of Dell Technologies Inc. Any rebroadcast of this information in whole or part without the prior written permission of Dell Technologies is prohibited. Following prepared remarks, we will conduct a question-and-answer session. [Operator Instructions] I’d like to turn the call over to Rob Williams, Head of Investor Relations. Mr. Williams, you may begin.

Robert Williams: Thanks, everyone, for joining us. With me today are Jeff Clarke, Yvonne McGill and Tyler Johnson. Our earnings materials are available on our IR website, and I encourage you to review our materials and presentation, which includes additional content to complement our discussion this afternoon. Guidance will be covered on today’s call. During this call, unless otherwise indicated, all references to financial measures refer to non-GAAP financial measures, including non-GAAP gross margin operating expenses, operating income, net income and diluted earnings per share. A reconciliation of these measures to their most directly comparable GAAP measures can be found in our web deck and our press release. Growth percentages refer to year-over-year change unless otherwise specified.

Given where we are in the macro cycle, we will be referencing sequential growth more frequently this quarter. Statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in our web deck and our SEC filings. We assume no obligation to update our forward-looking statements. Now I’ll turn it over to Jeff.

Jeff Clarke: Thanks, Rob. Coming into the quarter, we were cautious given our Q1 results, but the demand environment improved at a faster rate than we anticipated, particularly as we moved into June and July. Operationally, we executed well with expense controls, pricing discipline and lower input costs. We sharpened our focus on pricing this quarter, and we were selective on deals, particularly where share benefits would have been temporary. While revenue was down year-over-year, a better demand environment and strong execution enabled extraordinary Q2 results. Revenue was $22.9 billion, with operating income of $2 billion and diluted EPS of $1.74, well ahead of our initial expectations. We are encouraged with some of the signs we are seeing in the macro environment as we move into the second half.

We saw better underlying demand in the U.S. market and EMEA was better than anticipated. We also saw demand growth in government and SMB and our transactional demand improved through the quarter. However, most of our largest global customers remain careful with their spending levels. From a solutions perspective, we saw significant strength in AI-enabled servers. PowerFlex and PowerStore demand grew within our storage portfolio. PowerFlex, our proprietary software-defined storage solution has now grown 8 consecutive quarters with demand in Q2 more than doubling year-over-year. Workstation demand grew and was another bright spot that will continue to benefit from the rise of AI developers and data scientists can now fine-tune Gen AI models locally before deploying them at scale.

Commercial PC demand improved sequentially and as we move through the quarter. And S&P attach rates were strong, particularly in software. Our ASPs continue to expand across AI servers, traditional servers and commercial PCs. Overall, we were pleased with the quarter given strong sequential growth of 10% and growing interest in orders in AI solutions. Artificial intelligence is a strong tailwind for all things data and compute as well as CSG when you think about the potential for workstations and eventually all PCs. AI is expanding the TAM for total technology spending and is projected to grow at a 19% CAGR for the next couple of years to approximately $90 billion, including hardware and services. In Q2 alone, we saw unprecedented strength from our PowerEdge XE9680.

It’s the fastest ramping new solution in Dell history and builds on the success of other GPU-enabled servers we’ve been selling for years. The 9680 is a key element to our Dell Generative AI Solutions engineered to speed the deployment of a modular, secure and scalable platform for generative AI in the enterprise. AI service increased to 20% of our servers order revenue in the first half of the year and the 9680 was a big factor. Currently, we have approximately $2 billion of XE9680 orders in backlog and our sales pipeline is substantially higher. Gen AI represents an inflection point driving fundamental change in the pace of innovation while improving the customer expectation and enabling significant productivity gains and new ways to work.

As the #1 infrastructure provider, we are clearly positioned to serve the market in a unique and differentiated way. And we have the world’s broadest Gen AI infrastructure portfolio that spans from the cloud to the client. Customers big and small are using their own data and business context to train, fine-tune inference on Dell Infrastructure Solutions to incorporate advanced AI into their core business processes effectively and efficiently. We can help customers size, characterize and build the Gen AI solutions that meet their performance, cost and security requirements. Many of these new workloads will be on-prem or at the edge given the importance of latency, data security and cost. In the near term, we are seeing organizations concentrate on 4 Gen AI use cases, customer operations, content creation and management, software development and sales.

And internally, we are doing the same to enhance how we build products, service our customers and improve productivity and efficiency. As we think about the back half of the year, we are coming off a Q2 where we grew above normal seasonality and demonstrated the power of our model to generate cash in a sequential growth environment. You should expect us to focus on growing and extending our core business in the areas with the most attractive profit pools. Deliver innovation for our customers, remain disciplined on our pricing and focus on costs with multi-cloud edge and Gen AI as tailwinds. I like our hand and I look forward to talking more about our views on technology trends, strategy and innovation at our Securities Analyst Meeting in October.

Now over to Yvonne for a detailed Q2 financials.

Yvonne McGill: Thanks, Jeff. We’re pleased with our Q2 execution and an improving demand environment. We delivered revenue of $22.9 billion, down 13% and up 10% on a sequential basis with strong gross margins and strong operating expense and net working capital management. Currency remained a headwind and impacted revenue growth by approximately 130 basis points. Gross margin was $5.5 billion and 24.1% of revenue. Our gross margin rate was up 270 basis points, driven by lower input costs and pricing discipline. We did see increased pricing pressure in Q2, but we’re selective on deals depending on the customer and opportunity. As Jeff mentioned, we are focused on profitable opportunities rather than temporary share gains. And you can expect us to continue to focus on the more profitable segments of the market and maintain pricing discipline.

Operating expense was $3.6 billion, down 4% driven by lower discretionary spend in SG&A and was flat sequentially. Operating expense was 15.5% of revenue and we will continue to actively manage our spend as we move through the second half. Operating income was $2 billion, up 1% and 8.6% of revenue, with the impact of the decline in revenue offset by an increase in gross margin rate and lower operating expense. Our quarterly tax rate was 20.4%. Net income was $1.3 billion, up 1%, primarily driven by higher operating income and diluted EPS was $1.74, up 4% due to lower share count and higher net income. Our recurring revenue in the quarter was $5.6 billion, up 8%, and our remaining performance obligations, or RPO, was $39 billion, up 1% sequentially driven by deferred revenue.

Deferred revenue was up primarily due to increases in software and hardware maintenance agreements. ISG revenue was $8.5 billion, down 11% and but up 11% sequentially on the back of improving server and storage demand. We delivered storage revenue of $4.2 billion with demand growth in PowerStore and PowerFlex. Service and networking revenue was $4.3 billion. We saw server ASPs continue to expand and our AI server mix of server revenue demand continued to increase given the recent rise in customer interest in Generative AI Solutions. Both storage and service and networking revenue were up 11% sequentially. ISG operating income was $1 billion or 12.4% of revenue, up 140 basis points, driven by an increase and gross margin rate, offset by a decline in revenue.

Turning to CSG. The calendar Q2 PC market was down 14% in units but is now showing signs of improvement, up 7% sequentially. Our fiscal Q2 CSG revenue was $12.9 billion, down 16%, primarily driven by a decline in units, partially offset by higher average selling prices. Revenue grew 8% sequentially and commercial continues to fare better than consumer with commercial revenue growing sequentially to $10.2 billion. Consumer revenue was $2.4 billion. CSG profitability remained strong in Q2, with operating income of $1 billion or 7.5% of revenue, up 120 basis points, driven by an increase in gross margin rate and lower operating expense as we maintain pricing discipline and benefited from lower input costs. We remain focused on commercial and the high end of consumer, profitable relative performance and executing our direct attach motion for services, software, peripherals and financing.

Customer interest remains high in financing and consumption models that provide both payment flexibility and predictability. Our Q2 Dell Financial Services originations were $2.3 billion, up 1%. DFS ending managed assets reached $14.7 billion, up 9%, while the overall DFS portfolio quality remains strong and credit losses near historically low levels. During the quarter, we continued to see APEX momentum, including a strong double-digit percentage increase in a number of new APEX customers that have subscribed to our as-a-service solutions with strength in our Data Center Utility and Flex On Demand offerings. Turning to our cash flow and balance sheet. Our cash flow from operations was $3.2 billion, primarily driven by working capital improvement, sequential growth and profitability.

Within working capital, we reduced inventory $0.4 billion sequentially and continued strong collections performance with past due now at record low levels. With the work we’ve done on net working capital post pandemic, our cash conversion cycle has now improved to negative 50 days in Q2, in line with pre-COVID levels. Cash and investments was up $0.7 billion sequentially driven by free cash flow generation offset by $1.1 billion of debt paydown and $0.5 billion in capital returns. In Q2, we repurchased 5.2 million shares of stock at an average price of $49.53 and paid a $0.37 per share dividend. Our core leverage improved to 1.6x exiting the quarter, and we ended Q2 with $9.9 billion in cash and investments. which gives us flexibility to increase our return of capital going forward.

Since we implemented our current capital allocation framework six quarters ago, we have returned over 90% of our adjusted free cash flow in the form of share repurchase and dividends, and we continue to evaluate enhancements to our framework based on investor feedback. Turning to guidance. We’re seeing signs of stability across a number of areas within our business, including small and medium business and government. But our largest corporate and global enterprise customers are still measured in their IT project investments and spending plans. Against that backdrop, we expect Q3 revenue to be in the range of $22.5 million and $23.5 billion with a midpoint of $23 billion, flat sequentially. Currency continues to be a headwind, and we are expecting a roughly 40 basis point impact to Q3 revenue.

We expect both CSG and ISG revenue to be roughly flat sequentially. Although we remain disciplined and focused on profitable share, we expect a more competitive pricing environment. Combined with more muted component cost deflation, we expect gross margin rate will be down 150 basis points sequentially. Our continued focus on cost controls will drive lower sequential operating expense that partially offset expected gross margin dilution. We expect our Q3 diluted share count to be between $733 million and 737 million shares and our diluted EPS to be $1.45 plus or minus $0.10. For the full year, we’re raising our FY ’24 revenue expectations to be in the range of $89.5 billion and $91.5 million, down 12% at the midpoint. Given Q3 guidance, this implies sequential growth in Q4.

We expect interest and other to be roughly flat year-over-year. For our tax rate, you should assume 22.5%, plus or minus 100 basis points. We are increasing our expectations for diluted earnings per share to $6.30, plus or minus $0.20. In closing, we have strong conviction in the growth of our TAM over the long term with AI, multi-cloud and edge as tailwinds. We have generated $8.1 billion of cash flow from operations over the last 12 months, demonstrating our ability to drive efficiency in working capital during a more challenging demand environment, and our Q2 performance underscores the power of our model to generate cash when we return to sequential growth. We remain focused on executing our strategy, investing in innovation to expand our TAM and winning the consolidation of our core markets, including multi-cloud edge, telco and AI.

Expect us to continue to be disciplined in how we manage the business, focusing on what we can control and delivering to our customers and our shareholders. And we look forward to seeing you all at our Securities Analyst Meeting in October, where we’ll provide updates on our strategy, long-term value creation framework and capital allocation policy. Now I’ll turn it back to Rob to begin Q&A.

Robert Williams: Thanks, Yvonne. Let’s get to Q&A. We ask that each participant ask one question to allow us to get to as many of you as possible. Let’s go to the first question.

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Q&A Session

Operator: We will take our first question from Shannon Cross with Credit Suisse.

Shannon Cross : Jeff, can you talk a bit more about — you’ve talked a lot about it, but can you talk a bit more about the AI opportunity, discuss 4 core use cases, but can you talk on a segment and a geographic basis? And how should we think about ASP potential for both servers and storage with AI-oriented solutions. I’m just wondering, is AI going to drive sort of a change in hardware spend that you think is more of a secular positive versus maybe temporary in nature?

Jeff Clarke: Shannon, let me take a stab at that. First of all, we think AI — and I think I’ve said this on our last asked the experts call, but I think it’s worth reinforcing is, it’s just a new series of workloads and new incremental capability that goes across the PC to the data center to the cloud. And we think it is absolutely because of the uniqueness of the workload, a growth opportunity in all 3 of those areas. Distinct and how it’s built out, distinctive how it’s going to be used on the PC, opening a whole new opportunity to drive productivity and a great productivity device as is, being able to use these big foundational models at cloud scale. And then what we think really happens on the enterprise level and in business is sort of the notion of domain-specific process-specific or field of study type of AI, where we actually use customers’ data business will use their data they will tune the model and then run inference at site on edge, whether that be in a smart factory, smart hospital in a transportation network.

So when you think about the vertical nature of this and how it will actually work in the real world, we think that technology makes its way all the way out to the edge, AI follows where the data is going to be created, where the sensors are collecting the information and that allows us to put those compute resources for the data is actually being again, created. That is not specific to geography. It’s not specific to size of business that’s going to be really driven by the type of application and the usage environment. And I think that is what’s really exciting about this. We think it’s one size does not fit all. We think there’s a whole slew of our AI solutions, again, from the PC to workstations to what happens in the data center and the data center could be a single server running inference at the edge.

It could be defined as a small cluster doing a small micro or fine level tuning all the way into these big foundational models will renew cloud scale training. So in a nutshell, I guess that’s as quickly as I could describe the opportunity. We believe it is incremental. Am I going to say it doesn’t come at the expense of some data center servers? Of course, not. I don’t think we know it’s in the early innings. We do know the workloads are distinctly different. The architectures are distinctly different, and we will build different systems for AI and that massive, if you will, data processing that’s done in parallel versus how we’ve historically built applications in the past for the data center.

Operator: We’ll take our next question from David Vogt with UBS.

David Vogt : Can we just stick on AI for a second and maybe dig into how you’re thinking about your allocation or your ability to allocate — or get allocation to GPU capabilities, right? So obviously, it’s a bit of a rush right now with some limited supply and some gating factors, and you talked about $2 billion of servers in your order book. Can you kind of just share with us sort of how you see yourself competitively sitting into that queue? And are you seeing any sort of challenges in getting ample supply to sort of meet that order book? And how should we expect that order book to sort of filter through revenue as supply becomes available?

Jeff Clarke: Sure, David. Maybe the easiest measure to determine where we are with supply is demand is way ahead of supply. If you order a product today, it’s a 39-week lead time, which would be delivered the last week of May of next year. So we are certainly asking for more parts working to get more parts. It’s what we do. I’m not the allocator, I’m the allocatee. So we’re advocating our position on our demand. Again, we are winning business signaled by the $2 billion in backlog today with a pipeline that’s significantly bigger I was in the discussion yesterday with two different customers about AI, the day before about AI. It is constantly something that’s coming into our business that we’re fielding the opportunities. From different cloud providers to folks building AI as a service to enterprises now beginning to do proof of concept and trying to figure out how they do exactly what I just said earlier, use their data on-premise to actually drive AI to improve their business.

We’ll continue to work and advocate for more supply, and then I’ll also tell you, we’re tracking at least 30 different accelerator chips that are in the pipeline in development that are coming. So there are many people that see the opportunity. Some of these new technologies are fairly exciting from neuromorphic type of processors to types of accelerators there’s a series of new technologies and quite frankly, new algorithms that we think open up the marketplace and we’ll obviously be watching that and driving that across our businesses and helping customers.

Operator: We’ll take our next question from Samik Chatterjee with JPMorgan. Samik your line is open. If you could please check your mute button?

Samik Chatterjee: Sorry about that. Congrats on the results. Just trying to square the guidance for ISG to be flat when you talked about seeing order improvement? And maybe if you can talk about what are the — sort of what did you see in terms of linearity of orders during the quarter, both in sort of servers and storage. I mean I understand large enterprises might be still measured, but you did mention there are sort of other segments of the market or verticals that are spending, and it does look like you’re seeing more sort of macro green shoots of a macro improvement. So just trying to square like how much of that flat guidance sort of embeds pricing being the major driver of that sort of flattish guide versus demand? Just help me square that, please.

Yvonne McGill : Let me go ahead and start on that, Samik. So as we’re looking into the third quarter. And we’re talking about the external environment. We have a lot of near-term dynamics that we’re navigating through. We’re confident about the go forward, but we’re guiding to flat sequentially at $23 billion. We’re expecting stability we’ve seen in the transactional business. So I talked about small business, medium business and government. But in the ISG space, which you’re particularly asking about, we’re expecting that to be overall flat sequentially with servers a bit better, really leaning in on the GPU mix, but not expecting that rate of decline to improve much on the rest of the server portfolio. And then from a storage perspective, we’ve got a seasonality, normally seasonally down in the third quarter.

And so that storage, we’re expecting a lower storage performance in that quarter. Now at CSG, we also have it flat. We have some mix dynamics in there with mixing more towards the holiday period. So we’ll have that coming in. And we’ll have that also with some TRU pressure that we’re expecting from the external environment.

Jeff Clarke: Yes. I might add as a complement, Yvonne just said on the ISG specifically storage. As you mentioned, it’s seasonally down Q2 to Q3. And with the weakness in our enterprise customers, they happen to be the greatest concentration of the high-end or high-priced band storage arrays that we sell and that puts pressure on the P&L in Q3.

Yvonne McGill : That’s right. We haven’t seen those larger corporate and global enterprise customers really come back into the spending zone yet.

Operator: We’ll take our next question from Toni Sacconaghi with Bernstein.

Toni Sacconaghi: I just have a quick clarification in the question. I think you said your server backlog in revenue terms was 20% GPU or accelerator based. I just wanted to confirm that. And as context, could you add what was the percentage of server revenues this quarter that was GPU-based and a year ago? And then my question is just on operating margins, you’re kind of above your historical levels in PSG of 5% to 7% you’re above ISG historically, maybe 11% to 12%. Is there anything structurally that’s changing or was this kind of a unique quarter in terms of strong sequential growth in cost control and maybe even next quarter given the gross margin guidance, we should be back down to normal levels or is there something either about AI or about how you’re picking where you want to participate, that the kinds of margins we saw this quarter in both businesses might be something we might continue to see.

Jeff Clarke: I’ll take the first half of the question, Tony. I believe my remarks were 20% of the first half orders in servers or AI-based servers, the XE family, et cetera. And if you were to compare it against a year ago since the XE family of products did not exist, and that’s the vast majority of the backlog. It’s a very large percentage on a year-over-year basis. I actually did calculate it, but it’d be a very big number, given most of the $2 billion backlog I noted is XE9680 base.

Yvonne McGill : And then I’ll jump in on the profitability question. I think what we saw or what we did see in Q1 and Q2 was really, I think, a great example of our differentiated model, right, with the ability to capture that deflationary environment and translate it through the P&L quite quickly. We saw component deflation that was better than anticipated and stable TRUs, and that let us really deliver that higher margin rate. In Q3, though, we’re expecting a few things, right, a more competitive environment now that we’re seeing inventory levels more normalized. And we think that we’ll see more of our competitors have that broader access to lower component costs. And then I’d wrap on that with saying that we’re expecting a deflationary environment to continue, but less so more muted in the third quarter than what we saw in Q2.