Dell Technologies Inc. (DELL) Earnings Call Transcript & Summary

Hello, everyone, and thank you so much for joining us here, to the Dell Technologies fireside chat here at Citi Investment Research. My name is Jim Suva, and I am here specifically -- I got to reorientate my item. Perfect. I'm here with the Chief Financial Officer of Dell Technologies, Tom Sweet. Dell Technologies statements that relate to future results and events are forward-looking statements and are based on Dell Technologies' current expectations. Actual results and events in future periods may differ materially from those expressed or implied by these forward-looking statements because of the number of risks, uncertainties and other factors, including those discussed in Dell Technologies' periodic reports filed with the SEC. Dell Technologies assumes no obligation to update its forward-looking statements. We also know that Citi Investment Research has disclosures associated with this. And any subjects -- and any clients who are subject to MiFID II need to make sure that they have those agreements in place. No media or press are allowed on this. So first of all, this is Dell Technologies. Jim Suva here with Tom Sweet, the Chief Financial Officer of Dell.

So Tom, as we kick things off, boy, I got to tell you, person-to-person here. The events of 2019 and 2020 year-to-date, there's been a lot of changes, a lot of challenging situations for tech companies, including U.S.-China tensions, tariffs, the pandemic-related operational headwinds. Many companies are adjusting their business practices to become more nimble. What are your top priorities as Chief Financial Officer for Dell right now?

Well, thanks, Jim. And hey, it's good to see you only if it's just virtually, right? So it's too bad we can't do this in person, but I appreciate you having me on today. So well, it's clear, there's been a lot going on in the environment this year as we've navigated through the first 6 to 7 months of the year. I was mentioning to Michael Dell and Jeff Clarke the other day that I said it feels like this first couple of quarters of the year have taken about 2 years to get through so far. So it's been interesting to work our way through it. So look, it's -- like many of you. And we've been navigating through a work-from-home scenario and impacts to the daily life that all of our team members are going through. But even as we do that, we're clearly focused on how do we serve our customers? How do we ensure that we're providing the technology solutions that our customers need to drive their businesses? So right now, Michael, Jeff and I have been very focused on, again, helping our customers, making sure our employees are safe, but also thinking about how do we position the company for future growth? What are those growth tangents and vectors that we need to be focused on? And so it's -- and we're taking the learnings from what we've learned so far as we've gone through this COVID pandemic. We've seen customers' behaviors change, where they're now more willing to engage virtually. And how do you think about that in a post-COVID world? And how do you lever capabilities to better serve our customers? We've rolled out payment flexibility programs to help our customers who are navigating, how do they preserve capital but still need access to technology? And so it's been a really interesting 6 months. And then we've also obviously had the whole George Floyd dynamic that we've had to work our way through around racial and social injustice, and how do we ensure that we're building a -- continue to accelerate an inclusive culture? Having said all of that, I mean, we're extraordinarily focused on what are those future-ready growth vectors that we ought to be -- that we look to as growth opportunities? Areas like telco, areas like edge, areas like data management, data services are all areas that we're investing in even as we deinvest in other areas as we navigate the dynamics. And also you've mentioned China, right? China is a very big, important growth market for us. It's a -- our supply chain has a number of operations there. We're obviously pro-free trade, and we're hopeful that we can continue to work our way and that the governments can continue to work their way through that navigation and come to a constructive resolution. But we feel pretty good about our navigation to date, Jim. It's been an interesting half year. We're optimistic about the long term, but know we have more work to do as we work our way through the next number of quarters.

And Tom, you actually spoke on the topic a little bit earlier in your comments on the last question about capital allocation and cash. Can you remind investors about your debt paydown plans? I think stock buyback, you kind of suspended it given the pandemic. Just walk us through your capital allocation and your priorities and strategic priorities for your use of cash.

Yes. Jim, it's a question we get a lot. And we've been fairly consistent, I think -- or very consistent in how we think about this, which is, hey, from a capital allocation perspective, we're very focused on debt paydown. We've paid down $3.5 billion year-to-date as a Dell Technologies entity. We're scheduled to pay down another $5.5 billion as we go through the remainder of the year, all as we position the organization to get back to investment grade. We just finished the -- we just closed the RSA transaction here last week, and those proceeds will also go towards debt paydown as part of that $5.5 billion that we're going to do. So look, it's important for us, Jim. We think it's the right thing to do from an overall capital allocation perspective. We did have a bit of a share buyback early in the year, but we suspended that just given the uncertainty in the demand environment and making sure that we position the organization properly. And we think it's important from -- just as you think about our scale and breadth of business that we get back to investment grade. And we're obviously having conversations with the rating agencies. It's going to be their decision on when that -- when you cross that threshold and they make those calls. It's our job to position the company appropriately to drive that. So that's our navigation. That's what we're focused on. I'm pleased with the debt reduction to date. And we're just going to continue that framework as we move forward.

Sounds great. How about if we shift it over now to kind of the core fundamentals of the business? Specifically, you and some of your competitors have talked about as-a-service models. How are you approaching as a service? What's your view on it over the long term? And is there any impact to, say, cash flows or something we should be modeling? Or changes to revenue outlook as you look at as-a-service model more?

Yes. Jim, it's -- I think what's been interesting is, as we've navigated through this pandemic, is that there has been an increase in customer interest in these types of consumption models, whether it's as-a-service models or flexible consumption models or on-demand models. But those things that offer some variability, in many instances, take CapEx and make it -- change it into OpEx. And we've got a whole set of capabilities around our Dell Technology On Demand solutions that include both commitment-based models like Flex On Demand or pay as you go or pay as you grow, to the various usage models as we've discussed. And so again, what we're focused on is how do we help our customers acquire technology? And how can we help them in the way that they consume and pay for technology? And look, we like it. I like these types of these frameworks. I think from a predictability of cash flow, from a long-term relationship, from an overall profitability perspective, they're very useful and good models for us. And so we're focused on how do we grow these as-a-service models? And so if you recall in Q2, I highlighted the fact that our recurring revenue, which is a combination of utility, as-a-service and some of the other financing models that we have, grew 15% year-over-year to $6 billion a quarter. So you think about that, roughly 25% of our quarterly revenue is a recurring revenue framework. And we like that. We think it's -- we're going to continue to focus on growing it. DFS is a key enabler of how do we drive that. And so we're very, very focused on helping our customers drive these types of programs. So look, from a cash flow perspective, in terms of that question of how do you model it, we have a pretty incredibly efficient capital structure. And so I think -- and we use DFS and we place that against those DFS originations and finance receivables in quite an efficient way. So I think we feel good about our ability to continue to grow it. Customers are interested in it. And we're going to continue to push on this. And I think appropriately, from a long-term profitability framework, we think it's a really interesting proposition for us.

Tom, it's literally a week ago or 2 when you and I were talking, and as well as with your investors, on your recent results. And I got to tell you, they were very positive. You upsided on almost all metrics. But your commentary on the future seems almost like a yin and a yang, the opposite there, of a lot more cautionary. So maybe can you discuss your outlook for demand trends? Because you just had a fantastic quarter amongst coronavirus, amongst a lot of business and retail and hospitality and restaurant wind-downs or closures. And you had great results, but your outlook to me seemed pretty conservative or cautionary. Are you seeing something out there? Or walk us through your outlook for demand and how we should take your comments and kind of bridge it to just what stellar results you just had.

Well, thanks, Jim, and I do appreciate those comments. And the team did do a good job of executing through Q2. What I tried to convey as we talked on the call a few weeks ago was, hey, look, the demand environment to date is a bit uncertain. And so we are focused on -- we want to be thoughtful about our commentary out there. And I would remind you, Jim, what I reminded everybody on the call was, as you look at our seasonal pattern for Dell Technologies, Q2 and Q4 are generally our strongest quarters and Q1 and Q3 tend to be slightly softer quarters. And traditionally, what we see in Q3, as you go from Q2 to Q3, we typically historically get a sort of a -- from a revenue perspective, sort of a flat to a minus 2% quarter-on-quarter demand or revenue dynamic. We do think it's going to be a bit softer this year. Obviously, we've got the economic uncertainty with the pandemic. We've got some mix dynamics as we look at our client, our CSG business, where we've seen incredible growth and strength in government and education buying as you and I have chatted about. But that comes typically with the types of products they're buying are typically a lower ASP and a lower margin dollar product. And therefore you've got some mix dynamics that are also sort of playing into it. So my perspective was, look, I want to -- with the lack of clarity around the demand, I wanted to make sure that we sort of set the framework, I think, the way that -- and share with everybody the way we're thinking about it. We've had a -- we're still optimistic, obviously, over the long run. We just think the next couple of quarters are going to be a bit of -- we're going to have some navigation to do as we work our way through this. And so I'm optimistic. Again, we've taken share quite aggressively in storage, for instance, over the last couple of years, over 220 basis points. We've taken over 510 basis points of mainstream server revenue over the last 3 years. So we're continuing to consolidate. But yet, I do think that we're going to have to work our way through this uneven time over the next number of quarters.

Tom, you'd mentioned storage. You've been gaining a lot of share in storage. Maybe if you can talk a little bit more about looking more midterm, the pandemic. Has that resulted in more needs? And maybe we could talk about both storage and servers together independently, more need for connectivity? I know there is a side of the PC business, but maybe we can focus on servers and storage because you've been gaining share. Is there going to be a pent-up demand from this? Does it result in tailwinds? Or is it more difficult, where if you ship something to Citigroup, there's nobody in our building to really accept and sign the delivery and install it into the cabinets? Or at least those things are more complicated because there are people there to receive it, it's just a little more logistical complicated than in the past. Can you talk about servers and storage in the pandemic and how we should think about people using more data and more security, more connectivity, and how that should impact your servers and storage business?

Yes. Look, it's been an interesting time, Jim, and again you and I have chatted about this from time to time. What we saw with customers was a behavior where they pivoted pretty dramatically to the end user devices in the first part of the year, and so our -- in some instances, deferred investment in some of the infrastructure area. Having said that, we do think that there is an investment cycle that will -- that is going to happen in the infrastructure space. If you look at IDC forecast for calendar '21, for instance, you would see that they're forecasting growth in both mainstream server revenue as well as in storage. And we do think there is a bit of a -- there will be a bit of a pent-up demand. I do think, however though in the next couple of quarters, that we're still going to have to work our way through the unevenness, if you will, of the demand environment. We've refreshed our entire product line in storage. The receptivity has been quite strong. We're seeing pockets of growth in storage, for instance, in our PowerMax, our high-end storage with our data protection offerings. Yet, we still saw some softness in midrange. And we're optimistic that PowerStore, the new midrange product, is going to accelerate our performance in the midrange. And servers is an interesting dynamic as well. The server market has generally been a bit soft. We've seen softness in the transactional demand, meaning that the smaller-value transactions. We've seen the large business has continued to hold up quite well. But again, that's -- it's very much a geographic dynamic in terms of where the pockets of strength are. We've seen growth in -- the China market is growing, but yet the price points there have been pretty competitive. So we've been very deliberate there in what we do. So overall, the ISG space, the infrastructure space, has been a bit uneven. But over the long term, I think we're very bullish on what that looks like as customers continue to drive the hybrid cloud adoption that we're seeing. And so -- but we're going to have to work our way through the demand environment and continue to focus on serving our customers.

Tom, you actually touched on the product, the PowerStore. If I remember right, I think it launched in May time period or so.

Yes.

Can you kind of update us a little bit on the launch of that? And does it have a meaningful impact on your ISG, and any impact to margins? And the reason I ask is sometimes when companies launch new products, there's a lot of promotion and advertising or discounting that goes on. Other times that people launch a new product, it's a higher end, higher ASP of what's going in versus what's coming out. Or sometimes it's just simply you discount what the prior one was, so it's a net no change to the margins. How should we think about PowerStore?

Yes. Look, Jim, we're very optimistic about PowerStore. And you are right, it launched back in the May time frame. And the receptivity by the customer base has been quite strong. We have seen a strong growth in the pipeline of interest from customers in terms of the -- our sales pipeline, if you will. But we've also been a bit -- we've been a bit slowed down, quite frankly, by the pandemic in the sense of many of our customers are not in the office. So therefore, when you think about a new storage array with a new operating system and the work that most of our customers want to do in their labs to test it and qualify it, that's been a bit slower, if you will, in terms of working our way through some of the qualifications. But we're very optimistic. We think it's a great product. It's a differentiated product. As you recall and as you know, storage -- the storage selling cycle tends to be a bit longer, right? And so one of the things that we're seeing is perhaps that sales cycle is even a bit longer because of some of the qualification dynamics that I've highlighted to you. But there's a couple of things that we find pretty interesting, Jim. We've been shipping for about a quarter now, right, and we've acquired hundreds of new customers with PowerStore. And what's been interesting is, is that -- or hundreds of customers, I should say, with our PowerStore product and solution. What's been interesting is about 20% of those customers are either new to Dell or new to Dell storage. And so it's been a really interesting vehicle to begin to think about customer acquisition. And so we're very pleased with that. So look, we expect PowerStore to continue to ramp as we go through the year in terms of how does it translate into revenue. But as we enter the later half -- later this year and on into next year, we're very optimistic about the velocity that the PowerStore will continue to drive. And customers are very favorable with their impressions of it. So, so far, so good. But there's -- we're going to have to continue to make progress here.

And Tom, sticking with the infrastructure market. Your margins were much, much stronger and richer than expected. And this was despite revenue pressures and inflationary environment where components cost a lot more in the first half of the year compared to past historically, or when memory prices trailed down. What's really driven the margin improvement? Because it just seems like the whole world would see margin compression, yet Dell saw margin better than expected, which is great. But I can also wonder, not only what's driving it, is that kind of as good as it gets? Or is there still margin expansion opportunities?

Yes. Look, you did see operating margins clearly remain strong or stayed up as we worked our way through the first half of the year. I would tell you that, in many respects, we benefited -- or the operating margins benefited from the OpEx controls that we put in place. We talked about that in our Q1 call, Jim, if you recall, right, where we talked about the fact that we were limiting backfill. We were going to -- T&E, as most companies, there's not much of that going on now. We've limited consultants and contractors. We suspended our 401(k) match. All hard decisions and tough decisions, but we thought appropriate decisions to protect the P&L and protect the liquidity of the company, particularly given the uncertainty in the demand environment. And so that OpEx control obviously benefited the P&L. We saw it in Q1 and again in Q2. So I think in the immediate, that's clearly been helpful. Some other trends that I'd highlight for you, though, Jim, as we think about mix of product and mix of the various solutions is, we have seen growth in our high-value workloads and in those servers that customers buy for AI/ML-type capabilities. And they tend to carry a higher ASP, which generally translates into higher margins. So we've seen good, positive trends there as well. We're also very focused on some of the as-a-service and recurring revenues, which carry a higher-margin dynamic as well. So there's a number of trends that are working their way through the business. But I think what we're navigating right now or what we're very much focused on is how do we drive and sustain margins, at the same point in time, expand those areas that customers are seeing are focus areas for them, the as-a-service offerings, some of the new storage solution capabilities which carry a nice margin with it. So it's a mix of areas, Jim, to be honest, but very pleased with the result to date. And I think the team's done a really nice job of sort of navigating the environment to help our customers.

We have PCs in the later half of our discussion here because I often find myself reminding investors that Dell has a more outsized exposure to commercial PCs versus [ consumer PCs ], if I'm correct. So going back to school is a little bit disproportionate favor as opposed to returning back to work. So are you -- am I still right on that as far as a lot more exposure to commercial versus consumer? And are you expecting the trends to improve going forward as economies start to [ up and ] start to come back to employees coming back to work? Or what's your view on the PC sector and Dell's positioning?

Yes. Jim, look, I do think you're correct in the sense of if you think about the long-term dynamic, we're very much focused on the commercial PC. We think that's where the profit pool is. The fact that we have a direct selling organization allows us to do the attach motion to attach services, cross-sell. So all of that -- platform, the commercial PC platform, is a very stable and profitable business for us and generates really nice cash flow. There obviously are some dynamics that we've had to work our way through as we've come through the pandemic. We saw strong corporate PC growth in Q1, principally the notebook. The desktop clearly suffered as customers moved to mobility products. We saw that softness continue into Q2. We saw the corporate PC space soften in Q2, but yet we saw the acceleration of government and education as we worked our way through our Q2. And we also saw the acceleration of the consumer space, to your comment around learn from home. And so we saw really good growth in our consumer business. Our consumer direct online, for instance, was up 79% year-over-year. And so as we move now into Q3, as we've talked about on the call, we continue to see some of the mix dynamics in the PC space, where education and government continue to remain strong in the PC space, and the consumer space remains quite strong. We do think, over time, the corporate PC bounces back and we -- and that is the area of focus in the longer term that's of interest to us, given the profitability profile. But the reality is, is that you can't control the market and you need to take advantage of the market opportunities that are there. And to date, you look at government and education, which are quite strong, and we're going to push on those as well as take advantage and serve our consumer/customers, principally consumer through our direct selling motion, which we think is quite strong and very beneficial. So we'll see how the rest of the year works its way out. But long term, we're optimistic about the corporate PC. But clearly, lots of short-term or intermediate demand in the education space and in the consumer space at this point.

I imagine the component costs are a large feature also. So maybe can you give us your -- first of all, walk us through, when memory prices go up or down, and I'm sure it has to do with magnitude of the slope. Is it like a 1-quarter delay? Or does it hit you or help you right away? Do you pass all that through or some of it through? And again, it depends upon the magnitude of up or down on those components. Can you walk through investors about how that impacts Dell's margins of components and kind of what you kind of expect going forward for component pricing?

Yes, I'm happy to, Jim. And you know that there's a couple of product lines that are quite sensitive to component cost changes, right? Our PC space and in the server space tends to be quite sensitive. And let me remind everybody that last year, we saw unprecedented deflation, if you will, in the component cost. And from a Dell model, let me remind everybody that, one, we don't carry -- our inventory positioning is, given that we're a direct selling organization, tends to be less. So therefore, in a component cost deflation environment, that tends to be quite beneficial from a margin perspective, which is what we saw last year with our PC and servers. And memory costs were quite deflationary. They flipped to inflationary this year and were inflationary in Q2. And so in that type of model, what tends to happen, is that you've got to price the memory, and therefore, it tends to be a suppressant on operating margin until you can adjust pricing appropriately. And so that dynamic continues to be one that continues to -- year-over-year was a bit of a challenge. As we look forward, as we talked about on the call, Q2 was inflationary. And we think Q3 will be slightly inflationary, but we then think that memory flips to deflationary in Q4. And we talked about that on the call, given the demand environment that we're seeing. So -- and so what do we do about that? Well, it's all about how do you adjust your pricing and how do you adjust configuration strategies to ensure that, one, you're providing customers with the configurations that they need, but we're optimizing margins to the extent that we can. And as we talk -- when we make a list price adjustment, we tend to realize about roughly 50% to 60% of that list price adjustment in any given quarter, just given the flow around quotes and things of that sort. So that's the dynamic we're in right now. And component cost, as I said, for both our servers and PCs are -- those are the 2 principal areas where we see sensitivity.