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

Hello, everyone. It's so great to virtually see you. I'm Jim Suva, the IT hardware analyst here at Citigroup Investment Research. We're very pleased to have this keynote presentation and interactive discussion with Dell Technologies, stock ticker D-E-L-L. It will be myself as well as the Chief Financial Officer, Tom Sweet. A few housekeeping items. First of all, no media and no press. If you're a media or press, please disconnect immediately. If you are an investor subject to MiFID II, please ensure you have the applicable agreement in place. We do now have a few comments about disclosures. There are disclosures on the Citigroup Investment website, also known as Velocity as well as when you logged in and are available. I need to read the Dell safe harbor statement. 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 a 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. And I would note that is also on Dell Technologies Investor Relations website.

So first of all, Tom, I got to apologize. I wish we were doing this as a keynote in front of lunch, in front of over 1,000 investors, but they're all connected virtually. So sorry that it's not in person. But I can say what's interesting though is a lot of things have been changing. And as you CFO, as we start looking at getting closer to the spin-off and the core business becomes the focal point for you as a CFO, do you think about the business any differently?

Jim, let me just say it's great to be with you. I agree, I would rather do it in person, but it's good to see you virtually, and thank you for the invite to chat today. So look, I think if nothing else, the pandemic, as horrific as it has been over the last 18 months, has taught us is that technology has never been more essential, right? And we've seen the trends and all the way from the PC, which became a key capability as you think about work from home, learn from home and then the capabilities that customers need in their data center as they think through the technology trends that are continued to impact their business and the modernization that they're doing around their business model. So we're excited about the IT trends that we're seeing. We think about the world as multi-cloud. Our customers are looking at us to help them make that transition and manage their environments and drive outcomes. Our core markets, which to your point, if you think about Dell post-spin, our core markets are large markets, $1.3 trillion TAM. So there's ample headroom, I think, to position the business properly and to continue to grow. As you know, Jim, we have #1 positions in all of the categories that we compete in, right? We're #1 in client business revenue, #1 in external storage, #1 in converged and hyperconverged, #1 in server units and revenue. So we have a very broad and expansive portfolio. So -- and we're excited about the growth opportunities that we see, whether that's in telecom or in edge, as we think about data management, data services, those adjacent TAMs we think, are pretty interesting for us. And so if you step back and think about it holistically, great market opportunity, expanding TAM opportunities. We think we have a set of durable competitive advantages, given our scale, our services capability. Clearly, our supply chain, I think, has been doing a really nice job positioning the business. And you put that all together, and we're pretty pleased with our positioning. And we do think that we're going to be able to take advantage of some of these emerging growth trends and the continued expansion of the technology buying that we're seeing right now. So optimistic about the future.

And Tom, you just closed a recent quarterly earnings results. How would you characterize Dell's performance?

Look, I was -- and my team teases me from time to time, Jim, I was actually pleased with the quarter, right? You think about what we were able to accomplish in a pretty dynamic environment, given the supply chain challenges and the shift in demand, if you will, to a certain extent. And so we had an excellent quarter. We set a Q2 quarter -- second quarter revenue record at $26.1 billion. We saw our client business grow 27% year-over-year. Our infrastructure business, our ISG business, grew 3%. We saw very strong operating income growth. And so very pleased with that. The demand environment remained healthy. I think we grew in all of our categories, quite frankly, from a demand perspective. We saw -- as we entered the year, Jim, if you recall, what we talked about was the fact that we saw a healthy client environment as we entered this fiscal year that we're in. And we also saw an improving infrastructure environment, and that proved to be true. And in the second quarter, we saw our server and networking business grow 6%. We saw our storage business on a demand basis grow 2%, relatively flat to minus 1% on a shipped basis. We're continuing to take share. So look, I think across the portfolio, all those things that we can do better, but very pleased with what we're seeing and very pleased with the storage results that we saw last week from a share perspective, where we gained 193 basis points of midrange share, which is an area of focus for us with our new PowerStore offering. So all in all, I think we delivered. We've got to continue to work and the market continues to be dynamic, but pleased overall.

And during your last earnings call, you did mention a little bit on the outlook about above seasonal outlook. What's underlying that? And is it different in different geographies or different parts of your portfolio?

Look, I mean, as we exited Q2 and we're obviously in the midst of Q3, but we looked at the business, we looked at the demand environment, we looked at our -- where we were on backlog, when we talked about the fact that we had elevated backlog, just given the supply chain dynamics that we're working our way through. And we put that together and looked at the business. And from our perspective, we do see higher than normal historical sequentials from a revenue growth perspective. And we're -- and that was our guidance. You look across the environment that the demand continues to be healthy. The commercial demand, which we saw accelerate in Q2, leaves us optimistic for the rest of the year around the commercial environment. I think we're well positioned in the consumer PC environment as well. And look, I think the ISG business, as we expect, continues to, I think -- as we thought in the guidance, it continues to be improving as we go through the year. So you put it together and you say, okay, it feels like a pretty good quarter for us. Obviously, challenges that we've got to go drive and continue to execute against. But overall, pleased with the state of the demand.

Tom, I've known you for a long time and I've covered Dell for a long time. And I feel like we've been talking about supply constraints for a long time. A couple of years ago, it was CPUs. Sometimes, it was memory modules. And whether it be trade wars, a boat stuck in a canal sideways, a pandemic popping out, I feel like every year, we're talking about these kind of -- so is your outlook being impacted by supply constraints today? And if so, is it more on CSG or ISG or both?

Yes. Jim, great question. Look, our outlook is, obviously, we take into consideration where we are from a supply chain perspective. And you're right, you just listed sort of a litany of things that we've all navigated over the last number of years. And there continues to be challenges in the supply chain, given the shortage of semiconductors across not only our industry, but multiple industries, and the logistics chains, which are challenged, if you will, in terms of availability, cost and capacity. But again, I'm going to come back to one of our durable competitive advantages, which is our supply chain team does an outstanding job of coordinating and working with our supply base. We do, Jim, have a very large buy on an annualized basis. We're somewhere around a $70 billion spend a year, which is the largest in the industry. So that allows us to have, I think, very intimate conversations with our supply chain. We're flashing demand forecast to them well in advance so that we can continue to talk, think our way through and navigate the lead times on components. But clearly, what we've seen year-to-date is that through the second quarter, has that, the demand has outpaced our ability to pull supply in. And as a result of that, our backlog has grown. So look, we're not seeing cancellation rates change on us, which is something we monitor very carefully. And if you looked at the RPO statistics, as we talked to the remaining performance obligations, which we talked about in our earnings call a few weeks ago, you saw that, that increased, which was principally around backlog. So look, yes, it -- is our guidance being impacted by supply chain? Yes. But I think the team is doing a nice job of navigating through it. And that's what they pay us to do, which is to go execute and make sure we deliver the results.

Are you concerned at all about any double ordering in this situation with supply constraints? It's kind of natural to say, hey, maybe I order ahead or pull in some demand from future periods in the quarter or 2 ahead.

Yes. Look, it is something we watch and we think about a lot. But that gets back to my comment around cancellation rates, Jim. We haven't seen cancellation rates move on us. So they're relatively in line with historical rates, which gives us some assurance that we're not seeing a lot of double ordering, we're not seeing orders being placed and then canceled as customers potentially go to other avenues to get their technology needs. And so I think the industry, in general, is working its way through supply constraints. And obviously, we have them as well. You can look at lead times and how we're managing our way through that. But to date, we haven't seen a lot of evidence of double ordering and higher than normal or higher than historical cancellation rates.

Overall, every company on Monday, Tuesday and even today on Wednesday, has been talking about higher component costs. And while Dell is a very large company with large purchasing power, I think it's fair to talk about component costs. Are you doing some actions to try to mitigate it? And does higher component cost impact CSG more or ISG more? Or is it impacting them both?

I would say that we're not immune to the overall environment. So as we talked about on our earnings call, we have seen -- we saw component costs turn inflationary in Q2. We talked about on the call that we expected and see component costs being inflationary in Q3. In fact, the rate of inflation picked up from Q2 to Q3. So we are impacted by it, and it impacts both our client business and our infrastructure business, principally servers. And we're seeing the higher costs come through in areas like memory, SSD drives, displays have been impacted. And we're working our way through it. What have we done about it? One of the great advantages we have, Jim, is we have a direct model, right, where over 50% of my revenue is coming in from my direct sellers. And therefore, our ability to adjust configurations to what we have and optimize configurations, and I think is quite strong, and the team has executed well on that. We -- as we look at component cost increases and those higher input costs, we did make price adjustments for Q3 to ensure that we pass through some of those higher costs. Those have generally been well received. No customer likes to hear that their prices are going up, but they understand the environment. And so it's a lot of basic execution around making sure that our teams have the latest points of view on cost and how we need to price and working with our customers on configuration management. You put all of that together and that's the playbook that we're running to make sure that we're being as effective as we can in what is a challenging cost environment.

Tom, maybe if we can take it a level into more details, maybe let's start off with your PC segment. During COVID, we bought more PCs for my home, more on the consumer side. Now that I'm starting to go back to work, my desktop camera isn't as great a quality, the sound isn't as good. We're doing some upgrades on the enterprise side. Can you talk about PCs? Because many investors who I've known for 2 decades talk about a cycle and are fearful post-COVID of a big cliff falling off in demand for PCs. So can you talk about PCs?

Yes, happy to, Jim. And look, you and I have been talking PCs for a lot of years, right? And there's been various forecasts around the PC is dead and nobody's going to buy PCs anymore. But I think the pandemic has made everybody -- has sort of reset everybody's expectation that the PC is still an essential device and how you work from home or work remotely and how you learn from home or learn remotely. And as well as an entertainment device and a gaming device. And so we've seen, obviously, as has the industry, a resurgence in PC demand. And we actually think the PC demand has been re-rated. Pre-pandemic, we were somewhere around 260 million units a year on a go-forward basis. If you look at some of the IDC forecast and some of the other industry analyst conversations, you're going to see PC demand somewhere in the 330 million, 340 million units a year on average as you go through the next number of years. And so you're right, we saw penetration for household go up from 1 PC per person or 2 PC -- I'm sorry, 1 PC or 2 PCs per household to everybody in the household having a PC. The pivot to mobility, the work from home, learn from home, that's driven more notebook. The mix of notebooks has jumped up. Notebooks have a faster replacement cycle. And as you move back into the office with many of the customers going to hybrid, you're walking into, in many respects, PC estates that are 7 or 8 quarters aged. And so the technology needs to be refreshed. And so you put that all together, and we're very optimistic about the future of PCs, not that we won't have some ups and downs within the cycle, but over the long term, we believe that it's a sort of a growing market, a sort of low single-digit growth over the next 3 to 4 years, if you look at, say, the IDC forecast. And I think we're perfectly positioned to take advantage of that. Remember that, Jim, our mix is principally focused on the commercial PC, right? So roughly 70% of our revenue mix within the CSG business is directed at the commercial business, 30% consumer. We're #1 in commercial PC revenue. And so we're excited about the opportunity there as well as think about the PC as a platform. You mentioned it in your opening, in your question just then around, okay, but not in addition to the PC, what's the peripherals around the PC, which are highly profitable, right? And I'm attaching cameras, wireless keyboards and mice, I'm putting monitors there. I'm -- so there's just -- and I'm attaching services or financing. So we're pretty excited about the revenue opportunity and quite frankly, the stability of the profit and operating margin there as we go forward.

And if we look at your other segments, switch it over, say, ISG, can you talk about what factors are driving strength there, kind of near to midterm in ISG?

I think that goes back, Jim, to the trends we're seeing in the market, which is a year ago, when we were sort of in the depths of the pandemic, we saw customers pivot their budgets from data center and infrastructure to worker productivity, right? So they pivoted a lot of dollars towards the workstation or the PC environment. What we've seen as we got through last year and on and this year is a resurgence of investment back into the data center as companies are thinking about how do they modernize, how do they take advantage of the data that -- the data growth that they're seeing in terms of applying compute resources to drive analytics and advanced analytics against that data set. So we're seeing improving ISG demand, as we highlighted in Q2. A lot of demand now, server demand, compute demand has been quite strong. And so we're positive around that. We've seen an improving storage demand. We highlighted in our second quarter call that we just did that. Storage demand was up 2%. If you break that apart, what you would see is our mid-range demand, which is the biggest part of the external storage market was up 17%. Have a bit of headwinds on the high-end storage where we have a fair amount of exposure to, but that tends to be a bit cyclical and so very strong last year, a little less strong this year. But overall, I think we're pleased with the trends we're seeing and the customer interactions we're having as they continue to invest in modern infrastructure. They continue to invest in multi-cloud and they're looking for an essential technology partner like ourselves to help them on that journey as they digitize their business. So I think overall, we're feeling -- we're -- we feel pretty good about the ISG environment.

Tom, there's been a lot of talk at our conference about more flexible model, pay-as-you-go, pay-as-you-consume, flexible consumption, whether it be on storage, MIPS processed, maybe even hours used in a data center or even rent a PC or something like that. Can you talk about more of a more flexible consumption model? And would that have any impact on your financials?

Yes. And we've talked about this a lot over the last number of years, Jim. We -- our goal is to make sure that we offer our customers choice in how they want to consume our technology solutions, whether they want to buy it in a CapEx model, whether they want to buy it in a financing structure or whether they want to consume it on a demand or on an as consumption type model, which gets into -- and we've been offering various consumption type models for a number of years through DFS with our Flex On Demand. But as we think about how do we move forward and give our customers a more modern experience consuming technology, procuring technology and driving more of an outcome discussion versus a speeds and feeds discussion, that's the whole pivot to APEX, which is we think about the flexible -- the modern flexible consumption model that allows customers to go into a console and drive -- with a few clicks of a button, decide what type of outcome they want, what kind of SLA they want and how they -- and then turn that over to us in terms of providing a managed storage service or managed data center utility type model. And I think from a financial model, if you look at trends in the industry and trends, particularly in the data center, it suggests that as a service or consumption type models are going to continue to be a much more important part of the overall economic environment going forward. And so again, we're back to how do I ensure that I'm providing customers that opportunity to consume our technology in that fashion. And that's the whole impetus around APEX. We've talked -- it's early innings yet. So from a financial impact, there's really -- it's not a relevant conversation until we see the velocity and the growth of that. And so my whole goal right now is let's push this really hard, let's drive the velocity and as a service. I obviously like it from a stability of revenue, stability of cash flow framework, and we'll provide the appropriate commentary and guidance as this gets to of size where it becomes noticeable, if you will, or impactful in the financial statements. But for right now, it's early innings. And so we're focused on learning -- engaging customers and ensuring that we learn what they need, and we adjust the offering appropriately. And again, we'll update the investor and analyst community when it comes to be a point where it's at a size where we should be talking about it.

And Tom, your company has been pretty public about your spinout. Any milestones we should be thinking of or looking at to gauge the temple or mile markers?

Yes. Jim, we talked about it in the earnings call a few weeks ago that we were targeting early November to complete the spin. We do have a big milestone that we have yet to close in our contingency, if you will, on the spin, which is the process to obtain a private letter ruling from the IRS on the tax-free nature of the spin to the Dell shareholders. And that's in process. Teams are working very closely with the IRS and every -- the information we have, we believe it's on track, but we -- that's still an outstanding item. Absent that -- so that's got to get completed successfully, obviously, to move forward, and we're optimistic about that. But it's not done until it's done. In addition to that, we're continuing to work very closely with VMware, just on sort of the innovation targets that we've agreed to, the go-to-market motions and tying down sort of the last [ 2 sims ] on that. But I think I would tell you that everything is proceeding as planned. And I feel good about where we are at this point, Jim. So we've got to get through the remainder of these open items, but I still believe that the early November time frame is the right time frame to be thinking about.

And Tom, as Chief Financial Officer, capital allocation is very important to you because your CEO in Michael would love to spend more in certain areas. Yet you look at capital allocation, whether it be your debt rating agencies. We think about there's other ways to deploy capital, M&A, stock buyback and dividends. How should we think about capital allocation, especially kind of post-spin or core Dell?

Yes. Jim, we've been fairly public that post spin, we would evolve our capital allocation framework, right? And as a reminder to everybody, over the last 5 years, I think roughly 95% of our free cash flow has been devoted to debt repayment. And we paid down something in the neighborhood of $25 billion of core debt over the last 5 years to current time. And the spin transaction itself will provide for some dividends up to Dell Technologies, which we'll use to further pay down debt. So we'll pay down something if everything goes as planned, at least $16 billion of debt this year. And so our conversations with the rating agencies and the cash generation strength of the business, we feel good about getting back to investment grade. And so you pulled back and say, okay, so what happens post investment grade? And we'll talk more about it next week at our analyst meeting in a bit more detail. But I would tell you that we're going to broaden out our capital allocation. We will look at a shareholder capital return program, which will include elements of the dividend, elements of share buyback. Week-to-date, we generally haven't done a lot of, say, M&A and transactions over the last 5 years since EMC transaction. We will bring forward or put in place a targeted M&A framework that we'll be focused on where do we need IP or technology or other capabilities to further drive our growth areas, whether that's in telecom or edge or advanced storage capabilities or so be it. I don't think you should expect sort of large-scale M&A transactions out of us, that's not how we're thinking about it at this point. But you should expect us to be a bit more active in the M&A space, and we'll continue to invest in the business. So we'll talk more about it next week. But I do think that getting back to investment grade, which has been the journey we've been on and what we told investors now for a number of years around buying or paying down debt is probably the best use of cash that we can do to get the company back where we want it and remove that overhang from a valuation perspective. And I think our say-do ratio there has been quite strong. So I'm pleased with where we are, and we'll talk some more about it next week.

Yes. Tom, and if my memory is correct, I think your Investor Day is on September 23, and you've mentioned next week, but I think it's actually the 23rd. And during COVID though, many companies have kind of stopped giving investor days because they like to do it in person, and we really can't meet, although I'd love to come to Austin and see you in person. But why have an Investor Day during COVID when it's -- everything is virtual?

Jim, I think it's important to sort of -- I don't know if reset or reeducate or ensure that the investors and potential investors understand what Dell Technologies looks like post spin, what's our strategy, how do we think about our long-term financial framework and how do we think about capital outlook. So we collectively feel like now is the time ahead of the spin transaction to get out and have a conversation with our investor base and potential investors and our analyst community around what is Dell Technologies post-spin, what's our strategy, what's our -- how do we think about growth and opportunity. We -- I think we've done a nice job of navigating the dynamics of the environment. I think the execution focus of the management team and the organization has been quite strong. And so I think it's an appropriate time to have a conversation around what's the future look like from our point of view and having a conversation with our investors around here's how we think about the business. Here's how we think about the opportunity, here's how we think about the financial framework. And so I'm hopeful that it will be a positive. I think it will be a nice conversation next week.

Tom, you literally have hundreds of people connected to this webcast, which I know you can only see handsome me there. But aside from that, can you maybe use this opportunity before we wrap it up about what gets you excited about Dell? But maybe to educate investors on the maybe 1 or 2 questions you get asked the most, to clarify with such a large audience and educate them about 1 or 2 things that you get asked most frequently as Chief Financial Officer.

Yes. Jim, let me -- it's a great question. Look, I think I would say the following. If we look at the business and the markets that we compete in, very large markets, $1.3 billion TAM. Interesting adjacent markets like telecom and edge that we think add incremental growth opportunities. One of the -- and so the point is that these markets aren't going away, and there's headroom in these markets for us to continue to drive a consolidation play, an organic consolidation play if you look at our share gains over the last number of years, both in PCs and servers, midrange storage, hyperconverged infrastructure. I just think that what we have said we were going to do, we've been doing. Obviously, I'd like to do a bit better in overall storage, and that's an area of continued focus for us. But the opportunity to continue to grow in those core markets, I think, is pretty interesting. And then you add the adjacent areas of potential incremental growth. I think I get lots of questions around can you grow, can you grow consistently? And I think the markets are there. We got to go execute, but the opportunity is clearly there. The demand is not -- if you look at sort of intermediate-term demand forecast or technology spending forecast, the infrastructure business sort of mid-single-digit CAGR growth over the next 3 to 4 years. PC is sort of lower single digits, but growing, right? And so the PC demand is not going away over time. We feel good about that. That's sort of whole area has been re-rated. The world is not going to public cloud, Jim. The world's pivoted to multi-cloud, which has been where we thought it was going to go for a number of years. And so we are the best positioned company from -- a technology infrastructure company to help customers on that multi-cloud journey and optimization of their workloads and data. And then you look at our capital allocation framework, which allows for shareholder return, allows for continued investment. And you look at the execution ability of the organization. And again, step back and think about what we've been able to do over the last 5 years. We talked about the fact that we wanted to grow revenue at a faster pace than our -- grow revenue and then grow up EPS at a faster pace. We've done that. We've paid down debt. We've taken share. We've simplified the organization. So I think we've got a pretty high say-do ratio in terms of creating value for our shareholders. And my message is I think there's more value to be created there. Now we've got to go earn it and drive it, but these are pretty interesting value creation opportunity ahead for us. So I'm excited about the future.

Well, Tom, you answered both of my questions about the clarifications as well as what gets you excited about the future. I sincerely want to thank Tom for joining us here today as Chief Financial Officer of Dell Technologies, and remind everybody that on September 23, the company will be hosting an Investor Day. And this year, it is virtual, and we hope that you can attend it as virtually, I will also. Tom, any last parting words you'd like to share with this large audience?

Just say, hey, thank you for taking the time to check in with us today. Jim, thanks for having us, right? We always appreciate it. And look, we're excited about the opportunities ahead for Dell Technologies. And we look forward to chatting with and seeing you guys next week at our analyst meeting.

Great. Thank you so much. And good to see you, Tom. Hopefully, next year, it's in person, on stage, in front of everybody, live.

Be fun to do. Look forward to it, Jim. Thank you.