Dell Technologies Inc. (NYSE:DELL) Q3 2023 Earnings Call Transcript

Dell Technologies Inc. (NYSE:DELL) Q3 2023 Earnings Call Transcript November 21, 2022

Dell Technologies Inc. beats earnings expectations. Reported EPS is $2.3, expectations were $1.6.

Operator: Good afternoon, ladies and gentlemen. And welcome to the Fiscal Year 2023 Third Quarter Financial Results Conference Call for Dell Technologies Incorporated. I’d like to inform all participants that this call is being recorded at the request of Dell Technologies. This broadcast is the copyrighted property of Dell Technologies Incorporated. Any rebroadcast of this information in whole or part without prior written permission of Dell Technologies is prohibited. Following prepared remarks, we will conduct a question-and-answer session. I would now like to turn the call over to Rob Williams, Head of Investor Relations. Mr. Williams, you may begin.

Rob Williams: Thanks everyone for joining us. With me today are Jeff Clarke, Chuck Whitten, Tom Sweet 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 revenue, 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 webdeck and our press release.

Growth percentages refer to year-over-year change unless otherwise specified. 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 webdeck and our SEC filings. We assume no obligation to update our forward-looking statements. Now, I’ll turn it over to Chuck.

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Chuck Whitten: Thanks Rob. We delivered very good results including strong ISG revenue with record profitability and good CSG profitability, despite the difficult demand environment that we highlighted in our last earnings call. The net of our disciplined execution was Q3 revenue of $24.7 billion, down 6% with record operating income of $2.4 billion and record diluted EPS of $2.30. ISG revenue was $9.6 billion, up 12% while CSG was $13.8 billion, down 17%. From a macro perspective, Q3 played out as we previewed last quarter, soft underlying PC demand and slowing infrastructure demand, though storage did hold up fairly well relative to servers with growth in multiple storage types including high end and PowerStore. Our Q3 performance underscores our strategic focus, the advantages of our model and our ability to deliver differentiated results in any market environment.

Our unique sales model provides direct real time feedback from customers of all sizes and across geographies and industries, which allows us to see the demand environment shift faster than the rest of the industry. And as the demand environment changed, we reacted quickly and decisively, which showed in our results. We took actions to reduce costs, decreasing our operating expense 3% sequentially in Q2 and another 6% sequentially in Q3. We have now reduced quarterly operating expense by over $300 million since Q1. We reduced server backlog consistent with our Q2 commentary and delivered strong profitability as our model allowed us to access component cost deflation faster than the rest of the industry. And we stayed focused on relative performance in the most profitable segments of the market.

Despite some expected distortions in the PC market given elevated competitor backlog, we continued to gain commercial PC unit share in Q3 and have now gained share in 35 of the last 39 quarters. In ISG, we expect to extend our industry leading share positions in servers and storage when Q3 IDC results are announced in December. And we executed on all of the above without compromising our innovation agenda with 30 infrastructure launches in the last 13 weeks, including six new Dell APEX offerings, in strategic areas like multicloud, edge, and subscription and as-a-service. We’re excited about the launch of Project Frontier, our initiative to deliver an edge operations software platform focused on unifying edge operations across infrastructure and applications for a broad set of industries.

And earlier today, we announced the availability of PowerFlex, our flagship software defined storage solution, on AWS. With a cloud-first design point, PowerFlex on AWS is the first of Dell’s industry-leading storage offerings available in the public cloud as part of Project Alpine, our effort to bring our industry-leading storage software to public clouds to provide multicloud data mobility and simplify data management. It will enable customers to use Dell’s storage software capabilities and APIs wherever their data resides, without the need for purpose-built or specialized public cloud infrastructure. Our new Project Alpine related SaaS offerings will add to our growing portfolio of APEX solutions while enabling our customers to harness the power of multicloud.

Stepping back, the near-term market remains challenged and uncertain. On one hand, we are seeing some customers delay IT purchases. Other customers continue to move ahead with Dell given the criticality of technology to their long-term competitiveness and a growing need to drive near-term productivity through IT. The world continues to digitally transform, data continues to grow exponentially, and customers continue to look to technology to drive their business forward, no matter the economic climate. As the market leader in commercial PCs and infrastructure, we are well positioned whether a customer is seeking to drive growth, productivity and efficiencies, or a combination. We’re trusted advisors to our customers, and we have a business model that allows us to adjust quickly to meet their needs.

So, we are very confident in our ability to adapt and deliver results despite the near-term uncertainty. Q3 was proof of our underlying advantages and ability to execute no matter the environment. As always, we’ll continue to focus on what we can control: taking care of our customers, driving differentiated relative performance, delivering against our innovation agenda, managing our cost position, maintaining pricing discipline, and building a unique and winning culture with our team. This is the playbook that has served us well across multiple cycles, and no matter the backdrop, we intend to accelerate our strategic position, as we did in Q3. Now I’ll turn it over to Tom for the financials.

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Tom Sweet: Thanks Chuck. I’m pleased with our Q3 P&L performance despite the tougher near-term demand environment. As Chuck mentioned, we highlighted the softening environment and slowing ISG demand in our Q2 earnings conversation, and the third quarter generally played out as we expected, albeit with server demand velocity slowing a bit more than we anticipated. We continue to focus on executing our strategy to win in the consolidation and modernization of our core markets and we have executed well over the last few years and again in Q3. In ISG, we’ve grown our revenue for seven consecutive quarters and have grown our revenue at a 3% CAGR since fiscal year 20. We have been consistent structural share gainers in servers where we are number one, gaining 530 bps over the last 5 years in mainstream server revenue per IDC.

In storage, we are bigger than two and three combined, and with our refreshed storage portfolio, we have added to our number one position, gaining share over the last two quarters, and anticipate gaining share in both storage as well as servers again this quarter when IDC results come out in December. Our CSG business has grown at a 12% CAGR since fiscal year 20. As Chuck mentioned earlier, we have gained Commercial PC unit share in 35 of the last 39 quarters including Q3. Turning to our Q3 results. We delivered revenue of $24.7 billion, down 6% with strong ISG performance, particularly in servers. We reduced total backlog by $1.2 billion sequentially during the quarter with CSG backlog now in a more normal range and ISG backlog slightly elevated year-on-year, but substantially reduced from the beginning of the quarter.

Profitability was strong in Q3. Gross margin was $5.9 billion, up 2% and 23.7% of revenue. Gross margin percentage was up 2 points, primarily due to a favorable mix shift to ISG and a decrease in our cost of goods sold due to certain components turning deflationary along with declining logistics costs. FX remained a headwind and impacted revenue by approximately 420 basis points. Q3 operating expense was $3.5 billion, down 8% and 14.1% of revenue as we slowed hiring and reduced discretionary costs given the current macro environment. As a result, operating income was a record $2.4 billion, up 22% and 9.6% of revenue. Our year-to-date tax rate decreased to 18.2%, primarily due to geographic mix of income. Q3 net income was $1.7 billion, up 30%, primarily driven by growth in operating income and a decline in interest expense due to our lower debt balances.

Fully diluted earnings per share was a record $2.30, up 39% with diluted share count decreasing sequentially to 743 million shares as a result of share repurchases in Q3. Our recurring revenue is approximately $5.4 billion a quarter, up 11%. Our remaining performance obligations, or RPO, is approximately $39 billion, down Y/Y due to a decline in backlog partially offset by an increase in deferred revenue. Turning to our business units. In ISG, Q3 revenue was $9.6 billion, up 12% driven by a reduction in our server backlog, consistent with our Q2 call commentary. Servers and networking revenue was $5.2 billion, up 14% and Storage revenue was $4.4 billion, up 11%. As mentioned, we did see softening unit demand in servers somewhat offset by higher average selling prices given richer configurations driven by customers running more complex workloads.

ISG operating income came in at a record $1.4 billion or 14.3% of revenue, which was up 390 basis points as we benefited from scale with lower operating expenses and pricing discipline. Our Client Solutions Group revenue was down 17% to $13.8 billion, primarily due to underlying softness in both Commercial and Consumer demand. Commercial revenue was $10.7 billion, down 13% and consumer revenue was $3 billion, down 29%. Average selling prices trended higher in both Commercial and Consumer as customers bought PCs with richer configurations. CSG operating income was $1.1 billion, down 7% primarily due to scaling, partially offset by stronger gross margin percentage and lower operating expenses. CSG operating income was 7.7% of revenue. Dell Financial Services originations were $2.3 billion, up 17% with strength across geographies and DFS ended the quarter with $13.8 billion in assets.

We have historically seen stronger originations, and more recently an increasing interest in subscription models, as the macroeconomic environment slows. Turning to our cash flow and balance sheet. Our cash flow from operations was approximately $400 million in Q3 and is $3.9 billion on a trailing twelve month basis. Q3 cash flow was helped by profitability but offset by the sequential revenue decline in the P&L and a use in working capital. Within working capital, inventory was up sequentially as we strategically accelerated purchases of some key components as we continue to navigate through supply chain dynamics. Improving working capital efficiency and reducing inventory remains a priority. Our core debt balance is $16.2 billion and our core leverage ratio is 1.6x.

We ended the quarter with $6.5 billion in cash and investments, down $600 million sequentially principally due to $800 million in capital returns. Turning to capital allocation. We repurchased 16.3 million shares of stock in Q3 for $609 million and paid $238 million in dividends. In addition to our $1 billion annual dividend, since the beginning of our current share repurchase program, we have bought back 70.3 million shares for $3.36 billion. Going forward, we will continue our balanced capital allocation approach, repurchasing shares programmatically to manage dilution while maintaining flexibility to be opportunistic. Turning to guidance, considering the demand environment, we expect Q4 revenue between $23 billion and $24 billion, down 16% at the mid-point, with ISG roughly flat.

Similar to Q3, currency continues to be a headwind for us. We are expecting a roughly 500 basis-point impact to Q4 revenue. We continue to be focused on managing cost, however, we do expect to see a roughly $150 million OpEx increase sequentially given the extra week in our fiscal Q4. We expect our interest and other expense to be up $60 million sequentially driven by interest rate volatility and the impact on our derivatives portfolio. For our non-GAAP tax rate, you should assume 22% at the midpoint, which reflects a 19% plus or minus 100 basis points rate for the full year. We expect our diluted share count to be roughly 730 million 735 million shares. Netting this out, we expect diluted EPS in the range of $1.50 to $1.80, down 4% at the midpoint.

I recognize that many of you have questions about our view on fiscal year 24. It’s still early in our annual planning process. However, I’ll frame our current thinking. We expect ongoing global macroeconomic factors including slowing economic growth, inflation, rising interest rates and currency pressure to weigh on our customers, and as a result, their IT spending intentions even as they continue to digitize their businesses. These dynamics are creating a broader range of financial outcomes for our upcoming fiscal year, particularly as we think about the second half of the year. With what we know today, it’s likely next years’ revenue is below historical sequentials using our Q4 guidance as a starting point. In closing, we delivered strong third quarter financial results.

We have strong conviction in the growth of our TAM over the long-term even though some customers have paused purchases in the near-term. And we are committed to delivering our value creation framework with a revenue CAGR of 3% to 4%, a diluted EPS CAGR of 6% plus, and a net income to adjusted free cash flow conversion of 100% or better. Since fiscal year 20, our revenue has grown at an 8% CAGR, our diluted earnings per share has grown at nearly a 20% CAGR and we have exceeded our net income to adjusted free cash flow target in each of the last three fiscal years. We have also committed to return 4% to 60% of our adjusted free cash flow to our shareholders over time and have returned $4.1 billion of capital to our shareholders over the last 12 months through share repurchase and dividends.

We will continue to be disciplined in how we are managing the business and our financial posture in this complex macro environment, focusing on what we can control and helping our customers along their digital journey. Now, I’ll turn it back to Rob to begin Q&A.

Rob Williams: Thanks, Tom. 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.

Q&A Session

Operator: We’ll take our first question from Krish Sankar with Cowen and Company.

Krish Sankar: Yes. Hi. Thanks for taking my question. And Chuck, I’m just kind of curious, you mentioned about how the IT spending is softening. What do you see across the ecosystem? Is it across all enterprises, the large and smaller ones? And within that, where do you think they’re focusing their budgets on right now? Is it more server storage or software? Just kind of curious, any thoughts you can give on the IT spending environment we’re seeing.

Chuck Whitten: Yes. Thanks, Krish. Let me give you a little bit of the texture that we’re seeing. But maybe let me start by just highlighting. Look, we executed very well in what was a very dynamic environment. As we’ve highlighted, our principal objective in this environment is to deliver relative performance and share gain. And in Q3, we did that across client server and storage, and we delivered very good profitability. So, while we’re not going to get into specific demand numbers today, let me offer some texture on the environment that we’re seeing. First, I would just say that the CSG demand environment remains challenged with, as you saw in our results, consumer weaker than commercial. We saw slowing server growth. As Tom highlighted in our prepared remarks, it was probably a little bit worse than we anticipated at the time of our Q2 earnings call.

And so as we said, Q3 server revenue growth of 14% was aided by server backlog reduction and storage fared better. It’s ultimately not immune to the broader dynamics we’re seeing across customers, but we saw growth across multiple storage categories, including the high-end HCI and PowerStore. To your direct question about texture underpinning that, those dynamics were largely consistent across geographies, we’d say, verticals as well and customer size. There’s probably a couple of exceptions we would call out. One would be China, which had a much more pronounced weakness last quarter. And we would highlight the energy sector, the U.S. government sector and then medium business generally globally as performing better relative to the rest of the business.

And the customer feedback is very similar to what we described in Q2, very cautious and deliberate behavior in the face of what’s a lot of economic — macroeconomic dynamics out there. So, we’re hearing reassessment of budgets, reprioritization of spending and customers buying effectively for just their immediate needs. So net, I would say Q3 was a continuation of the trends that we called out during our Q2 earnings call.

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

David Vogt: Tom, maybe this is for you. Can you kind of elaborate on your earlier remarks about the framework for €˜24. Just to clarify, when you talk about — obviously, there’s a lot of moving pieces, but how do you think about the historical sequential moves as we move through the year? So, are you trying to communicate that we basically start with Q4 and then take sort of a normal sequential pattern over the last, let’s say, two to three years and sort of maybe haircut that a little bit given the uncertainty? Just trying to maybe level set since my line dropped a little bit. Thanks.