Dell Technologies Inc. — Form 10-Q Summary
Business context and period. The report covers the quarter and six months ended July 29, 2016 (Fiscal 2017 Q2 and first half), compared with the corresponding 2015 periods. Dell changed its name from Denali Holding Inc. on August 25, 2016. Continuing operations are reported in Client Solutions and Enterprise Solutions Group (ESG); Dell Services and Dell Software Group (DSG) are presented as discontinued operations following announced divestitures.
Key financial metrics
| Metric | Three months ended July 29, 2016 | Six months ended July 29, 2016 |
|---|---|---|
| Net revenue | $13.05 billion, up 1% year over year | $25.26 billion, down 1% |
| Gross margin | $2.33 billion; 17.8% of revenue, versus 16.0% | $4.52 billion; 17.9%, versus 15.7% |
| Operating income (loss) | $63 million, versus a $103 million loss | $(80) million, versus a $414 million loss |
| Net loss from continuing operations | $(264) million, versus $(292) million | $(690) million, versus $(738) million |
| Net income (loss), including discontinued operations | $572 million, versus $(265) million | $627 million, versus $(769) million |
| Diluted EPS | $1.41, including $2.06 from discontinued operations | $1.55, including $3.25 from discontinued operations |
| Cash from operating activities | Not presented separately for the quarter | $1.82 billion, versus $732 million |
Six-month investing cash outflow was $221 million and financing cash outflow was $849 million; cash and cash equivalents from continuing operations at period-end were $7.23 billion. Separately, $23.29 billion of merger-financing proceeds was held as restricted cash in escrow and was not available for general use.
At July 29, 2016, debt was $36.69 billion at principal value ($36.34 billion carrying value), versus $13.98 billion principal at January 29, 2016. The increase primarily reflects $23.25 billion of notes issued for the pending EMC merger. Cash, cash equivalents, and available ABL borrowings totaled $8.61 billion; ABL availability was $1.38 billion. The company reported compliance with its financial covenants.
Material changes and operating performance
- Revenue was broadly flat in Q2; first-half revenue declined 1%, primarily due to lower Client Solutions commercial revenue. Q2 Client Solutions revenue was flat, with consumer growth offsetting a commercial decline. First-half Client Solutions revenue fell 2%.
- ESG revenue was flat in Q2 and down 1% for the first half. Server and networking revenue was relatively resilient, while storage revenue declined 3% in Q2 and 2% in the first half.
- Gross margin improved, led by stronger Client Solutions product margins and a favorable cost position. Q2 operating income returned to positive territory. Non-GAAP operating income was $752 million in Q2, up 32%, and $1.29 billion for the first half, up 34%. These non-GAAP measures exclude specified items and should be considered alongside GAAP results.
- Interest and other expense rose to $349 million in Q2 and $568 million for the first half, mainly because of higher interest expense associated with merger financing. SG&A increased 5% in both comparison periods, reflecting investment in sales capabilities, marketing, and merger-related outside services.
- Operating cash flow improved year over year, aided by profitability and working-capital changes, particularly extended payment terms with certain suppliers. The cash conversion cycle improved to negative 60 days from negative 51 days, largely from an eight-day increase in days payable outstanding.
Outlook, transactions, risks, and unusual items
- EMC merger: The filing said the merger was expected to close September 7, 2016, subject to remaining conditions; EMC shareholder approval and final Chinese antitrust approval had been obtained. The merger was expected to substantially increase borrowing and interest requirements. Management expected combined-business cash flows to meet the higher debt service needs. The filing described up to $26.3 billion of debt financing and up to $4.4 billion of committed equity financing.
- Planned divestitures: Dell Services was expected to sell for approximately $2.9–$3.1 billion, with an estimated pre-tax gain of $1.7–$2.0 billion; DSG was expected to sell for approximately $2.3–$2.6 billion, with an estimated pre-tax gain of $1.0–$1.3 billion. Both transactions were expected to close in Fiscal 2017 Q4, subject to customary conditions. The filing recognized substantial tax benefits in discontinued operations, so reported net income and EPS should not be read as recurring operating performance.
- Management outlook: No full-year revenue or earnings guidance is provided in the supplied filing text. Fiscal 2017 capital expenditures were expected to be approximately $0.5 billion. Management anticipated uneven demand, intensifying competition in Client Solutions, and continued pressure in traditional storage, while identifying cloud, data-center, and combined Dell-EMC offerings as strategic opportunities.
- Unusual items: A vendor settlement agreed after quarter-end was expected to benefit Q3 gross margin by $88 million. The company also paid approximately $463 million to settle appraisal claims on certain shares. A Delaware court had set fair value for remaining appraisal shares at $17.62 per share, above Dell’s asserted $12.68 value; Dell expected to appeal. Merger-related litigation remained pending.
- Other risks: The filing discusses merger execution and financing, legal proceedings, tax audits, foreign exchange exposure, and uncertain future copyright levies. Potential tax audit resolutions could reduce unrecognized tax benefits by $300–$750 million over the next 12 months, with a possible material effect on the effective tax rate. A 100-basis-point increase in rates was estimated to increase annual interest expense by approximately $58 million on the variable-rate debt portfolio.
Most important facts for investors to verify
- Whether and when the EMC merger closed, the final consideration and financing structure, and the resulting combined debt and interest burden.
- Actual closing proceeds, gains, taxes, and timing for the Dell Services and DSG divestitures, compared with the stated estimates.
- How much of reported net income and EPS came from discontinued-operation tax benefits, versus ongoing continuing operations.
- The outcome and cash cost of the remaining appraisal proceedings, merger-related litigation, and tax audits.
- Whether operating cash-flow gains from supplier payment terms are sustainable and how margins and demand develop in Client Solutions, storage, and ESG.