Dell Technologies Inc. — FY2017 Form 10-K Summary
Reporting period: Fiscal year ended February 3, 2017 (53 weeks; the extra week was in Q4). Although the request identifies “2016 Q4,” this filing reports FY2017. Results are not directly comparable with prior years because EMC was acquired on September 7, 2016 and its results are included only from that date. Dell Services, Dell Software Group and the Enterprise Content Division are presented as discontinued operations.
Business context
Dell Technologies combines Client Solutions Group (CSG), Infrastructure Solutions Group (ISG) and VMware, alongside RSA, SecureWorks, Pivotal and Boomi. The company positions its portfolio around PCs, servers, storage, virtualization, cloud and security. CSG accounted for approximately 60% of FY2017 revenue. Dell held approximately 82.5% of VMware and 87.5% of SecureWorks at year-end.
Financial performance
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $61.642 billion | $50.911 billion |
| Gross margin | $12.959 billion; 21.0% | $8.387 billion; 16.5% |
| Operating income (loss) | $(3.252) billion | $(514) million |
| Continuing-operations net income (loss) | $(3.737) billion | $(1.168) billion |
| Net income (loss) attributable to Dell Technologies | $(1.672) billion | $(1.104) billion |
| Operating cash flow | $2.222 billion | $2.162 billion |
| Capital expenditures | $699 million | $482 million |
| Cash and cash equivalents at year-end | $9.474 billion | $6.322 billion |
| Total debt, carrying value | $49.390 billion | $13.631 billion |
Revenue rose 21%, primarily from the acquired EMC businesses; legacy-business revenue was described as relatively unchanged. Reported gross margin increased, but operating loss widened substantially as acquisition-related purchase accounting, intangible amortization, transaction costs and other corporate expenses increased. These items totaled $8.4 billion in FY2017 versus $2.7 billion in FY2016.
Management’s non-GAAP measures showed operating income of $5.113 billion, net income from continuing operations of $2.687 billion and adjusted EBITDA of $5.941 billion. These exclude material items, including purchase accounting, intangible amortization and transaction-related expenses; they are supplemental measures, not GAAP results.
Segments and material changes
- CSG: Revenue was $36.754 billion, up 2%; operating income was $1.845 billion, or 5.0% of segment revenue. Management cited stronger notebook demand, richer product mix and favorable costs.
- ISG: Revenue was $21.776 billion, up 45%, including acquired EMC storage; operating income was $2.393 billion, or 11.0% of revenue. Server and networking revenue was approximately flat.
- VMware: Included from the acquisition date; reported revenue was $3.225 billion and operating income was $1.113 billion. The partial-year period limits comparison with prior years.
The EMC merger was funded with approximately $45.9 billion of new debt, $4.4 billion of privately placed equity and cash on hand. Dell received approximately $7.0 billion in cash from three divestitures and recorded an aggregate after-tax gain of approximately $1.9 billion. It used divestiture proceeds and cash to repay approximately $7.0 billion of merger-related principal. Discontinued operations contributed $2.019 billion of FY2017 income, largely reflecting the divestiture gains.
Liquidity, debt and cash flow
Year-end cash was $9.474 billion, of which $3.2 billion was held by VMware; management said most cash was held outside the United States. Approximately $2.678 billion remained available under the revolving credit facility, giving reported cash, cash equivalents and available borrowings of $12.152 billion. Management stated these resources, together with expected operating cash flow and borrowings, would be sufficient for at least the next 12 months.
Debt principal was $50.356 billion ($49.390 billion carrying value), compared with $13.980 billion principal a year earlier. Fiscal 2017 investing cash outflow was $31.256 billion, including $37.629 billion net cash used for the EMC acquisition; financing cash inflow was $31.908 billion. Contractual obligations totaled $72.607 billion, including $50.356 billion of debt principal and $17.597 billion of interest. About $4.0 billion of bridge facilities were due in September 2017. The company reported compliance with financial covenants at year-end. Approximately $15.6 billion of debt was variable-rate; a 100-basis-point rate increase was estimated to add about $156 million to annual interest expense.
Outlook, commentary, risks and unusual items
- Management expected FY2018 capital expenditures of approximately $1.7 billion, primarily for infrastructure and strategic initiatives. The filing does not provide a specific revenue or earnings forecast.
- Management described PC demand as uneven and cyclical, with intensifying competition; it expected traditional server and storage markets to decline while cloud-native infrastructure remained a growth driver. Integration, cross-selling and realization of merger synergies were ongoing priorities, not assured outcomes.
- Integration costs and facility actions were expected to increase over the following 12 months. The filing says total integration costs could exceed anticipated savings; their full timing and amount were not yet identifiable.
- FY2017 included $807 million of day-one stock-based compensation charges associated primarily with accelerated EMC award vesting. Interest and other expense included $337 million of debt-extinguishment costs. These items, along with acquisition accounting and amortization, materially affected GAAP earnings.
- Key risks include substantial leverage and interest burden, refinancing and covenant constraints, integration and synergy execution, intense product and pricing competition, exposure to PC and traditional infrastructure declines, reliance on limited-source suppliers and outsourced manufacturing, foreign exchange, cybersecurity and data security, and tax and legal contingencies.
- Tax matters include approximately $3.1 billion of liabilities associated with uncertain tax positions; the company said it could not reliably estimate payment timing. The appeal of a court appraisal valuation in the Dell going-private matter was pending. The Ford VMware-related merger litigation remained unresolved; the company stated an adverse monetary judgment could affect operations.
- The company reported no off-balance-sheet arrangements likely to have a material effect. It said disclosure controls were effective, but relied on the newly public company transition exemption from management’s internal-control assessment and auditor attestation for this report.
Important facts for investors to verify
- How much of future operating cash flow will be available for debt reduction after interest, taxes, capital spending and working-capital needs?
- Whether merger integration costs, synergies and cross-selling results develop as management expects, and how these affect GAAP and non-GAAP earnings.
- Progress on refinancing or repaying near-term bridge debt and the impact of variable rates, covenants and restricted subsidiary cash.
- Underlying segment trends excluding acquired businesses, purchase-accounting effects and discontinued operations, especially CSG margins and ISG storage/server demand.
- Developments in tax audits and legal matters, particularly the appraisal appeal, Ford litigation and uncertain-tax-position liabilities.
- The effect of the tracking-stock structure, controlling stockholders and dividend policy on Class V shareholders; the filing states Dell Technologies did not intend to pay cash dividends in the foreseeable future.