Dell Technologies Inc. quarterly report, Q1 FY2020

Dell Technologies Inc. — Form 10-Q Summary

Business context and reporting period

This unaudited quarterly report covers the three months ended May 3, 2019 (Dell fiscal 2020 first quarter), compared with the three months ended May 4, 2018. Dell reports three segments: Infrastructure Solutions Group (ISG), Client Solutions Group (CSG), and VMware. Unless noted, amounts are in U.S. dollars.

Financial performance and liquidity

Metric	Q1 FY2020	Q1 FY2019
Net revenue	$21.9 billion	$21.4 billion
Gross margin	$6.8 billion; 31.0% of revenue	$5.9 billion; 27.5%
Operating income (loss)	$550 million; 2.5% of revenue	$(153) million; (0.7)%
Net income (loss)	$329 million consolidated; $293 million attributable to Dell	$(538) million consolidated; $(636) million attributable to Dell
Cash from operating activities	$682 million	$1.159 billion
Cash used in investing activities	$458 million	$149 million
Cash used in financing activities	$719 million	Cash provided: $543 million

• Revenue increased 3%; product revenue was essentially flat, while services revenue rose 10% to $5.2 billion. GAAP gross margin increased 16%.
• Non-GAAP operating income increased 8% to $2.2 billion; non-GAAP net income rose 3% to $1.2 billion. These are company-defined measures that exclude significant items and should be considered alongside GAAP results.
• Interest and other expense was $693 million, versus $470 million. Interest expense increased; management expects higher interest expense and lower investment income to continue in FY2020.
• At May 3, cash and cash equivalents were $9.0 billion; total debt principal was $54.2 billion ($53.5 billion carrying value). Current assets of $33.7 billion were below current liabilities of $43.5 billion. Dell reported $6.1 billion of available borrowings across facilities, including subsidiary facilities subject to restrictions on use.
• Operating cash flow declined from $1.2 billion, principally due to higher seasonal compensation and benefit payments, partly offset by improved profitability. Capital expenditures were $610 million, compared with $273 million.

Material changes and segment results

• ISG: Revenue fell 5% to $8.2 billion; operating income fell 10% to $843 million. Server and networking revenue declined 9% amid weaker demand and competitive pressures. Dell said it prioritized profitability over some server volume and expected near-term deflationary component costs.
• CSG: Revenue grew 6% to $10.9 billion; operating income rose 49% to $793 million. Commercial revenue increased 13%, while consumer revenue declined 10%. Lower component costs and a higher-margin product mix supported segment profitability.
• VMware: Revenue increased 13% to $2.3 billion, while operating income was essentially unchanged at $614 million. Higher sales and R&D-related compensation costs reduced its operating margin to 26.9% from 30.2%.
• Revenue growth was led by CSG and VMware and by services; ISG declined. Dell’s year-over-year GAAP operating-profit improvement also reflected lower amortization of intangibles and purchase-accounting charges.
• Dell refinanced debt during the quarter, issuing $4.5 billion of First Lien Notes and arranging a new term loan, among other changes. Management said the refinancing smoothed upcoming maturities; total debt principal was broadly unchanged from February 1, 2019.

Outlook, risks, contingencies, and unusual items

• Dell forecast FY2020 capital expenditures of $2.7–$2.9 billion, including $1.5 billion of property and equipment recognized under the new leasing standard. It stated that cash, expected operating cash flow, and available borrowing were expected to fund operations and obligations for at least the next 12 months. No overall revenue or earnings guidance is provided in the supplied filing text.
• On May 31, 2019, VMware transferred certain intellectual property to its Irish subsidiary. Dell expected to record an approximately $4.5 billion discrete tax benefit in FY2020’s second quarter; this was a subsequent event, not a first-quarter result. The quarter’s tax benefit included $405 million from a separate intra-entity asset transfer. These items materially affected the unusually high 330.1% effective tax rate on a $143 million pretax loss.
• Tax uncertainty includes $3.4 billion of unrecognized tax benefits. Dell said certain audit resolutions within 12 months could reduce these benefits by an estimated $500–$800 million, with a material effect on the effective tax rate. The IRS was reviewing fiscal 2007–2009 returns, and Dell anticipated a settlement before fiscal year-end.
• A securities class action remained pending, with a trial then scheduled for October 2019 if not dismissed. Separate putative class actions challenge the Class V transaction. Dell said it did not believe a material loss beyond accrued amounts was reasonably possible, while acknowledging that unfavorable outcomes could materially affect results in a period.
• New lease accounting brought $1.6 billion of operating lease liabilities and related right-of-use assets onto the balance sheet at adoption. Dell also reported that transfer restrictions on substantial shareholdings were scheduled to begin expiring June 27, 2019, potentially increasing shares eligible for resale.
• Management cited changing IT demand, competition, foreign-exchange exposure, variable-rate debt, and evolving storage and server markets. It said it was investing in R&D and sales capabilities while pursuing cost efficiencies. Disclosure controls were assessed as effective; lease-related systems and controls were still being reviewed and refined.

Important facts for investors to verify

• Whether growth in CSG and VMware can offset continued weakness in ISG, particularly server demand, and whether segment margins hold up.
• How much reported profitability depends on non-GAAP adjustments, the one-time tax benefits, and lower purchase-accounting amortization; compare these with GAAP results.
• Debt maturities, refinancing costs, interest-rate exposure, and the amount of cash and borrowing capacity actually available to the parent rather than subsidiaries.
• Cash conversion and capital spending against the FY2020 capex range, including the effect of DFS leasing and the new lease accounting.
• Outcomes and timing of tax audits and litigation, the expected second-quarter tax benefit, and the potential market impact of expiring share-transfer restrictions.