Business context and reporting period
This is Denali Holding Inc.’s unaudited Form 10-Q for the three months ended April 29, 2016 (fiscal Q1 2017), comparing results with the three months ended May 1, 2015. Denali was Dell’s parent; the filing presents consolidated Denali and Dell results, not results for a company reporting under the Dell Technologies name. The EMC merger was pending at quarter-end.
Following the planned sale of substantially all Dell Services, its results are reported as discontinued operations and excluded from continuing operations and segment results in both periods. The remaining reportable segments were Client Solutions, Enterprise Solutions Group (ESG), and Dell Software Group (DSG).
Financial performance and position
| Metric | Q1 FY2017 | Prior-year quarter |
|---|---|---|
| Revenue | $12.534 billion | $12.838 billion |
| Gross margin | $2.418 billion; 19.3% | $2.129 billion; 16.6% |
| Operating income (loss) | $(161) million | $(335) million |
| Continuing-operations net income (loss) | $(426) million | $(476) million |
| Net income (loss), including discontinued operations | $55 million | $(504) million |
| Cash from operating activities | $(63) million | $(895) million |
Revenue declined 2% year over year: product revenue fell 3% to $10.322 billion, while services and software-related revenue rose 2% to $2.212 billion. The gross margin improvement reflected higher Client Solutions product margins and a smaller negative impact from purchase-accounting adjustments. GAAP operating expenses rose 5% to $2.579 billion.
Management’s non-GAAP measures showed operating income of $565 million, up 37%, and net income from continuing operations of $306 million, up from $131 million. These measures exclude, among other items, purchase accounting, acquired-intangible amortization, and specified corporate expenses; they are not substitutes for GAAP results.
By segment, Client Solutions revenue fell 3% to $8.571 billion and operating income rose to $385 million. ESG revenue fell 2% to $3.613 billion and operating income fell 20% to $192 million. DSG revenue was nearly flat at $334 million; it reported operating income of $28 million versus a prior-year operating loss of $27 million.
Cash and equivalents were $6.139 billion at April 29, down from $6.576 billion at January 29. Total assets were $43.879 billion and total liabilities $42.147 billion. Debt was $13.479 billion principal ($13.144 billion carrying value), compared with $13.980 billion principal at January 29. Cash plus available ABL borrowing capacity totaled $7.761 billion, including $1.622 billion of available capacity; there were no ABL draws. Cash used in investing was $60 million and cash used in financing was $387 million. Capital expenditures were $92 million.
Changes, outlook, and material items
- Operating cash outflow improved substantially from the prior-year $895 million outflow, primarily due to working-capital movements, stronger receivables collections, and lower incentive-compensation payments.
- Management cited continued weak global PC demand, strategic pricing pressure, competition, and declines in traditional storage as challenges. It expects the demand environment and competition in Client Solutions to remain challenging; ESG also faces changes in storage and data-center architectures. The company continued investing in research and development and sales capabilities.
- Fiscal 2017 capital expenditures were expected to total approximately $0.5 billion. The fiscal year includes 53 weeks, with the extra week in Q4. No specific full-year revenue or earnings guidance is provided in the filing text.
- The Dell Services sale to NTT Data was expected to generate $2.9–$3.1 billion in cash and an estimated pretax gain of $1.7–$2.0 billion; closing was expected in Q3 FY2017, subject to customary conditions and regulatory approvals. Dell Services reported $674 million revenue and $481 million net income in the quarter; the result included a $461 million tax benefit, primarily related to the planned disposal. This benefit materially affected consolidated net income.
- The EMC merger consideration included $24.05 cash plus tracking shares for each eligible EMC share. The transaction required shareholder, regulatory, and other approvals and was to be funded through debt, committed equity, and cash. After quarter-end, subsidiaries completed a $20 billion first-lien note offering and agreed to issue $3.25 billion of unsecured notes, with proceeds held in escrow pending the merger.
- Material exposures include substantial merger financing and debt service, merger litigation, and Dell going-private appraisal proceedings. A May 31, 2016 court ruling set fair value at $17.62 per share for remaining appraisal claims, versus Dell’s recorded $13.75 per-share amount; appeal remained possible. The filing also describes tax audits and uncertain tax positions, including $3.2 billion of net unrecognized tax benefits. Management said it believed liquidity was sufficient for at least 12 months and to fund the merger, but this depends on expected operations, financing, and transaction completion.
Most important facts for investors to verify
- Whether the EMC merger closed, its final financing terms, and the resulting debt, interest burden, and equity structure.
- Whether the Dell Services sale closed on expected terms and how proceeds, gain, and discontinued-operation tax effects ultimately compare with estimates.
- Whether operating cash flow remains positive after the quarter’s working-capital improvement and how cash availability is affected by its substantial offshore balance.
- Whether weak PC and storage demand, pricing, and segment profitability improve or deteriorate, particularly in Client Solutions and ESG.
- The outcome and financial impact of appraisal litigation, merger-related lawsuits, and tax audits, including any appeal of the appraisal valuation.