Dell Technologies Inc. quarterly report, Q2 FY2020

Dell Technologies Inc. — Form 10-Q Summary

Reporting period: Second quarter and six months ended August 2, 2019 (fiscal 2020). Unaudited results are compared with the corresponding periods ended August 3, 2018, unless otherwise noted. Amounts are U.S. dollars.

Business context

Dell Technologies operates Infrastructure Solutions Group (ISG), Client Solutions Group (CSG), and VMware, alongside smaller businesses and Dell Financial Services (DFS). Its portfolio spans IT infrastructure, PCs, software, services, and customer financing.

Key financial results

Metric	Q2 FY2020	Q2 FY2019	Six months FY2020	Six months FY2019
Revenue	$23.37B	$22.94B	$45.28B	$44.30B
Gross margin	$7.33B; 31.3%	$6.12B; 26.7%	$14.12B; 31.2%	$12.00B; 27.1%
Operating income (loss)	$519M	$(13)M	$1.07B	$(166)M
Net income (loss)	$4.23B	$(461)M	$4.56B	$(999)M
Net income (loss) attributable to Dell Technologies Inc.	$3.42B	$(499)M	$3.71B	$(1.14)B
Operating cash flow	Six months: $3.96B	Prior-year six months: $3.79B

Q2 product revenue was $18.11B, essentially flat year over year; services revenue rose 10% to $5.26B.
Q2 GAAP gross margin rose 20%; the margin rate expanded 460 basis points. Management cited lower intangible amortization and deflationary component costs.
Q2 non-GAAP operating income was $2.74B, up 30%, and non-GAAP net income was $1.75B, up 39%. These company-defined measures exclude significant items and are not GAAP results.
Six-month capital expenditures were $1.08B, versus $561M a year earlier. Investing cash outflow was $1.28B; financing cash outflow was $2.92B.

Segments and changes versus prior year

ISG: Q2 revenue fell 7% to $8.62B, primarily as servers and networking declined 12% amid weaker demand and a deliberate focus on profitability. Storage revenue was flat. Segment operating income increased 4% to $1.05B.
CSG: Q2 revenue increased 6% to $11.75B. Commercial revenue rose 12%, supported by Windows 10 refresh demand; consumer revenue fell 12%. Operating income more than doubled to $982M, helped by lower component costs and product mix.
VMware: Q2 revenue rose 12% to $2.47B, with growth in software licenses and maintenance. Operating income increased 4% to $762M, while its operating margin declined to 30.9% from 33.5% as sales-related compensation and R&D costs increased.
Consolidated Q2 revenue grew 2%; product revenue was flat while services grew. Management attributed overall revenue growth mainly to CSG and VMware.

Liquidity, debt, and balance sheet

At August 2, cash and cash equivalents were $9.19B; total cash, cash equivalents, and restricted cash were $9.94B. Total assets were $115.52B.
Debt principal was $52.59B ($51.92B carrying value), down from $54.24B principal at February 1. Management reported $36.41B of core debt. Cash was $9.19B; DFS-related debt is associated with customer financing assets and should be assessed separately.
Available borrowings were reported at $6.09B, including facilities for VMware and Pivotal that are restricted to those subsidiaries’ purposes. Dell’s own revolving and China facilities had approximately $5.0B available.
Current assets were $35.32B versus current liabilities of $47.02B. Management said cash, future operating cash flow, and expected revolver borrowings should cover at least the next 12 months’ operations, debt service, capital expenditures, and other needs.
Operating lease adoption added $1.6B of lease liabilities and related right-of-use assets. At quarter-end, operating lease liabilities were $1.65B.

Outlook, risks, and unusual items

Tax-driven earnings: Q2 included a $4.5B discrete tax benefit from a VMware intra-entity intellectual-property transfer; a separate $405M benefit was recorded in Q1. Despite a Q2 pretax loss of $111M, the quarter reported net income of $4.23B. The six-month tax benefit was $4.82B. Management expects to realize the related deferred tax assets. The unusually high reported earnings therefore do not reflect operating profit alone.
Impairment: Dell recorded a $619M gross Virtustream impairment ($524M net of tax benefits) in Q2, covering goodwill, intangible assets, and property and equipment. No such assets remained for Virtustream at quarter-end.
Operating outlook: Management expected the Windows 10 refresh cycle to continue at least through fiscal year-end and near-term component-cost deflation to continue, but at a lesser rate than in the first half. It noted ongoing competitive pressure and weaker server demand. No specific full-year revenue or profit guidance is provided in the supplied filing text.
Capital spending and interest: Fiscal 2020 capital expenditures were expected to total $2.2B–$2.4B, including about $1.0B related to property and equipment under the new lease accounting standard. Management expected higher interest expense and lower investment income to continue during FY2020 following the Class V transaction.
Debt and refinancing: Dell said it would continue focusing on core-debt reduction and reported compliance with financial covenants. On September 5, 2019, after quarter-end, it initiated a refinancing intended to replace a $4.9B Term Loan B due 2023 with a modified $4.0B facility due 2025.
Tax and legal exposures: Unrecognized tax benefits were $3.5B. Dell said certain tax matters could resolve within 12 months, potentially reducing these benefits by $500M–$800M with a material effect on the effective tax rate. An IRS dispute concerning fiscal 2007–2009 transfer pricing remained in appeals; Dell anticipated a settlement before FY2020 year-end. Class V transaction litigation and other proceedings remain contingent risks; management did not believe a material loss beyond accrued amounts was reasonably possible, while noting outcomes are inherently unpredictable.
Subsequent transactions: VMware announced agreements to acquire Carbon Black for an expected $1.9B net cash payment and Pivotal for an expected $0.8B net cash payment plus VMware shares issued to Dell. Both were expected to close in the second half of FY2020, subject to approvals and other conditions.

Most important facts for investors to verify

How much of reported net income and EPS reflects the large, discrete tax benefits rather than recurring operating performance; review the deferred-tax-asset assumptions and future tax amortization.
Whether CSG and VMware growth can offset continuing ISG server weakness, and whether CSG’s refresh-cycle tailwind persists.
Debt repayment progress, refinancing terms, interest costs, maturity schedule, and liquidity available to Dell itself versus restricted subsidiaries and DFS.
The effect of the Virtustream impairment and whether further impairment risk exists, particularly for reporting units with limited fair-value headroom.
Cash conversion and capital needs, including the effect of DFS originations, lease accounting, and the $2.2B–$2.4B FY2020 capital expenditure outlook.
Developments in the IRS dispute, other tax audits, Class V litigation, and the announced VMware acquisitions.