Dell Technologies Inc. — Q2 Fiscal 2019 Form 10-Q
Reporting period: Three and six months ended August 3, 2018; comparative periods ended August 4, 2017. Amounts are in U.S. dollars. The company adopted the new revenue-recognition standard retrospectively, and prior-period figures were recast.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $22.9B (+18%) | $19.5B | $44.3B (+18%) | $37.5B |
| Gross margin | $6.1B; 26.7% | $5.0B; 25.4% | $12.0B; 27.1% | $9.4B; 25.1% |
| Operating income (loss) | ($13M) | ($665M) | ($166M) | ($1.94B) |
| Net loss | ($461M) | ($739M) | ($999M) | ($1.94B) |
| Net loss attributable to Dell Technologies Inc. | ($499M) | ($732M) | ($1.14B) | ($1.90B) |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $3.79B | $2.11B |
- Q2 product revenue rose 20% to $18.1B; services revenue rose 8% to $4.8B. For the six months, product revenue increased 21% and services revenue 8%.
- Q2 GAAP operating margin was approximately negative 0.1%, versus negative 3.4% a year earlier. GAAP improvement mainly reflected lower acquired-intangible amortization and purchase-accounting charges and higher ISG operating income.
- Non-GAAP operating income was $2.1B in Q2 (+13%) and $4.1B for the six months (+26%). Non-GAAP net income was $1.35B in Q2 (+21%) and $2.52B for the six months (+35%). These company-defined measures exclude, among other items, amortization, purchase accounting, transaction costs and other corporate expenses.
- Q2 segment revenue and operating income: Infrastructure Solutions Group (ISG) $9.23B and $1.01B; Client Solutions Group (CSG) $11.13B and $425M; VMware $2.19B and $736M. ISG revenue increased 24%, with servers and networking up 34%; CSG revenue grew 13%; VMware revenue grew 11%.
Cash, debt and liquidity
- At August 3, 2018, cash and cash equivalents were $15.3B, short-term investments $2.5B, and total cash, cash equivalents and restricted cash $15.8B. Cash and cash equivalents were up from $13.9B at February 2, 2018; more than half was held outside the United States.
- Current assets were $43.1B against current liabilities of $49.2B. Short-term debt was $9.1B; long-term debt was $40.4B.
- Total debt principal was $50.3B ($49.6B carrying value), including $37.1B of company-defined core debt. The company repaid about $3B of unsecured notes during the six months, including $2.5B of EMC notes, while DFS debt increased to $5.6B to support financing receivables.
- Six-month investing cash outflow was $162M and financing cash outflow was $1.99B, primarily reflecting debt repayments. Capital expenditures were $561M for the six months.
- Available borrowings under the main revolving and China facilities were approximately $3.8B; additional facilities available to VMware and Pivotal are restricted to those subsidiaries. The company stated that cash, expected operating cash flow and expected available borrowings should cover operations, capital expenditures, debt service and other needs for at least 12 months. It was in compliance with financial covenants at quarter-end.
Material changes and unusual items
- Revenue grew across all three reportable segments. ISG operating margin improved to 11.0% from 8.7%; CSG margin fell to 3.8% from 5.4% in Q2, partly because the prior-year quarter included a $68M vendor settlement benefit and current-period component costs and selling expenses were higher. VMware operating margin declined to 33.5% from 36.7%, reflecting higher sales-related compensation and R&D spending.
- GAAP results include substantial acquisition-related charges: intangible amortization and purchase-accounting adjustments affecting operating income were $1.7B in Q2 and $3.5B for the six months. Intangible amortization alone was $3.0B for the six months.
- Adoption of the new financial-instrument accounting standard generated gains on strategic investments of approximately $123M in Q2 and $223M for the six months; investment gains also contributed to lower net interest and other expense. These amounts are not necessarily indicative of recurring operating performance.
- Operating cash flow improved to $3.8B from $2.1B for the six months, which management attributed to business momentum, profitability and working-capital discipline. Inventory rose to $3.6B from $2.7B at fiscal year-end.
- The company recorded a $92M income-tax benefit for the six months, versus $1.11B a year earlier. Its provisional U.S. tax-reform benefit remains subject to finalization and could be materially revised.
Outlook, risks and contingencies
- Fiscal 2019 capital expenditures were expected to total $1.1B–$1.3B. The filing gives no clear full-year revenue, earnings or cash-flow guidance.
- Management expected ISG component costs to become slightly deflationary in the second half of FY2019 and CSG costs to be deflationary for the remainder of the year. It cited continued demand, but also storage-portfolio transition and competitive, cyclical pressure in PCs. Storage portfolio simplification was expected to take two to three years.
- The proposed Class V transaction would exchange each Class V share, at the holder’s election, for 1.3665 Class C shares or $109 cash, subject to a $9B aggregate cash cap. It was expected in the second half of FY2019 and required stockholder approval and other conditions. VMware had declared a conditional $11B special dividend; Dell expected its approximately $8.95B share to fund substantially all cash consideration. Dell anticipated a significant decline in cash and investments upon completion.
- Subsequent events included VMware’s agreement to acquire CloudHealth Technologies for approximately $500M in cash plus assumed unvested awards, subject to closing conditions, and Dell’s September 4 repayment of $600M of Term Loan A-3 debt.
- Risks highlighted include international exposure, currency movements, trade barriers and tariffs, global economic weakness, supplier and customer credit issues, higher interest costs on variable-rate debt, tax audits and uncertain tax benefits. A significant tax holiday was due to expire at the end of FY2019, with renewal uncertain.
- Management reported no reasonable possibility of a material legal loss beyond recorded accruals, while noting that litigation outcomes remain uncertain. The Dell appraisal proceedings were settled and no liability remained at quarter-end.
Most important facts for investors to verify
- Whether the Class V transaction received required approvals and closed on the stated terms, including the final cash-versus-stock elections, VMware dividend and resulting liquidity impact.
- Whether revenue growth translates into sustainable GAAP profitability and cash generation after acquired-intangible amortization, purchase accounting, interest and other excluded costs.
- Progress in reducing core debt and the impact of interest rates and DFS receivables growth on interest expense and liquidity.
- Whether CSG margins recover and ISG storage growth offsets server mix and competitive pressures; track segment margins as well as revenue.
- Final U.S. tax-reform accounting, tax-holiday renewals and outcomes of material tax audits.