Dell Technologies Inc. (NYSE:DELL) Credit Suisse 26th Annual Technology Conference Call November 30, 2022 10:55 AM ET
Company Participants
Chuck Whitten – Co-Chief Operating Officer
Conference Call Participants
Shannon Cross – Credit Suisse
Shannon Cross
Hi, everyone and thank you for joining us. My name is Shannon Cross, and I’m the IT hardware analyst here at Credit Suisse. Today, I am pleased to be joined by Chuck Whitten, who is the Co-COO of Dell Technologies.
So prior to getting started, Dell has asked me to read the following novel. This discussion may refer to non-GAAP results, including non-GAAP operating income, non-GAAP diluted earnings per share, non-GAAP operating expenses and adjusted free cash flow. For a reconciliation to the most direct comparable GAAP measures, please consult the slides labeled supplemental non-GAAP measures in the performance review available on the fiscal 2023 Q3 results page on investors.delltechnologies.com.
Dell Technologies’ statements that relate to future results and events are forward-looking statements and are based on Dell Technologies’ current expectations. Actual results and events in future periods may differ materially from those expressed or implied by these forward-looking statements because of a number of risks, uncertainties and other factors, including those discussed in Dell Technologies’ periodic reports filed with the SEC. Dell Technologies assumes no obligation to update its forward-looking statement.
With that Chuck, would you like to introduce yourself and tell us a little bit about your role at Dell and why you joined the company?
Chuck Whitten
Sure. And thanks for reading that. I know that we ate into a chunk of our time there. So yes, Chuck Whitten, I am the Co-Chief Operating Officer. I’ve been with Dell a little over a year, but you should sort of think of me a bit as a Dell Insider, I had worked with the company for over a decade as a strategic adviser at Bain. My responsibilities are running the business for Michael. So alongside Jeff Clarke, I oversee our Infrastructure Solutions Group, our Client Solutions Group, global operations, and we are responsible for setting strategic priorities across the leadership team, including our strategies for cloud and our new business development.
Question-and-Answer Session
Q – Shannon Cross
Great. So, your most recent earnings call was a bit subdued, to put it mildly. Can you provide some color on what you are seeing in the current macro? On a segment basis, maybe we can discuss what you are hearing from customers as they start to set their 2023 budgets?
Chuck Whitten
Well, sure. So last week, we reported Q3 earnings. We had record $2.4 billion of operating income and EPS of $2.30. That was up 39%. That was against the backdrop of a revenue decline of 6%. So that will give a bit of a feel for the dynamics. If I go by business, major business, the Q3 performance was very consistent with what we previewed in our Q2 earnings call. So the PC business continues to be challenged – consumer more challenged than commercial, our business in the quarter was down 17%. The server business continued to moderate over the course of Q3. And we had previewed that in Q2. I would say it maybe slowed even more than we anticipated in Q3 and our 14% revenue growth was driven by a reduction in our backlog. And so that explains our sort of performance in the server business. And then storage hung in there. It performed while we were up 11% on a P&L basis. We saw strength in multiple storage types, high-end hyperconverged infrastructure. PowerStore grew nicely and we’ll talk about that later, I believe. So that’s the kind of broad dynamics.
Look, by texture, geography, vertical, customer size. It was largely consistent. That performance, there is a few places I might call out as being slightly different than that average. China for, I think, reasons everybody understand a much more challenged environment. We saw strength in some verticals like energy, the U.S. government segment, medium business performed better than perhaps the average. But overall, it was relatively uniform dynamics. And what we heard from customers was very similar to what we heard in Q2, just a lot of caution entering the environment. I am revisiting my forward hiring. I am looking to reprioritize within my existing IT budgets. No one is saying I am throwing overboard my digital transformation investments. I am completely rethinking my technology strategy, but at minimum, at the moment of sort of caution and reflection from customers.
Against that, we performed really well. Our business has an advantaged model. We, given our large direct sales force, see these demand trends, I think, faster than the industry and it allows us to react and we like to say we focus on what we can control. So the first thing we can control is our cost position. If you look Q1 to Q2, our OpEx declined sequentially 3%. If you look Q2 to Q3, it declined 6%. We took $300 million out of OpEx since Q1. That contributed to our profitability. Our low inventory model also drives access to deflationary components faster than the rest of the market. And so you saw that play out in our profitability as well in Q3. Our gross margins were 23.7%, very good profitability, that’s up 200 basis points. And then we focus on gaining share. So we gained share in the commercial PC business in Q3. That’s 35 of 39 quarters. We expect when IDC reports results here in December, we will gain share in server and storage. And so again, it’s a challenging and a certain backdrop, but we are going to focus on what we can control.
Shannon Cross
Maybe could you clarify the guidance that you gave for fiscal 2024, which – I know you didn’t give guidance, you gave directional commentary, but it ended up with guidance, so perhaps that would be helpful? And then also, how do we think about free cash flow challenged this year for reasons I think we have discussed in the past, but then looking forward, is this something where you will see a significant bounce back or given the challenges with PCs at least in the first half of the year, is that going to be a bit more difficult to attain?
Chuck Whitten
Yes, sure. Let me start with guidance and maybe the upfront caveat, which is obvious is we are just into our Q4. It is an incredibly uncertain market and dynamic to forecast, particularly as you go into the back half of next year, but we thought it was prudent to offer some bit of guide on how we are thinking about next year. And so we said principally two things. First is, you should expect our revenue trajectory next year to be below normal sequentials and then to help you sort of think through what is below normal sequentials thing. I think Tom gave some helpful guidance in the Q&A. If you take our Q4 guidance of $23 billion to $24 billion, that’s down 16% at the midpoint. And then you look at our second half performance, our Q3 actuals in that guide, I think you will find yourself somewhere around down 11% for the second half of the year. That’s probably a good starting point for how you should think about next year. And so that was the guidance we gave. Again, with the caveat, it’s a very uncertain dynamic.
On cash flow, look, we don’t guide on free cash flow, but I think you characterized the dynamics correctly. Look, we are a very enviable free cash flow generating business. If you look at the last 4 years, excluding VMware, we generate on average about $6 billion in free cash flow. That’s a combination of our growth and our negative cash conversion cycle. Obviously, in this environment, that negative cash conversion cycle works against us as we had sequential declines. And so what you would have seen is about $400 million in Q3 of cash flow from operations. I think we are trailing 12 months something like $3.9 billion, so down from our historic averages.
Underneath that, you would see us primarily carrying higher inventory. Couple of reasons for that, I think one, obvious we’ve come through a relatively unique last couple of years of supply shortages. Our business is principally the assembly of kits. And so shortages of things like NIC cards can hold up a $10,000 server. So we have held more inventory to meet customer needs. I think that’s obvious and will work its way down over time. And then in Q3, we made some strategic purchases that we thought were economically advantageous for the company and that’s our Q3 inventory.
What it is not is a permanent change in the way we think about our working capital management. And so we are going to continue to press hard on our working capital when the market rebounds and we start to see sequential growth again, I think you will see our cash conversion cycle and our cash generation come back to what one would expect. Our long-term framework and commitment is that we are going to generate free cash flow in greater than 100% of our net income and that’s still our expectations over time.
Shannon Cross
How are you thinking about the PC industry, I mean short-term, lots of pressure? But from a longer term perspective, I mean, there is kind of two camps. There is one side says we go back to 250 million units annually. Another is we have reset the bar. And so maybe it’s 275, maybe it’s 300 once things sort of wash out. How – and I know no one has the correct crystal ball or you would be going to Vegas and not be sitting here. So like how do you think about it generally as you are putting together your plans?
Chuck Whitten
Yes. Well, look, I think my headline is I think we have seen a pre-foundry set in usage. But I think maybe one observation, I think we as an industry – and by the way, we have been guilty of this, Shannon, I have done a disservice in talking about aggregate units, because not all units are created equal in our industry and not all units have behaved the same way over the last couple of years. So let me give a few observations. Let’s just stay with IDC data, so we all have a common currency. If you look at a commercial unit on an ASP basis versus a chrome unit, it’s 3.5x more valuable on an ASP basis. If you look at a high price band consumer unit versus a mainstream consumer unit on an ASP basis, it’s 2.5x more valuable and chrome and mainstream consumer have been the most elastic up and down in this market. And so for us in our business that is principally centered on the commercial PC business. I think it’s helpful to look at units of commercial, excluding chrome and revenue as well. And I think when you unpack that, you are going to see the profound change in usage that we have seen. That profound change in usage is hybrid work. 75% of companies are now in a hybrid model. That means more notebooks with a faster refresh cycle. It also means richer configurations, more peripherals. It is not just a productivity device. It is our telephony. It is our videoconferencing equipment. And what we hear from customers time and time again is this matters to our employees now. And so we continue to hear it’s a CIO level issue and they are going to continue to invest in the end user experience. So there is a lot of reasons to be bullish about that market. If you pullback to the data again, stay on IDC, their latest 2023 forecast, you will see that market, the total market up 2019 to 2023, 5% on a unit basis and 15% on a revenue basis. That’s the change in usage. That’s more commercial units. That’s richer configurations. That’s what we believe is going to happen. So despite the caution and pause right now, we are very bullish on the PC – commercial PC market long-term.
Shannon Cross
Is there a way to think about the absolute gross profit dollars per PC and how that’s changed pre-pandemic to now for your commercial devices? I mean, prices have gone up, but configurations have become a little more rich, I don’t know…
Chuck Whitten
Yes. And we don’t give a lot of detail or guidance on that. But look, what I can tell you is let’s look at the ASPs in our business that increased in Q3 in the PC space. It was a combination of three factors: improving mix, not just commercial to consumer but within in our commercial business, I think more 7 series than 5 series or more workstations than mainstream. It was richer configurations across all of those and it was more attached, so more peripherals, more services, more of our displays. For us, it was a third, a third, a third. So, I mean there is a real material change in the underlying content that’s going into devices and they attach around it. That’s good for us as the leader in the commercial space.
Shannon Cross
No, that makes sense. Maybe if we can move to the server market, obviously, you benefited from backlog this last quarter, you saw more weakness maybe than you expected as you went through the quarter. How are you thinking about the server market and pricing as you look forward to 2023?
Chuck Whitten
Yes. Well, maybe on the market side, I think you said it in my opening, look it’s been a challenged market. It’s moderating in growth. It’s probably not surprising if you pull the lens back a little bit. As the market leader, we have just seen eight consecutive quarters of server growth. The industry has had high levels of backlog given shortages. And so I think you sort of put yourself in the shoes of an IT decision-maker. They are – looking at the macro uncertainty, they are saying, well, I have consumed a lot of compute. I maybe have more coming from the industry that’s on order. Let’s take a moment of reflection as we rack and stack our priorities. What have I consumed? What do I need? I think that feels like the digestion cycle we are in right now. Again, no one is canceling out right. They are digital transformation investments, but that’s the pause we feel. When that rebounds, I don’t have a crystal ball. And if you have the answer, I’d love it.
Look, pricing is a really important topic, because I think it’s another one we have to unpack very similar to what we just did with the PC industry. There are two trends that elevated our ASPs again in Q3 in the server business. One is content rate. So, content rate has continually increased in this market, that’s more SSDs, memory, richer GPUs. It’s the workloads that are – the servers are being asked to run. And that’s been a long-term trend. And then it’s commodity inflation and pricing for that. Back to my big animal pictures of what contributed to what in our business in Q3, two-thirds of the ASP increase was content rate. So that’s an important and hopefully very durable part of the market. One-third of it is related to commodity inflation. So look, in our forward guide, both for Q4 and next year, anytime you see a slowing demand environment in a deflationary environment, you should expect pricing pressure. So we are not assuming anything heroic about the way sort of ASPs hold up. I would say we have been very disciplined in testing elasticity out there. And we’re going to continue to be disciplined on that. Price is not necessarily the lever right now. I go out and pull given that I think what we’re facing right now is fundamentally a demand issue of – and reflection on digestion.
Shannon Cross
No, that makes sense. Moving to storage and everyone here probably had a fun night last night looking at NetApp. The storage has been resilient, I think, for lack of a better term for the last several quarters. And then we had the NetApp results. You’ve done well with PowerStore. How are you thinking about the market? How is PowerStore performing relative to your expectations?
Chuck Whitten
Yes. Well, look, as I said, our business held up very well in Q3. We were plus 11% on a P&L basis, and we saw pretty broad demand across the storage types. So we called out high-end hyper converged infrastructure. I’d say, unstructured PowerStore continued to grow. Look, our advantage in this market has been the breadth of our portfolio. So we’re number one across all storage types, high end, mid-range, entry, all flash, unstructured data protection, hyper, you name it. We lead in it. So that just gives us a position in the market, no matter the storage architecture or where the pockets of growth are, we tend to see it. It held up well in Q3.
To your specific question, look, PowerStore, it’s a really important product for us. It’s our marquee mid-range product, the first modern storage architecture put out in many, many years by us and by the industry. And it’s the space that we focus on because it is the place we have given up the most share. And it has performed exceptionally well. So they encourage – it’s, I think, the fastest-growing storage architecture upon the first 6 to 12 months of launch, it is growing healthy now, good double-digit growth. But I think most importantly, it’s attracting new customers to Dell, and we’re seeing repeat buying. So in Q3, 24% of customers were new to Dell that bought PowerStore and 45% of customers were a repeat buyer of PowerStores. So it’s just an encouraging trend. And so Look right now, as you look at our sort of forward guidance, we expect another seasonally strong storage quarter as always. And we’re going to continue to focus on relative share gain. Our last – I think last results for Q2, which were announced, we gained 300 basis points a share. It was widespread across all storage categories, we’re expecting to, again, gain share when you see the Q3 results announced here in a couple of weeks or a week.
Shannon Cross
When you say new to Dell, is there a way to think about ones where you’ve lost the share, they left sort of the EMC world and they went to somebody else and they have come back? Or is the repeat buyer was the…
Chuck Whitten
Well, yes, new to Dell – 24% would be – haven’t bought storage from us in some period of time in multiple years, right? Maybe back in the day, they bought something. But no, it’s a new acquisition for us of a customer. And the 48% are those that have deployed PowerStore and said, I need more of that, which is great.
Shannon Cross
And I’ve been a big proponent of hybrid cloud and infrastructure service, which would be your Project APEX over the last – since I launched, I guess. And – to me, it seems like this is the best way for hardware companies to compete against the cloud because at least you can walk in and say, here’s how you can price it ratably and here’s how Amazon is pricing it, maybe we can have an actually apples-to-apples discussion. So can you talk a bit about how Dell is thinking about? I know you talked – you’re talking more about Project APEX than you have prior, I think, in Infrastructure as a Service and how that fits in with your product portfolio?
Chuck Whitten
Yes, you bet. So look, as you said, it’s undeniable customers want to talk to us about flexible consumption. They also want to talk to us about financial flexibility broadly. And we’ve had, given our direct relationships and our large Dell Financial Services capabilities. Dialogues like this for many years. In fact, our Dell Financial Services business, our leasing business grew 17% in originations in Q3. It’s a countercyclical part of our business. So it’s a good asset. But on APEX specifically, look, we we’ve been trying to solve two customer requests, right? One is, hey, I want a common cloud-like experience across my multi-cloud, multi-data center, multi-edge environment. And I want flexible ways to consume. So I want the option to buy infrastructure. I want the option to subscribe to infrastructure, and I want the option to subscribe to infrastructure with your managed services on top of it. The latter two are where we have APEX focused.
And as you said, we started talking more about it. It’s been very successful. In Q2, we announced the milestone. We crossed the $1 billion ARR mark. In Q3, it continues to grow ARR at a healthy clip. We’re adding hundreds of customers to the franchise. It’s a very good product. And we’re focused on extending the offer set. And so you would have seen since August us announced a whole series of new APEX offers things like APEX, VMC, Tanzu support, APEX containers for OpenShift, APEX Data Storage Services target for the data protection backup, APEX high-performance compute. And so – we’re not looking to force customers down any one of those three routes I described, but we are offering kind of choice, and we will continue to add to the portfolio of managed service. It’s a very important part of our infrastructure strategy.
Shannon Cross
How is the margin profile of APEX contract or solution relative to going to more of a transactional sale? And I’m just wondering because it’s – I joke about – I don’t think about my iPhone costing $1,200, which I would – in theory, you would never want to spend that amount of money on the device in your pocket. But I think about it $65 a month, so it’s much easier for me to – for them to upsell me because I think about it ratably. Is that something that also carries through, especially?
Chuck Whitten
We haven’t talked a lot about the margin profile, but you would imagine it’s the similar sort of dynamics as a software company, right? Or your phone there where look, it is it is a higher-margin lifetime value opportunity for us. It gives customers the financial flexibility to not deploy as much cash upfront. But over time, there is value in that flexibility that they are paid for, and that’s reflected in the margin.
Shannon Cross
And switching over to sales, I’m just curious, how does Dell think about the channel now? Because over the years – and the same thing as some of your peers have done it, we love the channel. We want to go direct. We obviously you give up margin, but you also get benefits from going to the channel because there is obviously a significant increase in reach. So what’s your current thought on the best go-to-market strategy?
Chuck Whitten
We’re proudly omni-channel is how I would say it. So if you look at, call it, roughly $100 billion trailing 12 months, 50% is our direct sales force and 50% is the channel. And it’s exactly what you say. The channel brings us reach. They cover geographies that we don’t – maybe don’t cover as deeply. They bring us new customers and geographies where we both work together. And so when we do it right, it’s additive and it’s multiplicative, and that’s kind of been the dynamic. We haven’t really changed our channel strategy or posture regarding that. You are right that in pockets of our business, we will make more money when we sell direct, a PC business where we sell our services and we attach our peripherals is a very lucrative business for us.
But we’re very transparent with the channel on that as well. And so if they bring us new customers, they sell our services, right? It’s a multiplicative opportunity. And so we have a really – look, we have a competitively advantaged, I think, go-to-market engine with 32,000 sales makers and over 200,000 channel partners. So we’re, as I said, probably omni-channel.
Shannon Cross
Is there any way to enhance dell.com? And I’m just thinking in light of the current macro environment where costs are scrutinized heavily to try to do more. I don’t know if you call them inside sales, but.
Chuck Whitten
Yes. And the reality of it is, is both our physical sales makers. So we have many, many, many inside sales reps that cover – extend reach and think can form a customer environment versus our outside sales that are hunters. But dell.com’s an incredibly important asset as is our premier pages, which are sort of pages that are set up for our individual enterprise customers to be able to order online. And so look, from a margin standpoint in our business, the more we can eliminate human touches throughout the process, whether that’s a physical sales maker or that’s the friction that comes with now I need another server, do I pick up the phone and call a rep or do I go into my premier page? Online modernization has been a big push of ours, and it’s contributing to our enhanced margin performance. Our sales makers love it too because there is nothing like having your customer buy while you sleep, right? And it just sort of extends our productivity.
Shannon Cross
So thinking about your product portfolio and again, with the cash situation right now, you’re probably not itching or maybe you are, but it’s in to run out and make a big acquisition. But in theory, if this is a downturn, it’s the potential is that some of the companies you might acquire their valuations go down. So maybe it’s strike will hold or something. How are you thinking about acquisitions? And are there areas in the portfolio that you think you could enhance either organically or inorganically?
Chuck Whitten
Yes. Well, look, we think M&A is part of any good growth strategy. And frankly, I think it should be in all seasons, right? Good markets, down markets, I think we have an evergreen M&A strategy, so we’re always looking. We’ve said a few things about our M&A strategy. One is it should be strategic, and it shouldn’t surprise anybody at the places that we’re looking. So we’ve talked about our aspirations in new or very related markets to our core business like multi-cloud, the edge, telecommunications. Those are the types of spaces that you would imagine us needing to extend our capabilities. Two, our principal objective is extending our innovation and talent agendas in those spaces.
And then three, look, the reality is the circumstances around the EMC transaction, as an example. Big transformational sizable deals. It’s pretty unique circumstances. So we’re much more focused on these strategic talent and technology acquisitions in those spaces. You are right, obviously, in the public markets right now, there is been a reset in valuations. The spaces I’m describing are often in the private markets, some of those are still stickier, but we’re constantly looking, and you’ll see us being an acquirer in those spaces.
Shannon Cross
So is there a way to think about the amount of software content that you bring to commerce? Because I think one of the things that hardware companies sometimes get knocked by is that they show up with a box. And nobody’s in opinion, especially like on the storage side with the margins you get, nobody is paying you that for a box. they are paying that for everything you bring to the table. When you think about it internally at Dell, do you think about the software sort of separate? Or how is it managed about it from an outside perspective looking in?
Chuck Whitten
Yes. I think you’re right. I think that modern infrastructure is software, right? And you look at our – our storage business, we command the margins because of the software assets that we have in the space. And you see some of our assets that are pure software and easy to understand and products like our software-defined storage asset, PowerFlex or data protection assets or our thrusts in multi-cloud like Project Alpine, which is putting our file block and object storage software. But yes, internally of Dell, we tend to think of it, look, it’s these solutions, it’s software. And you – if I contrast to a public cloud conversation, public cloud is providing infrastructure, physical hardware and software, that’s – we do the same. We do it on-premise. And so I do think there is a fair nudge in your question of, is there a way to – for us to maybe help investors understand a little bit more the rich software assets we have because they are so key to our multi-cloud ambitions, and they are so key to how we’re winning in storage. There is probably work to do there so that you don’t have too many people think of it, hey, it’s just a box.
Shannon Cross
At one point HP did that, and then they ended up with autonomy. So there are some challenges with – with how you look at things, but I agree it could be helpful. What – just on our last question maybe is because I think it’s important and I think it’s also underappreciated is can you talk about the telco opportunity, the Dell seen?
Chuck Whitten
Sure. We’ve had a large business in telco for years, but principally with the IT departments of telco because the network itself has been closed, right? And now as operators have logically said, hey, my business model requires me to spend maybe less on the network and start to adopt modern cloud like open architecture, we’re a natural player in that space, right? And whether it’s Open RAN or it’s just the modernization of their network. They need industry standards. Cloud operating models broaden that we provide more open standard infrastructure than anybody. And so we’ve invested in a telecom business unit. Our goal is to drive incremental growth above what we do with the sort of our existing business in telco and it’s – and we’re having a lot of success in those dialogues. You can go read our press of the many architectural wins that we’ve had with operators around the world that are looking to sort of reduce the cost ultimately of their network. And so given our combination of assets, and infrastructure and our global services layer, which is very important in sort of bringing those components together if you’re going to go to an open network, we think we have a real play there. It will take some time to play out, but it’s an important investment as well.
Shannon Cross
Great. Well, maybe just in the last few – last minute or so, if you want to talk a little bit about what you’re – I’d like to end things on a positive note. What you’re most excited about now that you’ve joined Dell officially and looking forward in the next years?
Chuck Whitten
Yes, look, look, I would just leave everybody with – we have an amazing opportunity as a company. We performed exceptionally well in the last few years. Q3 was – we performed very, very well in a very difficult environment. We generated high levels of profitability. We gained share. We manage our cost, I think, quickly and decisively given our advantaged demand signal. So that’s what we mean when we say this business is positioned to outperform in any market environment. I think it’s a great time for investors to take a look at us. I think we have leadership positions in our core markets. I think we have a balance sheet that allows us to both invest and return capital to shareholders at an attractive rate. And I see lots of growth opportunities around the business. So no better time than right now to take a look at us.
Shannon Cross
Great. Well, thank you so much. Thank you for joining us and we will keep watching.
Chuck Whitten
Thank you.
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