Dell reported a strong Q2 as AI server demand remained robust with shipments rising 82% QoQ to $3.1 billion, an AI server backlog of $3.8 billion and a five-quarter pipeline that is “several multiples of our backlog.” Dell’s revenue beat by nearly $1 billion as servers and networking revenue rose 80% to a new record at $7.7 billion. Dell said that Q2 saw “exceptional AI optimized server demand” as its order pipeline expanded again sequentially.
However, Q3’s guide came up short, as Dell forecast revenue between $24 to $25 billion, or a single-digit sequential decline. The very large pipeline refers to Dell waiting for Blackwell’s GPUs, which was discussed on the call. Therefore, the fiscal year will end higher than previously guided, making Q3 inconsequential.
ISG’s growth this quarter was driven by servers and networking, with revenue accelerating to 80% YoY and 40% QoQ to $7.67 billion, a record for the segment. This was a 3700 bp sequential acceleration in the YoY growth rate, from 42.5% in Q1 to 79.5% this quarter.
Another pertinent point discussed on the call was the surprising margin expansion in the ISG segment of 300 bps QoQ. Dell explained the expansions is party because enterprise server margins are higher than cloud service providers (CSPs).
Revenue
Q2 revenue was $25.03 billion, beating estimates by $910 million. Revenue growth was 9.1%, accelerating from 6.3% YoY growth in the previous quarter, with servers and networking revenue growth accelerating significantly this quarter.
For Q3, Dell guided for revenue between $24 billion to $25 billion, with the midpoint of $24.5 billion coming up just short of analysts' expectations for $24.6 billion. Despite the implied miss, the guide still points to revenue growth accelerating by 100 bp QoQ to 10.1%; analysts were expecting growth of 10.6% in Q3.
Despite the lighter Q3 guide, management boosted its full-year revenue outlook, now seeing revenue between $95.5 billion and $98.5 billion, or $97 billion at midpoint for YoY growth of 10%. Management’s prior guidance called for $93.5 billion to $97.5 billion, (midpoint of $95.5 billion for 8% growth), so this represented a healthy $1.5 billion raise on strong momentum in AI servers and networking.
Key Segments
Infrastructure Solutions Group (ISG):
Revenue in Dell’s Infrastructure Solutions Group (ISG) accelerated significantly in the quarter and easily topped management’s forecast for mid-20 percent growth this quarter. ISG revenue grew 38% YoY to $11.65 billion, accelerating 1600 bp sequentially from 22% YoY growth in Q1. Management guided for ISG growth to be in the low-30% range for Q3, pointing to a slight deceleration sequentially. For the full-year, ISG’s growth is expected to be approximately 30% driven primarily by AI and growth in traditional servers.
ISG’s growth this quarter was driven by servers and networking, with revenue accelerating to 80% YoY and 40% QoQ to $7.67 billion, a record for the segment. This was a 3700 bp sequential acceleration in the YoY growth rate, from 42.5% in Q1 to 79.5% this quarter.
AI servers were a primary driver in the quarter, with orders revenue of $3.2 billion, up 23% QoQ from $2.6 billion in Q1 as Tier 2 cloud service providers and enterprise customers increased. AI server shipments rose more than 82% QoQ, from $1.7 billion in Q1 to $3.1 billion in Q2. Growth also extended beyond AI to traditional servers, as traditional server demand rose YoY for the third consecutive quarter and rose QoQ for the fifth consecutive quarter.
Dell continues to see AI servers driving growth in Q3, adding that its “AI optimized server pipeline again expanded Q/Q across both Tier 2 cloud service providers and enterprise and has now grown to several multiples of our backlog.” For context, AI server backlog remained at $3.8 billion, flat QoQ.
ISG’s adjusted operating margin also expanded 300 bp QoQ to 11% in Q2, easing some concerns about AI servers weighing on segment margins. Management maintained its full year view for 11% to 14% adjusted operating margins for ISG, suggesting more upside to margins in the back half of the year. Dell also expects operating margin to improve in Q3 as a result of improved ISG profitability.
Client Solutions Group (CSG):
Turning to Dell’s Client Solutions Group (CSG), growth was muted, declining (4%) YoY but rising 4% QoQ to $12.41 billion. Commercial revenue was flat YoY at $10.55 billion, while Consumer revenue declined (22%) YoY to $1.86 billion. Management said they saw “modest Commercial PC demand growth in the quarter.”
Dell is expecting growth in CSG in the second half of the year, with growth more concentrated in Q4. Q3 is expected to see flat to low single-digit growth, with management believing the “coming PC refresh cycle and the longer-term impacts of AI will create tailwinds for the PC market.” For the full-year, CSG is expected to also be “flat to low single digits for the year.”
CSG’s adjusted operating margin was 6.2%, increasing only 10 bp sequentially and contracting 130 bp YoY. Full-year operating margin is expected to be 5% to 7%, implying there will be little change as the year progresses.
Margins
Overall, Dell’s margins down the line remained resilient despite gross margin contracting, as Dell faces some competitive pressure and headwinds from increased AI server mix.
- GAAP gross margin was 21.4%, contracting 40 bp QoQ and 230 bp YoY as AI server mix rose and due to a more competitive pricing environment. Adjusted gross margin was 21.8%, contracting by the same amounts QoQ and YoY.
- Management guided for gross margin to decline 180 bp for the fiscal year due to “inflationary input costs, the competitive environment and a higher mix of AI optimized servers. We will continue to drive efficiencies in the business and expect operating expense to be down low single digits for the year.”
- GAAP operating margin was 5.4%, improving by 30 bp QoQ and 130 bp YoY. Adjusted operating margin was 8.1%, increased 150 bp QoQ but decreasing 50 bp YoY.
- GAAP net margin was 3.4%, down 90 bp QoQ but up 130 bp YoY. Adjusted net margin was 5.5%, up 140 bp QoQ but down 10 bp YoY.
Dell topped EPS expectations as adjusted margins improved quite significantly down the line in Q2.
- GAAP EPS of $1.17 beat expectations for $1.01.
- Adjusted EPS of $1.89 beat expectations for $1.71.
- For Q3, Dell sees adjusted EPS of $2.00, +/- $0.10, short of the consensus estimate for $2.18.
- For the full-year, Dell sees adjusted EPS of $7.80, +/- $0.25, slightly higher than the $7.72 estimate and indicative of a stronger Q4.
Cash Flows and Debt
Cash flows declined significantly YoY, but perked up sequentially.
- Operating cash flow was $1.34 billion in Q2, down (58%) YoY but up more than 28% QoQ. OCF margin was 5.4%, improving from 4.7% last quarter but down substantially from 14.0% in the year ago quarter.
- Adjusted cash flow was $1.28 billion in Q2, once again down (58%) YoY but up more than 106% QoQ. Adjusted FCF margin was 5.1%, up from 2.8% last quarter but down sharply from 13.3% in the year ago quarter.
- Cash and equivalents totaled $5.85 billion, as Dell repaid approximately $1 billion in debt during the quarter along with $712 million in shares repurchased and $316 million in dividends paid.
- Debt totaled $24.5 billion. The company stated their core leverage ratio was 1.4x.
- Inventory rose more than 24% QoQ to $5.95 billion, with the QoQ increase likely driven again by AI servers as was the case in Q1.
Earnings Call:
ISG Margins 300 Bps Expansion:
Questions on how Dell was capable of expanding ISG margins were abundant, as analysts were clearly impressed. In addition to the Q&A excerpt below, buried a bit into the call, Dell’s CEO also stated the enterprise servers come with higher margins than cloud service providers (CSPs) later in the call: “And I think we've said each of the last several calls and we'll say this call again, the margin selling to enterprises are better than the margins selling to our largest customers.”
Question
Amit Daryanani (Analysts)
I guess my question is really around ISG margins to really step up from 8% in Q1 to 11% in this quarter despite the [80%] sequential growth in [indiscernible]. So can you just talk about what's enabling this kind of margin expansion because really a lot of peers on the AI server side are struggling with trying to — are struggling with the margins, I feel right now.
So I'd love to understand kind of what's enabling this margin expansion? And then critically, as we think about this 11% to 14% target for the full year, what are the key inputs of building blocks together in the back half of the year?
Yvonne McGill (Executives)
Thanks, Amit. I will get started on that one. So we were very pleased with the operating income rate we saw in the second quarter of 11%, up 300 basis points quarter-over-quarter. That was really driven by improvement across the entire portfolio. I mean first, revenue was up quarter-over-quarter, 26%, which helped drive scale within the P&L. And as expected, the headwinds we saw in Q1 did not persist into Q2.
In storage, we had scale. We're price disciplined. We mixed more towards our own Dell IP storage offerings, which was very helpful and saw strength in North America enterprise.
In the traditional server space, the demand environment continued to improve, although we're still seeing some competitive pressures. And in AI servers, we had strong shipments with improved profitability and growing enterprise customers in that portfolio mix. I'd say, we do expect ISG operating income to finish FY '25 within our long-term framework that 11% to 14% and — and do expect as we move through the second half of the year that we'll continue to see that as we mix more towards our storage portfolio as we do each year.
-End Quote
Preparing to Ship for Blackwell
An analyst asked why Q3 would be down sequentially in the guide yet servers would end the year above previous guidance, to which the CFO answered: “I would say if we have the GPUs and the customers are ready, we're fully motivated and ready to ship more AI servers in the third quarter, but that is what's embedded in our guidance.”
Later, Blackwell was asked about more directly to which the CEO stated: “So when I think of the backlog limbs, I think at an opportunity of deliveries for customers next quarter and then in Q4 and then clearly into next year, and that implies Blackwell. We have sold our most advanced architecture aligned to Blackwell to a number of customers. We have sold H100 and H200s and availability. More importantly, customer availability to take the product, which is what Yvonne is reflecting in our guidance. She didn't make a demand statement. She made a shipment statement.
So demand with that 5-quarter pipeline that I described that is now multiples of our backlog is converting the backlog or converting that into orders as quickly as we can. That opportunity is in all sorts of architectures, the vast majority with NVIDIA, H100, H200 and Blackwell as well as a couple of other opportunities around AMD and Intel. But the vast majority is NVIDIA.”
-End Quote
The readthrough is that any lull from Q3 will be made up for in Q4, which obviously implies Blackwell.
CEO Remains Bullish on AI PCs
Q4 is also expected to be strong on CSG. Per the CFO opening remarks: “We expect growth in the second half of the year, particularly in the fourth quarter. The coming PC refresh cycle and the longer-term impact of AI will create tailwinds for the PC market.”
During the call, the CEO stated: “I know all of you have done your supply-based exit would indicate the same thing that refresh is heading towards end of '24, into '25. And what's important about that is as the refresh takes longer to start, history suggests it steps back faster because the Windows 10 end-of-life date is not moving. So we have a Windows 10 end-of-life date. We have an aging installed base of machines bought during the COVID era, all mounting to be refreshed with exciting new products built around AI and more AI applications are coming.”
Conclusion:
Dell looks to have some room in its valuation, and the report justifies us seeing if the roughly 25% upside in valuation will materialize. I do foresee the market going through a period of doubt on Blackwell before it arrives in volume. We have a strategy for this, which is to trim at key levels and buyback at lower levels. Regardless, Dell is one we want to own and be steadfast about as the signals are fairly clear it’s shaping up to be a major Nvidia supply partner on Tier 2 cloud service providers and enterprise AI.
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