Dell will report its Q1 earnings tomorrow at market close. The market will want to see strong QoQ AI revenue growth. Last quarter, the growth was 40% sequentially in Q4 to $800 million in AI optimized server revenue with a $2.9B backlog. The backlog grew 81% QoQ from $1.6B. Super Micro is hitting capacity, and building quickly to increase that capacity. In the meantime, it appears Dell is stepping in to fill AI server demand as a runner-up to SMCI.
For example, recently an analyst stated that Tesla is filling the bulk of its AI server order with Dell. Per the article, Amit Daryanani of Evercore stated: “While our impression is that SMCI has won some of the Tesla AI server business as well, allocations are heavily skewing towards Dell.”
It is not terribly difficult to imagine Dell as #2 for AI servers as it’s been #1 globally across all servers for some time. It’s estimated that SMCI will have about $25 billion in production capacity, which we discussed here. Current estimates are for an AI server market of $40 billion by end of 2024. Whether it’s the near-term TAM or if we simply look at Nvidia’s beat/raises, the conclusion is that more than just Super Micro will be needed to build AI servers.
Revenue
The management guide for the next quarter is $21 billion to $22 billion, representing YoY growth of 2.8% at the midpoint. Analysts are forecasting 3.3% growth for $21.61 billion. The company is expected to return to growth after six quarters of negative growth with a full recovery by H2.
Operating Segments
Revenue is rebounding as the Infrastructure Solutions Group (ISG) is expected to grow in the mid-to-high teens in Q1, led by traditional and AI server growth. ISG revenue declined for the fourth consecutive quarter in Q4. The revenue decreased by (-6%) YoY but grew by 10% sequentially to $9.3 billion. The main highlight of the last earnings report was that AI-optimized orders grew sequentially by 40%. The company reported AI revenue of $800 million, up from $500 million in Q3. Despite now being around only 4% of the total Q4 revenue, analysts expect strong AI revenue growth. Morgan Stanley analyst Erik Woodring expects AI revenue to reach $10 billion in the current FY 2025. This would represent fairly dramatic growth between now and calendar January 2025, yet lines up with the 2024 TAM of $40 billion and the delta of what SMCI is producing.
Management highlighted in the earnings call that the recovery in the PC market has been pushed to the second half of the year. However, there are favorable spots as the Q1 guide calls for a decline of (-3%) YoY in the Client Solutions Group (CSG), which is better than the decline of (-12%) YoY to $11.7 billion and a decline of (-23%) YoY in the same period last year.
Jeff Clarke, COO of the company, said in the earnings call, “In CSG, we remain optimistic about the coming PC refresh cycle as the PC install base continues to age, Windows 10 reaches end of life later next year, and the industry makes advances in AI-enabled architectures and software applications.”
We discussed the AI PC opportunity more in our previous write-up on Dell with a statement from management that the AI PC market will “absolutely” be bigger in H2 2024 than it was in H1 2024.
Margins
In the last quarter, margins improved YoY as the company juggles margin contraction and margin expansion in varied segments. The company is not expected to continue this trend of improving profit margins for a few reasons. First, the high-growth AI market is generating lower margins than the company’s other leading products. In addition, the company expects input costs to increase further in FY25, driven by anticipated inflation for component costs as the year progresses. Management also anticipates the pricing environment to be more competitive in FY25.
- Q4 gross margin increased 70 bps sequentially and 80 bps YoY to 23.8%.
- Adjusted gross margin improved 80 bps sequentially and 70 bps YoY to 24.5%, partly helped by the higher revenue mix of ISG revenue.
- The company also witnessed pricing pressures in PCs and servers, however, remained focused on profitable opportunities and expects this discipline to go forward.
Adjusted gross margin guide for the next quarter is 22.5%, down 200 bps sequentially and 220 bps YoY. The decline in gross margin is due to the seasonally lower storage revenue mix, higher AI-optimized server revenue mix, pricing pressures, and higher inflationary cost components.
- Operating margin remained flat sequentially and improved 190 bps YoY to 6.7%.
- Adjusted operating margin improved 80 bps sequentially and 90 bps YoY to 9.6%.
The improvement in the margins was due to higher gross margins and cost-cutting initiatives. The company also announced a reduction of staff in the recent quarter. Management expects the adjusted operating margin to trend lower sequentially in Q1 due to the factors discussed in the previous paragraph. Management expects improved performance as the year progresses.
- Net margin of 5.2% was up 270 bps from the year-ago quarter.
- The adjusted net margin improved 190 bps YoY to 7.2%.
- Adjusted EPS came at $2.20 and beat estimates by 27.9%.
- Management expects Q1 adjusted EPS to be $1.15 at the midpoint and is lower due to the factors already discussed above. The analysts expect Q1 adjusted EPS of $1.25, representing a YoY decline of (-4.7%).
Cash Flow and Balance Sheet
Last quarter, Dell announced a 20% hike in the annual dividend to $1.78 per share and substantial share buyback program reflects Dell's confidence in sustained cash flow generation and long-term value creation.
- Operating cash flow of $1.53 billion in Q4 represented a margin of 6.9% compared to $2.71 billion or 10.8% of revenue in the same period last year.
- Adjusted free cash flow for Q4 was $1.01 billion or 4.5% of revenue compared to $2.27 billion or 9.1% in the same period last year. However, for FY2024, the operating cash flows grew 143% YoY to $8.7 billion. Management has been focused on improving cash and working capital.
The company had $8.7 billion in cash and investments and $26 billion in debt. Debt is down from $26.6 billion in the September quarter as the company is focused on deleveraging. The company also reached its core leverage target of 1.5x, down from 1.6x in Q3 and 1.8x in the same quarter last year.
What to Watch
AI-Optimized Server and Backlog:
AI-optimized server backlog increased from $1.6 billion in Q3 to $2.9 billion in Q4. This is a five-quarter backlog. Jeff Clarke also mentioned the strong demand in the earnings call and how they are helping their customers who are in the early stages of AI.
“AI-optimized server orders increased by nearly 40% sequentially. We shipped $800 million of AI-optimized servers, and our backlog nearly doubled sequentially, exiting the fiscal year at $2.9 billion. Demand continues to outpace GPU supply, though we are seeing H100 lead times improving. We are also seeing strong interest in orders for AI-optimized servers equipped with the next generation of AI GPUs, including the H200 and the MI300X….”
Management also said that they will ship more in Q1 than in Q4 and any guide on the AI revenue is to be watched.
There are reports that lead times for servers powered by Nvidia’s H100 GPUs have come down eight to 12 weeks from the earlier 39 weeks, which should help to increase the AI revenues in coming quarters.
Dell’s Nvidia partnership and enterprise opportunity
At the Nvidia GTC event, Jensen Huang spoke iabout Dell AI servers for enterprises. "Everybody who is building these chatbots and Generative AI, when you are ready to run it, you need an AI factory and nobody is better at building end-end systems of very large scale for the enterprise than Dell. Any company and every company needs to build AI factory and it turns out Michael (Dell) is here he would happy to take orders.” you need an AI factory and nobody is better at building end-end systems of very large scale for the enterprise than Dell. Any company and every company needs to build AI factory and it turns out Michael (Dell) is here he would happy to take orders.” The company also recently announced Dell servers that support the latest Blackwell chips. The new servers offer liquid cooling technology that is expected to consume lower power.
We covered the enterprise opportunity more thoroughly in our last write-up.
Storage recovery
Storage revenue declined by (-10%) YoY and up sequentially by 16% to $4.5 billion. Management mentioned that Q1 is seasonally low for storage revenue, and that storage recovery typically lags servers by a couple of quarters. They mentioned that their storage business is expected to have strong growth opportunities in unstructured data. They are also optimistic about tapping the opportunity on-premises or at the edge network.
Per the last earnings call: “I need to mention we got a storage opportunity in there, that we have a networking opportunity in there, and we have a services opportunity in there and to go for the last of the bunch of financing opportunities. So those — how could you not be excited about that given the demand environment?”
AI PCs
During the last earnings call, management said that PC recovery was pushed to the second half of the year. However, they were positive on the coming PC refresh cycle and longer-term impact from AI. The company also recently announced new AI-PCs during the Dell Technologies World. According to Morgan Stanley, 64% of the new PCs in 2028 are expected to be AI PCs, of which Dell will be a large beneficiary.
Conclusion
Dell has done quite well recently. The stock is up 69.2% since the company reported Q4 results and has outperformed Nvidia, Super Micro, and the Nasdaq-100 index during this period. In our last write-up, we focused on Dell’s valuation as a primary part of the thesis. This was similar to our Super Micro thesis, which centers around the pivotal moment that a commoditized hardware company becomes valued like an AI stock. Dell is trading about one-third what SMCI is trading at on sales, and is trading at about two-thirds what Super Micro is trading at on PE ratio. Dell has about 5% AI revenue compared to Super Micro’s 50%. The company may end the year with 10% of revenue from AI. With that said, Dell is a cash cow with a dividend while Super Micro has to raise cash. So, this is not exactly apples-to-apples, but for those who are patient, we think Dell will close its valuation gap with SMCI.
Let’s see what happens tomorrow night. You’ll get a post-earnings writeup from the fundamentals team after market close. Knox will also address his trading plan for Dell in the weekly Advanced Market Signals webinar held Thursday at 4:30 p.m. Eastern.
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