Dell will release its Q2 FY2025 results on August 29th. The management revenue guide is $23.5 billion to $24.5 billion, representing YoY growth of 4.7% at the midpoint. The company also raised the FY2025 revenue guidance from $91 billion to $95 billion to a new range of $93.5 billion to $97.5 billion due to strong AI server demand.
Margins will be a key area of focus in the upcoming earnings and was the primary reason for the post-Q1 sell-off. Recently, Super Micro also witnessed a sell-off due to lower margins. Dell’s margins are under pressure due to inflationary cost increases, competition, and a higher mix of AI-optimized servers. The company forecasted adjusted gross margins to decline by 150 basis points for FY2025.
This report hinges on progress on AI PCs and the market will also want to see growth in AI servers, which reported 113% QoQ last quarter.
Revenue
- Q1 revenue grew by 6.3% YoY to $22.24 billion. This is an acceleration from a (-10.9%) decline in Q4. Next quarter is expected to slightly taper off to growth of 5.2% YoY for $24.12 billion in revenue, and then accelerate again to 10.6% growth in Q3.
- The Q1 revenue growth was helped by strong demand for AI servers and a return of growth in the commercial PC business.
- Analysts expect FY2025 revenue to grow 9.1% YoY to $96.49 billion. This compares to an acceleration from a (-13.6%) decline in FY2024.
- Analysts expect FY2026 revenue to grow 7.9% YoY to $104.15 billion.
Key Operating Segments
Revenue rebounded in the Infrastructure Solutions Group after four quarters of negative growth. Revenue grew by 22% YoY to $9.2 billion, primarily helped by strong server and networking revenue growth of 42% YoY to $5.5 billion. Storage revenue was flat YoY to $3.8 billion. Management has guided ISG revenue to grow by mid-twenties percent in Q2 and the combined ISG and CSG revenue to grow by 8% at the midpoint.
Infrastructure Solutions Group’s adjusted operating margin was 8%, down from 9.7% in the same period last year and 15.3% in the previous quarter. Margins were lower due to the increasing AI server revenue and seasonal low revenue for the storage segment. Management expects margins to improve, guiding the adjusted operating margin within the long-term target of 11 to 14% for FY2025.
Client Solutions Group’s revenue was flat at $12 billion. Commercial revenue grew by 3% YoY to $10.2 billion and consumer revenue declined by (-15%) YoY to $1.8 billion. Commercial PC demand stabilized, and management is optimistic about the PC refresh cycle and the long-term benefits of AI on the PC market.
CSG’s adjusted operating margin was 6.1%, down from 7% last year and 6.2% in the previous quarter due to competitive pricing. Management expects to be within the long-term target of 5 to 7% for FY2025.
Management expects ISG revenue to grow more than 20%, driven by strong AI demand, and CSG revenue to grow in the low single digits for FY2025. ISG and CSG combined are expected to grow 11% at the midpoint.
Margins
Margins are under pressure due to competition and a higher proportion of AI-optimized server revenue mix. The lower proportion of storage revenue seasonally also negatively impacted margins. As the year progresses, margins are expected to improve with a higher proportion of storage revenue and higher margin services revenue, offset by inflationary cost increase. The company is focused on reducing costs and has recently reduced the sales team.
- Q1 gross margin was 21.6%, down from 24% in the same period last year and 23.8% in the previous quarter. Adjusted gross margin was 22.2%, down from 24.7% in the same period last year and 24.5% in the previous quarter. The lower gross margin was due to the competitive pricing environment and higher AI-optimized server revenue mix.
- Management has guided adjusted gross margins to decline by about 150 basis points for FY2025 from 24.3% for FY2024 due to inflationary cost increases, competition, and a higher mix of AI-optimized servers. Previously, the guide given during Q4 results showed a decline of about 100 basis points.
- The operating margin was 4.1%, down from 5.1% in the same period last year and 6.7% in the previous quarter. The adjusted operating margin was 6.6%, down from 7.6% last year and 9.6% in the previous quarter. The drop in operating margin was due to lower gross margin and was partially offset by lower operating expenses due to cost cuts.
- Net income was $955 million or 4.3% of revenue compared to $578 million or 2.8% of revenue last year. The higher net income was due to the one-time tax benefit in the recent quarter.
- Adjusted net income was $923 million or 4.1% of revenue compared to $963 million or 4.5% of revenue last year.
EPS
The company missed the adjusted EPS estimates by 1.9% due to a competitive pricing environment, a lower proportion of storage revenue, and a higher mix of AI-optimized server revenue mix.
- GAAP EPS grew by 67.1% YoY to $1.32, helped by a one-time tax benefit. Adjusted EPS declined by (-3.1%) YoY to $1.27 and missed estimates by 1.9%.
- Management Q2 adjusted EPS guide is $1.65, +/- $0.10. Analysts expect adjusted EPS to decline by (-2.8%) YoY to $1.69 and then accelerate to 15% growth to $2.16 in Q3.
- Management FY2025 adjusted EPS guide is raised from $7.50 to $7.65, +/- $0.25. Analysts expect FY2025 adjusted EPS to grow 8.1% YoY to $7.71 and 20.9% growth in FY2026 to $9.32.
Cash Flow and Balance Sheet
The trailing twelve months adjusted free cash flow was $5.5 billion, which is higher than the five-year average of $4.8 billion. We would like to see the cash flow improve, particularly since the company has high debt.
- Operating cash flow was $1.04 billion or 4.7% of revenue compared to $1.78 billion or 8.5% of revenue in the same period last year.
- Adjusted free cash flow was $623 million or 2.8% of revenue compared to $687 million or 3.3% of revenue in the same period last year.
- The company returned $1.1 billion to the shareholders through $722 million in share repurchases and $336 million in dividends.
- The company had cash and investments of $7.1 billion and debt of $25.48 billion, compared to $8.68 billion and $26 billion in the previous quarter. The core leverage ratio has been maintained within the company’s target of 1.5x.
- During Q1, the company issued $1.0 billion of 5.4% senior notes due 2034. It used the proceeds to prepay a portion of the outstanding 6.02% senior notes due 2026, thereby increasing the maturity and decreasing the interest expenses.
- Inventory was $4.8 billion compared to $3.6 billion in the previous quarter due to higher inventory related to the AI server business.
Other Key Points to Watch
AI-Optimized Server and Backlog
The company’s AI-server optimized orders increased to $2.6 billion and AI shipment grew strongly increasing 113% sequentially to $1.7 billion. AI-server backlog increased to $3.8 billion from $2.9 billion in the previous quarter. However, was lower than the consensus estimates of $4 billion to $5 billion.
Jeff Clarke, COO and Vice Chairman, said in the earnings call, “In ISG, our AI-optimized servers orders increased to $2.6 billion, with shipments up more than 100% sequentially to $1.7 billion. We have now shipped more than $3 billion of AI servers over the last three quarters. Our AI server backlog is $3.8 billion, growing sequentially by approximately $900 million. Our AI optimized server pipeline grew quarter-over-quarter again and remains a multiple of our backlog.”
Storage revenue
Storage demand stabilized as revenue was flat in Q1 and accelerated from a (-10%) decline in the previous quarter. Storage revenue is expected to recover from the seasonal low quarters and benefit from the strong AI server demand. Management previously mentioned that storage recovery typically lags servers by a couple of quarters and also previously mentioned that “for every $1 of AI server, there's $2 of services, storage and other higher-margin things that come.”
AI PCs
Management remained optimistic about the coming PC refresh cycle. Jeff Clake said in the earnings call, “The PC installed base continues to age, Windows 10 will reach end of life later next year and the industry is making significant advancements in AI-enabled architectures and applications. We will continue to focus on commercial PCs, high-end of consumer, and gaming, driving a strong attach motion, a strategy that has served us well across various economic cycles.”
Earlier in May this year, the company announced new AI PCs during the Dell Technologies World.
Valuation
Dell is trading at a P/E ratio of 22.3 and a forward P/E ratio of 14.3, higher than the 5-year average P/E ratio of 12.5. Similarly, it trades at a P/S ratio of 0.9 and a forward P/S ratio of 0.8, above its average of 0.43. The P/S ratio peaked at 1.47 prior to the announcement of Q1 results and bottomed out at 0.72 on August 07th.
Conclusion
Dell is a beneficiary of AI servers, the new upgrade cycle coming for PCs, and AI PCs. Another catalyst is that the company might be included in the S&P 500 Index. Commercial PC and storage demand stabilized in Q1. At the same, margins are to be monitored in the upcoming quarter.
Many AI semis have stretched valuations. Dell does not have a stretched valuation yet went quite low on the last drawdown in sympathy with AI peers. Our goal is to de-risk the position at higher levels.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
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