Q1 2025 Summary
Published Jan 10, 2025, 5:10 PM UTC- ISG revenue is expected to grow over 20% fueled by AI, indicating strong momentum in AI-optimized servers as a significant growth driver for Dell.
- Dell Financial Services provides a competitive advantage, offering value-added services and financing options to AI server customers, enabling them with working capital and flexible payment solutions.
- ISG operating income rates are expected to improve and finish FY '25 within the long-term framework of 11% to 14%, driven by scaling the storage business, growth in traditional servers, and the additive impact of AI momentum.
- Declining Operating Margins Due to AI Servers: Despite adding $1.7 billion in AI server revenue, Dell's operating profit remained flat, indicating that operating margins for AI servers are effectively zero. This suggests that AI servers are margin rate dilutive, impacting overall profitability.
- Component Cost Inflation Leading to Margin Pressure: Dell anticipates inflation in component costs, especially DRAM and SSDs increasing mid-teens to 20% quarter-over-quarter in the second half, which will place further margin pressure on the company.
- Flat Storage Revenue and Low Operating Income in Storage: Storage revenue was flat year-over-year, and operating income in storage was low, partly due to a mix shift to lower-margin products and lack of expected uplift from AI servers, challenging the anticipated higher-margin opportunities from associated storage sales.
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AI Server Margins
Q: Were AI server margins effectively zero?
A: Management explained that while AI-optimized servers are margin rate dilutive but margin dollar accretive. The lower operating income in ISG was due to seasonal factors in storage and a shift towards large enterprise deals with lower margin rates. They expect ISG operating income rates to improve over the year and deliver within their long-term framework of 11% to 14%. -
ISG Margin Outlook
Q: What factors will support ISG margin expansion?
A: Management expects ISG operating income rates to improve due to scaling of the storage business, better mix towards Dell IP solutions, and recovery in traditional server margins with improved customer and geographic mix. They reaffirmed their expectation to deliver ISG operating income within the long-term framework of 11% to 14% for FY'25. -
Revenue from AI Servers
Q: Will AI servers drive higher-margin sales in services and storage?
A: Management believes each AI server sold leads to additional opportunities in storage, networking, and services. AI deployments require significant storage for data training, high-bandwidth networking, and services to help customers with AI strategy and implementation. While these benefits may take time to reflect in the P&L due to deferred revenue recognition, they remain confident in the long-term margin accretive impact of AI server sales. -
Competitive Pricing Impact
Q: Is Dell driving competitive pricing to gain share?
A: Management noted that competitive pricing is influenced by market conditions, especially in PCs and large enterprise deals. They are not leading on price in AI servers and are getting a premium for their engineering value. In traditional servers, competitive pricing is seen in large enterprise and bid deals, and they aim to win new customers for long-term portfolio sales, accepting lower margins initially. -
AI Customer Mix
Q: What's the customer mix for AI platforms?
A: Dell's AI server sales are currently skewed towards Tier 2 CSPs, but they are seeing growth in enterprise customers, with an increasing number of repeat buyers. They believe the opportunity in enterprise deployment of AI at scale is significant, and the number of enterprise customers and revenues in AI servers increased quarter-over-quarter. -
Component Inflation Impact
Q: How will component inflation affect margins?
A: Management expects component costs, particularly DRAM and SSDs, to increase mid-teens to 20% quarter-over-quarter in the second half of the year due to reduced supply. This will place margin pressure, and they plan to adjust pricing accordingly. They aim to recover about two-thirds of the cost increases over a 90-day period. -
PC Demand Outlook
Q: What's the outlook for commercial PC demand and AI PCs?
A: Management is encouraged by signs of stabilization and growth in the PC business after two years of decline. The installed base is old, with many devices reaching four years in age, indicating a refresh cycle. The upcoming end-of-life for a version of Windows may drive upgrades. They are optimistic about AI PCs, with new models launched and more coming, expecting AI features to drive demand. -
Inventory Increase
Q: Why did inventory increase significantly this quarter?
A: Inventory increased by $1.2 billion quarter-over-quarter, mainly due to ramping up the AI server business. Dell took ownership of AI gear components and holds inventory in backlog awaiting customer order fulfillment. No strategic purchases were made across the broader component base. -
Backlog Conversion
Q: How will AI server backlog convert to revenue?
A: The AI server backlog is complex, involving multiple technologies with different customer commitments and delivery dates. Backlog clearance depends on supply availability and customer priorities. Management has reflected their best estimate of backlog conversion in their outlook and continues to build backlog as they receive orders and await parts. -
Inference Opportunity
Q: When will enterprises adopt AI inference at scale?
A: Dell believes enterprises are at various stages of developing their AI strategies, focusing on data preparation and use cases like content creation and code generation. They are in early stages of inference deployment, and Dell sees a significant long-term opportunity as enterprises move from proof-of-concept to production, especially in AI inference, which they expect to be the largest use case over the decade.