Dell Technologies Inc. (DELL) Q4 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the Fourth Quarter Fiscal Year 2017 Earnings Conference Call for Dell Technologies Inc. I'd like to inform all participants this call is being recorded at the request of Dell Technologies. This broadcast is the copyrighted property of Dell Technologies Inc. Any rebroadcast of this information, in whole or in part, without the prior written permission of Dell Technologies is prohibited. As a reminder, the Company is also simulcasting this call at investors.delltechnologies.com. A replay of this Webcast will be available at the same location. Following prepared remarks, we will conduct a question-and-answer session. [Operator Instructions] I'd like to turn the call over to Rob Williams, Senior Vice President of Investor Relations. Mr. Williams, you may begin.

Thanks, Regina. Good morning and thanks for joining us. With me today is our Chief Financial Officer, Tom Sweet; our President of Infrastructure Solutions Group, David Goulden; and joining us from Europe is our Treasurer, Tyler Johnson. On this call, we will focus primarily on Q4 results. We will provide more details on our strategy, integration efforts and capital structure at our Investor Meeting on April 5. For more details, please see the Events section of our Web-site at investors.delltechnologies.com. We posted our fourth quarter press release and Web-deck on our Web-site and Q4 results will be filed on Form 10-K tomorrow. I encourage you to review these documents for additional perspective. In addition, fiscal 2017 had an extra week, which was incorporated into the Company's Q4 results Now I would like to highlight key changes to our financial statements due to the EMC merger and the announced divestitures. As mentioned last quarter, we are reporting EMC and VMware on the Dell Technologies fiscal year. VMware Inc. has now transitioned and will report their standalone financial results on the basis of Dell Technologies fiscal year, which started on February 4, 2017 and will end on February 2, 2018. Operationally, this transition will help align our combined financial goals and go-to-market approach. Due to the recent divestitures of Dell Services, Dell Software Group and the Dell EMC Enterprise Content Division, these businesses were reported as discontinued operations in Q4 results. In prior quarters, all assets and liabilities of these businesses were reclassified into the held-for-sale asset and liability categories on the balance sheet. On the income statement, the financial results of these businesses were reclassified out of the activity from continuing operations and listed separately in the category for discontinued operations. For more information, please refer to our SEC filings. Our Q4 non-GAAP operating income excludes approximately $3.5 billion of adjustments. The majority of these are non-cash and relate to purchase accounting and amortization of intangible assets. Please note that due to the EMC merger and to a lesser extent the Dell go-private transaction, there will continue to be significant bridging items between our GAAP and our non-GAAP results for the next few years, although the impact will decline in each subsequent quarter. Please refer to Slide 3 in the Web-deck for additional detail on the non-cash adjustments and the supplemental slides beginning on Slide 17, as well as our SEC filings for more details on our non-GAAP adjustments. As a reminder, please note that our prior year historical financials do not include EMC historical results, and unless otherwise specified, all growth percentages refer to fiscal year-over-year change, which is compared to Dell prior year results. During this call, we will generally reference non-GAAP financial measures, including non-GAAP revenue, gross margin, operating expenses, operating income, net income, EBITDA and adjusted EBITDA, on a continuing operations basis. A reconciliation of these measures to its most directly comparable GAAP measure can be found on Form 10-K and in the supplemental material of our Web-deck. Finally, I'd like to remind you that all statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in the cautionary statements section of our Web-deck. We assume no obligation to update our forward-looking statements. With that, I'll turn it over to Tom.

Thanks Rob. Fiscal 2017 was a busy year and I'm pleased with our progress. Over the course of the year, we successfully completed the merger of EMC, becoming the world's largest privately-controlled technology company with market-leading solutions. We divested certain businesses, including Dell Services, Dell Software Group and Dell EMC Enterprise Content Division. We successfully completed the IPO of SecureWorks. We maintained our capital allocation focus by delevering approximately $7 billion in debt since the transaction closed. We cumulatively repurchased $824 million of Class V shares, which Tyler will cover in more detail. And we continued to invest in key strategic areas, supporting our customers' Digital Transformation agenda, including hyperconverged, hybrid cloud, software-defined solutions and end-user computing. Our GAAP revenue for the full year was approximately $62 billion, with a GAAP operating loss of $3.3 billion. As Rob mentioned, our GAAP results were significantly impacted by non-cash purchase accounting and transaction cost. Non-GAAP revenue was approximately $63 billion, with operating income of $5.1 billion. CSG revenue was approximately $37 billion, up 2% for the full year. Our PC business outgrew the industry by 1,000 basis points and gained share year-over-year for the 16th consecutive quarter. Operating income was $1.8 billion, or 5% of revenue. In our ISG business, we exited the year with leading share positions in server units and storage revenue. Additionally, we are also number one in revenue share in converged infrastructure, all-flash arrays and purpose-built backup appliances. Switching to Q4, GAAP revenue was $20.1 billion, with a GAAP operating loss of $1.7 billion. Non-GAAP revenue was $20.6 billion. We saw pockets of growth and areas of improvement as we start to benefit from our synergies as a combined company. While consolidated year-over-year compares for ISG are not meaningful, CSG revenue grew 11% and we outgrew the industry in both consumer and commercial PC units. Our ISG business saw revenue growth in PowerEdge servers and strength in our emerging solutions, including all-flash arrays, hyperconverged systems and software-defined storage, but we did see softness in traditional external storage arrays. Gross margin at the consolidated level was $6.6 billion, or 32% of revenue. OpEx was $4.8 billion or approximately 23% of revenue, as we continued to execute on our cost initiatives and invest to drive growth in a rapidly changing market. Operating income was $1.8 billion, or 9% of revenue. Now let me turn it over to Tyler to cover our EBITDA, cash flow and capital structure.

Thanks Tom. Adjusted EBITDA for the quarter was $2.2 billion, or 11% of revenue. Please see Slide 17 in the Web-deck for more details on our EBITDA adjustments. In Q4, we generated cash flow from operations of $676 million. As a reminder, this includes approximately $1 billion in interest expense as the majority of interest payments occurs in Q2 and Q4 of each fiscal year. In addition, we paid approximately $500 million related to a tax settlement, and to a lesser degree there were impacts from integration and divestiture costs. Our cash and investments balance increased by $287 million versus the previous quarter, ending the year at $15.3 billion. Having just completed our first full quarter as a combined company, we are happy with the progress we have made in regards to our balance sheet and capital structure management. Since closing the EMC transaction, we have paid down $7 billion in debt. This includes $3.1 billion of Term Loan A and $2.2 billion of the Asset Sale Bridge loan retired in Q4, both funded by net proceeds from the divestitures. In addition, to date we have made payments of $1.6 billion on our revolver and paid $100 million in term loan amortization. These debt repayments result in a $200 million reduction in annualized interest expense on a run rate basis. At the end of Q4, we announced our intent to re-price our existing Term Loan B facility and raise an incremental $500 million, which will be used to partially pay down our $2.5 billion Margin Loan Bridge. We successfully closed this transaction on March 8, resulting in an expected incremental $40 million reduction in annualized interest expense on a run rate basis and apply the $500 million as planned. We ended the quarter with $50.4 billion in total principal debt. Of this amount, $43.7 billion is core debt. The remainder included approximately $5 billion of debt that funds our global Financial Services business and $1.5 billion of a bridge facility backed by legacy intercompany note due to Dell Technologies. Moving to our share repurchase program, last quarter we announced that our Board had authorized a new Class V common stock repurchase program for up to $500 million over a six-month period for the Class V Group. To fund the new program, Dell Technologies entered into a share purchase agreement to sell $500 million of VMware Class A common stock to VMware. Related to this announcement, we simultaneously suspended the previous $1 billion Class V common stock repurchase program which was for the DHI Group. As of today, we have repurchased approximately 8.4 million shares of Class V common stock for $500 million under the Class V Group repurchase program. Combined with what was repurchased under the original $1 billion DHI Group program, we've repurchased a total of $824 million or approximately 15.1 million shares. In addition, today we announced that our Board has approved an amendment to our existing Class V Group repurchase program for up to $300 million over six months and solely funded through a new VMware Class A stock purchase agreement with VMware. I want to reiterate that our overall capital allocation strategy has not changed and we remain focused on our plan to delever the balance sheet to profitable growth and strong cash flow generation. Let me turn it over to David.

Thanks Tyler. The Information Solutions Group or ISG had a solid quarter with share gains in key product areas, including all-flash arrays, converged integrated infrastructure, hyperconverged infrastructure and service. More on these in a moment. While we executed well in the growth areas of our portfolio, there continues to be pressure in traditional solutions as customers down-spend between IT and digital transformation initiatives. In total, Q4 revenue for the ISG business was approximately $8.4 billion, with operating income of $1 billion or 12% of revenue. Looking at our results by segments, our server and networking revenue of $3.6 billion increased 12%. In servers, we outgrew the market to regain the number one unit share position on a global basis according to IDC. The strength was driven by our mainstream PowerEdge business where we gained approximately 600 basis points of year-on-year revenue share against our closest competitor. Our high-volume cloud server business declined, which tends to fluctuate quarter to quarter based upon customer order patterns. While we are very pleased with the velocity of the server business this quarter, we continue to work to improve our cost structure and ensure we have the right solutions at the right price points to meet our customers' needs. We continue to invest in this business and look forward to announcing our next generation of service later this year. Our networking business grew approximately 2x the market and had its highest level of revenue in eight quarters, driven by our open networking strategy and by winning new service provider and web tech customers. Storage revenue of $4.8 billion was up substantially due to impact of the Dell EMC transaction. As a reminder, the change in the legacy EMC fiscal year from December to January along with our focus on working capital efficiency has caused a change in backlog, especially at the end of the calendar quarter. And this change will also result in a change in sales linearity, particularly in the first calendar quarter of 2017. So for today's call, we are going to talk about the performance of our storage business for calendar Q4 on a demand basis. We had a record-setting Q4 demand in our all-flash array business and exited the year with a growth rate of almost 100% to more than $4 billion demand run rate, gaining significant share. We believe we are nearly the size of the three next competitors combined as we continue to capture the market shift to all-flash. In converged infrastructure, our Vblock integrated infrastructure business also had its largest quarter ever with demand growing high-single-digits on a calendar basis. We remain the industry leader with well over 50% market share, as customers continue to look to us to make infrastructure easier while using best-of-breed products. Hyperconverged solutions have been a major growth initiative this year, and with the strength of our Dell EMC XC, VxRack and VxRail portfolio, we believe we are now the market leader on a calendar Q4 demand basis with strong triple digit growth. Within our appliance offerings, the demand for our Dell EMC XC solution grew triple digits as customer engagement remained strong. Our VxRail offering is seeing significant growth and ended the year on a nearly $400 million demand run rate basis, only 10 months after the product was introduced. The rapid growth is driven by customer demand for a fully integrated solution optimized for VMware environments. We expect the momentum to continue in Q1 with the introduction of our Enterprise Hybrid Cloud on VxRail and global availability of PowerEdge inside VxRail. Also within our hyperconverged portfolio, our VxRack solutions continue to gain traction in larger environments as we create a new category for data center scale hyperconverged infrastructure. As we move to fiscal 2018, we are extremely excited about our position in the market and confident in our ability to execute against the unparalleled solution portfolio, flexible consumption models and newly aligned go-to-market initiatives. We remain focused on serving the needs of our customers as they work towards IT and digital transformation initiatives to drive business value. I look forward to sharing more with you about our views of the market and our strategy at our upcoming Investor Meeting on April 5. Additionally, I am very excited about the many exciting product announcements we will make at Dell EMC World in May. So let me now turn it back over to Tom who will walk you through the Client Solutions Group.

Thanks David. The Client Solutions business had a strong fourth quarter as we further enhanced our portfolio of solutions and continued to focus on profitable growth. In addition, the overall market was better than expected for calendar Q4. According to IDC, worldwide PC unit shipments for calendar Q4 declined by 1.7%, exceeding their forecast of a negative 4.2%. We continue to drive market consolidation. According to IDC, we outgrew the market by 9.9 percentage points in calendar fourth quarter and have now gained share year-over-year for 16 consecutive quarters. Dell outperformed the worldwide market in both notebooks and desktops and in both commercial and consumer. We shipped 11 million PCs, which was the largest volume of products shipped since calendar Q4 of 2011. Turning to our fiscal results for CSG, revenue was $9.8 billion, up 11%. This growth was broad-based across both commercial and consumer. Commercial returned to growth up 12% as we saw a growth across all of our major commercial product lines. As is typical in Q4, we saw continued strength in consumer, which grew 9%. Operating income was $342 million, down 29% to 3.5% of revenue. The decline was primarily driven by pricing decisions in the quarter as well as some positive one-time items in the prior year period. As we mentioned on last quarter's call, the third quarter op inc margins were higher than what we've typically seen for CSG due to a benefit from a vendor settlement and favorable cost environments. So moving into Q4, we expected some movement back toward the normal range, especially as we have started to see an increase in component cost. We are focused on balancing growth and profitability as we move forward. Performance across both high-end consumer and commercial notebooks continues to be strong with XPS, Mobile Workstations and Latitude, each seeing positive growth. Our Alienware products also had very strong growth as consumers look to us as the leading brand in gaming for high-performance systems with fast processor power, high-resolution screens and the latest graphics technology. Desktops returned to growth this quarter, driven by OptiPlex and Precision Workstations, and we are starting to see the benefits of our investment and our focus on innovative form factors. Dell's focus on innovation was again evident at CES 2017. The Company secured 62 awards. At CES we announced several consumer and commercial innovations, including the world's smallest 13-inch 2-in-1 in our new XPS 13. This product boasts in its Infinity Edge screen, longer battery life, best-in-class security and has already won more than 30 awards since its launch in January. The Dell Canvas, which is the world's first horizontal smart workspace of its kind, aimed at enabling more effective drawing and creation capabilities. And the world's first 32-inch 8K high-definition display. We were pleased with the performance of CSG in fiscal 2017. Going forward, we remain focused on expanding our customer base as we continue to take profitable share. Now let me shift to the VMware segment and our other businesses. VMware had a strong quarter. Revenue from VMware in the Dell Technologies fiscal quarter was $1.9 billion, with operating income of $565 million or 29.2% of revenue. VMware helps customers grow and enable their private clouds with software-defined data center and end-user computing software and then expand with hybrid cloud and multi-cloud solutions. We are seeing their value resonate with customers, which is evident in their Q4 annualized NSX bookings run rate of $1 billion and over 2,400 NSX customers; their Q4 annualized vSAN bookings run rate of $300 million and over 7,000 vSAN customers; and their strong quarter for mobility products with increasing adoption of their complete workspace solution, Workspace ONE. In addition, revenue from our other businesses which include SecureWorks, RSA, Pivotal, and Boomi, was $480 million. SecureWorks standalone revenue was approximately $119 million, up 26.4%, as this business continues to experience strong demand for its subscription-based security solutions. They also continue to make progress in their path to profitability, driven by record gross margin and better operating leverage. Pivotal continued its momentum in the fourth quarter as it achieved strong top line growth, driven primarily by its subscription software. Pivotal Cloud Foundry saw impressive growth at scale and crossed a major milestone in calendar 2016 with bookings over $270 million, up 130%. Pivotal Cloud Foundry enables developers to deploy cloud-native apps on any public or private environment, including Azure, Google and AWS. Pivotal works with over one-third of the Fortune 100 and a rapidly growing portion of the Fortune 2000 as it benefits from our combined go-to-market approach. Dell Technologies delivers a strong portfolio of solutions and a force multiplier effect that provides us with the scale and the ability to serve our customers' needs across existing IT where we are the leader in servers, storage, virtualization, and PCs, and in the IT of tomorrow including hybrid cloud, cloud-native applications, software-defined data center, mobility, and security. So in closing, we remain focused on executing our strategy and we are on track with a broad set of integration activities. At the beginning of fiscal 2018, we introduced our new sales force segmentation model and channel program. While we are in the very early stages of the Dell EMC Partner Program, we have received overall positive feedback from our partners. As I mentioned last quarter, there may be some short-term disruption as our sales force and partners ramp in the new go-to-market activities. We will continue to drive against the cost and revenue synergies we have identified and we will continue to invest and provide great solutions and services to our customers. We are pleased with our results this year but we realize that there is more to be done as we continue to work our way through the integration and stay focused on our customers in the coming quarters. Now, I'll turn it back to Rob to begin Q&A.

Thanks Tom. Let's get to Q&A. We ask that each participant ask one question, with one follow-up if you have one. Regina, can you please introduce the first question?

[Operator Instructions] We'll take our first question from the line of Thomas Eagan with J.P. Morgan. Please go ahead.

My question is around margins. Tom, you talked about margins being lower this quarter and you had guided us to the fact that they would be lower, and also I was expecting because of DRAM prices being higher for them to be lower, but then you also mentioned things like pricing decisions. So I wondered if you could provide a little extra color around what that means and maybe how much impact some of these things had, like higher DRAM prices, on margins. And then David, same thing for ISG, you talked a little bit about you need to work to improve cost structure and things like that, but margins there were also down. So I wondered if you could provide a little bit more color around what was impacting margins there as well. Maybe you could break down some pieces for us. Thanks.

It's Tom. So look, from an overall perspective, particularly in the CSG space we had cautioned you guys last quarter that we didn't think that margins would, or our operating income percentages I should say, would hold given some of the dynamics we saw in Q3 coming into Q4. So look, I mean we clearly have a bit of a headwind on component cost with memory and some of the glass. I think that's going to continue to be a headwind as we go through the first half of the year at least. And then also, look I mentioned pricing decisions in my prepared comments. I do think that as we thought about how to balance growth and profitability, we were probably slightly more aggressive in the quarter in the sense of some of the acquisition deals that we were doing, some of our share positioning that we were doing. You also have to remember that the mix of the quarter is a little bit different, right. So you've got a higher consumer mix in the quarter given the seasonality of the holidays. And so, look, as always as we talk about the business, we're all about trying to drive ultimately growth in gross margin dollar growth. And so we did see a little bit of pressure on margin percent. I'm happy with the velocity of the business. And what we're always doing is trying to fine-tune what's the right pricing levels to be at given the state of the business, the state of the market and the cost structures that we're dealing with. So, that's sort of the dynamic we saw as we went through the quarter from a Client side, and I'll let David perhaps comment on some of the margin dynamics that we saw on the ISG side.

Tom, thanks for the question. Couple of factors here. One that impacts both gross margin and operating margin is bear in mind that Q3 was kind of a partial quarter which impacted things because it's just a bunch of moving parts due to timing of the acquisition that flows through the income statement. Operationally, you saw that we gained a significant amount of market share in service in a market that was relatively flat. So we did make a conscious decision to drive to get share gains in that marketplace and that came some expense on the margin side. From a server point of view, the DRAM pricing didn't affect as much in Q4 because we bought ahead of that. That's more a factor for us as we go into this current fiscal year.

Our next question will come from the line of Jeff Harlib with Barclays. Please go ahead.

Maybe you can update us on the synergy program, the $2 billion of savings that you expected to realize within 18 months, and the integration of sales coverage channel programs and how that should phase, and if you saw any of those savings in the first quarter, fourth quarter I should say?

It's Tom. Look, I think we are generally on track on the cost synergies to date from what we are executing against. I do think, and I alluded to it in my comments, that we are putting some investment back into the business around capacity, around some incremental solution. So we'll have to balance that as we go forward relative to where we are in our cost synergy track. From a coverage model, I highlighted and we had told you guys in Q3 as well that as we moved into the first quarter of fiscal 2018, as we move to a unified or a more cohesive selling motion and reorganize the sales organization that there was the opportunity for that to be a bit disruptive in the short term. We are early on in that and we don't give forward-looking guidance. I would say, I think we are generally on track with what we expected with the sales organization and our go-to-market motion. Customer feedback has been favorable in terms of trying to provide a more unified selling motion and a more cohesive selling motion across the family of businesses. There is still work to do there by the way. And then with the Partner Program, early feedback is very positive. So look, we have got a lot of work to do, so I don't want to avoid that, but I think so far so good.

Okay. And just a few on the cash flow side, just two quick things. First, should there be material cash taxes against the asset sale proceeds you have realized to date? And then, what about the working capital –plans to reduce working capital and generate cash from that, doesn't look like we have seen much of that yet but do you expect more going forward?

I will do the first part of that and then I'll let Tyler talk about the working capital program. As it relates to the – there are cash taxes that will come off out against the divestitures and those cash taxes get paid generally in Q1. And so dependent upon what the tax basis of these assets were, there is some differences between gross and net proceeds. Obviously I'm not going to get into the exact specifics on that, but we've accounted for that and thought through that as we thought about our delevering plan. So, that was also contemplated as we move forward. Tyler, do you want to comment on the working capital program?

Yes, no problem, Tom. So Jeff, we are making actually good progress. I mean I think we have seen some of it come through, but there is definitely more to go. And as we have talked about previously, if you look across all of the line items around inventory, receivables and payables, we think we have got different opportunities identified that we'll make past success on. So you will see more of that come through as we progress throughout the year.

Your next question comes from the line of Scott Wipperman with Goldman Sachs. Please go ahead.

Just jumping back on the cash flow just with the $500 million, I think you said it was a settlement payment this quarter. I just wanted a little bit more color around that and if there was any other one-time kind of items in the cash flow number this quarter, and then I have a follow-up.

It's Tom. So look, I mean the $500 million was essentially the settlement of the IRS examining the legacy Dell tax year 2004 to 2006, which has been out there and been in ongoing negotiation for a number of years. So we feel pretty good about how that resulted. Other than that unusual cash payments in the fourth quarter, the other thing that we had clearly some WFR type cash cost come through in the quarter and then the large interest expense payment. So those were generally the three big things. And lots of different puts and takes but those are the three big things in the cash from a Q4 perspective.

Got it. And then maybe just turning back to the business, somewhat related questions but I guess one on the server side, I mean the share gain, obviously a pretty substantial and impressive performance this quarter, I guess how sustainable do you think that is on the server side, if you could talk about a little bit what you are seeing in that market? And then similarly on the Client side, where are we in terms of the consolidation, market consolidation story that you guys have been driving for the last number of quarters?

On the server side, David can clearly go into a lot more detail on that. I mean, I think we feel pretty good about our momentum in sort of mainstream rack servers right now. The market is supposed to be a bit better as you walk into Q1. IDC I think is forecasting overall mainstream units to be roughly 1.7% and for the full year mainstream up 3.8%. So I think the market is generally okay. Obviously there is work to do, it's competitive, but I think a reasonable momentum as we go into the quarter. And I'll let David probably give you a bit more thoughtful answer on that. And then on the Client side, look I think if you look at the top three vendors now, according to IDC I think we are roughly at 60% market share on a combined basis, and I think that market consolidation story is clearly happening as you see some of the weaker players exiting or pulling back from the various pockets of participation that they were in. So, we do believe that in a consolidating market you have to take share and that's our focus. Obviously that share needs to be profitable share. And you heard our focus around some of the mobility products and the high-end products. We had really good results in the quarter, very pleased with our XPS and Latitude and Precision and Mobile Workstation velocity. So, I think that consolidation story continues. That's our focus. We will see as we go through the course of the year whether we get a Win 10 bump in terms of a refresh. We are thinking at some point that will happen. There is a lot of interest out there in the operating system. And then with some of the Intel processor introductions as we go through the year, that also gives a performance boost. So we are optimistic about the PC market this coming year, but we're still going to be down. IDC is still predicting a minus 2% type of a market and we'll have to see how it progresses as we go through the year. David, do you want to give any other color on the server question around velocity there?

Yes, I will, and again Scott, thanks for the question. So there are a couple of things going on in the server market. Mainstream serves as kind of the main focus. The hyperscale tends to be lumpy based upon individual companies buying or not in the quarter. But in mainstream, you go back and you look at Q4, in total the market was flat but the real growth was in the rack-scale servers where we are the strongest, and there we grew at over 2x the market. So in total, we regained our number one unit share position, we gained 200 basis points of mainstream revenue share, absolute call it 600 against our closest competitor. A couple of dynamics going on there that are driving it. In Q4, we started to get some cross-sell synergy. We definitely saw that occurring particularly into the ex-EMC-based, [indiscernible], but that's really just the starter things because that will now accelerate as we move to our new go to market structure in February this year where we put our field forces together and [indiscernible] passing lease that fully cross quoted on selling service both in enterprise and in commercial. So that should help us again this year. Now on top of that, we've got a major new product line that we are going to be launching midyear which again should be a boost and we are excited about that. So we see good things happening in servers. And last but not least, there is kind of an industry shift that's driving towards servers as more and more parts of the IT infrastructure stack becomes software-defined, they got to run somewhere, and they run on servers and particularly running on rack-scale service which is where we really focus. So a number of things that should help us as we go through the fiscal continue that positive trend.

Your next question comes from the line of Shannon Cross with Cross Research. Please go ahead.

I wanted to follow up on the last question. We have recently met with a few of your competitors in both the PC as well as the server space and the conversation there is, price increases are being implemented. It sounded like perhaps you guys didn't follow quite as rapidly as they certainly would've liked. So from that standpoint, I'm trying to figure out from your take what's going on or what will happen with elasticity of demand, because obviously component costs are up, you need to flow some of that through. If the industry goes, then perhaps it works, but are you a little more hesitant to try to take some of these pricing moves or are you expecting to do that both in servers as well as in PCs? And then I have a follow-up. Thanks.

It's Tom. So look, it's obviously I think the people that you've talked to and what they are saying publicly is relatively consistent in the context of there is a rising component cost environment right now. On the Client side we see it in memory, we see it in glass and LCD panels. On the server side and storage side, we are seeing it in SSD drives and memory. So it's all about balance, right. So you are trying to adjust your pricing relative to the marketplace and relative to your thinking around what's the demand elasticity impact. So we have made a number of pricing adjustments across both product lines, client and servers. Companies that are in the competition do that at different pace dependent upon inventory positions and channel inventories. And so there are a number of variables and dynamics out there. But the reality is that if you're seeing – we've seen some pretty significant cost increases in memory for instance, and you're just not going to be able to swallow those and not adjust pricing over the long run. Now, there is ways to adjust pricing, whether it's a list price, whether it's how much discounting authority you are giving to your sales organization. So there is ways to sort of manoeuvre your way through these dynamics of a headwind from a component cost. And we will have to see on elasticity to be honest, right. But we have a P&L to manage and we need to make sure that we are making the right decisions for the long-term. So it's all about balancing short term profitability pressures for instance because of the component costs with long-term positioning around where do we want to be from a velocity perspective. And so that's the balance we are driving right now. I think so far we've made some reasonable decisions. We will keep watching it. We are doing weekly pricing analytics and analysis and position analytics to see how the market is and where the market is, but David, I don't know if you would add anything but it's clearly a rising component cost environment right now.

So I think you said it well. I mean this is an industry-wide phenomenon and it's certainly impacting everybody and it's certainly of course impacting customers. Having said that, the factors that I talked about before, so this is clearly a bit of a headwind to the overall growth of infrastructure, on the other hand there are some tailwinds as well. So there is clearly a balance going on here. But we have absolutely made adjustments and we will continue to do so as the component prices move.

Okay, great. And then Tom, can you talk a little bit about the thought process behind share repurchase for DVMT versus debt paydown, just sort of how you think about overall within the Dell family in terms of use of cash right now? Clearly the VMware Dell transactions tend to work well together.

Look Shannon, I mean I want to be really clear on this. Our primary source, our capital allocation strategy is delevering. So nobody should be confused about that. On the other hand, we continue to look at the performance of VMware and the performance of the Tracker in the market and the return to our shareholders based upon some ownership percentages. And as a result of that, we've had some nice alignment as VMware is out managing their share buyback programs where there has been the opportunity to align what they are trying to do and align with what we are trying to do, which is utilize and make it a win-win I should say in the sense of VMware buying Class A shares from Dell EMC or EMC I guess and us then taking those proceeds and retiring Tracker and buying that Tracker. So, we are going to continue to look at these programs. We are not going to make any commitments on breadth and depth as we go through the year, but we will continue to look at that and see if there's some opportunistic opportunities in the market to take advantage of the discount between the two securities.

Your next question comes from the line of Steve Milunovich with UBS. Please go ahead.

David, on the [indiscernible] side, it seems like you've had a bit of a shift from kind of the new architecture of XtremIO to putting SSDs into your more traditional frames, and that seems to be working well. Is that still the case and do you see that continuing for some time or does there come a time when you really kind of need to have a pure optimized all-flash architecture, more like XtremIO that you are pushing first and foremost?

Steve, what we have done is we have as you correctly pointed out taken some of our traditionally hybrid products and actually enhanced the architecture quite substantially to take further advantage of all-flash and therefore produce all-flash version. So obviously VMAX All Flash came out early last calendar and was a strong success, as is XtremIO. So it's really a combination of both. What we're finding is that for example in the high end where we now have these two very competitive products, the general purpose application is actually very well suited to the VMAX All Flash. It includes data services. The XtremIO case is well suited for things that are very [indiscernible] instant copy centric. So the combination or they actually complement each other quite well. And of course we have done the same thing in the mid tier with our Unity, again created all-flash versions that are optimized for all-flash that could never accept a hard drive if anybody wanted to put one in. And we are going to do the same thing for our SC Compellent Series as well. So we believe that the vast majority of the frames in the mid tier, certainly the higher ends of the mid tier, and the higher end are all moving to this all-flash conflagration. And as I mentioned, while XtremIO was built from the ground up to take advantage of all-flash, we have done significant things to the way that VMAX is architected to really take full advantage of this very fast medium. So I actually see as a combination of both and I wouldn't characterize one as kind of optimizing, one as not, because they're both been optimized now to take advantage of it. And of course there are things coming along. You will see us have NVMe technology in the market later this year. So the family continues to move forward to take advantage of new medium.

Thank you. And then I wanted to ask about the competitive situation. One of the market research firms tracks the hardware and software sales into cloud which for you guys I assume is mostly private cloud, and you've got Cisco, HP Enterprise and yourselves all at 12%, and then if you want to throw in ODMs they are also at 12%. So it seems like a very competitive, fairly fragmented market selling into mostly on-prem which arguably could be declining. How do you view your strategic position differentiated, particularly relative to Cisco and HP Enterprise?

So everything gets cloud washed, Steve, these days and I think I am aware of the particular report which you are talking about. So first of all, cloud is not a place, it's an operating model and the operating model can be applied on-prem or off-prem. It's really providing IT as a service. And I think that everybody is going to implement some form of hybrid cloud. So it's also a combination of both. When you look at the kind of IT infrastructure marketplace, as we do that have service storage network, combined marketplace about $110 billion this year, we see strong double-digit growth in that infrastructure being sold into private cloud and into public clouds, but the biggest piece is still a non-cloud environment often virtualized. It's still two-thirds of the marketplace. So we see ourselves particularly well-positioned in letting people take advantage of on-prem and off-prem together with the strength of VMware, with the Pivotal layer, and our ability to put the complete solutions like our Enterprise Hybrid Cloud or Native Hybrid Cloud underneath it and also being able to complement that with virtual stream that uniquely handles these mission-critical workload. So we can go to our customers and say, we have got a cloud strategy for your mission-critical application, we got a cloud strategy for your general applications, and we got a cloud strategy for your new cloud-native applications, and that cloud strategy embraces both on-prem and off-prem solutions. So we think that's very differentiated. So we are actually excited about how we can face up against those companies that you mentioned as we go into this cloud era as opposed to cloud place.

And David, I would add, everything you said I clearly agree with, but we also have the other sort of cloud model dynamics is around consumption and pay-as-you-go and pay as you consume. And so we have multiple consumption models, financing models, from pure utility models all the way to pay as you consume. And so I do think that we are also trying to ensure that as we drive these solutions as David described that we also position some of the economics, models that the cloud offers to ensure that our customers have full choice and flexibility.

Your next question comes from the line of Robert Schiffman with Credit Suisse. Please go ahead.

Thank you so much for hosting the call. Maybe this is just one long question with a couple of parts, but I think your reaction this morning was a little bit of concern regarding EBITDA margins and I think it's somewhat [indiscernible]. I've heard a lot of what you said but just want to get a better sense of how much of pricing and incremental investment and OpEx impacts decision-making on your standpoint versus uncontrollable expenses and whether or not this is a little bit more of a just a time-shifting of expenses and that ultimately your free cash flow style or whatever your internal projections are, are still in line with what you thought three months ago, six months ago, and then ultimately from a balance sheet perspective has anything changed in terms of both your desire or your ability to delever in terms of the size and timing of what your initial expectations were? Thank you so much.

Robert, you are right, that is one very long question. So let me do it like this. So let's start with the margin conversation. So look, I think about this less as an OpEx or cost story as I think about the pricing dynamics and the mix dynamics that we continue to juggle with a pretty large set of solutions in various markets. So if you think about coming out of Q3 into Q4, we had told you guys that we thought Q4 would be a tighter operating margin quarter and it turned out to be. So I think we are very consistent and very transparent on how we think about the business and trying to ensure that you guys understand how we operate the business. Clearly there is we have got some pressures in component cost, we have got mix dynamics happening as we balance growth with profitability, and it's our job to sort of balance that across the set of portfolios. So I think that we will continue to make the right decisions around velocity at the top versus gross margin dollar delivery, which ultimately translates into operating income but there will be some fluctuations on that as we go from quarter to quarter. We are extraordinarily focused on cost and cost structure. So we continue to be driving aggressively against the synergy targets that we laid out. I will also tell you though that we have made some decisions to invest back into the business, things like sales force coverage, expansion of our CSB model into the next set of countries, expansion of different solutions with building out service provider support models. And so there are a number of investments that we think are the prudent things for the long-term to do and we will continue to make the right decisions for the long-term here as a company. And so look, I mean yes, margins were slightly lower. You also have to remember that they were a little bit higher in Q3 as David highlighted by the fact of the timing of the transaction. So we closed the EMC transaction on September 7. So we picked up only a portion of the quarter's sort of run rate operating expense and picked up a lot of their revenue and margin given the hockey stick that they have traditionally had at the end of the quarter. So, there are timing dynamics there too that you have to think your way through. So look, I mean we're going to continue to work at this, we're going to continue to make sure we make the right decisions and we're going to continue to make sure that we drive the right profitability models to drive cash flow, which gets into your second question around free cash flow and are we different now than what we thought six or nine months ago. The answer is probably yes to a certain extent. But it's all about how do we balance and make sure that we delever properly and efficiently, which we are extraordinarily committed to, and making sure that we drive the right business investment decisions along with that delevering strategy. So, the world's dynamic, it continues to evolve and change, we're going to continue to evolve and change our decisions as we go forward. But don't be confused, we will delever the balance sheet, that's our focus. We'll do that as promptly and efficiently as we can while we make the right investment decisions for the business. So look, I actually feel like the team has done a pretty good job navigating the first part of this integration, knowing that we have got a lot more work to do and that the markets are going to continue to move around on us a little bit given just the competitive nature and the changing IT consumption models that are out there. So, overall Robert, I think the team did a reasonable job for the quarter, more to do but I'm reasonably pleased with where we are as we step out of FY 2017 and come into FY 2018.

Your next question comes from the line of David Phipps with Citigroup. Please go ahead.

Could you talk about the seasonality of the business as we look forward on a quarterly basis or what historically given all the changes in the business from acquisitions and from divestitures? And then as a quick follow-up, can you qualitatively walk us through a bridge from the margin on the EBITDA from the third quarter at 13.3% to a 10.6% but qualitatively what were some of the big factors? Was the one-time payment a big factor, was it the acquisition of business, divestiture of high-margin business, or were there any mix changes at some of the component prices? I think that would be helpful to investors. I'm getting a lot of [indiscernible] on that right now.

From a seasonality perspective, I actually think we are trying to work our way through what the new seasonality looks like, to be a bit honest. I mean, if you remember, legacy Dell say like this coming out of Q4 would seasonally be down in Q1 on a revenue perspective. It tended to be probably the weakest quarter of the year in terms of revenue velocity as we come out of the buying season from a consumer perspective into the year budget flush from a commercial perspective. I think that legacy EMC also has a relatively weak Q1 and then builds through the year. And so I think at a macro level that's what we expect to see. I think linearity within the quarter is going to be a bit interesting. EMC traditionally ran at pretty heavy end of quarter linearity within the quarter, meaning that a lot of the revenue came through in the last two or three weeks of their calendar quarter. So now that we have shifted to a fiscal quarter, the dynamics of when does that demand show up and how does it show up is something we are still working, still trying to ensure that we understand the new patterns that are going to evolve given sales competition models, given customer buying habits. And so I tend to think about it like that, but I do expect that – we don't do forecast, we don't do guidance, but I think there are some historical seasonality patterns that you would expect to see in Q1 which has traditionally been a softer quarter. In terms of the EBITDA margins from Q3 to Q4, we see it from 13.3% to 10%, you've got to think about that in the context of some dynamics around the operating expenses that David referred to. That's probably 60 to 70 basis points of that change. We did have some pricing pressure, which is probably another 120 basis points of that change. And so look, I mean there is dynamics as we go from Q3 to Q4. It's our job to balance those out over time, which we'll continue to do. So I am not going to do an exact bridge for you but we are aware of the dynamics and we'll work our way through those as we go forward.

So just to clarify, so it was the – the settlement, is that part of the EBITDA mix or your one-time customer? So that you kind of called out the 180 basis points out of the 270 basis points, so we think the other 90 is from one-time factors?

Look, I mean again, if you look at the adjusted EBITDA, clearly we did have the settlement, generally would not have been there, is already reserved for. So [indiscernible] affect the current earnings. So I called it out, I gave you the two largest components of that, and then you also had some mix dynamics. And so look, I mean those are sort of the bridges that I would take you to, plus some of the WFR activity which is in there as well.

Our final question will come from the line of Dan Burke with Morgan Stanley. Please go ahead.

First, on the storage side, can you just speak to what you're seeing in the market and to the extent sales have been weaker, has this been a function of customers deferring purchases, moving to competitors, evaluating new technologies? Just any color there would be helpful.

Dan, this is David. Let me take that. There are a number of things that are happening in our numbers, particularly in the calendar Q4, which are impacting the revenue results that people are reporting and is actually impacting the market. We actually are [indiscernible] impact on the storage market ourselves, but let me explain what's happening there. So first of all, as we move into Dell, [indiscernible] our policies are really focused upon working capital efficiency, so that means we're going to have a much bigger backlog generally at the end of any period than we would have done inside of EMC. But then also we moved our fiscal from December to January. So now if you think about where things were at the end of December, there was no real focus upon optimizing what that backlog was. So we had a significant increase in our backlog in December for those two factors vis-a-vis a year ago that impacted our reported results as people like IDC might look at them and actually impacted the market. To give you a flavor of how we saw overall demand in the fiscal quarter if we could have actually gone back and created a true comparison year on year, we saw demand in the fiscal quarter down in the low to mid single-digit range which is actually a lot better than many of our traditional storage competitors who are seeing double-digit declines. Now to answer your question about what dynamics we're seeing in the marketplace, we're seeing a couple of things. We are seeing softness in the high end of the market and that seems to have continued for a little bit of time. We are actually seeing growth in the mid tier marketplace. We're also seeing a significant growth in all-flash, and as you mentioned and as I mentioned we are now a $4 billion run rate player, our share in all-flash is higher than it is in external storage in total. So as the market shifts towards all-flash, that should be good for us vis-a-vis others. And what we're seeing is in the marketplace customers are still making tactical decisions. There's a lot of work going on to look at IT transformation and future architectures. So the customers who haven't made those decisions yet in terms of what their IT transformation strategy is are still doing it very much by what they need and the more approach, different from how they were buying a couple of years ago. The customers who are moving forward with transformation are making longer term decisions, but that's still a smaller piece of the marketplace. So you've got a number of factors. I would comment that the move to all-flash is actually not deflationary for the storage marketplace because what happens is that all-flash is actually more expensive but then with data services, [indiscernible], compression, et cetera, you get the same dollar to gigabyte effectively as you do with the hybrid system. So that's one of the things that people talk about that we don't see being a factor. So we've had an impact on the marketplace as external people look at it based upon how we close our quarter, and there is still some softness in the marketplace, even that factored in, and then you get back to this combination of high end plus people making tactical shorter-term decisions as the market starts to slowly move towards a transformation agenda. The customers who are in this transformation mode are making big multiyear strategic purchases. So as more of that happens, then I think that could be a positive thing going forward. But those are the dynamics that we're seeing in the marketplace that hopefully gives you a few points of flavor to think about.

Yes, that was great. Just one quick follow-up, the other thing that we have seen some of your competitors discussing the market on the all-flash side, obviously you are facing an environment of rising NAND prices now, how is that going to impact your sales of all-flash arrays and traditional drive systems from both your perspective and then from the customers?

I think that as we talked about on one of the earlier questions, obviously the solid state drives and more importantly for DRAM, we see the impacts on DRAM pricing increases being more than SSDs and actually storage and therefore service more impacted by DRAM and storage arrays are relatively less impacted by that relative price increase. I still think that the value proposition for an all-flash system holds even in a slightly inflationary environment because you get so much additional performance from an all-flash system, you can do things with it you just can't do with a traditional storage-based system. So I don't see that momentum particularly changing. It might slow a little bit but I still think customers when they're looking at these purchases and they are thinking what they are going to do with the storage system for the next three or four years are still going to move predominantly to all-flash.

Great. Thank you.

Before we close, Rob, it's Tom, I wanted to go back and correct something I said when Robert and I were talking about the EBITDA walks. I grabbed the wrong number. So as we look at quarter on quarter EBITDA walk, I would say that roughly we've got about 250 basis points of OpEx pressure coming from the ISG or OpEx change coming from where we picked up the EMC legacy and from a quarter in Q3 to a full quarter in Q4. So that's a big piece of that change. We're obviously working on OpEx to bring that back down over the course of the coming year. And then we also had some cost variances and pricing variances that roughly make up about 70 to 80 basis points, offset by some favorable mix. So that's sort of the dynamic we saw going from Q3 to Q4. But I wanted to clarify that.

I appreciate that clarification, Tom. That wraps the Q&A. As a reminder, we have our Analyst Meeting or Investor Meeting in New York on April 5. This is a two-hour meeting and it will focus on strategy, integration efforts and capital structure. We are going to dedicate half of the time to Q&A. This is an invitation-only meeting due to limited availability, so please contact us if you're interested in attending. And finally, I appreciate you joining the call. We are available to take additional Q&A. Thanks.

This concludes today's conference call. We appreciate your participation. You may disconnect at this time.