Dell Technologies Inc

NYSE:DELL

Earnings Call Transcript 2020-Q2

[Operator]

Good afternoon, and welcome to the Fiscal Year 2020 Second Quarter Financial Results 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 part, without prior written permission of Dell Technologies is prohibited. Following prepared remarks, we will conduct a question-and-answer session. [Operator Instructions]

I'd now like to turn the call over to Rob Williams, Head of Investor Relations. Mr. Williams, you may begin.

[Robert Williams, Head of Investor Relations]

Thanks, Erika, and thanks for joining us. With me today are Vice Chairman, Jeff Clarke; our CFO, Tom Sweet; and our Treasurer, Tyler Johnson.

During this call, we will reference non-GAAP financial measures, including non-GAAP revenues, gross margins, operating expenses, operating income, net income, EPS, EBITDA, adjusted EBITDA, and adjusted free cash flow. A reconciliation of these measures to their most directly comparable GAAP measures can be found in our web deck and press release. Please also note that all growth percentages refer to year-over-year change, unless otherwise specified.

I want to mention that we will not be taking questions related to the Pivotal or Carbon Black transactions that VMware announced on August 22. 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 our web deck. We assume no obligation to update our forward-looking statements.

Now I'll turn it over to Jeff.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Thanks, Rob and thanks to all of you for joining us. Since we launched Dell Technologies, we’ve been consistent about our long-term view on global technology investment and what we have to do realize this unprecedented opportunity. We have to innovate and integrate across the full Dell Technologies portfolio. Doing this creates the next generation of technology infrastructure that enables digital organization's operating from the data economy.

We have to continue innovating within our business units to win the consolidation and generate cash. And of course, we have to do this with an eye towards the inevitable fluctuations and near-term demand. Today, I would like to touch on each of these areas and share some of the progress we’ve made executing against our strategic priorities.

To begin, let me emphasize the long-term drivers for our business remain intact. We are in the early stages of a technology-led investment cycle that is accelerating digital transformation. That investment cycle is fueled by the exponential increase in data, and data centric workloads that drive better business outcomes alongside an increasingly diverse and mobile workforce.

But to realize these outcomes, customers are grappling with increasing complexity across their operating environments and infrastructure including data proliferation, multi-cloud management, security, new stock for architectures, application, artificial intelligence and machine learning, all the while defining their approach to cloud and increasingly the Edge and IoT.

Take hybrid cloud as an example. Companies deploying hybrid cloud strategies want seamless compatibility, consitent infrastructure and operations across private clouds, public clouds, and the Edge. We are optimistic about IT spending because customers need a partner to help them address these challenges, one who is innovating and delivering a comprehensive end-to-end IT strategy.

In fact the latest IDC forecast for IT spending through 2023 excluding telco, backs up our optimistic view. IDC projects growth will be in more than 2x world GDP or about 4.3% per year on average. So as I said, we believe the long-term drivers of our business are intact.

This brings me to my second point. Dell Technologies is uniquely positioned to capitalize on this enormous opportunity. We’ve been hard at work innovating and integrating across the portfolio to deliver the future of technology infrastructure with solutions that dramatically simplify IT management. Last quarter we made major progress with the announcement of Dell Technologies cloud and unified work space.

Interest remains high in our Dell Technologies cloud platform, the easiest and fastest way to a consistent hybrid cloud experience that brings together Dell EMCs VxRail hyperconverged infrastructure with VMware's cloud foundation software stack, offering customers a single consistent platform for both traditional and cloud native workloads with flow full automation and integration for hybrid and multi cloud environment with consistent SLAs, tools, services and management from VMware and Dell/EMC.

The customer pay subscription fees for as long as they use it the same way they pay for public cloud infrastructure. CapEx becomes OpEx. Earlier this week at VMworld, we announced several other enhancements to our Dell Technologies cloud offerings, including new validated designs for storage arrays and servers, initial availability of the industry's first fully managed on premise data center-as-a-service offering, and general availability of new pay for what you use flexible consumption models.

In addition, we announced Dell Technologies cloud platforms now support VMware Pivotal container service.

And with VMware's recent announcement of its intent to acquire Pivotal, our solutions and speed to market get even stronger. Pivotal further extends VMware's Kubernetes capabilities for building, running, managing modern applications on an e-cloud.

Another powerful example of how we are innovating across Dell Technologies is Unified Workspace. This solution integrates capabilities across Dell devices and services, VMware and SecureWorks and now includes Dell Pro Manage, managed services that integrate Dell's highly skilled experts as part of the customer's IT teams.

Think about the IT investment cycle I mentioned earlier and the needs of the growing diverse and mobile workforce. Unified Workspace is an intelligent solution that tells you the specific devices and applications your workforce needs on their specific usage. Then it delivers those personalized devices directly to the end-user, pre-configured and preloaded with all the applications and security features they need. IT never has to touch the device.

With VMware's acquisition of Carbon Black, Unified Workspace will only improve at a comprehensive intrinsic security portfolio for the multi-cloud world and for modern applications and devices. As you can see we are delivering on our promise to innovate across Dell Technologies to create the future of technology infrastructure from the cloud to the edge, while dramatically simplifying the customer experience.

And this brings me to our next strategic priority, which is all about what we're creating in our business units to drive and win in the consolidation, generate cash flow and fuel innovation. We have the strongest solution set in our history with businesses that are consistently outperforming their competitors. In the data center, we're seeing significant traction from our new Unity XT midrange storage solution. And the strong acceptance of XT in the market gives us confidence as we ramp the solution and prepare to bring our next generation midrange storage offering to the market.

We are also seeing strong receptivity of our PowerProtect X400 and PowerProtect Software. The X400 delivers next generation data management and protection in a software defined scale out appliance. It is highly complimented by our PowerProtect Software offering that delivers data protection, deduplication, operation agility, self service and IT governance.

In Q2, VxRail orders grew 77% as organizations continue to benefit from a simple integration with VMware cloud foundation to enable hybrid cloud environment. It's just another example how we are collaborating with VMware to bring another first and best solution to the marketplace.

In Client Solutions, we introduced new XPS products with leading design and user experience, including more powerful processing and applications matched with thinner and lighter designs like our new XPS 13 2-in-1. And our Dell Latitude 7400 2-in-1 continues to receive incredible praise from the media and customers alike with PC World deeming it a nearly perfect combination of power and battery life. It is the first commercial laptop with built-in sensing technology.

Our teams are turning up industry's best products and solutions, executing in our priority to win the consolidation and generate cash flow, which brings me to my final point. As we invest and innovate to capture on the enormous opportunity in front of us, we must remain disciplined and mindful of the near-term environment in which we operate in.

So before I turn it over to Tom, let me shift gears to the current demand environment and our view on component cost. Our core Dell orders were up 4% excluding China and we're seeing a clear split between enterprise infrastructure and PC spending globally. In enterprise infrastructure the market is softer than we and the industry anticipated. We expected to remain soft through the balance we and the industry anticipated.

We expected to remain soft through the balance of the year, particularly in China. We feel really good about our ISG execution in Q2 given the market context. In the first half, we acquired approximately 21,000 ISG customers, up a 11% from the prior year. And moreover, ISG customers are purchasing multiple lines of businesses. Our storage business remains healthy in Q2 with orders up 1% and first half orders up 4%. Our sales team remain optimistic about our portfolio and positioning as we head into the second half of the year.

Turning to servers. The industry saw unprecedented growth last year and many customers are still digesting their CapEx investments. We're balancing revenue and profitability as we navigate through the current server dynamics. Our Q2 server revenue declined, but we realized higher margin dollars as we were consciously more selective on large low margin deals in all geographies.

Outside of China, our server orders were up 1% and we expect to gain share this quarter in North America and EMEA, when IDC publish its results next week. Our server ASPs remain strong, up high single digits as customers are increasingly buying higher end system support for their high -- high value workloads.

In Q2, CSG delivered record performance, driven by strong execution, the Win 10 refresh and a declining component cost environment. Longer-term, we expect to continue to drive share gains through innovation and execution as the industry continues to consolidate among the top vendors. We'll continue to focus on commercial, high-end consumer and gaming as well as increasing our attach of services, financing and software and peripherals.

In the supply chain, we expect the component cost environment to remain deflationary and aggregate through at least the end of the year. So it's important to note we expect the decline to significantly slowdown in the second half measured against the first half. This quarter we clearly benefited from the strength of our broad IT solutions portfolio, which helped us deliver strong results amid a short-term market volatility.

What we saw soft spending in pockets of the marketplace, our overall performance in Q2 reflected our competitive advantage. In the second half, you should expect us to continue to balance growth and profitability, but with a slightly higher bias towards maintaining growth at the portfolio level.

We have built a business to be successful in any environment. We're differentiated by our broad portfolio in the industry with leading solutions, our direct model, including services and financing and our world-class supply chain with its size and scale. Whether the market expands or declines, we expect to outperform the industry.

So to recap, we believe strongly that our long-term growth drivers are intact. We are innovating across the portfolio to create infrastructure for the digital future. We're investing and innovating to learn the consolidation and we are mindful of the near-term environment and we are confident we can outperform. Ultimately it's all about the customer and no one is better positioned than Dell Technologies to be our customers best, most trusted partner on their digital transformation journey.

With that, I will turn it over to Tom to talk about our Q2 results.

[Thomas Sweet, Chief Financial Officer]

Thanks, Jeff. Our model is focused on long-term profitable growth with the ability to adjust as needed based on market conditions. We're focused on growing faster than competitors in the industry, growing operating income and EPS faster than revenue and generating strong cash flow over time.

We executed well against these priorities again from Q2 as we balanced revenue and profitability with market conditions. While we saw a softer enterprise IT market this quarter, we continue to benefit from having the industry's broadest portfolio of solutions.

Revenue was $23.5 billion, up 1% with core orders revenue up 4% excluding China. And our deferred revenue balance increased to $25.3 billion, up 17%. FX remained a headwind this quarter impacting year-over-year growth rates by approximately 150 basis points. Gross margin was up 13% to $8 billion and was 34% of revenue, up 340 basis points driven by lower component cost and pricing discipline.

Operating expenses were $5.2 billion, up 6% due in part to investments we have made in sales coverage to expand our buyer base. In the quarter, new enterprise and commercial customer acquisitions were up over 10% from the prior year. And over the last six quarters, approximately 80% of our top 30,000 customers have purchased four or more lines of business from us.

We're pleased with our operating income, which was up 30% to $2.7 billion or 11.7% of revenue. Our EPS was $2.15 benefiting from strong operating profitability and a lower tax rate in the quarter due to revenue mix. Adjusted EBITDA was $3.2 billion or 13.5% of revenue and $11.2 billion on a trailing 12 month basis. We had a record cash flow quarter, generating $3.4 billion of adjusted free cash flow driven by strong profitability and working capital discipline.

Some of our working capital benefit came from reduced inventory as we are working through the supply chain dynamics that impacted cash flow last year. We also saw deferred revenue increased 17% to $25.3 billion with recurring revenue now making up 20% to 25% of our revenue each quarter.

Our services and software businesses continue to grow as we expand the portfolios adding revenue and cash flow stability and predictability. We repaid approximately $2 billion of gross debt in the quarter and $2.4 billion year-to-date. And we are well positioned to repay approximately $5 billion of gross debt in total in fiscal year '20. We have now paid down $17 billion of gross debt since the EMC merger.

Shifting to our business unit results, ISG revenue was $8.6 billion, down 7%. Storage revenue was flat at $4.2 billion. As Jeff mentioned, orders were up 1% driven by strength in Isilon and our industry-leading HCI solutions. We're seeing strong receptivity for new Unity XT solution in the mid range and we continue to press on growth levers within the broadest and most diverse portfolio in the industry.

Servers and networking revenue was $4.4 billion, down 12%. The global server market remains softer than anticipated coming into the year and has affected our server growth. The impact to our business was most pronounced in China again this quarter, where we were more selective on larger deals and focused on building sustainable long-term customer relationships.

ISG operating income was $1.1 billion or 12.2% of revenue. Operating income percentage was up 120 basis points, largely due to our business and geography mix as well as pricing discipline. Our VMware business unit had another good quarter with revenue of $2.5 billion, up 12%. Operating income was $762 million or 30.9% of revenue.

Based on VMware standalone results reported last week, VMware's growth in total revenue plus the sequential change in total unearned revenue was 17%. Core software defined data center license bookings grew in the high single digits. NSX license bookings were up over 30% and vSAN license bookings grew over 45%.

CSG delivered record revenue in units with strong profitability in Q2. Revenue was $11.7 billion, up 6%. Within CSG, commercial revenue was $9.1 billion, up 12% driven by double-digit growth in commercial notebooks, desktops and workstations. Consumer revenue was $2.7 billion, down 12% as we continue to prioritize commercial mix in the higher end of consumer PCs.

We saw strong profitability in CSG this quarter due to component cost declines, commercial consumer mix and pricing discipline. CSG operating income was $982 million or 8.4% of revenue. Going forward, you will continue to see us balance revenue and profitability against market dynamics.

Dell Financial Services originations were $2 billion, up 3%. We did record a non-cash charge of $619 million or $524 million net of tax benefits after a strategic review of our Virtustream business. We remain committed to serving our customers as we reposition the business.

Turning to our balance sheet and capital structure, we grew cash and investments in the quarter to approximately $10 billion even after the Q2 debt pay down of $2 billion. Our core debt balance ended the quarter at $36.4 billion, down over $12 billion since the EMC acquisition. And net core debt ended Q2 at $30.5 billion. Please see Slide 14 in our web deck for more details.

We're focused on maximizing free cash flow and our capital allocation strategy remains unchanged. We're committed to reducing leverage and achieving investment grade ratings. Given our recent debt pay down and refinancing activity, we have only $2.3 billion due in the next 18 months, excluding VMware. And we will continue to look for additional opportunities to smooth our debt maturity profile and optimize our capital structure.

We will maintain pricing discipline as we move into the back half of the year, while adjusting as appropriate given market and competitive dynamics. We're still monitoring the macroeconomic in IT spending environment as well as ongoing trade discussions between the U.S and China.

Moving to guidance. Based on Q2 results and our current expectations for the balance of the year and excluding the impact of VMware's Pivotal and Carbon Black acquisitions, we now expect fiscal year '20 GAAP revenue of $92.7 billion to $94.2 billion. Operating income of $2.9 billion to $3.3 billion and EPS of $5.45 to $5.90.

We're narrowing our non-GAAP revenue range for the current fiscal year to $93 billion to $94.5 billion. Due to our strong profitability in the first half of the year, we're increasing our non-GAAP operating income guidance range to $9.8 billion to $10.2 billion, and increasing our non-GAAP EPS guidance range to $6.95 to $7.40. We expect our non-GAAP tax rate to be 16% plus or minus 100 basis points.

In closing, we are well positioned. We're innovating to drive growth and future value and we're driving the core for share gain and cash flow. We have one of the industry's strongest and most comprehensive portfolios, its largest direct sales force and a world-class supply chain with size and scale and we're focused on enabling our customers digital future.

With that, I will turn it back to Rob to begin Q&A.

[Robert Williams, Head of Investor Relations]

Thanks, Tom. Let's get to Q&A. We ask that each participant ask one question to allow us to get to as many of you as possible. Erika, could you please introduce the first participant.

[Operator]

We will take our first question from Katy Huberty with JPMorgan.

[Kathryn Huberty, Morgan Stanley]

Thank you. Good afternoon. You mentioned a bias towards growth in the second half of the year. Does that imply that you expect a pass-through more of the lower memory prices into the next couple of quarters. And if so, which segments of your business would you expect to see the most price elasticity?

[Thomas Sweet, Chief Financial Officer]

Hey, Katy, it's Tom. So, look, I mean what we were trying to signal there is that as we think about the business and the business velocity which we like the ramp in business velocity during the quarter, we are starting to -- as we think about cost trends and the deflationary cycle that we are seeing which we is slowing, we do expect that will pass particularly in some of the server space probably have to pass more of those cost declines through. And in fact we are seeing a little bit more aggressiveness in some of those large enterprise and large deals that we said -- we mentioned in the first quarter. So the bias towards growth was really directed at trying to make sure we're a company that drives on scale. We are going to be balanced in the back half of the year, but I do think that from the dynamics that we're seeing right now that I would expect that we're going to see a bit more pricing aggressiveness in the back half. And I would probably point towards servers. I think we feel good about where the client business is and the storage business is from a pricing perspective. But I think servers may have some pressure point.

[Kathryn Huberty, Morgan Stanley]

Thank you. That’s very helpful.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

I would add to that. We certainly spend much of the first half of the year in servers, keeping our product line in our traditional price position and we are going to continue to price the product lines going forward to do that. And as Tom said, that's going to be our bias towards growth. And I think the other thing that we're signaling and we mentioned a couple of times is the fuel of that, the commodity deflation substantially slows in the second half, so we have to watch that. We are going to have a slight bias towards growth, keeping our eye on profitability in both of the businesses.

[Robert Williams, Head of Investor Relations]

Thanks, Katy.

[Operator]

Our next question is from Rod Hall with Goldman Sachs.

[Roderick Hall, Goldman Sachs Group Inc.]

Yes. Hi, guys. Thank you for the question. I wanted to ask about the trajectory of demand and where you guys are seeing weakness, where you’re seeing strength? When we look at other company that have reported enterprise, we’ve seen a pattern of weakness in large enterprises that seems to have developed in, let's say the June timeframe. And so, I'm wondering whether that has been the same for you and whether you’ve seen that continue to weaken or you think its stabilized? And then also would love to get a comment on small and medium businesses. Those seem to be have been more stable and I'm wondering if you could just confirm that, that’s also what you're seeing. Thanks.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Sure, Rod. Jeff here. When I look at the server business in particular, the softness that we’ve seen, we actually talked about it last quarter as well is in large bids and in China. So those large enterprise business that you mentioned, we continue to see softness there in -- as well as in China. In fact, if you were to look at our server business excluding China, we were actually had growth. Our business is up 1% in orders. We continue to see that pressure in the second half of the year. Tom alluded to just moments ago about the price aggressiveness that we think is turning up in the second half in those large orders, those large enterprise accounts. So I think that’s consistent with what you’ve seen. And then on MB and SB, we continue to see that business perform. We don’t break out the segment performance of the businesses, but it's been a area of growth for us and we will continue I think see that going forward.

[Roderick Hall, Goldman Sachs Group Inc.]

Great. Thanks, Jeff.

[Operator]

Our next question is from Toni Sacconaghi with Alliance Bernstein.

[Toni Sacconaghi, Sanford C. Bernstein & Co., LLC.]

Yes. Thank you. I'm wondering given your significant overage in operating profit year-to-date, why you wouldn't look to pay down more debt this year? I think your target was $4.8 billion. You mentioned close to $5 billion, which sounds pretty similar. Perhaps you can give us an updated view on what you think operating income will be for the year and why you wouldn't want to more aggressively pay down debt?

[Thomas Sweet, Chief Financial Officer]

Hey, Toni, it's Tom. Let me start and then I will let Tyler talk a little bit about our debt plan. And look I mean the guidance we gave clearly up the range around operating income given the over performance in the first half. We are -- we did in the quarter a $10 billion of cash, of which $6 billion of that you should think about as core. So look, I mean, I think we may have some flexibility of all things [indiscernible] to take a look at that as we go through the year. Right now as we look at the maturity stacks that we are [indiscernible] on addressing I think we feel good about the $5 billion. We will have to see what we where we, how the rest of the year unfolds and whether we would submit to doing even more than that. Tyler, I don’t know if you would add anything.

[Tyler Johnson, Treasurer]

No, I think you said it. I mean, the debt pay down remains the priority. So we continue to focus on that. We will see our cash continues to come in for the remainder of the year, but we feel very confident about the $5 billion we talked about. So making really good progress. If you look at our leverage ratios, we improved about half a turn going from the end of last year to where we’re now. So making great progress.

[Toni Sacconaghi, Sanford C. Bernstein & Co., LLC.]

Okay. And if I could just sneak in another one. I missed a couple of minutes, because I got disconnected on the call, so I apologize if you address this during that period. But you seem to suggest that you see more incremental price aggression in servers, but are pretty confident on the PC side. Are you suggesting that sort of the more normalized PC operating margin which is more than 300 basis points above -- currently above your prior indicated range that we should be thinking: a, about sustainability in mid to high single-digit or high single digits for PC operating margin at least for a few more quarters, or how much do you think the following component prices has boosted PC op margins above a normalized rate?

[Thomas Sweet, Chief Financial Officer]

Hey, Toni, it's Tom. So let me start and then Jeff can chime in here as well. As we think about our guidance as we think of the guidance as we gave, which was $9.8 billion to $10.2 billion, which was a raise of roughly about $700 million midpoint to midpoint. As we think about the back half of the year, it's clear as we look -- we see that the PC op margins benefited from a couple of things. One being the significant cost decline, of which we have probably priced through about 60% of that cost and we’ve also let some of that cost fall through the bottom. The other piece of the dynamic there has been the commercial client mix and we are up about 4% year-on-year from 69% to 73% of mix. And so that’s been beneficial as we navigated through the first half. I think as we get through the back half, I think we are going to see PC margins gradually normalize back towards the historic norms. We will have to see how that unfolds, but the rate of cost decline is significantly less than it is in the second half than it was in the first half. And as you think about pricing normalizing and the prices in the market beginning to capture a lot of that cost decline already. So we are thinking that PC margin gradually come back to more historical norms. Not in any sort of dramatic clip like fashion but I just think we're going to see those things gradually migrating back. Jeff, I don’t know what you would add.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

A couple of things. Part of our improvement or our performance in the first half you talked about two of them being the commercial mix and pricing through about 60% of the cost decline. Our direct commercial PC business grew double-digits which drive higher attach rates of services, peripherals and financing to tell. And we’ve seen an SRU improvement in there as well. And that led to the performance that you just spoke about, Toni. Conversely, when I look at the second half, the second half is tilting for its consumer. And consumer has a lower margin structure than our commercial business. We certainly have the uncertainty with trade and the associated cost that go along with trade as we head into the second half. And then I would point to some of the publicly available data, which I know you know very, very well to make our point, DRAM. If I look at DRAM exchange, if I look at where we started the first of the year to where we’re today, DRAM has fallen 60%, nearly 60%. If I look at what they say, the projection as for the remainder of the year, we see a 3% cost decline. So the rate of deflation is changing and we think the pricing environment will reflect that towards the end of the year.

[Robert Williams, Head of Investor Relations]

Thanks, Toni.

[Toni Sacconaghi, Sanford C. Bernstein & Co., LLC.]

Yes, it does. Thank you.

[Operator]

Our next question is from Paul Coster with JP Morgan.

[Paul Coster, JP Morgan Chase & Co.]

Yes. Thanks for taking my question. I will sneak into quick ones, if I may. First up, to what extent you think Windows 10 is kind of fueling the CSG growth this year and does that kind of set you out to tough comps next year? And on the China front, the business that you’re kind of foregoing at the moment, is that business that you think you will come back to some future point, or are you kind of moving on from that very competitive segment of the market? Thank you.

[Thomas Sweet, Chief Financial Officer]

Hey, Paul. Why don’t -- Jeff, why don’t you take the Win 10 comment and I will take China.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Yes, Paul. I mean, the industry data there is roughly 60%-ish plus through the Windows 10 migration. That is clearly been a source of growth for the commercial PCs business for the past year and half so. We see that continuing to be a source of growth for the remaining part of the year, and probably into the very early part of next calendar year. Tough compares of course, if you look at what the commercial PC business has performed for the past six quarters and what’s in front of us. It will be tougher compares next year. You see that and the industry forecast for PC growth next year which is going to be down. The latest forecast I believe has PCs down 4% next year. This year it's roughly flat, heavily biased towards commercial consumer being down and that will be a headwind as we go into the business next year. I would also tell you the things that we’ve done in the business to prepare us for that I think are pretty encouraging. We are going to focus on the consolidation that’s underway that the PC industry continues to consolidate towards the top three manufacturers. We’ve made investments and coverage and capacity across all sorts of customers from the smallest businesses to the largest businesses in the world. We think that expansion of coverage and capacity helps us in the long-term. And then we have new technologies that we think help us with our Unified Workspace driving a differentiated solution into the marketplace, that will be a source of growth for the business. And then clearly our focus on our direct commercial business and then the high-end consumer and gaming business are where you will see our focus as we head into next year.

[Thomas Sweet, Chief Financial Officer]

And, Paul, as it relates to China, the business that we've essentially chosen do not participate in this year has generally been in the hyper scale server space where the pricing dynamics have not made a lot of sense to us. And the other thing that we look at when we look at and evaluate large bids or large opportunities, to what extent is that business strategic to us and sticky, meaning is a long-term customer acquisition play where they're going to buy multiple LOBs and have the opportunity to sell the multiple different types of solutions and service capabilities. What we have generally seen with that, that the hyper scale business in China is that it tends to be very transactional. Where you're getting that business is rebid every quarter or every half year. And so -- and at the -- given that pattern and what we’ve seen, we chosen not to participate in it. And if that’s the pattern that continues -- you will see us continue to not participate in it. Instead we're very focused on growing the customer base in China and about building lasting sustainable customer relationship. So we have shifted the focus of the China business to we must rather than they go out and build the server buyer base into the mid and small enterprise, larger enterprise space, absent the hyper scale and not participate in that hyper scale space, just given the purchasing behavior and the buying behaviors that we're seeing. So I don't think that it was what we know right now that piece of that market is a -- well, it was still be there, it's not a lot of interest to us at this point in time.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

With the same characteristics we see globally are occurring in China. It's the second largest market in the world. We are entering a data economy. There's a big opportunity in the world of hybrid cloud is important, data analytics have the long-term attributes, the marketplace remain strong and we're very optimistic about that over the long-term, which is why we want the business build in the customer base, right? Because we want them out foundationally improving the scale.

[Paul Coster, JP Morgan Chase & Co.]

Thank you.

[Operator]

Our next question is from Aaron Rakers with Wells Fargo.

[Aaron Rakers, Wells Fargo Securities]

Yes. Thanks for taking the questions. I wanted to ask about the storage business. As you look at storage demand being healthy, but the revenue was only about flat this past quarter. We’ve seen bookings growth, orders growth kind of enter playing into effect here, up 4% from the first half. So how do you think about the progression or growth as you kind of think about the product cycle dynamics, what’s your expectation for the back half of the year in terms of the storage growth specifically?

[Jeffrey Clarke, Vice Chairman, Products and Operations]

When I look at the storage performance through the quarter, I certainly point to areas that I think are positive. We see our HCI business continuing to grow. I think we made reference earlier that our HCI business, specifically the VxRail component of that grew 77%. Our converged infrastructure business grew this past quarter to broad category of unstructured data grill and we saw actually good performance in our Unity and the new Unity XT mid range product had year-over-year growth as well. In addition to the PowerMax 2000 that introduced early last call for the high price bands in the mid range, all grew. I think we positioned the product line in a great rate, you will see some more announcements through the remainder of the year that will continue to refresh it and keep it competitive. And we expect: that to grow the marketplace. The marketplace is expected to growth in the last forecast, I think just under 3%. I would expect this to outperform in the market. The investments that we made in capacity and coverage, the tenure of that sales force continues to grow by the date. Literally and we're pretty optimistic about our prospects to outperform the marketplace in the second half of the year.

[Thomas Sweet, Chief Financial Officer]

And one thing I would add to that, and Jeff possibly highlighted a lot of that, how we are thinking about it is. One of the things we’ve been very focused on with the investment we made in the selling capacity has been around customer base expansion, which is why we highlighted the fact that in ISG, with year-over-year of 21,000 new buyers. I mean [indiscernible] the ISG is about whether they’re buying one LOB or two LOBs, but the point of it is that we are expanding the customer base to give this a broader feel or a broader base to sell them into. And so, we are encouraged by that and obviously we got to go out and execute and do this and make sure the sales motion is right on the coverage model, but one of the investment paybacks we’ve been looking for from this go-to-market investment that we’ve made over the last two years has been around, are we expanding [technical difficulty] by the trends we’re seeing that clearly [technical difficulty].

[Jeffrey Clarke, Vice Chairman, Products and Operations]

[Technical difficulty] marketplace we are certainly in the early stages in an area that we’ve referenced [indiscernible]. There is more data being created, there will be more data created on the edge. We have a leadership position across HCI, CI and external storage. And we've improved investment [technical difficulty] coverage that we talked about [technical difficulty] market.

[Aaron Rakers, Wells Fargo Securities]

Thank you.

[Operator]

Our next question is from Shannon Cross with Cross Research.

[Shannon Cross, Cross Research LLC]

Thank you very much. Jeff, can you talk a bit about what you’re seeing from customers with initial response to Dell Technologies cloud? And maybe in more in general just commentary from clients about cloud adoption, both hybrid and public? Thank you.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

I would be happy to. We had a good week this week. At VMworld, we talked about our Dell Technologies cloud platform. We actually made several announcements to extend that platform from what we announced at Dell Technologies world, the last week of April. And the interest this week has been very high, specifically we extended the platform of validated designs to support our PowerMax storage arrays and our Unity and Unity XT storage arrays and our PowerEdge MX compute. We also, which the thing I'm most excited about and that Pat and team did a great job on stage earlier in the week as we announced the initial availability of the first on prem data center-as-a-service. So managed service for data center on prem, the first -- the initial availability of that product which is pretty exciting for us. And then on top of that acknowledging or building upon what we announced back in that last week of April, we talked about new consumption models and we’ve added our Dell Technology cloud platform and our on demand payment terms that we can pay in any form of consumption. So very similar to how a public cloud operates today, we can actually bill the customer by usage and that’s been received quite well. So we're pretty excited about that capability. You think about we added VMware Pivotal container service support on top of that and we have a very comprehensive multi-cloud hybrid cloud in the marketplace. In fact the only one that allows you to move data workloads across the edge to on prem private data centers to the public clouds. That's what our customers are asking for. The ability to do that in a automated way, to be able to manage it in a consistent way. And our Dell VMware cloud allows us to do that. So I'm pretty bullish on the opportunities going forward. Does that make sense?

[Shannon Cross, Cross Research LLC]

Yes, thank you.

[Operator]

Our next question comes from Matt Cabral with Credit Suisse.

[Matthew Cabral, Credit Suisse]

Yes. Thank you. On ISG margins, I’m wondering if you could bridge the strength you saw in the quarter between mix, the commodity tailwinds and maybe other factors, and in particular just if you can touch a little bit on what margins for servers versus storage did for you on a year-over-year basis?

[Thomas Sweet, Chief Financial Officer]

Well, hey Matt, it's Tom. We don’t typically parse. We give you a revenue and an op [indiscernible]. So let me sort of try and give you some -- because I’m feeling nice today, let me give you some color around it, right? So -- but if we look at -- you just -- we looked at our margin -- gross margin or operating margin performance, let me start there. What I would tell you that, it's up a 190 basis points. I’m talking about Q-on-Q now. So from 10.3 to 12.2, I think that from a -- if you were to think your way through that, most of that goodness was principally OpEx goodness. And the actual gross margins were actually flat to slightly down. And if you parse that margin, what you would see is storage margins were stable and we saw some server -- we had server margins declining slightly. And if you think about what’s driving a server margin decline, it's really the things that we just previously talked about which we saw some pricing aggressiveness in large enterprise deals and we saw some mixed dynamics within China which drove some margin pressure downward. So that's sort of the environment we saw, and that's also why we are essentially sort of blasting the headlight on the fact that we do think that we will see a bit more server pricing aggressiveness here in -- as we go through the back half. So that's how -- that sort of our current thinking. I don't know, Jeff, you would add anything there. I think that's how we thought about it right now.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Spot on.

[Matthew Cabral, Credit Suisse]

That's very helpful. Thank you.

[Operator]

Our next question is from Amit Daryanani with Evercore ISI.

[Amit Daryanani, Evercore ISI]

Thanks a lot guys. I guess I’m going to have a broader question, but when I think about getting into the [indiscernible], the expectation was down and you -- you guys would essentially missed revenues, missed EPS, given what every of your -- all your peers have talked about in terms of the negative commentary. Your numbers are really much more better than that fear was. So I’m curious, what do you think is driving the delta of the better performance at Dell was your peers have been talking about. And importantly do you think this performance is sustainable as you go forward?

[Thomas Sweet, Chief Financial Officer]

Well, hey, Amit, it's Tom. Look, I won't comment on our peers. I mean what I would tell you is that if you think about the broad set of capabilities and solutions are in that the comprehensive portfolio we have, we think we have more growth levers and more levers that we can address and build upon with our customers, right? And so we have the most comprehensive portfolio in the IT infrastructure industry from our perspective. You think about the work that we've done on go-to-market over the last 2S with 1 billion of the customer base as we highlighted this quarter whether to round that 21,000 new buyers in ISG year-over-year or whether it's around the 11% growth or the 10% growth in customers, new acquisition customers. So we have been very focused on building our customer base as well. Now look, and we have obviously if you think about the financial performance, we clearly have been aided by -- we have had some deflationary cost environment in the first half of the year. And we are obviously signaling through my guidance that -- we have said that, that cost decline or that cost deflation substantially slows in the second half of the year. But our job and our model that [indiscernible] build us to grow at a premium to the market takes share I think relative share, in generally cash flow. And so that's the model we built and we think that's a model that sustains in all the different types of economic environments. And, look, I mean we are doing our best to execute the model and I think we have a pretty good execution quarter from my perspective. But again, I think it gets back to the broadness of the portfolio, if you look at the results, obviously we are aided by a strong CSG business this quarter. If we were a solely an infrastructure data center business that would have been a bit -- it has been quite a little bit of a different story, but a broad portfolio allows us to play the growth drivers that are available on the marketplace. And I think the team did a pretty good job on that.

[Amit Daryanani, Evercore ISI]

Thank you.

[Operator]

Our next question is from Wamsi Mohan with Bank of America.

[Wamsi Mohan, Bank of America Merrill Lynch]

Yes, thank you. Can you comment on the ability to absorb the higher tariffs coming here shortly and list for particularly around notebook and display. And your message is very clear around the server pricing. But how should we think about rising as a lever for share gains in storage. And if you intend to use pricing as a lever there. Can you be a little more specific around ATI and all flash? Thank you.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Sure. Why don't I take the tariff question. Wamsi that is Jeff. Clearly we have spent a lot of time planning and working through the very dynamic situation that we are living in today with tariffs. Our global supply chain of 25 manufacturing sites around the globe allows us to have the agility and flexibility we need to honestly fast and minimize the impact. We are focused on continuity of supply and continuity supply and delivery to our customers in managing that. But quite honestly, we are working through the challenges of List 4, which is what you are specifically talking about. We are mentioned List 1 through 3 in the previous calls. We successfully mitigated that cost impact to the vast majority of our product. There has been cases where we have not and we’ve raised price, and we will continue to work to mitigate the impact to our customers with List 4, chatting with all in one from September 1 followed December 15 with [indiscernible] monitors and notebooks. In some cases our costs are going to go up and we will have to prices. It's one of the comments I made earlier when you think about the second half and what’s different on our client business. We have the uncertainty of tariffs, the uncertainty of the associated costs than go along with it. We cannot observe all of that cost. And we will pass that alone to our customers in the form of price in various ways. How we do that? We're still working our way through. We spend a lot of time making sure that we have our manufacturing capabilities in place that the manufacturing sites are prepared, the manufacturing process are prepared for the changes, sourcing operations for our notebook all in ones and flat monitors. So that's where we are. I think that's the best answer I can give today. More to come. It is pretty dynamically. It has changed a couple of times. And we'll probably

continue to change, but that’s our guess.

[Thomas Sweet, Chief Financial Officer]

Hey, Wamsi, your other comment around pricing, obviously we did signal or signaling that we are seeing a bit more pricing aggressiveness in the server space. As it relates to our intension/strategy around pricing on storage and some of our product lines, I mean, we are not -- we don’t -- we are not driving any further significant change from our pricing strategy in our other LOBs. So we're obviously -- we have ensure that we are price competitive and relative to the environment in the market. But at this point there's no intension to do -- to use price as a lever on in some of these other areas.

[Wamsi Mohan, Bank of America Merrill Lynch]

Okay. Thanks a lot.

[Operator]

Our next question is from Simon Leopold with Raymond James.

[Simon Leopold, Raymond James & Associates, Inc.]

Great. Thanks for taking the question. I wonder if maybe you could talk a little bit more about trending from a geography and market vertical beyond what you’ve mentioned China a number of times, but I guess I'd like to hear a little bit more detail maybe versus Europe. And then you also talked about sort of the large enterprise weakness. Could you may be touch on some other verticals such as government led tight markets and maybe some of the dynamics, because it sounds to me that maybe Europe is a little bit better, government is a little bit better. Like some color beyond what we’ve talked about already. Thank you.

[Thomas Sweet, Chief Financial Officer]

Hey, Simon. This is Tom. Let me start and maybe Jeff can jump in. I’m going to try and keep this at a reasonably high level. But as we think about just geo based right now, we would tell you that in general we’ve seen North America demand has generally been quite -- has been healthy. And we are pleased with that. We're pleased with our Latin America demand.

I think we have seen some softening in Europe and whether that’s Brexit related or just short of general economic dynamics, hard to parse that. But I think we’re seeing some softening there. I mean we go to Asia, clearly we talked about China being a sort of a softer market for us this year. Pleased with what we're seeing in Japan. We are starting to see better velocity coming out of Australia, New Zealand. So I think in general, I mean that would be how I would frame it for you. On a vertical basis, our customer segment perspective, Q2 which is -- obviously the quarter we are reporting on its generally a strong education state and local government market in the U.S. And I would tell you that that spending seems to be holding up fine. We are optimistic about the federal business going into Q3 in the U.S. So across -- I think across the globe, government procurements continue to be on track. So that sort of what we’re seeing right now. Jeff, I don’t know if you would add anything to that.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

No, not at all. It's very good.

[Simon Leopold, Raymond James & Associates, Inc.]

Great. Thank you.

[Operator]

Our next question is from Jeriel Ong with Deutsche Bank.

[Jeriel Ong, Deutsche Bank Securities]

Thanks guys for letting me ask the question. I’m trying to reconcile the storage, the storage you guys mentioned storage is going to grow more than 3% year-on-year teams. But yet enterprise IT spends kind of continue to be weak throughout the rest of the year. It seems like I model your top line guidance that at least on a year-on-year basis between 3Q and 4Q. I’m actually seeing that year-on-year revenue should accelerate. Could you clarify if that’s true and kind of help me reconcile some of these statements and how that impact your full-year guidance? Thanks.

[Thomas Sweet, Chief Financial Officer]

Well, I’m not sure. It's Tom, Jeriel. So I’m not sure of what -- how you’re modeling and so maybe the team can help you with that offline. I would tell you that as we think about storage, I mean the market is sort of low single digits. And so that’s the forecast from IDC. Jeff talked about the fact we saw storage demand at 1% in Q2. The broader ISG comment which I think you’re referring to is that we continue to see softness in servers, And so you got to think about that mix dynamic, IDC is forecasting negative growth in servers for mainstream servers for the rest of the year. And so there are some interplay between those two LOBs as you model ISG. So maybe the team can take that offline and take a look at how you’re thinking about it. But as we look at the business, we expect to see server revenue, that’s the server market to continue to be challenging for the remainder of the year. With what know today. We are more optimistic about the storage market. Now it's still a -- it's not a double-digit growth market, but we are optimistic that given the improvement in the coverage model, all the work that Jeff has done with his team on product and product line positioning that we should -- we expect to see better results in storage. And so that's how we thought about the year at this point.

[Jeriel Ong, Deutsche Bank Securities]

Appreciate it. Thanks.

[Operator]

Our next question is from Andrew Vadheim with Wolfe Research.

[Andrew Vadheim, Wolfe Research]

Hi. Thank you. So to start the year, you discussed the expectation that investments in sales capacity and coverage would add OpEx. Then you begin to see the benefit of these investments ramp as you moved into the second half of the year. But it seems like today's commentary was that the second half will bounce growth and profitability, but maybe leaning towards growth. Can you just kind of level set where we are with regards to sales productivity?

[Thomas Sweet, Chief Financial Officer]

We look ahead. It's Tom. We don’t sort of talk about those numbers publicly. But I would tell you that we are seeing the capacity that we’ve added sort of ramping on the sort of the normal productivity curves that we would expect, right? Now you have to balance that against it is a bit tougher market than it was a year-ago. And so there are macro dynamics that you’re managing as you think about productivity. Although we don’t tend to give the sales orders a lot of brakes on -- we will just have to simply drive to the productivity levels that gets committed to. But [inaudible] it's a bit choppier market out there, particularly around server. So -- but the productivity curves that are on -- and you’re comment, we are biasing ourselves towards growth. What we’re trying to signal is that, we do want to make sure that the growth engine stays intact and that we’re -- we have a bias towards customer, base expansion, revenue base expansion even in a tougher market. The benefits of scale for us are quite significant and we want to make sure that scale advantage continues. So as we think about the fact that the year that was what we were trying to signal and we are still investing in sales capacity, I might add particularly as we think about some of the market opportunity as we set up for next year. So that’s how we’re thinking about it.

[Robert Williams, Head of Investor Relations]

Great. I think we had one more question.

[Andrew Vadheim, Wolfe Research]

Yes. We will take our final question from John Roy with UBS.

[John Roy, UBS Investment Bank]

Hey, maybe as a final, you were talking a lot about enterprise weakness and -- through [balance of the] back of the year. Maybe if you could give us some color on why you think that enterprise are doing that? Is it macro, is it trade, cloud, is it really just digestion, is it something else. Maybe if you could just kind of order what you're seeing out there and why the enterprises seem to be softer.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

I think we’ve talked about it before and I think even made a reference in our talking points earlier. Coming off the best server year in time and the best storage year in times in calendar 2018. If memory serves me, we roughly have the storage market growing 12% last year. And the server market 30%-ish if memory serves me right. There has been a digestion of that, but taken longer than I think all of the industry expected and find large that’s what we’re dealing with. Combined with the softness that we talked about and what has been one of the fastest growing markets in the world, China.

[Thomas Sweet, Chief Financial Officer]

Yes, I would also add that, and I’m not -- we don’t have enough visibility to parse that I think in the way you’re asking it. But most of us that are running large enterprises don't like uncertainty. And then you think about the macro environment, whether its tariffs or Brexit, or some of the other macro dynamics around interest rates and where GDP is trending. It does create an area of -- potentially an area of uncertainty. So that’s also probably have some level of dampening effect on the market. Having said that, well, right I mean, we think that we're optimistic about the back half of the year. We think we’re set up to continue to execute and companies are still spending. And companies are still in their digital transformation and they need to -- And I think about some of these IT investments as essential to their business model evolution. So we are continuing to press forward and drive the business.

[Robert Williams, Head of Investor Relations]

Great. Thank you.

[John Roy, UBS Investment Bank]

Great. Thank you.

[Jeffrey Clarke, Vice Chairman, Products and Operations]

Thanks, Jon. Hey as a reminder, we will be at the Citi Global Technology Conference in New York on September 4 and 5. We will also be hosting our business update for the investment community in New York on September 26. So we look forward to continuing the dialogue. Thanks for joining us today.

[Operator]

This concludes today’s conference. Call. We appreciate your participation. You may now disconnect.