Rob Williams - SVP of Investor Relations Tom Sweet - Chief Financial Officer David Goulden - President, Infrastructure Solutions Group Tyler Johnson - SVP & Treasurer.

Frank Jarman - Goldman Sachs Thomas Eagan - JPMorgan Jeff Harlib - Barclays Arun Seshadri - Credit Suisse David Phipps - Citi.

Good morning and welcome to the Second Quarter Fiscal Year 2018 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 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 for 30 days.

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 our Treasurer, Tyler Johnson. We posted our second quarter press release and web deck on our website, where this call is also being webcast.

Q2 financial results will also be filed on Form 10-Q tomorrow September 8. I encourage you to review these documents for additional perspective. Consistent with prior periods, our Q2 non-GAAP operating income excludes approximately $2.5 billion of adjustments.

The majority of these are non-cash and related 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 the web deck as well as our SEC filings for more details on our total non-GAAP adjustments. As a reminder, please note that our second quarter fiscal 2017 historical results do not include EMC, and unless otherwise specified, all growth percentages refer to fiscal year-over-year change, which may not be comparable due to the merger.

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 comparable GAAP measure can be found on Form 10-Q 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 [Technical Difficulty] We've combined two great companies, creating the essential infrastructure company with over 140,000 employees.

We've unified two global world-class sales forces and launched an integrated channel program, both of which are helping to drive strong velocity in revenue synergies across the segments, specifically for clients, servers and VMware.

We've rapidly delevered, paying down approximately $9.5 billion of gross debt after excluding DFS related debt, and we've repurchased approximately 19.7 million shares of Class V Common Stock, totaling $1.1 billion.

We've expanded our Dell Financial Services or DFS, portfolio to approximately $6.7 billion in financing receivables, up 30% year-over-year. And we are now the exclusive originator of the Dell EMC business and the preferred finance partner for VMware.

And we're driving industry leadership in multiple categories, including newer solutions such as all-flash and hyperconverged infrastructure. We also recently closed multiple large deals, including a multiyear, multi-solution agreement with General Electric.

This is just one example of the interest we are seeing from our customers to enter into large, multiyear agreements, which further validates the powerful combination we've created for our customers. We have been pleased with the velocity in many areas of the business and with the strong demand for our newer solutions.

While the integration has gone relatively smoothly in many areas, we recognize that we still have work to do to drive profitability higher and improve velocity in our storage business. As we work to improve these areas, we'll continue to stay focused on balancing growth and profitability. Moving to our results for the second quarter.

We were pleased with the top line momentum in the client business, servers and networking, hyperconverged infrastructure and all-flash arrays. Margin pressure persisted in parts of the business given the component cost environment and mix dynamics within the Infrastructure Solutions Group.

For Q2, GAAP revenue was $19.3 billion with a GAAP operating loss of $1 billion. Non-GAAP revenue was $19.6 billion. While year-over-year compares for ISG and VMware segments are not meaningful, the Client Solutions group grew revenues 7% to its highest revenue level in 3 years. On a standalone basis, VMware reported a revenue growth rate of 12%.

Gross margin at the consolidated level was $6.1 billion or 31.1% of revenue, which was impacted by a challenging component cost environment and mix shifts within ISG. We continue to believe memory costs will be a headwind through the remainder of the year even as we work to minimize the impact on the P&L. OpEx was $4.5 billion or 23.2% of revenue.

We remain focused on cost optimization and executing our cost initiatives, while also investing back in the business for the long-term success of the company. Operating income was $1.6 billion or 7.9% of revenue. I will now turn it over to Tyler to provide commentary on adjusted EBITDA, cash flow and capital structure..

Thanks, Tom. We had a strong quarter of cash generation in Q2 and paid down additional debt. Cash from operations was $1.8 billion, driven predominantly by profitability and ongoing working capital initiatives. Cash flow was impacted by interest payments, tax payments and strong growth in our DFS business.

As a reminder, the majority of our interest payments occur in Q2 and Q4. This strong cash flow generation enabled us to repay $1 billion of core debt during the quarter. Our cash and investments balance was $15.3 billion, up approximately $300 million versus the prior quarter.

Adjusted EBITDA for the quarter was 19% - was up 19% sequentially to $1.9 billion or 9.5% of non-GAAP revenue. Please see slide 19 in the web deck for more details on our EBITDA adjustments.

We ended the second quarter with $49.9 billion in total principal debt, down $800 million from the prior quarter as the $1 billion of core debt pay-down was partially offset by an increase in structured financing debt that funds DFS.

Our core debt ended the quarter at $40.5 billion, which is down from $48.8 billion at the time we closed the transaction last September. The remaining $9.4 billion of principal debt consisted of debt to fund our DFS business, the $2 billion margin loan and the $1.5 billion bridge facility backed by VMware legacy intercompany notes due to EMC Corp.

Early in the third quarter, VMware completed a $4 billion debt offering and used a portion of the proceeds to repay $1.23 billion of the legacy intercompany notes. Dell Technologies use the proceeds from this partial payment of the intercompany notes along with other cash to repay the $1.5 billion bridge facility.

Including these latest debt payments, we paid approximately $9.5 billion of gross debt, excluding DFS related debt, since closing the EMC transaction. We've provided a breakdown of our capital structure on slide 8 of the web deck.

To simplify the discussion going forward, in addition to categorizing the DFS related debt as non-core, we are creating a new line item for subsidiary debt that will include the recent VMware debt issuance.

This aligns with how we present our capital structure to the rating agencies and should help limit confusion, focusing our leverage discussions on core debt for Dell Technologies. As we mentioned on the last earnings call, we continue to see growth in our DFS business.

In Q2, originations were approximately $1.6 billion and financing receivables grew to approximately $6.7 billion, up 30% year-over-year, as DFS continues to benefit from the expanded base now including EMC and VMware. We also expanded our DFS operations to Australia and New Zealand in the second quarter.

I want to remind everyone that as the DFS business grows, so will our DFS related debt, which includes both allocated corporate debt and structured financing. In Q2, DFS-related debt ended approximately $600 million higher than the prior quarter.

We realized this increases the total gross leverage of the company, but this debt is supported and repaid by financing receivables and does not impact our overall deleveraging plans. Jumping to our share repurchase program. We have repurchased approximately 19.7 million shares of Class V common since inception of the program.

This includes 13 million shares under the Class V Group repurchase program. On August 24, we announced that our Board has approved a second amendment to our existing Class V Group repurchase program for up to $300 million over 6 months, which we intend to solely fund through a new Class A stock purchase agreement with VMware.

This combined arrangement remains an efficient way to repurchase shares, benefiting both Dell Technologies and VMware shareholders. We are pleased with our continued cash flow generation and the progress we've made on our deleveraging goals to date, and we remain committed to our conservative financial policy and overall capital allocation strategy.

Let me turn it over to David..

Thanks, Tyler. ISG continue to drive solid overall demand with orders up mid-single digits year-over-year. While server order velocity remains strong, storage orders declined in the mid-single digits, consistent with the last two quarters. We have robust plans to improve our storage order growth rate, which I'll expand on in just a moment.

But before we get further into our results, I wanted to highlight some of the broad trends across the business. This quarter showcased the power of the Dell Technologies portfolio as we drove revenue synergies across the family and signed several large multiyear strategic deals. The largest of these deals was a landmark partnership with GE.

The new agreement was one of the largest non-government contracts in our history and makes us GE's primary IT infrastructure provider.

Our broad portfolio and position as a private controlled company gives us the flexibility to partner with our customers on a long-term basis in a manner that best matches their needs, and we've made some proactive decisions to lean into these long-term relationship opportunities with our major customers.

A key example is the introduction of a new set of flexible consumption models or FCMs.

These include a long-term utility like structures that are billed [ph] monthly and new and transformational software license agreements or TLAs, that are built [ph] or financed upfront and make it more flexible for customers to substitute titles and pay for maintenance.

Both utility and TLAs have ratable revenue recognition characteristics that over time should drive more predictable and recurring revenue streams through our P&L. Turning to results for the quarter. Total Q2 revenues for the ISG business was approximately $7.4 billion, up 7% quarter-on-quarter.

The sequential increase was driven by our Server and Networking segment with revenue of $3.7 billion, up 16% both year-on-year and quarter-on-quarter. We saw good demand for our recently launched 14th generation PowerEdge server portfolio and are making good progress against our revenue synergy targets.

Overall, server demand grew in each of our major regions. In networking, our open networking strategy continues to gain momentum in the software-defined datacenter and with strategic cloud and server service provider customers. Our focused investments in the service provider market help drive more than 20% orders growth across the ISG portfolio.

Our storage revenue of $3.7 billion was roughly flat quarter-on-quarter, with orders up mid-teens quarter-on-quarter. The primary differences between our reported sequential revenue and orders demand was growth in our product backlog and an increase in flexible consumption deals.

We also continued to see strong growth in our Virtustream enterprise class public cloud with revenue growing more than 50% each quarter since the merger. As a reminder, the change in our fiscal year will cause third-party storage market share figures to compare different year-on-year fiscal periods until calendar Q2 2018.

Our storage market share figures are also impacted by flexible consumption models as more business is recognized ratably. Business model and calendar shifts aside, we still have work to do to improve our storage velocity, especially in the higher transaction volume commercial segment of the markets.

Our action plan includes better alignments of our sales teams through further [ph] changes and modify incentive problems to better emphasize and capture storage opportunities.

We're also adding several hundred storage specialists across our Commercial go-to-market segments, our global storage specialty team and our channel team to increase our storage go-to-market capacity. We expect the impact of these changes to build over the next few quarters.

To go hand in hand with these go-to-market initiatives, we'll continue to arm our sales team with a leading portfolio of products, and we're seeing good traction from the product introductions at Dell EMC World this past May.

For example, demand for our Isilon scale-out NAS grew double digits this quarter driven by our new architecture, which offers up to 6 times the IOPS [ph], 11 times the throughput and 2 times the capacity of the prior generation.

We also started shipping our new integrated data protection appliance late in the quarter and have a strong pipeline heading into Q3. In all-flash, we continue to see good growth at scale on a more than 2 times the size of our nearest competitor.

Our portfolio enhanced with a strong first quarter for our new VMAX 950 solution and in Q3, we expect further benefit from the launch of our new XtremIO solution X2. Our hyperconverged portfolio continues to grow triple digits with strength in both XC and VxRail.

Since the global launch of VxRail in March 2016, we sold more than 14,000 nodes to more than 2,000 customers. In addition, we have several exciting announcements planned for later this year to further strengthen our storage market position. Moving down to the income statements. Our operating income for ISG was $430 million or 5.8% of revenue.

During Q&A on the last call, we talked about five factors that will drive operating income improvement through the year. These factors were a seasonal volume improvements, a mix shift towards storage, more normalized backlog, pricing actions and improved storage go-to-market capabilities. Let me walk you through how each of these played out.

During the quarter, seasonal volume improvements drove higher operating income dollars in servers. And while we experienced solid seasonal volume improvements in storage orders, storage revenue was approximately flat sequentially due to the flexible consumption models and a build of higher margin storage backlog.

This impacted the server storage revenue mix within ISG. The pricing actions we took offset a portion of the commodity cost increases, but we still faced headwinds in the quarter.

And lastly, we are seeing storage go-to-market momentum with larger customers, and we have solid plans in place to improve order velocity in the higher transaction volume commercial segment of the market. Overall, storage growth rates were similar - storage order growth rates were similar in Q2 to Q4 and Q1.

We expect to see improved storage order growth rates in the second half. So to net things out from an orders perspective, improvement is starting to play out as expected, but the increase in flexible consumption models and an in-quarter backlog build dampened the impact to the P&L.

Notably, the impact to cash flow from these items is less than the impact to the income statement. We expect these factors to continue to be the key drivers of operating margin improvements through the rest of the fiscal year.

In summary, we continue to drive hard against operational improvement targets at our go-to-market for product portfolio and cost-out initiatives. We are encouraged by the overall velocity in the ISG group, and we are seeing the rationale between - behind the Dell EMC merger playing out.

We're leveraging our product portfolio and our ownership structure to build long-term customer relationships, and we believe we have an unmatched set of capabilities in the marketplace. Let me turn it back to Tom, who will walk you through the Client Solutions Group..

Thank you, David. The Client Solutions business had another strong quarter as we continue to take share globally while growing profitably. According to IDC, Dell outperformed the worldwide market, growing units 3.7% in calendar Q2 compared to a total industry decline of 3.1%.

We gained share year-over-year for the 18th consecutive quarter and hit our highest market share since 2006, with unit gains across every major region. We expect to continue to take share in this consolidating market with our focus on balancing growth and profitability. Moving to fiscal Q2 results.

Revenue for CSG was $9.9 billion, up 7% and was our highest revenue quarter since Q2 of fiscal 2015. Consumer revenue was up 10%, driven by growth in notebooks, continued strength in gaming and by initial traction from our CSDT country expansion program.

Commercial grew 6%, due in part to expansion of our customer base, as well as strength in the channel, mobile solutions and attached services. Operating income was $566 million, up 17% or 5.7% of revenue. CSG did benefit from a vendor settlement of approximately $70 million, which impacted the op inc rate by approximately 70 basis points.

We continue to execute on profitable growth despite ongoing challenges from the component costs and competitive environments. Let me go into a bit more detail on our momentum in CSG. This segment is benefiting from the execution of our strategic investments in growth areas of the market.

We saw strong momentum continued across both high end commercial and consumer notebooks as Latitude, Mobile Workstations and XPS each had double-digit growth during Q2. In calendar Q2, Dell ranked number one in unit share for workstations worldwide.

The expansion of our consumers and small business focus to 12 countries also helped drive growth in revenue and profitability. In addition to strength in notebooks, we are having success driving higher attach of services and accessories. Specifically, displays revenue grew double-digits during fiscal Q2.

And according to display search in calendar Q1, Dell remained in the number one display provider worldwide, which marks the 16th consecutive quarter. We also saw higher attach rates for our premium client service offering, ProSupport Plus, primarily driven by our Commercial clients business.

CSG has been performing well while managing a tough component cost environment. As we continue to work through these cost headwinds, we remain focused on continuing to drive velocity in our Commercial client business and on expanding our customer base through profitable share gains. Now shifting to the VMware segment and other businesses.

VMware had another strong quarter. Revenue from the VMware segment was $1.9 billion, and operating income was $561 million or 29.4% of revenue. Stand-alone VMware reported license and subscription bookings up double digits along with strength in NSX and vSAN.

We are pleased with momentum we've seen in cross-selling across the portfolio between the VMware and Dell sales forces as we leverage the family of businesses to expand our customer base.

We look for this business to continue to grow as it goes to market with its new product offerings, including VMware cloud on AWS and VMware app defense announced at VM World last week. We are excited about another announcement made last week at the VM World that truly simplifies that Dell Technologies is better together.

VMware and Pivotal launched Pivotal Container Service, or PKS, in collaboration with Google Cloud, delivering a simple way to deploy and operate production ready Kubernetes containers on VMware vSphere and Google Cloud platform. Revenue from our other businesses, which includes SecureWorks, RSA, Pivotal and Boomi, was $472 million.

Pivotal again delivered strong top line results, with rapid growth in Pivotal Cloud Foundry software solutions. In addition, the team continues to increase its customer footprint and expand its partner ecosystem.

SecureWorks released its stand-alone earnings yesterday, where it reported double-digit revenue growth to $116 million, continued gross margin expansion and solid operating cash flow. This business continues to focus on growing revenue and improving profitability as it looks to accelerate momentum heading into next year.

In closing, we've had many bright spots over the past year in the Dell Technologies family of businesses, with good velocity in client, servers, all-flash, hyperconverged infrastructure and software-defined datacenter, great progress on debt pay down and steady expansion of our DFS portfolio.

But as we said on past calls, we did expect some disruption due to the many changes brought into the organization, particularly in go-to-market. I think it's also fair to remind everyone that we've been doing this while managing our way through the most challenging cost environment in over a decade.

We believe we're making the right decisions for the long-term health of the business, and though we have made progress, we have work to do, some of these decisions may take longer to impact the results as we move forward. As a privately controlled entity, we have the flexibility to make these long-term decisions.

We are the only provider that has this level flexibility and breadth of solutions that can offer a single set of solutions, and this is resonating with customers and partners. We're pleased with how far we've come over the past year and are excited about the opportunities that lie ahead.

We will continue to focus on growing faster than the market, accelerating in growth opportunities like all-flash and hyperconverged and winning in the hybrid and multi-cloud environment.

We remain committed to driving cash flow generation, delevering [ph] the balance sheet and balancing cost actions with investments to position the business for the long-term success. With that, I'll turn it back to Rob to begin Q&A..

Thanks, Tom. Let's go 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..

Our first question will come from the line of Frank Jarman with Goldman Sachs. Please go ahead..

Great. Thanks for taking my questions guys. I guess, first, I just wanted to focus on the ISG segment margins a little bit. You talked about the five factors that would drive sequentially better performance, and you did show 110 basis points of operating margin improvement in the quarter on a sequential basis.

But historically, we would have seen a little bit better quarter-over-quarter growth. And obviously, on a year-over-year basis, it was down. So can you just help us better understand was it obviously, you should have had the seasonal uplift.

But when you think about the storage business in particular, how do we think about improving the trajectory of the business and how quickly can that happen with regards to thinking about the sales force additions and other actions you're taking there? Thank you..

Yes, Frank, thanks. This is David. Let me handle that for you. So yes, as you said, we do see modest improvement sequentially, and the 5 factors that we talked about that let us improve during the year are the key factors. From a storage point of view, we saw what we expected in terms of sequential growth to play out from an orders point of view.

We had a sequential order growth in storage in the mid-teens, just kind of the way you would expect to go from a Q1 to a Q2. But as I mentioned, sequentially, the revenue was roughly flat. That was impacted by two factors.

One was a build and storage backlog due to the timing of when the orders came in, in the quarter and our decision not to try and chase that backlog all out of the door in the actual quarter.

And also our choice to lean into these flexible consumption models, which led us to have a long-term relationships with customers, but basically those are recognize ratably. So we did see things playing out from a sequential order growth point of view. But the two factors that I mentioned dampened the impact on the sequential growth.

The last factor that you mentioned was the go-to-market ads, where we're doing very well in two of the major growth markets in storage in all-flash and hyperconverged.

The third area is the traditional mid-range storage system, which is heavily weighted to the Commercial marketplace, where as I mentioned, we're adding several hundred sales specialists.

We are modifying our incentives and really engineering the way we go out to that mid-market opportunity more aggressively, and that will start to build over the next several quarters. So those are the things that kind of altogether impacted what you saw happening in the storage business in the quarter..

Got it. Thank you. And so as I sort of walk that forward and think about a year ago, right, 3Q 2017, we typically seasonally see a pretty big bump in terms of margin performance for the segment.

And so when I think about seasonal uplift into 3Q, plus the backlog that you've essentially held back for the quarter and the order momentum that you're generating there plus the sales force, should we expect a typical 3Q margin trajectory for the ISG segment?.

Frank, the biggest driver of that is still going to be the storage business, and typically just to kind of go back to the heritage EMC model, typically Q2 and Q3 are relatively similar from a top line point of view. So any changes in operating margin account more related to kind of mix and backlog movements and things like that.

Obviously, exactly how much of the quarter winds up being in the flexible consumption models is yet to be figured out, that’s a kind of lumpy factor. A few large deals make a big difference.

But from a top line point of view, don't expect any significant difference really in the storage segments, which will be perhaps the biggest driver of operating margin as you move forward sequentially into Q3. Obviously, Q4 is much bigger quarter..

Great. Thank you..

The next question comes from the line of Thomas Eagan with JPMorgan. Please go ahead..

Good morning. Thanks for taking the question. On the last quarter, you coached us to thinking that this quarter would be maybe the worst quarter for those - the component headwinds.

And while the revenue that you produced was about in line with what we were thinking, the actual cost, especially on the Client Solutions side were better than what we thought.

So I wondered, you talked a little bit, Tom, about what things that you were doing to offset those costs on the cost of sales sides, maybe if you could just give us a little bit more color on that. And then I have a follow-up..

Sure, Tom. Hey, so look, we did tell you I think back in Q1 when we did this call that the sequential jump in component costs from Q1 to Q2 was relatively significant.

And as we look forward, we still think memory costs will be a headwind through the year, although we do think that Q2 to Q3, the sequential jump will be significantly less than what we saw in Q2. But that's obviously going to be a headwind.

But having said that, look, I mean, we haven't been static about what we're doing in the sense of managing configuration. We have adjusted price a number of times, as we balance both list price moves and our overall discounting framework that we've used, particularly in our Commercial base.

And I would tell you that in general, we've seen reasonably good success sort of navigating through this. It's obviously not perfect. And in general, what we have seen is a gradual mitigation of the component cost environment.

Now the question is as you go forward is balancing that, those pricing actions and component, our configuration actions that you're doing and trying to balance that growth velocity with profitability.

And so it's a careful balance here because as you know, Tom, we're a believer in premium growth to the market, and you've got to be careful around making sure that as you adjust prices appropriately, you're not somehow stymieing demand. And so it's been a balance that way.

I think the team's done a pretty good job, particularly in the client and in the server space sort of navigating through that.

There's more work to do, so I want to tell you that we've been perfect in that execution, particularly as I look at the server business, I think that there's an opportunity to continue to adjust, and we're pleased with the performance so far that we're seeing early in Q3 in that area.

Also, as you think about some of these storage and server space, particularly, you get a bit more lag in terms of how effective the price moves are given some of the longer nature of the contracts. And so price moves further in over a bit longer time frame, particularly in the datacenter space.

So all in all, look, I think the team's done a pretty reasonable job. We'll see how the environment migrates over the next couple of quarters and on into next year. And we're continuing to manage to drive both velocity of the business, as well as margin dollars. So that's the balance we're trying to thread right now..

Okay. Thanks. And then for my follow-up, I just wanted to be clear on the takeaway that you want us to have regarding deleveraging. Because I'm sure everyone appreciates that the details of getting a level of core debt and other debt, and subsidiary debt.

I want to make sure that we walk away with the right thought process and how you think about deleveraging.

When you talk about deleveraging, are we talking about all debt to all EBITDA, the way that you book it or are we talking about subtracting out VMware debt or subtracting out VMware EBITDA or some other measure? How will you guys when you say that you're deleveraging, how should we think about what that means?.

Yes. Hey, Tom, and I'll let Tyler do most of the heavy lifting on this question, but let me just be real clear with everybody as we think about deleveraging. We are focused on delevering the balance sheet, and we tend to talk about delevering as it relates to core debt, okay? And Tyler will take you through what we mean by core debt.

Clearly, the capital structure is getting a bit more complicated as we think about core debt, debt that supports our DFS business, which is backed by the cash flow from the financing receivables and now we have subsidiary debt with VMware, which is backed by the VMware cash flow. So I am very focused on core debt delevering. That's been our focus.

That's what you've heard us talk about, and Tyler perhaps can go into a bit more detail on how we’re managing through that and trying to provide you actually a bit more detail about it so that it's clear to you, and you can give us feedback whether that’s - we're successful in that area..

Yes, Tom, I think that the way Tom described it is correct, and it is complicated, right, because of the relationship with VMware and VMware's desire and need to balance their own capital structure to drive their own strategic initiatives.

But keep in mind, right, we've always talked about VMware or our cash balance ex VMware, right? So when you look at VMware's ability to pay off or to manage the debt that they've taken on the $4 million [ph] is obviously - they're obviously very comfortable with that, and the rating agencies are comfortable with that.

And then we want always be very distinctive about DFS, and I think you've heard me talk about it historically where I almost referred that as good debt because that's debt which is allowing our business to grow. It's supporting our customer needs. It's being settled through the financing receivables that come with that.

And as those kind of amortized down or pay down, right, that's what settles that debt.

So to Tom's point, we look at everything, but core debt is where you'll really see the emphasis of the deleveraging, right, which includes the term loans and the investment-grade nodes and the debt that was really there to fund the acquisition of EMC, the debt, which is ultimately settled through our cash flow generation and EBITDA generation. So….

Okay.

So just to be clear, Tyler, then its core debt which excludes the VMware debt and financing debt and also divided by EBITDA that excludes VMware EBITDA?.

Well, we look at it always, but to your point, right, I think there are different ways you can slice and dice it, and I know the rating agencies do the same thing.

So look, we're going to report recognizing that we still have this disconnect because of where the trailing 12 months that we need to really start reporting leverage ratios, but we're going to look at it always..

Okay. Thanks..

Your next question comes from the line of Jeff Harlib with Barclays. Please go ahead..

Good morning. Just following up in the storage business.

Can you just talk about if there are any further changes or challenges in the overall industry regarding the shift to flash and weakness in traditional and kind of mid-market? And what gives you confidence you can improve the orders in the second half of the year from where they've been on a year-over-year basis?.

Yes. Jeff, thank you. This is David. Let me take that. So within the storage industry, we're seeing I think the biggest kind of trend, which you see is a shift in the market mix towards more than mid-range storage systems.

So the high end of the market, the systems of over $500,000 are - that market is declining and has been declining in the kind of mid-teens percentage range. And the growth in the market is in the mid-range, the mid-range systems has become more capable.

It's still a significant difference in terms of the core capabilities of the kind of multiprocessor, scale, upscale out high-end systems, but nevertheless, the growth is in the mid-range. So that's a big dynamic that's going on.

In terms of the movement towards all-flash, that has now represented the majority of shipments in the high end of the marketplace, where the price performance benefits of all-flash really play out strongly. It's starting to take a bigger impact of the mid-tier market, as well.

Below $50,000 systems, there's not a lot of all-flash right now, probably won't be for a couple of years. In terms of where the growth opportunities are in the storage market, as I mentioned briefly before, there are really three major areas of growth within the overall storage marketplace. One is all-flash in general, where we're doing very well.

We're growing nicely at scale with 2 times the size of our nearest competitor in all-flash. The next is in hyperconverged, where again we're doing well partnering with VMware, a triple digit growth in that segment of the business.

And the third area, back to my earlier comment of growth in the market, is in that mid-range price band, which is where we have more work to do.

And that's where we are focused upon adding the sales resources, which I've talked about, changing our quota and compensation schemes to put more emphasis on the mid-market within storage, introducing more products, et cetera.

And we believe that, that investment in that mid-market storage opportunity is the thing that’s going to help us do better in the second half from a growth point of view than we did in the first half..

Hey, Jeff, it's Tom. I do think it's fair to say that, that sales force expansion will ramp over the next number of quarters, right? That's not going to be an immediate impact even as we build that capacity.

So Jeff, I think that you're going to see perhaps the storage velocity ramp more towards the latter half of the year versus - of the second half I should say versus the first half of the second half, so to speak. So I do think that this is going to be a gradual build as we adjust the coverage models, particularly in that Commercial space.

And lots of other levers being pulled, by the way, in terms of marketing programs and other things that we're doing around incentives and things of that sort. But look, I think this is one of those things that's going to take a little bit of time to work our way through.

But our focus there is to build back that velocity because it's clearly an area of the market that we're not performing as well as we should be, and it's just a focus area for us to drive velocity and it drives a nice margin flow as well. So we've got to get it fixed..

Got it, okay. And just my follow-up on free cash flow.

Were there any major unusual items during the quarter? And I know you were going to pay a significant taxes related to a prior asset sales, how much was that? And then anything you can say about lower drive free cash flow over the next few quarters, be it actions the company is taking or other seasonal issues?.

Yes. Look, I think you are right. I mean, we talked last quarter about the taxes that were related to divestitures, which was - that would have been netted into that cash flow. I don't have the exact number in front of me, but it was - I think it was somewhere around $800 million to $900 million, and so that was obviously fairly impactful.

I think the good news is and your question is the right question because you're thinking about it correctly. I think now as we move forward, you're going to start to see more the cash flow is less impacted by integration or acquisition or divestiture-type charges. And so you'll see it be more related to profitability and working capital.

And look, we're making great progress on our working capital initiatives. I mean, you could see there was a good benefit this quarter. That was partially driven by the P&L growth, which because of the negative cash conversion cycle obviously, it always goes off with cash.

But then within there also, great progress around getting the suppliers coordinated on both sides between the legacy EMC and Dell and moving channel partners to channel financing programs. And so those actions are continuing to happen, great progress. We expect to see some more benefits flow through the P&L.

But like you said, a lot of the one-offs, I think, are going to be behind us..

Hey, Tyler, I also think and Jeff, I think it's fair to say though as we think about things like the storage business, David mentioned it in his talking points that we are seeing more interest in these multiyear structures and particularly like these TLA structures, where what used to be ELA, which were billed [ph] upfront, revenue was recognized upfront, those things are highly profitable, and we are seeing because of customer interest and flexibility around their software titles that perhaps they're interested in, the structures are changing.

And as a result of that, from an accounting perspective, we're deferring that revenue, deferring that margin, but I'm still getting the cash flow upfront from that end. I think that's a phenomenon we're going to continue to see. Because as customers are navigating through sort of a more flexible environment, which is what they demand.

So I do think that that's going to be an area that we're going to have to continue to talk about and provide visibility to as we go forward because I think our EBITDA and adjusted EBITDA numbers are going to be well obviously, a calculation are going - we're going to have to think about how we think about some of these new types of structures..

Thank you..

Its good point. And just related to this, right, and as we think about the cash generation for the second half of the year, I mean, one thing, and I think I mentioned this on the last call as well. You know, look, we're happy with the debt pay-down we did this quarter, the $1 billion, and you'll continue to see us pay-down the debt as we talked about.

But we do have those maturities in the first half of next year. So you might see our cash balances or you will see our cash balances start to increase as we get towards and into Q4 as we position ourselves to settle those maturities. So just want people to be aware of that..

Thanks..

Your next question comes from the line of Arun Seshadri with Credit Suisse. Please go ahead..

Hi, good morning. Thanks for taking my questions. First, maybe for David. I just wanted to understand a little bit better about your flexible consumption models on the storage side.

Is there any way to quantify the storage backlog, I guess, the proportion of your backlog is what proportion would be under those models? And how do you - when you look at the backlog overall, what are the tenure [ph] of the backlog? And when do you expect to see realization of revenue under those - with the backlog that you have?.

Okay, thanks. So let me clarify a couple of things. When we talk about backlog, we're not talking about SDMs [ph] and I want to come back to that in just one minute. Backlog is the products that we take orders for in the quarter, and we don't shift in the quarter.

So that's different phenomena, I'm going to come back and explain the SDMs in just one moment, but the backlog is simply pro [ph] backlog that is not shipped at the end of the quarter.

That is impacted by a couple of things, the timing of order flow during the quarter and also just how much inventory we keep waiting for those orders to come in how much that we ship out during end of the quarter..

And Arun, hey, it's Tom. Remember what we said earlier on earlier calls, which was that we were not going to - unless the customer needed it, we were not going to drive extraordinary measures to try and optimize shipments at the end of the quarter from a rev rec perspective. We would let the shipments fall in the natural period in which they fall.

Quite frankly, because it was more cost-effective and more economical to do it that way. And so David is right. We had a SKU in linearity where orders came in very late in the quarter from pure storage product demand, and those were just typical co [ph] products that will ship out in Q3.

Now your follow-on question has to be well how do you think about backlog in Q3? The questions going to be we'll have to see how the linearity works in Q3 as we work our way through that. We have driven some changes in our comp plans to perhaps drive some incentive to bring those in earlier in the quarter.

I've had mixed success over my career trying to mix shift that curve. So we'll have to see. But backlog will just shift in the normal course, and we'll have to see what linearity looks like next quarter, right, as it relates to pure product backlog..

Exactly. So now let come back to the flexible consumption model that are different, specifically there are two things within this bucket of the flexible consumption models. The first of these transaction - these transformational software license agreements, we call them TLAs.

As Tom mentioned earlier, we used to have [ph] something called the ELAs, which were enterprise license agreements. Those were revenue upfronts, multiyear commitment revenue upfront. The TLAs are the next generation of that. They are typically for our storage software. They cover a multiyear period.

The customers basically taking a commitment to a basket of software products for a multiyear period, and under the structure, the TLAs we give the customer more flexibility in terms of how they substitute titles, we let them choose to when they want to basically start introducing maintenance on those proxy network or because of the nature of the TLA, it is now recognized ratably.

So that's one form of flexible consumption model.

The other form of flexible consumption model, which we are seeing growth in is product utilities, where previously a customer would have bought a fair amount of storage product, typically upfront storage or backup are now moved to a model where it's a utility purchase they are paying based upon use again over a multiyear period of time.

So those are the two things that in total are going to category called flexible consumption models. You asked for a sizing. So to put it into perspective, if we were to look at the total storage demand in the quarter, the flexible consumption models represented kind of mid-teens percentage of total storage demand.

So it does have a meaningful short term impact on the difference between what we're getting from the sequential growth in orders versus less of a growth in revenue. So that hopefully clarifies the dynamics around FCMs..

And remember what we talked about earlier, Arun, which is again on the TLAs, we'll build those upfront, so the cash flow comes up-front just like historically the ELA would. The utilities clearly an over time depending upon usage or whatever the mechanism is.

And so look, I mean, that's why I was trying to explain earlier, there are some dynamics that we have to help you guys with as we move forward from a how you think about EBITDA, how you think about cash, how do you think about order velocity within the business of the storage business given.

What I think is going to be continuing interest with our customers to explore these different types of structures given the flexibility that they are asking for.

And quite frankly, Michael and I have told the team to lean into these things in the sense of their great arrangements, they typically build out a framework for our customer relationship for a number of years. They tend to be nicely profitable over that period of time.

But it is a bit of a transition that we're seeing right now, even as quite frankly we still do need to drive mid-range storage and some of those others that’s on classical transactional demand generation that we need to do. So we've got to do both, and that's the focus that we have right now..

Thanks, Arun. Regina, I think we’ve got time for one more question..

Our final question will come from the line of David Phipps with Citi. Please go ahead..

Hi. Thanks for taking my question. So can we talk a little bit about the server business? You did extremely well there versus our model, and you introduced the 14th generation of PowerEdge.

Was there a bit of build-up from - the sales for the new PowerEdge that help drive some of the sales? Or was it more systematic or more selective when you look at the server business performance in the quarter?.

Yes, David, let me take that. So, yes we introduced and just started to ship towards the end of the quarter the 14G. So we started to ramp what was a kind of small percentage of our overall mix. I think what happens in servers was a couple of things. People really like the 13G family, particularly our strength in the rack scale systems.

We're seeing n a lot of synergy. We're seeing a lot of cross-sell in servers.

A lot of growth is coming from the enterprise segments where obviously we've been able to take the server business into our traditional high-end accounts that were the stronghold of the datacenter sales force that EMC side brought, but also we are seeing good growth in mid-market as well.

So the server business is I think relative to the top line firing on all cylinders. Right now, 14G I think gets a lot of people excited.

They like to see that there's a road map out there, it's kind of future-proofing their decisions kind of invest in the Dell portfolio there, but didn't make a very significant part of the quarter from either a bookings or revenue point of view yet..

David, I do think it's fair to say though that as you think about the server business that there is a particular like hyperconverged and vSAN, some of these other solutions that were software defined that were driving that.

That also falls in that - that generally takes a server with software, right? And so we are seeing incremental interest in some of these new form factors and solutions, which is also helping to drive that number as well..

Absolutely, which again goes back typically those running on rack scale systems….

Yes….

Which is kind of where our strength is in the server market at least. So yes, the kind of moving toward software defined, software-defined datacenters, hyperconverged is certainly one of the drivers in the server market and of course, working very closely with VMware has been a big driver of the server business as well..

And then as my follow-up. So you're driving from great strength now, the PC market with 18 consecutive quarters of taking market share. The server business is performing very well and as everyone has asked about like data [ph] storage business moves a little bit more rapidly forward.

So with some of the sales momentum that you've had in those lines of business when you look at the ISG group, are there - are you starting to gain some of these cross-selling tractions that you might have expected from the combination of all the entities with EMC?.

Look, this is Tom. I'll let David comment since it's his business.

But look, I think we've been pretty very pleased overall with the cross-selling activity that we have seen, and that was one of the sort of key thesis of the deal, which was between the family of businesses with VMware and Pivotal and our core business of client, server storage that and the fact that the customer bases didn't really overlap that well in terms of share - relative share for these respective business units or respective LOBs [ph] I should say.

That we have seen very good velocity in general with that cross-sell activity, really good velocity in the VMware capability, good velocity in client. We have pretty good velocity in server. We got some work to do in storage, to be blunt.

But that part of the structure of how we thought about that has I think has performed quite well, David, from my perspective..

I agree, Tom, and just to be fair and remind David that we've had set our go-to-market structure this way we've had two distinct go-to-market motions, one, the enterprise go-to-market segment focused upon the 3,000 biggest customers in the marketplace and then the Commercial go-to-market segment focus [ph] on everything else.

Obviously, the enterprise segments was largely comprised of the legacy EMC business, and that's where we've seen great lift in the cross-sell, where we've seen server, client. We've also let that group start to resell VMware as well, which has proven to be a lift and helpful.

And then in the commercial business, which is largely again not entire, largely the ex Dell team obviously, we move the related parts of ex EMC, in there seen strong growth again.

We're serving client VMware doing well and just you know, that one area where we still have to do some more work is in the storage momentum in the Commercial market segment.

So if you kind of look at all - if you look at that kind of matrix of kind of different go-to-market versus different products, I think we've seen everything we expected to see with one area for further improvement..

But I think overall though as we think about the year, so it's been a year now since we closed this merger that in general, what we wanted to do was get out of the gate strong from a velocity perspective, and I think in general, that's happened. Obviously, things - we've done a lot of things that I think worked reasonably well.

We’ve got some things that we have to continue to focus on whether it stores velocity or some of the other - continue to cost optimization work.

But again, those are all things that are in process that we'll continue to focus on and drive even if - again, I want to make sure everybody understands that the goal here is to get the velocity in the business back, make sure that we're driving the right sort of margin dollar profile here and then continue to delever the balance sheet from a core debt perspective because you will see I believe DFS debt continue to grow as the financing structures continue to grow [indiscernible] the interesting opportunities we have at DFS.

So that's the balance we're trying to drive and trying to make sure folks that follow us understand how we're going to – how we’re approaching this as we move forward..

Okay. All right, Thank you..

Okay. Thanks, Dave, thanks Tom. That wraps the call this morning. As a reminder, a replay of the webcast as well as the transcript will be available on investors.delltechnologies.com. Thanks for joining us..

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