Earnings Call Transcript - DELL Q4 2025

Operator, Operator

Good afternoon and welcome to the Fiscal Year 2025 Fourth Quarter Financial Results Conference Call for Dell Technologies Inc. I would like to inform all participants that this call is being recorded at the request of Dell Technologies. This broadcast is a 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. I would like to turn the call over to Paul Frantz, Head of Investor Relations. Mr. Frantz, you may begin.

Paul Frantz, Head of Investor Relations

Thanks, everyone, for joining us. With me today are Jeff Clarke, Yvonne McGill and Tyler Johnson. Our earnings materials are available on our IR website, and I encourage you to review those materials. Also, please take some time to review the presentation, which includes additional content to complement our discussion this afternoon. Guidance will be covered on today's call. During this call, unless otherwise indicated, all references to financial metrics refer to GAAP financial measures, including non-GAAP gross margin, operating expenses, operating income, net income, diluted earnings per share, free cash flow and adjusted free cash flow. A reconciliation of these measures to the most directly comparable GAAP measures can be found in our web deck and our press release. Growth percentages refer to year-over-year change unless otherwise specified. 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 and SEC filings. We assume no obligation to update our forward-looking statements. Now I'll turn it over to Jeff.

Jeff Clarke, CEO

Thanks, Paul, and thanks, everyone, for joining us. I am proud of the team's execution this year. We navigated an incredibly dynamic AI environment and accelerating server consolidation, a significant pivot to Dell IP storage and a lagging PC refresh and delivered results above our long-term value-creation framework. We grew our company while reducing our operating expenditures over the course of the year. Our modernization has made us more efficient and provided us the ability to invest more in innovation and in areas of strategic differentiation. Our FY '25 revenue was $95.6 billion, up 8%, with operating income of $8.5 billion. OpEx was reduced by 4% over the course of the year. This resulted in record EPS of $8.14, up 10%, and cash flow of $4.5 billion. We continue to differentiate ourselves with consistent performance through numerous economic cycles, different technology buying and adoption cycles and our rapidly innovating technology ecosystem. Some examples of the innovation from this past year. We added five platforms to our AI-optimized portfolio, including support of the oil architectures, the highlight being the PowerEdge XE9712 supporting NVIDIA's NVL72 GB200, which we were the first to ship in the world. We launched the Dell Infrastructure Rack Sobel system, our IR7000 and 5000 in both 21-inch and 19-inch versions, providing up to 96 GPUs in a rack and 786 GPUs in a scalable unit. We have made significant advancements of CPUs, cold plates metals and power distribution with our IR7000 supporting up to 480 kilowatts per rep. We introduced our direct-to-chip liquid cooling version of the 9680, providing 33% density improvement and 2.5 times improvement in energy efficiency. We made significant advancements to PowerStore with PowerStore Prime, our mid-range storage solution addressing the fastest-growing portion of the market. And we introduced the PowerScale F910 and F710 in our unstructured portfolio that is prime to support unstructured and AI workloads. We introduced the most Copilot+ PCs powered by ARM-based Qualcomm Snapdragon processors and also launched the broadest portfolio of Intel Meteor Lake commercial PCs, furthering our number one leadership position in commercial AI PCs worldwide. We continued our number one leadership in PC monitors with the world's first 4k monitors to achieve 5-star Eye Comfort certification. focused on expanding our peripherals portfolio selling everything around the PC docking stations, cameras, mice, keyboards and headsets, including the first and only holistic solution to manage your fleet of PCs and peripherals remotely, creating the best possible customer experience. And finally, we simplified our branding, redesigned our PC portfolio and broadened our silicon options across Intel, AMD and Qualcomm, setting us up well for the PC refresh. We are extremely well positioned to capture growth across every segment of our business and extend AI from the largest at-scale CSPs to enterprise workloads and out to the edge with the PC. These tailwinds and our unique operating model that leverages our leading product positions, our go-to-market engine, services and supply chain, underpin our confidence that our opportunity continues to grow as we look ahead to FY '26. Moving to Q4. Revenue was $23.9 billion, up 7%, driven by a robust ISG growth. We executed particularly strong with substantial operating margin improvement in ISG driven by our Dell IP storage portfolio. This resulted in EPS of $2.68, up 18%, growing faster than revenue. Turning to BU results. Let's start with ISG. The prospects for AI are strong, and we are very well positioned. In Q4, AI orders demand was $1.7 billion with $2.1 billion in shipments in order with $4.1 billion in backlog as customers work through technology changes. And in February, our partnership with XAI and other customers continued. We booked deals putting our AI backlog at roughly $9 billion as of today. Our pipeline expanded sequentially and has grown every quarter since the introduction of the 9680. We are seeing continued progress in AI from enterprise customers, albeit still earlier in their journey with sequential growth in both orders and customers. And our engineering services, financing and ability to optimize density and performance per watt are important differentiators for the largest at-scale CSPs and provide very efficient enterprise solutions. In traditional servers, the growth trajectory continues, up double digits in Q4. We've now seen five quarters of year-over-year demand. Our mix of 16G servers continues to increase as customers remain focused on consolidation to improve power efficiency and increase floor space. The server consolidation in the data center is expanding server TRUs driven by service with more CPU cores, storage and memory. In storage, we saw P&L growth for the second consecutive quarter with very strong profitability driven by our Dell IP storage portfolio. PowerStore, our flagship midrange product, has had strong demand growth for four consecutive quarters, the most recent three at double-digit demand growth. As I mentioned, the software and hardware updates we made with PowerStore Prime resonate with customers and partners. We have industry-leading 5:1 data reduction, delivered 30% improvement in IOPS Native MetroSync and QLC availability. We also saw double-digit demand growth in PowerScale, our leading unstructured storage platform, and continued growth in our buyer base with PowerFlex. We are well positioned in some of the fastest-growing categories within storage as customers shift towards disaggregated architectures. In CSG, we are seeing the recovery coming with strength in SMB, which historically is a leading indicator. We also saw large opportunities within the quarter, which were very competitive. Commercial was up 5%, marking the second consecutive quarter of year-over-year growth and the fourth consecutive quarter of demand growth. Consistent with what we saw coming out of Q3, customers are waiting to refresh to buy AI PCs that future-proof their purchases going forward. Consumer continues to be challenged with softer demand and elevating levels of discounting. We expect a broader PC refresh this year as the installed base continues to age, we get closer to the Windows 10 end of life and AI PCs are more broadly available. To close, I am proud of our FY '25 results and our ability to execute our strategy, leveraging our strengths to extend our leadership positions and capture new growth. The AI hardware and services TAM has nearly doubled over the course of the year to $295 billion in 2027, growing at a 33% CAGR. We are well positioned in AI, traditional servers, storage with our focus on Dell IP and PCs, including everything around the device. We continue to drive a disproportionate level of AI growth by demonstrating the value we provide to our customers and I'm excited for the tailwinds surrounding our business as we enter FY '26. Now over to Yvonne for more details about Q4.

Yvonne McGill, CFO

Thanks, Jeff. Let me begin with an overview of our Q4 performance, then I'll move to ISG, CSG cash and guidance. In the fourth quarter, we delivered strong profitability, specifically in ISG. Our total revenue was up 7% to $23.9 billion. This was driven by continued strength in servers. Our combined ISG and CSG business grew 10%. Gross margin was $5.8 billion or 24.3% of revenue. This is down 50 basis points due to a more competitive pricing environment, predominantly in CSG and an increase in our AI-optimized server mix. Within gross margin, we discovered previously unrecognized accumulated credits from suppliers. You'll find revised financial results within our Q4 press release that reflect higher gross margin and increased earnings per share for the relevant period. Operating expense was down 6% to $3.1 billion or 13.1% of revenue. FY '25 was a transformative year as we reevaluated, reimagined and modernized how we operate. This enabled us to unlock efficiencies and increase productivity, all while growing our core business double digits. Now let's look at operating income. We delivered a 22% increase to $2.7 billion or 11.2% of revenue. This was driven by higher revenue and lower operating expenses, partially offset by a decline in our gross margin rate. Q4 net income was up 15% to $1.9 billion primarily driven by stronger operating income. And our diluted EPS was up 18% to $2.68. Now let's move to ISG, where we delivered another quarter of strong performance. ISG revenue was $11.4 billion, up 22%. Servers and networking revenue was a Q4 record at $6.6 billion, up 37%. We continue to see strong demand across both AI and traditional servers. Storage revenue was up 5% to $4.7 billion, a second consecutive quarter of growth. We executed very well in storage. We had a record demand quarter for PowerStore. PowerScale grew double digits, and our PowerFlex buyer base grew. While the overall demand environment is lagging that of traditional servers, we see some promising trends. We had record ISG operating income of $2.1 billion, up 44%. This was driven primarily by higher revenue. Our ISG operating income rate was up again sequentially to a record 18.1% of revenue. The rate improvement of 480 basis points was the result of improved gross margins, especially in storage, and reduced operating expense. Within storage, we saw record profitability driven by a higher mix of Dell IP versus partner IP, improved product profitability and revenue scaling in what is seasonally our strongest quarter. Now let's turn to CSG. CSG revenue was up 1% to $11.9 billion. Commercial revenue was up 5% to $10 billion, while consumer revenue was down 12% to $1.9 billion. CSG operating income was $0.6 billion or 5.3% of revenue. This is down 90 basis points sequentially due to a more competitive pricing environment. We saw some promising signs as we went through November and December with pockets of strength in large deals, but overall saw a slowdown in January. As Jeff mentioned, we saw strength in small and medium business, which is historically a leading indicator. Profitability in commercial was weaker than expected as demand continued to push into the next fiscal year. In consumer, the demand environment remains soft and profitability remains challenged. We are ready and well positioned for a PC refresh with our simplified rebrand, leading go-to-market engine and focus on commercial PCs, the most profitable segments of the market. Shifting gears, Dell Financial Services continues to drive differentiated payment solutions for our customers. We exited the year with a record $15 billion in assets under management, up 5%. And when you normalize for the exit of our VMware resell business and the discontinuation of our commercial revolving product, DFS originations were up 7% in Q4 with a strong attach rate across the business. Now let's move to cash flow and the balance sheet. Q4 cash flow from operations was $0.6 billion. This was primarily driven by profitability, partially offset by working capital. Our cash conversion cycle was negative 31 days with $6.7 billion in inventory. We ended the quarter with $5.2 billion in cash and investments, down $1.4 billion sequentially. Our core leverage ratio was down sequentially to 1.2x. We returned $1.1 billion of capital to shareholders with 6.4 million shares of stock repurchased at an average price of $117.51 and paid a dividend of $0.45 per share. Since our capital reaching program began at the beginning of FY '23, we've returned $10.8 billion to shareholders through stock repurchases and dividends. We announced an 18% increase in our annual dividend to $2.10 per share, well above our long-term value-creation framework. Additionally, the Board of Directors has approved a $10 billion increase in our share repurchase authorization. This is a testament to our confidence in the business and our ability to generate strong cash flow. Turning to FY '26 guidance. IT spending is expected to grow with three underlying trends that we see. First, businesses are leveraging AI to enable competitive advantages, and we are seeing that in our opportunity pipeline that continues to expand. Second, data center modernization is well underway with a focus on consolidation and power efficiency. Third, customers are planning to refresh their PC installed base with AI-enabled devices. As these trends materialize, we will leverage our operating model that has driven value creation over the last 40 years. Against that backdrop, we expect revenue and EPS growth in FY '26 above our long-term value-creation framework. We expect FY '26 revenue to be between $101 billion and $105 billion with a midpoint of $103 billion, up 8%. We expect ISG to grow high teens driven by $15 billion of AI server shipments and continued growth in traditional server and storage. And we expect CSG to grow low to mid-single digits, more weighted towards the second half of the year. We expect the combination of ISG and CSG to grow 10% at the midpoint. Given the higher mix of our AI-optimized servers and the current competitive environment, we expect our gross margin rate to decline roughly 100 basis points. As our modernization efforts continue, we expect OpEx to be down low single digits year-over-year. We expect ISG operating income rate to be roughly flat year-over-year with CSG down slightly. We expect I&O to be between $1.4 billion and $1.5 billion. Diluted non-GAAP EPS is expected to be $9.30 plus or minus $0.25, up 14% at the midpoint, assuming an annual non-GAAP tax rate of 18%. For Q1, we expect revenue to be between $22.5 million and $23.5 billion, up 3% at the midpoint of $23 billion. ISG and CSG combined are expected to grow 6% at the midpoint with ISG growing low teens and CSG flat year-over-year. Gross margin rate will be lower sequentially given seasonally lower storage mix and a higher AI-optimized server mix. OpEx will be down low single digits year-over-year. We expect operating income rate to be down sequentially given typical seasonality in ISG with lower storage mix. We expect our diluted share count to be between 706 million and 710 million shares, and our diluted non-GAAP EPS is expected to be $1.65 plus or minus $0.10, up 25% at the midpoint. In closing, we delivered solid FY '25 results, well above our long-term value-creation framework. We generated $95.6 billion in revenue, record EPS of $8.14 and returned $3.9 billion of capital to our shareholders. We executed our strategy and expanded our lead in AI while positioning our core business for the opportunity ahead. Internally, we began a transformation to future-proof the company, focusing on supplying, automating and modernizing how we work. And as we look forward, I'm excited about the sustainable growth we see and the value we will continue to deliver to our customers and our shareholders. Now I'll turn it back to Paul to begin Q&A.

Paul Frantz, Head of Investor Relations

Thanks, Yvonne. Let's get to Q&A. In order to ensure we get to as many of you as possible, please ask one concise question. Let's go to the first question, operator.

Operator, Operator

The first question comes from Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Yes, thank you so much. Yvonne, could you talk through the fiscal '26 guide? And what sort of maybe some of the assumptions that are incorporated beyond what you stated? Your revenues are going to be up roughly in total about 7.7%, EPS up about 14%. But your comments on ISG and CSG margins are flat to down, and you noted a fairly competitive environment. So can you just bridge those sort of comments to your EPS growth? How much is coming potentially from buybacks? And have you made any tariff-related assumptions in these margin guides? Thank you so much.

Yvonne McGill, CFO

Thanks, Wamsi. So yes, in the guide for the year, we guided to the $103 billion of midpoint, up 8%, with everything growing, right? ISG and CSG expected to be up combined about 10%. If I look at ISG, which I think some of your question is coming from, we expect that to be in the high teens, fueled by that $15 billion of AI server shipments that we referred to as well as continued growth in both traditional server and storage, I'd say with storage in the low single digits. CSG, we do expect to grow in the mid-single digits coming up for the year that's just begun with that refresh cycle that we're expecting to be more weighted towards the second half of the year. OpEx is another area. We guided to it being down low single digits year-over-year. That's just a continuation of all of the efficiencies that we're driving across the entire company. And then the improving year-over-year to the 9.1%, up from 8.9%, so an improvement there. When I think of what to expect from an ISG standpoint from an operating level, we're saying roughly flat year-over-year. And we expect there to be continued competition, I guess, is the right way to put it in CSG. But again, we've guided and embedded that in there. And I go back to ISG real quick and say, hey, we are going to be growing the AI business while continuing to drive profitability there. So we'll continue to balance, as we have been doing, our growth and profitability. And we're going to manage pricing, we're going to manage the competitive environment, and we're going to continue to drive value for our shareholders.

Jeff Clarke, CEO

Thanks, Wamsi.

Operator, Operator

And the next question comes from Erik Woodring with Morgan Stanley.

Erik Woodring, Analyst

Thank you for taking my question. Jeff, a common concern from investors revolves around the risk of original design manufacturers entering the AI server market. As customers become more advanced, competition may increase, potentially putting downward pressure on margins. Essentially, there is a worry that AI servers might follow a cloud 2.0 model of disintermediation. Your strong AI server backlog certainly counters this concern. How would you address these worries if asked? Thank you.

Jeff Clarke, CEO

Sure. Thanks, Erik. I mean, do we see the ODMs in these large opportunities? Of course, we do. These are multibillion-dollar opportunities. Everybody tends to show up and wants an opportunity to win the business. When I step back and reflect why Dell and why we continue to be optimistic here is this is custom work. It takes significant engineering capability. It takes significant architecture capability to win. And in many cases, we're building a unique and differentiated solution for each and every customer. And our customers have learned to value what we've been able to bring to them across their deployments, whether that is the service side when we extend beyond an L10 server out of the factory with L11 and L12 and full integration of Iraq, on the network expertise we bring to do the install and deployment of very complex network arrays. When I think about service, the ability that we have a global service footprint, professional servers can show up anywhere to solve any related problem or hands-on in these very large deployments with full-time teams. Literally, they're 24/7 trying to get them up and running. I think about the financing capabilities that we have in our company and the ability to help these CSPs, these fast-growing companies grow at the rates they want with our financing capabilities, I think about our go-to-market coverage and I think about the expertise we have in the top 30-or-so CSPs digital natives, our ability to scale this to enterprise. Erik, every time I look at this question, and I don't really focus on ODMs or for that matter, other OEMs. I look at the differentiated value we are bringing to the marketplace with the Dell company bringing end-to-end solutions. And right now, it's valued. And right now, we continue to differentiate. Right now, we help these large-scale clusters get deployed faster than anybody else. I'll remind you, I probably did last time as well, we were the first to bring to market a GB200 rack. That's not by luck. It's by a lot of hard work, detailed engineering, collaborating in this case with NVIDIA and our customer to be able to take out every ounce of time and run at the speed of light, so to speak. So we're going to continue to invest in that differentiation. We're going to continue to make us stand out to be different. Our customers really value the full range of our capabilities. They like the notion of a single place to go. I'm not sure others bring that. I know we do, and I know we're extracting value from the marketplace for that with our customers and our deployments.

Erik Woodring, Analyst

Awesome. Thank you, Jeff. I appreciate it. Good luck, guys.

Operator, Operator

And the next question will come from Simon Leopold with Raymond James.

Simon Leopold, Analyst

Thank you very much for taking the question. I was wondering if you could give us your thoughts on your exposure to the U.S. federal government. Basically, how big is it typically as a percent of your revenue? And how are you thinking about the trend given all the noise we hear out of Washington around budget cuts and spending cuts?

Yvonne McGill, CFO

So Simon, I'll take a pass at that. We do business in 170-plus countries around the world. Obviously, our largest country is the United States, and we do business with the federal government. But I can't really parse out exactly what you're asking for. We're certainly going to lean into all opportunities that are ahead of us and continue to be successful in that space.

Jeff Clarke, CEO

No, I would add to what Yvonne said. We've had numerous times in our history where a country or a particular segment's demand was suppressed for various reasons. We've been able to navigate the cycles, I think, pretty successfully. Our underlying belief is the United States government will need technology. AI plays a pretty significant role in our nation. And I think the demand will materialize. We'll get through whatever is happening today. And we have a broad business to be able to do that. Whether it's PC, servers, storage, AI solutions, our services making it up in other parts of the world, other parts of the United States, we've again proven we've done that consistently, and we'll do so here.

Yvonne McGill, CFO

We can help drive efficiencies in every environment. So excited about the opportunity ahead.

Simon Leopold, Analyst

Thanks, Yvonne.

Operator, Operator

And our next question will come from Aaron Rakers with Wells Fargo.

Aaron Rakers, Analyst

Yes, thanks for taking the question. Just building on Erik's prior question, I'm curious, Jeff, as we really start to see the materialization of the Blackwell product cycle through your AI backlog, I'm curious, when you're engaged in like rack-scale configurations, how would you compare the margin profile of those relative to the AI business on, let's say, the Hopper product cycle? And can you talk a little bit about the levers that you see to improve that margin as we move through 2025? Thank you.

Jeff Clarke, CEO

Sure, Aaron. I think I mentioned in the last call that the Blackwell margins were lower than the Hopper margins and remain so today. We're still early. The deals are very large upfront. There's more competitors, so it's a more competitive landscape. And I'll probably sound a little redundant with the last answer with Erik. Look, this is a system design and architecture work. There's an ability to really distinguish our engineering and value add in that step, which is an opportunity for us to extract value and opportunity for us to reduce cost. These aren't reference designs or as we would affectionately call in the engineering community, they're not cookie-cutter designs. We're designing a unique rack, a unique power distribution unit. Our cooling, our manifold, the cold plate, the ability to engineer that and to drive that through the scale of our supply chain are opportunities for us, helping our customers attach with our networking with our storage or opportunities. And while still small, it remains an opportunity because every large cluster, and for that matter, every AI workload requires data to fulfill its need. Services, installation, deployment, those are value-add opportunities for us that we continue to build on, and then obviously, the ability to be a time-to-market advantage. Those are areas that we continue to focus on. They drive differentiation. I think Yvonne and I have been consistent for the better part of the year that AI servers are margin rate-dilutive. They are margin dollar-accretive. They are operating margin-positive. They are profitable. And what's really interesting for us, if we take the work that we're doing in these large clusters, it really scales nicely to the enterprise. It allows us to really take the efficiencies and learnings from what we're doing with the largest clusters in the world and build optimized solutions for very specific domain-specific AI use cases. And our experience to date is the AI margins in enterprise are better, and I think they'll continue to be, and that's what we're focusing on.

Aaron Rakers, Analyst

Okay, thanks, Eric.

Operator, Operator

And our next question will come from Michael Ng with Goldman Sachs.

Michael Ng, Analyst

Hi good afternoon. Thank you for the question. I just have one on the ISG margin outlook of flat year-over-year for the upcoming year. It's a great outlook, particularly considering AI server revenues growing 50%. So can you talk a little bit about the expectations for margins for some of the components, traditional servers, storage AI servers? I'm just trying to understand the ability to keep ISG margins flat despite presumably the dilutive effect from the AI server margins. Thank you.

Jeff Clarke, CEO

I think, Mike, maybe the way to look at this is the, first and foremost, as we think about holding ISG margins flat, I love the way that you asked the question, we're going to do that by growing at least $15 billion in AI servers. I know your question is how we're going to do that. But for us, that's a very important mark that we're going to be able to meet that operating range that we've committed to in our long-term framework and we're going to grow at a minimum of $15 billion in AI servers. And we're going to do that by what we've done in traditional servers and what we've done in storage. The storage leverage that Yvonne talked about earlier is front and center. When we grow the storage business and we control our expenses, scale matters, the operating margins improve. When we pivot to Dell IP storage, which we have done, our margins improve. The margins of our own IP are vastly superior to third-party IP. We've been doing that for some time. We made mention, I think, in our remarks about PowerStore. It's grown four consecutive quarters on the van line, the last three, double-digit; in the largest space in the external storage marketplace, midrange. It has differentiated features. We're going to continue to leverage our IP storage. We're building out the customer base with our direct sales force and our partner-first channel program. We're continuing to invest in the innovation and differentiation in our storage. And with our coverage, the broadest coverage in our industry, and the deepest specialty capability, we're going to continue to grow the customer base, which I might add, the PowerFlex customer base grew, the PowerScale customer base grew, the PowerStore customer base grew. And then lastly, we're looking to attach more storage to every AI opportunity that we have. Our traditional storage business continues to grow, five consecutive quarters of year-over-year growth. We've seen an expansion of ERUs as we see the consolidation continuing to occur in the data center to free up more floor space and become more power efficient. We see our 16G and 17G products ramping nicely. And those are driving, again, more cores, more memory, more SSDs, more margin dollars per server that we put in the marketplace. That's how we're doing it. If I missed anything, Yvonne...

Yvonne McGill, CFO

Thank you. I think you hit it.

Operator, Operator

And the next question will come from Ben Reitzes with Melius Research.

Ben Reitzes, Analyst

Hey, thanks guys. Appreciate it. Could you be more specific on the guidance for this year with regard to tariffs? What are you factoring in for China in particular? Is it the 10% or today, this morning's 20%? And then are you instituting any remedies? And what are your thoughts about remedies like raising prices, moving stuff around? And how are you adjusting for that? Thanks a lot.

Jeff Clarke, CEO

Well, Ben, maybe I'll take a swing at it, and Yvonne can clean up on this one here. Whatever was announced this morning, which we know things were announced this morning is not on what we just said. That said, this is a pretty darn dynamic environment as represented what we heard this morning. It's fluid. We built an industry-leading supply chain that's globally diverse, agile, resilient that helps us minimize the impacts of these trade regulations, tariffs to our customers and shareholders. We've been monitoring this for some time. We've taken our digital supply chain, our digital twins actually using some AI modeling to look at every possible scenario that you might imagine of this country, that country restrictions here, awaits here. To help us understand how we optimize our network and how we that in the least amount of time at the speed of Dell. And whatever tariff we cannot mitigate, we view that as an input cost. And as our input costs go up, it may require us to adjust prices. That's what we've done in the past. I can't imagine we're going to do anything differently. Yvonne, if I missed something.

Yvonne McGill, CFO

No, I think you hit it. We'll take into account the input costs and price accordingly in this competitive environment that we're operating in such, continue onwards.

Operator, Operator

And we'll take a question from David Vogt with UBS.

David Vogt, Analyst

Thank you, everyone. I want to ask about ISG xAI. Yvonne, if we consider your outlook, it suggests very strong growth in traditional server and storage. I know you recently reported positive numbers. However, what insights do you have about your performance against competitors in the marketplace? Additionally, how do we approach achieving high single-digit growth in this sector given the overall macro conditions we’ve discussed?

Yvonne McGill, CFO

We are anticipating growth across the entire portfolio in ISG. As I mentioned, we expect storage to grow in the low single digits, with servers growing even more, and at least $15 billion in AI server sales. There are plenty of opportunities available, with potential that exceeds what we’ve already experienced. Our pipeline is still expanding. Jeff, do you have anything to add regarding ISG? I feel confident and comfortable with the guidance we've provided for the entire year and the opportunities it presents.

Jeff Clarke, CEO

Yes, let me provide some additional details. Considering storage, we are shifting towards our Dell IP storage solutions. Modern workloads require an adaptable architecture that is efficient and enhances performance. We believe that a disaggregated architecture is the solution for these modern workloads. This shift presents a challenge for our significant presence in hyper-converged infrastructure, which is expected to decrease. However, we plan to address this by increasing our market share in the Dell IP storage portfolio, particularly in the midrange segment, along with our software-defined products like PowerFlex and PowerScale in the infrastructure space. This outlines a potential challenge that may not be immediately apparent, but it is indeed something we face as we transition towards a more profitable storage focus.

Yvonne McGill, CFO

I was going to say it's more profitable to do our own.

Jeff Clarke, CEO

There's revenue that we'll see go away at a lower margin rate, the HCI business. We have a secular decline in the high-end space where we're the market leader with our PowerMax product. So we're going to overcome those and drive the growth that Yvonne mentioned. And then traditional servers, I don't know if you've seen some of the recent market forecasts. It's low single-digit growth. We're going to take share. We've now had five consecutive quarters of year-over-year growth that's coming off eight quarters of a consolidation period or of a consumption period, I should say. And we think this consolidation continues. But the consolidation drives fewer units. Those units are actually higher in TRU because of the more cores, memory and SSDs I mentioned earlier. And we continue to see that driving our traditional server business. I hope that context helped a little bit.

David Vogt, Analyst

Great. Thanks, Jeff. Thanks a lot.

Operator, Operator

And moving on to Amit Daryanani with Evercore.

Amit Daryanani, Analyst

Thank you. I have a question regarding free cash flow. In fiscal 2025, it appears that your free cash flow is down a couple of billion dollars compared to 2024. Can you explain what is causing this decline in free cash flow? Additionally, Yvonne, could you help us understand how to approach free cash flow expectations as we look towards fiscal 2026? What factors should we be considering? It would be useful to have some context for fiscal 2026. Also, Jeff, I’d like to hear more about the operating leverage your team is demonstrating in fiscal 2026 despite the negative mix. There is a concern that this may not be sustainable and could be influenced by one-time headcount reductions or other factors. Could you discuss the sustainability of this growth?

Jeff Clarke, CEO

You go to, Tyler, then I'll come in on the durability of which structural changes we are making up in.

Tyler Johnson, Analyst

Amit, I remember thinking last year that cash flow would be a bit stronger. However, we didn't see the growth in CSG that we anticipated, which typically generates good cash. Additionally, we invested significantly in our AI business through inventory, leading to an increase in our inventory levels, which impacted CCC. Looking ahead to FY '26, I see several positives. Firstly, we're at a CCC level where we've historically improved, which will generate good cash. We expect solid CSG this year, which will also provide good cash. Moreover, growth in the P&L should contribute positively to our cash flow. Overall, I feel optimistic about our cash situation and expect it to exceed 1x.

Jeff Clarke, CEO

And then to your second question, I probably won't give you as much detail as you'd like because we think some of the changes we're making are very proprietary and differentiating us in the market, the fact that we can grow while reducing our operating expenditures, but Yvonne hit on it, Amit: simplify, standardize, automate. We are building a new company. We are what we call modernizing it. We've made reference to modernization. If you prefer, we're future-proofing the company and we're systematically going throughout all of the value streams in the company. And we are modernizing the work, the workflows, taking steps out of processes, taking out manual touches, simplifying and standardizing those processes, applying automation in the very technologies that we've talked about that get us excited in this marketplace, which is why we believe this AI thing makes its way to enterprise, we are deploying AI in the enterprise. The broad categories of use cases are industry-known, whether that's content creation and management, support assistance, natural language search, design and data creation, cogeneration or document automation. Those are broad enterprise use cases. We are deploying those types of technologies inside our company and seeing tremendous efficiency from that and it is durable. It's not a one-timer.

Yvonne McGill, CFO

What's so exciting is we're making all these changes, we're making investments. But we're driving all this efficiency to enable that. So the net, what you're seeing us guide to is a lower spend, but it's because we're driving all of these efficiencies that will enable us to invest in OP spending.

Jeff Clarke, CEO

Well, I think that's very important. I think I mentioned it in the remarks comment that we are reducing the cost. And we've built, if you will, the ability to invest more in our innovation engines, more in our areas where we drive distinct advantages. Our sales force, we've invested in our sales force over the past year, we've invested in services, we've invested in the supply chain while reducing our cost.

Yvonne McGill, CFO

And it's just the beginning. Thanks Amit.

Operator, Operator

And the next question will come from Matt Niknam with Deutsche Bank. Please go ahead.

Matt Niknam, Analyst

Hi, thanks so much for taking my question. My question is on CSG. I can ask about a different segment. The guidance implies an acceleration over the course of the year. And I'm just wondering what sort of visibility or confidence level you have there that this long-awaited PC refresh will finally materialize. And I ask that in context of a relative slowdown that was referenced in January?

Jeff Clarke, CEO

Yes, Matt, this may bring some optimism regarding our belief in the ongoing PC refresh. There are approximately 1.5 billion PCs in use today, and we estimate that about half are four years or older. This year, around 360 million PCs purchased in 2021 have reached that four-year mark, indicating a potential for refresh. More significantly, we are nearing the end of support for Windows 10. Over 500 million PCs are currently running Windows 10, of which many cannot upgrade to Windows 11, while more than 200 million can. These represent prime candidates for upgrades. Reflecting on the end of life for Windows 7, we acknowledge that we have substantial progress to make in these next nine months. Our small and medium business segment has shown strength, indicating positive movement. Japan, in particular, is displaying traditional signs of a refresh, which is expected to finalize by the end of October. Additionally, a crucial factor delaying refresh decisions seems to be the emergence of AI PCs. We launched several Lunar Lake-based notebooks this January, and more are on the way, including AMD AI PCs. Customers will want to explore their options to future-proof their purchases, as these investments will last at least four years. All of this gives us increased confidence that the refresh is approaching, although it is taking longer than any prior instances in my career. Nevertheless, the data indicates that it is happening at a steady rate, likely extending into the future. Does that provide clarity?

Matt Niknam, Analyst

It did. Thanks.

Jeff Clarke, CEO

Thanks, Matt.

Operator, Operator

And the next question will come from Ananda Baruah with Loop Capital.

Ananda Baruah, Analyst

Good afternoon, everyone. I appreciate you taking my question. I have one main question with a couple of related points. Jeff, could you discuss how your team is approaching the durability of server refreshes? In the last call, you mentioned that part of the current driving force is that people are refreshing older PCs for space and power efficiency in preparation for GenAI, ahead of upcoming processor refreshes. I'm curious about the traditional server growth in this context. Additionally, you previously mentioned targeting an increase in the attachment rate for your GenAI servers. I would love to hear your thoughts on that and how you plan to manage that over time. That’s all from me. Thank you.

Jeff Clarke, CEO

Sure. Let me address the server aspect again. As I mentioned, we have experienced five consecutive quarters of year-over-year growth following an eight-quarter period of adjustment. Our guidance indicates that this trend will continue for another four quarters, resulting in nine total quarters of growth, albeit at a slightly moderated pace. This growth is still fueled by the same factors you've identified, such as freeing up floor space and enhancing energy and cooling efficiency. When considering the installed base, Dell has a significant number of 13G and 14G servers that are all set to be replaced by the new 16G and 17G servers. The conversion rates suggest that three to four older servers can be replaced by one 16G server, and six to seven older servers can be replaced by one 17G server. This is due to their greater number of cores, increased memory, expanded storage, and improved energy efficiency, and we believe this trend will persist into fiscal year '26 and calendar year '25. We haven't observed any signs of it diminishing during this timeframe. Regarding your other question, the fundamental principle is that AI requires data. It consumes data rapidly, so it needs to be processed near the computational capabilities. This leads to opportunities in hot and warm storage, parallel file systems, unstructured file systems, and data management tools that facilitate data discovery and ingestion. We offer a leading platform for unstructured data and continue to enhance it with the F910 and F710 models I mentioned earlier. Nearly a year ago, we introduced Project Lightning, a parallel file system we are developing. We are bringing to the market an AI-driven parallel file system, and our Dell data lake house assists customers in preparing, managing, and utilizing their data. Our sales force is incentivized to integrate storage with AI opportunities, and we expect to see ongoing progress in this area.

Ananda Baruah, Analyst

Okay, thanks.

Operator, Operator

And our next question will come from Samik Chatterjee with JPMorgan.

Samik Chatterjee, Analyst

Hi, hopefully you can hear me now. Jeff, I wanted to revisit some of your prepared remarks regarding the $15 billion in AI server revenue you mentioned that you expect to grow to that level. I'm curious about how much of that growth is influenced by supply constraints, especially in relation to the visibility into supply that you have. Additionally, how much of your commentary on anticipated growth relates to supply dynamics versus demand dynamics? Should we expect more consistent growth for the quarter considering the visibility on supply? Thank you.

Jeff Clarke, CEO

Hopper supply is available today, and Blackwell is in production and ramping up. We are open for business and taking orders. As of day 27 of the fiscal year, I want to communicate that we've reached at least $15 billion in AI shipments. Our pipeline over the next five quarters continues to grow, significantly surpassing our backlog. We will pursue every opportunity with cloud service providers and in the enterprise sector. Large-scale systems are expanding rapidly, and models are evolving into reasoning models that demand more computational power, which translates to needing more computers. The use cases for enterprises are becoming clearer, driving the return on investment they seek to utilize AI more broadly. Algorithm innovation is accelerating as well. These reasoning models will require even greater computational capacity and are transitioning to a multimodal approach, which will further increase demand. We remain optimistic and do not view supply as a constraint. The focus is on building the right architecture. There is a customer readiness aspect to consider, such as powering new data centers and ensuring proper cooling and water supply. We also need to manage other materials beyond GPUs, including racks, cold plates, CDUs, and PDUs, all of which we coordinate. We have a clear view that our projection is at least $15 billion, and we will provide updates as needed. We are fully committed to this effort. I hope that clarifies things.

Paul Frantz, Head of Investor Relations

Thanks a lot, Samik. Justin, we'll take one more question, please, and then we'll hand it over to Jeff for a close.

Operator, Operator

Our final question will come from Asiya Merchant with Citigroup.

Asiya Merchant, Analyst

Thank you for including me. Jeff, could you provide insights on your pipeline and backlog? Specifically, how has the involvement of enterprises and sovereigns changed compared to last quarter, and what are your expectations as you progress through your pipeline and backlog? Thank you.

Jeff Clarke, CEO

The five-quarter pipeline has consistently grown quarter-over-quarter since the launch of the 9680. We saw growth in the CSP component, the enterprise component, and the enterprise customer base across sectors such as education, technology, manufacturing, and government. Our AI buyer base continues to expand, following what we shipped in Q4. Revenue in Q4 increased, and we welcomed more new buyers, reaching over a couple of thousand unique customers. There is a healthy mix of enterprise and CSPs. The growth trend is strong, and we are excited about the current available technologies. I apologize, but I don’t recall the second part of your question; if you remind me, I will answer it.

Asiya Merchant, Analyst

No, that's good. And then just to the extent that you see your attach with those enterprises, how much of that is really factored into your fiscal '26 guide?

Jeff Clarke, CEO

To the best of our ability, we consider the inclusion of our services—our professional services, deployment services, installation services, as well as our capabilities in networking and network installation, and storage sales. This all contributes to the comprehensive figure of at least $15 billion in AI servers within the marketplace.

Paul Frantz, Head of Investor Relations

Asiya, thank you, and handing it over to Jeff for our close.

Jeff Clarke, CEO

Sure. Thanks, everybody. I hope you can tell FY '25 was a strong year. We delivered 8% revenue and 10% EPS growth with $3.9 billion in capital returned to shareholders. Our AI business grew to $10 billion while also improving ISG margins year-over-year. In FY '26, we expect to grow revenue and EPS in excess of our long-term value framework. We expect our AI business will grow to at least $15 billion given our robust opportunity pipeline, our engineering, our services and financing advantages. This AI business drives incremental operating profit and is EPS-accretive. We'll continue to modernize the company, reducing operating expenses as we grow, driving further leverage in the P&L. We remain committed to our capital allocation framework, where we've announced an 18% increase in our annual dividend, and our share repurchase authorization increased by $10 billion. We're excited for the year ahead. Thanks for your time today.

Operator, Operator

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