Earnings Call Transcript
Dell Technologies Inc. (DELL)
Earnings Call Transcript - DELL Q2 2021
Operator, Operator
Good afternoon, and welcome to the Fiscal Year 2021 Second Quarter Results conference call for Dell Technologies Inc. I want to inform all participants that this call is being recorded at the request of Dell Technologies. This broadcast is the copyrighted property of Dell Technologies, Inc., and any rebroadcast of this information in whole or part without prior written permission from Dell Technologies is prohibited. Now, I would like to turn the call over to Rob Williams, Head of Investor Relations. Mr. Williams, you may begin.
Rob Williams, Head of Investor Relations
Thanks, Holly, and thanks, everyone, for joining us. With me today are our Vice Chairman and COO, Jeff Clarke; our CFO, Tom Sweet; and our Treasurer, Tyler Johnson. Our press release, financial tables, web deck, prepared remarks and additional trials are available on our IR website. The guidance section will be covered on today's call. During this call, unless we indicate otherwise, all references to financial measures refer to non-GAAP financial measures, including non-GAAP revenue, gross margin, operating expenses, operating income, net income, earnings per share, EBITDA, adjusted EBITDA and adjusted free cash flow. A reconciliation of these measures to their most directly comparable GAAP measures can be found in our web deck and press release. Please also note that all growth percentages refer to year-over-year change unless otherwise specified, and that VMware historical segment results have been recast to include Pivotal results. Additionally, I'd like to remind you that all statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in our web deck and SEC reports. We assume no obligation to update our forward-looking statements. Finally, before I turn it over to Jeff, I want to address the amended 13D that we filed on July 15 disclosing that Dell Technologies is exploring potential alternatives with respect to its ownership interest in VMware, including a potential spin-off of its ownership interest to Dell Technologies stockholders or maintaining the status quo. We believe a spin-off could benefit both Dell Technologies and VMware stockholders by simplifying capital structure and corporate structure and enhancing strategic flexibility while still maintaining a mutual beneficial strategic and commercial partnership. With that said, we will not address the filing any further or take questions related to this topic. Now I'll turn it over to Jeff.
Jeff Clarke, Vice Chairman and COO
Thanks, Rob. We are finishing up day 171 working remotely at Dell Technologies, and the novelty of the new normal has worn off. Michael sent a note to our team members earlier this month that captures the situation quite well, and I quote, 'this is going to be a marathon, and it’s going to be uneven and frustrating at times.' What I can tell you, and what you will see in our results today, is that our team has continued to deliver in extraordinary ways in this unprecedented environment. I'd like to provide several examples of our team's resiliency, tenacity, and adaptability; the grit that is inherent in our Dell Technologies culture. These examples demonstrate why I remain so optimistic about the future of the Company and our ability to consistently deliver no matter the obstacle. We are still largely working from home. We’re not alone in this dimension as we will highlight in our Q2 results. We have moved beyond work as a location. COVID-19 has made one thing clear to us: work is something you do, an outcome, not a place or a time. And it takes teamwork and a culture that prioritizes outcomes and results over effort. Though we have team members juggling many challenges: parenting, caregiving, citizens and countries still grappling with surges of the pandemic, our employee engagement and productivity is at an all-time high. We are seeing a human transformation right before our eyes, emphasizing trust, empathy, patience, and flexibility that will serve society and business long after these tough times are over. While working from home and navigating a turbulent market, we continue to drive innovation in new and different ways. Over the course of nine weeks in Q2, we had nine product and solution launches, all while working remotely. We now have completed the modernization of the ISG portfolio, and the pipeline continues to fill with more innovative solutions and products to meet the needs of the new normal. We have not broken stride with customers. We may even be building deeper relationships than we were pre-COVID. Customer engagements have become more frequent, richer in content, while reaching a greater audience within accounts. Customers bring more decision-makers and technologists to executive briefings, and we respond with deep solution architecture and engineering to deliver better business outcomes. And right in the middle of this global pandemic, we paused to listen to our team members and society at large, given what happened three days before we were last together: the murder of George Floyd. What we heard through a series of listening sessions was consistent: our Black team members want better representation, equal opportunity, efficacy, and to see measurable progress against our Diversity & Inclusion 2030 goals. That's what we all want. And the work of real change within our now virtual walls is well underway. I share this as a backdrop for the differentiated results we will report today. Our results come from a real competitive set of advantage but also real cultural differentiation and resiliency. That is why I'm excited about our Q2 performance and optimistic about our long-term trajectory. What we know from our conversations with customers is technology has never been more important. Similar to what we saw in Q1, customers' top digital priorities are enabling learning and work from home and creating automation and agility across IT for consistency and resiliency of operations. While the pandemic didn’t start the remote learning and work trend, it is certainly accelerating it. Take the financial sector and its need to enable secure work-from-home solutions. A major bank in EMEA had to move 200,000 of their 280,000 employees to work from home. To give them the managed access to application and data they needed, we implemented a VDI solution based on VMware Horizon, VMware Cloud Foundation, VxRail, along with 200,000 VDI clients and 2,000 servers and end-to-end services, all from one partner, fully integrated, to help the bank get their employees up and running securely. After all of this investment to enable remote everything, we will never go back to the way things were before. Here at Dell, we expect, on an ongoing basis, that 60% of our workforce will stay remote or have a hybrid schedule where they work from home mostly and come into the office one or two days a week. And we are not alone. Recent data shows that work from home is likely to increase by 20 points across all sizes of companies across all sectors. I think that is understated. And it will take more technology to ensure productivity and collaboration from anywhere. In our 10 years as a connected workplace, we've learned that it's a combination of technology, the right tools for workforce enablement, and culture. And we are sharing these best practices with our customers as they embark on this journey, a journey that will be transformational for customers and, as the only player to be able to bring real solutions that connect the edge, core, and cloud, will benefit Dell Technologies. Also showing up in our performance is demand for simpler, more agile IT across multiple clouds. Companies rush towards the flexibility and ease of public cloud but are now looking to hybrid cloud for a longer-term answer. Essentially, customers want a new operating model, one that consistently delivers the best of all clouds: private, public, and edge. One large hospital system is a great illustration. This customer wanted to modernize their environment to better support electronic medical record and imaging needs. They were happy with their public cloud implementation but needed seamless integration with their storage solutions to pull down data from the public cloud quickly and affordably. We delivered PowerMax and PowerScale in a managed service facility connected to their public cloud, allowing them to better manage and control their data. Because the storage is directly and securely connected to the public cloud at the source, data costs are reduced and latency issues are nearly eliminated. This is a great example of how we're building our entire portfolio for customers' cloud needs, with outcome-based decision-making top of mind. Similar to cloud, customers also want to consume more technology as a service, letting them pay for only what they use and to move fixed costs to variable costs, which is critically important right now given the environment. We continue to offer Dell Technologies Cloud on the most broad infrastructure portfolio with the new Dell EMC PowerScale Storage systems and Dell EMC Ready Solutions on VMware Cloud Foundation. Customers are finding immense value in Dell Technologies On Demand flexible consumption models. Customer demand for these models prompted us to expand our offerings to include Brazil, Chile, Colombia, India, and China. That is why we are doubling down on both Dell Technologies Cloud and Dell Technologies On Demand. Now let's move to our second quarter results. Despite a dramatic deceleration in U.S. GDP during the second calendar quarter of the year, our team stayed focused on the customer and delivered. Overall, we had a solid quarter relative to the macro environment with revenues of $22.8 billion, down 3%, and operating income of $2.6 billion or 11.5% of revenue. Our Client Solutions Group delivered revenue of $11.2 billion, down 5%. In our consumer business, we outperformed, fueled by another outstanding quarter from our consumer direct business that was up 56% based on orders. And our consumer direct online business was up 79% based on orders. We saw strong double-digit growth across all consumer notebooks and gaming systems driven by our premium XPS and Alienware brands, which were up 25% on an orders basis. Overall, notebook momentum continues with orders up 8% driven primarily by growth in consumer and commercial notebook needs at home and for remote work and learning. Infrastructure Solutions revenue was $8.2 billion, down 5%. We saw double-digit orders growth for data protection and VxRail in the second fiscal quarter and mid-single-digit orders growth for high-end storage. These are all sectors where we hold the #1 share position by a large margin and continue to have an opportunity for growth. And while it's a little early to comment on PowerStore performance, we continue to hear positive feedback and feel confident that the pipeline will drive profitable share gains, specifically in the mid-range segment this year. Our VMware business segment had another strong quarter, delivering $2.9 billion of revenue, up 10%. In addition to the depth and breadth of our portfolio, a big driver of our differentiated performance is our distinctive direct and channel coverage model of the entire IT market. In the second quarter, demand from government stayed strong, while education demand ramped, with orders up double digits for both verticals. Small and medium business demand improved through the second quarter as businesses opened back up once government restrictions were lifted. Take these results and combine them with the demand that we saw from large enterprises, health care, and the financial sector in Q1, and our first half was strong. We delivered $44.7 billion of revenue, $4.8 billion of operating income, and $5.7 billion of adjusted EBITDA. We made the appropriate tough decisions around our cost environment in the first half to limit spending and to protect liquidity given the uncertainty of the demand environment. Our track record of consistent profitable growth, share gains, innovation, and financial returns reinforces our strategy is working and doesn't change even amidst the uncertainty. We are focused on winning the consolidation in our core markets, innovating and integrating across Dell Technologies to create the next generation of infrastructure, and to do both while strengthening our distinct advantages as a company: our go-to-market capabilities and global services footprint, our supply chain, our product breadth and integration, our financing, and the strategic work we do with VMware. Over the last three fiscal years alone, CSG and ISG have delivered a combined $230 billion in revenue and $18 billion in operating income. Over the last three calendar years, we have gained 330 basis points of share in commercial client, 510 basis points of share in mainstream servers, and 120 basis points of share in mid-range storage. We have the right portfolio and the go-to-market plans in place, and the teams are focused on driving relative share. Back to why I'm so optimistic. The long-term trends in our business are favorable, and our sources of advantage are real. Though there is a high degree of uncertainty right now, our strategic position and the secular technology trends create long-term growth opportunities for us. We've been talking about the fourth industrial revolution for a while, and now the pandemic has accelerated its arrival. Organizations have had to pivot quickly. First, to work from home and learn from home, and now businesses are taking this opportunity to reinvent their models for a more connected, digital, automated, data-intensive, and distributed future. A future that is hybrid, the re-imagination of work as an outcome, not a place, reinforces the value of hybrid cloud and positions hybrid as the optimal cloud model to meet the new demands of a fluctuating world, essentially creating a hybrid cloud for a hybrid workforce, utilizing cloud as the modern IT foundation to deliver consistent experiences and economics across many places workloads, and people, reside. Dell is uniquely positioned to deliver on this hybrid reality, public cloud, sure, but also real growth and resiliency in private clouds and on-premise infrastructure. We have a history of investing in new businesses and technology solutions that layer into our portfolio and spur growth. Emerging technologies around widespread connectivity with 5G, data-driven insights at the edge, and expanding workloads in a hybrid cloud future will each create opportunities for long-term growth and value creations at Dell Technologies. Increasingly, customers are turning to Dell Technologies to shape this digital future. Given the unique advantages we've talked about, combining these advantages with our purpose-driven culture and track record of consistently growing our core businesses while investing in the long-term future, I like our hand. Now I'll turn it over to Tom for a look at our financials.
Tom Sweet, CFO
Thanks, Jeff. Overall, we were pleased with our performance, especially given the current environment. Despite the pandemic and economic headwinds, we're executing on our strategy in driving long-term value creation for Dell Technologies and our stakeholders. We're delivering relative growth and winning in the consolidation. We're creating differentiated Dell Technologies solutions through innovation and integration, and we're generating strong cash flow, enabling us to delever and create value for shareholders. Revenue for the second quarter was $22.8 billion, down 3% year-over-year. FX continued to be a headwind, particularly in Brazil, India, and China, impacting our growth rate by approximately 150 basis points. Revenue was up 4% sequentially, which was below our historical Q2 seasonal revenue range but was in line with our expectations as we discussed on our Q1 earnings call. Gross margin was $7.6 billion or 33.5% of revenue. Like Jeff said, we saw demand growth in education, state and local government, and consumer during Q2, which impacted gross margin given these customer verticals tend to deliver less margin dollars. The majority of cost actions taken in the first quarter remain in place and helped drive operating expenses down 4% year-over-year and down 3% sequentially to $5 billion. Some of these cost benefits are shorter-term reductions that will phase out over time. For example, we saw lower employee benefit claims during the government shelter-in-place periods, lower facilities-related costs, and reduced advertising and promotional spending in certain verticals. We believe some of these cost benefits will normalize as we move through the remainder of the year as we prepare sites to bring team members back to the office and benefit utilization normalizes. Operating income was $2.6 billion or 11.5% of revenue. While down 5%, operating income was up 21% sequentially driven primarily by the strong operating expense controls and business unit mix dynamics. Consolidated net income was $1.6 billion, down 7%. EPS was $1.92, down 11% year-over-year but up 43% sequentially. Adjusted EBITDA was $3.1 billion, down 2% at 13.6% of revenue. For the trailing 12 months, adjusted EBITDA was $11.8 billion. Total deferred revenue was $28.8 billion, up 14% year-over-year. Our recurring revenue, which includes deferred revenue amortization, utility, and as-a-service models is now approximately $6 billion a quarter, up 15%. As Jeff mentioned, we will continue to focus on providing as-a-service solutions for our customers across our portfolio, giving them more flexibility in cloud-like economics. Shifting to our business unit results. Client Solutions Group delivered revenue of $11.2 billion, down 5%. Demand for remote work and learning solutions from our education, government, and consumer customers drove strong consumer client and notebook performance. Consumer revenue was $3.2 billion, up 18% driven by the strong double-digit growth across all of our consumer notebooks and gaming systems. Our focus on premium consumer products is paying off. Our XPS and Alienware product lines saw combined orders growth of 25%. And as expected, commercial client was more challenged in Q2 with revenue of $8 billion, down 11% as double-digit growth in Latitude notebooks and commercial Chromebooks was offset by reduced demand in commercial desktops. CSG operating income was $715 million or 6.4% of revenue. CSG profitability was down from Q2 record levels last year, primarily due to a less deflationary component cost environment compared to a year ago, but we are pleased with the improved operating margin profile versus Q1. We continue to be very pleased with our Client Solutions Group performance. It is a stable business that consistently delivers strong cash flow and provides scale, helping us weather the different cycles year in and year out. ISG revenue was $8.2 billion, down 5%. Storage revenue was $4 billion, down 4% year-over-year but up 5% sequentially, and a bright spot given the macro environment. The strong demand for VxRail continued with double-digit orders growth again this quarter. Other storage highlights included triple-digit orders growth in our high-end PowerMax solution and double-digit orders growth in Data Protection. We saw softness in other areas of core storage, including mid-range. We continue to build pipeline for PowerStore and are pleased with the customer receptivity. We expect it to ramp through the second half of this year and heading into fiscal year '22. Servers and networking revenue was $4.2 billion, down 5% year-over-year but up 12% sequentially. Overall, servers were still challenged with some improvement in orders for mainstream servers. Our high-value servers built for artificial intelligence and machine learning workloads saw mid-single digit orders growth, though this is still a small piece of the overall server revenue mix. ISG operating income was $973 million or 11.9% of revenue, which was down 30 basis points, primarily due to lower server profitability as component costs were higher compared to Q2 of last year. Given the dynamics in the macro environment, the ISG results have been softer than we expected coming into this year. However, it is a critical component of our portfolio and one that we expect to improve as the overall economy and IT spending rebound. Over the last five fiscal years, we have grown this business organically and inorganically by more than $18 billion and is now on a greater than $30 billion run rate. It delivers excellent profitability and gives us a seat at the table during all of our customers' most critical IT infrastructure decisions. The VMware business unit had another strong quarter, delivering revenue of $2.9 billion, up 10%, and operating income of $894 million or 30.7% of revenue. Based on VMware's stand-alone results, subscription and as-a-service revenue grew 44% and comprised 22% of total revenue. The largest revenue contributors included the VMware Cloud Provider Program, Modern Applications, End User Computing, and Carbon Black. VMware Cloud on AWS once again had a triple-digit revenue growth rate. Before I move to the capital structure, I want to highlight Dell Financial Services, which continued its growth trajectory and had an outstanding second quarter. DFS originations were up 31% to $2.6 billion driven by strong VMware and EMEA performance. The introduction of the DFS Payment Flexibility Program in April has been very well received across all lines of business and customer segments. Earlier this month, we extended the program through the end of October with payment deferrals until 2021 as we continue to work together with our customers and partners to enable their businesses through these challenging times. Turning to the cash flow generation and our balance sheet. We generated cash flow from operations of approximately $3.3 billion driven by strong profitability and improved working capital dynamics as some of the COVID-19-related impacts on collections and inventory partially normalized. Adjusted free cash flow in Q2 was $3.6 billion, and on a trailing 12-month basis, adjusted free cash flow was $7.8 billion. Our liquidity position is strong, and we are comfortable with our capital structure. We ended the quarter with $12.3 billion of cash and investments and $5.9 billion of undrawn revolver capacity. From a debt perspective, we paid down approximately $3.5 billion of total debt during the second quarter, including $2.2 billion of core debt and $1.25 billion of VMware debt. Our total debt balance ended the quarter at $54.5 billion. This includes DFS-related debt of $10 billion and subsidiary debt of $6.3 billion in addition to our core debt and margin loan. Our core debt ended the quarter at $34.1 billion. Over the last four years since the EMC transaction closed, our core debt has been reduced by nearly $15 billion, demonstrating our commitment to pay down debt. While the total debt balance has decreased by a lesser amount over that period, this is primarily due to the debt added by VMware to support its own strategic initiatives and debt we have added specifically to fund DFS growth as customers increasingly value the payment flexibility that our financing solutions offer. As a reminder, a majority of the DFS debt is secured by financing receivables and is serviced by the cash flow generation from these receivables. Delevering continues to be the priority for our capital allocation, and we are committed to achieving investment-grade ratings. Our intent remains to reduce core debt by approximately $5.5 billion in fiscal year '21, which would be incremental to the $2.3 billion we've already paid year-to-date. Let me provide a few comments on the rest of the year. As you know, we withdrew our fiscal year '21 guidance during the first quarter. There continues to be a high degree of uncertainty for the remainder of this year. The latest global GDP and industry data indicates continuing, but moderating, declines for the second half of the year. Similar to Q2, we expect Q3 revenue to be seasonally lower than prior years, which has typically been flat to down 2% sequentially. As a reminder, we are currently on track to close the RSA transaction in early September. Historically, RSA contributed roughly $800 million in annual revenue, and approximately $200 million of operating income with similar back-end loaded seasonal trends to ISG. Turning to operating income. There are a few items that need to be considered. We saw component inflation in the second quarter and anticipate inflation again in Q3. We are seeing DRAM and SSD prices potentially softening as we move through the second half, with the benefit from this not showing up until later in the year. In addition, normal sequentials point toward a higher mix of consumer PCs in Q3, and recent IDC forecasts reflect a higher mix towards consumer PC and Chromebook units in Q3. Considering these items, along with the lower revenue sequentially, general macro challenges and VMware operating income expectations, we expect our operating margins to be lower sequentially. We are proud of our operating heritage. We will continue to manage the business, driving above-market performance. We are focused on what we can control while navigating through the macro, adjusting for the dynamic cost and currency environments while also balancing appropriate cost actions with necessary investments. In closing, we are winning the consolidation, and we're executing on our long-term drivers of value creation for Dell Technologies and our core markets. We are taking the appropriate corporate structure steps to optimize value, simplify, and align our focus areas as evidenced by the VMware merger with Pivotal, ongoing simplification of operations, the announced divestiture of RSA, and the exploration of alternatives with VMware. We will continue to create differentiated Dell Technologies solutions through innovation and integration across the entire family. Our goal is to create long-term value for all aligned shareholders by outgrowing our competitors, growing EPS faster than revenue and generating strong cash flow over time. And, as we continue to delever and get back to investment grade, we will look for other opportunities to return capital to shareholders. With that, I'll turn it back to Rob to begin Q&A.
Rob Williams, Head of Investor Relations
Thanks, Tom. Let's get to Q&A. We ask that each participant ask one question to allow us to get us to as many of you as possible. Holly, can you introduce the first question?
Operator, Operator
We'll take our first question from Katy Huberty with Morgan Stanley.
Kathy Huberty, Analyst
Last November, you guided to an operating margin this year that would be roughly in line with fiscal '19. But just looking at the first half of the year, you're tracking about 100 basis points above that level. So is that still a fair target? And how do you see the operating margin playing out for the next couple of quarters?
Tom Sweet, CFO
Thank you for the question, Katy. This is Tom. As we reflect on the first half of the year, we are generally satisfied with the organization's operating performance given the macro conditions. Much of this success is attributed to our cost management strategies, including cuts to travel and expenses, a hiring freeze, and other cost-saving measures. As we reach the midpoint of the year and look ahead to the second half, I want to remind you of some dynamics mentioned in my guidance. Typically, Q2 and Q4 are our stronger quarters, while Q1 and Q3 tend to be softer. In Q3, we expect to see shifts in demand and our client mix, particularly as we move toward the holiday season. This year, we will also factor in more educational and Chromebook sales, which could impact our margins. Additionally, with the planned divestiture of RSA in early September, we will see a decrease in operating income and revenue. Therefore, we anticipate potential downward pressure on operating margins in the latter half of the year, but we will monitor the situation closely. A key factor will be how the mix dynamics and component costs develop, which we believe will remain inflationary in Q3. The first half has been solid, and we will see how the second half evolves.
Kathy Huberty, Analyst
Tom, is it still realistic, though, that you could see a sub-10% margin for the year like in fiscal '19?
Tom Sweet, CFO
I don't think it reaches that level.
Operator, Operator
We'll take our next question from Simon Leopold with Raymond James.
Victor Chiu, Analyst
This is Victor Chiu in for Simon Leopold. Can you provide us with some color around the performance verticals maybe where you saw better demand in the quarter? I just kind of want to get a sense for the pieces, the puts and takes that surprised you relative to your expectations.
Tom Sweet, CFO
Yes. Let me share some general observations and then Jeff can discuss the dynamics of the business units we experienced. I want to remind you that in our Q1 call, we pointed out the seasonal pattern we observed, showing strong performance in February and March, particularly with a spike in March driven by the work-from-home trend as businesses and educational institutions adapted. However, as we mentioned earlier, we noticed a decline in demand in April, which continued into May, making May quite weak in terms of demand. June started to show signs of recovery, and by late June into July, we saw week-over-week improvement in demand, although it remained negative as we finished the quarter. There are various dynamics at play regarding how each business unit performed throughout the quarter. Now, I'll turn it over to Jeff, who can provide insights into what we saw in the ISG and PC segments.
Jeff Clarke, Vice Chairman and COO
Yes, I'm glad to elaborate, Victor. Building on Tom's comments, we clearly observed several trends from a vertical perspective. Education and government sectors experienced double-digit growth. Additionally, as Tom pointed out, we noticed improvements throughout the quarter, particularly in the SB and NB sectors, which showed week-over-week gains from early June to the end of the quarter. While these figures are still below typical seasonal levels, they did show progress from the start of the quarter. The largest transformation in the market continues as businesses invest in digital transformation and advance their digital initiatives. From a product standpoint, as Tom indicated, the trends of learning from home and working from home persisted throughout the quarter, especially towards the end, when many countries prepared for students to return to school, often in an online learning environment. We observed a shift among many institutional customers in the public sector historically using desktop or PC assets, as they transitioned to purchasing more notebooks during the quarter. Finally, on the ISG side, we saw strong demand for our data protection solutions, high-end storage offerings, and VxRail products. Both Data Protection and VxRail exhibited double-digit growth in orders for the quarter, and we experienced good demand for high-end storage, which grew in the single digits. I hope this information was helpful.
Operator, Operator
We'll take our next question from Matt Cabral with Crédit Suisse.
Matt Cabral, Analyst
On ISG, I was wondering if you can talk a little bit more about what pricing dynamics looked like across both storage and servers in the quarter. And just if you can comment on if you've any changes in the wider competitive environment as the demand environment has gotten a little more difficult.
Jeff Clarke, Vice Chairman and COO
I believe, Matt, that when we examine the server market, we maintained our discipline throughout the quarter, just as we did in Q1. The marketplace showed aggressive pricing for server deals, but we are not pursuing market share aggressively, as we don't think that's beneficial for our business. Our focus is on being disciplined and achieving profitable growth. The pressures we're experiencing in the ISG sector are largely driven by macroeconomic factors. The overall demand for ISG, including both storage and servers, has changed from our initial expectations at the beginning of the year. We've noticed customers delaying their investments, sometimes opting to maximize their current infrastructure during the first half of the year to adapt to the pandemic. However, the largest customers, which we consider digital leaders, continue to invest in their infrastructure and ongoing digital transformation initiatives. These major companies are still showing strong demand for servers and storage products. Looking ahead to the second half of the year, IDC has indicated that the external storage and mainstream server markets are facing increased pressure, adjusting their forecasts downwards by about 600 basis points. We believe we can navigate these challenges for the rest of the year and see potential for growth in both the server and external storage markets next year, with server forecasts indicating approximately 7% growth. We believe our portfolio is well-positioned to capitalize on this growth rebound. There are significant cross-selling opportunities within our customer base—our storage customers purchasing servers and vice versa. The potential in high-value workloads within the server market remains largely untapped for us, and while we've made some progress this quarter, there's still ample opportunity. Additionally, we see emerging prospects as the telecommunications industry moves toward standardizing on an open platform, which will enhance edge and data-intensive workloads. The ongoing shift to hybrid and private cloud solutions that we've observed over the past six quarters is likely to persist, making hybrid cloud the standard moving forward. I hope that provides clarity.
Operator, Operator
We'll take our next question from Toni Sacconaghi with Bernstein.
Toni Sacconaghi, Analyst
I would like to hear your thoughts on the demand reflected in your guidance. You mentioned that growth rates have been sequentially improving over the weeks, yet you're forecasting below-normal sequential growth for fiscal Q3. Most companies aren't experiencing this; most are projecting inline or better-than-normal sequential growth, unless they have some unique backlog relief or higher revenues in Q2 due to backlog, which doesn't seem to apply to Dell. Additionally, last quarter you appeared more optimistic about the ISG business, but now you seem more cautious. It seems that server growth in Q1 and Q2 was below seasonal averages, despite what appears to be an aggressive approach to financing. Can you address whether you have become more negative regarding the ISG business compared to three months ago? Why are you not forecasting at least sequential growth if weekly order patterns are improving? And why was there below-normal sequential server growth from Q1 to Q2 despite the increased financial promotions evident in the financing rise during the quarter and your comments on sequential improvement?
Tom Sweet, CFO
Toni, it's Tom. Let me give some context. Typically, we see growth from Q1 to Q2, as Q2 has historically been a strong season for education and state and local government purchases. Transitioning from Q2 to Q3 has usually shown a decline for us. After a strong Q2, we notice changes in the CSG business, with consumer spending increasing, which typically has a lower average selling price, followed by an uptick in Q4. This year, based on what we know so far, we observed improved demand entering July during Q2. However, the dynamics often shift in the next quarter as buying patterns change. Therefore, we are being cautiously optimistic about demand in Q3, considering the overall macro environment and our historical trends, which we anticipate may be a bit weaker. Specifically looking at the ISG segment, we usually experience a drop from Q2 to Q3. The three-year average decline is around 2% to 3% sequentially for ISG, and we must remember that RSA is part of this segment. Additionally, the IDC forecast for Q3 indicates a decrease of 12% for mainstream server revenue, excluding China, and a 10% drop in external storage revenue. Given these patterns and the current market conditions, we want to approach the quarter with careful consideration. We will push forward appropriately, but we believe the perspective we are sharing aligns with our observations. Jeff, do you have anything to add?
Jeff Clarke, Vice Chairman and COO
I would like to add that the market has more challenges in the second half compared to what ISG indicated 90 days ago. The latest forecasts have become more pessimistic regarding both external storage and servers. We will continue to operate and perform at a premium regardless of market outcomes, but the outlook has certainly worsened as we consider the uncertainty Tom mentioned for the second half. We will focus on our growth initiatives, including our marketing efforts and the Power Up program I referenced in our last earnings call. We will keep working to expand our customer base and concentrate on cross-selling opportunities across our portfolio. We aim to ramp up our PowerStore product, which has just entered the market and is performing well. However, we are confronting market conditions that are significantly different from those we faced 90 days ago.
Toni Sacconaghi, Analyst
Jeff, I want to follow up on your comments. I understand that IT budgets have likely been cut, as reflected in various CIO surveys. You mentioned a sequential decline that would be greater than usual, which seems inconsistent with the improvement in your order rate towards the end of the quarter. Is there anything in August that has made you more concerned? Aside from RSA, are there any other fundamental competitive issues that might suggest we shouldn't expect the order improvement seen throughout the quarter? I want to ensure we are fully aware of the situation.
Jeff Clarke, Vice Chairman and COO
Let's make sure, I think what Tom referenced, it was an overall number. And the one that we haven't talked about that has some headwind is the PC business. And we see a fundamental mix. While we're seeing an incremental increase in unit demand based on the learn-from-home and the continued work-from-home phenomena that's been underway, that is largely education-driven, that is largely lower-end ASPs that are associated with it. And I believe that's some of what Tom is referring to when we look at normal seasonal patterns. This is different. So if you look at the opportunity in the PC marketplace and where the growth is, it is heading towards the lower-end ASPs on that side of the marketplace. Does that help?
Operator, Operator
We'll take our next question from Wamsi Mohan with Bank of America.
Wamsi Mohan, Analyst
Just a follow-up on those PC comments. Your PC competitor just called out CPU and panel constraints. Is there an element on the below seasonal from a commodity procurement and supply chain perspective, too? Or is that not an issue for you guys? And I have a follow-up, if I could.
Jeff Clarke, Vice Chairman and COO
There are a couple of things to consider. Recently, IDC revised its forecast for the current quarter by 20 points, which is an unprecedented shift I've seen in my experience within a 6-week timeframe. This indicates unexpected demand driven by remote learning and one-to-one education initiatives. As I mentioned earlier regarding the public sector, more employees working from home require notebooks, and this demand was not anticipated. The industry's ability to predict this would have needed to occur several months ago, especially considering the lead times for silicon and LCDs. Looking at our product portfolio, we offer a wide range of options with standard lead times. However, in the growth areas like Chromebooks with 11.6-inch screens and education notebooks with 14-inch and 15-inch TN screens, there are supply constraints related to LCDs, particularly with glass and the necessary drivers, and there is also a shortage of low core count CPUs to meet this demand. I am confident that we will overcome these challenges in a timely manner, and our supply chain is actively responding. We are improving our product service lead times every day. This unanticipated surge in demand in this specific sub-segment has led to industry-wide shortages, and we are addressing it.
Wamsi Mohan, Analyst
Okay, that's helpful. I was wondering if you could share some insight on how investors should consider the timing for achieving investment grade. Before your announcement regarding the alternatives with VMware, there were initial expectations about this timing. With this new information, can you clarify if it alters the timeline for reaching investment grade or how investors should approach that?
Tyler Johnson, Treasurer
Wamsi, it's Tyler. I think we've discussed that we are in a different environment right now. I'm really pleased with our ongoing debt reduction efforts. We're committed to paying down $5.5 billion this year, and a portion of that will likely focus on the debt maturing next year. I'm confident in our capital structure and the decreasing debt levels. My discussions with the rating agencies have been positive, although they are considering the broader macroeconomic situation, which may affect their decisions. We're making the right strides, and I appreciate the direction we are headed in. We'll see how the remainder of the year unfolds, but I believe we are on track.
Tom Sweet, CFO
Tyler, we are currently at $34.1 billion in core, and I believe we've done well. In terms of capital allocation, there's been no change; our primary focus is on debt repayment. This will remain our strategy until we restore our capital structure to an investment-grade level. The timing of this will depend on the rating agencies, who look not only at our standalone performance but also the broader macroeconomic conditions and their overall perspective. We will stay focused on this.
Operator, Operator
We'll take our next question from Shannon Cross with Cross Research.
Shannon Cross, Analyst
Jeff, I'm interested in how the post-pandemic work environment is influencing your strategic focus, both for Dell and your customers. I'm curious about how this might change your investment priorities. Some have suggested that up to 50% of people may not return to the office, which seems quite aggressive. As you look a couple of years ahead, how is this shifting your approach?
Jeff Clarke, Vice Chairman and COO
Thanks for the question, Shannon. It's an interesting dynamic we're observing right now. Looking at Dell, I believe I mentioned in our prepared remarks that we've been evolving into a connected workplace for nearly 12 years. We envision a future where over 60 percent of our professional workforce will operate in a remote or hybrid environment, where visiting the office one or two days defines a hybrid workplace. This workplace will transform significantly. Instead of fixed workspaces, we anticipate a more collaborative and open environment that fosters teamwork, which we see as essential for the future of work. We believe there will be a 20- to 30-point increase in remote and hybrid work environments across all company types, sectors, and geographies. An interesting aspect is how the PC industry will adapt through what we've termed the three phases: do it light, do it right, and then innovate for a modern PC experience. Currently, we are still largely in the "do it light" phase, addressing sectors that have traditionally lagged in mobile adoption, such as public services and education, by providing them with computing resources to enable remote work and online activities. We will progress to a phase where "doing it right" becomes crucial, leading to significant innovation across our comprehensive portfolio. Elements like unified workspace will play a key role, allowing us to manage the lifecycle of devices, provision PCs via our cloud, conduct app and patch updates remotely, and perform proactive service calls. This will enhance the productivity of the devices in our customers' hands. It's clear that the PC continues to be the primary productivity device and is becoming essential for online education, which is promising for our industry. We need to adapt to the changes and determine what types of products are suitable for each user segment, and we are excited about the long-term innovation as we modernize the PC experience, potentially treating it as more of an as-a-service offering in the future. Does that help?
Operator, Operator
We'll now take our final question from Rod Hall with Goldman Sachs.
Rod Hall, Analyst
I wanted to revisit your comment about the mid-range weakness, Jeff, and connect it with PowerStore. Firstly, is this mainly due to the weakness among SMEs that many companies have been experiencing? Secondly, regarding PowerStore, are you noticing that it takes longer for people to test the product? Is there anything you are doing in the short term concerning pricing or the offering of other products to assist customers while they evaluate PowerStore in this challenging environment?
Jeff Clarke, Vice Chairman and COO
Sure. Let me start with a couple of thoughts because I love the question. One is, I think it's important to note we've completed the journey that I've spoken to you all over the past handful of years now of modernizing our ISG portfolio. The entire ISG portfolio now is powered up in our definition. If you think about the last three products of those nine products that we launched over the quarter, PowerStore, PowerScale, PowerFlex are all on the marketplace around the rest of the portfolio. Next week is an interesting time for us because the world's largest sales force is going through their annual technical training and will be clearly amped up on our new portfolio and its competitiveness across each and every sector that we participate in. Specifically with PowerStore, what we have done is we're doing more demos, more virtual demos. Clearly, this virtual world has made it a little more difficult, but it's a long selling cycle to begin with. We always thought about our PowerStore ramp in the second half of the year converting the pipeline that I talked about last time. If I was to reflect on what's happened in Q2, I would tell you, we're very happy with the early traction we've had with PowerStore. At less than a quarter of shipping, we have already acquired hundreds of new customers, 20% of them are new to Dell. 20% of our PowerStore customers are new to Dell. What's probably the more compelling from my point of view is we're seeing a strong correlation with our competitive swaps that are up 32% quarter-over-quarter. And we've seen 2x the level of competitive displacement revenue than the previous quarter since the launch of PowerStore. I think about the largest storage sales force on the planet, their expectations are high. They're enthusiastic about the product. Our expectations haven't changed at all about PowerStore. That sales force is out generating hundreds of new opportunities a week. We're doing many virtual demos every week on top of the pipeline that we referenced last time. So we absolutely believe we have a winner here. Our expectations haven't changed. Yes, we're dealing with a COVID environment that takes a little longer to do some of the evals, some of the certifications. But our team is being creative, helping customers do that. And then your last question about pricing, we didn't change our pricing on PowerStore. We went into the marketplace, and we priced PowerStore against the competition at the same level on an effective gigabyte. So in my mind, we’ve put a better product potentially in the hands of the market at the same price as our competitors on an effective gigabyte. I think that's a win in our hand.
Rob Williams, Head of Investor Relations
Thanks, Rob. And thanks, Jeff. All right. That's a wrap on Q&A. We'll see many of you virtually at the Citi Global Technology Conference on Tuesday, September 8. So thanks for joining.
Operator, Operator
This concludes today's conference call. We appreciate your participation. You may now disconnect at this time.