Earnings Call Transcript - DELL Q2 2022

Operator, Operator

Thanks, Jermiria, and thanks everyone for joining us. With me today are Jeff Clarke, Chuck Whitten, Tom Sweet, and Tyler Johnson. Our press release, financial tables, webdeck, prepared remarks and additional materials are available on our IR website. The guidance section will be covered on today’s call. During this call, unless we otherwise indicate, 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 webdeck and press release. Also note that all growth percentages refer to year-over-year change unless otherwise specified. 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 webdeck 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, Rob. Hi, everyone. Thanks for joining us today. We’ve made it through the first half of the year, and in this incredibly unpredictable environment, we delivered our best second quarter ever. That’s because whether we are reopening or reclosing, eating in restaurants or ordering out, returning to the office or staying at home, the one constant has been an unprecedented demand for technology. Another constant is our ability to execute against our stated strategy and deliver consistent performance, no matter the market dynamics. In the last week of June, we released an investor presentation where we outlined our differentiated strategy to drive growth and value-creation post the spin-off of VMware. As we’ve engaged with investors, there are a number of key points I want to reiterate today from that presentation. These can also be found on slide 4 of today’s earnings webdeck. First, we have leadership positions in large, stable and expanding markets with strong underlying fundamentals. Q2 was an exceptional example of how we leveraged our leadership positions to seize the opportunities in these growing markets. In Q2, we set a second quarter record with revenue up 15% to $26.1 billion, and record second quarter EPS of $2.24, up 17%. We have talked previously about our ability to quickly pivot the business where the demand is strongest and that was evident in these results. The need for better technology connectivity and productivity in the new 'Do-Anything-From-Anywhere' economy has driven strong IT spending across multiple industries and customer sizes, from large enterprises to medium businesses to small business and consumers. And we’re leaning in to capture our share of the strong IT spending. Our Client Solutions Group delivered record revenue of $14.3 billion, up 27% as we leaned into commercial, along with solutions in the broader client ecosystem, including Software & Peripherals, where we are number 1 in displays and we believe we gained more than 100 basis points of share in calendar Q2. There are positive secular trends at play in client, especially in the areas we are most focused, notably the commercial market, premium price bands and gaming that should enable stable growth over the next few years. The Infrastructure Solutions Group continued growth with revenue up 3%, to $8.4 billion, primarily driven by growth in servers and networking as customers modernize their IT infrastructure to enable data-driven AI and Machine Learning technologies. We were also encouraged by the strengthening of storage during the quarter and the overall demand for hyperconverged infrastructure and midrange storage. Tom will dive into more of the financial details of Q2 in just a moment. The second point is that we have durable competitive advantages that uniquely position us to win in our core and adjacent markets. A few I would call out that drove our Q2 performance. We have built an end-to-end innovation engine that delivers engineered solutions and software enhancements, based on our unparalleled market reach and ability to see across a customer’s full set of IT needs. These include management and orchestration, embedded intelligence, automation, predictive analytics, proactive support, telemetry and intrinsic security. A key example is PowerStore, our microservices-based midrange storage solution, which is ramping faster than any new architecture we’ve released with double-digit increases in net new storage buyers for both Q1 and Q2. We are utilizing our industry-leading scale and differentiated supply chain to successfully navigate through the operational challenges caused by the unprecedented demand that is way ahead of supply right now. Despite industry supply shortages, we shipped a record number of PCs and displays in the second quarter. The third important point is that we’re driving a differentiated strategy to seize the tremendous growth potential ahead. We are focused on winning the consolidation and modernizing our core businesses by driving ongoing share gains and improving margins through scale, engineering innovation and product mix shift. We are the clear number one in external storage, number one in hyperconverged infrastructure, number one in mainstream servers, number one in data protection appliances, and our client solutions business is number one in revenue. We have demonstrated the ability to adapt to the market dynamics over time, as evidenced by our commercial client share gains in 30 of the last 34 quarters and we have gained more than 700 basis points of share over that period. Additionally, we have gained more than 700 basis points of share for mainstream servers and approximately 200 basis points of share for external storage over the last five years, as of calendar Q1 2021 according to IDC data. We are focused on the midrange segment of storage and are pleased with the momentum we are seeing, but we know we still have work to do. When server and storage calendar Q2 share data is released in September, we expect share gains in both markets. We are also prioritizing customer outcomes and modernizing our business model with APEX, which provides an incremental growth opportunity as we introduce more as-a-service solutions and gain traction with current offers. For example, in July we announced GE is using APEX Data Center Utility, to blend automation and software architecture to support its increasing workloads from traditional IT applications to data analytics. With APEX, GE can scale up or down its data center, storage and compute resources on demand as the company executes an approach that adapts to each business unit’s strategy. We are innovating, integrating and partnering to create the technology ecosystem of the future for our customers, with our unique partnership with VMware as the centerpiece. We continue to drive new product innovation and business opportunities with VMware. For instance, in Q2 we launched new VxRail systems with the latest PowerEdge servers and new software advancements that deliver faster performance, as well as simplified deployment and management. Additionally, we introduced VxRail dynamic nodes that expand how customers can use existing Dell Technologies storage resources to support new multi-cloud workloads. VxRail continues to be an area of growth in one of the fastest growing segments in storage, with orders up 34% in Q2. We are also pursuing adjacent, high-value growth opportunities where we are uniquely positioned to win, areas like multi-cloud, edge, telecom, data management that open up adjacent, multi-billion dollar markets. We are investing in these opportunities and expect meaningful contributions from them in years to come, and we’re already seeing powerful customer use cases today. For example, our disruptive bet in telecommunications has led to multiple flagship wins to build open radio access networks or open RAN. We are working with Vodafone to build Europe’s first commercial open RAN, bringing more broadband access to European businesses and communities; with Orange to launch Europe’s first 5G standalone fully end-to-end cloud network, and with Deutsche Telekom, whose multivendor open RAN network in Neubrandenburg, Germany, is now live. These are just a few examples, and we are excited about the progress we’re making in this space. With these leading market positions, durable competitive advantages, and a differentiated strategy, I believe we can drive consistent growth and significant value creation. I’m really excited about the opportunities ahead and I look forward to talking in more detail at our virtual securities analyst meeting on September the 23rd. Before we go to Tom and our financial performance, let me introduce Chuck Whitten. As most of you are aware, in June we announced Chuck was joining me as co-Chief Operating Officer. He and I have worked together for many years alongside the rest of the leadership team to help shape Dell’s strategy and growth initiatives. Welcome, Chuck.

Chuck Whitten, C COO

Thanks, Jeff. And hello everyone. I’m thrilled to join the Dell Technologies leadership team and look forward to regularly engaging with investors. As Jeff said, I’ve worked for more than a decade with Michael, Jeff and the rest of Dell leadership on the Company strategy and positioning. The Company has tremendous opportunity ahead, and we’re focused on executing the strategy laid out in the June investor presentation. And we have never been more optimistic about our ability to innovate, delight customers, deliver growth and create value for all shareholders in the coming years. We operate in large, growing markets with ample headroom. The markets we target total $1.3 trillion today, with core markets growing in the low-single-digits and adjacent markets growing faster through 2024 as widespread digital transformation drives sustained technology investment. But beyond sheer size, those markets are evolving in ways that play to our market positions and the durable competitive advantages Jeff mentioned. As technology becomes ever more essential, more distributed, more hybrid, and more multi-cloud, customers need a scale, trusted, and global partner who can help them simplify and create business value from the PC to the core data center to the cloud to the Edge. In short, this company was built for this moment in technology, and there is substantial growth opportunity in both our core markets and in high-value adjacent markets where our competitive advantages matter. And the spin-off of VMware will unlock the opportunity for us to pursue a balanced capital allocation strategy and invest in sustained, profitable growth for years to come. Our strategy is good for customers, employees, and shareholders, and our first half results are proof. It’s clear to us that our strategy will drive sustained value creation post spin-off, and that’s what we’re focused on executing every day as a team. I look forward to speaking with you in more detail at the analyst meeting. Let me now turn the call over to Tom.

Tom Sweet, CFO

Thanks, Chuck. And glad you’re with us. I am pleased with our performance and the execution of our strategy as we delivered another quarter of consistent growth for revenue and profitability. Over the last four fiscal years, we’ve grown operating income faster than or equal to revenue every year. Secular trends such as work and learn from anywhere, digitalization of businesses and governments, and real-time decision making with edge data leads us to be optimistic on our long-term growth prospects. Revenue for the second quarter was a Q2 record at $26.1 billion, up 15%, driven by growth in all three business units, led by outstanding performance in CSG and growth in ISG. Demand was ahead of revenue growth as we managed supply constraints, which should not come as a surprise to anyone. Gross margin was $8.3 billion, up 9% at 31.9% of revenue. Gross margin as a percentage of revenue was 160 basis points lower, primarily due to a 540 basis-point revenue mix shift to CSG. We are navigating the inflationary cost environment and have adjusted prices for the higher input costs while being mindful of our competitive positioning. Operating expense was $5.5 billion, up 10% as we invest for long-term growth and we have certain costs come back from the depressed levels we saw last year. Given our strong performance, our variable costs such as sales compensation and bonus are running ahead of prior-year levels. We have been disciplined in our decisions and will continue to be prudently managing our expenses going forward. Operating income was also a second quarter record at $2.8 billion, up 7% and 10.8% of revenue. Our interest expense was down approximately $134 million given the progress on debt reduction, contributing to the expansion of our consolidated net income to $1.9 billion and earnings per share of $2.24, up 17%. Adjusted EBITDA was $3.3 billion, up 7% at 12.7% of revenue and for the trailing 12 months, adjusted EBITDA was $13.6 billion, up 16%. Our recurring revenue is approximately $6 billion a quarter, up 14%. Our remaining performance obligations or RPO is approximately $46 billion, up 24%, and includes deferred revenue plus committed contract value not included in deferred revenue. The growth was driven by an expanded backlog, given that demand is ahead of supply, in addition to solid performance in hardware and software maintenance. Excluding VMware, Dell’s RPO is approximately $35 billion, up 30%. Turning to the business units, we had another quarter of very strong performance by our Client Solutions Group, despite industry-wide supply chain challenges. CSG revenue hit a new record at $14.3 billion, up 27%, on the strength in demand for devices and solutions that offer improved connectivity and productivity. We continued to see strength across notebooks, but we also saw strong double-digit growth in commercial and desktop orders. As Jeff mentioned, we’ve leaned into commercial, where more than 70% of our CSG revenue comes from and commercial also contributed to our return to share gains per IDC’s calendar Q2 results. Commercial revenue was up 32% to a record $10.6 billion as businesses looked to upgrade devices and productivity solutions for their long-term in-office, remote and hybrid workforce environments. Consumer revenue was a second quarter record at $3.7 billion, up 17% as digital entertainment and e-commerce are still driving strong demand for upgraded experiences. CSG operating income was $995 million, up 39% and was 7% of revenue. We saw solid profitability primarily due to strong shipments, a mix shift to commercial and a balanced pricing environment. Moving to ISG, where revenue was up 3% to $8.4 billion, we saw a strong demand environment for compute and positive momentum in storage. Customers across all regions are investing in IT infrastructure, focused on multi-cloud solutions and accelerating digital transformation. Servers and networking reported its third consecutive quarter of positive growth with revenue of $4.5 billion, up 6% with strong demand across all customer segments and geographies. Storage revenue was $4 billion, down 1%. On an orders basis, we were encouraged to see positive overall storage growth of 2%, with ongoing demand in high-growth areas like hyperconverged infrastructure where VxRail orders were up 34% and in midrange storage, where orders were up 17%. PowerStore continues to ramp nicely, making up approximately 38% of our midrange storage portfolio. 23% of PowerStore customers in Q2 were net new to Dell storage. ISG operating income was flat at $970 million and was 11.5% of revenue. The VMware business unit revenue was $3.1 billion, up 8%, and operating income was $849 million, or 27% of revenue. Dell Financial Services originations were $1.9 billion, down 27%, due to the tougher comparison last year as more customers leveraged financing during the early stages of the pandemic. DFS ended the quarter with $12.6 billion in total managed assets, flat year-over-year, with global portfolio losses at historical lows. Turning to our capital structure and balance sheet, we generated strong cash flow in Q2 and are making good progress on delevering. Cash flow from operations was $1.7 billion. Although cash flow was slightly lower sequentially, impacted partly by working capital dynamics, our cash flow from operations was $4 billion through the first half of the year, which was up 56% compared to the same period last year. On a trailing 12-month basis, cash flow from operations was $12.8 billion, and excluding VMware it was $8.4 billion. Over the last three years on a trailing 12-month basis, cash from operations grew at a 15% CAGR. Cash and investments ended the quarter at $13.6 billion and approximately $7.5 billion for Dell, excluding VMware. During the second quarter, we paid down $3 billion of the $4 billion margin loan that was outstanding as of the beginning of the quarter, and we paid down the remaining $1 billion earlier this week. We have now paid down approximately $5.5 billion of debt year-to-date and expect to pay down at least $16 billion for the full fiscal year. Our core debt ended the quarter at $27.6 billion, and our core leverage ratio is approximately 2.2 times versus our long-term core leverage target of 1.5 times. We expect to achieve an investment grade corporate family rating once the VMware spin is finalized. Once we get to investment grade, there will be opportunity for a more balanced capital allocation policy, including shareholder capital return, investments to grow the business and value-enhancing mergers and acquisitions. We will provide more details on our post-spin capital allocation policy at our analyst meeting next month. Now to our outlook. From a macro point of view, the global economic recovery is driving broad demand across multiple sectors, including IT. As a result, demand for integrated circuits and components that are fundamental building blocks of today’s modern IT, automotive, industrial solutions and home appliances are in tight supply. One of our durable advantages is our industry-leading scale and supply chain expertise. This is serving us well in this environment, and we are actively managing demand that is ahead of the industry’s ability to deliver integrated circuits and components. For Q3, we now expect an above normal sequential revenue growth pattern and year-over-year growth up mid to high-teens. For CSG, we expect high-single-digit growth sequentially. For ISG, we expect low-single-digit growth sequentially. And for VMware, you should factor in their standalone revenue guidance which is roughly flat sequentially. Given this, we expect Q3 revenue overall to be up mid-single-digit sequentially versus a normal 2% decline. For Q3 operating income, we expect a mix shift to CSG sequentially, ongoing component cost dynamics, a modest increase in OpEx as we invest for growth, and we are considering the impact of VMware standalone guidance. With all of these factors, in our view, operating income dollars will be up 1% to 2% sequentially. Below the operating income line, we will continue to benefit from lower interest expense as we reduce our debt. But do keep in mind, the majority of our $16 billion plus in targeted debt pay-down will occur at the time of the VMware transaction, which we now estimate to close in early November. For Non-GAAP tax rate, you should assume 17%, plus or minus 100 basis points. In the absence of share repurchase activity, diluted share count should also increase slightly, sequentially. In closing, we have a track record of consistent execution across any economic or IT spending cycle given our durable competitive advantages, and we are investing in innovation and software development to differentiate our solutions and appliances. We are optimistic about the long-term growth prospects for our businesses. I’m confident in our ability to deliver consistent and predictable financial performance. From fiscal year ‘18 through fiscal year ‘21, we grew revenue at a 6% CAGR and grew Adjusted EBITDA at a 12% CAGR. And we generated nearly $28 billion in operating cash flow. We are well-positioned and have the right strategy to create long-term value for our stakeholders. We look forward to sharing more about our plans for core Dell with all of you on September 23rd. With that, I’ll turn it back to Rob to begin Q&A.

Operator, Operator

Thanks, Tom. Let’s get to Q&A. We’ll ask that each participant ask one question to allow us to get to as many of you as possible. Jermiria, can you introduce the first question?

Operator, Operator

We’ll take our first question from Krish Sankar with Cowen & Company. Please proceed.

Krish Sankar, Analyst

Yes. Thank you for taking my question. Jeff, I had a question on the PC side. It looks like your U.S. competitor had some operational misstep last quarter. And based on your above-seasonal October guidance for CSG, are you gaining market share in this environment, or are component constraints limiting it? And also in regards to the industry shortages, can you share where exactly you’re seeing those constraints? Is this like power management ICs and display drivers, or any other components? Any color there would be helpful. Thank you.

Jeff Clarke, CEO

Sure, Krish. Let me first answer your question about share. In the most recent IDC-published share data, Dell was the top share gainer of the top five manufacturers in the marketplace. We took share in total PCs; we took share in commercial PCs, our focus. We took more share than any of our other competitors in those spaces. So, to answer your question, yes, we’re taking share. We took 120 basis points of share, for example, in the commercial PC market in calendar Q2. Your specific question of where are the shortages in the industry, as we’ve, I think, mentioned through several of these calls now, it’s semiconductors. The industry demand, and industry being IT, consumer electronics, automotive, industrials, for electronics, for semiconductor continues to be strong. That is the area that is challenged certainly for us. We continue to work through it. I think, we are working through it reasonably well. The execution of our supply chain team is, I think, quite impressive with record shipments for the quarter for PCs, record shipments for displays. But, the types of devices would be scalers, TCONs, microcontrollers, power ICs, driver ICs, those types of devices are the ones that we see consistently challenged at different times. I hope that helps.

Operator, Operator

Our next question is from Rod Hall with Goldman Sachs.

Rod Hall, Analyst

Thanks for the question. I guess, I wanted to ask something on PCs as well. Your U.S. competitor has just signaled that they’re reducing their promotional and marketing spend assumptions substantially, and that had a big impact on margins in the quarter. And we’re assuming it will have a large impact on their PC margins looking forward. I’m just curious if you guys are seeing that kind of promotional and marketing spend reduction in the market today, and what you’re thinking in terms of your own expenditures in that respect in the back end of the year, given the demand dynamics against the supply dynamics? Thanks.

Jeff Clarke, CEO

We have not lowered our marketing or compensation for whether it’s our direct sellers or our channel partners. We’ve seen the demand of the market continue to pick up. It’s been pivoting or moving towards commercial, which generally has a lower marketing cost in it as well, but the selling costs are fairly consistent. And we don’t have any planned changes. We like where our business is. We think we are executing at a very high level. We saw a tremendous rebound in our premium products, whether that be our workstation products, our commercial desktop products. We continue to see strong demand for our commercial notebook products. Rod, I don’t know any other way to say this, other than demand was strong through the quarter. I think you probably saw that in our backlog growth that Tom alluded to before, and business is good.

Chuck Whitten, C COO

Hey Rod. I would also add that I think Jeff and I have a lot of scar tissue over the years where one of the things that we believe is that you have to have a consistent presence in the market in terms of driving demand and driving your message. And when you pull back, you tend to see the impacts of that, one to two quarters out. So, we like where we are. We like what we’re doing. We’re being disciplined in our spend. But, we also want to make sure that we are positioned thoughtfully in the market relative to the demand signals that we’re seeing.

Operator, Operator

Our next question is from Amit Daryanani with Evercore.

Amit Daryanani, Analyst

I guess, my question is on the storage side. And Jeff, I’d love to get your perspective here because overall sales of storage were, I think, down 1%, compares were fairly easy. And I think a couple of your peers in that space actually had double-digit growth yesterday. So, I’d love to understand, how do you think storage performed versus your own internal expectations this quarter? And then, what do you think is fundamentally needed for Dell to start gaining share on the storage side over the next few quarters?

Jeff Clarke, CEO

Thank you for the question. I believe we sometimes struggle to effectively communicate about our storage business. To start, we offer the widest range of products in the market, unmatched by any competitor. We lead in high-end, mid-range, entry-level, unstructured, object, all-flash, and modern storage, including software-defined and hyperconverged solutions. Our market share in the first quarter was 32.3%, which surpasses the combined shares of our second, third, fourth, and fifth competitors. As noted in our earlier comments, our business has grown in the mid-range and hyperconverged infrastructure sectors, and we believe we've outpaced our competitors in unstructured storage as well. In the mid-range sector, defined as price points between $25,000 and $255,000—representing about 60% of the market—we achieved a growth rate of 17%. This performance compares favorably against the figures from our pure-play competitors in the mid-range space. Notably, this marks the third consecutive quarter of 17% growth in mid-range storage. Across the last three quarters, we experienced growth rates of 8% in Q4, 23% in Q1, and 17% in Q2. Our mid-range business is expanding and gaining market share. We’ve recently introduced the PowerStore 500, which enables us to serve the entry-level price segment, thus covering all price points in the mid-range. Earlier this year, we also made seamless performance upgrades to our products. As we mentioned in our prepared remarks, our storage customer base has grown in double digits, and PowerStore is our fastest-growing new storage product in company history, with 23% of buyers being new customers and 20% being returning customers. We are confident in our high level of performance in mid-range execution. However, you pointed out a challenge we faced with a 2% growth in orders and a 1% decline in profit and loss. Our substantial high-end business is cyclical and saw a year-over-year decline, following a strong first half of the previous year. We are optimistic about our current situation and execution. While we have a diverse portfolio that is influenced by the cyclical nature of certain segments, our high-growth areas, particularly in hyperconverged infrastructure, saw VxRail grow by 34%, and mid-range growth at 17%. We are competing well against our pure-play competitors and are excited about the momentum. As I've said before, three data points indicate a trend; we now have a trend of three consecutive growth data points in mid-range storage.

Tom Sweet, CFO

Hey Amit, I would like to add that we have gained 200 basis points of storage share over the last five years, as Jeff mentioned in his prepared remarks. Would we like to gain more? Absolutely. However, we cover all segments of the storage market compared to pure-plays that are more narrowly focused. We will continue to work on it, with a focus on how to grow, profitably, while ensuring we meet our customer demands.

Operator, Operator

Our next question is from Aaron Rakers with Wells Fargo.

Aaron Rakers, Analyst

I wanted to ask about the RPO balance. You mentioned that your RPO, excluding VMware, increased by about 30%. To put this in context, your deferred revenue excluding VMware grew around 11% year-over-year. It's clear that the RPO balance is expanding much faster than core Dell deferred revenue. Can you help me understand how much of this growth is due to backlog buildup from supply constraints compared to the growth in software or subscription RPO? I'm trying to grasp the backlog buildup you are currently experiencing.

Tom Sweet, CFO

Yes. Hey Aaron, let me take that. So, you saw quarter-on-quarter that overall RPO was up roughly about $3.9 billion. The vast majority of that principally related to backlog growth, right? So, that’s how you should think about the RPO growth Q1 to Q2.

Jeff Clarke, CEO

Maybe just an add to that. If you think about that backlog growth and the momentum that we saw in our business, at least from our seat, that indicates strong demand for our products and our services as that backlog build. Our cancellation rates didn’t change over the quarter. Our ability to deliver for our customers or to our customer commitments, I think, is indicative of that cancellation rate not changing at all. Again, we shipped a record number of PCs and displays as we had the building backlog, and our supply chain team continues to be agile in this dynamic marketplace. We’re maneuvering to maximize shipments for our customers and probably just a little plug here. There are 200 PCs available today on dell.com with next-day ship ready to go.

Operator, Operator

Our next question is from Katy Huberty with Morgan Stanley.

Katy Huberty, Analyst

The guidance for above-seasonal 3Q growth is particularly impressive, given market concerns around slowing PC growth and the supply constraints that you’ve talked some about. So, can you just give more specifics around the products or end markets within CSG and any notable trends in ISG that’s driving the more bullish outlook? Thanks.

Tom Sweet, CFO

Yes, Katy. I think when we take a step back, we're encouraged by the current demand environment. While we face supply chain challenges and are constrained on certain components, the demand signals from our customers appear promising. As Jeff mentioned, there's strong client demand, particularly with our focus on commercial PCs, which increased this quarter. We've also observed sustained strength in commercial PC demand, which is encouraging, even with consumer demand growing in double digits this quarter. Regarding guidance, we're satisfied with CSG, as I noted earlier. In terms of ISG, there's a strong opportunity in computing, and we see improving performance in storage, though there's still work to be done in that area. We're optimistic about the spending trends in the data center. The key dynamic will be around the supply chain and whether Jeff and his team can obtain the necessary parts and configurations for shipping. Overall, the demand landscape for Q3 appears healthy. We discussed component cost inflation that began in Q2, which continues into Q3. We're addressing that with adjusted pricing, and it doesn't seem to have affected our demand signals. We believe we're in a solid position and just need to execute. Overall, we feel good about our current status.

Jeff Clarke, CEO

Yes. Katy, maybe just two points of color to emphasize what Tom said. We saw the movement in CSG towards commercial away from consumer and away from chrome to commercial, and we believe we positioned our supply chain to capture that momentum. And then, secondly, I think we’ve talked about this with our growing server momentum now three quarters in a row of server growth that we’re seeing a returned investment into the data center, that a couple of years of delayed investments in aging installed base, new product transitions with the new processors that are available in the marketplace, some of the supply uncertainty is having customers prioritize their projects to transform, modernize and protect their digital businesses, and we’re seeing that momentum build.

Operator, Operator

Our next question is from Toni Sacconaghi with Bernstein.

Toni Sacconaghi, Analyst

I was wondering if you could help quantify either the book-to-bill ratio or the extent of your current backlog. In response to a previous question, you mentioned that the remaining performance obligation was up, primarily due to backlog growth, totaling over $3 billion sequentially, which represents about 1.5 weeks of backlog. Could you clarify either the book-to-bill ratio or the size of the backlog as of the end of Q2, expressed in weeks by business? Additionally, concerning the above-seasonal guidance, what assumptions are you making about the backlog in Q3? Are you anticipating a drawdown, and how much of the above-seasonal growth is attributed to pricing and/or anticipated changes in backlog?

Tom Sweet, CFO

Well, Toni, there’s like three questions in that question.

Jeff Clarke, CEO

I counted five.

Tom Sweet, CFO

I don’t really want to discuss the specifics of our backlog. However, I can tell you that it has grown, which you might expect given the current demand conditions and supply limitations. Unlike some competitors, I won't specify how many weeks of backlog we have. I will simply mention that it has increased, and we need to address it. As we approach Q3, you should understand that we believe the demand environment remains strong. We have adjusted pricing due to higher input costs, which means there will be some impact on higher TRU. The key focus for Q3 will be our shipment mix, and that's the work Jeff and his team are currently engaged in, determining what products to send out. Overall, we are confident in our ability to manage this as reflected in the revenue guidance we shared.

Operator, Operator

Our next question is from Steven Fox with Fox Advisors.

Steven Fox, Analyst

I understand and it’s well documented where we are with the component constraints. So, I was curious how you would describe sort of the path out of this for the Company? How much more can you control on your own destiny going forward? And just to be clear, what is the impact you’re seeing like this quarter versus last quarter? Thanks.

Jeff Clarke, CEO

Well, thanks for the question. Look, in aggregate, the semiconductor industry needs more capacity. I think, we’ve talked about this before, but we’re seeing the same thing. It’s constrained. I think the constraints certainly last or go into next year. The most constrained nodes are the trailing nodes, most particularly the parts that come off the 8-inch network. Quite frankly, no one’s investing in a lot of new 8-inch capacity, if any. There’s a wafer and substrate shortages. We have assembly and test wire bonding lead frame areas are challenged. So, I think these are consistent things that we’ve talked about as we’ve got into the semiconductor challenge broadly across multiple industries. The path out of this is ultimately more capacity. It takes a long time to build these different fabs anywhere from a couple of years to three years depending on the process technology we’re talking about. And obviously, lots of capital is required to do that. Our job is that the environment we’re playing in, we’ve been directly managing our components for a very long time in this company. We have longstanding relationships and partnerships. We continue to let people know what our long-term demand is. It’s how we plan this company. And what we have found is those partnerships over long periods of time and consistency in those partnerships and the agreements that we have in place certainly help us navigate these types of situations. That’s what we’re focused on. You’re not going to see us get into the semiconductor business. It’s certainly not a core competence and something that we wouldn’t touch. We’re working with our partners to continue to understand what the demand characteristics long term look like for these marketplaces. I think as we’ve been consistent, we believe the PC market long term continues to grow. We believe the server industry continues to grow long term as we believe the same to be true of the storage business. And letting our partners know that there’ll be long term demand is the best thing we can do to ensure there will be capacity in the future.

Operator, Operator

Our next question is from Samik Chatterjee with JP Morgan.

Samik Chatterjee, Analyst

I wanted to follow up on the price increases you've mentioned before and also brought up today. Are we starting to see those affect your guidance for the next quarter? Considering the typical lag through the channel, when can we expect the full impact of that? Also, how do you view the benefit in magnitude between ISG and CSG?

Tom Sweet, CFO

Yes, I think about it this way: we have adjusted our pricing due to the higher costs we are experiencing, and Jeff has mentioned some of the constraints we face. I noted earlier that we anticipate Q3 will be inflationary in terms of component costs and expect Q4 to follow suit based on what we know now. We have discussed that with our diverse portfolio, adjusting prices takes some time to translate through. We've been proactive in this regard, and we expect that some of the price increases will affect Q3 and continue into Q4. The challenge we are navigating is related to the mixed dynamics in our backlog, which includes items priced at various points due to past cost factors. This is why my guidance reflects strong revenue expectations, but the operating income guidance is not as broad. Our EPS projections align closely with my operating income guidance due to the mixed dynamics involved. Importantly, the determining factor relies on how much we can ship within the quarter. Overall, I believe the teams have responded well. A positive aspect is that even with the price increases, we have not noted any changes in demand signals, which is encouraging. Our transactional velocity has remained stable despite the price hikes. We continue to have a strong backlog, and cancellation rates have not shifted. Thus, we feel optimistic about the overall environment. Customers have generally accepted the price increases, especially given the broader inflation affecting various commodities and areas. Additionally, there are limited alternatives available to them due to the industry's supply constraints.

Operator, Operator

Your next question comes from Shannon Cross with Cross Research.

Shannon Cross, Analyst

I’m curious about the PC side. How do you view Windows 11 and commercial demand, and how long do you think that will last? It seems like we’ve had several wins in the PC market, mostly favorable trends. I’m wondering how beneficial you think this will be.

Jeff Clarke, CEO

Hi Shannon, it’s Jeff. Good to hear your voice again. Look, we’re bullish on Windows 11. Our industry has a history of new operating systems driving an upgrade cycle. The upgrade cycle, when the product is formally released into the marketplace, we believe is there. We think Windows 11 brings a lot to end users from anywhere from a new user interface to the ability to see some productivity enhancements, run multiple desktops and such, drives a higher hardware specification, which is good for business. We have a large installed base that will continue to need to be refreshed against that. We believe that this is really a replacement of a PC, not an upgrade of an OS on an old PC. So, that generally drives demand in our industry. You couple that with what we believe is a general change in usage patterns that the PC has become more essential in this work-from-home, learn-from-home, game-from-home, buy-from-home, entertain-from-home world, and we think that we’re on the verge of new models where, a long time ago, we thought success was one PC per household, now we’re seeing multiple PCs per household. We’re seeing a more mobile PC base, which requires a more frequent upgrade or replacement cycle is the right word. We think the future is pretty bright for the PC. And a phrase that we’ve been kicking around the organization is all signs point to a stronger and longer demand cycle for PCs. And we think commercial PCs in particular will benefit from that.

Operator, Operator

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

Wamsi Mohan, Analyst

Yes. Thank you. And congrats on the solid quarter and guide. Jeff, can you update us maybe on the specific milestones for the VMware spin that you’re tracking? And any timing or milestones that you can share here at all outside of sort of the potential closing in November? And can you also tell us if you received accelerating the tax-free spin ruling from the IRS? Thank you.

Tom Sweet, CFO

Hey Wamsi, it’s Tom. Let me take that. As we track towards the potential VMware spin date of early November, we are still awaiting the private letter ruling from the IRS. That is the one major milestone we are focusing on. We’re continuing to work very closely with them and everything is tracking as expected. This is the remaining major hurdle. Everything else is moving as planned, with the teams collaborating effectively as we work through our workflows and work streams related to post-spin work, innovation targets, and go-to-market strategies. We feel good about where we are, but we do need to finalize and obtain a successful ruling from the IRS on the private letter ruling, which remains on track as of today.

Jeff Clarke, CEO

Yes. Thanks for the question, Wamsi. And I would also just say that we intend to continue to provide information. We’ve been pretty transparent to the best of our abilities as we move through this process, and we’ll continue to do that along with VMware. And we’ve released some preliminary non-GAAP P&Ls in conjunction with the roadshow materials back at the end of June. And we hope to give you some additional information in conjunction with or just prior to the analyst meeting on September 23rd. So, I look forward to continuing to provide additional insight as we move along here.

Operator, Operator

Our next question is from Sidney Ho with Deutsche Bank.

Sidney Ho, Analyst

My question is about the operating margins by segment. Your ISG margin has improved and is now close to the long-term trend. On the other hand, CSG has decreased slightly, but it remains strong. How do you anticipate the operating margins of both segments will trend over the next few quarters, considering the higher input costs? Perhaps you can be selective about which segment to prioritize in this supply-constrained environment. It seems Q3 may see a decline, but what about after Q3, especially as IT spending continues to recover? Thank you.

Tom Sweet, CFO

I don’t want to discuss long-term operating margin guidance on this call. However, I can share that we are pleased with the progress we've made in our CSG performance and strong profitability. We have previously indicated that we believe the business typically operates with an operating margin of around 5 to 6 points on a long-term basis. We're assessing whether this remains the right model moving forward, and we plan to provide updates at our analyst meeting on September 23rd. From an ISG perspective, we are happy with our progress, but recognize there is more to accomplish, especially as we focus on increasing storage growth, which usually leads to higher operating margins. Overall, we've made good progress, but there is always more to tackle. We will share our long-term outlook during the upcoming analyst meeting next month.

Operator, Operator

Our next question is from Simon Leopold with Raymond James.

Simon Leopold, Analyst

You did talk earlier about price increases, but I’m assuming, particularly within the CSG segment, you’re shifting your mix towards your higher profit, higher price products, and that’s a tailwind. So, just trying to understand how much of this good revenue trend, the revenue growth is driven by mix versus price increases. If you could just help us break this down in terms of kind of what’s sustainable here and what are the key factors on the overall growth. I assume it’s not just about more units. Thank you.

Tom Sweet, CFO

Hey Simon, you need to consider this: having experience in this business, it's clear that some of the TRU dynamics are influenced by the component cost environment, which means they will change as component costs change. Currently, due to higher input costs, we’ve raised prices, which does impact TRUs. We anticipate some positive effects from TRUs as we move into Q3 and likely into Q4, given the current component cost situation. Additionally, we remain optimistic about demand based on what we know right now; we expect the demand environment to stay positive unless there’s an unexpected change. Therefore, when thinking about future revenue, particularly in the near term, it will largely depend on the shipment mix. This is something we are actively evaluating, as the supply chain team addresses component shortages and availability. In summary, while TRU should provide some advantage, the dynamics of the shipment mix will ultimately determine how the P&L will unfold. We are confident in what we can achieve in Q3, which is reflected in the guidance we provided, and we will update you on Q4 at the right time.

Operator, Operator

We’ll now take our final question from Jim Suva with Citigroup.

Jim Suva, Analyst

Thank you. And a lot of my questions have been answered. So, I’ll just ask one question, and that’s a follow-up on the storage side. You talked about different end segments you feel pretty proud about and pleased about. But, when you look at the overall numbers, they look pretty disappointing relative to your competitors out there. So, the question is, are you guys like disengaging in quite a few markets and we should be aware at that, or what you’re talking about, the small slices that you’re doing okay at, are those early green shoots of what yet to come in the future?

Jeff Clarke, CEO

Well, let me work our way through that, Jim. So, the 17% growth that I mentioned is in the biggest part of the storage market. It represents 60% of the revenue, the midrange. The price bands it cover $25,000 to $250,000. We grew that 17% in the quarter, the third consecutive quarter that we’ve had growth in the midrange on the back of our new product PowerStore, which we’ve talked about is our game-changer in the mid-range, and it’s proven to be that to date. We’re excited, fastest-growing product we’ve ever launched through its first five quarters. We have a growing customer base, and we have repeat buyers. Good signs. Hyperconverged, the fastest-growing space in storage, where we have the privileged position of being the market leader. Our combined product with VMware, VxRail, grew 34%. So, in the two most important marketplaces, mid-range and the new 2-tier architecture, modern architecture, we’re the leader and we’re growing. And we’re growing at or a faster rate than our competitors in those spaces. What I mentioned before is in the high end where we have the privileged position of having a share position of in excess of 42%, that market is declining. It’s cyclical in nature. Last first half, it grew; this first half, it’s not growing. That business, we’re obviously exposed to a large percentage of that business being the market share leader with 42-plus-percent share is declining and we’re declining like the market is declining. I hope that helped put color to it.

Operator, Operator

All right. I appreciate it, Jim. I appreciate it, Jeff. Thanks to everyone for joining. Look forward to seeing you all at our securities analyst meeting. It will be virtual. It will be on September the 23rd in the morning, and additional details will continue to head your way. So, thanks again. Take care.

Operator, Operator

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