Earnings Call Transcript - DELL Q4 2022

Operator, Operator

Good afternoon, and welcome to the Fiscal Year 2022 Fourth Quarter and Year-end Financial Results Conference Call for Dell Technologies Inc. I want to let all participants know that this call is being recorded at Dell Technologies' request. This broadcast is the copyrighted property of Dell Technologies Inc., and any rebroadcast of this information in whole or in part without prior written permission from Dell Technologies, Inc. is not allowed. After the prepared remarks, we will have a question-and-answer session. Now, I will turn the call over to Rob Williams, Head of Investor Relations. Mr. Williams, you may begin.

Rob Williams, Head of Investor Relations

Thanks, Erica, and thanks, everyone, for joining us. With me today are Jeff Clarke, Chuck Whitten, Tom Sweet, and Tyler Johnson. Our earnings materials are available on our IR website, and guidance will be covered on today's call. During this call, unless otherwise indicated, 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. All financial numbers in our earnings materials are now presented on a continuing operations basis, unless otherwise noted, see Appendix C in our presentation for a recast of our P&L numbers. Growth percentages refer to year-over-year change unless otherwise specified. Statements made during this call that relate to future results and events are forward-looking statements based on current expectations. Actual results and events could differ materially from those projected due to a number of risks and uncertainties, which are discussed in our web deck and SEC filings. We assume no obligation to update our forward-looking statements. During the call today, Jeff will recap FY '22, the demand environment heading into FY '23 and supply chain dynamics in CSG. Chuck will cover ISG and our growth initiatives, and Tom will cover our Q4 financial results, capital allocation, and guidance. Now I'd like to turn it over to Jeff.

Jeff Clarke, CEO

Thanks, Rob. FY '22 was a historic year for Dell Technologies. In fact, the best in our company's history. We reached more than $100 billion in revenue and grew 17%, a huge achievement for a company of our scale and ahead of our long-term value creation growth rates. And our opportunity continues to grow as we look ahead to FY '23. We are more vital than ever to our customers in an expanding market led by digital transformation. IT investments remain a top priority for our customers as technology has become even more essential to their business. It's how you turn data into insight and action into better customer experience and competitive advantage. Customers also want choice and a trusted partner. Our position at the center of our customers' digital agenda and at the center of the technology ecosystem makes Dell the logical choice. You can see in how we're winning with customers like the Miami Dolphins, AT&T, and Vodafone, with the world's largest reinsurer, Munich Re, and one of India's largest manufacturers, Greenpanel, across data storage, hyperconverged infrastructure, and in adjacent opportunities like multi-cloud, as-a-service, edge, and telecom. We are continuing to gain share in our core businesses and these emerging opportunities where we can bring our advantages to bear. We have differentiated ourselves through consistent performance across different economic environments, uncredited challenges, and unforeseen events, and we have leaned into new opportunities always with an eye toward our customers. In FY '22, we delivered record revenue of $101.2 billion, record operating income of $7.8 billion, diluted EPS of $6.22, and record cash flow from operations of $7.1 billion, truly a record year. And Q4 was no different. We saw 17% growth in demand for our products and services in the quarter, with broad growth across geographies, industry verticals, and business units. As a result, we delivered record revenue up 16%. Operating income was a record, up 1%, but slightly below our November guidance as we optimize our performance based on customer needs, parts availability, and backlog dynamics. Being trusted partners to our investors and lenders as well as our customers is important to us. And in FY '22, we unlocked shareholder value by the spin of VMware, simplifying our capital structure, deleveraging our balance sheet, returning to investment-grade ratings, approving a share buyback program for up to $5 billion, and today, announcing a quarterly dividend at an initial annual rate of $1.32 a share. Now let me shift gears and share a little color on the current supply chain dynamics, and then we will move into BU performance. The global supply chain shortage of semiconductors and global logistics challenges for goods and components continue to impact just about every industry. We are still experiencing shortages of integrated circuits across a wide range of devices, including network controllers and microcontrollers that go into our products and solutions. The result is we are seeing an impact across client systems, servers, and storage. In addition, freight costs have continued to rise due to increased logistics rates, a higher mix of air due to ocean network congestion, and an increase in part expedites to meet customer needs. We have reduced our PC backlog over the last two quarters, and it is nearing the high end of its normal range. However, we expect PC backlog to grow in Q1. Our higher-margin ISG backlog increased again in Q4 to a record level due to a combination of very strong demand and the lack of component availability. We expect our ISG backlog to remain elevated through at least the first half of the year as part shortages continue. As we head into Q1, we do expect component costs to improve with modest deflation, while freight costs remain elevated. We are awaiting information from the recent NAND contamination announcement from Kioxia and Western Digital to evaluate the impact on Dell. Our supply chain speed, agility, and flexibility have enabled us to meet customer needs in this environment, though challenges remain. And our supply chain continues to be a durable competitive advantage as we navigate the unprecedented supply uncertainty. Turning to CSG. Our PC business logged another record year. We delivered record revenue of $61.5 billion, up 27%; record operating income of $4.4 billion or 7.1% of revenue; record unit shipments of 59.3 million units in calendar '21, up 18%, growing faster than any of the top three. And calendar year 2021 commercial share growth was up 70 basis points more than any of the top three and has now been up 470 basis points over the last five years. Turning to Q4. We delivered our sixth consecutive record CSG revenue quarter with $17.3 billion, up 26% with healthy demand, up 21%. Operating income was a record of $1.2 billion. We shipped a record 17.2 million PCs in calendar Q4, up 9% and now have gained share in 2 of the last 36 quarters. Our leading innovation continues to build a strong foundation for future CSG results. We won 47 awards at CES in January, where we introduced our new XPS 13, our thinnest ever gaming notebook, the Alienware 14, and an advanced commercial notebook concept built around sustainability, recyclability, and reuse. Hybrid work, learning, shopping, socializing, entertainment, and travel is all here to stay. And we expect commercial PC and premium consumer growth in FY '23, albeit at a moderating rate relative to a record year. Clearly, CSG had a fantastic year, and we are well positioned heading into FY '23 as the client systems total addressable market has reset to a higher level. I am very proud of our FY '22 results, our team, and the company and the culture we've created. And I'm incredibly excited about the road ahead with all of you. We expect another year of growth as we modernize the data center with automation and intelligence, deploy IT at the edge, and simplify multi-cloud for our customers. And with that, I'll turn it over to Chuck for some color on ISG and our growth initiatives.

Chuck Whitten, CFO

Thanks, Jeff. FY '22 was indeed one for the record books. We're in a privileged strategic position. We ended the year with great momentum, and we're incredibly optimistic about FY '23 and beyond. Turning to full year ISG results. Fiscal '22 revenue was $34.4 billion, up 4% for the year and underpinned by 4 consecutive quarters of growth. Widespread digital transformation continues to accelerate growth in infrastructure spend, and we were encouraged by growing demand across our portfolio of ISG solutions, specifically FY '22 storage orders grew at the fastest rate since the EMC acquisition, and all geographies grew storage for the year. Mid-range storage orders were up double digits in FY '22, and PowerStore remains the fastest ramping storage product in our company's history, with demand for our leading server products accelerating over the course of the year, culminating with record server demand in Q4. ISG operating income was $3.7 billion, flat year-over-year as both ISG revenue and margin were gated by supply constraints and corresponding backlog growth. As Jeff highlighted, we will continue to navigate the challenging supply environment with our differentiated business model, our advantaged supply chain, our product design flexibility, and our unique direct go-to-market, which creates a high-quality demand signal and gives us the ability to shape demand to where we have supply. Turning to Q4. Our final fiscal quarter of FY '22 was a microcosm of ISG's year, with strengthening demand across our storage and server portfolios. ISG demand was up 17%, with revenue up 3% to $9.2 billion. Storage demand growth was up for a third consecutive quarter and in the high single digits. Our leading storage portfolio, where we're #1 in high-end, midrange-entry unstructured object, all-flash, HCI, and data protection, enabled us to capture growth across a variety of storage architectures and customer sizes. For example, we saw double-digit demand growth in the high end, driven by select enterprise customers, 25% demand growth for our unstructured storage solutions, and 8% growth for HCI despite a tough year-over-year comparison. Within midrange, PowerStore demand continued to ramp in Q4, up 34% sequentially and now approximately 50% of our midrange SAN mix. Encouragingly, 26% of PowerStore buyers are new to Dell storage and 29% were repeat buyers, which are important leading indicators of future growth. Servers and networking revenue was up for a fifth consecutive quarter, up 7%. Storage revenue was roughly flat year-over-year due to backlog growth and storage software and services content that gets deferred and amortized over time. ISG operating income was $1.1 billion, down 7% due primarily to backlog growth, component inflation, and logistics costs. We continue to take pricing actions to mitigate cost increases, though component shortages and turbulent logistics markets remain risks that we are actively managing. In summary, FY '22 was a solid year for ISG as infrastructure markets rebounded with the business returning to growth. Our leading indicators of server and storage demand were ahead of revenue, and our integrated business model continues to deliver despite challenging supply dynamics. ISG is poised for a strong FY '23, given the momentum in the business. Tom will share thoughts on forward guidance in a moment. Before handing over to Tom, let me touch briefly on our priority growth initiatives. At our September Analyst meeting, we highlighted multiple growth opportunities both inside and outside our core business, including over $650 billion in total addressable market adjacent to our core, where our asset positions and durable competitive advantages give us a right to win. These are distinct markets like edge and telco, but also growth opportunities like our APEX branded as-a-service solutions that provide a modern consumption experience to our customers. Customers can buy our solutions, subscribe to our solutions, and select from different types of services, including fully managed service offerings depending on their needs. FY '22 was an important year as we launched solutions in these spaces, engaged customers, and made investments that positioned us for future growth. We were pleased with our strategic technical and commercial momentum in these businesses. In particular, we saw a rapid acceleration of our APEX Flex on Demand subscription offering as the year progressed, an important market indicator that our APEX strategy is resonating with customers. We also delivered a steady stream of innovations and customer wins in edge and telco in FY '22, giving us conviction in our long-term strategy. Noteworthy in Q4 was the expansion of our APEX Cloud Services portfolio with two new offers. APEX Multi-cloud Data Services, which deliver storage and data protection as a service with simultaneous access to all major public clouds through a single console. The solution allows customers to access the cloud services they want while maintaining control of their data on-premise, avoiding lock-in and egress fees, and enabling customers to meet regulatory and compliance requirements. And APEX Backup Services, which provide scalable, secure data protection with centralized monitoring and management for SaaS applications, endpoints, and hybrid workloads. The solution offers all-in-one protection with backup disaster recovery and long-term data retention and a 100% SaaS-based offering with no infrastructure to manage. FY '23 will be about continuing to push the innovation agenda in APEX, Telco, Edge, and multi-cloud. As these growth initiatives become more materially relevant, we will provide more detail. In closing, we enter FY '23 with a solid demand environment across our businesses and with a lot of confidence. And with that, I will turn it over to Tom.

Tom Sweet, CFO

Thanks, Chuck. In Q4, we delivered record revenue of $28 billion, up 16%, driven by another record quarter for CSG and continued growth in ISG with demand for servers and storage well ahead of revenue. Gross margin was $5.8 billion, flat year-over-year at 20.8% of revenue. Gross margin as a percentage of revenue was 320 basis points lower, primarily due to higher-than-anticipated component and logistics costs and higher CSG mix. We continue to take pricing actions to manage the impact of commodity and logistics cost variability. Part shortages and supply chain risk remain across the economy, and we expect ISG backlog to remain elevated through at least the first half of fiscal '23. Operating expense was $3.6 billion, roughly flat year-over-year at 13% of revenue, with the full year fiscal year '22 operating expense rate at 14.7%. We continue to invest for long-term growth but did benefit from lower compensation and benefits in the period. Looking ahead to fiscal year '23, we expect operating expense as a percentage of revenue to be slightly higher than fiscal year '22 as we invest in the business, employees return to work, and we engage in more business-related travel. Operating income was a record $2.2 billion, up 1% at 7.8% of revenue. This was slightly lower than our November guidance, given the impact of supply chain disruptions. Net income was $1.4 billion, up 2%, with growth in operating income and a decline in interest expense due to the reduced debt balances, offset by an increase in our effective tax rate. Our tax rate was 25.1%, higher than we expected at the time of our Q3 earnings call. The higher rate was driven by corporate transactions, including the refinancing and tender we executed in December. The combined effect reduced income in higher tax jurisdictions, resulting in lower utilization of available tax credits. The total tax impact was a reduction of approximately $0.19 to diluted non-GAAP EPS. Fully diluted EPS was $1.72, down 2%, with diluted share count increasing to 810 million shares as a result of the VMware spin. Adjusted EBITDA was $2.7 billion, up 3% at 9.6% of revenue and was $9.7 billion, up 12% for the full year. Our recurring revenue is approximately $5 billion a quarter, up 12%. Our remaining performance obligations, or RPO, is approximately $42 billion, up 20% and includes deferred revenue plus committed contract value not included in deferred revenue. Dell Financial Services originations in Q4 were $2.7 billion, up 12%. DFS ended the quarter with $13.5 billion in total managed assets. Turning to our cash flow and balance sheet. We generated strong cash flow as our cash flow from operations was $3.1 billion in Q4, mainly driven by top line growth and $2.7 billion of adjusted EBITDA. Q4 adjusted free cash flow was $3 billion. We are happy with the disciplined management of our working capital, although we continue to see higher inventory levels given the supply chain dynamics and component availability. We expect inventory balances to come down as the supply chain situation improves over the coming year. We repaid $10.6 billion of debt funded primarily with $9.3 billion in VMware dividend proceeds and retired $1.7 billion in existing long-dated high-coupon notes, funded through $2.25 billion in new bonds and balance sheet cash. The refinancing activity will save approximately $70 million in annual interest expense. We exited Q4 with a core debt balance of $16.1 billion and a cash and investments balance of $11.3 billion. Turning to capital allocation. As we have previously mentioned, we intend to return on average 40% to 60% of our adjusted free cash flow to shareholders over time. We repurchased 11.6 million shares of Class C common stock in Q4, totaling $659 million. And our intent is to continue buying shares going forward programmatically as we manage dilution and opportunistically return capital to shareholders, consistent with our capital allocation framework. Additionally, since the end of Q4 and through the close of business last Friday, we have repurchased an additional 4.2 million shares for $248 million. Program to date, we have repurchased approximately 5.4% of the outstanding Class C common stock. To complement our share repurchase program, our Board has approved a Q1 dividend of $0.33 per share. We expect the cash impact of our quarterly dividend payments to be approximately $1 billion, or roughly $1.32 per share for the full year, and we expect to have the opportunity over time to grow our dividend at least consistent with our long-term EPS growth in each case, subject to future Board approvals. For more details on the dividend announcement, please review today's press release and Form 8-K. Alongside capital return to shareholders, we will continue to invest in the business, deleverage toward our 1.5x gross core leverage goal, and pursue targeted M&A. Before I provide thoughts on Q1 and full-year guidance, I would like to invite Jeff back for a few comments on Ukraine.

Jeff Clarke, CEO

Thanks, Tom. Regarding Ukraine. First and foremost, our thoughts are with those families who have lost loved ones and all who are impacted. Our top priority at this time is supporting our Ukrainian team members as they attempt to relocate to a safe and secure environment. We are closely monitoring the situation and are working with employees to address their personal and family situations. As for business operations in the region, the situation is rapidly evolving, and we will share more details as they become available. Back to you, Tom.

Tom Sweet, CFO

Thanks, Jeff. Turning to Q1 and fiscal year '23. We're optimistic about the overall macroeconomic environment with global IT spending projected in the mid-single digits. Digital transformation is a top priority for our customers, and it's fueling our growth as our customers look to Dell as their partner in their multi-cloud journey. Against that backdrop, we expect Q1 revenue between $24.5 billion and $25.7 billion, up 11% at the midpoint with CSG and ISG growing. For the non-GAAP tax rate, you should assume 20% plus or minus 100 basis points, driven by higher overall U.S. tax on foreign earnings and lower interest expense going forward. This guidance assumes U.S. rates are not affected by any tax reform. And based on my earlier share repurchase commentary, we expect Q1 diluted share count between 785 million to 790 million shares. Netting this out, we expect non-GAAP diluted EPS in the range of $1.25 to $1.50, up 2% at the midpoint. I recognize that our EPS range is slightly wider than normal, but given a more dynamic component availability and logistics environment and elevated backlog, particularly in ISG, I believe it is appropriate. For fiscal year '23, we're coming off a very strong year with record performance in fiscal year '22. As a starting point, we suggest you align fiscal year '23 financial expectations with our long-term value creation framework, and we will provide an updated perspective on the year as we move forward. As a reminder, that's revenue growth in the 3% to 4% range and EPS growth at 6% or better over the long term. We also expect to deliver solid free cash flow and return significant capital back to shareholders with our announced dividend and share buybacks. As we think about Ukraine, I will reiterate that, first and foremost, our thoughts are with everyone who has been impacted, and we are supporting our team members in region as we closely monitor the developing news there. While our direct revenue exposure to Ukraine and Russia is minimal on a percentage basis, it is too early to determine any broader potential impact on our Q1 guidance and our initial thoughts on fiscal year '23. In closing, we delivered an extraordinary year with record revenue, operating income, EPS, and cash flow. We delivered significant shareholder value through the spinoff of VMware, the sale of Boomi, and disciplined and consistent debt paydown, resulting in an investment-grade rating. We also introduced a comprehensive capital allocation framework and began shareholder capital return actions with share buybacks and the announcement of a dividend. We remain focused on executing our strategy to consolidate and modernize our core and build new growth engines that enable our customers' multi-cloud future while delivering revenue and EPS growth with strong free cash flow to our shareholders over time. With that, I'll turn it back to Rob to begin Q&A.

Rob Williams, Head of Investor Relations

Thanks, Tom. Let's go to Q&A. We ask that each participant ask one question. It allows us to get to as many of you as possible. Erica, can you introduce the first question?

Operator, Operator

We'll take our first question from Shannon Cross with Cross Research.

Shannon Cross, Analyst

I would like to know how you are managing price increases in general. Considering the pressures on components and current geopolitical issues, what is your perspective on when we can expect to see the benefits of these price increases reflected in both CSG and ISG? Additionally, do you believe these adjustments will be enough to counterbalance the inflation in component costs, or is there a possibility of experiencing some pushback due to demand elasticity at some point?

Tom Sweet, CFO

Shannon, let me chat a little bit about that, then I'll ask Jeff and potentially Chuck to weigh in as well. So look, in general, as you think about the management of price increases, what we have been doing as we see costs that have been moving upward on us, effectively, given the volatility we're seeing particularly in the semiconductor space and the dynamics of when parts are arriving at our various factories, we have been adjusting prices as appropriate. I think part of the dynamic that we're seeing right now, though, is that given the fact that we do have elevated backlog, any price increases you're seeing are generally somewhat muted as you think through the impact to the P&L, given that it's got a flow through backlog. And so to the extent you have elevated backlog, which we clearly do in ISG and we're at the upper end of what we would characterize as the new normal in CSG, that's going to be a bit of a headwind in terms of the pricing activities ultimately manifesting themselves in the P&L. But our perspective is, look, to adjust prices as appropriate, we're always mindful of the market dynamic, to your point around elasticity, but we're also in an inflationary environment, which we're in, and we see that across multiple industries as you would all know, it's appropriate that we readjust pricing and make sure that we're getting appropriate value for our solutions. Jeff or Chuck, I don't know if you would add anything to that?

Jeff Clarke, CEO

Maybe a couple of comments, Shannon. One is, as we look at total input costs, we just went through an inflationary period in Q4. We think component costs go down slightly in Q1, offset by a flat to probably slightly increasing logistics costs to move material around to the factories when they're delivered. So one of our biggest challenges that we've been working through is chasing those costs that are associated with the volatility, the uncertainty of when parts show up out of factories that we can move them to our subassembly facilities and turn them all into finished products. And it's that volatility, if you will, or uncertainty that we're certainly is catching us a little bit, maybe surprise. We didn't see as much expedites of moving material around, which led to some of the compression margin that we've talked about. And so it's that precise thing that we're trying to get even more accurate about. When you look at the pricing environment that we're operating in today, as costs go up, it's being transferred into price, whether that's commercial PCs, whether that's the premium consumer side of our business, we're seeing the same thing broadly across the server base, and the same is true in our storage base. So that cost is being transferred into price as efficiently as we can, where we understand it and it could be planful and mindful. It's that volatility and uncertainty that cannot be planned for, and we're responding as fast as we can. And the higher levels of backlog, it's less efficient at capturing it. I hope that helped.

Operator, Operator

We'll take our next question from David Vogt with UBS.

David Vogt, Analyst

So just maybe when we think about the context of the full year from a demand perspective and all of the different moving pieces from a supply chain, I think Tom, Jeff, and Chuck all mentioned in the second half of the year is at the early, so we're going to see some improvement. Is that what sort of underpinning sort of the long-term framework sort of reiteration that we're thinking about? And if so, is there a way to quantify potentially what that revenue impact is from supply chain right now? I know it's sort of a difficult question to answer, but just trying to get a sense for how revenue is being held back by the supply chain at this point?

Tom Sweet, CFO

David, you need to consider it in that way. As we look at the current year, I want to emphasize that we are positive about the demand environment based on our current understanding. We anticipate the guidance I provided regarding Q1 revenue, which includes an approximate 11% growth year-over-year. We will continue navigating the supply chain issues, especially in ISG, where we foresee some challenges persisting at least through the first half of the year. It's important to consider how the sequential trends will play out throughout the year, starting with the long-term framework we presented. As we gain more clarity on the logistics and supply chain dynamics, we will keep you updated. Additionally, while we have mentioned that ISG backlog is elevated, we do foresee some challenges in the CSG sector for Q1, particularly regarding desktops due to component shortages. This will guide our approach as we progress through the first quarter and likely into the first half, but we remain optimistic for the year. As you adjust your models, remember that the concept of normal sequential trends may not apply as it has been a few years since we've experienced such variability. Overall, we are optimistic about our full-year outlook as it stands today.

Operator, Operator

We'll take our next question from Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Jeff, you mentioned that growth in commercial PC and premium consumer segments is expected to continue into fiscal '23. I'm curious about your perspective on this growth and your level of concern regarding inventory levels. You mentioned that the CSG backlog is projected to improve in the near term. Additionally, any insights you can share on how you view ASP trends, considering the changes in the commodity environment, would be appreciated.

Jeff Clarke, CEO

Sure, Wamsi. I think that was three different questions. I'll try to get to all of them. So first off, if we step back and we look at the environment, we've just gone through three consecutive years of growth getting the PC industry back to roughly 350 million units, and the total addressable market we believe has been reset. And if you look at where a large percentage of that growth has come from, it's come from commercial PCs and consumer PCs, generally an area that we're very strong in, commercial PCs represent roughly 75% of our revenues. Our view is those two premium sectors continue to grow. In calendar '22 or fiscal '23, we have commercial PCs growing mid-single digits, and we have premium consumer PCs growing low single digits. We obviously expect to take share on top of those numbers. Where the pressure will be is in low-end and mid-consumer price bands and in Chrome. You've heard us probably talk about this not all units are created equal. Some units are more valuable than others, and we believe we play in the most valuable space, commercial PCs and premium consumer PCs. So we're optimistic that we grow those valuable sectors, so the market grows in those valuable sectors, and we can continue to be a consolidator there. If we look at the ASP trends, the ASP trends have continued to move up as the commodity base has been inflationary. And then clearly, what I mentioned earlier, the increased cost in moving material, moving parts associated with logistics costs have certainly driven a pricing action as well. The pricing environment that we see today that I mentioned a little bit earlier, is there is pressure as inventory levels come back to normal on mid-range to low end consumer price bands and into Chrome. We still see challenges in getting all of the material for the premium price points in consumer and in commercial. So that's why Tom just made a reference to, for example, in desktops and displays, we actually see backlog building demand ahead of supply, if you will, in Q1, as we've spent the last two quarters reducing the backlog of our PC business. And in terms of absolute inventory, we've continued to take material we know that we need because if you don't take it, it's going somewhere else. That environment largely exists in the most valuable commodities. I think I got all those answered.

Operator, Operator

Your next question comes from the line of Toni Sacconaghi with Bernstein.

Toni Sacconaghi, Analyst

It's Toni Sacconaghi. I've had my last name messed up a lot but not my first name. Thanks for taking the question. I wanted to delve deeper into the guidance. In Q1, you're expecting a decline of about 11% sequentially; typically, the average over the last five years has been a decrease of 8%. It sounds like you're planning to build backlog in PCs. Are you also expecting an increase in your ISG backlog, or is it just related to PCs? Moreover, considering your guidance for 11% growth in Q1 and the usual seasonality in Q2, it suggests negative growth in the second half of the year. It seems like ISG will strengthen throughout the year, which could imply significant negative growth in PCs overall. Is that the message you intend to convey, or is there something I'm missing in my reasoning?

Tom Sweet, CFO

Yes. Look, I don't think we see negative growth in PCs overall, Toni. And I think...

Operator, Operator

We'll take our next question from Jim Suva with Citigroup.

Jim Suva, Analyst

I just have one question. And that is you commented on your prepared comments about assessing the Western Digital situation. I just wanted to get some color. I assume it's not that you got some contaminated bad drives out into your inventory and into the system. I assume it has more to do with supply availability and maybe even pricing. Is that right? And I assume you have more than one supplier for that and kind of what you meant by those commentaries for various outcomes?

Jeff Clarke, CEO

Happy to answer, Jim. Yes, we have multiple partners in NAND and SSDs for both client and enterprise class products. The reference I made was regarding the announcement by Kioxia and Western Digital about contamination in their factories, which means the products currently there are affected. In the future, this will likely create a supply gap. Typically, when there’s a supply shortage of a highly demanded commodity, pricing pressure arises. We want to communicate that there is a significant uncertainty because those two companies represent a large portion of output, which is now at risk due to the contamination issues. This will impact supply in the future, and we just want to signal that moving forward. I hope that answers your question. That was great color.

Operator, Operator

We'll take our next question from Simon Leopold with Raymond James.

Simon Leopold, Analyst

You've made this comment about having drawn down some of the backlog in PCs but then expecting backlog to build after the quarter. And I guess I'm trying to really split hairs a bit and understand is the rebuild of a backlog, is it the result of demand or supply constraints, or a combination you could unpack what's leading to backlog rising again.

Jeff Clarke, CEO

Do you want me to take that one, Tom?

Tom Sweet, CFO

Why don’t you start, Jeff? And I'll jump.

Jeff Clarke, CEO

If we look at each of the categories, what we're signaling is the semiconductor shortage that we've been talking about for a long time persists. Trailing nodes, whether it be a 40-nanometer node, a 55-nanometer node, 60-nanometer node, et cetera, a plethora of parts that go across all our devices continue to be in short supply. The output of that supply is nonlinear, meaning that sometimes it comes and sometimes it doesn't; sometimes it shows up on time, sometimes it's delayed. Working through that and taking advantage of our assembly capacity is ultimately the challenge and timing and the optimization that we're running through. So what we're signaling is that semiconductor shortage continues to hit our CSG product, most notably in our high-end display business and desktops, as Tom called out. And demand we see continuing, and our supply is short of that demand, hence the backlog growth. On the server side, same sort of thing with network controllers and microcontrollers and power ICs. Those have been the ones that I've called out in the past. They continue to be in short supply, and demand is ahead of that supply, hence the backlog build. And then a very similar trend, which we saw in Q4, we believe continues through the first half of this year, which is in storage, notably around the FPGAs and CPLDs all of the high-speed programmable logic devices that are in those controllers that we need, again, demand ahead of supply backlog build. So that's what we're signaling. We're signaling, I think in Chuck's remarks and my remarks, growth in our businesses, but it's challenged with the supply.

Operator, Operator

We'll take our next question from Amit Daryanani with Evercore.

Amit Daryanani, Analyst

Question. I guess I have one as well. If I think about the EPS growth in fiscal '22 and you talk about a long-term framework of 6% EPS growth. How does that break up, you think, in '23 between stock buybacks versus operating profit dollar growth? And maybe on the operating profit dollar growth you can just talk about, do you see CSG and ISG margins going up in '23? Or what other puts and takes there that would be helpful.

Tom Sweet, CFO

Yes, Amit, regarding the EPS growth we discussed, which is over 6%, consider this: when we introduced our capital allocation framework allocating 40% to 60% of shareholder returns through share buybacks and dividends, we have been implementing that. We are using the share buyback program primarily to manage dilution from our long-term incentive programs and the dilution associated with the VMware acquisition. Moving forward, for our Q1 guidance, we expect our share count to be approximately 785 million to 790 million shares from an EPS perspective. While I won't project our share buyback, we will be deliberate in how we approach it. Concerning operating profit margin, on an annual basis, we've consistently been around 7.7 to 7.8 over recent years, and I believe we will be in that range for the year. I won't provide guidance on operating margins by business segment, but it’s noteworthy that as we continue to drive demand for storage, there is potential for operating margin expansion in our ISG segment. Recently, the CSG segment has shown strong operating margins, although historically those margins have been weaker. This year may see some variability due to supply chain issues, changes in business mix, and demand dynamics, but overall, we anticipate reasonable profitability.

Operator, Operator

We'll take our next question from Rod Hall with Goldman Sachs.

Rod Hall, Analyst

I just wanted to ask about the implied margin trajectory into fiscal Q1 in the guidance. It looks like you're guiding at least down at the EBIT level, that margin down a little bit. And I wonder whether or at least you'd be willing to say that that's kind of where you see the bottom on margins? Or do you think there's potential for margins to deteriorate further? And then I have a follow-up to that.

Tom Sweet, CFO

Rod, as we consider our guidance for Q1, I want to walk you through the P&L a bit. We provided a revenue range of $24.5 billion to $25.7 billion, and we've indicated a tax rate of 20%. I've also shared our expectations for operating expenses for the year. In Q1, we anticipate operating expenses will increase from 14.7% by about 40 to 50 basis points as the year progresses. Regarding EPS, given the tax rate, I think it’s essential to briefly discuss interest and other charges. If you extrapolate Q4’s results, considering our debt repayment, we are looking at approximately $1.3 billion in interest and other charges. We plan to focus on reducing debt throughout the year, moving from a leverage ratio of 1.8x down to 1.5x, which will involve some debt repayment. Since we don't have any prepayable debt left, this will likely incur a make-whole premium, which we estimate to be around $150 million to $200 million for the year. Putting all these factors together, we expect an operating or gross margin in Q1 to be slightly higher than what we saw at the end of Q4, based on our current view of the business mix. That's generally our outlook for Q1.

Rob Williams, Head of Investor Relations

I'm going to try and keep moving here just in the interest of folks getting on the call for a question. So I appreciate your question.

Operator, Operator

We'll take our next question from Samik Chatterjee with JPMorgan.

Samik Chatterjee, Analyst

My question was really on the VMware relationship or the reseller relationship here. If I'm doing my math right, it does look like the revenue is translating to the profit line roughly an operating loss in the quarter of about $70 million or so. So I just wanted to check if I'm doing the math right there. And if that's the quarterly run rate we should be assuming going forward? Or is there some seasonality to that we should be mindful of? And certainly, how to think about sort of getting that back to a positive run rate in the future, what time period we should be thinking about?

Tom Sweet, CFO

Yes, the total from that other business is $70 million, which includes primarily VMware Resell, as well as Virtustream and SecureWorks. Over the past five years, we've been focused on growing our business and relationship with VMware. We've increased the contribution from VMware revenue at Dell to around the mid-30% range of VMware's total. As previously mentioned, our main goal has been increasing the velocity of VMware in terms of driving revenue and margin through VMware solution capabilities. With the VMware spin-off, we have work to do regarding pricing and navigating the complexities of the last five years of our relationships and contracts with customers. We are concentrating on adjusting pricing and processes over time, and it will take a while to impact the operating loss you're observing, which primarily stems from the VMware Resell dynamics. I anticipate it will be at least a 24-month journey to make progress in this area. However, I see it as an opportunity for improvement and better profitability over time, although it will require effort.

Operator, Operator

We'll take our next question from Krish Sankar with Cowen and Co.

Krish Sankar, Analyst

My question is more about the forecast. I think Jeff, or Tom or Chuck, you mentioned about 3% to 4% revenue growth. And given the fact that demand is exceeding supply, supply constraint and you kind of missed the gross margin numbers. Kind of curious, like Dell has historically been known for excellent inventory management. So how much of the demand forecast is actually tied to supply? And could supply concerns impact your demand forecast at this point?

Tom Sweet, CFO

I think supply is currently limited. Our focus is on collaborating with our sales team and customers to capture demand and ensure we sell configurations we know we can support with available components. The team has been effective in this regard. Considering our model is about 50% direct sales and 50% through channels, we have the ability to influence demand. However, there are industry-wide supply constraints affecting us and leading to additional costs, as mentioned by Jeff, due to delays in the logistics chain and the need to relocate products. This has put some pressure on our gross margin, which was evident in Q4. We are adjusting our pricing strategy in light of this situation. Pricing effectiveness can be challenging when backlog levels are high, but as we work through our backlog, that pricing will appear in our profit and loss statements. Overall, we anticipate that gross margin will gradually increase over the year, though not quickly, and there is still work needed to achieve that.

Jeff Clarke, CEO

Tom, maybe in addition to that is, look, we spent the quarter looking at the part profile and optimizing shipments, taking care of our customers and the commitments we gave to our customers. We know we incurred incremental cost to do that. There's no question. And we were chasing cost with price and with backlog building demand ahead of supply, if you will, we didn't catch it. But we know we made the right decision in the best long-term interest of the company by serving our customers. Our business, our Dell model will work through this. This is what our supply chain team does. Our model is differentiated. We believe the purest demand signal in the marketplace. We transmit that to our supply chain quicker and better than most in the industry. We're capable of demand shaping with our direct selling model, and our product leverage and product development model allows us to move and qualify more material, which is what we've been doing. I think we've navigated the last two years quite well as much as we may be saying backlog wins or headwinds in front of us, our supply chain team loves this stuff. This is what they do, and we're going to serve our customers, and we will find a way to overcome.

Operator, Operator

We'll take our next question from Aaron Rakers with Wells Fargo.

Aaron Rakers, Analyst

I wanted to ask a little bit about backlog. I know in the slide deck, you talked about, I think it was $41 billion or $42 billion of remaining performance obligations. And if I look at that number, last quarter, I think you actually disclosed that that was 36 billion, but today you're disclosing that was 41. So I guess I'm curious about what the difference is, if there's a change in the accounting of that. And then when I look at that, that difference of that RPO relative to deferred, that $14 billion, that's up from $9.4 billion a year ago, is that how we should think about the backlog that you've built? And do you think that you exit this next year at a more normalized backlog level? And what would that maybe look like?

Tom Sweet, CFO

Well, hey Aaron, it's Tom. Regarding RPO, looking at the Q3 backlog, our RPO was $41 billion and it increased to $42 billion. As we discussed, the backlog build was quite significant at the end of Q3. In Q4, we actually managed to reduce the backlog in our client base while increasing it in the ISG space. As you might expect, those businesses have different margin profiles, which affected the Q4 gross margin and profitability reported in the P&L. In the RPO, we have a combination of backlog changes, a deferred revenue component, and long-term contracts that have not yet been recognized in deferred revenue but still have performance obligations remaining. There are various types of services and capabilities included in that. We can delve into this further if that would be beneficial.

Rob Williams, Head of Investor Relations

Erica, let's give one last question then here to our newest lead analyst in the space who joined a little late here.

Operator, Operator

We'll take our final question from Eric Woodridge of Morgan Stanley.

[Unidentified Analyst], Analyst

I appreciate it, guys. Maybe I'll just end the Q&A with a question on cash flow, right? Maybe how should we think about cash flow growth tracking relative to operating your net income next year? I realize you don't guide to it, but just any qualitative or quantitative thoughts that you can share there? And then any specific puts and takes we should be thinking about as we go through the year, either on a seasonal basis or just overall for the year? But that's it for me.

Tom Sweet, CFO

Yes, Eric, welcome. As we consider cash flow, we don't provide specific guidance on it. However, if you recall our long-term financial framework, we aim for adjusted free cash flow to be at least 100% or more of net income. This trend appears to remain consistent. Historically, our ratios have been around 1.1 to 1.3 over the past several years, which could serve as a reasonable estimate for the upcoming year. We do see seasonal patterns in our cash flow; typically, Q1 is our weakest quarter, while Q2 and Q4 tend to be our strongest due to the seasonal revenue patterns. Q3 has usually been a bit softer. These patterns have evolved in recent years due to changing demand and the effects of the pandemic. That said, we are confident in our ability to generate cash flow. Over the last four years, we have averaged a 9% compound annual growth rate in adjusted free cash flow, while revenue has grown at a 6% CAGR and EPS has increased at a 16% CAGR. Our cash flow generation is strong, and the team has done well in managing the balance sheet with discipline. Overall, I feel positive about our cash flow generation. Tyler, do you have anything to add on this?

Tyler Johnson, Analyst

I think you gave a pretty good overview. So no, Tom, nothing to add.

Tom Sweet, CFO

All right. Thanks, everyone. We'll see you in two weeks in Morgan Stanley in San Francisco and Raymond James in Orlando and look for information from us on a technology-based discussion from Dell Technology World in early May. That wraps it. Talk to you soon.

Operator, Operator

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