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Executives

Robert Williams - Director of Investor Relations

Brian T. Gladden - Chief Financial Officer and Senior Vice President

Michael S. Dell - Founder, Chairman and Chief Executive Officer

Analysts

Kathryn L. Huberty - Morgan Stanley, Research Division

Steven Milunovich - UBS Investment Bank, Research Division

Mark A Moskowitz - JP Morgan Chase & Co, Research Division

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Shannon S. Cross - Cross Research LLC

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Maynard Joseph Um - Wells Fargo Securities, LLC, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Benjamin A. Reitzes - Barclays Capital, Research Division

Kulbinder Garcha - Crédit Suisse AG, Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

Brian Marshall - ISI Group Inc., Research Division

Chris Whitmore - Deutsche Bank AG, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Dell (DELL) Q2 2013 Earnings Call August 21, 2012 5:00 PM ET

Operator

Good afternoon, and welcome to the Dell Inc. Second Quarter Fiscal Year 2013 Earnings Conference Call. I'd like to inform all participants this call is being recorded at the request of Dell. This broadcast is the copyrighted property of Dell Inc. Any rebroadcast of this information in whole or part without the prior written permission of Dell Inc. is prohibited. As a reminder, Dell is also simulcasting this presentation with slides at www.dell.com/investor. [Operator Instructions] I'd like to turn the call over to Rob Williams, head of Investor Relations. Mr. Williams, you may begin.

Robert Williams

Thanks, Regina. With me today are Michael Dell and Brian Gladden. The web deck, along with our DellShares VLog featuring more insights on our Services business from Steve Schuckenbrock, has been posted to our website, and I encourage you to review them for additional perspective.

Next, I'd also like to remind you that all statements during this call that relate to future results and events are forward-looking statements that are based on current expectations. Actual results and events could differ materially from those projected in the forward-looking statements because of the number of risks and uncertainties, which are discussed in our annual and quarterly SEC filings and in the cautionary statement in our press release and web deck. We assume no obligation to update our forward-looking statements.

Please also note that we will be referring to non-GAAP financial measures, including non-GAAP gross margin, operating expenses, operating income, net income and earnings per share. Historical non-GAAP measures are reconciled to the most directly comparable GAAP measures in the web deck posted in the Investor Relations section at dell.com, in our press release and 8-K filed today. I encourage you to review these documents. Please also note that unless otherwise mentioned, all growth percentages refer to year-over-year progress.

Now I'd like to turn it over to Brian.

Brian T. Gladden

Thanks, Rob. We're executing our strategy to deliver end-to-end solutions with a flexible design point. This helped drive our Enterprise Solutions and Services business to $4.9 billion, up 6% with 14% growth in our server and networking business. ES&S is now over 1/3 of our revenue and over 1/2 of our non-GAAP gross margin.

Year-to-date, we've announced 6 acquisitions and closed 5 of them, all of which will help drive a higher mix of solutions with more predictable revenue and margin streams. In the second quarter, we closed Wyse, the global leader in cloud computing -- cloud client computing, and SonicWALL, a leader in unified threat management and next-generation firewalls. Both are off to a great starts, and their pipelines are up more than 35% sequentially. We're also excited about the pending acquisition of Quest Software, which we expect to close in the second half of the third quarter.

Growth in our ES&S business, good product execution and pricing discipline all contributed to solid profitability and quarter-on-quarter improvements in gross margins. While the client business deteriorated more than we expected, we've maintained gross margins in a challenging macro and competitive environment in this space.

For the quarter, we delivered revenue of $14.5 billion, down 8%. I'll refer to non-GAAP financial measures going forward. Our gross margin was 22.6%, up 60 basis points sequentially, including a benefit of $71 million, or 50 basis points, primarily related to a vendor settlement. Sequentially, OpEx dollars were basically flat at 14.8% of revenue. We continue to aggressively manage G&A and discretionary spending. At the same time, we had a strategic spend approaching $100 million sequentially. This consisted of OpEx from the acquired companies and incremental R&D.

Operating income was $1.1 billion or 7.8% of revenue. Cash flow from operations was $637 million. Our cash conversion cycle of negative 30 days deteriorated by 2 days sequentially, primarily driven by an increase in DSO of 3 days. A key driver of this DSO increase was a shift in mix to more complex ES&S opportunities, where customer terms are typically longer.

Our second quarter tax rate was 17.5%. We spent $400 million in the quarter, repurchased 29 million of Dell stock and ended the quarter with $14.6 billion in cash investments.

Earnings per share of $0.50 declined 7%, up 16% sequentially. In June, we announced that our Board of Directors approved a dividend policy with an expected quarterly rate of $0.08 per share, or $0.32 a share annually, beginning in the third quarter. We're committed to maintaining our disciplined capital allocation program that will increase the distribution of capital to shareholders to 20% to 35% of free cash flow. This program includes our dividend, stock repurchase and strategic investments.

Now I'd like to turn to our global business units. Large Enterprise revenue was down 3%. This business delivered ES&S growth of 9%, including 17% growth in servers and networking, which was offset by declines in the EUC business. Operating income for the business expanded 40 basis points sequentially driven by higher gross margins and OpEx reductions.

Our Public business was down 6% as we did not see the typical seasonal ramp in the state and local government business in the U.S. The softness was driven by continued budgetary challenges. Despite this, we remain disciplined, driving operating income up 150 basis points sequentially. Looking at the third quarter, the U.S. federal business is well positioned for the year end of their fiscal year, which occurs September 30, and we expect to see normal seasonality here.

SMB revenue declined 1%. Similar to Large Enterprise, there was strong ES&S growth of 15%, including 27% growth in services, which was offset by a contracting EUC business. The stronger mix resulted in gross margin expansion and a sequential operating income increase of 50 basis points. This business continues to be a great example of our ability to drive premium growth in strategic areas by providing customers with broad-based solutions that help them efficiently solve their business challenges.

Across the business segments, we're rapidly expanding our channel network to approximately 113,000 partners, with an increasing percentage certified in enterprise solution sales.

The Consumer business was a challenge, down 22% with notebook revenue down 26%. Operating income declined 60 basis points sequentially as the business increased gross margins, but the reduction in OpEx did not keep pace with the decline in revenue. While we held share in key mature markets like the U.S., emerging markets were very competitive with growth occurring predominantly in the low-value space where we have not participated. I'll address this in some more detail later.

Our BRIC revenue was down 15% with Asia-Pacific and Japan down 12%. Within APJ, our ES&S business increased 7%. Despite a challenging demand environment for desktops and notebooks, these are important markets for us, and we see improved growth potential going forward.

Turning to our lines of business. Our server and networking business grew 14%. Servers increased 8%, helped by the success of our 12th generation server line launch. The time-to-market and competitive differentiation of these servers is resulting in higher gross margins than our previous generations and ramped very quickly to over 50% of our mix exiting the quarter. Our networking business continued to gain momentum as our easy-to-manage and high-performing networking solutions are benefiting from the server transition to the 12th generation products.

Dell IP storage was up 6% to $416 million in the quarter. While this is below where we would have liked it, we believe this is roughly in line with the market. We're confident in our portfolio and focused on accelerating growth and improving execution.

As you may have seen in a separate press release this afternoon, we announced that Marius Haas has joined Dell to lead our Enterprise Solutions business. He inherits a business that is growing and in great shape. We want to thank Brad Anderson for his many contributions to Dell over the past 7 years. He spearheaded the development of a world-class server business, built our data center custom solutions business and oversaw the acquisition and integrations of EqualLogic, Compellent and Force10, among other contributions. As a result, Dell now has a portfolio of differentiated intellectual property in servers, storage and networking. Marius is a 20-year industry veteran who brings great business, strategic and operational expertise to Dell, and we're excited to have him on the team.

The Services business continues to deliver solid results. Business grew 3% to $2.1 billion driven by 7% growth in support and deployment and 35% growth in our security business. We're offsetting contraction in desktops and notebooks by selling more in-quarter services and increasing attach rates of our premium offerings. Gross margins increased sequentially for the sixth consecutive quarter as we continued to improve our cost structure and focus on higher-margin areas of the Services landscape. We continue to see very good leading indicators as our new signings were $974 million and $1.8 billion on a trailing 12-month basis. The mix of our second quarter new signings is very encouraging as approximately 2/3 are focused on infrastructure, cloud and security and 1/3 on apps and BPO. We continue to increase the breadth of our vertical capabilities. Many of these new signings are in verticals outside of our traditional areas of strength. Our Services backlog increased 5% with balanced growth in contracted services and extended warranty.

Our third-party server, software and peripheral revenue was down 9% with improved sequential gross margins. This business was impacted by the contraction in desktops and notebooks, combined with the continued pruning of low-value product segments consistent with our strategy.

Our desktop and mobility business was down 14% as we continued to maximize operating income in a challenging environment. Our focus continues to be on mid- and high-value systems, which contracted at an industry level in the second quarter. Our Latitude and OptiPlex products performed well in the commercial space, but we're seeing pressure on Consumer and entry-level corporate products. There's particular softness and pricing pressure in key emerging markets like India and China, as well as Western Europe.

In the quarter, we saw the channel drawing down inventory in anticipation of the Windows 8 launch. We also continued to see discretionary spending directed to alternative mobile devices like tablets and smartphones.

In light of these results and market dynamics, I think it's important to reiterate our client strategy. We're focused on continuing to drive our cost out initiatives to maximize operating income versus unit share [ph]. We'll continue to deliver a strong portfolio of systems targeting the mid and high-value spaces. We've refreshed our Latitude and XPS portfolios with products that are thinner and more powerful. We're building strong capabilities in security and systems management and have an industry-leading position in thin client solutions. And we're positioned to be a leader in addressing the emerging corporate BYOD trend with our current XPS 13, 14 and 15 notebooks and our upcoming tablets and converged devices. In addition, you'll see new Windows 8 Ultrabooks, all-in-one tablets and converged devices in the fourth quarter and headed into next year.

Now I'd like to discuss our outlook. In the third quarter, given the macro environment and soft Consumer business, we expect revenue to be down 2% to 5% sequentially. With the uncertain environment and competitive dynamics, we're lowering our FY '13 EPS outlook to at least $1.70 per share. This incorporates a $0.02 to $0.03 dilutive impact from the pending acquisition of Quest Software. For additional detail on the potential impact of this transaction, please refer to Slide 23 in the web deck.

We expect continued solid growth in Enterprise Solutions, Services and Software, combined with what we think is a realistic view of a challenging end user computing environment in the second half. We expect our full year tax rate to be between 20% and 22%.

Before we take questions, let me close with a few summary points. We're making progress on our strategy, and we'll continue to invest in building end-to-end solutions capabilities. This is a long-term strategy and will take time. In a tough environment, we did a solid job managing the business to optimize the P&L, and this will continue to be our focus.

We remain committed to a disciplined capital allocation program. This has allowed us to increase the amount of cash we're returning to our shareholders in the form of our recently announced dividend and our ongoing stock repurchase program.

Now let me turn it back to Rob.

Robert Williams

Thanks, Brian. Just a quick reminder to limit your questions to one with one follow-up. Regina, can we have our first question?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question will come from the line of Katy Huberty with Morgan Stanley.

Kathryn L. Huberty - Morgan Stanley, Research Division

Given the light PC revenue this quarter, what are your thoughts on whether Win 8 and the new Ultrabook and tablet form factors can actually get the PC market back to positive growth territory? If so, when do you think that happens? When are we back in positive growth? And how aggressively can Dell really participate with those new form factors given the focus on margins over revenue?

Brian T. Gladden

Look, I think we are bullish about the products that we have coming aligned with the Windows 8 launch. I think as you know, our mix of business tends to be more on the commercial side, so there might be a little bit more delay in terms of that having an impact for us as it sort of works its way through the Consumer side of the business. But we would expect, as you head into next year, seeing a bit of a benefit clearly as that works its way through the system and we see those products in the marketplace.

Operator

Our next question will come from the line of Steve Milunovich with UBS.

Steven Milunovich - UBS Investment Bank, Research Division

I wonder if you can give us an update on the sales execution issues that you had last quarter. That didn't seem to come up. And along with that, how your vStart 3-2-1 selling bundling is going.

Brian T. Gladden

Yes, I would say we are seeing progress here. This is not a single quarter sort of benefit that you see from these kinds of changes. It's a broad set of actions that we are still in the process of implementing. You could see some of the elements of the portfolio in the second quarter actually showing some good results here. Clearly, on the Enterprise side, we've seen some of the actions we've taken to improve our execution. So multiple quarter impact, early returns are pretty good, and we continue to make progress there.

Operator

Our next question will come from the line of Mark Moskowitz with JPMorgan.

Mark A Moskowitz - JP Morgan Chase & Co, Research Division

Brian, I just want to get a sense in terms of how investors should think about the cash conversion cycle going forward. The Enterprise Solutions transformation does seem to be taking hold here, and you are showing some progress. So how can it still stay in that negative 30 threshold? Should we start to think about maybe going into the negative 20s instead?

Brian T. Gladden

Yes, Mark, I mean, we've modeled it out, and I would tell you I think it does sort of play out a little bit slower than you would expect as you transition the overall mix of the company. There are some short term -- as you look at the DSO within the quarter, there are some elements of specific transactions with specific customers and a terms mix dynamic that plays out that I think we get back some as we move through the year. And the impact of the mix of the business actually happens over a longer period of time. So we're still comfortable in the low 30s. As you look at the remainder of this year and as we exit the year, we'll give you a bit of an update on that. But I think it's a little bit more gradual than what we saw this quarter.

Operator

Your next question will come from the line of Toni Sacconaghi with Sanford Bernstein.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

I was wondering if you could provide a little more color on some of the pricing environment that you discussed. I look at other PC vendors that reported, like Acer and Lenovo, and we actually saw their gross margins go up sequentially and their share performance be better than yours. So perhaps you can discuss which vendors you think are driving pricing, how you -- what you think is ultimately providing it and how you foresee that going forward. And I have a follow-up, please.

Brian T. Gladden

I think there were clearly pockets where we saw more competitive dynamics. I think we talked about emerging countries and a bit of a move to lower-value products in those markets as a dynamic that played out. So the lower-end, lower-value segments were places where we saw the most aggression and, to be honest with you, we avoided some of that. I think if you look at the notebook business in total for us, that the mix in -- the overall ASP change in the quarter was not that significant. So I don't know that it was a big driver in terms of the overall P&L, but there were pockets of aggressive competitive behavior without getting into specific vendor details. So we're going to continue to watch those as we move forward. And again, where we saw very aggressive pricing behavior, those are places where we did not necessarily participate, and that drives a lot of the revenue dynamics that you saw in the quarter.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

And then secondly, you talked about managing the P&L in a tough environment, and you did a good job on the OpEx side. But relative to your expectations at the beginning of the year, your EPS guidance is dramatically lower. And I guess the question is at what -- is there a trigger point for where you're looking at costs in a much more aggressive way than what you've done year-to-date given your current outlook for EPS relative to, I think what you had hoped to do, at the beginning of the year?

Brian T. Gladden

Yes. Look, I think we've -- what you saw in the quarter was a pretty good balance of being able to invest in the key areas of our growth. We've brought in the acquisitions, we invested incrementally in the Enterprise business, but we were able to manage OpEx in general to about a flat level with some disciplined cost actions on the G&A side as well as really discretionary spending across the portfolio. I don't think you'll see us -- I mean, I think that's the approach that we're going to continue to take, is continue to support funding in the important areas of growth in the business, but, at the same time, being aggressive on the cost reductions that we talked about at the analyst meeting. We're in the midst of really launching a broader program across the business that we think, over the course of the next 2 to 3 years, gets at the $2 billion of costs, as we talked about. And that will have broad implications across OpEx but also COGS [ph].

Operator

Our next question will come from the line of Shannon Cross with Cross Research.

Shannon S. Cross - Cross Research LLC

I just wanted to try to understand, relative to the plan that you put up at the Analyst Day in June where you talked about core -- you could handle a sort of a decline in core Dell of about 5% year-over-year. How do we think about what core Dell was this quarter? I mean, 14%, I think, for client. I'm sure there are some offsets there. And then again, sort of to Toni's question, flexibility in costs and margin and that, I mean, how should we sort of think about this in the context of the plan you put up in June?

Brian T. Gladden

Yes, well, I think you -- Shannon, you have to look at both sides of it. Clearly, on the Enterprise side of the business, we feel pretty good about the progress. And as we look forward and even look at the outlook that we're providing for the total year and the second half, pretty consistent view with what we talked about in terms of that continuing to grow and contributing strong profitability. I think the PC business, and maybe when you talk about that EUC business, which we talked about at the analyst meeting, we had the client business as well as SMP [ph] in that part of the business, the revenue sort of deterioration we saw in the quarter was clearly above anything we expected. And I think that's something that as we think about moving forward, you can't expect that, that business will have that sort of deterioration over a long period of time. We think, as you look at the second half of the year, it's going to be challenging environment for that part of the business, but should stabilize as we come out of that and get Windows 8 sort of in the marketplace. So I think clearly, a little more deterioration there than we expect -- faster than we expected and managed the P&L pretty well given that dynamic that we saw in the quarter.

Shannon S. Cross - Cross Research LLC

Okay, great. And then so second question is on linearity. Can you -- do things get worse in various geos or with various verticals? Any color you can give there?

Brian T. Gladden

Yes. To be honest, I wouldn't call out any linearity in terms of the quarter that was different. I think as you look at the results overall, we were surprised at where the emerging markets showed up in terms of overall revenue, but I wouldn't say that, that was getting worse or better as we exited the quarter. Pretty consistent throughout.

Operator

Next question will come from the line of Brian Alexander with Raymond James.

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

Brian, just to follow up on that Asia down 12%, BRIC revenue down 15% you touched on a little bit earlier, but if you can go into more detail on how much of the change here is market versus market share and how much is client versus Enterprise. It's been a key growth driver for Dell over the last several quarters, so I just wanted to get some more color on the regions.

Brian T. Gladden

Sure. Brian, I would say those markets in general, what we saw there was a challenging consumer dynamics that drove the overall financials. We did see solid performance from the Enterprise side of the business, and the Commercial side of the business was clearly better. So I think it's -- that's clearly what drove it. And when you look at that space in general, we saw demand growth in the market really isolated to the low-value segments of the PC business. And when you look at the mid- to higher-priced or higher-value elements of the portfolio or of the market, they were actually down within the quarter. So that was clearly where we were focused. We didn't participate in the lower-value segments, and that's how you get that sort of a result.

Brian G. Alexander - Raymond James & Associates, Inc., Research Division

Okay. And then just any additional thoughts on Enterprise spend as we head into the second half? I know you had a solid pipeline coming into the quarter. You had some pushouts from last quarter into this quarter. So how did that progress as the quarter went on? And are you expecting a normal flush as we head into Q4?

Michael S. Dell

Yes, this is Michael. The Enterprise demand, obviously in the second quarter, was solid. We think the 12th generation PowerEdge refresh continues to be strong. We're well positioned there. And increasingly, we're changing the sale to be a complete data center sale. So we feel good about that. We think the addition of Windows Server 2012 is going to be an additional catalyst in the second half of the year and feeling good about our portfolio there.

Operator

Your next question will come from the line of Amit Daryanani with RBC Capital Markets.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Just a question maybe on the PC-centric revenues and the level of degradation you saw. I think it was down about 14% between mobility and desktops. Can you just talk about how much of that issue was due to a channel drawdown ahead of Windows 8 versus some of the other issue that may be a bit more secular in nature? And then could you just maybe talk about given Microsoft is launching their own hardware with Surface, how do you think that plays out from your perspective, especially in the Consumer arena?

Brian T. Gladden

Yes. Look, I think as we've talked about, I mean, there clearly were slower growth or negative growth -- more negative growth in the mid- to the higher-value elements of the portfolio, and that's really what, I think in our case, drove some of the -- drove a 14% sort of decline. And a lot more growth in that business, in Consumer specifically, has been at the low end. And our choices to participate or not participate clearly affected the revenue in the quarter. But that's sort of is the dynamic that we see. There's also -- as we said, as you sort of head through the quarter, the second quarter, we began to see the channel begin to push out and try and draw down inventory levels of Windows 7-based product as they move into the fall, which we would expect to be one of the key drivers moving into the third quarter for us. So I think that's the overall framework that we see, and we don't expect a lot of -- there's really not a catalyst that we'd expect some growth in that space in the third quarter. As you think about Microsoft entering the space, clearly, as we think about it, we've spent time talking to Microsoft and understanding sort of how they're thinking about it. There clearly are opportunities for us, as Windows 8 comes through, in having differentiated products. And I think at the same time they have announced the Surface product that would be in the space, we will have products in there, and I think you'll see a diverse set of offerings that take advantage of what Windows 8 brings to market. So I don't know, Michael. Any comments?

Michael S. Dell

Yes, I mean, I think there's been some understanding of the number of units that are likely -- although it's a relatively small percentage, maybe in the 1% to 2% range of total PC units through the middle of next year, certainly with our business being more focused on commercial, centered around the Windows 7 transition, which is still very much under way, I'm feeling very good about the portfolio we have with OptiPlex, Latitude, Precision. The XPS product line is in good shape, and we're ready for Windows 8.

Operator

The next question will come from the line of Maynard Um with Wells Fargo.

Maynard Joseph Um - Wells Fargo Securities, LLC, Research Division

I just want to drive into your revenue decline guidance sequentially. You talked about normal seasonality in U.S. federal. It sounds like generally, ES&S business is doing well, and it also includes some of the Quest revenue. So it looks like the end user computing segment might be seeing a high single-digit decline sequentially. And I'm curious, how much of that is market mix related of the higher-end weakness versus ASP pressure versus you walking away from business? And when or if would you consider adjusting the lower-end markets? And I have a follow-up, if I could.

Brian T. Gladden

Clearly -- I think it's a combination, clearly. I would expect that the market in general will suffer through a bit of this inventory adjustment during the third quarter. I think that's just the reality of a transition like this that we would expect to see. I also would expect that the dynamics around some of the macro environments of the emerging countries and more growth being focused on the lower-value segments versus mid to high is something that we would expect to continue over the next couple of quarters here. So we're being conscious about that and managing the business for profitability, and I think that's why we end up in that sort of a revenue range.

Maynard Joseph Um - Wells Fargo Securities, LLC, Research Division

Okay. And then just given your free cash flow, where your free cash flow was, and then your commitment to share repurchase and dividends, how should we think about your M&A strategy? Should we expect a pause here or maybe more offshore acquisitions? And I'm also curious, just given all of your acquisitions, whether that drives a period of digestion before more consumption.

Brian T. Gladden

Look, I wouldn't say there's a change in the strategy. We'll continue with the framework around capital allocation that we've talked about. Obviously, that is the dividend. We continue to buy back in the quarter. We have done a fair amount of acquisition activity this year. And we're in the process of obviously, hopefully, closing Quest as we enter the second half of the third quarter here, and that's a relatively large acquisition. So there will be some digestion and then execution around the integration of those specific acquisitions. But our growth plans, as we move forward, will continue to be a combination of organic investments and continued inorganic investments.

Operator

Our next question will come from the line of Bill Shope with Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

And digging into your server commentary from earlier in the call a bit more, it looks like you're gaining share in what appears to be a weakening market. Is there any macro conservatism on servers in your second half outlook? Or are you generally assuming that share gains can counter any further macro deterioration in that segment?

Michael S. Dell

I think we're well positioned. We have the #1 position in North America. We were first to market, I mean, first to market with the x86 transition here in the first part of the year. Product line is lining up incredibly well versus others as we do a better job of selling a converged solution, selling storage and networking along with the servers, our blades are getting stronger. We -- we're -- this is the best server line we’ve ever had, and we feel very good about what we have planned for follow-on generations. So also, mobiles are moving to x86. So we're seeing continued shift in our Services business. We've got a very nice pipeline of application migration business that's developing around some of the capabilities that we built in Dell services and other acquisitions, like Make and Clerity, was added to that. So a combination of new workflows, new capabilities, strong product line, I think we're well positioned to grow there.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Okay. And then just as a quick follow-up, hopefully I didn't miss this earlier, but can you give us a quick update on how you're thinking about component prices for the second half? Is it still similar to what you were thinking before?

Brian T. Gladden

Bill, I don't think it's changed much. As I'm sure you know, I mean, the demand environment and some of the weakness in unit volumes, I think, has driven a little bit more deflation into the entire component cost environment, and we're seeing some of that but not dramatically different than what we thought.

Operator

The next question will come from the line of Ben Reitzes with Barclays.

Benjamin A. Reitzes - Barclays Capital, Research Division

I wanted to ask -- my first, I guess, is on Asia and some of the BRIC and growth markets. They were disappointing in the quarter, you mentioned, and you said that the outlook for those markets, well, would improve. I was just wondering why and why you felt that way. And then I have a quick follow-up.

Brian T. Gladden

Well, I think we're looking at sort of the macro forces in those markets, and we don't see in the short term a catalyst that changes that, Ben. I also think this dynamic of moving to lower-value, lower-priced sort of segments and that being the focus of the markets is a trend that I don't see changing over the next couple of quarters here. And as we get sort of into a better, well, hopefully better economic environment heading into next year with a new set of products, new portfolio, including some to address those markets typically, I think we would expect to see better growth.

Benjamin A. Reitzes - Barclays Capital, Research Division

Okay. And then just on storage, we saw a decline of 13%. Obviously, Dell IP was up, but the decline accelerated from the last quarter. And we must be getting to an end of that EMC-related revenue. I was just wondering when you guys thought the storage line would start to grow.

Brian T. Gladden

Well, look, I think we still have a fair amount, I'd say, to overcome next quarter, and then I think it sort of normalizes to something very close to current run rates. Hate to use that as an excuse. And I would tell you the 6% growth that we saw in the quarter was behind what we expected. Well, as we -- that portfolio is in good shape. The businesses are in good shape. We've seen -- overall, I think the pipelines look good. Competitors continue to be generally aggressive in parts of this business, but we would expect to see more growth there. And heading into the second half, the headwinds from that compares on EMC becomes a much smaller issue, and we really don't want to kind of talk about that anymore as we move forward.

Operator

The next question will come from the line of Kulbinder Garcha with Credit Suisse.

Kulbinder Garcha - Crédit Suisse AG, Research Division

I just want to clarify on the server growth that you guys saw. Can you just help us split out unit growth versus ASP increases? And in terms of this new server cycle that you guys speak about, can you give us any sense as to how significantly more gross margin accretive it is than the previous cycle? Then the question I have for, I guess, Brian, is on the OpEx point. Just to be clear, you guys spent $100 million more on R&D. Was it incremental R&D spend by you as well as your acquisitions? Or was it just $100 million do you spend more? I just want to understand why is there a question of making money. I thought it was, historically. Have you guys decided to change the OpEx structure in the near term?

Brian T. Gladden

Yes. On the server question, clearly, we've seen higher ASPs on higher-end configurations as we've launched the new products here. And as a result, it's driven expansion in terms of margin rates within the business. The 12G has had higher gross margins, and as that's mixed up to a higher percentage of our servers at higher prices, that's helped the overall profitability in the business. On the OpEx line, specifically on Quest, Kulbinder, it's -- there is a first accounting element that drives the short-term dilution of that business. As you think about the software acquisition, the write-off of the deferred revenue over the first couple of periods of that business ultimately more than offsets the accretion. On a cash flow basis, the business will be accretive really in the first period that we bring it in. So that's really the dynamic that we'll see in the second half of the year for Quest. And speaking about the $100 million, what we did, approximately between -- well, that $75 million is related to the acquisitions and their OpEx spend as you bring them into the portfolio in the quarter, specifically SonicWALL and Wyse being the 2 largest. In addition, we've spent about $30 million incrementally in R&D quarter-on-quarter sequentially around the Enterprise business. So that provides a little more detail.

Operator

Our next question will come from the line of Keith Bachman with Bank of Montréal.

Keith F. Bachman - BMO Capital Markets U.S.

I was hoping to -- if you could talk a bit more about the PC market away from what's in front of you during the current quarter. And broadly speaking, is Windows 8 enough to stimulate the market as you look out in the January and April quarters? Or do you need better economic cycles here? And more specifically for Dell, with Dell having -- or with tablets having a bigger role in the market and Dell having a much rich -- much richer mix of, say, clients -- PC clients versus tablets and consumers driving more of the change of growth rate, how do you see Dell positioned against that backdrop? And I do have a quick follow-up.

Brian T. Gladden

Yes, look, I think as you think about the next 2 quarters, there clearly is the -- what we would see in a typical transition from an operating system. And as our business is more heavily weighted towards the Commercial side of the business, we still continue to feel good about refresh opportunity. Well, I think we've seen data that would suggest only about 50% of that Windows 7 transition is complete, and that'll continue and will continue as we sort of play out over the next several quarters here before anybody really thinks about Windows 8 on the Commercial side. Those areas in the corporate or commercial customer base that are looking at tablets, clearly there is a wait-and-see sort of approach how you think about that playing out in the commercial enterprise. And as Windows 8 as an alternative with a tablet product that can work in the Enterprise as well with security, it's something that we hear a lot our customers talking about and really waiting for. So we would expect that -- that could be a catalyst. And there -- we'll be part of that, and our products are really focused on that part of the market.

Keith F. Bachman - BMO Capital Markets U.S.

Okay. And Brian, could you just speak to server and networking growth, net of acquisitions, in the quarter? It was up 14% year-over-year, and I was just wondering what the M&A impact was.

Brian T. Gladden

I guess I don't have that yet. I would tell you with server growth, it's -- really there's not any M&A impact, was 8% and networking was up 94%. So clearly Force10 had an impact. We can get that for you, Keith.

Operator

Next question will come from the line of Jayson Noland with R.W. Baird.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

I wanted to ask about Enterprise Solutions. Marius is well known and respected but tough to see the guy go that's built that portfolio up over the last few years. And I guess the question is do you expect any change of direction? And what's the resource commitment level given all these new technologies, be it software-defined networking or flash, out there?

Michael S. Dell

Well, look, I think we've got a great business, and I think we can make it even greater. And I think the reason that the gross margins in that business have been expanding is because we have an increasingly differentiated portfolio of solutions. And our intent is to only drive that more and further, so in time [ph] they’re highlighting or the sorts of things that we would be focused on. Just to also add to some of the prior questions, some of the shifts that are going on the industry are obviously moving workloads into the data center, and we're benefiting from that as well. So that you see more virtual, insert your adjective here, or down here in terms of the client, the network, the security, the storage, et cetera, those are all driving the Enterprise growth for us. So we're going to really make what is a great business today an even larger and more successful business.

Operator

Next question will come from the line of Brian Marshall with ISI Group.

Brian Marshall - ISI Group Inc., Research Division

You had -- you've had good success integrating deals in the past. Obviously, EqualLogic was a home run case. Both -- these were up probably anywhere from 5 to 10x in a few years after you acquired them. But obviously, you had the reinvestment business. I think the case in point recently was Compellent up 100% sequentially the first quarter you guys acquired it, but you’re invested. So I guess the question is, can you help us think about how we should think your revenue grows from some of the new deals like Quest and SonicWALL, Wyse, et cetera, and how that sort of balances out with this level of investment you're going to make on the OpEx side?

Brian T. Gladden

Yes, Brian, almost everything we've done from an acquisition standpoint clearly was a business case that was built around growth. And as part of the business case is we clearly have considered the investment required to accelerate growth and leverage the benefit of our sales capacity and customer relationships across the portfolio. So I think you'll continue to see more of that, and we will make the necessary investments as part of the deal structure, as part of the deal models, to drive that growth as part of the strategy.

Michael S. Dell

One of the other things we're finding is that many of these software acquisitions actually pull a lot of infrastructure. So if -- for example, when you think about we some time ago acquired a company called AppAssure, to -- which was already growing very fast in the backup, recovery, replication, high-availability space, and it turns out that a lot of customers are deploying unique server and storage environments for AppAssure. And so you're going to see us leverage our infrastructure strength with our emerging software capabilities as we complete the Quest acquisition to drive even further growth there.

Brian Marshall - ISI Group Inc., Research Division

Mike, was there a real summary -- think of that ratio like $1 software maybe pull forward $3 or $5 of hardware in that instance?

Michael S. Dell

That sounds good, but I don't have a particular rule that I'm ready to give you today about that. I think your mileage could vary dramatically depending on the type of solution. But certainly, we have a broad set of capabilities across services, security, software, enterprise, all manner of client devices. And so we're able to bring a much fuller suite of solutions and capture a much larger share of the opportunity.

Operator

Our next question will come from the line of Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank AG, Research Division

I wanted to ask about the demand trends you're seeing in the corporate client business. It looked awfully weak to me, yet you didn't really call it out as an area of weakness. For example, back-in-the-envelope SMB clients looked like they were down mid-teens, public down double digit. Why are you seeing such soft demand in corporate client given your comments around Windows 7? Just help us understand that.

Brian T. Gladden

Yes, I would say, Chris, that as you think about that, there has been a bit of a pause. I think as you think about corporate budgets and IT spending, the discretionary spending has been, to some extent, put on a back burner, and some of these -- clearly, these refresh activities have to continue, but there just taking a pause given the current environment and all the uncertainty in the environment. That's just kind of what we're seeing.

Michael S. Dell

Yes. And I'll add to that, Chris. I mean, when you think about the fact that China is down as a -- in total for the country for the first time as far back as I can remember and the declines in APJ in general and in Western Europe, those -- that happened in the commercial accounts as well. And that's a tough one to overcome when you've got a big impact in a region like that. Those are the types of things Brian talked about when you think about those are markets that are likely to snap back once we kind of work through what is a cautious environment. I think a lot of commercial customers are looking at their discretionary spend right now and saying, "Hey, I'm going to put some additional dollars to work in some of these enterprise solutions, but if I've got a decision to make, I might pull back a little bit on some of these client transitions and wait to see how things play out at a macro level." So I think you're seeing a little of that.

Chris Whitmore - Deutsche Bank AG, Research Division

And to follow up, I wanted to follow up on the storage question with the Dell-owned IP business. It looks like your server attach, thinking about Dell-owned IP attached to servers, it looks like it's actually declining. Yet Michael, in your comments, you talked about increasingly winning these whole data center sales. So can you help us understand? Is there a timing issue between the server and storage spend as they’re upgrading server versus storage? Or are you seeing some incremental and competition translate into a decreasing win rate in that storage business?

Michael S. Dell

I think we can definitely do more there. What I'd also tell you is that the line that separates what the server and what the storage is not as clear as it might have been a few years ago. If you look at our 12th generation servers, you'll notice that they have enormous -- huge capacities. And so you're seeing words of mouth. The storage show up inside the server itself. But 12G is certainly strong. Storage was not as strong as we'd like, and there's definitely room to grow that faster.

Operator

The final question will come from the line of Aaron Rakers with Stifel, Nicolaus.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

So one question and one quick follow-up. When we look at your guidance and you look at the various factors impacting the gross margin mix of the business, you talked about potentially more deflationary pricing environment component-wise. Can you help us understand what you're assuming on a growth margin perspective, particularly around the product gross margin, over the next 2 quarters as it relates to those 2 items? Or put another way, are you assuming that a consistent solutions and PC imply gross margin trend?

Brian T. Gladden

Yes. Aaron, obviously, we don't provide specific outlooks for gross margin or OpEx in detail. But I would -- so I'll give you a sense of the drivers and how we're thinking about them and maybe talk about the second quarter and then maybe how it moves forward. Clearly, we got the benefit in the quarter of improved mix. We saw the higher-margin elements in the business grow faster. The Services business has expanded margins, as we said, 6 quarters in a row, and that obviously helps. Given their lower margin -- the Consumer elements of the portfolio which would have the lower margins had the most sort of revenue weakness. The [indiscernible] prices were kind of a push in the quarter. And then as I said, pricing was generally mixed and a headwind in some parts of the business, but in some places, not so much. And I think also, currency in the quarter was a bit of a headwind at the margin line. And as we sort of move prices up around that, we clearly would expect that to be less of an issue as we move forward. So I think those are the dynamics. And as you think about the second half, it's -- I would say a lot of the same dynamics would be what we would expect to continue to play out, so.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then, Brian, if I can, a quick follow-up. In the context of your 20% to 35% spend on dividend and share repo, you also added a comment about strategic investments. I don't know if I misheard that, but I just want to understand. That 20% to 35%, is that specifically just share repurchase and dividend? Or is there something else that you might be thinking about? Okay.

Brian T. Gladden

Yes. Got it. In the broader capital allocation sort of program that we have, obviously has an element which is continued strategic investments and M&A as part of that, but that's beyond the 20% to 35%. 20% to 35% is for dividends and buyback.

Operator

We'll now turn the call over to Mr. Williams for closing remarks.

Robert Williams

Yes, thanks, Regina. I look forward to seeing everyone. We'll be at the Citi conference. And the week of Labor Day in New York, we'll be at Deutsche in Las Vegas and CLSA in Hong Kong. So we look forward to speaking to everyone over the coming quarter, and thanks for joining us today.

Operator

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

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