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Dell (DELL -22%) is under pressure today following its Q1 (Apr) earnings report last night. Following six consecutive large EPS beats, Dell surprised investors with just in-line EPS results last night. Revenue was a bright spot as it rose 6.3% yr/yr to $22.24 bln, which was better than expected. This marked Dell's return to yr/yr revenue growth after six consecutive yr/yr declines. Dell saw exceptional growth in servers and a return to growth in its commercial PC business.

• Margins appear to be the main problem in the quarter. That was particularly evident in the Q2 (Jul) guidance, which had upside revs but EPS guidance was well below analyst expectations. That combination usually means weak margins. The silver lining was that Dell raised FY25 EPS and revenue guidance, despite the lackluster Q1 EPS results and weak Q2 EPS guidance.
• Infrastructure Solutions Group (ISG) segment revenue jumped 22% yr/yr to $9.23 bln with 8.0% segment operating margin vs 9.7% last year. Server and networking revenue was a record $5.5 bln, up 42% yr/yr. Server demand was even stronger, with growth across both traditional and AI. AI-optimized server demand increased again sequentially as orders increased to $2.6 bln.
• What really stood out was that AI-optimized shipments were up more than 100% sequentially to $1.7 bln. Dell has now shipped more than $3 bln of AI servers over the last three quarters. Its AI server backlog is $3.8 bln, growing sequentially by $900 mln. Storage demand has stabilized with revs flat yr/yr at $3.76 bln.
• Turning to Client Solutions Group (CSG), segment revenue was flat yr/yr at $11.97 bln with 6.1% op margin vs 7.4% last year. Commercial revenue was $10.2 bln, up 3%, while consumer revenue was $1.8 bln, down 15%. Commercial PC demand has stabilized with demand improving as the quarter progressed. Dell expects commercial PCs to continue to improve as the year progresses.
• Dell also remains optimistic about the coming PC refresh cycle, driven by multiple factors: the PC install base continues to age, Windows 10 will reach end of life later next year, and the industry is making significant advancements in AI-enabled architectures and applications. Dell plans to continue to focus on commercial PCs and the high end of consumer and gaming.
• Margins were the main problem. Non-GAAP gross margin fell to 22.2% from 24.7% a year ago. Dell cited a more competitive pricing environment and a higher AI-optimized server mix. Non-GAAP operating margin declined to 6.6% from 7.6% last year. However, Dell expects operating margin to improve sequentially in Q2, driven by sequential growth in ISG and sequential growth and margin expansion in its storage business.

Overall, investors have gotten used to massive EPS beats with Dell, so this was a wake up call. Given strong demand for its AI-optimized servers and its collaboration with NVDA, investors have been bidding up Dell shares as an NVDA play. We think investor excitement about this business is warranted. However, when you take a step back, it is still a relatively small part of the overall business. Dell also sells traditional servers, networking, storage, commercial and consumer PCs etc. In terms of margins, we saw a pretty big compression in Q1 and you can see this impact on EPS. Also, Dell's comments about a more competitive pricing environment makes us a bit nervous about margins moving forward.