Dell (DELL)

Third Quarter 2009 Results

On November 20, 2008, Dell released results for the third quarter of fiscal year 2009, ended October 31, 2008. Revenue for the quarter was $15,162 million, below our $16,000 million estimate, and 3.1% below the $15,646 million reported in the third quarter of fiscal 2008. The year-over-year revenue decline was on a 3.0% increase in units. Although revenue was lower-than-expected, EPS of $0.37 during the quarter were above our estimate of $0.31 as well as above $0.34 reported in the year-ago quarter. Gross margin for the quarter was 18.8%, above our 16.7% estimate as well as above 18.5% reported in the third quarter of 2008. In addition, operating expenses fell to 12.1% of revenue, below our estimate of 12.2% and 13.2% in the year-ago quarter. This translated into operating margin of 6.7% versus 5.3% in the year-ago quarter. The improvement in operating margin during the quarter was driven by increased gross margin, which benefited from an improved mix of products and services, lower component costs, and continued progress on cost-reduction initiatives announced in April. The company reduced headcount to 80,800 in the quarter from 89,100 in the year-ago quarter.

By business unit, Asia-Pacific and Japan Commercial (APJ Commercial) posted revenue growth of 1.6% year-over-year to $1,818 million on unit shipment growth of 15.0%, and operating income was $123 million, up 61.8% year-over-year. Performance was aided by strong double-digit unit growth in emerging countries. In EMEA Commercial, revenue fell 5.1% year-over-year to $3,272 million on flat unit shipments. Operating income was $116 million, down from $211 million reported in the year-ago period. In Americas Commercial, revenue fell 7.7% to $7,229 million on the basis of a 14.0% decline in units. Operating profit was $763 million compared to $663 million in the year-ago period. Revenues in Global Consumer were up 10.5% year-over-year to $2,843 million on unit growth of 32.0%, led by continued success in the global retail channel and a more diversified product portfolio. Operating income was $112 million versus a loss of $24 million in the year-ago quarter. The improvement in profitability year-over-year was driven by a 24.0% reduction in operating expense dollars along with lower product and component costs. Revenue for the quarter from outside the U.S. was 48.0% of Dell's total revenue. For the BRIC countries of Brazil, Russia, India and China, revenue increased 20.0% and shipments 43.0%. They accounted for 9.0% of Dell's global revenue.

Global industry demand in the quarter slowed through October, adversely affecting the company's cash conversion cycle, which ended at negative 25 days, and resulted in negative cash flow from operations of $86 million. This compares to cash conversion cycle of negative 29 days and cash generation of $1,108 million in the previous quarter. Days' sales outstanding (DSO) stood at 36 versus 38 in the previous quarter. During the quarter, the company spent $400 million to buy back roughly 21 million shares. The company ended the quarter with $8,572 million in cash and short-term investments versus $9,033 million in the previous quarter. Long-term debt stood at $1,851 million at the end of the quarter versus $1,840 million in the previous quarter. The company has an established commercial paper capacity of $1.5 billion, with $250 million outstanding at the end of the quarter.

Dell did not provide guidance for the fourth quarter of fiscal 2009, but reiterated a cautious outlook. Dell expects weakening in global IT end user demand environment to continue for the foreseeable future. The company will continue to incur costs as it realigns its business to improve competitiveness, reduce headcount in certain areas, and invest in infrastructure, growth opportunities, and acquisitions. On a positive note, Dell continues to benefit from growth in emerging markets and its cost initiatives should benefit its P&L over the long-term. The company's current goal is to reduce its cost structure by about $3 billion annually by fiscal 2011.

New Products/Services

On November 17, 2008, Dell launched the Studio XPS desktop, a premium PC that features the new Hyper-Threading and Turbo Boost technology of Intel's new Core i7 processor. The Studio XPS desktop starts at $949 (without monitor) and can be customized with a variety of complementary high-performance components. The Studio XPS desktop with a Core i7 processor can deliver up to 44.0% faster video editing and encoding, plus outstanding performance on applications like image rendering, photo retouching, and editing. The Studio XPS desktop provides a near about similar performance and features found in full-size high-performance gaming rigs, like the Alienware Area-51 X-58 and the XPS 730x, into a smaller, more compact mini-tower. This technology provides rapid speed increases on demand and results in up to 65.0% performance improvement for the latest multithreaded applications.

On November 17, 2008, Dell announced that it has added two product categories to its laser printer line-up, high-end enterprise laser printers and single-function color laser printers. Two new printers - The Dell 7330dn A3 Laser Printer ($3299) for businesses and the Dell 1230c ($229) for the home office - represent Dell's continued investment to strengthen its laser printing portfolio. Dell is also introducing the 1320c Network Color Laser Printer and the 2330d and 2330dn Laser Printers. The 1320c printer offers networking as a standard for a mere $299 while the 2330d/dn laser printers deliver high-performance printing in a small form factor. All new Dell laser products are Energy Star compliant, and on average, use up to 25 percent less energy than conventional printer models. In addition to Dell's standard Limited Hardware Warranty and services, Dell also offers optional ProSupport Service for Printers. These services can help increase the efficiency of printer installation with extended options ranging from the end-user to IT Administrators.

On November 17, 2008, Dell announced that select configurations of the OptiPlex 760 and 960 desktops, Latitude E6400 and E4300 laptops, and Dell Precision M2400 mobile workstation meet ENERGY STAR 5.0 specifications recently issued by the U.S. Environmental Protection Agency. The company expects that additional systems will meet the requirements in the near future.

On November 13, 2008, Dell introduced eight new tower, blade and rack-mount PowerEdge servers based on the new Quad-Core AMD Opteron processors. The new PowerEdge servers and blades can help customers reduce IT complexity and costs.

On November 11, 2008, Dell unveiled the (PRODUCT) RED artwork for the Dell Studio laptops. This announcement expands on the Dell Art House offerings, and allows users to celebrate their personal style, while supporting The Global Fund's fight against AIDS. The Dell Studio 15 starts at $649 and the Dell Studio 17 starts at $799 these laptops can be personalized with (PRODUCT) RED artwork or Dell's other popular Art House designs by Mike Ming.

On November 3, 2008, Dell announced that it is developing new data de-duplication products as part of its TierDisk family of storage solutions and intends to simplify de-duplication functionality across its storage portfolio. The company expects to begin shipping systems for customers ranging from small-and-medium businesses to large enterprises early next year. Dell is working with industry leaders EMC and Quantum to provide compatibility across brand and product lines. Dell solutions will provide LAN or WAN efficient DR solutions by only replicating and maintaining unique block level data from backup or archive operations within or across sites. Dell will also offer a full range of services to help customers assess, design, and implement a comprehensive de-duplication solution. Dell's Data Management consulting assessment can rapidly identify the data is storage, its age, and its duplication in multiple locations.

On October 30, 2008, Dell announced the XPS One 24 and XPS One 24 (PRODUCT) RED. Available in the U.S. starting at $1,699, the updated design has a 24-inch, edge-to-edge 1080p HD display and premium JBL dual stereo speakers and sub woofer for immersive entertainment experiences. Dell also launched the new www.dell.com/everyday Web site, a one-stop holiday shopping destination for daily deals and personalization ideas.

On October 28, 2008, Dell announced a new line of OptiPlex commercial desktops, Flexible Computing Solutions and service offerings designed to reduce costs throughout the desktop lifecycle. Dell introduced four new platforms - OptiPlex 960, OptiPlex 760, OptiPlex 360, and OptiPlex FX160 (Dell's first thin client). These platforms cut power consumption up to 43.0%, speed serviceability time by more than 40.0% versus competition, and the service-ready desktops turn on a portfolio of services when needed.

On October 26, 2008, Dell introduced the Inspiron Mini 12, a small, easy-to-carry Internet companion. Like its counterpart the Inspiron Mini 9, the Mini 12 is ideal to surf the Web, chat with friends, blog, stream content, upload photos or enjoy online videos, music, and games. The Inspiron Mini 12 is available initially only in Japan through Bic Camera, Kojima, and Sofmap stores and other retail outlets. It will launch online globally by late November with configurations starting under $600 (U.S.). Ubuntu and Windows XP operating systems also will be available before the end of the year.

On October 16, 2008, Dell announced that it has redesigned Vostro desktop line for small businesses, with enhancements such as increased storage and expandability based on ongoing customer feedback. Starting at $319, the Vostro 220, 220s, and 420 are now available in North America and in most of South America, followed by Asia Pacific and Japan, Europe, Middle East and Africa (EMEA), and Brazil. Key improvements include: refined industrial design greater convenience through redesigned optical drive bays increased internal storage capacity with one terabyte hard drives offering up to 4 terabytes of internal storage in the Vostro 420 standard 10/100/1000 Gigabit Ethernet across full line for fast network access and The Vostro 420 high-performance system also offers dual display capability, and more expandability and flexibility with 10 total USB ports and seven total PCI/PCIe expansion slots for more network, sound or graphics cards. The redesigned line also has the latest Intel technology and performance with the Intel G45 Express chipset optional Blu-Ray Disk drives for data storage and video playback PS/2 and serial ports to enable use of older devices and the Vostro 420 offers an eSATA connector to transfer data to an external storage device faster than with USB.

On October 15, 2008, Dell announced that it is selling the Alienware Aurora desktop at 200 stores in the United States and through BestBuy.com.

On October 7, 2008, Dell announced the industry's first integrated disk-to-disk (D2D) based backup and recovery solution, the Dell PowerVault DL2000, that helps customers simplify data protection processes while slashing backup times by up to 52.0% and restore times by up to 77.0% compared to tape. An integrated hardware and software platform, the DL2000 automates and simplifies the setup and management of disk-to-disk backup allowing customers to optimize resources through a tiered storage strategy. The turnkey solution is designed to provide automated storage setup and centralized management to ease all aspects of backup, recovery and de-duplication. Advanced add-on features, such as archive and replication capabilities, can be integrated seamlessly to scale and increase functionality as per business demands. Dell will offer its storage consulting services to help customers better understand their existing storage environments and provide a clear, actionable path for more efficient storage deployments and operations.

On September 24, 2008, Dell announced the global launch of the Studio Desktop and Studio Slim Desktop, the newest additions to Dell's Studio line. With a starting price of $549, these stylishly designed PCs are packed full of entertainment enhancers including standard graphic support for DirectX 10 and optional Blu-ray Disc players and built-in HDMI for easy connections to HDTVs.

On September 24, 208, Dell announced that it will transition all of its new laptop displays to light-emitting diode (LED) in the next 12 months to become the greenest' technology company. Effective December 15, 2008, two-thirds of Dell Latitude E-Family laptops will be shipped with mercury-free LED back lighting as a standard feature. This includes the Latitude E4200, E4300, E6400, E6400 ATG and E6500. Also shipping with LED back lighting as a standard display will be the Dell Precision M2400 and M4400 mobile workstations. In addition to being mercury-free and highly recyclable, LED displays deliver significant energy savings compared to cold cathode fluorescent lamp (CCFL) technology. Dell also estimates that at least 80.0% of its total laptop volume will be delivered with LED as a standard back-lit display by the end of 2009 and 100.0% in 2010.

On September 24, 2008, Dell announced a one of a kind electronic privacy screen on the Latitude E6400 and introduced the M109S on-the-go pocket-sized projector. The company is also offering color across its Latitude mainstream and ultra-portable laptops. Dell also announced its most powerful mobile workstations, the Dell Precision M6400 and M6400 Covet, which are ISV-certified and available in anodized aluminum and vibrant orange (M6400 Covet only). The Dell Precision M6400 starts at $2,599 and is presently available. The M6400 Covet will be available by the end of the year. The systems feature twice the memory and triple the storage of similar systems currently available.

On September 10, 2008, Dell added to its EqualLogic product line a new, highly-scalable array - the PS5500E - and introduced advanced software features, including the EqualLogic Auto-Snapshot Manager/VMware edition to improve data protection for virtual server environments. The PS5500E builds upon Dell's EqualLogic family with 24 TB or 48 TB of raw capacity in a 4U array, which more than doubles the density and triples the capacity of its predecessor model, the PS5000E, with equivalent hard disk drives. With the PS5500E, an EqualLogic SAN can scale up to 576 TB under a single management interface. This new array can be combined in the same SAN group with the existing EqualLogic systems. It provides an ideal solution for consolidating common tiered business data and applications such as file services, moderate I/O email, databases and virtual server environments. It can also be deployed for capacity-intensive near-line storage tiers and for disaster recovery sites.

On September 8, 2008, Dell announced worldwide availability of the latest edition to its growing SMB server portfolio the Dell PowerEdge T100. According to a nine-country survey of small-business owners and decision makers recently conducted by Dell and the International Council for Small Business (ICSB), ensuring the safety of company data and adequate data back-up are two of the three top points and among the most important issues driving IT investments among small businesses worldwide. Starting at $449, the T100 is an ideal first server for businesses looking to build a networked server environment to enhance productivity, flexibility, and security.

On September 4, 2008, Dell unveiled the Inspiron Mini 9, an affordable Internet companion that can be fine-tuned to fit users' specific needs and deeds. With a starting weight of 2.28 lbs, the Inspiron Mini 9 comes with a bright 8.9-inch glossy LED display (1024x600) and large keypads. Dell has teamed up with Box.net to offer web-based file storage, access, and sharing to Inspiron Mini users, including a free Basic plan with 2GB of remote storage space, expandable to 25GB. Dell's Inspiron Mini will include a direct link to a Dell-exclusive home page on Box.net (www.box.net/dell), providing users with an easy way to add incremental online storage space to easily manage their digital lives. Box.net's service requires no software for downloading. With its OpenBox platform, Box.net enables people to edit documents and photos directly from their web-browser and post media to their blog or social networks, further enhancing the mobility and user experience on the Inspiron Mini. Individuals can personalize their Inspiron Mini with choice of colors (Obsidian Black or Alpine White) and interactive experience (optional Windows XP or Ubuntu 8.04 with custom Dell interface to debut soon). The Inspiron Mini with Windows XP Home is available immediately, starting at $399 while Inspiron Mini devices featuring an intuitive Dell-developed custom interface is expected to be available in a few weeks with a starting price of $349.

Reported Sale of Manufacturing Plants

On October 15, 2008, Dell announced the sale of its El Salvador contact center to Stream Global Services as part of company-wide efforts to increase the efficiency of its business and provide better value for customers. Stream is a global outsourcing company headquartered in Boston, Massachusetts, with more than 17,000 employees in 32 locations around the world. Dell will become a customer of Stream, continuing to utilize the El Salvador site for outsourced consumer sales and technical support services.

On September 5, 2008, The Wall Street Journal reported that Dell has approached contract computer manufacturers in recent months with offers to sell the manufacturing plants. The Journal said that Dell could sell most or all of its factories within the next 18 months to cut costs and attain greater profitability. Dell declined comment except to reiterate that the company eyes more outside manufacturing help and plans to expand its use of original design manufacturing (ODM) partnerships over time to deliver products faster and better serve customers in certain segments and geographical areas.

Partnerships

On October 27, 2008, Dell announced that Microsoft Corporation is working with Dell's Data Center Solutions (DCS) division to build-out and power Windows Azure, Microsoft's cloud services platform hosted in Microsoft data centers.

On October 23, 2008, Dell and Universal Music Group (UMG), the world's leading music company, announced a partnership to provide a simple, economic way to rapidly start a digital music library by pre-loading MP3 bundles on select new systems purchased on Dell.com. For the first time, individuals will now be able to select a variety of optional music bundles to be pre-installed on their new PC, creating highly personalized music collections right out of the box. As part of this unique offering, Dell and UMG have created 50 and 100-song music bundles starting at $25, each of which includes a curated selection of MP3s for approximately half of current standard per track pricing. As a result, they offer consumers twice the music for their money.

On October 1, 2008, Dell, Intel, and Motion Computing launched a new service to assess, design, and validate the quality and coverage of wireless networks soon to become the backbone of health care information flow. The new Mobile Point of Care (MPOC) Wireless Assessment service enable health care customers to assess whether their wireless network is reliable or not and can provide 100.0% coverage and 24/7 access to patient information.

On September 23, 2008, Dell and EMC announced expanded support for the Oracle Optimized Warehouse Initiative with a new solution designed to make it easier for companies to implement cost-effective, high-performing, scalable data warehousing. The Oracle Optimized Warehouse for Dell and EMC is built on Dell's next generation of PowerEdge rack-optimized servers and the new EMC CLARiiON CX4, the latest generation of the CLARiiON family of networked storage systems. The CLARiiON CX4, which includes virtual provisioning, flash storage, advanced connectivity and other capabilities, is offered by Dell under the Dell|EMC brand. This new pre-configured, validated Oracle Optimized Warehouse for Dell and EMC adds to the one terabyte solution released last year and greatly enhances the number of terabytes supported. Available through Dell, the Oracle Optimized Warehouse for Dell and EMC brings together Oracle Database Enterprise Edition, Oracle Real Application Clusters (RAC) and Oracle Partitioning with Dell's PowerEdge R900 with four quad-core Intel Xeon 7400 series processors and the Dell|EMC CX4-960 storage array includes virtual provisioning and support for 8-10 terabytes of data.

On September 15, 2008, Dell and Sonic Solutions announced a partnership to make downloading and recording DVD movies easy with the first PC-based Qflix drives. Using an intuitive application, Roxio Venue, movie collectors can search and select from a variety of major Hollywood hits available from CinemaNow, download them on their PC, transfer them to multiple digital devices in their home, and then create a permanent and portable DVD-format copy on Qflix DVD media.

Battery-Replacement Program

On October 30, 2008, Dell updated its battery-replacement program based on additional information that the company has received from lithium-ion battery supplier Sony. The U.S. Consumer Product Safety Commission has announced that certain notebook batteries manufactured by Sony have been recalled and Dell is listed among other system manufacturers in that announcement because it received some affected units, fewer than 300 worldwide. According to Sony, the 300 batteries may present a fire and burn hazard. The battery packs were manufactured by Sony on November 9, 2004 and April 11, 2005 and were shipped shortly thereafter with Latitude and Inspiron laptop systems or as service replacements. Sony has provided additional information to Dell relating to the company's 2006 recall of Sony lithium-ion batteries, expanding the number of potentially affected units by approximately 15,000. Dell has revised its existing recall Web site www.dellbatteryprogram.com to address both issues. Dell has asked customers with affected models to check the site, even if they had previously checked their battery as part of the original recall. Dell will voluntarily replace affected batteries at no charge and does not expect this recall to have a material adverse effect on its results of operations, financial position, or cash flows.

KEY POINTS

Dell has struggled to keep pace with the consumer market due to intense competitive pressure particularly in the low priced desktops and notebook market.

As per Gartner's preliminary forecast for the third calendar quarter of 2008, Dell's market share dropped to 13.6% from 14.1% in the year-ago quarter. Dell once again lost shares to its rival Hewlett-Packard (HP), whose market share rose to 18.4% in the third calendar quarter of 2008.

Enterprise-level capital spending is highly sensitive to changes in the economy. As rapidly deteriorating conditions in the global market weaken demand, many major economies have fallen into recession. With a worldwide economic downturn, IDC projected slowing growth in global technology spending in 2008. In the U.S., growth is expected to slow to 4.0% in 2008 versus 6.0% in 2007. IDC has also slashed its 2009 worldwide IT spending forecast to 2.6% from its previous estimate of 5.9%. In the U.S., it was expecting 4.2% growth, but now IDC has revised that to just 0.9%.

In an effort to remain competitive, Dell has been growing its investment in research and development, which increased 22.5% year-over-year in fiscal 2008.

Although Dell expects to take down its cost structure by about $3 billion annually by fiscal 2011, we believe this will come at the expense of revenue. Dell lacks the product diversity enjoyed by rival HP, who has recently announced that it would exceed analysts' forecasts for its most recent quarter.

Given a weak economic environment, we are lowering our estimates for fiscal 2009 and fiscal 2010.

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