Sluggish desktop and laptop sales continue to drag on Dell's profits, but improved margins and increased server and storage sales give investors hope
Dell continues to struggle with sluggish corporate technology spending and a U.S.-centric business that's exposing it to the heart of the global recession. But it reported better-than-expected fiscal second-quarter earnings Aug. 27 as the company made headway into profitable server and storage markets, even as the PC business suffers from bruising price competition.
Investors bid up Dell (DELL) shares after the computer maker reported stronger profit margins, and a mistaken early release of the results led to a wave of buying by Dell investors.
Dell's profits fell 23% and sales declined 22% for its fiscal second quarter ended July 31. Sales of desktop PCs and laptops—Dell's mainstay businesses—fell 33% and 21%, respectively. But revenues from corporate server computers and disk storage machines increased 7%. The prices of consumer and business PCs are falling rapidly, vexing computer makers that have relied on the machines for hefty chunks of their sales.
The results are "about as good as you can expect given the economic backdrop," says Ashok Kumar, analyst with Collins Stewart. "Enterprise improvement is going to be a 2010 story, and consumer sales are stabilizing."
Fewer Discounts, Tighter Budgets
Dell's gross profit margins in the second quarter increased by 1.5% to 18.7% of revenues as the company eschewed especially steep discounts and kept costs in check. Chief Executive Michael Dell said in a statement the company anticipates stronger revenues in the second half of 2009 than it reaped in the first. Wall Street analysts said large companies would increase technology spending next year as well.
There are harbingers of better computer sales on the horizon. Microsoft (MSFT) is scheduled to release its anticipated Windows 7 operating system in October, and the software could spur a spate of PC buying. In a conference call with reporters, Dell Chief Financial Officer Brian Gladden said he expects improvements in sales to consumers in the second half of the year and to corporate customers in 2010. "We're pleased with our financial performance," he said.
Dell is also holding the line on spending and has cut manufacturing costs aggressively. About 70% of Dell's product line now falls under a program to manufacture products less expensively, according to Gladden. Dell's operating costs declined 14% during the quarter, to $1.72 billion.
Mistaken Early Release
Investors were heartened by the results. Dell earned 24¢ per share, beating analysts' consensus estimates by a penny, and shares of Dell rose nearly 3% in extended trading Aug. 27. Shares of Dell had closed up 98¢, or 6.7%, at 15.65 after the stock got a boost from an accidental early release of the earnings report by Dell.
The shares had traded at about 14.60 to 14.70 for most of the day but spiked in price during the final minutes of trading after the second-quarter results were posted to Dell's Web site before the close of the market. Dell's trading volume surged in the last 20 minutes of the session. Asked about the mishap during the conference call, Gladden said the release had been posted early on Dell's Web site by mistake, and that once the error was detected the official press release was issued to wire services immediately.
Dell reported profits of $472 million for the quarter, on revenues of $12.8 billion. Wall Street had expected revenues of $12.59 billion, though Dell had already suppressed expectations at a meeting with analysts July 13, when it said weak corporate demand would mute sales and margins.
Dell's business was led by its server division, where unit shipments grew 12% and revenue increased by 9%. And sales of its EqualLogic storage computers increased 42% from a year ago.
Gross Margin Better Than Expected
Dell's gross margin, a key measure of profitability, was 18.7%, slightly better than analysts had expected. "They needed to print a gross margin of at least 18," says Richard Kugele, an analyst at Needham & Co.. Dell's margin also saw a $69 million one-time benefit resulting from the buyout of a revenue-sharing agreement from an undisclosed vendor. The result added about 50 basis points to Dell's gross margins, Gladden said.
PC industry margins have been under pressure in recent months due to rising prices of components such as hard drives, memory chips, and LCD screens, according to Kugele. The rise in component prices likely won't abate soon. Market research firm iSuppli said in an Aug. 4 report that certain memory chips are in short supply and forecast that the overall price of commodity components will rise again in the third quarter.
Dell's results came less than two weeks after Hewlett-Packard (HPQ) muted hopes that a recovery in technology stocks was soon in the offing when it reported third-quarter earnings on Aug. 18. HP said sales slid more than 2% while quarterly profits fell, and CEO Mark Hurd said the company was "not yet ready to call a turn" in the market despite encouraging signs.
Dell and HP's results appeared to be more of a trailing indicator of PC demand than chipmaker Intel (INTC), which on July 14 reported solid second-quarter results on improving demand for PCs among consumers. However, Intel CEO Paul Otellini said that sales to corporate customers, a sector to which Dell in particular has been exposed, remained weak.
The PC market is slowly coming back to life, but for now Dell is counting on other sectors of its business to buoy sales.