Cutbacks in computer buying chopped Dell's fourth-quarter profits nearly in half from a year earlier. But investors lifted the PC maker's stock in extended trading after the dour news was released on Feb. 26, amid optimism that aggressive cost-cutting will make Dell more competitive once the economy recovers.
Dell (DELL) sales fell 16%, and net income dropped 48% during the quarter ended Jan. 30, numbers that missed Wall Street's already-reduced expectations. Yet Dell said it plans to slice an additional $1 billion a year out of its annual expenses within two years, accelerating an existing cost-cutting plan and heartening investors who want Dell to compete more effectively with its chief rivals, Hewlett-Packard (HPQ) and Apple (AAPL). "The way we're running the business is around operating income and cash flow," CEO Michael Dell said during a conference call with analysts.
Investors are buying Dell shares on the hope that slimming down now will leave the company in good stead when the economy recovers and buyers open their wallets, says Avi Cohen, head of research at Avian Securities. "As you buy the stock today, you're buying recovery potential," he says. "Stocks haven't been moving based on what the reported numbers are. They're much more sensitive to general economic numbers and the health of a company's business going forward."
Worst PC Market in Years
Shares of Dell rose 15¢, or 1.8%, in extended trading, erasing the earlier decline that left the stock at 8.21 when markets closed. The shares have slumped almost 20% in 2009, and have lost more than two-thirds of their value in the past six months.
Dell and other computer makers are facing the worst PC market in years. HP on Feb. 18 reported a 19% drop in PC sales for the quarter that ended Jan. 31. Sanford C. Bernstein analyst Tony Sacconaghi said in a Feb. 24 research note that he now expects PC sales to decline 7.3% this year, compared with a previous forecast of 4.9% growth. Sales of servers that run Web sites and corporate networks have weakened as well.
As companies and consumers cut back on computer buying, Dell is taking an even bigger ax to costs. The company reduced operating expenses by 16%, or $363 million, in the quarter. That's faster than the 11% decline in Dell's third quarter.
More Aggressive Cost-Cutting
Chief Financial Officer Brian Gladden told analysts Dell now expects to reduce its annual expenses by $4 billion a year by January 2011, a steeper reduction than its previous goal of $3 billion. Dell has eliminated 9,300 jobs in the past year, and Gladden said more "streamlining the organization" is on tap. But he also said Dell is reducing the cost of the components that make up its products; its average cost per computer has fallen by 5% in the past year.
Manufacturing is getting cheaper, too. A quarter of the company's output now comes through contract manufacturers rather than Dell's own, more expensive factories. During the quarter, Dell announced it would close a factory in Limerick, Ireland, and move that site's production to Poland, eliminating 1,900 jobs.
It's unclear whether the cutbacks will be enough to revive a stalled turnaround effort at the company. Dell's share of PC unit sales fell to 13.7% during the fourth quarter, while chief competitor Hewlett-Packard's share grew to 19.6%, market researcher IDC said. On Dec. 31, Dell reorganized its management team, announcing the departures of operations chief Mike Cannon and chief marketing officer Mark Jarvis.
Gross Margins Contracting/leadin> The fourth-quarter results showed a business that's contracting on several fronts. Net income fell to $351 million, or 18¢ a share, and sales declined to $13.43 billion. Gross margins for the fourth quarter were 17.2%, compared with 18.8% a year ago.
Analysts had expected Dell to earn 26¢ a share on sales of $14.18 billion, and several cut their estimates for Dell ahead of the report. "Everybody was expecting the worst," says Avian analyst Cohen.
During the fourth quarter, Dell's commercial business in North and South America declined 17%, to $6 billion, and sales to business customers in Europe, the Middle East, and Africa were down 17%, to $3 billion. Sales in the once fast-growing markets of India, China, Russia, and Brazil declined 23%, Gladden said. CEO Dell said the company expects the release of Microsoft's Windows 7 operating system, expected later this year or in early 2010, to invigorate corporate PC buying, but that many customers are holding off until then. "We're starting to get pretty excited about Windows 7 and believe it will be an important catalyst for growth," he said.
Consumers Moving Down Market
Things were no better on the consumer side of Dell's business, where sales declined 7%, to $3 billion, despite an 18% increase in unit shipments as shoppers chose lower-priced desktops and laptops. In an effort to place its products where consumers want to buy them, direct-sales-oriented Dell has been selling its machines in more stores, and the company is emphasizing desktops and laptops printed with artsy graphics and forged from more expensive materials.
Still, many consumers are moving down market. Intel (INTC) CEO Paul Otellini said at a Feb. 25 conference in San Francisco that the popular mini laptops called netbooks are the "only bright spot of growth in the PC industry." But they also sell for $300 to $400—less than full-fledged portables.
Recent efforts by Dell to expand beyond PCs into consumer electronics like cell phones and music players haven't yet borne fruit, either. Dell needs a hit outside PCs, says Richard Shim, an analyst at IDC. "They really need to be a pioneer in a product category," he says. "They've always been a strong follower."
Dell lacks the large consulting services and printers businesses that HP has used to buffer itself from the deteriorating PC market. And it's less diversified in its products than Apple, which sells the hit iPod and iPhone. So for now, Dell is running one of its few effective plays, paring more costs from its operations. "We can and will continue to rapidly adjust our cost structure," CFO Gladden said.