Dell dispensed a dose of reality to investors who hoped tech's worst days were over. The computer maker said May 28 that first-quarter earnings tumbled 63%, and sales dropped 23%. On the heels of a tepid sales forecast from rival Hewlett-Packard last week, Dell's report showed that corporations shied away from buying computers in recent months and that they're holding off on placing new orders.
"We're seeing a big deferral of purchases among corporations," Dell CEO Michael Dell said on a conference call discussing results for the period that ended May 1. It was the second straight quarter of big profit declines at Dell, whose net income dropped 48% in the period that ended Jan. 30. Worse, the company doesn't see prospects for improvement. "We don't believe there's enough momentum to call a bottom yet," added Chief Financial Officer Brian Gladden.
Investors pushed shares of Dell (DELL) higher in extended trading, partly on the hope that companies will replace their aging fleets of PCs next year after Microsoft (MSFT) introduces its Windows 7 operating system, the successor to its poorly received Windows Vista software, which many companies skipped buying.
Shares of Dell have risen almost 35% in the past three months. But further gains may come only when it becomes clearer how quickly businesses will buy new PCs. Sales of desktops and notebooks account for 58% of Dell's sales. "You'll see a lot of bad news continue in the PC world for the time being," says Jayson Noland, a senior analyst at Robert W. Baird, who has a hold rating on Dell's stock. Dell shares had risen 36¢, or 3.2%, to 11.48 on May 28. They added about 1% in extended trading.
Wall Street is getting mixed signals from tech industry bellwethers. HP (HPQ) on May 19 said it expects sales to decline 4% to 5% in fiscal 2009, which ends in October. On the other hand, Intel (INTC) CEO Paul Otellini recently said that demand is returning to normal patterns in the current quarter, and executives at IBM (IBM) and Cisco Systems (CSCO) have said that tech demand had reached a nadir.
Dell's results barely exceeded analysts' earnings forecasts after discounting the cost of severance packages and facilities closures. Net income was $290 million, or 15¢ a share. Excluding 9¢ in restructuring expenses, Dell earned 24¢, vs. Wall Street's expectation of 23¢. Sales were $12.34 billion, vs. expectations of $12.66 billion. A year earlier, Dell earned 38¢ on $16.08 billion in sales.
Losing Share to HP
The pain was spread across Dell's businesses. Desktop computer sales fell 34%, notebook sales were down 20%, and sales of corporate server computers declined 25%. Dell has been losing share in PCs to HP, now the No. 1 seller of PCs in the U.S. and worldwide. Dell also faces more vigorous competition from Taiwanese vendor Acer, which has been gaining share.
Dell's share of the server market declined to 11% in the first quarter, according to market researcher IDC. Industrywide, server sales declined 24.5% during the quarter. In the 12 years that IDC has been keeping track, it was the worst period for sales of the machines that help companies run data centers and corporate networks.
Even as sales decline, Dell has been preserving profit margins through aggressive cost-cutting and refusing to lower prices too steeply. Gross margins were 17.6%, vs. 18.4% a year earlier. Dell has resisted cutting prices as sharply as other PC makers have to gain market share, Broadpoint AmTech (BPSG) analyst Dinesh Moorjani said in a May 26 research note. In February, Dell said it will accelerate cost reductions to pare annual expenses by $4 billion a year by January 2011, taking an additional $1 billion out of its yearly budget.
On the Acquisition Trail
Investors are keen to see how quickly Dell will pull the trigger on acquisitions to gain scale and move itself into more profitable pockets of the IT market. Dell executives said the company, flush with $10.13 billion in cash, is on the hunt for acquisitions, especially in the area of services that help customers install and manage hardware and software. "Asset prices are getting pretty attractive, and certainly we're looking at expanding inorganically," CEO Dell told analysts during the call.
The company has made 10 acquisitions in the past three years, and only one, storage company EqualLogic in 2007, has exceeded $1 billion in price. Dell may need to take bolder steps to compete with IBM and HP, which are strong in services. "The question is, do they do more of what they do well or change strategy?" says Paul Deninger, vice-chairman at investment bank Jeffries & Co. (JEF). "That's a decision the organization needs to make."
Dell is getting poised to make those very calls. It's trying to hire a mergers-and-acquisitions chief. CFO Gladden said Dell will use acquisitions to build its $1.2 billion services business. "It isn't like we're just sitting back watching other companies do consolidation," he says.
Dell's stock is down about 47% in the past year, declining further than those of IBM, Apple (AAPL), HP, and Intel. A rise in PC buying when Windows 7 arrives may help mitigate Dell's woes. But investors will also be looking for signs the company is willing to spend its cash hoard to enter new markets and broaden beyond the bruising PC market, where prices continue to fall.