Dell's Road to Recovery

First-quarter results and a plan to cut 10% of the computer maker's workforce sparked a share rally, but the hard work is just beginning

Four months into his second run as chief executive of Dell, Michael Dell has begun moving the computer maker down the long road to recovery.

On May 31, Dell (DELL) said fiscal first-quarter net income slipped to $759 million from $762 million a year earlier. Sales at the world's second-largest PC maker rose 2.8%, to $14.6 billion. The results for the period ended Apr. 30 exceeded analysts' estimates. (Dell didn't provide its own projections.) The report, along with an announcement that Dell would cut 10% of its workforce, sparked a 6% rally in the company's stock in extended trading.

Makeover, Legal Woes Ongoing

Investors were eager for some good news on the financial front. Dell is trying to bounce back after a multi-quarter stretch of sluggish growth, lost market share, and missed forecasts that culminated with the January ouster of Kevin Rollins as CEO. The company faces internal and outside investigations of its finances and on May 14 was sued by New York Attorney General Andrew Cuomo for allegedly deceptive marketing practices (see, 5/18/07, "Cuomo Kicks Dell When It's Down").

Indeed, Dell, which has been overhauling virtually every part of the company from the executive ranks to customer service, seemed to suggest that investors shouldn't get too excited just yet: "These efforts may cause short-term fluctuations in operating performance" but will benefit the company "in the long-term," the company said in a statement. It added that operating margins in the current fiscal second quarter "will be under pressure" compared with the prior quarter partly because of increased operating expenses.

Dell, which is based in Round Rock, Tex., said the results are preliminary, as it continues an internal investigation into certain accounting matters, a probe that began last fall. The Securities & Exchange Commission and the U.S. Attorney General for the Southern District of New York are also investigating the company. As was the case during the prior two quarters, Dell didn't host a conference call with analysts and said it will delay its annual shareholder meeting from July 20 to a later unspecified date.

Wal-Mart Deal Offers Fresh Challenges

Given Dell's sluggish revenue growth, it's under added pressure to slice operating expenses. So it has started "a comprehensive review of costs" and plans to eliminate about 8,800 employees over the coming 12 months.

But analysts expect those savings to be partly offset by new expenses, including costs related to the company's plan to sell PCs at more than 3,000 Wal-Mart Stores (WMT) starting June 10. To meet the large volumes of machines that the two companies hope to sell, Dell has surely already started making operational changes to its longstanding low-cost model of taking an order over the phone or online, building a PC to order, and shipping it directly to the customer. Selling through Wal-Mart, by comparison, means that Dell must assemble a large inventory of machines to keep in stock at each Wal-Mart store as well as manage costs associated with selling through an intermediary.

A Healthy Boost in Laptop Sales

Analyst Bill Shope of JPMorgan Chase (JPM), in a May 4 report, said that Dell is likely to continue to increase spending for customer service and technical support. Dell would also do well to boost spending for design and engineering, particularly in its notebook machines, which he calls "arguably undifferentiated." Dell "is not investing enough in this segment," Shope wrote.

However undistinguished its machines, Dell is benefiting from rising demand for computers that can be used anywhere. Laptop sales rose, increasing 7%, while desktop revenue fell 6%. For its PC business as a whole, average selling price during the quarter was 14% higher than a year ago. Analyst Brent Bracelin of Pacific Crest Securities said the higher selling price results partly from customers buying extra memory and other features they need to run the latest version of Microsoft's (MSFT) Windows Vista operating system, a trend he expects to continue in the coming quarters.

In Dell's smaller businesses, revenue for storage products rose 13%, to $500 million, and server sales grew 19%, to $1.6 billion.

Dell has said repeatedly that a hoped-for turnaround could take up to 18 months. But fiscal first-quarter results show early signs of progress.

Before it's here, it's on the Bloomberg Terminal.