Dell profits take (small) hit in Q3

Cost cutting saves the day

Reducing security risks from open source software

If you were looking for some good news out of Dell today as it reported its fiscal 2009 third quarter financial results, you will probably be disappointed. But not as much as you might think. That's good news of a sort considering the miserable week the global economy is having.

Dell's sales for the third quarter ending October 31 came to $15.2bn, down 3 per cent from the prior year. But the company eliminated headcount, converted about half of its consumer business to "cost optimized" design and manufacturing (which means overseas contract manufacturing, mostly) and cut other costs over the past year. That allowed operating income to rise by 22 per cent to just over $1bn. Even with a larger tax bite, Dell was able to bring $727m to the bottom line, down only 5 per cent. Thanks to the magic of share buybacks, though, the company was able to pump up earnings per share by 19 per cent, to 37 cents a pop.

Brian Gladden, Dell's chief financial officer, said that IT market was weakening, that the company expected the weakening demand to continue "for the foreseeable future," and that Dell's direct sales model allowed it to react more quickly than competitors to changes in the IT space.

On a conference call with Wall Street analysts after the market closed on Thursday, Gladden said that the company had reduced headcount by 11,600 employees in the past year (net of acquisitions) to 77,700 full-time employees and 3,100 temporary workers. Dell fired 2,200 employees in the quarter. (The company's operating expenses, said Gladden, have come down by over $200m compared to Q3 of fiscal 2008, largely because of layoffs).

He also confirmed that Dell has, in fact, instituted a hiring freeze, although it will be making selective hires to boost business or replace key people that leave. Gladden danced around the issue of further job cuts, but a hiring freeze plus a normal attrition rate mean the same thing ultimately. The real question, of course, is what will the attrition rate look like in an economy where getting a new job is perhaps a little bit tough.

So even as unit sales across all products fell by 3 per cent (to 10.54m units), the company was able to protect a lot of its bottom line (but obviously not all of it), and Michael Dell, the company's chairman and chief executive officer, said that to protect profits the company "did not participate in some business that was dilutive to the company."

Given the state of the economy, neither Gladden nor Dell wanted to be drawn out much about their expectations for IT spending and Dell's business looking ahead, and they would not discuss how fiscal Q4 was going at all. "We are planning on a pretty conservative set of assumptions and the belief that it is easier to dial it up than it is to dial it down," Gladden said when pressed for something a little more concrete. "In this environment, we are going to be very aggressive about cost. It is the one lever that we can control."

Dell, the man, said more than once on the call that Dell, the company, would be focusing on profits instead of market share and revenue growth.

While Dell has been focusing increasingly on data center products like servers, storage, and related services to bolster its top and bottom lines, the company is still predominantly a maker of desktop and laptop PCs. In fiscal Q3, Dell had just under $4.1bn in sales for desktop PCs in the quarter, down 14 per cent, and $4.85bn in sales for laptop, netbook, and other mobile devices, up 3 per cent. Software and peripherals for those PCs accounted for $2.86bn in sales, up 2 per cent. Server and networking sales were down 5 per cent in Q3 to $1.57bn, and disk and tape storage sales for corporate customers was flat at $622m.

On the commercial side of the Dell business, which accounted for $12.3bn in sales, revenues declined by 6 per cent. Notebook units were flat, desktop units were down 8 per cent, and server units fell by 4 per cent compared to Q3 fiscal 2008. On a rolling four-quarter basis, the commercial business generated 82 per cent of Dell's sales and 96 per cent of its profits. The consumer business may be up by 10 per cent to $2.84bn in the quarter, with notebook sales up 67 per cent (but desktop units down 20 per cent). But consumers account for less than a fifth of Dell's sales and hardly any of its profits.

Dell's services business, a relative bright spot, rose by 7 per cent in the quarter, to $1.45bn. One of those services, by the way, is the Dell Financial Services equipment financing business. Gladden said that back in September, when the Meltdown was getting into full swing, the company did a strategic review to decide if it would keep this unit or get rid of it, and it has decided that it would stay in the equipment financing biz despite the challenges. Dell's CFO said that the company has tightened its credit requirements five times over the past 18 months and admitted that Dell had to increase its reserves against possible losses based on the jittery economy. But he added that financing computers was still an important service that it offered.

On a geographical basis, Dell breaks out its corporate business by regions and lumps its relatively small consumer business into one global category. Sales in the Americas region for commercial products fell by 8 per cent to $7.22bn, while EMEA commercial sales fell by 5 per cent to $3.27bn. The Asia/Pacific-Japan region saw sales rise by 2 per cent, and the global consumer business (thanks in part to a 20,000-strong indirect retail channel Dell has created that now spans the globe) rose by 10 per cent. Operating income was hammered in EMEA but grew a little in the Americas and nearly doubled in Asia/Pacific-Japan.

As Dell said at the end of the second fiscal quarter back in August, demand dropped off across all industry verticals and this has continued in the third quarter. They were not more specific about how much of a drop off, or where.

The company exited the quarter with $7.9bn in cash and said that most of it was parked overseas. It wouldn't be surprising to see Dell doing acquisitions in the regions where it is generating profits, if it can find suitable acquisitions and if doing deals is politically possible. ®

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