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Dell Inc. (NASDAQ:DELL)

F3Q 2009 Earnings Call

November 20, 2008 5:00 pm ET

Executives

Lynn A. Tyson – Vice President, Investor Relations

Michael S. Dell – Chairman, Chief Executive Officer

Brian T. Gladden – Senior Vice President, Chief Financial Officer

Analysts

Kathryn Huberty – Morgan Stanley

Richard Gardner – Citigroup

Brian Alexander – Raymond James

Tony Sacconaghi - Sanford Bernstein

Bill Shope – Credit Suisse

[Ben Rice – Inaudible]

Louis Miscioscia - Cowen & Company

Keith Bachman – Bank of Montreal

Shannon Cross – Cross Research

Mark Moskowitz - J.P. Morgan

David Bailey - Goldman Sachs

Maynard Um – UBS

Jeff Fidacaro - Merrill Lynch

David Wong - Wachovia Capital Markets, LLC

Bill Fearnley - FTN Midwest Research

Shebly Seyrafi - Calyon Securities (NYSE:USA) Inc.

Operator

Good afternoon and welcome to the Dell Incorporated third quarter fiscal 2009 earnings conference call. I’d like to inform all participants this call is being recorded at the request of Dell. This broadcast is the copyrighted property of Dell Incorporated. Any rebroadcast of this information in whole or part without the prior written permission of Dell Incorporated is prohibited. As a reminder, Dell is also simulcasting this presentation with slides at www.Dell.com/investor.

(Operator Instructions) I’d like to turn the call over to Miss Lynn A. Tyson, Vice President of Investor Relations. Miss Tyson, you may begin.

Lynn A. Tyson

Thank you. With me today are Chairman and CEO Michael Dell, and Senior Vice President and CFO Brian Gladden. Brian will review our third quarter results and how our business model is positioned to effectively compete in this demand environment. He will also review the progress we’ve made in our initiatives to improve our competitiveness. Michael will follow with his perspectives on how our products and services are well suited to how customers are approaching their IT spending in this environment.

To get additional insights on our results this quarter, please read the Q&A with Michael and Brian that we posted on our Dell Shares blog on Dell.com. Also we’ve expanded the web depth that accompanies this call to capture additional information many of our shareholders have requested. All growth comparisons made on this call are year-over-year unless otherwise stated. Our IR calendar for the balance of the year includes Michael at CSFB on December 2 and [bee logs] covering our global services and consumer businesses.

Finally I’d like to remind you that all statements made during this call that relate to future results and events are forward-looking statements that are based on our current expectations. Actual results could differ materially from those projected in the forward-looking statements because of a number of risks and uncertainties which are discussed in our annual and quarterly SEC filings and in the cautionary statement contained in our press release and on our website. With that I’d like to turn it over to Brian.

Brian T. Gladden

Thanks Lynn. We’re pleased with our performance this quarter, especially against the backdrop of slowing global IT demands but we still have more work to do. Our direct model affords us the benefit of reading and reacting to demand signals faster than any company in our industry. As we’ve been indicating throughout this fiscal year, Dell has seen weakening in global IT and user demand and we expect this weaker demand environment to continue for the foreseeable future.

On our second quarter call we said we’d already taken actions to improve profitability in the company and you’re seeing it in our results this quarter. We achieved these results by continuing to improve our mix of products and services while also realizing the benefits of our initiatives to improve our cost structure and competitiveness. Our goal continues to be to drive a balance of liquidity, profitability and growth and optimize cash returns, regardless of the macroeconomic cycle.

So let me turn to the quarter which begins on Page 5 of our web deck. Revenue declined 3% on a 3% increase in units. Operating income reached 6.7% of revenue which helped to drive earnings per share up 9% to $0.37 a share. The improvement in operating income was driven by gross margins of 18.8% which benefited from improved mix, lower component costs and our cause initiatives in the quarter.

Improvement in operating income was also aided by strong, OpEx discipline with OpEx as a percentage of revenue of 12.1%. On a dollar basis this is an 11% decline in OpEx dollars versus last year. We also reduced headcount by another 2,200 sequentially. Our tax rate in the quarter was 28%, slightly higher than second quarter, primarily reflecting a shift in the mix of income to higher tax jurisdictions. We pointed out this dynamic to you in our second quarter earnings as well.

I also want to highlight that in this quarter, we overlapped an 18% tax rate in Q3 of last year. In the quarter on a pretax basis we absorbed $26 million of expense for amortization of purchased intangibles and $17 million in business realignment costs. We also recorded lower bonus expenses in the quarter versus last year, which favorably impacted operating income margin by about 50 basis points sequentially.

Cash flow from operations was a negative $86 million. Simply explained, while our receivables were down in the quarter with lower revenue, our payables were down significantly more as we reduced spending in the second half of the quarter. When our shipments, production and procurement returned to a more typical relationship, we expect a reversal of this cash dynamic. Our cash conversion cycle ended at negative 25 days, a decline of 4 days from our last quarter.

Year-to-date cash flow from operations is $1.2 billion. In the quarter we spent $400 million to buy back roughly 21 million shares. Despite what we believe to be an attractive valuation, we were conservative with our share repurchase this quarter, choosing instead to conserve cash given highly uncertain demand and capital markets. We ended the quarter with $8.9 billion in cash and investments.

Now let me turn to our business segments, which began on Page 8 of the web deck, with additional information in the supplemental section. I spent time with many of you after our second quarter earnings and I realized that we have an opportunity to better differentiate for you the dynamics of our global consumer business versus our global commercial businesses. So let me start with our global commercial business, which on a trailing four quarters basis is about 96% of our profit and 82% of our revenue.

Our customers here are our large commercial public and small and medium businesses. By the end of the second quarter we’d seen a slowdown on most verticals and we drove demand in areas where we had both profit and growth opportunities. As a result, revenue declined 6% on a 5% [audio impairment] decline in units. Operating income margins however [audio impairment] of 130 basis points sequentially to 8.1% of revenue, driven by our decision to protect this profitability as well as favorable OpEx scaling in a slowing demand environment.

Over the last four quarters, our mix of revenue and profit in our commercial business has improved with over a third of our revenues now coming from higher margin products like storage services and software peripherals. Michael will dive a little deeper into our enterprise products.

Notebook units were flat as we transitioned to our new Latitude E Series. Server units declined 4% and storage revenue was flat. Enhanced services revenue which is largely driven by our commercial business was up 7% to $1.4 billion. Looking at the regions, America’s commercial had an 8% decline in revenue on a 14% decline in units as operating income improved both sequentially and year-over-year. This reflects an improved mix of products and services and lower component costs.

EMEA commercial had a 5% decline in revenue on flat unit growth. As we mentioned last quarter, we took actions to improve profitability in Europe and these actions yielded a significant sequential improvement in operating income dollars in the quarter. The majority of this improvement was driven by lower OpEx and a better mix of products and services in the third quarter.

In APJ Commercial, revenue was up 2% on a 15% increase in units, while operating income was up over 60%. Performance was aided by strong double-digit unit growth in emerging countries. We also had great success with the channel business and in penetrating lower tier cities in China by leveraging the recently launched Vostro A Series. This product was specifically designed for emerging countries and now all the commercial products in emerging countries are cost optimized.

Let me turn to the global consumer business, which on a trailing four quarter basis is 4% of our operating income and 18% of our revenue. This business is undergoing a profound transformation. Our over arching goals with global consumer include broadening our product portfolio with a focus on great products that customers get excited about; expanding our points of distribution, including retail; growth in developing markets; an acceleration in our direct business; improving profitability by optimizing product costs; reducing OpEx and increasing the revenue and profit opportunities on each unit that we sell.

And in the quarter, revenue was up 10% on a 32% increase in units or 1.2 times the rate of the consumer industry. This growth was fueled by our continued success in the global retail channel and a more diversified portfolio of leading edge products. Year-to-date we’ve launched an industry leading product like the Inspiron 15-25, the Studio Hybrid Desktop and the Inspiron Mini. All these products have received rave reviews and have been recognized with multiple awards.

Operating income reached $112 million for the global consumer business or 4% of revenue versus a loss in the third quarter of last year. Year-to-date operating income was 1.2% of revenue. The improving in profitability year-over-year was driven by a 24% reduction in OpEx dollars. Sequentially, gross margins improved as roughly half of our volume has gone through a first round of cost optimization activity. And we also benefited from lower product and component costs.

In the near term, as this business continues to expand throughout the full spectrum of growth, I think operating income margins will be in the 1 to 2% range. With all the initiatives we have underway, we’re confident that over time we can improve margins even further for the global consumer business.

Before I turn to the outlook, let me touch on our cost initiatives, our commitment to our financing business and our overall liquidity. We continue to make significant progress against our cost initiatives, which benefit both the cogs and the OpEx line. As mentioned earlier, and we go into more detail on Pages 11 and 12 of our web deck, a larger portion of our total unit volume is now cost optimized which, depending upon the platform, can yield up to 30% reduction in the product cost.

OpEx in the quarter was down over $200 million versus the third quarter of last year and since the second quarter of last year our headcount is down by close to 11,600 heads net of acquisitions. And as we expand our global manufacturing and logistics footprint, we now have about a quarter of our transactional products going through contract manufacturers. This accomplishment positions us well to rapidly adjust our cost structure in an environment of slowing demand.

As we announced in September, after a strategic assessment we decided to keep Dell Financial Services. DFS is a strategic asset for Dell and drives incremental sales in margin and it’s profitable for us in the current environment and credit cycle. We will continue to effectively manage credit and funding risks in the DFS business. While DFS credit losses have increased as the environment has become more challenging, we continue to believe we’re adequately reserved. We tightened credit requirements five times over the last 18 months and we’re confident in our ability to fund new businesses and secure [cash] receivables.

Established securitizations remain liquid, although as would be expected deal costs have increased. As the credit market stabilizes, we’ll work to identify and execute cost effective funding strategies that will have a minimal impact on our corporate debt capacity.

Turning to liquidity on Page 16 and 17 of the deck, we’re comfortable with where we’re positioned and we’re not constrained. We have access to traditional short term and long term funding vehicles. We have an established commercial paper capacity of $1.5 billion with $250 million outstanding at the end of the quarter. And we issued $1.5 billion of long term debt in the first quarter of this year.

We filed a new debt shelf registration earlier this month which we can use for future debt issuances on an as needed basis as spreads come in and as capital market conditions improve. Before I turn it over to Michael, let me leave you with some key points on the quarter and our view of what we’re seeing in the industry.

Our direct model’s uniquely positioned to give us demand trends early, which allows us to adjust rapidly. And in Q3 we adjusted to the realities of the current industry dynamics. In a challenging demand environment, we focused on growth opportunities with a bias towards protecting profitability while improving our mix of products and services. This will continue, although there will be product segments and countries where we selectively choose to grow at a multiple of the industry.

Our initiatives to improve competitiveness and reduce costs are bearing fruit, as are the investments we’ve made to broaden our product portfolio in both our consumer and commercial businesses. In a softening demand environment, component cost declines typically accelerate and companies with superior asset velocities are able to take advantage of these improvements faster than others.

We believe global industry demand will continue to be challenging and we’ll work rigorously to scale our costs accordingly. We’ll continue to incur costs as we realign our business and improve our competitiveness, reduce headcount in certain areas and invest in infrastructure and acquisitions. In summary, we’ll continue to diversify our revenue base and products and aggressively drive our cost reduction initiatives which over time will yield improved liquidity, improved profitability and growth. With that, I’ll turn it over to Michael.

Michael S. Dell

Thank you Brian. We have been involved in a significant transformation here at Dell over the past 18 months. In April we outlined for you our five growth initiatives of consumer, enterprise, notebooks, S&V and emerging countries. In addition, we discussed our plans to improve our competitiveness. And we’ve made significant progress along those initiatives. We’ve identified and are aggressively taking down our cost structure by about $3 billion to regain cost leadership.

We’re well into transitioning to a higher mix of contract manufacturing to drive competitiveness, we’ve reduced our G&A substantially; our OpEx is now down by over $200 million in the third quarter versus the same quarter last year; we’ve revamped our entire product line in every category; and we’ve regained feature design leadership in many segments. So there’s been a great deal of progress. There is much to do but these are important foundations that position us to be a stronger and more nimble company.

This is a more challenging IT spending environment and there are three things you need to think about when considering Dell. First is that we are focused on expense management and regaining our cost leadership. Clearly there was progress in the quarter on G&A and cause consistent with the plan we outlined. And we’re on a path that will yield significantly increased cost savings; and an advantage cost structure in our direct business, which is roughly 75% of revenues; and a competitive cost structure in our channel business.

This will give us the ability to deliver not only more value for our customers but increase profitability. Second, our focus is on expanding our presence in the enterprise. Customers are looking for great technology to drive IT productivity and simplification, and they want it to be cost effective. This [absolutely] plays to Dell’s strengths and we can help them here. Virtualization, particularly in servers and storage, are key technologies that we’re embracing to drive this. So we’re taking a number of actions to address these needs.

First, we’re expanding our server coverage up to 95% of the market opportunities next year. We’ve also introduced the fourth generation of our Dell EMC Storage systems. We’ve expanded our ecologic solutions, introduced a new Power [Volt] product lines, all placing us in Gartner's leaders' quadrant for enterprise storage arrays. We’re significantly growing our virtualization solutions to help customers improve the ability to deploy and manage these solutions.

We’ve been a leader in power and cooling solutions with very efficient blades and two and four socket blade products that are 25% better in performance for watt than competitors. And we’ve expanded our data center custom solutions business with customers like Facebook, Microsoft, Amazon, Akamai and Baidu.

And finally, we’ve been growing our services activity. With remote infrastructure management we have an opportunity to go after the $2 that is tacked onto the every $1 that is spent in hardware. Now and this is really a major customer pain point in the roughly $1.2 trillion IT industry. So third for us in consumer business, clearly we’re making some progress. New products, we’ve got better cost, as we continue to make progress here those cost improvements will begin to show up in our emerging country business and our small medium business.

The consumer business had operating income of 1.7% so far this year, while units grew twice the industry and share was up 140 basis points. In the BRIC countries we grew 20% versus last year and BRIC is now 9.4% of revenues. So why don’t I stop there and we’ll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kathryn Huberty – Morgan Stanley.

Kathryn Huberty – Morgan Stanley

The perception in the market is that Dell is largely a fixed cost business which isn’t the picture that you painted this quarter, so can you just walk through some of the specific steps you’ve taken to become more flexible? And is there a metric that you can provide on the percentage of costs that are now variable?

Brian T. Gladden

You know, I think there’s a couple things. One is we’re working to variablize costs as much as we can. And when you think about contract manufacturing and the ODM strategy, that’s one big element. And I think that’s something that you’ll continue to see us do. I think the other thing that we’ve done is just been very aggressive with fixed costs in the G&A structure in the business. So no metric around that, but that’s been our approach and I think we’ve been pretty impressive.

Kathryn Huberty – Morgan Stanley

And Brian most of your peers back out restructuring charges every quarter. It looks like you continue to digest those in the P&L. What should we expect over the next couple of quarters in terms of will there be more charges? And how might the size compare to what you saw in the October quarter?

Brian T. Gladden

Yes, I think you’ve seen, you know, we do report GAAP and as you’ve seen it has declined a bit over the course of the year in terms of what we’ve incurred in each of the quarters. You know, we’ll continue to look at productivity opportunities. The way the accounting works there is we identify those and put the plans in place so you know we’ll incur those charges. You know, no real prediction on what that is.

Operator

Your next question comes from Richard Gardner – Citigroup.

Richard Gardner – Citigroup

Brian I was hoping – I heard your explanation on the payables but could you help us out with what that tells us about the linearity of the quarter in terms of demand and/or component procurement? Or perhaps even credit issues with some of your suppliers?

Brian T. Gladden

Yes, I’d start with, you know, really no credit issues with any suppliers in the quarter. We continue to watch that, but right now no significant concerns. It does tell you that there was some deterioration in demand over the course of the quarter. And I think you’ll see that we had a stronger August than we did September and October. And I would also say it does show you that there was a decline in terms of our spending in the last month of the quarter. So that gives you a sense for the trend we saw.

Richard Gardner – Citigroup

And would you mind providing a little bit more color perhaps on which segments experienced the deterioration and demand throughout the quarter? And I guess that’s a good segue into plans for future cost reductions as well. I know Katie asked a question about charges, but I thought I’d ask maybe more directly about the cost side.

Brian T. Gladden

Yes, I think Richard in this environment we’re going to continue to be very aggressive with costs. You know, it’s the one lever we can control. What was the first question?

Richard Gardner – Citigroup

Oh just a little more color around which segments experienced the deterioration toward the end of the quarter.

Brian T. Gladden

Yes, I would say the external demand environment’s pretty consistent with what we talked about at the beginning of the quarter. You know, it’s been slow in the U.S. It’s – Western Europe has been slow. Asia’s still obviously positive growth and emerging countries as Michael said, we found some nice growth there in the BRIC countries as well as other emerging countries in the quarter. So you know pretty consistent with the messages we shared the last time we were talking about it.

Operator

Your next question comes from Brian Alexander – Raymond James.

Brian Alexander – Raymond James

Could you give us an update on what percentage of global units shipped are cost optimized at this point and how does that vary by geography? It sounded from your comments that consumer is basically half way there and APJ is completely optimized, so where are we in the Americas and EMEA?

Brian T. Gladden

Yes, it’s not a regional dynamic. And I mean we have global product development and we go really platform by platform. You know, we talked about cost optimization for the consumer business where I think we’re at about 50% for the consumer business. And we continue to work through those portfolios really one at a time. And with launches in commercial of 25 launches year-to-date and 17 launches year-to-date in consumer, that’s pretty aggressive. And we will continue to knock that off over the next few quarters.

Brian Alexander – Raymond James

Could you say what percentage of the savings that you intend to realize as it relates to product optimization, you know, how much of that have you realized to date would be I guess the crux of what I was asking?

Brian T. Gladden

Yes, I guess the theory is as products ramp and you gain volume, that’s where you begin to realize the majority of the benefits. So I would say we’re still in the process and even early in the process of this cost optimization rolling through the P&L.

Operator

Your next question comes from Tony Sacconaghi - Sanford Bernstein.

Tony Sacconaghi - Sanford Bernstein

Michael I have one for you and then one for Brian, please. Michael you’ve talked a lot over the last year-and-a-half about dual objectives of growth and profitability. It certainly sounds like from your commentary on this call that the bias certainly over the last quarter was towards profitability. And I think you mentioned that that would continue to be the case. Am I hearing that right and should we –

Michael S. Dell

You heard it right, yes.

Tony Sacconaghi - Sanford Bernstein

And should we be thinking about the same balance going forward as we saw this quarter between those two?

Michael S. Dell

Well, you know, I think given the choice between profits and growth we’re going to go for the profits. And our belief is that with the changes that we’re making in our cost structure, we’re going to be able to do both of those together. But first priority for us is to retain solid profitability to the company and that’s what we demonstrated this quarter and that’s what we’re focused on.

Tony Sacconaghi - Sanford Bernstein

Brian, you talked about the strong progress in consumer and also the 50% of the product mix now being cost optimized. Yet you set an expectation that operating margins might actually be lower in the near term, 1 to 2 versus the 4% that you saw this quarter. Why given the strong growth rate that you’re seeing, out growing the market, gaining scale on a fixed cost base, increased percentage of products that are cost optimized, why do you actually foresee the operating margin take a step back in the short term?

Brian T. Gladden

Okay, Tony, I – we’re pleased with the progress that the consumer team’s making in expanding their footprint in retail and in gaining share overall in consumer and getting cost out of the business. And one of the things we’re working hard to do is to diversify revenue and margin opportunities for that business. And as you think about the kinds of, you know, ways we can do that in the consumer business, some of that is vendor and partner programs for the business. As you think about how that plays out, it may be that some of that’s a little lumpy.

And in the third quarter, you know, we had a little bit of that that showed up in the business and that’s just the way the business is going to be going forward. I think the thought process around 2% is a way to think about it in total for now. And I think over a longer period of time, we can see better than that.

Tony Sacconaghi - Sanford Bernstein

And then finally you, I think you said in your concluding remarks, Brian, that you would reduce headcount in certain areas. There’s also been talk of a hiring freeze at Dell. Can you comment on A, whether there is a hiring freeze and B, whether there has been decisions taken at this point to reduce headcount further?

Brian T. Gladden

Yes, I think the realities of this environment, you know, those are the kind of things we’re working through. There is right now a hiring freeze that we are applying across the business. That doesn’t mean we’re not selectively hiring where we need to for key roles. But it’s clearly one of the levers we have right now in terms of managing costs in this environment.

Tony Sacconaghi - Sanford Bernstein

And if I think about the hiring freeze, if attrition is I think about 20% at Dell that would suggest that with a hiring freeze your headcount would actually go down about 1.5% per month. Is that a – am I incorrect in that analysis?

Brian T. Gladden

Yes, I mean, we’re not going to confirm our attrition rates in the business. I’ll leave it at that.

Operator

Your next question comes from Bill Shope – Credit Suisse.

Bill Shope – Credit Suisse

You know, looking at the gross margin line would you guys characterize in the current gross margin levels as above sustainable levels? And then attached to that, can you comment on competitive pricing conditions you saw during the quarter?

Brian T. Gladden

You know, I think we made nice improvement in gross margins in the quarter. You know if you look at historical performance, we’re within the range of what I would consider historical gross margin range. I think this is a bit of a different time in terms of the market environment and I think that could change from quarter to quarter as we see the dynamics externally change. In terms of competitive pricing dynamics, I think it’s a competitive business. It continues to be excess capacity and I think you’ll continue to see competitive dynamics around pricing.

And I think there’s FX and currency impacts that are causing some changing the way people are thinking about pricing in certain markets, too.

Michael S. Dell

Yes, I think the reason you see our operating income up 22% and our revenues down is we did not participate in some business which was diluted to the company.

Bill Shope – Credit Suisse

And then going back to the consumer side of the equation, can you give us an update on your retail points of presence and how does the current economic environment impact your plans to scale up the retail footprint over the next couple of quarters?

Michael S. Dell

We now have our product available in over 20,000 retail outlets around the world, made continued progress in expanding that, I think. That’s the rate at which you’ll see us probably continue to expand our footprint there. We’ll keep doing that even in this environment.

Bill Shope – Credit Suisse

Michael, can you give us an update on your views of the [next] up market and how aggressive does Dell plan to be in this [phase]?

Michael S. Dell

You know, we weren’t diving into that in a big way. We certainly have products there. It appears to us that this is mostly a complementary product category. Certainly in the emerging countries it looks like its incremental and kind of new business. We were also the first with a product with 3G built in and that’s allowed us to do pretty well with a bunch of the carriers and we’re putting a number of those agreements in place right now.

Operator

Your next question comes from [Ben Rice – Inaudible].

Ben Rice – Inaudible

Brian and Michael, I just wanted to ask some questions about cash flow and then earnings. With regard to cash flow, trailing 12 months and you’re about $0.83 in free cash flow and in some of the quarters you were going for growth and then this quarter you obviously focused on profit and used cash. With growth arguably going slower and maybe you have to some severance even, how does cash get better from here? You say when it gets into balance, but can we expect cash to be better than the $0.83 in the trailing 12 months or does it continue to get worse from here before it gets better?

Brian T. Gladden

Well I think first off we will see a return to a typical relationship between shipments, production and procurement. It’s a matter of matching up and then driving more linear production and procurement that’s tied to the demand profile. And I think that’s a matter of really a one time adjustment. And I think you’ll see that come back in the next couple quarters. I think that’s how we would think about that.

In addition to that, we’re driving a lot of initiatives around working capital. And we’ve implemented working capital counsel that’s driving key processes and should ultimately result in an improvement of our cash conversion cycle, back to historical sorts of levels which is we would expect something close to the negative 30 days in the short term. So I think that’s the dynamic we see. We don’t expect it to get any worse. And those are the main drivers.

Bill Shope – Credit Suisse

And then just with regard to earnings, I mean so you would view the $0.83 as an artificially depressed level? And then you know usually earnings gravitates the free cash flow, etc. I mean, you know, given that we maybe have more charges coming and maybe bad debts need to go higher, etc., I mean do you see them converging or you view the cash more as one time lumpiness with regard to the slowdown in growth rate?

Brian T. Gladden

Yes, I mean that’s our view. It’s really a one time impact.

Operator

Your next question comes from Louis Miscioscia - Cowen & Company.

Louis Miscioscia - Cowen & Company

For what you can tell us from what you can see, can you make a comment on the revenue line? You obviously dropped about a billion quarter to quarter but obviously you had great profitability with that. Do you think that this new level of demand should hold through the next at least the next three months?

Michael S. Dell

I think it’s going to have a lot to do with the overall market environment. And you know again, we’re focused on what we can control. We’re aggressively driving costs in this environment and we’re focused on profitability in the market that we see out there. And there are spots within the market that we do see growth in places where we have gained share, even in the third quarter. So we’ll be selective in picking those spots and really no guidance on the overall revenue.

Louis Miscioscia - Cowen & Company

How about being three weeks into it? Has it stabilized or is it continuing to deteriorate for you?

Michael S. Dell

Yes, you know, again I would just say we expect relatively challenging environment to continue and we’re not going to today characterize what we see in fourth quarter demand.

Louis Miscioscia - Cowen & Company

You still have a ton of cash on the balance sheet, I think $4 per share, do you think you’ll start to resume a more aggressive share buy back program soon?

Michael S. Dell

I would say we do believe that the current price is actually very attractive, but at the same time we’re carefully watching liquidity in this environment. And we’ll balance those two things going forward and not really make any commitments around what we’re going to do right now.

Operator

Your next question comes from Keith Bachman – Bank of Montreal.

Keith Bachman – Bank of Montreal

On the operating expenses, Brian, I wasn’t sure how to read your comments when you said there was some bonuses that positively impacted and my trying to get at will OpEx stay about these levels into this current quarter?

Brian T. Gladden

Yes, you know, there was an adjustment in the accrued bonus for the company. Just driven off by what we see in the performance of the company. So I mean we will continue to drive dollars out of the OpEx line and it’s difficult to predict in terms of the revenue levels where we’re going to end up in terms of specific OpEx percentage, but I think you’ll continue to see costs coming out of OpEx.

Keith Bachman – Bank of Montreal

Well then the second one I had is if I just look at the January quarter, I know you don’t want to comment on revenues but what will the FX be impact be sequentially for you?

Brian T. Gladden

In the fourth quarter?

Keith Bachman – Bank of Montreal

Correct. In the January quarter, correct.

Brian T. Gladden

Yes, I mean, we have a very comprehensive hedging program in the company and you know I would say in the third quarter generally had no impact on the P&L, pretty negligible. I would expect given our hedging positions to be relatively well protected for the fourth quarter as well.

Keith Bachman – Bank of Montreal

Right, sorry, Brian I meant on the top line not on the bottom line.

Brian T. Gladden

Yes, you know it depends. I would take you back to the – in the third quarter, I mean we had probably 3 points of help on the revenue line and we just don’t know where the dollar’s going to be in terms of the fourth quarter.

Operator

Your next question comes from Shannon Cross – Cross Research.

Shannon Cross – Cross Research

Just a couple of questions. The first one, if we can dig a little bit more into the gross margin at 18.8 it was obviously strong. Can you maybe characterize product mix versus some of the other changes, you know components, etc. that you saw during the quarter just so we can get an idea of the magnitude of improvement?

Michael S. Dell

It’s going to depend by region. As you look at the product mix dynamics, I think on a global basis clearly we had nice progress in some of the higher margin products. Component pricing, I would say was slightly higher than sort of our traditional deflation that we would see in component pricing given the demand dynamics. And that’s about as much as we’ll share.

Shannon Cross – Cross Research

And then if you could talk just a little bit about some of the changes you made in Europe which you obviously started during last quarter but then went through this quarter? You said you’re focusing more on being able to recognize the revenue up front from services contracts, just if you can give us any more details in terms of how you’ve been able to turn Europe around.

Michael S. Dell

Yes, I think you know [Opt. Inc.] was up 150 basis points and it was driven by very good OpEx management in Europe as well as gross margin improvement in the quarter. You know, we were more effective in our pricing and selectivity in deals that we participated in. Obviously component pricing helped. Nothing changed in the way that we account for services. As we talked about at the end of the second quarter, that’s really not much of an impact for services. Services did well in the quarter and improved, but no significant impact on that.

Shannon Cross – Cross Research

What percent of your cash is overseas versus domestic at this point?

Michael S. Dell

Yes, it’s you know we’ve talked about it before. I mean, it is a majority of our cash.

Operator

Your next question comes from Mark Moskowitz - J.P. Morgan.

Mark Moskowitz - J.P. Morgan

I wanted to touch more on the direct model. You really seem to be adding an incremental glow here or luster to your comments on the direct model and it’s strange in this type of environment. Were you seeing in the quarter or toward the back half of the quarter a focus particularly on the Enterprise and S&B part of your business coming to you and saying hey, we want to spend our budgets before we lose them? Was that part of the margin benefit?

Brian T. Gladden

No.

Mark Moskowitz - J.P. Morgan

And then as far as the retail piece, was there any change or structural change in terms of some inventory pricing protection or marketing dollars in your providence to the channel this quarter versus prior?

Brian T. Gladden

No.

Mark Moskowitz - J.P. Morgan

And then can you give us a little more color in terms of what Dell is encountering in the blade server market? We are picking up indications that your two way and four way service have been well received. Can you talk a little bit about who you’re taking share from if you are taking share?

Michael S. Dell

Yes, we are actually growing in blades. You know, blades are a pretty concentrated business. There’s really kind of one-and-a-half competitors there. You know, we have done some pretty interesting things. We have blades that have a 50% greater memory footprint than our competition. We use about 20% less power, comparing our blades to our competitors. And so it’s been a nice area of growth. And we also introduced four socket AMD blade and now of course with the Shanghai processor, it’s in a pretty good position.

Mark Moskowitz - J.P. Morgan

And Michael as a follow up there, are you seeing any sort of add-ons in terms of the pull on services or software related to the blade?

Michael S. Dell

Yes, I mean what we see is the blades are often associated with large transactions which include deployment services, virtualization services, ecologic services, Dell EMC storage, you know really integrated programs that are a lot stickier for us and getting us much more into the kind of solutions that we’re really targeting.

Mark Moskowitz - J.P. Morgan

And then just lastly Brian if I could, as far as the use of the cash I heard the comments as far as share buyback, yes, no, being careful in this type of environment. But what about acquisitions in terms of boosting your ala carte services platform? You have a pretty ambitious plan there. It seems to be pretty compelling. You may need to add a few more assets there. Can you take advantage of the depressed equity markets and go out there and buy some assets?

Brian T. Gladden

The answer is yes and we’re reviewing those opportunities.

Operator

Your next question comes from David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

Some of the comments that you made about the consumer profitability, can you give us an idea of your [opt] margin targets for the commercial business over the next few quarters?

Michael S. Dell

We don’t provide guidance. I would say we’re pretty pleased with the way the profitability is for now. I think the perspective for commercial business is 8.1 in the quarter. I think we’ll continue to manage and look for what the market gives us. And I think that’s how we’re going to play it.

David Bailey - Goldman Sachs

And then on the debt shelf that you filed, can you talk about the uses of cash and maybe the timing of why you filed that now?

Brian T. Gladden

David, it’s just for us to be prepared in the marketplace in terms of when we might see something that becomes interesting. You know, for us just balancing out our capital structure and we had a shelf out there that had expired, so this gives us flexibility to see what’s happening in the marketplace. And as we balance our global cash, that’s just something we have to do.

Operator

Your next question comes from Maynard Um – UBS.

Maynard Um – UBS

Can you just talk about your new product launches in the backdrop of a weakening demand environment? Of the 24 new consumer products are you still on track or have you pulled back on some of those new product introductions so that’s helping you on your sales and marketing budgets?

Michael S. Dell

No, haven’t really pulled back on any product launches. I mean, we’ve certainly vectored our product development and marketing organizations to things that align closely with customer need so that would go right to savings and productivity, virtualization and those technologies that are going to yield immediate savings for customers.

Maynard Um – UBS

And then on the gross margin side, were there any kind of reversals there? Last quarter there were some deferred services pieces that hurt the gross margins. And is it kind of safe to presume that the lower consumer operating margin also implies that there’s going to be an impact to the gross margins next quarter?

Brian T. Gladden

There really were no one time events that were materially impacted gross margins in the quarter.

Maynard Um – UBS

And then just on the consumer op margin, I’m assuming they’re more of the channel marketing costs, things like that. Is that safe to presume going into the next quarter?

Brian T. Gladden

I’m sorry. Can you say that again?

Maynard Um – UBS

The guidance you gave of lower consumer operating margins into the next quarter, presumably the consumer side has lower gross margins as well. I’m just wondering if that’s a fair statement.

Brian T. Gladden

Yes, you know I think we’ll continue to grow the consumer business. I think it’s – as we said, I think there’s some timing of when margins are recognized in the quarter that gave us a better result this quarter than I think we would expect going forward. But you can expect that to continue to grow probably faster than the rest of the business just because it has.

Maynard Um – UBS

Can you just give us the linearity in this past quarter how you sell progressing? Obviously you saw weakness pretty soon into the quarter but how that progressed through the rest of the quarter?

Brian T. Gladden

Well I mean if you break the months down, we had reasonable year-over-year growth actually in the month of August. And I think what we saw was really a slower period of growth in September and then October relatively similar to what we saw in September. So that’s sort of the dynamic.

Operator

Your next question comes from Jeff Fidacaro - Merrill Lynch.

Jeff Fidacaro - Merrill Lynch

When you think about cost optimizing your units, can you tell us the way you’re going to use the OEMs and sort of the percent of units that are full systems now that are both either on the consumer side or on the commercial side? And where do you think that percentage can go to?

Brian T. Gladden

Yes. In terms of the optimization I mean it’s – we’ve implemented a process called Design to Value which is focused on really rebuilding each of the designs from the ground up, you know leveraging all the tools and then tearing down competitive products, tearing down our products and ultimately taking costs down in the design process. We collaborate and work with the ODM’s as part of that process as we develop new products. And even apply that principle to redesigning existing products. That’ll be a process that moves forward. As we talked about, that can provide up to 30% reduction in the product costs as we go through that process.

About a third of our transactional volume today is now moving from contract manufacturers. That will continue to increase. We’re not going to talk about where that ends up, but that’s a process we continue to drive. And that’s one of the elements that allows us to continue to take cost down as we make those moves.

Jeff Fidacaro - Merrill Lynch

When you look to leverage the partner direct program and expand the channel, can you talk about how that impacts cost and does that impact the ratio of direct versus indirect going forward?

Michael S. Dell

Well, if we grow partner direct then that’s more channel business for sure. The mix of the partner direct business has been pretty favorable, so the operating margins in that business are relatively similar to the commercial direct business, because of the mix of servers and storage and kind of advanced products. So we’re actively growing that, signing up more partners and I think you’ll see that piece of business continue to grow.

Operator

Your next question comes from David Wong - Wachovia Capital Markets, LLC.

David Wong - Wachovia Capital Markets, LLC

Your desktop year-over-year unit growth, can you give us an idea of what that was and what ASP change was year-over-year?

Brian T. Gladden

Desktop year-over-year growth?

David Wong - Wachovia Capital Markets, LLC

Yes, units.

Brian T. Gladden

I don’t have units here. I have revenue for desktops year-over-year was actually down 14% in the quarter.

David Wong - Wachovia Capital Markets, LLC

And you don’t have ASP’s? Do you have the ASP change?

Brian T. Gladden

Say that again. I’m sorry.

David Wong - Wachovia Capital Markets, LLC

The year-over-year ASP change in desktops then.

Brian T. Gladden

No we don’t have that.

David Wong - Wachovia Capital Markets, LLC

The other thing is for consumer is there an upper level of operating margin of which you’d start translating your cost controls into – cost savings into growth as opposed to improved margin? Or do you – in the long run do you want to get that operating margin as high as is possible?

Brian T. Gladden

Well I think a lot of it depends on how the margin plays out. There are places in the world today and certain product lines in our business where our strategy is to more aggressively gain share. And in some cases, that’s going to dilute margin rates. And that’s a selective strategy where we see long term growth opportunities, where we see opportunities to differentiate and longer term generate improved margins. So it really depends on what the markets will give us, how we play it. And I think in an environment where we see overall relatively weak demand, we’re going to lean harder on the profit and [opt incs] side.

David Wong - Wachovia Capital Markets, LLC

But is there a long term operating margin target for the consumer business?

Brian T. Gladden

You know, I think the guidance that we provided around consumer is over a window of probably fiscal year ’10. That’s about what we would expect, something in the 2% op inc low range. Beyond that, I think we could expand it and improve it and be somewhere between the key competitors in that space in terms of their margin rates.

Operator

Your next question comes from Bill Fearnley - FTN Midwest Research.

Bill Fearnley – FTN Midwest Research

Question on the direct model if I could, how are you guys seeing the up sell of the direct business working versus your expectations? And is this providing any type of boost to gross margins here in the near term with services attach, SMP attach or how is it helping or affecting gross margins?

Michael S. Dell

Yes, we continue to do pretty well there. I think one thing I mentioned earlier, we chose not to sell a fair amount of product that would have been very diluted to the company’s margin and profitability. And that of course shows up in an improvement in margins and everything that we did sell.

Bill Fearnley - FTN Midwest Research

Then switching gears but also on gross margin, any color on your negotiation with ODMs, EMS and other parties in the supply chain on the effect of margins? Is there any benefit there here in the current gross margin picture? How much negotiation room do you have on the current contracts? Does that help in gross margins?

Michael S. Dell

You know, we’re transforming the cost structure of the company with a view towards pretty big savings. And so as we make these changes, our total costs should come down to deliver products. That’s why we’re doing it. That’s kind of what we’re seeing. So we do believe we have pretty good leverage in those discussions.

Bill Fearnley - FTN Midwest Research

On the bill to materials with the gross margin did you gain more on the component side or was it product designs that really helped you on the product gross margin for the quarter?

Brian T. Gladden

Well, as you think about component cost declines, I mean typically the way that that plays out in the marketplace is those generally get passed on because everyone generally enjoys similar trends. We may see it a bit sooner, given our model but that’s the way we think about that. Clearly the product costs are those are differentiated and allow us to improve margins as we drop through some of those significant changes in the product costs.

Bill Fearnley - FTN Midwest Research

So [inaudible] were designed during the quarter?

Michael S. Dell

I’m not going to say that.

Operator

Your last question comes from Shebly Seyrafi - Calyon Securities (USA) Inc.

Shebly Seyrafi - Calyon Securities (USA) Inc.

Question for you Michael, Gartner just reduced its calendar ’09 PC unit growth forecast from 14% to 5%. I’d like to know if you think that’s reasonable and if you intend to gain share over the coming year?

Michael S. Dell

That’s a great question. You know, I don’t really know. I think that we’d like to gain share, sure we’d like to gain share but we’re more focused on having solid profitability. I don’t think we really know what the growth of the industry’s going to be next year. We’re planning a pretty conservative set of assumptions on the belief that it’s easier to dial it up than to dial it down.

Shebly Seyrafi - Calyon Securities (USA) Inc.

Do you think it’s potentially going to be negative PC unit growth in ’09? How would you handicap that?

Michael S. Dell

You know I don’t hazard a guess on that.

Shebly Seyrafi - Calyon Securities (USA) Inc.

Okay. Thank you.

Michael S. Dell

Okay. So just to close here, let’s just review kind of where we are. You know, so far this year earnings per share for the company are up 6% and Dell has a great balance sheet. We have strong customer relationships. We have a strong brand. We’re expanding the mix to products and services that we have, focused on the enterprise. The execution of Dell is improving. This is going to allow us to continue to deliver solid profitability. Customers are really focused on value right now. That’s really plays to Dell’s core strength.

And I think we have some opportunities to seize on here that our competitors can’t. We’re clearly choosing profit over growth, but we also believe the changes we’re making to our cost structure will allow us to achieve both over time. So thanks very much and we look forward to talking with you again soon.

Operator

This concludes today’s conference call. We appreciate your participation. You may disconnect at this time.

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Source: Dell Inc. F3Q 2009 (Qtr End 10/31/08) Earnings Call Transcript
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