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Dell Inc. (NASDAQ:DELL)

F1Q07 Earnings Conference Call

May 18 2006, 5:00 pm EST

Executives

Michael Dell - Chairman

Kevin Rollins - CEO

Jim Schneider - CFO

Lynn Tyson - VP, IR

Analysts

Richard Farmer - Merrill Lynch

Tony Sacconaghi - Sanford Bernstein

Richard Gardner - Citigroup

Harry Blount - Lehman Brothers

Ben Reitzes - UBS

Laura Conigliaro - Goldman Sachs

Bill Shope - JP Morgan

Andy Neff - Bear Stearns

Keith Bachman - Banc of America

Robert Semple - Credit Suisse

Bill Fearnley - FTN Midwest Securities

Brian Alexander - Raymond James

Presentation

Operator

Good afternoon, and welcome to the Dell Inc. first quarter Fiscal Year 2007 Conference Call. I would like to inform all participants this call is being recorded at the request of Dell. This broadcast is the copyrighted property of Dell Inc. Any rebroadcast of this information, in whole or in part, without the prior written permission of Dell Inc. is prohibited.

As a reminder, Dell is also simulcasting this presentation with slides at www.dell.com/investor. Later we will conduct a question-and-answer session. If you have a questions, press star, then one on your telephone keypad at any time during the presentation.

I would like to turn the call over to Ms. Lynn A. Tyson, Vice President of Investor Relations and Global Corporate Communications. Ms. Tyson, you may begin.

Lynn Tyson

Thank you, and thanks to all of you for waiting, as we are starting the call about 20 minutes late. With me today are Chairman Michael Dell, CEO Kevin Rollins, and CFO Jim Schneider.

Jim will review the first quarter results. However, his section will be slightly shorter than usual so that we can devote ample time to Kevin’s comments about our growth strategy. After Kevin’s comments, we will take Q&A, and then Michael will wrap up with some closing thoughts.

Please refer to our web deck on dell.com for additional information on our quarterly results and the outline of our growth strategy.

Before we begin, I want to highlight a few upcoming IR events. Jim will speak at UBS Conference next week in New York on the 23rd. On June 5, our Dell conference call series continues with an overview of Dell Financial Services. On June 13, Kevin will speak the Bear Stearns conference in New York. On July 13, we will discuss our client product strategy, and in September we will host our analyst meeting in New York City, beginning with a reception on the 12th and the meeting on the morning of the 13th. Reminders have been sent via e-mail and online registration will be sent out in July.

Finally, I would 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.

I would now like to turn the call over to Jim.

James M. Schneider

Thanks, Lynn. For the quarter, we generated $14.2 billion in revenue, an increase of 6% year over year. Operating income of $949 million, or 6.7% of revenue, includes more than $100 million of stock-based compensation, which we are now required to expense in our GAAP numbers. Excluding stock-based compensation, operating income margin was 7.5%. Operating income also reflects investments we are making to improve the customer experience as well as pricing decisions we took in the second half of the quarter, which we believe will drive growth in the future.

However, pricing is just one lever for us. We have multiple initiatives that drive profitable growth, which Kevin will discuss in a moment.

Operating expenses were 10.7% of revenue. Excluding stock-based compensation. operating expenses were 10%. EPS of $0.33, which includes $0.03 of stock-based compensation, was down 11%.

Cash flow from operations was $1 billion, and we ended the quarter with $11.1 billion in cash and investments. Our cash conversion cycle was a negative 42 days, and our return on total capital continues to lead the industry at 59%.

During the first quarter, we spent $1.7 billion to repurchase 58 million shares of our stock.

As I take you through our product and region performance, you will see that we grew in almost every region, customer segment, and product category, particularly in Europe and Asia. An exception to this was U.S. consumer, where we lost share, though we retained our number 1 share position by a wide margin.

Several factors are impacting our consumer business, and Kevin will address these in his comments.

In Q1, we expanded our business in strategic growth areas, including the Enterprise and services. Total Enterprise revenue, which includes servers, storage, and associated services and software and peripherals, grew 10%. Storage revenue was up 12% year over year.

During the quarter, we launched the Powerball MD1000, incorporating 3.5” serial attached SCSI drives, and we celebrated the fifth year of our EMC alliance with the launch of new 4GB Dell EMC CX mid-range storage systems.

Server revenue is up 3% year over year on unit growth of 8%. Enhanced services revenue grew 28% year over year to $1.4 billion, and our deferred revenues were up $200 million sequentially to $3.8 billion.

This week we announced a $40 million, four-year agreement with Unilever to manage 10,000 seats, and in managed print services, we recently announced a five-year multi-million dollar contract with Boeing for management of thousands of North American printers.

In software and peripherals, revenue grew 11%, with imaging revenue up 10% year over year. Consumables are up 54%, and now represent over 50% of our imaging revenue mix. Our U.S. color laser units were up 13% year over year, and our total laser unit mix is now 20%, up from 15% a year ago.

During the second quarter, we will introduce a new generation of business color, mono, and multi-function laser printers.

In mobility, revenue was up 12% on 36% unit growth as we refreshed our entire line-up, including mobile workstations, Latitude business notebooks and Inspiron systems. Desktop PC revenue decreased 3% year over year, on 4% unit growth, which was consistent with the growth rate of the overall desktop industry.

Turning to the regions, we reached a record mix of revenue of 44% from outside the United States. Our 25% increase in units outside the United States drove a 70-basis point increase in our share to 12.4%.

In Europe, revenue was up 6%, and we outpaced the industry with an 18% increase in units, driving our share up to 14%. Enterprise revenue grew 9%, led by a 13% increase in serve units, which drove our share up 60 basis points to 20.1%. In Germany, a 27% increase in units elevated Dell to the number 3 share position.

In Asia-Pacific and Japan, revenues grew 17% year over year, with units up 30%, or roughly twice the growth of the rest of the industry. As the fastest-growing, non-Asian company, we increased our share 1.2 points to a record 10%. In China, revenue was up 29%, as our 40% increase in units was almost twice that of the growth of the rest of the industry. In Japan, we were awarded a significant contract from the Japan Defense Agency for desktop and notebook PC’s, as well as services. This deal, valued at $36 million, is the region’s largest ever contract. Our merging countries in Asia also posted strong growth, led by a 54% increase and revenue in Korea, and a 40% increase in India.

In our Americas business unit, which includes our U.S. consumer business, revenue was up 4%. Our corporate business revenue was up in the mid-single digits, and our Americas International revenue was up 26% year over year. Furthering our longstanding relationship with the military, Dell won a large business award with the Army to provide desktop and notebook computers, displays, printers, and peripherals. The total contract is worth $5 billion over 10 years.

Turning to the second quarter, many of our shareholders have asked that we discontinue our practice of providing quarterly guidance. They would prefer we focus our forward-looking statements on long-term company specific and industry drivers, which is frankly how we manage the business.

We believe a long-term focus is more appropriate for a company our size, and is in the best interest of our shareholders. So we are ending our practice of providing specific quarterly guidance for revenue and earnings per share.

At our analyst meeting in September, we will discuss the qualitative and quantitative data we think is most relevant for our investors to focus on to gauge our success.

Since this will be a transition quarter from a guidance perspective, as you work on your models for the second quarter, I suggest that you think about the P&L being very similar to that of the first quarter.

In addition, we expect to spend at least $1 billion for share repurchase.

Lastly, I want to touch on our cash position. As many of you know, the majority of our cash is outside of the United States. This is typical for technology companies like Dell, who are generating increasing profits outside of the U.S.

Repatriating this cash does have economic consequences. Similar to other companies, and to augment our liquidity and provide additional flexibility, we are planning to issue up the $1 billion in short-term commercial paper. In the near-term, this funding will be used to fund DFS activities. I want to ensure you all are aware of this, since we did disclose in our fiscal year 2006 10K filing that we may access the capital markets. In all likelihood, we will tap the commercial paper market in our second quarter.

Now let me turn it over to Kevin for more detailed discussion of our strategy.

Kevin Rollins

Thanks, Jim. I want to focus my comments today on what has changed in the competitive landscape and what we are doing to ensure the Dell Direct model remains the preeminent model to bring value, relevant technology, and services to customers.

We have now seen enough data over the last year to understand that the industry is going through another period of change -- significant change in the short-term and certain consolidation over the long-term.

The competitive dynamic has been more intense than we planned for, or understood. Some competitors have become stronger as they eliminated inefficiencies in their models. Average selling prices in the high-volume transactional space, home and small business, particularly in the U.S., have declined sharply without offsetting component price improvements.

More than ever, customers are using service and support as a point of differentiation when making purchasing decisions. While these changes were occurring, we tried to achieve both high-growth and increased levels of profitability. This allowed competitors to improve their profitability off of low levels and in some cases accelerate their growth. While we still garner the majority of the industry’s profit pool, our growth suffered.

In the latter part of the quarter, we took a visible step with price to reassert the value of the direct model and what it can bring to customers. The elasticity in response to our pricing actions was not obvious in our quarter results, but we did see an uptick in unit growth in April.

Our plans for growth, however, are more than just price moves. Price is the simple story. We are rebuilding our model, leveraging the fundamental and unique elements that are extendable. These changes are most needed, and will be most evidenced, in our U.S. consumer business.

So let me touch briefly on three key areas of focus. First is customer service and support. We ceded ground on customer service and support in the transactional space in the U.S. This year we expect to spend over $100 million to regain our leadership position, and our entire organization is focused on becoming number one in customer experience and satisfaction worldwide. Nothing short of number one is acceptable to us.

To help us get there, we hired over 2,000 new sales and support personnel in the U.S., and we're enhancing the training of over 5,000 support personnel globally. We expanded support warranties and have several projects initiated to further reduce call queue times and improve the scope of our services. In fact, we have already reduced hold times by 50%. We are expanding call centers globally, including Ottawa, Canada; Oklahoma City; Manila in the Philippines and Nashville, Tennessee.

We're enhancing our e-support services, which include ServiceDirect, a one-stop shop for online customer-driven sales help and support tool. These services enhance customer satisfaction while driving greater cost leverage.

We launched our DellConnect, a remote diagnostic service which has already provided service to over 400,000 customers with a 95% satisfaction rate. 95%, I might remind you, is not a rate we have seen in our industry. This is way above the norm. These efforts will not be reflected in our customer satisfaction scores right away, but we are already receiving feedback from our customers as they appreciate and see the improvements we're making.

The second area is technological leadership. We have always been committed to providing our customers with leading technology, and this year we are unveiling the most technologically advanced product line Dell has ever had.

For example, in the enterprise we are launching new ninth generation servers featuring Intel's server optimized Woodcrest processors, which have performed extremely well with our customers in tests. Today we announced in our earnings release that we will offer AMD Opteron processors in our multi-processor servers by the end of this year, offering a great new technology for our customers at the high end of our server line.

In storage where we have grown double-digits for 16 of the past 17 quarters, we launched new Dell PowerVault storage systems and new Dell EMC storage area network products that extend our technology and performance lead in the mid-range SAN.

On the client side, our focus on the XPS brand, an acquisition of Alienware, signals a renewed vigor around product design and quality for desktops and notebooks. In the U.S. our XPS business is over $1.3 billion annually, and we will be launching new XPS systems next week, including a new mobile gaming system featuring the world's first 20-inch wide screen display and a next generation, high performance gaming desktop with aluminum case and ultimate quad-core graphics.

In mobility, our new Dual Core Notebooks are seeing great early acceptance with more than 30% unit growth in Q1. We will enhance this line in the fall with Intel's new energy efficient Merom processor. We're very excited about Intel's desktop optimized dual-core processor, Conroe, which we will have on our desktops and workstations later this year.

In printing we're expanding our portfolio while we continue to focus on higher volume products like work group laser printers. In enhanced service, we are on a $5.6 billion run-rate, and in the quarter we grew at 28%. Examples of our service capability include our five-year managed services and hardware relationship with the Mexico Secretary of Education, which is our largest service deal ever; and our multi-year contract with Boeing for our managed print services, which is an emerging business for us.

We will have more to say about the progress of our product line rollouts during near-term launches and at our analyst meeting on September 12th and 13th.

The third area is improving our cost structure through enhanced productivity and cost efficiencies. This covers a broad range of initiatives, targeted at bringing better value to our customers and improving execution.

Some of these initiatives, like customer service and critical demand generation programs, require investment. We expect, however, to get leverage from these investments as we reignite growth and scale. We will use improvements in our cost structure to drive growth and, over time, to improve our profitability.

On the cost side, for example, we are accelerating our plans to drive approximately $3 billion of cost improvements this year. This includes more structure and material costs, component and transformational costs in our factories, as well as improved warranty costs.

On the productivity side, we recently merged the leadership of our U.S. and non-U.S. shared contact centers. This new structure will help improve efficiencies and help drive a consistent global approach to delivering technical service and support. We have revamped our advertising in both the transactional and relationship space to focus on the core and unique attributes of the direct model with an emphasis on value over price.

An early indicator of our success was recently published in an AC Nielsen survey of 1,700 IT decision-makers in the U.S. and Europe. Dell was selected as the top U.S. brand, citing value for money and outstanding customer service.

All of the teams here at Dell are energized and committed to our customers, to driving a reinvigorated focus on product quality and technology leadership, and enhancing productivity. We are confident that we will come out of this environment stronger than ever.

Let me end with a brief look at why we are confident we have significant head room for growth. 95% of the world's population lives outside the U.S., accounting for 70% of global market share; we only have 12% share of this market. Global customers are increasingly asking for broader product lines, enhanced services, and global scale. Few companies will be able to meet these evolving needs in the future, and no company is better positioned than Dell to succeed.

The leaders in our industry will have global scale and will operate close to the customer. This is why Dell is making the right investments in our highest growth countries ranging from China to India to Germany to Brazil and Korea to ensure that we can design, manufacture and service our customers locally.

Our direct model has been embraced in every country we have launched in. We have gained share every year since 1995 in almost every customer segment and product category in each of our top 15 countries. Dell has less business outside the U.S. as a percent of sales than our largest competitor and our other technology company competitors. Our upside is clear.

To close, we are committed to driving industry-leading profitable growth now and in the future. Profits fuel cash and cash returns. We must reassert the attributes of the Dell direct model that are unparalleled at bringing value, relevant technology and services to customers.

With increasing pressure on margins, companies operating at lower marginal profit margins will not be able to build a strong future. For Dell, this type of environment plays to our strengths. While others may have to hold back on investment, we're highly focused on investing significantly in the customer experience, our product lines, our manufacturing capacity, our design centers and more.

There is no doubt we have work to do. However, Michael, myself and the entire team are firmly committed to taking the necessary steps to position our Company for sustainable long-term growth. This is not a one or two quarter play. We're driving for success for the next three to five years and beyond, and we are confident that we are making the right adjustments to succeed globally.

I would now like to turn it over to the operator for questions, and then Michael will wrap up. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Farmer - Merrill Lynch.

Richard Farmer - Merrill Lynch

Thank you. Jim and Kevin, three questions all on the same topic of elasticity. You mentioned that you have seen a pickup in unit demand since taking the actions that you took in the quarter. Can you help us quantify how much that would be?

A related question is just around what gives you the confidence that the elasticity is going to kick in for you with these actions? I remember in the July quarter of last year you had experimented with lower ASPs, and I think your conclusion was that the elasticity really wasn't there. So what is different in the data now or your analysis of the data that gives you the confidence that a much bigger price action is going to drive that elasticity?

Finally, just on the elasticity itself, what is your calculation telling you that elasticity is? I assume you must be getting that is greater than one given that you think it will reaccelerate growth, but can you help us quantify what that number is, unit elasticity with respect to price? Thanks.

Jim Schneider

Richard, let me answer your last question first. I cannot give you a number. Generally in this industry there is multi-variant considerations, and you move from an inelastic to an elastic range by hitting a point. At that point, it becomes very elastic. That has been the history and nature of the industry.

I think our belief is that over the past year or so, despite Q2, that we have let margins float up and have allowed our growth to essentially come to a stall; that it would need an acceleration of overall growth but also then an acceleration of quality and of productivity and of service and support to reignite that.

Our belief is based in a long history of an experience with elasticity in this business across multiple product lines. As we mentioned in the first quarter, we were a bit towards the end of the quarter before we got most of the pieces kicked in in the U.S. here for pricing adjustments, but we did see an uptick.

But I think the key is more than that. They key is really sustained pricing position, Richard. Most of our large corporate customers don't buy in the spur of the moment. They are making decisions over a long period of time and will make those decisions based on the best value they can get. So this is a sustained March we are on, not a one quarter quick hit elasticity phenomenon.

Operator

Our next question comes from Tony Sacconaghi - Sanford Bernstein.

Tony Sacconaghi - Sanford Bernstein

Just to go back to pricing for one second, and then I have another question. On the pricing side, you have outlined a multi-part plan here with investments in service, investments in products, a new partnership with AMD. Why did you feel that in addition to these investments that you needed to take price and industry margins down at this point?

Why not let the other components of your plan ultimately play out, if you do believe they will have some impact, rather than taking what appears to be a gross margin dollar destructive move in terms of pricing? Then I would like to follow up on your action plan.

Kevin Rollins

Tony, just our history in the industry and our experience over the past 20 years or so suggests that when we started to stall, something was going on. We think we clearly had some service and support issues, but that was fairly localized to segments here in the U.S.

The greater issue was where we were price competitive and reacting to some of our competitors' improvements in their overall efficiencies. We let it go on too long. Our history tells us, and we have even seen the examples now in markets and positions where we have moved back into price position, that it will accelerate growth. It does come at a margin bump, and so we're prepared to take that move to sustain the business longer term.

As we mentioned, it is not a one quarter pop. We're going to have to stay at this for awhile, and we believe that we will see sustained growth that will allow us then to work back into better levels of profitability over time.

Our goal is to run the Company for the strategic success of the Company for the long run, not for one quarter, not for one month.

Jim Schneider

If you go back a couple of years or more, you could see that over time we had been working to improve our operating margins. This was at a time of other consolidation in the industry. So they increased, and our revenues increased at a pretty solid rate, too.

What we have found in the past year, and many of you have commented on that, is that as we try to sustain these margins at this 8.7%, 8.8% rate that our revenue growth just started to decline. We have had three years for our competitors to take billions of dollars of write-offs, and for us to have 8 or 9 points of margin when their profitability was very low, and yet have growth above the industry, I think all these things became a little bit difficult to do at the same time.

So I think the way we look at it now, it's not like trying to ignite some price war, but to see where we can get the best combination of growth and profitability for the longer-term.

I mean the margins declined somewhat here in the past quarter, and we are trying to find this right spot as to where we can get growth that is higher than 6% and yet have good operating margins that we can then work on. It is easier to improve margins over time when we're getting the revenue growth. It is pretty hard when growth is declining.

Tony Sacconaghi - Sanford Bernstein

To that end, you also began this call by saying that things are very different from where they were and things have changed. How committed are you to sustaining your price activity if ultimately it does not translate into improvement? Will you choose to go more aggressive in price, or when might you acknowledge that maybe the marketplace is different from the elasticity or pricing perspective?

Historically you saw your price cuts pretty well immediately translate into share gains. If we see no impact in revenue growth in Q2, which is essentially what you're calling for, how long do you intend to sustain price cuts to try and generate revenue growth? At what point might you reconsider that this strategy while historically valid, may not be valid today?

Jim Schneider

Tony, inherent in your question is the assumption of failure, and I don't think we believe that. I think we believe that through sustaining growth rate we will see the growth. We have seen that historically. It did not happen in a quarter. It did not happen in a month. I think the expectation of being able to turn it on a dime is kind of irrational.

If you look at any historic period when we had to ramp growth again, it did not happen in the quarter, and we think it won't this time. But I think it is going to be the sustained application, thoughtful application of where to grow, how to grow and to do so as best you can improve profitability.

The reason we believe that is a good strategy is what Jim highlighted at the end of his comment, is it is very different to scale our overall costs and investments if we are shrinking. You haven't seen a company in this industry who has shrunk themselves into profitability and leadership.

So we intend to take the goals of aggressive pricing at the same time improving product quality, which will lower our costs; improving our overall service and support, which will actually lower our costs; and we think with a combined effort there that over a sustained multi-[quarter] period that we will be in better strategic shape and that over the long run our profitability will be better.

Tony Sacconaghi - Sanford Bernstein

Thank you for that. Just one more if I may on that separate topic. What of your action plans that you outlined for improved product and service is different from your plans six months ago or three months ago? Clearly AMD, I would imagine that a lot of the product and service initiatives had been put in place several months ago. Can you just give us a sense of what is incremental in terms of actions taken or decisions made over the last 90 days?

Jim Schneider

Well, it really started at the end of last year, but it has now accelerated, Tony. We have pulled together a team, a cross line of business within our product development teams to look at full life cycle costs and product quality management. We have had fairly disparate activities, somewhat siloed, somewhat sporadic. But we believe in order for us to meet the cost targets, frankly, the quality needs of our customers, reduce warranty costs, we have to up it.

So we have now taken some of our top engineers literally off of the field from engineering design and moved them into overall cost and quality activities. We call it "design it right and build it right" activities. I cannot quantify for you the cost and all the number of heads there.

It is proprietary, but the renewed focus and effort and measurement and management attention has significantly increased, and we have decided to not accept anything but number one status.

Operator

Our next question comes from Richard Gardner - Citigroup.

Richard Gardner - Citigroup

I was hoping, Jim, you might be able to help us understand why the P&L would look similar in the second quarter to the first quarter? You only had a half quarter of the pricing impact in Q1 and presumably you had not made all of the OpEx investments that you intend to make for things like customer experience.

Then also if you could give us a sense of what the timing of the OpEx investments will be? How they will ramp?

Finally, on pricing where are you getting more aggressive on price, exactly in terms of customer segments and geographic regions? How far along in that process are you at this point?

Jim Schneider

We are trying to get away from guidance but did not want to maybe totally light switch it. But to give you a sense, I mean I think it could be possible either way. We could have more revenue. We could have more OpEx. You could end up with rather similar net results for the quarter. So we are trying not to detail this all out.

But yes, I think that over time, I think the OpEx, our plan would be for that over time with the revenue growth to scale and to go down as a percentage of revenue. But in the short-term, it could actually go up, the investments we are making right now. It is dependent again on what the revenue growth actually is.

See if you normally take our usual progression from Q1 to Q2, we are relatively flat, but perhaps this year it is somewhat different. But at least the history is that it is relatively flat. If that was the case or went up slightly and we are spending more money on some of the things we just discussed, we could actually have OpEx go up as a percent of revenue. Even if you had more revenue and similar margins, you might reach sort of a similar EPS number. That is the thought behind that. I'm not trying to go too much in detail.

I think from a pricing standpoint we are trying to be selective, but yet across the board be a little bit more aggressive than what we were. I mean if you look at what we had for the forecast for the first quarter, we are calling for 6% revenue growth. You saw a slight up tick actually in April, which would imply that we were running a little bit behind that. That was to my point.

For us to keep at the same operating margins, yes, I think we could get revenue growth. But over time I think we would be worse off than if we made these pricing actions now and had stronger revenue growth out through the end of this year. That is why as to how quick this happens next quarter, it is a little hard to say.

Richard Gardner - Citigroup

Jim, how should we think about gross margin? I know you don't manage the business based on gross margin, but should we expect gross margin to be down more in the second quarter?

Jim Schneider

You know, we tried to give you some overall feel for it, but I don't want to get into specific OpEx or gross margin. Partly it depends on the mix of business as well.

Richard Gardner - Citigroup

All right. Thank you.

Operator

Our next question comes from Harry Blount - Lehman Brothers.

Harry Blount - Lehman Brothers

Thank you very much. Three questions if I might. First, coming back to the elasticity argument, if we take a look at desktop elasticity, it looks like that has been hovering around one. if we take a look at your pricing actions, are you taking pricing actions even in market segments where there is elasticity that is one or below? If so, why?

Jim Schneider

Well, I would like to tell you Harry that we have got this down to a perfect science and exactly what it is to the basis point, but that level of specificity does not exist by product, by segment. So I really can't tell you that. So elasticity in general exists. You have an elastic range and you have an inelastic range, and it is not uniform. So I'm sorry, but you won't be able to compute it using the metric you're trying to look at.

Harry Blount - Lehman Brothers

The second question relates to profitability. If we go back to prior times when the tech industry was slowing down '93, '94 and then right after the tech bubble obviously, each of those situations is somewhat different than today. But if we go back to those timeframes, particularly '93, '94, you guys took Op margins down to a 2% to 3% range for several quarters in a row. Do you guys have a level at which you would no longer reduce operating margins?

Jim Schneider

I think that is of a plan to fail, so we are not describing what will happen in the worst scenario. We're planning to be able to move to a position where we can grow, and that growth will leverage our fixed cost, and over time our profitability will improve again.

So I think that is kind of the strategy we're on right now. We're not drawing lines in the sands of where we're go and where we don't.

Harry Blount - Lehman Brothers

The last question is, Jim, you indicated historically on a seasonality basis you were flat, which I can see from the model, but also I would point out that during those timeframes you guys historically were growing faster than the market, and in many cases, by quite a significant amount.

In fact, from a market share perspective, you guys typically have done quite well. If we take a look at normal seasonality here and assume no share growth actually, consistent with what you had had in the U.S. this particular quarter, we are coming out with numbers that might be around $13.5 billion. Is that a number that seems to make a high level of sense for you?

Jim Schneider

Well, you know that was the point of maybe some of the other questions. Because I think that some of the pricing actions we have taken have had some impact in April, and we would hope to continue to do a little bit better.

Yes, it depends on the market. The market has been okay from a year-over-year standpoint, but it declines a bit seasonally obviously in Q1 from Q4, and it typically goes down some more in Q2.

We kind of bucked the trend somewhat with us overlapping into July because we start to pick up revenue in the public markets, particularly in education. So we tend to do better than what the calendar market would be. So you have to be careful with some of the calculations.

Harry Blount - Lehman Brothers

Great, thanks.

Operator

Our next question comes from Ben Reitzes - UBS.

Ben Reitzes - UBS

Good afternoon, thank you. A couple of questions. With regard to Europe, you talked about emerging markets and international markets as one of the strengths. But Europe had one of the slowest growth rates I can remember, probably at 6% sharp deceleration. Some of your competitors are also seeing a little slower growth there.

So while you are happy maybe with your unit growth in Europe, it clearly seems to be decelerating. Could you just talk about what is going on there, and are you really confident that Europe can help pick up some slack a little bit for the U.S.? Or is that something that you're concerned about? Then I have a question about the longer term.

Kevin Rollins

Well, we had actually probably the highest share gain in Europe that we have had in some time, and they are hitting a high point now of 14% of market share within the European market now at 14%. Europe I do think is a tad slower. We've heard that from a lot of people, and I think that is probably true. We don't know how much and how it will trend out.

Our business pricing was aggressive there. We did see good unit growth, but we will try to balance that a little bit with profitability but still go after those markets because our share position in many countries in parts of Europe, particularly Eastern Europe and Russia and some of the Middle Eastern markets, is not very high. So we need to grow in those countries. We saw a pretty good uptick in growth towards the end of the quarter. That is kind of all the flavor I think we maybe have to give you on Europe.

Ben Reitzes - UBS

Just long term with regard to your operating model, I mean I know you don't won't to get pinned down, but I'm going to try to pin you down. When do margins go back up? It sounds like you have a plan, $3 billion in savings or so. We're not really sure based on what you said when this hits the bottom line.

You also have a new processor partner at AMD. So could you just talk about -- I mean you obviously have said a few times here you don't expect a sale, but I would just like to know when do margins bottom out and start to tick up if your plan works according to what you're looking at?

Maybe if you can answer it, throw in how we think of this $3 billion in savings and maybe how we think of AMD as potentially helping or hurting your margins?

Jim Schneider

Well, I don't think we have a timeline on that. I think we are going to stick with the pricing moves as long as we deem it is necessary to strategically light the business up and create a change in the overall market dynamic. That may take awhile. We don't think this is a short-term quick turnaround. So we're prepared to make cost reductions this year, next year, as long as it takes to continue to be efficient and be able to drive and sustain a great value position for customers.

Ben Reitzes - UBS

$3 billion? Should we just assume that those are offsets to the pricing?

Jim Schneider

They could be. I mean we would like to be able to move margins, but I think we want to see it first some movement in the overall market share and growth position.

Operator

Our next question comes from Laura Conigliaro - Goldman Sachs.

Laura Conigliaro - Goldman Sachs

Just a follow-up on the AMD thing. How much will switching to Opteron by the end of the year help? Given that a lot of people, a lot of consultants and others, have really said that they expect Intel to actually close the technology gap by then?

Also related to that, how big a business is what you characterize as your high end server line? And you're talking about four-way servers and up, and is this really something that you expect might have an impact?

Kevin Rollins

Well Laura, you raised a good point. I think the issue is that we are seeing a whole new wave of products coming in the second half of the year and significantly improved ingredients, which will allow us to stay very competitive. We're going to bring the best technology to the market.

There have been some holes in the multiprocessor side that we're going to be filling. But Intel also has an extremely competitive Woodcrest part and Clover Town part. So as far as the impact, I mean that will somewhat depend on what the demand is in the market. But our product line, we feel, is going to be stronger than it has ever been in the server range.

Laura Conigliaro - Goldman Sachs

What is the catalyst that really caused you to come to this decision since your server growth has been slowing for some time? It really seems that the gap between the two companies' processors was perhaps wider before than it is now?

Kevin Rollins

Well Laura, if you look at our server business, while it has been slowing, it has still been gaining share pretty steadily all throughout last year. The bulk of the unit volume is still not in the four processor categories. It is in the mainstream categories. So there is still going to be, we think, good growth there.

I think what Mike was highlighting is our commitment to technology and making sure that at every product level, every product category, we have the best technology for our customers. At the higher end of the multi-processor space, we think we could do better, and we think now that the Opteron product can fill a hole there.

Laura Conigliaro - Goldman Sachs

Thank you.

Operator

Our next question comes from Bill Shope - JP Morgan.

Bill Shope - JP Morgan

Great. A few questions. First of all, did your cost improvements that you discussed include any material reductions in headcount, and if so, where and over what timeframe?

Kevin Rollins

No, we're not anticipating that because we're going to be investing in overall service and support heads and in demand generation heads, that will be offset then by kind of efficiencies across other portions of the business. So we are not anticipating a headcount action.

Jim Schneider

We anticipate continuing to grow our headcount consistent with our business growth.

Bill Shope - JP Morgan

Second on AMD, can you help us understand why you chose to move to AMD in servers but not in the PC side of the equation?

Michael Dell

I think it is back to kind of the current best technology discussion again we just had. There was a clear acceptance. You watched it in the market. You guys ask us every time we turn around, what product will we use. The question of technology at the high-end was a situation where AMD was very successful. The technology was good there, and so we're using it.

Bill Shope - JP Morgan

Okay, thank you.

Operator

Our next question comes from Andy Neff - Bear Stearns.

Andy Neff - Bear Stearns

I think people are coming away a little confused about what you're saying. I realize again you're not trying to give guidance, but it sounds like you're saying that operating expenses are going to be up. The EPS could look kind of similar this quarter, but revenues might be down. Also, you are taking margins down. So I'm trying to figure out how you get a similar quarter.

Jim Schneider

All the point I was trying to make is that if you look a normal progression in Q1 to Q2, there is actually not typically a whole lot of change, and that is all we were pointing out.

Andy Neff - Bear Stearns

You seem to be implying that you were going to try to introduce some change. Is that what you're saying?

Jim Schneider

No, I was just giving you a sense of what has historically happened within that quarter. There could be different puts and takes, but we are not trying to spell all that out.

Andy Neff - Bear Stearns

Again, just to try and clarify, you seem to be implying that you're looking -- are you starting a price war? Is that what you're saying? Are you trying to be more aggressive, or what is it you trying to get across here?

Jim Schneider

I think all we're saying is that we believe that our growth has slowed because we kept margins too high, and so we need to accelerate that growth. We know that price is one catalyst to do that, but we will have to do other things in order to sustain the growth and meet customer needs. That is why we have cost reduction and investments being made.

So it really is a kind of multi-pronged activity to accelerate growth but to do it appropriately and in a high-quality way. Our history and our experience says that works really well.

Andy Neff - Bear Stearns

Okay. Thank you.

Kevin Rollins

I think just one other point just for this on the OpEx questions that we are asked. We're talking about a lot of cost reductions and part of this is to be able to offset over time the amount of money we are putting back into the product, the customer service and support and to be able to have the sales generation capacity to get to grow.

So there is no question a lot of that expense will be perhaps incurred before you can get all of your expense reductions. But I think over time the goal will be to reduce our OpEx as a percent of revenue. You may just not see it in the next couple of quarters.

Operator

Our next question comes from Keith Bachman - Banc of America.

Keith Bachman - Banc of America

I have two questions if I could. I have heard a couple of comments on the phone call where you have talked about the recent price-centered actions, the price changes rather. You're just still working through those and have not had enough time to be implemented. But this is the third straight quarter where Dell management has commented on the need to tweak pricing and not always been successful. So I don't think it has been a short timeframe.

My question to you, Michael, is, have you given consideration to not pushing the price elasticity curve to try to maximize revenue but instead to try to maximize profit growth rather than revenue growth? What would the considerations be there? And I have a follow-up, please.

Michael Dell

Yes, I think Jim kind of touched on this in the previous answer, but if you look at the history of our company, we have for the majority of the last 22 years, asserted a position of delivering great value and great service to our customers. We know that, for a variety of reasons, basically all of which we have discussed, we have sort of not done as well in those areas as we could have.

We are going to reassert ourselves across product, quality, service, value, and we believe that is the right strategy for us to pursue to continue to grow.

Keith Bachman - Banc of America

Michael, I assume, given the challenges that you have faced in the last few quarters, that you have considered numerous activities that would be changes in what your using strategy is, and might have those included using more of a two-tier model in emerging geos to increase your touch?

Michael Dell

A two-tier model -- by two-tier, do you mean an indirect model?

Keith Bachman - Banc of America

Right.

Michael Dell

No, we are the direct company.

Keith Bachman - Banc of America

Okay. The final question is in terms of your comment today around technology being a key part of your consideration for processors, if in fact AMD continues to have leadership in more than just the four-way, does that then suggest that if the product roadmaps do not come to fruition and AMD has superior products that you will in fact grant processor wins to whoever has leadership in those areas?

Michael Dell

We will deliver the best technology to our customers.

Keith Bachman - Banc of America

Thank you.

Operator

Your next question comes from Robert Semple with Credit Suisse.

Robert Semple - Credit Suisse

Thank you. Just a question really on the competitive response. Historically, you guys have really competed against companies in mature geographies, today the third and fourth biggest PC vendors are Acer and Lenovo in geographies where they tend to accept lower profitability and tend to prioritize revenue a little bit more. I guess my question is why wouldn’t they have a very aggressive response to your pricing, relative to maybe what some of your other competitors have done historically?

Jim Schneider

Take China, for example. I think they already have had a very aggressive competitive response, and I think we are quite comfortable that we are up for the challenge there. Our business grew at almost 40% unit growth rate, profitability is very, very good in China, and that is kind of maybe the epicenter of one of those competitors, so I think we are pretty focused, pretty comfortable, and believe that our Dell Direct model, when executed appropriately, can win in any market.

Robert Semple - Credit Suisse

Okay, and then just a follow-up on Vista. Microsoft released the specs today. Obviously you guys have probably known them for some time. Were you at all disappointed with these? I mean, if you look on your website right now, just about every PC you sell can run the scaled-down version of Vista today, and frankly, most of them in the line-up can do the premium version as well. Were you hoping to see better systems configuration with this launch?

Jim Schneider

Well we certainly were not surprised, because we have been working on this with them for years. If you go to dell.com/vista, you can see a lot of details about which systems do and do not run various versions. We have already started shipping the Vista capable logos on our systems. I actually think with the combination of the unleashing of a lot of new micro-processor power, widescreen displays, 64-bit dual core, mobile broadband, there is a major upgrade cycle that is coming that is going to be punctuated as Vista comes into the market.

Robert Semple - Credit Suisse

Thank you.

Operator

Your next question comes from Bill Fearnley with FTN Midwest Securities.

Bill Fearnley - FTN Midwest Securities

Thank you. I had a quick question for you on printers here. Could you give anymore detail on the supplies part of the printer business in the quarter? Then, as you moved away from the single function printer market, how has your traction been in all-in-ones and photo versus your expectation, since you made the change?

Jim Schneider

We are driving this transition toward the all-in-one and away from the kind of bundled, low-end printer. Color lasers are now up to 23% of our laser mix, so that has been driving very strong. Consumables have been strong. You know, our unit growth obviously toggled back because of the getting away from the super low-end printers. We have a very large array of new laser printers that we will introduce over the course of the next several months, about 13 new products, and the reaction continues to be positive and we are committed to growing a large, printing and imaging business. This is a profitable category for us and one that we are going to continue to grow.

Bill Fearnley - FTN Midwest Securities

A quick follow-up, if I could, on upselling. Could you provide more color on your upselling efforts on PC’s here in the recent quarter for options and accessories? You have had issues with that in the past, and I wondered if your focus on that from previous quarters has played out versus your expectations on up-sell. Thank you.

Jim Schneider

Well, up-sell is a pretty large category. We talked about our software and peripherals category growing at 11%. It is almost twice the rate of the overall business, so it does well, but it is somewhat dependent upon how well we do with overall unit volume, and it is more tied to, in terms of the up-sell software and peripherals, tied to the transactional business. Large corporates do not tie them the same way, there is a kind of large contracts you get, and the up-sell there is much more of a services up-sell. It is part of our Dell model. We have executed it well and poorly at times. We believe that is a long-term profitable segment for us, and believe that with printers and TV’s and the other things that go in there, software, memory, hard disk drive, power protection products, that we can drive that at a multiple of our company for quite a while.

Bill Fearnley - FTN Midwest Securities

Thank you.

Operator

Your next question comes from Brian Alexander with Raymond James.

Brian Alexander - Raymond James

First, a clarification: you mentioned you saw a pick-up in units in April based on your pricing actions. I just wanted to ask if you see a commensurate pick-up in revenue and gross profit dollars? Then I have a follow-up.

Jim Schneider

Brian, again, we saw some improvement in April over the prior couple of months, but I do not think I will get into specific profit discussions on that, but I think we saw some pick-up there.

What was the other part of the question, Brian?

Brian Alexander - Raymond James

That was it for that one, but on the pricing action, just to go back to a question that was asked earlier, I am not sure we have a complete answer in terms of where specifically are you targeting these actions? It seems like you have been taking more targeted pricing actions internationally for a while. Your operating margins have been coming down for over a year, and growth has been pretty good. The only segment where margins have held up reasonably well is the Americas business segment, and I am not sure that is a terribly price sensitive customer set. So I was just wondering if you could give us a little bit more color on where you are targeting these actions more than other places?

Jim Schneider

Brian, there are general price actions, but we are not going to alert our competitors to the specific areas we are going after.

Brian Alexander - Raymond James

Final question, on inventory, it seems like it was up quite a bit year over year. Could you just comment on that?

Jim Schneider

Yes, I think the inventory is up a bit, you know, higher than we would have liked. Some of it is just timing issues at the end of the quarter. Nothing really specific there. I think you will see it come back down here in the next quarter.

Brian Alexander - Raymond James

Thank you.

Michael Dell

Great, thank you, Operator. Okay, I think that is the last question. So I want to thank you all for joining us and reiterate the points that Kevin made about our competitive environment and what we are doing to enhance the value we bring to our customers. The competitive environment has changed. Some competitors have gotten stronger. There has been price compression in the high-volume consumer transactional segment, and that has eroded industry profitability. More than ever, customers are using service as a point of differentiation.

These dynamics occurred while we drove growth and higher margins. This stalled our growth and gave some competitors the opportunity to improve profitability off of very low levels, and in some cases, grow share.

We are focused on re-establishing the value proposition of our model, delivering great value to our customers, and we have definitive plans in place to improve customer experience, product quality, and technology leadership. We also have plenty of opportunity to improve our cost position and drive better productivity.

We will continue to do what it takes to capture more than our fair share of the growth in the global IT market. Our level of investment, and the adjustments we are making are not intended to deliver a short-term benefit. Their impact will take time to unfold. Kevin and I, as well as the rest of our leadership team, are convinced that we are making the right changes and we intend to stay the course. We know that when we focus and execute on the key tenants of our direct model, we consistently drive industry-leading growth, profitability, and the liquidity.

I want to thank you all for joining us today to discuss our business and our strategy.

Operator

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

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Source: Dell Inc. F1Q07 (Qtr ended May 5 2006) Earnings Conference Call Transcript (DELL)
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