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Dell Inc. (NASDAQ:DELL)

F1Q10 Earnings Call

May 28, 2009 5:00 pm ET

Executives

Lynn A. Tyson - Vice President, Investor Relations

Michael S. Dell - Chairman of the Board, Chief Executive Officer

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

Analysts

Richard Gardiner - Citigroup

Katy Huberty - Morgan Stanley

Toni Sacconaghi - Sanford C. Bernstein

Benjamin Reitzes - Barclays Capital

Bill Shope - Credit Suisse

Mark Moskowitz - J.P. Morgan

Maynard Um - UBS

Shannon Cross - Cross Research

David Bailey - Goldman Sachs

Bryan Alexander - Raymond James

Keith Bachman - Bank of Montreal

Scott Craig - Banc of America

Jeff Fidacaro - Susquehanna

David Wong - Wachovia

Operator

Good afternoon and welcome to the Dell Inc. first quarter fiscal year 2010 earnings 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 prior written permission of Dell Inc. is prohibited.

As a reminder, Dell is also simulcasting this presentation with slides at www.dell.com/investor. (Operator Instructions)

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

Lynn A. Tyson

Thank you, Ashley. With me today are Chairman and CEO, Michael Dell, and Senior Vice President and CFO, Brian Gladden. Brian will review our first quarter results and then Michael will follow with his perspective on our strategy.

We just posted information on our IR site at dell.com, including a V-log with Brian on our blog on Dell shares, as well as our web deck. Please review both of these to get additional perspectives on our results and long-term strategy.

This quarter we finalized the globalization of our commercial business into three business units, large enterprise, public, and small and medium business. Our results this quarter reflect this new structure and so instead of revenue and operating income by region, we are reporting it by customer segment.

We’ve also made other changes to our external reporting, which are outlined in a blog post on Dell shares dated May 15th. I strongly encourage you to read this post to learn more about our new business unit structure, changes we’ve made to our reporting of services and other product categories, and also how we are reporting business unit operating income. The financial statements that accompany this quarter’s earnings release have our fiscal 2009 quarterly results restated for the lines that are impacted by the changes we made this quarter.

Our investor relations activities in Q2 will be focused on our annual analyst meeting here in Austin, Texas. The event will begin the evening of July 13th with a reception hosted by our full executive leadership team and select business leaders. The meeting on July 14th will feature presentations by Michael, Brian, and each of our business unit general managers.

Finally, I would like to remind you that all growth comparisons made on this call are year over year unless otherwise stated and 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.

Now I’ll turn it over to Brian.

Brian T. Gladden

Thanks, Lynn. We continued to execute against the key transformation priorities we’ve laid out for you over the past few quarters, delivering great technology, service, and value to our customers, making strong progress towards a leading cost position, and driving disciplined working capital management. We are pleased with our execution on these key activities and remain focused on the continued transformation of the company. We have much more to do.

Consistent with the second half of our last fiscal year, in our first quarter we again delivered stable profitability and improved our liquidity. We’ve also made progress in expanding our portfolio of products and services to better serve our customers. So let’s take a look at the P&L and key performance metrics for the first quarter, which you can find on page six and seven of the web deck.

Revenue was down 23% to $12.3 billion. The revenue weakness was primarily driven by softer demand in the commercial markets and our strategy to protect profitability in this environment. Revenue was down 8% sequentially versus our fourth quarter.

Gross margin was 17.6% for the quarter and excluding the impact of incurred organizational effectiveness costs, was 18.1%, reflecting the continued progress we are making reducing cost of goods sold, including optimizing our manufacturing and logistics network.

Operating expenses was down 15% and was 14.2% as a percentage of revenue. Organizational effectiveness expense, or OEE, was $185 million or $0.09 after tax. It’s split about one-third in cost of goods sold and two-thirds in our OpEx number.

After the earnings call, we often get questions about amortization of intangibles and performance based compensation expense, so this quarter I am adding these items to our formal talking points. The intangibles amortization was $39 million and primarily hit our COGS line. Expense related to our broad performance based long-term compensation plan, which is primarily equity, was $76 million, split roughly 15% in COGS and 85% in OpEx.

While we still see more opportunity to improve our overall cost position, we are pleased with our progress in OpEx management. Excluding the impact of COGS incurred related to OEE in the first quarter, and OEE stock option acceleration of forfeitures and reserve reversals in prior quarters, OpEx was down $350 million or 18% year over year, and $70 million or 4% sequentially.

Our tax rate for the first quarter was 29.6%. It’s driven by higher profits in the U.S., including a higher mix of enterprise products and services, plus higher incurred OEE costs that are in Europe.

Taking all this into account, our reported earnings per share for the quarter was $0.15.

Referring to slides eight and nine in the web deck, we had another good quarter managing our working capital. We generated $761 million in cash flow from operations with improvements in payables and receivables. Our cash conversion cycle improved three days to negative 28 days in the quarter. We continue to believe that over time we can generate cash flow from operations in excess of net income.

Turning to the balance sheet on slide 10, with the current uncertainty in credit markets and the rapidly changing IT competitive landscape, we’ll continue to protect our liquidity to ensure flexibility for organic and inorganic opportunities. We ended the quarter with $10.7 billion in cash and investments. We have a $1.5 billion commercial paper facility in place, of which $100 million was outstanding at the quarter end. And after improvements in the credit markets in April, we issued $0.5 billion in five-year notes.

Finally, we have additional capacity associated with the debt shelf registration we filed in Q4 in last year and we’ll continue to monitor the credit markets for possible favorable entry points.

I would like to spend a few minutes on the status of our COGS cost initiatives, which will continue to be a fuel for our growth going forward. As you may recall, in COGS we have two major buckets of savings, design to value and the optimization of our manufacturing and logistics supply chain. These two activities make up a majority of our $4 billion in targeted cost savings opportunities.

In design to value, 33% of our business clients and 57% of our consumer platforms have been redesigned and cost optimized, which now equate to more than 50% of our total ship volume.

In aggregate, we reduced our average cost per unit by 2% sequentially and 10% year over year. These cost reductions are incremental to the typical component cost reductions we generally experience in our industry. I should point out that we are still early in this process and we expect more benefits here.

In manufacturing and logistics, our goal is to optimize our global supply chain for service and costs by creating efficient supply chain models to most effectively serve our different customers around the world. For example, our move to more contract design and manufacturing with significantly lower cost assembly and logistics models for our fixed configuration and retail customers are the key strategy. We are separately enhancing our configure-to-order supply chain capabilities where custom configuration and factory integration for commercial customers are highly valued services.

As we expand our manufacturing and logistics footprint, approximately 30% of our volume is now going through contract manufacturers. This work, which is ongoing, variabilizes a majority of our manufacturing and supply chain costs, provides a buffer to declining volumes and a benefit to gross margins, essentially helping us to keep margins stable over the past few quarters.

Next I am pleased to share our business unit results today. I would like to thank our teams for the great work in the implementation of the new organization model and specifically in getting the new segment reporting and restatements completed for the first quarter earnings cycle.

The results, which you will also find on pages 13 through 16 of the web deck, directly reflect how our general managers are running the businesses, essentially focusing on revenue, operating margin, and cash by segment.

Let me go into a bit of detail on each unit. Large enterprise, which represents our largest commercial accounts, had a challenging quarter with revenue down 31% to $3.4 billion. Demand weakness was similar in each of the major regions of the world. On a relative basis, our largest global customers have been most conservative with their IT budgets and we expect them to be slower coming back. Despite the challenging short-term environment for this business, we continue to invest and add solutions capabilities that will drive future growth in the enterprise.

We want to selectively invest to acquire business and new accounts going forward and we are investing to continue to build out our enterprise product and service capabilities.

Public, which serves government, education, and healthcare accounts, was the strongest commercial segment this quarter, with revenue down 11% to $3.2 billion. Growth in our larger federal and national accounts offset weaker performance in state, provincial, local, and education accounts.

Operating profit dollars were up 6% while operating income percent was up 150 basis points, as we drove more vertical enterprise solutions and aggressively managed our OpEx.

Our small and medium business revenue was down 30% to $3 billion in the quarter, with IT demand strongest in Asia and softer in the Americas and EMEA. Operating income dollars were down in line with revenue, driving roughly flat margin rate performance.

In our commercial businesses, our currently hardware centric model admittedly places us in the more discretionary portion of constrained IT budgets in this environment. So we are focused on the execution on right-sizing our cost structure and investing smartly to build product, service, and selling capability.

Going forward, we’ll continue to focus our teams on growth in enterprise solutions and on acquiring accounts that provide solid long-term opportunities for Dell.

We again had strong unit growth in our consumer business, with unit volume up 12%, with revenues down 16% to $2.8 billion. While the consumer unit was roughly break-even at the operating income line in Q1, we are still confident in targeting 1% to 2% operating income percent for the year. We continue to build out our retail footprint in the consumer space and now have over 30,000 outlets on a global basis.

On a regional basis, Americas revenue was down 21%, EMEA was down 29% and APJ was down 20%. Our total revenue from BRIC countries was down 21% and made up about 9% of our total revenue. In BRIC, China saw the mildest of declines while Russia was the most pronounced. Revenue outside the U.S. was 48% of our total mix.

Moving briefly to a few key product highlights, in the client space, mobility units were down 5% and revenue was down 20% due to the soft demand in commercial segments and average selling price declines in consumer. Desktop units were down 26% with revenue declining 34%.

Turning to enterprise products and services, our server revenue was down 25% on a 28% decline in units. We continued the rollout of our new 11th generation servers and precision workstations and our Dell data center solutions business experienced double-digit revenue and unit growth off a modest but expanding base.

Our worldwide X86 server share was down year over year but up 90 basis points sequentially as we solidified our number two position.

Storage revenue was down 17% but Equal Logic revenue was up 71% and we launched our new PS6000 series of iSCSI storage arrays with increased performance at advanced virtualization capabilities.

Enhanced services revenue declined 8% to $1.2 billion. However, our support services, which deliver customizable support solutions for end users and IT professionals in Dell and non-Dell environments did extremely well. Our deferred revenue balance grew 4% to $5.6 billion.

Software and peripherals revenue declined 18%, which was in line with our overall systems decline of 17% for the quarter.

Also in the quarter, Technology Business Research announced Dell was the top company in its inaugural corporate sustainability index, measuring environmental initiatives. We scored particularly well in renewable energy use, recycling, and integration of a sustainability strategy into our business.

For additional information on our efforts, see page 19 of the web deck and read our quarterly SRI blog series on Dell shares.

Before I turn it over to Michael, let me leave you with some additional perspective on the quarter and our views on the demand going forward. Our direct customer relationships and tight supply chain help us to see demand signals earlier than any other company in the industry. The first quarter started with muted demand across our commercial segments, particularly in the U.S. and Europe. The second half of the quarter was better but driven by typical seasonality. When taking the entire quarter into account, we don’t believe there’s enough momentum to call a bottom yet.

For our second quarter, we expect seasonal improvements from our federal government, consumer, and education businesses. But it’s also important to note that Q2 and the first part of Q3 are generally periods when we see slower demand from larger commercial customers in the U.S. and Europe.

Further out, we are confident that the vast majority of commercial customers are deferring purchases and will accelerate spending on IT to take advantage of technology driven productivity improvements.

But this up-tick will be driven by a better economy and associated improvements in customer profit and tax receipts. We expect IT spending to pick up first here in the U.S. and then across the globe.

Until then, we will continue to focus on what we can control, which is satisfying our customers, adjusting our cost structure to the near-term realities of industry demand, and making strategic investments to improve our company for the long-term.

Finally, we do expect to continue to absorb OEE expenses this year as we align our business to improve competitiveness. Our goal continues to be to drive a balance of liquidity, profitability, and growth, optimizing cash returns regardless of the macroeconomic cycle. Our disciplined execution on working capital and our ongoing cost initiatives are a big part of that.

With that, I will turn it over to Michael.

Michael S. Dell

Thank you, Brian. Our first quarter results demonstrate that we are executing on reducing costs and delivering solid margins. Going forward, we are accelerating our operating agenda priorities and intensifying our cost focus to achieve the $4 billion cost reduction objective. This is going to enable solid earnings and cash flow and create the fuel for growth.

During the first quarter, we accomplished a key structural step and our four global business units are now up and running. Large enterprise and public will drive us further into the data center and services while consumer and SME still substantial revenue and unit growth opportunities which can be enhanced by our cost structure initiatives.

We are preparing for what we believe will be a powerful replacement cycle, with virtualization and our growing managed services capability playing a much larger role as the economy improves, and we are using a combination of organic growth, alliances, and acquisitions to grow servers, storage, services, and software.

For example, our eight-year relationship with EMC has delivered over $10 billion in storage solutions to our customers. Our Equal Logic storage business is now four times larger than when we acquired it, delivering a scalable, virtualized solution right in the sweet spot of data center growth.

In services, we’ve integrated several acquisitions to create a cloud based managed service offering to proactively monitor and manage IT networks for large customers and we are now just starting to bring this to small medium customers in the United States with the pro-managed brand.

With the release of our 11th generation servers, we launched the Dell management console, dramatically improving our systems management capability along with our partner, Symantec.

And last month, we announced an alliance with Piro Systems to deliver virtualized technology solutions for healthcare.

All of these actions together serve to shift our portfolio in the direction we want and will help us expand our operating margins with strong cash flow.

It should be clear to you that we’ve embarked on some major transformational initiatives on the cost side and we are making good progress against these objectives. Also important in our transformation are the shifts in our business to the data center, software, and services.

As we do all this, we remain committed to balancing liquidity, profitability, and growth. We have many great assets and we see significant opportunities to grow and expand from here. We are making progress but we have much more to do.

You will hear much more about all of this at our analyst meeting in July. We look forward to seeing all of you there.

So now let me open it up to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Richard Gardiner with Citigroup.

Richard Gardiner - Citigroup

Thank you very much. I wanted to ask a question regarding global SMB -- you recently made an announcement that you -- well, you announced agreements with Ingram Micro and Tech Data in the United States and Europe and I’m wondering how we should think about the margin in global SMB as you ramp with these distributor partners. In other words, should we be prepared for some transitory period where margins decline in global SMB as you give more margin to the distributors and before you are able to distribute selling expenses between that effort and your existing direct effort? Thank you.

Brian T. Gladden

Well, if you look at the business over the last several quarters, the operating margins have been relatively stable in SMB. And our intent is to manage the operating margins at a healthy level, even as we are growing the business. So I think we are pretty optimistic about the portfolio there and particularly the shift in that business -- you know, we continue to introduce new products that are really well suited for small and medium businesses that have increasing margins, so it’s a balance but I wouldn’t -- I wouldn’t necessarily look for margins to go down there.

Richard Gardiner - Citigroup

Okay. Michael, if I could ask one follow-up, there have been reports of you actually turning over customer lists for small to mid-sized businesses in some regions to your distribution partners and I’m wondering if you intend to go after that market direct or whether you are turning over customer lists not only in smaller regions but also maybe in larger markets like the U.S. and Europe. Thanks.

Michael S. Dell

You know, as part of our channel programs, we engage channel partners in many ways, including providing them leads and opportunities to expand their business with known prospects. That’s a fairly standard practice and as part of our channel activity, which is a very substantial one.

Operator

Our next question comes from Katy Huberty with Morgan Stanley.

Katy Huberty - Morgan Stanley

Thanks. Good afternoon. Michael, it sounds like you believe when corporate spending returns, it will be more focused on the data center than the traditional desktop notebook business. Is that a fair characterization? And if so, how do you go about ensuring that Dell best penetrates those accounts, given historically the relationships have been more on the PC side?

Michael S. Dell

Well, so let’s kind of level set here in the United States -- I think last count we had about 37% share of the X86 server units, so we’ve got a pretty good position there. I think what we are seeing certainly is a big deferral of purchases among corporations but when we talk to them, the thing I’m hearing is they are planning on a pretty big 2010 client refresh, and they are sort of planning around Windows 7. They’ve passed over Vista and they are sort of planning for that now.

I think the client installed base is getting pretty old in these companies and I think there will be quite a powerful cycle of upgrades in the client environment. I do think it will be different this time. I think they will be very focused on newer technologies like virtualization. They will be very focused on ROI. There will be some new opportunities around wireless and mobility, with hoteling and those sorts of things. We’ve been doing some pilots with some large companies and have had some great success there and we think there are some big opportunities there.

So I think there’s absolutely a data center opportunity and we are pushing further into solutions and our kind of enterprise sales capability but the client installed bases in these organizations are getting quite old and also the users are getting restless as the machines get to the fourth year or fifth year and at home they have a brand new product that’s got the latest operating system, the latest capability. That can’t go on forever.

Katy Huberty - Morgan Stanley

Got it. Thank you.

Operator

Our next question comes from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford C. Bernstein

Thank you. I have a couple of questions, please. The first one is can you comment on directionally on what percentage of the way are you towards your target of $4 billion in savings? And how should we be thinking about the savings that are left on the table? Are the majority of those COGS or do you still believe you have OpEx savings remaining?

Brian T. Gladden

I think from an OpEx standpoint, you can look at where we are versus the last four quarters and I think we are probably close to an annualized benefit in OpEx of something like $1.7 billion, $1.8 billion. I think - and we have made some incremental investments and some growth programs there, so that’s one area that we’ll continue to drive that down as we look at this demand environment. There is more opportunity in OpEx and that continues to be a focus.

I think COGS is, as we said last quarter, still earlier in that process. We’re about 30% of the volume through contract manufacturers, about 33% of our business client platforms are now cost optimized, and close to 60% of our consumer platforms are cost optimized. So those things continue. I think there’s -- and it’s about 50% of the volume there now that’s been cost optimized, so again I think we are further ahead in OpEx, still more to do in both but COGS will be the majority going forward.

Toni Sacconaghi - Sanford C. Bernstein

Brian, if I could just follow-up on the OpEx, so the $1.7 billion to $1.8 billion reduction, is that -- should we be thinking of that as part of the $4 billion or how do we think about the fact that your revenues have obviously come down a lot and if you were just scaling the business beyond incremental cost cutting, your OpEx would have come down quite a bit. In fact, your OpEx is about 250 basis points higher as a percentage of revenue than it was in more normalized times three and four years ago, so on one hand you can actually look at the OpEx and say relative to history, it’s a lot more out of whack than COGS is and have you really gotten any of that $4 billion other than just scaling for volume?

So I guess a follow-up question is are you -- do you actually think you are close to the end in OpEx and we should be thinking about an OpEx level that’s substantially higher than what you had before? And when we think about the 1.7 to 1.8, is that what you are counting as part of the $4 billion?

Brian T. Gladden

Well, look, I think part of what we did last quarter was take the commitment up from 3 to 4 and part of that was recognizing that we had to go farther, given the demand environment. So I think there’s more there. I think we have been taking -- making some structural changes that allow us to move back towards historical levels in terms of OpEx. But again, I think we need a little bit of help as well from the revenue line to get back to historical OpEx percentages. So more there, recognizing that in this demand environment we were going to have to do that. To be honest, we are running at more than $4 billion internally because we know we’ve got to do that.

Toni Sacconaghi - Sanford C. Bernstein

And then just related to that, on the -- how do you think about -- I mean, it’s actually, as you pointed out, your gross margins have held up remarkably well despite volume pressures recently, and that’s probably a signal that you are improving the COGS. When you do your own kind of analysis, a 23% decline in revenue year over year, all else being equal, what kind of negative pressure does that put on gross margins and therefore, we can infer how much you are kind of making up by better pricing and better cost cutting -- but if we just looked at a 23% decline in revenue, all else being equal, what kind of negative gross margin pressure does that put on Dell's business model?

Brian T. Gladden

I think clearly there are some elements of our manufacturing cost structure that are fixed versus variable. You know, we continue to try to variabilize as much as we can of that cost. That’s a major priority for us but without venturing a specific number out there, a lot of the work we are doing on the COGS line has allowed us to really cushion that margin rate in this environment when we see significant volume declines and I think the other thing that’s worth noting is our exposure to some of the higher margin markets is better than some of our competitors in terms of not as big a consumer business, not as big in net books, bigger in the enterprise -- those things all help us, I think, to have somewhat of a cushion on that gross margin line.

Toni Sacconaghi - Sanford C. Bernstein

Thank you.

Operator

Our next question comes from Benjamin Reitzes with Barclays Capital.

Benjamin Reitzes - Barclays Capital

I’ll ask I guess a couple -- you guys are unique in that you report -- you know, May is almost over. You said that you saw things get a little better but it was only due to seasonality at the end of the quarter -- any thoughts on May and as you go into the summer, with potential for Europe to weaken? And then I have a follow-up.

Michael S. Dell

We don’t see anything different in May in terms of the dynamics we saw for the first quarter, so no real improvement.

Benjamin Reitzes - Barclays Capital

Okay. And when -- just on your cash flow statement, can you reconcile for us what’s going on in the other assets line again? You have some FX related cash flow in there -- can you just talk about what that is and how it nets out over the course of quarters, and if that’s a positive benefit going forward? And then the other cash flow question is can you update us on where you are on bringing your off-balance sheet debt -- I believe it’s around $1.5 billion -- back on balance sheet? Was that pace slowed during the quarter or -- and how does that take place over the coming quarters? Thanks.

Brian T. Gladden

Overall cash flow, I think pretty straightforward, Ben. We benefited largely from improved working capital management in the quarter. There is a change in other current assets. That is a net benefit to cash in the quarter but there’s some timing impacts in there and there are obviously some working capital related elements within that other current assets, like reduction in in-transit shipments and the collections of vendor receivables. Those together working capital reductions generate about $300 million of cash and are in that other current assets.

The FX contract, it’s a similar conversation. We’ve been talking about this since the third quarter, when we talked about those settlements and how they were going to play out for us. You know, there’s about 250 that hit in the quarter that shows up as a positive in that other current assets line. Obviously there were offsets to that and as you look at it, I think the way to think about it if you look at it over a rolling 12-month cash flow measurement, it nets out to zero. So that is a round trip basically in terms of the impacts on our cash flow and we were penalized earlier for that and now we get a benefit if those FX contracts settle.

What was your second question, Ben?

Benjamin Reitzes - Barclays Capital

Just regarding your off-balance sheet debt -- you and I have talked before about roughly a $1.5 billion number that may need to be brought back on balance sheet, which would have I guess a negative cash impact and I’m just wondering what the pace of that is and how much of that needs to take place in future quarters that may impact cash flow or not.

Brian T. Gladden

We’ve talked about the conduits -- they are not really off balance sheet but we continue to in some cases have some impact as we unwind those and have to fund those. You know, we had a small amount in the quarter. We’ll continue to do that over the next few quarters. We also, Ben, continue to look at the markets and look for opportunities to reconstruct those conduits with other parties. So I’m not going to give you specifics there, necessarily, no.

Benjamin Reitzes - Barclays Capital

Okay. Thanks a lot.

Operator

Our next question comes from Bill Shope with Credit Suisse.

Bill Shope - Credit Suisse

Looking into the 2010 client refresh comments you made earlier, do you have any statistics on the average age of your installed base versus sort of historical levels that would help us understand the type of pent-up demand we may be looking at in that type of refresh cycle?

Michael S. Dell

The information that we have would say that it’s kind of moved out in the nine-month to a year range, so it’s a pretty big push-out. And that would say if you get the right combination of new product cycle and Intel’s got a very interesting one coming, Microsoft has a very interesting one coming, there are a number of other factors that you could ignite a powerful refresh cycle and that’s what we are planning for.

Bill Shope - Credit Suisse

Okay, great. And then on component pricing, can you give us the sense of where you are seeing trends go there and how you are managing that and how we should think about that impact to your margin performance beyond this quarter?

Brian T. Gladden

We would say that it’s a relatively mixed environment. There are some components right now where we are seeing some pressure. I think panels was a good example. Processors is a good example. But there are others that continue to be deflationary and we would obviously benefit from those. So relative to historical, probably not as favorable for us over the next couple of quarters but continues to be deflation in aggregate.

Bill Shope - Credit Suisse

And the last question on that, do you have any strategic inventory in those challenged areas?

Brian T. Gladden

You know, not enough to be -- not substantial amounts, Bill.

Bill Shope - Credit Suisse

Okay, prefect. Thanks, guys.

Operator

Our next question comes from Mark Moskowitz with J.P. Morgan.

Mark Moskowitz - J.P. Morgan

Good afternoon. Two quick questions here -- one, Brian or Michael, can you talk a little more about the consumer profile? Clearly your penetration with retail outlets is moving up and favorable and your unit trends are pretty handsome as well but the revenue though seems to be in stark contrast. Can you just talk about the quality of the units right now? Is this more of a Dell issue or is this more of a market issue?

Michael S. Dell

Well, I think the consumer, you know, average selling prices are down considerably. You can see this in some of our other competitors who had even larger drops in average selling price than Dell did. But clearly, you know, we are going through a pretty major change in the consumer business. We are committed to running the business in a 1% to 2% [operating] range and confident that we can improve the margins over time.

Mark Moskowitz - J.P. Morgan

And then the second question, kind of building on Katy’s question earlier, just as far as your confidence around really cementing Dell's relevance in the data center and the enterprise replacement cycle, Michael. I just want to get a sense, given that your cost transformation plans seem to be on track or a little ahead of plan here. Where or how should investors kind of think about Dell moving forward with more of a transformation on the model side in terms of inorganic opportunities to really cement your presence in the enterprise, either from a services play or from an enterprise hardware play? Because it seems like we are in a situation here like Brian said where it’s too early to call a bottom. Wouldn’t this be a good opportunity to take advantage of your cash position, make an acquisition, and take advantage of the downturn to kind of digest a big acquisition so you are stronger coming out of the downturn?

Michael S. Dell

Well, we are piling up cash and we think the cash flow is going to continue to be pretty powerful for the foreseeable future. Feeling pretty good about the operational improvements in working cash flow that are occurring. I think the assets that we have are strong ones and give us a great position to be able to extend as you are suggesting. You know, asset prices are getting pretty attractive and certainly we are looking at how we are going to expand inorganically. You know, in the last couple of years, we sort of entered this process -- we previously hadn’t really done acquisitions have done about 10 transactions, only one of them at any sort of size that would get anyone’s attention. That was the Equal Logic transaction. That business is now roughly four times larger than when we started and significantly more profitable. You know, it’s a very profitable fast-growing part of our business, so yeah, we’ll be looking in that direction and stay tuned.

Mark Moskowitz - J.P. Morgan

Thank you.

Operator

Our next question comes from Maynard Um with UBS.

Maynard Um - UBS

Can you just maybe talk about where you are in the build-out of your indirect channel and maybe if it’s easier, kind of what inning that you think you are in? And then maybe related to that, can you talk about the impact to gross margins as you presumably make a bigger push into the indirect channel? You know, it doesn’t look like there’s a time between the consumer mix shift and your pro forma gross margins for the product side, so can you just update us on your thoughts on what the impact of gross margins might be and whether programs like design to value and moves to contract manufacturing will offset that? Thanks.

Michael S. Dell

Well, again, consistent with our kind of profit goals in consumer, which I mentioned earlier, that’s kind of how we are targeting the changes in the supply chain and in the product designs. You know, if you sort of said well how many available outlets are there, it’s probably three or four times the number we are in today but it would be true that we’ve sort of gone to the more attractive ones earlier, but it would also be true that we are still growing within the ones that we are in, so we still have a long way to go and to grow in consumer retail expansion.

On the commercial side, I think the interesting thing here is that the operating margins are very consistent with the direct business and this has to do with the shift in mix and the partners really bringing the Dell products, which tend to be more enterprise focused, into new customer footprint that we haven’t been in before, and so that’s kind of the focus on the commercial side. We’ve got about 40,000 partners now globally. You know, we launched the partner direct program at the end of 2007 and we are seeing our partnerships kind of grow and expand with a growing group of solution partners.

Operator

Our next question comes from Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Thank you. A couple of questions -- Brian, can you just talk a little bit about on the cash flow side, you discussed sort of what happened this quarter but can you give us some idea of what we should be thinking about over the next few quarters in terms of puts and takes and cash flow, maybe thinking back year over year -- you know, in third quarter you had the FX but things we should just keep in mind? And then I had a follow-up.

Brian T. Gladden

Yeah, I think it’s going to have a lot to do with the top line in terms of how that plays out with working capital, so I think that’s something that you can model it out and play around with the sensitivity. If we see growth with a negative cash conversion cycle in the second half of the year, we should see pretty powerful cash flow return. We are going to continue to work all the details of working capital, all the line items there. I think we can hang on to this sort of a cash conversion cycle in this environment and when growth returns, it will get better. So in terms of FX and other moves, you know, don’t expect anything as dramatic in terms of -- you know, it will be hard to predict where the currencies go and with the dollar sort of going the other way, we can expect a little bit of maybe some timing impacts there, but nothing dramatic in terms of the outlook right now.

Shannon Cross - Cross Research

Okay, thanks. And then Michael, a question just with regard to emerging markets, you know, Lenovo has pulled back in India, people have talked, including you, about strength in China -- I’m just kind of curious about how you are thinking about where to put resources, how much to focus on some of these marketplaces and how you sort of see the competitive landscape within the emerging market?

Michael S. Dell

Well, I would say the word that comes to mind is attack -- I mean, we are on the attack in the BRIC countries and we are going to grow there. We see a lot of opportunity to grow in all of those countries and I’m pretty happy with our progress in the core BRIC -- when we get to kind of the next 10 or next 15, that’s an area of increasing attention for us. You know, we’ve done better in China and India and Brazil than some of the others, but we still see big opportunity there and we view ourselves as a consolidator in those new markets.

Operator

Our next question comes from David Bailey with Goldman Sachs.

David Bailey - Goldman Sachs

Great. Thank you very much. Just a couple of questions, please -- could you comment on any impact that you expect to see in the Blade Server market as Cisco enters it -- and more broadly, do you think it’s important to have products that combine functionality like server and zen networking in a single product?

Michael S. Dell

Well, let’s remember that the part of the market that has gotten a lot of attention recently is actually not a large part of the overall opportunity. And in the really large data centers, they tend to look very, very different from these full stack solutions. And we have a lot of experience there, having sold to a very high percentage of the really mega scale data centers. You know, you don’t see the -- what I’ll call proprietary networking approaches inside those data centers. You see very, very simplified networks and multi-tenant applications using large volumes of our servers and storage. And if I had to guess what the data center of the future looks like in five years, I actually think it’s more like that. So I think some of these vendors are hanging on to kind of the way of the past and you know, when we talk to customers, sure there’s an interest in having a fully integrated solution and they see some advantages and accountability there, but it’s also an incredibly expensive approach and it’s sort of a throw-back to what IT was 25 years ago. It’s a lock-in and we don’t see kind of huge traction there. So we can’t underestimate the significance of these moves by other companies but there are all sorts of counter-balancing effects that are likely to occur as new alliances get formed and customers look to where they are actually getting the best value.

David Bailey - Goldman Sachs

Okay, and then switching over to DSF, it looks like the charts might be from last quarter and I was wondering if you could give us an update on the originations year over year, as well as the loss in delinquency percentages?

Michael S. Dell

Originations are down in the first quarter but that’s the typical seasonality that we have with the strength in the consumer business in the fourth quarter.

David Bailey - Goldman Sachs

On a year-over-year basis?

Michael S. Dell

Sequentially down. On a year-over-year basis, I think they are similar. We can get back to you on that. I think in terms of delinquencies and losses, it continues to be challenging. I think as we look at the portfolio itself and the underlying quality of the new assets that we put into the portfolio as we have begun to tighten underwriting and effectively manage the quality of the portfolio, we are seeing improvements in the performance of that portion of the portfolio. But again, you could see in this quarter it’s 9.6% is where we are in terms of reserves and the delinquencies on 60-days plus are up to the 3.7%, so that’s the latest view. We still feel comfortable with the portfolio -- we feel like we are fully reserved and managing it pretty effectively, given the environment.

David Bailey - Goldman Sachs

Great. Thank you.

Operator

Our next question comes from Bryan Alexander with Raymond James.

Bryan Alexander - Raymond James

A clarification and a question on design to value, since it seems to be the biggest driver of cost reduction going forward -- so the clarification is when you say aggregate average cost per unit is down 10%, is that for total units or just the units that have been optimized? In other words, are the optimized units down closer to 20%, given that more than 50% of those have been cost optimized? And then I have a follow-up.

Brian T. Gladden

Yeah, that’s taking the savings we have generated over the total shipments.

Bryan Alexander - Raymond James

So that’s total shipments, so the optimized units would be down more than that?

Brian T. Gladden

That’s right.

Bryan Alexander - Raymond James

Okay. So how should we extrapolate the progress on cost per box reduction for the remaining 50% that haven’t been optimized? Are they likely to see a similar savings rate as what we have seen so far, or is that likely to go up or go down?

Brian T. Gladden

Well, I think it varies depending upon the individual platforms. I mean, as we’ve learned the techniques and apply the tools more broadly, I think we are moving more quickly through the process and I think we can get bigger benefits out. I do think we have attached the larger individual platforms that are there so it will take more time to work through some of the smaller ones as we execute. So that -- it’s probably likely to be pretty similar to what we have seen on the aggregate so far for the next waves.

Bryan Alexander - Raymond James

Thank you.

Operator

Our next question comes from Keith Bachman with Bank of Montreal.

Keith Bachman - Bank of Montreal

Thanks. I was hoping you could talk about enhanced services some. In the past, services have been highly correlated with unit ships. Over the past couple of quarters, enhanced services growth has outpaced that of the company. How should we be thinking about the potential here, particularly since the gross margins are so far above what the product side are?

Michael S. Dell

Well, we are driving an attach approach certainly on the -- the attach driven services, which are significant for us, but we are also driving more of the business to managed services. We keep winning some pretty substantial client manage services opportunities, which are giving us some annuity streams and some stickiness inside these customers, and again kind of using the assets that we acquire to shift the business in that direction.

And the infrastructure consulting side is growing as well -- that’s important for us as we sell more complex product solutions. So we certainly want to move more towards services and it’s a big focus for our teams.

Keith Bachman - Bank of Montreal

Mike, are there any metrics that you can give us in terms of where you think the attach rate is now on sales out versus where you want it to be, or any metrics associated with how we should be thinking about the growth potential here?

Michael S. Dell

The pro-support attach rate was about 36% in the first quarter, up pretty nicely from the fourth quarter and we are working hard to continue to drive more services attach and certainly the deferred services balance continues to grow, even while overall revenues were down, so we are clearly pointing in this direction and as you get this upgrade cycle that we are really preparing for, our intent would be even more to move those customers from as we mentioned to you many times before, from kind of product to service.

Keith Bachman - Bank of Montreal

Okay. Thank you.

Operator

Our next question comes from Scott Craig with Banc of America.

Scott Craig - Banc of America

Thanks. Good afternoon. Brian, just a question on the notebook ASPs -- on a year-over-year basis, they got a little bit worse this quarter but when you look at them, how much of that is from mix and how is net books playing into that? And how much can be attributed to maybe aggressive pricing, given the economic environment? And then just a quick question for Michael as well -- you guys mentioned you’re in 30,000 retail store fronts now. HP is at 80,000 plus. How far do you get or how close do you get to HP as you roll out this strategy and where is the end point there? Thanks.

Brian T. Gladden

On the notebook pricing, the majority of the decline we see is really driven by mix, as we see -- we grew nicely in the quarter on net books off of a relatively small base but it’s starting to become a relative piece of the consumer business and we’ve now got a product on the commercial side as well. But mostly mixing into lower ASP products, that’s where a lot of the growth is right now.

Michael S. Dell

On the retail footprint, I think there are some much larger and more valuable retailers and those are the ones that we are really concentrating on. We don’t necessarily want to just increase the number of doors. I think there are new countries where we want to do that. So for example in China and India, we added about 3,500 doors on a sequential basis, so a pretty big change in some of the emerging countries pointing to comments I made earlier. So we’ll be looking to do it selectively. If you take the U.S., for example, we’ve got some great big partners and we are driving a lot through them -- don’t really see the need to open a lot more doors here in the U.S.

Scott Craig - Banc of America

Okay. Thank you.

Operator

Our next question comes from Jeff Fidacaro with Susquehanna.

Jeff Fidacaro - Susquehanna

Just I want to go back to the strategies with the distributors -- can you talk a little bit about the opportunity to expand into more regions and even offer more products? In other words, what should we expect next as far as if you are happy with this initial start-up in the U.S. and Canada?

Michael S. Dell

Well, you said it -- it would be more products and more regions.

Jeff Fidacaro - Susquehanna

Is there a specific region you are likely to go into next? And what is the balance of offering more products versus some of the higher margin attach of services locally for Dell?

Michael S. Dell

You know, I think we will look across the business and look for where we think the best opportunities are. Clearly we have a much broader product portfolio than they’ve started out with. We’re learning how to do business with them, they’re learning how do to business with us and as we get that going, we will extend it into more regions and broader product categories.

I think when you look at our server and storage portfolio in particular, we think there are a lot of opportunities to expand distribution.

Jeff Fidacaro - Susquehanna

Great. Thank you.

Operator

Our next question comes from David Wong with Wachovia.

David Wong - Wachovia

Thank you very much. The contract -- the portion of your products that are made through contract manufacturing, how do you expect that percentage to change over the next few quarters? And when a product is moved to contract manufacturers, does this impact either gross margin or cash conversion cycles?

Michael S. Dell

We expect that to go up as we expand and continue to work to optimize our manufacturing costs and clearly we wouldn’t be doing it if we didn’t think we saw benefits in terms of margin rates and we think we can manage effectively to maintain cash conversion cycle, even with this structure. So we are working hard to do that and we think that’s possible.

David Wong - Wachovia

Great. And the other thing is restructuring charges, how many more quarters do you expect to have fairly significant restructuring charges for?

Michael S. Dell

You know, as we said, the timing very much depends upon the decision-making progress and how we move forward with our plans and as we finalize those plans and agree on those plans, we will incur those expenses in those quarters. We’re not going to give you a visibility or an estimate -- again, some of that still has a lot of volatility in how it moves around and when you take those expenses.

David Wong - Wachovia

Okay, thanks.

Operator

We will now turn the call over to Mr. Dell for closing remarks.

Michael S. Dell

Okay. Thank you, Operator. We are certainly I think making progress on our transformational activities and accelerating our operating agenda and cost initiatives. As we demonstrated in the first quarter, we’ve got strong cash flow and I believe Dell has a great set of assets. We see significant opportunities to expand our business. While we do all of this, we remain very committed to balancing liquidity, profitability, and growth. Thank you for your time today and we’ll talk to all of you again soon.

Operator

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

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