Dell Q3 2006 Earnings Conference Call Transcript (Prepared Remarks)

| About: Dell Inc. (DELL)
Investor Place

Q3 2006 Earnings Conference Call


Lynn Tyson, Vice President, IR and Corporate Communications
Jim Schneider, Chief Financial Officer
Kevin Schneider, President and Chief Executive Officer
Michael Dell, Chairman


Harry Blount, Lehman Brothers
Richard Gardner, Citigroup
Andrew Neff, Bear Stearns
Tony Saccanaghi, Sanford Bernstein
Rebecca Runkle, Morgan Stanley
Laura Conigliaro, Goldman Sachs
Ben Reitzes, UBS
Keith Bachman, Banc of America
Richard Farmer, Merrill Lynch
Bill Shope, JP Morgan
Steve Fortuna, Prudential Equity Group
Brian Alexander, Raymond James
Richard Chu, SG Cowen



Good afternoon and welcome to the Dell, Inc. Third-Quarter Fiscal Year 2006 Conference Call. I'd like to inform all participants that 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 part without prior written permission of Dell, Inc. is prohibited. As a reminder, Dell is also simulcasting this presentation with slides at Later we will conduct a question-and-answer session. Operator Instructions

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

Lynn Tyson, Vice President, IR and Corporate Communications

Thank you. With me today are Chairman, Michael Dell; CEO, Kevin Rollins; and CFO, Jim Schneider. Jim will review the third quarter results as well as our outlook for the fourth quarter. Kevin will follow with his perspective on the market and our strategy and then we'll take your questions. I'd like to remind you again that we've posted our presentation on our website at to accompany this call. We encourage you to read this deck for additional financial and operating results as well as a reconciliation of our GAAP and non-GAAP results.

Before we begin, I want to just give you an update on our Ion program for the balance of this fiscal year. We will continue our conference call series with executive management on January 9, with Joe Marengi, our Senior Vice President of Americas and Gary Kopshaught, our Head Services for Americas. They'll discuss our services strategy as well as our customer engagement strategy.

Finally, we want to remind you that all statements made during this call that relate to future results and events including our fourth-quarter outlook discussion 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'd now like to turn the call over to Jim.


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Jim Schneider, Chief Financial Officer

Thanks, Lynn. While we are disappointed we didn't reach our revenue target for the quarter. We are very pleased with our ability to deliver industry-leading profitability, consistent growth in earnings, and a balanced P&L. In the third quarter, revenue was up 11% as record earnings grew 18% on a non-GAAP basis. We delivered over 1.1 billion in cash flow from operations and invested over $1.4 billion to repurchase our stock.

Operational highlights include, Revenue outside the U.S. was up 20% year-over-year. Enhanced services revenue grew 36% year over year to $1.2 billion. In the Enterprise storage revenue was up 35% and server units were up 21% year-over-year. And software and peripherals revenue grew 25% year over year to 2.1 billion.

Turning to our results for the third quarter, we generated 13.9 billion in revenue, an increase of 11% year-over-year. GAAP EPS of $0.25 includes nonrecurring charges totaling 442 million, or $0.14 per share. As we mentioned in our October 31, press release, over $300 million of the charge is associated with the cost of servicing systems that included vendor part which failed to perform to our specifications. The remainder is related to workforce realignment and other actions designed to reduce complexity and provide greater efficiencies. Excluding these charges, EPS was $0.39 on a non-GAAP basis. For the remainder of the call, all references to our financial results will be non-GAAP, excluding the above-mentioned adjustments.

Our third-quarter operating margins came in at 8.6%. Operating expenses of 10% reflect increased investment in customer experience and seasonal investments in sales capacity in advance of the holiday-selling season.

Cash flows from operation for the quarter was 1.1 billion with free cash flow of over $1 billion. You should also note that beginning this quarter, we have also included a table in our web deck that reconciles cash flow from operations to our free cash flow.

Our cash conversion cycle was a negative 36 days and we ended the quarter with 12.3 billion in cash and investments. As I mentioned, we spent 1.4 billion to repurchase about 41 million shares. And year to date we have repurchased roughly 140 million shares which is more than three times the numbers of options we expect to grant for the full year.

Looking at our products and services, we delivered growth in key strategic segments, including servers, storage, services, and the important shift to mobility. In the enterprise we continue to expand our storage footprint with revenue up 35% year-over-year and our server revenue grew 16% year-over-year.

In the quarter, we are the first to market with our portfolio of single, dual, and four socket power head servers and precision workstations with Intel's new multicore Intel Xeon technology. This multicore solution delivers the largest generational performance gain ever seen in the most widely supported architecture in the world delivering 50% greater performance, while maintaining a common systems image for both single and multicore systems. To complement this multicore technology, we also unveiled the comprehensive database offering featuring the new Microsoft SQL server database so that customers can more effectively migrate their critical data with the complete database solution.

A good example of our model strength in bringing value, performance, and repeatability through standard-based computing and services is our recent agreement with TRW Automotive. As part of this global three-year agreement, Dell will install and support 24,000 desktops, notebooks, and workstations along with hundreds of PowerEdge servers and Dell EMC storage systems.

In addition, Dell will provide assessment and design services to help TRW implement its storage area networks. We continue to have great success in our high-performance computing clusters. Recently Brigham Young University installed six new Dell supercomputing clusters containing a total of 682 PowerEdge rack and Blade servers. And scientists at the University of Bonn recently upgraded to a Linux HPCC with 128 PowerEdge servers.

Our enhanced services revenue grew 36% year-over-year, to $1.2 billion, and the deferred revenues were up $200 million sequentially to 3.4 billion as our attach rate of extended services continues to grow. In a recent survey of hundreds of corporate IT buyers by CLO Magazine, Dell was rated number one among leading vendors for providing impeccable customer service. Also during the quarter, Dell’s superior value and quality was recognized with the star award, for service excellence in the category of mission critical support environments from the service and support professionals association.

In software and peripherals, revenue growth of 25% was driven by digital displays and imaging. We continue to see strong growth in laser printers and overall consumables as we place a greater emphasis on higher value laser and all in one inkjet printers. This mix shift helped to drive a 31% increase in total revenue, as consumables reached 46% of our Dell imaging revenue. For the quarter, we believe, our U.S. inkjet share will be 20% with laser share at 13%.

We are pleased that our printers will soon be recognized by a major rating service that conducts independent surveys of customer satisfaction and product quality. We also announced three new additions to our television lineup. A 50-inch plasma HDTV, a 37-inch LCD, and a 32-inch LCD all incorporating our latest technology designed to develop sharper images and leading-edge functionality.

In the fast-growing mobility space, units were up 38%. In the quarter, Dell became the first major computer supplier to announce multiple wireless carrier partnerships focused on integrated broadband capability. Desktop PC revenue declined 2% year-over-year as a shift to mobility continued. During the quarter, we refreshed our XPS line of high-performance computers with added performance, power, and style aimed at gamers and tech enthusiasts. We launched the M140 and M170 notebooks and three new desktops. All of our XPS products come with enhanced services and individualized support.

Turning to our regional performance, revenue outside the United States was up 20% year-over-year and was 40% of Dell's overall revenue. In Europe, our revenue grew 19% year-over-year with revenue outside the U.K. growing 25%. Our growth in the U.K. was slower than anticipated driven primarily by the public sector while France, Germany, and the UK home and small business segments continued to strong growth. In Asia-Pacific in Japan, we delivered revenue growth of 20% year-over-year, led by 71% year-over-year growth in services and 53% growth in software and peripherals. In China, units were up 46% year-over-year, with revenue up 29%. In the Americas international, our model continues to excel with revenue up 22% year-over-year. This growth is fueled by continued strength in Latin America, where mobility revenue was up over 30% year-over-year and server revenue was up over 20%.

In the United States, we gained share and remain the number one systems vendor in each of our segments. In Americas business unit revenue grew 10% as overall demand remained healthy. In the quarter we began shipping product from our third U.S. manufacturing facility located in North Carolina. This 750,000 square-foot plant will build systems for customers in the eastern United States. We also opened a new customer contact facility in Oklahoma City and expanded our small parts hub in Ohio which will speed the delivery of spare parts for field service.

The U.S. consumer business was challenging with revenue down 2% year-over-year. In the quarter, we announced that we will consolidate our U.S. consumer business back into our Americas business unit. This structure will allow us to drive additional efficiencies in our transactional businesses, and provide better value and services to our customers.

Before I turn it over to Kevin, let me touch on our fourth quarter. As Lynn noted, these comments contain forward-looking statements. For Q4 we are forecasting a revenue of 14.6 to 15.0 billion. Up 9 to 11% year-over-year. We expect margins in Q4 to contract modestly from Q3 driven by a seasonal increase in consumer and investments in our customer experience initiatives.

We expect investment and other income of about $60 million, a tax rate of 24.25% and at least $1.7 billion of share repurchase. As a result, we expect EPS between $0.40 and $0.42, an increase of 8 to 13% year-over-year. And as most of you know, we have an extra week in our fourth quarter. Historically, this has had a minimal impact on our overall results.

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

Kevin Schneider, President and Chief Executive Officer

Thanks, Jim. There are three points, key points that I want to make. First, our direct model is known for driving executional excellence and we are keenly focused on that for this quarter and for the future. Second, our model is still cost advantaged at all price points and in all products which drives our focus to balanced growth, in and across price bands, the result is solid revenue and earnings growth. Third, we are excited by a number of technology and product advancements coming in the next 12 months and will use our model to accelerate the accessibility of these advances to our customers through the Dell effect.

Let me expand on these points. After the second quarter, we took a hard look at our execution and began making changes to balance our product and our pricing model. In Q3 we took actions in three key areas. We implemented improvements to increase efficiency and drive lower operating expenses. We put processes in place to drive pricing consistency across customer segments. And we focused our resources to improve customer support. While we still have work to do, we are already seeing some results including the consolidation of the consumer in the small medium business sectors in the United States and the efficiencies that that brings. The pending launch of Tech Connect which allows Dell agents to remotely connect to a consumers computer via broadband to solve their problems. Third the acceleration of fiscal year '07 cost reduction initiatives, and lastly, the improvements in IT that are reducing complexity and improving our overall on-line capabilities.

Second category is our model in the how advantaged it is. We have an advantage cost position at all price points, and we are driving a better balance now that optimizes profit while providing sustainable top-line growth across all price points. We are focused on driving product and operating cost reductions, and we are reinvigorating growth in the premium space, while capturing market and profit share at all price points. We do this with superior technology, sell it in strategic management strategies, the management of our component mix to ensure superior share growth and profits. And you can see the results in our operating profit margin, which is from two to five times of that of every competitor.

Finally, the Dell model is optimized to bring the most relevant technology to our customers in the most efficient manner, and several trends look very promising over the next 12 months. For example, in the Enterprise where our growth is unabated we'll be launching several new products in the first half of next year, including our ninth generation server product line, which will be refreshed and features dual core processors, fully buffered NIM memory with advanced memory buffering that give our customers superior computing performance at a performance per watt lead. We'll be launching a new array of industry leading network storage products that will utilize new SATA technologies to improve price per gigabyte beyond the 70% declines we've already delivered. This will be a first to the market.

And new Dell open managed systems management software that will further improve our server and our storage capabilities incorporating imaging and printing product management as well. This combines nicely with an ongoing shift to data center applications to Linux and Windows and only Dell is positioned as a pure play enterprise vendor squarely focused on a scaleout strategy for the enterprise.

In the client space, the mix will shift to dual core mobile notebooks, and workstations with broadband wide and local area wireless. As well as the launch of our enhanced XPS desktops reflects our traditional focus on high value for customers and better margins for Dell. For example, our XPS line of high-performance workstations and notebooks grew at more than two times the growth of our mid tier and basic systems in Q3 and we expect that to continue.

Later next year, in the launch of Vista, for Microsoft, we'll provide a giant step forward in desktop and mobile computing functionality and we expect customers to begin configuring systems to effectively run Vista well in advance of the launch.

So with that, I'd like to open it up now for questions. Operator.



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