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Dell Inc. (NASDAQ:DELL)

F4Q08 Earnings Call

February 28, 2008 5:00 pm ET

Executives

Lynn A. Tyson - Vice President of Investor Relations

Donald J. Carty - Vice Chairman of the Board, Chief Financial Officer

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

Analysts

Bill Shope - J.P. Morgan

Benjamin Reitzes - UBS

Richard Gardner - Citigroup

Andrew Neff - Bear Stearns

Toni Sacconaghi - Sanford C. Bernstein

Louis Miscioscia - Cowen & Company

Kathryn Huberty - Morgan Stanley

Keith Bachman - Bank of Montreal

David Bailey - Goldman Sachs

Scott Craig - Bank of America

David Wong - Wachovia

Shannon Cross - Cross Research

Operator

Good afternoon and welcome to the Dell Incorporated fourth quarter fiscal year 2008 earnings conference call. (Operator Instructions) I’d like to turn the call over to Miss Lynn A. Tyson, Vice President of Investor Relations. Miss Tyson, you may begin.

Lynn A. Tyson

Thank you. With me today are Chairman and CEO Michael Dell and Vice Chairman and CFO Don Carty. Don will review the fourth quarter results, including product and regional highlights, as well as our cost and productivity initiatives. Michael will cover our strategy and progress on our five key growth initiatives and then we’ll move to Q&A.

Please refer to our web deck on dell.com/investor for additional information on our quarterly and full year results, including our financial scorecard. I also encourage you to periodically visit us at Dell Shares, our IR blog on dell.com, where you can ask questions and find timely information on our business.

We will be hosting our annual equity analyst meeting here in Round Rock, Texas, on April 2nd and 3rd. If you have not received an invitation, please contact my office.

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

I’d now like to turn the call over to Don.

Donald J. Carty

Thanks, Lynn and thank all of you for joining us this afternoon. Well, since our last call, the third quarter call three months ago, all of us at Dell have been very highly focused on executing against our key growth priorities and you’ll recall those five growth priorities are consumer, enterprise, notebooks, small and medium business, and emerging markets.

Let me just sum up our performance in the quarter. First, let me say we were very pleased with the acceleration of our growth, particularly in notebooks and emerging markets and in the consumer business. Second, this growth was driven by what we believe is the most robust portfolio of products and services in our entire history as a company. Third, while we did finish the quarter with some good progress on headcount reduction, we clearly have a lot more work to do on cost. And fourth, especially in the enterprise, we have an opportunity to lead on simplifying IT while reducing costs and complexity for our customers and that’s clearly the number one issue that faces all of our customers.

As I think you know, our financial goals are pretty straightforward -- to grow faster than the market, to improve our profitability, and to generate superior cash flow return for our shareholders.

Fiscal 2008 was a year of very substantial change in the company and it was a year of a pretty substantial transformation. We still have a lot of work to do, however. The good news is our performance in the fourth quarter has increased the confidence that all of us in management and at the board have that we have the right road map to achieve our targets and with a stronger footing and improved performance in the majority of our businesses, we’re now in a position to accelerate the cost reduction efforts that I referred to.

Let me turn to our Q4 and full year results and then I’m going to spend a little more time talking about our cost and productivity initiatives in the company.

In the fourth quarter, revenue growth accelerated 10% year over year as we generated $16 billion in revenue. Units were up 19% year-on-year and that was driven by rapid growth in emerging countries and in U.S. consumer business. Our operating expenses are not yet where we need them to be but they came in at 13.9% of revenues. Our operating income was $776 million, or 4.9%, which resulted in the earnings per share that we reported at $0.31.

At Dell, we are always focused on reporting GAAP results but it is also true that in the interest of greater transparency, it’s useful we know to all of you to identify some specific items that are in our financial results and this quarter, we’ve added an additional disclosure in our financial tables that quantifies the impact of a number of items, particularly including acquisitions, which ended up being included in our GAAP results. And in the quarter, we had $83 million in expense, or $0.04 a share that relates to the write-off of what’s in-process research and development that results from the acquisition of EqualLogic and Everdream. That’s in-process research and development at the time of acquisition.

We had $54 million in expense, or $0.02 a share that relates to the realignment of our business, including some severance costs and some facility closures that we’ve already publicly disclosed.

We have $27 million in expense, or $0.01 a share that continue to be the result of the investigation that was conducted here at Dell as part of the SEC inquiry.

We have $11 million in amortization expense associated with the purchased intangible assets associated with the acquisitions that I referred to a moment ago.

And on the favorable side, we have a reduction in a litigation reserve related to copyright levees that amounted to $58 million or $0.03 a share, and a $44 million expense reduction, or $0.01 a share that relates to an annual true-up for the full year of stock award forfeiture credits related to FASB-123R on stock-based compensation expense. That arises largely as a consequence of people leaving the company and therefore forfeiting stock awards that had not fully vested.

Now, earnings per share in the fourth quarter of fiscal 2007 also had several items. For comparability purposes, we thought it would be useful to highlight what those were. We had a $207 million reduction in the provision for employee bonuses or $0.07 a share that favorably impacted the fourth quarter of 2007. We had an $89 million expense, or $0.03 a share in that quarter that again related to the investigation that I referred to a moment ago, and we had a $36 million one-time gain on the sale of some real estate in financing and other income and that amounted to $0.01 a share. Now, I should just mention that all of those items end up getting recognized in different tax jurisdictions and therefore get tax affected at somewhat different rates.

Another important highlight of the quarter as we continue to evolve our foreign legal entity structure and that resulted in the movement of $5.3 billion to the U.S. where the funds can be used for general corporate purposes, including CapEx, acquisitions and importantly, share repurchase.

Cash flow from operations was $1.2 billion and we ended the quarter with $9.5 billion in cash and investments, and weighted average shares were 2.2 [billion]. Our cash conversion cycle was negative 36 days and our return on total capital was 34%.

In the quarter, we did spend $4 billion to repurchase $179 million shares of stock and that represented 8% of the outstanding stock at the time the quarter began. And this quarter, we expect to spend at least an additional $1 billion.

Turning to some highlights, looking at our full year performance we grew revenue 6% to $61.1 billion. We generated $3.4 billion of operating income. We increased earnings per share 15% to $1.31 per share and we generated $3.9 billion in cash flow from operations. And despite the challenges we faced last year, this performance again confirms for us a sense of confidence that our fundamental strategy is sound.

Let me give you a few more quarterly details and in doing so, I’ll switch to some regional highlights. Our Americas business grew revenue 7% year over year, driven by a 22% increase in Americas International. As the quarter progressed, we did see more conservative spending in some of the global accounts and in particular in financial services.

U.S. consumer revenue growth accelerated at 12%, driven by new products and expansion into the retail channel while posting a 2% operating loss in the quarter. We also gained over three points of share in the quarter, the largest increase in three years.

Growth and profitability are not [minor] for Dell. We have definitive plans to increase profitability in our consumer business, certainly up to competitive levels. That’s going to largely be driven by changes to our product design, manufacturing and delivery models, significant and targeted reductions in operating expenses, and an improved mix of product and services.

I’d like you to note that beginning in fiscal 2009, we will report a global consumer revenue unit and operating income number as we have largely now completed the global consolidation of this business.

Let me turn to EMEA, where revenue was up 8% year-on-year, driven by mid-teens revenue growth in France and a 70% growth in Poland, and operating income was up sequentially year over year.

In Asia-Pacific and Japan, revenue accelerated 28% year-on-year with a 41% increase in units. Operating income as a percent of revenue also increased, and India and China grew 57% and 32% respectively with all product categories performing at or above our expectations.

Moving briefly to product highlights, in client our focus on mobility continues to fuel improved growth as revenue increased 24% year-over-year, driven by a 37% increase in units, and our desktop revenue was up 2% on 10% unit growth. Software and peripheral revenue increased 15%. The S&P growth was aided by strength in displays and software licensing as we finalized the acquisition of ASAP in the fourth quarter. And as a result of that acquisition, we now have products from over 2,000 software publishers and that’s up from 200.

And enterprise server and storage revenue were each up 2% year-on-year. Product transitions and conservatism in the U.S. commercial segments did adversely affect growth in those product categories.

On a brighter note, services revenue was up 7% year over year but that doesn’t adequately describe our success in services. Our services sold in the quarter was up 17% year over year, so that our deferred services revenue balance grew 25% to $5.3 billion.

During the fourth quarter we, as you know, spent $2.1 million net of cash acquired on acquisitions closing on EqualLogic, Everdream, and ASAP and we of course also completed the purchase of CIP’s 30% interest in DFS.

Three weeks ago, we announced our intent to acquire Message One, a leading provider of e-mail archiving, continuity and recovery services and last week, we also completed the acquisition of the network storage company, which is a small data storage consulting company in the United Kingdom.

Let me turn now for a moment to our cost and sales productivity initiatives, where we evaluate all areas of our business, from how we design, configure, manufacture, distribute, and market our products to sales force productivity to how we align headcount at the staff level and at a front-line customer facing level. And we have identified a multi-billion dollar opportunity to improve efficiency and lower costs, which is going to be a very important step to achieve all of our financial goals.

Let me touch just briefly on three areas -- our cost of goods sold, including product design and manufacturing; our headcount; and lastly, sales productivity.

First, on the COGS front, our goal here is to design products that are cost optimized and to do so with faster development cycles and with competitive features. And in consumer, we’ve already had some real breakthroughs and a prime example of that is our new Inspiron 1525 notebook, which we launched last month. This is the first product that we have that went from concept to manufacturing in about half the time of previous products. And while we did that, we managed to reduce our bill of materials and manufacturing costs by $70 per box, while increasing features that customers value. This product has already won several awards, including an Editor’s Choice Award from Laptop Magazine and while volumes are building, this product allows us to profitably target a customer segment with an advantaged cost structure and that’s the discipline we’re going to put in place across all of our product categories.

The second thing I’ll touch on briefly is headcount. Now in May of last year, we targeted 10% reduction in headcount, or 8800 heads, and we’ve made some measurable progress, although we’ve got more to make.

In the past eight months, excluding acquisitions our headcount declined by 3200. Now, an awful lot of that happened towards the end of the year but we are pretty pleased with that result and we are pretty pleased with that result as a consequence of the fact that while we’ve been reducing heads, we’ve actually been investing heads in front-line activity. Our actual score on non-front-line heads is we’ve reduced 5300 of those heads. And let me be very clear -- we are going to hit that 8800. It may take us a little longer than we originally expected but we really feel a high degree of confidence that we have a clear line of sight on getting these costs out of our company.

And that brings me to the third area of cost where we have, in spite of the cost efforts we have underway, we have made investments in front-line and in our customer-facing capability. We have a global initiative to improve sales execution and coverage through better alignment with customers, targeted sales force investments, and in rapidly growing countries and customer segments, as well as investments in services and support.

In EMEA, in the third and fourth quarters we reorganized our country structure and aligned the organization around customer segments, similar to what we have in the United States. This actually allowed us to reduce the management layers and bring our sales teams closer to their customers and improve our coverage. And in the Americas, we’ve added additional specialized sales teams into several of our key customer segments.

And during the year, we increased the percentage of front-line heads considerably. When we started this effort, 54% of our employees were what we refer to as front-line employees. That’s now up to 57% and that’s a consequence of us having cut 5300 non-front-line people and added 2100 customer-facing positions in sales, service, and support.

Let me just summarize the cost discussion by saying we know we have more costs to take out. We are vigorously pursuing those opportunities. We made some very nice progress at the end of the fourth quarter and we’ve got a lot more planned for the first couple of quarters of this year. We are very confident in our road map though clearly some results, some initiatives are going to show results much quicker than others.

Let me turn to the outlook. There are a few puts and takes that you need to consider as you think about our performance over the next several quarters. First, we are going to continue to incur some costs as we realign our business to improve productivity and execution and reduce headcount and invest in infrastructure and acquisitions, and those actions will continue to drive a little non-linearity and volatility in our results.

Second, we are seeing, as I said, some conservatism in some IT spending in the U.S., especially in the financial services sector. It does remain to be seen, however, how this may unfold.

Third, for Dell the inherent asset philosophy of our model positions us we think in this kind of uncertain economic time very well, regardless of the economic cycle. When customers become more conservative with their spending, they often turn to technology partners like Dell who can provide better value, more flexibility, more simplicity, and lower costs.

And fourth, we are going to continue to benefit from improving performance in areas like emerging countries, notebooks, services, and enterprise, which are collectively driving a more diversified portfolio of both geographies and products.

Now against this backdrop, we have renewed our commitment to lowering our costs. Long-term, our focus remains on growth, improved profitability, and superior cash returns. We obviously look forward to discussing our priorities in a lot more detail at our analyst meeting when you are with us here in Round Rock on April 2nd and 3rd.

Let me close up and turn it over to Michael and when he concludes, we’ll have an opportunity for some Q&A.

Michael S. Dell

All right, thank you, Don. I would like to offer a few thoughts on our situation. I am encouraged that we grew slightly faster than the industry during the fourth quarter and it’s very clear that we still have significant work to do on our cost structure. And at the same time, we’re making some significant progress on our top five priorities that we believe will create great value for our customers and our shareholders.

The first is global consumer, where we started to deliver cutting edge products and we are delivering them faster and through more channels than ever before. With just 8% share of the global consumer opportunity, we have tremendous opportunity here.

We are now in over 10,000 retail stores worldwide and this business is on a $1 billion revenue run-rate with 1 million units sold worldwide. In the last six months, we launched new Inspiron notebooks, the XPS systems, including the XPS1 all-in-one desktop, the XPS M1330 and M1530, the XPS 720H2C gaming system with the Intel Core 2 Extreme Quad-core processor. These are best-in-class products that have swept 65% of the product awards available to them in the fourth quarter and about 300 awards for the entire year.

But we won’t grow at all costs. As Don has mentioned, we’re re-engineering our entire cost structure to be the best in the industry. Improvements in profitability will take some time as we build out a new portfolio of products but based on the actions we’re taking, I don’t see any impediment to Dell having similar levels of profitability to our competitors in this space.

The second opportunity for us it the enterprise and this is where we are using our platform of simplifying IT for our customers and it supports our approach to being a leader in storage, virtualization, and power and cooling complementing our traditional leadership in servers and systems.

In January, we launched our 10th generation blade server architecture. The PowerEdge M-Series is the most energy efficient blade server solution on the market, built from the ground up using energy smart technologies. With our data center solution offerings, we are an innovator in hyper-scale data centers. And our PowerEdge servers are number one in server performance for database and virtualization, overall price performance, and energy efficiency. We now have a full range of industry-leading servers covering 16 platforms.

In virtualization, we’re a leading partner with VMWare and we’ve recently begun a broadening of our strategic partnership that will begin the process of putting VMWare hypervisors across all virtualization certified Dell PowerEdge servers starting in early April. We also announced a partnership with Citrix to deliver XenSource embedded hypervisor technology across our PowerEdge server line this year, giving customers choice and increased management and interoperability in data center environments.

We also completed the acquisition of EqualLogic, the leader in iSCSI SANs. The iSCSI SAN space is expected to grow 138% annually over the next five years. Right after closing this acquisition, we introduced the PS5000 series, the next generation of SAN storage array, which is a great example of Dell offering a simple, affordable, and scalable solution with high performance.

Customers that have one or more EqualLogic storage arrays can benefit from virtualization technology that balances capacity, processing power, and network connectivity. All of this is part of the virtualization technology that EqualLogic software brings to the table.

We also introduced pro support service solutions, which breaks the one-size-fits-all fragmented support model that is prevalent in our industry. Pro support spans across all hardware and will enable commercial customers, including small and medium businesses, to obtain world-class service from Dell or our registered solution providers without paying for more than they need. This is really going to change the way corporate IT service works.

The third priority is notebooks, where we are reasserting our leadership, creating the best products for consumers and businesses. Our goal is simple -- to reclaim our heritage as the fastest, most innovative notebook provider in the world and this is really important now in an environment where notebooks, notebook growth will outpace desktop six-to-one.

To help us achieve this, we have separated our consumer and commercial design groups this year by focusing our consumer team on innovation and shorter design cycles. Since then, we have launched four notebook families for consumer in just six months. Our new Inspiron 1525 is the first product we’ve brought to market using this shorter design cycle and there’s a lot more innovation to come. This year we expect to launch almost 50% more new notebook platforms than last year.

The fourth is small and medium business, where our solutions are led by storage and blade products. We’ve begun two initiatives here that will transform our relationship with this $100 billion plus global segment. In the fourth quarter, we launched our partner direct channel program in the United States. Currently, Dell has more than more than 30,000 global partners around the world and this year, we generated $10 billion in revenue. With the expansion last month of Partner Direct in EMEA, we’re increasing the impact these partners will have on Dell’s growth.

We’re also building out our IT-as-a-service plan with a strategy focused on providing S&B customers and partners an entirely new model for service. This will be a configurable suite of mission-critical capabilities that rely on remote monitoring, simplification, and lifecycle management. It’s a [disruptive] model for IT services and I encourage you to watch this space.

And fifth, we’re bringing our products and services to a huge, rapidly growing emerging market around the world. We expanded our direct model into the BRIC countries and as Don mentioned, our revenues in those countries were up 36% on a 50% increase in units. These countries represent 8% of our total revenues and are on a $5.1 billion run-rate.

This is only the beginning. Emerging countries are a $64 billion opportunity for Dell. Over the long-term, these are the initiatives that will drive growth in revenue, earnings, and cash. I have confidence in it because I believe that customer-driven innovation in hardware, software, and services is our competitive advantage. We will achieve productive change by concentrating on the fundamentals: our competitiveness, in other words, cost and productivity; our five growth priorities, especially global consumer, storage, and emerging countries; and customer-driven innovation, which you’ve started to see in Q4 and you’ll see much more of over the course of this year.

We are focused and determined on driving superior growth, improving profitability, and excellent cash returns for our shareholders.

Now let me turn it back over to Lynn.

Lynn A. Tyson

Thanks, Michael. Before we begin Q&A, I ask that you refrain from multi-part questions and that way, we’ll be able to give everyone an opportunity to ask a question. With that, we’re ready to open it up for questions, please.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Bill Shope with J.P. Morgan.

Bill Shope - J.P. Morgan

Thanks. Michael, I think we all understand the margin implications of indirect versus direct sales, but could you help us understand how you are managing the supply chain side of the equation, in particular with build to forecast? How are you changing your management of buffer inventory for components, finished goods?

And on the production side, obviously you have more limited opportunities for customization in retail and so are you going to start building more standardized product lines to minimize the cost burden there?

Michael S. Dell

Well, we are doing a number of things. The first thing we’re doing is as part of the really re-look, clean sheet re-look at our manufacturing operations, we have found opportunities to better leverage our supply chain partners. And I think part of that is also creating effectively more than one supply chain alternative for how products reach their ultimate destination. So there is a simplified model here of products that are configured in a less complex way. We’ve been able to drive an enormous amount of cost out. That will be utilized not only in our direct customer relationships but in our partner relationships as well.

We’re also seeing that these partners are quite interested in our ability to deliver small lots very rapidly to individual stores, which takes a lot of inventory out of their distribution system. So we put all this together, we’re seeing a nice opportunity here. We’re managing closely and watching closely certainly the inventory levels and stocking levels as we go through the critical buying periods and product transition periods in the different countries that we are operating in.

Bill Shope - J.P. Morgan

Can you give us any color on what channel inventory looks like in this particular quarter?

Michael S. Dell

You know, I think it’s a bit early for us to be providing a lot of detail on that, particularly given the enormous ramp that the business is in. But we are monitoring it pretty closely. I can tell you that at Thanksgiving, we almost sold out -- in fact, did sell out of certain models. And I think we are still learning exactly how to balance it perfectly, but pretty pleased with our progress at this stage.

Donald J. Carty

Let me make one other observation about channel inventory that I think would be of some interest to you. With a number of our big retail partners for a variety of reasons, we will be using a sales out revenue model. And what that means is that we will not be booking revenue until it’s been sold out of the store. And so for a number of our relationships, there won’t be any confusion about what’s in the channel and what we’ve recognize as revenue. It’s a much more conservative model, obviously, than others in this space but it will represent a not insignificant piece of our retail business over time.

Lynn A. Tyson

We’re ready for the next question, please.

Operator

Your next question comes from Ben Reitzes with UBS.

Benjamin Reitzes - UBS

-- obviously --

Operator

Mr. Reitzes, your line is open.

Benjamin Reitzes - UBS

Hello? Can you hear me?

Operator

Yes, sir.

Benjamin Reitzes - UBS

Can you hear me?

Operator

Yes, sir.

Benjamin Reitzes - UBS

Okay. I wanted to reconcile your comments about the economy with regard to linearity in the quarter. Obviously revenues were a little below consensus and I wanted to get a feel for what you meant by weakness in financial services and how things are progressing and how you think Dell's well-advantaged in this and just anything -- any color there on how the business is progressing and linearity in the quarter would be helpful.

Michael S. Dell

Sure, Ben. You know, if you look at the United States on a calendar year basis, we absolutely gained share in our core business, and especially true in consumer. If you look at it on the financial quarter, we grew faster than our principal competitor in both the United States and Americas international.

You know, if I look at the three major regions of the world, we’re seeing I’d say decent growth in the United States and very robust growth outside the United States. And I wouldn’t be surprised if the U.S. is our slowest growing region, certainly for the next couple of quarters, given what we see going on in the economy. And we are certainly attacking in the other regions, but it is important to note that we actually gained share in the stronghold we have here in the United States.

Benjamin Reitzes - UBS

Thank you.

Lynn A. Tyson

Next question, please.

Operator

Your next question comes from Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Michael, you mentioned earlier that there was no reason that you shouldn’t be able to earn margins in retail or consumer that are comparable to your competition. I was just hoping you could give us a sense of exactly what you feel like you need to do. It sounds like the two key things are probably increasing the efficiency of the logistics and leverage supply chain partners more. How long does it take to make the necessary investments to improve the profitability? Things like tying information systems in and so forth? Is this a 12-month process or an 18-month process or a two-year process? How long do you think it will take to get the profitability to competitor type levels?

Michael S. Dell

You know, that’s a good question. We are right in the middle of that right now and I’ll tell you there’s a lot of costs to take out. Probably a good thing for us to tee up for the analyst meeting in April to give you a sense for some of the changes we are making there. I’ve been, along with Mike Cannon leading a series of meetings at Dell that we have about every two weeks, looking at all of these opportunities and we are driving it and making it happen.

In terms of giving you a specific date, I’m not sure that we’re ready to do that right now.

Donald J. Carty

I would just reinforce what Michael said though, Richard, around the opportunity here and it’s more than logistics and supply chain. Michael alluded to this when he was talking about consumer -- it’s product design. You know, you need to have the right product with the right features at the right cost, so you start right there. Product design logistics, supply chain, our OpEx levels and so on and so forth, so we see a lot of opportunity here. Probably premature to put an exact timetable on all of it but we really do have a very nice line of sight on things that need to be done here.

Richard Gardner - Citigroup

Okay. All right, thank you.

Operator

Your next question comes from the line of Andrew Neff with Bear Stearns.

Andrew Neff - Bear Stearns

I want to talk about the acquisitions and could you give us a sense of how we can monitor how the acquisitions -- you’re making some meaningful ones, such as EqualLogic -- how do we know how they are doing? And also, can you talk about how they are being integrated and edified?

And just to go back to something you said, Don, I just want to make sure -- when you said a moment ago that you would reflect sales out for retail, will that be for all retail or did you say selected? I just want to clarify what you are saying.

Donald J. Carty

Not all retail -- selectively. It depends on the TNC. We haven’t announced publicly just where we are in sales out and where we are not. We will probably as time goes by provide you with more transparency on that but certainly some of our big relationships will be sales out.

Michael S. Dell

You asked about the acquisitions. The acquisitions are integrated into the business and owned by the business leaders that are responsible for those areas, so if you take the EqualLogic acquisition, for example, this is part of Brad Anderson’s server and storage business. And so I think you can look to our performance in the enterprise and specifically in servers and storage over the next several quarters and several years and see how is that business doing. Now of course, we would have a bit more detailed information about that than you would because we are providing it at a kind of an [outward] basis.

ASAP is part of Paul Bell’s business because it’s primarily here in the Americas, although there are components in Europe and Asia, but it shows up in our software and peripherals line as part of the revenues that we report.

Donald J. Carty

And just to expand on that, a number of these acquisitions as you know have been around the software as a service business and building out that strategy -- Silverback, Everdream, the network storage company, Message One, and so on. Those are -- the way to monitor that one and this is similar to the remark Michael made about enterprise, is if you look at the growth in our services revenue, not just in the revenue we book every quarter but the growth in that deferred revenue account, these acquisitions are all part of building out that strategy and you should clearly see and expect to see acceleration in that very rewarding part of our business and services is a very rewarding part of our business.

Lynn A. Tyson

Next question, please.

Operator

Your next question comes from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford C. Bernstein

Thank you. You repeatedly mentioned a lot of cost opportunity going forward and how you plan on attacking it. Can you help us understand as context why cost has gone up so dramatically over the last couple of years? It looks like SG&A is up 46% versus two years ago, while revenues in the same time frame are up 8%. That’s a $2.5 billion incremental annual run-rate in SG&A that’s happened over the last two years, so it’s been an extraordinary ramp in SG&A. The 2100 customer-facing people is nothing. It’s about 10% of that ramp by my calculations, so what has caused the big ramp in SG&A? And when you talk about cost reduction, is this a big source of it? And if so, why did you let it get so high to start with?

Donald J. Carty

I think the candid answer to that is that we should not have let it get this high and I think we sort of acknowledged that when we were on the conference call in the last quarter.

I think the company anticipated a continued growth in revenues for a couple of years that was -- their anticipation was simply not achieved and we weren’t as prudent about cost control as we should have been.

We are highly focused on that and you will see substantial improvement in our OpEx as we move through the year but that’s only a piece of our cost opportunity. This is a company that if you tally up both OpEx and COGS, it’s got $58 billion of cost in it and we see opportunity across both the OpEx piece of this but also across the COGS piece of this and that’s why we’re -- we’ve expanded our view of what we need to manage to be the most effective and efficient provider here and it’s going to involve some significant cuts in our OpEx and it’s going to involve some significant cuts in our cost of goods sold.

Toni Sacconaghi - Sanford C. Bernstein

If I could just follow-up on that, Don, thank you for the answer but you said that you acknowledged it last quarter yet your SG&A went up another $120 million sequentially, so a run-rate of another -- you know, an annual run-rate of $500 million more. So if this was something that you fully acknowledged last quarter and were starting to do work on it, it still looks like the costs continued to escalate this quarter. So what is ultimately the inflection point that changes this from -- I think it’s like 12 straight quarters where SG&A has increased as a percentage of sales that actually reverses it and what triggers is? Is it substantial reduction in headcount or is it something else?

Donald J. Carty

Well, a couple of observations. The first observation, as you know, because we spelled a little bit of it out in the quarter, we have a couple of unusual items in the quarter, so I won’t revisit those because I don’t mean them to be an excuse for the question you are asking.

It does involve a lot of headcount cuts and a lot of other cuts but a lot of any company’s OpEx walks around on two feet. It’s the nature of overhead in the company. So we’ve got some real progress to make.

One of the comments I made is as we exited the quarter, we began to get a lot of traction here on headcount reduction. Why didn’t we get it earlier? We were very concerned that we find the right balance between the pace of cost cut and finding a way to reignite the growth in all the areas Michael’s talked about.

We believe we found the right balance. Could we have had OpEx lower in the quarter? We could have but we might have risked reigniting that growth and we’ve been all about the long-term here. We want to get this balance right. We wanted to get the emerging markets, the notebook business, the enterprise business, the services business, all going in the right direction and we had a lot of work to do on product, which I think we have now -- a lot of which we have now successfully executed on. Now our job is to demonstrate that we can pull down OpEx and we just wanted to do things in the right sequence.

Clearly some of the OpEx investment that we made in the third and fourth quarter has worked; otherwise we wouldn’t be fueling the growth that we’ve managed to fuel here.

Toni Sacconaghi - Sanford C. Bernstein

Thank you.

Lynn A. Tyson

Next question, please.

Operator

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

Louis Miscioscia - Cowen & Company

Yes, maybe you could go into your retail strategy a little bit more detail, in the sense you’ve now ramped up to over 10,000 stores but HP is still eight times that size. So I guess my question would be why not ramp up to a lot more, or unless that’s your plan? And also, in a number of stores, your number of SKUs in comparison to HP is still just a proportionate of theirs. Why not be a lot more aggressive in trying to get out both in the number of locations and the number of SKUs?

Michael S. Dell

I think you’ll see us continue to ramp this up. I mean, going from zero to 1 million units in a couple of quarters is pretty darn fast. You’ll see a continual set of announcements that expand the range of partners. I’ll also point out that if you look pretty closely at this, you’ll see that most of our progress to date in terms of sales out has been concentrated in the United States and so we’ve announced agreements with essentially all the leading retailers in Europe and those are beginning to take hold, beginning to come to fruition. There are many additional ones that we are working on expanding and are in the pipeline, so --

Donald J. Carty

A lot more to do. Every one of these deals with the big retailers around the world involve very explicit negotiations. We want to get the terms and conditions right. So do they. We don’t want to end up doing a whole lot of deals that we regret. We want them to be the right deals at the right time and I think we’ve got a pretty good balance in focusing on the ones we think that can pay off the biggest for us the fastest, and I don’t just mean that within the U.S.

If you look at the profile of what we’ve done in Europe and Asia, we really have laid in place a very good first pass coverage here, so I think we feel pretty good about it.

Louis Miscioscia - Cowen & Company

Thank you.

Lynn A. Tyson

Next question, please.

Operator

Your next question comes from Kathryn Huberty with Morgan Stanley.

Kathryn Huberty - Morgan Stanley

Thanks. I understand the consumer business as a whole remains unprofitable but is the new retail distribution business making money from the onset? And if not, what’s limiting profitability in what is typically a very high margin segment of the PC market?

Donald J. Carty

I think our challenge in profitability across the consumer business, whether it’s retail or direct, is similar and that is all the issues that Michael talked about -- the right product with the right distribution, with the right cost structure with the right supply chain with the right OpEx associated with it, and we have a lot of heavy lifting to do here. We know what it is but we have a lot of work to do.

Michael S. Dell

I think the example that Don mentioned earlier, the Inspiron 1525, which is a very popular product at retail today, which comes in at about a $70 lower cost point, those are exactly the types of things we need to do to get this business on the right footing in terms of growth and profitability.

Kathryn Huberty - Morgan Stanley

So is it fair to say that you invested in the OpEx infrastructure to support the new retail business and as you grow into that in larger size, that you’ll grow in the profitability or is there something more systemic that you need to do internally in terms of taking out costs?

Donald J. Carty

I think it’s more than that. There is cost to be taken out. We will grow into it but to Michael’s last example there, we need all of our product to be the right product at the right cost with the right design with the right supply chain, so it’s more than just an OpEx question. It is an entire cost management question across the board and we are really clear on the opportunity here. I mean, these are all things that we are working on.

Lynn A. Tyson

Next question, please.

Operator

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

Keith Bachman - Bank of Montreal

This one’s for you -- I’d like to talk to you about your current management team and how you plan on expanding it, if at all. And admittedly, you’re going through a lot of change. Some of the activities, as you indicate, are going well, some need additional scope. And all of the new business heads are reporting to you, so my question including is there any other specific areas, why not get a strong number two who has gone through some of these areas, an experienced change agent? And I have a follow-up, please.

Michael S. Dell

You know, we’ve got a lot of number twos here and I mean, if you look at the business, essentially we have a global consumer business and we have a commercial business. The commercial business consists of three large regions, a product group, services business, and then we have Mike Cannon running all the operations of the company in terms of manufacturing procurement. And --

Keith Bachman - Bank of Montreal

But sorry, Michael, all those individuals are reporting in to you. Are you the one monitoring their daily activities or weekly activities?

Michael S. Dell

We’re all monitoring this together.

Keith Bachman - Bank of Montreal

And is that the right model going forward then?

Michael S. Dell

We certainly believe it is.

Keith Bachman - Bank of Montreal

Okay, well, just one follow-up then -- you mentioned at the analyst day you were going to be providing some additional metrics associated with consumer business. Can we read that to suggest that you’ll be providing some specific metrics or targets for the businesses, similar to what HP and Sun and IBM have done?

Michael S. Dell

You know, in terms of targets, I think our intent at the analyst meeting is to give you the fullest view of the company’s strategy and direction and we’ll let you make your own conclusions as to what you think the performance of that business is going to be.

Lynn A. Tyson

All right, Operator, next question, please.

Operator

Your next question comes from David Bailey with Goldman Sachs.

David Bailey - Goldman Sachs

--a cut at the cost question. I’m just trying to understand if you can give a little bit more detail about which areas the headcount cuts are coming in and where the cost cuts are coming from because it sounded like when you said there were initiatives you wanted to get going and a lot of work on products you wanted to do before you started cutting heads, I mean, are the people that are leaving, were they part of these new initiatives?

Donald J. Carty

Make sure that you understand what I said -- we’ve taken well in excess of 5,000 people out of the company while we’ve put 2,000 other people back in and those are kind of net numbers. We’ve actually -- we probably actually had even more hirings and people change, so the mix of people has changed much more dramatically than the gross numbers would suggest.

So there’s a lot of change going on but we continue to have a lot more opportunity to take additional costs out of the company.

Michael S. Dell

I think there’s another important point here. I mean, this is a company that is making some very significant investments to change the portfolio and the nature of its business going forward. And if you look where Dell was about a year ago, we had finished a quarter where our unit volume was declining at 11% year over year. In the quarter that we just finished, our unit volumes were increasing 19%. That’s a pretty big change in the sheer momentum of the company.

In addition, when I look at all the investments that we are making, we believe those are the right ones. Would we like to see results coming faster? Absolutely.

David Bailey - Goldman Sachs

And when you talk about the 8800 number, that’s going to be a net number or a gross number of reduction?

Donald J. Carty

That is going to be the reduction from the core. That would not exclude any acquisitions that we -- that would not include any acquisitions we would do but setting aside acquisition, yes, 8800 is the right number.

Lynn A. Tyson

Operator, next question, please.

Operator

Your next question comes from Scott Craig with Bank of America.

Scott Craig - Bank of America

-- equation. How does it change some of the balance sheet and cash flow metrics as we go out a little ways? Because it would seem that those customers in general, the big retailers has much higher DSOs than what maybe you guys are used to. So I’m just wondering if there will be an impact there and then if there is, how you would offset that with payables or inventory or something like that. Thanks.

Donald J. Carty

The question is is the cash conversion cycle on the retail side the same as it is on our base business and the answer is it is not quite as good. However, it’s still a very positive cash conversion cycle for us and we shouldn’t lose sight that even if we grow the consumer business very quickly, the commercial business is still by far the biggest piece of our business.

And I might add, consumer direct will remain a very sizable piece of our business. So we would expect the company as it grows to still be -- have a massively negative cash conversion cycle and we don’t expect that to change.

Scott Craig - Bank of America

Okay, thanks.

Operator

Your next question comes from David Wong with Wachovia.

David Wong - Wachovia

What was the unit growth in the quarter? And it looks to me like your server growth seems to be a little less than X86 server growth of your major competitors. Is there some action you need to take to stabilize market shares there?

Michael S. Dell

Server units grew at about the rate of the industry. I believe it was up 10% year over year. We have seen some pretty interesting trends in the first quarter. It looks like our server growth is going to be quite a bit higher in the first quarter.

Donald J. Carty

Remember, as Michael alluded to, we have some new product that came, particularly the 10G blades and so on that came into the portfolio very late in the fourth quarter. Of course, we have EqualLogic product on the enterprise side as well as we enter the FY09 period.

Michael S. Dell

Also, the cloud solutions business that we told you about in the past has started to win some very substantial orders from some of the large mega-scale, hyper-scale data centers, search providers, those kind of things.

David Wong - Wachovia

Thanks.

Lynn A. Tyson

Operator, we’d like to take one more question before we turn the call back over to Mr. Dell, please.

Operator

Your final question comes from the line of Shannon Cross of Cross Research.

Shannon Cross - Cross Research

Yes, good afternoon. Just a question on the cash flow; you brought back I think $5 billion internationally. How much of your cash right now is domestic and did that play any role in your decision to buy $1 billion versus the $4 billion you bought during the prior quarter?

Donald J. Carty

No, this is exactly what we planned to do. Most of our cash is outside of the U.S. today because of the cash that came back into the U.S., of course a lot of it was used for the share repurchase in the fourth quarter.

As you know, we still have a very, very strong balance sheet, so we have an enormous amount of flexibility on what we could do. We periodically reassess our share repurchase. We think we had a pretty aggressive fourth quarter in that front, trying to catch up from a period where we weren’t buying. And we really don’t have any barrier to further buy back. It’s really a question of judgment by the management and the board of the company.

Shannon Cross - Cross Research

Okay, and what was your share count at the end of the quarter?

Donald J. Carty

Off the top of my head, 2 billion -- a little less than 2.1. Lynn, have you got that handy?

Lynn A. Tyson

Diluted was 2.2 billion.

Donald J. Carty

That’s average share count. That’s not --

Lynn A. Tyson

-- it was 2.1, 2.2.

Donald J. Carty

I think it’s under 2.1. I don’t have it -- I’m sorry I don’t have it in front of me. We’ll get back to you.

Shannon Cross - Cross Research

Okay. Thank you.

Donald J. Carty

Yeah, the number Lynn quoted was the weighted average and the actual share count as we come out of the quarter is below 2.1 billion. I think it’s 2.079 billion, if my memory serves me right but I apologize for not bringing that with us.

Michael S. Dell

Okay, well thank you very much for joining us today. I want to leave you with a couple of thoughts. First, our acceleration of growth that we saw in the fourth quarter is just the first step as we execute against our five priorities and we’ve got a lot more to do to restore our competitiveness so that we can deliver long-term profitable growth.

Second, we have a significant opportunity to reduce our costs while improving productivity. Third, I believe we now have the most robust portfolio of products and services in our company’s history, and fourth, especially in the enterprise, Dell's uniquely positioned to provide solutions for our customers that allow them to tackle the biggest challenges that they have, reducing complexity and costs by simplifying their IT environments.

Thank you for joining us today and we look forward to seeing you at our analyst meeting.

Operator

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

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