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Executives

Lynn Tyson - Investor Relations

Don Carty – Chief Financial Officer

Brian Gladden – Incoming Chief Financial Officer

Michael Dell - Chairman of the Board and Chief Executive Officer

Analysts

Richard Gardner - Citi

Ben Reitzes - Lehman Brothers

Katy Huberty - Morgan Stanley

Brian Alexander - Raymond James

David Bailey - Goldman Sachs

Keith Bachman - Bank of Montreal

Scott Craig - Banc of America

Toni Sacconaghi - Sanford Bernstein

Louis Miscioscia - Cowen and Company

Jeff Fidacaro - Merrill Lynch

Bill Fearnley - FTN Midwest

David Wong - Wachovia

Clay Sumner - FBR

Dell Inc. (DELL) F1Q09 Earnings Call May 29, 2008 5:00 PM ET

Operator

Good afternoon and welcome to the Dell Incorporated first quarter fiscal year 2009 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 Incorporated. Any rebroadcast of this information in whole or part without the prior written permission of Dell Incorporated is prohibited. As a reminder, Dell is also simulcasting this presentation with slides at www.dell.com/investor.

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

Lynn Tyson

Thank you. With me today are Chairman and CEO Michael Dell; Vice Chairman and CFO Don Carty and I'm very pleased to introduce Brian Gladden, SVP and our incoming CFO. Don will review our first quarter results, Brian will make a few comments and then he'll turn the call over to Michael who will cover our strategy and progress on our long-term goals and then we'll move on to Q&A. And as the operator noted, there is a new procedure that's been implemented by our conference call provider and you will only be able to queue up for your questions at the end of the prepared comments.

Please make sure to review our web deck on dell.com/investor for additional information on our results and as we mentioned last year, starting this quarter we now have four new external reporting segments: Americas Commercial, EMEA Commercial, APJ Commercial and Global Consumer. Prior to this quarter we had three segments: Americas, EMEA and APJ and we broke out U.S. Consumer.

So that you can easily update your models, our earnings release and web deck contain a table that has fiscal 2008 quarterly revenue and operating income broken out by the new four external reporting segments. Also, any references we make to Dell's unit growth as a multiple of the growth of the industry excludes Dell and all growth rates are year over year unless otherwise noted.

Please visit us at Dell Shares, our IR blog on dell.com where you can ask questions and find timely information on our business and our strategies. In late June, we will post a v-log featuring Brad Anderson, our Senior Vice President and head of our Enterprise business. Brad will take you through our virtualization strategy. If there are any specific questions you'd like us to address in the v-log, please let me or my team know.

On July 18 we will host our annual meeting of shareholders in Austin, Texas and our Q2 earnings call is scheduled for August 28 at 4 pm Central Daylight.

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 cost-sharing statement contained in our press release and on our website.

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

Don Carty

Thanks Lynn and good afternoon. A year ago, almost to the day, we laid out for you the five actions that we were taking to transform the company and restore our competitiveness, reignite growth and build the solutions that we believe were critical to customer needs. Those five actions were restructuring the organization to move decision-making closer to the customer; improving customer satisfaction; introducing new innovative products across our entire portfolio and across all our regions; globalizing services which at its core simplifies IT for our customers; and a comprehensive review of all costs with the goal of streamlining structure, eliminating bureaucracy and better aligning expenses with the business environment and our growth opportunities.

I think our results this quarter demonstrate we have made some progress, though there is still a lot more to be done. Driven by a more robust and targeted product portfolio, we had unit share gains worldwide in all major product categories and of course in all major regions.

A couple of examples, worldwide consumer units were up 47% and APJ and EMEA commercial units were up 31% and 30% respectively. Very importantly for us in the key so-called BRIC countries where over [14]% of the industry growth will come from in the next five years, we outperformed all major competitors across all product categories. We had revenue up 58% on a 73% increase in units. For us, BRIC now stands at close to 9% of our revenue mix. I should add our revenue mix from outside the United States reached a record high of 50%.

On the OpEx front we had our best OpEx scaling versus revenue growth in over two years and OpEx dollars actually declined sequentially against an increase in both units and revenue.

Our headcount is now down year-over-year by 7,000 excluding the impact of acquisitions and I think now well within striking distance of the 8,900 target that we talked to you about a year ago. As we said in April, we believe we have opportunities to reduce our headcount even further.

We improved operating income margin sequentially and we drove – and importantly we drove a 12% increase in earnings per share. Last year we said that the transformation of our company would take about 18 months to take hold. I think these results are evidence that our strategy of trying to reignite growth as a first step was the right one for us. Now with our sights firmly on improving our competitiveness, we are really beginning to realize the benefits of some of the cost initiatives that we've talked to you about.

As I take you through our results in more detail, you'll see that some aspects of our business have improved growth, some have improved profitability and some have both. We are very confident as we continue to execute against our growth strategies that all aspects of our business will benefit and contribute to an optimized balance of liquidity, profitability and growth for the company as a whole.

Let me turn to our first quarter results in more detail and then I'll make a couple of comments about our outlook for the balance of the year.

In the first quarter, we generated $16 billion in revenue, a 9% increase on a 22% increase in units, that's obviously our fastest growth in units in over two years. On a regional and channel basis, the growth in units was driven in large measure by emerging countries. It was also driven by our retail initiatives. On a product basis, the growth in units was driven by a 43% increase in mobility products.

Operating expenses were down 100 basis points sequentially to 12.9% of revenues. Operating income was $899 million or 5.5% of revenue resulting in earnings per share of $0.38.

Consistent with what we have talked about and what we did in the fourth quarter of last year, we have included in our earnings disclosure table some – a quantification of the impact of certain items that are in our GAAP results so let me briefly just touch on those and give you an indication of what lines of our P&L you'll find the impact on.

We had $106 million in expense which amounts to $0.04 a share that related to our ongoing efforts to realign our business; it includes largely severance costs and facility closures. But by way of reference, $82 million of that $106 million shows up in our OpEx.

We had $26 million or $0.01 a share in the amortization expenses of purchased intangible assets associated with the acquisitions we did. That $26 million ends up getting split about evenly between COGS and OpEx . We had $19 million in expense or $0.01 a share in investigative related costs and all of that expense, as it has in the past, falls into the OpEx category.

We had a $42 million increase in financing and other income or $0.02 a share related to an error in currency exchange rates from prior periods. We had a $46 million or $0.02 a share reversal in the provision for employee bonuses for fiscal 2008. Most of that, although not all of it, is in OpEx. We had a reduction in a litigation reserve related to a favorable ruling in a patent case of $55 million or $0.02 a share. All of that is in our – is in the COGS line.

I should, I just mentioned by way of reference we have been talking about investigative related expenses kind of every quarter to keep you up-to-date on that. That number is starting to drop to a smaller number and I think will probably drop a little further in the next quarter. I think it's small enough now that we will quit identifying it separately in future quarters.

Our cash flow from operations was $143 million. Cash flow was impacted by slightly lower payables but largely because the first quarter is the quarter where we have some significant outflows of cash associated with tax and associated with bonus payments. Our ability to generate cash remains very robust. I think it is evidenced by our trailing four quarter cash flow from operations of $4.2 billion and we believe that on an annualized basis, we can still easily generate cash flow from operations in excess of our net income.

We ended the quarter with $9.8 billion in cash and investments. In the quarter we spent $1 billion to buy back 52 million shares. That has driven over weighted average share count down to 2.04 billion. That is a 10% reduction versus Q1 of last year. Our share count actually finished the quarter at 2.02 billion and this quarter we expect to spend at least $1 billion on share repurchase.

During the quarter we raised $1.5 billion in private placement debt for general corporate purposes and we paid off $200 million in debt. Relative to F&O, I do want to point out that we think our run rate F&O will be in the $20 million to $30 million range per quarter driven by the reduction in our cash balances which of course are earning lower yields as well and we have increased interest expense that is driven by that higher debt balance.

Our cash conversion cycle which declined versus last year was negative 30 days, driven by increases in DSO, in DSI and a slight decrease in days payable outstanding. We expect our cash conversion cycle to remain significantly negative and we believe for this year will generally be in the 30 day range or better, reflecting in part our entry into the retail channel and on the inventory side, some strategic buys we have been making as we move through the year. Our return on total capital for the quarter was 42%.

Let me turn to some regional and product highlights. In APJ Commercial our revenue was up 19% to $2 billion on a 31% increase in units. Operating income was up 52% on a very balanced country segment and product performance. Revenue in India and China grew at 52% and 30% on a 68% and 43% increase in units respectively. This performance drove share gains in both countries, highlighted by India where our commercial units grew at significant multiple to market and we increased our share position by a full 4 points. We also claimed the number two share position in servers.

Global consumer revenue was up 20% to $2.9 million on a 47% increase in units and while off to an admittedly easy compare, profitability did improve and we talked a little bit about that when we were on the call last quarter. It now stands at 1.2% of revenue.

On a unit basis we grew it over two times the industry and we increased our global share by 1.2 points to 8.8%. We expand our global retail presence, adding Suning in China and Costco in the United States. We now have over 13,000 points of presence.

In addition, we continue to develop products that have more competitive features, more design, more cost points and while we still have a lot of work to do in the consumer business I think we're all comfortable with their performance and their progress in Q2 -- Q1.

Turning to EMEA Commercial, revenue was up 15% to $3.8 billion on a 30% increase in units with the fastest growth in the industry among major vendors, server units were actually up 20%, 2.5 times the rate of the industry. Growth in notebooks also outpaced the industry with a 59% increase in units. From a country perspective, units were up 20% in the UK and the region saw strong double-digit growth in several emerging countries like Russia and Turkey and the Ukraine.

Profitability in EMEA was adversely impacted by a favorable warranty change that actually helped Q1 of last year but more importantly a significant severance charge that was part of that $106 million I talked about earlier in Q1 of this year.

In our America's commercial business, revenue increased 1% to $7.3 billion on a 3% increase in units. Server shipments rose by 20%, more than four times the rate of the industry. Our mobility products were up 11% and desktops declined 2%. Operating income declined as the business absorbed acquisitions and invested in sales capability, particularly in the emerging markets of Latin America and I might add in sales capability associated with our storage products.

Similar to Q4, we continue to see conservatism in the U.S., especially in the financial sector as well as State and local governments and as well in the small and medium enterprise space.

I will just touch briefly on some product highlights. In client mobility units up 43% as we grew at a premium to the industry and that drove a 22% increase in revenue. We also grew at a premium to the industry in desktops with a 9% increase in units which drove a 5% decline in revenue. Growth in enterprise products and services accelerated very nicely in the quarter. Server revenues were up 4% but on a 21% increase in units, our fastest unit growth in over two years and three times the rate of the industry and that allowed us to gain 1.5 points of share in the quarter.

Our storage revenue jumped a very solid 15%, driven by strong growth from our Power Vault, Direct [inaudible] products and a full quarter now of EqualLogic. Our enhanced services revenue is up 13% aided by the first full quarter of our new Pro Support offerings. Our services attach rates increased by 24% and a key leading indicator of services growth, our deferred services revenue balance grew 23% to $5.4 billion.

Software and peripherals revenue increased 17%. As a result of our ASAP acquisition, S&P growth was aided by strength in software resale and the licensing business associated with that acquisition.

During the fourth quarter we spent $170 million net of cash – I am sorry, during the first quarter we spent $170 million net of cash acquired on acquisitions, closing on two: MessageOne and the Networked Storage Company.

Lastly, our strategic assessment of our financing business, DFS, continues. We should have an update for you by the third quarter.

As you will see when we file our 10-Q in early June, this capability, this financing capability continues to be a key enabler of sales for our U.S. business, especially Consumer Direct, and we believe we are very nicely and adequately reserved against the backdrop of what's happening in the credit markets.

In sum, I am really quite pleased with our performance in the quarter. I believe we are on the right trajectory to meet the long-term targets we set for you in April, which are to grow faster than the industry while generating sustainable EPS and cash flow growth.

Before I turn it over to Brian, let me just make a couple of observations about our outlook. There are a few items you should consider as you think about our performance over the balance of the year. First, we will continue to incur costs as we realign our business to improve competitiveness, reduce headcount and invest in infrastructure and acquisitions.

Second, we are seeing conservatism in IT spending in the U.S. and that has extended modestly from global and large customers into public, small and medium business accounts and we expect that to continue through the summer, particularly as many of these customer segments are seasonally slower.

Third, you will recall that we are overlapping a period of record cost declines in the same period last year.

Fourth, we will continue to benefit from improving performance in areas like emerging countries, notebooks, enterprise and services which collectively are driving a more diversified portfolio of geographies and products. Against this backdrop, we recently shared with you our plans to improve our competitiveness and we're targeting $3 billion in annualized savings by fiscal 2011. Long term our focus remains on growing units faster than the industry, improved profitability and superior cash returns with the focus on making decisions that deliver the best long-term results for our shareholders.

Now I personally couldn't be happier to introduce Brian Gladden. All of us at Dell are delighted that we were able to attract to the team someone with Brian's operational and financial background.

As you know, Brian joined Dell last week from Innovative Plastics Holdings BV, formerly, of course, GE Plastics. There Brian was President and CEO and prior to that he spent nearly 20 years at GE where he held a variety of financial and leadership roles including VP and GM of GE Plastics, CFO of GE Plastics, and CFO of GE Medical Systems Healthcare IT business. Brian will formally take the reigns as CFO on June 13, 2008 at which time I will happily move back to director-only status.

Brian Gladden

Thanks Don. On behalf of the company and our shareholders I'd like to thank you for the outstanding contributions that you have made to the organization as CFO over the past 16 months. Not to mention your board tenure of 16 years. Your personal commitment to integrity, transparency and accountability have set the bar for the entire company. We look forward to your continued leadership on the board.

I'm now nine days into my new role here and I'm ramping up quickly on Dell and the industry. Don and I are meeting regularly to discuss the organizational priorities and challenges and I'm quickly integrating into regular operating rhythms and bi-costly – bi-weekly cost meetings. I'm pleased with where we are headed. I feel strongly that a world-class financial organization is built around four key imperatives.

First, controllership and integrity must be at the heart of everything we do.

Second, we must be operationally engaged as business partners that help drive growth and profitability.

Third, we must engage with and respond to you, the owners of our company.

Finally, we must be good stewards of our company's capital, making decisions that maximize cash returns and drive long-term value creation. I look forward to meeting with you in the coming months. I'm very open to your ideas, concerns and feedback. This ensures that we, the Dell team, have the right priorities and plans to capture the incredible opportunities in front of us.

Let me now turn it over to Michael.

Michael Dell

Thank you Brian and welcome. In April I laid out long-term goals to drive shareholder value, including unit growth at a premium to the industry, executing on our $3 billion cost opportunity, delivering sustained EPS growth and executing on our five core initiatives and also growing our retail and channel for scale and profit.

We grew significantly faster than the industry on a worldwide basis and this was despite a more conservative commercial IT spending environment in the United States. We targeted $3 billion in annualized cost savings and have started to make progress and we are beginning to see positive results in our performance as cost savings begin to flow through the P&L during this quarter.

Let me go into a bit more detail. First we grew faster than the industry worldwide in all major product categories and regions and it has been three years since we have accomplished this.

Worldwide, we grew units 22% while the industry was up 14%. Looking at our major regions, we grew 11% in the United States while the industry was essentially flat.

In APJ we grew over 42% while the industry was up just 14% and in EMEA we grew 28% while the market was up 19%. This marks the first time in two years that we have outgrown the industry in all major regions.

On the product side, in notebooks we grew 43% while the industry was up 36% and in servers we outgrew all major competitors with a 21% increase in units while the industry grew 7%. In desktops we were up 9% while the industry contracted in the quarter and in storage our growth revenues accelerated to 15%.

On the cost side, we have identified and are aggressively targeting COGS and OpEx savings and I continue to lead meetings every two weeks for each focus area. We have detailed road maps, targeted savings, actions, executive ownership with accountabilities and specific timelines for the capturing of savings.

In the first quarter, we made progress against our initial goal of reducing headcount by 8,900. Year over year we've reduced our headcount before the impact of acquisitions by 7,000 which includes 3,700 just during this past quarter.

In our first quarter we recognized $106 million in severance and facilities-related expenses and we'll see more benefits as we fully move throughout the year. We also made adjustments to our compensation plans including evaluating and aligning our long-term incentive plans both cash and equity to current market conditions. Our total operating expenses were down 7% sequentially and while we still have much to do, I am encouraged by the progress we have made. I believe you see additional productivity improvements in the form of OpEx scaling and some additional headcount reductions even as we invest significantly in growth areas.

Turning to products, we grew faster than the industry in every worldwide product category. In the enterprise which is a core initiative for us, we had particularly strong results. In January, we launched nine new servers including the M600 and M605 two socket blades and the M1000E Blade enclosure, the R805 and R905 virtualization optimized servers. In addition, we are a leader in disruptive solutions for the cloud, powering about half of the fastest-growing Chinese Internet companies as well as the largest portal and the largest search engine providers in China. These launches, combined with our existing leading edge server line up helped us grow more than 8 percentage points faster than the industry and gain 1.5 share points worldwide.

In storage, we grew revenues by 15% and based on our own estimates, we again took share worldwide in Q1 with the launch of the Dell EqualLogic, PS5000 IP SAN and our Dell EMC-AX4 and 5I SANs, we extended our position as the number one worldwide provider of iSCSI SAN solutions.

Finally, our emerging country initiative had strong results. Recall that we define emerging countries as BRIC plus 10 and the combined 14 countries grew units at 62% and the revenue accelerated to 47% led by strong share gains in Brazil, India and China.

During the quarter we also launched the Dell 500 notebook which was specifically designed for emerging countries. We are now shipping this in China and India and will launch additional countries as well as we catch up with the phenomenal demand that we are seeing for this product.

We also launched our Partner Direct program in Europe and APJ this quarter. Since we launched the program in the United States in the fourth quarter, we have added over 3,500 new global partners and our channel business is now on a $12 billion run rate.

While I'm encouraged with our progress, we still have much work to do to restore our competitive position but over time I am confident that our broad, long-term goals which include our growth initiatives will drive growth in revenue, earnings, cash and ultimately shareholder value.

Let me turn it back over to Lynn.

Lynn Tyson

Thanks Michael. Before we begin the Q&A, please refrain from multipart questions so everyone has an opportunity to ask a question and as we said earlier, you should be queuing in right now and we will do our best to get to everyone. Operator?

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer portion of today's call. (Operator Instructions) We will take our first question from Richard Gardner from Citi.

Richard Gardner - Citi

Thank you very much. You did a great job with headcount. In the quarter you took out roughly three times as much as I think most of The Street was expecting in the quarter. Could you talk about where the reductions occurred in the quarter, what parts of the business in particular? And hopefully provide us with a new target since you have mentioned that there are additional opportunities for headcount cuts in the core business? Thanks.

Don Carty

Richard, I think if you look at where the headcount declined quarter over quarter, it was really across the board. The reason I think all of you had a lower expectation is we probably set that. I think I indicated at the analyst meeting that we would reduce at least 1,000 in the quarter. We were successful in accelerating a fair bit of headcount reduction from the second quarter and even the third quarter into the first quarter so we were able to move up some of our plans.

A fair bit of it came in the consumer business. We talked to you about the fact that we were concerned about our level of OpEx. Consumer has been trying to execute on a lot of fronts, product, new distribution, but also at the same time execute on the cost side. So a very substantial amount of the cuts came in Consumer. It was headcount that we planned to cut but as I said, we were able to accelerate a fair bit of it.

I don’t want you to walk away with the impression that it was just Consumer. With the exception of some areas where we were investing very clearly in sales capacity like APJ and the emerging markets of Eastern Europe, you saw headcount cuts virtually across the board, up through the management ranks to the most senior levels of the company. We thinned out the overhead pretty considerably in the quarter.

Richard Gardner - Citi

Don, would you care to talk about a new target for headcount cuts?

Don Carty

We are probably not going to reset the target. We told you we were heading to 8,900 and we are. I think, Michael, you had indicated we had a line of sight beyond that. What you are going to find is the culture we are building here is one where we are cutting costs every day for the rest of the life of this company. This is going to stay a very cost conscience company. We do hope to drive headcount further in a number of areas, and at the same time, of course, this is a growing company. We are now growing very rapidly so sales capacity, service capacity, those are areas we will have to invest in .

Michael, do you want to add to that?

Michael Dell

I think Don said it well. I mean we are embracing a new way of leading the company where there are areas, as Don said, where we are cutting, we are finding productivity opportunities, consolidating, driving savings. At the same time, making very significant investments in the new growth areas.

In fact, we are doing one so we can do the other, while certainly our intent is to grow the earnings of the company at the same time.

Operator

Your next question comes from Ben Reitzes with Lehman Brothers.

Ben Reitzes - Lehman Brothers

Thanks, good afternoon. I would like to ask a devil’s advocate question. If I calculate the gains in the quarter it is about $0.055 which puts around $0.32 to $0.33. Considering I had restructuring and some R&D in there as well, as well as the investigation, I just have always had that in there.

So versus consensus it would look to me like we are pretty close to the $0.33 on a $400 million to $500 million revenue beat, and you crushed our headcount reduction numbers. So I am wondering, are the headcount – like why don’t we have more leverage, actually, from real operating income from the headcount reductions, and is that coming? Thank you.

Don Carty

I think whenever headcount is reduced in a quarter, particularly as you accelerate headcount from the second quarter and the third quarter, some of this happened later in the quarter. I think, Ben, we’ve said to you that we would hope to exit the year with OpEx closer to historical levels and we are not there. We are not crowing about this OpEx level at this stage. It is progress, but both Michael and I said, I think in our comments, more to be accomplished.

Operator

Your next question comes from Katy Huberty - Morgan Stanley.

Katy Huberty - Morgan Stanley

What do you think the primary factors were behind such a meaningful inflection point in Enterprise market share, especially in light of the cautiousness you mentioned in U.S. Commercial IT spend and Dell’s higher exposure domestically versus the competition?

Don Carty

Let me make one observation and I will turn it to Michael because he can talk an awful lot more about our product makeup. One of the interesting things in this downturn in the U.S., we reference for you the financial services business as one of the pieces of the economy that slowed their buying a little bit. That has been true in all of our client products, but when it comes to Enterprise these customers still have vast amounts of data to manage and store and that data is growing. That market has been a little more robust.

I will let Michael comment on our relative competitive position because I think that has been a big piece of it as well.

Michael Dell

A couple things. We did have almost 37% share of the U.S. server opportunity, which was a peak, highest-ever share for us. I think Dell was one of the first companies to embrace virtualization on the server front a couple of years ago, and it is also fair to say the combination of virtualization on the server plus the storage and the addition of the EqualLogic offerings I think put a lot of focus with our sales organizations on driving Enterprise success. A lot of training, a lot of solution resources.

And then finally the last thing is I think we’ve had great success in cloud computing, both with the business, software as a service providers and a lot of the big Internet companies that Dell I think has won a disproportionate percentage of the large web-driven opportunities and continue to be focused on that.

So we were the only server company in the quarter to gain both revenue and unit share.

Operator

Your next question comes from Brian Alexander - Raymond James.

Brian Alexander - Raymond James

Thanks. On the Consumer profitability it looked like it improved and you had the best margin performance, I realize we are still at a low level, but best in five quarters based on your new reporting structure. Just talk about how much of the improvement on the consumer side was due to retail getting more efficient. Is that part of the business profitable and how confident are you that we will continue to show some gradual improvement in Consumer profitability versus retrenching to a loss situation in the next few quarters.

Don Carty

Brian, a good question. If you look at the Consumer P&L you can see some pretty good improvement on the overhead cost side, and certainly that contributed in part to the improved profitability. We are ramping volume very nicely. A lot of the COGS opportunity that we have talked about will benefit our Consumer business. We still have too many products that we think we are at a cost position on. We are successful in selling them, but by definition if our costs were better our margins would be better, so we have a lot to accomplish.

We don’t break out Retail and Direct profitability, but suffice it to say Direct is a lot more profitable than Retail so we have a ways to go in Retail, there is absolutely no doubt about it. Ron and his team are highly focused on it. We are a long way from being ecstatic about our results. We like the progress but there is a lot more to follow here.

Michael Dell

We are seeing some very encouraging things. We have had a great reception from channel partners and retailers. If you take, for example, our business in China. We believ China is going to become the largest retail market in the world for PCs. We, at the end of the first quarter, had about 1,800 stores selling Dell products in China, and the growth rate in units for the Consumer business in China was about 140%. We expect we will have about 3,500 stores by the end of the second quarter, selling our products in China. So we are on an absolute rapid expansion in what we think is going to be the fastest growing country in the world. The acceptance of our brand inside those partners is very strong.

Brian Alexander - Raymond James

So just to follow up, it sounds like we are still very early innings in a lot of the improvements you are making in this business such that there would be no good reason why you would regress from here, you should continue to improve in terms of overall profitability?

Michael Dell

We think it is a multi-year opportunity and we are taking all the right steps to build this to be a substantial value-creating part of our business.

Operator

Your next question comes from David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

Thank you very much. It looks like you saw a mid-teens decline in both server and notebook ASP this quarter on a year-over-year basis. Is that from mix or pricing or something else?

Michael Dell

As I highlighted at the analyst meeting as significant, Dell has been kind of over-indexed to large commercial business around the world. Our growth opportunities are substantially or very significant in Consumer and emerging countries where average selling prices are in fact lower, so that kind of explains the client side.

On the server side, industry ASPs have been coming down and as I said earlier, we are the only company in the industry to grow revenue share and unit share.

Don Carty

We did see some mix shift there as well. I mean, our representation in the lower end of that product category increased during the quarter.

Operator

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

Keith Bachman - Bank of Montreal

Hi, thanks for the question. Michael, I think this is for you. Those services in S&P had the best growth rate in well over a year. I was just wondering if you could speak a little bit to, you had some help from acquisitions. If you could pare it down in services and S&P on an organic basis?

Related, typically units is the best proxy for these two categories, unit growth. Is that still the case with the growth of the consumer businesses?

Michael Dell

Well, the Consumer Retail business doesn’t have as much service attached to it for sure, but during the quarter we had continued progress of our new Pro Support offering. Attach rates were up 24% on a year-over-year basis which is pretty staggering for an offering like this. We are putting a lot of resources into really solution selling. As I mentioned earlier, the focus on servers, storage and services, things that start with S, is a big focus for the tens of thousands of sales people that we have out there talking to our customers. And software too.

Don Carty

The question about organic versus non-organic, as you know we have acquired a number of very small companies to integrate into our service offering. We no longer break them out, they have become fully integrated into our service offering so we are not able to answer the question, but suffice it to say at least at this early stage the acquisitions would have had only a very trivial impact on the numbers Michael just talked about.

Operator

Your next question comes from Scott Craig - Banc of America.

Scott Craig - Banc of America

Good afternoon, thanks. Just quickly on the Retail business, I think last quarter you mentioned the Retail business specifically running at around a billion-dollar run rate. Can you give us an update there?

Also in your short experience on the retail side of things, what are you seeing from an attach rate perspective in your retail partners? Thanks.

Michael Dell

I am not sure we have that to provide you today. But I can tell you is we have about 13,000 retail partners. We added about 2,000 during the first quarter. Costco here in the United States, Suning who is the number two consumer electronics retailer in China, Hontu and a variety of others in China as well. We added Best Buy in Canada. Don’t have additional information for you.

Don Carty

Obviously most of our growth in the Consumer space came from Retail so if you look year over year you can see virtually all of that growth is retail.

Operator

Our next question is from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

Yes, thank you. You had mentioned at your analyst day that you thought the biggest source of cost savings was in fact in the cost of goods line item rather than in SG&A and OpEx. You saw some improvement in OpEx this quarter. We did not see any in terms of cost of goods sold, despite the fact that it was a very favorable component environment.

Understandably a lot of the cost savings initiatives on the COGS side are longer lead time. Can you give us a sense of when we should start to see some of the COGS initiatives, which again, maybe you can confirm, are really the bigger lever in your eyes. When do we start to see them take hold?

Given the mix shifts that you had talked about in terms of emerging market and consumer profitability, will they actually be evident in the income statement?

Michael Dell

We are going through a pretty significant implementation here of changes in our product road map to capture the COGS opportunity that we have highlighted for you before. It is not just COGS. There is a lot in OpEx as well. But you can think about this somewhat tied to the product cycle, so as we introduce new products and those have been more tightly defined from a value standpoint based on customer features and we have to go through qualification cycles and that sort of thing. But I think you will see this opportunity show up, but it certainly is going to ramp as we go through the year.

Operator

Your next question is from Louis Miscioscia with Cowen and Company.

Louis Miscioscia - Cowen and Company

Okay, thank you. Can you actually give us some idea of what you actually grew in constant currency? And obviously with your comments about the environment out there, would you say that things have actually deteriorated as you went through the quarter and even as we stand here now, into your next quarter, or was it rather linear as you were experiencing the past quarter?

Don Carty

Even though that was a two-part question, I am going to answer it. The constant currency question, we don’t publish details on that but you can assume, I think, that our currency effect obviously is somewhat less than the currency effect of some of our competitors whose share in the international market is somewhat larger than ours. If you use a number between 3% and 4% you are pretty close on the constant currency question.

The question on the economy, I don’t think we’ve seen it deteriorate. I think we see a little bit of spread, a little more hesitancy maybe in the small and medium business, but we haven’t seen any falling off a cliff here. This is sort of the same hesitancy we saw in the last quarter.

You know, from our perspective the good news about this is these are purchases that can get deferred, but they don’t get eliminated. As the cycle strengthens again, every time we’ve seen in the cycle in the past there is a backlog of demand for products. So we are not, at this stage at least, terribly troubled by it. Like everybody else, we’d love to see the economy more robust than it appears to be, but we are not uncomfortable with it. Michael, do you want to –

Michael Dell

The spending power we saw in the U.S. was about what we had thought it would be. We expected conservative spending and that is kind of what we saw. But it is also true that when you are selling a productivity enhancing device that has a defined life, you know, customers can delay the purchase of that for some period of time. However, at some point it becomes counterproductive to have tools that are too old.

So we believe and have seen throughout any number of cycles that there is kind of a rebound effect, and so we are staying very close to these large customers. We know that even the customers in sort of the most dire economic conditions have to upgrade their productivity tools, it is the last thing that they will cut. In fact, you know, the Enterprise business was strong as this is a place, if you look at data storage for example, data storage is not stopping. In fact, it continues to expand at an enormous rate and companies have to deal with that and we have great solutions for that.

Louis Miscioscia - Cowen and Company

So it wasn’t a signal that things are changing dramatically as we go here into the next quarter?

Don Carty

No, not at all.

Operator

Your next question comes from Jeff Fidacaro - Merrill Lynch.

Jeff Fidacaro - Merrill Lynch

Great. So why don’t you just address sort of the component pricing in your outlook there? Just remind us, how does Dell manage the component costs and how does that change, really, with the inclusion of retail and the OEM supply chain?

Michael Dell

I don’t think we are seeing anything dramatically different in component trends. You know, in an overall basis there are always things kind of moving around one way or another, but generally component trends have been following a fairly predictable pattern. The bigger thing for us is the efforts to really design in exactly the components we need and not kind of more or less. I think that is going to be a bigger source of savings and improvement in our P&L.

Don Carty

But to a point that was made earlier, this is not a period of really rapid component cost decreases. A year ago we were seeing kind of record cost component decreases. That is not the case today. In fact, probably a little firming on the memory side, I think you are all familiar with that going on. That has been one area where we have held strategic inventory and it served us very well.

But I agree with Mike, I don’t think we see anything particularly unusual unfolding in this environment.

Operator

Your next question comes from Chris Whitmore - Deutsche Bank.

Chris Whitmore - Deutsche Bank

Thanks, I wanted to follow up on the Consumer question, specifically looking to disaggregate the growth related to channel sales and channel inventory building versus sellthrough, if you could. Maybe some color on channel inventory levels.

Secondly, do you have a target for number of retail outlets by year end.

Michael Dell

We are tracking channel inventory quite closely, very cautious here to make sure that our channel partners don’t have too much inventory. It is in our best interest and in theirs as well. We are pretty happy with the level of channel inventory we have.

Don’t really have a goal for you in terms of number of partners or number of stores, but I think you will see us continue to add all over the world with a focus on the leading and best partners, and on getting further penetration with those partners. We don’t want to be – the opportunity here is massively larger than 13,000 stores so we are still more at the beginning of this process.

Operator

Your next question comes from Bill Fearnley - FTN Midwest.

Bill Fearnley - FTN Midwest

Good afternoon. If I could ask a question about the pricing environment, a large distributor and others have made negative comments about the pricing environment, especially in the U.S. in the business segment. Any additional color on what you saw last quarter in the pricing environment, and near-term thoughts on the pricing environment and how it affects your margins near term?

Michael Dell

I think the pricing environment has been pretty straightforward. I wouldn’t say there has been a dramatically different pricing environment. If anything, we might have tried some things in pricing that we wish we hadn’t done, but I would say pricing has been pretty typical.

Bill Fearnley - FTN Midwest

And when you say you hadn’t done it, do you think you were too aggressive in some instances but it still helped you on the revenue line?

Michael Dell

I think there were select areas where we were probably more aggressive than we should have been.

Bill Fearnley - FTN Midwest

Thanks.

Don Carty

Let me just add to what Michael just said. In those areas, sometimes when you see some softness you want to test elasticity so you play with pricing a little bit. In this kind of economic environment you don’t see as much elasticity. In hindsight, I don’t think it really helped our revenue line. I think to Michael’s point it probably, we probably would have had a little better profitability if we hadn’t done it, but it wasn’t extensive. There were just a few pockets where we experimented and in hindsight I think we would have done differently.

Operator

Your next question comes from David Wong - Wachovia.

David Wong - Wachovia

Thanks very much. Given that you are continuing to focus on cost cutting, should we expect restructuring charges will continue at roughly the same level, impacting EPS by $0.02 to $0.04 per quarter for the next few quarters?

Don Carty

That gets a little more specific than I am willing to get, but I did make the comment that we have still got cutting to go. We are not at our headcount target. We intend to get it. I should also point out one accounting anomaly; I mentioned that on our restructuring EMEA had resulted in a one-time charge. Under accounting rules we are only permitted to provide for the severance that is statutorally required. In Europe as you go from a decision to a discussion with Works Councils, what it finally costs you is usually significantly more than what is statutorially required, so we are likely to have another charge for that piece as we work through the details of those downsizings in EMEA which will impact the second and third quarter. And we also have some additional headcount cuts to come.

Operator

Your final question comes from Clay Sumner - FBR.

Clay Sumner – FBR

Thank you. I just wanted to revisit the COGS question. At analyst day I believe you said you had 30 some odd new notebook models coming out that had been designed to be more cost optimized for the consumer segment. I was just wondering if you could give us an update on where you are and how many of those have been launched?

Michael Dell

We have introduced, you know, quite a number of notebooks so far this year. We have certainly much more to go. I think you will see a very active back to school season for Dell in notebooks, and we will also be bringing out the Latitude E series. Latitude is the best-selling line of commercial notebooks in the developed world and we have our best ever notebooks, best ever line of notebooks that we have ever produced, so very excited about those.

Operator

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

Michael Dell

So thank you for joining us today. I want to leave you with a few thoughts. First of all, I am encouraged by the acceleration in our growth. Second, we continue to fill out our portfolio of products and services, and you will see much more from us over the balance of the year. And third, we continue to drive shareholder value by growing units at a premium to the industry, executing on our $3 billion cost opportunity, delivering sustained EPS growth and executing on our five core initiatives; and, growing our retail and channel for scale and profit. Thanks for joining us today, we look forward to speaking with you again.

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Source: Dell Inc. F1Q09 (Qtr End 5/2/08) Earnings Call Transcript
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