In comparing Dell's financial statements from 2012 and 2011, we can notice several discernible trends taking place; however, the interpretation of these trends is mixed. Generally, Dell experienced an increase in year-over-year net revenues and gross margins, but also a disproportionate increase in year-over-year operating expenses, primarily from selling, general, and administrative expenses. My analysis is targeted towards revenues, operating expenses, net income, and cash flows.
On a total revenue basis, Dell's revenues increased 0.938% year-over-year; however, breaking down the revenue composition illustrates an interesting new trend for Dell. Dell's total revenue is composed of its product sales and services. Dell's product sales revenue decreased 0.191% year-over-year, while its services revenue increased 5.86% year-over-year. The resulting net increase in revenues totaled a 0.938% increase, along with an increase in gross margins, from 18.53% in 2011, to 22.25% in 2012. This margin expansion is attributed to Dell's push towards margin expansion in product sales. Product margins increased from 15.84% in 2011 to 20.47% in 2012, while services margins decreased from 30.12% in 2011 to 29.54% in 2012. Overall, Dell has experienced relatively flat year-over-year total revenue growth, due to a weakening PC industry, but has pushed to increase its profitability through margin expansion.
Total operating expenses, composed of Selling, General, & Administrative and Research and Development expenses, increased 17.8% year-over-year. When broken down, much of this increase is attributable to a large increase in Selling, General, and Administrative (NASDAQ:SGA) expenses, with a less noticeable impact from Research and Development (R&D). Overall, SGA expenses increased 16.74%, from $7.3 billion in 2011 to $8.5 billion in 2012, while R&D expenses increased 29.5% from $661 million in 2011 to $856 million in 2012. Taken alone, the total operating expense increase is extremely negative, especially when accompanied with nearly flat revenue growth. It signifies a weakness within Dell with regards to managing its expenses, and also signifies a rapidly increasing competitive environment resulting from the lagging growth in the PC industry. Taken in overall context, however, there is some positive indication from the increase in operating expenses. Dell's Research & Development expenses increased 29.5% year-over-year, which signifies shrewdness in management's strategic orientation. Rather than increasing profitability through cutting back on R&D, especially in such a fragile economic market, Dell's management is doing exactly what needs to be done in such a competitive market: increasing expenditures on R&D, which is the lifeline of the company.
Overall, Dell's operating expenses as a percentage of revenues increased from 12.94% in 2011 to 15.11% in 2012, directly affecting Dell's bottom-line profitability because of its flat revenue growth. Typically, in a consolidating environment, such as the PC industry, operating expenses should increase, since expenses on advertisements and marketing will help preserve, or increase, market share. Nevertheless, Dell's organic revenue growth has declined despite its large increase in these expenditures, and growth may continue to decline unless Dell's management can increase its effectiveness in penetrating growing hardware industries, such as smartphones and tablets.
Year-over-year, Dell's net income increased 32.52%, from $2.6 billion in 2011 to $3.5 billion in 2012. Much of this bottom-line growth resulted from increased efficiencies in top-line expenses. Dell also experienced international tax rate efficiencies, especially from a 13% revenue growth in the Asian Pacific and Japan regions. Its overall effective tax rate fell from 21.34% in 2011 to 17.64% in 2012.
The 32.52% increase in Dell's net income is extremely interesting, especially since its net revenues only increased 0.938%. The entirety of this net income growth is due to top-line expense efficiencies, primarily through increased product margins. As a percent of sales, Dell's profit margin increased from 4.29% in 2011 to 5.63% in 2012. Although this increase in net income seems like a positive trend, it was generated primarily through operating efficiencies, and not through organic sales growth. This sort of profitability is more often than not short lived and not indicative of long-term profitability.
As a year-over-year trend, Dell's operating cash flows increased 39.25%, from $3.97 billion in 2011 to $5.53 billion in 2012. Much of this increase is due to Dell's $857 million increase in net income and increased efficiency in turning over its accounts and financing receivables accounts. When taken together, Dell's increased net income and increased receivable turnover efficiency contributed to a $1.85 billion increase in operating cash flows year-over-year. Overall, Dell has been trending towards increasing operating cash flows from 2011 to 2012, which is a strong signal in such a weak, illiquid, economic environment.
On a year-over-year trend, Dell's investing cash outflows increased tremendously, from $1.16 billion in 2011 to $6.2 billion in 2012. Of this $5.04 billion increase in investing cash outflows, $3.3 billion came solely through increased purchases of investments, such as securities. Dell also experienced an extraordinarily large expenditure from acquisitions in 2012, representing a $2.6 billion outflow in 2012, while only representing a $376 million outflow in 2011.
Finally, and most necessary for interpretation, is Dell's large increase in capital expenditures (capex), which increased from $444 million in 2011 to $675 million in 2012, a 52% increase. This increase in capex results from increased expenditures on improving current facilities, increasing the life of equipment, building new facilities, and other improvements which help generate future income for Dell. Overall, the increase in investing cash outflows signifies strength for Dell's long-term outlook, and confidence from management within the industry.
Dell's cash inflows from financing activities increased 21% year-over-year, from $477 million in 2011 to $577 million in 2012. In totality, this represented a net $100 million increase; of which, the most material events were Dell's activities in common stock repurchases, and proceeds and repayment of debt. In the past year, Dell has increased common stock repurchases by $1.9 billion; Dell also increased its proceeds from debt by $1 billion, while increasing its repayment of debt by $200 million.
Dell's strategic decision to increase its common stock repurchases from $800 million in 2011 to $2.7 billion in 2012 represents management's belief that its common stock is grossly undervalued in the market; however, this move also indicates an attempt to increase its stock's valuation by decreasing its number of outstanding shares, and more effectively increasing its earnings-per-share by Dell.
My general conclusion is that in the short-term, Dell is experiencing increased profitability primarily due to increased efficiencies in managing top-line expenses. Looking forward, though, Dell's organic product sales experienced a 0.192% decline, although it experienced a 0.938% net increase in revenues from an increase in services revenue. In the long-term, the implications of increasing net income solely through efficiencies in expenses, while experiencing relatively flat net growth, and negative organic growth, is a dangerous sign for Dell's long-term growth.
There is some light at the end of the tunnel, however; Dell has increased its Research and Development expenses by 29.5%, and its capital expenditures by 52%, which can trickle into increased future profitability.
To increase long-term profitability, Dell should utilize its increased operating leverage by dramatically increasing its advertising and marketing for its products to increase its market share. Due to Dell's expanded top-line margins, the effectiveness of advertisements and marketing on Dell's bottom-line becomes amplified significantly. Specifically, in 2012, every 1% increase in product sales trickled into a $102.2 million gross margin profit, as opposed to just $79.34 million in 2011.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.