Computer Giant's Drive Into Emerging Markets Leads to Discounting, Toll on Profit MarginsDell Inc. reported a 17% drop in quarterly profit, raising questions about the company's 18-month turnaround effort and whether a slowdown in business spending is spreading to Europe and Asia.
The results sent shares down 14%, or $3.48, to $21.73 at 4 p.m. Friday on the Nasdaq Stock Market.
Dell's declining profitability was a negative counterpoint to rival Hewlett-Packard Co., which last week reported a 14% jump in quarterly profit.
While Dell's report is likely to renew worries about business spending, the Round Rock, Texas, computer giant acknowledged that some of its woes were the result of its effort to reignite growth, something Chief Executive Michael Dell called "an imprecise process" in a conference call with analysts. He said that the company was "a bit too aggressive" in some of its businesses. Profit margins fell during the quarter.
Dell showed signs of solid demand, reporting an 11% jump in revenue for its fiscal second quarter ended Aug. 1 from a year earlier. The company, best known for business PCs, said shipments of consumer machines rose 53%.
But much of that growth didn't translate into new profit, as the company has faced falling PC prices and heavier spending on marketing. Chief Financial Officer Brian Gladden added that Dell also is seeing a slowdown in tech spending that is beginning to metastasize.
"It really started with big corporations, and we've seen slowing in state and local government spending, small to medium sized businesses as well," Mr. Gladden said in a conference call with reporters.
The company expects "continued conservatism" in business tech spending in the U.S. as well as Europe and "several countries in Asia."
Dell has lagged H-P in exploiting sales to Asian countries, but has been moving to catch up in markets that include China and India.
While commercial sales in the Asia-Pacific region and Japan have been brisk -- rising 16% in the period -- Dell has had to sell lower-priced PCs in those markets and spend heavily on advertising.
Bill Kreher, an analyst at Edward Jones, said he didn't expect such poor results, and said he is concerned that Dell will continue having trouble in emerging markets. "The weakness in Asia came as a big surprise," he said. "We didn't hear that type of disclosure from other companies like H-P."
Dell, one of the most consistent performers during the early part of the decade, ran into a series of problems that led Mr. Dell early last year to return to the CEO post after a three-year hiatus.
While he was away, the company lost the No. 1 position in global PC sales to H-P, and had some highly publicized problems with customer service.
The company, once known for selling exclusively through the Web and via telephone orders, subsequently moved into retail stores, and has begun emphasizing style and color in its consumer notebook PCs. Such efforts resulted in increased market share and a 28% jump in revenue from consumer PC shipments in the second quarter from a year earlier, but "profitability was roughly break even" in the consumer division, the company said.
Discount laptop sales remained strong, advancing 26% in the quarter from a year earlier. But sales of desktop computers declined 2%.
Unlike H-P, which makes money on software and technical services in addition to computers, Dell is almost entirely dependent on hardware. That means dropping PC prices have had a particularly big impact on its business in recent months, said Lou Miscioscia, an analyst at Cowen & Co. Dell's marketing spending also impacted its profitability. The company's gross profit margin declined to 17.2% in the recent quarter from 18.4% for the quarter ended in May and 19.9% in the year-earlier period.
Since Mr. Dell's return, the company has started revamping its manufacturing, increasing its reliance on contract PC makers and shutting down a factory in Texas. So far, though, such changes have been offset by rising expenses in marketing and investments in new product development.
Mr. Gladden said he holds meetings every other week to discuss Dell's expenses and said the company will continue a cost-cutting effort that began last year. He said Dell should hit its target of eliminating more than 8,800 jobs later this year. Investors will be paying close attention to ongoing cuts, said Mr. Kreher of Edward Jones. If PC and server prices continue falling, profit margins could be squeezed even more.
Investors will be paying close attention to ongoing cuts, said Mr. Kreher of Edward Jones, since PC and server prices are expected to continue falling, further squeezing profit margins.
The company said net income for the fiscal second period was $616 million, or 31 cents a share, compared with profit in the year-earlier period of $746 million, or 33 cents. Revenue rose to $16.43 billion from $14.78 billion.
By: Justin Scheck
Wall Street Journal; August 29, 2008
