Dell's Disappointing Quarter

The computer maker misses analysts' expectations and blames turnaround costs and "conservative" customer spending

by Arik Hesseldahl

Dell founder and chief executive, Michael Dell. Getty Images

Any hope that Dell (DELL) might be shielded from the U.S. economic slump was largely dashed on Feb. 28 after the computer maker reported fiscal fourth-quarter results that missed analysts' expectations.

The company reported an unexpected drop in per-share earnings and sales that missed consensus estimates by more than a quarter of a billion dollars. The stock fell in extended trading, after the figures were released.

Dell blamed the results on an ongoing effort to reverse the sales and market-share declines that led to last year's ouster of former Chief Executive Kevin Rollins, who was replaced by founder and Chairman Michael Dell.

Beefing Up Customer Service

Not only will Dell keep bearing expenses related to the turnaround, but customers are tightening belts, too. Dell said in a statement that it expects to "incur costs as it realigns its business to improve growth and profitability," conceding that the actions it takes may "adversely impact the company's near-term performance." "Conservative spending" by customers will also take a toll, Round Rock (Tex.)-based Dell said.

To spur growth, Dell is beefing up customer service, has begun selling through retail outlets, ending a long-standing strategy of direct-to-consumer sales, and it's eliminating almost 9,000 jobs, or 10% of its workforce (BusinessWeek.com, 11/30/07) . But the efforts are taking longer than expected to yield results, say analysts. Says Brent Bracelin of Pacific Crest Securities in Portland, Ore.: "The pace of the turnaound is as slow as molasses…. They are showing some progress but it's taking a lot longer than I would have expected, and the cost structure is a big concern."

Dell reported profit for the fiscal fourth quarter of $679 million, or 31¢ a share, far below the 36¢ analysts had expected. The results compared with $726 million or 32¢ a share a year earlier. Sales for the quarter were $16 billion, short of the $16.27 billion analysts forecast, but up from $14.5 billion a year earlier. Dell shares dropped about 4% in extended trading on Feb. 28, after the income report. The stock tumbled another 4.7% on Feb. 29, finishing at 19.90.

Finding the Right Balance

During a conference call with analysts, Dell Chief Financial Officer Donald Carty took pains to emphasize cost-cutting efforts, noting that the company had eliminated 3,200 jobs. At the same time, Dell added 2,100 employees in what it calls "front line" functions that deal directly with customers.

Carty said the full head-count reduction may take longer than initially planned. "The company had anticipated revenue growth that simply was not achieved, and we weren't as prudent on cost control as we should have been," Carty said. "We're also concerned about finding the right balance on cost cuts and finding a way to reignite growth. We're all about the long term, and we want to get the balance right." Selling, general, and administrative costs rose 29%, compared with a 10% increase in revenue. Research and development costs rose 30%.

Dell's results contrast with those of rival Hewlett-Packard (HPQ) whose strong earnings have defied the economic currents (BusinessWeek.com, 2/14/08). Hewlett-Packard said its fiscal fourth-quarter (ended Jan. 31) earnings surged 38% on strong notebook sales and international growth, while sales grew 13%, to $28.48 billion.

Better Luck Overseas

Not all of Dell's news was bad. Overall unit sales of computers grew by 19%. Dell computers were offered in 10,000 retail stores worldwide, and sales outside the U.S. grew by 16%, accounting for nearly half of sales, led mostly by a surge in the so-called BRIC countries—Brazil, Russia, India, and China—where sales grew by 36%. "We saw decent growth in the U.S.," Carty said. "But we saw very robust growth outside the U.S. I wouldn't be surprised if the U.S. is our slowest-growing region for the next couple of quarters."

Shaw Wu of American Technology Research in San Francisco says the quarter was "mixed," adding that Dell stock already has most of its bad news priced into it. "They're definitely selling PCs, but they have to get a lot more cost out of the business," he says.

How long is too long? Pacific Crest Securities' Bracelin says patience will wear thin within half a year. "If it's not turning around by the October quarter, then the pressure is really going to be on Michael Dell to do something serious, like make a change in leadership."

Hesseldahl is a reporter for BusinessWeek.com.