Dell's PC business drags down earnings

The company reported revenue of $14.4 billion, sharply below Wall Street's already reduced estimates of $14.9 billion, for its fourth fiscal quarter ending February 2. Profits were actually a bit higher than expected, with earnings coming in at 30 cents per share, compared with reduced expectations of 29 cents per share.

Dell had warned investors that fourth-quarter revenue and profits would fall short of expectations when it announced the resignation of former CEO Kevin Rollins in January. Analysts surveyed by Thomson First Call had originally been expecting revenue of $15.3 billion and earnings per share of 32 cents.

Compared with last year's fourth quarter, revenue was down 5.3 percent from $15.2 billion, and earnings per share were down 30 percent from 43 cents per share. These results are only considered preliminary; they are subject to change pending the outcome of internal and external investigations into the company's accounting practices, and they're unlikely to change for the better.

The investigations involve "certain accounting and financial reporting matters, including issues related to reserves and other balance sheet items," Dell said in a filing with the Securities and Exchange Commission Thursday afternoon. Bob Pearson, a Dell spokesman, declined to comment further on the specifics of the investigation other than to note that Dell is complying with the SEC and conducting its own "thorough" investigation of the matter.

Dell executives maintained their silence in reporting the poor results, declining to hold a conference call with the financial analyst community. The company does not plan to hold a conference call related to its earnings until the investigation into its accounting practices is completed, Pearson said.

Dell took an $89 million charge to pay for costs associated with the investigations during the quarter, the company said. This negatively affected earnings per share by 3 cents.

In its earnings press release, the company chose to highlight its growth outside of the U.S. and its server market growth. International unit shipments reached an all-time high, and revenue from international shipments now makes up 46 percent of Dell's total revenue. Server revenue inched up 2 percent from $1.4 billion last year to $1.5 billion this year.

But the numbers reported by Dell's core PC business were not good. Revenue from mobility products--essentially notebooks--dropped 2 percent on only a 2 percent increase in unit shipments. Desktop sales were even worse, with unit shipments declining 18 percent and revenue declining 17 percent. "Those numbers suggest to me that there's not a demand issue anywhere but Dell," said Stephen Baker, an analyst with The NPD Group.

The notebook factor
To some degree, the entire PC market is experiencing a shift in demand. Desktop PCs are falling out of favor with consumers in developed economies, who are switching to notebook PCs. And corporate customers--which account for a large portion of Dell's revenue--have eased back on their purchases over the last few months as they evaluate Microsoft's new Windows Vista operating system, especially in the U.S.

Dell, however, has been hit harder than most by such trends, because those segments--desktops, corporations and U.S. customers--have been its historical strength. Dell lost market share during the fourth calendar quarter, according to both IDC and Gartner.

Retail consumers have already expressed a clear preference for laptops--snapping up two notebooks for every desktop this past holiday season. And while corporations haven't shifted as quickly, they are headed in that direction. "That's a structural market shift that's moving away from Dell's strengths," Baker said.

In an ironic twist, Dell's poor performance helped boost its income. The company did not pay out $184 million in employee bonuses because it failed to meet its goals for the year, adding 6 cents to its earnings per share for the quarter.

Meanwhile, the company is taking steps to turn around its business. Michael Dell reinstated himself as CEO of the company, and he has brought on several heavy hitters, such as Ron Garriques of Motorola and Mike Cannon of Solectron, to run the consumer business and manufacturing organization, respectively. Rollins remains employed by Dell until May, but he does not come into the company's Round Rock, Texas, offices on a regular basis and is not playing a part in the company's reevaluation of its strategy, Pearson said.

Dell needs to make several changes, including a re-examination of its distribution and manufacturing strategies, but righting its ship on the product side should be job No. 1, Baker said.

"The thing we forget about Dell, until the last couple of years, they were the enthusiast company, the cutting-edge company," he said. "You could get the best desktop or notebook at a pretty good price (from Dell). They need to get back some of that swagger on the product side."