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New concerns confront Dell as it reports earnings

From supply shortages to the weak euro to a market shift that favors consumer PCs over corporate sales, the computer maker has its work cut out for it.

Dell Computer on Thursday is expected to report strong third-quarter earnings, but future quarters could be more challenging for the PC maker.

Dell is expected to meet or exceed revised third-quarter earnings estimates, according to a consensus of analysts polled by First Call/Thompson Financial, which predicts earnings per share of 25 cents for the third quarter.

A year earlier, Dell disappointed Wall Street, as quarterly net earnings declined 25 percent to $289 million, or 18 cents a share. An unexpected rise in memory prices added about $75 apiece to the manufacturing cost of about one-third of Dell's PCs.

But supply shortages, a weak euro, and a market shift that favors consumer PCs over corporate sales mean that the computer maker has its work cut out for it going forward, said analysts.

Dell faced third-quarter challenges once again this year. In early October, the Round Rock, Texas-based company issued an unexpected profit warning, indicating revenue would grow only 7 percent sequentially instead of the expected 10 percent.

Analysts now project revenue of about $8.2 billion, compared with $6.78 billion a year earlier and $7.67 billion in the second quarter. Before the warning, analysts had expected as much as $8.5 billion in revenue, or about an $800 million sequential gain.

Like Compaq Computer, IBM and Intel, among others, Dell took a hit in Europe as the euro's performance against the dollar caused a sales slowdown. But Dell admitted it also faced unique challenges, as the company struggled to work out organizational problems in its European operations.

Dell also warned that sales among certain dot-com operations unexpectedly plummeted, hitting high-margin products, such as servers and hosting services.

In an interview last month, Dell chief financial officer James Schneider told CNET News.com he thought the company could still meet original estimated earnings per share (EPS) as the company benefited from falling component prices.

"I'm confident about the original EPS for this quarter," he said. "It was supposed to go up about 3 cents. Component costs have come down, and we've been pretty aggressive on pricing."

Potential crisis area: hard drives
While the costs of many components started a rapid decline in September and October, Dell faces one potential crisis area: hard drives.

"Drive prices are way up. If Dell's in the spot market or short market for drives, they could be in bad shape," said IDC analyst Roger Kay.

Supply shortages from one or more major drive manufacturers mean higher costs to companies like Dell, cutting the margins the company makes on potentially every system it sells.

"Drives are a big component you can't get away from," Kay said. "It could really hurt Dell."

While Dell still expects to exceed $30 billion in sales this year, the company still faces potential problems going into the fourth quarter. In October, Dell warned EPS could be 1 cent to 2 cents shy of estimates.

Dell faces challenges to its core PC business as sales slow in the United States and abroad and as the consumer market dominates corporate sales. Worldwide PC shipments grew between 16 percent and 17 percent, according to estimates by market researchers Dataquest and IDC. But in the United States, Dell's core market, sales grew only 12.2 percent, according to Dataquest, and 9.4 percent as projected by IDC.

Dell also faces challenges as it grapples with changing market dynamics favoring consumer sales.

"Things have shifted to the consumer side the last few quarters in terms of growth rates," Kay said. "Companies like Gateway and (Hewlett-Packard), which emphasize those markets, are doing relatively better. Those companies that are positioned for corporate, like Dell, are doing relatively worse."

During the fourth quarter of 1999, PC sales in the consumer segment for the first time passed commercial sales here and in Japan.

Still, Dell benefits from a strong uptake in notebook sales, which could offset slower growth on the desktop, as well as from increased emphasis on higher-margin products, such as servers and storage.

During the third quarter, for example, the company broke off its storage operation as an independent division.