DELL:1Q00 Revenue and EPS In-Line, But 90 bp Decline in Gross Margin
Salomon Smith Barney
Wednesday, May 19, 1999
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--SUMMARY:--Dell Computer--PCs *Dell reported 1Q00 revenue and EPS in line with our estimates yesterday after the close. Revenue of $5.54B (+7% qtr/qtr and 40% yr/yr) was just slightly higher than our estimate of $5.49B. EPS of $0.16 were exactly in line with our estimate and the Street consensus. *Gross margin declined 90 basis points qtr/qtr from 22.4% to 21.5%. The gross margin decline was offset by a reduction in SG&A percentage, leaving operating margins flat with C1997 levels. *While we agree that the Internet will allow Dell to increasingly scale operating expenses with revenue over time, we were surprised at the magnitude of this quarter's gross margin and op ex margin declines. We view this as a sign of increasing competitive pressure. *Maintain Neutral rating and $30 target; no change in EPS estimates. --EARNINGS:----------------------------------------------------------------- FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Actual 01/99 EPS $0.11A $0.13A $0.14E $0.16E $0.53A Previous 01/00 EPS $0.16E $0.17E $0.19E $0.20E $0.72E Current 01/00 EPS $0.16A $0.17E $0.19E $0.20E $0.72E Previous 01/01 EPS $0.20E $0.21E $0.23E $0.25E $0.89E Current 01/01 EPS $0.20E $0.21E $0.23E $0.25E $0.89E Previous 01/02 EPS $N/A $N/A $N/A $N/A $N/A Current 01/02 EPS $N/A $N/A $N/A $N/A $N/A Footnotes: EPS are fully diluted. --FUNDAMENTALS:------------------------------------------------------------- Current Rank........:3-H Price 05/18/99......:$44.06 Prior Rank..........: Target Price........:$30.00 P/E 01/00...........:61.2X 52 Wk Price Range...:54.31 - 19.57 P/E 01/01...........:49.5X Proj. 5yr EPS Grth..:25.0% Return on Equity 99.:89.00% BookValue...........:$1.29 LT Debt-to-Capital..:N/A% Dividend............:$N/A Revenue 2000........:$24329.00 mil Yield...............:N/A% Shares Outstanding..:2784.00 mil Convertible.........:No Mkt. Capitalization.:$122663.04 mil Hedge Clause(s).....: Comments............: --OPINION:------------------------------------------------------------------ REVIEW OF QUARTERLY RESULTS: REVENUE Revenue of $5.54B (up 7% qtr/qtr and 41% yr/yr) was $50M higher than our estimate of $5.49B (up 6% qtr/qtr and 40% yr/yr) primarily due to slightly higher than expected unit shipments (2.40M versus our estimate of $2.36M). The slight upside to unit shipments appears to be attributable to stronger than expected results in North America and Asia Pacific (most likely China). --------------------------------------------------------------------- Summary of Results Actual Expected Year Ago Prior Quarter --------------------------------------------------------------------- Revenue $5,537,000 $5,486,177 $3,920,000 $5,173,000 Rev Growth (Yr/Yr) 41% 40% 51% 38% Gross Margin 21.5% 22.3% 22.3% 22.4% SG&A $508,000 $532,159 $388,000 $492,000 Net Income $434,000 $431,093 $305,000 $425,000 Diluted EPS $0.16 $0.16 $0.11 $0.15 --------------------------------------------------------------------- --------------------------------------------------------------------- Yr to Yr Unit Growth Actual Expected Prior Qtr 6 Qtr Range --------------------------------------------------------------------- Server 51% 51% 9% 9%-135% Workstation* 100% 125% 133% n/a Desktop 49% 45% 49% 49%-62% Portable 64% 68% 80% 64%-141% --------------------------------------------------------------------- Total 52% 50% 55% 52%-74% --------------------------------------------------------------------- * Dell did not sell any workstations prior to 3Q98 --------------------------------------------------------------------- Asset Management Metrics Actual Expected Prior Qtr --------------------------------------------------------------------- Inventory Turns 62 52 58 Days of Inventory 5.9 7.0 6.0 Days Sales Outstanding 35.0 34.0 37.5 Days of Payables 52.9 50.0 53.6 Cash Conversion Cycle -12 -9 -10 --------------------------------------------------------------------- --------------------------------------------------------------------- ASP Actual Expected Year Ago Prior Quarter --------------------------------------------------------------------- Overall $2,307 $2,323 $2,485 $2,343 Notebook $2,890 $2,900 $3,397 $2,910 Desktop $1,642 $1,725 $1,920 $1,740 --------------------------------------------------------------------- On a geographic basis, revenue growth was 45% yr/yr in the Americas, 29% yr/yr in Europe and 48% yr/yr in Asia. While 1Q00 revenue growth in the Americas and Asia represented an acceleration over prior quarters (in the Americas, 1Q00 growth was close to 3Q99 levels), growth in Europe deccelerated from last quarter's 40% growth and last year's 58% growth. Management stated that attach rates and the transactional (consumer) business could have been stronger in certain European country markets, and that this will be an area of focus going forward. --------------------------------------------------------------------- Yr to Yr Revenue Growth Current Quarter Prior Quarter --------------------------------------------------------------------- North America 45% 39% Europe 29% 40% Asia 48% 30% Total 41% 38% --------------------------------------------------------------------- GROSS MARGIN Dell management had warned the Street prior to this quarter that it would take advantage of operating leverage to lower gross margin and thereby drive revenue growth and market share gains. However, this quarter's reported gross margin was 21.5%, down 90 basis points sequentially and 80 basis points yr/yr. This was much sharper decline than we had expected (our estimate was 22.3%). Recall that Dell fell approximately $100 million short of consensus revenue expectations last quarter, admitting that it had not priced aggressively enough. In essence, Dell allowed its relative price advantage to narrow and lost business as a result. This quarter, Dell lowered gross margin to reclaim its cost advantage. Bulls will say that the worst is behind Dell, and that having reclaimed its relative cost advantage and simultaneously reduced operating expenses, the company should be well positioned to meet both top and bottom line expectations. We note, however, that this is the first quarter that we can remember when Dell was forced to reduce total corporate gross margins in order to maintain a price advantage. In the past, Dell was able to use positive mix shifts toward higher margin servers, notebooks and workstations to offset more competitive desktop pricing conditions. The same positive mix shift is underway, and yet Dell is now being forced to lower overall blended gross margins to maintain a price advantage. This is a clear signal, in our view, that Dell's compet itors have made progress toward closing the pricing gap. OPERATING EXPENSES The 90 basis point sequential decline in gross margin was partially offset by a 34 basis point decline in operating expenses as a percent of sales. Obviously, the company's operating margin declined sequentially (from 11.5% to 10.8%), but operating margin was relatively flat year over year (10.8% versus 10.9% one year ago). The decline in operating expenses relfected a sharp decrease in new hires during the quarter. While Dell reported 1,700 new permanent hires during the quarter, some 1,100 of these employees were already working for Dell last quarter in a temporary capacity; Dell merely brought them on board as permanent workers this quarter. Net, net, new hires contributing to the company's SG&A for the first time amounted to just 600 this quarter, versus 1,100, 2,600, 2,900 and 1,700 during the prior four quarters. Aside from Dell's aggresive hiring rate last year, the single most important factor allowing the company to scale operating expenses this quarter was the Internet. Dell managers in all areas of the business are aggressively steering customers to the Internet for sales, product information and technical support. It is difficult to quantify how much of this quarter's operating leverage was related to a shift toward the Internet, but Dell states that a full 30% of sales ($18M per day) are now taking place via the Internet. EARNINGS PER SHARE On balance, earnings per share of $0.16 were exactly in line with our estimate and the consensus. GUIDANCE Dell CFO Tom Meredith told analysts that the positive and negative factors affecting gross margin fell "fairly well balanced" at this time. He did, however, remark that a continued shift toward the Internet should give the company additional room to scale operating expenses during the coming 12-18 months. Net, net, Meredith appeared to signal that he did not perceive the immediate need for further gross margin reductions in order to achieve Dell's top line goals. Meredith also remarked that he would not be surprised if Dell's operating and net margins hovered around the current quarter's levels. Without any changes in our revenue assumptions, this implies no changes to F2000 or F2001 earnings estimates either. We do not expect significant upward or downward revisions to Wall Street's F2000 or F2001 earnings estimates today, and we are not changing our estimates either. OUR VIEW We maintain our Neutral rating on Dell shares. While we believe that there will be an inflection point sometime this year when incremental initiatives (China, consumer, SMB, sub-$1,000, high-end server, storage, new services) ramp sufficiently to mitigate the risk of an earnings shortfall, we believe there is significant earnings risk for at least one more quarter based on 1) increasing competition in Dell's core large accounts customer segment, and 2) continued declines in average selling prices due to the shift in mix toward low-end systems. Maintain Neutral rating and $30 price target. -------------------------------------------------------------------------- Salomon Smith Barney is a U.S. registered broker-dealer. 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