Dell Shares

Michael Dell said to Bloomberg in July "We have an enormous opportunity in front of us, but it will require some changes''.  Dell Shares, our new investor relations blog is among those changes and opportunities. It's an exciting initiative for all of us on the Investor Relations team. 

It is an opportunity for us to go beyond posting information on the investor relations section at dell.com and to be accessible and available, share perspectives and build and maintain relationships with our investors, potential investors and anyone and everyone who is interested in joining the conversations here.

Dell Shares is not just about us and Dell financial information.  It is also about you. Relationships are two way streets with shared benefits and responsibilities.  So, we expect to listen and learn from you - our investors and those participating in this journey. 

Twenty three years ago, Dell was founded on the premise that direct relationships with customers was a tremendous competitive advantage.  It was and still is.  To keep growing and meet changing markets, however, Dell's businesses are also expanding into other sales and distribution channels. 

So it is with communicating to investors.  While we speak to thousands of current and potential investors every year using traditional communications tools, this is an evolution to communicate using some of the web-based tools that foster more interaction. To keep growing and enhance our relationships with investors and others who might be considering our stock, we see that markets, information sources and how people want to interact are changing.  Credible and relevant organizations today are taking advantage of technology and the Web to share information and connect directly with customers, suppliers, employees and other stakeholders.

There is no reason we shouldn't take advantage of these trends and reach beyond the traditional media and analysts to connect directly with investors or others interested in our company.  Dell's direct business model and the work of our colleagues demonstrate the value of our direct relationships with our customers.  It is part of our corporate DNA and an asset to the company.  Therefore, Dell Shares is about Investor Relations at Dell expanding beyond the traditional approaches to IR with a view to being involved in direct relationships with our shareholders and potential shareholders. 

You may have already seen the fruits of our early efforts in the form of our new IR RSS feeds, email alerts, investor tools, and other innovative programs.  Dell Shares keeps us moving forward.  We expect to not just push out information, but to share perspective and understandings.  We hope that means that the information will be given context and meaning, that it becomes more digestible and accessible, that you can share the information, perhaps we could say we want to democratize financial information beyond just filing public data.  While we urge you to review the Dell Shares and Dell Online policy statements, you can expect timely posts from the IR team (and sometimes company executives) on business performance and strategy.

We'll also post your comments and questions, which we'll respond to- where appropriate - in a timely manner. Dell Shares is a new effort, maybe among the first in the industry, to establish an Investor Relations blog that not only increases the flow of information, but also opens up a dialogue.  As Michael Dell recently noted  there are conversations going on about us all the time and we want to be part of those conversations -- to listen, to learn and to contribute.  We hope Dell Shares will be among your choices of places to come for perspective and commentary on Dell. 

Sometimes, however, we may be quiet, as there are periods of the quarter and various topics we can't talk about, such as forward looking statements or non-publicly disclosed information (see RegFD).  We hope you will understand some of the constraints and legal obligations that may, from time to time, limit our commentary.  Also, have a little patience with us, because some of these limitations may also slow us down as we learn and sort our way through this new field. 

However, we do want you to seize this opportunity and take on the responsibility to educate yourself and become an informed and knowledgeable Dell investor. Ideally, this blog will serve as an additional source of information to your own informed and sound financial decisions.

We look forward to making Dell Shares an example of an unfiltered view of company strategy, performance, and results and place where direct shareholder relations are strengthened.  We also hope Dell shares offers you a great place to become more informed as an investor.

As Michael Dell said to Bloomberg on winning back investor confidence ``it will take as long as it takes...we are making investments, investments we believe will be required for the long term. We are not looking to do something in the short term that will dramatically improve our results but cause a problem later on.''

Dell Shares is also about an investment in the long term that will dramatically improve our direct relationships with our owners and the information you have to make informed financial decisions.  We are excited about the journey we are embarking on with you.

We look forward to hearing from you.

I know that sounds like a mouthful, so let me take a few minutes to discuss what we announced today.  In May of last year, we announced we were taking steps to improve the competiveness of our operating model, profitability and cash flow.  Restoring competitive advantage means fixing things in our business that will allow us to provide even more value to our customers - and investing in things that will allow us to deliver better and more products and services to our customers around the world.  

Improving profitability means just that and this can be achieved by improving our cost position which is embedded in cost of goods sold (COGS) - like designing products that have the right features for our customers - things they want and value.  Operating expenses (Opex) is also a part of profitability and we believe we can do a better job of managing these expenses - things like reducing headcount (net of acquisitions) and moving more of our people to front line positions - positions that actually touch the customer.  And when you generate profits - cash flow follows.  At least this is the case for Dell.  On an annualized basis we typically generate operating free cash flow in excess of net income - so the more net income we generate - the more cash we generate.  And at the end of the day it's cash that fuels shareholder value.

So in our press release we said we believe we have a $3 billion opportunity to reduce total costs - this includes both COGS and Opex.  Now this does not happen over night.  In fact we said we believe it will take three years to achieve an annualized savings of $3 billion.  This means that before you adjust for growth, we believe our costs at the end of our fiscal 2011 will be $3 billion lower than at the end of fiscal 2008.   A company can do several things with this benefit.  They can use it to strengthen their competitive position and invest back into their business which helps drive growth, they can use it to improve profitability, or they can do both.  We will use it for both - and the split will depend on a variety of things including marketplace dynamics and our growth initiatives.

In our release we also announced that we will be closing our desktop manufacturing in Austin, Texas.   Over the last three years, driven by the massive shift in customer preference for notebooks - especially among consumers, industry forecasts for the rate of growth of desktops have declined from 10.8 percent to 3.6 percent.  And the desktop to notebook mix in the U.S. has declined from a 70/30 split in 2005 in favor of desktops to a 50/50 split today.  Our fiscal fourth quarter of last year reflects this change as we grew notebook units year over year by 37 percent and desktops by 10 percent.

Lastly - in our release we announced we would undertake a strategic assessment of ownership and operating structure alternatives for our Dell Financial Services financing activities.  And that this assessment will primarily focus on the consumer and small/medium business aspect of this business.  We acquired the remaining 30 percent of DFS from our partner, CIT, in December of last year. 

There is a lot of concern out there right now about the credit markets and we've been getting a lot of questions so let me clarify two things relative to Dell. 

First, our assessment of our DFS business is unrelated to what is going on right now in the credit markets - we completed the acquisition and so the natural next step is to pursue our strategy, simple as that.  Many companies - GE and Target - to cite recent examples - often assess the ownership structure of their financing companies.  In our case we are primarily evaluating three key things:  (1) can DFS provide even better and most robust product offerings to our customers, (2) can we accelerate the investments we are making in DFS and, (3) are there more efficient ways to fund DFS.   Our assessment may result in no change, or a sale to or partnership with a fully dedicated financing company.

Second, relative to our consumer financing receivables - less than 20 percent of our net customer receivables - or $1.6 billion - were to subprime customers.   This percentage is similar to what it was in our fiscal third quarter.  Based on our assessment of these customers financing receivables and the associated risks, we believe we are adequately reserved.  If you are interested in this topic I encourage you to read Note 2 Financial Instruments, and Note 6 Financial Services of our Fiscal 2008 10K that we filed today.

To get an update on all of the initiatives we have underway at Dell - I encourage you to listen to our equity analyst meeting which will be held in Round Rock, Texas on Wednesday April 2^nd and Thursday April 3^rd.   You can reach the web cast and accompanying slides via this link: Dell Analyst Meeting.  If you can't listen right away - it will be up on our web site for a while.

Last Thursday, we announced that in the next several weeks, Dell XPS and Inspiron PCs would be carried in over 900 U.S. Best Buy locations and at bestbuy.com. With this agreement, Dell PCs will be available in over 10,000 locations worldwide, which in turn helps us drive towards one of our key strategic priorities: focusing on consumer. We've received several questions from the press and investors seeking additional insights into retail initiative and its impact on our business model. Since we've announced partnerships with Staples, Wal-Mart, Sam's Club, Gome, Carrefour, Bic Camera, Carphone Warehouse, and others over the past several months (with the intention of forging 1 to 2 partnerships in the top 20 countries over time), we thought this would be a good opportunity to discuss what the impact retail partnerships will have on our P&L and cash conversion cycle (CCC).

Let's tackle the impact of retail on our CCC first. To review, CCC is a metric used by investors to understand how long it takes a company to create cash flows. This metric takes into account the number of days a company keeps inventories (DSI), the amount of time it takes a company to collect money from customers (DSO), and the amount of time a company waits to pay its suppliers (DPO). In short, CCC = DSI + DSO - DPO. The shorter a company's CCC, the less time capital is tied up in the business, and hence, creates better cash flows. The beauty of the Dell model is that we typically don't take possession of parts inventory until a customer has ordered and paid for a system. Meanwhile, customers typically pay for systems immediately (with a credit card in the case of consumers), and we we'll usually ship a PC to a customer within a matter of days. Meanwhile, our suppliers don't receive payment for roughly 2 months after we take possession of parts (last quarter it was 81 days), so Dell's CCC was -35 days in Q3'08. Dell's strong cash position is then reinvested back into the business in the form of capital expenditures or acquisitions, as well as returned to shareholders in the form share repurchases.

So back to the impact of retail partnerships on our CCC. The most consistent question we've received is whether we'll see our days DSI and DSO go up when dealing with a large retailer. The best way to answer this question is to think of a retail partner similar to a commercial customer. Retail, like commercial customers, will order 100s, if not 1000s of PCs at once. And these PCs will likely consist of just several specific configurations. We'll build these PCs to the customer's specification from one of our 11 global manufacturing facilities, leverage our world-class supply chain, and ship directly to the customer much as we would a commercial customer -- so there's little impact on DSI. As for the impact on DSO, we expect retail's accounts receivables will look much the same as our commercial customers. And remember; roughly 85% of Dell's business today is driven by commercial customers, so the impact on overall DSO should be minimal.

From a P&L perspective, the retail model impacts our business differently than our direct-to-consumer model does. Though it's early in the initiative, we expect retail-driven gross margins will be lower than direct since we'll have to share part of the margin with our partners. On the other hand, the sales and marketing costs associated with the retail model should be lower since our retail partners will shoulder much of these costs. Further, another benefit of our retail model could be that these additional revenues will help offset some of the fixed costs associated with our direct business.

But it's important to remember that our US consumer business posted -1.4% operating profit in Q3'08. While the retail partnerships are a step in the right direction, there's still a lot to do to return this business to profitability. It could take time to ramp and fine tune the initiative, but eventually, we expect retail will be accretive to our bottom line.

Recently, we received a comment from a shareholder unhappy with our use of cash and lack of quarterly dividend, so we thought this would be an excellent opportunity to address the topic in the form of a blog post. First, we appreciate the comment and understand that Dell stock is part of many shareholders' savings.  Second, shareholders voted on this proposal last year, and 94% of shareholders did not support the measure. 

The Board's position has been that shareholder value is best delivered by using the company's cash to reinvest in growth, while returning capital to shareholders by managing dilution through a stock repurchase program. While the writer mentioned P&G, I think it's important to remember that different businesses demand different strategies.  Dell's business and the current business climate requires that we pursue growth, which involves investments that will help the company achieve a global position and growth rate necessary to return value to our shareholders. For example, in FY'07 we spent $895M on property, plant, and equipment to support our global expansion efforts; such as new customer contact centers in the Philippines, Malaysia, India, and Canada; new manufacturing facilities in Brazil, India, and Poland; new business centers in Philippines, Malaysia, and Canada; and expansion of design centers in China, India, and Taiwan.

Also, it's important to note that a stock repurchase program offers several advantages over a quarterly dividend: 1) the elimination or reduction of dilution; 2) more flexibility in balancing the return of capital to shareholders with other business objectives; and 3) more flexibility for shareholders to determine when they want to convert all or a portion of their investment into cash.

Dell shareholders will have the opportunity to vote on this topic again at this year's annual shareholder meeting. The Board's members, who are elected by shareholders, regularly consider whether we should pay a dividend and review how we deploy our available cash, while balancing the needs of the company for liquidity, the ability to generate earnings and cash flow, and the most effective means to enhance shareholder value. At this time, we believe we are headed in the right direction.

Tonight, we announced the results from our fiscal third quarter and hosted our first conference call in over a year (a replay of the call and downloads of the financials & presentation can be found here).  Since wrapping up our investigation, this was our first opportunity to host an earnings call to discuss not only our most recent quarter's results, but the long-term strategy of our company

Before getting into some of the details around our earnings, and consistent with this blog's purpose, I wanted to highlight the value and importance of listening to earnings calls - not just our own, but of any company's.  These calls provide investors and analysts (including individual shareholders to institutional investors, and sell-side brokerage analysts) one of the best ways to keep abreast of a company's performance and strategic priorities.   You are welcome to join ours or listen to the replay (here).

As for our performance in the third quarter, the key takeaways were that we improved revenues, units, and profitability. We saw strength in our mobility products and continued to expand our business in international markets - particularly in Europe and Asia. We achieved $766 million in net income, generated roughly $1 billion in cash from operations, and drove our cash and investments balance up to $14.6 billion. This in particular is important because when we talk about creating value for our shareholders, cash generation is the ultimate litmus test, and essentially our goal is to maximize cash flows from operations over the long-term

During the call, Michael Dell, Don Carty and Steve Schuckenbrock discussed our efforts and progress towards improving our current business, re-igniting growth, and building for the future. Here, we touched upon our new executive leadership team and global business groups, new XPS products and small business product line, and factory openings in Latin America and Eastern Europe. And with our recent acquisitions of Zing, Silverback, ASAP, and our planned acquisitions of EqualLogic and Everdream, you are seeing us expand our portfolio of products and services and position ourselves for long-term growth.

Each specific business priority is part of the larger picture of business priorities that are being driven by our belief that information technology can be simplified and that we can drive long term shareholder value by focusing on growth in the consumer market, emerging countries, notebooks, solutions for the enterprise, and products and services for small to medium sized businesses. Our goal is to grow faster than the addressable opportunity in these areas, while keeping the company focused on driving strong cash flows from operations. These are more than ample growth opportunities for growth; the key will be to prioritize and execute.

We feel 3Q's results highlight the progress we're making towards our strategic priorities and building for the future. We're making good progress towards these goals, but there's more to be done To be sure, the path of progress won't be completely linear, but that happens sometimes when you're building and investing for the future.