Q&A Regarding Dell Financial Services

Lynn Tyson — Tue, 27 Jan 2009 20:04:00 GMT

We recently received several good technical accounting questions regarding our DFS business from people in the investment community. In light of the recent news in the banking industry, this is understandable. Since our responses to these questions reflect information already in the public domain we thought it would be useful to post them to Dell Shares. The answers that you will find below come from information in the public domain that can be found in our earnings releases, earnings web decks, SEC filings and comments on our Investor Relations blog Dell Shares.

Also note that our accounting for DFS follows many FASB/GAAP guidelines for financing activities, including:

FAS 140: Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities
FAS 157: Fair Value Measurements
FAS 13: Accounting for Leases

These pronouncements serve as good reference points as you review our accounting and related disclosures.

Below you will find the questions we have recently received with respect to DFS along with the full detail of our answers. As always, please don't hesitate to call or email us if you have any questions or post directly to Dell Shares.

Question & Answers on DFS

Question: A general overview of the four types of financing receivables (Revolving loans, fixed-term leases and loans, residual interest and retained interest). The Q's and K's give a brief description of each but I'm looking for a bit more color for each:

Types of customers, timing of revenue recognition, etc.
Revolving Loans: general length, decline of no-interest promotional balance?
Fixed-term leases and loans
Residual interest
Retained interest
How much of Dell's revenue is financed through better than normal terms (net30)? i.e. through DFS or receivables greater than 30 days that are then securitized?

Answer: Receivables / Customers

There are two primary types of financing products:
- Revolving loans balances primarily reflect financings with Consumer customers, with a smaller portion to small business customers. Based on historical payment patterns, revolving loan transactions are typically repaid on average within 12 months.
- Fixed term leases and loans are offered to commercial customers, including large businesses, public entities, and small businesses. Terms are usually 24 and 36 months.

The decline of no-interest promotional balance is driven by a combination of strategic business decisions to end no-interest promotional loans to small business, lower the use of promotions as well as lower duration of no-interest promotional period in Consumer, and seasonality of Consumer sales.

Other financing receivables are:
- Residual interest: the remaining investment in equipment on sale-type leases
- Retained interest in securitized receivables sold by Dell

The vast majority of Dell terms are 30 days. New financing originations through DFS: $1.0 billion for the fiscal three months ended October 31, 2008 and $3.3 billion for the fiscal nine months ended October 31, 2008. We don't disclose percentages.

Revenue Recognition

All Dell product revenue is recognized up front with the exception of the residual interest Dell holds on leased equipment
Residual equipment revenue is recognized when the asset is disposed
Interest income is recognized over the life of the revolving or fixed term receivable
Fee income is recognized when assessed
For securitized receivables, gain or loss is recorded at time of sale. Accretion on retained interest is realized over time, along with quarterly valuation adjustments.

Question: Comparability of finance receivable balances before/after acquisition of remaining DFS interest from CIT. The FY09 filings note a portion of the receivables are due from CIT with a spike at February 1, 2008, is this related to the acquisition? Or is this related to a separate transaction? How will the expected decline in CIT funded receivables affect Dell's ability to offer customer financing? Cash flow?

Answer: The increased receivable due from CIT at fiscal year-end 2008 is not related to the acquisition of CIT's portion of DFS in Dec 2007, or any other specific transaction. CIT receivables were $444M at February 1, 2008 and were reduced to $31M on October 31, 2008. The decrease in the CIT receivables is primarily due to the liquidation of CIT receivables and funding lower volumes of promotional receivables through CIT.

Question: Residual interest valuation: can you walk me through the difference in the inputs for the "time of sale" and "valuation" inputs? Is this a time of sale vs balance sheet date comparison? Was the increase in monthly payment rates due to delinquencies or refinancing?

Receivable securitization:
Are the receivables interest bearing? (prior to securitization)
Is the retained interest the interest only portion of the securitized receivables?
Is the ABS a public securitization? i.e. public disclosure on the terms/performance?

Answer: The valuation of the retained interest is based on an expected future cash flows model which includes management's expectations of future payment rates and credit loss rates, reflecting Dell's historical rate of payments and credit losses, industry trends, current market interest rates, expected future interest rates, and other considerations. The monthly payment rate is the most significant estimate involved in the measurement process. Other significant estimates include the credit loss rate and the discount rate. The discount rate is a management estimate of the time value of money / required rate of return and is reflective of historical market-based rates and riskiness of the cash flows. We disclose valuation sensitivities in our footnote on financing receivables in each Form 10Q and Form 10K.

The difference between "time of sale" and "valuation" assumptions reflects the composition and characteristics of the assets sold, versus the total portfolio.

The increase in the monthly payment rate in the three month period ending October 31, 2008 reflects a change in the composition of assets sold during the period. We don't disclose the composition of assets sold.

Question: Are the receivables interest bearing? (prior to securitization)

Answer: Generally, yes.

Question: Is the retained interest the interest only portion of the securitized receivables?

Answer: Retained interest represents expected cash flows after all the other senior positions (principal and interest) are paid off.

Question: Is the ABS a public securitization? i.e. public disclosure on the terms/performance?

Answer: No. Dell has 3 private multi-seller conduit facilities.

Question: In reference to the receivables securitizations of $1.2B at 10/08 (asset securitization section), is that over and above the financing through DFS?

New financing originations through DFS: $1.0 billion for the fiscal three months ended October 31, 2008 and $3.3 billion for the fiscal nine months ended October 31, 2008.

Answer: $1.2 billion is part of DFS financing.

Dell Shares : Dell Financial Services

Q&A Regarding Dell Financial Services