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Dell's Ugly Earnings: 5 Takeaways

Aug 16, 2013 (10:08 AM EDT)

Read the Original Article at http://www.informationweek.com/news/showArticle.jhtml?articleID=240160098


On Thursday, Dell announced an undisputedly ugly earnings report that included a 72% year-over-year drop in profits.

To most companies, this sort of performance would be perceived as a disaster, flat out. But Dell is in a unique position, nearing the end of CEO and founder Michael Dell's six-month quest to take the company private. As a result, the earnings speak not only to Dell's current competitive prospects, but also to whether Michael Dell will be in charge long enough to turn things around.

What do the company's financial statements reveal about these topics? Here are five key takeaways from Dell's rocky earnings.

1. Dell slightly outperformed expectations.

Dell recorded $14.5 billion in revenue in its second fiscal quarter, which is actually basically flat compared to the same period in 2012. This exceeded analyst estimates, which were closer to $14.2 billion. Even though more than three-quarters of Dell's profits evaporated relative to last year, its $204 million in net income translated to 25 cents per share, one cent more than expected, according to Thomson Reuters.

[ For the latest on Dell's bid to go private, see Michael Dell Sweetens Buyout Bid. ]

2. Dell is selling more PCs but is still getting killed in the PC market.

In July, research firms Gartner and IDC released separate reports that suggested Dell's PC sales had begun to pick up. Indeed, Dell's computer business accounted for $9.1 billion, a 5% year-over-year drop that's not nearly as bad as it could have been, given the overall market. Unfortunately, Dell maintained its PC business largely by cutting prices. This tactic led to lower margins, and to overall profit of only $205 million. More than half of Dell's revenue comes from PCs and accessories.

3. The Enterprise Solutions Group is making progress, but not fast enough to compensate for the PC's business free-fall.

Dell's reliance on the floundering PC market is due in part to the fact that the company has largely missed out on the move toward mobile devices. That said, Dell has spent the last several years expanding beyond its PC base, with billions spent to acquire various companies and technologies. Last December, Michael Dell declared that the effort had turned the company into an end-to-end enterprise service provider. That was before the PC market had fully unraveled, however. The CEO now wants to take the company private to further develop this persona.

The Enterprise Solutions Group was the lone bright spot in the earnings report. Its revenue was $3.3 billion, up 8% from a year ago. Dell noted strong sales of networking hardware and server equipment. The company singled out demand for hyper-scale products, a new category of highly scalable data center technologies in which Dell has been an early leader.

Still, the Enterprise Solutions Group also testified to Dell's challenges. Though revenue was up, income slid 9%, to $137 million. That means Dell's enterprise business generated even less profit than its struggling PC business.

4. Dell's software business is coming along more slowly.

Software is another important element of Michael Dell's plan to make Dell a major enterprise services player. But unlike the Enterprise Solutions Group, which showed progress, the company's software projects are still finding their way. Dell's software business posted a $62 million operating loss. The company said it is working to enhance its software capabilities with investments that increase R&D and sales capacity.

5. Increases Michael Dell's chance of winning.

All in all, this was the kind of earnings report that shows why Michael Dell wants to take the company private in the first place. The company has valuable assets, but a turnaround is going to take time. Most investors won't have the patience to endure additional quarters like this one, and Michael Dell doesn't want to deal with oversight and scrutiny as he retools the company.

Still, Dell's plan has been challenged by activist investor Carl Icahn, who thinks the CEO's buyout offer cheats investors out of future profits. After months of sniping and a recent series of maneuvers that included a sweetened offer and a change in the shareholder voting procedures, Michael Dell finally seems poised for victory.

Icahn is still fighting Michael Dell in court, but for many investors, the earnings report is probably the last straw.

There are several clear reasons for shareholders to accept the buyout, according to a research note written by Cindy Shaw, managing director at investment analytics firm Discern. She noted that declining enterprise profits reinforce doubts that Dell can compete in a crowded market, and that the company's falling PC sales and struggles in the mobile market are also significant concerns. Discern expects Dell to go private, but says if it doesn't, the company's stock -- which was trading around $13.76 on Friday -- could fall below $10.