Good afternoon and welcome to the Dell, Inc. Third Quarter Fiscal Year 2009 earnings conference call. I would like to inform all participants that this call is being recorded at the request of Dell.
This broadcast is the copyrighted property of Dell, Inc. Any rebroadcast of this information, in whole or part, without the prior written permission of Dell, Inc. is prohibited.
As a reminder, Dell is also simulcasting this presentation with slides at www.dell.com/investor. Later, we will conduct a question and answer session. If you have a question, simply press * and 1 on your telephone keypad at any time during the presentation.
Lynn Tyson, Vice President of Investor Relations
With me today are Chairman and CEO, Michael Dell, and Senior Vice President and CFO, Brian Gladden. Brian will review our third quarter results and how our business model is positioned to effectively compete in this demand environment. He will also review the products we have made in our initiative to improve our competitiveness.
Michael will follow with his perspective on how our products and services are well-suited to how customers are approaching their IT spending in this environment. To get additional insights on our results this quarter, please read the Q&A with Michael and Brian that we posted on our Dellshares blog on www.dell.com
Also, we have expanded the web deck at our company to use this call to capture additional information many of our shareholders have requested. All growth comparisons made on this call are year-over-year, unless otherwise stated. On our calendar for the balance of the year includes Michael at CSFB on December 2 and blogs covering our Global Services and consumer businesses.
I would like to remind you that all statements made during this call that relate to future results and events are forward-looking statements that are based on our current expectations. Actual results could differ materially from those projected in the forward-looking statements because of a number of risks and uncertainties which are discussed in our annual and quarterly FCC filings and in the precautionary statement contained in our press release and on our website.
Brian Gladden, Senior Vice-President and CFO
We are pleased with our performance this quarter, especially against the backdrop of flowing global IT demand, but we still have more work to do. Our direct models afford us the benefit of reading and reacting to demand signals faster than any company in our industry.
As we have been indicating throughout this fiscal year, Dell has seen weakening in global IT and user demand, and we expect that this weakened demand environment to continue for the foreseeable future.
On our second quarter call, we said we had already taken actions to improve profitability in the company and you are seeing it in our results this quarter. We achieved these results by continuing to improve our mix of products and services while also realizing the benefits of our initiatives to improve our cost structure and competitiveness. Our goal continues to be to drive a balance of liquidity, profitability and growth, and optimized cash returns - regardless of the macro economic cycle.
So let me turn to the quarter, which begins on page 5 of our web deck. Revenue declined 3 percent on a 3 percent increase in units. Operating income reached 6.7 percent of revenue, which helped to drive earnings per share up 9 percent to 37 cents per share. The improvement in operating income was driven by gross margins of 18.8 percent which benefited from improvement, lower component costs, and our product initiatives in the quarter.
Improving operating income was also aided by strong Opex discipline. With opex the percentage of revenue at 12.1 percent. On a dollar basis, this is an 11 percent decline in Opex dollars versus last year. We also reduced head count by another 2,200 sequentially.
Our tax rate in the quarter was 28%, slightly higher than the second quarter, primarily reflecting a shift in the mix of income to higher tax jurisdictions. We pointed out this dynamic to you in our second quarter earnings as well. I also want to highlight that in this quarter, we overlap in 18% tax rate in Q3 of last year. In the quarter on pretax basis we absorbed $26 million of the expense for amortization of purchased and tangibles and $17 million in business realignment costs.
We also reported lower bonus expenses in the quarter versus last year, which favorably impacted operating income margin by about 50 basis points sequentially. Cash flow from operations was a negative $86 million. Simply explained, while our receivables were down in the quarter with lower revenue, our payables were down significantly more as we reduced spending in the second half of the quarter. When our shipments, production, and procurement return to a more typical relationship, we expect a reversal on this cash dynamic.
Our cash conversion cycle ended at negative 25 days, a decline of 4 days from our last quarter. Year-to-date cash flow from operations is $1.2 billion. In the quarter, we spent $400 million to buy back roughly 21 million shares. Despite what we believe to be an attractive valuation, we were conservative with our share repurchase this quarter, choosing instead to conserve cash given highly uncertain demand and capital markets. We ended the quarter with $8.9 billion in cash and investments.
Now let me turn to our business segment which begins on page 8 of the web deck, with additional information in the supplemental section.
I spent time with many of you after our second quarter earnings and I realized that we have an opportunity to better differentiate for you the dynamics of our global consumer business versus our global commercial businesses.
So let me start with our global commercial business, which on a trailing fourth quarter basis is about 96 percent of our profit and 82 percent of our revenue. Our customers here are large commercial, public, and small and medium businesses.
By the end of the second quarter, we have seen a slowdown in most verticals and we drove demand in areas where we had both profit and growth opportunities. As a result, revenue declined 6 percent on a 5 percent declining units. Operating income margins, however, increased 130 basis points sequentially to 8.1 percent of revenue. Driven by a decision to protect this profitability as well as favorable opex scaling in a slowing demand environment.
Over the last four quarters, our mix of revenue and profit in our commercial business has improved, with over a third of our revenues now coming from higher margin products like storage, services and software peripherals. Michael will dive a little deeper into our enterprise products.
Notebook units were flat as we transitioned to our new Latitude E series. Server units declined 4 percent and storage revenue was flat. Enhanced services revenue, which is largely driven by our commercial business, was up 7 percent to $1.4 billion. Looking at the regions, America’s commercial had an 8 percent decline in revenue on a 14 percent declining units as operating income improved both sequentially and year-over-year. This reflects improvements in products and services and lower component costs.
Americas commercial had a 5 percent decline in revenue on flat unit growth. As we mentioned last quarter, we took actions to improve profitability in Europe and these actions yielded significant sequential improvement in operating income dollars in the quarter. The majority of this improvement was driven by lower opex and a better mix of products and services in the third quarter. In APJ commercial, revenue was up 2 percent on a 15% increase in units, while operating income was up over 60 percent.
Performance was aided by strong double digit unit growth in emerging countries. We also had great success with the channel business and in penetrating lower cities of China by leveraging the recently lodged Voltro A-Series. This product was specifically designed for emerging countries and now all the commercial products in the emerging products are cost optimized.
Let me turn to the global consumer business, which on a trailing fourth-quarter basis is 4 percent of our operating income and 18 percent of our revenue. This business is undergoing a profound transformation.
Our overarching goals with global consumer include: broadening our product portfolio with a focus on great products that customers get excited about, expanding our points of distribution including retail, growth in developing markets and acceleration in our direct business. Improving profitability by optimizing product costs, reducing opex, increasing the revenue and profit opportunity on each unit that we sell. In the quarter, revenue was up 10 percent on a 32 percent increase in units, or 1.2 times the rate of the consumer industry.
This growth is fueled by our continued success in the global retail channel, and a more diversified portfolio of leading edge products. Here today, we have launched an industry leading product like the Inspiron 1525, the Studio Hybrid Desktop, and the Inspiron Mini. All these products have received rave reviews and have been recognized with multiple awards. Operating income reached $112 million for the global consumer business, or 4 percent of revenue versus a lull in the third quarter last year. Year-to-date operating income was 1.2 percent of revenue.
Improving the profitability year over year was driven by 24 percent reduction in opex dollars. Sequentially, gross margin improved as roughly half of our volume has gone through a first round of cost optimization activity. We also benefited from lower product and component costs. In the near term, as this business continues to expand throughout the full spectrum of growth, I think operating income margins will be in the 1 – 2 percent range. With all the initiatives we have under way, we are confident that over time we can improve margins even further for the global consumer business.
Before I turn to the outlook, let me touch on our cost initiatives, our commitment to our financing business, and our overall liquidity. We continue to make significant progress against our cost initiative, which benefits both the COGS and the opex line. As mentioned earlier, when we go into more detail on pages 11 and 12 of our web deck, a larger portion of our total unit volume is now cost optimized, which depending on the platform, can yield up to 30 percent reduction in the product cost. Opex in the quarter were down over $200 million versus the third quarter of last year, and since the second quarter of last year, the head count is down by close to 11,600 heads net of acquisitions.
As we expand our global manufacturing and logistics footprint, we now have about a quarter of our transactional products going through contract manufacturers. This accomplishment positions us well to rapidly adjust our cost structure in an environment of slowing demand.
As we know, since September, after a strategic assessment, we decided to keep Dell Financial Services. DFS is a strategic asset for Dell and drives incremental sales and margins and is profitable for us in the current environment and credit cycle. We will continue to effectively manage credit and funding risks in the DFS business. While DFS credit losses have increased as the environment has become more challenging, we continue to believe that we are adequately reserved. We tightened credit requirements 5 times over the last 18 months and we are confident in our ability to fund new businesses and securitize receivables. Established securitizations remain liquid, although, as would be expected, deal costs have increased. As the credit market stabilizes, we will work to identify and execute cost effective funding strategies that will have a minimal impact on our corporate debt capacity.
Turning to liquidity on page 16 and 17 of the deck, we are comfortable with where we are positioned and we are not constrained. We have access to traditional short term and long term funding vehicles. We have an established commercial paper capacity of $1.5 billion, with $250 million outstanding at the end of the quarter, and we issued $1.5 billion of long-term debt in the first quarter of this year. We filed a new debt self registration earlier this month, which we can use for future debt issuances on an as-needed basis as spreads come in a capital market conditions improve.
Before I turn it over to Michael, let me leave you with some key points on the quarter and our view of what we are seeing in the industry.
Our direct model is uniquely positioned to give us demand trends early, which allows us to adjust rapidly. In quarter 3, we adjusted to the realities of the current industry dynamics. In a challenging demand environment, we focused on growth opportunities with a bias toward protecting profitability, while improving our mix of products and services. This will continue, although there will be products, segments, and countries where we selectively choose to grow as a multiple to the industry.
Our initiatives to improve competitiveness and reduce costs are bearing fruit, as are the investments that we have made to broaden our product portfolio in both, our consumer and commercial businesses. In a softening demand environment, component costs to clients typically accelerate and companies with superior asset velocities are able to take advantage of those improvements faster than others.
We believe global industry demand will continue to be challenging and we will work rigorously to scale our costs accordingly. We will continue to incur costs as we realign our business to improve our competitiveness, reduce headcount in certain areas, and invest in infrastructure and acquisitions.
In summary, we will continue to diversify our revenue base and products and aggressively drive our cost reduction initiatives which, over time, will yield improved liquidity, improve profitability and growth.
Michael Dell, Chairman and CEO
We have been involved in a significant transformation here at Dell over the past 18 months. In April, we outlined for you our five growth initiatives of consumer enterprise, notebooks, SMB in emerging countries. In addition, we discussed our plans to improve our competitiveness and we have made significant progress along those initiatives.
We have identified and are aggressively taking down our cost structure by about $3 billion to regain cost leadership.
We are well into transitioning in to a higher mix of contract manufacturing to drive competitiveness.
We reduced our GNA substantially; our opex is down by over $200 million in the third quarter versus the same quarter last year.
We have revamped our entire product line in every category, and we have regained feature design leadership in many segments. There has been a great deal of progress. There is much to do, but these are important foundations that position us to be a stronger and more nimble company.
This is a more challenging IT spending environment and there are three things that you need to think about when considering Dell.
