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Dell: Softer PC Demand Trends May Weigh On Q3 Results

 November 12, 2012 02:32 PM

(By Mani) PC maker Dell, Inc. (NASDAQ: DELL) is expected to report lower third-quarter earnings results on Nov.15, hurt by softer demand and ongoing share losses in PCs.

Round Rock, Texas-based Dell is transitioning from a PC vendor to data center solutions and services vendor as soaring demand for tablets is hurting PC sales. Dell is shifting to higher-margin data center solutions consisting of servers, networking, storage and related software and services from traditional PC sales.

The enterprise solutions and services have accounted for 50 percent of gross margin and more than 30 percent of revenue. However, Dell remains committed to a profitable end-user computing business.

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Wall Street expects Dell to earn 40 cents a share, according to analysts polled by Thomson Reuters. This implies a 26 percent drop from 54 cents a share earned in the third quarter of last year, and 20 percent from 50 cents a share reported in the second quarter of 2012.

Dell might look to maintain its momentum of beating estimates it set in the second quarter. In the past four quarters, the company's earnings have topped consensus twice while missing them on two occasions. There has been no change in the consensus expectations in the last 60 days.

Quarterly revenues are expected to decline 9.5 percent to $13.91 billion. For the past two quarters, Dell reported single-digit drops in revenues, and guided that its third-quarter revenue would be down 2-5 percent from second-quarter levels due to subdued PC demand.

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"We think a steady decline in PCs will eventually impact its Services business, which may impede gross margin performance. Also, gross margins may get negatively impacted by increased pricing pressure across verticals," RBC Capital Markets analyst Amit Daryanani said in a client note.

The analyst expects gross margin to contract 100 basis points (bps) to 21.6 percent on reduced volumes and pricing pressure.

Meanwhile, Dell's Client segment had limited revenue growth opportunities in the October quarter, driven by softer demand trends ahead of the Windows 8 product launch. Furthermore, Dell conceded market share to international rivals as it attempts to focus on restoring the historical profitability of the business.

"We are currently estimating Dell's desktop PC business will report revenues of $3.1B and the Mobility segment will report revenues of $3.6B, each down ~7% sequentially," the analyst wrote.

According to market research firm Gartner, Dell's third quarter market share fell to 10.5 percent from from 11.0 percent in the second quarter, and PC unit shipments fell 14 percent year-over-year and 1 percent sequentially.

"While the revenue mix may enable better gross-margin mix, we suspect that much of that will be offset by deleverage in the model coupled with a challenging pricing environment. Nonetheless, lower desktop PC notebook units relative to our prior estimate should result in $0.01–0.02 reduction to FQ313 EPS," Daryanani said.

However, Dell should have respite from Servers & Networking segment, which is expected to aid results as strength in industry-standard server shipments remains healthy and helps offset near-term softness in networking demand. According to preliminary server unit shipment data from Gartner, Dell's server units should advance 14 percent year-over-year and 9 percent sequentially.

"We believe the company's 12th generation PowerEdge continues to benefit from first to market, and we continue to see greater adoption of these servers in the upcoming quarters given the launch in the March quarter," said Daryanani who sees fourth quarter server shipments to improve on a seasonal basis

Dell Services unit is expected to remain fairly stable on both sequential and year-over-year basis in the third quarter. However, a restrained IT spending environment will continue to limit revenue growth potential from this segment. In the near term, this segment should under-grow the industry on a revenue basis given a greater weighting toward PCs that should realize volume deceleration and limit services revenue growth

"We are now modeling this segment flat q/q (down 1% y/y). For the Jan-qtr, we expect revenue should advance 3% q/q and be up flat on a y/y basis," the analyst added.

Meanwhile, Dell has made a flurry of acquisitions recently, eight in the last 12 months as it continues to make a concerted effort to grow its Enterprise Solutions, Services and Software (ESS&S) product offering. During the next couple of quarters, it may have to contend with integrating the various acquisitions and their products into their sales mix and a softer IT spending environment that may limit organic revenue opportunities.

In addition, forex is still a headwind compared to last year, but it is improving sequentially. Dell has about 17 percent of its revenue tied to European sales, implying an incremental $50 million benefit to the company's top line from the time of the company's last guidance.

"In our view, the Oct-qtr average USD/EUR exchange rate of 1.274 vs. 1.247 on Dell's Q113 earnings release (a change of 2.1%) will be a tailwind to Dell's top line in the Oct-qtr on a sequential basis. We believe current FX rates should prove neutral to the company's full-year earnings guidance," Daryanani said.

Shares of Dell, which has a market cap of about $16 billion, fell 21 percent in the third quarter and 38 percent year-to-date. They were trading between $9.11 and $18.36 during the past 52-weeks.



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