Dell's Quarter Saved by Cost Cuts

Defying investors' fears that its earnings would fall victim to slumping tech demand, Dell turned in a surprisingly profitable third fiscal quarter by taking a big ax to costs.

Although Dell's (DELL) sales were more than $1 billion short of Wall Street estimates for the quarter that ended Oct. 31, a combination of job cuts, a hiring freeze, and lower materials costs helped earnings reach 37¢ per share, beating analysts' modest expectations of 31¢ per share. Shares of Dell gained more than 5% in extended trading. Earlier, the stock had lost 54¢, or 5.2%, to close at 9.81, amid a market slump.

Revenue and net income declined from a year earlier, but investors said Dell was successfully protecting profit amid a global economic slowdown that's sapped business and consumer demand for new computers and other tech gear. "In previous quarters it looked like the company was willing to grow share at any cost," says Bill Kreher, a technology analyst at Edward Jones who has a buy rating on Dell. That's what happened in the second quarter, when profit fell 17% on overly aggressive price cuts (BusinessWeek.com, 8/29/08). "In this environment they're aware that investors are more concerned with the bottom line," Kreher says.

Tough Act to Follow

For now, Dell may need to keep running the cost-cutting play, one of its few options in an environment that's forced other tech bellwethers, including Intel (INTC) and Cisco Systems (CSCO), to issue dour forecasts. Dell sliced 2,200 jobs and took advantage of lower PC component prices, analysts said. "Can they continue to cut costs like this?" says Jayson Noland, an analyst at Robert W. Baird, who has a neutral rating on Dell shares. The company may have to do so to boost its stock performance, since "nobody expects the economy to be a benefit to anyone."

From a cost-cutting perspective, the third quarter will be a tough act to follow. Sales declined 3%, to $15.16 billion, missing analysts' consensus expectation for $16.22 billion in sales. Net income fell 5%, to $727 million. But operating expenses fell 11%, and operating income rose 22%, the biggest gain in two-and-a-half years. Dell's consumer PC business, which it's counting on for future growth, posted an operating profit of $112 million, more than the last six quarters combined, according to Baird's Noland.

During a conference call with analysts, CEO Michael Dell said the company would continue to emphasize profit over market share. "Given the choice between profits and growth, we're going to go for the profits," he said. That's in large part because of "deteriorating demand" for tech products, Chief Financial Officer Brian Gladden added. "We had a stronger August than we had September or October," he told analysts. Cutting costs "is the one lever we can control."