November 11, 2004 4:52 PM PST

Component prices play key role in Dell earnings

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A decline in component prices translated to a boon for Dell's third-quarter earnings.

The PC maker on Thursday posted double-digit third-quarter revenue and profit increases thanks to higher gross margins and unit shipments that jumped 22 percent since the same period a year ago. Overall, the company sold about 8 million desktops, notebooks and servers during the quarter.

Dell posted a 33 cent per share profit on revenue of $12.5 billion for the fiscal quarter, which ended Oct. 29, matching Wall Street analysts' expectations, according to Thomson FirstCall.

Round Rock, Texas-based Dell also reaffirmed analysts' expectations for its fourth quarter, which ends in January. The company forecast a profit of 36 cents a share and revenue of $13.5 billion for the quarter. If Dell meets or exceeds those goals, it will pull in nearly $50 billion in revenue during its fiscal 2005, allowing it to reach its goal of $60 billion in annual revenue a year early, executives said.

PC components such as RAM, hard drives and LCD screens played a starring role in the revenue boost, analysts and Dell executives said.

Normally, component prices decrease at a steady, predictable rate. However, price drops on critical parts like RAM can slow down or sometimes reverse and begin creeping up when demand for computers is high. That was the case during the first half of the year, Dell said, but the third quarter saw component prices begin to drop again. Thus, with prices for parts like LCD screens and RAM on the decline again in the third quarter, the company could offer more aggressive prices, especially on notebooks, to motivate customers. Dell's notebook unit shipments rose by 35 percent during the quarter, the company said.

Although the quarter started fairly slowly for Dell, "the component environment has gotten more favorable for us for this quarter and for the fourth quarter as well," Kevin Rollins, Dell's CEO, said in a conference call with analysts.

Dell, which generally steers away from selling desktops for less than $400 and notebooks for less than about $800, at times took an aggressive approach during the quarter. For example, it offered a one-day, $750 rebate on notebooks priced at $1,500 or more in October.

"I think the interesting thing to point out is that (Dell's) gross margin popped up to 18.5 (percent)" from 18.2 percent during the quarter, said Brooks Gray, an analyst with Technology Business Research. "What that tells is us is Dell has been able to price its products more aggressively than the competition and take advantage of component cost declines, but still absorb some of those cost reductions to boost its profitability."

Indeed, because Dell basically buys only what it needs to build the PCs customers have already ordered--it typically keeps only a few days of inventory on hand--it's able to pass on price reductions more quickly. The low inventory can potentially hurt Dell when component costs rise. But even then, the company can help even out prices by decreasing the amount of RAM or the screen sizes it offers in its standard desktop and notebook PCs.

"The component cost environment has shifted back in Dell's favor after the industry experienced some increases across the first half of the year," Gray said. "I believe Dell will continue to be extremely aggressive on price. My expectation is Dell's management will want to capitalize on the (component cost) trend as much as possible and acquire market share from its No. 1 competitor, Hewlett-Packard."

Even if one type of part increases in price, the entire "basket"--as Dell executives refer to a collection of parts needed to build a PC--should continue to fall. RAM price declines might smooth out in the fourth quarter, analysts have said. If that happens, declining hard drive prices will more than offset it, Jim Schneider, Dell's CFO, said during the conference call.

Although falling component prices would also benefit Dell rivals such as HP, Dell has yet to see any broad-based moves by competitors to lower prices, Rollins said.

"We have not seen a fundamental change at all in pricing behavior by our competitors," he said.

Thus Dell, which is already tantalizing consumers with special offers and discounts for the holidays--it's currently offering 25 percent price reductions on some desktops and notebooks--expects to deliver steady gains during its fourth quarter.

Business buying has also been stronger, a trend Dell expects will continue, Rollins said.

 

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