November 18, 2010 / 9:22 PM / in 7 years

Dell's margins blow by Street as shares climb

SAN FRANCISCO (Reuters) - Dell Inc raised its yearly income forecast after third-quarter margins and earnings smashed expectations, helped by sliding costs of PC components and propelling its shares 6 percent higher.

The personal computer maker, which vies with Acer Inc for the No. 2 spot in the global PC market, expects stable demand from government and corporate customers and favorable component prices this current quarter.

Analysts pointed to a big beat on Dell’s closely watched gross margin number: about 20 percent in the third quarter on a non-GAAP basis versus expectations of 17.5 percent.

“Gross margins jumps out at you from what we’ve seen so far. That’s a level we haven’t seen for a long time from this firm,” said Morningstar analyst Michael Holt.

“That’s a dramatic rise there, which leads us to infer the corporate refresh cycle has been very beneficial for them.”

The PC maker, which benefited from falling prices for components such as hard drives and screens, also credited its resistance to joining an industry price war -- waged by the likes of Acer -- for shoring up margins.

“We see stable and good commercial demand for the business, and the component environment, we expect that to continue, and as a result, we think we should have a pretty solid fourth quarter,” CFO Brian Gladden told Reuters in a phone interview.

Gladden also waved off fears that government budget cuts would eat into its business. Dell exposure to weakening government spending was a major question mark following a warning by Cisco Systems last week about weak public-sector spending.

The share price rally following the earnings report reversed a 6 percent loss in Dell’s shares since Cisco’s warning last Wednesday. Dell’s shares were halted after-hours before rising 6.2 percent to $14.51 from their close of $13.67 on Nasdaq.

IN TURNAROUND

Dell’s turnaround effort has proceeded in fits and starts over the past few years, frustrating investors. The company has used M&A to try to diversify its portfolio, but it remains heavily reliant on sales of low margin PCs, which still make up half of its sales.

The company’s top line has benefited as corporations spend to upgrade aging IT hardware, but Dell has been challenged to translate sales growth into improved profitability.

Dell now expects full-year revenue to track toward the mid-point of the 14 percent to 19 percent growth range set earlier this year. However, revenue in the fiscal third quarter came in below analysts’ average forecast.

It expects non-GAAP operating income should grow between 28 and 32 percent, above an earlier forecast.

“Gross margin is obviously the key headline here at 20 percent, obviously well above the Street,” said Stifel Nicolaus analyst Aaron Rakers. “Leverage in the model is going to be key as people gauge the sustainability of what was a very strong gross margin number.”

Dell consequently beat earnings forecasts by a wide margin. It reported net earnings for the quarter ended October 29 of $822 million, or 42 cents a share, up from $337 million, or 17 cents a share, in the year-ago period.

Excluding items, Dell earned 45 cents a share, better than the average analyst estimate of 32 cents a share, according to Thomson Reuters I/B/E/S.

But revenue rose 19 percent to $15.4 billion, below Wall Street’s estimate of $15.76 billion.

Shares of Round Rock, Texas-based Dell had gained 2.4 percent in the regular session.

Editing by Edwin Chan, Gary Hill

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