Dell Q4 Earnings Call Transcript

123jump.com Staff
27 Apr, 2009
New York City

The personal computer maker revenue tumbled 16% to $13.4 billion in the quarter. Net quarterly income plunged 48% to $351 million. Earnings per share slumped to 18 cents from 31 cents a year-ago quarter. The company earned revenue of $61.1 billion for fiscal year 2009.

Dell, Inc. ((DELL))
Q4 2009 Earnings Call Transcript
February 26, 2009 5:00 p.m. ET

Executives

Lynn A. Tyson - Vice President of Investor Relations
Michael S. Dell – Chairman & Chief Executive Officer
Brian T. Gladden – Senior Vice President & Chief Financial Officer

Analysts

Richard Gardner – Citigroup
Kathryn Huberty – Morgan Stanley
Tony Sacconaghi - Sanford C. Bernstein & Co.
Bill Shope – Credit Suisse
Keith Bachman – Bank of Montreal
Benjamin Reitzes – Barclays Capital
Mark Moskowitz - JPMorgan
Chris Whitmore – Deutsche Bank
Shannon Cross – Cross Research
David Wong – Wachovia Capital Markets
Maynard Um – UBS
Jayson Noland – Robert W. Baird & Co.
Scott Craig – Bank of America/Merrill Lynch
Bill Fearnley, Jr. - FTN Equity Capital
Andy Hargreaves – Pacific Crest Securities

Presentation

Operator

Good afternoon and welcome to the Dell, Inc. fourth quarter fiscal year 2009 earnings conference call. I’d like to inform all participants 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 “*” then “1” on your telephone keypad at any time during the presentation. I’d like to turn the call over to Ms. Lynn A. Tyson, Vice President of Investor Relations. Ms. Tyson, you may begin.

Lynn A. Tyson

Thank you. With me today are Chairman and CEO, Michael Dell, and Senior Vice President and CFO, Brian Gladden. Brian will review our fourth quarter results, our ongoing initiatives to improve our competitive position and our working capital management activities. Michael will follow with his perspectives on strategy, particularly as it relates to the current IT spending environment.

To get additional insights on our results this quarter, please watch the Vlog interview with Brian Gladden hosted by Rob Williams, Director of Investor Relations. We posted it on our Dell Shares blog right after we posted earnings this afternoon. Also, we continue to refine the earnings web deck that accompanies this call to better address your questions. And so I encourage you to read it in detail.

All growth comparisons made on this call are year over year unless otherwise stated. Our IR activities begin this year with Brian at Morgan Stanley next week, and a Vlog covering global operations with Jeff Clarke, Vice Chairman, Operations and Technology.

Finally, I’d 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 SEC filings and in the cautionary statement contained in our press release and on our website.

With that I’ll turn it over to Brian.

Brian T. Gladden

Thanks Lynn. We started fiscal year 2009 with clear and simple operating priorities focused on five growth initiatives and a plan to capture $3 billion of cost opportunities by the end of fiscal year 2011. While we did call out a year ago that we were seeing signs of spending conservatism, we saw a good start to the year before customers began to defer their IT purchases in the second half of the year. Against this backdrop we focused our efforts on elements of our business and strategy we could control, delivering great technology, service, and value to our customers, progressing towards an industry leading cost position, and driving disciplined working capital management. Full year and fourth quarter financial results demonstrate the progress we made on several of these initiatives during the year. We’ll be the first to admit that this is a work in process and there is more to do.

In my comments I’m going to focus my attention on the current environment, but you’ll find a review of our full-year performance on page five and page 25 in the supplemental section of our web deck.

So let’s take a look at the P&L for the fourth quarter, which you’ll find on page six of the web deck. Revenue was down 16% to $13.4 billion as we saw a continued weak demand environment. As we announced earlier we absorbed $277 million or $0.11 after tax of expenses which were comprised of $134 million in organizational effectiveness costs and $143 million related to incremental stock-based compensation. The majority of these organizational effectiveness expenses are classified as cost of goods sold while the stock-based compensation is primarily in SG&A.

Gross margins have been relatively stable for the past several quarters and if you exclude the impact of the organizational effectiveness expenses and stock comp, gross margin rates were again above 18% for the quarter.

To help you better understand our OpEx progress, we absorbed $92 million in costs in the fourth quarter of last year and $152 million in the fourth quarter of this year related to the combination of organizational effectiveness, incremental stock comp costs, and the write-off of in-process R&D. These items masked the progress we’ve made in our underlying OpEx run rate. Adjusting for these items, OpEx was down $423 million in the quarter or 20% year over year. This progress in OpEx puts us in a much stronger competitive position as we enter fiscal year 2010.

Our tax rate for the full year was 25.4% which resulted in a 22.6% for fourth quarter. This is driven by lower profits in the US and a mix shift to notebooks. Taking all this into account, our reported GAAP EPS for the quarter was $0.18. We had a good quarter of execution in managing our working capital in a challenging environment. We generated $729 million in cash flow from operations with improvements in both inventory days and receivables, offset by a two-day decline in payables.

Our cash conversion cycle remains stable at a negative 25 days in the quarter. For the full year cash flow from operations was $1.9 billion. We continue to believe that over time we can generate cash flow from operations in excess of net income. Turning to liquidity and capital allocation on page nine and 10 of the deck, given the ongoing uncertainty in the credit markets and despite an increasingly attractive valuation we chose to forego share repurchases and conserve cash in the quarter.

We ended the quarter and the year with $9.5 billion in cash and investments. We continue to have access to traditional short-term and long-term funding vehicles, including a commercial paper facility of $1.5 billion of which $100 million was outstanding at the end of the quarter. As a reminder we filed a debt shelf registration early in the fourth quarter which we can use to augment our liquidity position.

At Lynn mentioned in a recent blog post, we’ve been getting a few questions on Dell Financial Services and again included additional detail on page 11 of the web deck. We saw a slight decline in our penetration rates year over year consistent with the credit tightening actions we’ve taken over the past 18 months. We’re closely monitoring the credit markets and continue to adjust our loss reserves to reflect the realities of the current economic situation. We’re also looking for opportunities to lower our cost of funding for DFS including bringing some of the funding onto our own balance sheet. Overall, we continue to be very comfortable with the profit contribution and returns we see in this business now and into the future.

I’d like to talk a bit about cost, and the status of our cost initiatives which have been a big focus for us and are clearly one of the areas where we can actually control the results in this environment. We see real opportunities to differentiate ourselves here and continue to make this a top operating priority. We can and we will continue to rapidly adjust our cost structure in an environment of slowing demand. In COGS, we have made progress on design to value and in making our manufacturing and supply chain costs more variable.

Nearly 40% of business client and over 40% of our consumer platforms by volume are now redesigned and cost optimized. In aggregate, we’ve reduced our average cost per box by 5%. I should point out that we’re still early in this process and expect more benefits here. As we expand our global manufacturing and logistics footprint approximately a quarter of our volume is now going through contract manufacturers. Progress here has provided a good buffer to declining volumes late in the year as we’ve been able to use these savings to remain competitive and deliver stable gross margins.

In OpEx fiscal year 2009 results show clear progress with adjusted OpEx down 6% for the full year and 20% in the fourth quarter, 400 basis points ahead of our revenue decline. Our progress here has accelerated over the course of the year and it involves reductions in all buckets of cost. We have engaged the whole company in our efforts on cost and we’re encouraged by our progress. As our teams have worked through these key COGS and OpEx initiatives we’ve identified an additional $1 billion in cost opportunities that we’re confident we can realize by the end of fiscal year 2011. Related to these further cost actions we’re today announcing that we expect to absorb organizational effectiveness expenses in the first quarter at a similar level to what we recognized in the fourth quarter as we further align our business to improve competitiveness.

Our goal continues to be to drive a balance of liquidity, profitability, and growth and optimize cash returns regardless of the macroeconomic cycle and our cost initiatives are a big part of that.

Now let me briefly turn to the performance of our business segments which you’ll find more details on in the supplemental section of the web deck.

We had strong unit growth in our global consumer business with unit volume up 18% and revenues down by 7%. Total year operating income for the global consumer business improved significantly to $143 million and 1.2% of revenue. We continue to build out our retail footprint in the consumer space and now have over 24,000 outlets on a global basis.

On the commercial side we were again disciplined in our execution. There were a few areas where we were able to drive growth but many regions and vertical segments were challenged by the economic environment and we worked to optimize margins. Our Americas commercial revenue declined 17%, operating profit actually increased from a year ago period by 160 basis points as we continued to exercise pricing discipline in this area and benefited from our strong cost management.

EMEA commercial revenue was down 17% as well, while operating margin as a percentage of revenue improved 90 basis points sequentially as enterprise revenue accounted for a larger portion of our total mix. The EMEA commercial business also took additional operating expense out of the business.

APJ commercial revenue was down 24% year over year as we saw a significant slowdown in the Pan-Asian economy. Specifically, we saw a pretty dramatic slowdown in both China and India. We saw a decline in China revenue while India though slower, still experienced mid single-digit revenue growth. Our total revenue from BRIC countries was down 23% from a year-ago period. BRIC countries in total made up over 7% of revenue while revenue outside the US was 48% of our total mix.

Moving briefly to a few key product highlights, in the client space mobility units were flat and revenue was down 17% due to the soft demand environment globally. Desktop units were down 21% with revenue declining 27%. On enterprise products and services, server revenue was down 16% on an 18% decline in units. We experienced strong double-digit unit and revenue growth in blades, four-socket rack servers, and our cloud computing initiatives.

Our x86 server share grew slightly in the quarter and we retained our number two position in the world. Storage had a relatively good quarter with revenue up 7% driven by strong growth in our PowerVault disk and EqualLogic iSCSI network storage solutions which were again up over 100%. Enhanced services revenue declined by 3% to $1.4 billion, however, our support services which deliver customizable support solutions for end users and IT professionals in Dell and non-Dell environments did extremely well.

Our deferred revenue balance grew 7% to $5.6 billion in the quarter. Software and peripherals revenue declined 6% with strong double-digit growth in software sales.

Now let me spend a moment on our newly announced segment structure. At the end of December we announced our intent during fiscal year 2010 to migrate our regional commercial segment to four global business units to better align our capabilities with our changing customer base. After this realignment is complete our operating structure will consist of the following four segments, global large enterprise, global public, global small and medium business, and global consumer. We plan on showing results in this new segment structure in the first half of fiscal year 2010.

Before I turn it over to Michael, let me leave you with some key points on the quarter and our views on demand.

As we’ve said in the past one of the real benefits of our direct customer relationships is that we’re able to see the demand signal earlier than any other company. We saw a shift to conservatism in IT spending early in 2008 and updated you through the year on the demand trends we were seeing. We experienced a significant deterioration in demand in our third quarter and while the fourth quarter was more linear than the third, the trend we saw late in Q4 and early in our first quarter is still negative as customers continue to defer purchases.

We cannot predict how deep or long this slowdown will be though we’re planning on it to be protracted. We will continue to focus on what we can control, which is satisfying our customers and rapidly adjusting our cost structure to the realities of industry demand. We will selectively take advantage of growth opportunities and make investments in areas that allow us to recognize lasting competitive advantages. We believe that our new global organization is better aligned with our customers and this will enhance our ability to act on their needs with even greater speed and efficiency.

We’ve identified an additional $1 billion in cost savings to be recognized by the end of fiscal year 2011. Our teams are aggressively executing on programs to capture these benefits as soon as possible. These new and incremental cost programs combined with our previously announced $3 billion opportunity in COGS and OpEx will put us in a stronger competitive position as we move through this year.

As I said in our first quarter we now expect to absorb organizational effectiveness expenses at a similar level to the fourth quarter as we further align our business to improve competitiveness. In summary, we will continue to execute on initiatives that diversify our revenue base and product portfolio and we’ll aggressively drive broad cost reduction initiatives which over time will yield improved liquidity, profitability, and growth.

With that, I’ll turn it over to Michael.

Michael S. Dell

Thank you, Brian. In the past 16 months we’ve improved our competitiveness with our $3 and now $4 billion cost initiative delivering strong growth in emerging countries and global consumer. We broadened our product portfolio launching new enterprise blades and Latitude E-Series Notebooks for commercial customers, and Inspiron Netbooks and Studio Hybrid desktops and notebooks for consumers.

We have expanded our services business with new offerings in enterprise solutions and remote infrastructure management. And we’ve introduced Dell to more people in more places than ever before expanding our consumer business to over 24,000 retail outlets. Through the first half of last year we delivered 10% revenue growth on 20% unit growth. As customers deferred purchases we quickly adapted by accelerating operating cost initiatives and focusing on cash flow and profitability over growth.

For the full year we achieved strong margins with 18% gross and 5.2% operating margin or 6% operating margin net of the OE and equity compensation issues that Brian mentioned earlier. We grew faster than the industry selectively gaining share with 34% unit growth in BRIC and 35% unit growth in global consumer. And we announced the next phase of our transformation, to global businesses that are organized around customers, organizations that allow us to best serve our customers’ needs and take advantage of the opportunities we see. Our strategy is to deliver disruptive technology and innovation and shift our business to higher margin products and services. Providing disruptively great value to customers and partners through a direct relationship is really about making IT simpler and more productive. And now more than ever, organizations are thinking about the total cost of operating and owning IT.

We want to deliver the power of the cloud and the Internet leveraging Dell.com and the persistent and unique connections that we have with our customers. We want to drive price performance and feature leadership across all of our businesses by creating efficient solutions that just work. And we want to get a larger share of the profit streams embedded in our growing installed base of hundreds of millions of products that we deliver, opportunities like search services, 3G originations, and other telecom opportunities. As we deliver more solutions for our customers these opportunities present themselves.

The second part of the strategy is to shift our solutions portfolio to higher margin solutions and reoccurring revenue streams like those found in servers, storage, services, and software that deliver on the first tenet of our strategy. We are driving the attachment of services onto our existing product platforms and expanding our capabilities further. Customers are very focused on outcomes. So pushing deeper into enterprise solutions is another key focus for us.

We’re going to add more capability and as we do this we find we’re involved really at the right level with these customers and enjoy more success. Finally software represents another opportunity for us to shift the portfolio. You’ve also seen us do more with customization and personalization, and we’ll take this further. Dell is a company that really drove the cost of hardware down over the last 25 years. But for every dollar that’s spent on hardware there’s $3 to $4 spent on everything else and that’s exactly where we’re heading for our future opportunities.

Let’s stop there, and we’ll open it up for questions.

Question-and-Answer Session

Lynn A. Tyson

Operator?

Operator

Ladies and gentlemen, we will now begin the question-and-answer portion of today’s call. If you have a question, please press “*1” on your telephone keypad. You will be announced prior to asking your question. If you would like to withdraw your question, press the “#” key. One moment, please, for the first question.

Our first question comes from Richard Gardner with Citigroup.

Richard Gardner – Citigroup

Hi, thanks very much. Brian, first you made a comment on linearity in the quarter and you said this quarter was more linear than last, which is a little bit different than what we’re hearing from companies like Cisco and HP, so I was hoping that maybe you could elaborate a little more on what you saw throughout the quarter and give a sense of how dramatic any falloff that you saw in January and early February might have been.

And then the second question is how should we think about how quickly you can take out costs? You’ve done a great job with cost and discretionary spending, but what is the goal here? Is it to try to maintain operating margins in the 5.5% range, even if we see a 15% to 20% decline in revenue for the full year? How should we think about that?

Michael S. Dell

Richard, this is Michael. I’m going to take the first part of your question and Brian will take the second. I think what this really speaks to is the purity of the demand signal that we have and what I would tell you is that we did not see a dramatically volatile demand signal. We saw changes in the demand week to week but when I look at the results and some of the statements from other participants in the industry at various levels in the supply chain they are quite a bit different from what we see in the end user, end customer demand on a day-to-day basis.

So I think here again having this contact with customers on a regular basis gives us a great opportunity to tune the business appropriately and we feel good about that.

Brian T. Gladden

Yes, Richard. On the cost question, the way we’re running the business right now given this environment is really we have multiple scenarios that we’re looking at around where the demand might be and what revenue looks like. And we’ve got a series of cost actions that we’re obviously working towards. Obviously we have the confidence that we can do more than we’ve already talked about and that’s - we’ll adjust the pace and our efforts around cost given what we see from the demand environment. So, I think there’s more there for us and I think we’ve shown we’ve got some good momentum there.

Richard Gardner – Citigroup

Okay. Well, thank you.

Operator

Our next question comes from Katie Huberty with Morgan Stanley.

Kathryn Huberty – Morgan Stanley

Thanks, good evening. Just two questions to follow-up on the cost reduction goals. First, on the $4 billion which is $1 billion incremental versus the prior plan, does that address the risk that the rate of demand deceleration will continue in this fiscal year or does it only consider the revenue trends you saw through January and then, secondly, I believe you’re now at about $1.5 billion annual run rate in terms of savings where might you be by the end of fiscal ’10.

Brian T. Gladden

Well, Katie, I think in terms of run rate I think if you look at OpEx it’s very simple to find where we are and if you look year over year for the fourth quarter and adjust for some of the items we talked about, it’s about $1.5 billion of run rate there in OpEx alone. So, the opportunity for us is to continue to drive both OpEx but clearly COGS, we still have a lot more opportunity. That’s the, one of the charts in the web deck lays out the progress we made on those initiatives and I would just tell you that we’re early in that process and as we continue to execute on the COGS efforts there you’ll see combined cost efforts that improve the OpInc for the business.

So, in terms of whether it’s enough to keep up with the demand, it’s hard to say what the demand is. We have multiple cases there that we’re managing to and as we see that play out we’ll adjust as quick as we can.

Kathryn Huberty – Morgan Stanley

Thanks.

Operator

Our next question comes from Tony Sacconaghi with Sanford Bernstein.

Tony Sacconaghi - Sanford C. Bernstein & Co.

Thank you. I just wanted to follow-up on that, Brian. You had mentioned that you had various planning scenarios for the current fiscal year. I guess the question is what is embedded in terms of the incremental $1 billion in cost reduction over the next two years. What is the base case planning assumption that you are setting that incremental $1 billion cost? Is it a level of year over year revenue decline consistent with what we saw this quarter or it is something better or worse than that?

Brian T. Gladden

I think, Tony, the simple way to answer that is we’re planning on a continuation of the environment we see today and that’s sort of what we’ve got ourselves comfortable with but I would also tell you we’ve got other scenarios that are worse than that and some that are better than that that have different operating agendas tied to them

Tony Sacconaghi - Sanford C. Bernstein & Co.

And if we think about that incremental $1 billion in cost opportunity, can you help us understand what the nature of those opportunities are. On page 17 in your slide deck you say reduce OpEx and headcount “as a fiscal year 2010 opportunity.” You also commented that you’re going to absorb more charges in Q1 so should we be thinking that a significant portion of the incremental $1 billion in opportunity is headcount, and I think my analysis would say if you assume the whole thing it would be 12% to 15% of your workforce. Can you comment on that please?

Brian T. Gladden

Yes. Tony, not going to comment on specific headcount impacts, but I can tell you that it’s a broad set of initiatives that cover really every bucket of cost and simplifying and streamlining the organization is part of that, but clearly there’s a lot of other costs to go after and as I said, I think COGS and product costs are clearly one of the bigger opportunities for us.

Tony Sacconaghi - Sanford C. Bernstein & Co.

And then finally on the product cost side, it sounds like you have made pretty good progress, I think you said about 40% of your units have average COGS down 5%, if you just did that math and you said all else being equal that would lead to about a two point boost in gross margin, certainly didn’t seem like you saw that this quarter, obviously you had volume effects to contend with, but when do we start to see that impact in terms of pushing up against your or helping gross margins go up if you’re part of the way through and should be gaining more and more each quarter, when will we and why won’t we see an improvement in gross margins going forward.

Brian T. Gladden

I think it fully depends on demand for a couple of reasons. Clearly, there’s a need to get units through the system at the new cost so the more we ship as we grow the costs go down. And we get to enjoy the benefits of those redesigns and relaunched products. I think more broadly when you think about demand and the mix environment that we see today, this cost reduction activity we’ve been through on the COGS line has given us some flexibility and a bit of a buffer to effectively manage our top line and how we play in certain markets.

So I think depending upon how the market demand plays out, Tony, you could start to see some of that and if not, we’ll use it to continue to be competitive and play in the marketplace.

Tony Sacconaghi - Sanford C. Bernstein & Co.

Thank you.

Operator

Our next question comes from the line of Bill Shope with Credit Suisse. Please go ahead.

Bill Shope – Credit Suisse

Looking at your gross margins, obviously I think they demonstrated your increasing focus on profit preservation versus pricing for growth. There’s been some movements back and forth here looking at the past few quarters. Can you give us a sense of how this message of profit preservation is being pushed throughout the organization? Were there material changes in the sales compensation structure, that of middle management and I guess looking forward would you characterize this as a relatively permanent way Dell will focus on the business.

Michael S. Dell

I think we’ve been pretty consistent here for several quarters and we’re not changing our approach. You’re right that there is a focus in terms of compensation plans, on gross margins and on mix particularly to drive mix shift further into servers, storage and services, which we saw kind of throughout the year and even if you look in the fourth quarter with a heavier consumer component, typically we had a healthy mix of those higher margin products.

Bill Shope – Credit Suisse

I guess just to follow-up on that, Michael, before this quarter if I looked at the July quarter versus the October clearly in the July quarter you said you had priced a little more aggressively than your cost allowed, or your cost savings allowed, and then you showed a nice improvement in the October quarter so what I’m trying to figure out here is sort of what is the forward plan particularly in this economic environment. Is what we saw this quarter the focus on gross margin preservation in particular? Is that really the marching orders you pushed through the organization going forward?

Michael S. Dell

Well, first of all I think the way we’re running the business is around operating income and cash flow and in this kind of demand environment really the focus should be around solutions and things that differentiate the product and the traction that we’re having with customers is in, I’m talking about virtualization and managed services and those kinds of things, not trying to drive a price message.

Bill Shope – Credit Suisse

Okay, great. Thank you.

Operator

Our next question comes from Keith Bachman with Bank of Montreal.

Keith Bachman – Bank of Montreal

Two questions, if I could. Brian, the first one on cash flow. Could you talk about how you see the cash cycle days unfolding over the next couple of quarters? Does it stay at these levels at the negative 25 type of days and related to that the CapEx was down to under $40 million, is that kind of the right CapEx run rate, if you could just talk about cash flow and then I will follow up, please. Thanks.

Brian T. Gladden

I think in terms of CapEx I think we’ve done a nice job taking CapEx out of the business and year over year I think you’d see a pretty dramatic reduction. I think you’ll see, if you take the total year spend for this year, I think that’s a reasonable assumption for next year, maybe slightly below that. And I think that’s how I’d think about it. In terms of the cash conversion cycle, we’ve been pretty consistent that we think we can get back to even a minus 30 and that’s the sort of target that we’re aligned around.

I think the current environment with the revenue declines and how that plays out on our working capital it makes it challenging and I think we’ll continue to work to try and get back towards 30 and in a more normal revenue environment I think we’d be back there. So, that’s how I’d play that assumption.

Keith Bachman – Bank of Montreal

Okay, thanks. And then my follow-up question, Brian, for you as well. You mentioned a few different times that you’re still working on the BOM to get the cost of the units down, given what you’re seeing so far in February. Is it reasonable to assume that gross margin stays roughly at these levels even against what you’re seeing roughly in the April quarter?

Brian T. Gladden

That’s what we’re working towards but it’s about OpInc for us and if we have all of these cost initiatives are aligned around driving towards an OpInc answer for the business and that’s how we’re driving the teams.

Keith Bachman – Bank of Montreal

Okay. Thank you, guys.

Operator

Our next question comes from Ben Reitzes with Barclays Capital.

Benjamin Reitzes – Barclays Capital

Hey, thanks a lot. There was one question I didn’t hear, so hopefully this wasn’t asked, but did you accrue a bonus in the quarter and if so, how much was it or if you didn’t how much did it help costs? And then what are your plans for bonus accrual for this year and how does that impact the costs on a year-over-year basis? And then I have a follow up.

Brian T. Gladden

Hey Ben. We did accrue a bonus in the period and we plan to have one in fiscal year ’10. That’s it.

Benjamin Reitzes – Barclays Capital

So, it wasn’t a material factor in the OpEx reduction though.

Brian T. Gladden

It was not.

Benjamin Reitzes – Barclays Capital

Okay. And then with regard to cash flow, I was just -- HP also had cash usage from payables and cash generation from AR and that kind of was the result of the linearity of the quarter that got weaker, you had that as well but you said the quarter was more linear. Can you just explain your cash flow dynamics, what’s going on with the payables versus receivables just so we can get more confidence that you generate cash next quarter instead of going back to a usage?

Brian T. Gladden

Yes, Ben, the receivables is purely a function of the volume and the revenue in the business and the timing of that, the linearity of that revenue. As I said we did see deterioration of demand and revenue during the quarter but not to the extent that we saw in the third quarter so it wasn’t as, it didn’t deteriorate as quickly. In payables, as you know, as our COGS levels go down, as OpEx spending goes down, as you also know we took inventory down, all of those things reduce the level of payables in the business and that’s how you see a contraction in the payables performance in the quarter.

So I think when you look forward a lot of it’s really got to be modeled around what you see in terms of revenue and demand. And if you could model that out I think it’s mapped around the rest of the cash performance.

Benjamin Reitzes – Barclays Capital

All right and then just housekeeping. What was currency in the quarter and what tax rate should we use to model you in FY10. Thanks.

Brian T. Gladden

Yes, currency was negligible and tax rate something in the 25, 26 range for next year would be a good assumption.

Benjamin Reitzes – Barclays Capital

Thanks a lot.

Brian T. Gladden

Yes, thanks, Ben.

Operator

Our next question comes from Mark Moskowitz with JPMorgan.

Mark Moskowitz – JPMorgan

Yes, thank you. Good afternoon. Two questions. Brian, can you talk a little more about the gross margin profile in terms of COGS? In one of your slides you talk about 25% of the volume now going through contract manufacturing, how should we think about that bogey for 2010. Is there any sort of hesitancy among the contract manufacturers that take on excess capacity in this type of environment?

Brian T. Gladden

We haven’t seen that and we continue to move more in that direction. I think that will be one of the levers as we look at COGS reductions during the course of the year in this environment and --

Michael S. Dell

That’s absolutely right. We continue to go further in that direction and we wouldn’t be surprised to see that number go up.

Mark Moskowitz – JPMorgan

Okay and then the second question. On the operation margins with respect to consumer you’re having some good uptick there in terms of revenues relative to the other parts of the business, can you talk though about the commensurate or the lack of commensurate boost in your operating margins for that business. Is this a function of just the cost structure or the supply chain not yet optimized for higher volumes?

Brian T. Gladden

For consumer, Mark?

Mark Moskowitz – JPMorgan

Yes.

Brian T. Gladden

I think the dynamics are consistent with what we talked about in the third quarter for consumer. There are multiple sources of revenue and margin in that business. They can be a little bit more lumpy. I think the way to think about profitability there is that we generated a 1.2% OpInc for the year which is a great improvement over where we were the year before. And we continue to track and improve that business and our target is as we’ve said 2% in the short-term and I think we made progress there.

The team has done a great job taking cost out of the consumer business, there’s no question and I think the retail footprint expansion and top line growth in the quarter was pretty good.

Mark Moskowitz – JPMorgan

Thank you.

Operator

Our next question comes from Chris Whitmore with Deutsche Bank.

Chris Whitmore – Deutsche Bank

Thanks very much. I wanted to follow-up on the last question with respect to your existing internal manufacturing. Should we anticipate more plant shutdowns given that you’re increasing your usage of contract manufacturers while unit volumes declined significantly? I would expect there to be meaningful excess capacity within your network.

Michael S. Dell

I think we’ve said that we’re in the midst of a review of our manufacturing capacity and we’ve talked about using additional contract manufacturers as one alternative for us, but haven’t made any decisions that are ready to go yet. We’re continuing to look at it.

Brian T. Gladden

And the end game there could take on several different forms. So when we’re ready to talk about it we’ll announce it.

Chris Whitmore – Deutsche Bank

Do any of the manufacturing partners have the appetite to take on more capacity, more manufacturing capacity at this time?

Michael S. Dell

We haven’t seen any lack of interest in our discussions with contract manufacturers.

Chris Whitmore – Deutsche Bank

Okay, last question for me is around Windows 7, are you seeing any behavior changes from your enterprise customers as it relates to Windows 7? Is that creating incremental deferrals of purchasing in your estimations?

Michael S. Dell

Well, I don’t know how much of this you’ve heard but we’re starting to get pretty excited about Windows 7 and believe it’s going to be an important catalyst for growth. Now having said that it will also push purchases until Windows 7 comes out so the discussions that we’re having with the larger customers are all around making sure that they’re kind of ready for Windows 7 and waiting for Windows 7 and investment protection kinds of things in the -- in any devices they might install this year.

Chris Whitmore – Deutsche Bank

Thanks a lot.

Operator

Our next question is from Shannon Cross with Cross Research.

Shannon Cross – Cross Research

Yes, thank you. A question with regard to your balance sheet, Brian, if you could talk a bit about how you expect it to trend. You’ve talked about working capital but I’m also curious on inventories and I’m also curious as to how you’re looking at your debt balance or your ability to raise debt, CP versus the asset-backed securities market. You obviously have your debt shelf. Just you know as we assume most of your cash is offshore, how should we think about how all these pieces will play together in fiscal 2010.

Brian T. Gladden

Yes, I would say Shannon, clearly a priority to maintain and manage our liquidity for us right now. I think as you said we do have the debt shelf out there. We have access to commercial paper and those seem to be viable alternatives and we’ll be opportunistic there where it makes sense but I also think we do have opportunity to improve our working capital performance including inventory levels and we made some progress in the quarter taking out almost $200 million of inventory. I think there’s more there.

We’ll continue to work on working capital as one way to shore up the balance sheet in this cycle.

Shannon Cross – Cross Research

Should we look at finance receivables to continue to be a use of increasing use of cash during the year?

Brian T. Gladden

I think so, as we look at the DFS business and how we feel about the growth there and what that enables for us in the rest of our business, it’s just a cost of capital decision in terms of how we fund those activities in DFS and t o the extent that it’s a better answer for us to put that on book versus use other vehicles, then that’s what we’ll do and I think that’s what you saw in the quarter.

Shannon Cross – Cross Research

Okay, great. And then just one quick question for Michael. All right, nobody has asked has asked the Netbooks question yet, so I’m curious as to how you’re seeing the Netbooks market trend, concerns on ASP, just any color you want to give us there. Thanks.

Michael S. Dell

We see the Netbook for us with a relatively low share in consumer as part of the consumer opportunity but I continue to believe it’s mostly incremental and even more so given our share in consumer. We’re continuing to expand the offering. We’ve been particularly focused on 3G and agreements with carriers embedding 3G, using our own sales engines as well, to sell 3G Netbooks and obviously broadening the range of products starting with 9, 12, and now 10 inch.

Shannon Cross – Cross Research

Great. Thank you.

Operator

Our next question is from David Wong with Wachovia.

David Wong – Wachovia Capital Markets

Thank you very much. Can you give us the approximate cash conversion cycle of product that goes through contract manufacturing?

Brian T. Gladden

It’s about the same as what we have for the rest of business. There’s not a whole lot of difference there given how we’ve structured those arrangements.

David Wong – Wachovia Capital Markets

Great. The other thing is you mentioned investment protection needed, some customers thinking about investment protection in anticipation of Windows 7, are there specific hardware characteristics you need to build into your products to make things Windows 7 compatible.

Michael S. Dell

Well, they’re thinking about all the features in Windows 7 and anticipating which of those they might use and ensuring that products are supported around those. We have aggressive plans in this area and I think as you see our products roll out over the course of the year, it’s fair to say they’re all Windows 7 ready and we’re kind of all over this being the leading provider to larger organizations. We know a lot about selling into an investment protection mindset.

David Wong – Wachovia Capital Markets

Right. Thanks.

Operator

Our next question is from Maynard Um with UBS.

Maynard Um – UBS

If I can ask the gross margin question a little differently, it obviously looks like the mix, mix was the biggest help to gross margins in the quarter and if I’m doing the math correctly it looks like your desktop, mobility, and S&P gross margins are down to around 11% from around 14% at the beginning of fiscal 2008, with some of the actions that you’re taking on improving COGS do you think we’re bottoming at these levels and I’m more particularly focused on these three segments so not taking into account mix.

Brian T. Gladden

I don’t know that, it’s really hard to tell what future gross margin dynamics are going to be. I think really tied to the demand environment and the competitive environment. Again, as I said we’re doing everything we can to get cost out of the box and get our overall costs out so we can actually be competitive no matter what happens. I think I wouldn’t get into commenting on the specific product lines and what we’re doing there, but we’re focused on cost programs in all of them.

Maynard Um – UBS

Okay and then related to the Netbook channel with wireless operators, what percentage of your mobility units do you think you can move through that channel over time and do you actually get any kickbacks from operators if a customer signs up for a wireless plan.

Brian T. Gladden

It’s a pretty small percentage today. Certainly we’re very focused on 3G originations and how the inclusion of 3G radios in our products increasingly and positively affects the economics.

Maynard Um – UBS

And then just last one for me. Can you just talk about levels of inventory in the indirect channel? Thank you.

Brian T. Gladden

We don’t have inventory in the indirect channel, that’s really all we can comment on.

Maynard Um – UBS

Okay. Thank you.

Michael S. Dell

Well, just to be clear, we do have some retail inventory. Our channel partners tend to have very, very little inventory. Most of them pass through inventory directly from our factories and contract manufacturer factories directly to the end point of use so any, the inventory we would have in the channel, we’ve been monitoring, measuring that very, very carefully to avoid the inherent risks that present themselves there and I think we’re doing a fine job there.

Operator

Our next question comes from Jayson Noland with Robert Baird.

Jayson Noland – Robert W. Baird & Co.

Thank you. Michael, you were talking about shifting the portfolio. I guess could you comment on the pace at which we could expect a shift and then organic development versus inorganic.

Michael S. Dell

Well, the shift is the big focus particularly as we organize the new commercial businesses, in terms of the large enterprise, public and SMB. We’ve created a number of new offerings; new capabilities will be created organically, some with partnerships and acquisitions as well. We continue to make small acquisitions and we’ll certainly look for additional ones.

Jayson Noland – Robert W. Baird & Co.

Thank you.

Operator

Our next question is from Scott Craig with Bank of America.

Scott Craig – Bank of America/Merrill Lynch

Thanks. Good afternoon. On the financing business it looks like the loss reserves are up to around 10% now. Brian, did we see that stabilize at all during the quarter or was it still kind of trending worse as we exited the quarter and we enter into the month of February and then secondly, on the retail business I think you mentioned around 24,000 points of purchase now. Is there a goal for that as you work into this fiscal year where you want to be at some point? Thanks.

Brian T. Gladden

On the financing receivables, or the losses in the financing portfolio it’s, I guess as we plan out the year and we look forward we would expect that to probably continue to be tough. I won’t comment on the trend during the quarter but we look at it constantly. We’ve taken significant actions to tighten credit down. We’ve done some pricing actions and other fee actions to mitigate some of these higher losses but we feel very comfortable with where we are in terms of the reserve for losses. We took it up in the quarter and we’ll continue to watch that as we go forward.

In terms of retail, we don’t have a goal as to where we end up there in terms of number of retail outlets. We’re methodically adding what we believe are the best and strongest retailers in the world. There are a number of retailers who are pretty upset with us right now because we haven’t offered our products through them, but I think it’s fair to say that the number of potential outlets is a couple of multiples greater than the current number.

Scott Craig – Bank of America/Merrill Lynch

Thanks.

Operator

Our next question is from Bill Fearnley with FTN Equity Capital.

Bill Fearnley, Jr. - FTN Equity Capital

Yes, thanks. Brian, if I could go to the component costs. Can you give the gives and takes during the quarter? You mentioned that you’re seeing a more normal environment year. What did you see in the previous quarter and what are you seeing near-term on components and the effect of gross margins? And I have a quick follow up.

Brian T. Gladden

I would say our point was I think in the fourth quarter it was more a historical normal component environment. I think it was a little bit better in the third quarter. We saw more component deflation in the third quarter and as we look out through the year, I think there’s going to be puts and takes in various categories of inventory or of components but I would say we’re characterizing it as a normal environment on average.

Bill Fearnley, Jr. - FTN Equity Capital

So no advance buys required here.

Brian T. Gladden

No, we’re managing our capital pretty tightly.

Bill Fearnley, Jr. - FTN Equity Capital

Okay and then one more follow up on the facilities, you had mentioned before you were thinking about trying to sell some of those facilities, any update there.

Brian T. Gladden

No.

Bill Fearnley, Jr. - FTN Equity Capital

That’s all I had. Thanks, guys.

Lynn A. Tyson

Operator, we will take one more question, please.

Operator

We''ll now take our final question from Andy Hargreaves with Pacific Crest.

Andy Hargreaves – Pacific Crest Securities

Thanks. I just have a couple of follow-ups actually to earlier questions. On the Netbooks your answer suggested that there isn’t really or you’re not expecting adoption of Netbooks in corporate environments. Is that the case and maybe why since they seem to be good devices for taking advantage of cloud computing and software and services type stuff?

Michael S. Dell

Well, it’s certainly possible but so far what we’re seeing is that the corporate users tend to prefer machines with larger screens, even if you look today, we offer corporate Notebooks at the 12-inch, 13-inch, 14-inch, 15-inch, 17-inch screen. The most popular one is the 15 inch. And it’s possible that there may be a move to smaller screens but the visualization of data is still very important to the users so we’re just not seeing a lot of demand for that.

Andy Hargreaves – Pacific Crest Securities

And then as a follow-up on that consumer question, as you expand to more outlets is there a diminishing return on that or are you seeing a diminishing return on that especially on the operating income line?

Michael S. Dell

I would say it’s been more geographic. We kind of started in the US and China and now we’re pretty focused on some of the big opportunities in Europe and so we’re kind of taking it a region at a time and doing it pretty methodically, but certainly our intent is to continue to have a healthy and profitable consumer business.

Andy Hargreaves – Pacific Crest Securities

Okay. Thank you.

Michael S. Dell

Okay, so let me thank you all for joining the call today. We have the financial strength, unique customer relationships, and we have a very strong brand. We’re aggressively improving our competitiveness and our execution while delivering solid profitability and maintaining a very strong balance sheet. We’re very focused on providing disruptively great value to customers while shifting our portfolio to higher margin products and services.

Thanks again for joining our call. We look forward to talking with you again soon.

Operator

This concludes today''s conference call. We appreciate your participation. You may disconnect at this time.