Online sales help Dell in Q3

But soaring memory prices, flat panel display shortages do the PC maker no good

Dell Computer met reduced analysts' estimates in its third quarter Thursday and expects the bottom line to improve in the fourth. On Thursday, the direct sales computer maker reported net income of $483m (£299m), or 18 cents a share, on sales of $6.78bn.

First Call consensus expected the PC maker to earn 18 cents a share in the quarter, although most analysts originally expected a profit of 20 cents a share before it issued a profit warning earlier in the quarter. Shares of Dell closed up 2 to 43 7/16 ahead of the earnings report and moved slightly higher in after-hours trading.

During a conference call with analysts, Dell executives predicted improved profit margins as memory prices subside. The company, which saw gross margin of 20.2 percent in the third quarter, suffered from a 150 percent increase in memory chip prices. "Our goal is to keep prices fairly tight against changes in component costs and allow margins to regain lost ground," said Tom Meredith, Dell's chief financial officer. "We would not be surprised to see margins come back to the range they were in in fiscal '98." In fiscal 1998, Dell saw gross margin of 22.5 percent.

Revenue in the January quarter should follow historical growth patterns, Meredith said, referring to fiscal 1998's fourth quarter. That period saw a sequential revenue increase of about 7 percent, though analysts noted that Dell's sequential growth in previous fourth quarters was far higher. "It's more reasonable to assume a more moderate rate of growth because of the law of large numbers," Meredith said.

The $6.78bn in third quarter sales represents a 41 percent improvement compared to the year-ago quarter when it pocketed $384m, or 14 cents a share, on sales of $4.8bn. Company officials credited strong international demand as well as booming online sales for the strong revenue growth.

Although rising memory prices did dent margins this quarter, Dell was able to reduce its quarterly operating expenses to 10.6 percent of revenue from 11.4 percent in the year-ago quarter.

Revenue was hurt by a shortage of flat panel displays for notebooks. But that problem seems to be easing, said Michael Dell, chairman and CEO. "We are seeing I'd say a significantly improved availability of flat panel screens than where we were two months ago," he said.

Sales from the www.dell.com site surged to $35m a day in the quarter, or roughly 43 percent of its total revenue. Web sales now carry an annual run rate of $12bn, which would qualify the Internet business alone as a Fortune 125 company, Meredith noted during the conference call.

In the quarter, European sales increased 22 percent on a year-over-year basis, and rose 8 percent sequentially. Company shipments in the region expanded at double the overall industry average, and Dell was again ranked No. 2 in the regional market share in the quarter.

In Asia-Pacific and Japan, Dell shipments expanded at three times the industry rate, and revenue rose 69 percent. Quarterly sales in China, where the company recently began its second full year of direct product sales, nearly tripled from one year ago.

Although some large corporate customers are cutting near-term spending because of a reluctance to buy new equipment until Year 2000 worries have dissipated, Y2K fears are expected to little overall effect on business, executives said. "Overall industry demand is very healthy," Meredith said. "We remain bullish despite the challenges around Y2K, component cost and component availability."

"Dell's still the company to beat in this space," said Jonathan Ross, an analyst at ABN AMRO. "They have a great business model."

Ahead of the earnings report, Ross said he expected a third-quarter profit of 18 cents a share on sales of $6.6bn, roughly a 37 percent improvement from the year-ago quarter. Last quarter, Dell beat Street estimates by 2 cents a share, earning $507m, or 19 cents a share, on sales of $6.14bn.

Analysts were also encouraged by management's claims that the Y2K dilemma wouldn't hamper its sales through the rest of the fiscal year. Ashok Kumar, an analyst at Piper Jaffray, said Dell should be able to sustain a 30 percent to 35 percent revenue growth and that all indicators point toward strong demand through fiscal 2000.

"As expected, the spike in DRAM pricing and the inability to pass the costs on to the company's transactional customers will have a negative impact on gross margins in the quarter," Kumar said in a research note. "The current quarter is impacted by a shortened reaction time. We do not believe Dell will be impacted next quarter, as the company has more time to adjust to this transitory supply/demand imbalance."

Most analysts are expecting worldwide PC sales growth of between 12 percent to 15 percent in 2000. The emergence of faster multimedia chips from the likes of Intel (Nasdaq: INTC) and Advanced Micro Devices (NYSE: AMD) is expected to create more demand for top-end machines with higher profit margins.

"As long as this short-term memory situation doesn't have any significant impact on Dell's business structure, the stock will keep growing at the level investors have come to expect," Ross said.

Dell shares fell to a 52-week low of 29 3/4 last November before rallying to a high of 55 in February. After Dell's profit warning, analysts revised their fiscal 2000 estimates downward from 76 cents a share to 73 cents a share.

Twenty-four of the 34 analysts tracking the stock maintain either a "buy" or "strong buy" recommendation.

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