Dell Profits Disappoint as Tech Spending Weakens

By Eric Auchard

SAN FRANCISCO (Reuters) - Dell Inc posted a surprisingly steep drop in quarterly earnings on Thursday and said companies around the world are cutting back on technology spending, sending its shares tumbling 10 percent and sparking fears of weakness in the whole tech sector.

The world's second-largest computer maker, which had cautioned in May that big U.S. companies had become more conservative with technology spending in the face of a weak economy, said slow demand had spread to Europe and Asia as well as U.S. state and local government and small business.

"The thing that is making the stock go down is they're starting to talk about demand destruction in Western Europe and in Asia," said John Menzies, a portfolio manager with Pacific Growth Equities in San Francisco.

"Up until this point the large tech companies, like the IBMs of the world, have done pretty well in holding up their earnings because they've had strong and consistent international demand," Menzies said. "This shows international economies are slowing down and Dell cited that specifically."

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The computer maker's profit fell 17 percent in the second quarter ended August 1, to $616 million, or 31 cents per diluted share, from the restated net income of $746 million, or 33 cents per diluted share, in the year-ago second quarter.

"Each geography saw profit growth well below revenue growth," Goldman Sachs analyst David Bailey wrote in a note to clients, referring to results in the company's core U.S. commercial business and operations in Europe and Asia-Pacific.

"It is conservatism that has been relatively consistent for the last six months or so, but it is somewhat spreading," Chief Financial Officer Brian Gladden told reporters on a conference call.

Excluding amortization and business realignment costs, Dell earned 33 cents per share, behind Wall Street's 36 cents per share target, according to Reuters Estimates.

Revenue offered a bright note as it rose 11 percent to $16.43 billion and topped all analysts' expectations.

But Dell also posted a disappointing drop in profit margins, to 17.2 percent of gross profit, from 19.9 percent a year earlier and 18.4 percent in the previous quarter. Operating margins also fell.

"Strategic actions to accelerate growth in certain areas of our business affected gross margins this quarter," Gladden said in a statement. Cost cuts, changes to its portfolio of products and an effort to push sales outside of U.S. and European markets would also hurt operating margins, he added.

Dell has cut 8,500 jobs so far out of a planned 8,900, and at least one analyst said the results could presage further cutbacks. Officials said an ongoing 3-year plan to cut $3 billion in costs would show benefits in the second half of its current fiscal year, which ends in January 2009.

Gladden said pricing actions to restructure how Dell sells computer services in Europe hurt the company's quarterly profit by 2 to 3 cents per share.

The Dell financial executive said its moves in Europe were "self-inflicted" rather than in response to competitive pressures in the region but cautioned that revenue deferrals tied to the restructuring of its European services business could serve as a drag on reported results later this year.

"It's a really tough tech market and Dell is obviously cutting costs, but it wasn't enough to offset the pressure on gross margin," said Shannon Cross of Cross Research.

"What people on the Street wanted to see was revenue growth and a solid gross margin number. Because if you sell things for no profit, to some extent, what's the point? This indicates that they might have to streamline even more now," she said.

Dell shares tumbled to $22.75 in extended trade following the quarterly report, after closing down 42 cents at $25.21 on Nasdaq.

(Additional reporting by Jim Finkle, Alex Dobuzinskis and Peter Henderson; editing by Richard Chang, Gary Hill)

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