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Thursday, January 27, 2000

"It is a bad plan that admits of no modification."
-- Publilius Syrus

Dell Misses Estimates, Not Big Picture

By Richard McCaffery (TMF Gibson)

Direct sales PC company Dell Computer (Nasdaq: DELL) fell in after-hours trading last night after warning investors that fiscal fourth-quarter earnings (excluding extraordinary items) will fall about $0.06 shy of analyst estimates.

The company said a shortage of semiconductor components and delayed purchases due to Y2K issues led to flat year-over-year earnings and slower-than-expected sales growth.

Further, Dell said investors should expect 30% revenue growth from here on out since the Round Rock, Texas manufacturer is now a $25 billion company.

Naturally, there was much wailing about the shortfall. I even heard one industry observer suggest Dell has gone too far with its just-in-time manufacturing approach, the implication being it will need to pad inventories a bit to meet blistering demand. Good thing Michael Dell is running the company, not this guy.

It's not significant that the company missed estimates, plain and simple. Bumps in the road such as Y2K and fluctuating component supplies are part of doing business in the technology industry, and Dell will get things straightened out. For the long-term investor, these jags are no big deal.

It is significant that the company's sales growth will slow to 30%, mainly because Dell's growth rate has defied gravity for so long. We knew the slowdown was coming, but it's still an event when it happens.

What's forgotten in the earnings stir is that Dell is a better, more profitable company today than it was a year ago. That's a fact. In terms of its ability to generate cash, which is a major component of what determines a company's intrinsic value, Dell is actually picking up speed.

Look at Dell's third-quarter income and cash flow statements for the last three years.

First Nine Months             1997-1998   1998-1999

Revenue growth                   52%         41%
Net income growth                57%       18.8%

Cash from operations growth      68%       83.5%
Free cash flow growth            64%         95%
Sure, the company's sales and earnings growth have slowed, but that's just what's happening on the surface. I highlighted the cash flow numbers since they're the best measure of Dell's real profitability, and you can see they're growing fast. As the company's influence, market share, and scale have increased, Dell's efficiencies flow right to the bottom line. There's no indication that won't continue.

As for concerns about PC growth slowing, we hear it every year. Overall, growth seems to be slowing, but Dell is growing two to three times faster than the computer systems market, which means it's capturing market share in a very fragmented industry. Further, the company has barely scratched the surface internationally.

As for the growth of information appliances -- believe it when you see it. Most of us do the bulk of our work on PCs and I think it will stay that way. Sure, I'd like to surf the Web in my car, but that doesn't mean I don't want a PC at home and in the office. Besides, if information appliances do take off, Dell will be right there.

Not that the company doesn't have issues. The missed estimates/slowing sales growth story has to be reported, and it's worth tracking. Just don't miss the forest for the trees. In my opinion, the company's greatest challenge is the need to keep customer service levels high since there's been anecdotal evidence it's been slipping. Also the company needs to increase penetration in the server business.

For the long haul, however, Dell has the technology, management team, and business model to reward shareholders for years to come.

News to Go

Life insurance company John Hancock (NYSE: JHF) raised $1.7 billion by selling 102 million shares at $17 a piece last night. The shares will begin trading today on the New York Stock Exchange.

Optical networking equipment company Sycamore Networks (Nasdaq: SCMR) will split its stock three for one on February 14. Shareholders on record as of February 4 will receive two shares for each share they own. Sycamore closed last night at $300 1/16.

Pharmaceutical company Eli Lilly (NYSE: LLY) reported that fourth-quarter net income (excluding one-time events) increased 22% to $671.7 million, or $0.61 per diluted share, compared to $561.6 million, or $0.50 per diluted share, a year ago. The results were in line with analyst estimates.

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