e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended
November 3, 2006
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or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to .
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Commission File
Number: 0-17017
Dell Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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74-2487834
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(State or other jurisdiction
of incorporation or organization)
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(I.R.S. Employer Identification No.)
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One Dell Way
Round Rock, Texas 78682
(Address of Principal Executive Offices) (Zip Code)
(512) 338-4400
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes o No þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check One):
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Large accelerated
filer þ
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Accelerated
filer o
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Non-accelerated
filer o
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of the close of business on October 19, 2007,
2,235,866,516 shares of common stock, par value $.01 per
share, were outstanding.
INDEX
Special Note
The Audit Committee of our Board of Directors recently completed
an independent investigation into certain accounting and
financial reporting matters. As a result of issues identified in
that investigation, as well as issues identified in additional
reviews and procedures conducted by management, the Audit
Committee, in consultation with management and
PricewaterhouseCoopers LLP, our independent registered public
accounting firm, concluded on August 13, 2007 that our
previously issued financial statements for Fiscal 2003, 2004,
2005, and 2006 (including the interim periods within those
years), and the first quarter of Fiscal 2007, should no longer
be relied upon because of certain accounting errors and
irregularities in those financial statements. Accordingly, we
have restated our previously issued financial statements for
those periods. Restated financial information is presented in
this report, as well as in our Annual Report on
Form 10-K
for Fiscal 2007. For a discussion of the investigation, the
accounting errors and irregularities identified, and the
adjustments made as a result of the restatement, see Note 2
of Notes to Condensed Consolidated Financial Statements included
in Part I Item 1
Financial Statements.
PART I
FINANCIAL INFORMATION
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ITEM 1.
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FINANCIAL
STATEMENTS
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DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(in
millions)
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November 3,
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February 3,
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2006
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2006
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(unaudited)
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As
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Restated
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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7,998
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$
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7,054
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Short-term investments
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1,320
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2,016
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Accounts receivable, net
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4,804
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4,082
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Financing receivables, net
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1,529
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1,366
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Inventories
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680
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588
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Other
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2,676
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2,688
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Total current assets
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19,007
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17,794
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Property, plant, and equipment, net
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2,215
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1,993
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Investments
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2,219
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2,686
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Long-term financing receivables, net
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311
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325
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Other non-current assets
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711
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454
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Total assets
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$
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24,463
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$
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23,252
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LIABILITIES AND STOCKHOLDERS EQUITY
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Current liabilities:
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Short-term borrowings
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$
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322
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$
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65
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Accounts payable
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10,335
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9,868
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Accrued and other
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6,958
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6,240
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Total current liabilities
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17,615
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16,173
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Long-term debt
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579
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625
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Other non-current liabilities
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2,789
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2,407
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Total liabilities
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20,983
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19,205
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Commitments and contingencies (Note 9)
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Redeemable common stock and capital in excess of $.01 par
value; 4 shares issued and outstanding (Note 12)
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88
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Stockholders equity:
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Preferred stock and capital in excess of $.01 par value;
shares issued and outstanding: none
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Common stock and capital in excess of $.01 par value;
shares authorized: 7,000; shares issued: 2,829 and 2,818,
respectively; shares outstanding: 2,223 and 2,330, respectively
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9,965
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9,503
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Treasury stock at cost: 606 and 488 shares, respectively
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(21,033
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(18,007
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Retained earnings
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14,556
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12,699
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Accumulated other comprehensive loss
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(96
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(101
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Other
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(47
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Total stockholders equity
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3,392
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4,047
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Total liabilities and equity
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$
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24,463
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$
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23,252
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
1
DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in millions,
except per share amounts; unaudited)
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Three Months
Ended
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Nine Months
Ended
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November 3,
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October 28,
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November 3,
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October 28,
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2006
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2005
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2006
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2005
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As
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As
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Restated
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Restated
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Net revenue
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$
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14,419
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$
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13,880
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$
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42,950
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$
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40,562
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Cost of net
revenue(1)
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12,028
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11,615
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35,913
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33,414
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Gross margin
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2,391
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2,265
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7,037
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7,148
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Operating expenses:
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Selling, general, and
administrative(1)
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1,531
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1,369
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4,414
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3,771
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Research, development, and
engineering(1)
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126
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104
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380
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335
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Total operating expenses
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1,657
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1,473
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4,794
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4,106
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Operating income
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734
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792
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2,243
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3,042
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Investment and other income, net
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66
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51
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170
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176
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Income before income taxes
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800
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843
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2,413
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3,218
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Income tax provision
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199
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208
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556
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693
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Net income
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$
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601
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$
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635
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$
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1,857
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$
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2,525
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Earnings per common share:
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Basic
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$
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0.27
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$
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0.27
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$
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0.82
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$
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1.04
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Diluted
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$
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0.27
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$
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0.26
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$
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0.82
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$
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1.02
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Weighted-average shares outstanding:
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Basic
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2,229
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2,395
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2,263
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2,423
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Diluted
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2,238
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2,435
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2,278
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2,476
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(1)
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Cost of revenue and operating
expenses for the three and nine-month periods ended
November 3, 2006 include stock-based compensation expense
pursuant to Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment. See
Note 6 of Notes to Condensed Consolidated Financial
Statements for additional information.
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions,
unaudited)
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Nine Months
Ended
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November 3,
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October 28,
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2006
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2005
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As
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Restated
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Cash flows from operating activities:
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Net income
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$
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1,857
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$
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2,525
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Adjustments to reconcile net income to net cash provided by
operating activities:
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Depreciation and amortization
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342
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287
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Stock-based compensation
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293
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14
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Excess tax benefits from stock-based compensation
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(62
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)
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Tax benefits from employee stock plans
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153
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Effects of exchange rate changes on monetary assets and
liabilities denominated in foreign currencies
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25
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(9
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)
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Other
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73
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82
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Changes in:
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Operating working capital
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41
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(138
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)
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Non-current assets and liabilities
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179
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327
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Net cash provided by operating activities
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2,748
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3,241
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Cash flows from investing activities:
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Investments:
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Purchases
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(7,346
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)
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(4,007
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)
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Maturities and sales
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8,656
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8,216
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Capital expenditures
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(566
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)
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(525
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)
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Acquisition of business, net of cash received
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(97
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)
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Net cash provided by investing activities
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647
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3,684
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Cash flows from financing activities:
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Repurchase of common stock
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(3,026
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)
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(5,250
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)
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Issuance of common stock under benefit plans
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230
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797
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Excess tax benefits from stock-based compensation
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62
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Issuance of commercial paper, net
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236
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|
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Other
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(14
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)
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(44
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)
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|
|
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|
|
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Net cash used in financing activities
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(2,512
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)
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|
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(4,497
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)
|
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|
|
|
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|
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Effect of exchange rate changes on cash and cash equivalents
|
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61
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|
|
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(62
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)
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|
|
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|
|
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Net increase in cash and cash equivalents
|
|
|
944
|
|
|
|
2,366
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Cash and cash equivalents at beginning of period
|
|
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7,054
|
|
|
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4,479
|
|
|
|
|
|
|
|
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Cash and cash equivalents at end of period
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$
|
7,998
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|
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$
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6,845
|
|
|
|
|
|
|
|
|
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|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
|
|
NOTE 1
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Basis of
Presentation
|
Basis of Presentation The accompanying
condensed consolidated financial statements of Dell Inc.
(Dell) should be read in conjunction with the
consolidated financial statements and accompanying notes filed
with the U.S. Securities and Exchange Commission
(SEC) in Dells Annual Report on
Form 10-K
for the fiscal year ended February 3, 2006. The
accompanying condensed consolidated financial statements have
been prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP). In
the opinion of management, the accompanying condensed
consolidated financial statements reflect all adjustments of a
normal recurring nature, as well as all adjustments discussed in
Note 2, Audit Committee Independent Investigation and
Restatement, considered necessary to fairly state the
financial position of Dell and its consolidated subsidiaries at
November 3, 2006 and February 3, 2006; the results of
its operations for the three and nine month periods ended
November 3, 2006 and October 28, 2005; and its cash
flows for the nine month periods ended November 3, 2006 and
October 28, 2005.
The preparation of financial statements in accordance with GAAP
requires management to make estimates and assumptions that
affect the amounts reported in Dells condensed
consolidated financial statements and the accompanying notes.
Actual results could differ materially from those estimates.
Dell is currently a partner in Dell Financial Services L.P.
(DFS), a joint venture with CIT Group, Inc.
(CIT). The joint venture allows Dell to provide its
customers with various financing alternatives. Dell consolidates
DFS financial results in accordance with Financial
Accounting Standards Board (FASB) Interpretation
No. 46R (FIN 46R) as Dell is the primary
beneficiary. See Note 7 of Notes to Condensed Consolidated
Financial Statements.
Acquisitions On May 8, 2006, Dell
acquired Alienware Corporation (Alienware).
Consequently, Alienwares financial position, results of
operations, and cash flows subsequent to acquisition are
included in the accompanying condensed consolidated financial
statements. Pro forma effects of the acquisition are not
material.
Stock-Based Compensation Effective
February 4, 2006, Dell adopted the fair value recognition
provisions of Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment
(SFAS 123(R)) using the modified
prospective transition method which does not require revising
the presentation in prior periods for stock-based compensation.
Under this transition method, stock-based compensation expense
for the third quarter and first nine months of Fiscal 2007
includes compensation expense for all stock-based compensation
awards granted prior to, but not yet vested at, February 4,
2006, based on the grant date fair value estimated in accordance
with the original provisions of SFAS 123, Accounting for
Stock-Based Compensation (SFAS 123).
Stock-based compensation expense for all stock-based
compensation awards granted after February 3, 2006 is based
on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R). Dell recognizes this
compensation expense net of an estimated forfeiture rate over
the requisite service period of the award, which is generally
the vesting term of five years for stock options and
five-to-seven years for restricted stock awards. In March 2005,
the SEC issued Staff Accounting Bulletin No. 107
(SAB 107) regarding the SECs
interpretation of SFAS 123(R) and the valuation of
share-based payments for public companies. Dell has applied the
provisions of SAB 107 in its adoption of SFAS 123(R).
See Note 6 of Notes to Condensed Consolidated Financial
Statements for further discussion on stock-based compensation.
Prior to the adoption of SFAS 123(R), Dell measured
compensation expense for its employee stock-based compensation
plans using the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). Dell applied the
disclosure provisions of SFAS 123 such that the fair value
of employee stock-based compensation was disclosed in the notes
to its
4
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
financial statements. Under APB 25, when the exercise price of
Dells employee stock options equaled the market price of
the underlying stock at the date of the grant, no compensation
expense was recognized.
Recently Issued Accounting Pronouncements In
February 2006, the FASB issued SFAS No. 155,
Accounting for Certain Hybrid Instruments
(SFAS 155), which is an amendment of
SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133), and
SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities a replacement of FASB Statement
No. 125 (SFAS 140). SFAS 155
allows Dell to elect to account for financial instruments with
embedded derivatives as a whole on a fair value basis, instead
of bifurcating the derivative from the host financial
instrument. This statement also requires Dell to evaluate its
interest in securitized financial assets to identify any
freestanding derivatives and embedded derivatives, and clarifies
that concentrations of credit risk in the form of subordination
are not embedded derivatives. SFAS 155 is effective for all
financial instruments acquired, issued, or subject to a
remeasurement event after the beginning of Dells Fiscal
2008. Dell determined that its retained interest in securitized
assets contains embedded derivatives and elected to account for
the entire asset on a fair value basis. The fair value basis did
not have a material effect on Dells results of operations,
financial position, or cash flows.
In March 2006, the FASB issued SFAS No. 156,
Accounting for Servicing of Financial Assets an
amendment of FASB Statement No. 140
(SFAS 156). SFAS 156 requires an
entity to recognize a servicing asset or servicing liability
each time it undertakes an obligation to service a financial
asset by entering into a servicing contract in specific
situations. Additionally, the servicing asset or servicing
liability is initially measured at fair value; however, an
entity may elect the amortization method or
fair value method for subsequent reporting periods.
SFAS 156 is effective beginning Dells Fiscal 2008.
Adoption of SFAS 156 did not have a material effect on
Dells results of operations, financial position, or cash
flows.
In June 2006, the Emerging Issues Task Force reached a consensus
on Issue
No. 06-3,
Disclosure Requirements for Taxes Assessed by a Governmental
Authority on Revenue-Producing Transactions
(EITF 06-3).
The consensus allows an entity to choose between two acceptable
alternatives based on their accounting policies for transactions
in which the entity collects taxes on behalf of a governmental
authority, such as sales taxes. Under the gross method, taxes
collected are accounted for as a component of revenue with an
offsetting expense. Conversely, the net method excludes such
taxes from revenue. Companies are required to disclose the
method selected pursuant to APB Opinion No. 22,
Disclosure of Accounting Policies. If such taxes are
reported gross and are significant, companies are required to
disclose the amount of those taxes. The guidance should be
applied to financial reports through retrospective application
for all periods presented, if amounts are significant, for
interim and annual reporting periods beginning after
December 15, 2006, which is Dells Fiscal 2008. Dell
records revenue net of such taxes.
In July 2006, the FASB issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109
(FIN 48). FIN 48 clarifies the accounting
and reporting for uncertainties in income tax law. This
Interpretation prescribes a comprehensive model for the
financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions taken or expected to be
taken in income tax returns. Dell adopted this Interpretation in
the first quarter of Fiscal 2008, and this adoption resulted in
a decrease to stockholders equity of approximately
$62 million. In addition, consistent with the provisions of
FIN 48, Dell changed the classification of
$1.1 billion of income tax liabilities from current to
non-current liabilities because payment of cash is not
anticipated within one year of the balance sheet date.
In September 2006, the SEC issued Staff Accounting
Bulletin No. 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements (SAB 108).
SAB 108 addresses the process of quantifying financial
statement misstatements; however, it does not
5
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
address how to assess materiality in interim financial
statements. SAB 108 establishes the dual approach for the
evaluation of the impact of financial statement misstatements.
SAB 108 was effective for Dells Fiscal 2007. There
was no impact on Dells results of operations, financial
position, or cash flows due to the adoption of SAB 108.
However, this guidance was considered in the determination by
Dell to restate its previously issued financial statements as
discussed in Note 2 of Notes to Condensed Consolidated
Financial Statements.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (SFAS 157),
which defines fair value, provides a framework for measuring
fair value, and expands the disclosures required for assets and
liabilities measured at fair value. SFAS 157 applies to
existing accounting pronouncements that require fair value
measurements; it does not require any new fair value
measurements. SFAS 157 is effective for fiscal years
beginning after November 15, 2007 and is required to be
adopted by Dell beginning in the first quarter of Fiscal 2009.
Management is currently evaluating the impact that SFAS 157
may have on Dells results of operations, financial
position, and cash flows.
In February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities
(SFAS 159), which provides companies with
an option to report selected financial assets and liabilities at
fair value with the changes in fair value recognized in earnings
at each subsequent reporting date. SFAS 159 provides an
opportunity to mitigate potential volatility in earnings caused
by measuring related assets and liabilities differently, and it
may reduce the need for applying complex hedge accounting
provisions. If elected, SFAS 159 is effective for fiscal
years beginning after November 15, 2007, which is
Dells Fiscal 2009. Management is currently evaluating the
impact that this statement may have on Dells results of
operations and financial position, and has yet to make a
decision on the elective adoption of SFAS 159.
Reclassifications To maintain comparability
among the periods presented, Dell has revised the presentation
of certain prior period amounts reported within the Notes to
Condensed Consolidated Financial Statements. For further
discussion regarding the presentation of service obligations
honored, see Note 8 of Notes to Condensed Consolidated
Financial Statements.
|
|
NOTE 2
|
Audit Committee
Independent Investigation and Restatement
|
Background and
Scope of the Investigation
In August 2005, the Division of Enforcement of the SEC initiated
an inquiry into certain of Dells accounting and financial
reporting matters and requested that Dell provide certain
documents. Over the course of several months, Dell produced
documents and provided information in response to the SECs
initial request and subsequent requests.
In June 2006, the SEC sent Dell an additional request for
documents and information that appeared to expand the scope of
the inquiry, with respect to both issues and periods. As
documents and information were collected in response to this
additional request, Dells management was made aware of
information that raised significant accounting and financial
reporting concerns, including whether accruals, reserves, and
other balance sheet items had been recorded and reported
properly. After evaluating this information and in consultation
with PricewaterhouseCoopers LLP, Dells independent
registered public accounting firm, management determined that
the identified issues warranted an independent investigation and
recommended such to the Audit Committee of Dells Board of
Directors.
On August 16, 2006, the Audit Committee, acting on
managements recommendation, approved the initiation of an
independent investigation. The Audit Committee engaged Willkie
Farr & Gallagher LLP (Willkie Farr) to
lead the investigation as the independent legal counsel to the
Audit Committee. Willkie Farr in turn engaged KPMG LLP
(KPMG) to serve as its independent forensic
accountants.
6
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
The scope of the investigation was determined by Willkie Farr,
in consultation with the Audit Committee and KPMG. The
investigation involved a program of forensic analysis and
inquiry directed to aspects of Dells accounting and
financial reporting practices throughout the world, and
evaluated aspects of its historical accounting and financial
reporting practices since Fiscal 2002 and, with respect to
certain issues, prior fiscal years.
Summary of
Investigation Findings
The investigation raised questions relating to numerous
accounting issues, most of which involved adjustments to various
reserve and accrued liability accounts, and identified evidence
that certain adjustments appear to have been motivated by the
objective of attaining financial targets. According to the
investigation, these activities typically occurred in the days
immediately following the end of a quarter, when the accounting
books were being closed and the results of the quarter were
being compiled. The investigation found evidence that, in that
timeframe, account balances were reviewed, sometimes at the
request or with the knowledge of senior executives, with the
goal of seeking adjustments so that quarterly performance
objectives could be met. The investigation concluded that a
number of these adjustments were improper, including the
creation and release of accruals and reserves that appear to
have been made for the purpose of enhancing internal performance
measures or reported results, as well as the transfer of excess
accruals from one liability account to another and the use of
the excess balances to offset unrelated expenses in later
periods. The investigation found that sometimes business unit
personnel did not provide complete information to corporate
headquarters and, in a number of instances, purposefully
incorrect or incomplete information about these activities was
provided to internal or external auditors.
The investigation identified evidence that accounting
adjustments were viewed at times as an acceptable device to
compensate for earnings shortfalls that could not be closed
through operational means. Often, these adjustments ranged from
several hundred thousand to several million dollars, in the
context of a company with annual revenues ranging from
$35.3 billion to $55.8 billion and annual net income
ranging from $2.0 billion to $3.6 billion for the
periods in question. The errors and irregularities identified in
the course of the investigation revealed deficiencies in
Dells accounting and financial control environment, some
of which were determined to be material weaknesses, that require
corrective and remedial actions. For a description of the
control deficiencies identified by management as a result of the
investigation and Dells internal reviews described below,
as well as managements plan to remediate those
deficiencies, see Part I
Item 4 Controls and Procedures.
Other Company
Identified Adjustments
Concurrently with the investigation, Dell also conducted
extensive internal reviews for the purpose of the preparation
and certification of Dells Fiscal 2007 financial
statements and its assessment of internal controls over
financial reporting. Dells procedures included expanded
account reviews and expanded balance sheet reconciliations to
ensure all accounts were fully reconciled, supported, and
appropriately documented. Dell also implemented improvements to
its quarterly and annual accounting close process to provide for
more complete review of the various business unit financial
results.
Restatement
Adjustments
As a result of the issues identified in the Audit Committee
independent investigation, as well as issues identified in
additional reviews and procedures conducted by management, the
Audit Committee, in consultation with management and
PricewaterhouseCoopers LLP, concluded on August 13, 2007
that Dells previously issued financial statements for
Fiscal 2003, 2004, 2005, and 2006 (including the interim periods
within those years), and the first quarter of Fiscal 2007,
should no longer be relied upon because of
7
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
certain accounting errors and irregularities in those financial
statements. Accordingly, Dell has restated its previously issued
financial statements for those periods. Restated financial
information is presented in this report, as well as in
Dells Annual Report on
Form 10-K
for Fiscal 2007.
The nature of the restatement adjustments and the impact of the
adjustments for the three-month period ended October 28,
2005 are shown in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Month
Period Ended October 28, 2005
|
|
|
|
|
|
|
Adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
Other
|
|
|
Provision
|
|
|
|
|
|
|
|
|
|
recognition
|
|
|
|
|
|
reserves
|
|
|
for
|
|
|
|
|
|
|
As
|
|
|
Software
|
|
|
|
|
|
Warranty
|
|
|
and
|
|
|
income
|
|
|
As
|
|
|
|
Reported
|
|
|
sales
|
|
|
Other
|
|
|
liabilities
|
|
|
accruals
|
|
|
tax(a)
|
|
|
Restated
|
|
|
|
(in millions,
except per share data)
|
|
|
Net revenue
|
|
$
|
13,911
|
|
|
$
|
(69
|
)
|
|
$
|
38
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
13,880
|
|
Cost of net revenue
|
|
|
11,660
|
|
|
|
(72
|
)
|
|
|
30
|
|
|
|
13
|
|
|
|
(16
|
)
|
|
|
|
|
|
|
11,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
2,251
|
|
|
|
3
|
|
|
|
8
|
|
|
|
(13
|
)
|
|
|
16
|
|
|
|
|
|
|
|
2,265
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
1,391
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
(23
|
)
|
|
|
|
|
|
|
1,369
|
|
Research, development, and engineering
|
|
|
106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
1,497
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
(25
|
)
|
|
|
|
|
|
|
1,473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
754
|
|
|
|
3
|
|
|
|
7
|
|
|
|
(13
|
)
|
|
|
41
|
|
|
|
|
|
|
|
792
|
|
Investment and other income, net
|
|
|
50
|
|
|
|
|
|
|
|
2
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
804
|
|
|
|
3
|
|
|
|
9
|
|
|
|
(14
|
)
|
|
|
41
|
|
|
|
|
|
|
|
843
|
|
Income tax provision
|
|
|
198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
|
|
|
|
208
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
606
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
635
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2,395
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,395
|
|
Diluted
|
|
|
2,435
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,435
|
|
|
|
|
a)
|
|
Primarily represents the aggregate
tax impact of the adjustments.
|
8
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
The nature of the restatement adjustments and the impact of the
adjustments for the nine-months ended October 28, 2005 are
shown in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Month Period
Ended October 28, 2005
|
|
|
|
|
|
|
Adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
Other
|
|
|
Provision
|
|
|
|
|
|
|
|
|
|
recognition
|
|
|
|
|
|
reserves
|
|
|
for
|
|
|
|
|
|
|
As
|
|
|
Software
|
|
|
|
|
|
Warranty
|
|
|
and
|
|
|
income
|
|
|
As
|
|
|
|
Reported
|
|
|
sales
|
|
|
Other
|
|
|
liabilities
|
|
|
accruals
|
|
|
tax(a)
|
|
|
Restated
|
|
|
|
(in millions,
except per share data)
|
|
|
Net revenue
|
|
$
|
40,725
|
|
|
$
|
(190
|
)
|
|
$
|
27
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
40,562
|
|
Cost of net revenue
|
|
|
33,484
|
|
|
|
(187
|
)
|
|
|
48
|
|
|
|
78
|
|
|
|
(9
|
)
|
|
|
|
|
|
|
33,414
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
7,241
|
|
|
|
(3
|
)
|
|
|
(21
|
)
|
|
|
(78
|
)
|
|
|
9
|
|
|
|
|
|
|
|
7,148
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
3,802
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
(34
|
)
|
|
|
|
|
|
|
3,771
|
|
Research, development, and engineering
|
|
|
338
|
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
335
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
4,140
|
|
|
|
|
|
|
|
3
|
|
|
|
(1
|
)
|
|
|
(36
|
)
|
|
|
|
|
|
|
4,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
3,101
|
|
|
|
(3
|
)
|
|
|
(24
|
)
|
|
|
(77
|
)
|
|
|
45
|
|
|
|
|
|
|
|
3,042
|
|
Investment and other income, net
|
|
|
170
|
|
|
|
|
|
|
|
10
|
|
|
|
(3
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
176
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
3,271
|
|
|
|
(3
|
)
|
|
|
(14
|
)
|
|
|
(80
|
)
|
|
|
44
|
|
|
|
|
|
|
|
3,218
|
|
Income tax provision
|
|
|
711
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18
|
)
|
|
|
693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,525
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
1.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2,423
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,423
|
|
Diluted
|
|
|
2,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,476
|
|
|
|
|
(a)
|
|
Primarily represents the aggregate
tax impact of the adjustments.
|
9
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Revenue
Recognition Adjustments
Software Sales The largest revenue
recognition adjustment relates to correcting the timing and
amount of revenue recognized on the sale of certain software
products. Dell is a reseller of a broad array of third-party
developed software. Individually significant categories of
software are analyzed for application of the appropriate
accounting under American Institute of Certified Public
Accountants (AICPA) Statement of Position
No. 97-2,
Software Revenue Recognition
(SOP 97-2).
However, the allocation of software sales revenue between the
software license (recognized at point of sale) and post-contract
support (deferred and recognized over time) for other high
volume, lower dollar value software products has historically
been assessed as a group and the post-contract support revenue
was deferred based on an estimate of average Vendor
Specific Objective Evidence (VSOE). During the
course of its internal reviews, Dell determined that its
application of
SOP 97-2
for these high volume software products was not correct. Dell
has determined that the most appropriate application of
SOP 97-2
is to defer all of the revenue from these other
software offerings and amortize the revenue over the
post-contract support period as VSOE has not been appropriately
established. Additionally, during the course of its reviews,
Dell identified certain software offerings where it had
previously recognized the gross amount of revenue from the sale
but where it functions more as a selling agent as opposed to the
principal in the sale to the customer. In those cases Dell
should have recognized the revenue net of the related cost
pursuant to EITF Issue
No. 99-19,
Reporting Revenue Gross as a Principal vs. Net as an
Agent.
Other The other revenue recognition
adjustments include cases where Dell recognized revenue in the
incorrect periods or recognized the incorrect amount of revenue
on certain transactions, and cases where the allocation of
revenue among the individual elements of the sale was not
correct. The primary categories of other revenue recognition
adjustments include the following:
|
|
|
SAB 104 Deferrals Instances were
identified where Dell prematurely recognized revenue prior to
finalization of the terms of sale with the customer, or prior to
title and/or
risk of loss having been passed to the customer. Sometimes these
situations involved warehousing arrangements. Additionally,
there were situations where revenue was incorrectly deferred to
later periods despite title
and/or risk
of loss having passed to the end customer. Under SAB 104,
there were also cases where the in-transit deferral calculation
for the period end was not appropriately calculated or was based
on incorrect assumptions.
|
|
|
Deferred Warranty Revenue Pursuant to FASB
Technical Bulletin
No. 90-1,
Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts, Dell defers and amortizes the
revenue from the sale of extended warranties and enhanced
service level agreements over the service period of the
associated agreement. In some instances Dells accounting
estimates of the agreement durations were not correct, resulting
in revenue being recognized over a shorter time period than the
actual contract durations. Additionally, an error was identified
in the amount of deferred revenue recognized and amortized
during the restatement period.
|
|
|
Customer Rebate Accruals Dells
U.S. Consumer segment and small business group historically
offered various forms of rebates to stimulate sales, including
mail-in rebates. The rebate redemption liability is estimated at
the time of sale based on historical redemption rates for the
various types of promotions. Dell has determined that this
liability was overstated due to a number of factors, including
failure to update redemption rates when appropriate, additional
amounts accrued for expected customer satisfaction costs, and
unsupported incremental accruals recorded in addition to the
calculated redemption liability estimate.
|
|
|
Japan Services Transactions In late January
2007, a Japanese systems integrator with whom Dells
Japanese services division did business, filed for bankruptcy.
The bankruptcy trustee publicly indicated that the systems
integrator had engaged in fictitious transactions. Dell promptly
commenced an internal
|
10
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
investigation led by Dells Ethics Office to determine
whether its Japanese business unit had engaged in any fictitious
transactions with the systems integrator. Dell hired independent
outside counsel who retained independent accountants to lead the
investigation. The investigation determined that almost all of
the transactions of the Japan services business involving the
systems integrator likely were fabricated, as were certain
additional smaller transactions involving two other Japanese
systems integrators. The impact of the adjustments reduced net
revenue and cost of revenue to eliminate the effect of the
fictitious transactions.
|
|
|
|
Sales Reflected in Cost of Sales There were
transactions identified involving the sale of certain computer
component commodities and parts where the net proceeds were
presented as a reduction of cost of sales rather than as revenue.
|
Warranty
Liabilities
The issues related to Dells warranty liabilities include
situations where certain vendor reimbursement agreements were
incorrectly accounted for as a reduction in the estimate of the
outstanding warranty liabilities. There were also instances
where warranty reserves in excess of the estimated warranty
liability as calculated by the warranty liability estimation
process were retained and not released to the income statement
as appropriate. Additionally, certain adjustments in the
warranty liability estimation process were identified where
expected future costs or estimated failure rates were not
accurate.
Other Reserves
and Accruals
Many of the restatement adjustments relate to the estimates and
reconciliation of various reserves and accrued liabilities,
including employee benefits, accounts payable, litigation, sales
commissions, payroll, employee bonuses, and supplier rebates.
Dell extensively reviewed its accruals and underlying estimates,
giving consideration to subsequent developments after the date
of the financial statements, to assess whether any of the
previously recorded amounts required adjustment. Dell conducted
expanded account reviews and expanded balance sheet
reconciliations to ensure that all accounts were fully
reconciled, supported, and appropriately documented. As a result
of this review, Dell determined that a number of its accruals
required adjustment across various accounting periods. The
largest of these adjustments are described in more detail below:
|
|
|
Employee Bonuses Certain employee bonuses
were not accrued correctly, including the timing of the
recording of the accrual for the employee bonuses. Additionally,
in certain cases when excess accruals resulted from differences
in the actual bonus payments, the excess accruals were not
adjusted as appropriate.
|
|
|
Vendor Funding Arrangements In some instances
vendor funding arrangements were not accounted for appropriately
under EITF Issue No.
02-16,
Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor. Certain amounts
received from vendors were recorded as a reduction in operating
expenses instead of being correctly recorded as a reduction of
cost of goods sold. Additionally, certain amounts received were
retained on the balance sheet and released in future periods
despite the earnings process having been complete in the earlier
period. Finally, there were instances where the benefit of
certain vendor funding was recorded prior to the completion of
the earnings process.
|
|
|
Unsubstantiated Accruals and Inadequately Reconciled
Accounts In some instances accrual and reserve
accounts lacked justification or supporting documentation. In
certain cases these accounts were used to accumulate excess
amounts from other reserve and accrual accounts. However, these
excess reserves were not released to the income statement in the
appropriate reporting period or were released
|
11
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
for other purposes. In some instances accounts had incorrect
balances because they had not been properly reconciled or
because reconciling items had not been adjusted timely.
|
The table below summarizes the effects of the restatement
adjustments on the Consolidated Statement of Financial Position
at February 3, 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 3,
2006
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
Reported
|
|
|
Adjustments
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
7,042
|
|
|
$
|
12
|
|
|
$
|
7,054
|
|
Short-term investments
|
|
|
2,016
|
|
|
|
|
|
|
|
2,016
|
|
Accounts receivable, net
|
|
|
4,089
|
|
|
|
(7
|
)
|
|
|
4,082
|
|
Financing receivables, net
|
|
|
1,363
|
|
|
|
3
|
|
|
|
1,366
|
|
Inventories
|
|
|
576
|
|
|
|
12
|
|
|
|
588
|
|
Other
|
|
|
2,620
|
|
|
|
68
|
|
|
|
2,688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
17,706
|
|
|
|
88
|
|
|
|
17,794
|
|
Property, plant, and equipment, net
|
|
|
2,005
|
|
|
|
(12
|
)
|
|
|
1,993
|
|
Investments
|
|
|
2,691
|
|
|
|
(5
|
)
|
|
|
2,686
|
|
Long-term financing receivables, net
|
|
|
325
|
|
|
|
|
|
|
|
325
|
|
Other non-current assets
|
|
|
382
|
|
|
|
72
|
|
|
|
454
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
23,109
|
|
|
$
|
143
|
|
|
$
|
23,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term borrowings
|
|
$
|
|
|
|
$
|
65
|
|
|
$
|
65
|
|
Accounts payable
|
|
|
9,840
|
|
|
|
28
|
|
|
|
9,868
|
|
Accrued and other
|
|
|
6,087
|
|
|
|
153
|
|
|
|
6,240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
15,927
|
|
|
|
246
|
|
|
|
16,173
|
|
Long-term debt
|
|
|
504
|
|
|
|
121
|
|
|
|
625
|
|
Other non-current liabilities
|
|
|
2,549
|
|
|
|
(142
|
)
|
|
|
2,407
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
18,980
|
|
|
|
225
|
|
|
|
19,205
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redeemable common stock and capital in excess of par value
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock and capital in excess of par
|
|
|
9,540
|
|
|
|
(37
|
)
|
|
|
9,503
|
|
Treasury stock
|
|
|
(18,007
|
)
|
|
|
|
|
|
|
(18,007
|
)
|
Retained earnings
|
|
|
12,746
|
|
|
|
(47
|
)
|
|
|
12,699
|
|
Accumulated other comprehensive loss
|
|
|
(103
|
)
|
|
|
2
|
|
|
|
(101
|
)
|
Other
|
|
|
(47
|
)
|
|
|
|
|
|
|
(47
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
4,129
|
|
|
|
(82
|
)
|
|
|
4,047
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and equity
|
|
$
|
23,109
|
|
|
$
|
143
|
|
|
$
|
23,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Statement of
Financial Position Adjustments
In addition to the income statement adjustments described above,
certain Statement of Financial Position classification
adjustments were also identified. These include
(i) correcting the classification of advances under credit
facilities by DFS from other current and non-current liabilities
to short-term borrowings and long-term debt as appropriate;
(ii) correcting the presentation of liabilities for
estimated litigation settlements by presenting estimated
insurance recoveries as a receivable from the insurance carriers
rather than as a reduction of the estimated settlement
liability; (iii) correcting an error in the calculation and
recording of the tax benefit of employee stock options which had
an offsetting impact on accrued and other liabilities and
stockholders equity; (iv) adjusting the fair value of
long-term debt, where the interest rate is hedged with interest
rate swap agreements; and (v) adjusting deferred revenue to
record professional and deployment services impacting accounts
receivable and accrued and other liabilities. These balance
sheet corrections in classification are included in the
adjustments column above.
Statement of Cash
Flows
The following table presents the major subtotals for Dells
Statement of Cash Flows and the related impact of the
restatement adjustments discussed above for the nine months
ended October 28, 2005:
|
|
|
|
|
|
|
|
|
|
|
Nine Months
Ended
|
|
|
|
October 28,
2005
|
|
|
|
As
|
|
|
As
|
|
|
|
Reported
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Net cash provided by (used in):
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,560
|
|
|
$
|
2,525
|
|
Non-cash adjustments
|
|
|
567
|
|
|
|
527
|
|
Changes in working capital
|
|
|
(200
|
)
|
|
|
(138
|
)
|
Changes in noncurrent assets and liabilities
|
|
|
330
|
|
|
|
327
|
|
|
|
|
|
|
|
|
|
|
Operating activities
|
|
|
3,257
|
|
|
|
3,241
|
|
Investing activities
|
|
|
3,424
|
|
|
|
3,684
|
|
Financing activities
|
|
|
(4,477
|
)
|
|
|
(4,497
|
)
|
Effect of exchange rate changes on cash and cash
equivalents(a)
|
|
|
(110
|
)
|
|
|
(62
|
)
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
|
2,094
|
|
|
|
2,366
|
|
Cash and cash equivalents at beginning of period
|
|
|
4,747
|
|
|
|
4,479
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
6,841
|
|
|
$
|
6,845
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
|
The cash flows have been revised to
reflect a closer approximation of the weighted-average exchange
rates during the reporting periods. For most periods, this
revision reduced the previously reported effect of exchange rate
changes on cash and cash equivalents and with an offsetting
change in effects of exchange rate changes on monetary assets
and liabilities denominated in foreign currencies and changes in
operating working capital included in cash flows from operating
activities.
|
13
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
November 3,
|
|
|
February 3,
|
|
|
|
2006
|
|
|
2006
|
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Inventories:
|
|
|
|
|
|
|
|
|
Production materials
|
|
$
|
396
|
|
|
$
|
325
|
|
Work-in-process
|
|
|
54
|
|
|
|
43
|
|
Finished goods
|
|
|
230
|
|
|
|
220
|
|
|
|
|
|
|
|
|
|
|
Inventories
|
|
$
|
680
|
|
|
$
|
588
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 4
|
Earnings Per
Common Share
|
Basic earnings per share is based on the weighted-average effect
of all common shares issued and outstanding, and is calculated
by dividing net income by the weighted-average shares
outstanding during the period. Diluted earnings per share is
calculated by dividing net income by the weighted-average number
of common shares used in the basic earnings per share
calculation plus the number of common shares that would be
issued assuming exercise or conversion of all potentially
dilutive common shares outstanding. Dell excludes equity
instruments from the calculation of diluted earnings per share
if the effect of including such instruments is antidilutive.
Accordingly, certain employee stock options have been excluded
from the calculation of diluted earnings per share totaling
314 million and 162 million shares during the third
quarter of Fiscal 2007 and Fiscal 2006, respectively, and
276 million and 103 million shares during the
nine-month periods ended November 3, 2006 and
October 28, 2005, respectively.
The following table sets forth the computation of basic and
diluted earnings per share for the three and nine month periods
ended November 3, 2006 and October 28, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Restated
|
|
|
|
(in millions,
except per share amounts)
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
601
|
|
|
$
|
635
|
|
|
$
|
1,857
|
|
|
$
|
2,525
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2,229
|
|
|
|
2,395
|
|
|
|
2,263
|
|
|
|
2,423
|
|
Effect of dilutive options, restricted stock units, restricted
stock, and other
|
|
|
9
|
|
|
|
40
|
|
|
|
15
|
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
2,238
|
|
|
|
2,435
|
|
|
|
2,278
|
|
|
|
2,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.27
|
|
|
$
|
0.27
|
|
|
$
|
0.82
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.27
|
|
|
$
|
0.26
|
|
|
$
|
0.82
|
|
|
$
|
1.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 5
|
Comprehensive
Income
|
Dells comprehensive income is comprised of net income,
unrealized gains and losses on derivative financial instruments
related to foreign currency hedging, unrealized gains and losses
on marketable
14
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
securities classified as available-for-sale, unrealized gains
and losses related to the change in valuation of retained
interests in securitized assets, and foreign currency
translation adjustments.
The following table summarizes comprehensive income for the
three- and nine-month periods ended November 3, 2006 and
October 28, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
601
|
|
|
$
|
635
|
|
|
$
|
1,857
|
|
|
$
|
2,525
|
|
Unrealized gains (losses) on foreign currency hedging
instruments, net
|
|
|
19
|
|
|
|
(23
|
)
|
|
|
(25
|
)
|
|
|
76
|
|
Unrealized gains (losses) on marketable securities, net
|
|
|
26
|
|
|
|
(10
|
)
|
|
|
27
|
|
|
|
(30
|
)
|
Valuation of retained interests in securitized assets
|
|
|
4
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
(1
|
)
|
|
|
|
|
|
|
(7
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
649
|
|
|
$
|
602
|
|
|
$
|
1,862
|
|
|
$
|
2,569
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description of
the Plans
Employee Stock Purchase Plan Dell has a
shareholder approved employee stock purchase plan
(ESPP) that permits substantially all employees to
purchase shares of Dells common stock. Effective
July 1, 2005, participating employees were permitted to
purchase common stock through payroll deductions at the end of
each three-month participation period at a purchase price equal
to 85% of the fair market value of the common stock at the end
of the participation period. Upon adoption of SFAS 123(R)
in Fiscal 2007, Dell began recognizing compensation expense for
the 15% discount received by the participating employees. Common
stock reserved for future employee purchases under the plan
aggregated 11 million shares at November 3, 2006 and
16 million shares at February 3, 2006. The
weighted-average fair value of the purchase rights under the
ESPP during the three and nine month periods ended
November 3, 2006 was $3.43 and $3.92, respectively.
Employee Stock Plans Dell has the following
four employee stock plans (collectively referred to as the
Stock Plans) under which options, restricted stock,
and restricted stock units were outstanding at November 3,
2006:
|
|
|
The Dell Computer Corporation 1989 Stock Option Plan (the
1989 Option Plan)
|
|
|
The Dell Computer Corporation Incentive Plan (the 1994
Incentive Plan)
|
|
|
The Dell Computer Corporation 1998 Broad-Based Stock Option Plan
(the 1998 Broad-Based Plan)
|
|
|
The Dell Computer Corporation 2002 Long-Term Incentive Plan (the
2002 Incentive Plan)
|
The Stock Plans are administered by the Leadership Development
and Compensation Committee of Dells Board of Directors.
The 1989 Option Plan, the 1994 Incentive Plan, and the 1998
Broad-Based Plan have been terminated (except for options
previously granted under those plans that are still
outstanding). Consequently, awards are currently only being
granted under the 2002 Incentive Plan.
15
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
The 2002 Incentive Plan provides for the granting of stock-based
incentive awards to Dells employees, non-employee
directors, and certain consultants and advisors to Dell. Awards
may be incentive stock options within the meaning of
Section 422 of the Internal Revenue Code, nonqualified
stock options, restricted stock, or restricted stock units.
There were approximately 268 million and 272 million
shares of Dells common stock available for future grants
under the Stock Plans at November 3, 2006 and
February 3, 2006, respectively. To satisfy stock option
exercises, Dell has a policy of issuing new shares, as opposed
to repurchasing shares on the open market.
Stock Option Agreements The right to purchase
shares pursuant to existing stock option agreements typically
vests pro-rata at each option anniversary date over a five-year
period. The options, which are granted with option exercise
prices equal to the fair market value of Dells common
stock on the date of grant, generally expire within ten to
twelve years from the date of grant. Dell has not issued any
options to consultants or advisors to Dell since Fiscal 1999. In
conjunction with the adoption of SFAS 123(R) in the first
quarter of Fiscal 2007, Dell changed its method of attributing
the value of stock-based compensation expense from an
accelerated approach a straight-line method. Compensation
expense for all stock option awards granted on or prior to
February 3, 2006 is recognized using an accelerated
multiple-option approach with the exception of stock options
granted in Fiscal 2002 and Fiscal 2003, for which compensation
expense is recognized using a straight-line method.
Restricted Stock Awards Awards of restricted
stock may be either grants of restricted stock, restricted stock
units, or performance-based stock units that are issued at no
cost to the recipient. For restricted stock grants, at the date
of grant, the recipient has all rights of a stockholder, subject
to certain restrictions on transferability and a risk of
forfeiture. Restricted stock grants typically vest over a
five-to-seven-year period beginning on the date of grant. For
restricted stock units, legal ownership of the shares is not
transferred to the employee until the unit vests, which is
generally over a five-year period. Dell also grants
performance-based restricted stock units as a long-term
incentive in which an award recipient receives shares contingent
upon Dell achieving performance objectives and the
employees continuing employment through the vesting
period, which is generally over a five-year period. Compensation
expense recorded in connection with these performance-based
restricted stock units is based on Dells best estimate of
the number of shares that will eventually be issued upon
achievement of the specified performance criteria and when it
becomes probable that certain performance goals will be
achieved. The cost of these awards is determined using the fair
market value of Dells common stock on the date of the
grant. Compensation expense for restricted stock awards with a
service condition is recognized on a straight-line basis over
the vesting term. Compensation expense for performance-based
restricted stock awards is recognized on an accelerated
multiple-award approach based on the most probable outcome of
the performance condition. In accordance with SFAS 123(R),
deferred compensation related to restricted stock awards issued
prior to Fiscal 2007, which was previously classified as
other in stockholders equity, was classified
as capital in excess of par value upon adoption.
Temporary Suspension of Option Exercises, Vesting of
Restricted Stock Units, and ESPP Purchases As a
result of Dells inability to timely file its Annual Report
on
Form 10-K
for Fiscal 2007, Dell suspended the exercise of employee stock
options, the vesting of restricted stock units, and the purchase
of shares under the ESPP. Dell expects to resume the exercise of
employee stock options by employees, the vesting of restricted
stock units, and the purchase of shares under the ESPP when it
is again current in its reporting obligations under the
Securities Exchange Act of 1934.
Dell agreed to pay cash to certain current and former employees
who held in-the-money stock options (options that have an
exercise price less than the current stock market price) that
expired during the period of unexercisability. Within
45 days after Dell files its Annual Report on
Form 10-K
for Fiscal 2007, Dell will make payments relating to
in-the-money stock options that expired in the second and third
quarters of
16
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Fiscal 2008, which are expected to total approximately
$113 million. Dell will not continue to pay cash for
expired in-the-money stock options once the options again become
exercisable.
General
Information
Stock Option Activity The following table
summarizes stock option activity for the Stock Plans during the
nine-month period ended November 3, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
Number
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
of
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Term
|
|
|
Value
|
|
|
|
(in
millions)
|
|
|
(per
share)
|
|
|
(in
years)
|
|
|
(in
millions)
|
|
|
Options outstanding February 3, 2006
|
|
|
343
|
|
|
$
|
31.86
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
7
|
|
|
|
26.62
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(10
|
)
|
|
|
12.68
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(3
|
)
|
|
|
25.93
|
|
|
|
|
|
|
|
|
|
Cancelled/expired
|
|
|
(17
|
)
|
|
|
36.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding November 3, 2006
|
|
|
320
|
|
|
$
|
32.18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest (net of estimated
forfeitures) November 3,
2006(a)
|
|
|
315
|
|
|
$
|
32.26
|
|
|
|
5.4
|
|
|
$
|
209
|
|
Exercisable November 3,
2006(a)
|
|
|
292
|
|
|
$
|
32.66
|
|
|
|
5.3
|
|
|
$
|
207
|
|
|
|
|
(a)
|
|
For options vested and expected to
vest and options exercisable, the aggregate intrinsic value in
the table above represents the total pre-tax intrinsic value
(the difference between Dells closing stock price on
November 3, 2006 and the exercise price, multiplied by the
number of in-the-money options) that would have been received by
the option holders had the holders exercised their options on
November 3, 2006. The intrinsic value changes based on
changes in the fair market value of Dells common stock.
|
Other information pertaining to stock options for the three and
nine month periods ended November 3, 2006 is as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
Nine Months
Ended
|
|
|
November 3,
2006
|
|
November 3,
2006
|
|
|
(in millions,
except per option data)
|
|
Weighted-average grant date fair value of stock options granted
per option
|
|
$
|
6.54
|
|
|
$
|
6.72
|
|
Total intrinsic value of options
exercised(a)
|
|
$
|
15
|
|
|
$
|
149
|
|
|
|
|
(a)
|
|
The total intrinsic value of
options exercised represents the total pre-tax intrinsic value
(the difference between the stock price at exercise and the
exercise price, multiplied by the number of options exercised)
that was received by the option holders who exercised their
options during the three and nine month periods ended
November 3, 2006.
|
At November 3, 2006, $173 million of total
unrecognized stock-based compensation expense, net of estimated
forfeitures, related to stock options is expected to be
recognized over a weighted-average period of approximately
1.4 years.
17
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Non-vested Restricted Stock Activity
Non-vested restricted stock awards at November 3, 2006 and
activities during the nine-month period ended November 3,
2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
Number
|
|
|
Average
|
|
|
|
of
|
|
|
Grant Date
|
|
|
|
Shares
|
|
|
Fair
Value
|
|
|
|
(in
millions)
|
|
|
(per
share)
|
|
|
Non-vested restricted stock February 3, 2006
|
|
|
2
|
|
|
$
|
34.66
|
|
Granted
|
|
|
20
|
|
|
|
28.55
|
|
Vested
|
|
|
(1
|
)
|
|
|
28.72
|
|
Forfeited
|
|
|
(2
|
)
|
|
|
30.43
|
|
|
|
|
|
|
|
|
|
|
Non-vested restricted stock November 3, 2006
|
|
|
19
|
|
|
$
|
28.98
|
|
|
|
|
|
|
|
|
|
|
For the three and nine month periods ended November 3,
2006, the weighted-average grant date fair value of restricted
stock awards granted during the period was $28.33 and $28.55 per
share, respectively. At November 3, 2006, $351 million
of unrecognized stock-based compensation expense, net of
estimated forfeitures, related to non-vested restricted stock
awards cost is expected to be recognized over a weighted-average
period of approximately 2.6 years.
Expense
Information under SFAS 123(R)
For the three and nine month periods ended November 3,
2006, stock-based compensation expense, net of income taxes, was
allocated as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
November 3,
|
|
|
|
2006
|
|
|
2006
|
|
|
|
(in
millions)
|
|
|
Stock-based compensation expense:
|
|
|
|
|
|
|
|
|
Cost of net revenue
|
|
$
|
11
|
|
|
$
|
47
|
|
Operating expenses
|
|
|
65
|
|
|
|
246
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense before taxes
|
|
|
76
|
|
|
|
293
|
|
Income tax benefit
|
|
|
(23
|
)
|
|
|
(88
|
)
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
|
|
$
|
53
|
|
|
$
|
205
|
|
|
|
|
|
|
|
|
|
|
Prior to the adoption of SFAS 123(R), net income included
compensation expense related to restricted stock awards but did
not include stock-based compensation expense for employee stock
options or the purchase discount under Dells ESPP. Total
stock-based compensation expense was $76 million and
$293 million for the three and nine month periods ended
November 3, 2006, respectively. As a result of adopting
SFAS 123(R), income before income taxes and net income were
lower by $57 million and $40 million, respectively,
for the three-month period ended November 3, 2006, and
$222 million and $156 million, respectively, for the
nine-month period ended November 3, 2006, than if Dell had
not adopted SFAS 123(R). The impact on both basic and
diluted earnings per share for the three and nine month periods
ended November 3, 2006 was $0.02 and $0.07 per share,
respectively. The remaining $19 million and
$71 million of pre-tax stock compensation expense for the
three and nine month periods ended November 3, 2006,
respectively, is associated with restricted stock awards that,
consistent with APB 25, are expensed over the associated vesting
period.
Stock-based compensation expense recognized for the three and
nine month periods ended November 3, 2006 is based on
awards expected to vest, reduced for estimated forfeitures.
SFAS 123(R) requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods
if actual
18
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
forfeitures differ from those estimates. In the pro forma
information required under SFAS 123, forfeitures were
accounted for as they occurred. Prior to the adoption of
SFAS 123(R), tax benefits resulting from tax deductions in
excess of the stock-based compensation expense recognized for
those options were classified as operating cash flows. These
excess tax benefits are now classified as financing cash flows
with an offsetting amount classified as a use of operating cash
flows. This amount was $62 million for the nine-month
period ended November 3, 2006. In addition, there was no
material stock-based compensation expense capitalized as part of
the cost of an asset.
Pro Forma
Information under SFAS 123 for Periods Prior to Fiscal 2007
Prior to the adoption of SFAS 123(R), Dell measured
compensation expense for its employee stock-based compensation
plans using the intrinsic value method prescribed by APB 25.
Under APB 25, when the exercise price of Dells employee
stock options equaled or exceeded the market price of the
underlying stock on the date of the grant, no compensation
expense was recognized. Dell applied the disclosure provisions
of SFAS 123 as amended by SFAS 148 as if the
fair-value-based method had been applied in measuring
compensation expense.
The following table illustrates the effect on net income and
earnings per share for the three and nine month periods ended
October 28, 2005 as if Dell had applied the fair value
recognition provisions of SFAS 123 to stock-based employee
compensation:
|
|
|
|
|
|
|
|
|
|
|
October 28,
2005
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
As
|
|
|
As
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
(in millions,
|
|
|
|
except per share
data)
|
|
|
Net income
|
|
$
|
635
|
|
|
$
|
2,525
|
|
Deduct: Total stock-based employee compensation determined under
fair value method for all awards, net of related tax effects
|
|
|
(153
|
)
|
|
|
(567
|
)
|
|
|
|
|
|
|
|
|
|
Net income pro forma
|
|
$
|
482
|
|
|
$
|
1,958
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
|
Basic as restated
|
|
$
|
0.27
|
|
|
$
|
1.04
|
|
|
|
|
|
|
|
|
|
|
Basic pro forma
|
|
$
|
0.20
|
|
|
$
|
0.81
|
|
|
|
|
|
|
|
|
|
|
Diluted as restated
|
|
$
|
0.26
|
|
|
$
|
1.02
|
|
|
|
|
|
|
|
|
|
|
Diluted pro forma
|
|
$
|
0.20
|
|
|
$
|
0.79
|
|
|
|
|
|
|
|
|
|
|
On January 5, 2006, Dells Board of Directors approved
the acceleration of vesting of certain unvested and
out-of-the-money stock options with exercise prices
equal to or greater than $30.75 per share previously awarded
under equity compensation plans. Options to purchase
approximately 101 million shares of common stock, or 29% of
the outstanding unvested options, were subject to the
acceleration. The weighted-average exercise price of the options
that were accelerated was $36.37. The purpose of the
acceleration was to enable Dell to reduce future compensation
expense associated with these options upon the adoption of
SFAS 123(R).
Valuation
Information
SFAS 123(R) requires the use of a valuation model to
calculate the fair value of stock option awards. Dell has
elected to use the Black-Scholes option pricing model, which
incorporates various assumptions,
19
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
including volatility, expected term, and risk-free interest
rates. The volatility is based on a blend of implied and
historical volatility of Dells common stock over the most
recent period commensurate with the estimated expected term of
Dells stock options. Dell uses this blend of implied and
historical volatility, as well as other economic data, because
management believes such volatility is more representative of
prospective trends. The expected term of an award is based on
historical experience and on the terms and conditions of the
stock awards granted to employees. The dividend yield of zero is
based on the fact that Dell has never paid cash dividends and
has no present intention to pay cash dividends.
The weighted-average fair value of stock options and purchase
rights under the employee stock purchase plan was determined
based on the Black-Scholes option pricing model weighted for all
grants during the period, utilizing the assumptions in the
following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Expected term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
3.8 years
|
|
|
|
3.8 years
|
|
|
|
3.4 years
|
|
|
|
3.8 years
|
|
Employee stock purchase plan
|
|
|
3 months
|
|
|
|
3 months
|
|
|
|
3 months
|
|
|
|
3 months
|
|
Risk-free interest rate (U.S. Government Treasury Note)
|
|
|
4.7
|
%
|
|
|
4.1
|
%
|
|
|
4.8
|
%
|
|
|
3.9
|
%
|
Volatility
|
|
|
28
|
%
|
|
|
26
|
%
|
|
|
28
|
%
|
|
|
24
|
%
|
Dividends
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
NOTE 7
|
Financial
Services
|
Joint Venture
Agreement
Dell offers various customer financial services for its business
and consumer customers in the U.S. through DFS, a joint
venture with CIT. Loan and lease financing through DFS is one of
many sources of financing that Dells customers may select.
Dell recognized revenue from the sale of products financed
through DFS of $1.5 billion and $1.6 billion during
the three month periods ended November 3, 2006 and
October 28, 2005, respectively, and $4.5 billion and
$4.6 billion during the nine month periods ended
November 3, 2006 and October 28, 2005, respectively.
On September 8, 2004, Dell and CIT executed an agreement
that extended the term of the joint venture to January 29,
2010 and modified certain terms of the relationship. In
accordance with the extension agreement, net income and losses
generated by DFS are currently allocated 70% to Dell and 30% to
CIT. At November 3, 2006 and February 3, 2006,
CITs equity ownership in the net assets of DFS was
$25 million and $14 million, respectively, which is
recorded as minority interest and included in other non-current
liabilities.
The extension agreement provides Dell with the option to
purchase CITs 30% interest in DFS in February 2008, for a
purchase price ranging from approximately $100 million to
$345 million. Dell currently expects that the purchase
price will likely be towards the upper end of that range. If
Dell does not exercise this purchase option, Dell is obligated
to purchase CITs 30% interest upon the occurrence of
certain termination events, or upon the expiration of the joint
venture on January 29, 2010.
Dell is dependent upon DFS to facilitate financing for a
significant number of customers who elect to finance products
sold by Dell. Dell also purchases loan and lease receivables
facilitated by DFS on substantially the same terms and
conditions as CIT. Dells purchase of these assets allows
Dell to retain a greater portion of the assets future
earnings. During the three and nine month periods ended
November 3,
20
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
2006, Dell funded approximately 35% of these financing
transactions. The percentage of transactions that Dell will
purchase under the extension agreement is expected to be
approximately 50% in Fiscal 2008.
DFS is a full service financial services entity; key activities
include the origination, collection, and servicing of financing
receivables related to the purchase of Dell products. While DFS
services CIT funded receivables, Dells obligation related
to the performance of these receivables is limited to the cash
funded reserves established at the time of funding.
Financing
Receivables
The following table summarizes the components of Dells
financing receivables, net of the allowance for estimated
uncollectible amounts:
|
|
|
|
|
|
|
|
|
|
|
November 3,
|
|
|
February 3,
|
|
|
|
2006
|
|
|
2006
|
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Financing receivables, net:
|
|
|
|
|
|
|
|
|
Customer receivables:
|
|
|
|
|
|
|
|
|
Revolving loans, net
|
|
$
|
821
|
|
|
$
|
1,025
|
|
Leases and loans, net
|
|
|
611
|
|
|
|
302
|
|
|
|
|
|
|
|
|
|
|
Customer receivables, net
|
|
|
1,432
|
|
|
|
1,327
|
|
Residual interests
|
|
|
293
|
|
|
|
274
|
|
Retained interest
|
|
|
115
|
|
|
|
90
|
|
|
|
|
|
|
|
|
|
|
Financing receivables, net
|
|
$
|
1,840
|
|
|
$
|
1,691
|
|
|
|
|
|
|
|
|
|
|
Short-term
|
|
$
|
1,529
|
|
|
$
|
1,366
|
|
Long-term
|
|
|
311
|
|
|
|
325
|
|
|
|
|
|
|
|
|
|
|
Financing receivables, net
|
|
$
|
1,840
|
|
|
$
|
1,691
|
|
|
|
|
|
|
|
|
|
|
Financing receivables primarily consist of revolving loans and
fixed-term leases and loans resulting from the sale of Dell
products. If customers desire revolving or term loan financing,
Dell sells equipment directly to customers who, in turn, enter
into agreements to finance their purchases. For customers who
desire lease financing, Dell sells the equipment to DFS, and DFS
enters into direct financing lease arrangements with the
customers.
|
|
|
Customer receivables are presented net of an allowance for
uncollectible accounts. The allowance is based on factors
including historical trends and the composition and credit
quality of the customer receivables. The composition and credit
quality varies from investment grade commercial customers to
subprime consumers. Customer receivables are charged to the
allowance at the earlier of when an account is deemed to be
uncollectible or when the account is 180 days delinquent.
Recoveries on customer receivables previously charged off as
uncollectible are adjusted to the allowance for uncollectible
accounts. The following is a description of the components of
financing receivables:
|
|
|
|
|
-
|
Revolving loans offered under private label credit financing
programs provide qualified customers with a revolving credit
line for the purchase of products and services offered by Dell.
From time to time, account holders may have the opportunity to
finance their Dell purchases with special programs during which,
if the outstanding balance is paid in full, no interest is
charged. These special programs generally range from 3 to
18 months and have an average original term of
approximately 13 months. Revolving loans bear interest at a
variable annual percentage rate that is tied to the prime rate.
|
21
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
|
-
|
Leases with business customers generally have fixed-terms of two
to three years. Future maturities of minimum lease payments at
November 3, 2006 are as follows: 2007: $38 million;
2008: $50 million; 2009: $29 million; and 2010:
$8 million. Fixed-term loans are also offered to qualified
small businesses for the purchase of products sold by Dell.
|
|
|
|
Dell retains a residual interest in the leased equipment. The
amount of the residual interest is established at the inception
of the lease based upon estimates of the value of the equipment
at the end of the lease term using historical studies, industry
data, and future
value-at-risk
demand valuation methods. On a periodic basis, Dell assesses the
carrying amount of its recorded residual values for impairment.
Anticipated declines in specific future residual values that are
considered to be
other-than-temporary
are recorded in current earnings.
|
|
|
Retained interests represent the residual beneficial interest
Dell retains in certain pools of securitized finance
receivables. Retained interests are stated at the present value
of the estimated net beneficial cash flows after payment of all
senior interests. In estimating the value of retained interests,
Dell makes a variety of financial assumptions, including pool
credit losses, payment rates, and discount rates. These
assumptions are supported by both Dells historical
experience and anticipated trends relative to the particular
receivable pool. Dell reviews its investments in retained
interests periodically for impairment, based on estimated fair
value. Any resulting losses representing the excess of carrying
value over estimated fair value that are other-than-temporary
are recorded in earnings. However, unrealized gains are
reflected in stockholders equity as part of accumulated
other comprehensive income. In the first quarter of Fiscal 2008,
Dell adopted SFAS 155, and as a result, all gains and
losses are recognized in income immediately and are no longer
included in accumulated other comprehensive income.
|
Asset
Securitization
During the first nine months of Fiscal 2007 and Fiscal 2006,
Dell sold $747 million and $253 million, respectively,
of fixed-term leases and loans and revolving loans to
unconsolidated qualifying special purpose entities. The
qualifying special purpose entities are bankruptcy remote legal
entities with assets and liabilities separate from those of
Dell. The sole purpose of the qualifying special purpose
entities is to facilitate the funding of finance receivables in
the capital markets. Dell determines the amount of receivables
to securitize based on its funding requirements in conjunction
with specific selection criteria designed for the transaction.
The qualifying special purpose entities have entered into
financing arrangements with three multi-seller conduits that, in
turn, issue asset-backed debt securities in the capital markets.
Transfers of financing receivables are recorded in accordance
with the provisions of SFAS 140.
Dell retains the right to receive collections on securitized
receivables in excess of amounts needed to pay interest and
principal as well as other required fees. Upon the sale of the
financing receivables, Dell records the present value of the
excess cash flows as a retained interest, which typically
results in a gain that ranges from 2% to 4% of the customer
receivables sold. Dell services the securitized contracts and
earns a servicing fee. Dells securitization transactions
generally do not result in servicing assets and liabilities, as
the contractual fees are adequate compensation in relation to
the associated servicing cost.
Dells securitization program contains structural features
that could prevent further funding if the credit losses or
delinquencies on the pool of sold receivables exceed specified
levels. These structural features are within normal industry
practice and are similar to comparable securitization programs
in the marketplace. Dell does not currently expect that any of
these features will have a material adverse impact on its
ability to securitize financing receivables.
22
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
NOTE 8
|
Warranty
Liability and Related Deferred Revenue
|
Revenue from extended warranty and service contracts, for which
Dell is obligated to perform, is recorded as deferred revenue
and subsequently recognized over the term of the contract or
when the service is completed. Dell records warranty liabilities
at the time of sale for the estimated costs that may be incurred
under its limited warranty. Changes in Dells deferred
revenue for extended warranties and warranty liability for
standard warranties, which are included in other current and
non-current liabilities on Dells Condensed Consolidated
Statements of Financial Position, are presented in the following
tables:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005(b)
|
|
|
2006
|
|
|
2005(b)
|
|
|
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Deferred revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue at beginning of period
|
|
$
|
4,024
|
|
|
$
|
3,284
|
|
|
$
|
3,707
|
|
|
$
|
2,904
|
|
Revenue deferred for new extended warranty and service contracts
sold(a)
|
|
|
810
|
|
|
|
719
|
|
|
|
2,383
|
|
|
|
2,048
|
|
Revenue
recognized(a)
|
|
|
(684
|
)
|
|
|
(524
|
)
|
|
|
(1,940
|
)
|
|
|
(1,473
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue at end of period
|
|
$
|
4,150
|
|
|
$
|
3,479
|
|
|
$
|
4,150
|
|
|
$
|
3,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current portion
|
|
$
|
2,033
|
|
|
$
|
1,786
|
|
|
$
|
2,033
|
|
|
$
|
1,786
|
|
Non-current portion
|
|
|
2,117
|
|
|
|
1,693
|
|
|
|
2,117
|
|
|
|
1,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue at end of period
|
|
$
|
4,150
|
|
|
$
|
3,479
|
|
|
$
|
4,150
|
|
|
$
|
3,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
|
Prior period amounts have been
changed to reflect the current year presentation of service
obligations honored. There is no impact to the Condensed
Consolidated Statements of Financial Position or Condensed
Consolidated Statements of Income as a result of this change.
|
|
(b)
|
|
During the third quarter of Fiscal
2006, Dell recognized a product charge of $307 million for
estimated warranty costs of servicing or replacing certain
OptiPlextm
systems that include a vendor part that failed to perform to
Dells specifications. At November 3, 2006 and
October 28, 2005, $114 million and $274 million,
respectively, of the accrued warranty obligation remain for
servicing or replacing additional
OptiPlextm
systems.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005(b)
|
|
|
2006
|
|
|
2005(b)
|
|
|
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Warranty liability:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warranty liability at beginning of period
|
|
$
|
929
|
|
|
$
|
712
|
|
|
$
|
951
|
|
|
$
|
722
|
|
Costs accrued for new warranty contracts and changes in
estimates for pre-existing
warranties(c)
|
|
|
343
|
|
|
|
574
|
|
|
|
918
|
|
|
|
1,085
|
|
Service obligations
honored(a)
|
|
|
(315
|
)
|
|
|
(336
|
)
|
|
|
(912
|
)
|
|
|
(857
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warranty liability at end of period
|
|
$
|
957
|
|
|
$
|
950
|
|
|
$
|
957
|
|
|
$
|
950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current portion
|
|
$
|
706
|
|
|
$
|
751
|
|
|
$
|
706
|
|
|
$
|
751
|
|
Non-current portion
|
|
|
251
|
|
|
|
199
|
|
|
|
251
|
|
|
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warranty liability at end of period
|
|
$
|
957
|
|
|
$
|
950
|
|
|
$
|
957
|
|
|
$
|
950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
(a)
|
|
Prior period amounts have been
changed to reflect the current year presentation of service
obligations honored. There is no impact to the Condensed
Consolidated Statements of Financial Position or Condensed
Consolidated Statements of Income as a result of this change.
|
|
(b)
|
|
During the third quarter of Fiscal
2006, Dell recognized a product charge of $307 million for
estimated warranty costs of servicing or replacing certain
OptiPlextm
systems that include a vendor part that failed to perform to
Dells specifications. At November 3, 2006 and
October 28, 2005, $114 million and $274 million,
respectively, of the accrued warranty obligation remain for
servicing or replacing additional
OptiPlextm
systems.
|
|
(c)
|
|
Changes in cost estimates related
to pre-existing warranties are aggregated with accruals for new
warranty contracts. Dells warranty liability process does
not differentiate between estimates made for pre-existing
warranties and new warranty obligations.
|
On August 14, 2006, Dell announced a voluntary recall of
approximately 4.2 million Dell-branded lithium-ion
batteries with cells manufactured by a supplier. From
April 1, 2004 through July 18, 2006, Dell sold or
provided these batteries individually or as part of a service
replacement with notebook computers. This recall has not had a
material impact on Dells results of operations, financial
position, or cash flows, as Dell was indemnified by the
manufacturer of these batteries.
|
|
NOTE 9
|
Commitments and
Contingencies
|
DFS Purchase Commitment Pursuant to the joint
venture agreement between Dell and CIT, Dell has an obligation
to purchase CITs 30% interest in DFS at the expiration of
the joint venture on January 29, 2010, for a purchase price
ranging from approximately $100 million to
$345 million. Dell currently expects that the purchase
price will likely be towards the upper end of the range. See
Note 7 of Notes to Condensed Consolidated Financial
Statements.
Restricted Cash Pursuant to an agreement
between DFS and CIT, Dell is required to maintain escrow cash
accounts that are held as recourse reserves for credit losses,
performance fee deposits related to Dells private label
credit card, and deferred servicing revenue. Restricted cash
specific to the consolidation of DFS in the amount of
$407 million and $453 million is included in other
current assets on Dells Consolidated Statements of
Financial Position at November 3, 2006 and February 3,
2006, respectively.
Legal Matters Dell is involved in various
claims, suits, investigations, and legal proceedings that arise
from time to time in the ordinary course of its business. As
required by SFAS No. 5, Accounting for
Contingencies (SFAS 5), Dell accrues a
liability when it believes that it is both probable that a
liability has been incurred and that it can reasonably estimate
the amount of the loss. The following is a discussion of
Dells significant legal matters.
|
|
|
Investigations and Related Litigation In
August 2005, the SEC initiated an inquiry into certain of
Dells accounting and financial reporting matters and
requested that Dell provide certain documents. The SEC expanded
that inquiry in June 2006 and entered a formal order of
investigation in October 2006. The SECs requests for
information were joined by a similar request from the United
States Attorney for the Southern District of New York
(SDNY), who subpoenaed documents related to
Dells financial reporting from and after Fiscal 2002. In
August 2006, because of potential issues identified in the
course of responding to the SECs requests for information,
Dells Audit Committee, on the recommendation of management
and in consultation with PricewaterhouseCoopers LLP, Dells
independent registered public accounting firm, initiated an
independent investigation, which was recently completed. For
information regarding the Audit Committees investigation,
the accounting errors and irregularities identified, and the
restatement adjustments, see Note 2 of Notes to Condensed
Consolidated Financial Statements. Although the Audit Committee
investigation has been completed, the investigations being
conducted by the SEC and the SDNY are ongoing. Dell continues to
cooperate with the SEC and the SDNY.
|
24
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Dell and several of its current and former directors and
officers are parties to securities, Employee Retirement Income
Security Act of 1974 (ERISA), and shareholder
derivative lawsuits all arising out of the same events and
facts. Four putative securities class actions that were filed in
the Western District of Texas, Austin Division, against Dell and
certain of its current and former officers have been
consolidated as In re Dell Inc. Securities Litigation,
and a lead plaintiff has been appointed by the court. The lead
plaintiff has asserted claims under sections 10(b), 20(a),
and 20A of the Securities Exchange Act of 1934 based on alleged
false and misleading disclosures or omissions regarding
Dells financial statements, governmental investigations,
known battery problems, business model, and insiders sales
of its securities. This action also includes Dells
independent registered public accounting firm,
PricewaterhouseCoopers LLP, as a defendant. Four other putative
class actions that were also filed in the Western District by
purported participants in the Dell Inc. 401(k) Plan have been
consolidated as In re Dell Inc. ERISA Litigation, and
lead plaintiffs have been appointed by the court. The lead
plaintiffs have asserted claims under ERISA based on allegations
that Dell, certain current officers, and certain current and
former directors imprudently invested and managed
participants funds and failed to disclose information
regarding its stock held in the 401(k) Plan. In addition, seven
shareholder derivative lawsuits that were filed in three
separate jurisdictions (the Western District of Texas, Austin
Division; the Delaware Chancery Court; and the state district
court in Travis County, Texas) have been consolidated into three
actions, one in each of the respective jurisdictions, as In
re Dell Inc. Derivative Litigation, and name various current
and former officers and directors as defendants and Dell as a
nominal defendant. On October 8, 2007, the shareholder
derivative lawsuit filed in the Western District of Texas was
dismissed without prejudice by the court. The Travis County,
Texas action has been transferred to the state district court in
Williamson County, Texas. The shareholder derivative lawsuits
assert claims derivatively on behalf of Dell under state law,
including breaches of fiduciary duties. Finally, one purported
shareholder has filed an action against Dell in Delaware
Chancery Court under Section 220 of the Delaware General
Corporation Law, Baltimore County Employees Retirement
System v. Dell Inc., seeking inspection of certain of
Dells books and records related to the internal
investigation and government investigations. Dell intends to
defend all of these lawsuits vigorously.
|
|
|
Copyright Levies Proceedings against the IT
industry in Germany seek to impose levies on equipment, such as
personal computers, multifunction devices, and printers that
facilitate making private copies of copyrighted materials. The
total levies due, if imposed, would be based on the number of
products sold and the per-product amounts of the levies, which
vary. Dell, along with other companies and various industry
associations are opposing these levies and instead are
advocating compensation to rights holders through digital rights
management systems.
|
There are currently three levy cases involving other equipment
manufacturers pending before the German Federal Supreme Court.
Adverse decisions in these cases could ultimately impact Dell.
The cases involve personal computers, printers, and
multifunctional devices. The equipment manufacturers in these
cases recently lost in the lower courts and have appealed. The
amount allowed by the lower courts with respect to PCs is
12 per personal computer sold for reprographic copying
capabilities. The amounts claimed with respect to printers and
multifunctional devices depend on speed and color and vary
between 10 and 300 for printers and between 38
and 600 for multifunctional devices. On December 29,
2005, Zentralstelle Für private Überspielungrechte
(ZPÜ), a joint association of various German
collection societies, instituted arbitration proceedings against
Dells German subsidiary before the Arbitration Body in
Munich. ZPÜ claims a levy of 18.4 per PC that Dell
sold in Germany from January 1, 2002 through
December 31, 2005. On July 31, 2007, the Arbitration
Body recommended a levy of 15 on each PC sold during that
period, for audio and visual copying capabilities. Dell and
ZPÜ rejected the recommendation and Dell expects that the
matter will proceed to court. Dell will continue to defend this
claim vigorously.
25
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
|
|
|
Lucent v. Dell In February 2003, Lucent
Technologies, Inc. filed a lawsuit against Dell in the United
States District Court for Delaware, and the lawsuit was
subsequently transferred to the United States District Court for
the Southern District of California. The lawsuit alleges that
Dell infringed 12 patents owned by Lucent and seeks monetary
damages and injunctive relief. In April 2003, Microsoft
Corporation filed a declaratory judgment action against Lucent
in the United States District Court for the Southern District of
California, asserting that Microsoft products do not infringe
patents held by Lucent, including 10 of the 12 patents at issue
in the lawsuit involving Dell and Microsoft. These actions were
consolidated for discovery purposes with a previous suit that
Lucent filed against Gateway, Inc. In September 2005, the court
granted a summary judgment of invalidity with respect to one of
the Lucent patents asserted against Dell. In addition, in
decisions made through May 2007, the court granted summary
judgment of non-infringement with respect to five more of the
Lucent patents asserted against Dell. The court has ordered
invalidity briefing with regard to other patents at issue in
view of the April 30, 2007, U.S. Supreme Court
decision in KSR v. Teleflex. Fact and expert
discovery has closed, and the three actions have been
consolidated. Trial is scheduled to begin in February 2008. Dell
is defending these claims vigorously. Separately, Dell has filed
a lawsuit against Lucent in the United States District Court for
the Eastern District of Texas, alleging that Lucent infringes
two patents owned by Dell and seeking monetary damages and
injunctive relief. That litigation is pending and discovery is
proceeding.
|
|
|
Sales Tax Claims Several state and local
taxing jurisdictions have asserted claims against Dell Catalog
Sales L.P. (DCSLP), an indirect wholly-owned
subsidiary of Dell, alleging that DCSLP had an obligation to
collect tax on sales made into those jurisdictions because of
its alleged nexus, or physical presence, in those jurisdictions.
During the first and second quarter of Fiscal 2008, Dell settled
suits filed by the State of Louisiana and the Secretary of the
Louisiana Department of Revenue and Taxation in the
19th Judicial District Court of the State of Louisiana, and
by two Louisiana parishes, Orleans Parish and Jefferson Parish,
in the State of Louisiana 24th Judicial District Court.
Dell also settled similar claims made by a number of other
Louisiana parishes and by the State of Massachusetts. These
settlement amounts did not have a material adverse effect on
Dells financial condition, results of operations, or cash
flows. While there are ongoing claims by certain other state and
local taxing authorities, DCSLP disputes the allegation that it
had nexus in any of these other jurisdictions during the periods
in issue, and is defending the claims vigorously. Dell does not
expect that the outcome of these other claims, individually or
collectively, will have a material adverse effect on its
financial condition, results of operations, or cash flows.
|
|
|
Income Tax Dell is currently under audit in
various jurisdictions, including the United States. The tax
periods open to examination by the major taxing jurisdictions to
which Dell is subject include Fiscal 1999 through Fiscal 2007.
Dell does not anticipate a significant change to the total
amount of unrecognized benefits within the next 12 months.
|
Dell is involved in various other claims, suits, investigations
and legal proceedings that arise from time to time in the
ordinary course of its business. Although Dell does not expect
that the outcome in any of these other legal proceedings,
individually or collectively, will have a material adverse
effect on its financial condition or results of operations,
litigation is inherently unpredictable. Therefore, Dell could
incur judgments or enter into settlements of claims that could
adversely affect its operating results or cash flows in a
particular period.
|
|
NOTE 10
|
Segment
Information
|
Dell conducts operations worldwide and is managed in three
geographic regions: the Americas; Europe, Middle East, and
Africa (EMEA); and Asia Pacific-Japan
(APJ). The Americas region, which is based in Round
Rock, Texas, covers the U.S., Canada, and Latin America. Within
the Americas, Dell is further
26
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
segmented into Business and U.S. Consumer. The Americas
Business (Business) segment includes sales to
corporate, government, healthcare, education, and small and
medium business customers, while the U.S. Consumer segment
includes sales primarily to individual consumers. The EMEA
segment, based in Bracknell, England, covers Europe, the Middle
East, and Africa. The APJ region, based in Singapore, covers the
Asian countries of the Pacific Rim as well as Australia, New
Zealand, and India.
Corporate expenses are included in Dells measure of
segment operating income for management reporting purposes;
however, with the adoption of SFAS 123(R), beginning in
Fiscal 2007 stock-based compensation expense is not allocated to
Dells reportable segments. The following table presents
net revenue by Dells reportable segments as well as a
reconciliation of consolidated segment operating income to
Dells consolidated operating income for the three and nine
month periods ended November 3, 2006 and October 28,
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
|
|
|
October 28,
|
|
|
November 3,
|
|
|
October 28,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
As
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
|
|
|
Restated
|
|
|
|
|
|
|
(in
millions)
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business
|
|
$
|
7,620
|
|
|
$
|
7,292
|
|
|
$
|
22,232
|
|
|
$
|
21,018
|
|
U.S. Consumer
|
|
|
1,624
|
|
|
|
1,913
|
|
|
|
5,322
|
|
|
|
5,534
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
|
|
|
9,244
|
|
|
|
9,205
|
|
|
|
27,554
|
|
|
|
26,552
|
|
EMEA
|
|
|
3,378
|
|
|
|
3,107
|
|
|
|
9,829
|
|
|
|
9,181
|
|
APJ
|
|
|
1,797
|
|
|
|
1,568
|
|
|
|
5,567
|
|
|
|
4,829
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
14,419
|
|
|
$
|
13,880
|
|
|
$
|
42,950
|
|
|
$
|
40,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business
|
|
$
|
624
|
|
|
$
|
816
|
|
|
$
|
1,843
|
|
|
$
|
2,171
|
|
U.S. Consumer
|
|
|
26
|
|
|
|
91
|
|
|
|
94
|
|
|
|
327
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
|
|
|
650
|
|
|
|
907
|
|
|
|
1,937
|
|
|
|
2,498
|
|
EMEA
|
|
|
154
|
|
|
|
186
|
|
|
|
356
|
|
|
|
589
|
|
APJ
|
|
|
6
|
|
|
|
120
|
|
|
|
243
|
|
|
|
376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated segment operating income
|
|
|
810
|
|
|
|
1,213
|
|
|
|
2,536
|
|
|
|
3,463
|
|
Other product
charges(a)
|
|
|
|
|
|
|
(338
|
)
|
|
|
|
|
|
|
(338
|
)
|
Selling, general, and administrative
charges(b)
|
|
|
|
|
|
|
(83
|
)
|
|
|
|
|
|
|
(83
|
)
|
Stock-based compensation
expense(c)
|
|
|
(76
|
)
|
|
|
|
|
|
|
(293
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated operating income
|
|
$
|
734
|
|
|
$
|
792
|
|
|
$
|
2,243
|
|
|
$
|
3,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
|
Other product charges include
$307 million for estimated warranty costs of servicing or
replacing certain
OptiPlextm
systems that include a vendor part that failed to perform to
Dells specifications, as well as additional charges for
product rationalizations and workforce realignment.
|
|
(b)
|
|
Charges relate to workforce
realignment expenses, primarily for severance and related costs
of $50 million, cost of operating leases on office space no
longer utilized of $4 million, and a write-off of goodwill
of $29 million.
|
|
(c)
|
|
Stock compensation expense of
$4 million and $13 million for three- and nine-month
periods ended October 28, 2005, respectively, is included
in the total consolidated segment operating income.
|
27
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
Commercial
Paper
On June 1, 2006 Dell implemented a $1.0 billion
commercial paper program with a supporting $1.0 billion
senior unsecured revolving credit facility. This program allows
Dell to obtain favorable short-term borrowing rates. Dell pays
facility commitment and letter of credit participation fees at
rates based upon Dells credit rating. Unless extended,
this facility expires on June 1, 2011, at which time any
outstanding amounts under the facility will be due and payable.
The facility requires compliance with conditions that must be
satisfied prior to any borrowing, as well as ongoing compliance
with specified affirmative and negative covenants, including
maintenance of a minimum interest coverage ratio. Amounts
outstanding under the facility may be accelerated for typical
defaults, including failure to pay principal or interest,
breaches of covenants, non-payment of judgments or debt
obligations in excess of $200 million, occurrence of a
change of control, and certain bankruptcy events.
At November 3, 2006, $236 million was outstanding
under the commercial paper program and due within 90 days.
The weighted-average interest rate on these outstanding
short-term borrowings was 5.3% at November 3, 2006. There
were no outstanding advances under the commercial paper program
as of October 26, 2007. Dell intends to use the proceeds of
the program and facility for general corporate purposes,
including funding DFS growth.
DFS Credit
Facilities
DFS maintains credit facilities with CIT that provide a maximum
capacity of $750 million to fund leased equipment. These
borrowings are secured by DFS assets and contain certain
customary restrictive covenants. Interest on the outstanding
loans is paid quarterly and calculated based on an average of
the two- and three-year U.S. Treasury Notes plus 4.45%. DFS
is required to make quarterly payments if the value of the
leased equipment securing the loans is less than the outstanding
principal balance. At November 3, 2006 and February 3,
2006, outstanding advances from CIT totaled $124 million
and $133 million, respectively, of which $84 million
and $63 million, respectively, is included in short-term
borrowings and $41 million and $70 million,
respectively, is included in long-term debt on Dells
Condensed Consolidated Statements of Financial Position. The
credit facilities expire on the earlier of (i) the
dissolution of DFS; (ii) the purchase of CITs
ownership interest in DFS; or (iii) the acceleration of the
maturity of the debt by CIT arising from a default.
Long-Term Debt
and Interest Rate Risk Management
In April 1998, Dell issued $200 million 6.55% fixed rate
senior notes with the principal balance due April 15, 2008
(the Senior Notes) and $300 million 7.10% fixed
rate senior debentures with the principal balance due
April 15, 2028 (the Senior Debentures).
Interest on the Senior Notes and Senior Debentures is paid
semi-annually, on April 15 and October 15. The Senior Notes
and Senior Debentures rank equally and are redeemable, in whole
or in part, at the election of Dell for principal, any accrued
interest, and a redemption premium based on the present value of
interest to be paid over the term of the debt agreements. The
Senior Notes and Senior Debentures generally contain no
restrictive covenants, other than a limitation on liens on
Dells assets and a limitation on sale-leaseback
transactions involving Dell property.
Dells inability to timely file its periodic reports with
the SEC constituted a technical breach of the covenants to which
the Senior Notes and the Senior Debentures are subject. Those
covenants specify that a Notice of Default must be
issued, and Dell must have failed to cure the deficiency within
90 days of the notice, before the debt is callable by the
holders. Because Dell has not received a Notice of
Default, Dell is not in default of these debt covenants;
therefore, the Senior Notes and the Senior Debentures are
classified as
28
DELL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(unaudited)
long-term liabilities at November 3, 2006. With the filing
of its past due periodic reports with the SEC, Dell is no longer
in breach of the covenants.
Concurrent with the issuance of the Senior Notes and Senior
Debentures, Dell entered into interest rate swap agreements
converting Dells interest rate exposure from a fixed rate
to a floating rate basis to better align the associated interest
rate characteristics to its cash and investments portfolio. The
interest rate swap agreements have an aggregate notional amount
of $200 million maturing April 15, 2008 and
$300 million maturing April 15, 2028. The floating
rates are based on three-month London Interbank Offered Rates
plus 0.4% and 0.8% for the Senior Notes and Senior Debentures,
respectively. As a result of the interest rate swap agreements,
Dells effective interest rates for the Senior Notes and
Senior Debentures were 6.1% and 6.4%, respectively, for the
third quarter of Fiscal 2007.
The interest rate swap agreements are designated as fair value
hedges. Although the Senior Notes and Senior Debentures allow
for settlement before their stated maturity, such settlement
would always be at an amount greater than the fair value of the
Senior Notes and Senior Debentures. Accordingly, the Senior
Notes and Senior Debentures are not considered to be pre-payable
as defined by SFAS 133 and related interpretations. The
changes in the fair value of the interest rate swaps are
assessed in accordance with SFAS 133.
|
|
NOTE 12
|
Redeemable Common
Stock
|
Dell inadvertently failed to register with the SEC the sale of
some shares under certain employee benefit plans. As a result,
certain purchasers of common stock pursuant to those plans may
have the right to rescind their purchases for an amount equal to
the purchase price paid for the shares, plus interest from the
date of purchase. At November 3, 2006, Dell has classified
4 million shares ($88 million) that may be subject to
the rescissionary rights outside stockholders equity,
because the redemption features are not within the control of
Dell. These shares have always been treated as outstanding for
financial reporting purposes.
|
|
NOTE 13
|
Subsequent
Events
|
On August 2, 2007, Dell announced the planned acquisition
of ASAP Software, a leading software solutions and licensing
services provider, and currently a subsidiary of Corporate
Express. The acquisition will strengthen Dells existing
software business by integrating ASAPs complementary
expertise in managing software licensing, purchasing, renewals,
and compliance. The acquisition is anticipated to close during
Dells fourth quarter of Fiscal 2008.
On August 13, 2007, Dell completed its previously announced
acquisition of ZING Systems, Inc., a consumer technology and
services company that focuses on always-connected audio and
entertainment devices. ZING Systems, Inc. will be integrated
into Dells Consumer Product Group and will be used to
continue improving the entertainment experiences provided to
customers.
29
|
|
ITEM 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
SPECIAL NOTE: This section,
Managements Discussion and Analysis of Financial
Condition and Results of Operations, contains
forward-looking statements based on our current expectations.
Actual results in future periods may differ materially from
those expressed or implied by those forward-looking statements
because of a number of risks and uncertainties. For a discussion
of risk factors affecting our business and prospects, see
Part II Item 1A Risk
Factors.
All percentage amounts and ratios were calculated using
the underlying data in thousands. Unless otherwise noted, all
references to industry share and total industry growth data are
for personal computers (including desktops, notebooks, and x86
servers), and are based on information provided by IDC Worldwide
Quarterly PC Tracker, September 2007. Share data is for the
calendar quarter, and all our growth rates are on a fiscal
year-over-year basis. Unless otherwise noted, all references to
time periods refer to our fiscal periods.
AUDIT COMMITTEE
INDEPENDENT INVESTIGATION AND RESTATEMENT
Background
In August 2005, the Division of Enforcement of the United States
Securities and Exchange Commission (the SEC)
initiated an inquiry into certain of our accounting and
financial reporting matters and requested that we provide
certain documents. Over the course of several months, we
produced documents and provided information in response to the
SECs initial request and subsequent requests.
In June 2006, the SEC sent us an additional request for
documents and information that appeared to expand the scope of
the inquiry, with respect to both issues and periods. As
documents and information were collected in response to this
additional request, our management was made aware of information
that raised significant accounting and financial reporting
concerns, including whether accruals, reserves, and other
balance sheet items had been recorded and reported properly.
After evaluating this information and in consultation with
PricewaterhouseCoopers LLP, our independent registered public
accounting firm, management determined that the identified
issues warranted an independent investigation and recommended
such to the Audit Committee of our Board of Directors.
On August 16, 2006, the Audit Committee, acting on
managements recommendation, approved the initiation of an
independent investigation. The Audit Committee engaged Willkie
Farr & Gallagher LLP (Willkie Farr) to
lead the investigation as independent legal counsel to the Audit
Committee. Willkie Farr in turn engaged KPMG LLP
(KPMG) to serve as its independent forensic
accountants.
Scope of the
Investigation
The scope of the investigation was determined by Willkie Farr,
in consultation with the Audit Committee and KPMG. The
investigation involved a program of forensic analysis and
inquiry directed to aspects of our accounting and financial
reporting practices throughout the world, and evaluated aspects
of our historical accounting and financial reporting practices
since Fiscal 2002 and, with respect to certain issues, prior
fiscal years.
Willkie Farr and KPMG assembled an investigative team that
ultimately consisted of more than 375 professionals, including
more than 125 lawyers and 250 accountants. Investigative teams
were deployed in our three geographic regions
Americas (including our corporate functions); Europe, Middle
East and Africa (EMEA); and Asia Pacific-Japan
(APJ). Information and documents were gathered from
company personnel worldwide. Using proprietary search software,
the investigative team evaluated over five million documents.
Investigative counsel also conducted over 200 interviews of
approximately 150 individuals, and the KPMG accountants, in
connection with their forensic work, conducted numerous less
formal discussions with various company employees. In addition,
using a proprietary software tool designed to identify
potentially questionable journal entries based
30
on selected criteria (for example, entries made late in the
quarterly close process, entries containing round dollar line
items between $3 million and $50 million, and
liability-to-liability transfers), KPMG selected and reviewed in
excess of 2,600 journal entries that were highlighted by the
tool or specifically identified by the forensic teams
investigating specific issues.
Summary of
Investigation Findings
The investigation raised questions relating to numerous
accounting issues, most of which involved adjustments to various
reserve and accrued liability accounts, and identified evidence
that certain adjustments appear to have been motivated by the
objective of attaining financial targets. According to the
investigation, these activities typically occurred in the days
immediately following the end of a quarter, when the accounting
books were being closed and the results of the quarter were
being compiled. The investigation found evidence that, in that
timeframe, account balances were reviewed, sometimes at the
request or with the knowledge of senior executives, with the
goal of seeking adjustments so that quarterly performance
objectives could be met. The investigation concluded that a
number of these adjustments were improper, including the
creation and release of accruals and reserves that appear to
have been made for the purpose of enhancing internal performance
measures or reported results, as well as the transfer of excess
accruals from one liability account to another and the use of
the excess balances to offset unrelated expenses in later
periods. The investigation found that sometimes business unit
personnel did not provide complete information to corporate
headquarters and, in a number of instances, purposefully
incorrect or incomplete information about these activities was
provided to internal or external auditors.
The investigation identified evidence that accounting
adjustments were viewed at times as an acceptable device to
compensate for earnings shortfalls that could not be closed
through operational means. Often, these adjustments were several
hundred thousand or several million dollars in the context of a
company with annual revenues ranging from $35.3 billion to
$55.8 billion and annual net income ranging from
$2.0 billion to $3.6 billion for the periods in
question. The errors and irregularities identified in the course
of the investigation revealed deficiencies in our accounting and
financial control environment, some of which were determined to
be material weaknesses that require corrective and remedial
actions. For a description of the control deficiencies
identified by management as a result of the investigation and
our internal reviews described below, as well as
managements plan to remediate those deficiencies, see
Part I Item 4 Controls
and Procedures.
Other Company
Identified Adjustments
Concurrently with the investigation, we also conducted extensive
internal reviews for the purpose of the preparation and
certification of our Fiscal 2007 and prior financial statements
and our assessment of internal controls over financial
reporting. Our procedures included expanded account reviews and
expanded balance sheet reconciliations to ensure all accounts
were fully reconciled, supported, and appropriately documented.
We also implemented improvements to our quarterly and annual
accounting close process to provide for more complete review of
the various business unit financial results. These additional
reviews identified issues involving, among other things, revenue
recognition in connection with sales of third party software,
amortization of revenue related to after-point-of-sale extended
warranties, and accounting for certain vendor reimbursement
agreements.
Restatement
As a result of issues identified in the Audit Committee
investigation, as well as issues identified in the additional
reviews and procedures conducted by management, the Audit
Committee, in consultation with management and
PricewaterhouseCoopers LLP, our independent registered public
accounting firm, concluded on August 13, 2007 that our
previously issued financial statements for Fiscal 2003, 2004,
2005, and 2006 (including the interim periods within those
years), and the first quarter of Fiscal 2007, should no longer
be relied upon because of certain accounting errors and
irregularities in those
31
financial statements. Accordingly, we have restated our
previously issued financial statements for those periods. See
Note 2 of Notes to Condensed Consolidated Financial
Statements included in Part I
Item 1 Financial Statements.
Overview
Our Company
As a leading technology company, we offer a broad range of
product categories, including desktop computer systems, mobility
products, servers, storage, software and peripherals, and
services. We are the number one supplier of desktop and notebook
systems in the United States, and the number two supplier
worldwide. Our past performance has been the result of a
persistent focus on delivering directly to our customers
relevant technology and services at the best value.
Our business strategy is evolving. Historically we utilized our
direct customer model and highly efficient manufacturing and
logistics to lower the cost of technology for our customers. We
are now simplifying information technology for our customers
from point of sale to the usability of our products to the
service solutions we sell. Using this strategy, we strive to
provide the best possible customer experience by offering
superior value; high-quality relevant technology; customized
systems; superior service and support; and differentiated
products and services that are easy to buy and use. We also
offer various financing alternatives, asset management services,
and other customer financial services for business and consumer
customers. To reach even more customers globally we have
launched new distribution channels to reach commercial customers
and individual consumers around the world.
Although the focus of our business strategy is selling directly
to customers, we also utilize indirect sales channels when there
is a business need. During Fiscal 2008, we began offering Dell
Dimensiontm
desktop computers and
Inspirontm
notebook computers in retail stores in the Americas and
announced partnerships with retailers in the U.K., Japan, and
China. These actions represent one of the first steps in our
retail strategy, which will allow us to extend our model and
reach customers that we have not been able to reach directly.
We manufacture most of the products we sell and have
manufacturing locations worldwide to service our global customer
base. Our build-to-order manufacturing process is designed to
allow us to significantly reduce cost while simultaneously
providing customers the ability to customize their product
purchases. We also have relationships with third-party original
equipment manufacturers that build some of our products (such as
printers and projectors) to our specifications, and we are
exploring the expanded use of original design manufacturing
partnerships and manufacturing outsourcing relationships in
order to deliver products faster and better serve our customers
in certain markets.
Current Business
Environment
We participate in a highly competitive industry that is subject
to aggressive pricing and strong competitive pressures; however,
we believe that our growth potential remains strong. In the
U.S., rising energy prices, weakening real estate markets, and
inflationary pressures may lead to slower economic growth, which
may affect IT and consumer spending during the fourth quarter of
Fiscal 2008. A slow down in the U.S. economy could
adversely impact other regional markets. Economic conditions in
our international markets, which are key to our expansion goals,
are highlighted by growing economies in Central and Eastern
Europe, expansion in Asia Pacific-Japan (APJ), and
continued development in Latin America. Overall, expected
industry growth is in line with prior year growth.
32
Third Quarter
Performance
|
|
|
|
|
Share position
|
|
|
|
We shipped more than 9 million units, resulting in a
worldwide PC share position of 16.9%.
|
Net revenue
|
|
|
|
Revenue increased 4% year-over-year to $14.4 billion, with
unit shipments up 3% year-over-year.
|
Operating income
|
|
|
|
Operating income was
$734(a) million
for the quarter, or 5.1% of revenue, as compared to
$792(b) million
or 5.7% of revenue for third quarter of Fiscal 2006.
|
Earnings per share
|
|
|
|
Earnings per share increased 3% to
$0.27(a)
for the quarter compared to
$0.26(b)
for the third quarter of Fiscal 2006.
|
|
|
|
(a)
|
|
Operating income and earnings per
share for the three-month period ended November 3, 2006
include stock-based compensation expense pursuant to Statement
of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment. See Note 6 to Condensed
Consolidated Financial Statements included in
Part I Item 1 Financial
Statements for additional information.
|
|
(b)
|
|
Results for the three-month period
ended October 28, 2005 include charges aggregating
$421 million ($338 million of other product charges
and $83 million in selling, general, and administrative
expenses) related to the cost of servicing or replacing certain
OptiPlextm
systems that include a vendor part that failed to perform to our
specification, workforce realignment, product rationalizations,
excess facilities, and a write-off of goodwill. The related tax
effects of these items totaled $96 million.
|
Results of
Operations
The following table summarizes the results of our operations for
the three and nine month periods ended November 3, 2006 and
October 28, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
(in millions,
except per share amounts and percentages)
|
|
|
Net revenue
|
|
$
|
14,419
|
|
|
|
100.0
|
%
|
|
$
|
13,880
|
|
|
|
100.0
|
%
|
|
$
|
42,950
|
|
|
|
100.0
|
%
|
|
$
|
40,562
|
|
|
|
100.0
|
%
|
Gross margin
|
|
$
|
2,391
|
|
|
|
16.6
|
%
|
|
$
|
2,265
|
|
|
|
16.3
|
%
|
|
$
|
7,037
|
|
|
|
16.4
|
%
|
|
$
|
7,148
|
|
|
|
17.6
|
%
|
Operating expenses
|
|
$
|
1,657
|
|
|
|
11.5
|
%
|
|
$
|
1,473
|
|
|
|
10.6
|
%
|
|
$
|
4,794
|
|
|
|
11.2
|
%
|
|
$
|
4,106
|
|
|
|
10.1
|
%
|
Operating income
|
|
$
|
734
|
|
|
|
5.1
|
%
|
|
$
|
792
|
|
|
|
5.7
|
%
|
|
$
|
2,243
|
|
|
|
5.2
|
%
|
|
$
|
3,042
|
|
|
|
7.5
|
%
|
Net income
|
|
$
|
601
|
|
|
|
4.2
|
%
|
|
$
|
635
|
|
|
|
4.6
|
%
|
|
$
|
1,857
|
|
|
|
4.3
|
%
|
|
$
|
2,525
|
|
|
|
6.2
|
%
|
Earnings per share diluted
|
|
$
|
0.27
|
|
|
|
N/A
|
|
|
$
|
0.26
|
|
|
|
N/A
|
|
|
$
|
0.82
|
|
|
|
N/A
|
|
|
$
|
1.02
|
|
|
|
N/A
|
|
Consolidated
Revenue
In both the third quarter and first nine months of Fiscal 2007,
consolidated revenue grew year-over-year across all product
categories, with the exception of desktop PCs. Desktop PCs
declined year-over-year 9% for the third quarter and 4% for
first nine months of Fiscal 2007, continuing the trend of the
past few quarters. This decline in revenue reflects an
industry-wide shift to mobility products and strong competitive
pricing pressures. This pricing pressure resulted in a 4% drop
in average selling price for the third quarter and 5% for the
nine months ending November 3, 2006. Revenue outside the
U.S. for the third quarter and first nine months of Fiscal
2007 comprised 43% of consolidated revenue, compared to 40% for
the same periods in the prior year.
During the first nine months of Fiscal 2007, we saw intensive
competitive pressure, particularly for lower priced desktops and
notebooks, as competitors had competitively priced products with
better product ID and more relevant feature sets. As a result,
particularly in the United States, we lost share in the consumer
segment in notebooks and desktops, which slowed our overall
growth in unit shipments, revenue, and profitability.
33
Revenues by
Segment
We conduct operations worldwide and manage our business in three
geographic regions: the Americas, EMEA, and APJ. The Americas
region covers the U.S., Canada, and Latin America. Within the
Americas, we are further segmented into Business and
U.S. Consumer. The Business segment includes sales to
corporate, government, healthcare, education, and small and
medium business customers within the Americas region, while the
U.S. Consumer segment includes sales primarily to
individual consumers within the U.S. The EMEA region covers
Europe, the Middle East, and Africa. The APJ region covers the
Asian countries of the Pacific Rim as well as Australia, New
Zealand, and India.
The following table summarizes our revenue by reportable segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
(in millions,
except percentages)
|
|
|
Net revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business
|
|
$
|
7,620
|
|
|
|
52.8
|
%
|
|
$
|
7,292
|
|
|
|
52.5
|
%
|
|
$
|
22,232
|
|
|
|
51.8
|
%
|
|
$
|
21,018
|
|
|
|
51.8
|
%
|
U.S. Consumer
|
|
|
1,624
|
|
|
|
11.3
|
%
|
|
|
1,913
|
|
|
|
13.8
|
%
|
|
|
5,322
|
|
|
|
12.4
|
%
|
|
|
5,534
|
|
|
|
13.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
|
|
|
9,244
|
|
|
|
64.1
|
%
|
|
|
9,205
|
|
|
|
66.3
|
%
|
|
|
27,554
|
|
|
|
64.2
|
%
|
|
|
26,552
|
|
|
|
65.5
|
%
|
EMEA
|
|
|
3,378
|
|
|
|
23.4
|
%
|
|
|
3,107
|
|
|
|
22.4
|
%
|
|
|
9,829
|
|
|
|
22.9
|
%
|
|
|
9,181
|
|
|
|
22.6
|
%
|
APJ
|
|
|
1,797
|
|
|
|
12.5
|
%
|
|
|
1,568
|
|
|
|
11.3
|
%
|
|
|
5,567
|
|
|
|
12.9
|
%
|
|
|
4,829
|
|
|
|
11.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
14,419
|
|
|
|
100.0
|
%
|
|
$
|
13,880
|
|
|
|
100.0
|
%
|
|
$
|
42,950
|
|
|
|
100.0
|
%
|
|
$
|
40,562
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas Americas revenues increased
slightly for the third quarter and the nine-month period ended
November 3, 2006, as compared to prior periods. Growth of
5% in our Americas Business segment for the third quarter and 6%
for the first nine months of Fiscal 2007 was offset by a decline
of 15% for the third quarter and 4% for the first nine months in
our U.S. Consumer segment compared to the same periods of
the prior year. Americas International produced strong revenue
growth of 26% and 27% year-over-year for the third quarter and
first nine months of Fiscal 2007, respectively.
|
|
|
|
|
-
|
Business For the three- and nine-month
periods ended November 3, 2006, we experienced strong
performance in corporate accounts, particularly medium-sized
commercial customers. The slow down of growth was due to weak
performance in desktop revenue and mobility growth at less than
overall U.S. sales growth. Desktop PCs revenues declined 6%
for the third quarter of Fiscal 2007 and 4% for the nine months
ending November 3, 2007, due to shifts to mobility and
competitive pricing pressures.
|
|
|
-
|
U.S. Consumer U.S. Consumer
revenue declined 15% for the third quarter of Fiscal 2007 and 4%
for the nine months ended November 3, 2006. This decline
was driven by lower desktop PC demand with units down 34% for
the third quarter of Fiscal 2007 and 15% for the nine months
ended November 3, 2006. As competitive price pressures
continue and as notebooks became more affordable, we continue to
see a shift to mobility products in U.S. Consumer; however,
we failed to capitalize on this shift, with mobility units down
6% and revenue down 3% for the third quarter of Fiscal 2007.
|
|
|
|
EMEA EMEA revenue grew 9% for the
third quarter and 7% for the first nine months of Fiscal 2007.
Revenue growth was driven primarily by increases in mobility
products, storage, and enhanced services sales. Unit growth was
9% for the third quarter and 11% for the nine months ended
November 3, 2006. France and Germany drove the
year-over-year revenue growth while the United Kingdom declined
slightly.
|
|
|
APJ APJ revenue grew 15% on unit
growth of 23% for the three-month period ended November 3,
2006 and 15% on unit growth of 27% for the nine-month period
ended November 3, 2006. China reported revenue growth of
25% and 29% year-over-year for the third quarter and first nine
months of Fiscal 2007, respectively; and South Korea, India,
Singapore, and Malaysia produced significant year-over-year
|
34
|
|
|
growth at rates well above the overall region. Mobility
products, storage, enhanced services, and software and
peripherals revenues posted strong gains during the third
quarter and first nine months of Fiscal 2007. While unit growth
was strong, competitive pricing pressured average selling prices
to decline 7% compared to the same period in the prior year.
|
Revenue by
Product and Services Categories
We design, develop, manufacture, market, sell, and support a
wide range of products that are, in many cases, customized to
individual customer requirements. Our product categories include
desktop computer systems, mobility products, software and
peripherals, servers and networking products, and storage
products. In addition, we offer a wide range of enhanced
services.
In Fiscal 2007, we performed an analysis of our enhanced
services revenue and determined that certain items previously
classified as enhanced services revenue were more appropriately
categorized within product revenue. Fiscal 2007 balances reflect
the revised revenue classifications, and prior periods have been
revised to conform to the current period classification. The
change in classification of prior period amounts resulted in an
increase of $295 million to desktop PCs, $165 million
to mobility, $8 million to software and peripherals,
$12 million to servers and networking, and $4 million
to storage for the nine-month period ended October 28,
2005. This change in classification was completely offset by a
decrease in enhanced services of $484 million for the
nine-month period ended October 28, 2005.
The following table summarizes our net revenue by product and
services categories:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
(in millions,
except percentages)
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Desktop PCs
|
|
$
|
4,783
|
|
|
|
33
|
%
|
|
$
|
5,229
|
|
|
|
38
|
%
|
|
$
|
15,066
|
|
|
|
35
|
%
|
|
$
|
15,774
|
|
|
|
39
|
%
|
Mobility
|
|
|
3,968
|
|
|
|
27
|
%
|
|
|
3,649
|
|
|
|
26
|
%
|
|
|
11,595
|
|
|
|
27
|
%
|
|
|
10,466
|
|
|
|
26
|
%
|
Software & peripherals
|
|
|
2,287
|
|
|
|
16
|
%
|
|
|
2,082
|
|
|
|
15
|
%
|
|
|
6,688
|
|
|
|
15
|
%
|
|
|
6,025
|
|
|
|
15
|
%
|
Servers & networking
|
|
|
1,529
|
|
|
|
11
|
%
|
|
|
1,383
|
|
|
|
10
|
%
|
|
|
4,228
|
|
|
|
10
|
%
|
|
|
4,001
|
|
|
|
10
|
%
|
Enhanced services
|
|
|
1,272
|
|
|
|
9
|
%
|
|
|
1,090
|
|
|
|
8
|
%
|
|
|
3,755
|
|
|
|
9
|
%
|
|
|
3,015
|
|
|
|
7
|
%
|
Storage
|
|
|
580
|
|
|
|
4
|
%
|
|
|
447
|
|
|
|
3
|
%
|
|
|
1,618
|
|
|
|
4
|
%
|
|
|
1,281
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
14,419
|
|
|
|
100
|
%
|
|
$
|
13,880
|
|
|
|
100
|
%
|
|
$
|
42,950
|
|
|
|
100
|
%
|
|
$
|
40,562
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
Desktop PCs Revenue from sales of
desktop PCs consists of Dell
XPStm,
Dell
OptiPlextm,
Dell
Dimensiontm,
Alienware
Auroratm,
Alienware
Area-51®,
and Alienware
ALXtm
desktop computer systems and Dell
Precisiontm
and Alienware
MJ-12®
desktop workstations. Desktop PCs revenue declined 9% on a unit
decrease of 5% year-over-year for the third quarter of Fiscal
2007, and declined 4% on a unit decline of 1% for the first nine
months of Fiscal 2007. Average selling prices declined 4%
year-over-year for both the third quarter and nine months ended
November 3, 2006. The overall decline in revenues was
driven by a 12% revenue decline in the Americas for the third
quarter and 7% decline for the first nine months of Fiscal 2007,
primarily in the U.S. Consumer business. During the same
time periods, APJ desktop PC revenues increased 3% and 7%,
respectively. Business and consumer demand continues to shift
toward mobility products as notebook computers become more
affordable. During the third quarter of Fiscal 2007, we launched
Quad-core processors on our XPS 710 Extreme desktop as well as
on Dell
Precisiontm
workstations. In addition, we introduced our 64-bit dual core
Dimensiontm
and
OptiPlextm
systems featuring AMD processors.
|
|
|
-
|
Mobility Revenue from mobility
products consists of Dell
XPStm,
Dell
Latitudetm,
Dell
Inspirontm
and Alienware
Auroratm,
Alienware
Area-51®,
Alienware
Sentiatm,
Alienware
ALXtm
notebook computer systems, Dell
Precisiontm
and Alienware
MJ-12®
mobile workstations, Dell MP3 players, and Dell
Aximtm
handhelds. Mobility revenue grew 9% on unit growth of 17%
year-over-year for the third quarter
|
35
|
|
|
|
|
and 11% on unit growth of 24% year-over-year for the first nine
months of Fiscal 2007. As notebooks become more affordable and
wireless products become standardized, demand for our mobility
products continues to grow rapidly. During the third quarter of
Fiscal 2007, we introduced Dell LatitudeTM and Dell InspironTM
notebooks featuring AMD processors.
|
|
|
|
|
-
|
Software and Peripherals Revenue from
sales of software and peripherals consists of Dell-branded
printers, monitors (not sold with systems), plasma and LCD
televisions, projectors, and a multitude of competitively priced
third-party peripherals, software, and other products. Software
and peripherals revenue increased 10% year-over-year in the
third quarter and 11% during the first nine months of Fiscal
2007. This increase was driven primarily by revenue growth in
APJ of 52% and 46% for the third quarter and first nine months
of Fiscal 2007, respectively.
|
|
|
-
|
Enhanced Services Enhanced services
consists of a wide range of services including assessment,
design and implementation, deployment, asset recovery and
recycling, training, enterprise support, client support, and
managed lifecycle. Enhanced services revenue increased 17% and
25% year-over-year for the three and nine month periods ended
November 3, 2006, respectively. As a result of expanding
our service offerings and capabilities globally, we increased
our deferred revenue balance by $443 million to
$4.2 billion in the third quarter of Fiscal 2007 as
compared to Fiscal 2006. Our new Platinum Plus offering drove an
increase in premium service contracts year-over-year, and we now
have more than 300 Platinum Plus customers.
|
|
|
-
|
Servers and Networking Revenue from
sales of servers and networking products, consisting of our
standards-based
PowerEdgetm
line of servers and
PowerConnecttm
networking products, grew 10% on unit growth of 12%
year-over-year for the third quarter and 6% on unit growth of 8%
year-over-year for the first nine months of Fiscal 2007. This
revenue growth was driven by our Americas segment which grew 12%
and 6% for the third quarter and first nine months of Fiscal
2007, respectively. Servers and networking remains a strategic
focus area. We competitively price our server products to
facilitate additional sales of storage products and higher
margin enhanced services. In the third quarter of Fiscal 2007,
we began shipping two new
PowerEdgetm
servers featuring AMD
Opterontm
processors, providing customers an additional choice for
high-performance two-socket and four-socket systems. We also
launched the industrys first standards-based Quad-Core
processors for two-socket blade, rack, and tower servers.
Combined with the 9G servers launched last quarter with Intel
Xeon 5100 series processors, we now provide the broadest
selection of industry-standard servers in our history.
|
|
|
-
|
Storage Revenue from sales of storage
products, consisting of a comprehensive portfolio of storage
solutions with services, including Dell | EMC and
Dell
PowerVaulttm
storage devices, increased 30% and 26% for the third quarter and
first nine months of Fiscal 2007, respectively. The growth was
led by EMEA storage revenue increase of 42% for the third
quarter of Fiscal 2007. We also grew storage revenue in the
Americas by 27% for the both the third quarter and first nine
months of Fiscal 2007. During the quarter, we announced a
five-year extension to our partnership with EMC.
|
Gross
Margin
The following table presents information regarding our gross
margin for the three and nine month periods ended
November 3, 2006 and October 28, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
Nine Months
Ended
|
|
|
November 3,
2006
|
|
October 28,
2005
|
|
November 3,
2006
|
|
October 28,
2005
|
|
|
|
|
% of
|
|
|
|
% of
|
|
|
|
% of
|
|
|
|
% of
|
|
|
Dollars
|
|
Revenue
|
|
Dollars
|
|
Revenue
|
|
Dollars
|
|
Revenue
|
|
Dollars
|
|
Revenue
|
|
|
|
|
|
|
As
|
|
As
|
|
|
|
|
|
As
|
|
As
|
|
|
|
|
|
|
Restated
|
|
Restated
|
|
|
|
|
|
Restated
|
|
Restated
|
|
|
(in millions,
except percentages)
|
|
Net revenue
|
|
$
|
14,419
|
|
|
|
100.0
|
%
|
|
$
|
13,880
|
|
|
|
100.0
|
%
|
|
$
|
42,950
|
|
|
|
100.0
|
%
|
|
$
|
40,562
|
|
|
|
100.0
|
%
|
Gross margin
|
|
$
|
2,391
|
|
|
|
16.6
|
%
|
|
$
|
2,265
|
|
|
|
16.3
|
%
|
|
$
|
7,037
|
|
|
|
16.4
|
%
|
|
$
|
7,148
|
|
|
|
17.6
|
%
|
Our margins as a percentage of net revenue declined for the
first nine months of Fiscal 2007 as compared to the same period
in the prior year. For the third quarter, the increase in margin
was primarily due to a
36
favorable component cost environment. These favorable component
costs for the third quarter were not enough to offset product
price declines for the nine months ending November 3, 2006,
which resulted in gross margin for the nine months ending
November 3, 2006 being lower than the same period in the
prior year. The product price declines were due to a highly
competitive and aggressive environment. We continuously
negotiate with our suppliers in a variety of areas including
availability of supply, quality, and cost. These real-time,
continuous supplier negotiations support our business model,
which is able to respond quickly to changing market conditions
due to our direct customer model and real-time manufacturing.
Our component costs reflect both ongoing supplier discount
arrangements as well as shorter-term incremental discounts and
rebates, based on such factors as volume, product offerings and
transitions, supply conditions, and joint activities. Because of
the fluid nature of these ongoing negotiations, the timing and
amount of supplier discounts and rebates vary from time to time.
In Fiscal 2007, we added a second source of micro processors
(chip sets) ending a long-standing practice of
sourcing from only one manufacturer. We believe that moving to
more than one supplier of chip sets is beneficial for customers
long term, as it adds choice and ensures access to the most
current technologies. We now sell the second source of chip sets
across all of our hardware product categories. During the
transition from sole to dual sourcing of chip sets, gross and
operating income margins were negatively impacted as we
re-balanced product and category mix.
On August 14, 2006, we announced a voluntary recall of
approximately 4.2 million Dell-branded lithium-ion
batteries with cells manufactured by a supplier From
April 1, 2004 through July 18, 2006, we sold or
provided these batteries individually or as part of a service
replacement with notebook computers. This recall has not had a
material impact on our results of operations, financial
position, or cash flows, as we were indemnified by the
manufacturer of these batteries.
Operating
Expenses
The following table summarizes our operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
|
|
|
Nine Months
Ended
|
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
November 3,
2006
|
|
|
October 28,
2005
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
|
|
% of
|
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
Dollars
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
As
|
|
|
As
|
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
|
|
|
|
|
Restated
|
|
|
Restated
|
|
|
|
(in millions,
except percentages)
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
$
|
1,531
|
|
|
|
10.6
|
%
|
|
$
|
1,369
|
|
|
|
9.8
|
%
|
|
$
|
4,414
|
|
|
|
10.3
|
%
|
|
$
|
3,771
|
|
|
|
9.3
|
%
|
Research, development, and engineering
|
|
|
126
|
|
|
|
0.9
|
%
|
|
|
104
|
|
|
|
0.8
|
%
|
|
|
380
|
|
|
|
0.9
|
%
|
|
|
335
|
|
|
|
0.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
$
|
1,657
|
|
|
|
11.5
|
%
|
|
$
|
1,473
|
|
|
|
10.6
|
%
|
|
$
|
4,794
|
|
|
|
11.2
|
%
|
|
$
|
4,106
|
|
|
|
10.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative During
the third quarter and first nine months of Fiscal 2007, selling,
general, and administrative expenses increased 12% to
$1.5 billion and 17% to $4.4 billion, respectively,
compared to $1.4 billion and $3.8 billion in the same
periods of Fiscal 2006. Stock-based compensation expense and
costs related to headcount growth primarily drove the increase
in selling, general, and administrative expenses in the third
quarter and first nine months of Fiscal 2007 versus the
comparable periods in the prior year. Stock-based compensation
expense included in selling, general, and administrative was
$57 million and $215 million for the third quarter and
first nine months of Fiscal 2007, respectively. During the first
nine months of Fiscal 2007, we made incremental customer
experience investments to improve customer satisfaction,
purchase and repurchase preferences, as well as, customer
support. As a result, we have increased our headcount through
direct hiring and replacing contract staff with our employees.
We spent $47 million in the third quarter and
$78 million for the first nine months of Fiscal 2007 for
customer experience.
|
|
|
Research, development, and engineering During
the third quarter and first nine months of Fiscal 2007,
research, development, and engineering expenses increased 20% to
$126 million and 13% to
|
37
|
|
|
$380 million, respectively, compared to $104 million
and $335 million in the same periods of Fiscal 2006.
Stock-based compensation expense of $8 million and
$31 million for the three- and nine-month periods ended
November 3, 2006, contributed to the year-over-year
increase. We manage research, development, and engineering
spending by targeting those innovations and products most
valuable to our customers, and by relying upon the capabilities
of our strategic partners. We will continue to invest in
research, development, and engineering activities to support our
growth and to provide for new, competitive products. We have
obtained 1,711 patents worldwide and have applied for 1,763
additional patents worldwide at November 3, 2006.
|
Stock-based
Compensation
We have four stock-based compensation plans, in addition to an
employee stock purchase plan, with outstanding stock and stock
options. We currently use the 2002 Long-Term Incentive Plan for
stock-based incentive awards. These awards can be in the form of
stock options, stock appreciation rights, stock bonuses,
restricted stock, restricted stock units, performance units, or
performance shares.
Stock-based compensation expense totaled $76 million and
$293 million for the three and nine month periods ended
November 3, 2006, respectively, compared to $5 million
and $15 million for the three and nine month periods ended
October 28, 2005, respectively. The increase is due to the
implementation of Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment
(SFAS 123(R)). We adopted SFAS 123(R)
using the modified prospective transition method under
SFAS 123(R) effective the first quarter of Fiscal 2007.
Included in stock-based compensation for Fiscal 2007 is the fair
value of stock-based awards earned during the period, including
restricted stock grants, restricted stock awards, and stock
options, as well as the discount associated with stock purchased
under our employee stock purchase plan. Prior to adoption of
SFAS 123(R), we accounted for our equity incentive plans
under the intrinsic value recognition and measurement principles
of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB
25), and its related interpretations. Accordingly,
stock-based compensation for the fair value of employee stock
options with no intrinsic value at the grant date and the
discount associated with stock purchased under our employee
stock purchase plan was not recognized in net income prior to
Fiscal 2007. For further discussion on stock-based compensation,
see Note 6 of Notes to Condensed Consolidated Financial
Statements in Part I
Item 1 Financial Statements.
At November 3, 2006, there was $173 million and
$351 million of total unrecognized stock-based compensation
expense related to stock options and non-vested restricted
stock, respectively, with the unrecognized stock-based
compensation expense expected to be recognized over a
weighted-average period of 1.4 years and 2.6 years,
respectively.
As a result of our inability to timely file our Annual Report on
Form 10-K
for Fiscal 2007, we suspended the exercise of employee stock
options, the vesting of restricted stock units, and the purchase
of shares under our employee stock purchase plan. With the
filing of this report and our other past due periodic reports,
we are again current in our periodic reporting obligations and,
accordingly, expect to resume the exercise of employee stock
options by employees, the vesting of restricted stock units, and
the purchase of shares under our employee stock purchase plan.
We agreed to pay cash to certain current and former employees
who held in-the-money stock options (options that have an
exercise price less than the current stock market price) that
expired during the period of unexercisability. Within
45 days after we file our Annual Report on
Form 10-K
for Fiscal 2007, we will make payments relating to in-the-money
stock options that expired in the second and third quarters of
Fiscal 2008, which are expected to total approximately
$113 million. We will not continue to pay cash for expired
in-the-money stock options once the options again become
exercisable.
Investment and
Other Income, net
Net investment and other income primarily includes interest
income and expense, gains and losses from the sale of
investments, investment related fees, and foreign exchange
transaction gains and losses. Net
38
investment and other income increased to $66 million and
decreased to $170 million for the third quarter and first
nine-month period of Fiscal 2007, respectively, compared to
$51 million and $176 million for the same periods in
Fiscal 2006, respectively. This fluctuation is primarily due to
higher interest rates, partially offset by a decrease in
investment income earned on lower average balances of cash and
investments. The decrease in net investment and other income for
the first nine months of Fiscal 2007, compared to the same
periods in Fiscal 2006, decreased due to foreign exchange
fluctuations in the first and second quarter of Fiscal 2007.
Income
Taxes
On October 22, 2004, the American Jobs Creation Act of 2004
(the Act) was signed into law. Among other items,
the Act creates a temporary incentive for
U.S. multinationals to repatriate accumulated income earned
outside the U.S. at an effective tax rate of 5.25% versus
the U.S. federal statutory rate of 35%. In the fourth
quarter of Fiscal 2005, we recorded an initial estimated income
tax charge of $280 million based on the decision to
repatriate $4.1 billion of foreign earnings. This tax
charge included an amount relating to a drafting oversight that
Congressional leaders expected to correct in calendar year 2005.
On May 10, 2005, the Department of Treasury issued further
guidance that addressed the drafting oversight. In the second
quarter of Fiscal 2006, we reduced our original estimate of the
tax charge by $85 million as a result of guidance issued by
the Treasury Department. As of February 3, 2006, we
completed the repatriation of the expected $4.1 billion in
foreign earnings.
We reported an effective tax rate of approximately 24.9% for the
third quarter of Fiscal 2007, as compared to 24.6% for the same
quarter last year. For the nine-month periods ended
November 3, 2006 and October 28, 2005, our effective
rate was 23.0% and 21.5%, respectively. The increase in our
effective tax rate is due to the $85 million adjustment in
the second quarter of Fiscal 2006 offset by a higher proportion
of our operating profits being generated in lower foreign tax
jurisdictions during the third quarter of Fiscal 2007 as
compared to a year ago. In addition during the second quarter of
Fiscal 2007, there was a reserve release in the amount of
$31 million related to a change in estimate of an income
tax audit related item. The differences between our effective
tax rate and the U.S. federal statutory rate of 35%
principally result from our geographical distribution of taxable
income and differences between the book and tax treatment of
certain items.
Off-Balance Sheet
Arrangements
Asset Securitization During the third quarter
of Fiscal 2007, we continued to sell customer financing
receivables to unconsolidated qualifying special purpose
entities. The qualifying special purpose entities are bankruptcy
remote legal entities with assets and liabilities separate from
ours. The sole purpose of the qualifying special purpose
entities is to facilitate the funding of finance receivables in
the capital markets. We determine the amount of receivables to
securitize based on our funding requirements in conjunction with
specific selection criteria designed for the transaction. The
qualifying special purpose entities have entered into financing
arrangements with three multi-seller conduits that, in turn,
issue asset-backed debt securities in the capital markets.
Transfers of financing receivables are recorded in accordance
with the provisions of Statement of Financial Accounting
Standards No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities
(SFAS 140). During the first nine months of
Fiscal 2007 and Fiscal 2006, we sold $747 million and
$253 million, respectively, of customer receivables to
unconsolidated qualifying special purpose entities.
We retain the right to receive collections on securitized
receivables in excess of amounts needed to pay interest and
principal as well as other required fees. Upon the sale of the
financing receivables, we record the present value of the excess
cash flows as a retained interest, which typically results in a
gain that ranges from 2% to 4% of the customer receivables sold.
We service these securitized contracts and earn a servicing fee.
Our securitization transactions generally do not result in
servicing assets and liabilities, as the contractual fees are
adequate compensation in relation to the associated servicing
cost.
39
In estimating the value of the retained interest, we make a
variety of financial assumptions, including pool credit losses,
payment rates, and discount rates. These assumptions are
supported by both our historical experience and anticipated
trends relative to the particular receivable pool. We review our
investments in retained interests periodically for impairment,
based on their estimated fair value. Any resulting losses
representing the excess of carrying value over estimated fair
value that are other-than-temporary are recorded in earnings.
However, unrealized gains are reflected in stockholders
equity as part of accumulated other comprehensive income. In the
first quarter of Fiscal 2008 we adopted SFAS 155 and, as a
result, all gains and losses are recognized in income
immediately and are no longer included in accumulated other
comprehensive income. Retained interest balances and assumptions
are disclosed in Note 7 of Notes to Condensed Consolidated
Financial Statements included in Part I
Item 1 Financial Statements.
Our securitization program contains structural features that
could prevent further funding if the credit losses or
delinquencies on the pool of sold receivables exceed specified
levels. These structural features are within normal industry
practice and are similar to comparable securitization programs
in the marketplace. We do not expect that any of these features
will have a material adverse impact on our ability to securitize
financing receivables. We closely monitor our entire portfolio,
including subprime assets, and take action relative to
underwriting standards as necessary.
Liquidity and
Capital Commitments
Liquidity
Our cash balances are held in numerous locations throughout the
world, including substantial amounts held outside of the
U.S. Most of the amounts held outside of the
U.S. could be repatriated to the U.S., but under current
law, would be subject to U.S. federal income taxes, less
applicable foreign tax credits. Repatriation of some foreign
balances is restricted by local laws. We have provided for the
U.S. federal tax liability on these amounts for financial
statement purposes except for foreign earnings that are
considered indefinitely reinvested outside of the
U.S. Repatriation could result in additional
U.S. federal income tax payments in future years. Where
local restrictions prevent an efficient intercompany transfer of
funds, our intent is that those cash balances would remain
outside of the U.S., and we would meet our U.S. liquidity
needs through operating cash flows, external borrowings, or
both. We utilize a variety of tax planning and financing
strategies with the objective of having our worldwide cash
available in the locations in which it is needed.
We ended the third quarter of Fiscal 2007 with
$11.5 billion in cash, cash equivalents, and investments,
compared to $12.2 billion at October 28, 2005. We
invest a large portion of our available cash in highly liquid
and highly rated government, agency, and corporate debt
securities of varying maturities at the date of acquisition. Our
investment policy is to manage our investment portfolio to
preserve principal and liquidity while maximizing the return
through the full investment of available funds.
The following table summarizes the results of our Condensed
Consolidated Statement of Cash Flows for the nine month periods
ended November 3, 2006 and October 28, 2005:
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|
|
|
|
|
|
|
|
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Nine Months
Ended
|
|
|
|
November 3,
|
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October 28,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
As
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|
|
|
|
|
|
Restated
|
|
|
|
(in
millions)
|
|
|
Net cash flow provided by (used in):
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|
|
|
|
|
|
|
Operating activities
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|
$
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2,748
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|
|
$
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3,241
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|
Investing activities
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|
|
647
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|
|
|
3,684
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|
Financing activities
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|
|
(2,512
|
)
|
|
|
(4,497
|
)
|
Effect of exchange rate changes on cash and cash equivalents
|
|
|
61
|
|
|
|
(62
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)
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
$
|
944
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|
|
$
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2,366
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|
|
|
|
|
|
|
|
|
|
40
Operating Activities Cash provided by
operating activities during the nine-month period ended
November 3, 2006 was $2.7 billion, compared to
$3.2 billion for the same period of Fiscal 2006. The
decrease in operating cash flows was primarily led by a
reduction in net income offset by changes in operating working
capital. Cash flows from operating activities resulted primarily
from net income during both periods, which represents our
principal source of cash. Our direct model allows us to maintain
an efficient cash conversion cycle, which compares favorably
with that of others in our industry.
Prior to the adoption of SFAS 123(R), tax benefits
resulting from tax deductions in excess of the compensation cost
recognized for those options were classified as operating cash
flows. These excess tax benefits are now classified as a source
of financing cash flows, with an offsetting amount classified as
a use of operating cash flows. This amount was $62 million
for the nine months ended November 3, 2006.
The following table presents the components of our cash
conversion cycle at November 3, 2006 and February 3,
2006:
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|
|
|
|
|
|
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|
November 3,
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|
February 3,
|
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|
|
2006
|
|
|
2006
|
|
|
|
|
|
|
As
|
|
|
|
|
|
|
Restated
|
|
|
Days of sales
outstanding(a)
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|
|
33
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|
|
|
29
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|
Days of supply in inventory
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|
|
5
|
|
|
|
5
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|
Days in accounts payable
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|
(78
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)
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|
|
(77
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)
|
|
|
|
|
|
|
|
|
|
Cash conversion cycle
|
|
|
(40
|
)
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|
|
(43
|
)
|
|
|
|
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|
|
|
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|
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|
(a)
|
|
Days of sales outstanding
(DSO) is based on the ending net trade receivables
and most recent quarterly revenue for each period. DSO includes
the effect of product costs related to customer shipments not
yet recognized as revenue that are classified in other current
assets. At November 3, 2006 and February 3, 2006, DSO
and days of customer shipments not yet recognized were 30 and
3 days and 26 and 3 days, respectively.
|
Our cash conversion cycle decreased three days at
November 3, 2006 from February 3, 2006. This decline
was driven by a four day increase in days of sales outstanding,
largely attributed to a higher percentage of our revenue coming
from our customers requiring payment terms, as well as longer
terms and a higher percentage of our revenue coming from outside
the U.S., where payment terms are customarily longer. This
decline was offset by a
one-day
increase in days in accounts payable, largely attributed to an
increase in the number of suppliers with extended payment terms
as compared to Fiscal 2006.
We defer the cost of revenue associated with customer shipments
not yet recognized as revenue until they are delivered. These
deferred costs are included in our reported days of sales
outstanding because we believe it presents a more accurate
presentation of our days of sales outstanding and cash
conversion cycle. These deferred costs are recorded in other
current assets in our Condensed Consolidated Statements of
Financial Position and totaled $425 million and
$417 million at November 3, 2006 and February 3,
2006, respectively.
Investing Activities Cash provided by
investing activities for the nine-month period ended
November 3, 2006 was $647 million, compared to
$3.7 billion for the same period of the prior year. Cash
provided by and used in investing activities principally
consists of net maturities and sales or purchases of
investments, net of capital expenditures for property, plant,
and equipment. The decrease in the cash provided by investing
activities during the nine-month period ended November 3,
2006, when compared to the same period in the prior year is
primarily because during the nine-month period ended
October 28, 2005, we re-invested a lower amount of proceeds
from maturities and sales of investments to build liquidity for
share repurchases and to prepare for the repatriation of
$4.1 billion of foreign earnings, which was completed in
Fiscal 2006. Also included in investing activities for the nine
months ended November 3, 2006 is the acquisition of
Alienware Corporation, which closed on May 8, 2006 and is
included in our results for the third quarter of Fiscal 2007.
Financing Activities Cash used in financing
activities during the nine-month period ended November 3,
2006 was $2.5 billion, compared to $4.5 billion during
the same period last year. Financing activities
41
primarily consist of the repurchase of our common stock,
partially offset by proceeds from the issuance of common stock
under employee stock plans, issuance of commercial paper, and
other items. The year-over-year decrease in cash used in
financing activities is due primarily to the decrease in funds
used to repurchase 118 million shares at an aggregate cost
of $3.0 billion during the nine-month period ended
November 3, 2006, compared to 138 million shares at an
aggregate cost of $5.3 billion in the same period last
year. In September 2006, we suspended our share repurchase
program pending completion of the Audit Committee investigation.
In addition, we realized a decrease in proceeds from the
issuance of common stock under our employee stock plans, but
received $236 million in issuance of commercial paper.
We believe our ability to generate cash flows from operations on
an annual basis will continue to be strong, driven mainly by our
profitability, efficient cash conversion cycle, and the growth
in our deferred enhanced services offerings. In order to augment
our liquidity and provide us with additional flexibility, we
implemented a commercial paper program with a supporting credit
facility on June 1, 2006. Under the commercial paper
program, we issue, from time-to-time, short-term unsecured notes
in an aggregate amount not to exceed $1.0 billion. We use
the proceeds for general corporate purposes, including funding
Dell Financial Services L.P. (DFS) growth. See
Note 11 of Notes to Condensed Consolidated Financial
Statements included in Part I
Item 1 Financial Statements for a further
discussion of our commercial paper program. At November 3,
2006, $236 million was outstanding under the program. There
were no outstanding advances under the commercial paper program
as of October 26, 2007.
Capital
Commitments
Redeemable Common Stock and Other Rescissionary
Rights We inadvertently failed to register with
the SEC the sale of some shares under certain employee benefit
plans. As a result, certain purchasers of common stock pursuant
to those plans may have the right to rescind their purchases for
an amount equal to the purchase price paid for the shares, plus
interest from the date of purchase. At November 3, 2006, we
have classified approximately 4 million shares
($88 million) that may be subject to the rescissionary
rights outside stockholders equity, because the redemption
features are not within our control. These shares have always
been treated as outstanding for financial reporting purposes.
Certain purchasers of common stock pursuant to these plans who
sold their shares for less than the purchase price may have the
right to rescind their purchases for an amount of cash equal to
the purchase price plus interest minus the proceeds of the sale.
Share Repurchase Program We have a share
repurchase program that authorizes us to purchase shares of
common stock in order to increase shareholder value and manage
dilution resulting from shares issued under our equity
compensation plans. However, we do not currently have a policy
that requires the repurchase of common stock in conjunction with
share-based payment arrangements. The aggregate dollar amount
authorized for repurchase is $30.0 billion. Approximately
$1.4 billion of that authorized amount was available for
repurchases at November 3, 2006. We temporarily suspended
our share repurchase program in September 2006 pending
completion of the Audit Committee investigation. We anticipate
recommencing our share repurchase program in the fourth quarter
of Fiscal 2008.
We typically repurchase shares of common stock through a
systematic program of open market purchases. During the
three-and nine-month periods ended November 3, 2006, we
repurchased approximately 16 million and 118 million
shares, respectively, at an aggregate cost of $335 million
and $3.0 billion, respectively. The significant decrease in
share repurchases during the third quarter of Fiscal 2007 was
due to the temporary suspension of our share repurchase program
in September 2006. We anticipate recommencing our share
repurchase program in the fourth quarter of Fiscal 2008. For
more information regarding share repurchases, see
Part II Item 2
Unregistered Sales of Equity Securities and Use of
Proceeds.
Capital Expenditures During the nine-month
period ended November 3, 2006 we spent approximately
$566 million on property, plant, and equipment primarily on
our global expansion efforts and infrastructure investments in
order to support future growth. Product demand and mix, as well
as ongoing efficiencies in
42
operating and information technology infrastructure, influence
the level and prioritization of our capital expenditures, which
totaled $896 million for Fiscal 2007. Capital expenditures
for Fiscal 2008 (related to our continued expansion worldwide,
the need to increase manufacturing capacity, and leasing
arrangements to facilitate customer sales) are currently
expected to reach approximately $900 million. These
expenditures are expected to be funded from our cash flows from
operating activities.
DFS Purchase Commitment Pursuant to our joint
venture agreement with CIT Group, Inc. (CIT), we
have an option to purchase CITs 30% interest in DFS in
February 2008, for a purchase price ranging from approximately
$100 million to $345 million. We currently expect that
the purchase price will likely be towards the upper end of that
range. If we do not exercise this purchase option, we are
obligated to purchase CITs 30% interest upon the
occurrence of certain termination events or upon the expiration
of the joint venture on January 29, 2010. See Note 7
of Notes to Condensed Consolidated Financial Statements included
in Part I Item 1
Financial Statements.
Restricted Cash Pursuant to an agreement
between DFS and CIT, we are required to maintain escrow cash
accounts that are held as recourse reserves for credit losses,
performance fee deposits related to our private label credit
card, and deferred servicing revenue. Restricted cash specific
to the consolidation of DFS in the amount of $407 million
and $453 million in restricted cash is included in other
current assets at November 3, 2006 and February 3,
2006, respectively.
Recently Issued
Accounting Pronouncements
See Note 1 of Notes to Condensed Consolidated Financial
Statements included in Part I
Item 1 Financial Statements for a
description of recently issued accounting pronouncements,
including the expected dates of adoption and estimated effects
on our results of operations, financial position, and cash flows.
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|
ITEM 3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
For a description of our market risks, see
Part I Item 7
Managements Discussion and Analysis of Financial Condition
and Results of Operations Market Risk in our
Annual Report in
Form 10-K
for the fiscal year ended February 3, 2006. Our exposure to
market risks has not changed materially from the description in
the Annual Report in
Form 10-K.
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|
ITEM 4.
|
CONTROLS
AND PROCEDURES
|
This Report includes the certifications of our Chief Executive
Officer and Chief Financial Officer required by
Rule 13a-14
of the Securities Exchange Act of 1934 (the Exchange
Act). See Exhibits 31.1 and 31.2. This Item 4
includes information concerning the controls and control
evaluations referred to in those certifications.
Background
The Audit Committee of our Board of Directors has completed an
independent investigation into certain accounting and financial
reporting matters. As a result of issues identified in that
investigation, as well as issues identified in additional
reviews and procedures conducted by management, the Audit
Committee, in consultation with management and
PricewaterhouseCoopers LLP, our independent registered public
accounting firm, concluded on August 13, 2007 that our
previously issued financial statements for Fiscal 2003, 2004,
2005, and 2006 (including the interim periods within those
years), and the first quarter of Fiscal 2007, should no longer
be relied upon because of certain accounting errors and
irregularities in those financial statements. Accordingly, we
have restated our previously issued financial statements for
those periods. See Part I
Item 2 Managements Discussion and
Analysis of Financial Condition and Results of
Operations Audit Committee Independent Investigation
and Restatement and Note 2 of Notes to Condensed
Consolidated Financial Statements included in
Part I Item 1 Financial
Statements.
43
As a result of managements review of the investigation
issues and its other internal reviews, we have identified the
following control deficiencies as of February 2, 2007 that
constituted material weaknesses in our internal control over
financial reporting:
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|
|
Control environment We did not maintain an
effective control environment. Specifically:
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|
|
|
|
-
|
We did not maintain a tone and control consciousness that
consistently emphasized strict adherence to GAAP. This control
deficiency resulted in an environment in which accounting
adjustments were viewed at times as an acceptable device to
compensate for operational shortfalls, which in certain
instances led to inappropriate accounting decisions and entries
that appear to have been largely motivated to achieve desired
accounting results and, in some instances, involved management
override of controls. In a number of instances, information
critical to an effective review of transactions and accounting
entries was not disclosed to internal and external auditors.
|
|
|
-
|
We did not maintain a sufficient complement of personnel with an
appropriate level of accounting knowledge, experience, and
training in the application of GAAP commensurate with our
financial reporting requirements and business environment.
|
The control environment, which is the responsibility of senior
management, sets the tone of the organization, influences the
control consciousness of its people, and is the foundation for
all other components of internal control over financial
reporting. The control environment material weaknesses described
above contributed to the material weaknesses related to our
period-end financial reporting process described below.
|
|
|
Period-end financial reporting process We did
not maintain effective controls over the period-end reporting
process, including controls with respect to the review,
supervision, and monitoring of accounting operations.
Specifically:
|
|
|
|
|
-
|
Journal entries, both recurring and nonrecurring, were not
always accompanied by sufficient supporting documentation and
were not always adequately reviewed and approved for validity,
completeness, and accuracy;
|
|
|
-
|
Account reconciliations over balance sheet accounts were not
always properly and timely performed, and the reconciliations
and their supporting documentation were not consistently
reviewed for completeness, accuracy, and timely resolution of
reconciling items; and
|
|
|
-
|
We did not design and maintain effective controls to ensure the
completeness, accuracy and timeliness of the recording of
accrued liabilities, reserves, and operating expenses, primarily
related to our accrued warranty obligations, goods and services
received but not invoiced, customer rebates, and nonproduction
operating expenses.
|
These material weaknesses resulted in the restatement of our
previously issued annual and interim financial statements for
Fiscal 2003, 2004, 2005, and 2006 and the first quarter of
Fiscal 2007, and adjustments, including audit adjustments and
adjustments related to the investigation and our internal
reviews, to our annual and other interim financial statements
for Fiscal 2007. In addition, these material weaknesses could
result in misstatements of substantially all of our financial
statement accounts that would result in a material misstatement
of our annual or interim consolidated financial statements that
would not be prevented or detected on a timely basis.
Our management, under new leadership as described below, has
been actively engaged in the planning for, and implementation
of, remediation efforts to address the material weaknesses, as
well as other identified areas of risk. These remediation
efforts, outlined below, are intended both to address the
identified material weaknesses and to enhance our overall
financial control environment. In January 2007, Michael S. Dell
re-assumed the position of Chief Executive Officer and Donald J.
Carty assumed the position of Chief Financial Officer. The
design and implementation of these and other remediation efforts
are the commitment and responsibility of this new leadership
team.
44
|
|
|
Our new leadership team, together with other senior executives,
is committed to achieving and maintaining a strong control
environment, high ethical standards, and financial reporting
integrity. This commitment will be communicated to and
reinforced with every Dell employee and to external
stakeholders. This commitment is accompanied by a renewed
management focus on decision-making and processes that are
intended to achieve maximum shareholder value over the long-term
and a decreased focus on short-term,
quarter-by-quarter
operating results.
|
|
|
As a result of the initiatives already underway to address the
control deficiencies described above, we have effected personnel
changes in our accounting and financial reporting functions.
Consequently, many of the employees involved in the accounting
processes in which errors and irregularities were made are no
longer involved in the accounting or financial reporting
function. In addition, we have taken, or will take, appropriate
remedial actions with respect to certain employees, including
terminations, reassignments, reprimands, increased supervision,
training, and imposition of financial penalties in the form of
compensation adjustments.
|
|
|
We are in the process of reorganizing the Finance Department,
segregating accounting and financial reporting responsibility
from planning and forecasting responsibility, with a renewed
commitment to accounting and financial reporting integrity. We
have appointed a new Chief Accounting Officer and have
strengthened that position, making it directly responsible for
all accounting and financial reporting functions worldwide. In
addition, we are implementing personnel resource plans, and
training and retention programs, that are designed to ensure
that we have sufficient personnel with knowledge, experience,
and training in the application of GAAP commensurate with our
financial reporting requirements.
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|
|
We will continue our efforts to establish or modify specific
processes and controls to provide reasonable assurance with
respect to the accuracy and integrity of accounting entries and
the appropriate documentation, review, and approval of those
entries. These efforts include:
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|
|
|
-
|
Centralization of the development, oversight, and monitoring of
accounting policies and standardized processes in all critical
accounting areas, including areas involving management judgment
and discretion;
|
|
|
-
|
Implementation and clarification of specific accounting and
finance policies, applicable worldwide, regarding the
establishment, increase, and release of accrued liability and
other balance sheet reserve accounts;
|
|
|
-
|
Creation of a revenue recognition accounting resource function
to coordinate complex revenue recognition matters and to provide
oversight and guidance on the design of controls and processes
to enhance and standardize revenue recognition accounting
procedures;
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|
|
-
|
Improving the processes and procedures around the completion and
review of quarterly management representation letters, in which
our various business and finance leaders make full and complete
representations concerning, and assume accountability for, the
accuracy and integrity of their submitted financial results;
|
|
|
-
|
Extending the time between the end of a financial reporting
period and the public release of financial and operating data
with respect to that period, giving our accounting organization
more time to appropriately process the close of the accounting
records and analyze the reported results prior to public
announcement;
|
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|
-
|
Enhancing the development, communication, and monitoring of
processes and controls to ensure that appropriate account
reconciliations are performed, documented, and reviewed as part
of standardized procedures; and
|
|
|
-
|
Increasing the focus by the internal audit function and the
Chief Accounting Officer on the review and monitoring of key
accounting processes, including journal entries and supporting
documentation, revenue recognition processes, account
reconciliations, and management representation letter controls
and processes.
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45
|
|
|
We will implement company-wide training (led by the Chief
Accounting Officer and other finance executives with appropriate
accounting expertise) to enhance awareness and understanding of
standards and principles for accounting and financial reporting.
This training will include:
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|
|
|
|
-
|
Development and communication of an accounting code of conduct
that will serve as a set of guiding principles emphasizing our
commitment to accounting and financial reporting integrity, as
well as transparency and robust and complete communications
with, and disclosures to, internal and external auditors;
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|
-
|
Comprehensive programs for all finance personnel globally (with
initial focus on personnel directly responsible for accounting
and financial reporting) covering all fundamental accounting and
financial reporting matters, including accounting policies,
financial reporting requirements, income statement
classification, revenue recognition, vendor funding, accounting
for reserves and accrued liabilities, and account reconciliation
and documentation requirements; and
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|
-
|
Appropriate programs for other company personnel, including
senior management, to emphasize the importance of accounting and
financial reporting integrity.
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|
We will invest in the design and implementation of additional
and enhanced information technology systems and user
applications commensurate with the complexity of our business
and our financial reporting requirements. It is expected that
these investments will improve the reliability of our financial
reporting by reducing the need for manual processes, subjective
assumptions, and management discretion; by reducing the
opportunities for errors and omissions; and by decreasing our
reliance on manual controls to detect and correct accounting and
financial reporting inaccuracies.
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|
|
We will reemphasize and invigorate our communications to all
Dell employees regarding the availability of our Ethics Hotline,
through which employees at all levels can anonymously submit
information or express concerns regarding accounting, financial
reporting, or other irregularities they have become aware of or
have observed. In addition, these communications will emphasize
the existence and availability of other reporting avenues or
forums for all employees, such as their management chain, their
Human Resources representatives, the Ethics Office, the
Ombudsmans Office, the Legal Department, and direct
contact with the Chief Financial Officer or the Audit Committee.
|
The Audit Committee has directed management to develop a
detailed plan and timetable for the implementation of the
foregoing remedial measures (to the extent not already
completed) and will monitor their implementation. In addition,
under the direction of the Audit Committee, management will
continue to review and make necessary changes to the overall
design of our internal control environment, as well as policies
and procedures to improve the overall effectiveness of internal
control over financial reporting.
We believe the remediation measures described above will
remediate the material weaknesses we have identified and
strengthen our internal control over financial reporting. We are
committed to continuing to improve our internal control
processes and will continue to diligently and vigorously review
our financial reporting controls and procedures. As we continue
to evaluate and work to improve our internal control over
financial reporting, we may determine to take additional
measures to address control deficiencies or determine to modify,
or in appropriate circumstances not to complete, certain of the
remediation measures described above.
Evaluation of
Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in
Rules 13a-15(e)
and
15d-15(e)
under the Exchange Act) are designed to ensure that information
required to be disclosed in reports filed or submitted under the
Exchange Act is recorded, processed, summarized, and reported
within the time periods specified in SEC rules and forms and
that such information is accumulated and communicated to
management, including the chief executive officer and the chief
financial officer, to allow timely decisions regarding required
disclosures.
46
In connection with the preparation of this Report, Dells
management, under the supervision and with the participation of
the current Chief Executive Officer and current Chief Financial
Officer, conducted an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures.
Based on that evaluation, the restatement of previously issued
financial statements described above, and the identification of
certain material weaknesses in internal control over financial
reporting (described above), which we view as an integral part
of our disclosure controls and procedures, our Chief Executive
Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures were not effective as of
November 3, 2006. Nevertheless, based on a number of
factors, including the completion of the Audit Committees
investigation, our internal review that identified certain prior
period adjustments, efforts to remediate the material weaknesses
in internal control over financial reporting described below,
and the performance of additional procedures by management
designed to ensure the reliability of our financial reporting,
we believe that the consolidated financial statements in this
Report fairly present, in all material respects, our financial
position, results of operations and cash flows as of the dates,
and for the periods, presented, in conformity with GAAP.
Changes in
Internal Control Over Financial Reporting
During the third and fourth quarters, and since the end, of
Fiscal 2007, we have begun the implementation of some of the
remedial measures described above, including
(a) communication, both internally and externally, of our
commitment to a strong control environment, high ethical
standards, and financial reporting integrity; (b) certain
personnel actions; (c) the reorganization of the Finance
Department to separate accounting and financial reporting
responsibility from planning and forecasting responsibility and
to strengthen the Chief Accounting Officer role, giving it
direct and centralized responsibility for all accounting and
financial reporting functions worldwide; (d) the design and
implementation of a comprehensive training program for all
Finance Department personnel; (e) the implementation of
more rigorous period-end financial reporting policies and
processes involving journal-entry approval, supporting
documentation, account reconciliations, and management
representation letters; (f) an increased corporate audit
focus on key accounting controls and processes, including
documentation requirements; (g) extension of the time
between the end of reporting periods and earnings release dates
to give the accounting organization more time to close the books
and process and analyze results; and (h) the design and
implementation of a new internal global ethics awareness
campaign, including refreshed tools, resources, and policies.
The following specific actions were taken in the third quarter
of Fiscal 2007: Implemented more rigorous policies and processes
regarding journal entry approval, supporting documentation,
account reconciliations, and management representation letters;
and extended the time between quarter-end and earnings release.
PART II
OTHER INFORMATION
|
|
ITEM 1.
|
LEGAL
PROCEEDINGS
|
We are involved in various claims, suits, investigations, and
legal proceedings that arise from time to time in the ordinary
course of our business. As required by Statement of Financial
Accounting Standards No. 5, Accounting for Contingencies
(SFAS 5), we accrue a liability when we
believe that it is both probable that a liability has been
incurred and we can reasonably estimate the amount of the loss.
The following is a discussion of our significant legal matters.
Investigations
and Related
Litigation
In August 2005, the U.S. Securities and Exchange Commission
(SEC) initiated an inquiry into certain of our
accounting and financial reporting matters and requested that
we provide certain documents. The SEC expanded that inquiry in
June 2006 and entered a formal order of investigation in October
2006. The SECs requests for information were joined by a
similar request from the United States Attorney for the Southern
District of New York
47
(SDNY), who subpoenaed documents related to our
financial reporting from and after 2002. In August 2006, because
of potential issues identified in the course of responding to
the SECs requests for information, our Audit Committee, on
the recommendation of management and in consultation with
PricewaterhouseCoopers LLP, our independent registered public
accounting firm, initiated an independent investigation, which
was recently completed. For information regarding the Audit
Committees investigation, the accounting errors and
irregularities identified, and the restatement adjustments see
Part II Item 2
Managements Discussion and Analysis of Financial Condition
and Results of Operations Audit Committee
Independent Investigation and Restatement and Note 2
of Notes to Condensed Consolidated Financial Statements included
in Part I Item I
Financial Statements. For a description of the control
deficiencies identified by management as a result of the
investigation and our internal reviews and managements
plan to remediate those deficiencies, see
Part I Item 4 Controls
and Procedures. Although the Audit Committee investigation
has been completed, the investigations being conducted by the
SEC and the SDNY are ongoing. We continue to cooperate with the
SEC and the SDNY.
Dell and several of our current and former directors and
officers are parties to securities, Employee Retirement Income
Security Act of 1974 (ERISA), and shareholder
derivative lawsuits all arising out of the same events and
facts. Four putative securities class actions that were filed in
the Western District of Texas, Austin Division, against Dell and
certain of our current and former officers have been
consolidated as In re Dell Inc. Securities Litigation,
and a lead plaintiff has been appointed by the court. The lead
plaintiff has asserted claims under sections 10(b), 20(a),
and 20A of the Securities Exchange Act of 1934 based on alleged
false and misleading disclosures or omissions regarding our
financial statements, governmental investigations, known battery
problems, business model, and insiders sales of our
securities. This action also includes our independent registered
public accounting firm, PricewaterhouseCoopers LLP, as a
defendant. Four other putative class actions that were also
filed in the Western District by purported participants in the
Dell Inc. 401(k) Plan have been consolidated as In re Dell
Inc. ERISA Litigation, and lead plaintiffs have been
appointed by the court. The lead plaintiffs have asserted claims
under ERISA based on allegations that Dell, certain current
officers, and certain current and former directors imprudently
invested and managed participants funds and failed to
disclose information regarding our stock held in the 401(k)
Plan. In addition, seven shareholder derivative lawsuits that
were filed in three separate jurisdictions (the Western District
of Texas, Austin Division; the Delaware Chancery Court; and the
state district court in Travis County, Texas) have been
consolidated into three actions, one in each of the respective
jurisdictions, as In re Dell Inc. Derivative Litigation,
and name various current and former officers and directors as
defendants and Dell as a nominal defendant. On October 8,
2007, the shareholder derivative lawsuit filed in the Western
District of Texas was dismissed without prejudice by the court.
The Travis County, Texas action has been transferred to the
state district court in Williamson County, Texas. The
shareholder derivative lawsuits assert claims derivatively on
behalf of Dell under state law, including breaches of fiduciary
duties. Finally, one purported shareholder has filed an action
against us in Delaware Chancery Court under Section 220 of
the Delaware General Corporation Law, Baltimore County
Employees Retirement System v. Dell Inc., seeking
inspection of certain of our books and records related to the
internal investigation and government investigations. We intend
to defend all of these lawsuits vigorously.
Copyright Levies Proceedings against the IT
industry in Germany seek to impose levies on equipment, such as
personal computers, multifunction devices, and printers that
facilitate making private copies of copyrighted materials. The
total levies due, if imposed, would be based on the number of
products sold and the per-product amounts of the levies, which
vary. We, along with other companies, and various industry
associations are opposing these levies and instead are
advocating compensation to rights holders through digital rights
management systems.
There are currently three levy cases involving other equipment
manufacturers pending before the German Federal Supreme Court.
Adverse decisions in these cases could ultimately impact us. The
cases involve personal computers, printers, and multifunctional
devices. The equipment manufacturers in these cases recently
lost in the lower courts and have appealed. The amount allowed
by the lower courts with respect to PCs is 12 per personal
computer sold for reprographic copying capabilities. The amounts
claimed with
48
respect to printers and multifunctional devices depend on speed
and color and vary between 10 and 300 for printers
and between 38 and 600 for multifunctional devices.
On December 29, 2005, Zentralstelle Für private
Überspielungrechte (ZPÜ), a joint
association of various German collection societies, instituted
arbitration proceedings against our German subsidiary before the
Arbitration Body in Munich. ZPÜ claims a levy of 18.4
per PC that we sold in Germany from January 1, 2002 through
December 31, 2005. On July 31, 2007, the Arbitration
Body recommended a levy of 15 on each PC sold during that
period, for audio and visual copying capabilities. Dell and
ZPÜ rejected the recommendation and we expect that the
matter will proceed to court. We will continue to defend this
claim vigorously.
Lucent v. Dell In February 2003, Lucent
Technologies, Inc. filed a lawsuit against us in the United
States District Court for Delaware, and the lawsuit was
subsequently transferred to the United States District Court for
the Southern District of California. The lawsuit alleges that we
infringed 12 patents owned by Lucent and seeks monetary damages
and injunctive relief. In April 2003, Microsoft Corporation
filed a declaratory judgment action against Lucent in the United
States District Court for the Southern District of California,
asserting that Microsoft products do not infringe patents held
by Lucent, including 10 of the 12 patents at issue in the
lawsuit involving us and Microsoft. These actions were
consolidated for discovery purposes with a previous suit that
Lucent filed against Gateway Inc. In September 2005, the court
granted a summary judgment of invalidity with respect to one of
the Lucent patents asserted against us. In addition, in
decisions made through May 2007, the court granted summary
judgment of non-infringement with respect to five more of the
Lucent patents asserted against us. The court has ordered
invalidity briefing with regard to other patents at issue in
view of the April 30, 2007, U.S. Supreme Court
decision in KSR v. Teleflex. Fact and expert
discovery has closed, and the three actions have been
consolidated. Trial is scheduled to begin in February 2008. We
are defending these claims vigorously. Separately, we have filed
a lawsuit against Lucent in the United District Court for the
Eastern District of Texas, alleging that Lucent infringes two
patents owned by us and seeking monetary damages and injunctive
relief. That litigation is pending and discovery is proceeding.
Sales Tax Claims Several state and local
taxing jurisdictions have asserted claims against Dell Catalog
Sales L.P. (DCSLP), an indirect wholly-owned
subsidiary of ours, alleging that DCSLP had an obligation to
collect tax on sales made into those jurisdictions because of
its alleged nexus, or physical presence, in those jurisdictions.
During the first and second quarter of Fiscal 2008, we settled
suits filed by the State of Louisiana and the Secretary of the
Louisiana Department of Revenue and Taxation in the
19th Judicial District Court of the State of Louisiana, and
by two Louisiana parishes, Orleans Parish and Jefferson Parish,
in the State of Louisiana 24th Judicial District Court. We
also settled similar claims made by a number of other Louisiana
parishes and by the State of Massachusetts. These settlement
amounts did not have a material adverse effect on our financial
condition, results of operations, or cash flows. While there are
ongoing claims by certain other state and local taxing
authorities, DCSLP disputes the allegation that it had nexus in
any of these other jurisdictions during the periods in issue,
and is defending the claims vigorously. We do not expect that
the outcome of these other claims, individually or collectively,
will have a material adverse effect on our financial condition,
results of operations, or cash flows.
We are involved in various other claims, suits, investigations
and legal proceedings that arise from time to time in the
ordinary course of our business. Although we do not expect that
the outcome in any of these other legal proceedings,
individually or collectively, will have a material adverse
effect on our financial condition or results of operations,
litigation is inherently unpredictable. Therefore, we could in
the future incur judgments or enter into settlements of claims
that could adversely affect our operating results or cash flows
in a particular period.
There are many risk factors that affect our business and results
of operations, some of which are beyond our control. The
following is a description of some of the important risk factors
that may cause our actual results in future periods to differ
substantially from those we currently expect or desire.
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Declining general economic, business, or industry conditions
may cause reduced net revenue. We are a global
company with customers in virtually every business and industry.
If the economic climate in the U.S. or abroad deteriorates,
customers or potential customers could reduce or delay their
technology investments, which could decrease our net revenue and
profitability.
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Failure to maintain a cost advantage may result in reduced
market share, revenue, and profitability. Our
success has historically been based on our ability to profitably
offer products at a lower price than our competitors. However,
we compete with many companies globally in all aspects of our
business. Our profitability is also affected by our ability to
negotiate favorable pricing with our vendors, including vendor
rebates, marketing funds, and other vendor funding. Because
these supplier negotiations are continuous and reflect the
ongoing competitive environment, the variability in timing and
amount of incremental vendor discounts and rebates can affect
our profitability. We cannot guarantee that we will be able to
maintain our cost advantage if our competitors improve their
cost structure or business model, if we are not able to
negotiate favorable pricing or rebate arrangements with our
vendors, or if our competitors take other actions that affect
our current competitive advantage. An inability to maintain our
cost advantage or determine alternative means to deliver value
to our customers may adversely affect our market share, revenue,
and profitability.
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Our ability to generate substantial
non-U.S. net
revenue faces many additional risks and uncertainties. Sales
outside the U.S. accounted for approximately 43% of our
consolidated net revenue for the nine-month period ended
November 3, 2006. Our future growth rates and success are
dependent on continued growth in international markets. Our
international operations face many risks and uncertainties,
including varied local economic and labor conditions, political
instability, and unexpected changes in the regulatory
environment, trade protection measures, tax laws (including
U.S. taxes on foreign operations), copyright levies, and
foreign currency exchange rates. Any of these factors could
adversely affect our operations and profitability.
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Our profitability may be affected by our product, customer,
and geographic sales mix and by seasonal sales
trends. Our profit margins vary among products,
customers, and geographies. In addition, our business is subject
to certain seasonal sales trends. For example, sales to
government customers (particularly the U.S. federal
government) are typically stronger in our third fiscal quarter,
sales in EMEA are often weaker in our third fiscal quarter, and
consumer sales are typically strongest during our fourth fiscal
quarter. As a result of these factors, our overall profitability
for any particular period will be affected by the mix of
products, customers, and geographies reflected in our sales for
that period, as well as by seasonality trends.
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Infrastructure failures could harm our
business. We depend on our information technology
and manufacturing infrastructure to achieve our business
objectives. If a problem, such as a computer virus, intentional
disruption by a third party, natural disaster, manufacturing
failure, or telephone system failure impairs our infrastructure,
we may be unable to book or process orders, manufacture, and
ship in a timely manner or otherwise carry on our business. An
infrastructure disruption could cause us to lose customers and
revenue and could require us to incur significant expense to
eliminate these problems and address related security concerns.
The harm to our business could be even greater if it occurs
during a period of disproportionately heavy demand.
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Our failure to effectively manage a product transition could
reduce the demand for our products and the profitability of our
operations. Continuing improvements in technology
mean frequent new product introductions, short product life
cycles, and improvement in product performance characteristics.
Product transitions present execution challenges and risks for
any company. If we are unable to effectively manage a product
transition, our business and results of operations could be
unfavorably affected.
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Disruptions in component availability could unfavorably
affect our performance. Our direct business
model, as well as our manufacturing and supply chain
efficiencies, give us the ability to operate with reduced levels
of component and finished goods inventories. Our financial
success is partly due to our supply chain management practices,
including our ability to achieve rapid inventory turns. Because
we
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maintain minimal levels of component inventory, a disruption in
component availability could harm our financial performance and
our ability to satisfy customer needs.
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Our reliance on suppliers creates risks and
uncertainties. Our manufacturing process requires
a high volume of quality components from third-party suppliers.
Defective parts received from these suppliers could reduce
product reliability and harm the reputation of our products.
Reliance on suppliers subjects us to possible industry shortages
of components and reduced control over delivery schedules (which
can harm our manufacturing efficiencies), as well as increases
in component costs (which can harm our profitability).
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We could experience manufacturing interruptions, delays, or
inefficiencies if we are unable to timely and reliably procure
components from single-source or limited-source
suppliers. We maintain several single-source or
limited-source supplier relationships, either because multiple
sources are not available or the relationship is advantageous
due to performance, quality, support, delivery, capacity, or
price considerations. If the supply of a critical single- or
limited-source material or component is delayed or curtailed, we
may not be able to ship the related product in desired
quantities and in a timely manner. Even where multiple sources
of supply are available, qualification of the alternative
suppliers and establishment of reliable supplies could result in
delays and a possible loss of sales, which could harm operating
results.
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Our business is increasingly dependent on our ability to
access the capital markets. We will increasingly
rely upon access to the capital markets to fund financing for
our customers and to provide sources of liquidity in the
U.S. for general corporate purposes, including funding DFS
growth. If we are unable to access the capital markets, we may
not be able to fully fund customer financing opportunities or
planned share repurchases without repatriation of foreign cash
balances. See Part I
Item 2 Managements Discussion and
Analysis of Financial Condition and Results of
Operations Liquidity and Capital
Commitments Liquidity. Although we believe
that we will be able to maintain sufficient access to the
capital markets, adverse changes in the economy, deterioration
in our business performance, or changes in our credit ratings
could limit our access to these markets.
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We face risks relating to our ineffective internal
controls. As a result of our review of issues
identified during the recently completed independent Audit
Committee investigation into certain accounting and financial
reporting matters, as well as our internal review, management
has identified several deficiencies in our control environment
that constitute material weaknesses and, consequently, has
concluded that our internal control over financial reporting was
not effective at February 2, 2007. In addition, management
has concluded, based primarily on the identification of the
material weaknesses, that our disclosure controls and procedures
were not effective at November 3, 2006. See
Part I Item 4 Controls
and Procedures. If we are unable to successfully remediate
these material weaknesses in a timely manner, investors may lose
confidence in our reported financial information, which could
lead to a decline in our stock price, limit our ability to
access the capital markets in the future, and require us to
incur additional costs to improve our internal control systems
and procedures.
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Litigation and governmental investigations or proceedings
arising out of or related to our recent accounting and financial
reporting investigation could result in substantial
costs. We could incur substantial costs to defend
and resolve litigation or governmental investigations or
proceedings arising out of or related to the recently completed
Audit Committee investigation into certain accounting and
financial reporting matters. See Part I
Item 2 Managements Discussion and
Analysis of Financial Condition and Results of
Operations Audit Committee Independent Investigation
and Restatement. In addition, we could be exposed to
enforcement or other actions with respect to these matters by
the SECs Division of Enforcement or the
U.S. Department of Justice. For a description of pending
litigation and governmental proceedings and investigations, see
Part II Item 1 Legal
Proceedings Investigations and Related
Litigation.
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The acquisition of other companies may present new
risks. We recently began to pursue a targeted
acquisition strategy designed to augment areas of our business.
These acquisitions may involve significant new risks and
uncertainties, including distraction of management attention
away from our current business operations, insufficient new
revenue to offset expenses, inadequate return of capital,
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integration challenges, new regulatory requirements, and
unidentified issues not discovered in our due diligence process.
No assurance can be given that such acquisitions will be
successful and will not adversely affect our profitability or
operations.
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Failure to properly manage the distribution of our products
and services may result in reduced revenue and
profitability. We use a variety of distribution
methods to sell our products and services, including directly to
customers and through retail partners and third-party
value-added resellers. Our inability to properly manage and
balance these various distribution methods could harm our
operating results.
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Failure to effectively hedge our exposure to fluctuations in
foreign currency exchange rates and interest rates could
unfavorably affect our performance. We utilize
derivative instruments to hedge our exposure to fluctuations in
foreign currency exchange rates and interest rates. Some of
these instruments and contracts may involve elements of
market and credit risk in excess of the amounts recognized in
our financial statements. Further, revenue from our
international operations may decrease if we do not effectively
hedge our exposure to currency fluctuations.
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Our continued business success may depend on obtaining
licenses to intellectual property developed by others on
commercially reasonable and competitive terms. If
we or our suppliers are unable to obtain desirable technology
licenses, we may be prevented from marketing products, could be
forced to market products without desirable features, or could
incur substantial costs to redesign products, defend legal
actions, or pay damages. While our suppliers may be
contractually obligated to indemnify us against such expenses,
those suppliers could be unable to meet their obligations. Also,
our operating costs could increase because of copyright levies
or similar fees by rights holders and collection agencies in
European and other countries. For a description of potential
claims related to copyright levies, see
Part II Item 1 Legal
Proceedings Copyright Levies.
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Our success depends on our ability to attract, retain, and
motivate our key employees. We rely on key
personnel to support anticipated continued rapid international
growth and increasingly complex product and service offerings.
There can be no assurance that we will be able to attract,
retain, and motivate the key professional, technical, marketing,
and staff resources we need, particularly in light of the
reduction in the total number of equity shares granted to
employees as part of their total compensation packages. New
regulations and other factors could make it harder or more
expensive for us to grant equity-based awards to employees in
the future, putting us at a competitive disadvantage or forcing
us to increase cash compensation.
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Loss of government contracts could harm our
business. Government contracts are subject to
future funding that may affect the extension or termination of
programs and are subject to the right of the government to
terminate for convenience or non-appropriation. In addition, if
we violate legal or regulatory requirements, the government
could suspend or disbar us as a contractor, which would
unfavorably affect our net revenue and profitability.
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The expiration of tax holidays or favorable tax rate
structures could result in an increase of our effective tax rate
in the future. Portions of our operations are
subject to a reduced tax rate or are free of tax under various
tax holidays that expire in whole or in part during Fiscal 2010
through Fiscal 2019. Many of these holidays may be extended when
certain conditions are met. If they are not extended, then our
effective tax rate could increase in the future.
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Current environmental laws, or laws enacted in the future,
may harm our business. Our operations are subject
to environmental regulation in all of the areas in which we
conduct business. Our product design and procurement operations
must comply with new and future requirements relating to the
materials composition of our electronics products, including
restrictions on lead, cadmium, and other substances. On
July 1, 2006, the European Union adopted the Restriction of
Hazardous Substances Directive. The labeling provisions of
similar legislation in China became effective on March 1,
2007. If we fail to comply with the rules and regulations
regarding the use and sale of such regulated substances, we
could be subject to liability. Beginning in August 2005, we
became subject to the European Union Waste Electrical and
Electronic Equipment Directive as enacted by individual member
states of the European Union (WEEE Legislation). The
WEEE Legislation makes producers of electrical goods, including
computers and printers, responsible for collection, recycling,
treatment, and disposal of recovered products. While
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we do not expect that the impact of these environmental laws and
other similar legislation adopted in the U.S. and other
countries will have a substantial unfavorable impact on our
business, the costs and timing of costs under environmental laws
are difficult to predict.
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Armed hostilities, terrorism, natural disasters, or public
health issues could harm our business. Armed
hostilities, terrorism, natural disasters, or public health
issues, whether in the U.S. or abroad, could cause damage
or disruption to us, our suppliers or customers, or could create
political or economic instability, any of which could harm our
business. These events could cause a decrease in demand for our
products, could make it difficult or impossible for us to
deliver products or for our suppliers to deliver components, and
could create delay and inefficiencies in our supply chain.
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ITEM 2.
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UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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Issuance of
Unregistered Securities
As a result of our inability to file our Annual Report on
Form 10-K
for Fiscal 2007 on its due date (April 3, 2007), we
suspended our sales of Dell securities under our various
employee benefit plans. In preparing for that suspension, we
discovered that we had inadvertently failed to file with the SEC
certain registration statements relating to securities under the
plans.
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Employee Stock Purchase Plan We maintain an
Employee Stock Purchase Plan that is available to substantially
all our employees worldwide. In 1994, stockholders approved
additional shares for issuance under our Employee Stock Purchase
Plan. We recently discovered that the issuance of these
additional shares was never registered. Consequently, we have
inadvertently issued approximately 54 million unregistered
shares under this plan since 1996.
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Retirement Plans We maintain a 401(k)
retirement savings plan that is available to substantially all
of our U.S. employees and a separate retirement plan that
is available to our employees in Canada. Both of those plans
contain a Dell Stock Fund, and both plans allow
participants to allocate some or all of their account balances
to interests in the Dell Stock Fund. The Dell common stock held
in the Dell Stock Funds is not purchased from Dell; rather, the
plan trustees accumulate the plan contributions that are
directed to the Dell Stock Funds and purchase for the Dell Stock
Funds shares of Dell common stock in open market transactions.
Nevertheless, because we sponsor the plans, we are required to
register certain transactions in the plans related to shares of
Dell common stock. We recently discovered that we may be deemed
to have been required to file a
Form S-8
in July 2003 to register additional share transactions in the
401(k) Plan, and we should have filed a
Form S-8
to register share transactions in the Canada retirement plan in
1999. Consequently, we may be deemed to have inadvertently
failed to register transactions in the two plans relating up to
approximately 37 million shares.
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We intend to file registration statements on
Form S-8
to register future transactions in these plans as soon as
practicable. Nonetheless, we may be subject to civil and other
penalties by regulatory authorities as a result of the failure
to register. We have implemented monitoring and reporting
procedures to ensure that in the future we timely meet our
registration obligations with respect to these and other
employee benefit plans.
The failure to file registration statements noted above was
inadvertent, and we have always treated the shares issued under
the Employee Stock Purchase Plan or held in the Dell Stock Funds
under the retirement plans as outstanding for financial
reporting purposes. Consequently, these unregistered
transactions do not represent any additional dilution. We
believe that we have always provided the employee-participants
in these plans with the same information they would have
received had the registration statements been filed. The
outstanding shares subject to potential recission rights are
reflected as redeemable common stock on our Condensed
Consolidated Statement of Financial Position.
53
Purchases of
Common Stock
Cash Payments for
Certain Employee Stock Options
As a result of our inability to timely file our Annual Report on
Form 10-K
for Fiscal 2007, we suspended the exercise of employee stock
options. As a result, stock options held by current and former
employees expired while the holders had no ability to exercise
them or otherwise prevent their expiration. Therefore, we agreed
to pay cash to certain current and former employees who held
in-the-money stock options that expired during the period of
unexercisability.
If an in-the-money stock option expired during the period in
which it was not exercisable because of our filing delinquency,
we will pay to the holder in cash an amount of up to the
difference between the calculated value of the
option and its exercise price. For this purpose, the
calculated value is equal to the average closing
price of Dell common stock during the week immediately preceding
the week in which the expiration date occurred. Payment will be
made within 45 days after the date we file our Annual
Report on
Form 10-K
for Fiscal 2007, so long as the holder has executed an agreement
providing for a release of any claims the holder may have
against us and obligating the holder to return the cash to us if
the holder, while employed by us or within one year following
receipt of the payment, engages in certain conduct that is
detrimental to us (such as serious misconduct or breach of
confidentiality, non-competition or non-solicitation
obligations). Cash payments related to stock options that
expired in the second and third quarters of Fiscal 2008 will be
paid to approximately 1,100 current and former employees,
including certain executive and former executive officers, and
are expected to total approximately $113 million.
Share Repurchase
Program
We have a share repurchase program that authorizes us to
purchase shares of common stock in order to increase shareholder
value and manage dilution resulting from shares issued under our
equity compensation plans. However, we do not currently have a
policy that requires the repurchase of common stock in
conjunction with share-based payment arrangements. As of
November 3, 2006, our share repurchase program authorized
the purchase of shares of common stock at an aggregate cost not
to exceed $30.0 billion, and through that date
$28.6 billion had been spent to repurchase shares. We
suspended our share repurchase program in September 2006 pending
completion of the Audit Committee investigation. The following
table sets forth information regarding our share repurchases or
other acquisitions of common stock during the third quarter of
Fiscal 2007:
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Total
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Approximate
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Number of
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Dollar Value
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Shares
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of Shares that
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Repurchased
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May Yet be
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as Part of
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Repurchased
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Total Number
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Average
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Publicly
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Under the
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of Shares
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Price Paid
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Announced
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Announced
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Period
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Repurchased(a)
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per
Share
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Plans
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Plan(b)
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(in millions,
except average price paid per share)
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Repurchases from August 5, 2006 through September 1,
2006
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14
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$
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21.96
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14
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$
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1,463
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Repurchases from September 2, 2006 through
September 29, 2006
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2
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$
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22.29
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2
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$
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1,415
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Repurchases from September 30, 2006 through
November 3, 2006
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$
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1,415
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Total
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16
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$
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22.00
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16
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(a)
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During the third quarter,
8,598 shares were withheld from Dell employees to pay taxes
and fees associated with the employees exercise of stock
options; the average market value of the shares withheld was
$21.70. All other shares were purchased in open-market
transactions.
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(b)
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Our share repurchase program was
announced on February 20, 1996; and the program authorizes
us to purchase shares at an aggregate cost not to exceed
$30.0 billion.
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(a) Exhibits See Index to
Exhibits below.
55
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
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DELL INC.
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/s/ THOMAS
W. SWEET
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Date: October 30, 2007
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Thomas W. Sweet
Vice President, Corporate Finance and
Chief Accounting Officer
(On behalf of the registrant and as
principal accounting officer)
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INDEX TO
EXHIBITS
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Exhibit
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No.
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Description of
Exhibit
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3
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.1
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Restated Certificate of Incorporation, filed February 1,
2006 (incorporated by reference to Exhibit 3.3 of
Dells Current Report on
Form 8-K
filed on February 2, 2006, Commission File
No. 0-17017)
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3
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.2
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Restated Bylaws, as amended and effective March 8, 2007
(incorporated by reference to Exhibit 3.1 of Dells
Current Report on
Form 8-K
filed on March 13, 2007, Commission File
No. 0-17017)
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4
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.1
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Indenture, dated as of April 27, 1998, between Dell
Computer Corporation and Chase Bank of Texas, National
Association (incorporated by reference to Exhibit 99.2 of
Dells Current Report on
Form 8-K
filed April 28, 1998, Commission File
No. 0-17017)
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4
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.2
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Officers Certificate pursuant to Section 301 of the
Indenture establishing the terms of Dells
6.55% Senior Notes Due 2008 (incorporated by reference to
Exhibit 99.3 of Dells Current Report on
Form 8-K
filed April 28, 1998, Commission File
No. 0-17017)
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4
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.3
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Officers Certificate pursuant to Section 301 of the
Indenture establishing the terms of Dells
7.10% Senior Debentures Due 2028 (incorporated by reference
to Exhibit 99.4 of Dells Current Report on
Form 8-K
filed April 28, 1998, Commission File
No. 0-17017)
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4
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.4
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Form of Dells 6.55% Senior Notes Due 2008
(incorporated by reference to Exhibit 99.5 of Dells
Current Report on
Form 8-K
filed April 28, 1998, Commission File
No. 0-17017)
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4
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.5
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Form of Dells 7.10% Senior Debentures Due 2028
(incorporated by reference to Exhibit 99.6 of Dells
Current Report on
Form 8-K
filed April 28, 1998, Commission File
No. 0-17017)
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31
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.1
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Certification of Michael S. Dell, Chairman and Chief Executive
Officer, pursuant to
Rule 13a-14(a)
under the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
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31
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.2
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Certification of Donald J. Carty, Vice Chairman and Chief
Financial Officer, pursuant to
Rule 13a-14(a)
under the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
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32
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.1
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Certifications of Michael S. Dell, Chairman and Chief Executive
Officer, and Donald J. Carty, Vice Chairman and Chief Financial
Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
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Filed herewith. |
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Furnished herewith. |
57