Technology giant Dell (Nasdaq:DELL) now bills itself as an "innovative technology and services" provider. This is a welcome change from its previous focus on laptop and desktop computers, which continues, especially in the consumer market, to cede market share to new applications. This shift is boosting profits handsomely, but the market may still be holding out for signs it can grow its top line.
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Most Recent Quarterly Recap
Dell reported net revenue during its fiscal third quarter that was essentially flat, at $15.4 billion, and consisted of a 2% drop in product sales that was more than offset by 8% growth in service revenue. By product category, the server and networking segment posted robust 13% growth to account for 13.6% of the total top line. Beyond services, the remaining segments posted negative growth, with the largest declines in storage and desktop PCs, which fell 15 and 6%, respectively. Software and mobility revenues each fell 2%, to round out the units. By customer, large enterprise clients grew the fastest at 4%. Consumer was the weakest, falling 6%, as this segment embraces tablet devices and smartphones from the likes of Apple (Nasdaq:AAPL) and competing applications powered by Google's (Nasdaq:GOOG) Android software system.

A continued migration away from computers and into more lucrative services, helped send gross margins up 16% to $3.5 billion. An 18% jump in operating expenses tempered operating income growth to 12%, as operating profits reached $1.1 billion, or 7.4% of sales. Interest expense reduced net income growth to 9%, as profits reached $893 million, but share buybacks boosted the per-share growth back to 17%, as earnings came in at 49 cents. The balance sheet remained strong, with a net cash position of roughly $5.6 billion, or $3 per diluted share. Free cash flow production fell slightly to about $637 million, or 35 cents per diluted share. (For more on buybacks, see How Buybacks Warp The Price-To-Book Ratio.)

Outlook
Dell relayed that its sales growth is "trending to the lower end of the range of its revenue outlook of 1 to 5% full fiscal-year growth," but that operating income should grow between 17 and 23%. Analysts currently project full-year sales growth of only 1%, total sales just north of $62 billion and earnings of $2.11 per share.

The Bottom Line
Dell's shift to higher-margin businesses has been impressive and has largely gone unnoticed by the market. Currently, it trades at a forward P/E of just about seven. Industry rival Xerox (NYSE:XRX) has also successfully migrated into services, but trades at a similar forward earnings valuation. Both deserve applause for adapting in the fast-changing technology market. In stark contrast, Eastman Kodak (NYSE:EK) looks to have failed to evolve and has seen its share price fall to close to $1 per share. (For more on the forward P/E, see How To Use The P/E Ratio And PEG To Tell A Stock's Future.)

In Dell's case, investors may be holding out for tangible signs that sales growth will return. Without it, there is only so much Dell can do to boost profits from its existing business. It has relied on acquisitions to migrate into faster-growing tech markets, but will eventually need to prove it can also grow organically.

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At the time of writing Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

Tickers in this Article: DELL, AAPL, GOOG, XRX, EK

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