Reason for Report: 2Q14 Earnings Update

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report: 2Q14 Earnings Update

Prev. Ed.:Jun 12, 2013; 1Q14 Earnings Update (broker material considered till May 23, 2013)

Brokers’ Recommendations: Neutral: 88.2% (15 analysts); Negative: 11.8% (2 analysts); Positive: 0.0% (0)

Prev. Ed:22, 2, 0

Brokers’ Target Price: $13.38 (↑$0.22from last edition; 10 analysts) Brokers’ Avg. Expected Return:(2.9%)

*Note: Although dated Sep 27, 2013, share price and brokers’ material are as of Aug 27, 2013.

Note: A Flash update on 1Q14 earnings was done on Aug 19, 2013

Note: The tables below (Revenues, Margins and Earnings per Share) contain material from fewer brokers than in the Valuation table. The extra figures in the Valuation table are taken from reports that did not have accompanying spreadsheet model

Portfolio Manager Executive Summary

DELL Inc.(DELL) is the global leader in direct marketing of computing products and services. The company designs, develops, manufactures, sells, and offers support to a wide range of computer systems that are customized to meet varied customer requirements. The company hasa broad range of product categories, including desktop computer systems, mobility products, software and peripherals, servers and networking products, enhanced services, and storage products.

Industry Outlook:The computing market is currently going through a few changes. In the relatively mature developed nations, growth is increasingly coming from more portable devices, such as tablets and ultrabooks. Growth opportunities abound in developing countries but these markets are typically more cost sensitive. Therefore, in both markets, there is a growing demand for cheaper computing devices. In this backdrop, companies with more of an enterprise focus (clients, servers, or software) will come out stronger, not just because they will be less impacted by this change but also because they will be relatively more insulated from cost pressures.

Competitive Position: Dell faces intense price and product feature competition from large and small branded and generic rivals. The company lost share, both in the U.S. and internationally, as its growth did not meet the overall personal computer systems growth. This was mainly due to intense competitive pressure in its U.S. Consumer business, particularly in lower priced desktops and notebooks, as well as a slight decline in its worldwide desktop shipments.

Of the analysts in the Digest group covering DELL, 88.2% were neutral, and 11.8% were negative.Nonewere positive on the stock. Target prices range from $11.00 to $15.00, averaging $13.38. The expected return from the current share price provided by the analysts is (2.9%).

Neutral– (Equivalent ratings: Hold, Market Weight, Market Perform, Average, Sector Perform and Equal Weight) – 15 analysts or 88.2% –Majority of the analysts prefer adopt a caution stance, given the pending decision on Dell’s leveraged buyout by Michael Dell. Due to a slump in the PC market, Dell’s revenues like all other players in the industry are likely to decline. There is still some uncertaintyon whether Dell will be able to maintain its cost discipline in the face of increasing investments. Aggressive pricing due to stiff competition would keep margins under pressure.

However, the analysts believe that the privatization of Dell is likely to offer greater flexibility to accelerate its investments.Dell's enterprise portfolio has increased as a percent of total revenue. These factors could help improve margins over time.Management believes that an expanding customer base will help it to earn huge profits and it is with this end in view that it has transformed itself into an end-to-end solutions provider.

Bearish – (Equivalent ratings: Sell and Underperform) – 2 analysts or 11.8% – Analysts are bearish on the stock due to the persistently weak PC market.

General Outlook: DELL’s growth opportunities include its potential for international expansion, particularly in Europe, Asia, and Latin America; expansion into new high-growth product categories, such as storage, printing, and services and the evolution of new technologies including multi-core PCs and servers that are expected to provide sales growth and stock upgrading opportunities.

Sep27, 2013

Overview

Key investment considerations as identified by the analysts are as follows:

• The analysts considerDELL as a well-established, low-cost leader in the PC market with only short-term challenges to its business model.
• DELL has market share growth opportunities in servers, storage, printers, and services for commodity products.
• DELL has the opportunity to gain share in the PC market outside the U.S.
• DELL has the most competitive supply chain logistics in the industry due to its direct model.
• DELL is experiencing continued strong momentum in the U.S. enterprise markets.
• The company has the potential to turn around its activities, and has increased its focus on profitability improvement.

• The rising component costs could put DELL’s operating margin under pressure.
• DELL operates in a highly-competitive market with peers like IBM, HPQ, and Acer.
• The sequential lag in revenue growth and cash flow is a major concern for the analysts.
• Reliance on Intel as a sole source supplier of microprocessors appears to be risky for DELL, though a relationship with AMD has recently been established.
• The PC market could be turning into a commodity industry.
• Enterprise IT budgets could become tighter and consumer spending could also become weaker.

Based in Texas, Round Rock, Dell Inc. (DELL) is a diversified information-technology supplier and partner and sells a comprehensive portfolio of products and services worldwide. Dell and its subsidiaries engage in the design, development, manufacture, marketing, sale, and support of a range of computer systems and services worldwide. The company’s products and services enable customers to build their information-technology and Internet infrastructures. The company also offers a range of products such as enterprise systems, which include servers, storage, workstations, and networking products; client systems such as notebook and desktop computer systems; printing and imaging systems; and software and peripherals, including titles, monitors, plasma and LCD televisions, MP3 players, handhelds, and notebook accessories.

Dell's four global business segments are Large Enterprise, Public, Small and Medium Business (“SMB”), and Consumer. Large Enterprise includes sales of IT infrastructure and service solutions to large global and national corporate customers. Public includes sales to educational institutions, governments, health care organizations, and law enforcement agencies, among others. SMB includes sales of complete IT solutions to small and medium-sized businesses. Consumer includes sales to individual consumers and retailers around the world.

Dell also offers various services, including information-technology management services; professional services in technology consulting, application development, solutions integration, and infrastructure design; deployment services; support services; and training and certification services. Its customers include large corporate, government, healthcare, and education accounts, as well as small-to-medium businesses and individual customers. The company markets and sells products and services directly to customers. For further information, please visit

Note: DELL’s fiscal year ends on Jan 31; fiscal references differ from the calendar year.

Sep27, 2013

Long-Term Growth

According to the analysts, an investment decision for DELL should be premised upon its strength in the PC market, the ability of the company to maintain its operating margin given the increasing component costs, and the long-term growth prospects.

Corporate and government demand for PCs has been strong over the past year, helping to lift the industry after the recession. But consumer demand has decline significantlydue high unemployment and the lure of new gadgets such as tablet computers and smartphones. The worldwide PC market is facing stiff competition from next generation ultra-portable gadgets (mainly tablets). Moreover, the commoditization of PCs has resulted in price wars. The players can only adjust product prices in an effort to maintain their respective market shares. In the long term, Dell’s PC business should continue to see challenges from Apple in tablets. But Dell is well positioned in the enterprise vertical, which could cushion it to an extent.

Dell isfocused on the expansion of its enterprise solutions, which include servers, networking, storage, services and software capabilities. Management believes that it can increase its profits by focusing on data center, information management, cloud computing and software. Dell believes that the strategic expansion of its client offerings is critical for the long-term success of the business.

Dell has acquired more than 12 businesses since the start of fiscal year 2012.These acquisitions have helped the company to expand its core capabilities in a variety of enterprise offerings, including storage, networking, virtualized server, data center, and desktop solutions, and software-as-a-service application integration and also expand its customer financing activities.

The company recently modified its corporate structure to align it with its products and services, execute its strategies and to better serve customers. Presently, its product and business services segment comprises End-User Computing Group, Enterprise Solutions Group, Dell Services and Dell Software Group.

Sep27, 2013

Target Price/Valuation

Provided below is a summary of valuation/ratings as compiled by Zacks Research Digest:

Risks to DELL’s target price include a softer-than-expected IT spending environment, an unexpected rise in component costs, and increased competition in the core PC business. Specifically, an inability to return the gross margin to historical levels, the continued weakness in DELL’s U.S. consumer business, and an inability to grow market share overseas may also pose significant risks to the stock’s performance.

Recent Events

On Sep 12, 2013, Shareholders of Dell voted in favor of the $24.9 billion privatization bid by Michael Dell, founder of Dell, and Silver Lake Management during the special meeting. Moreover, the Dell board announced a quarterly cash dividend of 8 cents per share to be paid on Oct 22. The deal is expected to be closed before the fiscal third quarter of 2014.

On Aug 15, 2013, Dell announced 2Q14 financial results. Highlights are as follows:

• Total revenue was $14.5 billion, remained flay ony/y basis

• Earnings per share declined to $0.25 from $0.50reported in the year-ago quarter

• Cash and cash equivalents plus short-term investments were $11.8 billion versus $10.9 billion

Revenues

According to the company press release, total revenue was $14.5 billion in 2Q14, flat y/y.

Product revenues dropped 1.0% year over year to $11.3 billion, while Services, including software related revenuesgrew 4.0% year over yearto $3.2 billion. The year-over-year decline in product revenues was offset by the increase in services revenues.

Provided below is a summary of revenue as compiled by Zacks Research Digest:

Operating Segments (as per press release)

Enterprise Solutions Group: Enterprise Solutions Group revenues were $3.3 billion, up 8% y/y. Operating income was $137.0 million, down 9.0% y/y.Dell server, networking and peripherals revenues increased 10.0% y/y. Dell networking revenues recorded a rise of 19.0% on a year-over-year basis while Dell storage revenues declined 7.0% y/y.

Dell Software: Segment revenues were $310.0 million.

Dell Services : Services revenueswere $2.1 billion, up 2.0% y/y.

End User ComputingGroup: The End User Computing segment revenues were $9.1 billion, down 5.0% y/y, primarily due to a 5.0% revenue decline in peripherals and third-party software revenues and a 10.0% decline in mobility segment revenues. However, Dell desktop and thin client revenues were up a marginal 1.0%

Outlook

Given the company’s announcement (on Feb 5) of going private through a leveraged buyout, the company did not providean outlook for 3Q14 or FY14.However, Dell continues to see a significant opportunity for corporate PC refreshes to Windows 7.

Analysts continue to be uncertain in view of the impending buyout as customers may delay their purchases until there is more clarity.

The analysts believe that Dell has some impediments for growth in the short term in the form of macro economic slowdown, execution issues, fierce competition and weak demand for PCs.

The analysts believe that since consumer tastes and preferences are shifting towards tablets and smartphones from PCs and since Dell does not have much penetration in those spheres so it might adversely affect Dell’s market position. As a result, its sales may fall leading to lowering of margins as well.

The company is making efforts to improve its competitive position and profitability levels.Despite this, analysts are uncertain over the pace of turnaround and its ability to maintain cost discipline due to a likely increase in investment.

Please refer to the DELL Zacks Research Digest spreadsheet for more details on revenue estimates.

Margins

According to company’s press release, gross profit was $2.84 billion in 2Q14, down13.0% y/y. Gross margin was 19.6% y/y, contracting 300 basis points(bps). Margin contraction was mainly due to unenthusiastic revenue growth.

Selling, general and administrative expenses were $2.1 billion in 2Q14, up6.0% y/y, and 14.4% oftotal revenue. Research and development expenses were $320 million, up 23.0% y/y and 2.2% of total revenue. Non-GAAP operating expenses were up 4% from the year-ago quarter to $2.24 billion. As a percentage of revenues, operating expenses expanded 60 bps during the same period.

Non-GAAP operating income was $602.0 million in 2Q14 versus $1.12 billion in the year ago quarter. Operating margin came in at 4.1% versus 7.7% in the year-ago quarter.

Non-GAAP net income decreased 51.0% in 2Q14 y/y to $433.0 million. Net margin was 2.9% versus 6.0% in the year-ago quarter.

Provided below is a summary of margins as compiled by Zacks Research Digest:

Outlook

Given the company’s announcement (on Feb 5) of going private through a leveraged buyout, the company did not providean outlook for 3Q14 or FY14.

The analysts believe that management will remain focused on profitability while benefiting from the acceleration in the enterprise PC refresh cycle. Also, Dell's enterprise portfolio has increased as a percent of total revenue. These factors could help improve margins over time.

However, some analysts think that deceleration of the growth rate in the Public operating unit, increasing operating expenses due to continued investments in newer areas and planned expansion in enterprise solutions and services portfolio through consecutive acquisitions, and aggressive pricing due to stiff competition could keep margins under pressure, going forward.

Dell strives to increase end user computer (EUC) margin over the longer term, analysts remain uncertain on this front.

Please refer to the DELL Zacks Research Digest spreadsheet for more details on margin estimates.

Earnings per Share

As per the company press release, Dell reported non-GAAP EPS (excluding amortization of intangibles of $0.11, acquisition-related charges of $0.05 and other charges of $0.03)of $0.25,which declined considerably from $0.50per share reported in the year-ago quarter.

Provided below is a summary of EPS as compiled by Zacks Research Digest:

Outlook

Given the company’s announcement (on Feb 5) of going private through a leveraged buyout, the company did not providean outlook for 3Q14 or FY14.

Following the 2Q14 earnings release, majority of the analysts lowered their FY14 and FY15 estimates to reflect continued weakness in the PC business and the pending LBO.

Analysts believe that the combination of slowing PC unit growth, tougher enterprise growth and competition, and the lack of well-defined Mobile Internet and Cloud Computing platforms and margin pressure will limit EPS growth in the quarters to come.

Please refer to the DELL Zacks Research Digest spreadsheet for more details on EPS estimates.

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