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Dell's Margin Erosion Prompts Selloff

Computer maker Dellshares fell 13 percent Friday, as both earnings and margins fell short of Wall Street estimates.

Dell posted its fiscal second-quarter earnings late Thursday, and said profit fell 17 percent, hurt in part by PC price cuts. For the three-month period that ended Aug. 1, Dell's earnings dropped to $616 million, or 31 cents per share, from $746 million, or 32 cents per share in the same period last year.

Excluding amortization and business realignment charges, Dell said it would have earned 33 cents per share. Analysts surveyed by Thomson Reuters had forecast a profit of 36 cents per share.

Investors sent Dell shares down $3.28, or 13 percent, to $21.92.

Sales rose 11 percent to $16.4 billion, ahead of Wall Street's view for $15.9 billion in sales. And Dell said operating expenses fell to their lowest point in six quarters.

But the company slashed PC prices too sharply in the quarter, offsetting its attempts to cut costs and eroding its gross margin. Analysts had hoped Dell's margin would hold steady at last quarter's level of 18.4 percent, but instead it sank to 17.2 percent.

In a conference call, Chief Financial Officer Brian Gladden said Dell made "strategic pricing" changes in Europe, the Middle East and Africa to speed up growth and fend off competition from its larger competitor, Hewlett-Packard. The company also deferred some services-related profit from that region to a later quarter.

"If I look at the situation in the second quarter, we would have to say it was more self-inflicted," Chief Executive Michael Dell said in a conference call. "Whenever you're restarting growth, what I can tell you is, it's an imprecise process. (There were) some parts of the business where we were probably too aggressive."

Sharon Cross, an analyst for Cross Research, said that Dell bulls were hopeful that if the company was aggressive in pricing but managed to cut costs somewhere in the supply chain, the company could still pull off flat margins.

(Watch the accompanying video for more on what analysts are saying about Dell's earnings...)

"That obviously is not the case," said Cross, who rates the stock a "Sell."

Cross said she thought Dell cut prices to some extent in other regions, too. Gladden indicated that Dell is also taking aim at back-to-school shoppers with lower prices.

Shaw Wu, an analyst for American Technology Research, also noted that Dell sold more low-end computers in the quarter, adding to the margin woes.

In a tough consumer economy, companies such as HP can make up for weaker PC sales with better results from high-end servers or printers, but Wu said Dell's business is so tied to PC sales that it has little choice but to lower prices.

"When you look at their arsenal, price is really their only weapon," he said.

Dell said the company would reach its goal of 8,900 jobs cut in the current third quarter. Since the target was set last year, Dell has already cut more than 8,500 workers, excluding the impact of acquisitions.

The company said slower information-technology spending has spread from the U.S. to Western Europe and parts of Asia, and said it expects that trend to continue.

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