UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

(Mark One)
x		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: January 29, 2010
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to

 

Commission file number: 0-17017

 

Dell Inc.

(Exact name of registrant as specified in its charter)

 

 

One Dell Way, Round Rock, Texas 78682

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: 1-800-BUY-DELL

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ  No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

 

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 þ  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer þ		Accelerated filer o
Non-accelerated filer o  (Do not check if smaller reporting company)		Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the registrant’s proxy statement relating to the annual meeting of stockholders in 2010. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The words “may,” “will,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “aim” and similar expressions as they relate to us or our management are intended to identify these forward-looking statements. All statements by us regarding our expected financial position, revenues, cash flows and other operating results, business strategy, legal proceedings and similar matters are forward-looking statements. Our expectations expressed or implied in these forward-looking statements may not turn out to be correct. Our results could be materially different from our expectations because of various risks, including the risks discussed in this report under “Part I — Item 1A — Risk Factors.” Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances, including unanticipated events, after the date on which such statement is made.

 

All percentage amounts and ratios were calculated using the underlying data in thousands. Unless otherwise noted, all references to time periods refer to our fiscal years. Our fiscal year is the 52 or 53 week period ending on the Friday nearest January 31.

 

Unless the context indicates otherwise, references in this report to “we,” “us,” “our” and “Dell” mean Dell Inc. and our consolidated subsidiaries.

 

General

 

Dell delivers innovative technology and services which customers trust and value. As a leading technology company, we offer a broad range of product categories, including mobility products, desktop PCs, software and peripherals, servers and networking, and storage. Our services include a broad range of configurable IT and business related services, including infrastructure technology, consulting and applications, and business process services.

 

Our company is a Delaware corporation and was founded in 1984 by Michael Dell on a simple concept: by selling computer systems directly to customers, we can best understand their needs and efficiently provide the most effective computing solutions to meet those needs. Over time we have expanded our business model to include a broader portfolio of products and services, and we have also added new distribution channels, such as retail, system integrators, value-added resellers, and distributors, which allow us to reach even more end-users around the world. To optimize our global supply chain to best serve our global customer base, we have transitioned a portion of our production capabilities to contract manufacturers.

 

Our global corporate headquarters are located in Round Rock, Texas. Dell Inc. is a holding company that conducts its business worldwide through its subsidiaries. When we refer to our company and its business in this report, we are referring to the business and activities of our consolidated subsidiaries. We operate principally in one industry, and we manage our business in four global customer oriented operating segments that we identify as Large Enterprise, Public, Small and Medium Business, and Consumer.

 

We are committed to managing and operating our business in a responsible and sustainable manner around the globe. This includes our commitment to environmental responsibility in all areas of our business. See “Government Regulation and Sustainability” below for additional information. This also includes our focus on maintaining a strong control environment, high ethical standards, and financial reporting integrity. See “Part II — Item 9A — Controls and Procedures” for a discussion of our internal control over financial reporting.

 

Business Strategy

 

Dell built its reputation as a leading technology provider through listening to customers and developing solutions that meet customer needs. We are focused on providing long-term value creation through the delivery of customized solutions that make technology more efficient, more accessible, and easier to use.

 

We are focused on improving our core business, shifting our portfolio to higher-margin and recurring revenue streams over time, and maintaining a balance of liquidity, profitability, and growth. We consistently focus on generating strong cash flow returns, allowing us to expand our capabilities and acquire new ones. We seek to grow revenue over the long term while improving operating income and cash flow growth. We have three primary components to our strategy:

 

 

 

By successfully executing our strategy and driving greater efficiency and productivity in how we operate, we believe we can help customers grow and thrive.

 

Operating Business Segments

 

All of our goals begin and end with the customer. Striving to meet and exceed customer needs is at the heart of everything we do. During the first quarter of Fiscal 2010, we reorganized the manner in which we manage our business from geographic commercial segments identified as Americas Commercial, EMEA Commercial, and APJ Commercial, to global commercial business units we refer to as Large Enterprise, Public, and Small and Medium Business (“SMB”). Our global Consumer business unit remained the same. This alignment creates a clear customer-centric focus, which we believe allows us to serve customers with faster innovation and greater responsiveness, and enables us to better understand and address their challenges. Our four global business segments are:

 

 

 

For financial information about the results of our reportable operating segments for each of the last three fiscal years, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Segment Discussion” and Note 14 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

Products and Services

 

Our aim is to provide customers with integrated business solutions. We design, develop, manufacture, market, sell, and support a wide range of products and services that can be customized to individual customer requirements. Our products and services are organized between enterprise solutions and client categories. Enterprise solutions include servers, storage, and related services, software and peripherals. Client includes mobility, desktop products, and also related services, software and peripherals. Our services include a broad range of configurable IT and business services, including infrastructure technology, consulting and applications, and business process services. We also offer or arrange various customer financial services for our business and consumer customers in the U.S.

 

 

We focus on developing modular and scalable technologies that incorporate highly desirable features and capabilities at competitive prices. We employ a collaborative approach to product design and development in which our engineers, with direct customer input, design innovative solutions and work with a global network of technology companies to architect new system designs, influence the direction of future development, and integrate new technologies into our products. Through this collaborative, customer-focused approach, we strive to deliver new and relevant products and services to the market quickly and efficiently. Our total research, development, and engineering expenses were $624 million for Fiscal 2010, $665 million for Fiscal 2009, and $693 million for Fiscal 2008, including acquisition related in-process research and development expenses of $2 million for Fiscal 2009 and $83 million for Fiscal 2008.

 

 

Third parties manufacture some of the products we sell under the Dell brand. We have expanded our use of contract manufacturers and manufacturing outsourcing relationships to achieve our goals of generating cost efficiencies, delivering products faster, better serving our customers in certain segments and geographical areas, and delivering a world-class supply chain. Our manufacturing and distribution facilities are located in Austin, Texas; Winston-Salem, North Carolina; Nashville, Tennessee; Penang, Malaysia; Xiamen, China; Hortolândia, Brazil; Chennai, India; and Lodz, Poland. Beginning in Fiscal 2009, we have reduced our fixed costs by selling, closing and consolidating manufacturing and other facilities, and have moved towards a more variable cost manufacturing model. In connection with our implementation of this model, we have announced the closure of our Winston-Salem manufacturing facility and the sale of our Poland facility, both expected to be finalized in Fiscal 2011. See “Part I — Item 2 — Properties” for information about our manufacturing and distribution locations.

 

Our manufacturing process consists of assembly, software installation, functional testing, and quality control. Testing and quality control processes are also applied to components, parts, sub-assemblies, and

systems obtained from third-party suppliers. Quality control is maintained through the testing of components, sub-assemblies, and systems at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly, ongoing production reliability audits, failure tracking for early identification of production and component problems, and information from customers obtained through services and support programs. We are certified to the ISO (International Organization for Standardization) 9001: 2008 Quality management systems standard. This certification includes most of our global sites that design, manufacture, and service our products.

 

We purchase materials, supplies, product components, and products from a large number of vendors. In some cases, multiple sources of supply are not available and hence we have to rely on single-source vendors. In other cases, we may establish a working relationship with a single source or a limited number of sources if we believe it is advantageous to do so due to performance, quality, support, delivery, capacity, or price considerations. This relationship and dependency has not caused material supply disruptions in the past, and we believe that any disruption that may occur because of our dependency on single- or limited-source vendors would not disproportionately disadvantage us relative to our competitors. See “Part I — Item 1A — Risk Factors” for information about the risks associated with single- or limited-source suppliers.

 

 

 

Our PowerConnect^tm switches connect computers and servers in small to medium-sized networks. PowerConnect^tm products offer customers enterprise-class features and reliability at a high value to our customers.

 

 

 

 

 

 

 

 

 

Desktop PCs — We target sales of the Alienware^tm line of desktop computers to customers seeking features ranging from multimedia capability to high performance gaming. The Studio^tm line of compact and stylish consumer desktops includes the Hybrid, our most power efficient consumer desktop. We have designed the Inspiron^tm line of desktop computers for mainstream PC users requiring the latest features for their productivity and entertainment needs. We offer the OptiPlex^tm line to help business, government, and institutional customers manage their total cost of ownership by offering a portfolio of secure, manageable, and stable lifecycle products. The Vostro^tm line is designed to provide technology and services to suit the specific needs of small businesses. Dell Precision^tm desktop workstations are intended for professional users who demand exceptional performance from hardware platforms optimized and certified to run sophisticated applications, such as those needed for three-dimensional computer-aided design, digital content creation, geographic information systems, computer animation, software development, computer-aided engineering, game development, and financial analysis.

 

 

We offer or arrange various customer financial services for our business and consumer customers in the U.S. through Dell Financial Services L.L.C. (“DFS”), a wholly-owned subsidiary of Dell. DFS offers a wide range of financial services, including originating, collecting, and servicing customer receivables related to the purchase of Dell products. DFS offers private label credit financing programs through an unrelated, nationally chartered bank, to qualified consumer and Commercial customers and offers leases and fixed-term financing to Commercial customers. Financing through DFS is one of many sources of funding that our customers may select. For additional information about our financing arrangements, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financing Receivables” and Note 4 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

To support the financing needs of our customers internationally, we have aligned with a select number of third party financial services companies. These financial services companies work directly with our customers to originate and service financing arrangements, enabling customers to finance and purchase Dell products and services.

 

For additional information about our products and services, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Segment Discussion — Revenue by Product and Services Categories,” and Notes 4 and 14 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

Geographic Operations

 

Our global corporate headquarters are located in Round Rock, Texas. We have operations all over the world and conduct business in many countries located in the Americas, Europe, the Middle East, Asia and other geographic regions. We have invested in high growth countries such as Brazil, Russia, India, and China, or “BRIC,” and we expect to continue our global expansion in the years ahead. Our continued expansion outside of the U.S. creates additional complexity in coordinating the design, development, procurement, manufacturing, distribution, and support of our increasingly complex product and service offerings. We intend to continue to expand our global capabilities as our international business continues to grow. For additional information on our product and service offerings, see “Products and Services — Manufacturing and Materials” and “Part I — Item 2 — Properties.” For information about percentages of revenue we generated from our operations outside of the U.S. for each of the last three fiscal years, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.”

 

Competition

 

We operate in an industry in which there are rapid technological advances in hardware, software, and service offerings and face on-going product and price competition in all areas of our business from branded and generic competitors. We compete based on our ability to offer profitable and competitive solutions to our customers that provide the most current and desired product features, as well as on customer service, quality, and reliability. This is enabled by our direct relationships with customers, which allow us to recognize changing customer needs faster than many of our competitors. This connection with our customers allows us to best serve customer needs and is one of our competitive advantages.

 

We are committed to balancing our mix of products and services to optimize profitability, liquidity, and growth. We believe this strategy will help us achieve higher margins, but may put pressure on our industry unit share position for personal computers and servers at certain times.

 

Sales and Marketing

 

We sell our products and services directly to customers through our online store at www.dell.com, dedicated sales representatives, telephone-based sales, and through a variety of indirect sales channels. Our customers include large

global and national corporate businesses, public institutions including government, education and healthcare organizations, and law enforcement agencies. Our customers also include small and medium-sized businesses, individual customers, and retailers. Within each geographic region, we have divided our sales resources among these various customer groups. No single customer accounted for more than 10% of our consolidated net revenue during any of the last three fiscal years.

 

Our sales and marketing efforts are organized around the evolving needs of our customers. Our direct business model provides direct communication with our customers, thereby allowing us to refine our products and marketing programs for specific customer groups. Customers may offer suggestions for current and future Dell products, services, and operations on an interactive portion of our Internet website called Dell IdeaStorm. This constant flow of communication allows us to rapidly gauge customer satisfaction and target new or existing products.

 

For large business and institutional customers, we maintain a field sales force throughout the world. Dedicated account teams, which include field-based system engineers and consultants, form long-term relationships to provide our largest customers with a single source of assistance, develop specific tailored solutions for these customers, and provide us with customer feedback. For large, multinational customers, we offer several programs designed to provide single points of contact and accountability with global account specialists, special global pricing, and consistent global service and support programs. We also maintain specific sales and marketing programs targeted at federal, state, and local governmental agencies, as well as healthcare and educational customers.

 

We market our products and services to small and medium-sized businesses and consumers primarily by advertising on television and through the Internet, advertising in a variety of print media, and mailing or emailing a broad range of direct marketing publications, such as promotional materials, catalogues, and customer newsletters.

 

We also sell our products and services through indirect sales channels. In the U.S., we sell products indirectly through third-party solution providers, system integrators, and third-party resellers. We also offer select consumer products in retail stores in several countries in the Americas, Europe, the Middle East, and Africa, which we refer to as “EMEA,” and Asia-Pacific Japan (“APJ”). Outside the U.S., we sell products indirectly through selected retailers to benefit from the retailer’s existing end-user customer relationships and valuable knowledge of traditional customs and logistics in the country and to mitigate credit and country risk as well as because sales in some countries may be too small to warrant a direct sales business unit. Our goal is to have strategic relationships with a number of major retailers in larger geographic regions. During Fiscal 2010, we continued to expand our global retail presence, and we now reach over 56,000 retail locations worldwide. Our retailers include Best Buy, Staples, Wal-Mart, DSGI, GOME, and Carrefour, among others.

 

Patents, Trademarks, and Licenses

 

At January 29, 2010, we held a worldwide portfolio of 2,577 patents and had an additional 2,418 patent applications pending. We also hold licenses to use numerous third-party patents. To replace expiring patents, we obtain new patents through our ongoing research and development activities. The inventions claimed in our patents and patent applications cover aspects of our current and possible future computer system products, manufacturing processes, and related technologies. Our product, business method, and manufacturing process patents may establish barriers to entry in many product lines. While we use our patented inventions and also license them to others, we are not substantially dependent on any single patent or group of related patents. We have entered into a variety of intellectual property licensing and cross-licensing agreements. We have also entered into various software licensing agreements with other companies. We anticipate that our worldwide patent portfolio will be of value in negotiating intellectual property rights with others in the industry.

 

We have obtained U.S. federal trademark registration for the DELL word mark and the Dell logo mark. We own registrations for 81 of our other marks in the U.S. At January 29, 2010, we had pending applications for registration of 24 other trademarks. We believe that establishment of the DELL word mark and logo mark in the U.S. is material to our operations. We have also applied for or obtained registration of the DELL word mark and several other marks in approximately 195 other countries.

From time to time, other companies and individuals assert exclusive patent, copyright, trademark, or other intellectual property rights to technologies or marks that are important to the technology industry or our business. We evaluate each claim relating to our products and, if appropriate, seek a license to use the protected technology. The licensing agreements generally do not require the licensor to assist us in duplicating its patented technology, nor do these agreements protect us from trade secret, copyright, or other violations by us or our suppliers in developing or selling these products.

 

Government Regulation and Sustainability

 

 

Our business is subject to regulation by various federal and state governmental agencies. Such regulation includes the radio frequency emission regulatory activities of the U.S. Federal Communications Commission; the anti-trust regulatory activities of the U.S. Federal Trade Commission, the U.S. Department of Justice, and the European Union; the consumer protection laws and financial services regulations of the U.S. Federal Trade Commission and various state governmental agencies; the export regulatory activities of the U.S. Department of Commerce and the U.S. Department of Treasury; the import regulatory activities of U.S. Customs and Border Protection; the product safety regulatory activities of the U.S. Consumer Product Safety Commission; the investor protection and capital markets regulatory activities of the Securities and Exchange Commission; and the environmental, employment and labor, and other regulatory activities of a variety of governmental authorities in each of the countries in which we conduct business. We were not assessed any material environmental fines, nor did we have any material environmental remediation or other environmental costs, during Fiscal 2010.

 

 

Environmental stewardship and social responsibility are both integral parts of how we manage our business, and complement our focus on business efficiencies and customer satisfaction. We use open dialogue with our stockholders, customers, vendors, and other stakeholders as part of our sustainability governance process where we take candid feedback and offer honest discussions on the challenges we face globally. Our environmental initiatives take many forms, including maximizing product energy efficiency, reducing and eliminating sensitive materials from our products, and providing responsible, convenient computer recycling options for customers.

 

We are committed to becoming carbon neutral in our operations. We have set business requirements for our suppliers to disclose and reduce their greenhouse gas, or “GHG,” impacts. We were the first company in our industry to offer a free worldwide recycling program for our consumers. We also provide consumers with no-charge recycling of any brand of computer or printer with the purchase of a new Dell computer or printer. We have streamlined our transportation network to reduce transit times, minimize air freight and reduce emissions. Our packaging is designed to minimize box size and to increase recycled content of materials along with recyclability. When developing and designing products, we select materials guided by a precautionary approach in which we seek to eliminate environmentally sensitive substances (where reasonable alternatives exist) from our products and work towards developing reliable, environmentally sound, and commercially scalable solutions. We also have created a series of tools that help customers assess their current IT operations and uncover ways to reduce both the costs of those operations and their impact on the environment.

 

Backlog

 

We believe that backlog is not a meaningful indicator of net revenue that can be expected for any period. The backlog at any point in time may not translate into net revenue in any subsequent period, as unfilled orders can generally be canceled at any time by the customer. Our business model generally gives us flexibility to manage backlog at any point in time by expediting shipping or prioritizing customer orders toward products that have shorter lead times, thereby reducing backlog and increasing current period revenue. Although backlog at the end of Fiscal 2010 was higher than at the end of Fiscal 2009 and Fiscal 2008, the difference was not material when compared to our annual revenue during Fiscal 2010.

Trademarks and Service Marks

 

Unless otherwise noted, trademarks appearing in this report are trademarks owned by us. We disclaim proprietary interest in the marks and names of others. EMC is a registered trademark of EMC Corporation.

 

Available Information

 

Our principal executive offices are located at One Dell Way, Round Rock, Texas 78682, and our telephone number at that address is 1-800-BUY-DELL.

 

We maintain an Internet website at www.dell.com. All of our reports filed with the SEC (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports) are accessible through the Investor Relations section of our website at www.dell.com/investor, free of charge, as soon as reasonably practicable after we electronically file the reports with the SEC. You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. Information on our website is not incorporated by reference into this report and does not otherwise form a part of this report.

 

Employees

 

At the end of Fiscal 2010, we had approximately 96,000 total employees (consisting of 94,300 regular employees and 1,700 temporary employees), compared to approximately 78,900 total employees (consisting of 76,500 regular employees and 2,400 temporary employees) at the end of Fiscal 2009. Our acquisition of Perot Systems added 23,800 regular employees. Approximately 36,600 of the regular employees at the end of Fiscal 2010 were located in the U.S., and approximately 57,700 regular employees were located in other countries.

 

Executive Officers of Dell

 

The following table sets forth the name, age, and position of each of the persons who were serving as our executive officers as of March 5, 2010:

 

Name		Age				Title
Michael S. Dell			45			Chairman of the Board and Chief Executive Officer
Peter A. Altabef			50			President, Services
Bradley R. Anderson			50			Senior Vice President, Enterprise Product Group
Paul D. Bell			49			President, Public
Jeffrey W. Clarke			47			Vice Chairman, Operations and Technology
Andrew C. Esparza			51			Senior Vice President, Human Resources
Stephen J. Felice			52			President, Consumer, Small and Medium Business
Ronald G. Garriques			46			President, Communication Solutions
Brian T. Gladden			45			Senior Vice President and Chief Financial Officer
Erin Nelson			40			Senior Vice President and Chief Marketing Officer
Stephen F. Schuckenbrock			49			President, Large Enterprise
Lawrence P. Tu			55			Senior Vice President, General Counsel and Secretary

 

Our executive officers are elected annually by, and serve at the pleasure of, our Board of Directors.

 

Set forth below is biographical information about each of our executive officers.

 

 

 

Our business, operating results, financial condition and prospects are subject to a variety of significant risks, many 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.

 

 

We are a global company with customers in virtually every business and industry. Our performance depends significantly on global economic conditions. Commercial customers and consumers may postpone spending amid concerns over reduced asset values, fluctuating energy costs, geopolitical issues, the availability and cost of credit, unemployment, and the stability and solvency of financial institutions, financial markets, businesses, and sovereign nations. Weak global economic conditions could have a number of adverse effects on our business, including weaker customer demand, potential insolvency of key suppliers resulting in product delays, the inability of customers to obtain credit to finance purchases of our products on favorable terms, and potential customer insolvencies, all of which could negatively impact our liquidity and ultimately decrease our net revenue and profitability.

 

Our financial services activities are negatively affected in the current adverse economic environment by loan delinquencies and defaults. Although the trend of increasing loan delinquencies and defaults has slowed, defaults impact our net credit losses and we may need to increase our reserves for customer receivables in the future. In addition, anticipated changes in financial services regulation could unfavorably impact the profitability and cash flows of our consumer financing activities.

 

 

We operate in an industry in which there are rapid technological advances in hardware, software and service offerings, and face aggressive product and price competition from both branded and generic competitors. We compete based on our ability to profitably offer competitive solutions with the most current and desired product features, as well as on customer service, quality and reliability. We expect that competition will continue to be intense and that our competitors’ products may be less costly, provide better performance or include additional features when compared to our products. Our efforts to balance our mix of products and services to optimize profitability, liquidity, and growth may also put pressure on our industry unit share position in the short-term. As we continue to expand globally, we may see new and increased competition in different geographic regions. In addition, barriers to entry in our businesses generally are low and products can be distributed broadly and quickly at relatively low cost.

 

 

A variety of factors could prevent us from achieving our goal of better aligning our product and service offerings and cost structure with customer needs in the current business environment. We are currently focused on reducing our operating expenses, reducing total costs in procurement, product design, transformation, and simplifying our structure. For example, we may experience delays in the anticipated timing of activities related to our cost savings plans and higher than expected or unanticipated costs to implement the plans. As a result, we may not achieve our expected cost savings in the time anticipated, or at all. In such case, our results of operations and profitability may be negatively impacted, making us less competitive and potentially causing us to lose industry unit share.

 

 

Continuing improvements in technology result in frequent new product and services introductions, short product life cycles, and improvements in product performance characteristics. In addition, we are increasingly sourcing new products and transitioning existing products through our contract manufacturers and manufacturing outsourcing relationships in order to generate cost efficiencies, deliver products faster and better serve our customers in certain segments and geographical areas. The success of product transitions depends on a number of factors, including the availability of products in appropriate quantities and costs to meet demand, and the risk that new or upgraded products have quality or other defects. These product transitions present execution challenges and risks. If we are unable to effectively manage a new product transition, our business and results of operations could be unfavorably affected.

 

 

Our growth strategy involves reaching more customers worldwide through new distribution channels, such as consumer retail, expanding our relationships with value-added resellers, and augmenting select areas of our business through targeted acquisitions. As we reach more customers worldwide through an increasing number of new distribution channels, such as consumer retail, and continue to expand our relationships with value-added resellers, inventory management becomes more challenging and successful demand forecasting becomes more difficult. Our goal continues to be to optimize the balance of liquidity, profitability, and growth with a focus on moving the weight of the product portfolio to higher margin products and recurring revenue streams. Our ability to grow sales of these higher margin products, services

and solutions depends on our ability to successfully transition our sales capabilities in accordance with our strategy and to add to the breadth of our higher margin offerings through selective acquisitions of other businesses. If we are unable to effectively manage the growth of our distribution capabilities and grow our product and services offerings, our business and results of operations could be unfavorably affected.

 

 

Our profitability is affected by our ability to achieve favorable pricing with our vendors and contract manufacturers, including through negotiations for vendor rebates, marketing funds, and other vendor funding received in the normal course of business. 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. These vendor programs may change periodically, potentially resulting in adverse profitability trends. Our inability to establish a cost and product advantage, or determine alternative means to deliver value to our customers, may adversely affect our industry unit share position, revenue, and profitability.

 

 

We obtain many of our products and all of our components from third party vendors. In addition, we are continuing to expand our use of contract manufacturers and manufacturing outsourcers. While these relationships generate cost efficiencies, they reduce our direct control over production. Our manufacturing and supply chain efficiencies give us the ability to operate with reduced levels of component and finished goods inventories. Our increasing reliance on these vendors subjects us to a greater risk of shortages, and reduced control over delivery schedules of components and products, as well as a greater risk of increases in product and component costs. Because we maintain minimal levels of component and product inventories, a disruption in component or product availability could harm our financial performance and our ability to satisfy customer needs. In addition, defective parts and products from these vendors could reduce product reliability and harm our reputation.

 

 

We maintain several single-source or limited-source supplier relationships, either because multiple sources are not available or because the relationships are advantageous to us due to performance, quality, support, delivery, capacity, or price considerations. If the supply of a critical single- or limited-source product 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 our operating results.

 

 

We acquire companies as a part of our overall growth strategy. 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, integration challenges, new regulatory requirements, and issues not discovered in our due diligence process. As a result, such acquisitions may adversely affect our profitability or operations. In addition, if we make changes in our business strategy or if external conditions adversely affect our business operations, we may be forced to record an impairment charge for goodwill or intangibles, which would lead to decreased assets and reduced net operating performance.

 

 

Sales outside the U.S. accounted for approximately 47% of our consolidated net revenue in Fiscal 2010. Our future growth rates and success are dependent on continued growth of our business outside the U.S., including in the key developing countries of Brazil, Russia, India, and China. Our international operations face many risks and uncertainties, including varied local economic and labor conditions, political

instability, and 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.

 

 

Our profit margins vary among products, customers, and geographic markets. 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 may be adversely affected by the mix of products, customers, and geographic markets reflected in our sales for that period, as well as by seasonal trends.

 

 

We are increasingly dependent on access to debt and capital sources to provide financing for our customers and to obtain funds in the U.S. for general corporate purposes, including working capital, acquisitions, capital expenditures, funding customer receivables, and share repurchases. Additionally, we have customer financing relationships with companies whose business models rely on accessing the capital markets. The inability of these companies to access such markets could force us to self-fund transactions or forego customer financing opportunities, potentially harming our financial performance. The debt and capital markets may experience extreme volatility and disruption from time to time in the future, resulting in higher credit spreads in the capital markets and higher funding costs for us. The cost of accessing debt and capital markets has increased in recent periods as many lenders and institutional investors require higher rates of return. Lenders have also tightened lending standards, and reduced or ceased their lending to certain borrowers. Deterioration in our business performance, a credit rating downgrade, volatility in the securitization markets, changes in financial services regulations or adverse changes in the economy could lead to reductions in debt availability and could limit our ability to continue asset securitizations or other financings from debt or capital sources, reduce the amount of financing receivables that we originate, or negatively affect the costs or terms on which we may be able to obtain capital, any of which could unfavorably affect our net revenue, profitability, and cash flows.

 

 

Contracts with the U.S. Government and foreign governments 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 applicable government could suspend or disbar us as a contractor, which would unfavorably affect our net revenue and profitability.

 

 

Many of our services contracts allow the customer to:

 

 

These customer actions may adversely affect our revenue and profitability.

 

In addition, we estimate our costs to deliver the services at the outset of the contract. If we fail to estimate accurately, our actual costs may significantly exceed our estimates, even for a time and materials contract, and we may incur losses on the services contracts.

 

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. If we are not successful in monitoring our foreign exchange exposures and conducting an effective hedging program, our foreign currency hedging activities may not offset the impact of fluctuations in currency exchange rates on our future results of operations and financial position.

 

 

We enter into numerous financing arrangements, including foreign currency option contracts and forward contracts, with a wide array of bank counterparties. As a result, we are subject to the risk that the counterparty to one or more of these contracts will default, either voluntarily or involuntarily, on its performance under the contract. In times of market distress, a counterparty may default rapidly and without notice to us, and we may be unable to take action to cover our exposure, either because we lack the contractual ability or because market conditions make it difficult to take effective action. In the event of a counterparty default, we could incur significant losses, which could harm our business, results of operations, and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our ability eventually to recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding. In addition, our deposits at financial institutions are at risk.

 

 

We are involved in various claims, suits, investigations, and legal proceedings that arise from time to time in the ordinary course of our business and that are not yet resolved, including those described elsewhere in this Report. Additional legal claims or regulatory matters may arise in the future and could involve stockholder, consumer, antitrust, tax and other issues on a global basis. Litigation is inherently unpredictable. Regardless of the merit of the claims, litigation may be both time-consuming and disruptive to our business. Therefore, we could incur judgments or enter into settlements of claims that could adversely affect our operating results or cash flows in a particular period. For example, we could be exposed to enforcement or other actions with respect to the continuing SEC investigation into certain accounting and financial reporting matters. In addition, our business, operating results and financial condition could be adversely affected if any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions.

 

 

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. Although our suppliers might be contractually obligated to obtain such licenses and indemnify us against such expenses, those suppliers could be unable to meet their obligations. In addition, our operating costs could increase because of copyright levies or similar fees by rights holders and collection agencies in European and other countries.

 

 

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 2011 through Fiscal 2019. Many of these holidays may be extended when certain conditions are met, or terminated if certain conditions are not met. If they are not extended, or if we fail to satisfy the conditions of the reduced tax rate, then our effective tax rate would increase in the

future. Our effective tax rate could also increase if our geographic sales mix changes. We are under audit in various tax jurisdictions. An unfavorable outcome in certain of these matters could result in a substantial increase to our tax expense. In addition, changes in tax laws (including U.S. taxes on foreign operations) could adversely affect our operations and profitability.

 

 

If management is not successful in maintaining a strong internal control environment, we could have weaknesses in our control environment, causing investors to lose confidence in our reported financial information. This 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.

 

 

Our operations are subject to environmental and safety 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, energy efficiency and collection, recycling, treatment, transportation and disposal of our electronics products, including restrictions on mercury, lead, cadmium, lithium metal, lithium ion and other substances. If we fail to comply with applicable rules and regulations regarding the transportation, use and sale of such regulated substances, we could be subject to liability. The costs and timing of costs under environmental and safety laws are difficult to predict, but could have an unfavorable impact on 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 delays and inefficiencies in our supply chain.

 

 

We depend on our information technology and manufacturing infrastructure to achieve our business objectives. If a disruption, such as a computer virus, natural disaster, failure of a manufacturing or telecommunications system, lost connectivity, or intentional tampering or data-breach by a third party impairs our infrastructure, we may be unable to receive or process orders, manufacture and ship products in a timely manner, or otherwise conduct our business as usual. A disruption could cause us to lose customers and revenue, particularly during a period of disproportionately heavy demand, and could result in the unintentional disclosure of company or customer information and could damage our reputation. We also could incur significant expense in remediating these problems and in addressing related data security and privacy concerns.

 

 

We rely on key personnel to support anticipated continued rapid international growth and increasingly complex product and service offerings. We may not be able to attract, retain, and motivate the key professional, technical, marketing, and staff resources we need.

 

None.

 

At January 29, 2010, we owned or leased a total of approximately 19.7 million square feet of office, manufacturing, and warehouse space worldwide, approximately 9.4 million square feet of which is located in the U.S. We owned approximately 57% of this space and leased the remaining 43%. Included in these amounts are approximately 1.8 million square feet that are either vacant or sublet.

 

Our principal executive offices, including global headquarters, are located at One Dell Way, Round Rock, Texas. Our business centers, which include facilities that contain operations for sales, technical support, administrative, and support functions, occupy 10.3 million square feet of space, of which we own 36%. We own 4 million square feet of manufacturing space. Our design centers are housed in 1.5 million square feet of space, of which we own 49%.

 

Our acquisition of Perot Systems Corporation during Fiscal 2010 added over 3.0 million square feet of office and data center space worldwide, which is included above. During Fiscal 2010, we closed a manufacturing plant in Limerick, Ireland and a business center in Twin Falls, Idaho, and we sold our remanufacturing facility in Lebanon, Tennessee and business center in Pasay City, Philippines. At the end of Fiscal 2010, a business center in Coimbatore, India was under construction.

 

We plan to close our Winston-Salem, North Carolina manufacturing facility in Fiscal 2011 and have announced the sale of our Lodz, Poland manufacturing facility. We may continue to sell, close, and consolidate additional facilities depending on a number of factors, including end-user demand, capabilities, and progress in our continuous evaluation of our overall cost structure. We believe that our existing properties are suitable and adequate for our current needs and that we can readily meet our requirements for additional space at competitive rates by extending expiring leases or by finding alternative space.

 

As discussed in “Part I — Item 1 — Business,” we have four operating segments identified as Large Enterprise, Public, SMB and Consumer. Because of the interrelation of the products and services offered in each of these segments, we do not designate our properties to each segment. All four segments use substantially all of the properties at least in part, and we retain the flexibility to make future use of each of the properties available to each of the segments.

 

The information required by Item 3 is set forth under the captions “Legal Matters” and “Copyright Levies” in Note 9 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” and is incorporated herein by reference.

 

Market for Common Stock

 

Our common stock is listed on the Global Select Market of The NASDAQ Stock Market LLC under the symbol DELL. Information regarding the high and low sales prices per share of our common stock for Fiscal 2010 and Fiscal 2009, as reported by the NASDAQ Global Select Market, is set forth in Note 16 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” and is incorporated by reference herein.

 

Holders

 

At March 5, 2010, there were 30,125 holders of record of Dell common stock.

 

Dividends

 

We have never declared or paid any cash dividends on shares of our common stock and currently do not anticipate paying any cash dividends in the immediate future. Any future determination to pay cash dividends will be at the discretion of our Board of Directors.

 

Purchases of Common Stock

 

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. We did not repurchase any shares during the fourth quarter of Fiscal 2010. At January 29, 2010, the remaining authorized amount for future purchases under our share repurchase program was $4.5 billion.

Stock Performance Graph

 

The following graph compares the cumulative total return on Dell’s common stock during the last five fiscal years with the S&P 500 Index and the Dow Jones Computer Index during the same period. The graph shows the value, at the end of each of the last five fiscal years, of $100 invested in Dell common stock or the indices on January 29, 2005, and assumes the reinvestment of all dividends. The graph depicts the change in the value of our common stock relative to the indices at the end of each fiscal year and not for any interim period. Historical stock price performance is not necessarily indicative of future stock price performance.

 

 

 

The following selected financial data should be read in conjunction with “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II — Item 8 — Financial Statements and Supplementary Data” and are derived from our audited financial statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” or in our previously filed Annual Reports on Form 10-K.

 

 

This section should be read in conjunction with “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

OUR COMPANY

 

We are a leading integrated technology solutions provider in the IT industry. We offer a broad range of products, including mobility products, desktop PCs, software and peripherals, servers and networking, and storage products. Our services offerings include infrastructure technology, consulting and applications, and business process services. We also offer various financing alternatives, asset management services, and other customer financial services for business and consumer customers.

 

We built our reputation as a leading technology provider through listening to customers and developing solutions that meet customer needs. We are focused on providing long-term value creation through the delivery of customized solutions that make technology more efficient, more accessible, and easy to use. Customer needs are increasingly being defined by how they use technology rather than where they use it, which is why in the first quarter of Fiscal 2010, we transitioned from a global business that is managed regionally to businesses that are globally organized. We reorganized our geographic commercial segments to global business units to reflect the impact of globalization on our customer base. Our four global business segments are Large Enterprise, Public, Small and Medium Business (“SMB”), and Consumer. We also refer to our Large Enterprise, Public, and SMB segments as “Commercial.”

 

We maintain a highly efficient global supply chain, which allows low inventory levels and the efficient use of and return on capital. We have manufacturing locations around the world and relationships with contract manufacturers. This combined structure allows us to optimize our global supply chain to best serve our global customer base. To maintain our competitiveness, we continuously strive to improve our products, services, technology, manufacturing, and logistics.

 

We are continuing to invest in initiatives that will align our new and existing products and services around customers’ needs in order to drive long-term sustainable growth, profitability, and liquidity. During Fiscal 2010, we acquired Perot Systems Corporation (“Perot Systems”), which expands our services business and better positions us for immediate and long-term growth through the sale of additional enterprise solutions. Our business model also includes selling through distribution channels, such as retail, system integrators, value-added resellers, and distributors, which allows us to reach even more end-users around the world. We are investing resources in emerging countries with an emphasis on Brazil, Russia, India, and China (“BRIC”), where, given stable economic conditions, we expect significant growth to occur over the next several years. We are also creating customized products and services to meet the preferences and requirements of our diversified global customer base. We will focus our investments to grow our business organically as well as inorganically through alliances and strategic acquisitions.

RESULTS OF OPERATIONS

 

Consolidated Operations

 

The following table summarizes our consolidated results of operations for each of the past three fiscal years:

 

 

In Fiscal 2010, our overall net revenue decreased year-over-year due primarily to the global economic slowdown that began during the second half of Fiscal 2009. The weakened economy continued to impact the IT spending of our Commercial customers, which accounted for 77% of our overall revenue for Fiscal 2010. Our Consumer segment experienced significant unit demand growth year-over-year, but a mix shift to lower-priced products and competitive pricing pressures resulted in a decrease in Consumer revenue and profitability. During the second half of Fiscal 2010, the IT industry started to see signs of economic recovery, and as a result, our unit shipments during the fourth quarter of Fiscal 2010 improved year-over-year for all of our segments. Overall, we have seen indications of strengthening demand in the Commercial segments and continued growth in the Consumer segment, and we believe that, as the global economy continues to recover, our revenue in Fiscal 2011 should improve relative to Fiscal 2010.

 

During Fiscal 2010, we focused on balancing liquidity, profitability, and growth by emphasizing areas that provided profitable growth opportunities. We also took actions in this challenging demand environment to shift towards a more variable cost manufacturing structure, reduce operating expenses, and improve our working capital management. We are beginning to see the positive impact of these efforts and expect that the benefits of our strategy will carry into Fiscal 2011, with anticipated enhanced operating leverage should revenue growth return. We will continue to work on additional cost reduction and efficiency efforts.

 

We will continue to focus our efforts on providing best-value solutions to our customers in all areas of enterprise, including servers, storage, services, and software. We believe these solutions are customized to the needs of users, easy to use, and affordable. During the fourth quarter of Fiscal 2010, we acquired Perot Systems, a worldwide provider of information technology and business solutions, and we expect to increase our portfolio of solutions offerings to our customers. Additionally, we will continue our overall strategy of seeking to balance profitability and liquidity with revenue growth.

 

Revenue

 

Fiscal 2010 compared to Fiscal 2009

 

 

 

Overall, our average selling price (total net revenue per unit sold) during Fiscal 2010 decreased 8% year-over-year mostly due to competitive pricing pressures and a change in product mix towards lower-priced offerings, particularly in our Consumer segment. Average selling prices in Consumer declined 21% during Fiscal 2010, mostly due to our expansion into retail and a continuing shift in mix to lower-priced products. In the Consumer business, our market strategy is to expand our product offerings and customer coverage, by focusing on optimized products and services that have the features that customers value. We continue to see competitive pressure, particularly for lower priced desktops and notebooks. We expect this competitive pricing environment will continue for the foreseeable future. The average selling prices for our Commercial segments remained relatively flat from Fiscal 2009.

 

Outside the U.S., we experienced a 16% year-over-year revenue decline for Fiscal 2010 as compared to an approximate decline of 11% in revenue for the U.S. during the same period. Revenue outside the U.S. represented approximately 47% of net revenue for Fiscal 2010. At a consolidated level, BRIC revenue increased 4% during Fiscal 2010 and has been increasing sequentially since the fourth quarter of Fiscal 2009. We are continuing to expand into emerging markets by tailoring solutions to meet specific needs of these customers, and enhancing relationships to provide customer choice and flexibility.

 

During Fiscal 2010 and Fiscal 2009, the principal currencies in which we transact business experienced more volatility primarily due to macroeconomic conditions, including the global recession. However, we manage our business on a U.S. Dollar basis and utilize a comprehensive hedging strategy intended to mitigate the impact of foreign currency volatility over time. As a result, the impact of currency movements was not significant to our consolidated results of operations or any related trends.

 

Fiscal 2009 compared to Fiscal 2008

 

 

Revenue outside the U.S. represented approximately 48% of Fiscal 2009 net revenue. Outside the U.S., we produced 4% year-over-year revenue growth for Fiscal 2009 as compared to a 3% decline in revenue for the U.S. The decline in our U.S. revenue was mainly attributable to our Commercial business in the U.S., which was impacted by the downturn in the global economy during the second half of Fiscal 2009. Our U.S. consumer business also was impacted by the economic slowdown; however, this business’s revenue grew during Fiscal 2009, aided by our expansion into retail through an increased number of worldwide retail locations. BRIC revenue grew 20% during Fiscal 2009 as we tailored solutions to meet specific regional needs, and enhanced relationships to provide customer choice and flexibility. From a worldwide product perspective, the continued decline in desktop unit sales and prices, and decreases in mobility selling prices contributed to our Fiscal 2009 performance.

Gross Margin

 

The following table presents information regarding our gross margin during each of the past three fiscal years:

 

 

Fiscal 2010 compared to Fiscal 2009

 

 

During Fiscal 2010, our services gross margin decreased in absolute dollars compared to the prior year with a corresponding decrease in gross margin percentage. Our solution services offerings faced competitive pricing pressures in the current economic environment, resulting in lower gross margin percentages.

 

We continue to actively review all aspects of our facilities, logistics, supply chain, and manufacturing footprints. This review is focused on identifying efficiencies and cost reduction opportunities while maintaining a strong customer experience. As a result of this review to date, we have begun using contract manufacturers in an effort to migrate towards a more variable cost manufacturing model. This shift has resulted in the announced closures of our North Carolina manufacturing plant, as well as the pending sale of our Poland facility and the closure of the Limerick, Ireland, facility. During Fiscal 2010 and 2009, the cost of these individual severance and facility actions was $481 million and $282 million, respectively, of which approximately $237 million and $146 million, respectively, affected gross margin. We continue to actively evaluate our overall cost structure, including product design and manufacturing costs. We expect that we will continue our overall cost reduction activities, which may include selected headcount reductions, as well as other cost reduction programs. While we believe that we will have completed a significant portion of our manufacturing transformation once we finalize the closures of our North Carolina and Poland facilities, we expect to implement additional cost reduction measures depending on a number of factors, including end-user demand, capabilities, and our continued simplification of our supply and logistics chain. See Note 8 of the Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for additional information on severance and facility action costs.

 

As we continue to evolve our inventory and manufacturing business model to drive cost efficiencies, 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 structure, which is able to respond quickly to changing market conditions due to our customer-facing model. Such negotiations are focused on achieving the lowest net cost of our various components, independent of the pricing strategies used by our supplier base. Because of the fluid nature of these ongoing negotiations, the timing and amount of supplier discounts and rebates vary from

time to time. These discounts and rebates are allocated to the segments based on a variety of factors, including strategic initiatives, to drive certain programs. We monitor our suppliers’ net cost, including vendor funding programs, and work to mitigate any disruptions or price disadvantages caused by changes in our supplier programs.

 

In general, gross margin and margins on individual products and services will remain under downward pressure due to a variety of factors, including continued industry-wide global pricing pressures, increased competition, compressed product life cycles, potential increases in the cost and availability of raw materials, and outside manufacturing services. We expect to continue to see pressure on certain component costs, and we will continue to adjust our pricing strategy and shift towards a variable cost manufacturing model with the goals of optimizing growth and profitability. We will continue to invest in initiatives that will align our new and existing products and services with customers’ needs, particularly for enterprise products and solutions. As we shift our focus more to enterprise products and solutions, we believe the improved mix of higher margin sales will positively impact our gross margin over time.

 

Fiscal 2009 compared to Fiscal 2008

 

During Fiscal 2009, our gross margin decreased in absolute dollars and in gross margin percentage as a result of decreases in average selling prices from competitive pricing pressures and further expansion into retail through an increased number of worldwide retail locations. The year-over-year gross margin percentage decline can be further attributed to the fact that Fiscal 2008 witnessed unusually high component cost declines, whereas Fiscal 2009 component cost declines returned to more typical levels. During Fiscal 2009, we closed our desktop manufacturing facility in Austin, Texas, and sold our call center in El Salvador.

 

Operating Expenses

 

The following table presents information regarding our operating expenses during each of the past three fiscal years:

 

 

Fiscal 2010 compared to Fiscal 2009

 

 

Compensation and benefits expense, excluding expenses related to headcount reductions, decreased approximately $300 million in Fiscal 2010 compared to Fiscal 2009. With the increase in retail volumes, which typically incur less advertising costs, advertising expenses decreased approximately $200 million year-over-year from Fiscal 2009. Due to company-wide spending control measures, there were large decreases in most other categories of expenses, including travel, maintenance, telecom, utilities, training, and recruiting, resulting in savings of over $340 million.

 

These decreases were partially offset by an increase in accounts receivable bad debt of $40 million resulting from the challenging business environment. SG&A expenses related to headcount and infrastructure reductions through our on-going cost optimization efforts were $237 million for Fiscal 2010 compared to $136 million for Fiscal 2009. SG&A expenses for Fiscal 2010 also included approximately $115 million of costs related to the acquisition of Perot Systems.

We expect integration costs related to our acquisition of Perot Systems to continue over the next fiscal years. In addition, we will continue to review our costs across all processes and organizations with the goals of reducing complexity and eliminating redundancies. Since the second quarter of Fiscal 2008 and through the end of Fiscal 2010, excluding the 23,800 employees we added from Perot Systems, we have reduced headcount by approximately 20,000 and closed a number of our facilities. While we have made significant progress in the transformation of our manufacturing and logistics areas, we expect to take further actions to reduce costs while investing in strategic growth areas.

 

 

Fiscal 2009 compared to Fiscal 2008

 

 

Operating and Net Income

 

Fiscal 2010 compared to Fiscal 2009

 

 

Fiscal 2009 compared to Fiscal 2008

 

 

SEGMENT DISCUSSION

 

During the first quarter of Fiscal 2010, we reorganized our geographic commercial segments to global business units. Our four global business segments are Large Enterprise, Public, Small and Medium Business, and Consumer, reflecting the impact of globalization on our customer base.

 

Severance and facility action expenses, broad based long-term incentive expenses, in-process research and development, amortization of purchased intangible assets costs, and acquisition-related expenses in relation to our acquisition of Perot Systems are not allocated to the reporting segments. These costs totaled $1.2 billion during Fiscal 2010, $805 million during Fiscal 2009, and $650 million during Fiscal 2008. See Note 14 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for additional information and reconciliation of segment revenue and operating income to consolidated revenue and operating income.

 

The following table presents our net revenue and operating income by our reportable global segments:

 

 

 

 

Fiscal 2010 compared to Fiscal 2009

 

 

During Fiscal 2010, operating income percentage decreased 70 basis points year-over-year to 5.7%. Operating income deteriorated as revenue decreased year-over-year due to lower demand. Additionally, operating expenses as a percentage of revenue increased year-over-year even though operating expense dollars decreased 17%. We believe that Large Enterprise is well positioned for better operating leverage going forward as demand strengthens, and as we continue to shift our enterprise storage and server products to higher margin offerings.

 

 

During Fiscal 2010, operating income percentage increased 120 basis points year-over-year to 9.4%. Operating income was positively impacted by a year-over-year improvement in gross margin percentage during Fiscal 2010 as we continued to optimize our pricing and cost structure and sell higher value solutions to our customers. The addition of Perot Systems contributed 3% to the growth in operating income. Also favorably impacting operating income was a 5% year-over-year decrease in operating expenses during Fiscal 2010, driven by cost savings related to headcount reductions and improved spending controls on SG&A and RD&E expenditures.

 

 

Operating income percentage increased 10 basis points year-over-year to 8.6% during Fiscal 2010. Operating income dollars decreased 18% as revenue and unit shipments decreased significantly for both periods. Also impacting operating income was a slight increase in gross margin percentage during Fiscal 2010. We were also able to reduce operating expenses during Fiscal 2010, mainly due to tighter spending controls on SG&A and RD&E expenses.

 

 

Consumer’s operating income percentage declined approximately 1.5 percentage points year-over-year to 0.9%. Consumer’s operating performance was affected by a year-over-year decline in gross margin during Fiscal 2010 mainly due to the previously mentioned revenue declines and to component cost pressures. Even though operating expenses decreased year-over-year, operating expenses as a percentage of revenue remained relatively flat during Fiscal 2010 as compared to Fiscal 2009. During the fourth quarter of Fiscal 2010, we announced plans to combine Consumer and SMB under a single leadership team to reduce overall costs, though we will continue to manage and report the two segments separately.

 

During Fiscal 2010, Consumer’s revenue and operating income was favorably impacted by a second quarter $53 million transaction, in which a vendor purchased our contractual right to share in future revenues from product renewals sold by the vendor. Excluding this transaction, Consumer’s Fiscal 2010 operating income percentage would have been 0.4% instead of 0.9%. We may from time to time enter into similar agreements as we intend to monetize other elements of the consumer business.

 

We sell desktop and notebook computers, printers, ink, toner, displays, and accessories through retailers. Our goal is to have strategic relationships with a number of major retailers in our larger geographic regions. We expanded our global retail presence over the prior year, and now reach over 56,000 retail locations worldwide, compared to 24,000 at the end of Fiscal 2009.

 

Fiscal 2009 compared to Fiscal 2008

 

 

For Fiscal 2009, operating income dollars declined 13% year-over-year, and operating income percentage decreased 70 basis points year-over-year to 6.4% from 7.1%. Operating income deteriorated due to lower demand which drove decreases in both revenue and costs of revenue.

 

 

For Fiscal 2009, operating income dollars remained flat on the revenue growth, while operating income dollars and percentage were positively impacted by the growth in unit shipments and a 1% increase in average selling prices, the effects of which were partially offset by a 5% increase in cost of revenue and a 3% increase in operating expenses.

 

 

For Fiscal 2009, operating income percentage remained flat year-over-year at 8.5%. However, operating income dollars decreased 5% year-over-year as revenue decreased mainly due to a 6% decline in average selling prices in a competitive pricing environment, partially offset by a reduction in cost of revenue of 7% year-over-year. As a result, we experienced a slight improvement in our gross margin percentage.

 

 

Consumer’s operating income percentage increased year-over-year by approximately 100 basis points to 2.4%. Operating income was negatively impacted by a 17% decrease in average selling prices. Additionally, operating expenses declined 19% year-over-year as we began to realize the benefits from our cost-improvement initiatives.

 

Revenue by Product and Services Categories

 

We design, develop, manufacture, market, sell, and support a wide range of products that in many cases are customized to individual customer requirements. Our products and services are organized between enterprise solutions and client categories. Enterprise solutions include servers, storage, and related services, software and peripherals. Client includes mobility, desktop products, and also related services, software and peripherals.

 

The following table summarizes our net revenue by product and service categories for each of the past three fiscal years:

 

 

Fiscal 2010 compared to Fiscal 2009

 

 

Servers and Networking — The decline in our server and networking revenue during Fiscal 2010 was due to demand challenges across all Commercial segments and regions. Unit shipments decreased 12% year-over-year, though average selling prices increased 6% year-over-year driven by improved product mix toward our new product lines such as the introduction of our 11th generation PowerEdge^tm servers during Fiscal 2010.

Storage — All Commercial segments contributed to the year-over-year decrease in storage revenue during Fiscal 2010. Dell EqualLogic^tm performed strongly with year-over-year revenue growth of 45%. We are shifting towards more Dell-branded and co-branded storage offerings, which generally can be sold with service solutions and provide increased margin opportunity. During Fiscal 2010, we introduced easy-to-manage storage products such as the EqualLogic^tm PS6 series with fast 10Gb Ethernet. We also introduced our PowerVault^tm NX300 storage server, which is designed to simplify file sharing and collaboration for growing small businesses.

 

 

The dynamics of our services business will change as we continue to integrate Perot Systems. With Perot Systems, we will extend our services business further into infrastructure business process outsourcing, consulting, and application development. We also anticipate expanding our existing managed and modular services businesses.

 

 

Software revenue from our S&P line of business, which includes software license fees and related post-contract customer support, is included in services revenue, including software related on the Consolidated Statements of Income. Software and related support services revenue represents 39% of services revenue, including software related during Fiscal 2010.

 

 

Mobility — Revenue from mobility products (which include notebook computers, mobile workstations, and smartphones) declined during Fiscal 2010 even though unit shipments increased 7% over Fiscal 2009 due to an industry mix shift to lower priced mobility product offerings. The unit increase was primarily driven by a 32% year-over-year increase in Consumer, while Commercial units declined 12% for the same period. Overall, Consumer mobility revenue increased 4% year-over-year, while Commercial declined 20%. We believe the on-going demand trend towards mobility products will continue, and we plan to address this demand by expanding our product platforms to cover broader feature sets and price bands.

 

Desktop PCs — During Fiscal 2010, revenue from desktop PCs (which include desktop computer systems and workstations) decreased on unit declines of 17%. In the marketplace, we are continuing to see rising end-user demand for mobility products, which contributes to further slowing demand for desktop PCs, as mobility growth is expected to continue to outpace desktop growth. The decline in desktop PC revenue was also due to the on-going competitive pricing pressure for lower priced desktops and the slowdown in global IT end-user demand during Fiscal 2010. Consequently, our average selling price for desktops decreased 11%

year-over-year as we continued to align our prices and product offerings with the marketplace. During Fiscal 2010, desktop revenue decreased across all segments.

 

Fiscal 2009 compared to Fiscal 2008

 

 

Servers and Networking — During Fiscal 2009, revenue from sales of servers and networking products remained flat year-over-year on a unit increase of 4%. The flat revenue growth was mainly due to demand challenges. To address the demand challenges and drive growth, we adjusted our pricing and product strategy to shift our product offerings to lower price bands. Consequently, our average selling price for servers and networking products decreased 3% year-over-year during Fiscal 2009. During Fiscal 2009, we experienced double digit growth in blades, 4-Socket rack servers, and our cloud computing initiatives.

 

Storage — The growth in revenue from sales of storage products was led by strength in our PowerVault^tm line and the strong performance of our EqualLogic^tm iSCSI networked storage solutions, which we acquired in Fiscal 2008. SMB and Public contributed to the increase in storage revenue with year-over-year growth of 36% and 15%, respectively, for Fiscal 2009.

 

 

Mobility — During Fiscal 2009, revenue from mobility products grew 4% on unit growth of 24%. The average selling prices of our mobility products across all of our segments dropped 17% year-over-year due to a soft demand environment and the continued expansion into retail by our Consumer segment. Expansion into retail also contributed to our overall revenue growth as mobility revenue in Consumer increased 29% year-over-year on unit growth of 60%, as compared to a decline in mobility revenue of 8% on unit growth of 6% in our Commercial business. Large Enterprise and SMB experienced declines in mobility revenue of 16% and 3%, respectively, on a unit decline of 2% and unit growth of 10%, respectively.

 

Desktop PCs — During Fiscal 2009, revenue from desktop PCs decreased year-over-year on a unit decline of 4%. The decline was primarily due to the on-going competitive pricing pressure for lower priced desktops and a softening in global IT end-user demand. Consequently, our average selling price for desktops decreased 6% year-over-year during Fiscal 2009 as we aligned our prices and product offerings with the marketplace. For Fiscal 2009, desktop revenue decreased across all segments. Our Consumer, Large Enterprise, SMB, and Public segments experienced year-over-year desktop revenue declines of 17%, 11%, 10% and 6%, respectively.

Stock-Based Compensation

 

We use the 2002 Long-Term Incentive Plan, amended in December 2007, 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 $312 million for Fiscal 2010, compared to $418 million and $436 million for Fiscal 2009 and Fiscal 2008, respectively. Stock-based compensation expense for Fiscal 2009 includes $104 million of expense for accelerated options, and for Fiscal 2008 includes cash payments of $107 million made for expired in-the-money stock options. For further discussion on stock-based compensation, see Note 13 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

Interest and Other, net

 

The following table provides a detailed presentation of interest and other, net for Fiscal 2010, 2009, and 2008:

 

		January 29,				January 30,				February 1,
		2010				2009				2008
		(in millions)
Interest and other, net:
Investment income, primarily interest		$	57			$	180			$	496
Gains (losses) on investments, net			2				(10	)			14
Interest expense			(160	)			(93	)			(45	)
CIT minority interest			-				-				(29	)
Foreign exchange			(59	)			115				(30	)
Other			12				(58	)			(19	)
Interest and other, net		$	(148	)		$	134			$	387

 

Fiscal 2010 compared to Fiscal 2009

 

During Fiscal 2010, our investment income declined, even with higher average balances, primarily due to a decrease in market yield of over 200 basis points from Fiscal 2009 to an average of approximately 48 basis points. We continued to maintain a portfolio of instruments with shorter maturities, which typically carry lower market yields. Increased term and short-term debt during Fiscal 2010 resulted in increased interest expense. Other, in the table above, primarily reflects the fair market value adjustments related to our deferred compensation plan investments. We recognized a $24 million increase and a $35 million decline in the fair market values of our deferred compensation plan investments during Fiscal 2010 and Fiscal 2009, respectively.

 

The year-over-year decrease in foreign exchange for Fiscal 2010, as compared to Fiscal 2009, was primarily due to increased costs on our hedge program, as well as revaluation on balances in unhedged currencies, as most foreign currencies strengthened relative to the U.S. Dollar during Fiscal 2010. In addition, for Fiscal 2009, a $42 million gain resulted from the correction of errors in the remeasurement of certain local currency balances to the functional currency in prior periods. A deferred revenue liability was incorrectly remeasured over time based on changes in currency exchange rates instead of remaining at historical exchange rates. We also incorrectly measured a tax liability at historical rates instead of being remeasured over time based on changes in currency exchange rates.

 

Fiscal 2009 compared to Fiscal 2008

 

The year-over-year decrease in investment income for the fiscal year ended January 30, 2009, was primarily due to decreased interest rates on lower average investment balances. Gain (losses) on investments decreased for Fiscal 2009 as compared to Fiscal 2008, primarily due to a $11 million loss recorded for other-than-temporarily impaired investments during Fiscal 2009. The year-over-year increase in interest expense in Fiscal 2009 was attributable to interest on the $1.5 billion debt issued in the first quarter of Fiscal 2009. CIT non-controlling interest was eliminated due to our purchase of CIT Group Inc.’s (“CIT”) 30% interest in Dell Financial Services L.L.C. (“DFS”) during the fourth quarter of Fiscal 2008. Foreign exchange increased year-over-year from Fiscal 2008 primarily due to

revaluation gains from unhedged currencies. During Fiscal 2009, we recognized a $35 million decline in the fair market value of our investments related to our deferred compensation plan. These expenses are included in Other in the table above.

 

Income and Other Taxes

 

Our effective tax rate was 29.2%, 25.4%, and 23.0% for Fiscal 2010, 2009, and 2008, respectively. 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 permanent differences between the book and tax treatment of certain items. The increase in our effective income tax rate for Fiscal 2010 from Fiscal 2009 was primarily due to an increased mix of profits in higher tax rate jurisdictions. Our foreign earnings are generally taxed at lower rates than in the United States. We continue to assess our business model and its impact in various tax jurisdictions.

 

Deferred tax assets and liabilities for the estimated tax impact of temporary differences between the tax and book basis of assets and liabilities are recognized based on the enacted statutory tax rates for the year in which we expect the differences to reverse. A valuation allowance is established against a deferred tax asset when it is more likely than not that the asset or any portion thereof will not be realized. Based upon all the available evidence, including expectation of future taxable income, we have determined that we will be able to realize all of our deferred tax assets, net of valuation allowances.

 

The adoption of the accounting guidance for uncertain tax positions resulted in a decrease to stockholders’ equity of approximately $62 million in the first quarter of Fiscal 2008. For a further discussion of the impact of uncertain tax positions, see Note 10 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

We are currently under income tax audits in various jurisdictions, including the United States. The tax periods open to examination by the major taxing jurisdictions to which we are subject include fiscal years 1997 through 2010. As a result of these audits, we maintain ongoing discussions and negotiations relating to tax matters with the taxing authorities in these various jurisdictions. Our U.S. federal income tax returns for fiscal years 2007 through 2009 are currently under examination by the Internal Revenue Service (“IRS”). In April 2009, the IRS issued a Revenue Agent’s Report (“RAR,”) for fiscal years 2004 through 2006 proposing certain assessments primarily related to transfer pricing matters. We disagree with certain of the proposed assessments, primarily related to transfer pricing matters, included within the RAR and have protested them in accordance with IRS administrative appeals procedures. The first meeting between Dell and the IRS Appeals Division is scheduled for early 2010. We anticipate the appeals process will involve multiple meetings and could take several years to complete before additional clarity will emerge regarding potential outcomes. We continue to believe that adequate reserves have been provided relating to all matters contained in tax periods open to examination. However, should we experience an unfavorable outcome in the matter before the IRS Appeals Division, such an outcome could have a material impact on our financial statements. Although the timing of income tax audit resolution and negotiations with taxing authorities are highly uncertain, we do not anticipate a significant change to the total amount of unrecognized income tax benefits within the next 12 months.

 

We take certain non-income tax positions in the jurisdictions in which we operate and have received certain non-income tax assessments from various jurisdictions. We are also involved in related non-income tax litigation matters in various jurisdictions. These jurisdictions include Brazil, where we are in litigation with a state government over the proper application of transactional taxes to warranties and software related to the sale of computers as well as the appropriate use of state statutory incentives to reduce the transactional taxes. Tax litigation in Brazil has historically taken multiple years to resolve. While we believe we will ultimately prevail in the Brazilian courts, we have also negotiated certain tax incentives with the state that can be used to offset potential tax liabilities should the courts rule against us. The incentives are based upon maintaining a certain number of jobs within the state. We believe our positions are supportable, a liability is not probable, and that we will ultimately prevail. In the normal course of business, our positions and conclusions related to our non-income taxes could be challenged and assessments may be made. To the extent new information is obtained and our views on our positions, probable outcomes of assessments, or litigation change, changes in estimates to our accrued liabilities would be recorded in the period in which the determination is made.

ACCOUNTS RECEIVABLE

 

We sell products and services directly to customers and through a variety of sales channels, including retail distribution. At January 29, 2010, our accounts receivable, net was $5.8 billion, a 23% increase from our balance at January 30, 2009. This increase in accounts receivable was primarily due to the addition of Perot Systems receivables, a higher mix of retail receivables, and an increase in fourth quarter revenue as compared to Fiscal 2009. We maintain an allowance for doubtful accounts to cover receivables that may be deemed uncollectible. The allowance for losses is based on specific identifiable customer accounts that are deemed at risk and a general provision based on historical bad debt experience. As of January 29, 2010 and January 30, 2009, the allowance for doubtful accounts was $115 million and $112 million, respectively. Based on our assessment, we believe we are adequately reserved for expected credit losses. We monitor the aging of our accounts receivable and have taken actions in Fiscal 2010 to reduce our exposure to credit losses, including tightening our credit granting practices.

 

FINANCING RECEIVABLES

 

At January 29, 2010, and January 30, 2009, our net financing receivables balances were $3.0 billion and $2.2 billion, respectively. The increase was primarily the result of our funding a higher percentage of our customer receivable originations on balance sheet and the consolidation of the special purpose entity (“SPE”) in the second quarter of Fiscal 2010, as discussed below. We expect growth in financing receivables to continue throughout Fiscal 2011 as CIT continues to decrease its proportion of fundings and we consolidate our off-balance sheet securitizations as we adopt changes in accounting guidance that become effective in the first quarter of Fiscal 2011. To manage the growth in financing receivables, we will continue to balance the use of our own working capital and other sources of liquidity, including securitization programs.

 

During Fiscal 2010, we continued to transfer certain customer financing receivables to SPEs in securitization transactions. The purpose of the SPEs is to facilitate the funding of customer receivables through financing arrangements with multi-seller conduits that issue asset-backed debt securities in the capital markets. The SPEs may or may not be consolidated depending on the terms and conditions of the arrangements.

 

Upon the sale of the customer receivables to nonconsolidated qualified SPEs, we recognize a gain on the sale and retain a beneficial interest in the pool of assets sold. During Fiscal 2010 and Fiscal 2009, $784 million and $1.4 billion, respectively, of customer receivables were funded via securitization through nonconsolidated qualified SPEs. Our risk of loss related to these securitized receivables is limited to the amount of our retained interest in the transferred pool of receivables. We expect to consolidate the two remaining nonconsolidated SPEs in the first quarter of Fiscal 2011 when we adopt the new accounting guidance for variable interest entities and transfers of financial assets and extinguishment of financial liabilities.

 

In the second quarter of Fiscal 2010, a conduit that funded revolving loans entered scheduled amortization and the SPE was consolidated. The previously securitized finance receivables were recorded at fair value, which was based on the net present value of future cash flows, in the second quarter upon consolidation. At January 29, 2010, the balance of these receivables was $435 million, and there was no associated structured financing debt. The balance of these previously securitized revolving loan receivables will continue to decline as no new receivables will be put into this asset pool.

 

In the fourth quarter of Fiscal 2010, we initiated a new securitization program to fund revolving loans through a consolidated SPE which we account for as a secured borrowing. At January 29, 2010, the structured financing debt related to this program was $164 million and the balance of the corresponding revolving loan receivables was $314 million.

 

CIT, formerly a joint venture partner of DFS, has a limited role in the financing activities of DFS. We have reduced our reliance on CIT, which funded approximately 15% and 34% of DFS financing receivables during Fiscal 2010 and Fiscal 2009, respectively. We expect CIT to continue to fund a small portion of fixed term leases and loans through the second quarter of Fiscal 2011. At January 29, 2010 our exposure to CIT is immaterial. During Fiscal 2010, revolving loans were offered by DFS under private label credit financing programs facilitated by unrelated, nationally chartered banks.

We maintain an allowance to cover expected financing receivable credit losses. The allowance for losses is determined based on various factors, including historical and anticipated experience, past due receivables, receivable type, and customer risk profile. At January 29, 2010, and January 30, 2009, the allowance for financing receivable losses was $237 million and $149 million, respectively. The increase in the allowance is primarily due to an increase in revolving loan customer receivables. Based on our assessment of the customer financing receivables, we believe that we are adequately reserved.

 

The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 was signed into U.S. law on May 22, 2009, and will affect the consumer financing provided by DFS. This Act will impose new restrictions on credit card companies in the areas of marketing, servicing, and pricing of consumer credit accounts. We do not expect the changes will substantially alter how consumer credit is offered to our customers or how their accounts will be serviced. Commercial credit is unaffected by the change in law. Some provisions of the law are now in effect, with the majority of provisions of the new law effective in February 2010 and August 2010. We are compliant with the legislation that currently is in effect and expect to be compliant with future regulations by the established deadlines. Some of the future regulations, including changes to rules relating to late fees, are subject to additional clarification. We do not expect the impact of these pending changes to be material to our financial results in future periods.

 

See Note 4 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for additional information about our financing receivables.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

See the “Financing Receivables” section above and Note 4 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for information about our off-balance sheet arrangements.

 

MARKET RISK

 

We are exposed to a variety of risks, including foreign currency exchange rate fluctuations and changes in the market value of our investments. In the normal course of business, we employ established policies and procedures to manage these risks.

 

Foreign Currency Hedging Activities

 

Our objective in managing our exposures to foreign currency exchange rate fluctuations is to reduce the impact of adverse fluctuations on earnings and cash flows associated with foreign currency exchange rate changes. Accordingly, we utilize foreign currency option contracts and forward contracts to hedge our exposure on forecasted transactions and firm commitments in more than 20 currencies in which we transact business. Our exposure to foreign currency movements is comprised primarily of certain principal currencies. During Fiscal 2010, these principal currencies were the Euro, British Pound, Japanese Yen, Canadian Dollar, and Australian Dollar. We monitor our foreign currency exchange exposures to ensure the overall effectiveness of our foreign currency hedge positions. However, there can be no assurance that our foreign currency hedging activities will continue to substantially offset the impact of fluctuations in currency exchange rates on our results of operations and financial position in the future.

 

Based on our foreign currency cash flow hedge instruments outstanding at January 29, 2010, and January 30, 2009, we estimate a maximum potential one-day loss in fair value of approximately $86 million and $393 million, respectively, using a Value-at-Risk (“VAR,”) model. By using market implied rates and incorporating volatility and correlation among the currencies of a portfolio, the VAR model simulates 3,000 randomly generated market prices and calculates the difference between the fifth percentile and the average as the Value-at-Risk. In Fiscal 2009, both higher volatility and correlation increased the VAR significantly. Forecasted transactions, firm commitments, fair value hedge instruments, and accounts receivable and payable denominated in foreign currencies were excluded from the model. The VAR model is a risk estimation tool, and as such, is not intended to represent actual losses in fair value that will be incurred. Additionally, as we utilize foreign currency instruments for hedging forecasted and firmly committed transactions, a loss in fair value for those instruments is generally offset by increases in the value of the underlying exposure.

Cash and Investments

 

At January 29, 2010, we had $11.8 billion of total cash, cash equivalents, and investments. The objective of our investment policy and strategy is to manage our total cash and investments balances to preserve principal and maintain liquidity while maximizing the return on the investment portfolio through the full investment of available funds. We diversify our investment portfolio by investing in multiple types of investment-grade securities and through the use of third-party investment managers.

 

Of the $11.8 billion of cash, cash equivalents, and investments, $10.6 billion is classified as cash and cash equivalents. Our cash equivalents primarily consist of money market funds. Due to the nature of these investments, we consider it reasonable to expect that they will not be significantly impacted by a change in interest rates, and that these investments can be liquidated for cash at short notice. As of January 29, 2010, our cash equivalents are recorded primarily at cost, which approximates fair value.

 

The remaining $1.2 billion of cash, cash equivalents, and investments is primarily invested in fixed income securities, including government, agency, asset-backed, and corporate debt securities of varying maturities at the date of acquisition. The fair value of our portfolio is affected primarily by interest rates more than by credit and liquidity risks. We attempt to mitigate these risks by investing primarily in high credit quality securities with AAA and AA ratings and short-term securities with an A-1 rating, limiting the amount that can be invested in any single issuer, and investing in short– to intermediate-term investments whose market value is less sensitive to interest rate changes. Our exposure to asset and mortgage-backed securities is less than 1% of the value of the portfolio. The total carrying value of investments in asset-backed and mortgage-backed debt securities was approximately $4 million and $54 million at January 29, 2010 and January 30, 2009, respectively. Based on our investment portfolio and interest rates at January 29, 2010, a 100 basis point increase or decrease in interest rates would result in a decrease or increase of approximately $4 million in the fair value of the investment portfolio.

 

We periodically review our investment portfolio to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. At January 29, 2010, our portfolio included securities with unrealized losses totaling $2 million, which have been recorded in other comprehensive income (loss), as we believe the investments are not other-than-temporarily impaired. While these available-for-sale securities have market values below cost, we believe it is probable that the principal and interest will be collected in accordance with the contractual terms, and that the decline in the market value is primarily due to changes in interest rates and not increased credit risk.

 

The fair value of our portfolio is based on prices provided from national pricing services, which we currently believe are indicative of fair value, as our assessment is that the inputs are market observable. We will continue to evaluate whether the inputs are market observable in accordance with the accounting guidance on fair value measurements. We conduct reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact our fair value disclosures.

 

LIQUIDITY, CAPITAL COMMITMENTS, AND CONTRACTUAL CASH OBLIGATIONS

 

Current Market Conditions

 

We regularly monitor economic conditions and associated impacts on the financial markets and our business. During the second half of Fiscal 2010, as the global capital markets showed some improvements, we continued to be cautious given the downturn in the macroeconomic environment and the recent instability of the financial markets. We continue to evaluate the financial health of our supplier base, carefully manage customer credit, diversify counterparty risk, and monitor the concentration risk of our cash and cash equivalents balances globally. Additionally, we maintain a conservative investment portfolio with shorter duration and high quality assets.

 

We monitor credit risk associated with our financial counterparties using various market credit risk indicators such as credit ratings issued by nationally recognized rating agencies and changes in market credit default swap levels. We perform periodic evaluations of our positions with these counterparties and may limit exposure to any one counterparty in accordance with our policies. We monitor and manage these activities depending on current and expected market developments.

See “Part I — Item 1A — Risk Factors” for further discussion of risks associated with our use of counterparties. The impact on our Consolidated Financial Statements of any credit adjustments related to these counterparties has been immaterial.

 

Liquidity

 

Our cash balances are held in numerous locations throughout the world, including substantial amounts held outside of the U.S. The majority of our non-U.S. domiciled cash and investments are denominated in the U.S. dollar. 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. In some countries, repatriation of certain 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 permanently reinvested outside of the U.S. We utilize a variety of tax planning and financing strategies with the objective of having our worldwide cash available in the locations where it is needed.

 

We have an active working capital management team that monitors the efficiency of our balance sheet by evaluating liquidity under various macroeconomic and competitive scenarios. These scenarios quantify risks to the financial statements and provide a basis for actions necessary to ensure adequate liquidity. During Fiscal 2010, we continued to monitor and carefully prioritize capital expenditures and other discretionary spending.

 

The following table summarizes our ending cash, cash equivalents, and investments balances for the respective periods:

 

		Fiscal Year Ended
		January 29,				January 30,
		2010				2009
		(in millions)
Cash, cash equivalents, and investments:
Cash and cash equivalents		$	10,635			$	8,352
Debt securities			1,042				1,106
Equity and other securities			112				88
Cash, cash equivalents, and investments		$	11,789			$	9,546

 

We ended Fiscal 2010 and Fiscal 2009 with $11.8 billion and $9.5 billion in cash, cash equivalents, and investments, respectively. Cash generated from operations is our primary source of liquidity and we believe that internally generated cash flows are sufficient to support business operations. Over the past year, we have utilized external capital sources to supplement our domestic liquidity to fund a number of strategic initiatives, including the acquisition of Perot Systems that was completed in the fourth quarter of Fiscal 2010. Outstanding as of January 29, 2010, was $3.3 billion in principal on long-term notes, $496 million in commercial paper, and $164 million in structured financing debt. We expect to continue to grow our business through strategic acquisitions, which will impact our future cash requirements and liquidity. We will continue to utilize external capital sources, such as notes and other term debt, commercial paper, or structured financing arrangements, to supplement our internally generated sources of liquidity as necessary. In November 2008, we filed a shelf registration statement with the SEC for an unspecified amount of debt securities. The amount of debt securities issuable by us under this registration statement from time to time will be established by our Board of Directors.

The following table contains a summary of our Consolidated Statements of Cash Flows for the past three fiscal years:

 

 

Operating Activities — Cash flows from operating activities were $3.9 billion during Fiscal 2010 compared to $1.9 billion during Fiscal 2009 and $3.9 billion during Fiscal 2008. For Fiscal 2010, the increase in operating cash flows was primarily led by the improvement of our cash conversion cycle, specifically through operational improvements related to our vendor programs, the effects of which were partially offset by the decrease in net income and growth in financing receivables. In Fiscal 2009, the decrease in operating cash flows from Fiscal 2008 was primarily led by the deterioration of our cash conversion cycle, slower growth in deferred service revenue, and a decrease in net income. Our negative cash conversion cycle combined with revenue growth typically results in operating cash generation in excess of net income. See “Key Performance Metrics” below for additional discussion of our cash conversion cycle.

 

Investing Activities — Cash used in investing activities during Fiscal 2010 was $3.8 billion as compared to cash provided of $177 million during Fiscal 2009, and $1.8 billion cash used by investing activities during Fiscal 2008. Investing activities consist of the net of maturities and sales and purchases of investments; net capital expenditures for property, plant, and equipment; and net cash used to fund strategic acquisitions. Cash used to fund strategic acquisitions, net of cash acquired, was approximately $3.6 billion during Fiscal 2010, primarily related to the acquisition of Perot Systems, compared to $176 million during Fiscal 2009 and $2.2 billion during Fiscal 2008. In Fiscal 2009 as compared to Fiscal 2008, lower cash flows from operating activities and lower yields on investments resulted in lower net proceeds from maturities, sales, and purchases. In Fiscal 2008, we re-invested a lower amount of our proceeds from the maturity or sales of investments to build liquidity for share repurchases and for cash payments made in connection with acquisitions.

 

Financing Activities — Cash provided by financing activities during Fiscal 2010 was $2.0 billion as compared to cash used of $1.4 billion during Fiscal 2009 and $4.1 billion in Fiscal 2008. Financing activities primarily consist of proceeds and repayments from the issuance of long-term debt, the issuance of common stock under employee stock plans, the issuance of long-term debt and the repurchase of our common stock. The year-over-year increase in cash provided by financing activities was mainly due to the reduction of our share repurchase program from Fiscal 2009.

 

During Fiscal 2010, we issued $1.5 billion principal amount of senior term notes, which was comparable to Fiscal 2009. Due to the overall strength of our financial position, we believe that we will have adequate access to capital markets. We intend to maintain the appropriate debt levels based upon cash flow expectations, the overall cost of capital, cash requirements for operations, and discretionary spending, including for acquisitions and share repurchases.

 

We have a $1.5 billion commercial paper program with supporting $1.5 billion senior unsecured revolving credit facilities, enabling us to obtain favorable short-term borrowing rates. During Fiscal 2010, we issued commercial paper with original maturities both greater than and less than 90 days. We continue to be active in the commercial paper market by issuing short-term borrowings to augment our liquidity as needed. We ended Fiscal 2010 and Fiscal 2009 with $496 million and $100 million in outstanding commercial paper, respectively. Our $500 million credit facility expires on April 2, 2010, and our $1.0 billion credit facility expires on June 1, 2011. We intend to enter into a

new $1.0 billion senior unsecured revolving credit facility upon expiration of the current $500 million facility, thereby expanding the size of our commercial paper program with supporting credit facilities to $2.0 billion.

 

We issued $164 million in structured financing-related debt to fund our financing receivables as previously discussed in the “Financing Receivables” section above.

 

Standard and Poor’s Rating Services, Moody’s Investors Service, and Fitch Ratings currently rate our senior unsecured long-term debt A-, A2, and A, respectively, and our short-term debt A-1, P-1, and F1, respectively. These rating agencies use proprietary and independent methods of evaluating our credit risk. Factors used in determining our rating include, but are not limited to, publically available information, industry trends and ongoing discussions between the company and the agencies. We are not aware of any planned changes to our corporate credit ratings by the rating agencies. However, any credit rating downgrade will increase our borrowing costs and may limit our ability to issue commercial paper or additional term debt.

 

See the debt section in Note 3 of the Notes to Consolidated Financial Statements under “Part II — Item 8 Financial Statements and Supplementary Data” for further discussion of our debt.

 

In Fiscal 2010, the amount of shares repurchased was immaterial to financing activities. During Fiscal 2009, we repurchased approximately 134 million shares at an aggregate cost of $2.9 billion compared to approximately 179 million shares at an aggregate cost of $4.0 billion in Fiscal 2008. We also paid, in Fiscal 2009, the principal on the senior notes of $200 million that matured in April 2008.

 

Key Performance Metrics — Our cash conversion cycle for the fiscal quarter ended January 30, 2010 improved from the fiscal quarter January 30, 2009, and was consistent with the fiscal quarter ended February 1, 2008, as our direct business model allows us to maintain an efficient cash conversion cycle, which compares favorably with that of others in our industry.

 

The following table presents the components of our cash conversion cycle for the fourth quarter of each of the past three fiscal years:

 

		January 29,				January 30,				February 1,
		2010				2009				2008
Days of sales outstanding(a)			38				35				36
Days of supply in inventory(b)			8				7				8
Days in accounts payable(c)			(82	)			(67	)			(80	)
Cash conversion cycle			(36	)			(25	)			(36	)

 

 

 

 

 

Our cash conversion cycle improved by eleven days at January 29, 2010, from January 30, 2009, driven by a fifteen day improvement in DPO, the effect of which was partially offset by a three day increase in DSO and one day increase in DSI. The improvement in DPO from January 30, 2009, was attributable to our ongoing transition to contract manufacturing, further standardization of vendor agreements, and the timing of supplier purchases and payments during Fiscal 2010 as compared to Fiscal 2009. The increase in DSO from January 30, 2009, was primarily attributable to our growth in consumer retail, whose customers typically have longer payment terms, and to foreign currency movements due to the U.S. Dollar weakening slightly, offset by a reduction in past-due

receivables. We believe that we can generate cash flow from operations in excess of net income over the long term and can operate our cash conversion cycle at mid negative thirty days or better. The deterioration in DSI from January 30, 2009, was primarily attributable to an increase in finished goods inventory and strategic materials purchases.

 

Our cash conversion cycle contracted by eleven days at January 30, 2009, from February 1, 2008, driven by a thirteen day decrease in DPO, which was partially offset by a one day decrease in DSO and a one day decrease in DSI. The decrease in DPO from February 1, 2008, was attributable to procurement throughput declines as a result of declining demand, reduction in inventory levels, and a decrease in non-production supplier payables, as we continue to control our operating expense spending, and the timing of purchases from and payments to suppliers during the fourth quarter of Fiscal 2009 as compared to the fourth quarter of Fiscal 2008. The decrease in DSO from February 1, 2008, was attributable to the timing of revenue due to seasonal impact, partially offset by a shift in customers with longer payment terms.

 

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 DSO because we believe this reporting results in a more accurate presentation of our DSO and cash conversion cycle. These deferred costs are recorded in other current assets in our Consolidated Statements of Financial Position and totaled $523 million, $556 million, and $519 million, at January 29, 2010, January 30, 2009, and February 1, 2008, respectively.

 

Capital Commitments

 

Share Repurchase Program — Our Board of Directors has approved a share repurchase program that authorizes us to purchase shares of common stock through a systematic program of open market purchases 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 to offset share-based compensation arrangements. For more information regarding share repurchases, see “Part II — Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

 

Capital Expenditures — During Fiscal 2010 and Fiscal 2009, we spent $367 million and $440 million, respectively, on property, plant, and equipment primarily on our global expansion efforts and infrastructure investments in order to support future growth. Product demand, product mix, and the increased use of contract manufacturers, as well as ongoing investments in operating and information technology infrastructure, influence the level and prioritization of our capital expenditures. Capital expenditures for Fiscal 2011, related to infrastructure refreshment and strategic initiatives, are currently expected to reach approximately $500 million. These expenditures are expected to be funded from our cash flows from operating activities.

 

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 in the amount of $147 million and $213 million is included in other current assets at January 29, 2010, and January 30, 2009, respectively.

Contractual Cash Obligations

 

The following table summarizes our contractual cash obligations at January 29, 2010:

 

 

 

 

Principal Payments on Long Term Debt — Our expected principal cash payments related to long term debt are exclusive of hedge accounting adjustments or discounts and premiums. We have several outstanding long-term unsecured notes with varying maturities depending on the agreement. For additional information, see Note 3 of Notes to Consolidated Financial Statements under “Part II — Item 8 — Financial Statements and Supplementary Data”.

 

Operating Leases — We lease property and equipment, manufacturing facilities, and office space under non-cancellable leases. Certain of these leases obligate us to pay taxes, maintenance, and repair costs.

 

Purchase Obligations — Purchase obligations are defined as contractual obligations to purchase goods or services that are enforceable and legally binding on us. These obligations specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. Purchase obligations do not include contracts that may be cancelled without penalty.

 

We utilize several suppliers to manufacture sub-assemblies for our products. Our efficient supply chain management allows us to enter into flexible and mutually beneficial purchase arrangements with our suppliers in order to minimize inventory risk. Consistent with industry practice, we acquire raw materials or other goods and services, including product components, by issuing to suppliers authorizations to purchase based on our projected demand and manufacturing needs. These purchase orders are typically fulfilled within 30 days and are entered into during the ordinary course of business in order to establish best pricing and continuity of supply for our production. Purchase orders are not included in the table above as they typically represent our authorization to purchase rather than binding purchase obligations.

 

Purchase obligations decreased approximately $404 million from January 30, 2009, to $383 million at January 30, 2010. The decrease was primarily due to the fulfillment of commitments to purchase key components and services, partially offset by the renewal of or entry into new purchase contracts.

 

Interest — See Note 3 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for further discussion of our debt and related interest expense.

 

Risk Factors Affecting Our Business and Prospects

 

There are numerous significant risks that affect our business, operating results, financial condition and prospects. Many of these risks are beyond our control. These risks include those relating to:

 

 

For a discussion of these risk factors affecting our business and prospects, see “Part I — Item 1A — Risk Factors.”

 

Critical Accounting Policies

 

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires certain estimates, assumptions, and judgments to be made that may affect our Consolidated Statements of Financial Position and Consolidated Statement of Income. We believe our most critical accounting policies relate to revenue recognition, business combinations, warranty accruals, income taxes, and loss contingencies. We have discussed the development, selection, and disclosure of our critical accounting policies with the Audit Committee of our Board of Directors. These critical accounting policies and our other accounting policies are also described in Note 1 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data.”

 

Revenue Recognition and Related Allowances — We frequently enter into sales arrangements with customers that contain multiple elements or deliverables such as hardware, software, peripherals, and services. Judgments and estimates are necessary to ensure compliance with GAAP. These judgments relate to the allocation of the proceeds received from an arrangement to the multiple elements, the determination of whether any undelivered elements are essential to the functionality of the delivered elements, and the appropriate timing of revenue recognition. We offer extended warranty and service contracts to customers that extend and/or enhance the technical support, parts, and labor coverage offered as part of the base warranty included with the product. Revenue from extended warranty and service contracts, for which we are obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract or when the service is completed. Revenue from sales of third-party extended warranty and service contracts, for which we are not obligated to perform, is recognized on a net basis at the time of sale, as we do not meet the criteria for gross recognition.

We record reductions to revenue for estimated customer sales returns, rebates, and certain other customer incentive programs. These reductions to revenue are made based upon reasonable and reliable estimates that are determined by historical experience, contractual terms, and current conditions. The primary factors affecting our accrual for estimated customer returns include estimated return rates as well as the number of units shipped that have a right of return that has not expired as of the balance sheet date. If returns cannot be reliably estimated, revenue is not recognized until a reliable estimate can be made or the return right lapses. Each quarter, we reevaluate our estimates to assess the adequacy of our recorded accruals for customer returns and allowance for doubtful accounts, and adjust the amounts as necessary.

 

Dell sells its products directly to customers as well as through retailers. Sales to our retail customers are generally made under agreements allowing for limited rights of return, price protection, rebates, and marketing development funds. We have generally limited the return rights through contractual caps. Our policy for sales to retailers is to defer the full amount of revenue relative to sales for which the rights of return apply unless there is sufficient historical data to establish reasonable and reliable estimates of returns. When contractual caps are included in the agreement and there is no reasonable and reliable historical data to make an estimate on returns, we defer revenue equal to the amount of the contractual cap. All other sales for which the rights of return do not apply are recognized upon shipment when all applicable revenue recognition criteria have been met. To the extent price protection and return rights are not limited, all of the revenue and related cost are deferred until the product has been sold by the retailer, the rights expire, or a reliable estimate of such amounts can be made. Generally, we record estimated reductions to revenue or an expense for retail customer programs at the later of the offer or the time revenue is recognized. Our customer programs primarily involve rebates, which are designed to serve as sales incentives to resellers of our products and marketing funds.

 

We report revenue net of any revenue-based taxes assessed by governmental authorities that are imposed on and concurrent with specific revenue-producing transactions.

 

The Financial Accounting Standards Board (“FASB”) issued new guidance that amends the current revenue recognition guidance for multiple deliverable arrangements. It allows the use of management’s best estimate of selling price for individual elements of an arrangement when neither vendor specific objective evidence nor third party evidence is available. Additionally, it eliminates the residual method of revenue recognition in accounting for multiple deliverable arrangements. In conjunction with the new guidance on multiple deliverable arrangements, the FASB also issued a new pronouncement that modifies the scope of the software revenue recognition guidance to exclude tangible products that contain both software and non-software components that function together to deliver the product’s essential functionality. This pronouncement does not have a significant impact on us as we do not have a significant number of revenue arrangements with software elements. Both of these pronouncements are effective for fiscal years beginning on or after June 15, 2010 (our Fiscal 2012), but early adoption is permitted. Both pronouncements must be adopted at the same time. We have elected to early adopt these pronouncements in the first quarter of Fiscal 2011 on a prospective basis. Based on a preliminary evaluation, the adoption of this guidance will not have a material impact on our Consolidated Financial Statements.

 

Business Combinations and Intangible Assets Including Goodwill — During Fiscal 2010, Dell adopted the new FASB guidance on business combinations and non-controlling interests. The new guidance on business combinations retains the underlying concepts of the previously issued standard in that the acquirer of a business is required to account for the business combination at fair value. As under previous guidance, the assets and liabilities of the acquired business are recorded at their fair values at the date of acquisition. The excess of the purchase price over the estimated fair values is recorded as goodwill. The new pronouncement results in some changes to the method of applying the acquisition method of accounting for business combinations in a number of significant aspects. Under the new guidance, all acquisition costs are expensed as incurred and in-process research and development costs are recorded at fair value as an indefinite-lived intangible asset. Prior to the adoption of the new guidance, in-process research and development costs were immediately expensed and acquisition costs were capitalized. Further, the new guidance generally requires restructuring charges associated with a business combination to be expensed subsequent to the acquisition date. The application of business combination and impairment accounting requires the use of significant estimates and assumptions.

Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis in the second fiscal quarter, or sooner if an indicator of impairment occurs. To determine whether goodwill is impaired, we determine the fair values of each of our reportable business unit using a discounted cash flow methodology and then compare the fair values to the carrying values of each reportable business unit. We concluded that there were no impairment triggering events during Fiscal 2010. As of July 31, 2009, the Fiscal 2010 annual testing date, Dell’s market capitalization, including common stock held by affiliates, was $26.2 billion compared to stockholders’ equity of $5.6 billion. We have determined that a 10% decrease in the fair value of any one of our reporting units as of January 29, 2010 would have no impact on the carrying value of our goodwill. Though we believe our estimates are reasonable, these fair values require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.

 

Warranty — We record warranty liabilities at the time of sale for the estimated costs that may be incurred under the terms of the limited warranty. The specific warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include technical support, parts, and labor over a period ranging from one to three years. Factors that affect our warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy our warranty obligation. The anticipated rate of warranty claims is the primary factor impacting our estimated warranty obligation. The other factors are less significant due to the fact that the average remaining aggregate warranty period of the covered installed base is approximately 15 months, repair parts are generally already in stock or available at pre-determined prices, and labor rates are generally arranged at pre-established amounts with service providers. Warranty claims are reasonably predictable based on historical experience of failure rates. If actual results differ from our estimates, we revise our estimated warranty liability to reflect such changes. Each quarter, we reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.

 

Income Taxes — We calculate a provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position. Additionally, we use tax planning strategies as a part of our global tax compliance program. Judgments and interpretation of statutes are inherent in this process. We provide related valuation reserves, where appropriate.

 

Loss Contingencies — We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required. Third parties have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, and other intellectual property rights to technologies and related standards that are relevant to us. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially and adversely affected.

New Accounting Pronouncements

 

Variable Interest Entities and Transfers of Financial Assets and Extinguishments of Liabilities — We transfer certain customer financing receivables to special purpose entities. In Fiscal 2011, the new FASB guidance on variable interest entities and transfers of financial statements and extinguishment of liabilities will be effective for us. Under the prior guidance, special purpose entities were exempt from variable interest entity accounting. Upon adoption of the new guidance in the first quarter of Fiscal 2011, we will apply variable interest entity accounting to these special purpose entities and consolidate these special purpose entities in our Consolidated Financial Statements. As of January 29, 2010, the unpaid principal balance of the securitized receivables and associated debt held in the unconsolidated special purposes entities were $774 million and $624 million, respectively. Upon consolidation, the retained interest of $151 million will be eliminated. The new FASB guidance will require us to perform an ongoing analysis to determine whether our variable interests give us a controlling financial interest in the special purpose entities. See Note 4 of Notes to Consolidated Financial Statements included in “Part II — Item 8 — Financial Statements and Supplementary Data” for additional information about our financing receivables.

 

Response to this item is included in “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk” and is incorporated herein by reference.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

To the Board of Directors and

Shareholders of Dell Inc.:

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Dell Inc. and its subsidiaries (the “Company”) at January 29, 2010 and January 30, 2009, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 29, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As described in Note 5, in Fiscal 2010, the Company changed the manner in which it accounts for business combinations. As described in Note 10 and Note 1, respectively, in Fiscal 2008, the Company changed the manner in which it accounts for uncertain tax positions and certain hybrid financial instruments.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As described in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, management has excluded Perot Systems Corporation from its assessment of internal control over financial reporting as of January 29, 2010 because it was acquired by the Company in a purchase business combination during Fiscal 2010. We have also excluded Perot Systems Corporation from our audit of internal control over financial reporting. Perot Systems Corporation is a wholly-owned subsidiary whose total assets (excluding allocated intangibles and goodwill) and total revenues represent 3% and 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended January 29, 2010.

 

/s/ PRICEWATERHOUSECOOPERS LLP

 

Austin, Texas

March 18, 2010

DELL INC.

 

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(in millions)