UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

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)

 

(512) 338-4400

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes 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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o     No 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.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No þ

 

As of the close of business on May 29, 2009, 1,953,985,884 shares of common stock, par value $.01 per share, were outstanding.

 

 

PART I — FINANCIAL INFORMATION

 

 

DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(in millions)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share amounts; unaudited)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

DELL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions; unaudited)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 

 

Basis of Presentation — The accompanying Condensed Consolidated Financial Statements of Dell Inc. (“Dell”) should be read in conjunction with the Consolidated Financial Statements and accompanying Notes filed with the U.S. Securities and Exchange Commission (“SEC”) in Dell’s Annual Report on Form 10-K for the fiscal year ended January 30, 2009. The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, the accompanying Condensed Consolidated Financial Statements reflect all adjustments of a normal recurring nature considered necessary to fairly state the financial position of Dell and its consolidated subsidiaries at May 1, 2009, and the results of its operations and its cash flows for the three months ended May 1, 2009, and May 2, 2008.

 

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in Dell’s Condensed Consolidated Financial Statements and the accompanying Notes. Actual results could differ materially from those estimates. The results of operations and cash flows for the three months ended May 1, 2009, are not necessarily indicative of the results to be expected for the full year.

 

Recently Issued and Adopted Accounting Pronouncements — In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (“SFAS 141(R)”). SFAS 141(R) requires that the acquisition method of accounting be applied to a broader set of business combinations and establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, any noncontrolling interest in the acquiree, and the goodwill acquired. Dell adopted SFAS 141(R) in the first quarter of Fiscal 2010. The adoption of SFAS 141(R) did not have any impact on Dell’s Condensed Consolidated Financial Statements.

 

In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No. 157 (“FSP 157-2”), which delayed the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Dell adopted the provisions of FSP 157-2 related to non-financial assets and liabilities effective in the first quarter of Fiscal 2010. The adoption of the provisions of SFAS 157 related to nonfinancial assets and nonfinancial liabilities did not have a material impact on Dell’s Condensed Consolidated Financial Statements. See Note 3 of Notes to the Condensed Consolidated Financial Statements for additional information.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 requires that the noncontrolling interest in the equity of a subsidiary be accounted for and reported as equity, provides revised guidance on the treatment of net income and losses attributable to the noncontrolling interest and changes in ownership interests in a subsidiary, and requires additional disclosures that identify and distinguish between the interests of the controlling and noncontrolling owners. Dell adopted SFAS 160 in the first quarter of Fiscal 2010. The adoption of SFAS 160 did not have any impact on Dell’s Condensed Consolidated Financial Statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS 161”), which requires additional disclosures about the objectives of derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on Dell’s Condensed Consolidated Financial Statements. SFAS 161 does not change the accounting treatment for derivative instruments. Dell adopted SFAS 161 in the first quarter of Fiscal 2010. See Note 3 of Notes to the Condensed Consolidated Financial Statements for additional information.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

Recently Issued Accounting Pronouncements —  In April 2009, the FASB issued FSP 157-4 Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Indentifying Transactions That Are Not Orderly (“SFAS 157-4”), which provides additional guidance on measuring the fair value of financial instruments when markets become inactive and quoted prices may reflect distressed transactions. The provisions of FSP 157-4 are effective for Dell beginning in the second quarter of Fiscal 2010. Management is currently evaluating the impact of the adoption of FSP 157-4 but does not expect the adoption to have a material impact on Dell’s Condensed Consolidated Financial Statements.

 

In April 2009, the FASB issued FSP FAS No. 107-1 and APB No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 require disclosures about the fair value of financial instruments for annual and interim reporting periods of publicly traded companies. FSP FAS 107-1 and APB 28-1 is effective in reporting periods ending after June 15, 2009, and is required to be adopted by Dell beginning in the second quarter of Fiscal 2010. Management does not expect the adoption of this FSP to have any impact on Dell’s Condensed Consolidated Financial Statements.

 

In April 2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2, Recognition and Presentation of Other-Than Temporary Investments (“FSP FAS 115-2 and 124-2”). FSP FAS 115-2 and 124-2 amends the other-than-temporary impairment guidance for debt securities. Under FSP FAS 115-2 and 124-2, the pre-existing “intent and ability” trigger was modified such that an other-than-temporary impairment is now triggered when there is intent to sell the security, it is more likely than not that the security will be required to be sold before recovery in value, or the security is not expected to recover the entire amortized cost basis of the security. Credit related losses on debt securities will be considered an other-than-temporary impairment recognized in earnings, and any other losses due to a decline in fair value relative to the amortized cost deemed not to be other-than-temporary will be recorded in other comprehensive income. FSP FAS 115-2 and 124-2 is effective in reporting periods ending after June 15, 2009, and is required to be adopted by Dell beginning in the second quarter of Fiscal 2010. Management is currently evaluating the impact of the adoption of FSP FAS 115-2 and 124-2 but does not expect the adoption to have a material impact on Dell’s Condensed Consolidated Financial Statements.

 

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”), which provides guidance to establish general standards of accounting for and disclosures of events that occur after balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for interim or fiscal periods ending after June 15, 2009, and is required to be adopted by Dell beginning in the second quarter of Fiscal 2010. Management is currently evaluating the impact of the adoption of SFAS 165 but does not expect the adoption to have a material impact on Dell’s Condensed Consolidated Financial Statements.

 

Out of Period Adjustments — In the first quarter of Fiscal 2009, Dell recorded adjustments related to net revenue, cost of net revenue, operating expenses, and investment and other income that in the aggregate increased income before income taxes by approximately $110 million. The two largest of these corrections include a reversal of the provision for Fiscal 2008 employee bonuses and foreign exchange rate errors. These errors increased income before income taxes by $46 million and $42 million, respectively. Because these errors, both individually and in the aggregate, were not material to any of the prior years’ financial statements, including Fiscal 2009 financial statements, Dell recorded the correction of these errors in the first quarter of Fiscal 2009 financial statements.

 

Reclassifications — Dell expects its enhanced services revenue to exceed 10% of total net revenue in Fiscal 2010. Enhanced services revenue includes infrastructure consulting, deployment of enterprise products and computer systems in customers’ environments, asset recovery and recycling, computer-related training, IT support, client and enterprise support, and managed service solutions. To maintain comparability among the periods presented, Dell has revised the Fiscal 2009 presentation of the components of net revenue and cost of net revenue presented in the Condensed Consolidated Statements of Income in order to disclose net revenue and cost of net revenue for services as required by the SEC Regulation S-X article 210.5-03 “Income Statements.” In conjunction with separating enhanced services revenue and related cost, Dell elected to classify revenue and cost of net revenue related to

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

standalone software sold with post contract customer support (“PCS”) in the same line item as enhanced services in our Condensed Consolidated Statements of Income. Services revenue and cost of services revenue captions on the Condensed Consolidated Statements of Income include Dell’s enhanced services and software from Dell’s software and peripherals product category. This software revenue and related costs include software license fees and related PCS that is sold separately from computer systems through our software and peripherals product category. Dell recognizes software revenue and related costs in accordance with the requirements of AICPA Statement of Position No. 97-2, Software Revenue Recognition. Dell has not established vendor specific objective evidence to support a separation of the software license and PCS elements; therefore, software license revenue and related costs are included in services revenue and cost of revenue and are generally recognized over the term of the arrangement. The revision had no impact to total net revenue and total cost of net revenue.

 

Dell has revised the presentation of certain prior period amounts reported within cash flow from operations presented in the Condensed Consolidated Statements of Cash Flows. The revision had no impact to the total change in cash from operating activities.

 

 

 

 

Fair Value Measurements

 

On February 2, 2008, Dell adopted the effective portions of SFAS 157 for all financial assets and liabilities and non-financial assets and liabilities accounted for at fair value on a recurring basis. On January 31, 2009, Dell adopted FSP 157-2 for all non-financial assets and liabilities accounted for at fair value on a non-recurring basis. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, Dell uses various methods including market, income, and cost approaches. Dell utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs. The adoption of FSP 157-2 did not have a material effect on the Condensed Consolidated Financial Statements for the first quarter of Fiscal 2010.

 

As a basis for categorizing these inputs, SFAS 157 establishes the following hierarchy that prioritizes the inputs used to measure fair value from market based assumptions to entity specific assumptions:

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

The following tables present the hierarchy for Dell’s assets and liabilities measured at fair value on a recurring basis as of May 1, 2009, and January 30, 2009:

 

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

The following section describes the valuation methodologies Dell uses to measure financial instruments at fair value:

 

Investments Available for Sale — The majority of Dell’s investment portfolio consists of various fixed income securities such as U.S. government and agencies, U.S. and international corporate, and state and municipal bonds. This portfolio of investments, as of May 1, 2009, and January 30, 2009, is valued based on model driven valuations, whereby all significant inputs are observable or can be derived from or corroborated by observable market data for substantially the full term of the asset. Dell utilizes a pricing service to obtain fair value pricing for the majority of the investment portfolio. Pricing for securities is based on proprietary models, and inputs are documented in accordance with the SFAS 157 hierarchy. Dell conducts reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact the SFAS 157 hierarchy disclosure. The Level 3 position represents a convertible debt security that Dell was unable to corroborate with observable market data. The investment is valued at cost plus accrued interest as this is management’s best estimate of fair value.

 

Investments Trading Securities — The majority of Dell’s trading portfolio consists of various mutual funds and equity securities. The Level 1 securities are valued using quoted prices for identical assets in active markets. The Level 2 securities include various mutual funds that are not exchange traded and valued at their net asset value, which can be market corroborated.

 

Retained Interest in Securitized Receivables — The fair value of the retained interest is determined using a discounted cash flow model. Significant assumptions to the model include pool credit losses, payment rates, and discount rates. These assumptions are supported by both historical experience and anticipated trends relative to the particular receivable pool. Retained interest in securitized receivables is included in financing receivables, current and long-term, on the Condensed Consolidated Statements of Financial Position. See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information about retained interest.

 

Derivative Instruments — Dell’s derivative financial instruments consist of foreign currency forward and purchased option contracts. The portfolio is valued using internal models based on market observable inputs, including forward and spot prices for currencies and implied volatilities. Credit risk is also factored into the fair value calculation of our derivative instrument portfolio. Credit risk is quantified through the use of credit default swap spreads based on a composite of Dell’s counterparties, which represents the cost of protection in the event the counterparty or Dell were to default on the obligation.

 

The following tables show a reconciliation of the beginning and ending balances for fair value measurements using significant unobservable inputs for the three months ended May 1, 2009, and May 2, 2008:

 

 

 

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

Unrealized gains or (losses) on retained interest and the convertible debt security are reported in income.

 

Financial Items Measured at Fair Value on a Nonrecurring Basis — Certain assets and liabilities are measured at fair value on a nonrecurring basis and therefore are not included in the above recurring fair value table. The balances are not material relative to Dell’s balance sheet, and there were no material non-recurring adjustments to earnings to disclose under the provisions of SFAS 157 for the three months ended May 1, 2009, and May 2, 2008.

 

Non-financial Items Measured at Fair Value on a Nonrecurring Basis — Non-financial assets such as goodwill; intangible assets; and property, plant, and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when impairment is recognized. Dell performed impairment analyses in the first quarter of Fiscal 2010. Based on the results of the impairment tests, Dell determined no impairment of goodwill; intangible assets; or property, plant, and equipment existed as of May 1, 2009.

 

Derivative Instruments and Hedging Activities

 

Foreign Currency Instruments

 

As part of its risk management strategy, Dell uses derivative instruments, primarily forward contracts and purchased options, to hedge certain foreign currency exposures. Dell’s objective is to offset gains and losses resulting from these exposures with gains and losses on the derivative contracts used to hedge them, thereby reducing volatility of earnings and protecting fair values of assets and liabilities. Dell applies hedge accounting based upon the criteria established by SFAS No. 133, Accounting for Derivative instruments and Hedging Activities, (“SFAS 133”), whereby Dell designates its derivatives as fair value hedges or cash flow hedges. Dell estimates the fair values of derivatives based on quoted market prices or pricing models using current market rates and records all derivatives in the Condensed Consolidated Statements of Financial Position at fair value.

 

Cash Flow Hedges

 

Dell uses a combination of forward contracts and purchased options designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in its forecasted transactions denominated in currencies other than the U.S. dollar. The risk of loss associated with purchased options is limited to premium amounts paid for the option contracts. The risk of loss associated with forward contracts is equal to the exchange rate differential from the time the contract is entered into until the time it is settled. Both of these contracts typically expire in 12 months or less. For derivative instruments that are designated and qualify as cash flow hedges, Dell records the effective portion of the gain or loss on the derivative instrument in accumulated other comprehensive income (“OCI”) (loss) as a separate component of stockholders’ equity and reclassifies these amounts into earnings in the period during which the hedged transaction is recognized in earnings. Dell reports the effective portion of cash flow hedges in the same financial statement line item within earnings as the changes in value of the hedged item.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

For foreign currency forward contracts and purchased options designated as cash flow hedges, Dell assesses hedge effectiveness both at the onset of the hedge as well as at the end of each fiscal quarter throughout the life of the derivative. Dell measures hedge ineffectiveness by comparing the cumulative change in the fair value of the hedge contract with the cumulative change in the fair value of the hedged item, both of which are based on forward rates. Dell recognizes any ineffective portion of the hedge, as well as amounts not included in the assessment of effectiveness, currently in earnings as a component of investment and other income (expenses), net. Hedge ineffectiveness for cash flow hedges was not material for the three months ended May 1, 2009. During the three months ended May 1, 2009, Dell did not discontinue any cash flow hedges that had a material impact on Dell’s results of operations as substantially all forecasted foreign currency transactions were realized in Dell’s actual results.

 

The following table summarizes the fair value of the foreign exchange contracts on the Condensed Consolidated Statement of Financial Position for the three months ended May 1, 2009, as well as the amount of hedge ineffectiveness on cash flow hedges recorded in earnings for the respective period:

 

 

Other Foreign Currency Derivative Instruments

 

Dell uses forward contracts to hedge monetary assets and liabilities, primarily receivables and payables, denominated in a foreign currency. The change in the fair value of these instruments represents a natural hedge as their gains and losses offset the changes in the underlying fair value of the monetary assets and liabilities due to movements in currency exchange rates. These contracts generally expire in three months or less. These contracts are considered economic hedges and are not designated as hedges under SFAS 133, and therefore, the change in the instrument’s fair value is recognized currently in earnings as a component of investment and other income (expense), net. For the first quarter of Fiscal 2010, the gain on the contracts that was recognized in Financing and Other Income was $46 million.

 

Derivative Instruments Additional Information

 

The gross notional value of foreign currency derivative financial instruments was as follows:

 

		May 1, 2009
		Gross
		Notional
		(in millions)
Cash flow hedges		$	5,692
Other derivatives			591
		$	6,283

 

Cash flows from derivative instruments are presented in the same category on the Condensed Consolidated Statements of Cash flows as the cash flows from the intended hedged items or the economic hedges.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

While Dell has derivative contracts in more than 20 currencies, the majority of the gross notional values are denominated in the Euro, British Pound, Japanese Yen, Canadian Dollar, and Australian Dollar.

 

Dell accounts for derivatives under FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, which allows for net presentation of its derivative instruments in a statement of financial position due to right of setoff by counterparty under master netting arrangements. As a result, there are contracts in an asset position recorded in the other current liabilities, and vice versa. As required by SFAS 161, the fair value of the derivative instruments presented on a gross basis is as follows:

 

 

Dell has reviewed the existence and nature of credit-risk-related contingent features in derivative trading agreements with its counterparties. Certain agreements contain clauses whereby upon a change of control and if Dell’s credit ratings were to fall below investment grade, counterparties would have the right to terminate those derivative contracts where Dell is in a net liability position. As of May 1, 2009, there has been no such triggering event.

 

Debt

 

Commercial Paper

 

Dell has a $1.5 billion commercial paper program with a supporting $1.5 billion senior unsecured revolving credit facility that allows Dell to obtain favorable short-term borrowing rates. On April 3, 2009, Dell entered into a replacement 364-day $500 million credit facility, which expires on April 2, 2010. Additionally, Dell has a five-year $1.0 billion credit facility that will expire on June 1, 2011. There were no events of default as of May 1, 2009.

 

At May 1, 2009, there was $100 million outstanding under the commercial paper program and no outstanding advances under the related revolving credit facilities. The weighted-average interest rate on these outstanding short- term borrowings was 0.20%. At January 30, 2009, there was $100 million outstanding under the commercial paper program and no outstanding advances under the related revolving credit facilities. Dell uses the proceeds of the program for short-term liquidity needs.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

India Credit Facilities

 

At May 1, 2009, there were no outstanding advances from Citibank India, and at January 30, 2009, outstanding advances from Citibank India totaled $12 million and are included in short-term debt on Dell’s Condensed Consolidated Statements of Financial Position. There have been no events of default.

 

Long-Term Debt

 

The following table summarizes our long-term debt:

 

 

The 2014 Notes were issued during the first quarter of Fiscal 2010, under an automatic shelf registration statement that was filed in November 2008. The net proceeds from the offering of the 2014 Notes were approximately $497 million after payment of expenses of the offering. The estimated fair value of all the Notes in aggregate was approximately $2.0 billion at May 1, 2009, compared to a carrying value of $2.0 billion at that date. All Notes are unsecured obligations and rank equally with our existing and future unsecured senior indebtedness. The Notes effectively rank junior to all indebtedness and other liabilities, including trade payables, of Dell’s subsidiaries. The 2014 Notes were issued pursuant to an Indenture dated April 1, 2009, between Dell and a trustee, with terms and conditions substantially the same as those governing the 2013 Notes, 2018 Notes, and 2038 Notes.

 

The principal amount of the Senior Debenture was $300 million at May 1, 2009. The estimated fair value of the long-term debt was approximately $301 million at May 1, 2009, compared to a carrying value of $398 million at that date as it includes termination of the interest rate swap agreements in the fourth quarter of Fiscal 2009.

 

As of May 1, 2009, there were no events of default for the Notes and the Senior Debenture.

 

NOTE 4 — FINANCIAL SERVICES

 

Dell Financial Services L.L.C.

 

Dell offers or arranges various financing options and services for its business and consumer customers in the U.S. through Dell Financial Services L.L.C. (“DFS”), a wholly-owned subsidiary of Dell. DFS’s key activities include the origination, collection, and servicing of customer receivables related to the purchase of Dell products.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

Dell utilizes DFS to facilitate financing for customers who elect to finance products sold by Dell. New financing originations, which represent the amounts of financing provided to customers for equipment and related software and services through DFS, were $0.9 billion, and $1.1 billion, during the three months ended May 1, 2009, and May 2, 2008, respectively.

 

CIT Group Inc. (“CIT”), formerly a joint venture partner of DFS, continues to have the right to purchase a percentage of new customer receivables facilitated by DFS until the end of Fiscal 2010. CIT’s contractual funding right on a cumulative annual basis was up to 35% in Fiscal 2009 and is up to 25% in Fiscal 2010. For the three months ended May 1, 2009, CIT’s funding percentage was approximately 31% as agreed to by CIT and Dell. DFS services the receivables purchased by CIT. However, Dell’s obligation related to the performance of the DFS originated receivables purchased by CIT is limited to the cash funded credit reserves established at the time of funding.

 

Financing Receivables

 

The following table summarizes the components of Dell’s financing receivables, net of the allowance for financing receivables losses:

 

 

Of the gross customer receivables balance at May 1, 2009, and January 30, 2009, $33 million and $45 million, respectively, represent balances which are due from CIT in connection with specified promotional programs.

 

Customer Receivables — The composition and credit quality of customer receivables vary from investment grade commercial customers to subprime consumers. Dell’s estimate of subprime customer receivables was approximately 21% and 20% of the gross customer receivable balance at May 1, 2009, and January 30, 2009, respectively.

 

As of May 1, 2009, and January 30, 2009, customer financing receivables 60 days or more delinquent were $60 million and $58 million, respectively. These amounts represent 3.7% and 3.4% of the ending gross customer financing receivables balances for the respective periods.

 

Net principal charge-offs for the three months ended May 1, 2009, and May 2, 2008, were $30 million and $18 million, respectively. These amounts when annualized represent 7.2% and 4.7% of the average gross outstanding customer financing receivable balance (including accrued interest) for the respective three month periods.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

The following is a description of the components of customer receivables:

 

 

Residual Interest — Dell retains a residual interest in the leased equipment. The amount of the residual interest is established at the inception of the lease based upon estimates of the value of the equipment at the end of the lease term using historical studies, industry data, and future value-at-risk demand valuation methods. On a quarterly basis, Dell assesses the carrying amount of its recorded residual values for impairment. Anticipated declines in specific future residual values that are considered to be other-than-temporary are recorded in current earnings.

 

Retained Interest — Retained interest represents the residual beneficial interest Dell retains in certain pools of securitized financing receivables. Retained interest is stated at the present value of the estimated net beneficial cash flows after payment of all senior interests. Dell values the retained interest at the time of each receivable transfer and at the end of each reporting period. The fair value of the retained interest is determined using a discounted cash flow model with various key assumptions, including payment rates, credit losses, discount rates, and the remaining life of the receivables sold. These assumptions are supported by both Dell’s historical experience and anticipated trends relative to the particular receivable pool. The weighted average assumptions for retained interest can be affected by many factors, including asset type (revolving versus fixed), repayment terms, and the credit quality of assets being securitized.

 

The following table summarizes the activity in retained interest balances for the three months ended May 1, 2009, and May 2, 2008:

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

The table below summarizes the key assumptions used to measure the fair value of the retained interest at time of transfer within the quarter and at the balance sheet date, May 1, 2009:

 

 

The impact of adverse changes to the key valuation assumptions to the fair value of retained interest at May 1, 2009, is shown in the following table:

 

		May 1, 2009
		(in millions)
Adverse Change of:
Expected prepayment speed: 10%		$	(1	)
Expected prepayment speed: 20%		$	(4	)
Expected credit losses: 10%		$	(13	)
Expected credit losses: 20%		$	(20	)
Discount rate: 10%		$	(5	)
Discount rate: 20%		$	(10	)

 

The analyses above utilized 10% and 20% adverse variation in assumptions to assess the sensitivities in the fair value of the retained interest. However, these changes generally cannot be extrapolated because the relationship between a change in one assumption to the resulting change in fair value may not be linear. For the above sensitivity analyses, each key assumption was isolated and evaluated separately. Each assumption was adjusted by 10% and 20% while holding the other key assumptions constant. Assumptions may be interrelated, and changes to one assumption may impact others and the resulting fair value of the retained interest. For example, increases in market interest rates may result in lower prepayments and increased credit losses. The effect of multiple assumption changes were not considered in the analyses.

 

Asset Securitization

 

During the first three months of Fiscal 2010 and Fiscal 2009, Dell transferred $233 million and $421 million, respectively, of fixed-term leases and loans and revolving loans to unconsolidated qualifying special purpose entities. The qualifying special purpose entities are bankruptcy remote legal entities with assets and liabilities separate from those of Dell. The purpose of the qualifying special purpose entities is to facilitate the funding of financing receivables in the capital markets. The qualifying special purpose entities have entered into financing arrangements with three multi-seller conduits that, in turn, issue asset-backed debt securities in the capital markets. Two of the three conduits fund fixed-term leases and loans, and one conduit funds revolving loans. The principal balance of the securitized receivables at May 1, 2009, and January 30, 2009, was $1.3 billion and $1.4 billion, respectively.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

Dell services securitized contracts and earns a servicing fee. Dell’s securitization transactions generally do not result in servicing assets and liabilities as the contractual fees are adequate compensation in relation to the associated servicing cost.

 

The revolving securitization agreement continues under scheduled amortization. During this scheduled amortization period, all principal collections will be used to pay down the outstanding debt amount related to the securitized assets. The right to receive cash collections is delayed until the debt is fully paid. During the scheduled amortization, no transfers of new revolving loans will occur. Additional purchases made on existing securitized revolving loans (repeat purchases) will continue to be transferred to the qualified special purpose entity and will increase the retained interest in securitized assets on the balance sheet.

 

Once the amount of the beneficial interest in the revolving credit conduit owned by third parties falls below 10%, Dell will be required to recognize the fair value of the assets and liabilities relating to the revolving securitization transaction on the balance sheet. The overall impact to the balance sheet will be an increase in accrued and other current liabilities, representing the unpaid portion of the outstanding debt, which is immaterial. As of May 1, 2009, the principal balance of the revolving securitized receivables was $616 million, and the balance of the debt associated with those assets was $184 million.

 

Dell’s securitization programs contain standard structural features related to the performance of the securitized receivables. These structural features include defined credit losses, delinquencies, average credit scores, and excess collections above or below specified levels. In the event one or more of these features are met and Dell is unable to restructure the program, no further funding of receivables will be permitted and the timing of expected retained interest cash flows will be delayed, which would impact the valuation of the retained interest. For the revolving transaction currently under scheduled amortization, performance features have been suspended.

 

As of May 1, 2009, and January 30, 2009, securitized financing receivables 60 days or more delinquent were $60 million and $63 million, respectively. These amounts represent 4.7% and 4.6% of the ending securitized financing receivables balances for the respective periods.

 

Net principal charge-offs for the three months ended May 1, 2009, and May 2, 2008, were $36 million and $28 million, respectively. These amounts when annualized represent 10.6% and 8.7% of the average outstanding securitized financing receivable balance for the respective three month periods.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

Goodwill

 

Goodwill allocated to Dell’s business segments as of May 1, 2009, and January 30, 2009, and changes in the carrying amount of goodwill were as follows:

 

 

Goodwill and indefinite lived intangibles are tested annually during the second fiscal quarter and whenever events or circumstances indicate impairment may have occurred. If the carrying amount of goodwill exceeds its fair value, estimated based on discounted cash flow analyses, an impairment charge would be recorded. In the first quarter of Fiscal 2010, Dell evaluated goodwill and indefinite lived intangibles for potential triggering events that could indicate impairment in connection with the new alignment of its business segments. Based on the results of the impairment tests, Dell determined that no impairment of goodwill and indefinite lived intangible assets existed at May 1, 2009. The goodwill adjustments are primarily the result of contingent purchase price considerations related to prior acquisitions and the effects of foreign currency fluctuations.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

Revenue from extended warranty and service contracts including support agreements, for which Dell is obligated to perform, is recorded as deferred enhanced services revenue and subsequently recognized over the term of the contract or when the service is completed and the costs associated with these contracts is recognized as incurred. Deferred software related revenue is included in accrued and other current and other non-current liabilities on Dell’s Condensed Consolidated Statements of Financial Position. Dell records warranty liabilities at the time of sale for the estimated costs that may be incurred under its limited warranty. Changes in Dell’s deferred enhanced services revenue for extended warranties and its warranty liability for standard warranties, which are included in accrued and other current and other non-current liabilities on Dell’s Condensed Consolidated Statements of Financial Position, are presented in the following tables:

 

 

 

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

 

Severance Costs and Facility Closures — In Fiscal 2008, Dell announced a comprehensive review of costs that is currently ongoing. Since this announcement and through the end of the first quarter of Fiscal 2010, Dell reduced its headcount and closed certain Dell facilities. Results of operations for the first quarter of Fiscal 2010 include net pre-tax charges of $185 million for these actions, which is comprised of $175 million related to headcount reduction and a net $10 million related to facilities actions, including accelerated depreciation. In the first quarter of Fiscal 2009, costs related to severance and facility closures were $106 million. As of May 1, 2009, and January 30, 2009, the accrual related to these cost reductions and efficiency actions was $183 million and $98 million, respectively, which is included in accrued and other liabilities in the Condensed Consolidated Statements of Financial Position.

 

Restricted Cash — Pursuant to an agreement between Dell and CIT, Dell is required to maintain escrow cash accounts that are held as recourse reserves for credit losses, performance fee deposits related to Dell’s private label credit card, and deferred servicing revenue. Restricted cash in the amount of $197 million and $213 million is included in other current assets at May 1, 2009, and January 30, 2009, respectively.

 

Legal Matters — Dell is involved in various claims, suits, investigations, and legal proceedings. As required by SFAS No. 5, Accounting for Contingencies, Dell accrues a liability when it believes that it is both probable that a liability has been incurred and that it can reasonably estimate the amount of the loss. Dell reviews these accruals at least quarterly and adjusts them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel, and other relevant information. However, litigation is inherently unpredictable; therefore, Dell could incur judgments or enter into settlements of claims that could adversely affect its operating results or cash flows in a particular period.

 

The following is a discussion of Dell’s significant legal matters.

 

 

Dell and several of its current and former directors and officers were named as parties to the following securities, Employee Retirement Income Security Act of 1974 (“ERISA”), and shareholder derivative lawsuits all arising out of the same events and facts.

 

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

 

The Board of Directors received a shareholder demand letter, dated November 12, 2008, asserting allegations similar to those made in the securities and shareholder derivative lawsuits against various current and former officers and directors and PricewaterhouseCoopers LLP, and requesting that the Board of Directors investigate and assert claims relating to those allegations on behalf of Dell. The Board of Directors is considering and will address the demand.

 

 

On December 29, 2005, Zentralstelle Für private Überspielungrechte (“ZPÜ”), a joint association of various German collection societies, instituted arbitration proceedings against Dell’s German subsidiary before the Arbitration Body in Munich. ZPÜ claims a levy of €18.4 per PC that Dell sold in Germany from January 1, 2002, through December 31, 2005. On July 31, 2007, the Arbitration Body recommended a levy of €15 on each PC sold during that period for audio and visual copying capabilities. Dell and ZPÜ rejected the recommendation, and on February 21, 2008, ZPÜ filed a lawsuit in the German Regional Court in Munich. Dell plans to continue to defend this claim vigorously and does not expect the outcome to have a material adverse effect on its financial condition or results of operations.

 

Dell has various other claims, suits, investigations, and legal proceedings that arise from time to time in the ordinary course of its business, including matters involving stockholder, consumer, antitrust, tax, intellectual property, and other issues on a global basis. Dell does not expect that the outcome in any of these other legal proceedings, individually or collectively, will have a material adverse effect on its financial condition or results of operations.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

 

The following table summarizes comprehensive income for the three months ended May 1, 2009, and May 2, 2008:

 

 

 

Dell’s effective income tax rate was 29.6% for the first quarter of Fiscal 2010, as compared to 23.5% for the same quarter in the prior year. The increase in the effective rate in the first quarter of Fiscal 2010 as compared to the effective rate in the first quarter of Fiscal 2009 is primarily due to increased profitability mix in higher tax rate jurisdictions and the accrual of interest and penalties related to uncertain tax positions. The Fiscal 2009 effective tax rate reflects decreases in uncertain tax positions resulting from the effective settlement of an examination in a foreign jurisdiction and reevaluation of certain tax incentives, partially offset by the accrual of interest and penalties related to uncertain tax positions. The differences between the estimated effective income tax rate and the U.S. federal statutory rate of 35% principally result from Dell’s geographical distribution of taxable income and differences between the book and tax treatment of certain items. The income tax rate for Fiscal 2010 will be impacted by the actual mix of jurisdictions in which income is generated.

 

Dell is 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 Dell is subject include fiscal years 1997 through 2009. As a result of these audits, Dell maintains ongoing discussions and negotiations relating to tax matters with the taxing authorities in these various jurisdictions. Dell’s U.S. Federal income tax returns for fiscal years 2004 through 2006 are under examination, and the Internal Revenue Service (“IRS”) has issued a Revenue Agent’s Report proposing certain assessments primarily related to transfer pricing matters, which Dell has protested in accordance with IRS administrative procedures. Dell anticipates this audit will take several years to resolve and believes that it has provided adequate reserves related to the matters under audit. However, should Dell experience an unfavorable outcome in this matter, it could have a material impact on its results of operations, financial position, or cash flows. Although the timing of income tax audit resolutions and negotiations with taxing authorities are highly uncertain, Dell does not anticipate a significant change to the total amount of unrecognized income tax benefits within the next 12 months.

 

Dell takes certain non-income tax positions in the jurisdictions in which it operates and has received certain non-income tax assessments from various jurisdictions. Dell is also involved in related non-income tax litigation matters in various jurisdictions. Dell believes its positions are supportable, a liability is not probable, and that it will ultimately prevail. However, significant judgment is required in determining the ultimate outcome of these matters. In the normal course of business, Dell’s positions and conclusions related to its non-income taxes could be

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

challenged and assessments may be made. To the extent new information is obtained and Dell’s views on its positions, probable outcomes of assessments, or litigation change, changes in estimates to Dell’s accrued liabilities would be recorded in the period in which such determination is made.

 

 

Basic earnings per share is based on the weighted-average effect of all common shares issued and outstanding and is calculated by dividing net income by the weighted-average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding. Dell excludes equity instruments from the calculation of diluted earnings per share if the effect of including such instruments is antidilutive. Accordingly, certain stock-based incentive awards have been excluded from the calculation of diluted earnings per share totaling 247 million shares and 275 million shares for the first quarter of Fiscal 2010 and Fiscal 2009, respectively.

 

The following table sets forth the computation of basic and diluted earnings per share for the three months ended May 1, 2009, and May 2, 2008:

 

 

 

During the first quarter of Fiscal 2010, Dell completed its reorganization from Dell’s geographic commercial segments (Americas Commercial; Europe, Middle East, and Africa Commercial; and Asia Pacific-Japan Commercial) to global business units (Large Enterprise, Public, and Small and Medium Business), reflecting the impact of globalization on Dell’s customer base. Dell’s four global business segments are Large Enterprise, Public, Small and Medium Business (“SMB”), and its existing Consumer segment. Large Enterprise includes sales of IT infrastructure and service solutions to large global and national corporate customers. Public includes sales to educational institutions, governments, health care organizations, and law enforcement agencies, among others. SMB includes sales of complete IT solutions to small and medium businesses. Consumer includes sales for individual consumers and retailers around the world.

 

DELL INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

 

During the reorganization, Dell identified revenue activities that were managed and reported within Dell’s commercial business, but which had characteristics more consistent with Dell’s consumer business. As a result, these activities were realigned into Dell’s Consumer segment during the first quarter of Fiscal 2010. Prior period amounts have been reclassified from Dell’s commercial segments to Dell’s Consumer segment to conform to the current period presentation.

 

The business segments disclosed in the accompanying Consolidated Condensed Financial Statements are based on this organizational structure and information reviewed by Dell’s management to evaluate the business segment results. Dell’s measure of segment operating income for management reporting purposes excludes severance and facility closure expenses, broad based long-term incentives, acquisition-related charges such as in-process research and development, and amortization of intangibles.

 

The following table presents net revenue by Dell’s reportable global segments as well as a reconciliation of consolidated segment operating income to Dell’s consolidated operating income for the three months ended May 1, 2009, and May 2, 2008:

 

 

 

SPECIAL NOTE:  This section, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements based on our current expectations. Actual results in future periods may differ materially from those expressed or implied by those forward-looking statements because of a number of risks and uncertainties. For a discussion of risk factors affecting our business and prospects, see “Part I — Item 1A — Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 30, 2009.

 

All percentage amounts and ratios were calculated using the underlying data in thousands. Unless otherwise noted, all references to industry share and total industry growth data are for personal computers (including desktops, notebooks, and x86 servers), and are based on preliminary information provided by IDC Worldwide Quarterly PC Tracker, May 18, 2009. Share data is for the calendar quarter and all our growth rates are on a fiscal year-over-year basis. Unless otherwise noted, all references to time periods refer to our fiscal periods.

 

OVERVIEW

 

Our Company

 

We are a leading technology solutions provider in the IT industry. We are the number two supplier of computer systems in the United States, and the number two supplier worldwide. We offer a broad range of products, including mobility products, desktop PCs, software and peripherals, servers and networking, and storage products. Our enhanced services offerings include infrastructure consulting, deployment of enterprise products and computer systems in customers’ environments, asset recovery and recycling, computer-related training, IT support, client and enterprise support, and managed service solutions. We also offer various financing alternatives, asset management services, and other customer financial services for business and consumer customers.

 

We were founded on the core principle of a direct customer business model, which creates direct relationships with our customers. These relationships allow us to be on the forefront of changing user requirements and needs while competing as one of the industry leaders in selling the most relevant technology, at the best value, to our customers. We continue to simplify technology and enhance product design and features to meet our customers’ needs and preferences.

 

Our direct customer business model includes 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 third-party original equipment manufacturers. This 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 around customers’ needs in order to drive long-term sustainable growth, profitability, and operating cash flow. We have expanded our business model to include new distribution partners, such as retail, system integrators, value-added resellers, and distributors, which allow 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 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.

 

As part of our overall growth strategy, we have completed strategic acquisitions to augment select areas of our business with more products, services, and technology. We expect to continue to grow our business organically, and inorganically through alliances and through strategic acquisitions.

 

Customer needs are increasingly being defined by how they use technology rather than where they use it, which is why we have transitioned from a global business that is run regionally to businesses that are globally organized. During the first quarter of Fiscal 2010, we completed our reorganization from our geographic commercial segments [Americas Commercial; Europe, Middle East, and Africa (“EMEA”) Commercial; and Asia Pacific-Japan (“APJ”) Commercial], to global business units [Large Enterprise, Public, and Small and Medium Business (“SMB”)],

reflecting the impact of globalization on our customer base. To simplify reporting, we aligned certain countries that represent a small percentage of our total revenue with a single global segment, based mainly on the countries’ customer base. This realignment creates a clear customer focus, which allows us to serve customers with faster innovation and greater responsiveness, thus allowing us to capitalize on competitive advantages, while strengthening execution and synergies. We began managing and reporting in our new business segment structure in the first quarter of Fiscal 2010. Our four global business segments are:

 

 

RESULTS OF OPERATIONS

 

Consolidated Operations

 

The following table summarizes the results of our operations for the three months ended May 1, 2009, and May 2, 2008:

 

 

Share Position — We shipped 9.1 million units in the first quarter of Fiscal 2010. According to IDC, in the first quarter of calendar year 2009, we maintained our second place position in the worldwide computer systems market with a share position of 13.9%, which is consistent with our share position of 13.9% for the fourth quarter of calendar 2008. However, we lost 1.6 percentage points of share since the first quarter of calendar 2008 due to our commercial business’s slower unit growth as we pursued profitable growth opportunities in a slow global IT demand environment.

 

The challenging economic conditions that began in the second half of Fiscal 2009 continued to be prevalent in the first quarter of Fiscal 2010. As a result, we experienced a decline in global IT end-user demand. Consistent with the second half of Fiscal 2009, we focused on balancing liquidity, profitability, and growth by selecting areas that provided profitable growth opportunities. We also took actions to reduce operating expenses, optimize product costs, and improve working capital management, and we will continue these actions throughout Fiscal 2010. We will also selectively invest in strategic growth opportunities.

 

Product Revenue — Product revenue and unit shipments decreased year-over-year by 27% and 17%, respectively, for the first quarter of Fiscal 2010. Our product revenue performance is primarily attributed to a decrease in customer demand as a result of the challenging economic environment and a reduction in average selling prices.

 

Services Revenue, including software related — Services revenue remained relatively flat year-over-year with a 1% decrease in the first quarter of Fiscal 2010. Our services revenue performance is primarily attributed to an 8% year-over-year decrease in enhanced services revenue, offset by a 12% increase in software related revenue.

 

Overall, our average selling price (total revenue per unit sold) during the first quarter of Fiscal 2010 decreased 8% year-over-year. Average selling prices were adversely impacted by a change in revenue mix between our commercial and consumer business. Selling prices in our commercial business are typically higher than our consumer business selling prices, and during the quarter our consumer unit shipments grew 12% while our commercial unit shipments declined 27% year-over-year. Average selling prices were also affected by our increased presence in consumer retail, which typically has lower average selling prices than our consumer on-line and phone direct business. Average selling prices in our Consumer segment declined 25% year-over-year for the first quarter of Fiscal 2010 compared to a 3% increase in selling prices for our commercial business. Within Consumer, average selling prices were also adversely impacted by a shift in product mix from higher priced computer systems to lower priced offerings and by a competitive pricing environment. Our market strategy has been to concentrate on solution sales to drive a more profitable mix of products and services, while pricing our products to remain competitive in the

marketplace. During the first quarter of Fiscal 2010, we continued to see competitive pressure, particularly for lower priced desktops and notebooks, as we targeted a broader range of products and price bands. We expect this competitive pricing environment will continue for the foreseeable future.

 

Revenue outside the U.S. represented approximately 48% of net revenue for the first quarter of Fiscal 2010. Outside the U.S., we experienced a 26% year-over-year revenue decline for the first quarter of Fiscal 2010 as compared to a 20% decline in revenue for the U.S. At a consolidated level, BRIC revenue declined 21% during the first quarter of Fiscal 2010 as compared to the same period in the prior year; however, BRIC revenue in our Consumer segment increased 17% year-over-year. We will continue to tailor solutions to meet specific regional needs, enhance relationships to provide customer choice and flexibility, and expand into these and other emerging countries that represent the vast majority of the world’s population. From a worldwide product perspective, the continuing decline in desktop unit sales and prices and competitive pricing pressure in mobility contributed heavily to our first quarter of Fiscal 2010 performance.

 

We manage our business on a U.S. Dollar basis, and as a result of our comprehensive hedging program, foreign currency fluctuations did not have a significant impact on our consolidated results of operations.

 

Operating Income — In the first quarter of Fiscal 2010, operating income decreased 54% year-over-year to $414 million. The decline was driven by a decrease in end-user demand, overall competitive pricing pressures, and a shift in product mix that resulted in lower average selling prices. Operating expenses decreased 15% year-over-year; however, operating expenses as a percentage of revenue increased to 14.2% for the first quarter of Fiscal 2010 from 12.9% for the first quarter of Fiscal 2009. We continued to aggressively manage our operating cost structure as we realigned our business. In the first quarter of Fiscal 2010, we took organizational actions to reduce costs, and accordingly, we recorded severance and facility closure expenses of $185 million.

 

Net Income — In the first quarter of Fiscal 2010, net income decreased 63% year-over-year to $290 million. Net income was impacted by a 54% year-over-year decline in operating income, a 101% decline in investment and other income (expense), and an increase in our effective tax rate to 29.6% from 23.5%.

 

Revenues by Segment

 

During the first quarter of Fiscal 2010, we completed our previously communicated reorganization from our geographic commercial segments (Americas Commercial, EMEA Commercial, and APJ Commercial), to global business units (Large Enterprise, Public, and Small and Medium Business), reflecting the impact of globalization on our customer base. Our four global business segments are Large Enterprise, Public, Small and Medium Business, and our existing Consumer segment.

 

During the reorganization to global business units, we identified revenue activities that were managed and reported within our commercial business, but which had characteristics more consistent with our Consumer business. As a result, these activities were realigned into our Consumer segment during the first quarter of Fiscal 2010. Prior period amounts have been reclassified from our commercial segments to our Consumer segment to conform to the current period presentation.

The following table summarizes our revenue by reportable global segments for the three months ended May 1, 2009, and May 2, 2008:

 

 

 

We sell desktop and notebook computers, printers, ink, and toner through retail partners. Our goal is to have strategic relationships with a number of major retailers in our larger geographic regions. During the first quarter of Fiscal 2010, we continued to expand our global retail presence, and we now reach over 30,000 retail locations worldwide.

 

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 product categories include mobility products, desktop PCs, software and peripherals, servers and networking products, and storage products. In addition, we offer a range of services.

 

In the first quarter of Fiscal 2010, we performed an analysis of our enhanced services revenue and determined that certain items previously classified as enhanced services revenue were more appropriately categorized within product revenue. Also, certain items previously categorized as mobility, desktop PC, and servers and networking revenue were more appropriately reclassified to storage revenue. Fiscal 2009 balances reflect the revised revenue classifications. The net change in classification of prior period amounts resulted in a decrease of $55 million to mobility, an increase of $81 million to desktop PCs, an increase of $65 million to servers and networking, a decrease of $104 million to enhanced services, and an increase of $13 million to storage in the first quarter of Fiscal 2009.

 

The following table summarizes our net revenue by product and service categories for the three months ended May 1, 2009, and May 2, 2008: