Dell Wins Truce

Investors offer an olive branch after the company's earnings blowout.
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Kevin Rollins bought himself some time late Tuesday.

But if Dell's

(DELL) - Get Report

embattled CEO wants to keep his job, the troubled computer maker will have to do more than

deliver one strong quarter.

Reason No. 1: The notable improvement in third-quarter gross margins, the main factor in the company's 6-cent-a-share upside surprise, and a good 2 points better than many analysts expected -- may not be sustainable. "Given the continuing competition in the PC sector, we do not believe the gross margin growth Dell posted in this quarter is sustainable into next quarter," said ThinkEquity analyst Eric Ross.

Gross margins improved sequentially in the third quarter by nearly 150 basis points to 17% and operating margins were up by about the same amount to 5.7%.

After Tuesday's close, the company said it posted net income of $677 million, or 30 cents a share, beating the Thomson First Call analyst estimate of 24 cents a share. It was the first strong quarter in about a year and Wall Street reacted happily, despite longer-term misgivings. In recent trading Wednesday, shares were up $2.35, or 9.5%, to $27.17 -- a level not seen for seven months.

Ross, who wrote one of the more bearish notes following Dell's surprisingly strong third quarter, sees the strong bounce the stock is getting Wednesday as an opportunity to sell into temporary strength.

Indeed, Dell was knocked out of its lead in the worldwide PC market by

Hewlett-Packard

(HPQ) - Get Report

in the last quarter, and may be forced to cut prices as it seeks to remain competitive. ThinkEquity does not have an investment banking relationship with Dell.

Dell itself acknowledged the immediate headwinds in its release Tuesday, saying "in the near term, improvement in growth and profitability may not be linear due to a variety of factors, including the timing of continued investments in customer experience, global expansion, and new product introductions, as well as a muted seasonal uplift due to changes in the mix of product and regional profit."

More positively, however, FBR analyst Clay Sumner said it appears that the dip in margins in the previous quarter was a bottom and that margins on extended warranties, a major issue, "are in better shape than we thought."

Sumner added that one of the issues under investigation by the

Securities and Exchange Commission

may be related to accruals for warranties. Dell reported its quarterly results late because of the investigation, provided much less detail on its results than is customary and did not hold the usual post-announcement call with analysts and reporters. FBR does not have an investment banking relationship with Dell.

In any case, the investigation clearly overhangs the stock.

Bear Stearns analyst Andrew Neff was generally bullish on the report and upgraded the stock to outperform. Even so, he noted that Dell "is not out of the woods," and in a clear warning to CEO Rollins, he added: "Any more missteps could result in management changes at the top, which could also be a positive catalyst." Bear Stearns doesn't have a banking relationship with Dell.