Dell 2005 Annual Report Download - page 31

Table of Contents
• Operating Activities — Cash flows from operating activities during fiscal 2006, 2005, and 2004 resulted primarily from net income, which represents our
principal source of cash. In fiscal 2006, the decrease in operating cash flows was primarily led by changes in operating working capital accounts, including
income taxes payable. In fiscal 2005, the increase in operating cash flows was primarily led by an increase in operating income and the improvement in our
cash conversion cycle.
Operating cash flows have historically been impacted by income tax benefits that result from the exercise of employee stock options. These tax benefits
totaled $261 million, $249 million, and $181 million in fiscal 2006, 2005, and 2004, respectively. These benefits are the tax effects of corporate income tax
deductions (that are considered taxable income to the employee) that represent the amount by which the fair value of our stock exceeds the option strike
price on the day the employee exercises a stock option. Upon adoption of Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based
Payment in the first quarter of fiscal 2007, cash flow from operations will be reduced by the excess tax benefit associated with employee stock option
exercises.
• Key Performance Metrics — Our direct business model allows us to maintain a leading asset management system in comparison to our major competitors.
We are capable of minimizing inventory risk while collecting amounts due from customers before paying vendors, thus allowing us to generate annual cash
flows from operating activities that typically exceed net income. The following table presents the components of our cash conversion cycle for each of the
past three fiscal years:
February 3, January 28, January 30,
2006 2005 2004
Days of sales outstanding(a)(d) 29 27 27
Days of supply in inventory(b) 4 4 3
Days in accounts payable(c) (77) (73) (70)
Cash conversion cycle (44) (42) (40)
(a) Days of sales outstanding ("DSO") is based on the ending net trade receivables and most recent quarterly revenue for each period. DSO includes the effect of product costs related to
customer shipments not yet recognized as revenue that are classified in other current assets. At February 3, 2006, January 28, 2005 and January 30, 2004, days of sales in accounts
receivable and days of customer shipments not yet recognized were 26 and 3 days, 24 and 3 days and 24 and 3 days, respectively.
(b) Days supply of inventory is based on ending inventory and most recent quarterly cost of sales for each period.
(c) Days in accounts payable is based on ending accounts payable and most recent quarterly cost of sales for each period.
(d) Financing receivables have been separately classified on the balance sheet as of February 3, 2006. Prior period balances have been reclassified to conform to the current
presentation. Days sales outstanding have also been recalculated for all periods presented to reflect the reclassifications of certain items previously included in accounts receivable to
financing receivables.
Our cash conversion cycle improved two days at February 3, 2006 from January 28, 2005. This improvement is due to two contributing factors: (i) a four
day increase in days in accounts payable largely attributed to the timing of payments to vendors at the end of the period compared to the prior year and an
extra week of operations in fiscal 2006, and (ii) a two day decline in days of sales outstanding attributed to increased international revenue where typical
customer payment terms are longer.
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 days of sales outstanding because we believe it presents a more accurate presentation of our days of sales outstanding and cash conversion
cycle. These deferred costs are recorded in other current assets in our consolidated statement of financial position and totaled $420 million, $430 million,
and $387 million as of February 3, 2006, January 28, 2005 and January 30, 2004, respectively.
28