RSSThe Dell Debacle: How Serious is the Damage?
By Scott M. Fulton, III | Published August 17, 2007, 12:28 PM
When a parent finds his child with chocolate on her cheeks saying she hasn't been sneaking candy from the pantry, he may find himself giving the oft-repeated lecture about how small lies are just as bad as big ones. If he then goes to work as the chief financial officer of a corporation, he might find himself in the position of explaining away accounting fraud as a minor deficiency in the context of a major company, reminding stockholders that corporate revenues are big and adjustments to those revenues, real or imaginary, are often small.
Dell Computer CFO Don J. Carty attempted to appear less like a parent yesterday afternoon. At his press conference, he first tried to paint a picture of a company where little men made little adjustments to meet little targets, in the context of a big manufacturer with a big customer base and a big number of outstanding shares.
But Carty doesn't wear the role of apologist well; in fact, from an historical perspective, he looks better as a father figure. In 2003, as the chairman and CEO of AMR, the parent company of American Airlines, Carty successfully negotiated a seemingly impossible deal between his company and a flight attendants' union, which was believed to have saved the company from bankruptcy. The thanks Carty got came by way of a note of congratulations from his successor, who took his job literally the following week.
Don Carty may have fixed AMR; and amid the most conspicuous absence of CEO Michael Dell yesterday, he was clearly there to fix Dell. But one gets the feeling that he has assumed the temporary role of "Dad" in this dysfunctional family, to rescue his foster child from financial burden, only to exit the stage later once that child is well enough to resume his role in the world, where he can pretend such burdens don't really matter.
So the little excuse about the lies Dell Computer told on its financial statements being small in the context of a big company, didn't fit this CFO. He did try to make the extent of the "irregularities" seem insignificant quantitatively. But then he started the long, arduous process of leading his foster child in the act of coming clean.
For slightly more than four years, Dell's accountants and Carty's predecessors made adjustments to publicly reported earnings and profit/loss statements to make it appear that certain business segments were doing better than they actually were. The child had chocolate stains on his face, and it was now time to tell the story of where it came from.
Robbing Peter to pay Peter
"The investigation raised questions relating to numerous accounting issues, most of which involved adjustments to various reserves and accrued liability accounts," Carty stated, referring to the company's internal audit, which discovered irregularities in certain kinds of accounts payable. In other words, for certain accounting periods, company divisions may have had expenses that it chose to defer to later periods...which may have been deferred again, and so on.
"The investigation identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets," the CFO continued. "According to the investigation, these activities typically occurred on or around quarter-end, and the investigation found evidence that in that time frame, account balances were reviewed sometimes at the request or sometimes with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met. The investigation concluded that a number of these adjustments were improper, including the creation and release of accruals and reserves that appear to have been made for the purpose of enhancing internal performance measures or reported results, as well as transfers of excess accruals from one liability account to another, and the use of the excess balances to offset what were unrelated expenses in later periods."
If you've ever filed taxes for your own business, you know the difference between the "cash" method of accounting and the accrual method. With the latter, the principle is that you record expenses at the time they're generated, not when they're paid. The theory is that cash on hand can be "virtually" spent at the time a debt comes up, so it does no good for the cash to be recorded as though it were on hand. But the secret to accrual is deciding when an expense truly occurs.
Expenses offset revenues, with the remainder recorded as income. If you can change the period of time in which expenses occur, you can make it seem that your company is reaping more income than it truly is. Of course, that presumes you truly will record those expenses later, and that they don't just magically disappear.
"Now, many of the errors and irregularities offset each other during the restatement period, and most of them relate to the timing and recognition of income and expenses," Carty told analysts yesterday.
His explanation did not go into specifics - we probably won't see those until the US Securities and Exchange Commission releases its report on its own separate investigation. But Carty suggested that Dell's internal investigation uncovered numerous instances of this kind of time shifting, which some think isn't unethical - or as unethical as other kinds of fraud - because it isn't really so much theft as it is time shifting. This is why he stated repeatedly yesterday that these instances would probably "offset" or "reverse themselves."
It is a problem, however, when you take into account the motivation behind this shifting. Remember that the original SEC investigation started looking into how the company accounted for the distribution of stock options to its managers and senior executives. It might not hurt the balance sheet all that much to shift accrued expenses from one account to another, or to create reserves (receivables from nowhere, payments to oneself) that compensate for expenses. But if the end product is to make the income number look bigger, that affects the appearance of company performance...which affects its stock price, and thus the value of shares held by senior executives, and thus the value of options held by those executives.
As companies in the recent past have been found to do, senior executives are compensated in part with options. The practice of backdating options (the original subject of the Dell investigation) is not illegal; here, companies pretend options were distributed on a date back when its stock value was lower. If a company knew its income numbers might not meet street estimates, its accountants could use those accrual principles Carty referred to adjust the appearance of those numbers. Suddenly, the company's performance appears to "beat the street," and a one-penny difference could trigger a stock rally. In just a few days' time, those executives' options are worth millions more.
Next: Is there an Intel connection?
BWAHAHAH, Suck it up Dell.
And I quote Michael Dell ""What would I do? I'd shut it down and give the money back to the shareholders" (talking about Apple in the 90s)
....take your own advice moron... "laughs"
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|The actual problem has been spelled out. It just shows that many don't understand it.
It's a virus of many US enterprises, and that is good corporate governance
In a nutshell, this is about Dell making acquisitions and occuring liabilities that are deferred on the books. As a result the profits look larger (as there are less expenses reported on than is reality). The result is likely to effect end share price (inflate it).
Dell knows whats coming from the SEC audit reports, and have attempted to pre-jump the ruling, to lessen the impact on the stock.
Expect a hefty fine on the company and potentially some executives. (current and former).
In a market that is transfixed on double digit growth margins per quarter, it's not unrealistic to see this occur.... and I'm sure that Dell is one of many that fall into this category.
Whilst the US market expects and demands double digit growth quarter on quarter, you can be guaranteed this 'accounting practise' will continue.
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|I have yet to hear any article on the subject be very specific about the actual problem. The articles I've read (this article included) just talk about "OMG!!!!!!1 Dell lied to us!" and Mr. Carty's response.
I realize we don't have a lot of specifics yet, but really that's what we need here. Is this really just a matter of money being moved from one department budget to another? Or is it really "cooking" the books by making up numbers entirely?
If it's a matter of budget allocations as Mr. Carty seems to be claiming, then in the grand scheme of things, who the hell cares? If you made $10 billion, you spent $3 billion, and thereby end up with a profit of $7 billion, who cares how that money was divided up between department budgets?
I know, I know... the investors will care, right? Well sure, of course they do. They've made investments in the company and have been lied to, strictly speaking. In the grand scheme of things, however, are investors going think THIS kind of error matters enough to sink the company? Especially since Dell, by way of Mr. Carty, has admitted its mistake and is working to correct it and come clean. The simple reality-- short term, it will hurt Dell, no doubt about it. Investors will drop out their support as punishment for the lies, but long-term investors are going to recognize a sign of responsibility in Dell and they'll continue to support them; life will go on.
On the other hand, if Dell's books were truly "cooked" and the numbers were just made up to fluff the books and genuine fraud was committed, then Dell will be severely hurt. At that point, the only way for them to recover is if Dell can identify these executives, fire any remaining in the company, and prosecute them for fraud. If that includes Michael Dell, then so be it.
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|Thanks for the comment, GoodThings2Life. (By the way, is there any chance you work for GE?) I do want to address some of your concerns:
Until the SEC issues its first reports - which it may do fairly soon - there's a lot of specifics about the Dell revelations that we simply do not know. We don't know who, by name, transferred money from reserves accounts or accruals from one segment to another, or who authorized those transfers. We don't know how much was transferred for certain, nor exactly when. We don't know the nature of those reserves accounts - for example, were they legitimate reserves or were they created for the express purpose of being robbed when necessary to pad certain income line-items?
You ask, is this just a matter of moving funds from slot A to slot B, and if it is, then who cares? It matters because you may be a shareholder. Your pension fund may be invested in Dell. You may have a retirement fund whose mutual fund allotments include investments in Dell.
It matters because you may work for a company (this is why I asked about GE) that has a significant investment in Dell equipment. That company may rely on service and support for several years down the road, and if Dell is in trouble, then that support may not be as forthcoming as it would be otherwise.
But if it's just s***ing numbers around, then isn't the damage to all of us out here pretty small? No. Look at Lucent, one of the last companies to have tried almost exactly the same scheme with its accounting as Dell has admitted to. It was the caretaker of Bell Laboratories, at one time the greatest single stockpile of American intellectual property. Now it's owned by the French telecom company Alcatel. And what did Alcatel do the moment it bought Lucent, almost on the same day? It began a strategy of suing other companies for patent infringement, with the idea of collecting back the money it paid for Lucent over a two-year period. It started with Microsoft, as you'll recall. Initially, Alcatel won that MP3 infringement verdict. But now that's been overturned, and its recoup plan has been trashed. Alcatel may find itself selling patents to individual holding companies just to keep up its financing commitments.
In that case, the damage caused by simply s***ing the numbers around, became huge. Dell owns some IP, but certainly not as much as Lucent. Yet it's still a major American employer. If shareholder confidence plummets in the light of further revelations, its market cap could crash through the cellar floor. In that worst-case scenario, selling off company divisions becomes an option. Remember Alienware?
See, the purpose of s***ing those numbers around was most likely to make Dell's performance beat "street estimates." Those financial analysts' estimates are what helps set the company's share price targets. If the analysts have no faith in Dell, they won't provoke interest in Dell stock. Pension funds and mutual funds will pull out, and everyday people lose parts of their life savings.
That's why it matters. That's why sounding the alarm bell and shouting, "Dell lied to us!" is important.
-SF3
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|Yes, I previously worked for General Electric.
While I understand the point you're making, I disagree with it ending up as the reality here.
If they truly cooked the books, yes, it will be a major issue from an investment standpoint and certainly a support standpoint. But there's not enough evidence for this scenario yet, and I see no point in getting all paranoid about it.
Unlike Lucent, Dell doesn't have the massive amount of research and development patents that Bell Labs had. I'm not saying they have none, of course, just nothing comes to mind that is as significant.
Regardless, patent lawsuits are business model these days as you report frequently. They suck, but they aren't going away any time soon.
Even so, I return to my original point: what is the likelihood that such a catastrophic situation becoming reality? Less than you think, in my opinion. I think Dell's admission and response to the issue is going to have a similar effect as Microsoft's admission to the Xbox 360 issues. It may cost them in the short term, but long term it will prove favorable to them.
Anyway, thanks for the thoughtful response.
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|Maybe Michael Dell and Michael Vick will share a cell.
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|This took place between 2003 and 2006. Michael Dell wasn't even there, he returned to the company in 2007.
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|I think you made yourself clear on the other article that you hate Dell, you hate Michael, and you are pretty much a jerk. Enough already, we get it.
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