Though Dell has finished an internal investigation into its accounting practices, there are still plenty of questions about the company, which not long ago could do no wrong in the minds of investors and customers.
What we know now is that Dell's finance department was apparently willing to fudge numbers to ensure it would hit or surpass its quarterly earnings forecasts. They seem to have done that with the knowledge of, or sometimes at the request of, senior executives. And they did it because Dell's accounting department didn't strictly follow generally accepted accounting principles (GAAP), chief financial officer Donald Carty said in a conference call on Thursday afternoon. Carty became chief financial officer after Jim Schneider stepped down in January.
The department used "inappropriate accounting decisions and entries that appear to have been largely motivated to achieve desired accounting results", Carty said during the call with investors, apparently reading from a document filed with the Securities and Exchange Commission explaining the results of the company's investigation.
The company felt so pressured to meet Wall Street expectations that its finance department bent accounting rules to make up for shortfalls in certain quarters and under-reported earnings results in others, each time ensuring that Dell did in fact hit the earnings targets that financial analysts were expecting. Carty didn't go into detail, but it appears much of the accounting manipulation involved the timing of expenses and payments recognised on Dell's balance sheets.
So who knew about the financial shenanigans, and when? Carty said executives knew and even encouraged it, but he won't say exactly who those executives were, and is so far refusing to single anyone out for responsibility. "I'm not going to talk about any individual by name," Carty said. "We've taken what we believe to be appropriate actions with respect to personnel involved in this, up to and including terminations."
More importantly, how did this happen at a company widely considered to be conservative and, above all, trustworthy? Dell's explanation is that not only did it not maintain a culture that emphasised strict adherence to GAAP rules, it didn't have enough employees with the proper accounting training or experience to know better.
In addition, Dell said inadequate resources in its accounting department were partly to blame, and — in a remarkable acknowledgment for a company that pioneered selling computers on the internet — that much of its accounting is done manually, with very few electronic trails.
Carty acknowledged that Dell "underinvested in IT resource in the financial area". He also told investors "financial systems can't be blamed for irregularities, but they can occasionally be blamed for errors".
It's not uncommon, of course, for companies to be motivated by short-term results. It's just surprising that Dell has become such an egregious example of that short-term thinking.
"I think every company that's public feels the pressure of being a public company and [hitting] quarterly numbers. I think that's why you see companies issuing quarterly guidance," said Brent Bracelin, a financial analyst with Pacific Crest Securities. "It certainly isn't a comforting feeling that they were manipulating numbers. It happened in the past. [The] most important thing is they addressed it and quantified it."
We've taken what we believe to be appropriate actions with respect to personnel involved in this, up to and including terminations
Donald Carty, Dell
Overall, the financial impact to Dell's bottom line is limited. Between the fiscal years 2003 and 2006, Dell's net income was more than $12bn (£6bn). The audit committee now says that the actual net income Dell earned during that period is $50m to $150m less. Earnings per share for that time frame will probably be two to seven cents per share lower.
But how, exactly, does something like this happen? A look at the Dell quarters in question (notably, a period when the company was being praised for strong profits while rival HP was struggling to meet Wall Street expectations) may provide some answers.
In the first quarter of fiscal year 2003, Dell announced profits of $457m, or 17 cents per share, on revenue of $8.1bn for the quarter. Analysts had been expecting a profit of 16 cents per share and revenue of $7.86bn for the quarter, according to First Call.
According to the corrected information Dell released on Thursday, the net income for that quarter should have been 10 percent lower, around $410m. Against 2.67 billion outstanding shares that quarter, that would have been 15 cents a share, missing expectations.
In Dell's second quarter of fiscal 2004, it reported net income of $621m, or 24 cents a share. Analysts had been expecting 24 cents a share. With the restatement, Dell should have earned $561m, or 21 cents a share.
The fourth quarter of Dell's fiscal 2005 was an anomaly, as the company took a one-time charge of $280m for repatriating foreign earnings after the passage of the American Jobs Creation Act. GAAP net income for that quarter was $667m, or 26 cents a share. Without the charge, it was $947m, or 37 cents a share. Analysts were expecting, without the charge, 36 cents a share.
After the restatement, Dell actually earned $620m in GAAP net income, or $900m without the charge, which would have been 35 cents a share.
The main problem was in the way Dell was keeping track of its reserve and accrued liability accounts, which is money set aside, for example, when the company sells a warranty on one of its computers. It's up to Dell to estimate how much will be necessary to set aside should…
