Dell Talking Again After Audit

More than four years of intentionally mistated results will cost the computer maker millions. Says one exec: "This is not a happy story"

Dell (DELL) shareholders had been investing under a cloud of uncertainty for a year as the world's No. 2 PC maker conducted an accounting probe that choked off the flow of information. The struggling computer maker hadn't held a quarterly conference call in 12 months, executives were absent from the speaking circuit, and investors were wondering whether the company's current management team would emerge unscathed.

On Aug. 16, Dell reopened the tap. After an extensive audit, Dell concluded that finance staff, including senior managers, intentionally misstated results and misled auditors for more than four years to make it look as if Dell had performed better than it did. As a result, the company will restate results for fiscal years 2003 through 2006 and the first quarter of 2007, reducing net income by $50 million to $150 million, or 2 cents to 7 cents a share for the span. Reported revenue will likely drop 1%.

In an Aug. 16 filing with the Securities & Exchange Commission, Dell described an environment of systematic deceit, with employees recording false balance sheet items and other accounting entries for hundreds of thousands or millions of dollars. Dell said senior executives at the company had asked employees to change account balances—usually at the close of a quarter—so the company could meet financial performance goals. Finance employees created false bookkeeping entries, gave incomplete information to headquarters, and falsified information given to Dell's auditors, PricewaterhouseCoopers. In the case of one foreign transaction, "We did find evidence of fraud," Chief Financial Officer Donald Carty said in a conference call with investors. "This has been a very difficult and arduous road for the company," Carty said. "This is not a happy story."

Risk Lessens for Investors

Still, Dell is determined to commence the current chapter on a high note. A Dell spokeswoman opened the conference call with the news that company founder and Chief Executive Officer Michael Dell will speak at a Citigroup (C) technology conference in New York on Sept. 5. The affirmation of Dell's command, combined with the promise of a return to quarterly earnings calls and the relatively small amount of lost profits—Dell earned more than $12 billion during the period covered by the restatement—will give investors more transparency and could be cause for relief, says Brent Bracelin, a vice-president and senior research analyst at Pacific Crest Securities. "They want to send a message that Michael Dell is still part of the future of the company," Bracelin says. "That's the biggest question mark out there."

Added information may not include quarterly forecasts, Dell indicated. During the call, Carty pointed to a "decreased focus on short-term, quarter-by-quarter operating results" as part of the fallout from the misstatements. But the end of Dell's internal investigation will at least let investors—and Dell management—concentrate on how to generate future sales growth and profits, Bracelin says. "For the first time in a year, we have a quantification of what the impact will be," he says. "As an owner of Dell six months ago, you actually had more risk than you do today."

Dealing With Turnover, Too

Not that the road ahead will be easy. Dell's resurgent rival, Hewlett-Packard (HPQ), which in 2006 surpassed Dell as the No. 1 supplier of PCs, outperformed analysts' expectations during its fiscal third quarter (see, 8/17/07, "HP: 'Firing on All Cylinders'"). An SEC investigation into Dell's accounting remains under way. And Dell has struggled with lower profits, turnover in the executive suite, and slowing growth. "Now they can go back to focusing on HP," says Rob Enderle, principal of technology industry consultancy Enderle Group, which counts Dell as a client. Dell's comparable performance won't be known until Aug. 30. "HP blew the doors off," Enderle says.

Dell has had to manage the accounting investigation while new management tries to effect a turnaround. On Jan. 31, Michael Dell retook the reins as CEO, dismissing chief executive Kevin Rollins. In December, 2006, Carty, a Dell board member and former chairman and CEO of American Airlines parent AMR (AMR), became CFO after the resignation of Chief Financial Officer James Schneider. The company is trying to ignite growth and profits, and reinvigorate Dell's all-business brand in a PC market where much of the strength is coming from sales to consumers (see, 3/2/07, "Dell's Doubtful Turnaround").

During its first quarter, which ended May 4, Dell said revenue increased by less than 3%, to $14.62 billion, and net income declined to $759 million, compared with $762 million the prior year. Dell plans to file a preliminary second-quarter report Aug. 30, and file its annual report for 2007 in early November. Shares of Dell closed 37¢ lower at $25.93 Aug. 16 in advance of the disclosure. The shares are up more than 3% in 2007, following a sharp decline in 2006.

Lawyers Dispatched

In its press release, Dell said the SEC probe of Dell's accounting practices, which began informally exactly a year ago, continues. In November, 2006, the company delayed filing its annual report, and announced the SEC had launched a formal investigation into its finances (see, 11/16/06, "Dell Delays Amid the SEC Probe"). Dell's own 375-person, $135 million investigation began in August, 2006—the law firm Willkie Farr & Gallagher deployed 125 lawyers to Dell offices around the globe. The attorneys interviewed 146 Dell employees. Meanwhile, 250 accountants from KPMG combed Dell's books.

The upshot: a housecleaning that's led to the dismissal of perhaps two dozen employees, according to Enderle, with more dismissals to come. Dell also appointed employee Thomas Sweet as its chief accounting officer, with worldwide supervision over accounting and reporting. The company plans to overhaul its accounting controls, and buy new computer systems to cut more manual bookkeeping out of the process.

Dell's announcement dwelled on bad behavior that occurred in the past. Its shareholders can only hope the company now has more energy to devote to its uncertain future.

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