Dell Reports More Trouble

Dell Reports More Trouble
By Arik Hesseldahl
SEPTEMBER 12, 2006
Copyright by Business Week


News of a widening federal probe of the computer maker's finances is leaving analysts concerned about management's ability to right the troubled ship

In what's become an all-too-familiar pattern, computer maker Dell on Sept. 11 made a disclosure that left investors dismayed and its share price lower.

This time, Dell (DELL) said that a federal investigation into its finances and accounting had widened, that it would shelve a stock buyback plan, and that it would delay filing quarterly documents with the U.S. Securities & Exchange Commission. But, like other recent announcements by the computer maker, the problem was as much what Dell kept under wraps as what it disclosed.

Here's what the computer maker did say: The U.S. Attorney for the Southern District of New York had subpoenaed documents relating to Dell's financial reporting from 2002 to the present. Previously, on Aug. 17, Dell said the SEC started an informal investigation of "revenue recognition and other financial and accounting matters" related to periods prior to Dell's fiscal-year 2006 or calendar-year 2005. At the time, Dell said the matter wouldn't have a material effect.

TOP-LEVEL DOUBTS. That investigation turned up "the possibility of misstatements in prior period financial reports, including issues relating to accruals, reserves, and other balance-sheet items," Dell said on Sept. 11. Don Carty, a Dell director and chairman of the audit committee investigating the matter, said in the statement it's not clear whether the issues discovered will be material.

Toni Sacconaghi of Sanford Bernstein said in a research note that fraud "appears unlikely," as does "significant revenue restatement." Still, the investigation is likely to undermine confidence in Dell executives, including CEO Kevin Rollins, already under pressure because of disappointing growth and concerns over the company's customer service.

"Dell's senior management team has been under fire over the last 6+, quarters for its deteriorating financial performance and its ostensible inability to grasp the severity of the issues and put in place an effective action plan," Sacconaghi wrote. "Today's disclosure that the company also appears to have been remiss in understanding its own financial controls is likely to further unnerve investors."

More than 80 companies, many of them in technology, are being scrutinized for how they handled share options granted to executives. "In a way, I'd almost prefer it if they had an options problem, because I'm at a loss to figure out what it is if it's not related to options," says Charles Wolf, analyst with Needham & Co. in New York. "They are being very closemouthed about it. But it's hard to figure out where they might have played with the numbers. It's really hard to imagine that Dell has been cooking the books."

EXECUTIVES TO SPEAK. Indeed, investors already had a lot of reasons to be unnerved, and the most recent news sent Dell's stock down 46 cents, or more than 2%, to $21.19 on Sept. 11. Its stock price has dropped $14 and change in the last year, and earnings have tumbled.

At the time, Dell CFO James Schneider blamed price cuts that were too aggressive in the face of waning demand. Additionally, Dell's decision to include microprocessors from Advanced Micro Devices (AMD) in its server and PC lines might have soured its relationship with chipmaker Intel (INTC), which had previously been Dell's exclusive supplier of microprocessors. That August earnings report came on the heels of a massive notebook battery recall involving batteries acquired from a division of Sony (SNE), as well as ongoing concerns over customer service.

Rollins and Dell Chairman Michael Dell are scheduled to host two media conference calls on Sept. 12, one to announce new products—four new consumer desktop PCs are expected, some of which will support AMD processors—the other to give an update on what Dell called "customer experience initiatives."