Home > Breaking News > Dick Smith LIVE: Obsolete Stock The Focus As Nick Abboud Back In Witness Stand

Dick Smith LIVE: Obsolete Stock The Focus As Nick Abboud Back In Witness Stand

Former Dick Smith CEO Nick Abboud is back in the dock for the NSW Supreme Court hearing today, with obsolete stock procedures in the crosshairs.

A freeze on items being moved to obsolescence categories has been discussed, and barristers have noted that incorrect obsolescence provisioning would have impacted on Dick Smith’s earnings and profit figures.

Barristers grilled Abboud on his lack of accounting experience and the fact that he never held a CEO position before taking over the top job at Dick Smith. They also said he had a “significant financial incentive” to make sure the company’s IPO was successful following its sale by Woolworths to Anchorage Capital.

Abboud was asked if he had wholly designated responsibility for financial statements to CFO Michael Potts, which he denied.

The court saw an affidavit by Abboud (with the exception of the last sentence below, which was not admitted into evidence).

Abboud was asked about the period of time to which this policy on obsolescence referred, which he did not recall.

Abboud was asked about an email regarding obsolescence provisioning, whether these provisions were implemented by him or Woolworths. He said he did not remember.

He was asked about another email from Bill Wavish about clearing quit stock, discontinued lines, and not for reorder.

Barristers asked about the provisioning methodology used in calculations of FY13 financials, and whether they took into account the amount of inventory on hand.

Abboud did not remember assumptions about stock on hand, sales, age of stock, or margin history. He said he did not recall what the provisioning methodology was at the time. It was noted that Deloitte believed the market carried a risk of obsolete and unsaleable inventory. Barristers said that $1.1 million was brought to account in 2014 as opposed to 2013 after being reversed, which Abboud confirmed. Abboud did not recall whether the methodology used in 2014 was the same as in 2013. Abboud said he did not remember a new system of stock aging being introduced during his entire tenure as CEO, despite what barristers said were recommendations by Deloitte. Below is a paragraph from an affidavit filed by Abboud.

In an email from Tim Fawaz, discontinued product was detailed. Abboud then in another email called for a plan on discontinued product, on which a meeting may have been held according to another email from Neil Merola. Abboud said he did not remember a meeting.

In an email to buyers and merchandise managers, Chris Borg outlined initiatives to manage intake and exit on no reorder and discontinued stock. This included a freeze on items being shifted from Active status to Discontinued, No Reorder or Quit as part of end of life processes.

Abboud denied that this initiative was made at his direction, and said he did not remember whether he was aware of it. He said he did know about items moving to D, N or Q requiring balance sheet provisioning, but that he did not recall a policy that no items be moved in or out of Quit status.

Barristers put to Abboud that during his tenure as CEO, items in Active that should have been in D, N or Q would have made the provision for obsolescence too small, meaning earnings and profit would have been higher. He agreed that this would have been the case.

An email from Borg to Abboud, and one from Borg to IT staff, detailed changes made to the Dick Smith AS400 computer system surrounding the reclassification of stock.

Abboud said he did not remember having a discussion with Borg about this. He conceded that buyers could initially classify inventory into obsolescence categories as detailed in his affidavit, but the restrictions were later put in place. Barristers put to him that he was concerned that items being put in D, N or Q would impact on provisioning, which he denied. He conceded that during the freeze period, the obsolescence provisioning would be wrong, and said he did not remember telling Deloitte about the freeze.

During a discussion between Judge Ball and barristers for both sides, the judge indicated that any accusation that Dick Smith had deliberately miscategorised stock in order to inflate the profits of the company had not been pleaded, and said he would not take any submissions on the subject.

The court was shown a slide from a Deloitte presentation in 2013, concerning vendor receivables.

Abboud was asked if he recalled suggestions by Deloitte that the vendor receivables system could be improved; he said he did not. He also said he did not recall if the system was changed.

He was also asked if he recalled Deloitte saying that internal controls and financial reporting were poor; he said he did not.

He also said he did not remember if any of Deloitte’s recommendations were taken up before the company’s prospectus was issued. The court was shown a management letter sent by Deloitte in 2013.

Abboud said it was likely he would have read the letter, and conceded he would have been made aware of Deloitte’s advice on stock obsolescence. He also said he would have expected the CFO to focus on areas highlighted in the report.

The court saw another section of the report saying that Deloitte considered rebate accrual revenue recognition a matter of high priority, and recommended reviews of processes in the area.

Deloitte also found that Abboud himself had been overpaid at one point, and that certain journals were posted with no supporting documentation. Abboud was asked if he was concerned about the journal issue, to which he said he would have been and that the CFO’s job was to attend to them promptly. Barristers asked about plans surrounding the Dick Smith IPO, and put to Abboud that he made tens of millions of dollars as a result of the successful float. Abboud denied it, saying he did not sell his resulting shares.

Abboud was questioned about his role on the due diligence committee for the float. Wavish and Potts were also on the DDC.

Abboud confirmed that part of his role and the other Dick Smith executives on the committee was to ensure that the prospectus was correct and not misleading.

Abboud said he did not recall signing any director questionnaire as part of his DDC role. The court was shown part of a Deloitte letter around the IPO concerning the directors’ responsibilities.

He confirmed that the directors – including himself but not Potts – and not Deloitte were responsible for financial information in the prospectus, as well as internal controls.

The court saw part of the chairman’s letter from the Dick Smith prospectus concerning Abboud.

Abboud agreed that messages surrounding his performance and Dick Smith’s forecast growth were important parts of the chairman’s letter.

Abboud said he was comfortable with how the prospectus (as seen above) presented the 1Q14 results. He said results in FY2011-13 were impacted by Woolworths’ management, and that 1Q14 was the first quarter where results were affected by his transformation program after taking the helm.

When questioned if he believed whether a negative or zero result in 1Q14 would have reflected poorly on his transformation program, he said no; however, barristers took him back to his previous response regarding its success. They asked if different statements would have needed to be made in the prospectus if NPAT had been zero in that quarter, and Abboud demurred on the question. He was pressed harder, and said that an NPAT of zero could have still been a good result if compared to a worse result in the previous year.

The court saw part of a report by Deloitte ahead of the prospectus, which noted that ageing of inventory was based on last activity date for an SKU rather than the individual date of purchase, thus impacting the accuracy of ageing.

Abboud said he did not recall any improvement to the ageing system between the report and the prospectus. He said that at this point inventory was at its lowest level in years following a clearance program. Abboud demurred on a question about whether he would have felt restrictions on buyers moving stock between categories should have been reported to Deloitte.

The affidavit from Abboud said a new “End of Life” classification was introduced in 2014. He said he did not recall if this category was to designate stock that was not to be reordered, though this was confirmed in the same affidavit.

He confirmed the category was to replace No Reorder, and that No Reorder had a 20% provision whereas EOL had a 2% provision.

Barristers put to Abboud that EOL was introduced to reduce the rate of provision that would otherwise have gone to NR. An email from Chris Borg said that EOL was to be viewed as the same provisioning as Active, so as to move items between the two categories with no financial impact to the business or audit.

It was suggested to Abboud that SKUs that should have been moved to No Reorder were being held in Active before the EOL category was introduced, and he said he couldn’t say one way or the other.

Abboud said he could not recall any time when stock was held in Active so as to attract a 2% provision rather than 20%. He also said he did not recall a DNQ water level of $25m as outlined in another Borg email.

The court was shown minutes from a 2014 Board meeting where Abboud said the company was $900,000 behind budgeted EBITDA.

Abboud confirmed that hitting EBITDA forecasts in the prospectus would result in a $1.25 million bonus for himself, but said it was not his motivator and he was focused on running a profitable business.

A Borg email showed that tracking had not improved by April, to which Abboud requested “quick action”.

Questioning returned to O&A, with an email shown in which Abboud directed a “big lift” in O&A.

He confirmed that the company policy was to get a big lift in O&A for marketing. He said he did not recall plans at the time to protect EBITDA, but did recall after shown an email from himself on the issue.

Barristers suggested another email regarding a meeting with Michael Potts and John Skellern referred to the plan to protect EBITDA; Abboud said he did not recall if he got into work that day, as his wife was ill.

Abboud confirmed he remembered a cut in marketing budgets in Q4 2014, but couldn’t recall if target cuts were met. An email from him at the time said “step 1 locked in”.

He said the company did not necessarily cut marketing itself, instead obtaining cheaper rates. Barristers suggested that step 2 was to step up O&A correction in Q4, which Abboud said sounded correct. The court saw a spreadsheet detailing increased O&A targets for buyers totalling $7 million.

An email from Wavish showed that the company at the time was considering reaffirming prospectus forecasts.

Forecast scenarios at the time showed that even in the worst case, O&A rebates would increase significantly. Abboud confirmed that the plan was to achieve greater O&A with a $20m OTB outlay, which he said was for tax time promotions.

An email from Borg suggested that if sales margins did not improve, the company risked an O&A increase to make up the shortfall.

Abboud did not say it was a “threat” from Borg, but said he was warning buyers of the risk of O&A increasing. Another email from Abboud directed Borg, Skellern, Hirsch, Bonham, and Sullivan to collect $4.7 million in April.

Abboud confirmed that gross profits continued to fall and O&A continued to increase. He said he did not recall increasing the requirement from $4.7m to $5.5m. An email from Borg to buyers detailed an incentive competition for buyers to achieve O&A targets, with the top prize being $20,000 towards a new car.

The court was shown an email chain involving game publisher Take 2 Interactive in which games were invoiced at inflated prices and rebated as O&A.

Abboud said that, if he had been made aware of practices like this, he would not have accepted them. Barristers argued that this would not have been an unexpected outcome from policies such as the O&A incentive competition. Abboud responded that honesty and integrity were requirements for the competition as laid out in the terms.

Abboud confirmed he believed this kind of arrangement as detailed in the emails would not be an example of honesty and integrity. Barristers zeroed in on the last sentence of the conditions, asking if it was the case that misappropriation of funds into O&A would not result in disqualification if they were authorised by an MM or director.

The court was also shown an email from a Jackson Industries employee, Chris Dyson, detailing an agreement where the O&A was below the invoiced price increase, and Abboud confirmed that the Dick Smith buyer would have been terminated had he been made aware.

Darren Freeman, the employee involved, was later made redundant, Abboud said. He added that while Bonham and his team’s conduct was “disappointing” it did not reflect on the company or its O&A strategy.

Another email chain around Kaiser Baas products showed Carl Bonham suggesting to Abboud a similar arrangement. Abboud told Bonham in the email that he was “proud of him” for getting 20% O&A, but did not want to “play in the space” of uplifted product.

Barristers put to Abboud that if he had regarded Bonham’s conduct as “outrageous”, he would have been more aggressive in telling him to stop. Abboud said he had made it very clear to Bonham that he did not want uplift on product. He said Bonham had never sent him another email with such deals after this date, and he had assumed Bonham had got the message.

The court saw a slide from a presentation by Freeman discussing inflated receipts on camera, power bank, and charger prices from brands including Kaiser Baas (but not Canon), with the inflated amounts diverted to O&A. Abboud said he was not aware of the presentation, and agreed he would have been “quite shocked” had he known. It was noted that Freeman himself had not been able to say whether Abboud had been present.

He also said he was “quite shocked” that nobody at Dick Smith had brought this to his attention, and that he would have been “horrified” had it been presented to him. He confirmed he would have regarded the practice as not company policy. He said he would have been greatly concerned at the result, namely major overstocks of overpriced, non-ranged, and reduced-margin products that had to be cleared. Barristers asked if the practice could distort buying decisions, and Abboud agreed.

The court was shown an email from Abboud directed to a number of Dick Smith executives, three of whom – Neil Merola, John Skellern, and George Papacosta – had worked with him at Myer.

In the email, Abboud directed that O&A needed to be over $18 million.

At a May 2014 board meeting, Abboud confirmed that despite the company being $2.1m behind budgeted EBITDA year to date, prospectus forecasts would be achieved. Barristers asked if his confidence stemmed from O&A figures, but he said it was due to a combination of factors.

Sales and gross profit at the time were below budget, he confirmed. Cost of doing business was also below budget, while O&A rebates were above budget.

The live stream can be viewed at https://epiq.events.corrivium.live/dick-smith.

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