Harvey Norman Accounts Slammed, Questions Raised Over Viability Of Franchisees
Gerry Harvey, it appears wants to blame everyone else but Harvey Norman management for his business problems that are currently under investigation by the Australian Securities and Investments Commission. Some commentators have described Harvey’s result earlier this month as nothing but a copiously-lipsticked pig.
The Australian Financial Review claim that the sheer audacity of retailer Gerry Harvey may well justify a PhD thesis. Senior management are moving to sell down their shareholdings.
Not content with describing a former friend as “a Dog” because he raised questions about Harvey Norman accounts Gerry is now dumping his problems down to his accountants Ernst & Young.
After declaring a $449 million net profit on August 31, the market was skeptical of Harvey Norman’s accounting practices, they responded by wiping 7.35 per cent off the company’s shares (or $362 million of its market cap).
Now serious questions are being asked about the viability of the Harvey Norman franchisee network with several franchisees now having to face up to individual credit checks by consumer electronics and appliance manufacturers and distributors after more than 100 went belly up last year.
In a scathing piece, the AFR said that while Harvey trumpets his “unprecedented” profit, the measure of his earnings’ quality – cash conversion – is alarmingly poor, falling to 82 per cent in FY17 from 97 per cent in FY16 and 99 per cent in FY15.
This was driven by weaker cash conversion from his franchisees, down to 91 per cent in FY17 (from 101 per cent in FY16) and to 55 per cent in the second half – the lowest in a decade.
That is, the gap between the amount he billed franchisees ($969 million) and the amount they ponied up ($882 million) blew out dramatically the AFR claims.
The issues Harvey Norman franchisee faces raises serious questions as to the viability of the Harvey Norman franchisee operation considering Amazon launching in Australia.
There is now a real possibility that millions of dollars could be stripped from the revenues of franchisees who appears to be facing real issues going forward claim analysts.
Because, Harvey Norman “has no legal obligation to discharge the liabilities of a franchisee to suppliers … a constructive obligation arose … by an established pattern of past practice” whereby Harvey Norman paid Samsung or Electrolux whatever its distressed franchisees owed them. Harvey’s had “created an expectation on the part of those suppliers that [it] would discharge those debts”. Not anymore! In recent months, the franchisor has “rectified any incorrect expectations [that it] would discharge any of the debts owed by a franchisee to a supplier” the AFR said.
The reality is that Harvey Norman didn’t generate enough free cash flow to pay the difference so they resorted to increased borrowings – increased by $126 million (no coincidence: free cash flow was $119 million less than his two dividend payments).
Harvey needs to expunge his “constructive obligation” because under International Financial Reporting Standards, it is proof of control. And if you control an entity, you must consolidate it, an accounting treatment that would present the market with an unobstructed view of the true economic position of Harvey’s entire enterprise.
Instead, the franchisees’ newfound onus has the effect of transferring all default risk on around $450 million of electronics, whitegoods and furniture stock onto their manufacturers, adding around 85 basis points on franchisee turnover into their trade credit insurance premiums (little wonder the insurers’ phones are ringing hot, and that suppliers are still transacting directly with the franchisor so as not to void their policies).
The AFR said that Breville and Dyson aren’t charities – they’d feed this impost straight back into their wholesale prices, effectively slugging Harvey Norman another $48 million each year. For comparison, JB Hi-Fi’s net margin is 367bps so, to avoid consolidation, Harvey would surrender a quarter of his net margin!
But having placated ASIC and EY with a clear repudiation of his constructive obligation, Gerry turns around and picks an enormous hole in his own elegant solution, saying on national (pay) television last week that “nothing has ever changed”.
“If a franchisee failed and didn’t pay the account, we are under no obligation to pay it,” he told Peter Switzer of Sky News. “But, guess what? For our reputation, sure we pay it. Every supplier knows that.” That there is the sound of gun shooting foot.
Despite Gerry’s indignation, the distinction is important because more than 100 Harvey Norman franchisees hit the fence each year. That – and the rest – has been hiding in plain sight for 30 years.
In the glory days, with John Skippen (now Slater & Gordon chair) as his CFO, Harvey had the levers to smooth profits because he could always recover them.
Not now. Not since the internet led Dapto punters away from shiny-arsed, middle-aged up-salesmen in industrial parks.
Not since JB entered shopping centres and quietly ate his lunch. Not since the pet projects: his dairy farms and mining camps and his Slovenian expansion. And certainly not since he claimed he’ll price match Amazon with $80 million cash at hand and $80 million of debt headroom!
Harvey bought a million shares last week but his COO John Slack-Smith dumped 367,000 of them, cashing chips worth $1.4 million.
The miracle is coming undone and Gerry can’t take the scrutiny. “We have auditors called Ernst & Young and guess what auditors do? They sign off on accounts! They signed off last year, the year before, the year before, the year before.”
But after five years, EY’s signing audit partner Katrina Zdrillic has not been extended, with Metcash auditor “Sugar” Renay Robinson taking her place, she has yet to sign-off on the FY17 accounts. Now it’s over to her claims the AFR.