March 16, 2005

Another one bites the dust (oops, make that "two")

In the last issue of TPM Update, I mentioned that "Office Max is the latest (but not the last) retailer to be hit by a trade promotion accounting scandal." We all knew that there were more to come, but I must admit that I wasn't expecting two more quite so quickly.

A couple weeks ago it was announced that Saks will have to restate earning over several years because it took markdown allowances improperly from its vendors. According to Reuters (3/3/05), "During fiscal 1999 through 2003, Saks Fifth Avenue improperly collected up to about $21.5 million from vendors, the Birmingham, Alabama-based company said, citing preliminary estimates."

And something that happened back in January just came across my desk, and it seems especially interesting.

Daisytek, a distributor of computer supplies and office products with over $1.5 billion in sales, went into bankruptcy in 2003. Now, based on a consent agreement with the Securities & Exchange Commission, it appears that it was fiddling with trade promotion funding that did them in.

According to the SEC order, dated 1/24/05:

"4. Daisytek regularly announced earnings forecasts it could not meet, and its inability to meet those forecasts led it to implement a practice known as "booking to budget." The practice involved, on a monthly basis, booking fictitious "budgeted" revenue and expense amounts, based on the earnings forecasts and budgeted expenses, instead of actual revenue and expense amounts.

"5. At the end of each quarter, Daisytek closed the gap between its actual results and the "booked to budget" amounts by making large inventory purchases. The large inventory purchases provided the Company with vendor allowances such as rebates, market development funds ("MDF"), and co-op funds, which the Company immediately booked as revenue or as reductions to the cost of goods sold during the quarter. Daisytek thereby instantly inflated reported earnings and appeared more profitable.

"6. The large, quarter-end inventory purchases negatively affected Daisytek's liquidity and operations because they typically involved products that were unnecessary for the Company's operations, but on which manufacturers provided large vendor allowances because such products were slow moving. As a result, Daisytek exhausted its capital through purchases of slow-moving products, which hampered its ability to maintain sufficient inventory of its fastest moving 'A' products."

Not a good way to do business, from the stockholders' point of view. But, for the officers, I imagine it helped keep those quarterly bonuses coming in. Even more interesting, though, is this charge by the SEC:

"9. Daisytek failed to provide material information, in quarterly and annual reports filed with the Commission, about its reliance on vendor allowances or the effects vendor allowances had on its operations. Funds from vendor allowances often exceeded the earnings reported by Daisytek. For example, Daisytek recorded $22 million of vendor allowances in its books for the year ended March 31, 2002, and reported annual net income of $10.85 million in its Form 10-K. The Company did not disclose, however, that a significant portion of its reported earnings came through vendor allowances, as opposed to sales."

Does the SEC now believe that retailers/distributors need to report if they are heavily reliant on vendor allowances? For example, if their allowances exceed their earnings? Since that includes the great majority of retailers, the SEC would be requiring, essentially, that all retailers must report how much they get in allowances (something I was advocating several years ago).

Could get interesting.

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