Timba, Awhile back you posted some great stuff on Dell Cash flow. Thought you [and the thread] might find this controversy on Dell's inventory treatment interesting [Caps & [comments] are mine for emphasis in my notes]
DELL'S ACCOUNTING TRIMS INVENTORY, SHIFTS SOME PCS (UPDATE4) 4/7/03 By Peter J. Brennan
Round Rock, Texas, April 7 (Bloomberg) -- ``Inventory can mean the difference between success and failure in our industry.'' Those words from Dell Computer Corp. Chairman Michael Dell in a 2000 speech embody the company's mission to stay lean.
Dell's inventory numbers mostly stack up well when compared with rival makers of personal computers. WHAT MAKES THEM LOOK EVEN LEANER AGAINST COMPETITORS IS AN APPROACH TO ACCOUNTING FOR INVENTORY THAT ONLY DELL EMPLOYS. Without it, Dell's inventory might double from its current three days. Apple Computer Inc. has the next-lowest inventory in the industry, at four days.
Apple, Hewlett-Packard Co. and Gateway Inc. count COMPUTERS IN TRANSIT TO CUSTOMERS as INVENTORY on the balance sheet. DELL, THE WORLD'S SECOND-LARGEST PC MAKER BY UNITS SHIPPED, TREATS IN- TRANSIT PCS DIFFERENTLY, MIXING THEM WITH ``OTHER CURRENT ASSETS.''
That clouds its inventory picture, investors said.
``It makes the job of an analyst or an individual investor very difficult because it's comparing apples and oranges,'' said Tim Ghriskey of Ghriskey Capital Partners LLC, a hedge fund that manages $100 million and has bought and sold Dell shares in the past year.
Less Risk
Investors like low inventory, especially in businesses such as PCs, where the profit on each unit sold is relatively small. It means less risk of obsolescence. It also indicates how well products are selling and shows that a company's capital isn't tied up in non-productive assets. A growing inventory means a company is making products that aren't selling.
Dell's ``return on assets is much higher than the industry average,'' said Christian Koch, senior technology analyst for Trusco Capital Management, who sold Dell shares in 2001 because he believed the company was overvalued. ``They've done a great job of selling Wall Street and institutional investors on the pros of their business model. One of the pros is their inventory.'' [ROA shouldn't change by shifting shipped PC's from Inv to OCA]
Dell, the best-performing stock in the U.S. in the 1990s, says its method complies with accounting rules.
``It's totally variable,'' Michael Dell said in an interview. ``There's NO STANDARD WAY OF ACCOUNTING FOR INVENTORY IN THE CHANNEL. Dell doesn't have any inventory in the channel; we have Dell and we have the customer.''
Less Clarity
Some investors say DELL'S DIFFERENT ACCOUNTING CATEGORIES UNDERMINE CLARITY.
``Having those numbers included in a category called `other' is not the best idea,'' said James Lyon, who helps to manage $340 million at Oakwood Capital Management in Los Angeles and owned 70,180 Dell shares as of December. ``I'm a big fan of transparency.''
At the end of the fourth quarter, Round Rock, Texas-based Dell reported $306 million in inventory -- less than the $400 million of in-transit PCs. Under inventory methods used by Hewlett- Packard and Gateway, Dell's inventory figure would have been $706 million.
Dell spokesman Mike Maher provided the fourth-quarter in- transit figure. Normally, investors don't see a breakdown of Dell's ``other current assets'' category and are unable to determine a total inventory figure to compare with competitors.
Dell DOESN'T CONSIDER IN-TRANSIT PRODUCTS TO BE INVENTORY BECAUSE THEY'VE ALREADY BEEN SOLD AND THE TITLES TRANSFERRED TO CUSTOMERS, spokesman T.R. Reid said.
Recognizing Revenue
In 1999, the U.S. Securities and Exchange Commission staff set policies intended to clarify the accounting of finished goods. The SEC policy statement said, in part, that FOR COMPANIES TO RECOGNIZE REVENUE, ``DELIVERY HAS OCCURRED or services have been rendered.'' In some cases, according to the document, DELIVERY IS CONSIDERED TO HAVE OCCURRED WHEN THE TITLE HAS BEEN TRANSFERRED AND THE BUYER HAS ``ASSUMED THE RISKS AND REWARDS OF OWNERSHIP.''
Still, the rules are open to interpretation, say the companies and accountants. Companies such as HEWLETT-PACKARD AND GATEWAY HAVE TAKEN THE SEC MEMO TO MEAN THAT GOODS IN TRANSIT SHOULD BE TREATED AS INVENTORY UNTIL CUSTOMERS RECEIVE THEM.
Another exception is International Business Machines Corp., the world's third-largest maker of personal computers. Once the title to a product is handed over, the unit is considered to be out of IBM's inventory, even if it's not yet in a customer's hands, spokesman Bill Hughes said.
Title Transferred
IBM doesn't treat the units in a separate accounting category like Dell; once the title is transferred, revenue is booked.
``Our inventory levels now stand at a 20-year low,'' IBM Chief Executive Sam Palmisano told investors in the company's latest annual report. IBM's inventory includes computer-related finished goods other than PCs.
Dell shares have risen 9.3 percent over the past year, while IBM's declined 17 percent. The Nasdaq Computer Index has fallen 24 percent over the same period, and the Standard & Poor's 500 Index has dropped 22 percent.
Dell rose 1 cent to $28.88 at 4 p.m. New York time on the Nasdaq Stock Market.
There are no in-transit accounts at Hewlett-Packard, the world's No. 1 maker of PCs by units shipped; at Gateway, which ranks No. 3 in the U.S.; or at Apple Computer, No. 5 in the U.S., according to these companies. They treat PCs as inventory until customers receive them.
``We have conservative accounting practices,'' Hewlett- Packard spokeswoman Rebeca Robboy said. ``For us, it's either revenue or inventory. There's no limbo category.''
Until Delivery
Gateway breaks out ``finished goods'' when it reports total inventory.
``After we make a sale, we continue to account for it as inventory until the customer accepts delivery,'' Gateway spokesman Brad Shaw said.
Some accountants say Dell and IBM can argue that they are interpreting the rules correctly. Some of IBM's PC shipments, for example, are part of larger computer-services contracts where individual components aren't booked separately.
``You cannot simply look at the announced policy and conclude one is right and one is wrong,'' said Andrew Bailey, a former academic fellow at the SEC who studied revenue recognition. ``Dell and IBM are probably both within their rights, presuming they are not stuffing their pipelines.''
The rules are set up so that investors can compare the inventory of a company with its own prior periods, Bailey said. They are not as good at ensuring that comparisons can be made among different companies, he said.
``Comparability across firms has always been a problem,'' Bailey said. The accounting industry has decided that ``there can be variability across firms.''
Clarity Needed
Still, accountants and investors said companies like Dell should be clearer.
``I'd be inclined to label it `inventory in transit' or `inventory to customers''' rather than part of other current assets, said Walter Schuetze, a former SEC chief accountant.
Dell's three days of inventory compares with Gateway's eight days, Apple's four days and Hewlett-Packard's 40 days, according to company filings. IBM doesn't report days of inventory.
Dell's inventory is ``a bit misleading when you compare it to, say, Gateway,'' Ghriskey said.
Hewlett-Packard's inventory is higher in part because it sells PCs, printers and other goods through retailers and distributors. Gateway operates about 192 retail stores that stock items including televisions and cameras.
As Lyon of Oakwood Capital sees it, Dell should clarify what it's doing.
``It would probably be appropriate to disclose the dollar value of those shipments'' of finished goods, Lyon said. ``As analysts, we can decide whether to include it in inventory calculations or not. Disclosing that number would be more helpful.'' |
