What Everyone Should Learn From Dell

Well, it's official: Dell (Nasdaq: DELL  ) cheated.

In a press statement released yesterday after the market closed, management said it would have to restate four years' worth of earnings. Cumulatively, the changes are expected to add up to $50 million to $150 million, or $0.02 to $0.07 per share.

How did it come to this? I could summarize the findings of Dell's audit committee, but it's probably best for you to get details straight from the source. Here are the critical excerpts:

The investigation identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets ... these activities typically occurred at the close of a quarter ... Account balances were reviewed, sometimes at the request or with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met. [Emphasis mine.]

And it gets worse:

The investigation concluded that a number of these adjustments were improper, including the creation and release of accruals and reserves that appear to have been made for the purpose of enhancing internal performance measures or reported results, as well as the transfer of excess accruals from one liability account to another and the use of the excess balances to offset unrelated expenses in later periods. The investigation found that sometimes business unit personnel did not provide complete information to corporate headquarters and, in a number of instances, purposefully incorrect or incomplete information about these activities was provided to internal or external auditors. [Emphasis mine.]

The tyranny of the quarter
See the pattern at work here? In the quest to beat the unwinnable expectations game, Dell managers broke the law and, worse, bilked investors by forcing the company to spend precious capital on a year-long investigation. It consumed the lives of 375 staffers, who reviewed more than 5 million documents and interviewed more than 200 other employees. "Shameful" is too kind a word to describe this Gordian mess.

Management says it has already taken steps to fire or reassign staffers who played a role in the scam. Fine. But will this really solve the problem? No, I don't think so.

Rewind to May of 2004 with me. Take a look at Dell's first-quarter earnings release. Skip to paragraph three. See the problem? It's here: "The company has now met or exceeded guidance to investors for 13 straight quarters ..."

I won't blame Wall Street for the rogue actions of Dell's executive team. It should be punished to the full extent of the law if, as the audit committee report suggests, it knowingly falsified results. But, let's be honest, would any of this have occurred if there weren't an unhealthy obsession with "beating expectations" on a quarterly basis? No, I don't think so.

If you really want to create Dell 2.0, Mike...
I should mention that Dell had to stop giving guidance when investigations into its financial reporting began. But it's one of the few to get off the treadmill. Secure Computing (Nasdaq: SCUR  ) , Salesforce.com (NYSE: CRM  ) , and Dell rival Hewlett-Packard (NYSE: HPQ  ) are among those still dutifully running in circles.

That's why smarter Fools than I -- Bill Mann and Jim Gillies come to mind -- have been screaming about this for years. Now that Dell has tried to cheat the expectations game, and cost shareholders money in the process, can we finally make a vow to stop playing?

I'm not so sure. What would Wall Street's sell-side legion do without quarterly numbers over which to agitate, ruminate, and cogitate? Would it (gasp!) resort to valuing entire businesses? Perish the thought!

But, of course, that's exactly how it should be. Analysts are smart. Really smart, in fact. They can do better than the advanced game of keno that quarterly number-crunching has become. And Michael Dell can help to lead them to this promised land.

It all starts with a single phrase, Mike. Say it with me: "I will never again issue quarterly guidance so long as I am the CEO of Dell." Good, now say it 500 more times before the next earnings call. Consider it part of that, um, Dell 2.0 thing you cooked up a few months back. At least then we'll know you meant it.

Dell is a selection of both the Stock Advisor and the Inside Value stock-picking services. Try either service free for 30 days by clicking on the appropriate link. There's no obligation to subscribe.

Secure Computing is a Rule Breakers recommendation.

Fool contributor Tim Beyers owned shares of Secure Computing at the time of publication. Find Tim's portfolio here and his latest blog commentary here. The Motley Fool's disclosure policy left its crystal ball at the repair shop. Sorry, no soothsaying today.


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