So, how much is Motley Fool Inside Value pick Home Depot (NYSE:HD) cooking the books? Maybe we'd better back up and ask, "Is Home Depot cooking the books?"
That's certainly what a New York Post article, colorfully titled "Screw Probe," would have us believe. Basically, the article reiterates charges that the paper made back in August -- that Home Depot stores were using improper vendor charges to fluff up earnings. The new news, by the Post's account, is that it's learned the SEC has asked for evidence in the case, thus beginning the dreaded "informal investigation."
At issue are allegations of inflated "return-to-vendor" charges -- money Home Depot stores receive back from vendors for damaged goods. The Post stories quote a former employee, Michael Davis -- who has a wrongful termination case pending against Home Depot -- who alleges that he was fired as a result of resisting the practice. Davis gives the example of a $1,000-per-month credit paid by a unit of Royal Phillips Electronics (NYSE:PHG) to cover damaged light bulbs. The contention is that Home Depot would charge the $1,000 every month, no matter if the damages came out to less than the $1,000.
How concerned should shareholders be? Well, I'm one of them, and I've got a pretty low tolerance for shenanigans, and here's my take. Not so much. At least not now.
First, Home Depot reportedly now has systems in place to preclude such behavior. Second, even if there was a-doin's transpirin', it's tough to know exactly what the fluffier financial fallout would be. Shareholders who are real sticklers for details in the ol' cost-of-goods-sold column might have more reason to stay wary regarding other accounting changes, such as the 2004 change, detailed in the most recent 10-K, regarding accounting for vendor co-op advertising. That little change inflated Home Depot's gross margins by a full 1.22 percentage points. It seems legit, but it's not what I'd call "quality" earnings growth.
Finally, remember that we're not dealing with allegations that come from disinterested parties. Davis has his wrongful termination suit, and another anonymous Post tipster in the latest article, the one who "suspects," that this goes on at a national level -- well, that person is a Home Depot vendor.
In fact, vendor disputes like these are increasingly common in an era when the big retailers have gotten bigger and demand ever-more favorable terms from their suppliers. In clothing retailing, "charge-back" disputes have triggered lawsuits against the likes of Saks (NYSE:SKS) and Federated Department Stores (NYSE:FD), prompted financial restatements and executive head-lopping, and reportedly spawned an organization called "Vendor Coalition for Equitable Retailer Practices," though I can't find much more than a couple of press releases that come from the group.
The bottom line is this: Sure, we need to keep our eyes open. That's always true. We've seen abuse of similar allowances at other retailers, and we need to be sure that Home Depot is clean in this regard. But until there's better evidence that a scheme exists, or that it's something condoned or tolerated by those making the decisions higher up the food chain, there's no reason to jump ship.
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Seth Jayson just wishes Home Depot would take care of the rampant theft problem and foul-mouthed employees at his local store. At the time of publication, he had shares of Home Depot but no position in any other firm mentioned. View his stock holdings and Fool profile here. Home Depot is a Motley Fool Inside Value recommendation. Fool rules are here.
