Former directors and managers face court to explain what went so wrong

Batteries. Mountains of them. Almost 12 years' stock of Dick Smith-branded batteries -- that has been the most memorable image to emerge this week from a court hearing that is probing the retailer's collapse.

The issue of inventory control -- or lack of control -- loomed large in the New South Wales Supreme Court, where Dick Smith receiver Ferrier Hodgson is questioning 10 of the company's former directors and managers. The Australian Securities and Investments Commission is also conducting an investigation.

Evidence obtained under oath during the hearings may be used to decide whether there is a case for criminal charges over the company's failure in January, which resulted in the loss of about 3300 jobs, including more than 400 in New Zealand.

As well as hearing about all those batteries, the court has heard claims that Dick Smith's chief executive was out of his depth, tried to decipher inscrutable notes about the retailing business, been told about remote-controlled kettles, and even heard a former director claim the company didn't have to go bust after all.

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The mountain of batteries highlighted claims about the way Dick Smith decided what products to buy.

In October last year, company secretary David Cooke sent an email to chief executive Nick Abboud and chief financial officer Michael Potts, querying why the business was holding so much private-label stock.

"Dick Smith AA Battery 40-pack, 141 months' cover in Australia," the email read. "Dick Smith AAA Battery 30-pack, 131 months' cover."

That meant, based on sales in the preceding four weeks, the retailer had enough AA batteries to last nearly 12 years, and enough AAA batteries to last just under 11 years.

The epic stockpile might have been explained in a letter to former Dick Smith directors and executives, from lawyers for Ferrier Hodgson, which alleged various "wrongful acts" that led to the company's demise, including inflating earnings by deliberately buying too much stock and booking rebates from suppliers as profits.

The retailer earned the rebates by meeting goals such as ordering or selling a certain number of units.

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In its report into the company's failure, liquidator McGrathNicol found that as sales fell, Dick Smith increasingly made purchasing decisions based on the rebates, rather than customer demand.

That led to a build-up in unsaleable and outdated inventory, which had to be liquidated in the peak Christmas period, leading to intense pressure on margins that made it harder for the company to pay its debts.

"In periods of low profitability, some rebates provided a short-term incentive for management to prefer a certain supplier and product, because the rebate increased profit in the month of purchase, rather than when the product was sold (as ordinarily would be the case)," said McGrathNicol.

In court this week, Bill Wavish, who was on the board until March 2015, defended the rebate policy.

"There seems to be a view that rebates are bad," Wavish told the court.

Former Dick Smith CEO and managing director Nick Abboud. Photo / File
Former Dick Smith CEO and managing director Nick Abboud. Photo / File

"Rebates are good -- retailers cannot survive without supplier rebates. For most companies, including Dick Smith and Woolworths, the total of supplier financial support during the year exceeds their profit. You avoid maximising rebates at your peril.

"The issue was not [whether rebates] are a good thing. The issue is how are they accounted for -- and the auditors were happy."

Another former director giving evidence was Jamie Tomlinson, who told the court Dick Smith "didn't need to fail".

The company "wasn't insolvent, it didn't breach accounting standards, and in my view the banks acted with reckless disregard for the wider interests of all stakeholders," Tomlinson said.

"I think [Dick Smith's bankers] formed a view that the management team were just not up to it, and I think they lost faith in the competency of the CEO and to some extent the CFO," he said.

I think Nick [Abboud] should go soon, within three months, and Michael [Potts] to follow after the new CEO is in place. Nick has no credibility with suppliers, shareholders, some management and me.

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"It was an issue of competence, not dishonesty or deceit."

"My trust in [Abboud] eroded. When we got to the pointy end in December and dealing with the banks, they I think experienced a similar emotional response dealing with this management team."

When Dick Smith collapsed, it owed about A$400 million, including A$140m to lenders HSBC and Westpac.

Tomlinson, who joined Dick Smith's board in April 2015, also criticised Abboud, who is scheduled to appear before the hearings next month.

Tomlinson said Abboud spruiked Court hearings try to unravel the disaster that was Dick Smith.

Nick Abboudan ill-fated expansion into whitegoods by claiming the retailer's "connected" appliances would mean "you can lie in bed and boil the kettle".

Tomlinson recalled a board meeting when Abboud informed directors that Dick Smith was setting aside 10 per cent of floor space in 100 stores to move into appliances to compete with the likes of Harvey Norman.

A Dick Smith store located on Karangahape Rd in Auckland. Photo / Nick Reed
A Dick Smith store located on Karangahape Rd in Auckland. Photo / Nick Reed

"I was told, appliances are going to move to 'connect'. I asked what that meant, and I clearly remember because it made me laugh," Tomlinson said.

"Nick said to me, 'It means you can lie in bed and boil the kettle'."

Tomlinson told the court he began his own investigations into the health of the business and became concerned at the "extent of investment in private label which was untested with consumers".

"We were purchasing everything from batteries and cables [to] asking consumers to trade off a branded TV for Dick Smith TV.

"I thought it was a leap of faith. Ultimately it failed because we ended up with a lot of poor inventory. I myself wouldn't buy a Dick Smith TV. I also observed products like phone brands and the like -- I just don't know who was going to buy them."

On December 20, 2015, a few weeks before Dick Smith went into voluntary administration, Tomlinson emailed chairman Rob Murray.

"I think Nick [Abboud] should go soon, within three months, and Michael [Potts] to follow after the new CEO is in place. Nick has no credibility with suppliers, shareholders, some management and me."

I was told, appliances are going to move to 'connect'. I asked what that meant, and I clearly remember because it made me laugh.

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The court also faced the challenge of decoding Dick Smith documents.

In one bizarre exchange, Barrister Jeremy Giles SC, acting for Ferrier Hodgson, referred to a document produced by former company secretary David Cooke for the receivers.

"It says, 'Sell private label product bought at 98c, back to the supplier at 78c, and rebuy it at 78c or even 77c, with a 'risk' related adjustment ... reflecting a commercial arms-length trade would get it into stock at the new rates, generate cash and make a profit.' What was that about?" asked Giles.

"I don't know," Cooke said. "I don't know whether I wrote that line."

Giles asked: "Do you have any understanding about why selling private label product bought at 98c back to a supplier at 78 or even 77c would generate cash and make a profit?"

"No," Cooke said.

Then there was a scribbled note that seemed to go to the very heart of how retailing works. It said: "Retailer buy cheaper than dearer."

It was an issue of competence, not dishonesty or deceit.

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The note was written by former non-executive director Lorna Raine, who told the court: "I think that refers to a discussion that as a retailer it's better to buy stock at a cheaper price than a more expensive price."

Giles appeared incredulous.

"Surely there is an element of stating the obvious," he said. "What was the discussion about?"

Raine said she didn't "recall the specifics of the conversation".

Ex-director Wavish was himself a topic of discussion in the court. Wavish represented private equity firm Anchorage Capital Partners, which bought Dick Smith from Woolworths for A$20m and made A$500m after floating it on the stock exchange nine months later.

When Wavish confirmed plans to leave the board, chairman Murray wrote: "He will leave a hole in terms of his enormous retail knowledge ... in behaviour and leadership terms, this is candidly a blessing."

Tomlinson told the court he had "never met Mr Wavish [but] I know he's a very capable man".

"But it was explained to me that he was a man of a very strong personality, that at the board meetings he tended to dominate conversations, and at audit committee meetings in particular he would run those in a manner that was very clear he was in control."

As well as Abboud, other former Dick Smith personnel summonsed include chairman Murray and Anchorage Capital's Phillip Cave.

- additional reporting from the Herald staff.