Nearly all suppliers who sold products to Dick Smith were required to "do their job" by paying additional marketing fees to help "sell through" the product, a court has heard.
Former Dick Smith chief executive Nick Abboud, giving evidence in the NSW Supreme Court on Thursday, defended the company's controversial rebate policy as crucial to reducing inventory levels following the purchase of the company from Woolworths by private equity firm Anchorage Capital Partners.
Abboud said in November 2011 under Woolworths' ownership, the company was holding $450 million of inventory - compared with around $253 million ar the end of the 2013 financial year - which he blamed on suppliers "not [doing] their job by paying for promotion to help sell out the product".
"As the product is purchased it's about selling out the product," he said under questioning from receivers Ferrier Hodgson. "A good buyer can go and buy a product and get the supplier to ensure it sells through. A bad buyer can get the product and not get the support."
Abboud said Dick Smith had $85 million worth of marketing assets to sell to suppliers in the way of TV spots, radio, website advertising and catalogue space.
"The strategy here was to make sure we say [to the suppliers], hang on, we're not just going to buy the stock, you have to promote the stock to sell it," he said. "When you're buying stock I expect you to make sure the supplier is actually helping us with the program we've got in TV, radio, press, so they can help promote their brand."
The so-called "over-and-above" rebates would be attached to stock purchases recorded as an increase in profits or a reduction in marketing expenses.
Asked why the company wouldn't simply negotiate a lower price with the supplier, Abboud said it was "actually totally separate".
"When you buy the goods it's pretty set what you're buying and all the terms and conditions under the trading agreements," he said. "I'm going to buy the product - now how are you going to help me sell it in 390 stores."
Most retail companies such as Dick Smith rely on supplier support in the form of rebates as a normal part of doing business.
But in its report into the company's failure, not presented to court, liquidator McGrathNicol said Dick Smith's declining performance appeared to have led to management "making decisions on what stock to buy (and at what volumes) based on the rebate attached to the stock, rather than customer demand".
That led to a build-up in unsaleable and outdated inventory, which had to be liquidated in the peak 2015 Christmas period, leading to intense margin pressure that ultimately impacted the company's ability to pay its debts.
REBATES 'NOT PRIORITISED'
Abboud said he was "not aware" of any shift in focus of Dick Smith's buying team to obtaining O&A rebates instead of prioritising stock which could be sold most profitably, nor did he develop such a policy.
"Absolutely not. The buyers were focused on getting sales and profit," he said.
"Their interest is buying the right stock, that's the priority. The outcome of doing that is, yes, do that, but to sell out your product you need to get the supplier help you sell out through buying marketing."
He said the decision that vendor rebates should be a key element in the company's strategy to grow margin and profitability was made by the board and management.
Asked what controls the company had in place regarding the quality, range and level of inventory purchased, Abboud said each buyer had a "road map" and make decisions based on what they thought would sell best.
Abboud also defended the level of investment in private label. "The private label business was the most important part of the company delivering on its gross profit," he said.
"Up to December 2016 private label was 37 per cent of the company's total profit on approximately 15 per cent of sales and approximately 18 per cent of inventory.
"The products we were selling in private label were actually cheaper than the national brands, higher margins, we never had an issue where we had to recall a product, and it was in Dick Smith's DNA as far back as when Dick Smith himself was running the business."
'I'M AWARE OF ONE INCIDENT'
Abboud was also asked about an email from a lighting contractor, which appeared to be negotiating "price-inflated rebates", whereby a supplier increases the cost-price of an item with the difference then rebated back to Dick Smith - a move typically used to artificially boost earnings.
"We probably need to discuss your purchase potential and if you wish to include price-inflated rebates that would automatically add a percentage to the purchase price for rebate back to you at the end of the year," the December 2014 email to Dick Smith's procurement team said.
Abboud said he was "not aware" of Dick Smith entering into any such arrangements with suppliers. "I'm aware of one incident in 2015 and the head of one part of buying was told absolutely not to enter into that agreement," he said.
"There was an email that was sent to me, and the structure [of the agreement] I was not prepared to accept. I made that very clear."
On Wednesday, the court heard from former chief financial officer Michael Potts, who said the improved profitability of Dick Smith before it floated on the stock market in 2013 was "largely" through negotiation of additional payments from suppliers
The court previously heard from Anchorage managing director Phillip Cave, who represented the private equity firm on the Dick Smith board until early last year.
Anchorage bought Dick Smith from Woolworths for $20 million in 2012 and made $500 million after floating it on the stock exchange nine months later.
Cave stressed that the rebate program was inherited from Woolworths and continued under Anchorage's management. "The policy started in Woolworths' time," Cave said. "Woolworths' position was to maximise rebates - it was fully, clearly out there. It didn't start with us. We decided to continue."
CFO SOUGHT TO REIN IN 'OVERSPENDS'
Continuing his evidence from Wednesday, Potts said by July 2015 he had concerns about "overspends" on certain products, and sought to introduce a more thorough approval process.
"As the CFO I was always concerned about inventory levels - too low, too high - and seeking an explanation as to how it occurred," he said.
"Are the reasons any malfeasance? No. You can see the breakdown. It was always buyers with great ideas - let's buy stock for this reason or that reason.
"If we look through what the overspend was [in July]: 'Pull forward for Father's Day', 'extra stock of GoPro', 'new Kindle launch'. There were always opportunities [to buy above their allocated budget] the buyers were taking up and getting approved by [buying head Rod] Orrick.
"They were all good ideas in themselves and quite difficult to argue against."
Potts said purchases over buyers' "open-to-buy" budget would sometimes be escalated to Abboud for approval. An internal email summarising the "July overspend" referred to an additional $2.3 million worth of GoPro cameras "as directed by Nick".
"Mr Abboud had authorisation as the CEO to approve those overspends," Potts said. "I don't believe Abboud was directing those additional purchases but he was approving them."
$60 MILLION WRITE-OFF 'REJECTED'
Potts was directed to a handwritten amendment he made in September 2015 to a draft presentation from external consultants who had been brought in to review Dick Smith's inventory situation.
"Overreliance on O&A rebates leading to wrong pricing and purchasing decisions," the note by Potts read.
Asked whether he had a concern by that stage that the company was buying products to obtain O&A rebates, Potts said it was "not materially but perhaps" a reason. "There were a number of reasons why inventory was purchased," he said.
On 30 November 2015, Dick Smith's shares plunged more than 50 per cent after the company announced a $60 million writedown in the value of its inventory. The company collapsed in January 2016 with $400 million in debts, including $140 million to lenders HSBC and Westpac.
Potts told the court he "rejected" the $50 to $60 million inventory writedown figure floated by the consultants at a meeting on 26 October 2015, on the basis of discussions with head of merchandise planning Chris Borg.
"He had views around obsolete inventory and the appropriate provision against it was nowhere near that value," Potts said. "[The consultants] were suggesting a more extreme version of inventory management than was previously undertaken in the business."
Potts said he had never heard of a retail business like Dick Smith being recommended to operate on a model of 10 weeks' inventory cover, as assumed under the consultants' model used to arrive at the $60 million figure.
"It could have [led to loss of sales]," he said.
Ferrier Hodgson is questioning the group of former directors and managers using powers under sections 586A and 597B of the Corporations Act. The securities regulator is conducting its own investigation into the collapse.
The hearings continue.