How 'Project Enabler' got Dick Smith hooked on the supplier rebate 'drug'

Dick Smith collapsed in January 2016 with around $400 million in debt, including $140 million to lenders HSBC and Westpac. Photo / Michael Craig

Dick Smith's "drug addiction" that ultimately killed the business was kicked off under an internal scheme called "Project Enabler", a court has heard.

In 2013, following private equity firm Anchorage Capital Partners' purchase of the business from Woolworths, Dick Smith ramped up its reliance on controversial supplier rebates under the project outlined in an external review of the company's supply chain.

Giving evidence before the NSW Supreme Court on Tuesday, Anchorage managing director Phillip Cave - who represented the firm on the Dick Smith board until early last year - defended the policy of "maximising" rebates.

The court had previously heard from fellow Anchorage executive Bill Wavish, also a former Dick Smith board member, who admitted to masterminding the rebate strategy with chief executive Nick Abboud and chief financial officer Michael Potts.

"The policy started in Woolworths' time," Mr Cave said. "Woolworths' position was to maximise rebates - it was fully, clearly out there. It didn't start with us. We decided to continue."

Mr Cave said when Anchorage purchased the business, there was concern that "rebates were under pressure and we wouldn't be able to obtain the same level of rebates independently" due to the buying scale of Woolworths, Big W and Dick Smith.

"We employed a consultant called Exact, and Exact reported to the board in February 2013 that there was an opportunity to look at the whole supply chain [to gain] an improvement of about $18 million.

"Of that $18 million, $6 million was from an increase in rebates. It was called Project Enabler and we approved it at that board meeting. We saw a position of maximising rebates as a good position and healthy for the business."

The name is particularly ironic, given the court previously heard from former non-executive director Jamie Tomlinson, who, in a December 2015 email to chairman Rob Murray, characterised the reliance on the rebates as a "drug addiction".

"I also note from my own investigation that Mr Abboud is the instigator of the reliance on the O&A drug, an addiction that started in the second half of FY14 and stepped up in FY15 when the inventory build-up began," Mr Tomlinson wrote on the need to ditch the CEO, just weeks before the company collapsed.

In its report into the company's failure, liquidator McGrathNicol found that as sales fell, Dick Smith increasingly made purchasing decisions based on the level of so-called "over and above" rebates the company could earn from suppliers rather than what customers actually wanted to buy.

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.

Dick Smith collapsed in January 2016 with around $400 million in debt, including $140 million to lenders HSBC and Westpac.

Barrister Jeremy Giles SC, acting for Ferrier Hodgson, has been grilling former directors and managers about the company's policy on rebates and their accounting treatment, inventory purchasing, store expansion, and decisions to increase credit lines with HSBC and Westpac, among other topics.

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.

Asked whether any consideration was given to how the policy of maximising rebates may impact on stock purchasing decisions, Mr Cave argued "equal if not more" importance was placed on stock turnover as rebates.

"Rebates were an encouragement to buy product, but stock turn was a key element, equal to rebates if not more so," he said. "You had to manage your stock turn. The quantity of stock purchased was clearly the responsibility of management.

"Management had KPIs to match in their budget. KPIs revolved around profitability, but stock turn was a key element of that, and then you break that down into segmental areas.

"For example, someone in buying might have had a responsibility for telephony and have been encouraged to buy [a product] because of the great rebate, but the counter to that was stock turn. If they got great rebates but low stock turn they weren't meeting their KPIs."

Along with Mr Wavish, Mr Murray and Mr Tomlinson, others already questioned have been former company secretary David Cooke, directors Lorna Raine and Robert Ishak, and property and supply chain director John Skellern.

Appearing last week, Mr Murray maintained that he was unaware of the factors that led to the electronics retailer's demise until it was too late, and defended the company's strategy of rolling out new stores and taking on more debt.

"There's a lot of wise people after the event," Mr Murray said. "A book's a lot easier to write after the conclusion's been written."

Mr Cooke, the first to appear last month, revealed how he became concerned in late 2015 that the company was holding nearly 25 years' worth of stock in private label batteries. In his evidence, Mr Wavish said his first "orange light" that something was wrong came around February 2015, when it emerged the retailer was holding nearly $100 million in excess stock.

Ferrier Hodgson is questioning the group of 10 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.

Evidence obtained under oath during the hearings may be used to determine whether there is a case for criminal charges to be brought. Mr Potts is set to give evidence on Wednesday, with Mr Abboud appearing on Thursday and Friday.